Series 7 Practice Exam 4 Q&A

The Bond Buyer contains a 20-Bond Index and an 11-Bond Index. The bonds included in the 11-Bond Index have an average rating of:

AA+ Explanation: The 11-Bond Index contains general obligation bonds with an average rating on S&P of AA+ and on Moody's of Aa1. The 20-Bond Index has an average rating on S&P of AA and on Moody's of Aa2.

If a broker-dealer goes bankrupt, the trustee appointed under the Securities Investor Protection Act is responsible for: I. Notifying the firm's customers that the firm is in the process of being liquidated II. Distribution of securities owned by customers that are held by the firm III. Seeing that the distribution of cash and securities are administered in an orderly manner

I, II, and III Explanation: If a corporation goes bankrupt, it is the responsibility of the SIPC trustee to follow through on all of the items listed.

Which TWO of the following securities are considered defensive stocks? I. A construction company II. An energy company III. A food distributor IV. An automobile manufacturer

II and III Explanation: A defensive stock is not drastically affected by a downturn in the economy. Those companies involved in the necessary areas of life are considered defensive (e.g., energy or utilities, tobacco, food, clothing, soft drink, and candy companies). Construction, mining, steel, automobile, and heavy equipment manufacturing companies are more affected by an economic downturn.

ABC Corporation has filed a registration statement with the SEC. A registered representative may:

Send a preliminary prospectus to clients to obtain indications of interest Explanation: During the registration period, a registered representative may not send research reports to clients nor accept orders and payments for new issues from clients. The registered representative may send a preliminary prospectus and receive indications of interest from his clients.

A corporation is issuing 5,000,000 shares of stock at a public offering price of $13 per share. The manager of the underwriting syndicate receives $0.15 per share. The syndicate members' compensation is $0.65 per share for each share they sell. The selling group's concession is $0.40 per share for each share they sell. The syndicate is allocated 4,000,000 shares and the selling group is allocated 1,000,000 shares. Assuming that all of the shares are sold, what amount will the syndicate members receive for their risk on shares sold by the selling group?

$0.25 per share for a total of $250,000 Explanation: The members of the syndicate receive $0.25 per share for their risk. Since the selling group was allocated 1,000,000 shares, the syndicate will receive $0.25 per share on 1,000,000 shares for a total of $250,000

What is meant by 4.50% less 3/4 for a municipal bond selling in the secondary market?

$1,000 bond at 4.50 yield - $7.50 Explanation: Quotes for serial municipal bonds are usually per $1,000 and on a yield-to-maturity basis. The less 3/4 represents the concession or discount offered to another dealer. 3/4 point = $7.50.

An individual purchases two BP (British pound) 150 calls @ 9.20. The contract size is 10,000 BP. The total cost for the contracts is:

$1,840 Explanation: British pound option premiums are quoted in cents per unit. To convert to dollars, the decimal point must be moved two places to the left. The total cost is calculated by multiplying the contract size (10,000) by the premium expressed in dollars ($.0920) and is $920 (10,000 x .0920) per contract. Since the individual purchased two contracts, the total cost is $1,840.

A customer's initial trade in a margin account is the short sale of 500 shares of DEF stock at $20. After making the required deposit, the credit balance in the account is:

$15,000 Explanation: The credit balance in a short margin account is determined by adding the short sale proceeds and the Reg T deposit. In this example, the short sale proceeds are $10,000 (500 shares x $20). The Reg T requirement is $5,000 ($10,000 x 50%). The credit balance is $15,000

A customer makes an initial investment of $75,000 in a high-yield bond fund with a purchase of 3,850 shares. Over the next four years, the customer deposits another $48,000 and also reinvests $17,000 of distributions for a total of 2,895 additional shares. If the fund is currently valued at $26.51, what is the customer's cost basis using the average cost method?

$20.76 Explanation: To calculate the cost basis using the average cost method, divide the sum of all investments (including reinvested distributions) by the total number of shares owned by the investor. The investor purchased $75,000 of the fund, giving him 3,850 shares. Over the next five years, the customer deposited another $48,000 and also reinvests $17,000 of distributions for a total of 2,895 additional shares. The sum of all investments is $140,000 ($75,000 + $48,000 + $17,000) and the total shares owned is 6,745 (3,850 + 2,895). Therefore, the average cost is $20.76 ($140,000 ÷ 6,745). The current value of the fund is not relevant.

An investor writes an uncovered RST May 25 put for a premium of 4. When RST is at 16, the put option is exercised. If the stock is immediately sold at the current market price, what is the investor's profit or loss?

$500 loss Explanation: If the stock is put to the writer, he would have to buy the stock for $2,500. His cost basis for tax purposes would be $2,100 ($2,500 strike price - $400 premium received). Since he then sold the stock for $1,600, he would have a net $500 loss ($2,100 - $1,600).

An investor purchases a $100,000 face value municipal bond with a 5-year maturity at 105. After two years, the bond is sold at 95. For tax purposes, the investor has a(n):

$8,000 loss Explanation: When a municipal bond is purchased at a premium, the bond's premium must be amortized to find an adjusted cost basis. If the bond is sold above the adjusted cost basis, the result is a capital gain. If the bond is sold below the adjusted cost basis, the result is a capital loss. If the bond is held to maturity, there is neither a loss nor a gain for tax purposes. This is because the adjusted basis would equal the par value after the premium is amortized. This bond is purchased at $105,000 with a 5-year maturity. The premium of $5,000 ($105,000 - $100,000 = $5,000) must be amortized over a 5-year period ($5,000 divided by 5 years equals $1,000 per year). Therefore, each year the original cost of the bond is reduced by $1,000. If the bond is sold after 2 years, the adjusted cost basis is $103,000 ($105,000 - $2,000 = $103,000). Since the bond is sold at $95,000, there is a capital loss of $8,000 ($103,000 - $95,000).

Napa Tools 7 1/4% bonds due in 2038 are listed in a financial publication as having closed the previous day at 81 7/8. The closing price of Napa Tools bonds is:

$818.75 Explanation: Corporate bonds may be quoted in fractions as a percentage of par value. The closing price of 81 7/8 is equal to 81 7/8% of the $1,000 par value. When converted to a decimal, it equals .81875 of $1,000. Therefore, the correct answer is $818.75.

A customer has funded his Roth IRA with $200,000. The account has grown to $470,000. At age 70 1/2, the customer is considering taking his first distribution. His distribution this year is based upon a 27.4 period of time. If he fails to take his distribution, what is his penalty?

0 Explanation: This question contains information that is not essential to answering the question and is used as a distracter. There is no required minimum distribution (RMD) requirement for a Roth IRA. If the question had focused on a traditional IRA, the penalty would be 50% of the RMD amount.

A notice of sale appears showing that RFQ corporation is selling 800,000 units at $60 per unit. Each unit consists of 2 shares of preferred stock and a warrant for 1/2 share of common stock. If all of the warrants are exercised, how many shares will be outstanding?

1,600,000 shares of preferred and 400,000 shares of common Explanation: Each unit was composed of 2 shares of preferred stock and a warrant for 1/2 share of common stock. There will immediately be 1,600,000 (800,000 x 2) shares of preferred outstanding. If the warrants are exercised, there will be 400,000 (1/2 of 800,000) shares of common stock outstanding.

The amount of margin that must be deposited by the purchaser of an option contract is:

100% Explanation: According to Federal Reserve Board Regulation T, options may not be bought on margin. Therefore, the buyer will need to deposit 100% of the purchase price, which is the premium.

A customer purchased an initial public offering of stock at $38 a share. The current market price is $24 and the EPS is 19 cents. If the company has no plans to pay a cash dividend, what is the price/earnings ratio of the company?

126.3 Explanation: The price/earnings ratio is found by dividing the current market price of $24 by the earnings per share of 19 cents. This equals a price/earnings ratio of 126.3 ($24 / $.19). The IPO price and the amount of the dividend are not relevant in calculating the price/earnings ratio.

A corporation calls for the redemption of 1,000,000 shares of convertible preferred stock. The corporation announces that the convertible preferred will be redeemed at a price of $20 plus an accumulated dividend of 12 cents. Each share of preferred can be converted into 1/2 share of common. The preferred stock is selling at $19. There are 2,000,000 shares of common outstanding. Earnings for the common stock are $2.50 per share. The common stock is selling at 35.75. What will the market price of the preferred stock be if it is selling at parity with the common stock?

17.88 Explanation: The preferred stock is convertible into 1/2 share of common stock. The common stock is selling for 35.75. Parity (or equality in dollar value) for the preferred stock is 1/2 of 35.75 (17.88).

A municipal bond pays interest on February 1 and August 1. A customer purchasing the bond on Monday, April 30 will need to pay the seller the purchase price plus accrued interest for:

92 days Explanation: The trade date is Monday, April 30. The bond pays interest on February 1 and August 1. Accrued interest is calculated from the last interest payment date, up to but not including the settlement date. The settlement date is Thursday, May 3. The following calculation illustrates the answer. February 30 days March 30 days April 30 days May 2 days 92 days

Which of the following orders would you place for a customer who wants to hold her auction rate security if the interest rate is set at 3.4% or higher?

A bid order Explanation: A current holder of an auction rate security may indicate she wants to continue to hold the security only if the rate is set at or above a specified rate. If the clearing rate sets below the interest or dividend rate that the holder or prospective holder specifies in her bid, the holder will be required to sell the securities subject to her bid, and the prospective buyer will not acquire the securities. Auction dealers refer to bids by prospective holders as buy orders and bids by holders as roll-at-rate orders.

Which of the following securities may NOT be purchased in a discretionary account without prior written approval by the customer? a. An exchange-traded note b. A variable-rate demand obligation c. A direct participation program d. A collateralized mortgage obligation

A direct participation program Explanation: A registered representative may not purchase a direct participation program in a discretionary account without prior written approval by the customer.

A corporation is in the 34% tax bracket. Which of the following choices provides the BEST return if the corporation wanted to invest some of its surplus cash? a. A preferred stock paying a 5 1/2% dividend b. A corporate bond yielding 7% c. A common stock paying a 5% dividend d. A municipal bond yielding 5.5%

A municipal bond yielding 5.5% Explanation: According to the corporate dividend exclusion, corporations may exclude from taxation 70% of eligible dividends received from investments in stock of other corporations. For those corporations owning 20% or more of another corporation's outstanding common or preferred shares, the exclusion increases to 80% of dividends received. To find the after-tax return of each investment, multiply the return on the security by the complement of the tax rate. For the taxable non-equity position, this rate is 66% (100% minus 34%) or .66. For each taxable equity position, we assume an exclusion of 70%. The corporation's effective tax rate on the residual 30% of income from an equity investment, can be calculated by multiplying the corporation's statutory tax rate of 34% by the residual percentage (34% x 30% = 10.2%). The amount the corporation would earn after tax is the complement of 10.2%, which equals 89.8% (.898). The municipal bond interest is tax-free to the corporation. Now we can compare the after-tax return on each security. The after-tax return on the preferred stock is 4.94% (5.5% x .898). The after-tax return on the common stock is 4.49% (5.0% x .898). The after-tax return on the corporate bond is 4.62% (7.0 % x .66) since the corporation must pay the full statutory 34% rate on this non-equity security. The after-tax return on the municipal bond is 5.5% since no taxes are due on the coupon.

When a member firm issues a research report, it must be approved by:

A supervisory analyst Explanation: When a member firm issues a research report, it must be approved by a supervisory analyst. A supervisory analyst must be registered as such with FINRA and is required to pass a separate examination.

A husband or wife may give a lifetime tax-free gift to a spouse of:

An unlimited amount Explanation: A husband or wife may give a lifetime tax-free gift of an unlimited amount to a spouse. Any person may give a gift or $14,000 per person, per year without incurring a gift tax.

In a dispute between a registered representative and his employer, the dispute typically must be settled by:

Arbitration Explanation: Any dispute between firms, a firm and its registered representative, or a firm and a clearing corporation must go to arbitration. A dispute between a firm and one of its customers can go to arbitration at the option of the customer.

When trading equity securities, the term dark pool is BEST defined as trading:

Between investors, allowing them to buy and sell securities anonymously without quotes being displayed Explanation: A dark pool is a source of liquidity for large institutional investors and high-frequency traders, and this system would not disseminate quotes. The system can be operated by broker-dealers or exchanges, and allows these investors to buy and sell large blocks of stock anonymously. The objective is to allow these investors to trade with the least amount of market impact, with low transaction costs. Some dark pools provide matching systems and can also allow for participants to negotiate prices. Normal market hours are 9:30 a.m. to 4:00 p.m. and trading outside these times is referred to as extended-hours trading

The purpose of a sinking fund is to redeem a corporation's:

Bonds Explanation: A sinking fund is used by an issuer to set aside funds that will be used for the purpose of redeeming a corporation's bonds prior to or at maturity.

A portfolio's mix of investments and two potential investors are described below. 50% municipal debt 30% blue-chip common stock 10% equity mutual funds 10% money-market funds Investor A: A 45-year-old single mom who just received a $5,000,000 inheritance. Her current salary pays her living expenses and she also contributes the maximum amount to her employer's retirement plan. She is very conservative, wants to maintain the value of her portfolio as she ages, and is concerned about the tax implications of investing her inheritance. Investor B: A 65-year-old single male who receives a significant pension as well as continuing income from the residuals in a previous business relationship. He is concerned with generating too much taxable income, but is still willing to assume some risk in his portfolio

Both Investor A and Investor B Explanation: Although Investor A is conservative, she should still maintain a moderate percentage of equities in her portfolio, which this mix provides. Additionally, she should be concerned about the tax implication of her investment returns after the $5,000,000 inheritance. The inclusion of municipal bonds in the portfolio provides that benefit. Investor B seems financially secure and is willing to assume some risk in his portfolio, therefore, maintaining a portion of the portfolio in equities would be suitable. The municipal bonds would also provide a source of tax-free income for him as he ages.

Which of the following types of debt BEST defines a municipal issuer's total bonded debt? a. Long-term debt only b. Both short-term and long-term debt c. Both long-term and short-term debt plus overlapping debt d. Long-term debt plus overlapping debt

Both long-term and short-term debt plus overlapping debt Explanation: Total bonded debt is the sum of both long-term and short-term debt of a municipality plus its applicable share of overlapping debt. Overlapping debt is that portion of the debt of other government units for which residents of a particular municipality are responsible, such as services or facilities shared by several municipalities.

An investor purchases a Canadian dollar September 80 call and writes a Canadian dollar September 82 call. This position is a

Bullish spread Explanation: A spread is the simultaneous purchase and sale of options of the same class (both calls or puts), on the same underlying security, with different strike prices and/or expiration months. A debit spread is created when the premium of the option purchased is greater than the premium of the option sold. The September 80 call, which is the right to buy the Canadian dollar at 80, is more valuable than an option that provides the right to buy at 82. Therefore, the call purchase will be the controlling factor in the spread. Since buying calls is bullish, a call debit spread is a bullish strategy.

A customer is willing to accept a partial execution on an order to buy up to 800 shares of XYZ stock at 30. If the client does not want the unexecuted portion to be left open, this order should be entered as:

Buy 800 XYZ at 30 IOC Explanation: An immediate-or-cancel (IOC) order must be executed immediately but does not need to be executed in its entirety. Part of the order may be executed. The unexecuted portion of a day order or a GTC order is placed on the designated market maker's book. A not-held (NH) order gives the floor broker discretion as to when to execute the order.

An investor believes that the U.S. dollar will strengthen in the coming months. Which of the following option strategies provides the greatest potential gain?

Buying euro puts Explanation: If the U.S. dollar strengthens, the euro will typically fall. Buying euro puts provides the greatest potential gain. There are no listed options on the U.S. dollar. Selling options provides a maximum gain that is limited to the total premium. Short straddles are profitable only if the underlying investment remains stable in price.

A customer gave his registered representative an order to buy 1,000 shares of GM at the market. If the execution report from the floor of the exchange states that 1,200 shares were purchased at 78, the:

Customer is obligated to accept only the amount ordered, not executed Explanation: The customer is not required to accept more than the original order for 1,000 shares. However, the order should not be cancelled. Since an error was made, the registered representative should speak with his supervisor to determine how to handle the situation. Entering a new order to buy 1,000 shares does not solve the problem because, if it is executed, the firm will then be long 2,200 shares of stock.

Investors who are seeking income may invest in all of the following securities, EXCEPT: a. Special tax bonds b. Lease rental bonds c. Moral obligation bonds d. Capital appreciation bonds

Capital appreciation bonds Explanation: A capital appreciation bond (CAB) has a similar structure to a zero-coupon bond. CABs do not pay periodic interest and are NOT suitable for investors who seek income.

A registered representative, when selling a limited partnership, is NOT required to:

Certify that the customer is an institutional investor as defined by SRO rules Explanation: A registered representative would be required to certify that she informed the customer of all relevant facts relating to the lack of marketability and liquidity of the limited partnership. In addition, after obtaining information about the customer's investment objectives, financial and tax status, other investments, and future financial needs, the RR must have reasonable grounds to believe the customer has sufficient net worth and income to lose his entire investment, or has other liquid assets. The RR must certify that the customer is suitable, and is in a financial position to be investing in this limited partnership. There is no requirement to certify that the customer is an institutional investor. There is a difference between an accredited investor (having at least $1,000,000 net worth or $200,000 of annual income), which is defined under Regulation D, and an institutional investor (a financial institution or an account with at least $50,000,000 of invested assets), which is defined by FINRA.

A customer wishes to close out a short option position by liquidating the option. The registered representative should mark the order ticket:

Closing purchase Explanation: The client initially had an opening sale transaction. To liquidate the short option position, the client must purchase the option contract. The registered representative should, therefore, mark the order ticket closing purchase.

Co. A Co. B Co. C Co. D Earnings per Share $2.00 $6.50 $5.20 $7.80 Dividends $0.10 $2.50 $2.60 $6.00 Percentage of Retained Earnings 95% 62% 50% 23%

Company A Explanation: Company A would best suit those needs as it is probably a growth company since it has the smallest dividend payout ratio and the largest percentage of retained earnings. The company pays out only 5% of its earnings in the form of dividends, retaining 95% to finance its growth.

Which of the following statements regarding the Roth IRA is NOT TRUE?

Contributions are tax-deductible Explanation: While contributions to traditional IRAs are tax-deductible under certain conditions, contributions to a Roth IRA are nondeductible. Individuals may contribute up to $5,500 per year if they have earned income and if they meet certain income eligibility requirements. Qualified distributions are tax-free and are not subject to the 10% early withdrawal penalty.

A municipality's debt limit is the maximum amount of:

Debt a municipality may incur Explanation: A municipality's debt limit is the maximum amount of debt a municipality may incur and is important in the credit analysis of a general obligation bond. Choice (d) would be relevant for a revenue bond.

On Monday August 3, the board of directors of XYZ Corporation issued a press release stating that at today's meeting, they had decided to pay a 25-cent quarterly dividend. The checks for the dividend are to be sent out on September 15. The checks will be made out to anyone who is recorded as a shareholder as of Friday, August 28. The first trading day on which purchasers of XYZ stock will not receive the dividend is Wednesday, August 26, which is called the:

Ex-dividend date Explanation: The ex-dividend date is the first day a stock trades without a dividend and this date is typically two business days prior to the record date. Therefore, a person who purchases the stock on or after the ex-dividend date is not entitled to the dividend.

Which of the following statements is TRUE concerning the suitability of a Section 1035 exchange?

Exchanges made within 36 months of a previous exchange are generally considered inappropriate Explanation: In order for a 1035 exchange to be considered appropriate, the individual must benefit from the new contract, and the representative must sign off on its suitability. Exchanges made within 36 months of a previous exchange are generally considered inappropriate. Higher returns do not guarantee suitability. Surrender periods on the new contract are one of the major factors in determining suitability.

The City of Fremont, Nebraska is issuing revenue bonds to increase its electric power generating facilities and to replace outstanding bonds. Interest on the bonds will be:

Exempt from federal income tax Explanation: For individual investors, the interest derived from state and municipal bonds is exempt from federal income tax. The investor may need to pay state taxes, depending on the tax status of the investor's home state.

The U.S. government does NOT guarantee the payment of interest and principal for which of the following securities?

FHLMC (Freddie Mac) securities Explanation: The U.S. government guarantees the payment of interest and principal on all Treasury securities, savings bonds, and securities issued by the Government National Mortgage Association (GNMA or Ginnie Mae). Securities issued by the Federal Home Loan Mortgage Corporation (FHLMC [Freddie Mac]), a government-sponsored enterprise (GSE), are not guaranteed or backed by the U.S. government.

Which of the following choices is NOT taxable to the owner of mutual fund shares? a. Dividends that were reinvested at net asset value b. Fund shares that appreciated which are exchanged for other shares in the same family of funds c. Fund shares held by the investor, which have appreciated but have not yet been sold d. A capital gains distribution that was reinvested at net asset value

Fund shares held by the investor, which have appreciated but have not yet been sold Explanation: Owning fund shares that have appreciated in value does not incur taxes. The appreciation becomes taxable as a capital gain when the shares are sold for the profit. An exchange within a family of funds is considered a sale and subsequent purchase, and will be a taxable event if the sale resulted in a gain. Dividends and capital gain distributions are taxable events whether or not they are reinvested

An investor purchasing a reverse convertible security would be MOST interested in:

High current income Explanation: An investor purchasing a reverse convertible security is seeking an above-market coupon rate. Reverse convertible securities are short-term notes issued by banks and broker-dealers that usually pay a coupon rate above prevailing market rates. They are considered structured products because, in addition to the coupon rate, the investor may be required to purchase shares of an underlying asset at a fixed price. The underlying asset may be an equity security unrelated to the issuer, or a basket of stock, or an index. The issuer agrees to pay this higher coupon rate since it has an option to sell a security to the investor if the price of the security falls below a specified value known as the knock-in level. If the price of the underlying asset stays above the knock-in level, the investor will receive the high coupon and the full return of her principal (the most beneficial option). The investor will not be able to participate if the underlying asset increased. If the underlying asset falls below the knock-in level, the investor will be obligated to purchase shares of the underlying asset at a fixed price. The price of this asset may have depreciated below the knock-in level and the investor may receive substantially less than the original principal.

A high net worth investor seeking safety of principal would MOST likely invest in which of the following securities?

High-grade general obligation bonds Explanation: Safety of principal refers to a customer being able to preserve or retain the initial amount of, the investment over its life. Many bonds offer investors this feature. The higher the rating, the greater the likelihood the investor will achieve safety of principal. High-grade generally refers to an investment-grade or highly rated bond. A general obligation bond would also offer a high net worth investor tax-exempt income. High-yield refers to non-investment- grade or junk bonds that would expose the investor to the risk of not achieving safety of principal.

Which of the following statements are TRUE relating to the auction of T-bills? I. Three- and six-month T-bills are auctioned weekly II. Three- and six-month T-bills are auctioned on a discount-yield basis but one-month T-bills are auctioned on a coupon equivalent yield basis III. Noncompetitive tenders are awarded at the highest yield of the accepted competitive tenders IV. The purchaser must hold the securities until maturity

I and III Explanation: Three- and six-month T-bills are auctioned weekly. All T-bills are auctioned on a discount-yield basis with noncompetitive tenders awarded first and receiving the highest yield (lowest price) of the accepted competitive tenders. These securities are highly liquid and may be sold by a purchaser anytime prior to maturity.

Which TWO of the following statements are TRUE under the Uniform Transfers to Minors Act (UTMA) regarding a custodian account in which an individual is custodian for her son? I. The securities purchased must be suitable for the minor II. The mother's Social Security number is used for purposes of reporting and paying taxes III. The custodial relationship is terminated when the son reaches majority IV. The securities will be registered in the mother's name until the son reaches the age of majority

I and III Explanation: A custodian under the Uniform Transfers to Minors Act is required to act under the Prudent Man Rule in the handling of the account. The custodian may make any transactions that a prudent man or woman would make for her own account. The transaction, however, must be suitable for the minor. All stock in the account must be registered in the name of the custodian as custodian for the minor. The account would be registered, for example, as "Mary Jones as custodian for Robert Jones under the New York Uniform Transfers to Minors Act." The custodial relationship is terminated when the minor reaches the age of majority.

If the FRB engages in repurchase agreements, which TWO of the following statements are TRUE? I. The money supply is being increased II. The money supply is being decreased III. The fed funds rate could rise IV. The fed funds rate could decline

I and IV Explanation: The immediate result of an FRB repo is an increased money supply, which would have the effect of lowering interest rates.

Which TWO of the following statements are TRUE regarding the buyer and writer of a combination? I. The buyer of a combination expects the market to be volatile II. The writer of a combination expects the market to be volatile III. The buyer of a combination expects the market to remain stable IV. The writer of a combination expects the market to remain stable

I and IV Explanation: The writer (seller) of a combination (a call and a put) believes the underlying security's price will remain stable. The buyer of a combination expects that the market price of the underlying security will be volatile.

A securities firm is permitted to charge customers a fee for: I. Collecting dividends and/or interest II. Appraisal of securities III. Holding securities in safekeeping IV. Transfers and/or exchanges

I, II, III, and IV Explanation: Securities firms may charge customers for all services they provide as long as the charge is fair and reasonable.

Money received by a corporation when it sells its stock above its par value is called:

Paid-in capital Explanation: Money received by a corporation when it sells its stock above its par value is called capital surplus or paid-in capital. This is different from earned surplus (retained earnings), which is profits that have been retained by the company and have not been paid as dividends.

A customer contacts her registered representative concerning the bid and offer prices of mutual funds listed in various financial publications and Web sites. Which TWO of the following statements are TRUE? a. The bid price is equal to the net asset value minus the redemption fee b. The bid price is equal to the net asset value and does not include the redemption fee c. The offer price is equal to the net asset value plus the sales charge d. The offer price is equal to the net asset value minus the sales charge

II and III Explanation: The bid price of a mutual fund is also equal to the net asset value (NAV) and is the price a customer will receive if shares are sold. It does not include the redemption fee, which may be charged when the customer sells her shares. The offer price is equal to the NAV plus the sales charge, if any, and is the price a customer would pay to purchase shares of a mutual fund.

Fred's Auto Centers is looking to raise $10 million to expand its business. The company has entered into an agreement to raise the capital through Winco Securities, a local investment banking firm. Winco Securities has made no guarantee that it will be able to raise the full amount of the offering. Which TWO of the following statements regarding this scenario are TRUE? I. This is an example of a firm-commitment underwriting II. This is a best-efforts underwriting III. Winco is acting as an agent for Fred's Auto Centers IV. Winco is acting as principal in this underwriting

II and III Explanation: The underwriting is being done best-efforts, since no guarantee to raise the $10 million has been made by Winco Securities. Winco is acting as an agent in the transaction because any unsold shares will be retained by Fred's Auto Centers. Winco will be compensated only for the shares it sells and assumes no liability in the deal.

Which TWO of the following statements are TRUE concerning bank-qualified municipal bonds? I. To qualify, the municipality may only issue up to $10,000,000 every six months II. To qualify, the municipality may only issue up to $10,000,000 annually III. Commercial banks may receive a 70% tax deduction of the interest costs IV. Commercial banks may receive an 80% tax deduction of the interest costs

II and IV Explanation: Bank-qualified bonds are issued by small municipalities and, to qualify, a municipality may only issue up to $10,000,000 annually. This is done to encourage commercial banks to invest in locally issued municipal securities. Commercial banks that purchase this type of security are permitted to deduct 80% of the interest cost paid to depositors on the funds used to purchase the bonds.

Which TWO of the following choices are differences between exchange-traded funds (ETFs) and exchange-traded notes (ETNs)? a. ETFs may be traded in the secondary market and ETNs cannot b. ETNs carry issuer risk that is tied to the creditworthiness of the financial institution backing the note and ETFs do not have issuer credit risk c. ETF returns are based on the performance of an index and ETNs pay a fixed coupon rate d. ETNs have a maturity date and ETFs do not

II and IV Explanation: ETNs are a type of unsecured debt security. This type of debt security differs from other types of bonds and notes because ETN returns are linked to the performance of a commodity, currency, or index minus applicable fees. ETNs do not usually pay an annual coupon or specified dividend. Similar to ETFs, ETNs are traded on an exchange, such as the NYSE, and may be purchased on margin or sold short. Investors may also choose to hold the debt security until maturity. ETNs carry issuer risk that is tied to the creditworthiness of the financial institution backing the note. If the issuer's financial condition deteriorates, it could negatively impact the value of the ETN, regardless of how its underlying index performs.

A client is notified by his broker-dealer that certain trades may be executed by an Electronic Communication Network (ECN). Which TWO of the following choices are risks of using this type of system? I Trades are not subject to SRO regulations II There may be a limited ability to execute transactions III Higher commissions are possible IV The system may only accept certain types of orders

II and IV Explanation: Some broker-dealers use ECNs to execute customer orders. ECNs act as matching systems to execute orders from subscribers. Some broker-dealers will use a market maker during normal business hours and an ECN to execute trades after normal business hours (after 4 p.m.). If the system cannot match a buyer and seller, a client's order may have a limited ability to be executed. Some ECNs will accept only certain types of orders, such as limit orders. Trades are subject to SRO regulations and the commissions clients are charged generally are not higher if a broker-dealer uses an ECN.

An investor is interested in purchasing an interest in a real estate limited partnership. To exhibit suitability, the investor could provide:

Past tax returns Explanation: When investing in a DPP, the customer must verify that he meets all suitability standards. This can be accomplished by furnishing documents such as past tax returns and a statement of net worth

The spot prices of foreign currencies are determined:

In the Interbank market Explanation: The spot prices for foreign currencies are determined in the Interbank market, which consists of commercial banks trading currencies.

A customer purchases a step-up, long-term certificate of deposit. The initial interest rate:

Is lower than current market rates Explanation: A long-term (maturity exceeding one year), step-up CD offers an investor an interest rate that is initially lower than current market rates will pay for that maturity period. The rate will then be adjusted upward at predetermined intervals established by the offering bank. Since they are traded in the secondary market, changes in interest rates will cause the price of this security to fluctuate. Some long-term CDs will be callable by the issuing bank, and the investor may be required to reinvest the funds at prevailing lower interest rates.

A customer purchases 1,000 shares of ATT stock at 30, requiring a $15,000 deposit in her margin account. On the payment date, ATT is selling at 35 per share but the customer has not paid for the transaction. Which of the following actions is considered free-riding?

Liquidating the stock at 35 and using the sale proceeds to pay for the $15,000 margin requirement Explanation: The customer would not be permitted to liquidate the stock and use the sale proceeds to pay for the margin requirement. This illegal practice is known as free-riding. To satisfy the $15,000 margin requirement, the customer may deposit the full amount in cash or twice the amount in marginable securities. If there is a legitimate reason for the customer not paying, an extension may be requested.

If the Federal Reserve Board increases the discount rate, you would expect:

Long-term bonds to decrease more in price than short-term bonds Explanation: If the FRB increases the discount rate, the general level of interest rates increases. The prices of long-term bonds decreases more in price than the price of short-term bonds.

A transfer agent does NOT perform which of the following functions?

Make sure that outstanding shares do not exceed authorized shares Explanation: The transfer agent is responsible for issuing new certificates, cancelling old certificates, keeping a record of shareholders and the number of shares each owns, and handling problems that come about in cases of missing, lost, stolen, or mutilated securities. The registrar makes sure that outstanding shares do not exceed authorized shares.

Which of the following statements is NOT TRUE regarding negotiable CDs?

Maturities of more than one year are prohibited Explanation: Negotiable CDs are traded in the secondary market in minimum denominations of $100,000 but typically trade in $1,000,000 denominations. They are issued by commercial banks and are secured only by the bank's credit. Maturities of less than one year are common but there is no time limit.

A municipal dealer gives another dealer a firm quote of par for a block of municipal bonds. The dealer that gave the quote

Must do the trade at par

Under what circumstances may a variable annuity be recommended as a short-term investment?

Never, since this practice is prohibited under industry rules Explanation: Under industry rules, mutual funds or annuities may not be recommended as short-term investments or trading vehicles. The fact that a product is no-load does not change this SRO prohibition. There is no such thing as a CDSC reduction agreement.

Which of the following scenarios will have a negative effect on the U.S. balance of payments? a. An increase in U.S. exports to foreign countries b. Foreign purchases of U.S. securities c. New U.S. investments abroad d. New foreign investments in the U.S.

New U.S. investments abroad Explanation: New U.S. investments abroad will tend to increase the basic deficit in the U.S. balance of payments because dollars are leaving the U.S. and are being invested in foreign countries.

A municipal dealer would violate MSRB rules if it gave a quote that is:

Nominal and not specified as such Explanation: MSRB rules require that any quote be bona fide (firm at the time given). Nominal or subject quotes are permitted if they are identified as such at the time given.

When referring to call option contracts, the term open interest means the:

Number of contracts that have not been closed out through a sale or by expiration Explanation: The term open interest, when referring to call option contracts, means the number of contracts that have not been closed out through a sale or by expiration.

Which of the following items is NOT an appropriate asset for an equipment leasing program?

Oil and gas pipe Explanation: Oil and gas pipe is not an appropriate leasing item. Unlike the other assets listed, it would be difficult for the bond trustee to seize the oil and gas pipe collateral and resell it to another user in case of a default by the bond issuer.

When a stock is at its resistance price, a technical analyst will most likely say that it is:

Overbought Explanation: A stock is overbought at its resistance level and oversold at its support level.

A variable annuity contract holder dies during the accumulation period. In this situation, which of the following statements is TRUE regarding the tax consequences? a. All proceeds pass to the beneficiary tax-free b. Proceeds in excess of cost are taxable as capital gains to the beneficiary c. Proceeds in excess of cost are taxable as ordinary income to the beneficiary d. Proceeds are not taxable if the beneficiary rolls them over into an IRA

Proceeds in excess of cost are taxable as ordinary income to the beneficiary Explanation: When a variable annuity contract holder dies during the accumulation period, the proceeds in excess of cost are taxable to the beneficiary as ordinary income.

A 17-year-old, whose birthday is approaching, wants to open his own brokerage account at a firm. Which of the following choices is the BEST course of action for the RR to take?

Refuse to open the account Explanation: Minors are not permitted to open accounts with broker-dealers since they are not legally responsible and could reject certain transactions once they reach the age of majority. The age of majority is actually determined by the state. In most states, the age of majority is age 18.

Income that is derived from which of the following sources may NOT be used to fund an IRA contribution?

Rental income received from a summer rental Explanation: Contributions that are made to an IRA must be based on taxable compensation which includes salary or wages (part-time or full-time), bonuses, tips, commissions, net income from self-employment, and taxable alimony. IRA contributions may not be based on rental income from properties, funds received from annuity contracts, or funds received from dividends and interest from securities in a portfolio.

Mrs. Jones is interested in selling 500 shares of her REIT. The sale will be handled in a manner similar to the:

Sale of a closed-end fund listed on the NYSE Explanation: There is a secondary market for REITs (real estate investment trusts). The vast majority of REITs trade on the NYSE with prices determined by supply and demand. Closed-end funds are funds that are often bought and sold on the NYSE that trade in a similar manner.

A client owns 2,000 shares of TBDR. She expects a decline in the market and instructs her broker to sell 1,500 shares of the stock. The order ticket will be marked:

Sell long Explanation: Since the client owns shares equal to or greater than the amount she plans to sell, the order ticket will be marked sell long. Sell short is used if the client does not own the security and will deliver borrowed securities. Selling short against the box is used when a client with a long position sells the same security but borrows the stock to effect delivery rather than delivering the long position. The ticket to sell is still marked short.

Which of the following transactions is not prohibited under the Securities Exchange Act of 1934?

Short sales of municipal bonds Explanation: All of the choices listed are prohibited according to the Securities Exchange Act of 1934 except short sales of municipal bonds. Short sales of securities are subject to the borrowing requirements of Regulation SHO. This makes choice (c) a violation. Municipal bonds are exempt securities and are not subject to the borrowing requirements of Regulation SHO. Any person that buys or sells a security for the purpose of attempting to stop the price from falling (pegging) or rising (capping) is engaging in a manipulative action. Persons who enter into transactions to increase volume, without ownership changing, have engaged in painting the Tape. This is a manipulative act and is a violation.

An investor who sells 1 GE Dec 50 call and sells 1 GE Dec 40 put has:

Sold a combination Explanation: Selling a call and put on the same security with different strike prices, or different expiration dates, is a short combination.

In a municipal bond underwriting, the difference between what the issuer receives and the public offering price is known as the:

Spread Explanation: The spread in a municipal bond underwriting is the gross profit earned by the syndicate. It is the difference between the amount the issuer receives for the bonds and the public offering price for the bonds. The takedown is the discount given to syndicate members by the manager of the syndicate on any bonds sold. The concession is a trade discount given to dealers who are not members of the syndicate. For example, a syndicate member may take down bonds at par minus 5/8 and sell them to the public at par, making a 5/8-point profit. The dealer who is not a member of the syndicate may buy the bonds at par minus 1/4-point concession and sell them to the public at par, making a 1/4-point profit.

On Tuesday, the S&P 500 Index closed at 1,600. At 11:30 the next morning, the S&P 500 Index is at 1,488. All NMS stocks will:

Stop trading for 15 minutes Explanation: If the S&P 500 Index falls by 7% from the previous trading day's closing price, it is defined as a Level 1 Market Decline and triggers a 15-minute trading halt. In this question, the drop from the closing price of 1,600 to 1,488 the next day (112 points) is a 7% decline.

An investor must pay accrued interest for a secondary market purchase of:

Tax anticipation notes Explanation: Zero-coupon bonds and Treasury bills are original issue discount securities and trade without accrued interest. While Series EE bonds are also OID securities, they do not trade in the secondary market. Tax anticipation notes (TANs) are typically interest-bearing securities and trade with accrued interest.

Listed options are issued and guaranteed by:

The Options Clearing Corporation Explanation: Options that are listed on exchanges are issued and guaranteed by the Options Clearing Corporation. The exchange on which the option trades sets the terms of the option contract.

A broker-dealer may reject a delivery of municipal bonds if:

The bonds are lacking a legal opinion Explanation: A delivery of municipal bonds may be rejected if they do not meet good delivery requirements such as missing or mutilated coupons or lack of a legal opinion. A change in market price is not a reason for rejecting delivery of municipal bonds (or any other security).

A customer is short 100 ABC at $120. The market is moving up sharply and the customer decides to cover her short position. The customer instructs her registered representative to cover the short position at the market on the close. The order will be executed at:

The closing price of the day

An individual purchases 600 shares of BAZ preferred stock. One week later the stock pays a dividend of $1.20 per share and the investor sells the stock the next day. For tax purposes, how will the dividends be taxed?

The dividend will be taxed as ordinary income Explanation: Currently, dividends paid on stock held by individuals for more than 60 days during the 120-day period beginning 60 days before the ex-dividend date are taxed at a maximum rate of 20%. This is the same maximum tax rate as long-term capital gains. Since the individual held the stock less than the 60-day period, the dividend is taxed as ordinary income. The corporate dividend exclusion allows a corporation to exclude from taxation 70% of the dividends it receives from other corporations.

In which of the following documents are bid limitations for a new municipal bond issue found?

The notice of sale Explanation: The notice of sale is published by the issuer. It announces the issuer's intention to sell an issue and invites securities firms to compete for the issue. All information pertaining to the bidding would be contained in the notice of sale.

Which of the following statements is TRUE concerning the responsibilities of a principal at a broker-dealer?

The principal must approve retail communications prior to use Explanation: Principal approval is required for retail communications prior to use, not within 10 days of use. All trades must be reviewed by a principal promptly. Any RR who has outside employment must notify his employer, but principal approval is not required

When analyzing a mutual fund's expenses, an analyst does NOT consider:

The sales load charged to buy fund shares Explanation: When analyzing a mutual fund's expenses, an analyst is concerned about the amount of expenses as compared to the amount of money managed by the fund. This comparison is made by calculating the fund's expense ratio (operating expenses divided by total net assets). The operating expenses include management fees (which is usually the largest expense) and the fee paid to the fund's custodian. Total net assets are the fund's assets minus liabilities. Sales charges are not considered expenses of the fund.

A FINRA member subscribing to CQS, calls a market maker displaying a quote on the system and executes a trade. This transaction is considered to have occurred in the:

Third market Explanation: CQS displays quotations by members for NYSE and NYSE MKT (formally NYSE Amex) listed securities. Transactions in listed securities between FINRA members in the over-the-counter market are considered third-market transactions. Although executed in the over-the-counter market, such transactions must still be reported to the Tape.

What is the basic balance sheet equation?

Total Assets = Total Liabilities + Stockholders' Equity

All of the following trades may be executed in a cash account, EXCEPT the sale of a(n): a. Common stock b. Preferred stock c. Covered call option d. Uncovered call option

Uncovered call option Explanation: All of the trades listed may be executed in a cash account except the sale of an uncovered call option. If the option is exercised, the writer must buy stock at an unknown market price. The sale of uncovered options may be executed only in a margin account.

An exercise limit is the maximum number of options contracts that a customer may exercise in a five-consecutive-business-day period for each:

Underlying stock on each side of the market Explanation: Exercise limits relate to the maximum number of contracts that an individual may exercise during a five-business-day period for each underlying stock on each side of the market. Exercise and position limits apply cumulatively to all accounts that a customer maintains at all brokerage firms, not for each account at each firm.

A customer has a restricted margin account. The customer sells $7,000 worth of securities and on the same day buys $5,000 worth of other securities. The Regulation T margin requirement is 50%. The customer may:

Withdraw cash equal to the margin requirement on the net amount Explanation: When a customer buys and sells securities in a restricted margin account on the same day, it is called a same-day substitution and the transactions are netted against each other. In this question, the sale of $7,000 and the purchase of $5,000 result in a net sale of $2,000. The entire amount will be used to reduce the customer's debit balance, and the customer's SMA will be credited with an amount equal to the net sale proceeds multiplied by the Reg T requirement ($2,000 x 50% = $1,000). If desired, the customer may then borrow this amount.

If an equity option is exercised, when is the settlement date for the stock transaction?

Within three business days Explanation: When an equity (stock) option is exercised, delivery of the underlying stock and payment for the stock is expected within 3 business days (regular-way settlement for stock).

Under SRO rules, the carrying firm must complete the transfer of a customer account:

Within three business days of validation of the transfer instructions Explanation: If a customer wants to transfer an account to another broker-dealer, she must sign a transfer request. The firm where the client has the existing account is known as the carrying firm and the new firm is known as the receiving firm. According to SRO rules, the transfer of a customer account must be completed by the carrying party within three business days of validation of the transfer instructions. The carrying firm must either validate the instructions or take exception within one business day

An individual purchases $100,000 face value of a 6% municipal bond at a dollar price of 101 1/2. The bond's maturity is 7-1-27, but the issue has been called for redemption on the first call date of 7-1-15 @ par. The customer's confirmation should show the:

Yield to call Explanation: Since the bond has been called, the yield to the call must be shown because the maturity is no longer of importance. Taxable equivalent yield and after-tax yield are never shown since the investor's tax bracket and/or capital gains rate cannot be accurately predicted.

A customer owns a municipal bond that has been escrowed to maturity. Which of the following statements is TRUE? a. The issuer has deposited money in an escrow account that will contain U.S. government securities used to pay off the municipal bonds at maturity b. The issuer has deposited money in an escrow account that will contain U.S. government securities used to pay off the municipal bonds prior to maturity c. The issuer has deposited money in an escrow account that will contain other municipal bonds used to pay off the municipal bonds at maturity d. The issuer has deposited money in an escrow account containing U.S. government securities that will create a tax liability for the municipal bondholder at maturity

a. The issuer has deposited money in an escrow account that will contain U.S. government securities used to pay off the municipal bonds at maturity Explanation: When interest rates fall, a municipality may want to engage in advance refunding. In this case, the municipality will sell a new issue with the proceeds of the sale going into an escrow account containing U.S. government securities. Since the municipal bond has been escrowed to maturity, the U.S. government securities would be purchased with a maturity date that coincides with the maturity date of the municipal bonds.

A registered representative who previously was the CEO of a cosmetics company wants to send a report to clients. She will include detailed information concerning individual equity securities of cosmetics companies she feels are good investments. Although the report analyzes different stocks she feels are attractive investments, it does not contain a recommendation. Which of the following statements is TRUE? a. This is not a research report since the report does not contain a recommendation b. This is a research report and requires approval c. This is not a research report since the RR does not hold the title of a research analyst d. This is a research report but does not need to be approved

b. This is a research report and requires approval Explanation: A registered representative does not need to hold the title of research analyst in order for the report to be considered a research report. If the report provides sufficient information concerning individual equity securities for a client to make an investment decision and is distributed to clients, it is considered a research report. A research report must be approved by a supervisory analyst and contain the proper disclosure.

Which of the following investors is LEAST likely to purchase a collateralized debt obligation (CDO)? a. Agawam Commercial Bank & Trust Company b. Oakdale Pension Fund c. Robert & Susan Abramowitz, JTWROS d. Lincolnshire Hedge Fund

c. Robert & Susan Abramowitz, JTWROS Explanation: Due to their highly complex nature, CDOs are generally not suitable for retail investors. A CDO (collateralized debt obligation) is a sophisticated financial instrument that begins with an individual loan (such as a mortgage or corporate debt). These loans are placed in a pool, and investors then purchase a security (bond, tranche, slice) that represents an interest in that pool. Each of these securities has a different maturity and credit risk, depending on the nature of the collateral behind it. This type of investment carries many risks and considerations that make it largely unsuitable for a typical retail investor.

Which of following investment allocations is the BEST recommendation for a customer with an aggressive risk tolerance? a. 10% large-cap equity funds, 5% international equity mutual funds, 55% bond funds, and 30% cash b. 15% large-cap equity funds, 5% small-cap equity funds, 15% international equity funds, 45% bond funds, and 20% cash c. 35% large-cap equity funds, 15% small-cap equity funds, 15% international equity funds, 30% bond funds, and 5% cash d. 50% large-cap equity funds, 20% small-cap equity funds, 20% international equity funds, 5% bond funds, and 5% cash

d. 50% large-cap equity funds, 20% small-cap equity funds, 20% international equity funds, 5% bond funds, and 5% cash Explanation: An aggressive risk tolerance is for investors who want high growth and do not need income. These investors are willing to accept high volatility and the possibility of substantial loss of their principal. Choices (a), (b), and (c) offer too small of an allocation in equities

A customer sells $1,000 worth of stock in a restricted margin account. All of the following statements are TRUE, EXCEPT the: a. Market value of the account will be reduced b. SMA will be increased c. Debit balance will be decreased d. Equity will be increased

d. Equity will be increased Explanation: When securities are sold in a restricted account, the customer is permitted to withdraw an amount equal to the FRB initial margin requirement (currently 50%). This amount is first credited to the SMA and may then be withdrawn. The full amount of the sale is used to reduce the debit balance. The market value will decrease since securities were sold. The equity will remain the same since the market price and debit balance were reduced by the amount of the sale. If the customer withdraws the amount credited to the SMA, the debit balance will increase and the equity will decrease.