Series 7 Exam

An investor wishes to invest in a limited partnership participation. Listing an investment objective of capital appreciation without producing currently taxable income, which of the following choices would be most suitable regarding the investor's criteria? A) Raw land B) Low-income housing C) Oil and gas income program D) Equipment leasing Explanation Of the program choices listed, raw land will satisfy an investor's criteria for potential capital appreciation without producing currently taxable income.

A) Raw land Of the program choices listed, raw land will satisfy an investor's criteria for potential capital appreciation without producing currently taxable income. LO 11.e

A customer asks if there are any debt instruments providing income that might at least keep pace with inflation and offer some tax advantages. What suitable recommendation could be made that would meet the customer's criteria? A) TIPS B) ADRs C) GNMAs D) U.S. T-bills

A) TIPS Explanation Treasury Inflation Protection Securities (TIPS) are debt instruments specifically designed to provide income that keeps pace with inflation. Issued by the U.S. Treasury, the interest is tax exempt at the state and local level. Neither GNMAs nor Treasury bills (T-bills) meet all of these criteria, and American depositary receipts (ADRs) are not debt instruments. LO 1.b LO 7.a

A client interested in Treasury bills (T-bills) asks you to explain their features. Which of these is correct? A) They are quoted with a bid higher than the ask. B) They are generally callable after the first 6 months. C) They are all auctioned on a monthly basis. D) They have a maximum maturity of 365 days.

A) They are quoted with a bid higher than the ask. T-bills pay no interest; they are issued at a discount and are direct obligations of the U.S. government. They are not callable and have maximum maturities of 52 weeks (not 365 days) or less. Most T-bills are auctioned weekly.

Your customer wrote a September 918 index call at 4.15 five months ago. The option expired, and the customer received no assignment notice. For tax purposes, it should be taxed and reported as A) a $415 short-term capital gain. B) ordinary income of $9,180. C) ordinary income of $415. D) a $41.50 short-term capital loss.

A) a $415 short-term capital gain. When options contracts expire, writers (sellers) report a capital gain equal to the premium amount received; in this case, the amount is $415. Because options only have a nine-month life cycle, all capital gains and losses are short term. LO 10.i

Your new customer directs you to open a cash account. He wants to give trading authorization to his brother but does not want his brother to have any other authority in the account. The two required documents needed by your firm to open the account as directed would be a new account form and A) a limited power of attorney. B) a tenants in common agreement. C) a full power of attorney. D) a durable power of attorney.

A) a limited power of attorney. A new account form is required to open the new account, and a limited power of attorney is needed if the customer wishes to give trading authorization to someone else. Although the limited power of attorney gives the third party trading authority, it prohibits that party from withdrawing assets from the account as a full power of attorney would. LO 1.d

A municipal securities advertising piece intended to be distributed to retail customers must be approved by A) a municipal securities principal or a general securities principal. B) a municipal securities principal and the MSRB. C) a general securities principal or a branch manager. D) a branch manager and the MSRB.

A) a municipal securities principal or a general securities principal. Explanation Municipal securities advertising intended to be distributed to retail customers must be approved by a municipal securities principal (Series 53) or a general securities principal (Series 24). LO 6.h

A new account is opened at your firm and you notice that there is a trusted contact person form attached to the documentation. You could safely surmise that this is an account for A) a specified adult. B) a corporation. C) a minor. D) a trust.

A) a specified adult Per FINRA Rule 2165, a specified adult "is a natural person age 65 or older or a natural person age 18 or older who the member reasonably believes has a mental or physical impairment that makes the individual unable to protect his own interests." FINRA requires members to make reasonable efforts to obtain the name of and contact information for a trusted contact person. This person must be someone age 18 or older who may be contacted about the customer's account. The rules do not require a customer to provide trusted contact information, only that the firm make the effort. LO 1.d

You are asked to read the preliminary prospectus for a new issue of common stock for a client. You would expect the preliminary prospectus to include A) an overview and history of the issuer's business and any risks associated with the offering. B) an overview and history of the issuer's business and the final offering price. C) the effective date of the offering and the final offering price. D) the effective date of the offering and the risks associated with the offering.

A) an overview and history of the issuer's business and any risks associated with the offering. The preliminary prospectus will include an overview and history of the business as well as any risks associated with it. The preliminary prospectus cannot include the effective date or public offering price (POP) because they have yet to be determined. LO 20.c

A customer of a broker-dealer has a portfolio of investments where expected payments from mortgages back the securities via a process known as securitization. These securities are best described as A) asset-backed securities. B) stock rights. C) high-yield bond options. D) commodity options.

A) asset-backed securities. Asset-backed securities are ones whose value is backed by the expected cash flow from a pool of assets such as mortgages, other types of loans, credit card debt, and leases. Pooling individual smaller and sometimes less liquid assets into larger securities allows them to be sold easier to investors. This process is known as securitization, and when done with mortgages, are sold as collateralized mortgage obligations (CMOs). LO 12.c

A corporation has issued debt securities backed by the securities of other companies that it holds in its corporate investment portfolio. These debt securities are known as A) collateral trust bonds. B) equipment trust certificates. C) mortgage bonds. D) subordinated debentures.

A) collateral trust bonds. A corporation issuing debt securities secured by a pledge of another company's securities it holds is issuing collateral trust bonds. LO 5.a

The possibility of losing all or part of a person's invested principal in a debt security because of the issuer's failure best describes A) credit risk. B) inflation risk. C) market risk. D) business risk.

A) credit risk Credit risk, also called default risk, involves the danger of losing all or part of one's invested principal through an issuer's failure. Although credit risk is most often associated with debt securities, when a company cannot pay its debt, the equity securities can wind up worthless. This is the risk taken by investors buying stock in highly leveraged companies. The higher the rating, the lower the credit risk. LO 14.a

The Securities Act of 1933 does not regulate A) municipalities registering a revenue bond for building an airport terminal. B) review of a registration form submitted to the SEC before a public sale of stock. C) the delivery of a prospectus when selling a municipal bond mutual fund. D) the use of a preliminary prospectus during the cooling-off period.

A) municipalities registering a revenue bond for building an airport terminal. Municipal securities are exempt from the registration requirements of the Securities Act of 1933. LO 20.c

A customer of your broker-dealer wants to grant his registered representative the right to make investment decisions for his account. This would be done by A) providing the registered representative with the prescribed discretionary authorization form before the first discretionary trade. B) authorizing the registered representative to determine the price or time of the trade once the client has entered the order. C) providing FINRA with the prescribed discretionary authorization form before the first discretionary trade. D) providing the registered representative with the prescribed discretionary authorization form not later than settlement date of the first discretionary trade.

A) providing the registered representative with the prescribed discretionary authorization form before the first discretionary trade. A discretionary account always requires prior written authorization from the customer in the form of a limited power of attorney. The limited power of attorney is the document that grants the registered representative the authorization to trade, and it is sometimes known as the trading authorization.

XYZ, Inc., has 5 million shares outstanding and will issue 1 million shares of new stock through an upcoming rights offering. Regarding the rights offering, a registered representative (RR) should know that A) the exercise price is generally lower than the current market price at issuance. B) the value of the right will generally increase after the ex-date. C) XYZ will issue 1 million rights. D) a shareholder will generally have two to three weeks to exercise the rights.

A) the exercise price is generally lower than the current market price at issuance. The exercise price is generally below the current market price at issuance. None of the other choices are true because the value of the right drops on the ex-rights date. Each existing share receives 1 right, so in this case, XYZ will issue 5 million rights. An investor must exercise the rights within 30-45 days of issuance; otherwise, they will expire. LO 3f

A customer wishing to open a numbered account must be informed that A) he must supply a written statement attesting to his ownership of the account. B) numbered accounts are restricted to cash accounts. C) he must supply proof of U.S. citizenship and reside permanently in the United States. D) the account may only be opened with prior permission from the SEC.

A) he must supply a written statement attesting to his ownership of the account Numbered—or symbol—accounts require that a written statement, which is signed by the client and acknowledges ownership, be kept on file. LO 2.g

Your 66-year-old customer invested $35,000 in a nonqualified variable annuity. It now has a value of $55,000, and your customer wishes to make a random withdrawal of $30,000. What is the tax liability that results if the customer is in the 28% tax bracket? A) $5,600 B) $7,600 C) $2,800 D) $8,400

A) $5,600 Explanation Partial or random liquidations of a variable annuity are taxed on a last-in, first-out (LIFO) basis, which means that the last dollars into the account, the earnings, are withdrawn first. Of the $30,000 withdrawn, $20,000 represents deferred earnings or income that is now taxable at the 28% rate (0.28 × $20,000 = $5,600). No penalty applies because the investor is older than age 59½.

Which of the following is not a characteristic associated with auction rate securities (ARS)? A) Are backed by the full faith and credit of the U.S. federal government B) Have the risk of failed auctions C) Use a Dutch auction method to establish a new clearing rate D) Are long-term securities that reset the rate paid at predetermined short-term intervals

A) Are backed by the full faith and credit of the U.S. federal government ARS are long-term securities, typically issued by municipalities that are tied to short-term interest rates. A Dutch auction method is used to reset a new rate, known as the clearing rate, at predetermined short-term intervals. Failed auctions—ones where no bids are received to reset the rates—are an inherent risk with ARS. LO 6.b

Your client, age 52, is considering taking distributions from her qualified retirement plan. A portion of her contributions were made with after-tax dollars. Which of these is correct? A) Distributions of earnings are 100% taxable, and a 10% penalty will be applied to the distributions. B) Distributions of earnings are tax free, but a 10% penalty will be applied to the distributions. C) Distributions of cost basis is 100% taxable, and a 10% penalty will be applied to the distributions. D) Distributions of earnings are tax free, and there will not be a penalty applied to the distributions.

A) Distributions of earnings are 100% taxable, and a 10% penalty will be applied to the distributions. For qualified plans, distributions of earnings are tax deferred until taken. When taken, those earnings are 100% taxable. Unless meeting one of the exceptions (e.g., death, disability), distributions taken before age 59½ will have a 10% penalty applied. When there is a cost basis (after-tax contributions), that portion is always returned tax and penalty free. LO 1.g

Which of the following statements regarding hedge funds is correct? A) Hedge funds are usually structured as a partnership. B) Hedge funds are typically registered with the SEC as open-end investment companies. C) Hedge fund managers, like mutual fund managers, are compensated largely based on assets under management. D) Hedge funds are passively managed in an attempt to provide predictable returns for investors.

A) Hedge funds are usually structured as a partnership. Hedge funds are usually structured as a partnership with the general partner as investment manager and the investors as limited partners. In general, hedge funds are exempt from registration with the SEC. Hedge funds are actively and aggressively managed, seeking superior returns—and they are best suited for wealthy, sophisticated investors. Under the typical 2% + 20% fee schedule, hedge fund managers are largely compensated for performance, not assets under management. LO 12.a

Which of the following collateralized mortgage obligation (CMO) tranches tends to have low extension and reinvestment risk? A) PACs B) Z-tranche C) Companion D) TACs

A) PACs PACs have targeted maturity dates. They are retired first, and offer protection from prepayment risk and extension risk (the chance that principal payments will be slower than anticipated) because changes in prepayments are transferred to companion tranches, also called support tranches. LO 12.d

An investor writes 1 XYZ 180 call at 6.65. If the investor makes a closing purchase at the call's intrinsic value when the stock is at $184.75, he realizes a gain of A) $265.25. B) $190.00. C) $180.00. D) $147.50.

B) $190.00. The investor received a premium of $665. The position was closed with a purchase at intrinsic value: $475. The net profit is the difference, or $190. LO 10.c

In an existing margin account with no SMA, if a customer buys 300 ABC at 40 and simultaneously buys 3 ABC OCT 40 puts at 2.50, the customer must deposit A) $5,250. B) $6,750. C) $6,375. D) $6,100.

B) $6,750. Buying 300 shares at 40 ($12,000) requires a deposit of $6,000. In addition, the customer is purchasing 3 puts with a total premium of $750 (3 × 2½). Most options have no loan value and must be paid in full. Adding $6,000 and $750 results in a deposit of $6,750. LO 16.d

The following information has been reported for ABC stock: Annual dividend = $2 PE ratio = 20 Closing price = $100 What is the dividend payout ratio? A) 2% B) 40% C) 20% D) 30%

B) 40% The dividend payout ratio is computed by dividing the dividend by the earnings per share ($2 ÷ $5 = 0.4, or 40%). LO 13.d

You are listening to another registered representative (RR) speak about Rule 147 offerings and recognize that one of his statements is incorrect. Which of these is not correct? A) Stock sold under Rule 147 is sold in an exempt transaction. B) Buyers of stock issued under Rule 147 are subject to a one-year holding period before selling to a nonresident. C) Under one Rule 147 provision that can be met, an issuer must derive 80% or more of its revenue from the state in which its principal office is located. D) Rule 147 applies to intrastate stock offerings.

B) Buyers of stock issued under Rule 147 are subject to a one-year holding period before selling to a nonresident. Holders of shares issued under Rule 147, the intrastate offering exemption, cannot resell their shares to nonresidents of the state for a period of six months from the date of purchase. LO 20.e

A registered representative (RR) is explaining characteristics of equity-linked notes (ELNs) and exchange-traded funds (ETFs) to a new client. All of the following statements are true except A) ETFs can hold assets like stocks, bonds, or commodities, or can track an index. B) ELNs are equity instruments. C) ELNs can be traded OTC or on a listed exchange. D) ETFs trade on listed exchanges much like stocks.

B) ELNs are equity instruments. ELNs are debt instruments. Their final payment at maturity is based on the performance of a single stock, a basket of stocks, or an equity index. These notes can be traded OTC or on listed exchanges. ETFs trade on listed exchanges and have many of the same trading characteristics as stocks. Their portfolios can hold assets such as equity securities, debt securities, or commodities, and many ETF portfolios are structured to track the performance of a specific index. LO 4.g

Which of the following is an interest-bearing instrument? A) Commercial paper B) Jumbo CD C) Zero-coupon bond D) Treasury bill

B) Jumbo CD Jumbo (negotiable) CDs are one of the few money market instruments issued at face value. Unlike those issued at a discount, they are interest bearing. LO 4.c

During the onboarding process of a personal securities account for a 65-year-old investor, the registered representative (RR) attempts to obtain the name of a trusted contact person who will be notified if the firm suspects exploitation. However, the investor looking to open the account declines to provide a contact name and information of a trusted adult. What is the best course of action? A) The firm cannot open an account of someone age 65 or older without the name of a trusted contact person. B) Open the account, and place a notation in the customer's file indicating the refusal to provide a trusted contact person. C) Open the account, and inform the investor that disbursements from the account must be made on the extended disbursement form providing a detailed explanation of the disbursement. D) Open the account, but place a dollar limit on disbursements from the account.

B) Open the account, and place a notation in the customer's file indicating the refusal to provide a trusted contact person. The firm is required to make a reasonable attempt to obtain the name and contact information of a trusted person. In the event the customer chooses not to provide it, the account may be opened without restriction. LO 14.c

A municipality wants to issue industrial revenue bonds to benefit a local company who employs hundreds of the municipality's residents. Regarding these bonds, which of the following is true? A) The issuance of these bonds would require voter approval. B) The credit rating of the bonds is dependent on the credit rating of the company, not the municipality. C) Because these bonds are used for a nonpublic purpose, the interest income will not be subject to the alternative minimum tax. D) Interest is paid from revenues collected through property assessments and taxes.

B) The credit rating of the bonds is dependent on the credit rating of the company, not the municipality. The debt service for IDRs is derived from the lease payments made by the leasing corporation to the issuing municipality; it is not derived from local property taxes. Therefore, the credit rating of the bonds is dependent on the creditworthiness of the leasing corporation. Because they are revenue bonds, they do not require voter approval, and because they are for nonpublic purpose, they may be subject to the AMT for some investors. LO 6.c

One of your clients is an executive with a corporation that covers him under a qualified defined benefit pension plan. In addition, the client has maxed out his IRA contributions. With retirement coming up in about a decade, he decides to make a $100,000 lump sum deposit to a single premium deferred annuity. Then, he will begin monthly investments of $5,000 into a periodic payment deferred annuity. He does not plan to annuitize. Instead, he will withdraw funds from the annuities as needed. When those withdrawals are made, how will they be taxed? A) There is a combination of ordinary income and return of principal based on the exclusion allowance. B) The earnings will be taxed as ordinary income and will be withdrawn first using LIFO. C) The earnings will be taxed as capital gains and will be withdrawn first using LIFO. D) A portion of each payment will be taxed as ordinary income with the balance considered a return of principal.

B) The earnings will be taxed as ordinary income and will be withdrawn first using LIFO. Because this is a nonqualified annuity, there are no contribution limits and, once the earnings have been received, the balance is a tax-free return of the original principal. Annuities never receive capital gains treatment. 9a

A 2X leveraged inverse ETF tracks an index that has recently fallen 2%. If the ETF was priced at $25 per share before the drop in the indices price, where should the ETF be priced now, assuming the ETF portfolio performed as intended? A) Down $1 per share B) Up $1 per share C) Down $2 per share D) Up $4 per share

B) Up $1 per share An inverse fund portfolio attempts to mirror returns that are the opposite of the index it is tracking. Therefore, if the index has fallen, this ETF should be up. A leveraged ETF attempts to produce returns that are a multiple of those produced by the index it is tracking. Therefore, if this index has fallen by 2%, the 2x leveraged fund should move twice as much (4%). With the index dropping by 2%, this inverse fund will rise by 4%; that is, $1 on a $25 index. LO 8.h

One of your customers asks you to interpret her observation that the short interest in a stock she owns has been rapidly increasing over the past four months. Aligning with the short interest theory, you would tell her that this is A) an indication of predictable stability in the stock. B) a bullish indicator. C) a bearish indicator. D) an indication of predictable volatility in the stock.

B) a bullish indicator. While short interest in a stock represents the number of shares sold short, the short interest theory considers rising short interest a bullish indicator. Each share that has been sold short must be replaced (covered) at some point. To replace the stock shorted, an investor must go into the market to buy that stock. When all of those short sellers have to buy back stock they shorted, it puts upward pressure on the prices of those stocks. LO 13.e

In what is commonly known as a proceeds transaction, one of your clients is using the proceeds from the liquidation of one stock to purchase another stock. In compliance with the 5% markup policy for these transactions, the markup will be computed based on A) the markup or compensation to the dealer on the buy side of the transaction. B) a combination of both the buy side and the sell side compensation to the dealer. C) the compensation to the dealer for each side of the transaction separately. D) the markdown or compensation to the dealer on the sale side of the transaction.

B) a combination of both the buy side and the sell side compensation to the dealer. This is known as a proceeds transaction, which is the sale of one position, and the purchase of another with the proceeds of the sale. The 5% markup policy is applicable to proceeds transactions. In compliance with the policy, the markup is computed by adding the compensation made by the dealer on the sell side to that made by the dealer on the buy side, and applying the total to the inside market on the buy side. LO 13.g

A customer is trying to understand any differences between a rollover and a trustee-to-trustee transfer as they relate to his qualified retirement plans. An accurate explanation would be that A) a rollover can occur as often as one wishes, but a trustee-to-trustee transfer can occur only once every 12-month period. B) a rollover can occur only once every 12-month period, but a trustee-to-trustee transfer can occur as often as one wishes. C) both rollovers and trustee-to-trustee transfers can occur as often as one wishes. D) both rollovers and trustee-to-trustee transfers can occur only once every 12-month period.

B) a rollover can occur only once every 12-month period, but a trustee-to-trustee transfer can occur as often as one wishes. For qualified retirement plans, a rollover is permitted only once in every 12-month period, while a trustee-to-trustee direct transfer can occur as often as one wishes. LO 1.g

Your customer, age 46, has been investing money in a variable annuity for several years. He plans to stop the deposits to meet current financial obligations, but he does not intend to withdraw any of the funds already invested until retirement, which is still several years away. Until the withdrawals are made, the client will be holding A) annuity units. B) accumulation units. C) accumulation shares. D) deferred units.

B) accumulation units. Until the customer withdraws funds or annuitizes, the annuity is still in the deferral stage, and the customer is holding accumulation units. LO 9.c

One of your clients has the opportunity to participate in his employer's employee stock purchase plan (ESPP). Before enrolling, he should be aware that funds will come out of his paycheck on? A) a pretax basis, and those contributions are not deductible on his tax return. B) an after-tax basis, and those contributions are not deductible on his tax return. C) a pretax basis, and those contributions are deductible on his tax return. D) an after-tax basis, and those contributions will be deductible on his tax return.

B) an after-tax basis, and those contributions are not deductible on his tax return. Contributions to an ESPP are payroll deductions. Though the contribution percentage is calculated on one's pretax salary, they are taken after tax. Contributions to ESPPs are not deductible on one's tax return.

Under the Securities Act of 1933, SEC registration is required for A) a commercial paper offering of $30 million maturing in 180 days. B) an offering of $25 million of a corporate bank holding company. C) a municipal revenue note offering of $4 million. D) a private placement offering of $60 million by a brokerage firm.

B) an offering of $25 million of a corporate bank holding company. While some banks and savings and loans are exempt, issuers' corporate bank holding companies are not. Private placements, municipal securities, and commercial paper (short term) are all exempt from federal registration.

When an analyst adds back the current year's depreciation to the net income, she is computing the company's A) net value of fixed assets B) cash flow from operations C) cash flow from investments D) earnings per share

B) cash flow from operations Cash flow from operations is computed by adding the year's depreciation deduction to the net income. LO 7.d

To achieve its goals, an inverse ETF uses A) preemptive rights. B) derivatives and debt. C) short selling. D) arbitrage.

B) derivatives and debt. An inverse ETF will almost always use derivatives, such as options and, in the case of a leveraged ETF, will use debt, primarily in the form of margin. Inverse ETFs do not engage in short selling; they are an alternative to selling short a specific index without the unlimited risk potential of the short sale. Arbitrage is used, typically by institutional investors, to the advantage of temporary imbalances between the ETF's net asset value and market price. LO 8.h

Having been a customer of a broker-dealer for over 10 years, currently holding equity positions and cash in his account, Daryl Smith wants to purchase 1,000 shares of a penny stock. Smith is A) required to receive both the suitability statement and the disclosure. B) exempt from the requirement to receive a suitability statement but subject to the disclosure requirement. C) exempt from the disclosure requirement but must receive a suitability statement. D) exempt from both the requirement to receive a suitability statement and the disclosure requirement.

B) exempt from the requirement to receive a suitability statement but subject to the disclosure requirement. Smith meets the criteria for an established customer under the penny stock rules. Established customers are exempt from the suitability statement requirement but not from the disclosure requirements. LO 3.j

Your client asks you to explain a not-held order. You could correctly explain that a not-held order A) can be filled only on the last trade of the day. B) gives time or price discretion to the floor broker. C) can only be done in a discretionary account. D) must be executed immediately and in its entirety.

B) gives time or price discretion to the floor broker. With a not-held order, the customer gives the firm's time or price broker the discretion as to time or price. Remember, however, that time and price alone do not require the order to be done in a discretionary account. LO 16.a

One of your customers is exploring the possibility of investing in a limited partnership (LP). To start the conversation, you think it would be wise to caution about what is generally considered to be one of the biggest disadvantages, which is A) the flow-through of certain expenses and losses. B) lack of liquidity. C) the flow-through of income. Therefore, investors owning units in the limited partnership may not be able to locate buyers. D) having an investment managed by general partners.

B) lack of liquidity. The greatest disadvantage to LPs is their lack of liquidity. The secondary market for LP interests is extremely small. Therefore, investors owning units in the limited partnership may not be able to locate buyers. The flow-through of income, losses, and expenses are considered advantages as the income can be sheltered by the expenses and losses. Having the investment managed by others is also considered an advantage, relieving the LPs from day-to-day operations and liability. LO 11.c

A customer has entered a day order to buy XYZ at 31.50. An hour before the market closes, she calls you and says that she is considering changing the order to a good-til-canceled (GTC) order. You tell her that A) this is a good strategy, but order replacements must be verified in writing by the customer. B) she should consider leaving the day order entered for the remainder of the day, and if left unexecuted, should enter a GTC order in the morning so that her existing day order would not lose its priority before today's close. C) she should consider entering another day order tomorrow morning because day orders have preference in execution over GTC orders. D) the mandatory service charge for canceling and replacing imposed by all exchanges makes this order replacement strategy too costly to be of benefit.

B) she should consider leaving the day order entered for the remainder of the day, and if left unexecuted, should enter a GTC order in the morning so that her existing day order would not lose its priority before today's close. Explanation Orders maintain priority on the order book on the basis of the time of entry. Canceling and reentry loses the existing priority. Leaving the day order for the remainder of the day, and if left unexecuted, entering a GTC the next day, is the best order replacement strategy in this situation. LO 16.a

A registered representative (RR) correctly explains to a new customer who wants to learn about the tax and risk characteristics of collateralized mortgage obligations (CMOs) that the securities are A) taxable only in the state where the mortgages originated from and are backed by the federal government. B) taxable at all levels and subject the holders to prepayment risk. C) tax exempt in the states where the mortgages originated from and they subject holders to prepayment risk. D) tax exempt at the federal level and do not have fixed maturity dates.

B) taxable at all levels and subject the holders to prepayment risk. CMOs are taxable at all levels. One of the primary risks of CMOs is prepayment of principal because they are backed by mortgage paper. If interest rates fall, mortgage holders will refinance paying off existing mortgages earlier than expected. LO 12.c

A bond is being issued to build a toll road. It has been identified that the state does not own all of the property that the road is going to be built upon. This would most likely be disclosed in A) the trust indenture. B) the qualified legal opinion. C) the prospectus. D) the bond resolution.

B) the qualified legal opinion. Any legal uncertainty of which bondholders should be informed is first identified by the legal opinion obtained by the municipality issuing the bond. Municipal bonds are exempt from registration with the SEC, and therefore, do not have a prospectus requirement. The full and fair disclosure document for municipal bonds is called the official statement (which would disclose this information as well). LO 6.c

Your customer has purchased a 5.8 % LMN corporate bond in a regular way transaction. Settlement for this bond trade is A) trade date plus one business day. B) trade date plus two business days. C) trade date plus four business days. D) trade date.

B) trade date plus two business days. Regular way settlement on corporate security and municipal bond security trades is T + 2.

A customer opens a new margin account and immediately purchases 200 shares of XYZ stock, which is trading at $9 per share. The customer must deposit A) $2,000. B) $900. C) $1,800. D) $450.

C) $1,800. If the first trade in a long margin account is less than $2,000, the customer must deposit 100% of the purchase price. LO 16.d

An investor's margin account has a short market value of $9,000 and a credit balance of $13,000. Assuming Regulation T is 50%, a maintenance call will be triggered if the short market value increases above A) $13,000. B) $9,000. C) $10,000. D) $11,000.

C) $10,000. Minimum maintenance rules require a minimum maintenance of 30% for a short margin account. The maintenance level is determined by dividing the credit balance by 1.3 ($13,000 ÷ 1.3 = $10,000). LO 16.d

With ABC stock trading at 33.10, a customer buys 2 ABC Jun 35 puts at 4.35. What is the time value of each contract? A) $4.90 B) $0 C) $2.45 D) $1.90

C) $2.45 Time value is the premium minus the intrinsic value ($4.35 − $1.90 = $2.45). LO 10.c

An investor contributes $200,000 in cash to an oil and gas partnership. The partnership has entered into a nonrecourse loan for $500,000. The customer's cost basis in the program is A) $300,000. B) $500,000. C) $200,000. D) $700,000.

C) $200,000. Cost basis in all direct participation programs (DPPs), other than real estate, consists of actual investment plus any recourse financing. Because this note is nonrecourse, it is not included in the customer's cost basis. LO 11.f

For margin purposes, valuing a short position by marking to market will occur how often? A) At the end of business each week on Friday B) Only in months when margin activity in the account will generate a statement to the customer C) At the close of each business day D) No more than once per month

C) At the close of each business day All positions, long or short, are marked to market daily for purposes of valuing the position. LO 16.c

A customer interested in a collateralized mortgage obligation (CMO) might look to which of the following for historical data or projections regarding mortgage prepayments? A) FINRA B) Bond Buyer C) PSA D) DEA

C) PSA The Public Securities Association (PSA) is the source of historical data for prepayment projections on CMOs. LO 12.d

Which of the following types of risk cannot be eliminated through diversification under the modern portfolio theory? A) Interest rate risk B) Business risk C) Systematic risk D) Liquidity risk

C) Systematic risk Market risk, sometimes referred to as systematic risk, cannot be diversified away. The risk of investing in a single industry or sector can be diversified away by investing in several industries with returns not correlated to each other. A general downturn in the market, however, cannot be eliminated through diversification. LO 14.a

An investor has purchased American depositary receipts (ADRs) to achieve portfolio diversification. Holding the ADRs in a portfolio entitles the investor to dividends paid in A) the foreign currency and the ability to trade ADRs on foreign markets. B) the foreign currency and the ability to trade ADRs on U.S. securities markets. C) U.S. dollars and the ability to trade ADRs on U.S. securities markets. D) U.S. dollars and the ability to trade ADRs on foreign markets.

C) U.S. dollars and the ability to trade ADRs on U.S. securities markets. Explanation Dividends on ADRs are declared in the foreign currency, and are paid to investors in U.S. dollars. This is why ADR investors bear currency risk. ADRs trade on U.S. markets, either on an exchange or OTC. LO 3.g

Which of the following statements regarding convertible debentures is true? A) The issuer pays a higher rate of interest, compared with a comparable nonconvertible debenture. B) The issuer has the right to convert the debentures during the time period specified in the indenture. C) When compared with similar nonconvertible debentures, convertible debentures are issued with a lower coupon rate. D) The debenture holders receive a variable rate of interest.

C) When compared with similar nonconvertible debentures, convertible debentures are issued with a lower coupon rate. A conversion feature is a benefit to the debtholder. It allows the debtholder a choice to either continue holding the debt represented by the debenture or to convert it into shares of common stock of the underlying issuer. Everything that is done in the securities industry has to be a win/win situation. The win for the debtholder in this instance is the ability to take advantage of the capital appreciation potential the common stock may offer, and the win for the issuer is that by offering something extra to the debenture purchaser, that purchaser is willing to accept a lower interest rate on the debt (as compared to a nonconvertible debenture) and therefore giving the issuer a lower cost of capital. It is the debtholder, not the issuer who determines when and if to convert. LO 2.j

A customer has $10,000 of capital losses and $2,000 of capital gains in her portfolio this year. The tax consequences would be A) a $3,000 loss deduction with no loss carried forward. B) a $10,000 loss deduction in the current year. C) a $3,000 loss deduction with a $5,000 loss carried forward. D) a $8,000 loss deduction in the current year. Explanation The customer's net tax consequence is a loss of $8,000. Each year, individuals are permitted to deduct $3,000 in losses from their income, and any excess may be carried over to the following year. In this case, after the $3,000 deduction, the excess carried over to the following year would be $5,000. LO 3.i

C) a $3,000 loss deduction with a $5,000 loss carried forward. The customer's net tax consequence is a loss of $8,000. Each year, individuals are permitted to deduct $3,000 in losses from their income, and any excess may be carried over to the following year. In this case, after the $3,000 deduction, the excess carried over to the following year would be $5,000. LO 3.i

A toll road authority issues a revenue bond backed by the revenue stream from the tolls collected. In addition, the state has agreed to cover any shortfall. This bond is categorized as A) an overlapping debt issue. B) a moral obligation bond. C) a double-barreled bond. D) an industrial revenue bond.

C) a double-barreled bond. A bond secured by both a defined source of revenue (other than property taxes) and the full faith and credit of an issuer that has taxing powers, such as the state, is known as a double-barreled bond. LO 6.b

Regarding convertible debentures, one characteristic of which your clients should be aware of is that A) the conversion feature protects against an early call. B) they generally pay a higher interest rate than nonconvertible debentures. C) although they trade in line with the issuer's common stock, they are less volatile than the common shares. D) it is generally best to convert when the common stock is selling below its parity price.

C) although they trade in line with the issuer's common stock, they are less volatile than the common share The lower volatility of a convertible debenture stems from the fact that it has fixed interest payments and will be redeemed at maturity as any other bond or debenture would. No such guarantees apply to common stock. LO 1.b LO 5.c

Because of their unlimited potential loss, short positions A) can only be taken by those who are accredited investors. B) must be approved by a designated principal before execution. C) are marked to the market at the close of each day. D) require a higher initial margin deposit.

C) are marked to the market at the close of each day. Explanation Although most securities positions are marked to the marked on a daily basis, it is more important that this be done with short positions because of how quickly they can reach the maintenance margin level. The initial margin is the same as long purchases, and the term accredited investors applies principally to private placements. Short sales, just as with any transaction, must approved by a principal, but not in advance. LO 16.c

A registered representative is the subject of a disciplinary action that results in a fine and a 60-day suspension of registration. During the 60-day suspension period, the registered representative may A) only perform clerical or administrative functions for the member. B) only perform investment advisory services. C) be paid for business generated before the suspension date. D) be paid for business that they refer to other registered representatives while serving the suspension.

C) be paid for business generated before the suspension date. During a period of suspension of registration, the individual may not perform any duties for the broker-dealer, whether they require registration or not. They may not be paid for business referred to other registered personnel, but they may receive commissions for business placed before the date of the suspension. 18d

All of the following statements regarding municipal advertising are true except A) it must not be misleading. B) copies must be kept for four years. C) copies must be sent to the Municipal Securities Rulemaking Board (MSRB). D) it must be approved by a principal.

C) copies must be sent to the Municipal Securities Rulemaking Board (MSRB). All municipal advertising must be approved, in writing, by an appropriate principal before the first use and kept on file for four years. It need not be filed with the MSRB because the MSRB has no enforcement authority. LO 19.c

When investing in a direct participation program (DPP), an investor should know that some asset types cannot be depreciated or depleted. One example of such an asset would be A) buildings. B) gas. C) crops. D) oil.

C) crops. Natural resources like oil and gas can be depleted and buildings are a depreciable asset, but farm crops are considered to be renewable assets. LO 11.f

A client, age 52, wants to know if there are any circumstances that will allow withdrawals from her IRA without having to pay the 10% penalty. One example you could give is A) housing expenses while she is unemployed. B) up to $10,000 annually for the first-time purchase of a principal residence. C) education expenses for one of her grandchildren. D) premiums for medical insurance in excess of defined adjusted gross income (AGI) limits.

C) education expenses for one of her grandchildren. Distributions before age 59½ are subject to a 10% penalty, as well as regular income tax. The 10% penalty is not applied in the event of the following: death; disability; purchase of a principal residence by a first-time homebuyer (up to $10,000—lifetime); education expenses for the taxpayer, a spouse, a child, or a grandchild; medical premiums for unemployed individuals; medical expenses in excess of defined AGI limits; and Rule 72(t): substantially equal periodic payments. LO 1.g

With respect to elective deferrals, a 403(b) plan must meet the requirements of the universal availability rule. Under this rule, if any employee of the employer maintaining the 403(b) may participate, then all of the employer's employees must be given the opportunity to participate. Certain employees may be excluded, including A) any substitute teacher. B) employees who normally work less than 1,200 hours per year. C) employees who normally work less than 20 hours per week. D) individuals not contributing to an IRA.

C) employees who normally work less than 20 hours per week. The IRS considers 20 hours per week to be equivalent to 1,000 hours per year (where mandatory eligibility begins). Working less than that allows the employer to exclude the employee from participation. Although most substitute teachers are likely to fall short of the 1,000 hours per year, any who meet that requirement must be given eligibility. Contributing to an IRA has nothing to do with plan eligibility. LO 1.i

Even in the best firms, there are times when a customer files a complaint. FINRA recordkeeping requirements for those complaints is A) two years. B) three years. C) four years. D) six years.

C) four years. Explanation Although the general recordkeeping requirements are three years, with some of the corporate-type documents being six years, FINRA has selected four years as the retention period for customer complaints. LO 15.e

While looking at a report of trades that had been executed for your customers in the secondary market, you would not see included A) agency securities. B) American depositary receipts (ADRs). C) mutual fund shares. D) municipal bonds.

C) mutual fund shares. There is no secondary trading market for mutual funds. All purchases and redemptions are done through the issuer or underwriter. All shares sold are newly issued shares (primary market). LO 8.c

A broker-dealer wants to reference its membership with FINRA on its website. Regarding the reference, all of the following are true except A) there is no requirement that any FINRA member broker-dealer shall reference FINRA by name or logo on its website. B) if the FINRA reference is made, a hyperlink to FINRA's website must be in close proximity to the reference. C) the FINRA reference is intended to demonstrate that the broker-dealer has the approval of FINRA in all of its business dealings. D) if the FINRA reference is made, a hyperlink to FINRA's website is mandated by FINRA.

C) the FINRA reference is intended to demonstrate that the broker-dealer has the approval of FINRA in all of its business dealings. There is no requirement to list or mention FINRA membership or any other self-regulatory organization (SRO) membership on a broker-dealer website. If, however, a broker-dealer chooses to have the FINRA name or logo on its website, it should never be displayed in such a way as to imply—or mean to imply—approval of FINRA. If FINRA or its logo is used, a hyperlink to the FINRA website is required, and it must be placed in close proximity to the reference. LO 19.d

For an oil and gas limited partnership (LP), allowances in the form of deductions are allowed by the IRS to be taken to compensate for a depleting resource. The allowance can be taken based on A) the amount of the natural resource extracted. B) the cost of moving the natural resource to refiners and distributors. C) the amount of the natural resource sold. D) the condition or grade of the natural resource.

C) the amount of the natural resource sold. Depletion allowances may be taken only once the oil or gas is sold and is based on the amount sold (depleted). LO 11.f

You use fundamental analysis to help make investment decisions. For this type of analysis, you would not be interested in A) positioning of a company within its industry. B) corporate financial statements. C) trading volume and price patterns. D) current business conditions.

C) trading volume and price patterns. Fundamental analysis looks at the company itself or the economy, whereas technical analysis looks at trading patterns. The words charts, price, and volume are usually indicators that the analysis is technical. LO 13.e

An investor purchased 200 shares of DCAST common stock at $200 per share. What is the adjusted cost basis per share of this position after the company pays a 100% stock dividend? A) $400 B) $200 C) $100 D) $50

C) $100.00 Explanation The total value of the initial position is unchanged, remaining at $40,000 (200 times $200). After the stock dividend, the investor owns 400 shares (200 times 100% = 200 + 200 = 400). Therefore, the adjusted cost basis is $100.00 per share ($40,000 divided by 400 = $100). Perhaps you recognized that a 100% stock dividend has the same effect as a 2:1 split. That is, the stock's cost basis is cut in half. It is important to remember that anytime there is a distribution resulting in additional shares (stock split, stock dividend), the cost basis per share is reduced while the total account value remains the same. LO 3.b

A website maintained by a fund company shows that one of the company's mutual funds currently has a NAV of $9.50 and a public offering price (POP) of $10 per share. Your client sees this information and enters an order to make a $10,000 purchase. He asks you to calculate the number of shares he will be able to buy with today's investment. You would respond that A) based on the $10 POP, he will be receiving exactly 1,000 shares into his account immediately. B) based on the 5% sales charge, he will be receiving exactly 950 shares into his account immediately. C) it cannot be determined until after the order is processed by the fund at the next calculated (forward) price. D) based on the $9.50 NAV, he will be receiving exactly 1,052.63 shares into his account at the end of the day.

C.) it cannot be determined until after the order is processed by the fund at the next calculated (forward) price. Mutual funds use forward pricing, so the purchase or redemption price is never known until after the order is processed. This order will be executed at the next calculated POP. LO 8.c

An investor with no other positions sells 1 ABC Jun 25 put at 1.50. If the put is exercised when the stock is trading at 24, and the investor immediately sells the stock in the market, what is the investor's profit or loss? A) $150 loss B) $50 loss C) $150 profit D) $50 profit

D) $50 profit Explanation The investor has the obligation to buy the stock at the strike price of 25. The stock is currently worth 24, which is a loss of 1. The investor's premium of 1.50 minus the loss of 1 leaves a net profit of 0.50 (0.50 × 100 = $50). LO 10.h

XYZ Corporation declares a 4-for-3 stock split. An investor long 600 shares will receive how many additional shares? A) 800 shares B) 300 shares C) 100 shares D) 200 shares

D) 200 shares Explanation With a 4-for-3 split, the investor will receive additional shares equal to one-third of the current holdings. For every three shares held, an investor receives a fourth share. The investor will now have 800 shares, but the question is only asking about the additional shares, not the total. LO 3.b

The Achieving a Better Life Experience (ABLE) Act limits eligibility to individuals with significant disabilities where the age of onset of the disability occurred before turning age A) 50½. B) 21. C) 18. D) 26.

D) 26. The ABLE Act limits eligibility to individuals with significant disabilities where the age of onset of the disability occurred before turning age 26. LO 6.g

Which of the following customer information should a registered representative (RR) be most concerned about if opening a margin account? A) Has a high risk tolerance B) Wants to leverage the investment C) Participates in a 401(k) plan at work D) Does not have sufficient savings for an emergency

D) Does not have sufficient savings for an emergency Before investing, it is important that the investor have some fundamentals covered, such as cash reserves in the event money is needed immediately (e.g., house needs a new roof, furnace needs to be replaced, a medical procedure is needed and insurance won't cover it). LO 2.a

Which items would change if a company buys equipment for cash? The working capital The total assets The total liabilities The shareholders' equity A) IV only B) I and II C) II and IV D) I only

D) I only Explanation The general balance sheet formula is assets = liabilities + shareholders' equity. A purchase of equipment for cash would affect working capital by reducing current assets. However, it would not affect total assets because it is an exchange of one asset (cash) for another asset of equal value (equipment). Because no loan was needed, it does not affect total liabilities, nor does it affect equity. LO 13.d

A registered representative (RR) at a broker-dealer mentions continuity of life as it pertains to limited partnerships (LPs). The reference can best be explained by which of the following statements? A) Continuity of life is a characteristic of LPs because they are scheduled to end on a predetermined date. B) LPs will exist until the last partner is deceased. C) LPs have continuity of life, which means they will exist in perpetuity. D) LPs do not have continuity of life because unlike corporations, a limited partnership will end on a predetermined date.

D) LPs do not have continuity of life because unlike corporations, a limited partnership will end on a predetermined date. Explanation Continuity of life is a corporate characteristic that must be avoided for a partnership to qualify as a direct participation program. The phrase refers to the fact that a corporation should exist in perpetuity. LPs, however, are all scheduled to end on a predetermined specific date. LO 11.c

ABC stock is going ex-dividend today, and certain orders on the order book must be reduced prior to the opening. For a cash dividend of 0.12, which of the following orders would be reduced? A) Sell 100 ABC at 50. B) Buy 100 ABC at 50 stop. C) Buy 100 ABC at the market. D) Sell 100 ABC at 45 stop.

D) Sell 100 ABC at 45 stop. Explanation Orders that are entered below current market value would be reduced unless do not reduce (DNR) instructions are received. Those orders are buy limits, sell stops (BLiSS) orders. These orders are reduced by the amount of the dividend on the ex-dividend date for a cash dividend distribution. LO 16.a

Your customer wants to buy 1,000 shares of XYZ stock and has entered a not-held order with instructions to you to purchase the stock when you feel the price looks right. Under the rules, this order will be treated as A) a limit order. B) a good-til-canceled (GTC) order. C) an immediate-or-cancel (IOC) order. D) a day order.

D) a day order. Explanation Unless the customer designates that the order is GTC, a not-held order is treated as a day order, and any unexecuted portion of the order remaining at the end of the day will be canceled. LO 16.a

Your customer wants you to recommend an option strategy that will prove profitable in a highly volatile stock, regardless of which direction the stock price moves. To suit the client's objective, you should recommend A) a short straddle. B) a debit put spread. C) a credit call spread. D) a long straddle.

D) a long straddle. A long straddle consists of a put and a call on the same security with the same strike price and the same expiration date. Should the stock increase, the call will increase in value. If the stock declines, the put will increase in value, making the position profitable if the stock moves in either direction. LO 10.f

A customer who is long 500 shares of XYZ writes 7 calls against the position. This is an example of A) a vertical spread. B) portfolio insurance. C) a long straddle. D) a ratio write.

D) a ratio write A ratio write is used to describe the position when more call options are written than there are shares of stock available to cover the call. In this case, the customer has 5 covered and 2 uncovered calls. It should also be recognized that the two uncovered calls represent an unlimited maximum loss potential. LO 10.d

A U.S. investor owns an American depositary receipt (ADR). The net tax liability to the investor for any dividends received is A) any foreign income tax due, but not U.S. income tax. B) the total of both foreign and U.S. income tax due. C) zero, because there is no tax liability to U.S. investors who purchase foreign government issues. D) any U.S. income tax due, credited by any amount of foreign income tax withheld.

D) any U.S. income tax due, credited by any amount of foreign income tax withheld. Any income to a U.S. investor is always subject to U.S. income tax. If foreign income tax is withheld in the country of origin, then that tax may be taken as a credit against the U.S. tax due. LO 3.g

The manager of an equity fund wishes to hedge the fund's portfolio against a possible market decline. Of the strategies listed, to provide the best protection, the manager would buy A) broad-based index calls. B) narrow-based index puts. C) narrow-based index calls. D) broad-based index puts.

D) broad-based index puts. Explanation The best way to hedge a long position is to buy puts. In this case, the broad-based index would be a better match for the stock portfolio than a narrow-based index. LO 10.g

A U.S. importer orders computer components from a Japanese manufacturer with payment to be made in yen upon delivery. To hedge against the dollar weakening against the yen before payment is due, the importer should A) sell yen calls. B) buy yen puts. C) sell yen puts. D) buy yen calls.

D) buy yen calls. If the dollar was to weaken against the yen, then the yen would increase in value. If one wished to gain as the result of an asset's increased value, the appropriate option strategy is the purchase of a call. As a general rule, to hedge, importers buy calls on the foreign currency, whereas exporters buy puts. LO 10.g

A broker-dealer that is a financial advisor to a municipal issuer A) can act as an underwriter of the issuer's bonds in a negotiated underwriting only if they want to receive compensation for both services. B) can act as an underwriter of the issuer's bonds in a competitive bid underwriting only if they want to receive compensation for both services. C) can act as an underwriter of the issuer's bonds in a negotiated underwriting or competitive bid underwriting and receive compensation for both services. D) cannot act as an underwriter of the issuer's bonds in a negotiated or competitive bid underwriting and receive compensation for both services.

D) cannot act as an underwriter of the issuer's bonds in a negotiated or competitive bid underwriting and receive compensation for both services. Broker-dealers acting as financial advisors to a municipality regarding a municipal issue are prohibited by MSRB Rule G-23 to also act as underwriters for the same issue regardless of whether the underwriting process has been done by competitive bid or was negotiated. In the event that an exception is allowed, or the broker-dealer performs an advisory function specifically associated with the underwriting, the broker-dealer would be limited to accepting fees for the advisory service only and not be allowed to accept fees for any underwriting services. LO 6.h

Upon assignment, the writer of an exchange listed equity call option must A) pay for the underlying stock to buy within two business days. B) deliver the underlying stock to sell within one business day. C) pay for the underlying stock to buy within one business day. D) deliver the underlying stock to sell within two business days.

D) deliver the underlying stock to sell within two business days. Assignment of an equity call option requires the assigned party to deliver the underlying stock. This is treated the same as any other sale of stock. Regular way delivery is two business days after the trade date. In the case of assignment, the trade date is the assignment date.

The item that is not true when you read a bond quote of 6.5s of 29 at 99 is A) the bond matures in 2029. B) if traded at this price, the yield to maturity rather than the yield to call would be shown on the confirmation. C) the bond is trading at a 1-point discount. D) if the price quote was changed to a basis quote, the yield would be less than 6.5%.

D) if the price quote was changed to a basis quote, the yield would be less than 6.5%. Explanation This bond is trading at a discount of 1 point ($10); therefore, a basis quote, which is the bond's yield to maturity, will be greater than the 6.5% coupon, not less than 6.5%. YTC is only shown when it produces the lowest yield. That would never be the case with a bond traded at a discount. LO 6.a

An investor wanting to purchase municipal bonds should be aware that in most instances, if she buys the bond and then later sells it for a profit, then A) both interest received and capital gains will be exempt from taxation. B) interest received will be taxable, but the capital gains are exempt from taxation. C) neither interest received nor capital gains will be exempt from taxation. D) interest received will be exempt from taxation, but not the capital gains.

D) interest received will be exempt from taxation, but not the capital gains. The interest on municipal debt is largely exempt from taxation, but not the capital gains. LO 6.f

A debt securities analyst is examining a municipality's statutory debt limit, which he knows can limit the issuer from A) issuing revenue bonds. B) limiting or capping property taxes. C) raising property taxes. D) issuing general obligation bonds.

D) issuing general obligation bonds. Explanation A municipality may be limited by a self-imposed statute regarding the amount of GO debt it may incur. LO 6.c

With the underlying stock at $37, an ABC Jan 35 call is trading at $2. All of the following statements regarding the option are true except A) it is in the money. B) it is at parity. C) it is trading at breakeven. D) it has time value.

D) it has time value. Explanation This option is at parity or breakeven, which occurs when the premium equals the in-the-money amount. An option trading at parity has no time value. When an option has no time value remaining, it is very near or at the moment of expiration. 10c.

You believe XYZ stock will be rising and want to recommend a spread position to your client that would be profitable if it does. Of the positions listed, you would recommend that the client go A) long 1 XYZ Jan 40 call and short 1 XYZ Jan 30 call. B) short 1 XYZ Jan 40 put and long 1 XYZ Jan 50 put. C) short 1 XYZ Jan 30 call and long 1 XYZ Jan 50 call. D) long 1 XYZ Jan 30 put and short 1 XYZ Jan 40 put.

D) long 1 XYZ Jan 30 put and short 1 XYZ Jan 40 put. Of the choices given, the correct answer is the credit put spread. Credit put spreads are bullish. Anytime the long option in a spread has a lower strike price than the short position, the spread is known as a bullish spread. We refer to that strategy as buy low, sell high (BLSH). LO 10.e

Your customer, who lives in State A, is in the highest federal and state income tax bracket. She is considering purchasing some State B municipal bonds with an Aa rating for her portfolio. You correctly explain that municipal bonds generally pay A) lower interest rates than corporate issuers of the same quality and maturity because of the tax treatment of their capital gains. B) lower interest rates than corporate issuers of the same quality and maturity because the interest is tax free on a state, local, and federal level. C) higher interest rates than corporate issuers of the same quality and maturity, but this is offset by the more favorable tax treatment of the interest. D) lower interest rates than corporate issuers of the same quality and maturity because of the tax treatment of their interest.

D) lower interest rates than corporate issuers of the same quality and maturity because of the tax treatment of their interest. As a result of the tax-advantaged status of municipal bond interest (tax free on the federal basis; sometimes tax free on the state and local basis), municipalities generally pay lower interest rates than corporate issuers when the bonds are of similar quality and maturity. The interest on State B bonds will not be free of taxation on the state and local level in State A—the exemption only applies to residents of State B. Because the interest is tax free, these bonds are more suitable for those in higher tax brackets. LO 6.f

If a municipal bond has a call provision, this will tend to A) have no effect on the price. B) make the bond more attractive to investors because most bonds are called at a premium. C) place a floor on how low the price will decline. D) make the bond less attractive to investors because a call would terminate the interest payments.

D) make the bond less attractive to investors because a call would terminate the interest payments. The possibility of a call is unattractive to the investor. In most cases, bonds are called when their interest rate is above the current market rate. This means the investor must give up that higher yielding security. It is attractive to the issuer because with a call, the bonds are bought back at par or a small premium, and interest payments end. LO 6.d

A 50-year-old investor purchases a single payment deferred variable annuity with a premium of $50,000. Five years later, the value of the account is $45,000, and the investor makes a $10,000 withdrawal. The tax consequences of this action would be A) ordinary income on the $5,000 difference between the purchase price and the current value plus a penalty of 10% because the investor is only 55 years old. B) ordinary income on the entire $10,000 withdrawn plus a penalty of 10% because the investor is only 55 years old. C) ordinary income on the $5,000 difference between the purchase price and the current value. D) no tax is due.

D) no tax is due. Investors in variable annuities are only taxed on the earnings of the account. This account lost money—there were no earnings to be taxed. LO 9.d

A bond is quoted as QRS Zr 39. This quote tells an investor that the bond A) is backed by the U.S. government. B) pays interest annually. C) pays interest semiannually. D) pays no interest until maturity.

D) pays no interest until maturity. The initials Zr in the bond quote indicate that this is a zero-coupon bond. Zero-coupon bonds pay all interest at maturity even though the investor is taxed annually as if he had been receiving the interest over the life of the bond. LO 5.a

An immediate dilution to earnings per share (EPS) would be least likely to occur from A) conversion of debentures. B) a 10% stock dividend. C) a 2:1 stock split. D) refunding a bond at par.

D) refunding a bond at par. Explanation When a bond is refunded at par, the cash used is equal to the reduction in the liability resulting in no immediate corporate EPS (the number of shares remains the same). A stock split, a stock dividend, and conversion of a debenture increase the number of shares outstanding. Because the earnings haven't changed and there are more shares, the EPS is lower (diluted). LO 13.d

An hour ago, you entered a sell limit order for your customer in XYZ stock. Looking at a current quote, you could expect the order to have been executed if A) the offer or ask price for XYZ is lower than your customer's sell limit, and the last reported price in the stock is above the sell limit price. B) the bid price for XYZ is higher than your customer's sell limit, and the last reported price in the stock is below the sell limit price. C) the offer or ask price for XYZ is lower than your customer's sell limit, and the last reported price in the stock is below the sell limit price. D) the bid price for XYZ is higher than your customer's sell limit, and the last reported price in the stock is above the sell limit price.

D) the bid price for XYZ is higher than your customer's sell limit, and the last reported price in the stock is above the sell limit price. A sell limit order sets the minimum price an investor will accept. The order should have been executed if the current bid price is higher than the sell limit or the last reported price in the stock is higher than the sell limit. LO 16.a

Approval of a new options account by a principal may occur before A) the new account form has been completed. B) the customer has been furnished an options disclosure document. C) the customer has provided essential suitability information. D) the customer has verified information on the new account form.

D) the customer has verified information on the new account form. Explanation For the account to be opened, it would need to be approved by a principal first. To do so, a new account form would have to be completed, suitability information would have to have been supplied by the customer, and an options disclosure document would have to have been provided to the customer. The new options customer must verify information on the new account form within 15 days of opening the account. LO 10.j

Your customer has just signed a limited partnership subscription agreement. Regarding the signing of this agreement, it is important for the customer to know that A) the registered representative (RR) and general partner are required to sign before the customer can become a limited partner. B) a new agreement is required anytime assets in the partnership are bought or sold. C) a copy of the agreement signed by all partners must be filed with the SEC. D) the customer will be considered a limited partner only after the subscription agreement has been signed by the general partner.

D) the customer will be considered a limited partner only after the subscription agreement has been signed by the general partner. One of the unique characteristics of DPPs (limited partnerships) is that a customer must be accepted by the general partner to become a limited partner in the venture. Therefore, the customer is not a limited partner until the general partner signs the subscription agreement. LO 11.d

A customer's confirmation of a municipal securities transaction must include A) the highest potential yield the customer may receive and information regarding the catastrophic call provision. B) the highest potential yield the customer may receive and the amount of markup or markdown in a principal transaction. C) the lowest potential yield the customer may receive and information regarding the catastrophic call provision. D) the lowest potential yield the customer may receive and whether the bond is taxable or subject to the alternative minimum tax.

D) the lowest potential yield the customer may receive and whether the bond is taxable or subject to the alternative minimum tax. Customer confirmations always reflect a worst-case scenario (lowest) regarding yield. Any possible tax ramifications, such as the bond being designated as an AMT bond, must also be disclosed. Catastrophe call provisions need not be disclosed on a confirmation. Commissions and markups/markdowns are disclosed, but not the highest yield. ** This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback. LO 6.h

The IRS has determined that the NYNY real estate existing property limited partnership is abusive. The most likely reason would be because A) each partner received enough in losses to shelter all income. B) all of the assets were found to be rental properties. C) no net profit was generated after losses were taken. D) there was no viable profit motive.

D) there was no viable profit motive. To qualify as a limited partnership direct participation program (DPP), above all else, there must be a viable chance to make a profit. Any DPP established without a profit motive or with the intention of only generating tax losses for investors may be determined abusive by the IRS subjecting the partners to penalties including prosecution for fraud. LO 11.g