Test 1

In order to recommend a fee based account to a customer, under FINRA rules, the customer must be provided with a(n): A. disclosure document, at or prior to, account opening B. disclosure document within 15 days of account opening C. investment adviser brochure, at or prior to, account opening D. investment adviser brochure within 15 days of account opening

The best answer is A. FINRA requires that, if a fee based account is recommended to a customer, the customer must receive a disclosure document that details all services provided and costs involved, at, or prior to, account opening. question # 5-1-106-2 Customer Accounts: Account Basics: Specific FINRA Product / Customer Suitability Rules: Non-Managed Fee-Based Account: Procedures Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

On Monday, May 10th, 2015, a customer buys 5 XYZ 9% subordinated debentures M' 8-01-38 at 89 5/8 plus accrued interest in a regular way trade. On January 13th, 2016, the customer sells the bonds at 90 3/8 plus accrued interest in a regular way trade. For tax year 2015, the customer's reported interest income is: A. $97.50 B. $127.50 C. $225.00 D. $351.25

The best answer is A. For tax purposes, interest is reported as it is received on a cash basis. Thus, only interest payments actually made by the issuer in tax year 2015 are included. The customer bought the bonds on Monday, May 10th, 2015. The customer receives the August 1st interest payment in 2015. The next payment will be made on February 1st, 2016, so only one interest payment is reported for 2015. One interest payment (August 1st) 9% bonds x $5,000 face amount = $450.00 annual interest income/2 = $225.00 interest payment reported on that year's tax return. In addition, the accrued interest that the buyer paid to the seller is deducted from the reported interest income. The bonds were purchased on Monday, May 10th, 2015, so regular way settlement takes place on Thursday, May 13th. Interest accrues up to, but not including the 13th. Thus, the buyer had to pay the seller accrued interest for: Feb: Mar: Apr: May: 30 days 30 days 30 days 12 days Total: 102 days 102 days/360 days per year x $90 annual interest per bond x 5 bonds = $127.50 accrued interest paid. The reported taxable interest income is $225.00 interest received less $127.50 accrued interest paid = $97.50 taxable interest income. Note: This is a very difficult question and a minor item for the exam. question # 8-3-7-4 Taxes / Tax Shelters: Taxation of Corporate and Government Securities: Bond Overview: Reported Interest Income for Tax Purposes Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A new customer, age 45, has been terminated from his assembly-line job of the past 20 years at an automotive parts supplier. During that time period, he has accumulated $124,000 in the company's 401(k) plan. He wishes to rollover the funds to an IRA account with your brokerage firm. This customer, who is an unsophisticated investor, has the entire 401(k) invested in a growth mutual fund and has no other investments. As the representative for this customer, your IMMEDIATE concern should be: A. communicating effectively with an unsophisticated customer in an understandable manner to assess financial goals and risk tolerance B. setting the investment allocation strategy that should be employed in order to provide sufficient retirement income for this individual C. creating a financial plan that emphasizes asset preservation and that is likely to provide a prolonged income stream for a prolonged period of retirement D. minimizing the tax consequences of any recommended transactions to increase the long-term growth potential of investments made

The best answer is A. This customer has a "blue-collar" job and is an unsophisticated investor. He has no other investments than his 401(k), all in one growth mutual fund. The registered representative's immediate concern should be communicating effectively with such an unsophisticated customer using simple, understandable language, in order to assess the customer's financial goals and risk tolerance level. The other concerns are important as well, but they come into play after the customer's investment objectives are determined. question # 7-5-56-2 Investment Companies: Retirement / Education / Health Savings Plans: Individual Retirement Account: Rollover Considerations Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A customer buys 100 shares of ABC at $65 and buys 1 ABC Jan 65 Put @ $3. At which market price is the position profitable? A. $70 B. $68 C. $65 D. $62

The best answer is A. To breakeven, the customer must recover the $3 paid in premiums and the $65 paid for the stock (total of $68). He must sell the stock in the market above $68 to have a profit. The only choice above $68 is Choice A, which is $70. To summarize, the formula for breakeven for a long stock / long put position is: question # 3-3-7-2 Options: Hedging Strategies: Long Stock / Long Put: Summary - Profitability Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A customer shorts 1 ABC Jan 35 Straddle for a total premium of $350. At expiration, ABC closes at $29 and the customer is exercised. As a result, the customer will have a: A. $250 loss B. $600 gain C. $600 loss D. $950 gain

The best answer is A. When a customer sells a straddle, he sells a call and a put on the same stock with the same strike price and expiration. In this case the customer: Sells 1 ABC Jan 35 Call Sells 1 ABC Jan 35 Put $350 Credit If the market stays exactly at $35, both positions expire and the customer would gain the $350 credit. In this case, the market declines to $29. The call expires "out the money," while the put is 6 points "in the money" and will be exercised at a loss of 6 points = $600 loss. Since $350 was received in premiums, the net loss is $250. question # 3-5-14-3 Options: Straddles: Short Straddle: Market Down Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A municipal term bond with 13 years remaining has been pre- refunded at 103 to a call date 3 years in the future. If a customer buys this bond, the yield shown on the confirmation will be computed to: A. the call date including the 3 point call premium B. the call date excluding the 3 point call premium C. maturity including the 3 point call premium D. maturity excluding the 3 point call premium

The best answer is A. When a municipal bond is pre-refunded, the issuer escrows sufficient government securities to pay the interest on the bonds until the earliest call date, at which point the bonds are called (with any applicable call premiums being paid) and paid off with the escrowed governments. A customer who buys advance refunded bonds knows they will be called. Any yield that is shown must be computed to the call date, including any call premiums - in essence, the call date becomes the new maturity date for the issue. question # 4-6-6-1 Trading Markets: MSRB Customer Disclosure and Settlement Rules: Pricing Pre Refunded Bonds Quoted on a Yield Basis Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

The purchaser of a variable annuity bears which of the following risks? I Interest rate risk II Expense risk III Mortality risk IV Investment risk A. I and IV only B. II and III only C. I, II, III D. I, II, III, IV

The best answer is A. Both mortality risk (the risk that the annuitant lives longer than expected) and expense risk (the risk that expenses of running the separate account are higher than expected) are borne by the issuer of a variable annuity contract. The customer assumes the investment risk, since the annuity payment varies with the performance of the securities funding the separate account. With any investment, customers assume legislative risk and interest rate risk. Legislative risk for a variable annuity contract would be Congress changing the tax law. Interest rate risk is inherent in any product that gives the holder a stream of payments - if market interest rates rise, the value of the stream of payments decreases. question # 7-3-4-4 Investment Companies: Variable Annuities (UITs): Overview: Guarantees Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

As the initial transaction in a new short margin account, a customer sells 1,000 ABC @ $24 per share. The stock then rises to $25. After the market rise, the customer's equity in the account is: A. $11,000 B. $12,000 C. $13,000 D. $14,000

The best answer is A. Initially, the account sets up as: Credits - Short Market Value = Equity % Sale $24,000 $24,000 0 Margin $12,000 $12,000 Total $36,000 $24,000 $12,000 50% If the market value rises to $25,000, the account will show: Credits - Short Market Value = Equity % $36,000 $25,000 $11,000 44% question # 5-4-7-4 Customer Accounts: Short Margin Accounts: Account Increasing in Value - Equity Computation Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

(Refer to the exhibit window to answer the following question) The AEP Nov 20 Call has time value of: A. 0 B. .25 C. .50 D. 20.25

The best answer is A. The AEP Nov 20 Call is trading at parity (the market price is $20.25, so intrinsic value is .25; and the premium is .25 point). Such a contract has no time value. question # 3-8-34-3 Options: Equity (Stock) Options: Equity Option Financial Listings: Time Value Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

On the same day, in a margin account, a customer buys 1 ABC Jan 45 Call @ $13 and sells 1 ABC Jan 60 Call @ $2. The maximum potential gain is: A. $400 B. $1,100 C. $1,500 D. unlimited

The best answer is A. The customer has purchased a long call spread. The positions are: Buy 1 ABC Jan 45 Call @ $13 Sell 1 ABC Jan 60 Call @ $ 2 $11 Debit If the market rises above $60, both calls will be exercised for a 15 point profit on the stock (buy at $45 and sell/deliver at $60). Since the net premium paid was 11 points, the net gain is 15 - 11 = 4 points. This is the maximum potential gain. question # 3-6-4-7 Options: Spreads: Long Call Spread: Maximum Potential Gain Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

The shortest initial maturity available for Treasury Bills is: A. 4 weeks B. 13 weeks C. 26 weeks D. 52 weeks

The best answer is A. Treasury Bills are issued in initial 4 week (1 month); 13 week (3 month); 26 week (6 month); and 52 week (12 month) maturities. question # 2-3-2-7 Debt: U.S. Government Debt: Treasury Bills: Maturity Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

"Phantom income," which can occur in a limited partnership program, is: A. taxable income created if a partnership asset is ceded to a lender, when the loan balance exceeds asset depreciated value B. taxable income created if a partnership asset is ceded to a lender, when the loan balance exceeds asset fair market value C. non-taxable income created if a partnership asset is ceded to a lender, when the loan balance exceeds asset depreciated value D. non-taxable income created if a partnership asset is ceded to a lender, when the loan balance exceeds asset fair market value

The best answer is B. "Phantom income" is a rather nasty IRS concept that states that if a loan is forgiven, the amount of the unpaid loan becomes taxable income to the beneficiary. If a partnership loan is forgiven, (or partially forgiven, for example when an asset is given to the lender in return for forgiveness of the loan), "phantom income" is generated to the extent that the loan balance exceeds the asset's market value. "Phantom income" is taxable income, even though no actual cash income is received by the beneficiary. question # 8-2-28-3 Taxes / Tax Shelters: Tax Advantaged Investments: Disposition of a Partnership Unit: Phantom Income Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Interest income from which of the following securities is subject to State and Local tax? A. Treasury Bonds B. Fed Nat Mortgage Assoc Bonds C. Federal Home Loan Bank Bonds D. Puerto Rico Bonds

The best answer is B. As a rule, interest income from U.S. Government securities is subject to Federal tax and exempt from State and Local tax. As a general rule, interest income from agency securities is subject to Federal tax and exempt from State and Local tax. However, the interest income from securities issued by the housing agencies that sell pass through certificates is fully taxable. These are: Federal National Mortgage Association ("Fannie Mae") Government Nat Mortgage Association ("Ginnie Mae") Fed Home Loan Mortgage Corporation ("Freddie Mac") Interest income received from bonds issued by territories or possessions is always triple exempt. question # 2-4-100-1 Debt: Municipal Debt: Taxation: Tax Free Bonds Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Which of the following are defined as products offered by investment advisers? I Non-managed fee based accounts II Managed fee based accounts (wrap accounts) III Per trade commission charge accounts A. I only B. I and II only C. II and III only D. I, II, III

The best answer is B. Fixed fee accounts (non-managed fee based accounts) only cover trading costs. They do not include charges for asset allocation and portfolio management. Wrap accounts include asset allocation and portfolio management. Any fixed fee product is defined as an "investment adviser" product. Per trade commission charge accounts are brokerage products. If a firm offers fixed fee accounts, it must do so through a registered Investment Adviser subsidiary; and its representatives must be licensed as "IARs" - Investment Adviser Representatives. question # 5-1-107-3 Customer Accounts: Account Basics: Specific FINRA Product / Customer Suitability Rules: Non-Managed Fee-Based Account: Definition Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A customer that wishes to open an account to buy new issues is required to make a: I positive representation that he or she is not restricted within 12 months preceding the first purchase II negative representation that he or she is not restricted within 12 months preceding the first purchase III positive representation that he or she is not restricted annually thereafter IV negative representation that he or she is not restricted annually thereafter A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. In order for a customer to buy IPOs (Initial Public Offerings) of equity securities, the customer must sign a representation letter that he or she is not restricted from buying the issue under FINRA rules (FINRA prohibits industry "insiders" from buying the issue from the underwriter). Because the customer must sign this representation, this is a "positive" affirmation. Annually thereafter, the customer must be sent a notice that the firm has the customer's representation on file that he or she is not restricted, and that if this has changed, the customer must notify the firm so that the account file can be amended. Because the customer does not sign this representation, this is a "negative" affirmation. question # 9-4-45-2 Regulations: FINRA Rules: Customer Accounts: Buying IPOs - Qualifying Account Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Which statements are TRUE regarding market risk for bondholders? I As interest rates rise, the price of long term bonds falls faster than that of short term bonds II As interest rates rise, the price of short term bonds falls faster than that of long term bonds III To avoid market risk, a customer would invest in bonds with long term maturities IV To avoid market risk, a customer would invest in bonds with short term maturities A. I and III B. I and IV C. II and III D. II and IV My answer was D

The best answer is B. Market risk for a bondholder is the risk of rising interest rates forcing the price of a bond to drop. As interest rates rise, the price of a long term bond falls faster than that of a short term bond. To avoid market risk, a bondholder would want to invest in the shortest maturity possible. question # 2-1-10-1 Debt: Bond Basics: Factors Affecting Bond Price Volatility: Maturity Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A customer purchases a reverse convertible note. Under which scenario will the customer receive less than par value at maturity? A. The market price of the reference stock has declined, but is not below the knock-in price B. The market price of the reference stock has declined and is below the knock-in price C. The market price of the reference stock has risen above the knock-in price but is below par D. The market price of the reference stock has risen above the knock-in price and is above par

The best answer is B. Reverse convertible notes were created for customers looking for enhanced yield in a low interest rate environment. Of course, any enhanced yield comes with higher risk. The note is linked to the price movements of an underlying stock (or very rarely, an underlying index). At maturity, the holder will receive par value, as long as the price of the reference stock is above the "knock-in" price (typically 70-80% of the initial reference price). On the other hand, if, at maturity, the reference stock falls below the "knock-in" price, then the holder will receive the shares of stock. Thus, if the market price of the reference stock declines below the "knock-in" price, the customer receives the stock at maturity and not par value. question # 2-5-35-1 Debt: Money Market Debt / Structured Products: Structured Products: Reverse Convertible Notes Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A municipal securities firm based in Los Angeles that effects transactions solely on an principal basis places the following advertisement in the local newspaper: "We Search The Market To Buy Bonds To Fill Your Orders At The Lowest Price!" Which statement is TRUE regarding this advertising claim? A. This is prohibited under MSRB rules because such ads can only be placed in trade publications B. This is prohibited under MSRB rules because the statement is materially untrue C. This is prohibited under MSRB rules because the advertisement must be approved by the MSRB prior to use D. This is permitted under MSRB rules without restriction

The best answer is B. Since this firm effects trades solely on a principal basis, it carries inventory and is a market maker. Thus, its claim to "search the market to fill your order" for municipal bonds is untrue, since the firm only sells out of inventory as a dealer. The MSRB does not require any filing of advertising, and advertisements can be placed in any medium. However, statements made in advertising cannot be fraudulent. question # 9-6-35-2 Regulations: MSRB Rules: Advertising Rules: Prohibited Statements Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A customer is long 100 shares of ABC stock, believes that the market will remain flat for the next 6 months. To maximize income from the position, which strategy is best? A. covered call write B. ratio call write C. short call spread D. short against the box

The best answer is B. To get income from a long stock position, the customer would sell a call to collect the premium. If the customer is certain that the market will not move, even greater income can be generated by "ratio writing" - that is, selling more call contracts (collecting more premiums) than shares owned. However, for the extra income received also comes extra risk if the market should rise. question # 3-7-1-2 Options: Ratio Strategies / Options Strategies Summary: Ratio Call Writing: Overview Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

The first use of funds under a "gross lien revenue pledge" is to pay the: A. operation and maintenance fund B. debt service fund C. debt service reserve fund D. maintenance reserve fund

The best answer is B. Under a gross revenue pledge, bondholders have claim to the gross revenues of the facility. After the debt service is paid, then operation and maintenance is paid. Contrast this with a "net revenue pledge." Under this pledge, bondholders only have claim to net revenues after operation and maintenance is paid. In this case, the first use of funds is to pay operation and maintenance. question # 2-4-13-1 Debt: Municipal Debt: Revenue Bond: Gross Revenue Pledge Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A customer, age 69, has never invested in securities. She is retired with no dependents, living on a fixed pension of $35,000 per year. She has a savings account with $160,000 and her home is fully paid. She desires to supplement her retirement income, assuming minimal risk. The best recommendation would be for the customer to invest $100,000 of her cash savings into a(n): A. variable annuity contract B. CMO planned amortization class tranch C. SPDR D. income (adjustment) bond

The best answer is B. CMO planned amortization classes give a good yield that is 50 or so basis points higher than equivalent maturity Treasuries and are extremely safe. These meet the customer's objective of additional income with low risk. Since this customer is only earning $35,000 per year, she is in a low tax bracket - making tax-deferred variable annuities unattractive. SPDRs - Standard and Poor's 500 Depository Receipts are an exchange traded fund that consists of equities - which don't provide much income. Income bonds only pay interest if the corporation has enough "income" - so these are not appropriate either. question # 10-4-41-3 Analysis: Portfolio Analysis: Portfolio Management: Basic Recommendation Examples Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Growth in the separate account of a variable annuity offering a GMIB is: I guaranteed as to minimum rate II not guaranteed as to minimum rate III capped as to maximum rate IV not capped as to maximum rate A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. GMIB - Guaranteed Minimum Income Benefit will give a minimum guaranteed growth rate for an additional cost. This guarantee only occurs at annuitization and covers the accumulation phase. The maximum rate that can be earned in the separate account during the accumulation phase is not capped by the GMIB rider. question # 7-3-34-5 Investment Companies: Variable Annuities (UITs): GMIB - Guaranteed Minimum Income Benefit Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A 70-year old client wants to invest in U.S. Treasury securities. When performing the suitability determination, the client informs the registered representative that he is looking for after-tax income, liquidity, and market risk. The registered representative should be LEAST concerned with the: A. client's tax bracket B. client's age C. coupon of recommended Treasury securities D. maturity of recommended Treasury securities

The best answer is B. Since Treasury securities are the safest security, they are an appropriate recommendation for a 70-year old client. So age really is not a concern with this recommendation. The client's tax bracket is a concern because the income is Federally taxable. If the client is in the highest tax bracket, maybe municipal bonds would be a better recommendation. The coupon of the recommended Treasury securities is important because this client wants income. Regarding the maturity of the recommended Treasury securities, the recommendation of a 30-year bond as opposed to a shorter-term investment could subject the customer to a high level of market risk (loss of market value if interest rates rise). This is another concern, since the customer wants to avoid market risk. question # 10-4-82-4 Analysis: Portfolio Analysis: Portfolio Management: Suitable Recommendations - Older Customers - II Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Which of the following is NOT defined as an "investment company" under the Investment Company Act of 1940? A. Face Amount Certificate Company B. Real Estate Investment Trust C. Management Company D. Unit Investment Trust

The best answer is B. The Investment Company Act of 1940 defines 3 types of investment companies; face amount certificate companies, unit investment trusts, and management companies. Real Estate Investment Trusts are not defined under the Investment Company Act of 1940 because they do not invest in securities; rather, they make real estate investments. question # 7-1-1-2 Investment Companies: Overview: Types of Investment Companies Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Which statements are TRUE regarding closed end investment companies? I The initial offering of shares is made under a prospectus II Shares are redeemable with the issuer at Net Asset Value III Shares trade in the secondary market at prevailing market prices IV The portfolio of investments is not managed A. I and II only B. I and III only C. III and IV only D. I, III, IV

The best answer is B. The initial offering of closed end investment company shares is made under a prospectus. Then the shares are listed on an exchange and trade like any other stock. The shares are not redeemable; they are negotiable. The portfolio of investments is managed - this is a closed-end management company. question # 7-2-34-1 Investment Companies: Management Companies: Publicly Traded Funds: Overview Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Which statement is TRUE about a Targeted Amortization Class (TAC)? A. A TAC is a variant of a PAC that has a higher degree of prepayment risk B. A TAC is a variant of a PAC that has a lower degree of prepayment risk C. A TAC is a variant of a PAC that has a higher degree of extension risk D. A TAC is a variant of a PAC that has a lower degree of extension risk

The best answer is C. A Targeted Amortization Class (TAC) is a variant of a PAC. A PAC offers protection against both prepayment risk (prepayments go to the Companion class first) and extension risk (later than expected payments are applied to the PAC before payments are made to the Companion class). A TAC bond protects against prepayment risk; but does not offer the same degree of protection against extension risk. A TAC bond is designed to pay a "target" amount of principal each month. If prepayments increase, they are made to the Companion class first. However, if prepayment rates slow, the TAC absorbs the available cash flow, and goes in arrears for the balance. Thus, average life of the TAC is extended until the arrears is paid. Therefore, both PACs and TACs provide "call protection" against prepayments during period of falling interest rates. TACs do not offer the same degree of protection against "extension risk" as do PACs during periods of rising interest rates - hence their prices will be more volatile during such periods. question # 2-3-42-1 Debt: U.S. Government Debt: CMOs: TAC Tranche Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Which of the following statements about warrants are TRUE? I. At issuance, warrants have intrinsic value II. Warrant valuation is directly influenced by the market price of the common stock III. Warrant valuation reflects market expectations for future earnings of the company IV. Warrant valuation reflects the life of the instrument A. I and II only B. III and IV only C. II, III, IV D. I, II, III, IV My answer was D

The best answer is C. At issuance, warrants typically have exercise prices well above the current market price of the common stock. Thus, for the warrant to have real value, the market price of the common must rise above the exercise price of the warrant. Warrant valuation is directly influenced by the common stock price, the life of the warrant, and expectations for future corporate earnings. question # 1-3-5-5 Equities: Special Securities and Financial Listings: Warrants: Features Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A customer buys 1 Euro October 140 Call @ 6 when the Euro is trading at 135. The contract: is A. trading at parity B. "in the money" C. "out the money" D. "at the money"

The best answer is C. Calls go "out the money" when the market price is lower than the strike price. Since the market price is 135 (cents) while the contract allows the customer to buy at a strike price of 140 (cents), the call is "out the money" by 5 cents. question # 3-11-10-3 Options: Foreign Currency Options: Contracts: In / Out Money Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Which options orders are permitted? I A corporation selling calls against its underlying stock II A custodian selling calls against securities in a custodian account III An individual selling naked calls in a discretionary account IV An investment company selling calls against securities in its portfolio A. I and II only B. III and IV only C. II, III, and IV D. I, II, III, IV

The best answer is C. Issuers are prohibited from selling call options against their underlying stock. If they were exercised, they could simply issue more shares to deliver on the exercise notice, diluting existing stockholder's equity. Furthermore, the issuance of the new shares would require a registration with the SEC. Thus, issuers are prohibited from selling calls against their own stock. There is no prohibition on investment companies selling calls against stocks held in their portfolios - this is a very popular strategy for enhancing income. Custodians can also sell covered calls against securities held in the custodian account to increase income. In a discretionary account, all orders are permitted as long as a written power of attorney is received from the customer and the trades are suitable for the account. question # 9-7-10-2 Regulations: CBOE Rules: Issuers Selling Calls Against Own Stock Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

AMCE Corporation Income Statement Net Sales $20,000,000 Cost of Goods Sold 5,000,000 Gross Margin 15,000,000 Operating Expenses 4,000,000 Operating Income 11,000,000 Bond Interest 1,000,000 Net Income Before Tax 10,000,000 Tax at 50% 5,000,000 Net Income After Tax $5,000,000 ACME's capitalization consists of $10,000,000 worth of 10% Debentures, maturing 2040, convertible at $25; and $400,000 shares of Common at $1 Par outstanding. What is ACME's fully diluted earnings per common share? A. $1.77 B. $3.44 C. $6.88 D. $16.67

The best answer is C. To compute Diluted Earnings Per Share, the income statement must be recast to include the effect of bond conversion. The adjusted income statement is: Gross Margin $15,000,000 Operating Expenses 4,000,000 Operating Income 11,000,000 Bond Interest Expense 0 11,000,000 Taxes at 50% 5,500,000 Net Income After Tax $5,500,000 Since the $10,000,000 of bonds are convertible at $25, then 400,000 ($10,000,000 / $25) new shares will be issued. Diluted earnings per share is: $5,500,000 400,000 + 400,000 = $5,500,000 800,000 = $6.88 per share question # 10-1-18-2 Analysis: Fundamental Analysis: Income Statement: Fully Diluted Earnings per Share Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

In determining the Net Interest Cost to the issuer in a competitive bid municipal bond sale, which statements are TRUE? I Any premium is added to Net Interest Cost II Any premium is subtracted from Net Interest Cost III Any discount is added to Net Interest Cost IV Any discount is subtracted from Net Interest Cost A. I and III B. I and IV C. II and III D. II and IV Guessed this one right.

The best answer is C. When awarding a bid, the issuer deducts any premium paid by the underwriter from the total interest cost to arrive at the Net Interest Cost. Conversely, the issuer adds any discounts taken by the underwriter to the total interest cost to arrive at the net interest cost. The lowest Net Interest Cost wins the bid. question # 6-2-14-3 New Issues: Municipal Underwritings: Competitive Bid: Effect of Premium or Discount on Bid Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Banker's Acceptances are: A. money market instruments subject to the Securities Act of 1933 B. capital market instruments subject to the Securities Act of 1933 C. money market instruments exempt from the Securities Act of 1933 D. capital market instruments exempt from the Securities Act of 1933

The best answer is C. Bankers Acceptances are a money market instrument used to finance imports and exports. They are an exempt security under the Securities Act of 1933 and can be sold without a prospectus. question # 9-1-3-3 Regulations: Securities Act of 1933: Exempt Issues: Money Market Instruments - Banker's Acceptances Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A customer calls her registered representative and says the following: "I'm looking for a safe investment for $100,000 that I have, that will give me a moderate level of income. I have 2 children, ages 12 and 13, and I will need to use these monies to pay for their college education, starting in 5 years." All of the following recommendations would be suitable EXCEPT: A. Treasury bond mutual fund B. Treasury bonds with 5, 6, 7, 8, and 9 year maturities C. GNMA pass-through certificates with 5, 6, 7, 8, and 9 year maturities D. FNMA debentures with 5, 6, 7, 8, and 9 year maturities

The best answer is C. GNMA pass-through certificates represent an ownership interest in a pool of underlying mortgages. Each month, the mortgage payments made into the pool are "passed through" to the certificate holders. If interest rates drop, then the homeowners in the pool will refinance their mortgages and prepay their old higher rate mortgages. These prepayments are passed through to the certificate holders, who are paid off much earlier than expected. If these payments are reinvested, since interest rates have fallen, the overall rate of return falls, and the anticipated monies needed to fund the college education will not be available. Prepayment risk does not exist with conventional debt securities. question # 10-4-46-2 Analysis: Portfolio Analysis: Portfolio Management: Suitable Recommendations - Situations Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

20 Basis points equals: A. .002% B. .02% C. .2% D. 2%

The best answer is C. Since 1 Basis Point = .01% = $.10, 20 Basis Points = .20% = $2.00. question # 2-3-60-2 Debt: U.S. Government Debt: Quotes: Treasury Bill Basis Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

On the same day in a margin account, a customer buys 1 ABC Jan 35 Call @ $8 and sells 1 ABC Jan 50 Call @ $2 when the market price of ABC is $41. The position will be profitable if: I both contracts expire II both contracts are exercised III the spread between the premiums widens IV the spread between the premiums narrows A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. Since this is a debit spread, if both positions are exercised, the customer gains the difference in the strike prices (buy at $35; sell at $50) minus the difference in premiums paid ($6 debit). If both positions expire, the customer loses the difference between the premiums ($6 debit). To be profitable, a debit spread must be closed out (traded) at a larger credit. Thus, the spread between the premiums must widen. question # 3-6-7-3 Options: Spreads: Long Call Spread: Widening / Narrowing Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

The Securities Exchange Act of 1934 regulates trading of which of the following? I Corporate Stock II Corporate Bonds III Options IV Commodities Futures A. I only B. II only C. I, II, III D. I, II, III, IV

The best answer is C. The Securities Exchange Act of 1934 regulates trading of all non-exempt securities, including common stocks, preferred stocks, corporate bonds, options on securities, etc. It does not regulate the trading of commodities, since these are not securities, and thus, are not regulated under the Securities Acts. Rather, futures (commodities) are regulated by the CFTC - the Commodities Futures Trading Commission. Please note, also, that the Securities Exchange Act of 1934 states that manipulation is fraud under the Act, whether the manipulation involves either non-exempt or exempt securities. question # 9-2-3-2 Regulations: Securities Exchange Act of 1934: Overview: Applicability to Futures Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Corporate officers who wish to trade their own company's stock must comply with all of the following rules EXCEPT: A. filing change of holding reports with the SEC B. prohibitions on short sales of that company's stock C. purchase restrictions through the exercise of stock options D. trading is restricted to decisions based on publicly available information

The best answer is C. There is no restriction on corporate officers' buying their company's stock through the exercise of stock options. Many companies compensate their officers with stock option packages. Officers must report their trades to the SEC within 2 business days of the trade, since they are classed as "insiders;" insiders are prohibited from selling their company's stock short except for year-end "short against the box" trades; and insiders can only trade based on publicly available information. question # 9-2-10-4 Regulations: Securities Exchange Act of 1934: Insider Rules: General Provisions Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Which information would be included on a When, As and If Issued trade confirmation for a bond trade? A. Settlement date B. Amount of accrued interest C. Total transaction cost D. Agent or principal transaction

The best answer is D. A "When, As and If Issued" trade occurs without knowing the settlement date. When the securities are finally issued, a settlement date is set. If the settlement date is unknown, the amount of accrued interest due is unknown (interest accrues up to, but not including settlement). If the amount of accrued interest is unknown, the total transaction cost is unknown. The confirmation would state whether the trade was performed by the firm as agent or dealer. question # 4-5-13-1 Trading Markets: Customer Disclosure and Settlement Rules: When, As, and If Issued Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A corporation can redeem its debt securities prior to their maturity date by which of the following methods? I Purchasing outstanding debt securities in the open market II. Tendering for outstanding debt securities at a price determined by the issuer III. Calling outstanding securities at pre-established dates and prices IV Forcing conversion of convertible bonds where the market price of the bond has risen above the call price A. I and III only B. II and IV only C. II, III, IV D. I, II, III, IV I picked C.

The best answer is D. A corporation can retire its debt prior to maturity by all of the methods listed. It can purchase outstanding debt securities in the open market, which it would do if the market price of the bonds was below the call price. It can make a formal tender offer to all bondholders to buy outstanding debt securities at a price determined by the issuer. It can call outstanding securities at pre-established dates and prices. Finally, it can force conversion of convertible bonds that have appreciated in the market by calling them. Rather than tender the bonds to the issuer at the lower call price; the convertible bondholders will convert into the more valuable equivalent number of shares of common stock. question # 2-2-23-1 Debt: Corporate Debt: Retirement Provisions Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Which of the following statements are TRUE regarding a municipal bond issue that is advance refunded? I The security that backs the advance refunded bonds will change after the issue is refinanced II The bondholder's lien on pledged revenues will be defeased in accordance with the terms of the bond contract III The marketability of the advance refunded bonds will increase IV The funds to pay the debt service requirements on the advance refunded bonds are set aside in escrow A. II only B. III and IV only C. I, II, IV D. I, II, III, IV

The best answer is D. All of the statements are true regarding advance refunding of a municipal bond issue. In an advance refunding, the issuer floats a new bond issue and uses the proceeds to "retire" outstanding bonds that have not yet matured. These funds are deposited to an escrow account and are used to buy U.S. Government securities. The escrowed Government securities become the pledged revenue source backing the refunded bonds. These bonds no longer have claim to the original revenue source. Since there is a new source of backing for the bonds (and an extremely safe one!), the credit rating on the pre-refunded bonds increases, as does their marketability. The pre-refunded bonds no longer have any claim to the original pledged revenues - and thus have been "defeased" - that is, removed as a liability of the issuer. question # 2-4-50-1 Debt: Municipal Debt: Defeasance: Advance Refunding Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Which of the following are TRUE statements about the trading of bonds and their prices? I Bonds trading at a premium are more likely to be called than bonds trading at a discount II A bond trading at a discount can indicate that the issuer's rating has deteriorated III Discount bonds will appreciate more rapidly as interest rates fall than will similar premium bonds IV A bond trading at a discount can indicate that interest rates have risen A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV

The best answer is D. All of the statements are true regarding bonds. If a bond issued at par is trading at a discount, it can indicate that the issuer's rating has deteriorated or that market interest rates have risen. As interest rates fall, discount bonds will appreciate at a faster rate than will premium bonds. The change in value of the bond's price is a result of an increased "present value" of the remaining interest payments to be received. This increase in the "value" of the remaining interest payments is a larger percentage of a discount bond's price than of a premium bond's price. Thus, as interest rates drop, discount bonds rise faster than premium bonds. Similarly, as interest rates rise, discount bond prices fall faster than premium bond prices. If the bond is trading at a discount and is then called, then the issuer will have to pay par for the bonds. Why not, instead of paying par, purchase the bonds at the current market price? It would be better to pay the discount than the full market value. Furthermore, a bond trading at a discount indicates that market interest rates have risen - why would an issuer call in such an issue, when it has a bargain interest rate? The only bonds that are likely to be called are those trading at premiums - meaning that market interest rates have fallen. The issuer can call in the premium bonds at a price close to par, and refund at lower current market interest rates. question # 2-1-44-3 Debt: Bond Basics: Summary Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

An NMS stock can only be sold short on an up bid if its price falls by at least: A. 1% B. 2% C. 5% D. 10%

The best answer is D. If an NMS (National Market System stock - NYSE, NYSE-MKT (AMEX), or NASDAQ listed) falls by 10% or more, it can only be sold short on an "up bid" for the remainder of that trading day and the entire next trading day. Thus, it can only be sold short into a rising market. This stops the relentless short selling of stocks with the intent of driving market prices down - a market manipulation. question # 4-2-45-1 Trading Markets: NYSE Trading: Regulation SHO: Up Bid Rule Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

The DMM (Specialist) on the NYSE, just prior to market opening, has orders to sell 100,000,000 shares of ABC stock at the open, but only has orders to buy 5,000,000,000 shares. Because of the extreme order imbalance, the DMM, at the open, displays "ABC - OPD" on the Network A Tape. Which statement about this is FALSE? A. The NYSE has delayed the opening of the stock B. Other markets are permitted to trade the stock C. This is a non-regulatory trading halt D. Any other market that wishes to trade the stock during the halt must get prior FINRA approval

The best answer is D. OPD stands for "Opening Delayed." This is a non-regulatory halt, which is quite different from a "halt" imposed by a regulator, such as the SEC or FINRA. For example, in the "good old days," the NYSE would routinely delay the opening of trading in a stock if there was a large opening order imbalance (many more opening sell orders than buy orders). During the halt, the Specialist/DMM would attempt to round up matching buy orders, so that there could be an orderly opening. The NYSE learned that this was not such a great idea, because institutions that could not trade the stock on the NYSE simply went to regional exchanges, Third Market Makers and ECNs to do their trades instead. So each time the NYSE did this, they lost market share! Needless to say, they don't do this anymore - except in test questions of course! question # 4-2-46-3 Trading Markets: NYSE Trading: Non-Regulatory Trading Halts Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

100 Basis Points equal: A. $.01 B. $.10 C. $1.00 D. $10.00

The best answer is D. One basis point = .01% in interest, or .01% of $1,000 par in annual interest = $.10. 100 basis points equal 1% of annual interest on a $1,000 per bond = $10.00. question # 2-4-77-1 Debt: Municipal Debt: Trading: Basis Points Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

All of the following are functions of the Federal Reserve Board EXCEPT: A. acting as fiscal agent for the U.S. Treasury B. auditing commercial banks for compliance with banking and MSRB regulations C. lending funds to member banks through the discount window D. setting margins on municipal securities

The best answer is D. The Federal Reserve has the power to set margins for non-exempt securities only. It cannot set margins for exempt securities such as governments and municipals. The Fed acts as fiscal agent for the Treasury, conducting the weekly Treasury auctions. It audits commercial banks for compliance with banking and MSRB rules. It lends funds to member banks at the discount rate. question # 10-2-13-3 Analysis: Economic Analysis: Federal Reserve: Overview Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Which of the following individuals trades on the New York Stock Exchange Floor? I Specialist (DMM) II Floor Broker III Two Dollar Broker IV Competitive Trader A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is D. The Specialist (now renamed the DMM - Designated Market Maker) is the assigned market maker in a security on the NYSE floor. The Floor Broker handles orders as agent for retail member firms. The Two Dollar Broker executes orders for retail member firms, usually when its Floor Brokers are too busy. The name comes from the fact that they used to charge $2 per trade. A Competitive Trader is a person that trades for his own account (this really doesn't happen any more, but it is tested). question # 4-2-2-4 Trading Markets: NYSE Trading: Market Participants Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A customer sells short 100 shares of ABC at $35 and buys 1 ABC Jul 35 Call @ $3. The stock falls to $30 and the customer closes the option contract at $1 and buys the stock at the current market price. The customer has a: A. $200 loss B. $300 loss C. $200 gain D. $300 gain

The best answer is D. The customer sold the stock for $35 bought a call, paying a premium of $3 per share. The customer closes the stock position by purchasing the stock in the market at $30 for a gain of 5 points ($35 sale; $30 purchase). The customer closes the option position by selling the option at $1, for a loss of 2 points ($3 purchase; $1 sale). The net gain is: 5 - 2 = 3 points or $300. question # 3-3-15-3 Options: Hedging Strategies: Short Stock / Long Call: Summary - Trading Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserv

The January stock option contracts of a company assigned to Cycle 3 have just expired. Which contracts will commence trading on the CBOE? A. February B. March C. July D. September

The best answer is D. The options cycles are: Cycle 1 Jan Apr Jul Oct Cycle 2 Feb May Aug Nov Cycle 3 Mar Jun Sep Dec Cycle 3 contracts are issued for the months of Mar - Jun - Sept - Dec. One can always get a contract for this month, next month, and the next 2 months in the Cycle. In January, prior to expiration, the contracts that will trade are January (this month), February (next month), March and June (the next 2 months in the cycle). After January contracts expire, the contracts that will trade are February (this month), March (next month), June and September (the next 2 months in the cycle). question # 3-8-4-3 Options: Equity (Stock) Options: O.C.C.: Contract Specifications - Option Cycles Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A registered representative employed by ABC broker/dealer is good friends with an independent venture capitalist. The venture capitalist asks the registered representative to obtain investors for a private placement that he is forming. Which statement is TRUE? A. The registered representative can direct customers to the private placement since this is an exempt transaction B. The registered representative cannot direct customers to the private placement since his broker-dealer is not the private placement sponsor C. The registered representative can direct customers to the private placement only if the venture capitalist is a member of FINRA D. The registered representative can direct customers to the private placement only with the prior written approval of his employer

The best answer is D. Under FINRA rules, registered representatives are prohibited from effecting "private securities transactions." As a registered representative, one is an agent for the firm and all transactions must be effected through the firm in one's agency capacity. However, FINRA does allow an exemption from this prohibition. If a registered representative: provides written notice to the member of the transaction, and details in writing any compensation to be received, and obtains express approval in writing from the member firm, then the associated person can perform the transaction. In addition, the member must record the transaction on its books as if it had been effected through the firm. question # 9-4-43-2 Regulations: FINRA Rules: Customer Accounts: Private Securities Transactions Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

All of the following technical indicators would be considered to be bearish EXCEPT: A. a breakout through a support level B. a head and shoulders top formation C. an inverted Saucer formation D. Odd lot short sales

The best answer is D. A breakout through a support level is bearish, as is a head and shoulders top formation, and an inverted saucer formation. A head and shoulders top formation shows that the market has topped and is heading downward; an inverted saucer formation shows the same - that the market has topped and is heading downward. The Odd Lot theory states that the small investor tends to trade odd lots and that the small investor is always wrong. Thus, the knowledgeable investor should do the opposite of what the small investor does. In this case, the small investor is selling, so, one should buy (a bullish indicator). question # 10-5-14-4 Analysis: Technical Analysis: Summary: Bearish Indicators Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

A closed end fund's Net Asset Value is $8.50. The market price of the fund could be: I $8.00 II $8.50 III $9.00 IV $9.50 A. II only B. I and II C. III and IV D. I, II, III, IV

The best answer is D. Because closed-end funds trade like stocks, the fund's pricing is reflective of investor's sentiment towards the fund. The fund can trade at a discount to Net Asset Value when investors become disenchanted with the fund. This will occur if the fund gives an inferior return. Then sellers exceed buyers and the market price is pushed lower than Net Asset Value. When buyers exceed sellers, and the fund gives a superior return relative to the market rate of return for similar investments, the ask price is pushed higher. Thus, closed-end funds can trade at NAV; below NAV; or above NAV. question # 7-2-37-4 Investment Companies: Management Companies: Publicly Traded Funds: NAV Relative to POP Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

The Dow Jones Averages consist of: A. 15 stocks B. 20 stocks C. 30 stocks D. 65 stocks

The best answer is D. The Dow Jones Averages have 65 stocks - 30 industrials, 20 transportations and 15 utilities. The Dow Jones Industrial Average, which is the most widely quoted of the 3 averages, includes 30 stocks. question # 10-3-14-4 Analysis: Market Analysis: Stock Market: Dow Jones Averages Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

In a Real Estate Limited Partnership, the general partner refinances an existing $5,000,000 mortgage on a $10,000,000 property to the original amount of $8,000,000. The interest rate on both mortgages is the same. The purpose of this action by the General Partner is to: A. decrease the limited partners' basis in the partnership B. decrease the operating and maintenance expenses of the property C. increase operating cash flow D. increase interest deductions for the limited partners

The best answer is D. The general partner is increasing the amount of the mortgage on the property to increase interest deductions to the limited partners (since the new loan is for a larger amount at the same interest rate). The basis in the partnership will increase due to this transaction. The partnership basis is increased by the assumption of either recourse or non-recourse debt in a real estate limited partnership. This transaction will not increase operating cash flow. Cash flow from operations will actually decrease due to the higher interest expense. However, the partnership will have an additional $3,000,000 of cash ($8,000,000 new mortgage vs. $5,000,000 old mortgage), to either invest or to make cash distributions to the limited partners. question # 8-2-23-1 Taxes / Tax Shelters: Tax Advantaged Investments: Partnership Basis: Effect of Mortgage Refinancing Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved

Customer Q, age 40, is married with 3 young children. He earns $120,000 per year and has $10,000 of liquid assets to invest. The customer has no current portfolio, but does own his home, worth $400,000 against which there is a $200,000 mortgage. The customer informs you that his father just died, leaving him an inheritance of $150,000. He wishes to invest the money so that he can retire in 20 years, using the investment's income. The best recommendation to the customer is to invest the $150,000 in: A. a large cap stock mutual fund B. CMO companion tranches with a 20 year average life C. TIPs with a 20 year maturity D. a low-load variable annuity separate account with a growth objective

The best answer is D. This customer wishes to fund his retirement 20 years from now. Large capitalization stock mutual funds don't provide a lot of income, and are subject to a greater degree of market risk unless the investment time horizon is very long (which it isn't in this case) - so these are not the best retirement investment for this customer. CMO companion tranches are very risky - not the best idea. Remember, these are the "buffer" tranches that absorb prepayment and extension risk. TIPs provide inflation protection, but the real rate of return is quite low (the price of "safety"), so if the customer lives a long time, the income will not be sufficient for retirement. A variable annuity will pay until the customer dies. Low sales charge variable annuities provide assured retirement income - best meeting the customer's objective. question # 10-4-42-3 Analysis: Portfolio Analysis: Portfolio Management: Intermediate Recommendation Examples Copyright 1989-2015 Edward Fleur Financial Education Corporation All Rights Reserved