Series 7 Mid Term
Investors who are subject to AMT must have which of the following preference items added to adjusted gross income to calculate their tax liability? A) Interest on a private purpose municipal bond B) Income from a municipal security issued to finance parking garages C) Distributions from a corporate bond mutual fund D) Interest on a municipal bond issued to finance highway construction
A) Interest on a private purpose municipal bond On the exam, whenever you see a private purpose municipal bond, the interest on the bond is a tax preference item for the purpose of the alternative minimum tax.
Which of the following is an issuer of federal agency securities? A) The Tennessee Valley Authority B) The Indiana Highway Authority C) The U.S. Treasury D) The California Urban Development Authority
A) The Tennessee Valley Authority The TVA is a federal agency formed as an act of Congress in 1933. As such, the debt securities it issues are considered federal agency securities. Treasury issues are simply that—issues of the Treasury, not an agency. The other two choices are municipal bonds.
The market attitude of a customer who establishes a credit call spread is A) bearish. B) speculative. C) neutral. D) bullish.
A) bearish. In a call spread, a customer is buying one call and selling another with different strike prices and/or expirations. In any spread, one of the options is dominant. In a short call spread, the short call position is dominant because it has the higher premium; writing calls is bearish.
For U.S. investors holding American depositary receipts (ADRs), dividends received are A) subject to a foreign withholding tax. B) tax free in both the country of origin and in the United States. C) tax free in the country of origin. D) taxed as a capital gain in the United States.
A) subject to a foreign withholding tax. Any tax taken on dividends received from ADRs is taken in the country of origin. This is a foreign withholding tax for U.S. investors. The foreign withholding tax may later be taken as a credit against any U.S. income taxes owed by the U.S. investor.
A municipal issuer is frequently able to diversify a single municipal bond issue by maturity because A) every state issues municipal bonds. B) many municipal securities are very marketable. C) many municipal bonds are serial issues. D) municipal securities are mostly long term.
C) many municipal bonds are serial issues. A way for a municipal issuer to potentially make the issue more attractive is to diversify by having a range of maturities. That way, the issue will appeal to those investors whose needs might be short term, immediate term, or long term. Serial maturity means that within a single issue, portions of the issue mature at intervals, some short term, others intermediate term, and the balance long term. Municipal bonds typically mature serially.
All of the following securities are issued at a discount except A) commercial paper. B) zero-coupon bonds. C) Treasury bills. D) CDs.
D) CDs. CDs are interest-bearing debt instruments issued by banks at their face value. All of the others are issued at a discount.
Which of the following investment companies registered under the Investment Company Act of 1940 can include senior securities in its capital structure? A) Open-end management investment companies B) Unit investment trusts C) Face-amount certificate companies D) Closed-end management investment companies
D) Closed-end management investment companies Only the closed-end company is legally permitted to issue senior securities (preferred stock and bonds).
Ratio call writing exposes an options investor to which of these? Limited loss Unlimited loss Limited gain Unlimited gain A) I and IV B) II and IV C) I and III D) II and III
D) II and III Ratio call writers assume unlimited loss potential in a rising market and limited gain potential in a falling market. Maximum gain—while limited—occurs if the stock is trading at the strike price of the short calls at expiration.
Sam Brown has several stock rights. Which of the following is not an alternative regarding these stock rights? A) Gifting the rights to his son to exercise B) Redeeming them from the issuer for cash C) Exercising the stock rights before expiration to purchase shares of stock D) Selling in the open market at the prevailing market price
B) Redeeming them from the issuer for cash Rights are not redeemable by the issuer. They may be sold in the secondary market or given to someone else to trade or exercise. If exercised, rights are exchanged for an appropriate number of shares of the underlying common stock.
With regard to a variable annuity, all of the following may vary except A) the number of accumulation units. B) the number of annuity units. C) the value of accumulation units. D) the value of annuity units.
B) the number of annuity units. During the accumulation phase, the number of accumulation units will increase as additional money is invested. When the contract is annuitized, the annuitant is credited with a fixed number of annuity units. Once annuitized, the number of annuity units does not vary. The value of accumulation and annuity units varies with the investment performance of the separate account.
The Investment Company Act of 1940 contains a number of terms used to describe investment companies. When used as an adjective, the term diversified would apply to which type of investment company? A) Management company B) Unit investment trust C) Face-amount certificate company D) Business development company
A) Management company The Investment Company Act of 1940 divides investment companies into three principal classifications. Those are the face-amount certificate company, the UIT, and the management company. Management companies are further divided into open-end and closed-end companies. The act goes one step further and has management companies divided again into diversified and nondiversified companies. It is not expected that you will have to know what a BDC (business development company) is.
When it comes to issuing a debt security, which of the following features will generally enable the issuing corporation to borrow at the lowest interest rate? A) Cumulative B) Convertible C) Zero-coupon D) Callable
B) Convertible Because the convertible feature offers potential growth through the exercise of the conversion option, the interest rate on these securities is generally lower than other debt issues of the same corporation. The call feature increases the reinvestment risk and that is compensated for with a higher coupon. The descriptive adjective cumulative refers to dividend payments on preferred stock, but not to bonds. Because zero-coupon bonds pay nothing until maturity, that added risk requires a higher yield to attract investors.
A registered representative cannot adequately advise a client without knowing the client's financial status. When determining that status, it is important to differentiate between financial and nonfinancial considerations. Which of the following would be considered a financial consideration rather than a nonfinancial one? A) The client's membership in Greenpeace B) The client's rare coin collection C) The fact that both parents were smokers who died of lung cancer D) The client's marital status
B) The client's rare coin collection Financial considerations are those that can be categorized as an asset or a liability (something that can be assigned monetary value). Rare coins are certainly something of monetary value. The other choices are nonfinancial because you really can't put a number on them. The Greenpeace membership and the lung cancer deaths of the parents are likely indicators of certain investments that would probably not be suitable due to the values of the client.
Several investors open an account in joint tenancy. Which of the following statements regarding the account is true? A) Mail need only be sent to one of the parties to the account. B) Only one designated account holder need sign a margin agreement or other forms pertinent to the account. C) Checks may be made payable to one tenant of the account. D) Checks need not be endorsed by all parties to the account in order to be deposited.
A) Mail need only be sent to one of the parties to the account. While mail only needs to be sent to one of the parties to the account, checks for disbursements from the account must be made payable to all parties and endorsed by all parties in order to be deposited. Any required forms pertinent to the account, such as a margin agreement or options agreement, must be signed by all parties.
All of the following option strategies could be effectively used in a bear market except A) a short straddle. B) a credit call spread. C) a debit put spread. D) a short call.
A) a short straddle. Short straddles are appropriate only in flat or neutral markets. The writer will lose in a rising market (the call will be exercised) or a falling market (the put will be exercised). Short calls and short call spreads are bearish, as are debit (long) put spreads.
An investor purchases a TIPS bond with a 3% coupon. During the first year, if the inflation rate is 8%, the principal value of the security at the end of that year will be closest to A) $1,080.00. B) $1,081.60. C) $1,030.23. D) $1,030.00.
B) $1,081.60. The principal value of a TIPS bond is adjusted semiannually by the inflation rate. The exact calculation would be $1,000 × 104% × 104%, which equals $1,081.60. Each six months, the interest is paid on that adjusted principal and that is why the security keeps pace with inflation. There is a shortcut that will always work on the exam. Just recognize that the principal value increases based on the inflation rate compounded semiannually. Take the simple interest rate and choose the next highest number. In this example, 8% simple interest would be $80 (which would always be one of the choices). Because the computation is done twice per year, the compounding effect makes the correct choice slightly higher.
If an investor purchased a municipal bond in the secondary market, which of the following would not be a factor in calculating the total dollar amount paid for the bond? A) The dated date B) The scale C) The coupon rate D) The settlement date
B) The scale The scale, or reoffering scale, represents the prices and/or yields (listed by maturity date) at which new issue securities are offered for sale to the public by the underwriting syndicate. Because this question refers to a secondary market purchase, the scale would not apply. When computing the total price of a bond purchase, we need to know the accrued interest. Because interest is computed up to—but not including—the settlement date, clearly that is required information. The dated date is the date from which interest begins to accrue. True, this is only applicable for the first interest payment, but the question doesn't specify that this bond has already made that payment. Remember, secondary market transactions can take place the same day the new issue is released. Finally, it would be impossible to compute the accrued interest without knowing the interest rate being paid by the issuer. There is an important test-taking tip here. Scale has not appeared in the material yet, so we do not expect you to know what it means. But you should know that the other three items are necessary to compute the total purchase price. By process of elimination, scale must be the correct choice. This logic can be helpful on the real exam.
A registered investment company whose share price fluctuates independently of its net asset value is most likely A) a unit investment trust. B) an index mutual fund. C) a closed-end fund. D) an open-end fund.
C) a closed-end fund. Closed-end funds' share prices can differ significantly from their NAVs. Open-end (mutual) fund shares are purchased and redeemed at their NAVs. UITs are redeemable at NAV.
If ABC Corporation reports a loss for the year, it is obligated to pay interest on all of the following except A) debentures. B) variable rate bonds. C) adjustment bonds. D) convertible bonds.
C) adjustment bonds. Even if a corporation reports a loss, the corporation is obligated to pay interest on all of its outstanding debt except for income (adjustment) bonds. Adjustment bonds require interest to be paid only if ABC has sufficient earnings and the payment is declared by the board of directors.
Trade confirmations must show yield to call on which of the following callable bonds? A) 5½%, 5½% basis, maturing 2040 B) 6½%, 7% basis, maturing 2040 C) 6½%, at par, callable 2028, maturing 2059 D) 5½%, 5% basis, maturing 2040
D) 5½%, 5% basis, maturing 2040 Bond confirmations must disclose the lower of the yield to maturity (YTM) or yield to call (YTC). On a bond selling at a premium, the YTC is the lower of the two. The terminology here shows the coupon, the basis (YTM), and the maturity date (and, in one case, the call date). The 5½% bond with a 5% basis is the only bond trading at a premium. We know that because the YTM (or basis) is lower than the coupon. Even though the 6½% bond maturing in 2059 is callable relatively soon, because the bond was purchased at par, CY, YTM, and YTC are all equal to the coupon (nominal) rate, so the investor won't suffer a loss of principal with an early call.
The XYZ Corporation's A-rated convertible debenture is currently selling for 90. If the bond's conversion price is $40, what is the parity price of the stock? A) $40 per share B) $22.50 per share C) $44 per share D) $36 per share
If the bond's conversion price is $40, it means the bond is convertible into 25 shares ($1,000 par value divided by the $40 conversion price). Parity means equal, so what does each share have to be worth so that 25 of them are equal to $900? Dividing $900 by 25 shares results in a parity price of $36. That does not mean the stock is selling for $36 per share (probably a bit less), but at $36, holding the bond or converting into the stock gives the investor equal value. Some students quickly see that the bond is 10% below its par value, so the stock, to be equal, must be 10% below the conversion price. Take 10% off $40 and the result is $36. Either way works.
