9-9 Units 7, 8, 9

Mutual funds will qualify as regulated investment companies and follow the pipeline or conduit theory. Doing so requires that a minimum of __% of the NII be distributed to investors in the form of dividends. Any portion not distributed is taxable to the fund.

90%

A customer buys a 6% Treasury bond, maturing in 10 years, at a price of 91.07. The yield to maturity is A) greater than nominal yield. B) same as current yield. C) less than nominal yield. D) less than current yield.

A Explanation A bond whose price is below par or at a discount has a higher yield to maturity than current yield, which in turn is higher than the nominal yield.

A municipal securities dealer informed XYZ municipal bond fund that it was the leading retailer of XYZ shares and that, in return, XYZ should employ the dealer in effecting more transactions for the fund's portfolio. Which of the following statements regarding the request is true? A) It is not permissible because it violates the MSRB anti-reciprocal rule. B) It is permissible because MSRB rules do not cover municipal bond issuers or funds. C) It is permissible because it suggests a more reciprocal arrangement between the two parties. D) It is not permissible because municipal securities dealers are not allowed to execute trades for the portfolios they underwrite.

A Explanation An investment company must select a dealer to execute its portfolio transactions based on services provided. It is a violation of the anti-reciprocal rule (Municipal Securities Rulemaking Board Rule G-31) for an investment company to choose a firm to trade its portfolio based solely on sales of units or shares of the fund.

Alternative minimum tax (AMT) A) is assessed against high annual income earners and disallows some deductions and exemptions used to calculate adjusted gross income. B) is assessed against high annual income earners and gives them special deductions that lower income earners do not get. C) is assessed against all self-employed individuals. D) is assessed against low annual income earners and allows special deductions for them to be taken.

A Explanation The AMT is assessed against high annual income earners. When calculating adjusted gross income, some deductions and exemptions are disallowed, resulting in a higher taxable adjusted gross income.

All of the following are expenses to the operation of mutual funds except A) the compensation paid to the underwriter or distributor. B) the fees paid to the fund's investment adviser. C) the custodian bank's charges. D) the legal costs of SEC filings.

A Explanation The underwriters receive their compensation from the sales charges. Investors pay those charges rather than the fund itself.

For a mutual fund that collects a 12b-1 fee, which of the following statements are true? The fund may use the money to pay for mailing sales literature. Advertising materials must always state that the fund is no load. The fund may use the money to pay for commissions on portfolio transactions. The fund's prospectus must disclose the fee. A) I and II B) I and IV C) III and IV D) II and III

B Explanation 12b-1 fees may be used only to cover promotional and other distribution expenses for funds that are distributors of their own shares; fee amounts must be disclosed in the prospectus. The fund may not use the term no load in any communications with the public if the 12b-1 fee and other service fees exceed 0.25% of average net assets.

Most mutual funds operate as regulated investment companies. This means that A) their principal underwriter (sponsor) is a FINRA member. B) they qualify for special tax treatment under Subchapter M of the Internal Revenue Code. C) they register with the SEC under the Investment Advisers Act of 1940. D) they register with the SEC under the Investment Company Act of 1940.

B Explanation Triple taxation of investment income can be avoided if the mutual fund qualifies under Subchapter M of the IRC. To avoid taxation under Subchapter M, a fund must distribute at least 90% of its net investment income to shareholders. The fund then pays taxes only on the undistributed amount. This rule applies to management companies (open-end and closed-end) and UITs. That means ETFs are also included. Although not investment companies registered under the Investment Company Act of 1940, REITs can also take advantage of Subchapter M's tax benefits.

All of the following statements concerning a variable annuity are correct except A) the invested money will be professionally managed according to the issuer's investment objectives. B) a majority vote from the shareholders is required to change the investment objectives. C) variable annuities will protect an investor against capital loss. D) an insurance and securities license is needed to sell a variable annuity.

C Explanation As the name implies, the investment performance of a variable annuity's portfolio (separate account) can vary, and the investor bears the risk of any potential decline in its value. Many variable annuities invest the separate account in mutual funds.

A customer has a nonqualified variable annuity. Once the contract is annuitized, monthly payments to the customer are A) 100% tax free. B) 100% tax deferred. C) partially a tax-free return of capital and partially taxable. D) 100% taxable.

C Explanation The investor has already paid tax on the contributions, but the earnings have grown tax deferred. When the annuitization option is selected, each payment represents both capital and earnings. The money paid in will be returned tax free, but the earnings portion will be taxed as ordinary income.

If an investor keeps $100,000 invested in U.S. Treasury bills at all times during a 10-year period, she is subject to which of the following? Stable principal Unstable principal Stable interest Unstable interest A) II and III B) II and IV C) I and IV D) I and III

C Explanation Treasury bills are purchased at a discount and mature at face value. This feature provides principal stability to investors who own them. The discount on bills is determined by current market interest rates and fluctuates accordingly.

Closed-end funds are purchased on an exchange or over the counter where buyers pay the __________ plus ____________. open-end fund/mutual funds—are purchased at the ______________________, which includes a ________________. Management company offerings include both __________________ and _____________________ funds.

Closed-end funds are purchased on an exchange or over the counter where buyers pay the asking price plus a commission. open-end/mutual funds are purchased at the public offering price, which includes a sales charge. Management company offerings include both open-end and closed-end funds.

Variable annuity salespeople must register with all of the following except A) FINRA. B) the SEC. C) the state insurance department. D) the state banking commission.

D Explanation Variable annuity salespeople must be registered with FINRA and the state insurance department. Registration with FINRA is de facto registration with the SEC. No registration is required by the state banking commission.

Mutual funds have several different methods for assessing charges to become shareholders. Define the loads for: A B C

Purchasers of Class A shares pay a sales charge on each investment. Because the sales charge comes off the amount invested, it is called a front-end load. Class B and C shares have back-end loads, Class C shares charge a 12b-1 fee quarterly with a small back-end load in the first year.

T-bills, T-notes, and T-bonds are sold through _____________. Agency securities are sold through ___________.

T's sold through auctions that award securities to the most competitive bids. Agency securities sold through selling groups appointed by the agency

The greater the yield, the _________ the price.

The greater the yield, the lower the price.

Manager and Custodial fees are apart of a company's ________________ Sales load is a selling cost contained within the _________________ _____________

The management fees paid by an investment company are part of the operating expenses of the fund. Custodial fees are also part of the operating expenses. A sales load is a selling cost contained within the underwriting agreement.

A client invests $2,200 in an open-end investment company and signs a letter of intent for a $10,000 breakpoint. If he deposits $11,000 six months later, which of the following statements is true? A) He will receive a reduced load on $13,200 worth of shares. B) He will receive a reduced load on $10,000 worth of shares. C) He will receive a reduced load on $8,800 worth of shares. D) He will not receive any reduction in the sales load.

A Explanation An investor signing a letter of intent has 13 months to contribute funds to reach the reduced load. The sales charge in this case, then, will be based on the total investment of $13,200. If at the end of the 13 months the investor had not invested up to the breakpoint, the fund would liquidate enough shares to pay the difference in sales load.

A purchase or redemption order for investment company shares must be executed at a price based on A) the net asset value next computed after the fund receives the order. B) the net asset value last computed before the fund receives the order. C) the net asset value computed at the close of trading on the NYSE the day before the fund receives the order. D) the best net asset value computed the same day the fund receives the order.

A Explanation Purchase or redemption of mutual fund shares occurs at the first net asset value calculated after the fund receives the order. This is known as forward pricing.

The mutual fund industry is highly regulated. One of the areas regulated is that of making disclosures. An example of that is that mutual funds must provide reports to their shareholders on A) a biannual basis. B) a quarterly basis. C) a biennial basis. D) an annual basis.

A Explanation The Investment Company Act of 1940 requires that mutual funds provide their shareholders with reports twice per year (biannually). One of the reports is the annual report with audited financial statements (also filed with the SEC), and the other is the semiannual report. Biennial reporting would be every two years.

If a 42-year-old customer has been depositing money in a variable annuity for five years, and he plans to stop investing but has no intention of withdrawing any funds for at least 20 years, he is holding A) accumulation units. B) annuity units. C) mutual fund units. D) accumulation shares.

A Explanation The customer, in the accumulation stage of the annuity, is holding accumulation units. The value of the customer's account is converted into annuity units if and when the customer decides to annuitize the contract.

An investor purchased a 2x leveraged inverse ETF for $10,000. The ETF was linked to the performance of the S&P 500. During the first period, the S&P 500 rose by 8%, while during the next period, the index fell by 7%. What is the investment's value at the end of the second period? A) $9,576 B) $9,844 C) $9,976 D) $10,044

A Explanation The investment's value at the end of the second period would be $9,576. In 2× leveraged inverse ETF, the value of the shares would move in an opposite direction to an index by twice the amount of movement of the index. When the S&P 500 rose by 8%, the leveraged inverse ETF would have fallen by 16%. The investment value would have declined to $8,400 ($10,000 × 16% = $1,600; $10,000 - $1,600 = $8,400). When the S&P 500 fell by 7%, the leveraged inverse ETF would have increased by 14% from $8,400 to $9,576 ($8,400 × 14% = $1,176). $8,400 + $1,176 = $9,576.

Which of the following statements regarding the Government National Mortgage Association (GNMA) is true? A) GNMA originates loans to home buyers and sells the mortgage-backed securities to private lending institutions. B) Private lending institutions approved by GNMA originate eligible loans and sell the mortgage-backed securities to investors. C) Lending institutions apply to GNMA for funds to lend to residential home buyers. D) GNMA approves residential mortgages for home buyers.

B Explanation GNMA is a government-owned corporation that approves private lending institutions, such as banks and mortgage companies, to originate eligible loans, pool them into securities, and sell the GNMA mortgage-backed securities to investors. GNMA does not originate loans, and it does not issue or sell securities.

Paying a premium of $10 per bond, Tracey bought 10 municipal bonds with 20 years to maturity. Ten years later, she sold the bonds for 103. For tax purposes, she has A) a $200 loss. B) a $250 gain. C) a $300 loss. D) a $200 gain.

B Explanation The cost per bond is $1,010. The amortization amount each year is 10/20 years, which equals $0.50 per year. $0.50 per year × 10 years = $5 per bond. After 10 years, the adjusted cost basis is $1,005 per bond. She sells the bonds for $1,030 per bond. $1,030 − $1,005 = $25 per bond 25 × 10 = $250 gain.

The management fees paid by an investment company are part of A) the sales load. B) the operating expense of the fund. C) the custodial fees. D) the underwriting agreement.

B Explanation The management fees paid by an investment company are part of the operating expenses of the fund. Custodial fees are also part of the operating expenses. A sales load is a selling cost contained within the underwriting agreement.

Gifts exceeding $100 may be given by a registered representative to A) a customer of the representative. B) a registered representative of another member firm. C) the registered representative's unregistered sales assistant. D) a treasurer for an issuer of municipal securities.

B Explanation There are no restrictions on giving gifts to colleagues employed by the same firm—registered or not. Registration would be required to split commissions, but not for making a gift.

Parents planning to save for their children's education would probably find all of these suitable except A) Coverdell ESAs. B) Section 529 plans. C) money market mutual funds. D) Treasury STRIPS.

C Explanation Although money market mutual funds are safe investments, they offer no potential growth of capital and provide low income. The 529 and ESA plans offer tax benefits and investment options that can provide the necessary growth. The Treasury STRIPS are the safest zero-coupon securities available and promise a definite return until maturity.

Which of the following securities would have a Moody's MIG rating? A) GOs B) T-bills C) TANs D) BAs

C Explanation TANs are tax anticipation notes. These are short-term municipal securities and that is what Moody's MIG ratings represent. MIG stands for Municipal Investment Grade. GOs are rated with the normal letter ratings and BAs (bankers' acceptances) and T-bills are not municipal securities.

One of your customers has recently celebrated a 58th birthday. The investor began a regular investment program into shares of the KAPCO Growth Fund over twenty years ago. The account is showing a substantial gain. Because retirement is getting closer, you suggest using the exchange privilege offered by the KAPCO fund group. Your recommendation is to place half of the holdings into the KAPCO Balanced Fund. Following this recommendation would result in A) tax deferral of any gains because the investor has not received any proceeds. B) tax deferral of any gains because the money is still in the KAPCO fund group. C) a taxable transaction for those shares exchanged. D) a taxable transaction for those shares exchanged plus a 10% tax penalty for early withdrawal.

C Explanation The exchange or conversion privilege allows the investor to exchange shares of one fund in a family of funds for another at net asset value. The benefit is the saving of sales charge. The IRS treats this exchange as the sale of one security and the purchase of another. Therefore, any gains will be subject to tax. There is no 10% tax penalty. That applies only when there has been deferral of earnings, such as in an IRA.

A customer is receiving annuitized payments from a variable annuity. The annuitized payments are viewed for tax purposes as A) exempt from taxes. B) earnings only and taxable. C) all return of cost basis and nontaxable. D) part earnings and part cost basis.

D Explanation Annuitized payments from a variable annuity are viewed for tax purposes as part earnings and part cost basis. The earnings are taxable, but the cost basis is returned tax free.

A 38-year-old investor places $25,000 into a single premium deferred variable annuity. Twenty years later, with the account valued at $72,000, the investor surrenders the policy. If the investor is in the 25% marginal income tax bracket, the total tax liability is A) $25,200. B) $11,750. C) $18,000. D) $16,450.

D Explanation Only the deferred growth is taxable. In this case, it is the difference between the surrender value of $72,000 and the cost basis of $25,000. That $47,000 is taxed at the marginal rate of 25%. Furthermore, because the investor is younger than 59½ (38 + 20 = 58), there is the additional 10% penalty tax. Effectively, this is a 35% tax on $47,000.

An investor placed $5,000 into a 200% leveraged index ETF. During the first period, the index against which the ETF was measured rose by 10%. In the second period, the same index fell by 20%. What is the value of the leveraged ETF investment at the beginning of the third period? A) $4,400 B) $5,400 C) $5,600 D) $3,600

D Explanation The investment value would be $3,600 at the beginning of the third period. In a leverage ETF, the investment result of the portfolio is a multiple of the performance of the index it is measured against. In this question, the ETF value will increase or decrease by 200% (2 times) of the performance of the index. In the first period, the index rose by 10%; therefore, the ETF rose by 20%. The $5,000 investment would have risen to a value of $6,000 ($5,000 times 20% = $1,000 + $5,000). During the second period, the index fell by 20%. The ETF value would have declined by 40% ($6,000 times 40% = $2,400); therefore, the $6,000 investment value would have declined by $2,400 to $3,600.

Ten municipal bonds were purchased with 9% nominal yield for settlement on February 1, 2015. The maturity date of the bonds is July 1, 2035. What is the number of days of accrued interest on the 10-bond trade? A) 37 B) 29 C) 31 D) 30

D Explanation The maturity month and day will always match one of the two semiannual coupon dates. Because maturity is July 1, the bond pays interest on January 1 and July 1 of each year. With settlement on February 1, the bond accrued interest from January 1 up to, but not including, settlement (30 days).

Which of the following is not part of the Federal Farm Credit System (FFCS)? A) Federal Home Loan Bank B) Federal Land Bank C) Federal Intermediate Credit Bank D) Bank for Cooperatives

A Explanation The Federal Land Bank, Bank for Cooperatives, and Federal Intermediate Credit Bank are all parts of the FFCS. The Federal Home Loan Bank is not.

United States Treasury notes are intermediate length securities. Treasury notes are not issued with maturities of A) 4 years. B) 2 years. C) 7 years. D) 5 years.

A Explanation U.S. Treasury notes are issued with maturities of 2, 3, 5, 7, and 10 years.

A letter of intent for a mutual fund does not contain which of the following provisions? A) The letter can be backdated 90 days to include a previous deposit. B) The fund will keep some of the initially issued shares in an escrow account to ensure payment of the full sales load. C) The fund can halt redemption during the time the letter of intent is in effect. D) The time limit is 13 months.

B Explanation A letter of intent is not binding on the client in any way. Should the client decide to liquidate the account before completing the letter, the company will reduce the redemption by the amount of shares held in escrow.

A registered representative explaining variable annuities to a customer would be correct in stating that a variable annuity guarantees an earnings rate of return. a variable annuity does not guarantee an earnings rate of return. a variable annuity guarantees payments for life. a variable annuity does not guarantee payments for life. A) II and IV B) II and III C) I and III D) I and IV

B Explanation A variable annuity does not guarantee an earnings rate because earnings will depend on the performance of the separate account. However, it does guarantee payments for life (mortality).

Your 65-year-old client owns a nonqualified variable annuity. He originally invested $29,000 four years ago, and it now has a value of $39,000. If your client, who is in the 28% tax bracket, makes a lump-sum withdrawal of $15,000, what tax liability results from the withdrawal? A) $0 B) $2,800 C) $3,800 D) $4,200

B Explanation This annuity is nonqualified, which means the client has paid for it with after-tax dollars and has a basis equal to the original $29,000 investment. Consequently, the client pays taxes only on the growth portion of the withdrawal ($10,000). The tax on this is $2,800 ($10,000 × 28%). Because the client is older than age 59½, she does not pay 10% premature distribution penalty tax.

Which of the following statements regarding the Federal Farm Credit System securities are not true? A) The proceeds are used to make loans to farmers. B) They are direct obligations of the U.S. government. C) They issue short-term notes and long-term bonds. D) Interest is tax exempt at the state and local levels.

B Explanation With the exception of Ginnie Mae, all agency securities are indirect obligations of the U.S. government.

A 38-year-old investor places $25,000 into a qualified single premium deferred variable annuity. Twenty-two years later, with the account valued at $72,000, the investor surrenders the policy. If the investor is in the 25% marginal income tax bracket, the total tax liability is A) $11,750. B) $18,000. C) $25,200. D) $16,450.

B Explanation Because this is a qualified annuity, the entire withdrawal is taxable. The surrender value of $72,000 has a cost basis of $0.00. That $72,000 is taxed at the marginal rate of 25%. Because the investor is older than 59½ (38 + 22 = 60), there is no additional 10% penalty tax. Effectively, this is a 25% tax on $72,000.

All of the following investment strategies offer either fully or partially tax-deductible contributions to individuals who meet eligibility requirements except A) IRAs. B) defined contribution plans. C) variable annuities. D) Keogh plans.

C Explanation Contributions to a nonqualified variable annuity are not tax deductible. Contributions to an IRA may be tax deductible, depending on the individual's earnings and participation in a company-sponsored qualified retirement plan. Please note that all annuities are non-qualified unless something in the question indicates otherwise. For example, if the question deals with annuities in a 403(b) plan, it must be qualified.

Freddie Mac does which of the following? Issues pass-through securities Purchases student loans Purchases conventional residential mortgages from financial institutions Issues securities backed directly by the full faith and credit of the U.S. government A) II and III B) I and IV C) I and III D) II and IV

C Explanation Freddie Mac is a publicly owned and traded U.S. government agency that issues pass-through securities based on a pool of conventional residential mortgages purchased from financial institutions. Ginnie Mae is the only U.S. agency that issues securities backed by the full faith and credit of the U.S. government.

Dollar cost averaging (DCA) will always result in a lower cost per share than the price paid per share except A) when the price for each purchase is decreasing. B) when the price for each purchase is increasing. C) when the price for each purchase is the same. D) when the price for each purchase is fluctuating..

C Explanation There are two requirements for a dollar cost averaging program to work. The first is that the same amount must be invested at each specified interval. The second is that the price per transaction does not remain the same. If that is the case, then the average cost per share and average price paid per transaction are the same. The price needs to move for DCA to show a benefit.

A registered representative's compensation consists of trailer commissions. The most likely reason for this is A) the registered representative has entered into a deferred compensation package with the firm. B) some of the representative's customers own mutual funds with 12b-1 charges. C) some of the representative's customers own stock in trucking companies. D) the registered representative is sharing the account with another representative.

C Explanation Trailer commissions are a feature when you have customers owning mutual funds with 12b-1 charges. In most cases, those charges are levied every year and, over time, can add up to considerable compensation to the representative.

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 $350,000 plus 10% penalty if under 59½. B) the beneficiary will owe ordinary income taxes on $500,000 plus 10% penalty if under 59½. C) the beneficiary will owe ordinary income taxes on $350,000. D) the beneficiary will owe ordinary income taxes on $500,000.

C 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.

Which of the following statements regarding a unit investment trust is not true? A) It is considered an investment company. B) It invests according to stated objectives. C) It charges no management fee. D) Overall responsibility for the fund rests with the board of directors.

D A unit investment trust (UIT) has no board of directors; rather, it has a board of trustees. A UIT must follow a stated investment objective (as must any investment company) and does not charge a management fee because it is not a managed portfolio.

A customer invests $18,000 in a mutual fund and signs a letter of intent for $25,000 to qualify for a breakpoint. One year later, the shares are valued at $25,100 even though she made no new investments. Which of the following statements regarding this situation is true? A) The investment no longer qualifies for a breakpoint. B) Shares held in escrow will be liquidated at the appreciated value. C) The letter of intent is considered to be fulfilled. D) The representative should remind the customer that she signed a letter of intent 12 months ago.

D Explanation A letter of intent must be met with dollars invested within 13 months. The customer needs to invest an additional $7,000 to fulfill her letter of intent. The representative should remind the customer of her intention to qualify for the reduced sales charge.

In which of the following mutual funds is it most likely that a dividend paid by that mutual fund would be nontaxable to the shareholders? A) The FFLQX Sunbelt Growth Fund B) The WVCXC Gas and Electric Utilities Fund C) The CHXKC Preferred Stock Income Fund D) The ABQYX State I Municipal Bond Fund

D Explanation A mutual fund whose portfolio consists of tax-free municipal bonds has its net investment income taxed, when distributed as a dividend, in the same manner the individual bonds are taxed. This is an example of a single state fund where the income is not only tax exempt on the federal level, but tax exempt to residents of State I as well.

The investment adviser of the GEMCO Special Situations Fund would find which of the following companies least attractive for the fund's portfolio? A) DEF Pharmaceuticals, whose application for approval of a new disease-fighting drug will likely be approved by the FDA B) GHI Technologies, whose new microchip devices have caught the attention of the largest manufacturer in the field C) JKL Transportation Services, a company preparing to report a profit for the first time in four years D) ABC Corporation, whose shareholders have just reelected the current board of directors

D Explanation A special situations fund looks for special situations. Those are defined as management changes, turnaround situations (loss to profit), or new developments. A company reelecting the existing board of directors is not sending a message of something special going on.

All of the following are risks associated with most mutual funds except A) expense risk. B) market risk. C) tenure risk. D) liquidity risk.

D Explanation Under federal law, mutual funds must redeem shares within seven days of receipt of the investor's request. There is never a need to find a buyer for the shares. Therefore, mutual funds have little to no liquidity risk. As with any investment, there is market risk for most mutual funds (little to none with money market funds, but they would have to be specified in the question). Expense risk is the uncertainty as to future expenses incurred by the fund. The higher the expense ratio, the lower the performance. Management fees, transaction costs, and regulatory filing fees can change. Another risk is that the management team that has brought the fund great success in the past might leave or be terminated. That is what tenure risk is all about.

Define FINRA rule 2330

FINRA Rule 2330 (Members' Responsibilities Regarding Deferred Variable Annuities) establishes sales practice standards regarding recommended purchases and exchanges of deferred variable annuities, including requiring a reasonable belief that the customer has been informed of the various features of annuities (such as surrender charges, potential tax penalties, various fees and costs, and market risk); and, prior to recommending the purchase or exchange of a deferred variable annuity, requiring reasonable efforts to determine the customer's age, annual income, investment experience, investment objectives, investment time horizon, existing assets and risk tolerance.

An investor purchases $10,000 worth of Treasury bills on November 27 and holds them until they mature on March 30 of the following year. For purposes of taxation, the interest from those Treasury bills is treated as A) ordinary income subject to federal income tax. B) tax-free income. C) a short-term gain. D) partially ordinary income and partially capital gain.

A Explanation Interest on Treasury bills, notes, and bonds is taxable as ordinary income at the federal level. It is exempt from state and local taxation.

Your client makes two municipal bond purchases from your firm's trading desk. One of the bonds has a nominal yield of 5% and a basis of 6%. The other has a coupon rate of 7.5% and a yield to maturity of 6%. If your client holds both bonds to maturity, the tax consequences when receiving the principal will be A) no gain and no loss. B) a capital gain on the first bond and a capital loss on the second one. C) a capital gain on the first bond and no capital loss on the second one. D) tax-free income on the first bond and no capital loss on the second one.

A Explanation The first bond is selling at a discount. We know that because the basis (yield to maturity) of 6% is higher than the coupon or nominal rate of 5%. The second bond is selling at a premium. We know that because the yield to maturity (basis) of 6% is lower than the coupon or nominal rate of 7.5%. Because the bonds were purchased from the firm's trading desk, we know these are secondary market trades rather than a purchase of new issue from the syndicate. Municipal bonds purchased in the secondary market at a discount have that discount accreted and taxed as ordinary income each year. By maturity date, the discount has been fully accreted, so there is no gain and no loss. The same is true with municipal bonds purchased at a premium. The premium is amortized each year over the life of the bond so that at maturity there is no gain and no loss.

A dealer in U.S. government securities quotes a 5-year Treasury note at 89.12-89.16. In dollars, that represents a spread of A) $1.25. B) $0.04. C) $0.125. D) $4.00.

A Explanation Treasury notes and bonds are quoted in fractions of 32nds. The spread between the bid and the ask is 4/32nds. In simpler terms, that is 1/8th. Each point is $10.00, so this 1/8th of $10.00 is equal to $1.25.

A dealer in U.S. government securities quotes a 5-year Treasury note at 89.12-89.16. In dollars, that represents a spread of A) $1.25. B) $0.125. C) $0.04. D) $4.00.

A Explanation Treasury notes and bonds are quoted in fractions of 32nds. The spread between the bid and the ask is 4/32nds. In simpler terms, that is 1/8th. Each point is $10.00, so this 1/8th of $10.00 is equal to $1.25. 16/32 -12/32 = .125 X 10 = $1.25

Securities transactions take place in the primary and secondary markets. Which of the following investment companies can trade in both? A) An open-end fund B) A closed-end fund C) A face amount certificate company D) A unit investment trust

B Explanation All of these can have primary market transactions. In the case of the closed-end investment company (CEF), it is the initial public offering and, if desired, an additional public offering. The CEF is the only one of these choices where shares trade in the secondary markets. Investors holding shares of a CEF can trade the shares freely, just like any other stock. However, owners of the other types of investment companies will find there is no market for their shares if they wish to sell. That is not a problem, though, because these investment companies stand ready to redeem shares continuously. Technically, when the UIT buys back its shares, it is considered a secondary market transaction. However, for exam purposes, because the trust is the only buyer in the marketplace and the price is not subject to negotiation, it is not a true secondary market transaction.

An important basic characteristic of common stocks that makes them a suitable type of investment for the separate account of variable annuities is A) the yield is always higher than bond yields. B) changes in common stock prices tend to be more closely related to changes in the cost of living than changes in bond prices. C) the yield is always higher than mortgage yields. D) the safety of the principal invested.

B Explanation Because common stocks are not fixed-dollar investments, they have the opportunity to keep pace with inflation.

A registered representative (RR) has just explained to a customer that to purchase a particular security, the customer would pay the asking price plus a commission, not a sales charge. Which of the following is the RR speaking of? A) All open-end funds B) Any closed-end fund C) Mutual funds D) All management company offerings

B Explanation Closed-end funds are purchased on an exchange or over the counter where buyers pay the asking price plus a commission. The RR could not be speaking of all open-end funds because mutual funds—one classification of open-end funds—are purchased at the public offering price, which includes a sales charge. Management company offerings include both open-end and closed-end funds.

All of the following statements regarding dollar cost averaging are correct except A) dollar cost averaging is a passive investment strategy. B) dollar cost averaging decreases the risk of loss. C) an employee stock purchase plan is one way to use dollar cost averaging. D) dollar cost averaging is the investment of a fixed amount of money each period.

B Explanation Dollar cost averaging is a passive investment strategy using a fixed dollar amount to purchase shares no matter what the price is. The fixed dollar amount buys more shares when the price is lower and fewer shares when the price is higher. While this strategy can lower the average cost per share over time, it does not assure profitability or decrease the risk of loss.

A customer purchases an XYZ municipal bond at 108. It is scheduled to mature in 16 years. After owning the bond for 10 years, she sells the bond at 102. What capital gain or loss must she report for tax purposes at the time of the sale? A) $20 gain B) $10 loss C) $10 gain D) $60 loss

B Explanation If a municipal bond is purchased at a premium, the premium must be amortized over the time until maturity. An $80 premium on a 16-year municipal bond indicates that $5 will be amortized each year ($80 / 16 = $5). Ten years at $5 per year is $50 of amortization. Therefore, after 10 years, the tax basis would be $1,080 minus $50, or $1,030 (103). Because the sale was for 102 ($1,020), the customer has a $10 loss on one bond.

An investor redeems 200 shares of ABC Fund, which has no redemption fee. If the quote is $12.05 bid $13.01 asked, what amount will the investor receive? A) $2,602.00 B) $2,410.00 C) $1,098.00 D) $2,275.50

B Explanation If a mutual fund has no redemption fee, the investor will receive the bid price per share (net asset value) multiplied by the number of shares being redeemed. In this case, the investor would receive $2,410 ($12.05 × 200 shares).

A customer purchases a municipal bond in the secondary market with a settlement date of August 1. If the next interest payment is September 1, which of the following statements regarding interest on this bond are true? The bond pays interest on March 1 and September 1 each year. The seller must pay accrued interest no later than settlement day. Accrued interest on this bond is computed using actual days elapsed. On September 1, the buyer will receive from the issuer interest for the period March 1 through August 31. A) II and IV B) I and IV C) II and III D) I and III

B Explanation Municipal bond accrued interest is calculated using a 30-day month and a 360-day year, with interest paid every six months. On settlement day, August 1, the buyer will pay the seller five months accrued interest from March 1 through July 31. Then on September 1, the next interest payment date, the buyer will receive payment for the full semiannual interest directly from the issuer.

Five years ago, the ABCD mutual fund bought 200,000 shares of Comet Industries at an average price of $42.25. After a series of accounting scandals, the shares are now trading at $6. If the fund decides to sell its shares, what will be the impact of the sale of Comet shares on the net asset value (NAV) of the ABCD fund? A) The NAV will rise B) The NAV will not change C) The NAV will fall D) This depends on whether the fund can claim a tax loss on the sale

B Explanation Portfolio holdings in a mutual fund are marked to the market each day. Therefore, the NAV of the fund already reflects the current value of each security in its portfolio, including Comet Industries. When the fund sells the position, the value of the stock is replaced by an equivalent amount of cash, so NAV does not change.

Due to the excellent skill of the investment management team, the XYZ Growth Fund has realized significant long-term capital gains in its portfolio. The fund may distribute these gains to its shareholders A) quarterly along with the dividend payment B) no more than once every 12 months C) as often as biennially D) as often as semiannually

B Explanation Section 19 of the Investment Company Act of 1940 states that "it shall be unlawful for any registered investment company to distribute long-term capital gains more often than once every twelve months." Dividends do not have any restriction on frequency.

Which of the following statements regarding Treasury bills T-bills are true? The government auctions T-bills at a discount. The difference between the cost of a T-bill and its value at maturity is treated as a capital gain. T-bills have longer maturities than T-notes. The minimum denomination of a T-bill is $100 face amount. A) II and IV B) I and IV C) II and III D) I and III

B Explanation T-bills are sold at a discount and can be purchased in minimum denominations of $100. The difference between the purchase price and the maturity value is taxed as interest income, not as a capital gain. Treasury bills are short-term investments maturing in 1 year or less. T-notes have maturities of 2 to 10 years. T-bonds have maturities of longer than 10 years.

An individual purchases a variable life insurance policy. Under federal law, the individual is entitled to a complete refund of all premiums paid if the request is made within A) the first 30 days after the policy was delivered to the owner. B) 45 days from the execution of the application, or for 10 days from the time the owner receives the policy, whichever is longer. C) the first 24 months after the policy was delivered to the owner. D) 10 days from the execution of the application, or for 45 days from the time the owner receives the policy, whichever is longer.

B Explanation The Investment Company Act of 1940 specifies a free-look period for the purchaser of a variable life insurance policy. That period is the longer of 45 days after the execution of the application or 10 days after the actual policy is delivered to the owner. The 24 months is the minimum time limit for the exchange of the variable policy into another form of permanent insurance.

Variable annuities generally include an assumed interest rate. This is A) the annual rate at which annuity payments will increase. B) the annual rate of return required to maintain the level of annuity payments. C) the rate used to illustrate the future growth prospects of the contract. D) the annual dividend rate that will be paid to contract holders.

B Explanation The assumed interest rate (AIR) is the rate the insurance company assumes the separate account will earn during the payout period. If the assumption is wrong, the monthly payments will be adjusted accordingly. If the separate account earns more than the AIR, the next month's payment is increased. If the separate account earns less than the AIR, the next month's payment is reduced. If the account earns the assumed rate, monthly payments will not change.

All of the following have an impact on the marketability of a block of municipal bonds except A) the length of time until the bonds mature. B) the dated date of the bonds in the block. C) the price and date of call provisions. D) the quantity and quality of the bonds in the block available.

B Explanation The dated date has no effect on marketability. A close call date or low call premium can make an issue less marketable because the chance of a call is greater. Maturity, quality, and the size of the block affect marketability.

In most cases, a mutual fund is structured as a corporation. Because of certain tax regulations, it is important for the fund to compute its net investment income. That computation is A) dividends minus interest received on portfolio securities, minus the operating expenses of the fund. B) interest plus dividends received on portfolio securities, minus the operating expenses of the fund. C) interest plus dividends received on portfolio securities, plus realized capital gains, minus the operating expenses of the fund. D) interest minus dividends received on portfolio securities, minus the operating expenses of the fund.

B Explanation The net investment income (NII) of a mutual fund is the gross investment income of the fund minus the fund's operating expenses. The gross investment income is the sum of the interest and dividends received on the holdings in the fund's portfolio. Subtracting the operating expenses results in the net investment income. In general, mutual funds will qualify as regulated investment companies and follow the pipeline or conduit theory. Doing so requires that a minimum of 90% of the NII be distributed to investors in the form of dividends. Any portion not distributed is taxable to the fund. Capital gains distributions are treated separately and also have a 90% distribution requirement.

An investor, age 36, has a net worth of $650,000, with an annual income of $65,000. Wanting to add to an existing portfolio, the investor is not concerned about generating more income, as that seems to be adequate already. However, the investor does note that keeping taxes to a minimum is an objective. Which of the following funds would be the most suitable, given the investor's objectives? A) Fund Z: invests in preferred shares; turnover ratio of 50% B) Fund X: invests in companies with long-term growth potential; turnover ratio of 25% C) Fund W: invests in utility companies; turnover ratio of 25% D) Fund Y: invests in companies that have capital appreciation potential; turnover ratio of 100%

B Explanation This investor is not concerned about income. This would eliminate the utility and preferred share funds (Fund Z and Fund W). Of the remaining two funds, Fund X and Fund Y both have the same general objective, but the one with the lower turnover ratio would generate less tax liability. The portfolio turnover ratio reflects a fund's holding period of securities being bought and sold by the fund manager. If a fund has a turnover ratio of 100%, the entire portfolio is likely to turn over in a year, and capital gains distributions are likely to be short term and subject to the maximum tax rate. That increases the tax liability, and therefore, is not the best option. By contrast, a 25% turnover ratio means the average holding period of the securities in the portfolio is four years. This would mean that any capital gains distributions are more likely to be long term and subject to a lower tax rate.

An investor, age 36, has a net worth of $650,000, with an annual income of $65,000. Wanting to add to an existing portfolio, the investor is not concerned about generating more income, as that seems to be adequate already. However, the investor does note that keeping taxes to a minimum is an objective. Which of the following funds would be the most suitable, given the investor's objectives? A) Fund Z: invests in preferred shares; turnover ratio of 50% B) Fund X: invests in companies with long-term growth potential; turnover ratio of 25% C) Fund Y: invests in companies that have capital appreciation potential; turnover ratio of 100% D) Fund W: invests in utility companies; turnover ratio of 25%

B Explanation This investor is not concerned about income. This would eliminate the utility and preferred share funds (Fund Z and Fund W). Of the remaining two funds, Fund X and Fund Y both have the same general objective, but the one with the lower turnover ratio would generate less tax liability. The portfolio turnover ratio reflects a fund's holding period of securities being bought and sold by the fund manager. If a fund has a turnover ratio of 100%, the entire portfolio is likely to turn over in a year, and capital gains distributions are likely to be short term and subject to the maximum tax rate. That increases the tax liability, and therefore, is not the best option. By contrast, a 25% turnover ratio means the average holding period of the securities in the portfolio is four years. This would mean that any capital gains distributions are more likely to be long term and subject to a lower tax rate.

One of your customers had a sideline business that was just sold for $100,000. The customer is 47 and wants to put that money into an investment that can be left alone for the next 20 years until expected retirement. Which of the following is likely the most suitable choice for this customer? A) An investment grade bond fund with an average duration of 20 years B) A target date fund with a date 20 years from today C) A portfolio that is 70/30 equities today gradually rebalancing to 50/50 at retirement age D) A small-cap growth fund with reinvestment of distributions

B Explanation This is exactly what target date funds are designed for. As the investor gets closer to the target retirement age, the portfolio managers shift the concentration from equities to fixed income. Why doesn't the 70/30 shifting to 50/50 portfolio work here? Because the question states that the customer wants a "hands off" approach, something the target date fund does automatically. The small-cap growth fund might be too aggressive and a bond fund is not aggressive enough when the time horizon is 20 years.

Which of the following statements regarding Treasury bills are true? They are sold in minimum denominations of $10,000. They are offered with maturities ranging up to 52 weeks. Their interest is exempt from taxation at the state level. They are callable by the U.S. Treasury at any time before maturity. A) I and II B) II and III C) I and III D) II and IV

B Explanation Treasury bills are sold in minimum denominations of $100 and are not callable before maturity. T-bills are regularly offered with maturities from four weeks to as long as 52 weeks from issuance and are issued at a discount. Interest on Treasury bills is taxable at the federal level only.

A customer buys a municipal bond in the secondary market at 96 that has four years to maturity. Two years later, the customer sells the bond at 99. The tax consequences of this investment are A) three points of ordinary income. B) two points of ordinary income and one point of capital gain. C) two points of capital gain and one point of ordinary income. D) three points of capital gain.

B Explanation When a municipal bond is purchased in the secondary market at a discount, the annual accretion is taxed as ordinary income. The annual accretion is one point per year (four points divided by four years to maturity). Therefore, when the bond is sold two years later, its cost basis is 98. If the bond is sold at 99, there is a long-term capital gain of one point per bond. Also, there is ordinary income taxation on the accretion of two points.

An investor in the 28% income tax bracket is considering purchasing either a 4% municipal bond or a 5% corporate bond. Which of the following statements regarding the two bonds' after-tax yields is true? A) The yield difference cannot be determined. B) The two bonds' yields are equivalent. C) The municipal bond's yield is higher than the corporate bond's yield. D) The corporate bond's yield is higher than the municipal bond's yield.

C Explanation Investors should invest in municipal bonds if the return after taxes is higher than comparable taxable bonds. To compare the two bonds, use the tax-free equivalent yield formula: (taxable yield) × (100% - tax bracket) = (tax-free equivalent yield). In this case, 5% × (100% - 28%) = 5% × 0.72 = 3.6%. Because the municipal bond yields 4% tax free, the investor should buy it; after taxes have been paid, the corporate bond yields only 3.6%.

Most business development companies (BDCs) are classified as A) an exchange-traded fund. B) a unit investment trust. C) a closed-end investment company. D) an open-end investment company.

C Explanation Most BDCs register as closed-end investment companies (CEF) and trade in similar fashion in the secondary markets. Federal law places some restrictions on the investment flexibility of a BDC that are not required of regular CEFs. A major difference between BDCs and the other investment companies is the active role played in the management of the businesses in the portfolio. That is what business development is about helping smaller businesses develop into larger ones.

A new municipal bond issue had a dated date of January 1, 2018. The first coupon was due on August 1, 2018. The customer bought for settlement on September 1, 2018. How many months of accrued interest must he pay at settlement? A) Six months B) Eight months C) One month D) Seven months

C Explanation On a new bond issue, the issuer sets the dated date. That is the date from which interest first begins to accrue. It is not unusual for the first interest payment date to be more than six months from the dated date. That is known as a long coupon (longer than six months). Therefore, on August 1, 2018, seven months of interest was paid (January through the end of July). The customer did not purchase the bond until late August and owes interest only from the August 1, 2018, coupon payment date up to, but not including, the September 1 settlement date (one month).

One of the features of variable insurance products is the ability to withdraw money from the policies. Which of the following statements is correct? A) Withdrawals from both are taxed on a LIFO basis. B) Withdrawals from both are taxed on a FIFO basis. C) Withdrawals from variable annuities are taxed on a LIFO basis, while those from variable life are taxed on a FIFO basis. D) Withdrawals from variable annuities are taxed on a FIFO basis, while those from variable life are taxed on a LIFO basis.

C Explanation One advantage to withdrawing cash value from a variable life insurance policy is that it receives FIFO treatment. That means there is no tax until the withdrawal reaches the cost basis (premiums paid) of the policy. With annuities, the taxation is LIFO. Therefore, the first money withdrawn is taxable. In addition, if the policyowner is not yet 59, the 10% penalty applies. **This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback.

A 38-year-old investor places $25,000 into a single premium deferred variable annuity. Twenty-two years later, with the account valued at $72,000, the investor surrenders the policy. If the investor is in the 25% marginal income tax bracket, the total tax liability is A) $18,000. B) $16,450. C) $11,750. D) $25,200.

C Explanation Only the deferred growth is taxable. In this case, it is the difference between the surrender value of $72,000 and the cost basis of $25,000. That $47,000 is taxed at the marginal rate of 25%. Because the investor is older than 59½ (38 + 22 = 60), there is no additional 10% penalty tax. Effectively, this is a 25% tax on $47,000.

An investor purchases investment company shares paying an ask price that is a 5% premium to the company's net asset value (NAV). Two years later, the investor liquidates the position at a bid price that is 10% below the NAV. This investment was in A) a unit investment trust (UIT) B) a face amount certificate (FAC) C) a closed-end investment company D) an open-end investment company

C Explanation Pricing of closed-end investment company shares is based on supply and demand. That is because they trade in the secondary markets. Therefore, the investor's buying price and selling price could be a premium or discount to the net asset value per share (NAV). All the other investments here are redeemable at the NAV. As a consequence, the ask price would not be a discount to the NAV nor could the redemption price (the bid) be at a discount to the net asset value

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 this investor wished to exchange this policy for one offered by a competing company, A) the investor would be liable for ordinary income taxes plus the 10% penalty on $350,000. B) the investor would be liable for ordinary income taxes on $350,000. C) using a 1035 exchange would avoid any current taxation. D) the tax-free exchange privilege applies only when the exchange is within the same insurance company.

C Explanation Section 1035 of the Internal Revenue Code permits the exchange of an annuity to another annuity, whether issued by the same or a competing company, with the tax-deferral on earnings continuing. These exchanges can also be made from an insurance policy to an annuity, but not from an annuity to an insurance policy.

A registered representative's customer is speaking of a variable life insurance contract she owns. She makes several statements regarding the contract. Which of the following is not an accurate statement concerning a variable life insurance contract? A) The portion of the premium invested in the insurance company's general account is used to provide for the minimum guaranteed amount of the death benefit. B) There is no guarantee regarding the investment results of the separate account. C) The death benefit can never be more than the guaranteed benefit. D) The policy provides a minimum guaranteed death benefit.

C Explanation The minimum guaranteed death benefit is provided by that portion of the payment invested in the insurance company's general account. The remainder of the premium is invested in the separate account. While there is no guarantee on how investments in the separate account will perform, depending on its investment performance, the separate account could provide for a larger death benefit than the minimum guaranteed amount.

In most cases, a mutual fund is structured as a corporation. Because of certain tax regulations, it is important for the fund to compute its net investment income. That computation is A) interest plus dividends received on portfolio securities, plus realized capital gains, minus the operating expenses of the fund. B) dividends minus interest received on portfolio securities, minus the operating expenses of the fund. C) interest plus dividends received on portfolio securities, minus the operating expenses of the fund. D) interest minus dividends received on portfolio securities, minus the operating expenses of the fund.

C Explanation The net investment income (NII) of a mutual fund is the gross investment income of the fund minus the fund's operating expenses. The gross investment income is the sum of the interest and dividends received on the holdings in the fund's portfolio. Subtracting the operating expenses results in the net investment income. In general, mutual funds will qualify as regulated investment companies and follow the pipeline or conduit theory. Doing so requires that a minimum of 90% of the NII be distributed to investors in the form of dividends. Any portion not distributed is taxable to the fund. Capital gains distributions are treated separately and also have a 90% distribution requirement.

If a registered representative is seeking to sell shares of an investment company to a client, which of the following statements would be accurate and permissible regarding her recommendation? When the client redeems his shares, he will not immediately know their dollar value. If the client invests just before the dividend distribution, he can benefit by receiving the added value of that dividend. If the client purchases the shares of two or more funds in the same family of funds, he may be entitled to a reduced sales charge. The purchase of Class B shares always provides the greatest return on investment. A) I and IV B) II and IV C) I and III D) II and III

C Explanation The purchase of two funds in the same family of funds may qualify an investor for combination privileges. At redemption, he will receive the next price calculated (forward pricing), which is not yet known. Class B shares, or deferred sales charge shares, may or may not provide the best return. Share class suitability can depend on the amount invested and the client's individual needs. Lastly, while the dividend is received if the fund shares are purchased before the ex-dividend date, there is no added value. The fund share price is reduced by the amount of the dividend on the ex-dividend date, just as it would be for a cash dividend paid on equity securities.

Financial footnotes found in which of the following would be of the greatest importance to your broker-dealer's retail customers? The broker-dealer's principal-approved advertising Balance sheets of stocks you've recommended to them Income statements of stocks you've recommended to them Your broker-dealer's website page showing the history of the firm A) I and IV B) I and III C) II and III D) II and IV

C Explanation While footnotes found anywhere are of importance, those found in financial statements, such as balance sheets and income statements, would be the most important to your broker-dealer's customers when evaluating investment recommendations.

A 38-year-old investor places $25,000 into a single premium qualified deferred variable annuity. Twenty years later, with the account valued at $72,000, the investor withdraws $50,000. If the investor is in the 25% marginal income tax bracket, the total tax liability is A) $16,450. B) $11,750. C) $12.500. D) $17,500.

D Explanation Because this is a qualified annuity, the entire withdrawal is taxable. In this case, it is all $50,000. That $50,000 is taxed at the marginal rate of 25%. Furthermore, because the investor is younger than 59½ (38 + 20 = 58), there is the additional 10% penalty tax. Effectively, this is a 35% tax on $50,000.

Certain events will affect the net asset value (NAV) per share of a mutual fund. Which of the following events will not affect NAV? A) The value of the fund portfolio's securities fluctuating B) The fund receiving cash dividends on the securities in its portfolio C) The fund paying dividends to its shareholders D) Fund shares being redeemed by the fund upon the request of shareholders

D Explanation Dividends paid and received by the fund directly affect NAV. Changes in the portfolio value affect NAV because the securities are marked to market daily. Although share redemption will reduce total NAV, the number of shares outstanding decreases in proportion, so the NAV per share stays the same. NAV: (assets - liabilities)/ outstanding shares

Although there are general suitability rules that always apply, FINRA's Rule 2330 on variable annuity suitability specifies that, to be considered suitable, there is a reasonable basis to believe that the customer has been informed—in general terms—of various features of A) deferred annuities of all types. B) single premium variable annuities. C) immediate variable annuities. D) deferred variable annuities.

D Explanation FINRA's primary suitability concern is with deferred variable annuities. That does not mean there are no requirements for being careful with the others, it is just that most of the violations have involved the deferred VA.

For a retired person, which of the following investments would provide the greatest protection against inflation? A) Fixed annuities B) Municipal bonds C) Corporate bonds D) Variable annuities

D Explanation Fixed-income instruments, like bonds and fixed annuities, are subject to purchasing power risk. Variable annuities provide protection from inflation because their monthly income can increase depending on the separate account's performance.

Most business development companies (BDCs) are classified as A) an open-end investment company. B) an exchange-traded fund. C) a unit investment trust. D) a closed-end investment company.

D Explanation Most BDCs register as closed-end investment companies (CEF) and trade in similar fashion in the secondary markets. Federal law places some restrictions on the investment flexibility of a BDC that are not required of regular CEFs. A major difference between BDCs and the other investment companies is the active role played in the management of the businesses in the portfolio. That is what business development is about helping smaller businesses develop into larger ones.

One of your customers would like to purchase a government agency security for the UTMA account of her daughter. The daughter worked in construction over the summer and would like to use $1,275 of her savings for the purchase. Securities issued by which of these agencies could be purchased for this account? A) Federal Farm Credit System B) Student Loan Marketing Association C) Federal Home Loan Mortgage Corporation D) Federal National Mortgage Association

D Explanation Of this group, the only agency that would be able to sell $1,275 of securities is Fannie Mae. Their securities are available with a minimum denomination of $1,000 and then increments of $1. FHLMC also has the $1,000 initial minimum, but with $1,000 increments. The same numbers apply to the FCS, and Sallie Mae's minimum is $10,000. Another agency that would have met the investor's need is GNMA.

Amortization of a municipal bond premium does which of the following? Increases cost basis Decreases cost basis Increases reported interest income Decreases reported interest income A) I and IV B) I and III C) II and III D) II and IV

D Explanation Tax law requires municipal bond premiums to be amortized. The effect of amortization is to decrease reported interest income and cost basis. If held to maturity, the cost basis will have been amortized down to par. Therefore, at maturity, there is no reported capital loss.

Most exchange-traded funds (ETFs) are structured as open-end investment companies. However, they should not be confused with mutual funds. Among the differences between the two is that ETFs A) compute their NAV hourly. B) can issued preferred stock. C) track indexes. D) are traded in the secondary markets.

D Explanation The ET in ETF stands for exchange-traded (not the movie character). That is a solid hint that these trade on the exchanges. Stock exchanges are secondary markets. Because mutual funds are always part of a continuous new issue, their sale takes place in the primary market. Redemptions are back through the fund, not on any securities marketplace. There are mutual funds that track indexes just as ETFs do. Both compute their NAV as of the 4 pm close of the markets. No open-end investment company can issue preferred stock.

FINRA Rule 2330 deals with a member's responsibility in the sale of certain insurance company-based products. Specifically the concern is with A) taking loans against the cash value of a variable life insurance policy. B) subsequent changes to the separate account allocations in a deferred variable annuity. C) purchases and sales of deferred annuities. D) purchases and sales of deferred variable annuities.

D Explanation This FINRA rule applies to purchases and sales of deferred variable annuities and initial allocations to the separate account. It does not apply to fixed annuities or variable life insurance. Because it only deals with the purchase or sale or initial allocations, a client with a deferred variable annuity wishing to change the separate account allocation does not come under the rule.

A customer purchases 10 8% Treasury notes at 101-16. What is the dollar amount of this purchase? A) $10,812 B) $10,015 C) $10,116 D) $10,150

D Explanation Though the denomination of the T-notes purchased is not given, always assume par ($1,000) unless told differently in the question. Remember that government notes and bonds are quoted in 32nds. Therefore, a quote of 101-16 means 101 plus 16/32. 101 + 1/2 = $1,015; $1,015 × 10 bonds = $10,150.

All of the following are characteristics of Treasury receipts except A) they are zero-coupon bonds. B) the certificates may represent either the principal or the interest portion of the securities that were deposited with a trustee. C) they are stripped bonds. D) accumulated interest is not subject to federal taxation.

D Explanation Treasury receipts are zero-coupon instruments, which are purchased at a discount and mature at face value. Although interest is not paid annually on receipts, investors receive a 1099 original issue discount that reports the amount of interest imputed for that year. This interest must be reported to the IRS as taxable income.