Series 7 Prac exam 2

If an investment company invests in a fixed portfolio of municipal or corporate bonds, it is classified as A) a unit investment trust. B) a growth fund. C) a utilities fund. D) a closed-end company.

A Explanation A unit investment trust issues shares that represent units of a particular portfolio; management has no authority—or only limited authority—to change the portfolio. The portfolio is fixed, not traded.

T-bills are quoted A) on an annualized discount yield basis. B) in 32nds. C) as a percentage of par. D) in 16ths.

A Explanation T-bills do not bear interest. T-bills trade and are quoted on an annualized discount yield basis.

If a corporation has a dividend payout ratio of 70%, the undistributed earnings will A) decrease book value. B) increase retained earnings. C) increase earnings per share. D) increase capital surplus.

B Explanation Retained earnings represent income that has not been paid out to shareholders.

Which of the following would be of least interest to a technical analyst? A) Advance/decline line B) Short interest ratio C) Price-to-earnings (P/E) ratio D) Trading volume

C Explanation Technical analysts rely on price and trading trends to determine when to buy or sell stock. They are not interested in the specific financial information of an issuer. P/E ratios are of greater interest to fundamental analysts.

In a rising market, all of the following strategies are appropriate except A) debit call spreads. B) long calls. C) short puts. D) short stock/short put.

D Explanation Investors who short stock have sold borrowed shares and profit when the market price declines.

Define the exporting/importing acronyms IPEC EPIC

Exporters buy Puts and Importers buy Calls. Because there are no options on the U.S. dollar, the Swiss company should buy calls on its own currency to hedge In other words, EPIC works in reverse if the question is dealing with a foreign company. Then it is IPEC for Importers buy Puts and Exporters buy Calls.

A customer purchases five 6.25% U.S. Treasury notes at 98.24. How much will the customer receive on each interest payment date? A) $156.25 B) $153.50 C) $154.30 D) $312.50

A Explanation Although minimum purchase denominations can be less, always use par value ($1,000) for these calculations. A 6.25% bond pays $62.50 annually (6.25% × $1,000 = $62.50). Therefore, a customer purchasing five bonds receives $312.50 each year. Because Treasury notes pay semiannually, each interest payment equals $156.25.

An investor who is long TCB stock for six months buys 1 call on TCB. If the call expires in eight months, and the investor sells the stock three months after the call expires, what does he realize on the stock? A) Long-term gain or loss B) Long-term gain or short-term loss C) Short-term gain or long-term loss D) Short-term gain or loss

A Explanation The purchase of a call has no effect on a long stock position's holding period. The call only allows more stock to be purchased; it does not allow the stock to be sold. The investor held the stock for 17 months, exceeding the holding period required for long-term capital gains treatment (more than one year).

If a customer writes 1 ABC Nov 60 put at 3.50, and the put is exercised when ABC is 57.50, the customer's cost basis in ABC stock is A) $57.50. B) $56.50. C) $54.00. D) $60.00.

B Explanation At exercise, the premium of the contract affects the cost basis of the stock acquired. Because the premium of 3.50 was received when the put was written, the cost basis of the stock will be $60 per share less the premium, or 56.50.

Correspondence—one of the three categories of communication with the public—is defined as A) written communications only that has been made available to 25 or fewer retail investors within the past six months. B) any written or electronic communication that is distributed or made available to 25 or fewer retail investors within any 30-calendar-day period. C) communication that is targeted only at individuals who currently maintain accounts with the broker-dealer. D) electronic communication only that has been made available to 25 or fewer retail investors within the past six months.

B Explanation Correspondence can be written or electronic and targeted at either a broker-dealer's account holders or nonaccount holders. The criteria that makes communication a correspondence is that it is distributed to 25 or fewer retail customers within any 30-calendar-day period.

To be designated as an accredited investor under Regulation D, a married couple investing in a joint account must have income in the past two years of at least A) $500,000. B) $300,000. C) $100,000. D) $200,000.

B Explanation To be accredited, a couple must have at least $300,000 in annual income. For individuals, the income threshold is $200,000.

All of the following regarding Section 529 education savings plans are true except A) they are not subject to income limitations. B) withdrawals at the federal level for qualified education expenses are tax free. C) tax-deductible contributions are at the federal level. D) there are high contribution limits.

C Explanation Contributions are made with after-tax dollars and are not deductible.

A customer purchases 200 shares of XYZ at 17.50 and writes 2 XYZ Jan 20 calls at 1. At expiration, with the stock trading at 19, the options expire worthless. If the customer sells his long stock at the current market price, the gain is A) $700. B) $250. C) $500. D) $350.

C Explanation The customer buys stock at $17.50 and sells his shares at $19 for a gain of $300. In addition, the customer keeps the $200 in premiums, for an overall gain of $500.

Congress passed the Trust Indenture Act of 1939 to protect bondholders. It requires that issuers of eligible bonds appoint a trustee to ensure that promises (covenants) between the issuer and the trustee who acts solely for the benefit of the bondholders are carried out. The Trust Indenture Act of 1939 applies to which of the following issues offered on an interstate basis? A) A corporate bond in the amount of $38 million with a maturity of 10 years B) A municipal general obligation bond in the amount of $200 million with a maturity of 20 years C) A corporate bond in the amount of $500 million with a maturity of 8 months D) A corporate bond in the amount of $200 million with a maturity of 20 years

D Explanation There are four basic elements qualifying a bond issue for coverage under the Trust Indenture Act of 1939. Those are as follows: It is a corporate issue, The issue size is more than $50 million within 12 months. The maturity is 9 months or more. It is offered interstate. A $200 million corporate bond issue with a 20-year maturity would be covered under the act, and the other choices would not.

Which of the following orders on the order book will not be filled if the stock rises? A) Buy stop B) Buy stop limit C) Sell limit D) Sell stop

D Explanation Those orders on the book which are above the current market will be executed if the stock rises. Those open orders above the current market are buy stops (including buy stop limits) and sell limits.

Which of the following forms of business is preferred when the goal is raising a significant amount of capital? A) General partnership B) LLC C) S corporation D) C corporation

D Explanation When there is a need for significant capital, it is the C corporation that is the form to use.

On March 1, an individual, age 40, wants to open and fund a Roth IRA at the maximum permitted level. She earns less than the adjusted gross income level that would limit her contribution. What is the maximum amount that she may place in a new Roth IRA? A) $12,000 B) $7,000 C) $6,000 D) $14,000

A Explanation Based on her age (less than 50), her maximum contribution would be $12,000, specified as $6,000 for two separate years of contributions. Because she is opening the account on March 1, she would be permitted to make contributions for the prior tax year (up until the April 15 tax filing deadline), as well as for the current tax year.

One of your clients is neutral to bearish on a particular stock and would like to sell calls on it to generate some income. Wishing to minimize risk, you would suggest the client cover the call or take other steps to protect against unlimited loss. That could be done in all of the following ways except A) simultaneously purchasing a put on that stock with a strike price lower than that of the short call. B) simultaneously purchasing a call on that stock with a strike price lower than that of the short call. C) depositing a security convertible into 100 shares of the stock into the account. D) depositing 100 shares of the stock into the account.

A Explanation Buying a short put does not cover a long call or offer protection against loss. If the stock price rises, the writer of the call loses and the put expires worthless. There are several ways to cover a call. The most common is being long the underlying stock. Short calls can also be covered by a security convertible into the appropriate number of shares. That would include convertible preferred stock, convertible debt securities, and warrants. They must be convertible without cost (that is generally the case and can be assumed unless the question says otherwise). A third way to cover a short call is with a long call. The strike price has to be the same or lower and the long call cannot expire before the short call. Buying a short put does not cover a long call. However, in this case, although the writer is protected, the long call will cost more than the short, so the objective of income will not be realized. Buying a call with a higher strike price will result in a net credit (income), and the writer is protected to the extent of the difference between the strike prices and the credit. This is your basic credit call spread.

All of the following records must be retained for 3 years except A) customer statements. B) fingerprint cards for terminated personnel. C) copies of retail communication. D) audio tapes of orders handled by the trading room.

A Explanation Customer statements must be retained for 6 years. The other choices are all 3-year records.

The interest from which of the following bonds is subject to federal income tax? State of Nebraska City of Duluth Treasury notes Federal National Mortgage Association (FNMA) A) III and IV B) I and II C) II and IV D) I and III

A Explanation Direct federal debt, such as a Treasury note, is subject to federal income tax but exempt from state tax. FNMA bonds are subject to federal, state, and local taxes. State and city bonds, being municipals, are exempt from federal income tax.

Which of the following ratios is normally considered adequate coverage of interest and principal charges for a municipal revenue bond? A) 2:1 B) 7.5:1 C) 1:1 D) 3:1

A Explanation Generally, a sound debt service (interest and principal) coverage ratio for municipal revenue bonds is 2:1. In other words, $2 of revenue is collected for every $1 of debt service.

Which of the following statements regarding a Regulation T extension are true? It is granted by a self-regulatory organization. It is granted by the transfer agent. An extension is automatically granted once the extension request is made. Extensions are not automatically granted and may be denied. A) I and IV B) II and III C) I and III D) II and IV

A Explanation In certain cases where the customer cannot make payment by the fourth business day following the trade date, the broker-dealer can request an extension from the self-regulatory organization (SRO) that is its designated examining authority (DEA), usually FINRA. Extensions are not automatic, may be denied, and are granted at the discretion of the SRO.

An arbitration proceeding involving a customer in an amount over $100,000 has been agreed to. In such an arbitration dispute, which of the following is true? A) The customer can request that all three of the arbitrators selected be from the public sector. B) Only nonpublic (industry) arbitrators can be used for disputes in amounts greater than $100,000. C) Disputes in amounts greater than $100,000 are always heard by a single arbitrator. D) Both parties must agree before three arbitrators can be used in disputes involving amounts greater than $100,000.

A Explanation In disputes involving a customer for amounts greater than $100,000, three arbitrators will be used unless both parties agree to one. In the case where three arbitrators are used, the customer can request that all three arbitrators be selected from the public sector.

A municipal securities principal must approve all of the following except A) legal opinions. B) the opening of new customer accounts. C) each transaction in municipal securities. D) the handling of written customer complaints.

A Explanation Municipal securities principals are required to approve all new customer accounts, all municipal transactions, and the handling of customer complaints. Legal opinions are prepared by bond counsel to determine the authority of an issuer and tax treatment of new municipal issues.

In a municipal offering, which of the following would ordinarily be found in the agreement among underwriters? The legal opinion The appointment of the bond counsel The concession The takedown A) III and IV B) I and IV C) I and II D) I only

A Explanation Of the choices given, only the concession and the takedown would generally be found in the agreement among underwriters, which is found in the syndicate agreement. The agreement among underwriters does not include the legal opinion or the appointment of the bond counsel. The legal opinion and the appointment of the bond counsel would be found in the official statement.

Which of the following are likely to have a low beta? A) Public utility stocks B) Technology stocks C) Software stocks D) Aerospace stocks

A Explanation Public utility stocks tend to have low betas, as do other defensive stocks. Technology, aerospace, and software stocks tend to have high betas.

The Investment Company Act of 1940 has a number of rules relating to variable life insurance policies. All of these are included except A) the maximum allowable sales charge is 8.5% of the premium payment. B) the free-look provision for 45 days after execution of the application. C) the minimum cash value loan provision after 3 years. D) the variable life contract exchange provision is good for a minimum of 24 months.

A Explanation The 8.5% maximum sales charge is the FINRA rule relating to mutual funds. The Investment Company Act of 1940 requires that sales charges on a fixed-premium variable life contract may not exceed 9% of the payments to be made over the life of the contract. The contract's life, for purposes of this charge, is a maximum of 20 years.

Which of the following is not a correct statement in respect to the at-risk provisions when investing in a direct participation program (DPP)? A) The at-risk provisions do not apply to oil and gas exploration programs. B) Losses disallowed by the at-risk provisions in any one year may be carried over to following taxable years. C) Qualified nonrecourse financing is excluded from tax basis except in the real estate programs. D) Deductions or losses are limited to the investors' invested capital plus their percentage of partnership liabilities for which they are personally liable.

A Explanation The at-risk provisions (you can only deduct what you can lose) apply to all DPPs. Real estate has one unique feature in that nonrecourse financing is part of the investor's tax basis.

An investor opens the following options position: Long 1 ABC Aug 50 call @ 5½; short 1 ABC Aug 55 call @ 3½. What is the investor's maximum gain, maximum loss, and breakeven point? A) Maximum gain is $300; maximum loss is $200; breakeven is $52. B) Maximum gain is $200; maximum loss is $300; breakeven is $52. C) Maximum gain is $300; maximum loss is $200; breakeven is $53. D) Maximum gain is $200; maximum loss is $300; breakeven is $53.

A Explanation The first step is to identify the position. This is a debit call spread. It is a debit spread because the option purchased costs more than the one sold. The investor purchased the 50 call for a premium of 5½ and sold the 55 call for a premium of 3½. That difference (5½ minus 3½), a debit of $200, is the most the investor can lose. This is a bullish spread (the investor bought the low strike price and sold the high strike price). If the investor is correct and the stock rises, the short call will be exercised. That means the writer will have to sell the stock at $55 per share. However, the investor will exercise the 50 call and deliver the stock purchased for $5,000 and receive proceeds of $5,500. The $500 profit is reduced by the $200 it cost to put on the spread. That means a net gain of $300. The fastest way to do a question like this is to subtract the debit from the strike price difference (5 points here) and you have your maximum gain. In this case, it is $5 ‒ $2 = $3. Breakeven follows the call-up rule; add the net premium (the debit of $2) to the lower strike price ($50) to arrive at $52.

A customer buys 1 XYZ Dec 30 call at 7 and sells 1 XYZ Dec 40 call at 1. Two months later, if the customer closes the positions when the spread is trading at 9 points, the customer has A) a gain of $300. B) a loss of $100. C) a gain of $100. D) a loss of $300.

A Explanation The investor established a debit spread and paid a net premium of $600 (7 − 1). The spread widened to 9, giving the investor a profit of $300 (9 − 6). Debit spreads are profitable if the spread between the premiums widens.

If stock market indexes, such as the S&P 500 and the Dow Jones Industrial Average, are advancing daily, and the number of advancing stocks relative to declining stocks is falling, a technical analyst will conclude that the market is A) overbought. B) oversold. C) unstable. D) becoming volatile.

A Explanation The momentum of the market advance seems to be easing as the number of advancers to decliners is leveling out. It looks like the decline/advance line is moving in a direction away from advancers. A technical analyst would conclude that the market is overbought and approaching a top.

Purchasers of municipal revenue bonds are interested in knowing the priority of their claim on the revenues generated by the project. In general, the most senior position is held by A) a gross revenue pledge. B) a net revenue pledge. C) a GO revenue pledge. D) an inverted revenue pledge.

A Explanation The simplest way to think about this question is to look at our paycheck. What is the higher number - your gross pay or your net (take-home) pay? You could also say, "Who has the first claim on my earnings?" The government and that is why the taxes come out of your gross paycheck rather than your net check. The concept is the same here. In a gross revenue pledge, interest to the bondholders is paid out of the gross revenues before any other deductions. In a net revenue pledge, certain expenses are paid first, and then, from what remains, the bondholders receive their due.

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

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

All of the following can be associated with asset-backed securities except A) minimal risk. B) the securitization of assets. C) expected cash flow from credit card debt, leases, auto loans, and mortgages. D) pooling individual assets into larger financial securities to be sold to investors.

A Explanation The value of asset-backed securities 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. However, the cash flow from these assets is not guaranteed in any way, and therefore, these securities cannot be characterized as carrying minimal risk.

If a U.S. corporation exports machine tools to Switzerland and will be paid in Swiss francs (SF), to protect against foreign-exchange risk, it should A) buy SF puts. B) sell SF calls. C) buy SF calls. D) sell SF puts.

A Explanation What is the concern of this corporation? If, when the Swiss company pays for the tools, the value of the SF has fallen against the U.S. dollar, the company will receive less money. For example, if the bill is for 100,000 Swiss francs and, at the time of the sale, that amount of SF is worth $110,000 (each SF is worth $1.10), a decline in the value of the SF to $1.05 means the exporter will receive $105,000 instead of the expected $110,000. To hedge against a decline value (regardless of the asset), we buy puts. In the case of exporters from the Unitred States, they buy puts on foreign currency. There are two important acronyms to remember, EPIC and IPEC. Referring to U.S. based companies, Exporters buy Puts and Importers buy Calls. Because there are no options on the U.S. dollar, the Swiss company should buy calls on its own currency to hedge In other words, EPIC works in reverse if the question is dealing with a foreign company. Then it is IPEC for Importers buy Puts and Exporters buy Calls.

A company has filed for an IPO at $20 par value. The IPO is priced at $30 per share. Where on the balance sheet is the extra $10 recorded? A) Capital surplus B) Retained earnings C) Excess par value D) Distributed dividends

A Explanation When new stock is issued, any funds paid for the stock in excess of the par or stated value is called capital surplus. In this case, it is the $10 above the $20 par. It might also appear on your exam as paid-in surplus.

When is the sales charge deducted from purchases of mutual fund shares made under a letter of intent? A) When each purchase is made B) Monthly C) Annually D) When each letter of intent is completed

A Explanation When the customer makes the first investment under a letter of intent, the reduced sales charge applies immediately and to each subsequent investment. With each additional investment, the same reduced charge is deducted. If the customer does not invest the amount stated in the letter, the full sales load applies retroactively to the total investment.

Investors placing zero-coupon bonds in their portfolios are most likely to be looking to provide accumulation of capital. current income. protection against reinvestment risk. tax deferral. A) I and III only B) II and IV only C) I and IV only D) II and III only

A Explanation Zero-coupon bonds are always purchased at a discount because they pay no interest. At maturity, the bondholders receive the maturity value. That represents the initial investment plus interest. Therefore, the investors are receiving more capital than invested (capital accumulation). Zero-coupon securities avoid reinvestment risk because there are no periodic interest payments to be reinvested. When you purchase one of these securities, the quoted yield to maturity is exactly what you will earn if you hold it to the end. With no interest payments, there is no current income. There is no tax deferral with a zero. In fact, unless it is a zero coupon municipal bond, there is phantom income; income not currently received but currently taxable.

The placement ratio, as shown in The Bond Buyer, represents the dollar value of A) bonds placed divided by bonds offered. B) bonds placed divided by bonds unsold. C) bonds offered divided by bonds placed. D) bonds offered divided by bonds unsold.

A bonds placed divided by bonds offered.

Which of the following statements best describes the effect of reinvesting mutual fund distributions? A) Dividends from investment income that are reinvested have tax-deferred status. B) The reinvestment of capital gains and dividends results in a higher cost basis. C) The reinvestment of capital gains and dividends has no effect on cost basis. D) Capital gains that are reinvested have tax-deferred status.

B Explanation Because reinvested distributions are taxed in the year received, the investor's cost basis is increased by the amount of the distribution. This is to prevent those distributions from being taxed twice. They are taxed once as the dividend or capital gain and then, if not added to the cost basis, would be taxed a second time when the shares are sold. Reinvestment of these distributions does not avoid or defer current taxation. This is not the same as receiving a stock dividend where the taxes are deferred until those shares are sold.

As the initial transaction in a new margin account, your customer shorts 100 shares of DMF at 30. With Regulation T at 50%, she will receive a margin call for A) $1,500. B) $2,000. C) $750. D) $3,000.

B Explanation Because the total market value of the transaction is $3,000, the initial margin would be $1,500 (50% of $3,000). However, minimum initial margin is $2,000.

ALFA Enterprises pays a quarterly dividend of $0.15 and has earnings per share of $2.40. What is the dividend payout ratio? A) 30.00% B) 25.00% C) 6.25% D) 14.40%

B Explanation Earnings per share are typically calculated for a year, so the annual dividend of $0.60 ($0.15 × 4) is divided by $2.40 to calculate what percentage of earnings is paid as a dividend—or rather, the dividend payout ratio (0.60 / 2.40 = 25%).

Which of the following is the least suitable mutual fund transaction? A) Encouraging an investor in a high tax bracket with an income objective to invest in a municipal bond fund B) Encouraging a mutual fund shareholder to switch from one fund family to another while a deferred load is in existence C) Encouraging a retired 65-year-old investor to invest a small percentage of his savings in a large-cap growth fund D) Encouraging an investor in his early 30s to invest in an emerging markets mutual fund

B Explanation Encouraging a mutual fund shareholder to switch from one fund family to another while a deferred load is in existence is not in the client's best interest, as the client might be subject to substantial additional sales charges.

Failure to honor a firm quote is called A) trading ahead. B) backing away. C) interpositioning. D) front running.

B Explanation Failure to honor a stated quote is a rules violation called backing away

Toby Jensen originally purchased 400 shares of CSC stock on margin at a price of $60 per share. The initial margin requirement is 50%, and the maintenance margin is 25%. CSC stock price has fallen dramatically in recent months, and it closed today with a sharp decline, bringing the closing price to $40 per share. Based on FINRA requirements, will Jensen receive a maintenance margin call? A) No, the account meets the minimum initial margin requirement. B) No, the account meets the minimum maintenance margin requirement. C) Yes, because the account is below the house maintenance requirement. D) Yes, the account does not meet the minimum maintenance margin requirement.

B Explanation Minimum maintenance requires equity equal to 25% of the current market value. If the price per share is $40, then the value of the 400 shares is $16,000. That would make the minimum equity requirement $12,000. The initial purchase was $24,000 resulting in a debit balance of 50%, or $12,000. If the LMV is $16,000 and the debit balance is $12,000, the account is right at the minimum maintenance level. Toby might be below the house maintenance, but because that is not given in the question, there is no way to tell.

All of the following statements regarding Nasdaq Level 3 are true except A) quotes are entered by market makers. B) this level is used by registered representatives only. C) the system shows the inside quote. D) actual interdealer quotes are displayed.

B Explanation Nasdaq Level 3 is the interactive level of the Nasdaq system through which market makers enter and update their quotes. The best quote available (the inside market) is also shown on the Level 3. Registered representatives use the Nasdaq Level 1, which displays the inside market quote only.

The IRS requires a municipal bondholder to use straight-line amortization for the purpose of determining the annual A) decrease to a discount bond's cost basis. B) decrease to a premium bond's cost basis. C) increase to a premium bond's cost basis. D) increase to a discount bond's cost basis.

B Explanation Premiums are amortized; discounts are accreted. For municipal bonds bought at a premium, the bondholder must adjust cost basis annually in such an amount that, if held to maturity, there is no reported capital gain or loss. The amortization is straight line, or the same amount must be amortized each year.

Which of the following statements regarding margin calls are true? Customers are entitled to an extension of time. Customers are not entitled to an extension of time. Firms can sell securities without first contacting the customer. Firms cannot sell securities without first contacting the customer. A) I and III B) II and III C) I and IV D) II and IV

B Explanation Some customers mistakenly believe that a firm must contact them for a margin call to be valid, which is not the case. Most firms will attempt to notify their customers of margin calls but are not required to do so. Also, there is no entitlement when it comes to an extension of time.

All of the following must be considered by an investment adviser representative before recommending a municipal general obligation (GO) bond to a customer except A) the municipal security's rating. B) the municipality's coverage ratio. C) the customer's tax status. D) the customer's state of residence.

B Explanation The coverage ratio is specific to revenue bonds only and tells how many times annual revenue from that issue will cover the debt service of the issue. It is not a factor of suitability to be considered when recommending a GO bond, but more of a factor to consider when comparing two municipal revenue bonds. The customer's state of residence and tax status are essential when determining suitability for a municipal security. The security's rating is also important because it measures the overall safety and quality of the bond.

The most stringent test of a corporation's ability to meet its current obligations is A) the price-to-earnings ratio. B) the quick ratio. C) the current ratio. D) the debt-to-equity ratio.

B Explanation The quick ratio, sometimes called the acid-test ratio, is a more stringent test than the current ratio because it excludes inventory. The debt-to-equity ratio deals with long-term debt rather than current liabilities. The price-to-earnings (P/E) ratio does not deal with assets and liabilities.

An investor in which of the following products may not receive dividends? A) Shares of preferred stock B) Oil and gas limited partnership interests C) Units in a UIT D) Shares of common stock

B Explanation The structure of a limited partnership does not allow for the payment of dividends. If there is income, it flows through to the investor, but it is not considered a dividend. Common stock can pay dividends and preferred stock is purchased for its dividend payout. UITs pay dividends in a manner similar to mutual funds.

The OEX index (Standard & Poor's 100) closes at 379.70, up 0.60 from the prior day's close. The holder of 10 in-the-money calls makes an unrealized gain of A) $6. B) $600. C) $60. D) $6,000.

B Explanation This unrealized gain is $600 (10 calls × 0.60 × $100 = $600).

An Eastern account underwriting of $100 million in municipal bonds is established. ALFA Securities agrees to underwrite 10% of the issue and sells out its allotment of $10 million. However, some of the other firms participating in the deal are not as successful, and $15 million worth of bonds remain unsold. What is ALFA Securities' financial obligation? A) Pooled responsibility for $15 million B) $1.5 million C) $0 D) $150,000

B Explanation Undivided liability in an Eastern account means this member is liable for 10% of the unsold bonds (10% × $15 million = $1.5 million).

A 58 year-old investor owns a single premium deferred variable annuity with a current value of $500,000. The original investment was $150,000 and the contract has a death benefit provision. If the investor suddenly passes away and the beneficiary receives a lump sum payout, A) the beneficiary will owe ordinary income taxes on $500,000 plus 10% penalty if under 59½. B) the beneficiary will owe ordinary income taxes on $350,000. C) the beneficiary will owe ordinary income taxes on $350,000 plus 10% penalty if under 59½. D) the beneficiary will owe ordinary income taxes on $500,000.

B Explanation When receiving the death benefit in a lump sum, the beneficiary's tax situation is the same as if the owner surrendered the policy with one critical difference. Surrender before reaching age 59½ leads to the 10% tax penalty, but that penalty is waived in the case of death. It is only the deferred earnings (in this question, the $350,000 difference between the initial deposit and the current value) that is subject to taxes. As is always the case with annuities, the taxation is always as ordinary income, never capital gains.

Mutual fund shareholders are often advised to enroll in automatic dividend reinvestment programs. In those programs, the investor can elect to have all distributions, or just those from income or just those from capital gains, automatically reinvested in additional shares of the fund. Among the advantages to the investor would be A) the additional shares are purchased below the NAV. B) deferral of taxes until the shares are sold. C) automatic compounding of the investment. D) the additional shares are not subject to 12b-1 fees.

C Explanation Similar in concept to the compounding of interest in a savings account, when distributions are reinvested rather than withdrawn, the capital has an opportunity to compound. Taxes are due in the year for which the distribution is paid (no tax break here). The shares are purchased at NAV; there are never cases where mutual fund shares are purchased below the NAV. If the fund has a 12b-1 charge, it would apply to the reinvested shares just as any other shares.

The yield to maturity of an outstanding revenue bond has just fallen from 3.8% to 3.4%. All of the following could explain the drop except A) the bond's rating has improved. B) market interest rates have fallen. C) the bond's debt coverage ratio has fallen. D) the bond has added insurance.

C Explanation A falling debt coverage ratio is bad news because it indicates that the facility is not generating as much revenue as planned. It would be similar to the effect on your credit rating if you took a 20% or so pay cut. When a bond's rating goes up, the added safety means less risk and that will lead to a lower yield to investors. If interest rates in the market drop, the yields of outstanding bonds will reflect that. Adding insurance to a bond always increases the safety and leads to lower yields.

Each of the following types of orders will remain open (working orders) until certain conditions are met, except A) good-till-canceled orders. B) stop limit orders. C) market orders. D) stop orders.

C Explanation A market order is executed immediately at the prevailing market price. A stop, or stop limit, order is not triggered until a set price is hit or passed through. A good-til-canceled order remains open until executed or canceled.

Which of the following securities are exempt from the registration and disclosure provisions of the Securities Act of 1933? Any interest in a railroad equipment trust certificate Municipal bonds U.S. government securities Commercial paper maturing in 270 days or less A) II and III B) I and II C) I, II, III, and IV D) I and III

C Explanation All the securities listed are exempt from the registration and disclosure provisions of the Securities Act of 1933.

Your customer is interested in a leveraged fund and makes the following statements about leveraged funds to you. Which of the statements is not true? A) The funds attempt to return a multiple of the return of a benchmark index they are tracking, perhaps two or three times. B) Some leveraged funds are exchange-traded products. C) There are no unusual risks associated with these funds, other than those incurred with any index tracking fund. D) These funds sometimes use derivatives products to achieve their stated goals.

C Explanation Because the fund objective is to achieve returns that are a multiple of the returns of the benchmark index, the result could be a multiple of any loss incurred by the benchmark index, as well. In addition, because these funds use derivatives products to achieve their stated objectives, they may not be suitable for some people, given the additional risks associated with those products.

One of your customers mentions that she heard a friend say that whenever she buys stock, she has her registered representative use the DRS program. When the customer asks you for an explanation, you would reply that the DRS is A) the dividend reporting service where the dates of all upcoming dividends are reported to the investor. B) the Dow-rating system where all listed stocks are assigned a rating based on expected future performance. C) the Direct Registration System, where the customer's name as owner is recorded in book-entry form at the issuer or its transfer agent. D) the Direct Reporting System, where execution of transactions is reported simultaneously to the firm and the customer.

C Explanation DRS stands for Direct Registration System. It is a program that began in the mid-1990s as an alternative to "street name" registration for customer securities. Like street name, DRS is based on electronic bookkeeping. In direct registration, a stock is registered in an investor's name, but the company that issued the stock (or its transfer agent) is the one that holds the security in book-entry form, instead of a broker-dealer. All the other choices are made-up distractors. **This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback.

If your great-grandmother is interested in safety, liquidity, and tax-free income, which of the following would you recommend? A) A high-yield income fund B) An exploratory oil and gas pool C) An insured short-term municipal bond fund D) Income bonds

C Explanation High-yield income funds usually invest in low-rated bonds, and income bonds do not pay interest unless the board of directors declares a payment. An insured short-term municipal bond mutual fund is relatively safe, very liquid, and provides income free from federal tax.

KPT, Inc., is preparing to report its net income for the past year. An increase in which of the following causes a decrease in the reported net income? Tax rate Cash dividend Allowance for bad debts Retained earnings A) II and III B) II and IV C) I and III D) I and II

C Explanation Higher taxes mean less net income. The allowance for bad debts is an expense item, and increasing it lowers operating income. Dividends are paid out of retained earnings, which have no effect on the net income the company reports.

An affiliate of an issuer that holds control stock for five months sells 1,000 shares for a $10,000 profit. How will this transaction be treated? A) Any profits can be kept by the seller, subject to tax. B) These short-swing profits must be escrowed by the issuer until the holding period is satisfied. C) These short-swing profits must be disgorged from the holder of the stock to the issuing corporation. D) The sale will be voided by the issuer and the stock returned to the original owner.

C Explanation If control stock is sold before a six-month holding period, any profits are defined as short-swing profits, and the company receives the profits. The term disgorged refers to the profits being removed from the affiliate and given to the issuer.

Interest rate risk is intrinsic to all types of fixed-income investments, including debt securities and preferred stock. When interest rates go up, market prices decline. Although not commonly associated with common stock, some common stock investments are subject to interest rate risk. The common stock of which of the following companies would be most affected by interest rate risk? A) Common stock shares of a company that has recently filed for bankruptcy B) Common stock shares of investment company growth funds C) Common stock shares of public utility companies D) Common stock shares of ABC High Tech Company

C Explanation Interest rate risk affects the shares of public utility common stock in two ways. First, for most investors, public utility stocks are attractive because of their dividend yield. Therefore, if market interest rates rise, unless the utility can increases the dividend, the price of the stock will decline. That is where the second part comes into play. Public utilities are known for their highly leveraged capital structures. Put simply, they borrow a lot of money. An increase to market interest rates will likely cause their borrowing expenses to rise. With increased expenses, earnings fall and that can lead to a reduction to the dividend payout. The primary factor affecting the market price of shares of growth companies is the future expectations of earnings growth for these companies. Therefore, their market prices are not correlated with current interest rate changes. In addition, these companies rarely pay much, if any, dividend. As stated in the question, interest rate risk applies to companies paying income. Bankrupt companies do not pay dividends. High tech companies typically have very little debt in their capital structure and rarely pay dividends, so their common stock prices are not interest rate sensitive.

When a company issues additional preferred stock and bonds, which of the following will be the net result? A) It is impossible to tell without the specific amounts of equity and debt issued. B) Leverage is not affected because one issue is equity, the other is debt, and the net effect on leverage is zero. C) Leverage is increased. D) Leverage is decreased.

C Explanation Leverage is the use of investors' money at a fixed cost to benefit the common shareholders. Both preferred stock and bonds are fixed-rate issues. Therefore, issuing more preferred stock or bonds increases the leverage of the common stockholders.

A blind pool offering A) generates nonallocated income. B) is connected with oil and gas leases. C) is one in which 25% or more of the properties are not specified. D) is one in which the properties are purchased on a lottery basis.

C Explanation Many times, large real estate or oil and gas programs are offered in the form of a blind pool. In a blind pool, 25% or more of the specific properties (in real estate) or sites (in oil and gas) have not been identified at the time of the offering. When investing in a blind pool, the participants are relying on the expertise of the program sponsor to select locations that will prove profitable.

A couple in a high tax bracket is interested in minimizing their tax liability while diversifying their portfolio. Which of the following best fits their investment objectives? A) GNMAs B) Corporate convertible bonds C) Tax-exempt unit trusts D) Preferred stock

C Explanation Municipal unit trusts provide tax-free income to unit holders. Unit holders have an undivided interest in the underlying portfolio of municipal bonds. The trust consists of a number of different issues, and therefore has an element of diversification.

If near-term liquidity were the only objective for a client, which of the following pairs of investments would represent the most/least liquid? A) Variable annuity/money market mutual funds B) Variable annuity/direct participation programs C) Exchange-listed equities/direct participation program D) 10-year corporate bonds/U.S. T-bills

C Explanation Of the pairings offered to choose from, exchange-listed equities are considered liquid, as they could be easily divested of, and direct participation programs, which all have predetermined (scheduled) end dates, would be the least liquid.

The common stock of Porcine Meat Products, Inc., is currently selling at $60 per share. It has a P/E ratio of 12:1 and pays an annual dividend of $3 per share. That would make Porcine's EPS equal to A) $3. B) $36. C) $5. D) $2.

C Explanation The P/E ratio measures the relationship between a stock's market price and the earnings per share (EPS). The ratio for this company is 12 times the earnings. If the market price is $60, then the earnings must be 1/12th of that or $5 per share. The annual dividend is irrelevant to the question. It is one of those extra numbers that FINRA likes to include in a question

A customer opens the following positions: Buy 100 shares of HDH @60; buy 1 HDH Feb 60 put @4. What is the customer's maximum gain, maximum loss, and breakeven point? A) Maximum gain is $400; maximum loss is $5,600; breakeven point is $56. B) Maximum gain is unlimited; maximum loss is $5,600; breakeven point is $56. C) Maximum gain is unlimited; maximum loss is $400; breakeven point is $64. D) Maximum gain is $6,400; maximum loss is $400; breakeven point is $64.

C Explanation The first step is to identify the position. This is a long stock position with a protective put. That is, the customer has purchased the stock and purchased a put to protect the downside. Using an option as a form of insurance is the primary reason why the industry refers to the price of an option as the premium. On questions with stock and an option, it is usually best to compute the breakeven point first. Breakeven is when the long stock can be sold at the customer's total cost. That cost is the price of the stock ($60) plus the price paid for the option ($4), or $64. If the stock should rise above $64, the customer will let the 60 put expire and maintain the long stock position. An investor with a long stock position has unlimited potential gain. If the stock price should decline, no matter how low it drops, the customer can exercise the long put and sell the stock for $60 per share. That means the maximum loss is the premium paid for the option, $400. Why doesn't the breakeven follow the "put-down" rule? That rule applies when the only positions are options. Once there is a long or short stock position along with an option position, it is the stock controlling the breakeven.

Which of the following transactions in the same security will affect the holding period of a security held for 12 months or less? Buy a put Buy a call Sell short Sell a put A) II and IV B) II and III C) I and III D) I and II

C Explanation The holding period of a capital asset is based on the amount of time the asset is held at risk. When there is no longer the possibility of a loss, there is no longer any risk. Buying a put or selling short effectively removes the risk from a transaction and destroys any short-term holding period. The short-term holding period will not become a long-term holding period for tax purposes, as long as the offsetting position (put or short) is maintained.

A customer buys 1 LMB Aug 70 put for 4 and 1 LMB Aug 70 call for 4. The customer will break even at $62 $66 $74 $78 A) II or III B) I or III C) I or IV D) II or IV

C Explanation To break even, the customer must recover $800 paid in premiums. On the long 70 call, this occurs if the market price rises to 78. On the long 70 put, this occurs if the market price falls to 62.

When customers receive their account statements, they will generally not include A) interest charged on debit balances in margin accounts during the statement period. B) security positions at the end of the statement period. C) trade dates of all transactions during the statement period. D) total cost of purchases and net proceeds of sales made during the statement period.

C Explanation Trade dates appear on the trade confirmations.

Last week one of your customers placed a good-til-canceled order to sell 200 shares of ABC with an 18 stop when the stock was trading at $18.85. It is now the ex-date for a $0.55 dividend and the order has not yet been executed. What has happened to your customer's stop order? A) It is increased to $18.55. B) It is canceled. C) It is reduced to $17.45. D) It remains at $18.

C Explanation Unless the customer has given DNR (do not reduce) instructions, open buy limit orders and open sell stop orders are reduced on the ex-dividend date by the amount of the dividend.

Many mutual fund investors elect to reinvest their dividends into additional shares of the fund. When an investor does this with dividends paid by a common stock fund, A) the additional shares are purchased at the public offering price. B) they are tax free until the shares are sold. C) the dividends are taxable in the year received. D) the investor's cost basis is reduced by the amount of the dividend.

C Explanation Unlike dividends from a municipal bond fund or UIT, which are exempt from federal income tax, dividends from stock funds (or taxable bond funds) are taxable in the year paid, regardless of whether they are reinvested or taken in cash. The test wants you to know that there is no tax advantage to reinvesting distributions. There are other benefits, such as reinvestment at NAV instead of POP, but tax breaks is not one of them. As it happens, when dividends are reinvested, the investor's tax basis increases by the amount of the dividend.

An analyst comparing revenues with expenses is most likely analyzing A) capitalization. B) working capital. C) cash flow. D) liquidity.

C The analyst is most likely measuring the income statement for cash flow (money coming in against money going out). Working capital analysis—not the income statement—would involve examining the balance sheet's current assets and current liability entries. Capitalization analysis involves examination of long-term debt and stock issues. Liquidity analysis involves examining current assets and liabilities from the balance sheet.

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 and must be filed with FINRA at least 10 business days before first use or publication. C) a retail communication that needs approval, but not filing, by a designated DCI principal. D) a retail communication and must be filed with FINRA within 10 business days of first use or publication.

D Explanation 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.

If a registered representative gave her retail customers copies of sales literature for a variable annuity she was recommending and promised to send the prospectus soon, which of the following statements are true? She should not have distributed sales literature without the prospectus. It was okay to distribute the sales literature and send the prospectus later to those who were interested. She should not have recommended a specific variable annuity without having the prospectus available. Because she only answered questions about the investment, she was not required to provide a prospectus. A) I and II B) II and IV C) III and IV D) I and III

D Explanation A prospectus must precede or accompany any solicitation, including distribution of sales literature to retail customers.

Which of the following statements regarding index options are true? Exercise is settled in cash. Exercise settlement value is based on the value of the index at the time exercise instructions are received. Exercise settlement value is based on the closing index value on the day exercise instructions are tendered. Exercise settlement is T+2. A) I and II B) II and IV C) II and III D) I and III

D Explanation All index option exercises are settled in cash. The amount a writer owes the holder is known as the intrinsic value of the option, and the settlement value is based on the closing index value on the day exercise instructions are tendered. Exercise settlement is the next business day.

A municipal issuer publishes an official notice of sale to indicate that the offering will be made A) through a private placement. B) for none of these. C) on a negotiated basis. D) on a competitive basis.

D Explanation An official notice of sale is the issuer's method of inviting competitive bids on a new issue. It sets forth all of the information about the issue that a dealer would need to make a bid, including the size of the offering; the maturity dates; and the date, time, and place of the sale

You have two customers who are a couple. Each person has an individual account. They also have a JTWROS account in both names. One of the customers asks you to transfer funds from the other person's individual account in order to meet a margin call in the requesting customer's margin account. To do this. A) you need the approval of a designated principal. B) because they are both signatories on the joint account, you need the authorization of this customer only. C) you need the authorization of both parties on the account and approval of a designated principal. D) you need the authorization of both customers.

D Explanation Because the customer asking for the transfer is not a signatory on the other customer's individual account, you need the authorization of both of them. As long as both consent, there is no need for authorization by a principal. However, in the real world, your firm may want to look at transfers of this type. Just remember, we are teaching the test world.

Which of the following debt securities does not have a fixed maturity date? A) General obligation bond B) Subordinated debenture C) Treasury STRIPS D) Collateralized mortgage obligation (CMO)

D Explanation CMOs are mortgage-backed securities. Because mortgages are often paid off ahead of the scheduled maturity, the exact maturity date of a CMO is uncertain.

All of the following would be considered either retail communications or correspondence except A) a written communication to all of the firm's customers regarding a new mutual fund being offered. B) an electronic communication distributed through the firm's website regarding potential opportunities with the firm as a registered representative. C) a letter to 10 individual investors within the past week regarding a new investment strategy. D) an email to several municipalities sent out in a single day offering your firm's services for underwriting their municipal securities.

D Explanation Communications with government entities, which includes municipalities, fall under the heading of institutional communications. The others are all examples of either retail communications or correspondence, depending on how many recipients there are within a 30-calendar-day period. (Retail equals more than 25 retail investors within any 30-calendar-day period, and correspondence is 25 or fewer retail investors within any 30-calendar-day period.)

When must a new options customer—who has not yet traded options—receive the Options Clearing Corporation's (OCC's) current disclosure document? A) At or before the time the registered representative signs the customer approval form B) Within 15 days of the ROP's approval of the customer's account for options trading C) No later than 15 days after the ROP signs the options customer approval form. D) At or before the time the account receives approval for options trading

D Explanation Customers must receive the OCC Disclosure Booklet at or before the time their account is approved for options trading.

If your customer owns 100 shares of a volatile stock and wants to limit downside risk, you may recommend A) writing calls and selling puts. B) shorting the same stock. C) buying calls. D) buying puts.

D Explanation Downside risk is reduced by purchasing a put with a strike price at or close to the stock's purchase price. Should the stock decline below the strike price, the investor can exercise the put at the strike price. Selling put options will increase the downside risk. Buying calls is a bullish strategy that increases downside risk. Shorting stock will lock in the current price but will limit upside potential.

When a major decline occurs within a few minutes of the close, trading is halted on all markets for the remainder of the trading day. Under the market-wide circuit breaker (MWCB) rules, market-on-close (MOC) orders pending at the time trading is halted A) should be held for execution on the following trading day. B) should be held for execution on the following trading day unless canceled by the customer. C) are converted to market orders and executed at the opening on the following trading day. D) must be canceled.

D Explanation During shorter market-wide trading halts that will allow trading to resume on that same trading day, pending and new incoming orders should be forwarded to the appropriate market for execution upon the resumption of trading. If a halt closes the market for the remainder of the trading day, MOC orders pending at the time trading is halted should be canceled. MOC orders received after trading is halted should be declined.

A customer, long 100 shares of ABC at 73, writes 1 ABC Apr 75 call at 2 to generate additional income. ABC stock subsequently moves higher, at which time, the customer is exercised. For tax purposes, which of the following statements are true? Cost basis is $73 per share Cost basis is $71 per share Sales proceeds are $75 per share Sales proceeds are $77 per share A) I and III B) II and IV C) II and III D) I and IV

D Explanation If a covered call writer is exercised, cost basis (for tax purposes) is the cost of stock purchased. Sales proceeds are adjusted (strike price plus premium) to reflect the premium received.

A client purchases 1,000 shares of the XYZ Value Fund when the NAV is $18.75 and the POP is $19.74. Five years later, the client makes a gift to her daughter when NAV is $24.50 and POP is $25.79. The daughter elects to receive all distributions in cash. Two years after the gift, she sells all shares when the NAV is $34.25 and POP is $36.05. What are the tax consequences of this sale? A) Long-term capital gain of $17,300 B) Long-term capital gain of $16,310 C) Long-term capital gain of $15,500 D) Long-term capital gain of $14.510

D Explanation In the case of a gift of securities, the donee acquires the donor's cost basis—$19.74 per share. Sale (redemption) takes place at the NAV ($34.25) for a profit of $14.51 per share (times 1,000 shares = $14,510.00).

An initial public offering is conducted A) on the New York Stock Exchange. B) in the secondary market. C) directly with principal shareholders. D) with the issuer generally through an underwriter.

D Explanation Initial public offerings are a type of primary offering, meaning the issuer (generally through an underwriter) sells the new shares to the public. While shares may trade in the secondary market (between members of the public) on the New York Stock Exchange, such transactions would be after the IPO.

A limited partner (LP) invests $100,000 in a movie production limited partnership with a nonrecourse note for $300,000. The partnership liquidates, and the LP receives $100,000. His loss, for tax purposes, is A) $300,000. B) $200,000. C) $100,000. D) $0.

D Explanation LPs are liable for their investments and any shares of recourse debt. They are not liable for nonrecourse debt. Because the LP received the full amount of his original investment at the liquidation of the partnership, he has no loss to declare.

Nasdaq Level 1 service A) displays the bid and ask quotes, with size, for each market maker in a particular listed security. B) enables market makers to update their quotes. C) displays the bid and ask quotes, with size, for each market maker in a particular unlisted security. D) displays the inside market: highest bid and lowest ask.

D Explanation Level 1 service provides subscribers with the inside market. The inside market is the highest bid price anyone is displaying and the lowest ask price anyone is displaying, via the Nasdaq quotation system.

A customer buys 100 shares of RAN common stock at $62.75 per share and simultaneously buys one RAN Jan 60 put at 1. By January, the market price of the RAN stock has risen to $66.25 per share. The investor allows the put to expire worthless (who would exercise the option to sell stock at 60 when the market price is $66.25?), and the customer sells the RAN at the current price of $66.25 per share resulting in A) a loss of $250. B) a loss of $100. C) a gain of $350. D) a gain of $250.

D Explanation Looking at each trade separately, the customer buys 100 shares of the RAN at $62.75 and sells the shares at 66.25 for a $350 gain. The customer pays $100 for the put, which expires worthless, resulting in a $100 loss. Overall, the gain is $250. Alternatively, the investor's cost is $62.75 for the stock plus one point for the put. That is a total cost of $63.75 per share. The put is worthless and the sale of the shares brings in $66.25. Once again, there is a gain of $250.

Prompt disclosure of unintentional selective disclosure of material corporate information is a requirement of A) SEC Rule 10b-18 B) Regulation S-P C) Regulation SHO D) Regulation FD

D Explanation Regulation FD (Fair Disclosure) is an issuer disclosure rule (all issuers) that addresses selective disclosure such as may be given to securities market professionals and others that may trade on the basis of the information. If the disclosure of information is intentional, the issuer must make a simultaneous disclosure to the public. If the disclosure was unintentional, the issuer must make disclosure promptly. Promptly means under the regulation not later than 24 hours or the commencement of the next day's trading on the New York Stock Exchange, whichever is later (which accommodates for weekends and holidays) after a senior official of the issuer learns of the disclosure. Regulation S-P deals with the privacy rules, and Regulation SHO is the locate requirement for short sales. Rule 10b-18 deals with an issuer buying back its own stock in the open market.

Which of the following events will cause the special memorandum account (SMA) to decrease? An increase in the short market value (SMV) A decrease in the long market value (LMV) The purchase of long securities on margin The short sale of securities A) I and III B) II and IV C) I and II D) III and IV

D Explanation SMA, once created, does not go away until used. Using the SMA to buy more securities or sell more securities short will decrease the amount of SMA.

Which of the following is typically the largest component of a corporate underwriting spread and is received by members of the selling group? A) Manager's fee B) Underwriting fee C) Reallowance D) Concession

D Explanation The concession tends to be the largest component of a corporate underwriting spread. That is paid to the members of the selling group. The manager's fee is generally the smallest component.

Which of the following types of municipal bond issues is associated with a flow of funds? A) Tax anticipation notes (TANs) B) School district bond C) General obligation (GO) bonds D) Revenue bonds

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

Your customer has made a margin purchase of 100 shares of DMF at 50. Two days later, before the customer has met his call, the current market value of DMF is 60. How much must your customer now deposit? (Regulation T is 50%.) A) $2,000 B) $3,000 C) $1,500 D) $2,500

D Explanation The investor must come up with the initial call of $2,500. The amount of margin required for a new purchase is based on the current market value of the security at the time of purchase.

A client with an options account contacts the registered representative handling the account with instructions to open the following spread: Buy 1 ABC 100 call and Sell 1 ABC 105 call at a 5-point debit. Under FINRA rules, this order A) should be turned in immediately. B) will be executed at the next available trade meeting the 5-point limit. C) is for a bull call spread. D) should be refused.

D Explanation The order should be refused because it is impossible for it to be profitable. This is a bull call spread (but that is not the correct answer here because it has nothing to do with FINRA rules) and will become profitable when the spread widens. With strike prices of 100 and 105, it can never widen more than 5 points. If the client paid 5 points for the spread, once commissions are factored in, the client must lose money and certainly cannot profit. FINRA looks at this as an uneconomic position, and the firm should refuse to take the order.

A client is trying to decide between a par value corporate bond carrying a coupon rate of 6.25% per year and a par value municipal bond that pays an annual coupon rate of 4.75%. Assuming all other factors are equal, and your client is in a 28% marginal income tax bracket, which bond do you tell the client to purchase and why? A) The corporate bond because the after-tax yield is 4.5%. B) The municipal bond because its equivalent taxable yield is 6.3%. C) The corporate bond because the after-tax yield is 6.25%. D) The municipal bond because its equivalent taxable yield is 6.6%.

D Explanation This is calculated using the tax-equivalent yield formula: municipal yield / (100% − investors tax bracket) 4.75 / (1 − 0.28) = 6.6%. By comparison, the 6.6% tax-equivalent yield of the municipal bond is higher than the 6.25% yield of the taxable corporate bond, making the municipal bond the higher yielding investment, given the investor's 28% tax bracket. Alternatively, you could solve this by simply deducting the taxes due on the corporate bond and comparing that to the coupon on the tax-free municipal bond. It would go like this: 6.25% minus 28% tax equals 6.25 minus 1.75 equals 4.50%. That is less than the 4.75% received after taxes (because there are no taxes) on the municipal bond. So, either way, the municipal bond is a better deal for this client.

A municipal bond in default is in good delivery form if past-due and current coupons are attached. the bond is insured. subsequently due coupons are attached. the issuer files a default guarantee letter with the Municipal Securities Rulemaking Board. A) I and IV B) II and IV C) II and III D) I and III

D Explanation To be in good delivery form, a municipal bond must be accompanied by all unpaid coupons: past due, currently due, and subsequently due. Insurance or letters of guarantee do not constitute good delivery.