Unit 1 and Unit 2

Your broker-dealer acts as a prime broker for ABC Fund. In this arrangement, your broker-dealer is likely providing which of the following services? I. Execution of all transactions for the fund portfolio II. Clearing services III. Lending for trades done on margin IV. Ensuring that all exchange trading rules are complied with A) II and III B) II and IV C) I and IV D) I and III

A) II and III The prime broker would supply clearing services and lending services for a marginable transaction, as well as back-office support such as cash management, account statements, and transaction processing. Actual executions and abiding by all exchange rules when transactions occur is the responsibility of the executing broker-dealers.

One of your customers, age 52, wishes to open an IRA. His annual income is more than $200,000 and consists entirely of income from rental real estate and income from a trust fund. What amount may your customer contribute to his IRA this year? A)$0 B)$6.000 C)$7,000 D)$5,500

A)$0 To open an IRA, a person needs earned income. Income from rental real estate is passive income, while income from a trust fund is portfolio income. This customer has no earned income.

Which of the following can be rolled over into an IRA? I. Another IRA II. Balances from savings accounts III. A corporate profit-sharing plan IV. Judgments from lawsuit settlements A)I and III B)I and IV C)III and IV D)II and III

A)I and III Assets from any qualified corporate plan or from another IRA may be rolled over into an IRA.

A customer who has just started an IRA will be vested A)at age 70. B)immediately. C)in two years. D)in five years.

B)immediately. Investors are always vested immediately in their IRAs.

An employee of another broker-dealer would like to open an account with your firm. Under FINRA rules, all of the following statements regarding the employee and the account are true except A)the employer must be notified, in writing, of the opening of the account. B)the employer must grant prior written approval to open the account. C)the employer must approve each transaction before entry of the order. D)if the employer requests them, they must receive duplicate copies of all account transactions.

C)the employer must approve each transaction before entry of the order. FINRA rules do not require prior approval of individual transactions by either the broker-dealer at which the account has been opened or the employing broker-dealer. The rules do require that the employing broker-dealer be notified, in writing, and that they give prior written consent before the account can be opened. Duplicate copies of account statements and confirmations must be supplied only if the employing broker-dealer has requested them.

Your customer opens a Coverdell ESA for his niece. To meet qualified education expenses of $9,000, she takes a distribution of $10,000. The amount of the distribution in excess of her education expenses that represents earnings in the account will be A)taxable to the uncle, the donor to the plan. B)automatically reinvested back into the plan. C)nontaxable to either party. D)taxable to the niece, the beneficiary of the plan.

D)taxable to the niece, the beneficiary of the plan. Any excess distribution representing earnings that is not used to meet qualified education expenses is taxable to the beneficiary who took the distribution.

All of the following are true regarding nonqualified deferred compensation plans except A)employees may use accumulated funds as collateral for a bank loan. B)income taxes on compensation are not due until constructive receipt. C)the plans need not be offered to all employees. D)IRS approval is not needed for deferred compensation plans.

A)employees may use accumulated funds as collateral for a bank loan. Deferred compensation is a promise made by an employer to defer a certain amount of an employee's salary upon retirement. The employee has no right to the money until retirement, death, or disability, and thus cannot use it as collateral.

Under ERISA, all of the following retirement plans must set standards for vesting, eligibility, and funding except A)Keogh plans. B)profit-sharing plans. C)deferred compensation plans. D)corporate pension plans.

C)deferred compensation plans. Deferred compensation plans are not qualified plans and may be discriminatory. Keogh, profit-sharing, and corporate pension plans must meet set standards for vesting, eligibility, and funding under ERISA.

One important respect in which the Roth 401(k) differs from the Roth IRA is that A)RMDs from the Roth 401(k) must begin at age 72 while there are no RMDs from the Roth IRA. B)withdrawals from a Roth 401(k) are subject to tax on the earnings whereas all qualified withdrawals from a Roth IRA are tax-free. C)it is only the Roth IRA that provides for catch-up contributions for those age 50 and older. D)contributions to the Roth 401(k) are made with pre-tax funds while those to the Roth IRA are from post-tax funds.

A)RMDs from the Roth 401(k) must begin at age 72 while there are no RMDs from the Roth IRA. It is only the Roth IRA where the participant never has RMDs. In both cases, contributions are with after-tax money and withdrawals are tax-free. Both have the catch-up provision, and it is $6,000 in the Roth 401(k) and $1,000 in the Roth IRA.

One concern that FINRA has with fee-based accounts is that they might lead to A)reverse churning. B)churning. C)over-trading. D)higher commissions.

A)reverse churning. Churning is the practice of over-trading an account, resulting in higher commissions. Reverse churning occurs when a client in a fee-based account pays more in fees than would be paid in a commission-based account. This is generally the case when the customer trades infrequently.

All of the following securities would be suitable investments for a traditional IRA except A)AAA rated municipal bonds. B)AAA rated U.S. government agency bonds. C)blue-chip common stocks. D)A rated corporate bonds.

A)AAA rated municipal bonds. Municipal bonds, which generate tax-free interest income, are unsuitable for retirement plans. One loses the federally tax-free income at distribution.

All of the following are true regarding nonqualified deferred compensation plans except A)employees may use accumulated funds as collateral for a bank loan. B)IRS approval is not needed for deferred compensation plans. C)income taxes on compensation are not due until constructive receipt. D)the plans need not be offered to all employees.

A)employees may use accumulated funds as collateral for a bank loan Deferred compensation is a promise made by an employer to defer a certain amount of an employee's salary upon retirement. The employee has no right to the money until retirement, death, or disability, and thus cannot use it as collateral.

Reasonable-basis suitability, as used in FINRA Rule 2111 means the member or associated person making the recommendation should have a reasonable basis to believe that the recommendation A)is suitable for at least some investors. B)will result in a lower cost to the investor than comparable issues. C)has a reasonable basis for believing that the security will outperform others in its industry. D)has a reasonable basis for meeting the specific customer's needs.

A)is suitable for at least some investors. The reasonable-basis obligation requires a member or associated person to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors.

Complying with the suitability rules involves evaluating all of the following except A)qualitative suitability. B)customer-specific suitability. C)quantitative suitability. D)reasonable-basis suitability.

A)qualitative suitability. Under FINRA Rule 2111, there are three main obligations: reasonable-basis suitability, customer-specific suitability, and quantitative suitability. There is no such thing as qualitative suitability.

A 40-year-old individual who is covered by an employer-sponsored retirement plan wants to save more for retirement. Which of the following is the most suitable recommendation? A)A hedge fund utilizing high-risk, high-potential yield strategies B)A Roth IRA, as long as the individual's income level does not exceed the maximum allowed to make a contribution (phase-out schedule) C)A traditional IRA, as there will be no limit to the amount of the contribution that can be deducted D)An investment account utilizing only tax-free municipal bond mutual funds

B)A Roth IRA, as long as the individual's income level does not exceed the maximum allowed to make a contribution (phase-out schedule) Given the limited information, the Roth IRA is the most suitable as long as the investor's income level, due to the phaseout schedule, does not limit what can be contributed to the IRA. Dollars invested will grow, and distributions will be tax free as long as the dollars have been in the account for five years once the IRA owner has reached age 59½. Because the individual is covered by an employer-sponsored plan, we know that the contribution to a traditional IRA may not be fully tax deductible, if at all, and the earnings would be taxable when distributed. Growth in an investment account would be taxable, and the utilization of tax-free municipal bonds with low yields are unlikely to accommodate saving for retirement. Hedge funds utilizing high-risk investment strategies are inappropriate for retirement saving.

If a business owner's goal is to establish an entity that features ease in raising capital and limits personal liability, which of these entities is the most appropriate? A)An S form of corporation B)A limited liability company (LLC) C)A sole proprietorship D)A general partnership

B)A limited liability company (LLC) If a business owner's goal is ease in raising capital, the limited liability company (LLC) is preferable because it has no restrictions on the number or nationality of investors. While the regular or C corporate form is also preferable, the S form of corporation is limited to a maximum of 100 potential shareholders, none of whom may be a nonresident alien. The sole proprietorship and general partnership carry unlimited personal liability.

When discussing a client's finances, which of the following would be of least importance when planning to make a lump-sum investment? A)Expected inheritance B)Current salary C)Year-end bonus D)Winning the lottery

B)Current salary Salary enables the registered representative to determine the funds available for periodic investment. A lump-sum investment could be made with money from an inheritance, a year-end bonus, or lottery winnings.

Which of the following statements regarding Coverdell Education Savings Accounts (ESAs) are true? I. After-tax contributions of up to an indexed maximum per student per year are allowed. II. Contributions may not be made for students past their 18th birthday. III. If the account value is not used for educational purposes, it can be rolled over into a traditional IRA. IV. Distributions are always taxable. A)I and III B)I and II C)II and IV D)III and IV

B)I and II Coverdell ESAs allow after-tax contributions of up to $2,000 per student, per year, for children until their 18th birthday. If the accumulated value in the account is not used by age 30, the funds must be distributed and are subject to income tax and a 10% penalty, or they are rolled over into a different Coverdell ESA for another family member.

Which of the following occurs in a partnership account if one partner dies? A)The surviving partners are considered joint tenants. B)The account is frozen until a new or amended partnership agreement is received. C)The surviving partners are considered joint tenants and receive the deceased partner's share. D)The surviving partners receive the deceased partner's share.

B)The account is frozen until a new or amended partnership agreement is received. Upon a partner's death, a partnership account is automatically frozen until a new or amended partnership agreement is received. The deceased partner's share usually goes to an estate, not to the other partners.

A nonqualified deferred compensation plan is often used by corporations to A)comply with ERISA. B)retain high salaried key employees. C)reduce their current income tax burden. D)replace an outdated qualified plan.

B)retain high salaried key employees. Key employees in higher tax brackets do not get the full benefit of bonuses or pay increases because so much goes to pay the taxes. The attractiveness of the deferred compensation program is that those funds are deferred until a later time, such as retirement, when it is expected that the individual will be in a lower tax bracket. Nonqualified plans are not covered by ERISA. This enables the company to "pick and choose." The deferred compensation plan doesn't affect current corporate taxation because nothing is expended; the deduction does not come until the compensation is paid in the future. Deferred compensation plans are most often used to supplement, not replace, qualified plans.

You have a client who owns a small business. The business provides an ERISA-qualified plan for employees. Your client manages the investments and asks you about permitted strategies. ERISA rules would permit which of the following investments? A)U.S. Treasury bonds purchased from a plan participant B)Uncovered call options C)Covered call options D)Stamp collections

C)Covered call options Uncovered call options carry a potentially unlimited risk of loss. As such, ERISA has declared them unsuitable for investments in a qualified plan. However, covered calls, as well as protective puts, are allowable investments. Selling a security to or buying a security from a plan participant is a prohibited transaction. Most collectibles are not permitted in ERISA plans.

Which of the following circumstances must be met for a fiduciary to trade options in a trust account? I. Special circumstances are determined by the broker-dealer. II. The trust agreement states the trustee has the power to trade options. III. The trust's investment objectives are determined to be compatible with options trading. IV. Only covered options may be traded by a fiduciary. A)I and III B)II and IV C)II and III D)I and IV

C)II and III A fiduciary account may only trade options if expressly authorized to do so and if suitable for the beneficial owner of the account.

Buying municipal bonds would normally not be considered suitable for A)an individual investor. B)a mutual fund portfolio. C)a defined benefit plan portfolio. D)a corporation's investment account.

C)a defined benefit plan portfolio. A defined benefit plan is a form of qualified tax-deferred corporate pension plan. Tax-free municipal bonds would never be considered suitable for a tax-deferred account on the exam. An individual investor, a mutual fund portfolio, and a corporate investment account could benefit from receiving tax-free municipal bond interest.

All of the following qualified plans are covered by ERISA guidelines except A)profit-sharing plans. B)401(k) plans. C)public sector plans. D)private sector plans.

C)public sector plans. Public sector plans are not covered by ERISA guidelines. Corporate and certain union retirement plans are subject to ERISA guidelines.

If two customers are tenants in common in a joint account, which of the following statements are true? I. If one of the tenants dies, the survivor will automatically assume full II. ownership. III. They need not make equal investments in the account. IV. They need not have equal interests in the property in the account. V. If one of the tenants dies, the account need not be frozen. A)I and IV B)II and IV C)I and III D)II and III

D)II and III Under tenants in common, the tenants may make unequal investments in the account and may own a disproportionate interest in the property in the account. If one of the tenants dies, their assets are passed to their estate, not to the surviving joint tenant. The account must be frozen until this is carried out.

An employer-sponsored retirement plan that pays a specific benefit to participants at their normal retirement age is A)a defined contribution plan. B)a Section 401(k) plan. C)a supplemental employee retirement plan. D)a defined benefit plan.

D)a defined benefit plan. A traditional defined benefit plan promises to pay a specific benefit to a participant at his normal retirement age, as specified by the plan document.

A corporate profit-sharing plan must be set up under A)An administrator. B)a beneficial ownership. C)a conservatorship. D)a trust.

D)a trust. All corporate pension and profit-sharing plans must be set up under trust agreements. A plan's trustee assumes fiduciary responsibility for the plan.

Opening a margin account involves a number of different documents. The document describing how the interest on the margin debt is calculated is generally known as A)the risk disclosure document. B)the loan consent agreement. C)the hypothecation agreement. D)the credit agreement.

D)the credit agreement. It is the credit agreement, sometimes referred to as the margin agreement, that describes the creditor-debtor relationship. This includes the method of computing interest on the debit balance (the amount owed). The hypothecation agreement allows the broker-dealer to maintain possession of the margined securities as collateral for the loan, and the loan consent agreement allows the broker-dealer to lend out the client's margined securities. The risk disclosure document is provided to make sure the client understands the risks of margin trading.

A teacher has a 403(b) plan, and the school system he works for has deposited $10,000 into his plan over a 12-year period. At retirement, if the teacher withdraws the total value of $16,000, on what amount does he pay tax? A)$10,000 B)$16,000 C)$6,000 D)$8,000

B)$16,000 A 403(b) plan is a qualified retirement plan; contributions to the plan are made before taxes, and the growth of the contract is tax deferred. Any distribution from a 403(b) plan is fully taxable to the participant at the ordinary income tax rate.

Greater Growth Capital (GGC), a FINRA member firm, has just been acquired by Better Retirement Outcomes (BRO), a much larger FINRA member. If GGC would like to effect a bulk transfer of its customer accounts using a negative consent procedure, FINRA rules A)prohibit GGC from charging a fee to any existing GGC customers who elect to transfer their accounts to BRO, but permit a nominal charge if the customer wishes to transfer to another member firm. B)prohibit GGC from charging a fee to any existing GGC customers who decide to transfer their accounts to a different firm. C)require GGC to obtain affirmative written consent before transferring a customer's account to BRO. D)require that GGC send a notice to each affected customer at least 60 calendar days before it effects the bulk transfer

B)prohibit GGC from charging a fee to any existing GGC customers who decide to transfer their accounts to a different firm. In the case of a bulk transfer, such as when a member firm is acquired by another member, some customers may wish to opt out of the transfer. In those cases, it is prohibited for them to be charged any fees for transferring their accounts to another member firm. This is true only if the customer opts out during the allowable time period, which is 30 calendar days, not 60. The FINRA rule permits negative consent as long as the requirements are met.

Payments received by the owner of a 403(b) plan are A)not taxable. B)taxable only to extent of earnings. C)taxable only to extent of the owner's cost basis. D)100% taxable.

D)100% taxable. When tax-sheltered annuity funds are withdrawn, they are fully taxed at ordinary income rates. Funds were contributed pretax and earnings accumulate tax deferred. Because no taxes were ever paid, the full withdrawal is taxable.

A 40-year-old individual who is covered by an employer-sponsored retirement plan wants to save more for retirement. Which of the following is the most suitable recommendation? A)An investment account utilizing only tax-free municipal bond mutual funds B)A traditional IRA, as there will be no limit to the amount of the contribution that can be deducted C)A hedge fund utilizing high-risk, high-potential yield strategies D)A Roth IRA, as long as the individual's income level does not exceed the maximum allowed to make a contribution (phase-out schedule)

D)A Roth IRA, as long as the individual's income level does not exceed the maximum allowed to make a contribution (phase-out schedule) Given the limited information, the Roth IRA is the most suitable as long as the investor's income level, due to the phaseout schedule, does not limit what can be contributed to the IRA. Dollars invested will grow, and distributions will be tax free as long as the dollars have been in the account for five years once the IRA owner has reached age 59½. Because the individual is covered by an employer-sponsored plan, we know that the contribution to a traditional IRA may not be fully tax deductible, if at all, and the earnings would be taxable when distributed. Growth in an investment account would be taxable, and the utilization of tax-free municipal bonds with low yields are unlikely to accommodate saving for retirement. Hedge funds utilizing high-risk investment strategies are inappropriate for retirement saving.

Designating a beneficiary with a transfer on death (TOD) provision may be done in which of the following accounts? A)Individual account only B)Individual account, joint tenants with right of survivorship (JTWROS), and joint tenants in common (TIC) C)Individual account and joint tenants in common (TIC) D)Individual account and joint tenants with right of survivorship (JTWROS)

D)Individual account and joint tenants with right of survivorship (JTWROS) The TOD designation is limited to the individual account and the JTWROS account.

If earnings decline significantly, which of the following employer-sponsored qualified retirement plans can reduce or even eliminate its contribution for the year? A)Defined benefit plan B)Defined contribution plan C)401(k) plan D)Profit-sharing plan

D)Profit-sharing plan A special feature of the profit-sharing plan is that employer contributions may be reduced or skipped when earnings fall. In each of the others, contributions must be made at the stated or, in the case of the defined benefit plan, the actuarially computed amount.

What type of account allows for the irrevocable transfer of almost any kind of asset, including works of art and real estate, for the benefit of a minor? A)Tenants in common B)Coverdell ESA C)UGMA D)UTMA

D)UTMA UTMA expanded the types of property that are transferable into a custodial account. One of the main differences between an UTMA and UGMA is the types of assets they can hold. Assets within an UGMA are limited to cash (bank deposits), stocks, bonds, mutual funds, and other securities and insurance policies. UTMAs allow almost any kind of asset, including works of art and real estate. As with other assets, the title is registered in the name of a custodian for the benefit of the minor. Although there are a few states that allow the custodial property to remain in an UTMA account until the minor reaches age 25, more than half of the states set the age of majority for UTMA at 21 instead of 18.

Under ERISA, all of the following retirement plans must set standards for vesting, eligibility, and funding except A)corporate pension plans. B)profit-sharing plans. C)401(k) plans. D)deferred compensation plans.

D)deferred compensation plans. Deferred compensation plans are not qualified plans and may be discriminatory. 401(k), profit-sharing, and corporate pension plans must meet set standards for vesting, eligibility, and funding under ERISA.

Regulation BI calls for broker-dealers and their associated persons to meet a care obligation when making a recommendation to a retail customer. In describing the nature of the care, the rule requires that those making recommendations adhere to all of these except A)reasonable prudence. B)reasonable diligence. C)reasonable care. D)reasonable skill.

A)reasonable prudence. In the original rule proposal, the SEC had four care requirements, including prudence. After careful consideration of comments received, it "concluded that its inclusion creates legal uncertainty and confusion, and it is redundant of what we intended in requiring a broker-dealer to exercise diligence, care, and skill, and its removal does not change the requirements under the Care Obligation. Accordingly, the Care Obligation requires broker-dealers to ''exercise reasonable diligence, care, and skill'' to meet the three components of the Care Obligation." **This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback.

When a customer, who is at least 59½, withdraws money from a traditional IRA that has been funded totally with deductible contributions, A)the entire amount withdrawn is subject to taxation at ordinary income tax rates. B)the basis is taxed as ordinary income, and the gains are taxed at the capital gains rate. C)the entire amount withdrawn is subject to taxation at ordinary income tax rates with an additional 10% penalty. D)the withdrawal causes the entire IRA balance to be subject to taxation at ordinary income tax rates.

A)the entire amount withdrawn is subject to taxation at ordinary income tax rates. All withdrawals from a traditional IRA that has been funded with pretax contributions are subject to taxation at ordinary income tax rates. There is no 10% penalty once the account holder has reached age 59½.

Tenants in common (TIC) ownership provides that a deceased tenant's fractional interest in an account is retained by which of the following? A)Will be decided during probate B)The deceased tenant's estate C)The surviving tenant D)The registered representative for the account

B)The deceased tenant's estate TIC ownership of an account provides that a deceased tenant's interest in an account is retained by that tenant's estate and not passed on to the surviving tenant.

Which of the following types of retirement plans would be most beneficial to a young employee of a corporation? A)Defined benefit pension plan B)Profit-sharing plan C)Defined contribution pension plan D)Keogh plan

C)Defined contribution pension plan The most beneficial corporate pension plan for a younger employee would be the defined contribution plan. The employee has many years in the workforce, so the investments made with the defined contributions will have a maximum amount of time to grow.

Regulations regarding how contributions are made to tax-qualified plans relate to which of the following ERISA requirements? A)Nondiscrimination B)Reporting and disclosure C)Vesting D)Funding policy

D)Funding policy The funding policy covers how an employer contributes to, or funds, a retirement plan.