ME 1 Part 2
Closed-end investment company shares may be I. traded in the secondary markets, including the exchanges and over-the-counter (OTC) markets. II. sold in the OTC primary market only. III. redeemed by the closed-end investment company. IV. traded by institutional investors.
A) I and IV Once a closed-end investment company has distributed shares, those shares are traded in the secondary market by both individual and institutional investors. LO 7.b
An investor purchased 100 shares of a bond ETF at $50 per share on September 5, 2020. On November 1, 2020, and February 1, 2021, the fund distributed a $0.50 per share dividend. On May 11, 2021, the investor sold all the shares at $57 per share. What are the 2021 tax consequences of the sale? A) Short-term capital gain of $700 B) Short-term capital gain of $600 C) Short-term capital gain of $700, interest income of $50 D) Short-term capital gain of $700, dividend income of $50
A) Short-term capital gain of $700 Taxation of the sale of an ETF is similar to that of a mutual fund. The question asks about the tax consequences of the sale, so we ignore the dividend distributions. Buying at $50 per share in September and selling at $57 per share the next May is a $700 capital gain over a period of less than one year. LO 7.i
One of your customers would like to begin an investment program calling for regular monthly contributions of $200. Which of the following would be the best source for determining if this plan is reasonable? A) The investor's income statement B) The investor's savings account C) The investor's balance sheet D) The investor's objectives
A) The investor's income statement When it comes to the ability to make ongoing contributions to an investment program, the income statement is usually going to be the most reliable tool for verification. It is from the income statement that discretionary income (the amount left over after paying expenses) is determined. The balance sheet indicates any lump sum availability. The savings account is a part of the balance sheet. Objectives are important, but they are not a financial measurement. LO 12.a
Which of the following statements regarding a member firm's handling of a discretionary account is true? A) The registered representative may not effect transactions excessive in size or frequency in view of the customer's resources. B) Margin may not be used in a discretionary account. C) A principal must approve each discretionary order before execution. D) The registered representative must obtain written authorization from the customer before placing each order.
A) The registered representative may not effect transactions excessive in size or frequency in view of the customer's resources. A discretionary account allows the registered representative to place orders without consulting the customer. It does not relieve him of the obligation to execute only suitable orders. LO 12.d
The Trust Indenture Act of 1939 covers all of the following securities transactions except A) a sale of an issue of $5 billion worth of Treasury bonds maturing in 2025. B) a corporate bond issue worth $55 million sold interstate. C) a public issue of debentures worth $60 million sold by a single member firm throughout the United States. D) a sale of an equipment trust bond issue worth $62 million.
A) a sale of an issue of $5 billion worth of Treasury bonds maturing in 2025. The Trust Indenture Act of 1939 requires all corporate debt issues of $50 million or more sold interstate to have a trust indenture. U.S. governments are exempt. LO 1.b
One of the effects of Regulation BI is to place a limitation on the use of the descriptive term A) financial advisor. B) agent. C) stockbroker. D) registered representative.
A) financial advisor. LO 12.c
A broker's broker does all of the following except A) makes a market in securities. B) acts as agent for dealers. C) assists in placing securities. D) conceals the identity of the principals.
A) makes a market in securities. A broker's broker acts as the agent in transactions by facilitating the movement of blocks of bonds. The broker's broker is allowed to conceal the identities of the contra-parties, thus protecting investment strategies. A broker's broker does not make a market in securities. LO 5.e
New offering: 800,000 units at $6 per unit. Each unit has two shares of common stock and one warrant. Each warrant is to purchase half a share of common stock. Based on this information, how many shares of stock will be sold, and how many warrants will be sold? A) 800,000 shares and 200,000 warrants B) 1.6 million shares and 800,000 warrants C) 800,000 shares and 400,000 warrants D) 1.6 million shares and 400,000 warrants
B) 1.6 million shares and 800,000 warrants Warrants may be distributed to stockholders in an underwriting as part of a unit. The warrant is a form of bonus to entice investors to purchase the unit. As each unit contains two shares, 1.6 million shares are being distributed. As each unit also includes one warrant, 800,000 warrants are being distributed. LO 2.c
The over-the-counter (OTC) market could be characterized as what type of market? A) First B) Dealer C) Auction D) Primary
B) Dealer LO 2.d
A 10-year bond, callable in five years at par, is sold at a discount. Rank the following yields from lowest to highest. I. Nominal yield II. Current yield III. Yield to call IV. Yield to maturity
B) I, II, IV, III LO 3.c
A resident of New York City purchases an Albany, New York, general obligation bond and receives $600 of interest from that bond during the year. How is that $600 taxed? A) It is subject to federal income tax at ordinary rates. B) It is not subject to federal income tax. C) It is subject to state income tax at ordinary rates. D) Taxation is deferred until the bond matures.
B) It is not subject to federal income tax. Interest from public purpose municipal bonds is exempt from federal income tax, and most states have chosen to make interest on their municipal bonds exempt from state income tax to residents of their states. LO 5.g
Due to a sudden drop in earnings, the board of directors of Amalgamated Metal Industries (AMI) has voted to suspend all dividend payments this year. This would have the least effect on holders of AMI's A) callable preferred stock. B) cumulative preferred stock. C) adjustable-rate preferred stock. D) common stock.
B) cumulative preferred stock. The notable feature of cumulative preferred stock is that it carries any skipped dividends on its books. They appear as dividends in arrears. This arrearage must be paid before any dividend can ever be paid on the company's common shares. There is no guarantee that the company will ever be able to make up those dividends, but in none of the other choices is there any concept of arrearage. LO 2.b
An investor's portfolio has a beta coefficient of 0.85. If the overall market declined by 10% over the course of a year, the portfolio's value has likely A) increased by 8.5%. B) decreased by 8.5%. C) decreased by 11.76%. D) increased by 10.85%.
B) decreased by 8.5%. A beta coefficient of 0.85 means that the portfolio is considered to be 0.85 times as volatile as the overall market. Therefore, if the market declines by 10%, the portfolio with a beta of 0.85 is likely to decline by only 8.5% (0.10 × 0.85). LO 15.a
FINRA's rule on communications allows member firms to use testimonials in retail communications as long as certain disclosures are made. Among those disclosures is A) indicating that if any compensation is paid for the testimonial, the fact that it is a paid testimonial. B) indicating that if more than $100 in value is paid for the testimonial, the fact that it is a paid testimonial. C) indicating that if $100 or more in value is paid for the testimonial, the fact that it is a paid testimonial. D) indicating that if less than $100 in value is paid for the testimonial, the fact that it is a paid testimonial.
B) indicating that if more than $100 in value is paid for the testimonial, the fact that it is a paid testimonial. Retail communications or correspondence providing any testimonial concerning the investment advice or investment performance of a member or its products must prominently disclose that if more than $100 in value is paid for the testimonial, the fact that it is a paid testimonial. Would the exam ever want you to know that it is more than $100 rather than $100 or more? Yes. ** This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback. LO 19.b
The writer of an equity call option who is assigned A) must deliver stock within one business day. B) must deliver stock within two business days. C) can enter a closing transaction on the day the exercise notice is received. D) can enter a closing transaction any time before exercise settlement.
B) must deliver stock within two business days. If exercised, the assigned call writer must deliver the underlying stock within two business days (regular way settlement for equity transactions). LO 9.a
After opening an account for a retail customer, an associated person is required to send the customer a copy of the account record A) within 10 days of the account closing. B) once every 36 months. C) every year. D) within 45 days of the account opening.
B) once every 36 months. For updating purposes, the member firm must send a copy of the account record to customers at least every 36 months thereafter. However, supervisors must always look for red flags, which may indicate something has changed in the circumstances of the customer. LO 18.b
In light of the many cases involving variable annuities where there was failure to supervise egregious unethical behavior, FINRA's Rule 2330, Members' Responsibilities Regarding Deferred Variable Annuities, evolved. One of the specific concerns that the regulators have with deferred variable annuities is sales personnel recommending that an investor switch from an existing contract to a new one. In the case of variable annuities, these exchanges are typically done under the provisions of IRS Section 1035. One of the factors in determining if the exchange is suitable is whether the customer has had another deferred variable annuity exchange within the preceding A) 30 months. B) 12 months. C) 36 months. D) 24 months.
C) 36 months. One requirement Rule 2330 covers is determining the suitability of a deferred annuity exchange for a particular customer. Factors that must be considered include whether the customer would incur a surrender charge, be subject to a new surrender period, lose existing benefits, or be subject to increased fees or charges; if the customer has had another exchange within the preceding 36 months; and other factors. LO 8.e
Municipal bonds would be considered the most suitable for which of the following customer scenarios? A) An investor in a low income bracket wanting income in their IRA B) An investor in a high-income bracket wanting growth for their investment account C) An investor in a high-income tax bracket wanting income for their investment account D) An investor in a moderate income tax bracket seeking growth in their employer-sponsored 401(k) plan
C) An investor in a high-income tax bracket wanting income for their investment account Interest received from bonds make them more appropriate for investors with income objectives rather than growth objectives. Because interest from municipal bonds is tax free, they benefit those in higher tax brackets the most. Lastly, because the interest is tax free, they have no place in a tax-favored account such as an IRA or 401(k) plan. LO 5.g
Income from which of the following investments is passive income? I. Real estate direct participation programs (DPPs) II. Vacation cottage rentals III. Real estate investment trusts (REITs) IV. Collateralized mortgage obligations (CMOs)
C) I and II Passive income results from DPPs and personal real estate rentals. REITs and CMOs are securities, and income from securities is considered portfolio income. LO 10.e
A sell limit order is executed when a stock is I. rising. II. falling. III. at or below the limit price. IV. at or above the limit price.
C) I and IV A sell limit order is placed above the prevailing market price. Therefore, it may be executed if the market is rising. If executed, limit orders will be filled at the limit price or better, which in the case of a sell limit is the limit price or higher. LO 16.a
Which of the following are defined as penny stocks? I. Nasdaq stock trading at $4 per share II. OTC Link stock trading at $4 per share III. Listed stock trading at $4 per share IV. Pink Sheets stock trading at $4 per share
C) II and IV A penny stock is a non-Nasdaq (OTC Link, OTC Pink, or Pink Sheets) stock trading under $5 per share. If a stock is listed on an exchange or is on Nasdaq, it is not a penny stock, regardless of price. LO 2.f
Which of the following best describes alpha for an investor's portfolio? A) It is a measure of each portfolio asset's risk to arrive at the risk associated with the entire portfolio. B) It is a measure of risk that adjusts in accordance with the performance of a known benchmark. C) It is a measure of performance that adjusts for risk, relative to a known benchmark. D) It is the prediction of performance aligning with the risk of a known benchmark.
C) It is a measure of performance that adjusts for risk, relative to a known benchmark. LO 15.a
John is the annuitant in a variable plan, and Sue is the beneficiary. Upon John's death during the accumulation period, Sue takes a lump-sum payment. What is her total tax liability? A) It is the ordinary income on the proceeds over the cost basis plus 10% of the net gain (if any) if Sue is younger than 59½ years old. B) The entire amount is taxed as ordinary income because it is not life insurance. C) It is the proceeds minus John's cost basis taxed as ordinary income at Sue's tax rate. D) None, because it is the proceeds from a life insurance company.
C) It is the proceeds minus John's cost basis taxed as ordinary income at Sue's tax rate. Annuity death benefits are generally paid in a lump sum. The beneficiary is taxed at ordinary income rates during the year the lump sum is received. The amount taxed is the amount of the lump-sum payment minus the deceased's cost basis in the investment. LO 8.d
A municipal revenue issue's flow of funds statement is contained in A) the legal opinion. B) the notice of sale. C) the bond contract. D) the agreement among underwriters.
C) the bond contract. The bond contract describes the nature of the contract and the issuers' duties to bondholders. The bond contract is a more expansive document than a bond resolution. The contract is comprised of the bond resolution (or trust indenture) and other security agreements and laws in force at the time of bond issuance. LO 5.a
The market price of a convertible bond depends on all of the following except A) the rating of the bond. B) the value of the underlying stock into which the bond can be converted. C) the conversion prices of bonds from similar companies. D) current interest rates.
C) the conversion prices of bonds from similar companies. LO 4.d
Which of the following would best describe, "Bought 1 Jan 55 call at 3 and sold 1 Jan 60 call at 1"? A) A bear vertical spread B) A bull horizontal spread C) A bear time spread D) A bull vertical spread
D) A bull vertical spread The client paid two points out of pocket for a call spread. Break even here is 57. Your client wants the stock to go up; hence, a bull spread. Because the exercise prices are different, it is also a vertical spread. LO 9.f
Your customer's portfolio consists of 40% long-term government bonds, 20% preferred stock, and 40% common shares of utility companies. Which of the following may have the single largest impact on the entire portfolio? A) Oil and gas price movements B) Corporate earnings C) Foreign currency fluctuations D) Interest rate movements
D) Interest rate movements Of the four answer choices, interest rate movement is the most likely to impact each of the portfolio components. Interest rates and bond prices have an inverse relationship, and their movement often determines whether investors might seek out investment alternatives with higher returns, such as dividend-paying utilities and fixed-dividend preferred shares. LO 14.a
A technical analyst has been charting ABC stock and notes that the support/resistance levels are $20 and $30, respectively. If the analyst expects ABC to fall through support, which of the following orders should he enter? A) Buy 100 ABC 30.25 stop B) Buy 100 ABC 20.50 stop C) Sell 100 ABC 29.75 stop D) Sell 100 ABC 19.50 stop
D) Sell 100 ABC 19.50 stop An analyst who expects a stock to fall through support is anticipating that the stock will decline. He can take advantage of this trend by establishing a short position at the top of the decline. He will enter a sell stop order just below the support price. LO 16.a
On the morning of the ex-date for a cash dividend, which of the following orders on the order book will not be reduced? A) Sell stop limit B) Buy limit C) Sell stop D) Sell limit
D) Sell limit It is sell limit and buy stop orders that are placed above the market and are not reduced. Orders entered below the prevailing market [unless marked DNR (do not reduce)] are reduced on the morning of the ex-date by the amount of the cash dividend. Those orders are buy limits and sell stops, including sell stop limits. LO 16.a
A customer who is long 1 XYZ Sep 50 call could create a spread by combining it with which of the following positions? A) Short 1 XYZ Sep 50 put B) Long 1 XYZ Sep 60 call C) Long 1 XYZ Sep 50 put D) Short 1 XYZ Sep 60 call
D) Short 1 XYZ Sep 60 call
Registered representatives must amend their Form U4 when all the following occur except A) if they obtain a professional credential. B) if they move residences. C) if they are arrested for a misdemeanor involving financially related issues. D) if they obtain a college degree.
D) if they obtain a college degree. Registered representatives must amend their Form U4 if they move, are arrested for any felony for financially related misdemeanors, or obtain a professional credential. College degrees are not disclosed on the Form U4. LO 20.a
Debt service on an industrial revenue bond is secured by
D) lease payments paid by a corporation. LO 5.c
Your customer wishes to purchase 500 of the Class A shares of the KAPCO balanced fund. This morning's quotes show the shares at POP $10.00 and NAV $9.50. At noon today, the order is placed when all of the market indices are up. If the market remains up and the closing quotes show the NAV of the fund is up $0.38, how much will the customer pay for the 500 shares? A) $5,200 B) $5,190 C) $4,940 D) We do not know how much because we must wait for POP to be computed based on the day's close.
A) $5,200 Mutual funds use forward pricing. That means the public offering price and the redemption price are based on the close of the market on the day the order is entered. After this order was entered, the NAV as of the close was up $0.38 from the previous day. That makes the NAV per share $9.88 ($9.50 + 0.38). We know the Class A shares carry a 5% sales charge. The previous POP was $10, and the NAV was $9.50. That $0.50 difference divided by the POP of $10.00 equals 5%. We compute the new POP (the customer is buying so we need the purchase price) by dividing the NAV of $9.88 by 0.95, and that equals a POP of $10.40 per share. Multiply that times 500 shares to arrive at the correct answer of $5,200. LO 7.c
A customer contributed $1,000 a year for 10 years to his tax-deferred nonqualified variable annuity. The value of the separate account is now $30,000. If the customer takes a withdrawal of $10,000, what are the tax consequences? A) There is no tax, as the withdrawal is considered return of capital. B) Any tax due is deferred. C) The entire $10,000 is taxable as ordinary income. D) Two-thirds of the withdrawal is taxable as ordinary income.
C) The entire $10,000 is taxable as ordinary income. The $30,000 contract value represents $10,000 of contributions and $20,000 of earnings. When a partial withdrawal is made from an annuity, the earnings are considered to be taken out first for tax purposes (or last-in, first-out). Therefore, ordinary income taxes will apply to the entire $10,000. In addition, if the customer is not at least 59½, there will be an additional tax penalty of 10%. LO 8.d
A stockholder owns 200 shares of common stock in a corporation that features statutory voting. If an election is being held in which six candidates are running for three seats on the board, the stockholder could cast the votes in which of the following ways? A) 600 votes for any one director B) 300 votes for each of two directors. C) 100 votes for each of six directors. D) 200 votes for each of three directors
D) 200 votes for each of three directors A stockholder has one vote per seat for each share of stock he owns. Thus, in this case, the stockholder has a total of 600 votes. Under the statutory voting method, he must allocate an equal number to each seat, or 200 for each of three seats. LO 2.a
Which of the following positions meets the IRS definition of a married put? A) Buy one ABC 50 put and sell one ABC 55 put B) Buy 100 shares of ABC at $50 per share and simultaneously sell one ABC 50 put C) Buy one ABC 50 call and buy one ABC 50 put D) Buy 100 shares of ABC at $50 per share and simultaneously buy one ABC 50 put
D) Buy 100 shares of ABC at $50 per share and simultaneously buy one ABC 50 put A married put is a specific type of protective put. Anytime a put option is purchased while the investor is long the underlying stock, it is considered a protective put because it is a hedge against a move to the downside. When the put and stock are bought at the same time, the strategy is known as a married put and has a special tax benefit. Normally, purchasing a put option on stock held less than the long-term holding period causes the existing holding period on the stock to be erased. In the case of the married put, the holding period of the stock is not affected. LO 9.i
Several years ago, a client purchased 1,000 shares of RADAK common stock at $50 per share. Today, the stock is selling for $100 per share and the investor is nervous about the future for the market. An order is turned in to sell 10 RADAK 105 calls at a premium of 2 and buy 10 RADAK 95 puts at a premium of 2. This strategy is A) exposing the investor to potential unlimited loss. B) a combination. C) a diagonal. D) a cashless collar.
D) a cashless collar. The answer is a cashless collar. It is cashless is because the calls are sold for 2 and the puts bought for 2. That means no out-of-pocket cash. The investor has "put a collar" on the long position in the stock by selling an out-of-the-money call and buying an out-of-the-money put. If the option purchase was more expensive than the one sold, it is still a collar, but not cashless because the investor would have to come up with the difference. For example, if the cost of the put was 3 while the proceeds from the call was 2, the client's cost would be one point to establish the collar. The exam will want you to know that collars (cashless or not) are used to protect an existing profit. LO 9.g
Minimum distributions from a traditional IRA must begin A) a year after the owner turns 59½. B) once the owner retires. C) as soon as the owner turns 59 1/2. D) by April 1 of the year after the owner turns 73.
D) by April 1 of the year after the owner turns 73. Minimum distributions from a 401(k) or a traditional IRA, SEP IRA, or SIMPLE IRA must begin by April 1 of the year after the owner turns 73 if the client reaches 72 after December 31, 2022. LO 13.e
All of the following statements regarding Section 529 plans are true except A) the assets in the account are controlled by the account owner, not the child. B) contributions to a 529 plan may be subject to gift taxation. C) states impose very high overall contribution limits. D) the income level of the contributor can affect the annual contribution amount.
D) the income level of the contributor can affect the annual contribution amount. Unlike Coverdell ESAs, the income level of the contributor will not affect annual contributions under a Section 529 plan. LO 5.h
