Series 7 Test Questions 12

A customer is considering an investment in a hedge fund noting he has heard much about their high yield potential from a business acquaintance. In a discussion with him about these types of funds which of the following statements is TRUE?

Hedge funds often use higher degrees of leverage and more sophisticated investment strategies than mutual funds ****Hedge funds utilize aggressive investment strategies not limited to selling securities short, and purchasing on margin. Often hedge funds have minimum initial investment requirements and lock-up provisions making withdrawals impossible for a period of time. These qualities of hedge funds make them less suitable for all investors and more suitable for high net worth and income (sophisticated) investors. Both mutual funds and hedge funds pool investors' money to manage a single portfolio of assets. Hedge funds are unregulated while mutual funds are regulated under the Investment Company Act of 1940.****

Because money market instruments are designed to meet the short-term cash needs of issuing institutions, which of the following is NOT a money market instrument?

Newly issued Treasury notes issued to meet a specific government funding requirement ****A newly issued Treasury note would have a maturity of 2 to 10 years and would not be considered a money market instrument. A Federal Farm Credit Bank note maturing in one year or less is a money market instrument, as is commercial paper issued by the finance corporation of a major automobile manufacturer with a maturity of less than one year. Municipal construction loans issued to provide short-term financing for a construction project are money market securities.****

Which of the following would exclude a bond from being covered under the Trust Indenture Act of 1939?

Offering with a maturity of less than 9 months ****The Trust Indenture Act of 1939 is applicable to corporate debt issues that are nonexempt, are over $50 million to be issued within 12 months, are offered interstate, and have maturities of 9 months or more. An offering made that would mature in less than 9 months would be excluded from coverage under the act.****

A registered representative makes the following comment to his client, "Writing options is a good way to increase your income on this stock." Which of the following should be included with this comment?

You may lose future profits and risk of loss is still possible ****Because the registered representative is recommending covered call writing, he should also explain the risks involved.****

Encouraging a customer to purchase mutual fund shares in an amount just under the next dollar volume bracket (which entitles the customer to a reduction in sales charges) or remaining silent on the matter is called:

a breakpoint sale ****In a breakpoint sale, a customer unknowingly buys investment company shares in an amount just under a dollar bracket that would qualify for reduced sales charges. As a result, the registered representative receives a somewhat higher commission but the customer pays higher sales charges, reducing the number of shares purchased and resulting in a higher cost per share.****

An investor purchases a municipal bond at par for $10,000 on February 15, 1997. On August 15, 1997, if the investor sells the bond for $10,500, for tax purposes the $500 profit is recognized as

a short-term capital gain ****When municipal bonds are purchased at par and subsequently sold at a higher price, the resulting profit is taxed as a capital gain. Only interest income from municipal bonds is exempt from taxation. This gain is not classified as long-term because the investor did not hold the bond for more than 1 year.****

An agent is permitted to open all of the following customer accounts EXCEPT:

an account in the name of Mrs. Jones opened by Mr. Jones ****An agent is not permitted to open an individual account in the name of a third person.****

A municipal finance professional (MFP) is

an employee of a broker/dealer engaged in municipal security representative activities other than retail sales or who solicits municipal securities business for the broker/dealer ****As per the Municipal Securities Rulemaking Board (MSRB) a municipal finance professional (MFP) is an associated person of a broker/dealer who is primarily engaged in municipal securities representative activities other than retail sales to individuals, who solicits municipal securities business for the broker/dealer, or who is in the supervisory chain above MFPs as described.****

A broker/dealer has set up a prime brokerage account for one of its customers. This customer is most likely

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

All of the following are true regarding a fail to deliver EXCEPT

even though a fail to deliver has occurred and is still outstanding, FINRA mandates that the seller still be paid ****The seller cannot be paid as long as the fail to deliver exists. Fail to deliver occurs when the selling BD does not deliver the securities in good deliverable form. The buyer or the selling BD can buy in the securities to complete the transaction, and any loss incurred to do so will become the responsibility of the seller who failed to deliver.****

Depletion allowances apply to all of the following EXCEPT:

real estate ****Depletion is applicable to natural resources such as mining or timber. It is not applicable to real estate. However, buildings can be depreciated****

If a customer is long 10 ABC Jul 50 calls at 4.50, the contracts give the holder the:

right to buy stock ****A long call gives the holder the right to buy stock.****

Libby sees a tombstone advertisement for a new issue of Southwest Barge subordinated convertible debentures. The bonds will carry an 11-1/4% 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:

the issue may be junior-in-lien to another security issue. ****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 as the bonds are identified as debentures, and having to convert to common stock is not a threat since she is the one that will, if she desires, exercise the conversion privilege.****

A sophisticated investor wants to purchase stock of a foreign company or an American depositary receipt representing the shares of that company. The purchase would align with the investor's goal of growth and income, but he makes several statements about the potential purchase and only one of them is accurate. You feel it is important to point out and discuss from a suitability perspective which statements were not, and which one was accurate. The accurate statement was

the purchase of American depositary receipts representing the shares exposes me to currency risk ****From a suitability perspective, correcting any inaccuracies about an investment that an investor might have is important. Currency risk cannot be avoided when investing in foreign companies either directly or using ADRs. While ADRs trade on U.S. exchanges, foreign shares do not, and ADR issuers generally do not pass on voting rights to the ADR holders.****

All of the following are TRUE concerning a Coverdell Education Savings Account (ESA) EXCEPT

unused balances may be used for any purpose the beneficiary chooses ****The maximum contribution permitted for any beneficiary is $2,000 per year. The beneficiary need not be related to the contributor(s). ESA accounts may be rolled over to change investment vehicles or to change beneficiaries. Account balances may be used for education only.****

An investor interested in acquiring a convertible bond as part of his investment portfolio would:

want the safety of a fixed-income investment along with potential capital appreciation ****An investor who wants the safety of a fixed-income investment with the potential for capital gains would be most interested in purchasing a convertible bond. However, because convertible bonds can be exchanged for common stock, their market price tends to be more volatile during times of steady interest rates than other fixed-income securities.****

If a customer wishes to purchase a nonexempt security in a cash account, Regulation T requires a broker/dealer to receive payment in full

within 4 business days ****Regulation T requires that a broker/dealer receive payment in full, from a customer making a purchase of this type in a cash account, no later than 4 business days after the trade date (regular way settlement plus two additional business days).****

All of the following regarding the official statement for a new municipal issue are true EXCEPT that it:

is also called a prospectus ****The official statement is the disclosure document for each new issue of exempt municipal bonds. Although it is similar to a prospectus, these terms are not synonymous. The official statement commonly includes information about the call provisions of the bond, creditworthiness of the issuer, and other information potential purchasers should know before investing.****

A customer buys 300 LMN at 45 and writes 3 LMN Aug 45 calls at 4. The customer will profit under all of the following circumstances EXCEPT if LMN:

is below 41 at expiration ****Breakeven is 41 (45 − 4). If the stock is below 41 at expiration, the customer will incur a loss.****

An insured municipal bond is purchased by your client in the secondary market. After the sale, MSRB rules would require you to:

make delivery of the certificates accompanied by evidence of insurance, either on the face of the certificates or in a separate document. ****Although it is likely that the confirmation would include a statement that the bonds are insured, it is also necessary to provide the client with some proof of that insurance, either on the bond itself or, in the case of book entry delivery, as a separate document.****

All of the following information must be on an order ticket EXCEPT:

price of a market order ****Price would not be included on a ticket for a market order, but it would be on the ticket for a limit, stop, or stop limit order.****

Closed-end investment company shares may be:

traded in the secondary markets, including the exchanges and OTC markets. traded by institutional investors. ****Once a closed-end investment company has distributed shares, those shares are traded in the secondary market by both individual and institutional investors.****

A municipal issuer's total debt is made up of which of the following?

Direct debt Overlapping debt ****Municipal bond analysts examine an issuer's total debt to determine an issue's safety. Debt that is not a burden on the municipality is not included in total debt. Defeased debt and paid-up debt can be removed from the municipality's debt accounts. Direct debt is debt issued by the municipality, and overlapping debt is the municipality's share of debt issued by authorities that draw revenues from the same sources as the municipality. Together, direct debt and overlapping debt constitute the municipality's total debt.****

Rank the following in order of payment at liquidation, from first to last.

Employee wages. Accrued taxes. Subordinated debentures. Preferred stock ****When a corporation is liquidated, employee wages are paid first, followed by taxes, secured debt, debentures and general creditors, unsecured debt, subordinated debt, preferred stock, and common stock.****

Which of the following choices is least similar to the others?

Financial Guaranty Insurance Corp. ****Standard & Poor's, Fitch, and Moody's are all agencies that rate debt securities including municipals and equity securities as well. The Financial Guaranty Insurance Corp. is one of several entities that insure municipal bonds.****

What is the size of one LEAPS contract?

100 shares ****Like a standard options contract, the size of a LEAPs contract is 100 shares.****

An investor establishes the following positions: Long 1 XYZ Apr 45 call at 3.50 Long 1 XYZ Apr 45 put at 2.75 The investor's strategy will realize a gain if XYZ trades above:

51.25 ****A long straddle is profitable if the stock price moves sharply in either direction. In this example, the investor paid a premium of 6.25 to establish the straddle. To realize a gain, the stock must either fall below the strike price minus the combined premium (45 − 6.25 = 38.75) or rise above the strike price plus the combined premium (45 + 6.25 = 51.25).****

Which of the following quotes represents a municipal dollar bond quote?

85½ ****Dollar bond quotes are based on a percentage of face amount (Par $1,000). Therefore, a quote of 85½ is 85½% of $1,000, or $855.****

All of the following have been recognized by the SEC under the Credit Rating Agency Reform Act as being registered with the commission to rate debt instruments. Which of the following historically has specialized in ratings for the insurance sector?

A.M. Best ****A.M. Best historically has specialized exclusively on the insurance marketplace. They issue financial strength ratings measuring insurance companies' ability to pay claims and rate financial instruments issued by insurance companies, such as bonds and notes. They can issue debt and financial strength ratings for other sectors as well, under the Credit Rating Agency Reform Act.****

Which of the following would be the least considered factor in determining if a particular type of options trading is suitable for a customer?

Ability to meet margin calls ****Remember that while most firms require that options trades be done in margin accounts, options purchases are not marginable. Therefore, of the choices listed, the ability to meet margin calls would be the least considered factor regarding suitability.**** LET THE RECORD SHOW THIS IS NOT CORRECT IRL. PEOPLE TRADE OPTIONS IN MARGIN ACCOUNTS IN THE TRILLIONS, KAPLAN IS A FAILURE COMPANY WITH LOSER EMPLOYEES

A new client, age 25, earning $41,000 annually has saved $20,000 to allocate for the first time to an investment portfolio. The client conveys that while he would like to see some growth, an investment with moderate risk and some downside protection are important objectives for his first time investing. Aligning with the client's investment experience and objectives, which of the following would be the most suitable?

Balanced fund ****A balanced fund, which consists of both equities and debt instruments, not only aligns with the growth objective but also offers some downside protection against falls in market due to the debt portion of its portfolio. Equity index funds move with the markets and offer no downside protection. A money market fund would not align with growth and a municipal bond fund would have no benefit for an investor in a lower income bracket.****

Which of the following statements regarding Treasury receipts are TRUE?

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

Which of the following orders is reduced on the order book on the ex-dividend date for a cash dividend?

Limit order to buy ****Only orders placed below the market price are reduced for cash dividends on the order book. Buy limits and sell stops are entered below the market price.****

Which of the following orders are NOT placed on the order display book?

Market Not held ****Market orders are executed immediately and are not placed on the order book. Not held orders are not presented to the order book.****

Unrealized gain in a mutual fund portfolio does which of the following?

Represents the undistributed income and the growth in market value of securities held in the portfolio. Is realized by shareholders only when they redeem their shares. ****Unrealized gains result from asset appreciation and undistributed income. This increase in value is reflected in an appreciation of the mutual fund shares. Investors realize this appreciation only by selling their shares.****

Given the current business climate, an investor believes that a number of industries will be going through a consolidation over the next 2 to 3 years. Willing to invest $30,000 in the opportunity to profit if the consolidation occurs, which of the following would be the most suitable recommendation?

Special situation fund ****A special situation fund can be specific to mergers and acquisitions within a particular industry or among many and would be a suitable choice given the investor's opinion that consolidation may occur. Sector funds focus on only one industry or area and corporate bond funds would have no advantages in cases of industry consolidation. Purchasing standard option contracts on select companies only would be extremely speculative and their nine month life cycle would require that the positions be reinstated over a 2- to 3-year period adding to commission costs.****

Which of the following statements are TRUE of mutual fund dividend distributions?

The fund pays dividends from net investment income. An investor is liable for taxes on distributions, whether taken in cash or reinvested in the fund. ****Mutual funds pay dividends from net investment income, and shareholders are liable for taxes on all distributions, whether reinvested or taken in cash.****

A client is trying to decide between a par value corporate bond carrying a coupon rate of 6.25% per year and a par value municipal bond that pays an annual coupon rate of 4.75%. Assuming all other factors are equal and your client is in a 28% marginal income tax bracket, which bond do you tell the client to purchase and why?

The municipal bond because its equivalent taxable yield is 6.6% ****This is calculated using the tax-equivalent yield formula; Municipal yield / (100% − investors tax bracket) 4.75 / (1 − .28) = 6.6%. By comparison, the 6.6% tax-equivalent yield of the municipal bond is higher than the 6.25% yield of the taxable corporate bond making the municipal bond the higher yielding investment given the investors 28% tax bracket.****

Which of the following strategies would be considered most risky in a bull market?

Writing naked calls ****Writing naked calls provides unlimited liability and the most risk. Buying a call would be an attractive strategy in a bull market with risk limited to calls paid. Writing naked puts risks only the difference between the strike price and zero, less any premium received. Buying a put is a bearish strategy with risk limited to the amount paid for the put.****