S7 Mock Exam 5 (Part 3)
A customer has a margin account with a market value of $20,000, a debit balance of $12,000, no special memorandum account (SMA), and Regulation T at 50%. If the customer sells $2,000 worth of stock, the amount released to SMA is A) $1,000. B) $500. C) $300. D) $400.
A) $1,000. This is an example of a restricted account with equity below the 50% Regulation T requirement. In a restricted account, 50% of the sale proceeds is released to SMA (50% × $2,000 = $1,000). LO 16.d
An investor's portfolio contains the following four bonds: ABC 7% due in 2040 DEF 6% due in 2040 GHI 5% due in 2040 JKL 8% due in2040 Which of these bonds would show the greatest price change as a percentage of its current market price if interest rates jumped by one percentage point? A) GHI 5% due in 2040 B) DEF 6% due in 2040 C) ABC 7% due in 2040 D) JKL 8% due in 2040
A) GHI 5% due in 2040 The longer the duration, the greater the price volatility (price change as a percentage of current value) when there is a change to market interest rates. When all bonds have the same (or approximately the same) length of time to maturity, the bond with the lowest coupon rate will have the longest duration. Conversely, the one with the highest coupon rate will have the shortest duration and changes in interest rates will have the least impact on it. LO 4.e
Which of the following statements regarding prepayment of CMOs are ordinarily true? I. If interest rates fall, prepayments increase. II. If interest rates rise, prepayments increase. III. If interest rates fall, prepayments decrease. IV. If interest rates rise, prepayments decrease.
A) I and IV When interest rates fall, homeowners often refinance their homes to take advantage of lower interest rates, resulting in the existing mortgages being paid off early. Also, homeowners tend to sell their homes to upgrade to larger homes when mortgage interest rates (and monthly payments) are low. When interest rates rise, homeowners do not usually refinance, and housing turnover is reduced. LO 12.d
Collateralized mortgage obligation (CMO) tranche A has been created to have the most predictable near-term principal pay off. A tranche set up in this way will have I. the highest reinvestment risk. II. the least reinvestment risk. III. a higher yield. IV. a lower yield.
A) II and IV A CMO created to have the most predictable near-term principal pay off will have lower reinvestment risk and lower yield than other CMOs. LO 12.d
Which of the following mortgage-backed securities would provide investors with the most predictable maturity date? A) Planned amortization classes (PACs) B) Fannie Maes C) Targeted amortization classes (TACs) D) Ginnie Maes
A) Planned amortization classes (PACs) PACs are planned amortization class collateralized mortgage obligations and have established maturity dates. Prepayment risk is transferred to the PAC companion—or support—class bonds. LO 12.d
Which of the following activities can take place in a cash account? A) Purchase of new issue common stock B) Borrowing money C) Uncovered option writing D) Short sale of stock
A) Purchase of new issue common stock A customer may only borrow money or securities from a broker-dealer in a margin account. Uncovered call options must occur in a margin account, and uncovered put options can only occur in a cash account when certain criteria are met. Short sales must occur in a margin account. LO 16.d
An example of a taxable bond issued by a municipal government is A) a Build America Bond (BAB). B) a general obligation bond (GO). C) a tax anticipation note (TAN). D) Series EE bonds.
A) a Build America Bond (BAB). BABs are municipal issues created under the Economic Recovery and Reinvestment Act of 2009 to assist in reducing the cost of issuing municipalities and to stimulate the economy. Bonds to fund municipal projects have traditionally been sold in the tax-exempt arena, but BABs are taxable obligations. LO 6.b
With regard to a variable annuity, all of the following may vary except A) number of annuity units. B) value of accumulation units. C) value of annuity units. D) number of accumulation units.
A) number of annuity units. During the accumulation phase, the number of accumulation units will increase as additional money is invested. When the contract is annuitized, the annuitant is credited with a fixed number of annuity units. Once annuitized, the number of annuity units does not vary. The value of accumulation and annuity units varies with the investment performance of the separate account. LO 9.c
The term for the annual reduction of a municipal bond's cost basis purchased at a premium is A) straight-line amortization. B) straight-line accretion. C) compound amortization. D) compound accretion.
A) straight-line amortization. Amortization is the process by which the cost basis of a bond bought at a premium is decreased during the holding period. Because the cost basis is reduced by equal amounts every year, amortization is done on a straight-line basis. At maturity, the cost basis has been reduced to par. LO 6.e
The KAPCO Growth mutual fund's annual report shows receipt of $10,000,000 of interest income from corporate bonds, $15,000,000 in cash dividends, and $5,000,000 of operating expenses. According to the conduit theory, how much must the fund distribute to investors if it wishes to avoid paying any taxes? A) $18,000,000 B) $20,000,000 C) $10,000,000 D) $16,000,000
B) $20,000,000 According to Subchapter M of the Internal Revenue Code, the conduit theory requires that an investment company pay out a minimum of 90% of its net investment income (NII) to investors. In that case, the fund pays taxes on the remaining 10%. However, distributing 100% of the NII leaves no taxable income remaining. A fund's net investment income is the gross investment income minus the expenses. The NII for this fund is the interest ($10 million) plus the dividends ($15 million) minus the expenses ($5 million). That is $10 million + $15 million = $25 million minus $5 million = $20 million. LO 8.f
A real estate limited partnership is created for $800,000 with 1 general partner and 10 limited partners. Each of the limited partners has an equal 10% share. The proceeds are used to purchase an office building for $2 million. The additional financing is provided by a non-recourse bank loan. Economic conditions cause the occupancy rate to fall dramatically, and the partnership is dissolved as insolvent. Each limited partner may claim a loss of A) $2,000,000. B) $200,000. C) $80,000. D) $120,000.
B) $200,000. Losses may only be claimed to the extent of tax basis. The initial $800,000 was divided 10 ways, so each LP had a basis of $80,000. To this was added the share of the financing of $1.2 million. That is another $120,000 basis (10% of $1.2milion) bringing the total to $200,000 ($80,000 + $120,000). That is the maximum loss that can be claimed. It is important to note that nonrecourse financing adds to basis only in RELPs. Because the loan adds to the basis of all LPs equally, you could also solve this by taking the total $2 million investment and dividing it by 10 to arrive at the same $200,000. LO 11.f
ADJ Corporation's charter has authorized 10,000,000 shares of common stock. It has issued 5,000,000 shares and has 1,000,000 shares in its treasury. How many shares of common stock are currently outstanding? A) 5,000,000 shares B) 4,000,000 shares C) 9,000,000 shares D) 6,000,000 shares
B) 4,000,000 shares Shares outstanding are those that are in the hands of the public. To determine the number of outstanding shares, take the number issued minus the number in the treasury. In this question, that is 5 million minus 1 million = 4 million. If, at a later time, ADJ should decide to issue some of the authorized, but unissued shares, the number of outstanding shares will obviously increase. The same would happen if the company sold some of the treasury stock in the open market or used it to pay stock dividends to current shareholders. LO 3.a
Which of the following methods of real estate investing is a flow-through vehicle? A) Common stock in a homebuilding company B) A real estate limited partnership (RELP) C) A real estate investment trust (REIT) D) Purchasing a condominium as a personal residence
B) A real estate limited partnership (RELP) Limited partnership vehicles provide for a flow-through of the program's income or loss. A REIT is not a DPP and does not offer flow-through of losses (although IRS rules require the REIT to pay out at least 90% of its taxable income to avoid being taxed as a corporation). Many investors play the real estate market by investing in the stock of companies that are in the real estate business. Stock is not a flow-through vehicle. Although owning a personal residence can be considered an investment (you do hope the property will appreciate), it is not a security and there is no income or loss to flow through. LO 11.f
Some limited partnership programs provide potential tax credits to partners. Which of the following typically provide potential tax credits? I. Rehabilitation of historic properties II. Equipment leasing III. Developmental oil and gas programs IV. Government-assisted housing programs
B) I and IV 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
The end of the month closing price for the common shares of Momentum Growth Industries (MGI) for the past six months has been charted as 88, 95, 100, 103, 104, and 104. Each month has seen a decrease in the daily average trading volume. This is likely a signal to a technical analyst that A) MGI stock is oversold. B) MGI stock is overbought. C) MGI stock has reached a support level. D) MGI's earnings per share have flattened.
B) MGI stock is overbought. Let's define overbought (and oversold). Over means to an excess. We know that stock prices are based on supply and demand. Increased demand pushes prices up. When the demand slows down, so does the rate of price increase. This is usually accompanied by a reduction in trading volume. Oversold is the opposite. An abundance of sellers leads to a decline in the stock's price, and as the sellers begin to leave the market, the reduced supply along with reduced trading volume indicates a bottom (a support level). In our question, the rate of monthly price increase has slowed and the trading volume is less. This is a sign of an overbought stock (fewer buyers in the market) that has reached a resistance level. The "throwaway" answer here relates to the EPS, something that is not used by a technical analyst. LO 13.e
A client has purchased a non-qualified variable annuity from a commercial insurance company. Before the contract is annuitized, your client, age 60, withdraws some funds for personal purposes. What is the taxable consequence of this withdrawal to your client? A) A 10% penalty plus the payment of ordinary income tax on all of the funds withdrawn B) Ordinary income taxation on the earnings withdrawn until reaching the owner's cost basis C) A 10% penalty plus the payment of ordinary income tax on funds withdrawn in excess of the owner's basis D) Capital gains taxation on the earnings withdrawn in excess of the owner's basis
B) Ordinary income taxation on the earnings withdrawn until reaching the owner's cost basis Contributions to a non-qualified annuity are made with the owner's after-tax dollars. Distributions from such an annuity are computed on a last-in, first-out basis, with the income taxed first. Once the cost basis is reached, any further withdrawals are a nontaxable return of principal. Because the client is older than 59½ at the time of distribution, the additional 10% penalty tax is not incurred. LO 9.d
When must a new options customer return a signed option agreement? A) Before the first order is entered B) Within 15 days of the account approval C) Before the account is approved by a registered options principal D) At the time or before the customer receives the options disclosure document
B) Within 15 days of the account approval The option agreement must be signed and returned within 15 days of account approval. This agreement states the customer will abide by the rules of the options exchange and the OCC and will not violate position or exercise limits. If it has not been returned, the customer can only close out existing positions. No new positions may be opened. LO 10.j
If a customer buys 1 ABC Jan 50 call at 2 and 1 ABC Jan 50 put at 4 when ABC is at 49, the maximum potential gain is A) $600. B) unlimited. C) $400. D) $200.
B) unlimited. Maximum gain in a long straddle is unlimited if the market moves up. If the market moves to zero, the gain is $4,400 (50 − 6 = 44). LO 10.f
If a customer fails to meet a Regulation T margin call of $2,500, securities may be sold out of the account with a value of A) $2,500. B) $3,333. C) $5,000. D) $8,000.
C) $5,000. Securities valued at twice the Regulation T cash call must be sold out if a customer fails to meet a Regulation T margin call ($2,500 × 2 = $5,000). LO 16.d
Which of the following balance sheet entries may be affected when a company pays a cash dividend? I. Shareholders' equity II. Total assets III. Total liabilities IV. Working capital
C) II and III When a company pays a cash dividend, the dividends payable (a current liability) and the cash account (current assets) are reduced by the same amount. Because liabilities and assets are each reduced by the same amount, working capital is not affected. Shareholders' equity—or net worth—is also not affected when the dividend is paid. LO 13.c
Exchange-traded funds (ETFs) I. pass on capital gains to investors annually. II. can be bought and sold throughout the trading day. III. have high expense ratios. IV. have low expense ratios.
C) II and IV Noted advantages of ETFs are that they have low operating costs, and thus, low expense ratios, and they can be bought and sold throughout the trading day. LO 8.h
Which of the following best describes a debenture? A) A corporate debt obligation that allows the holder to purchase shares of the company's common stock at specified dates before maturity B) A long-term corporate debt obligation with a claim against securities rather than against physical assets C) Unsecured corporate debt D) An investment in the debt of another corporate party
C) Unsecured corporate debt A debenture is unsecured corporate debt. LO 5.a
When participating in an underwriting of a new equity issue, FINRA rules would permit a member firm to grant concessions or other allowances to A) the issuer. B) a suspended member firm. C) another member firm. D) a U.S. nonmember broker-dealer.
C) another member firm. When engaged in an underwriting, a member can grant discounts and other concessions only to other member firms. A suspended member must be treated like a member of the general public (no discounts or concessions). Issuers are on the other side of the underwriting; they receive the proceeds, not a portion of the underwriting fees. LO 18.d
When recommending the purchase of a DPP to a client, as with all other investments, the recommendation must be suitable. FINRA adds some extras requirements in the case of DPPs. Among those is the requirement that the investor is A) an accredited investor. B) able to emotionally handle the ups and downs of the market. C) in a position to take full advantage of any tax benefits generated by the DPP. D) in need of a liquid investment.
C) in a position to take full advantage of any tax benefits generated by the DPP. FINRA's Rule 2310 lists a few suitability standards necessary for recommending DPPs. Among those is the ability of the investor to make use of any potential tax benefits. Although DPPs are frequently sold as private placements, even then not all of the investors have to be accredited. DPPs are considered illiquid investments, and without a secondary market, there are no "roller coaster" ups and downs. LO 11.h
All of the following qualified plans are covered by ERISA guidelines except A) private sector plans. B) profit-sharing plans. C) public sector plans. D) 401(k) 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. LO 1.i
A registered representative has been doing some research on his own. He would like to share the information with some of his clients and sends an email to 15 of them. He also has some prospects he's been working on and sends the email to 12 of them during the same week. Under the FINRA rule on communications with the public, this would be considered A) an electronic communication. B) correspondence. C) retail communication. D) exempt from the principal approval requirements.
C) retail communication. FINRA defines a retail communication as "any written (including electronic) communication that is distributed or made available to more than 25 retail investors within any 30-calendar-day period." It is important to understand that retail investors includes current and prospective customers. Because this report will be sent to 27 within the 30-calendar-day period, it fits the definition. Like virtually all retail communications, principal approval is necessary before it is used. Is this an electronic communication? Yes it is, but the exam will want the more specific response—retail communication. LO 19.a
A producer of fine French wines has just signed a contract to export $10 million of wine to a distributor in the United States. Using listed foreign currency options, this producer would have the best protection against currency risk by A) taking a long position in euro puts. B) taking a long position in U.S. dollar puts. C) taking a long position in euro calls. D) taking a long position in U.S. dollar calls.
C) taking a long position in euro calls. There are no listed options in the U.S. dollar. That reduces your choice to a long euro put or call. Because the contract will be paid for in dollars, the producer is concerned that the dollar will fall against the euro. Or, stated another way, the concern is that the euro will rise against the dollar so that the $10 million will not buy as many euros as on the day the contract was signed. When one is afraid the price of asset will rise, such as those who take a short position in a stock, the best protection is buying a call. The easiest way to remember this is through the acronym, IPEC - Importers buy Puts and Exporters buy Calls. This is used when the party involved in the question is in a foreign country. Because we are dealing with a French exporter, buying calls on the local currency offers the best protection. LO 10.g
An analyst interested in measuring the breadth of market movement as an indicator of future market direction would monitor A) the betas of the S&P 500 stocks. B) the Dow Jones Industrial Average. C) the advance/decline line. D) the Value Line Index.
C) the advance/decline line. The advance/decline line, which measures the number of stocks that have advanced versus the number of stocks that have declined, is an indicator of the breadth of the market's advance or decline.
The legal contract stating the issuer's obligation to pay back a specific amount of money on a specific date to its bondholders is best described as A) the official notice of sale. B) the prospectus. C) the trust indenture. D) the official statement.
C) the trust indenture. A trust indenture delineates the covenants or promises made by an issuer to its bondholders. Those would include the amount of the debt, the maturity date, and the rate of interest. A trustee would also be identified in the indenture who would act on behalf of the bondholders in the event of default on any of the indenture's provisions. LO 4.a
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 A) $47.75. B) $45.00 C) $48.50. D) $51.25.
D) $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). LO 10.f
According to the Investment Company Act of 1940, a diversified mutual fund may hold, at most, what percentage of a corporation's voting securities? A) 50% B) 5% C) 75% D) 100%
D) 100% To be considered a diversified investment company, the company must follow the 75-5-10 rule. That rule requires 75% of the fund's assets to be diversified, such that within that 75%, the mutual fund owns no more than 10% of a target company's voting securities. Additionally, within that 75% of assets, no diversified investment company may invest more than 5% of its portfolio in a single company's securities. However, there are no restrictions on the other 25%. That can all be in one stock, making 30% of the fund's assets in one company. While many mutual funds have total assets in excess of $1 billion, 30% of those assets ($300 million or more) can theoretically buy all of the outstanding voting shares of a company and control 100%. LO 8.a
When reading a corporation's annual report, a registered representative notices that there are 100 million shares authorized, 70 million shares outstanding, and 10 million shares in the treasury. Based on this information, the representative would deduce the number of unissued shares is A) 80 million. B) 30 million. C) 10 million. D) 20 million.
D) 20 million. Of the 100 million authorized shares, 80 million have been issued (the 70 million outstanding plus the 10 million in the treasury). That leaves 20 million shares still unissued. LO 3.b
A customer buys AC Growth Fund and enjoys a substantial paper capital gain. When he believes the market has reached its peak, he switches into AC Income Fund within the AC family of funds. He incurs a small service fee but is not charged an additional sales charge. What is the tax effect? A) Any gain or loss is deferred until he liquidates the AC Income Fund. B) It is a tax-free exchange. C) The tax basis of AC Income Fund is adjusted to reflect the gain in AC Growth Fund. D) Any gain in AC Growth Fund is taxable because the exchange is treated as a sale and a purchase.
D) Any gain in AC Growth Fund is taxable because the exchange is treated as a sale and a purchase. The exchange is treated as a sale of the growth fund shares followed by a purchase of the income fund shares. The gain or loss is determined by comparing the cost basis of the growth fund shares with the net asset value at the time of exchange. Any difference is a capital gain or loss, even though the proceeds were immediately used to purchase the income fund. LO 8.e
Which of the following is not part of the Federal Farm Credit System (FFCS)? A) Federal Intermediate Credit Bank B) Bank for Cooperatives C) Federal Land Bank D) Federal Home Loan Bank
D) Federal Home Loan Bank The Federal Land Bank, Bank for Cooperatives, and Federal Intermediate Credit Bank are all parts of the FFCS. The Federal Home Loan Bank is not. LO 7.c
Dale Wells, a British citizen temporarily working in the United States, wants to form a business venture with other investors. Wells is looking for favorable tax treatment of earnings and losses. Wells also wants to limit the number of investors but is willing to share control of the enterprise with others to attract them. What business form would you advise? A) S corporation B) C corporation C) Limited partnership D) General partnership
D) General partnership Limited partnerships would not work because the other investors have limited say in how the enterprise is run. C corporations do not provide favorable tax treatment of gains or losses. Although an S corporation appears to be the right answer, only U.S. citizens or resident aliens can own one. LO 1.c
One of your clients enters a sell stop order at $42.40, limit $42.15. Assume that the trades occur in the following sequence: 42.45, 42.40, 42.75, 42.27, and 41.91. At which of the following prices could this order be executed? I. $41.91 II. $42.27 III. $42.40 IV. $42.75
D) II and IV As a sell stop order with a limit of $42.15, no order may be executed below the limit price of $42.15. This order will be triggered at the price of $42.40. The only remaining prices that will meet the limit requirement after it is triggered are $42.27 and $42.75. Remember, it takes two trades for any stop order: one to trigger the order, the other for execution. LO 16.a
Rank the following from first to last in order of payment at liquidation of a corporation. I. General creditors II. Preferred stock III. Subordinated debentures IV. Accrued taxes
D) IV, I, III, II The complete order of liquidation is as follows: secured debt, debentures and general creditors, subordinated debentures, preferred stock, common stock. LO 5.b
A new municipal bond issue had a dated date of January 1, 2018. The first coupon was due on August 1, 2018. The customer bought for settlement on September 1, 2018. How many months of accrued interest must he pay at settlement? A) Seven months B) Eight months C) Six months D) One month
D) One month On a new bond issue, the issuer sets the dated date. That is the date from which interest first begins to accrue. It is not unusual for the first interest payment date to be more than six months from the dated date. That is known as a long coupon (longer than six months). Therefore, on August 1, 2018, seven months of interest was paid (January through the end of July). The customer did not purchase the bond until late August and owes interest only from the August 1, 2018, coupon payment date up to, but not including, the September 1 settlement date (one month). LO 6.e
Which of the following statements regarding the Federal Farm Credit System securities are not true? A) Interest is tax exempt at the state and local levels. B) The proceeds are used to make loans to farmers. C) They issue short-term notes and long-term bonds. D) They are direct obligations of the U.S. government.
D) They are direct obligations of the U.S. government. With the exception of Ginnie Mae, all agency securities are indirect obligations of the U.S. government. LO 7.c
Which of the following investment strategies would be permitted in your customer's IRA? A) Selling uncovered put options B) Buying stock on margin C) Taking short positions on a stock D) Writing covered call options
D) Writing covered call options The covered call option is considered an appropriate investment strategy for an IRA and ERISA-compliant corporate plans as well. The risk is actually less than simple ownership of the underlying stock, and that is what makes it an eligible strategy. Margin (buying on credit) or selling short (unlimited potential loss) are never permitted in an IRA. The sale of uncovered options is another strategy considered too risky for an IRA. LO 1.g
Démodé Classic Investments (DCI) is planning a direct mail campaign to several thousand potential investors. The topic of the campaign deals with owning real estate through direct participation program limited partnerships. Under FINRA Rule 2210 on communications with the public, this is considered A) correspondence and needs review, not approval, by a designated DCI principal. B) a retail communication that needs approval, but not filing, by a designated DCI principal. C) a retail communication and must be filed with FINRA at least 10 business days before first use or publication. D) a retail communication and must be filed with FINRA within 10 business days of first use or publication.
D) a retail communication and must be filed with FINRA within 10 business days of first use or publication. A direct mail communication to more than 25 existing and/or potential clients within a 30-day period is a retail communication. Unless an exception applies, a designated principal of the firm must approve all retail communications. DPPs are part of a group of securities (other common examples are investment companies and CMOs) where filing with FINRA within 10 business days of first use or publication is the rule. LO 19.d
A designated market maker is permitted to do all of the following except A) buy and sell for a proprietary account. B) accept a limit order. C) represent a bid and offer simultaneously. D) accept a not-held order.
D) accept a not-held order. A specialist (designated market maker) on the floor does not deal directly with the public. Therefore, a designated market maker cannot accept any order that requires the exercise of discretion. A not-held order is one in which the floor broker can choose the price or time of execution. LO 16.a
The principal tax benefit of investing in an exploratory oil and gas drilling program is derived from A) depreciation expenses. B) recapture. C) capital appreciation. D) intangible drilling costs (IDCs).
D) intangible drilling costs (IDCs). IDCs, which are a significant portion of all drilling costs, are a major tax advantage to a limited partner and are tax deductible in the year in which they are incurred. IDCs are costs that, after incurred, hold no salvage or ongoing value. Examples include labor and geological survey. LO 11.f
Private placements A) may be advertised under all circumstances. B) can only be advertised when 35 or fewer of the investors are non-accredited. C) may never be advertised under any circumstance. D) may be advertised if all of those solicited are accredited investors.
D) may be advertised if all of those solicited are accredited investors. To solicit or advertise private securities offerings, all purchasers of the advertised securities must be accredited investors, or the business must reasonably believe that the investors are accredited investors at the time of the sale. LO 20.e
Stop orders may be used for each of the following except A) to establish positions. B) to protect profits on short positions. C) to protect profits on long positions. D) to lock in a specific price to close out a position.
D) to lock in a specific price to close out a position. Stop orders are contingent orders that are triggered when the stock trades at or through a stated price. When triggered, they become market orders to buy or sell. They are used by technical traders to establish positions above or below resistance and support levels, respectively. Stop orders never guarantee a specific execution price. LO 16.a
