Unit 2 Series 7

Who attests to the legality of a bond issue and issues a legal opinion on a proposed new municipal bond issue?

Bond Counsel The issuer hires a firm or an individual to act on its behalf as bond counsel. LO 6.a

Hedge funds are 1. highly regulated. 2. use investment techniques suitable for most investors. 3. are unregulated. 4. use investment techniques most suitable for sophisticated investors.

3 and 4 Hedge funds are unregulated and have aggressively managed portfolios that employ investment techniques such as shorting positions, utilizing derivative products, and trading on margin—all generally considered suitable for sophisticated investors. LO 12.b LO 1.c

A mutual fund that charges 12b-1 fees may use the money to cover all of the following except A)printing costs. B)management fees. C)sales fees. D)promotion costs.

B 12b-1 fees may not be used to pay for the portfolio manager's fees, only for sales promotions and fees and other activities relating to the distribution of the fund's shares. LO 8.d

All of the following will affect the working capital of a corporation except A)a decrease in liabilities. B)payment of a cash dividend. C)declaration of a cash dividend. D)an increase in assets.

B Working capital is defined as current assets minus current liabilities. Payment of a cash dividend will reduce current assets (cash) and current liabilities (dividend payable) by the same amount, leaving working capital unchanged. LO 13.d

Which of the following are fair and equitable methods for the assignment of options contracts by a brokerage firm to a customer?

First-in, first-out or random selection Options Clearing Corporation (OCC) rules allow broker-dealers to assign customers using first-in, first-out or random selection methods. In addition, the OCC also states that any other fair method is allowed. LO 10.b

In April, a customer sold short 100 shares of QRS stock at $50 and simultaneously wrote 1 QRS Jan 50 put for a premium of $7. If the January put is exercised when the market value of QRS is 43 and the stock acquired is used to cover the short stock position, what is the customer's profit or loss per share?

a $7 gain Because the stock is purchased on exercise of the short put for $50 and is used to cover the $50 short sale, the investor incurs no gain or loss on the stock. The customer keeps the $700 collected in premiums for a profit of $7 per share. LO 10.h

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 one year. LO 6.f

he capitalization structure of an open-end investment company can include

one issue of common stock. Open-end investment companies may only issue shares of common stock. Preferred stock, bonds, and other forms of senior securities are not allowed. It is the closed-end investment company that can have a preferred stock and bond offering. Don't confuse what a mutual fund uses to raise money (the common stock it issues) with what it does with that money. The capital raised from the sale of shares may be used to buy whatever securities meet the fund's objectives. LO 8.b

All of the following are suitability considerations when a registered representative recommends a municipal bond purchase to a customer except

whether or not the bond is in the broker-dealer's inventory to sell. The customer's state of residence and tax bracket are important because these factors help establish the tax benefits offered by the municipal bond. The issuer's debt rating is important in evaluating the credit risk assumed by the investor. The bond's availability in the dealer's inventory is not a suitability factor. LO 6.c

Holders of common shares may generally vote on

whether the company should issue additional preferred stock. Common shareholders must vote to approve the issuance of additional preferred stock because additional preferred shares dilute the common shares' residual assets under a liquidation. Common shareholders do not vote to declare dividends. Board members select the chairman of the board. Shareholders do not get involved in the daily operational activity of the corporation. LO 3.c

Which of the following statements regarding stock index options are true? Trades are settled the next business day. Trades are settled on the third business day. Exercise settlement involves the delivery of stock. Exercise settlement involves the delivery of cash.

1 and 4 Index option trades settle the next business day, and cash is delivered upon exercise of the option. Exercised index options also settle next business day. LO 10.g

Some limited partnership programs provide potential tax credits to partners. Which of the following typically provide potential tax credits?

1. rehabilitation of historic properties and 2. gov assisted housing programs Historic rehabilitation and government-assisted housing are two programs that offer potential tax credits. Tax credits are no longer available for equipment leasing, and while developmental oil and gas programs offer high intangible drilling costs, these are not investment tax credits. LO 11.e

Records relating to terminated representatives must be retained for how many years?

3

Under SEC Rule 10b-13, a company that is the target of a tender offer must provide its shareholders with a statement indicating acceptance or rejection of the offer within

10 business days of the announcement Once a tender offer is announced, the target company, within 10 business days of the announcement, must provide its shareholders with a statement indicating acceptance or rejection of the offer and the reasons for the position taken. LO 14.b

Debenture

A debenture is unsecured corporate debt.

A gain on the sale of a long equity put option is

Always a short-term capital gain

Example of a derivative security

Options are known as derivative securities because they derive their value from that of the underlying security. LO 10.a

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

$10 Loss If a municipal bond is purchased at a premium, the premium must be amortized over the time until maturity. An $80 premium on a 16-year municipal bond indicates that $5 will be amortized each year ($80 / 16 = $5). Ten years at $5 per year is $50 of amortization. Therefore, after 10 years, the tax basis would be $1,080 minus $50, or $1,030 (103). Because the sale was for 102 ($1,020), the customer has a $10 loss on one bond. LO 6.e

A customer purchases 10 8% Treasury notes at 101-16. What is the dollar amount of this purchase?

$10,150 Though the denomination of the T-notes purchased is not given, always assume par ($1,000) unless told differently in the question. Remember that government notes and bonds are quoted in 32nds. Therefore, a quote of 101-16 means 101 plus 16/32. 101 + 1/2 = $1,015; $1,015 × 10 bonds = $10,150. LO 7.b

A 38-year-old investor places $25,000 into a single premium deferred variable annuity. Twenty-two years later, with the account valued at $72,000, the investor surrenders the policy. If the investor is in the 25% marginal income tax bracket, the total tax liability is

$11,750 Only the deferred growth is taxable. In this case, it is the difference between the surrender value of $72,000 and the cost basis of $25,000. That $47,000 is taxed at the marginal rate of 25%. Because the investor is older than 59½ (38 + 22 = 60), there is no additional 10% penalty tax. Effectively, this is a 25% tax on $47,000. LO 9.d

An investor purchased 100 shares of ABC common stock at $60 per share on March 2, 2019. At the same time, an ABC Oct 55 put was purchased at $2. On June 2, 2020, the investor sold the stock for $85 per share. As a result, the tax consequences are

$2,300 Long-Term capital gain The purchase of the put on stock at the same time as the purchase of the stock makes this a married put. This means that the purchase of the put does not affect the holding period of the stock. When the stock was sold in June 2020, the holding period was 15 months, well over the long-term requirement. As far as the math, the cost is $62 per share ($60 cost of the stock plus $2 for the put). The sale price was $85, the gain is $23 per share, $2,300. LO 10.i

A municipal bond is purchased at a discount in the secondary market at 90. The face amount is $10,000, and the bond has 10 years to maturity. If the bond is sold for 97 after five years, what is the taxable gain?

$200 When a municipal bond is bought at a discount in the secondary market, the discount is accreted and taxable as ordinary income. Accretion increases cost basis. Therefore, five years later, the bond's cost basis is 95. At that point, the customer has a two-point capital gain. Had the bond been bought as an original issue discount, the annual accretion is considered interest income and is not taxable. LO 6.e

An investor redeems 300 shares in ACE Fund. When the investor bought the shares at $12, the net asset value (NAV) was $11.08. If the current public offering price is $12.50, and the NAV is $11.80, the investor receives

$3,540 Shares are redeemed at NAV. If the investor redeems 300 shares at an NAV of $11.80, he receives $3,540 (300 × $11.80). LO 8.c

An active options trader establishes the following position: Long 10 ALF Apr 40 calls at 6 Short 10 ALF Apr 50 calls at 2 What is the breakeven point?

$44 The breakeven on a call spread is determined by adding the difference in premiums (6 − 2 = 4) to the lower strike price. In this case, the net debit is four points. Therefore, 4 plus 40 equals 44.

A married couple owns Class A shares of the KAPCO Balanced Fund as follows: The older of the pair has an individual account with a current value of $10,000. The other individual's account is valued at $20,000, and they have a JTWROS account valued at $12,000. KAPCO offers rights of accumulation and has breakpoints at $25,000 (4%), $50,000 (3%), and $100,000 (2%). How much will the sales charge be if they invest an additional $15,000 into the JTWROS account?

$450 All the accounts are combined under rights of accumulation. With a total of $42,000 currently, the additional $15,000 brings their investment past the $50,000 breakpoint. That means that the entire investment is charged the 3% rate. LO 8.d

If an investor purchases 2 Dec 81.50 Swiss franc calls at 2.5 (each contract is 10,000 francs), how much does the investor pay for the position?

$500 One call offered at 2.5 is equal to $250 multiplied by two contracts, for a total premium of $500. LO 10.g

one of your customers invests $20,000 in an oil and gas limited partnership program. The Schedule K-1 she receives at year-end from the partnership indicates that operating revenues and operating expenses were exactly the same. In addition, her share of the year's depletion allowance is $6,000. During the year, she received a cash distribution of $8,000. What is her basis as of year-end?

$6,000 She began with a basis of $20,000 (her original investment). During the year, she received a distribution of $8,000. That lowered her basis (the amount of money "at risk") to $12,000. In addition, the depletion represents a nonoperating expense that can be taken as a loss. That brings the basis down to $6,000. LO 11.f

Which combination of the following statements regarding the investment strategy known as dollar cost averaging is true? 1. Invests the same dollar amount each period over a length of time 2. Purchases the same number of shares each period over a length of time 3. Lowers average cost per share over a length of time (assuming share price fluctuations) 4. Invests the same dollar amount each period to protect the investment from loss of capital

1 and 3 Dollar cost averaging is when an equal dollar amount is invested periodically. This does not prevent capital losses but can lower the average cost per share because of periods of decline in the stock price. During those times, the fixed dollar amount will allow for the purchase of more shares at the lower price. LO 8.e

Regarding the taxation of dividends received from corporate securities, which of the following are true? 1. Nonqualified dividends are taxed at the rate the investor's ordinary income will be taxed. 2. Nonqualified dividends are not taxed. 3. Qualified dividends are taxed at a maximum rate specified by the IRS and will depend on the investor's income tax bracket. 4. Qualified dividends are taxed at the rate the investor's ordinary income will be taxed.

1 and 3 For income tax purposes, corporate dividends are divided into two categories: qualified and nonqualified. We don't expect you'll be tested on what makes a dividend qualified or not, but you will need to know the difference in taxation. Qualified dividends are taxed at the same rate as long-term capital gains—a rate significantly lower than the ordinary income tax rate levied against nonqualified dividends. That lower rate ranges from 0% to as high as 20%, with an even higher effective rate for those with an extraordinarily high income. For most investors, the rate is 15%, and that is the number you should use in any computations. With ordinary income tax rates on nonqualified dividends as high (currently) as 37%, there is a real benefit for most investors to receive qualified dividends. LO 3.i

According to Municipal Securities Rulemaking Board rules, if a customer purchases a municipal bond from your firm, the confirmation must disclose

1 whether your firm acted as agent or principal. 2 your firm's address. Customer trade confirmations must make explicit disclosures regarding the terms of the transaction and the parties involved. The broker-dealer must always disclose the capacity in which it acted (i.e., principal or agent.) The confirmation must show the name of the person for whom the trade was executed (i.e., the customer). The name, address, and telephone number of the broker-dealer must be shown so a customer may contact the firm easily. The settlement date is also required, but the broker-dealer is not required to disclose where it acquired the bonds or the price it paid. LO 15.a

Which of the following is not generally associated with an existing real estate direct participation program? A)Appreciation potential B)Immediate income stream C)Known history of income and expenses D)Lower risk than other types of real estate programs

A Appreciation potential is generally not associated with existing real estate programs because most appreciation occurs in the earliest years for real estate assets. LO 11.e

Which of the following records must kept for the life of a broker-dealer organized as a corporation? A)Minutes of the board of directors' meetings B)Customer new account forms C)Complaint records D)The general ledger

A The stock certificate book, articles of incorporation or partnership agreement, and minutes of the directors' meetings are to be kept on file and accessible for the life of the firm. The new account form and the general ledger are six-year records, and the complaint file is the only record with a four-year retention requirement. LO 15.e

A customer is short 10 ABC Dec 50 calls at 2.50 and short 10 ABC Dec 50 puts at 3.50. Before expiration, ABC declines to 40.50, and the customer is assigned on his put position while his short calls expire worthless. A month later, he liquidates his long position at 45 for

A gain of $1,000 The customer opens two short positions on 10 contracts each, so his account is credited with premiums of $2,500 for the calls and $3,500 for the puts. The calls expire worthless, but the short puts are exercised, so the investor must buy the stock at the strike price. This results in a debit of $50,000 ($5,000 per contract × 10 contracts), and the stock is then sold at a credit of $45,000. LO 10.f

An investor sells short 100 shares at 50 and sells a 50 put at 5. If the put is exercised when the stock is trading at 45, the investor realizes

A gain of $500 When the short put is exercised, the investor buys stock at $50 that she can use to cover the $50 short sale. The investor realizes no gain or loss on the stock, but she collected $500 in premiums, for a gain of $500. LO 10.d

Special tax bonds are

A special tax bond is backed by one or more designated taxes (sales, cigarette, fuel, alcohol, etc.) other than ad valorem taxes. The designated tax need not be directly related to the project purpose. These bonds are not considered self-supporting debt. LO 6.b

In a declining market, which of the following is most volatile?

A stock with a beta of 2.0 Beta is a measure of a stock's volatility relative to the overall market, as measured by the S&P 500. A stock with a beta of 2.0 will move twice as fast as the overall market, while a stock with a beta of 0.5 will move half as fast as the overall market. LO 13.b

A customer sells securities and uses the proceeds to buy more securities at the same cost. Under the 5% markup policy, the markup is calculated on

A)the total of both sides. The firm must consider the entire transaction (a proceeds transaction) when calculating the markup. LO 3.j

All of the following documentation is necessary for a publicly subscribed limited partnership except A)a cash flow analysis. B)a partnership agreement. C)a certificate of limited partnership. D)a subscription agreement.

A: Cash Flow Analysis The certificate gives public information about the partnership and is filed in the home state. The partnership agreement spells out the roles of the general and limited partners. The subscription agreement is the instrument by which the limited partners invest. LO 11.c LO 1.a

Your customer is interested in long-term corporate bonds. Which of the following interest rate environments makes a call protection feature most valuable to your customer?

ANSWER: DECLINING INTEREST RATES A call protection feature is an advantage to bondholders in periods of declining interest rates. When interest rates are falling, issuers are more likely to call in bonds previously issued at higher interest rates. For bondholders, calling bonds creates reinvestment risk, as they are unlikely to be able to reinvest at the rate they had been earning. Call protection gives the bond holder a specified length of time during which the bond cannot be called. LO 4.b

Long-term securities issued by municipalities that use a Dutch auction method to reset short-term interest rates known as clearing rates are

ARS Auction Rate Securities ARS are long-term securities issued by municipalities that use a Dutch auction to reset interest rates at short-term intervals. The reset rate is known as the clearing rate and establishes the rate paid during the period following the auction. LO 6.b

You are reviewing a company's financial statements to assist a customer. What kind of information is most likely to be found in the footnotes to those financial statements?

Accounting methods used Footnotes to a company's financial statements will contain important financial information such as accounting methods used, as well as important management philosophy that may impact the company's overall financial health and performance. LO 8.d

To calculate a capital gain or loss on the sale of an original issue discount municipal bond, the discount must be

Accredited The IRS term for adjusting the cost basis of a discount bond upward is accretion. Amortization is the means of adjusting a premium bond's cost basis. LO 6.f

Which of the following customer accounts requires the sending of monthly customer statements?

An account containing penny stocks It is the account containing penny stocks where the customer must receive a monthly statement. In all other cases, the required frequency is not less than quarterly. LO 3.j

A company has reverse split its common stock. The effect on the earnings per share will be

An increase When a reverse split takes place, the number of outstanding shares is reduced. Because the split has no effect on earnings of the company, dividing those earnings by fewer shares will cause an increase to the earnings per share. LO 3.b

U.S. Treasury bills are issued for all of the following maturities except

As of the authoring date of this question, Treasury bills are issued for terms of 4, 8, 13, 26, and 52 weeks. The Treasury auctions the 52-week bill every four weeks and the 4-, 8-, 13-, and 26-week bills every week. LO 7.b

When the issuer of an insured municipal bond defaults, what does the insurance company do?

Both principal and interest are returned over the remaining term of the bond. Both interest and principal are paid as scheduled over time through the life of the bond. The idea is that the bondholder should not see a problem. The insurer will just take up the liability and run with it without missing a beat. LO 6.d

The general partner of an oil and gas drilling program might be considered to have a conflict of interest for all of the following reasons except A)owning mineral rights on undeveloped adjacent land. B)borrowing funds from the partnership. C)managing the partnership. D)commingling the funds of several different programs.

C Managing the partnership is what the general partner's job is, so there would not be a conflict of interest. Owning a potentially competing project could be a conflict of interest. Commingling (combining) investor funds from different programs is not legal and would certainly present a conflict, as would borrowing money from the partnership. LO 11.d

Under SEC and FINRA recordkeeping rules, all of the following records must be retained for three years only except A)the subsidiary ledgers. B)a trial balance. C)the blotter or any record of original entry. D)order tickets.

C The six-year records include blotters, the general ledger, the stock record, customer ledgers, and customer account information. LO 15.e

If an investor sells 1 TCB Jul 40 put and buys 1 TCB Jul 50 put, and subsequently sells the Jul 50 put, what is the consequence?

Capital Gain or Loss The investor opens with a vertical (price) spread. If she closes out one of the legs of the spread, she has a capital gain or loss for tax purposes as of the closing trade date. LO 10.i

DERF Corporation has a significant amount of cash on hand. The chief financial officer (CFO) has suggested to the chief executive officer (CEO) that it might be wise to pay off $10 million of the company's outstanding debt. There are four bond issues outstanding, and your broker-dealer is approached for advice on determining which issue to repay. Which of these four issues would the firm recommend? A)$30 million @12% due in 15 years, non-callable B)$25 million @5% due in 5 years, callable at 104 C)$10 million @6% due in 20 years, callable at par D)$15 million @8% due in 10 years, callable at 101

D Anytime we have extra cash, it can make sense to pay off debt. Corporations feel the same way. When it comes to deciding which debt to repay, the wisest move is to pay down the debt with the highest interest cost. In this case, that would be the 12% bond. However, that bond is non-callable. Based on the inverse relationship between interest rates and bond prices, the 12% bond is going to be selling at a higher price than any of the others. Any savings in interest payments would be more than offset by the price the company would have to pay to buy the bond in the open market. The next highest interest rate is 8% and that bond will cost us a slight premium of $10 per bond to call. Although the 6% bond is callable at par, the company would be far better off removing an 8% debt than one at 6%. In fact, the 1 point call premium is saved after the first semiannual interest payment. A partial call, calling in $10 million of the 8% bond, should be the recommendation. LO 4.b

All of the following events will affect the net asset value (NAV) per share of a mutual fund except A) changes in the market value of the fund's portfolio of securities. B)the fund pays dividends to its shareholders. C)the fund receives cash dividends on the securities in its portfolio. D)wholesale redemption of fund shares.

D Dividends paid and received by the fund directly affect NAV. Changes in the portfolio value affect NAV because the securities are marked to market daily. While share redemption will reduce total NAV, the number of shares outstanding decreases in proportion, so the NAV per share stays the same. LO 8.a

Customers seeking to open an options account may have the account approved by A) the registered investment adviser managing the client's portfolio. B)the registered representative handling the account. C)the branch manager, only as long as they have a Series 10 registration or are a Registered Options Principal (ROP). D)the branch manager initially as long as it is subsequently approved by a principal who has a Series 10 registration or is a Registered Options Principal (ROP).

D In general, an options account will be approved by a Limited Principal with a Series 10 license or a Registered Options Principal (ROP). If the branch office manager is not a Registered Options Principal or a Limited Principal—General Securities Sales Supervisor, account approval or disapproval shall, within ten (10) business days, be submitted to and approved or disapproved by a Registered Options Principal or a Limited Principal—General Securities Sales Supervisor. LO 10.j

A married couple both hoping to retire within the next five to seven years have expressed having a low-risk tolerance regarding the stock market. They have a combined income of $350,000. Given this information, which of the following portfolio mixes would be most suitable? A)Treasury bills, common stock, options B)Treasury bills, corporate bonds, preferred stock C)Direct participation programs, real estate investment trusts, preferred stock D)Treasury notes, municipal bonds, GNMAs

D In light of their low risk tolerance, U.S. government securities would certainly be suitable, and the time frame noted for retirement allows for middle term T-notes to be useful. Given their higher income level, tax-free municipal bonds could also have a place in the portfolio. Longer term GNMAs would accommodate monthly income, should that be desirable upon retirement. The remaining product suggestions are either illiquid (DPPs) or do not align with their risk aversion (common, preferred, options, and REITs). LO 11.h

Real estate investment trusts (REITs) can distribute all of the following to their shareholders except A)stock dividends. B)capital gains. C)cash dividends. D)capital losses.

D REITs can distribute their income to shareholders but not their losses. Under subchapter M of the Internal Revenue Code, they must distribute at least 90% of their income to shareholders in the form of cash dividends. LO 11.b

For purposes of the SEC Rule 15g-9 dealing with penny stocks, the term established customer does not include a person who has A)effected a securities transaction in an account more than one year before the proposed penny stock transaction. B)purchased the securities of three different penny stocks on three different days involving three different issuers. C)deposited funds or securities in an account more than one year before the proposed penny stock transaction. D)both a cash and a margin account with the firm.

D Rule 15(g)9 deals with sales practices relating to penny stocks. If a member is soliciting new customers to buy penny stocks, the member must prepare a suitability statement showing why the proposed penny stock trade is suitable for that customer. A suitability statement is not required if the member is soliciting an established customer. The type of account or the number of accounts is not part of the definition. An established customer is one who has effected a securities transaction, made a deposit of funds or securities in an account at least 1 year before the proposed penny trade, or made 3 purchases of penny stocks on 3 separate days involving 3 different issuers. LO 3.j

An investor wants to allocate 15% of an existing portfolio to mirror the overall market's performance. This investor understands and is comfortable with mutual funds as an investment and market risk. The client notes her dislike for funds that are so actively managed that it adds to high portfolio turnover and high transaction and management fees. Which of the following would be a suitable recommendation, given the client's investment criteria?

Equity Index Fund An equity index fund mirrors a market index and should perform in line with the overall market's performance. Because its portfolio mirrors an index, it is not actively managed, and therefore, has lower expenses than managed funds. Asset allocation funds are actively managed with higher portfolio turnover and expenses, and neither money market funds nor government bond funds would be used to mirror the overall market's performance. LO 8.h

Certain events will affect the net asset value (NAV) per share of a mutual fund. Which of the following events will not affect NAV?

Fund shares being redeemed by the fund upon the request of shareholders Dividends paid and received by the fund directly affect NAV. Changes in the portfolio value affect NAV because the securities are marked to market daily. Although share redemption will reduce total NAV, the number of shares outstanding decreases in proportion, so the NAV per share stays the same. LO 8.c

A Treasury bond is quoted in The Wall Street Journal as follows: Bid 100:15 Asked 100:17 Bid Chg. -1 Yield 7.9 From this information, you know that the nominal yield is

Greater than 7.90% The Bid and Asked prices show that the Treasury bond is being quoted at a premium (above par), with a yield to maturity of 7.9%. When bonds are trading at a premium, the nominal yield (coupon rate) is greater than the yield to maturity. LO 7.b

A customer buys a 6% Treasury bond, maturing in 10 years, at a price of 91.07. The yield to maturity is

Greater than NOMINAL YIELD A bond whose price is below par or at a discount has a higher yield to maturity than current yield, which in turn is higher than the nominal yield. LO 7.b

An investor would sell a put because

He is bullish A put seller (writer) will benefit as long as the market price of the underlying security does not drop substantially. His position is bullish. LO 10.d

For which of the following would the net revenue-to-debt service ratio be applicable?

Hospital Bonds This is the coverage ratio. Because revenue bonds are only backed by funds generated by a specific source, it is important that net revenues exceed debt service requirements. Hospitals are often built with the proceeds of revenue bond issues. LO 6.b

An investor redeems 200 shares of ABC Fund, which has no redemption fee. If the quote is $12.05 bid $13.01 asked, what amount will the investor receive?

If a mutual fund has no redemption fee, the investor will receive the bid price per share (net asset value) multiplied by the number of shares being redeemed. In this case, the investor would receive $2,410 ($12.05 × 200 shares). LO 8.c

If MCS is trading at 43 and the MCS Apr 40 call is trading at 4.50, what is the intrinsic value and the time value of the call premium?

Intrinsic Value 3 Time Value 1.5 The option is in the money by three points (the strike price on the call is 40 and the market price is 43). Because the actual premium is 4.50, the balance of 1.50 represents time value. Remember P - I = T (Premium minus intrinsic value equals the time value). LO 10.c

If a customer is long ABC Sep 30 calls, and the stock becomes subject to a trading halt on the floor of the NYSE, the customer is permitted to

Issue exercise instructions If trading in the underlying security is halted, options trading on that security is also halted. However, the customer may still issue exercise instructions to the Options Clearing Corporation because this is an off-floor transaction. LO 10.i

A corporation must have stockholder approval to

Issues convertible bonds Stockholders are entitled to vote on the issuance of additional securities that would dilute shareholders' equity (the shareholders' proportionate interest). Conversion of the bonds would cause more shares to be outstanding, thus reducing the proportionate interest of current stockholders. Decisions that are made by the board of directors and do not require a stockholder vote include the repurchase of stock for its Treasury, declaration of a stock dividend, and declaration of a cash dividend. LO 3.c

A summary statement of all interest and dividends credited to a customer's account must be sent to the primary accountholder each year in

January Member firms must provide an IRS Form 1099 to the primary account holder of all the interest and dividends credited to the account in January. This form is used in the customer's tax return preparation. LO 15.b

Which of the following risks would least impact collateralized mortgage obligation (CMO) investors?

Liquidity Risk CMO investors are always subject to rate risk, which includes maturity and prepayment risk. Because CMOs trade over the counter, they are fairly liquid, allowing investors to purchase or sell them easily at fair market value. LO 12.d

With regard to position limits, what is the bullish, or buy side of the market?

Long Call and Short Put

An investor opens the following options position: Long 1 ABC Aug 50 call @ 5½; short 1 ABC Aug 55 call @ 3½. What is the investor's maximum gain, maximum loss, and breakeven point?

Maximum gain is $300; maximum loss is $200; breakeven is $52. The first step is to identify the position. This is a debit call spread. It is a debit spread because the option purchased costs more than the one sold. The debit of $200 is the most the investor can lose. This is a bullish spread (the investor bought the low strike price and sold the high strike price). If the investor is correct and the stock rises, the short call will be exercised. That means the writer will have to sell the stock at $55 per share. However, the investor will exercise the 50 call and deliver the stock purchased for $5,000 and receive proceeds of $5,500. The $500 profit is reduced by the $200 it cost to put on the spread. That means a net gain of $300. The fastest way to do a question like this is to subtract the debit from the strike price difference (5 points here) and you have your maximum gain. In this case, it is $5 ‒ $2 = $3. Breakeven follows the call-up rule; add the net premium (the debit of $2) to the lower strike price ($50) to arrive at $52. LO 10.h

If a registered options principal is asked to approve a discretionary order to buy 1 XYZ Oct 60 put and sell 1 XYZ Oct 55 put for a net debit of $5, he should

NOT approve the order Because this is a debit spread, the maximum gain occurs if both sides are exercised. If this occurs, the investor earns $5 (buy stock at 55 when the short put is exercised and sell stock at 60 by exercising the long put). Because the net premium paid for the spread is $5, there can never be any gain. This spread is not economical. LO 10.j

An investor purchased a single premium deferred variable annuity 20 years ago. The premium deposit was $50,000. The account is now worth $200,000 and the investor is still working. When does the investor have to begin taking required minimum distributions?

Never with a non-qualified annuity On the exam, unless stated to the contrary, every annuity is nonqualified. One of the benefits of nonqualified annuities is that there is no age at withdrawals must commence. In general, earnings withdrawn prior to age 59½ are subject to the additional 10% penalty on top of tax at ordinary rates. LO 9.d

The coupon on a bond can be described as its

Nominal Yield The coupon on a bond is also known as the nominal yield, and it indicates the annual interest paid. For example, a 4% bond pays $40 of interest per year. LO 4.e

Where can option orders be executed?

Options orders can be executed on the NYSE, the CBOE, and the Nasdaq PHLX, which offers a hybrid of electronic and on-floor execution availability.

Market interest rates have risen steadily over the past several months. The market price of which two of the following shares would probably reflect the biggest impact of this change?

Preferred Stock and Public Utility Stock Stocks that are interest rate sensitive will reflect the impact of a change to market interest rates more than others. Preferred stock, with its fixed dividend, and utility stocks, with their high degree of debt leverage, are considered interest rate sensitive. The yield of the money market fund will change, but the price is fixed at $1 per share. LO 14.a

Which of the following types of municipal bond issues is associated with a flow of funds?

Revenue Bonds The flow of funds only relates to municipal revenue bonds. It describes the priority of disbursing revenues from the project. TANs are backed by taxes to be collected, while GO bonds are backed by the issuer's taxing authority. School districts are funded by GO bonds. LO 6.b

A mutual fund portfolio consists entirely of stocks of companies with either new products just released in the marketplace or companies holding patents pending. This mutual fund is best described as

Special situation funds buy securities of companies that are considered to be in a position to benefit from special nonrecurring situations. Those could be new management, new products, patents pending, takeover, or turnaround situations.

A couple in a high tax bracket is interested in minimizing their tax liability while diversifying their portfolio. Which of the following best fits their investment objectives?

Tax-exempt unit trust

The Nasdaq Stock Market permits listing for all of the following

The Nasdaq Stock Market is an equity and equity equivalent market. Listed are common stock, preferred stock, warrants, limited partnerships, American depositary receipts, and convertible bonds. Straight debt securities are not part of Nasdaq. LO 3.h

The rate on an adjustable preferred stock may be indexed to

The Treasury Bill Rate The dividend on an adjustable rate preferred stock is tied to a particular interest rate, and the Treasury bill rate is a common benchmark. LO 3.e

Which of the following describe a securities exchange? The highest bid and the lowest offer prevail. Only listed securities can be traded.

The highest bid and the lowest offer prevail. Only listed securities can be traded. An exchange is not a negotiated market but an auction market in which securities listed on that exchange are traded. No minimum price is set for securities. Rather, the highest bid and the lowest offer prevail. LO 3.h

Trading in expiring options series concludes the same day as expiration at

The official close is 4:00 pm ET on the third Friday of the expiration month. Expiring options may be exercised until 5:30 pm ET on the same day. LO 10.a

When XYZ stock trades at 40, and an XYZ Oct 35 call trades at 5, which of the following is true?

The time value is zero. An option's premium consists of time value and intrinsic value. In this situation, the call is in the money by 5 (intrinsic value is 5), because the market value of 40 exceeds the strike price of 35 by 5. If the total premium is 5, and the intrinsic value is 5, the time value must be zero. The option is at parity, which means the premium equals the intrinsic value. Remember P - I = T (Premium minus intrinsic value equals the time value). LO 10.c

If a customer believes the Swiss franc will depreciate against the U.S. dollar, which of the following option strategies may best take advantage of the expected depreciation?

Uncovered Call Writing Call writing is bearish, while credit put spreads, debit call spreads, and uncovered put writing are bullish. LO 10.g

If an investor swaps identical issues of stock to establish a loss that is disallowed, the transaction is known as

Wash Sale The wash sale rule disallows claiming a tax loss on the sale of stock if the investor purchases a substantially identical security within 30 days either before or after the date of such sale. LO 13.h

Under Municipal Securities Rulemaking Board (MSRB) rules, which of the following yields for a callable bond would be shown on a confirmation?

Yield based on nearest in-whole call MSRB rules require that yield to call based on the nearest (near-term) entire issue (in-whole call) be disclosed on a customer's confirmation. With a partial call, the bond being purchased may or may not be included in the call, and with a catastrophe call provision, a call would only occur if an unpredictable event requires the issuer to call the bonds. LO 15.a

An investor wants to invest $20,000 but anticipates needing those funds in five years for a business investment. Currently, with inflation rising, the government is expected to take action to push interest rates up to reduce the money supply. Given these conditions, which of the following securities would be the least suitable for this investor who needs a specific amount of money in five years?

Zero-tranche collateralized mortgage obligation (CMO) with an estimated five years of life A zero-tranche CMO is subject to interest rate risk as well as extension risk when interest rates rise, and therefore, it would not be suitable for a customer that needs her investment back at a specific point in the future. By contrast, a four-year zero coupon bond will mature within the anticipated time frame for needing the funds and would be the most suitable choice of the answers given. LO 12.d

Your client currently holds XYZ stock in her portfolio. You notice that the put-call ratio for options trading on XYZ stock has been increasing over the past several days. The increase in the ratio would indicate that

for the underlying XYZ stock, more puts than calls are being traded. The ratio is a measure of puts traded to calls traded and is calculated by dividing the number of traded puts by the number of traded calls (puts / calls). As the ratio increases, it reflects that more puts than calls are being traded and is therefore a more bearish indicator of investor sentiment. LO 10.d

One of the distinguishing differences between variable annuities and mutual funds is that variable annuities

have a separate account The variable part of a variable annuity is the separate account. That is what makes it a security product similar to a mutual fund. The only guarantee with a variable annuity is that, once annuitized, payments will continue for life (or the designated period certain). The amount of those payments will vary based on the performance of the separate account. One of the negative features of variable annuities is that they typically have surrender charges that can last a decade or longer. LO 9.a

Which of the following best describes alpha for an investor's portfolio?

it is a measure of performance that adjusts for risk, relative to a known benchmark. Alpha is a measure of performance that adjusts for risk, relative to a known benchmark. The alpha for any investment type, a particular asset, or portfolio is the abnormal rate of return on the investment in relation to what would normally be predicted by the benchmark. LO 13.b

A 27-year-old client is in the lowest tax bracket and seeks an aggressive long-term growth investment. If his investment adviser representative recommends a high-rated general obligation municipal bond, the investment adviser representative (IAR) has

made an unsuitable recommendation based on the client's needs and objectives. In recommending a conservative, tax-exempt investment to this customer, the IAR has failed to make a suitable recommendation given the client's objectives. Municipal bonds are better suited for individuals in high tax brackets and offer little upside appreciation potential. LO 6.f

Probably the most significant difference between a business development company (BDC) and any other investment company registered under the Investment Company Act of 1940 is that a BDC

makes available significant managerial assistance to the investments in their portfolio. All other registered investment companies are passive investors. That is, they do not take an active role in the management of the companies held in their portfolios. The purpose behind BDCs is just that - help small companies with management issues. BDCs, like most other investment companies, qualify as regulated investment companies by distributing at least 90% of their net investment income. Doing so enables them to avoid tax on the distribution. Like closed-end funds and ETFs, shares of BDCs trade actively in the secondary markets. Many trade on the NYSE and the Nasdaq Stock Market, while others trade OTC. As do all registered investment companies, BDCs file annual reports with the SEC. LO 8.b

FINRA Rule 2330 deals with a member's responsibility in the sale of certain insurance company-based products. Specifically the concern is with purchases and sales of deferred variable annuities.

purchases and sales of deferred variable annuities. This FINRA rule applies to purchases and sales of deferred variable annuities and initial allocations to the separate account. It does not apply to fixed annuities or variable life insurance. Because it only deals with the purchase or sale or initial allocations, a client with a deferred variable annuity wishing to change the separate account allocation does not come under the rule. LO 9.e

The dated date on a municipal bond issue is

the date on which the bonds begin accruing interest.

Net asset value (NAV) per share for a mutual fund can be expected to decrease if

the fund has made dividend distributions to shareholders. The NAV per share will rise or fall relative to the value of the underlying portfolio. If dividends are distributed to shareholders, the fund's assets decrease, and their per-share value will decline accordingly. Appreciation of the portfolio and dividends received will increase the value. Redemption of shares will have no impact on the NAV per share, as the money paid out is offset by a reduced number of shares outstanding. LO 8.c