Practice test 5
An investor purchased a municipal bond at par to yield 5.5% to maturity. If, two years later, she sold the bond at a price equivalent to a 5% yield to maturity, the investor incurred
a capital gain. Ex: Because the investor sold the bond at a price that will yield less than the yield when she purchased the bond, the bond must have been sold for more than the investor paid for it. Therefore, the investor profited by that difference. Remember, the higher the price, the lower the yield.
Typically, general obligation bonds are not sold short because
thin markets may make it difficult to cover a short municipal position Ex: Because the municipal trading market is thin, it is often difficult to cover (buy back) a municipal security that has been sold short. It is easy to short 100 shares of GM (borrow the stock), for example, because an equivalent 100 shares of GM can be purchased on the NYSE at any time.
If an investor practices value investing, which of the following stock types is he least likely to purchase? A) A stock that is presently selling for two-thirds of net current assets B) A stock that has exhibited a high dividend yield in the past C) A stock with a low (P/E) ratio D) A stock with an above-average price-to-earnings (P/E) ratio
- A stock with an above-average price-to-earnings (P/E) ratio Ex: A growth investor looks for stocks with above-average (P/E) ratios. Conversely, a value investor focuses on stocks with low P/E ratios, a low price-to-book value, and historically high dividend yields.
All of the following statements regarding a municipality's debt limit are true
- that revenue bonds are not affected by statutory limitations. - that the purpose of debt limits is to protect taxpayers from excessive taxes. - that unlimited general obligation bonds may be issued when a community's taxing power is not restricted by statutory provisions. Ex: The debt limit is the maximum amount of debt a municipality can have.
If a customer is long 1 ABC Oct 50 call at 11 and short 2 ABC Oct 60 calls at 5, the maximum loss potential is
- unlimited Ex: The customer is short two calls and long one call, leaving one of the short calls uncovered. The loss potential for a naked call writer is unlimited on the upside. If exercised, the writer must buy the stock at the current market price so it will be delivered at the strike price.
If a customer writes 1 Jul 80 put at 7, and the put is exercised when the market price is at 70, for tax purposes, what is the effective cost basis of the stock put to the seller?
73 Ex: The cost basis is 80 (the price at which the writer must buy) minus 7 (the premium the writer was paid), or $73 per share
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?
Covered call options Ex: 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.
All of the following ratios are measures of the liquidity of a corporation except A) quick ratio. B) current ratio. C) acid test ratio. D) debt/equity ratio.
Debt/equity ratio Ex: Liquidity ratios measure a firm's ability to meet its current financial obligations and include the current ratio and acid test (quick) ratio. However, the debt/equity ratio is a capitalization ratio and measures the amount of leverage compared to equity in a company's overall capital structure.
FINRA rules require broker-dealers to conduct anti-money laundering training
On an ongoing basis Ex: Rather than set a fixed schedule, FINRA rules require that anti-money laundering training be conducted on an ongoing basis.
Where must the SEC's no-approval clause appear in a prospectus?
On the cover Ex: The SEC wants investors to know that it does not approve or disapprove new issues. The disclaimer statement must appear on the cover of all prospectuses.
If a customer transfers his holdings from one fund to another within the same family of funds, what are the tax consequences?
On the transaction date, any gain or loss is recognized for tax purposes. Ex: An exchange is a taxable event. The cost basis of the shares in the original account must be compared to their redemption value. Any gain or loss is recognized in the year of the exchange. The exchange privilege allows the investor to avoid paying an additional sales charge. It does not allow the investor to avoid taxes.
REIT fact
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.
Completion of a rights offering
Successful completion of a rights offering generally results in a slight decline in the market price of the stock. This is because the subscribers were able to purchase at a price below the current market. This would have a small dilutive effect, causing a slight reduction in the market price. The rights offering is of additional shares, so the number outstanding would increase. Most corporations use a standby underwriter who will buy any shares that were not exercised. Please note: From a test-taking skill point of view, when you have two answer choices that are the opposite of each other (the price would rise slightly or the price would decline slightly), in almost all cases, one of those two must be the correct answer.
An investor has losses on the sale of municipal bonds. Which of the following, for tax purposes, is true?
The losses can be applied against the gains on the sale of any other security. Ex: Losses on the sale of one investment can generally be deducted against gains on the sale of any other investment.
A customer invests $18,000 in a mutual fund and signs a letter of intent for $25,000 to qualify for a breakpoint. One year later, the shares are valued at $25,100 even though she made no new investments. Which of the following statements regarding this situation is true?
The representative should remind the customer that she signed a letter of intent 12 months ago. Ex: A letter of intent must be met with dollars invested within 13 months. The customer needs to invest an additional $7,000 to fulfill her letter of intent. The representative should remind the customer of her intention to qualify for the reduced sales charge.
If an investor swaps identical issues of stock to establish a loss that is disallowed, the transaction is known as
Wash sale Ex: 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.
Cash dividends from real estate investment trusts (REITs) are
taxed as ordinary income. Ex: Cash dividends from REITs are taxed as ordinary income. A maximum rate for qualified dividends, which applies to qualified common stock dividends, does not apply to dividends from REITs.
J.B. Collingsworth is the CEO and largest single shareholder in Collingsworth Industries, Inc. (CII). Three months ago, J.B. purchased 2,000 shares of CII in the secondary market at $6 per share. Yesterday, J.B. sold those shares for $8 per share. Under federal law,
the $4,000 profit on the sale must be returned to CII Ex: J.B. has violated the "short swing" profit rule of the SEC. That rule states that any affiliate of a public company realizing a profit on a sale of that company's stock within a six-month period of the purchase, must return that profit to the company. The term used is "disgorged." There is nothing illegal about this, but J.B. doesn't get to keep the profit. The sale is well under the Form 144 de minimis limit of 5,000 shares or $50,000 in market value. Because the shares were purchased in the secondary market, they are already registered. Nothing in the question implies that J.B. was acting on inside information.
