Series 7 Part 2 (units 3-5) Prac quiz

The FDIC provides insurance for CDs up to $__________

$250,000.

A DMF convertible bond (convertible into 25 shares) has increased 20% above par in market value. Which of the following would you expect the price of the DMF's common stock to be? A) $48 B) $42 C) $40 D) $32

A Explanation $1,000 (par) + 20% = $1,200 / 25 shares = $48. Alternatively, it is ordinarily the 20% increase in the value of the common stock that has caused the bond to increase 20% in value. $1,000 divided by 25 shares equals $40 plus 20% equals $48.

ZYX Corporation has 100 million shares of common stock authorized in its charter, with 80 million shares outstanding. The board of directors of ZYX could vote to take which of the following actions? A) Declare a stock dividend of 10% B) Announce an additional public offering of 40 million shares of common stock C) Issue 20 million shares of a 4%, $100 par preferred stock, convertible at $50 D) Declare a 2:1 stock split

A Explanation A corporation cannot issue more shares than authorized. True, there could be a vote to amend the charter, but be careful not to read anything into the question that is not given. A 10% stock dividend will require issuing 8 million more shares. That will bring the total outstanding to 88 million. A 2:1 stock split would need an additional 80 million shares and ZYX has only 20 million left. With only 20 million authorized, but unissued shares remaining, where is ZYX going to get 40 million shares for the additional public offering? Likewise, the convertible preferred is convertible into two shares each ($100 par divided by the $50 conversion price). That would also require 40 million shares to be available if everyone elected to convert. As mentioned in the beginning, if Company ZYX wished to conduct a 2:1 stock split, or offer 40 million additional shares, either through a public offering or the issuance of convertible preferred stock, an amendment to the corporate charter, approved by the board of directors and the shareholders, would be necessary.

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) 200 votes for each of three directors B) 300 votes for each of two directors. C) 600 votes for any one director D) 100 votes for each of six directors.

A Explanation 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.

The legal contract stating the issuer's obligation to pay back a specific amount of money on a specific date to its bondholders is best described as A) the trust indenture. B) the official notice of sale. C) the prospectus. D) the official statement.

A Explanation A trust indenture delineates the covenants or promises made by an issuer to its bondholders. Those would include the amount of the debt, the maturity date, and the rate of interest. A trustee would also be identified in the indenture who would act on behalf of the bondholders in the event of default on any of the indenture's provisions.

The SEC recognizes all of the following under the Credit Rating Agency Reform Act as being registered with the commission to rate debt instruments. Which of them historically has specialized in ratings for the insurance sector? A) A.M. Best B) Standard & Poor's C) Fitch Ratings D) Moody's

A Explanation A.M. Best historically has specialized exclusively on the insurance marketplace. They issue financial strength ratings measuring insurance companies' ability to pay claims and rate financial instruments issued by insurance companies, such as bonds and notes. They can issue debt and financial strength ratings for other sectors as well under the Credit Rating Agency Reform Act.

A corporation is having a rights offering. The terms of the offering require eight rights plus $88 to purchase one share. With the stock's current market price at $112 per share, the theoretical value of one right on the ex-rights date is A) $3.00. B) $0.30. C) $2.67. D) $0.27.

A Explanation Because the question is asking about the value on the ex-rights, it means we use the regular formula. That is, the (market price minus the subscription price) divided by the (number of rights it takes to buy one share). Plugging in the numbers gives us ($112 - $88) ÷ (8) = $24 ÷ 8 = $3.00

QED Corporation, whose common stock is currently selling for $90 per share, is having a rights offering. The terms of the offering require seven rights plus $83 to subscribe to one share of stock. Compute the theoretical value of a right on the ex-rights date. A) $1.00 B) $0.875 C) $1.125 D) $7.00

A Explanation Because this is ex-rights (without the rights), the formula does not include the "+1." The formula is (M ‒ S). Plugging the numbers in, we have ($90 ‒ $83) = $7.00 ÷ 7 = $1.00 (N) (7)

The 5% markup policy applies to which of the following? Exempt transactions Agency transactions Principal secondary market trades New issues A) II and III B) I and II C) III and IV D) I and III

A Explanation The 5% markup policy applies to all secondary market transactions. It does not apply to exempt transactions, transactions requiring the delivery of a prospectus, or issues sold at a fixed offering price.

All of the following are characteristics associated with equity-linked notes (ELNs) except A) they are equity securities. B) they are considered to be nonconventional structured investments. C) they can be exchange traded or traded over-the-counter (OTC). D) they have final payments at maturity linked to the return of an underlying stock or basket of stocks.

A Explanation Despite their name, ELNs are debt instruments, not equity instruments. They have a partial fixed return, as well as a final payment linked to the performance of a single stock or equity index. Some are exchange traded, while others trade OTC. FINRA, who considers ELNs to be nonconventional structured investments, has expressed concerns that investors might not fully understand ELNs or the risks associated with them.

A convertible bond callable at 101 is trading at 105. The bond is a 4% bond convertible at $25. The common stock is trading at $27. If an investor bought the bond and converted, her profit would be A) $30. B) $75. C) $40. D) $20.

A Explanation First, calculate the number of shares each bond will convert to: $1,000 (par) divided by $25 per share equals 40 shares per bond. With market value at 105, each bond costs $1,050. What is the stock parity price? $1,050 divided by 40 shares equals $26.25 per share. Current market value of the stock minus stock parity price equals profit (or loss). $27.00 − $26.25 = $0.75 per share × 40 shares = $30.

If a fund has a fixed portfolio of municipal bonds with long maturities, how will substantial changes in general interest rates affect the fund's portfolio? A) The current value will fluctuate significantly, but the investment income will remain relatively unchanged. B) Both the income and the current value will fluctuate significantly. C) Both the income and the current value will remain unchanged. D) The current value will not change, but the investment income will fluctuate significantly.

A Explanation For a fund with a fixed portfolio of long-term municipal bonds, the market value of the portfolio will fluctuate with changing interest rates, but the income will remain unchanged.

For individual public investors, dark pools of liquidity A) lessen the transparency of the overall market as volume, quote and price information, and market participant identity is unknown. B) allow them to enter orders that are sent directly to the trading floors of stock exchanges. C) allow them to give an order to their broker-dealer to buy or sell securities while only referencing an account known by a number and not their name. D) prevent them from having their own orders entered on exchanges for execution.

A Explanation For individual public investors, dark pools of liquidity lessen the transparency of the overall marketplace. The pools refer to transactions that take place primarily among institutional traders or trading desks in large block transactions away from stock exchange floors, where volume, quote and price information, and participant identity are unknown. Though the existence of dark liquidity pools detracts from market transparency, it does not prevent individual public investors from having their own orders executed on listed exchanges.

A customer buys a 5% bond at par. The bond is callable in five years at par and matures in 10 years. Which of the following statements is true? A) YTC is the same as YTM. B) Nominal yield is higher than either YTM or YTC. C) YTC is higher than YTM. D) YTC is lower than YTM.

A Explanation If a bond is trading at par, the nominal yield (coupon rate) equals current yield equals yield to maturity (YTM) equals yield to call (YTC). YTC is higher than YTM if the bond is trading at a discount to par. YTC is lower than YTM if the bond is trading at a premium over par. Nominal yield is higher than either YTM or YTC if the bond is trading at a premium over par.

An investment banker purchasing what is left unsold from a rights offering is engaging in A) standby underwriting. B) firm commitment underwriting. C) preemptive rights underwriting. D) all or none underwriting.

A Explanation In many cases, when a corporation is issuing new shares, existing shareholders receive preemptive or stock rights to buy these new shares to maintain their current proportionate ownership. In the event some of the rights are not used, the standby underwriter agrees to purchase those unsubscribed for shares.

Rank the following from safest to most risky. AAA-rated corporate bonds Blue-chip stocks U.S. government securities Tech stocks A) III, I, II, IV B) II, III, IV, I C) I, III, IV, II D) III, II, I, IV

A Explanation It should be obvious that U.S. government securities would be first and tech stocks last. As for options II and III, stocks will fluctuate more in price than highly rated corporate bonds.

In active trading, a bond of standard size rises in price from 98 5/8 to 101¾. This represents a dollar change of A) $31.25. B) $0.3125. C) $312.50. D) $3.125.

A Explanation Let's take this step by step remembering that every point in a bond quote equals $10 and every 1/8 of a point equals $1.25 ($10/8=$1.25). Method #1 1) The increase is 3 1/8 points (101 ¾ minus 98 5/8 = 101 6/8 minus 98 5/8 = 3 1/8 2) 3 1/8 = $30 (3 times $10 per point) + $1.25 which equals $31.25 Method #2 1) 101 3/4 = 101 x $10 = $1,010 + 3/4 of $10 = $7.50, total price is $1,017.50. 2) 98 5/8 = 98 x $10 = $980 + 5/8 of $10 = $6.25. total price is $986.25. 3) The difference between the two prices is $1,017.50 minus $986.25 which = $31.25.

All of the following securities trade in the over-the-counter (OTC) market except A) open-end investment companies. B) government and agency securities. C) Nasdaq securities. D) American depositary receipts.

A Explanation Municipal bonds, government and agency securities, and corporate securities (listed and unlisted) all trade in the OTC market. Foreign securities trade in the United States if the companies comply with SEC registration and disclosure requirements. Mutual fund shares (open-end companies) do not trade.

Reggie owns a convertible bond that converts into 20 shares of common stock. The current market value of the bond was 118½ at the close on Friday, April 1. A 30-day call is announced before the opening on Monday, April 4, at a price of 102. The stock is trading at $57.75. What should Reggie do? A) Convert the bond into the stock B) Sell the bond C) Hold the bond to maturity D) Redeem the bond at the call price

A Explanation Reggie will not be allowed to hold the bond to maturity because it is being called. The real question is whether he should sell the bond, allow it to be called, or convert it to the underlying stock. Now that the call has been announced, the market value of the bond will fall to meet the call price. This occurs as a result of declining demand. (Who wants to buy a bond that is about to be called at a lower price?) Thus, redeeming the bond at the call price and selling the bond would both yield the same results: $1,000 times 102% equals $1,020. If he converts the bond, he will get the following results: 20 shares times $57.75 equals $1,155. Therefore, it makes the most sense to convert the bond.

The Nasdaq Stock Market permits listing for all of the following except A) nonconvertible debt securities. B) convertible bonds. C) warrants. D) common stock.

A Explanation The Nasdaq Stock Market is an equity and equity equivalent market. Listed are common stock, preferred stock, warrants, limited partnerships, American depositary receipts, and convertible bonds. Straight debt securities are not part of Nasdaq.

The over-the-counter (OTC) market could be characterized as what type of market? A) Dealer B) First C) Primary D) Auction

A Explanation The OTC market is a dealer market.

A convertible bond has a conversion price of $40 per share. If the market value of the bond rises to a 12.5-point premium over par, which of the following are true? Conversion ratio is 25:1 Conversion ratio is 28:1 Parity price of the common stock is $42 Parity price of the common stock is $45 A) I and IV B) II and III C) I and III D) II and IV

A Explanation The conversion ratio is computed by dividing par value by the conversion price ($1,000 par / $40 = 25). Parity price of the common stock is computed by dividing the market price of the convertible bond by the conversion ratio ($1,125 / 25 = $45). Or, 112.5% × $40 = $45.

An investor sells 10 5% bonds at a profit and buys another 10 bonds with a 5¼% coupon rate. The investor's yearly return will increase by A) $2.50 per bond. B) $1.00 per bond. C) $1.50 per bond. D) $2.00 per bond.

A Explanation The first bonds are 5% and pay $50 per year per bond. The new bonds are 5¼% and pay $52.50 per year per bond, for a difference of $2.50 per bond.

It would be expected that your firm would employ heightened suitability standards when evaluating recommendations for A) structured products. B) nonvoting common stock. C) cumulative preferred stock. D) sovereign debt.

A Explanation The higher the risk of the investment, the greater the need for checking suitability. Structured products, such as equity-linked notes and exchange-traded notes, are considered complex products. In many cases, FINRA has discovered that registered representatives had inadequate understanding of the investment, leading to their making unsuitable recommendations.

An investor's portfolio contains the following four bonds: ABC 7% duein 2040 DEF 6% due in 2040 GHI 5% due in 2040 JKL 8% due in2040 Which of these bonds would show the greatest price change if interest rates jumped by one percentage point? A) GHI 5% due in 2040 B) JKL 8% due in 2040 C) DEF 6% due in 2040 D) ABC 7% due in 2040

A Explanation The longer the duration, the greater the price volatility when there is a change to market interest rates. When all bonds have the same (or approximately the same) length of time to maturity, the bond with the lowest coupon rate will have the longest duration. Conversely, the one with the highest coupon rate will have the shortest duration and changes in interest rates will have the least impact on it.

A Nasdaq market maker buys 1,000 shares of stock from a customer at its bid to satisfy a customer order. This is an example of A) a principal trade. B) a block trade. C) a riskless principal trade. D) an agency trade.

A Explanation The market maker is acting in a principal (dealer) capacity.

A corporation pays a 10% stock dividend to common stockholders. All the following are true regarding this dividend except A) the beauty of stock dividends is that they are nontaxable. B) the total value of the position is unchanged when the dividend is paid. C) the dividend is taxable in the year the sale of the shares takes place. D) the cost basis per share is adjusted based on the stock dividend.

A Explanation The stock dividend is taxable, but unlike cash dividends, which are taxed when received, stock dividends are taxable in the year the shares are sold.

An investor purchased 200 shares of Hightown National Bank (HNB) common stock at $120.06 per share. Thirteen months later, HNB pays a 15% stock dividend. Three months after that, the investor sells the shares received from the stock dividend at $112.57 per share. The tax consequence to the investor is A) $245.10 long-term capital gain. B) $122.55 short-term capital gain. C) $245.10 short-term capital gain. D) $$1,879.10 long-term capital gain.

A Explanation The total value of the initial position is unchanged, remaining at $24,012 (200 times $120.06). After the stock dividend the investor owns 230 shares (200 times 15% = 30 + 200 = 230). Therefore, the adjusted cost basis is $100 per share ($24,012 divided by 230 = $104.40). The question tells us that the investor sells those 30 additional shares at $112.57 per share. That is a difference of $8.17 per share. Multiply that gain by 30 shares and the result is a profit of $245.10. It is a long-term gain because the holding period of shares received from a stock dividend or stock split begins with the initial purchase, not the receipt of the new shares. It is important to remember that anytime there is a distribution resulting in additional shares (stock split, stock dividend), the cost basis per share is reduced while the total account value remains the same. If you have to guess, or are running out of time, when you see two identical numbers with the only difference being short- or long-term gain, in almost all questions, one of those two is the correct answer. Now you have a 50% chance of guessing correctly and, if you remember that the holding period always begins with the initial purchase, then the odds are 100% in your favor.

Libby sees a tombstone advertisement for a new issue of Southwest Barge subordinated convertible debentures. The bonds will carry an 11¼% coupon, are convertible into common stock at $10.50, and are being issued to the public at 100. The proceeds of the issue will be used specifically for purchasing new Southwest barges. Libby's concerns about the issue could include which of the following? A) The issue may have a junior claim to another security issue. B) She should not be concerned, as the bonds will be first in liquidation. C) The new barges might sink, and the collateral would be gone. D) The company might demand that she accept common stock for her bond.

A Explanation The word subordinated is the key to the question. A subordinated bond has other debt holders ahead of it in the event of liquidation. The barges do not serve as collateral, as the bonds are identified as debentures, and having to convert to common stock is not a threat because she is the one that will, if she desires, exercise the conversion privilege.

Reasons why a corporation might engage in a stock buy-back program would include all of these except A) reducing annual interest expense. B) having stock available for future acquisitions. C) using the stock for employee stock options. D) increasing earnings per share.

A Explanation There is no interest expense with stock. When a company buys back its stock, it becomes treasury stock. That stock is no longer outstanding. Buying back the stock should cause the earnings per share to increase (there are now fewer shares outstanding). Many times one company will acquire another one by paying for the purchase with its treasury stock rather than cash. Many companies offer employees ownership opportunities through employee stock options. This is a way to ensure that the company has enough stock to meet the needs.

An investor is looking to add some fixed-income securities to their portfolio. A registered representative suggests either the ABC 6s of 2050, or the XYZ 6s of 2043. Should there be an increase to market interest rates, A) the ABC bonds will suffer a price decline greater than the XYZ bonds. B) the ABC bonds will enjoy a price increase greater than the XYZ bonds. C) the XYZ bonds will enjoy a price increase greater than the ABC bonds. D) the XYZ bonds will suffer a price decline greater than the ABC bonds.

A Explanation This is a basic duration problem. When interest rates change, the bond with the longest duration will have the greatest price change. When there are two bonds with the same coupon rate (6%), the bond maturing latest has the longest duration. That tells us that the ABC bonds will fluctuate more than the XYZ bonds. Then, we need to remember that when interest rates increase, bond prices fall. That means that while both bonds will decline in price, the decline of the ABC bonds will be greater.

An investor purchases a zero coupon bond at a price of 64. The bond matures in nine years. Five years later, the investor sells the bond at a price of 80. This would result in A) a long-term capital loss of $40. B) a long-term capital gain of $160. C) a long-term capital loss of $200. D) no gain and no loss.

A Explanation This question deals with accretion of the discount. The discount here is $360 (the difference between the $640 paid and the $1,000 maturity value). With nine years until maturity, the annual accretion is $360 divided by nine, or $40 per year. After five years, the bond's basis has increased by $200 ($40 times 5 years) to $840. The sale at $800 represents a long-term loss of $40.

An investor purchases a newly issued convertible bond at par. The bond is convertible at $25. Three years later, the underlying common stock is trading at $33 per share. If the investor sells the bond at the parity price, A) there is a long-term capital gain of $320. B) the investor has no gain and no loss. C) there is a long-term capital gain of $8 per share. D) there is a long-term capital loss of $175.

A Explanation This question involves several steps. The first is to determine the conversion ratio in shares. A bond convertible at $25 per share has a share conversion rate of 40 shares ($1,000 ÷ $25). The second step is to compute the parity price. That is, what are those 40 shares worth? Multiply 40 shares by $33 per share and that equals $1,320. When the bondholder sells the bonds at parity, that $1,320 is received. The $320 profit over the $1,000 initial cost is a long-term capital gain. An alternative that might be easier for some is to look at the appreciation of the stock. It is $8 per share higher than the conversion price of $25. That represents an increase of 32% (8 ÷ 25). If the bond is at parity with the stock, its price must be 32% higher and that brings us again to the $1,320 price

A 7% convertible debenture is selling at 101, and it is convertible into the common stock of the same corporation at $25. The common stock is currently trading at $23. What is the parity price of the debenture? A) $920 B) $850 C) $910 D) $929

A Explanation To determine the parity price of the bond, first find the number of shares the debenture is convertible into (conversion ratio) by dividing par value by the conversion price ($1,000 / $25 = 40 shares). Next, multiply the current price of the common by the conversion ratio. The result is the parity price of the bond (40 shares × $23 = $920).

JDX Corporation's charter has authorized 10,000,000 shares of common stock. It has issued 5,000,000 shares and has 1,000,000 shares in its treasury. JDX decides to use all of the treasury stock to pay a dividend to shareholders. As a result, the number of outstanding shares is A) 5,000,000. B) 6,000,000. C) 4,000,000. D) 10,000,000.

A Explanation Treasury stock is stock that has been issued and reacquired by the company. At that point, it is no longer outstanding in the hands of the public. Sending those shares out as a dividend puts them back in the hands of the investing public. Now, all of the five million issued shares are outstanding.

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) 1.6 million shares and 800,000 warrants B) 1.6 million shares and 400,000 warrants C) 800,000 shares and 400,000 warrants D) 800,000 shares and 200,000 warrants

A Explanation 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.

A customer owns a 7.5% ABC convertible bond currently trading at 115. The conversion price is $40. What is the parity price of the common? A) $46.00 B) $28.75 C) $34.00 D) $44.00

A Explanation What does parity price mean? Here is what it says in the LEM: Calculating Conversion Parity Parity means that two securities are of equal dollar value (in this case, a convertible bond and the common stock into which it can be converted). The question is looking for the parity price of the common stock. That is the market price per share, where the total value of the stock received upon conversion equals the market price of the bond. There are two ways to do this. The first is generally the easiest to understand. We are told that the bond has a conversion price of $40. That means you can get 25 shares if you wish to convert. That is because the issuer is basically saying, "We owe you $1,000 and will let you spend it on our stock at $40 per share." Now that we know we can get 25 shares, what does each share have to be worth to equal $1,150? If you divide $1,150 by 25 shares, the result is $46. The other method to do this is as follows: The bond is selling at a 15% premium. To be equal to that, the stock must be selling at a 15% premium over the conversion price. $40 times 115% equals $46. If that makes sense to you, it is much faster than the first method.

PDQ Corporation has a 6.25% $100 par value convertible preferred stock (conversion ratio of 4) outstanding. The stock has an antidilution covenant. If PDQ declares a 10% stock dividend, the antidilution covenant will adjust A) the conversion price to approximately $22.73. B) the conversion price to approximately $27.50. C) the par to $110. D) the par to $90.

A Explanation When a $100 par value preferred stock is convertible into four shares of common stock, the conversion price is $25 per share, ($100 ÷ 4 = $25). The antidilution covenant means the investors will have the same conversion rights after a stock split or stock dividend as they had before. After a 10% stock dividend, each share of preferred stock will be convertible into 4.4 shares (4 shares x 110% = 4.4). The par value of the preferred stock does not change. Divide that $100 par value by the new number of shares to get the new conversion price. It looks like this: $100 ÷ 4.4 = 22.73. Alternatively, you can divide the original conversion price of $25 by 110% arrive at the same answer.

The DCAV corporation has declared a 10% stock dividend. Which of the following is true regarding the shareholders receiving the stock dividend? A) The stock dividend would not be taxable upon receipt by the shareholder. B) The stock dividend would increase the cost basis per share. C) The stock dividend would decrease their percentage of ownership within the corporation. D) The stock dividend would increase their percentage of ownership within the corporation.

A Explanation When a stock dividend is paid, the shareholders receive a dividend of additional shares instead of cash. The effect of this is an increase in the number of share with a reduction in the cost basis of each share. Because there is no monetary impact, there is no current taxation. The stock dividend would decrease their original cost basis. Although the stock dividend is not taxable upon receipt, it would be taxable upon the sale of the shares if sold for more than the adjusted cost basis. Stock dividends have no effect on a shareholder's proportionate ownership of the corporation.

A respected analyst reports that last week's T-bill rate at 1% is lower than the rate for the preceding week and lower than the average for the past month. Which of the following is true? A) Investors are paying more for T-bills. B) Prices are descending. C) The general level of interest rates is increasing. D) Investors are paying less for T-bills.

A Explanation When the rate is lower, the price has gone up. This means investors are paying more as interest rates are going down.

ABC Corporation has outstanding a 7.75% convertible debenture currently trading at 102. The bond is convertible into common stock at $40. ABC stock is trading $45 per share. Which of the following statements is true? A) To profit in this situation, the investor should buy the bonds and short the stock. B) An arbitrage opportunity does not exist in this situation. C) The bond is at parity with the stock. D) To profit in this situation, the investor should buy the stock and short the bonds.

A Explanation With a conversion price of $40, the bond is convertible into 25 shares of ABC common stock ($1,000 / $40 = 25 shares). As the common stock is currently trading at $45 per share, the value of the stock as converted would be $1,125 (25 shares × $45 = $1,125), which is greater than the current price of the bond ($1,020). Therefore, the bond and the stock are not at parity. An investor could profit in this situation by shorting the stock and buying an equivalent number of bonds. A bond could be purchased for $1,020 and immediately converted into stock worth $1,125—a risk-free profit opportunity.

An investor owns a convertible debenture with a conversion price of $10. If a 10% stock dividend is paid on the company's common stock, which of the following is true? A) The conversion price will be adjusted to $9.09. B) The conversion price will be adjusted to $11.00. C) The investor will receive 1 share of the common stock. D) The investor will receive 10 shares of the common stock.

A To get 110 shares from a $1,000 principal, the price must be reduced. The computation is $1,000 divided by 110. That equals $9.09 per share.

Match the fractions to the dollars they represent: 1/8 1/4 3/8 1/2 5/8 3/4 7/8

All fractions of $10 1/8=1.25 1/4=2.50 3/8=3.75 1/2=5.00 5/8=6.25 3/4=7.50 7/8=7.75

Which of the following statements regarding a $1,000 corporate 8.50% bond offered at 110 is true? A) The bond's current yield is lower than its yield to maturity. B) The bond's current yield is calculated by dividing its annual interest by its market price. C) The bond is a discount bond. D) To determine the bond's current yield, its stated rate must be compared against other fixed-rate investments in the client's portfolio.

B A bond's current yield is calculated by dividing its annual interest by its current (market) price. The current yield will be higher than its yield to maturity, which will include the premium return. The determination of a bond's yield is unrelated to other bonds. In addition, this is a premium bond, not a discount bond.

Which of the following statements regarding corporate debentures are true? They are certificates of indebtedness. They give the bondholder ownership in the corporation. They are unsecured bonds issued to finance capital expenditures or raise working capital. They are the most senior security a corporation can issue. A) II and IV B) I and III C) I and II D) III and IV

B Debentures are debt securities that represent unsecured loans of the issuer. They are senior to common and preferred stock in claims against an issuer. They are issued to finance capital expenditures or raise working capital.

ABC Corporation has issued a convertible preferred stock with a par value of $100. The stock is convertible at $40. The current market price of the stock is $80. It would be correct to state that the conversion ratio is A) 2:1. B) 2.5:1. C) 4:10. D) 4:5.

B Explanation When a $100 par preferred has a conversion price of $40, the stockholder can convert into 2.5 shares. That is a 2.5:1 ratio. The current market price of the stock is only relevant if the question asks about the parity price (which is $32).

A bond has a 7% coupon and an offering price of 108. The bond matures in ten years. An investor purchasing this bond at the offering price would have a yield to maturity closest to A) 7.80%. B) 5.96% C) 7.50%. D) 7.22%.

B Explanation "When you pay more, you get less," Anytime a bond is purchased at a premium (a price above par), the yield to maturity (as well as the current yield and yield to call) must be lower than the nominal yield (the coupon rate). If you stop and think for a moment, there can be only one possibly correct answer. With a coupon rate of 7%, the answer must be something less than that. As will likely be the case on the exam, there is only one choice that is less than 7%. If you want to do the computation using our formula, it is: Annual interest - (premium ÷ years to maturity) ÷ average price of the bond. Plugging in the numbers we have: $70 - ($80 ÷ 10) ÷ [($1,080 + $1,000) ÷ 2]. This works out to: $62 ÷ $1,040 = 5.96%. However, as stated above, with only one number below the coupon rate, that has to be it. A variation of this question has two choices below the coupon. If that were the case here, the other choice would be 6.48%. That is the current yield ($70 ÷ $1,080). You need to remember that with a bond selling at a premium, the YTM will always be lower than the CY.

A corporation is likely to call eligible debt when interest rates are A) stable. B) declining. C) rising. D) volatile.

B Explanation A corporation generally calls in its debt when interest rates are declining to replace old, higher interest rate debt with new, lower interest rate issues.

All of the following statements describe stock rights except A) they are issued by a corporation. B) they are most commonly offered with debentures to make the offering more attractive. C) they are short-term instruments that become worthless after the expiration date. D) they are traded in the secondary market.

B Explanation A corporation issues rights to existing shareholders to allow them to purchase enough stock—within a short period and at less-than-current market price—to maintain their proportionate interest in the company. Rights need not be exercised but may be traded in the secondary market. Warrants, not rights, are often issued with debentures to sweeten the offering.

Which of the following callable municipal bonds trading on a 7% basis is most likely to be called? A) 7.5% coupon, callable at 105 in 2030 B) 7.5% coupon, callable at 100 in 2030 C) 6.5% coupon, callable at 100 in 2030 D) 6.5% coupon, callable at 105 in 2030

B Explanation An issuer will call the higher coupon bonds before calling the lower coupon bonds. Of the two bonds with coupons of 7.5%, the one with the lower call price will likely be called first.

DERF Corporation has a significant amount of cash on hand. The chief financial officer (CFO) has suggested to the chief executive officer (CEO) that it might be wise to pay off $10 million of the company's outstanding debt. There are four bond issues outstanding, and your broker-dealer is approached for advice on determining which issue to repay. Which of these four issues would the firm recommend? A) $25 million @5% due in 5 years, callable at 104 B) $15 million @8% due in 10 years, callable at 101 C) $30 million @12% due in 15 years, non-callable D) $10 million @6% due in 20 years, callable at par

B Explanation Anytime we have extra cash, it can make sense to pay off debt. Corporations feel the same way. When it comes to deciding which debt to repay, the wisest move is to pay down the debt with the highest interest cost. In this case, that would be the 12% bond. However, that bond is non-callable. Based on the inverse relationship between interest rates and bond prices, the 12% bond is going to be selling at a higher price than any of the others. Any savings in interest payments would be more than offset by the price the company would have to pay to buy the bond in the open market. The next highest interest rate is 8% and that bond will cost us a slight premium of $10 per bond to call. Although the 6% bond is callable at par, the company would be far better off removing an 8% debt than one at 6%. In fact, the 1 point call premium is saved after the first semiannual interest payment. A partial call, calling in $10 million of the 8% bond, should be the recommendation.

An investor had a $20,000 capital loss, a $15,000 capital gain, and $50,000 in income for the year. How much of the income is taxable? A) $50,000 B) $47,000 C) $20,000 D) $30,000

B Explanation Capital losses may be used to reduce taxable income. The first step is to net the gains and the losses. This investor has a net loss of $5,000. Of that net loss, a maximum of $3,000 can be written off against the income for the year. That reduces the investor's taxable income to $47,000. The unused $2,000 of the net loss is carried forward to subsequent tax years until utilized.

Which of the following are characteristics of commercial paper? It is registered with the SEC. It is a short-term debt instrument. It is issued by commercial banks. It is unsecured debt. A) I and III B) II and IV C) I and II D) III and IV

B Explanation Commercial paper represents the unsecured debt obligations of corporations needing short-term financing. Because commercial paper is issued with maturities of less than 270 days, it is exempt from SEC registration under the Securities Act of 1933.

Holders of common shares may generally vote on A) which member of the board of directors should be chairman. B) whether the company should issue additional preferred stock. C) whether a cash dividend is to be declared. D) whether an administrative assistant should be promoted to management.

B Explanation Common shareholders must vote to approve the issuance of additional preferred stock because additional preferred shares dilute the common shares' residual assets under a liquidation. Common shareholders do not vote to declare dividends. Board members select the chairman of the board. Shareholders do not get involved in the daily operational activity of the corporation.

JEG Corporation common stock is currently trading at $25 per share. The par value of JEG stock A) is most likely $25 per share. B) has nothing to do with the current market value of the stock. C) is most likely more than $25 per share. D) is most likely less than $25 per share.

B Explanation Common stock has a par or stated value on the corporation's books that has nothing to do with the market price of the stock. That price can be above, below, or the same as the par value. The market price is determined by supply and demand.

If a stock undergoes a 1-for-5 reverse split, which of the following increases? Market price per share Number of shares outstanding Earnings per share Market capitalization of the company A) II and III B) I and II C) I and III D) III and IV

C Explanation After a reverse split, there will be fewer shares outstanding. As a result, market price and earnings per share will increase. Overall, the market capitalization of the company will not change.

A registered representative has a customer looking to invest in stock for income. The customer is looking for the highest fixed rate of return available based on her risk profile. Which of the following would be least suitable? A) Cumulative preferred B) Convertible preferred C) Straight preferred D) Callable preferred

B Explanation Convertible preferred stock is convertible into the issuer's common stock. This conversion feature has value if the market price of the underlying stock should increase. Because of that feature, issuers are able to attract investor interest with a lower dividend on this preferred stock compared with preferred stock that has no conversion feature. Therefore, it would be the least suitable investment for this client.

Which of the following debt instruments would likely be suitable for sophisticated investors only? A) Jumbo CDs B) Equity-linked notes C) First mortgage bonds D) Debentures

B Explanation Despite the misleading name, ELNs are debt instruments. When traded on an exchange, they are exchange-traded notes (ETNs). In either case, these are considered alternative products with unique risks, and therefore, not suitable for most investors. Although debentures are corporate debt without any pledged collateral, some of the financially strongest companies in the country issue them and receive high ratings. Even though Jumbo CDs require a minimum of $100,000, it does not require any sophistication to understand the product.

Regarding the taxation of dividends received from corporate securities, which of the following are true? Nonqualified dividends are taxed at the rate the investor's ordinary income will be taxed. Nonqualified dividends are not taxed. Qualified dividends are taxed at a maximum rate specified by the IRS and will depend on the investor's income tax bracket. Qualified dividends are taxed at the rate the investor's ordinary income will be taxed. A) I and IV B) I and III C) II and III D) II and IV

B Explanation For income tax purposes, corporate dividends are divided into two categories: qualified and nonqualified. We don't expect you'll be tested on what makes a dividend qualified or not, but you will need to know the difference in taxation. Qualified dividends are taxed at the same rate as long-term capital gains—a rate significantly lower than the ordinary income tax rate levied against nonqualified dividends. That lower rate ranges from 0% to as high as 20%, with an even higher effective rate for those with an extraordinarily high income. For most investors, the rate is 15%, and that is the number you should use in any computations. With ordinary income tax rates on nonqualified dividends as high (currently) as 37%, there is a real benefit for most investors to receive qualified dividends.

One of your individual customers would like to add some foreign debt securities to their portfolio. When told that the investment would be $2,500, the best suggestion would be to A) contact a broker-dealer in the foreign country of choice and open an account there. B) invest in a mutual fund concentrating in foreign debt securities. C) use one of the overseas branches of your firm to suggest the appropriate issues. D) tell the customer that $2,500 is below the minimum purchase quantity of foreign bonds.

B Explanation For small investments, a mutual fund or exchange-traded fund (ETF) is usually going to be the most suitable choice. Most countries do not allow nonresident noncitizens to open local brokerage accounts, and that is a pretty impractical idea anyway. If your firm has an overseas office, it could be a source of information, but when only $2,500 is involved, purchasing individual bonds issued by a foreign nation is usually not reasonable.

Without an exemption, member firms are required to provide purchasers of penny stocks each of the following except A) current inside bid and ask quotation. B) quarterly statements. C) compensation to be earned by both the member firm and the associated person. D) a risk disclosure document.

B Explanation If an exemption is not available, purchasers of penny stocks must receive the risk disclosure document, current inside bid and ask quotation, information on the compensation to be received by both the representative and the member in connection with the transaction, and monthly, not quarterly, statements.

An investor might expect to receive the greatest gain on an investment in a corporate bond by purchasing A) short-term bonds when interest rates are low. B) long-term bonds when interest rates are high. C) long-term bonds when interest rates are low. D) short-term bonds when interest rates are high.

B Explanation If an investor purchases bonds when market interest rates are high, a drop in interest rates will lead to a corresponding increase in bond value. Long-term debt instruments will fluctuate to a greater degree than those with short-term interest rates. Thus, long-term debt offers the greater chance of gain.

A term used to define certain alternative forms of debt financing, such as equity-linked notes (ELNs) and exchange-traded notes (ETNs), is A) combination products. B) structured products. C) high-risk investments. D) principal protected products.

B Explanation In Notice to Members 05-59, FINRA defined a structured product as "securities derived from or based on a single security, a basket of securities, an index, a commodity, a debt issuance and/or a foreign currency." The most important thing for you to know for the exam is that these generally carry higher risk than other debt securities. These should be recommended only when the registered representative has a thorough understanding of the product and believes it is suitable for the specific investor. Yes, these are high-risk investments, but that is not the term used to describe them.

An investor owns 400 shares of ABC common stock. ABC's board of directors has declared a 5:4 stock split. As a result, the investor will receive how many additional shares? A) 500 shares B) 100 shares C) 80 shares D) 40 shares

B Explanation In a 5:4 stock split, the shareholder will own five shares for each four shares currently held. This investor owns 400 shares so, after the split, the account will have 500 shares in it. The difference between 400 and 500 is 100 additional shares. If you chose 500, that is the total number of shares that will be owned, but the question does not ask for that—it asks for the number of additional shares.

When comparing preemptive rights and warrants, one similarity is A) the length of time before they expire. B) their voting privilege. C) their exercise price relative to the market price of the underlying stock. D) the method by which the issuer distributes them to shareholders.

B Explanation In an odd play on words, the only similarity here is that neither of them have voting rights. Warrants are long-term while rights are short-term. The exercise price of a right is below the current market while that of a warrant is above. Only rights are distributed to existing shareholders in proportion to the investor's current stock ownership. Warrants are not sent to shareholders; they are most often part of another issue.

SEC rules require that customers be given a copy of the risk disclosure document before their first transaction in a penny stock. The member firm must receive a signed and dated acknowledgment from the customer that the document has been received. In addition to obtaining the client's signature, the SEC requires the firm to wait at least A) five business days after receiving the statement before executing the first trade. B) two business days after sending the statement before executing the first trade. C) two business days after receiving the statement before executing the first trade. D) five business days after sending the statement before executing the first trade.

B Explanation It is SEC Rule 15g-2 that requires the firm wait at least two business days after sending the risk disclosure document before executing the first penny stock trade for a new customer.

Interest and principal on a Eurodollar bond issued in Germany are paid A) in German euros. B) in U.S. dollars. C) in German deutsche marks. D) in European Union euros.

B Explanation It is always the final part of the word that describes the currency of a eurobond. A Eurodollar bond pays in U.S. dollars, while a Euroyen bond would pay in Japanese yen.

When reading a corporation's annual report, a registered representative notices that there are 100 million shares authorized, 70 million shares outstanding, and 10 million shares in the treasury. Based on this information, the representative would deduce the number of unissued shares is A) 10 million. B) 20 million. C) 30 million. D) 80 million.

B Explanation Of the 100 million authorized shares, 80 million have been issued (the 70 million outstanding plus the 10 million in the treasury). That leaves 20 million shares still unissued.

The Securities Exchange Act of 1934 deals with all of the following except A) marking sales long or short on an order ticket. B) filing an updated prospectus. C) monitoring accounts for insider trading violations. D) filing of financial statements by broker-dealers.

B Explanation Prospectus filing is a requirement of the Securities Act of 1933.

An investor purchased a new issue corporate zero-coupon bond for $600. The bond has a maturity of 20 years. Six years later, the investor sells the bond for $700. For tax purposes, this would result in A) a capital gain of $20. B) a capital loss of $20. C) a capital gain of $100. D) a capital loss of $280.

B Explanation The $400 discount is accreted over the 20 years to maturity. That is an annual accretion of $20. After 6 years, that is $120, making the tax basis of the bond $720. Because the sale at $700 is $20 less than the basis, the investor has a long-term capital loss.

The 5% markup policy would apply to all of the following equity transactions except A) an agency trade done on an exchange. B) a primary market transaction. C) a riskless principal transaction. D) a proceeds transaction.

B Explanation The 5% markup policy applies to secondary market transactions in nonexempt securities.

Riskless and simultaneous transactions by a broker-dealer are A) permissible only in new issue underwritings. B) permissible if they comply with the 5% policy. C) permissible only if there is a profit for a customer. D) not permissible under any circumstances.

B Explanation The 5% policy applies to all types of nonexempt secondary market transactions, including riskless and simultaneous transactions.

The KPL Corporation is considering having its stock listed on the New York Stock Exchange (NYSE). Who will make the final decision as to whether it will be listed? A) FINRA B) The NYSE C) The Board of Directors of KPL D) The SEC

B Explanation The NYSE has certain requirements that a company must meet before its stock can be considered for listing. Because the NYSE sets the requirements, it must make the final decision.

The KPL Corporation is considering having its stock listed on the New York Stock Exchange (NYSE). Who will make the final decision as to whether it will be listed? A) The SEC B) The NYSE C) The Board of Directors of KPL D) FINRA

B Explanation The NYSE has certain requirements that a company must meet before its stock can be considered for listing. Because the NYSE sets the requirements, it must make the final decision.

A corporation has an outstanding issue of 8% convertible debentures with a conversion price of $25. The bond indenture contains an antidilutive clause guaranteeing the debt holders the right to maintain proportionate equity conversion in the corporation. If the company pays a 10% stock dividend to its common shareholders, how will that affect the debenture holders? A) They will receive four shares of the common stock. B) The bonds will now be convertible at approximately 22.73. C) Each debenture holder will receive a check for $100. D) The interest rate on the debentures will increase to 8.8%.

B Explanation The antidilutive provision means the debenture holders will be able to convert into an equivalent share value as before. With a conversion price of $25, the bond is convertible into 40 shares ($1,000 ÷ $25). After the 10% stock dividend, they should be able to have 10% more shares, or 44 shares. That means the conversion price must be reduced. Divide $1,000 by 44 shares and the result is $22.73. Remember, anytime there is a stock dividend, prices go down.

An investor seeking income combined with a conservative level of risk would purchase A) junk bonds. B) AA-rated mortgage bonds. C) AAA-rated convertible debentures. D) unrated income bonds.

B Explanation The conservative level of risk eliminates the income bonds and the junk bonds. Income bonds pay interest only if the issuer has the funds to do so. Junk bonds are named such because of their high risk. Even though the convertible debentures have a higher rating than the mortgage bonds, the difference is relatively insignificant at that level and either would be suitable for the conservative investor. However, because of the convertible feature, it is always true on the exam that the income return is lower than non-convertible issues. Therefore, the most suitable for this investor would be the mortgage bonds.

A customer sells securities and uses the proceeds to buy more securities at the same cost. Under the 5% markup policy, the markup is calculated on A) each side separately. B) the total of both sides. C) the sell side only. D) the buy side only.

B Explanation The firm must consider the entire transaction (a proceeds transaction) when calculating the markup.

A customer has $12,000 of capital gains, $15,000 of capital losses, and $50,000 adjusted gross income. How much unused loss is carried forward to the following tax year? A) $3,000 B) $12,000 C) $0 D) $15,000

C Explanation After netting capital gain and losses, the customer has a net capital loss of $3,000. Because $3,000 of net losses can be deducted from income in any single tax year, there is no carryforward.

The ELLA Distributing Company issued a bond with a nominal yield of 5%. The bond matures in 12 years and is currently trading at 94. The bond's yield to maturity is closest to A) 5.32%. B) 5.67%. C) 4.64%. D) 5.00%.

B Explanation The first point to notice is that the bond is trading at a discount. When bonds trade at a discount, our yield chart and example tells us that the yields, in ascending order, are nominal yield, current yield, yield to maturity, and yield to call. That last one is of no relevance to this question because a call feature is not mentioned anywhere. Therefore, we know that the yield to maturity must be greater than the nominal (coupon) yield of 5%. There are only two choices that are, so if you are running out of time or do not remember how to do this, at least you have a 50% chance. However, 50% doesn't pass the exam, so let's make that 100%. The yield to maturity computation is tricky, but current yield is not. It is simply the coupon divided by the current market price. In our question, that is 5% divided by 94 equals 5.32% (or $50 divided by $940). We know the yield to maturity for a bond selling at a discount is higher than its current yield. That means the correct answer must be greater than 5.32%. If you have a question like this on the actual exam, there will be only one choice higher than the current yield. As shown in the LEM, the YTM calculation goes like this: [annual interest + (discount divided by the number of years to maturity)] divided by the average price of the bond Plugging in the numbers, we get a numerator of $50 + ($60 divided by 12 years) = $50 + $5 = $55. The denominator is ($940 + $1,000) divided by 2 = $1,940 divided by 2 = $970. Solve by dividing $55 by $970 and the answer is 5.67%.

An investor wants to maximize income using debt securities. Which of the following lists rank securities from the least suitable to the most suitable recommendation if income is the investment objective? A) Treasury bills, convertible bond, income bond B) Income bond, convertible bond, nonconvertible bond C) Nonconvertible bond, convertible bond, income bond D) Convertible bond, income bond, nonconvertible bond

B Explanation The income (or adjustment) bond is the least suitable because it is issued by companies coming out of bankruptcy with interest payable only if the money is available. Therefore, it is not suitable given the objective. A convertible bond has a lower coupon than a nonconvertible bond because of the convertibility feature. Therefore, if seeking to maximize income, the corporate bond would be the most suitable of the three choices (from least to most: income bond, convertible bond, and nonconvertible bond).

If a company splits its stock 3 for 2, how many additional shares will be issued to an investor who owns 200 shares? A) 300 B) 100 C) 500 D) 400

B Explanation The investor will receive an additional 100 shares from a 3-for-2 stock split. To calculate the additional shares as a result of a split, multiply the existing number of shares by the split rates (200 shares × 3/2 = 300 shares). Because the investor owned 200 shares, she will be issued 100 additional shares, bringing ownership to 300 shares.

Four years ago, you declared a net capital loss of $23,000 on your tax return. You have had no further capital gains or losses since then. For that year and the next two, you took the maximum allowable income deduction. How much may you deduct from your income this year, and how much loss will you have to carry forward? A) $3,000/$12,000. B) $3,000/$11,000. C) $2,000/$12,000. D) $2,000/$11,000.

B Explanation The maximum allowable deduction against income is $3,000. You will have taken four such deductions against $23,000, which leaves you with $11,000 to carry forward ($23,000 - $12,000).

Most rating services rate which of the following? A) Reinvestment risk B) Quality C) Marketability D) Durability

B Explanation The rating services are concerned with quality, which is defined as the ability of the issuer or guarantor to pay (default risk).

An investor purchased 200 shares of DCAST common stock at $200 per share. What is the adjusted cost basis per share of this position after the company pays a 100% stock dividend? A) $50 B) $100 C) $200 D) $400

B Explanation The total value of the initial position is unchanged, remaining at $40,000 (200 times $200). After the stock dividend, the investor owns 400 shares (200 times 100% = 200 + 200 = 400). Therefore, the adjusted cost basis is $100.00 per share ($40,000 divided by 400 = $100). Perhaps you recognized that a 100% stock dividend has the same effect as a 2:1 split. That is, the stock's cost basis is cut in half. It is important to remember that anytime there is a distribution resulting in additional shares (stock split, stock dividend), the cost basis per share is reduced while the total account value remains the same.

An investor purchases a newly issued convertible bond at par. The bond is convertible at $25. Three years later, the underlying common stock is trading at $33 per share. If the investor sells the bond at the parity price, A) there is a long-term capital gain of $8 per share. B) there is a long-term capital gain of $320. C) the investor has no gain and no loss. D) there is a long-term capital loss of $175.

B Explanation This question involves several steps. 1. conversion ratio in shares. A bond convertible at $25 per share has a share conversion rate of 40 shares ($1,000 ÷ $25). 2. compute the parity price. That is, what are those 40 shares worth? Multiply 40 shares by $33 per share and that equals $1,320. The $320 profit over the $1,000 initial cost is a long-term capital gain. An alternative that might be easier for some is to look at the appreciation of the stock. It is $8 per share higher than the conversion price of $25. That represents an increase of 32% (8 ÷ 25). If the bond is at parity with the stock, its price must be 32% higher and that brings us again to the $1,320 price.

Before effecting a penny stock transaction with a customer, the member firm must A) verify that the customer has sufficient funds in the account. B) provide the customer with a current bid and asked quote on the stock. C) provide the customer with the price of the most recent trade in the stock. D) receive the signed copy of the risk disclosure document.

B Explanation To avoid price gouging, SEC Rule 15g-3 requires that no penny stock transaction may take place without the member firm providing the customer with the current inside market quotes. Those are the highest bid and the lowest ask price currently quoted. The current quotes are more important to the customer than the most recent trade because that trade may have been hours or even days ago. Trading may commence two business days after sending the risk disclosure document.

Which of the following debt instruments trades with accrued interest? A) Zero-coupon issues B) Negotiable CDs C) Treasury bills D) Bankers acceptances

B Explanation To trade with accrued interest, the security must pay interest. Of the choices, the only one that is interest bearing is the negotiable (jumbo) CD. All of the others are issued at a discount and return the face value at maturity.

A bond convertible at $50 is selling at 105% of parity, while the common stock has a current market value of $45. What is the market value of the bond? A) $900 B) $945 C) $1,045 D) $1,000

B Explanation When a bond is convertible at $50, it means the holder can exchange each $1,000 par value bond for the company's common stock at a rate of $50 per share. Dividing $1,000 (always use the par value, not the market value) by $50 results in a conversion rate of 20 shares per bond. With the bond convertible into 20 shares and the market price of each share currently $45, the parity price, the price at which the value of the stock and the bond are the same, is $900, (20 x $45). The question tells us that the bond is selling for 105% of the parity price. That would be $900 x 105% = $945. An alternative method is to recognize that the stock is selling for 10% below its conversion price ($45 is $5 less than $50 and $5 ÷ $50 = 10%). That means the parity price of the bond must be 10% below the par value, or $900 (which is 10% less than $1,000). Once you have the $900, multiply by 105% to arrive at the correct answer of $945.

One of your clients asks about a recent purchase of a preferred stock. When looking at online information about the stock, the client notices that no par value is assigned. How does the company determine the amount of dividend to be paid? A) The board of directors determines the amount each quarter based on current interest rates. B) On a no-par preferred stock, the dividend is a stated rate. C) On a no-par preferred stock, the company has the flexibility to increase or decrease the dividend as earnings warrant. D) On a no-par preferred stock, the dividend is paid as a percentage of the common stock dividend.

B Explanation When a preferred stock is issued without a stated or par value, the dividend rate is stated in dollars. For example, it could be a $2 preferred. That would mean quarterly dividends of $0.50; $2 per year. Although the company is under no obligation to pay a preferred dividend (unless it plans to pay a dividend on its common stock), and the board of directors can pay a partial dividend, that does not mean the dividend can be increased over the stated rate.

An investor owns a convertible debenture with a conversion price of $10. If a 10% stock dividend is paid on the company's common stock, which of the following is true? A) The investor will receive 10 shares of the common stock. B) The conversion price will be adjusted to $9.09. C) The investor will receive 1 share of the common stock. D) The conversion price will be adjusted to $11.00.

B Explanation You can assume that any convertible security on the exam will have an anti-dilutive provision. That means that a stock dividend or stock split will not cause the investor's conversion privilege to be diminished. With a conversion price of $10, the investor was able to convert into 100 shares ($1,000 divided by $10). After the 10% stock dividend, the investor must be able to convert into 10% more shares (110 shares). To get 110 shares from a $1,000 principal, the price must be reduced. The computation is $1,000 divided by 110. That equals $9.09 per share.

An investor purchases zero-coupon bonds issued by the U.S. Treasury due to mature in 18 years at $100,000. Which of the following might describe the primary reason for selecting that investment vehicle? The investor is 65 years old and needs the reliability of current income. The investor is 45 years old and has purchased these in an IRA rollover account and wants the assurance of funds for retirement. The investor is 30 years old and has a newborn child and wishes to assure funds for a college education. The investor is 20 years old, has just received an inheritance, and wishes to shelter income for as long as possible. A) I and IV B) II and III C) III and IV D) I and II

B Explanation Zero-coupon bonds maturing in 18 years would assure the 45-year-old of the face value at age 63. Being in an IRA, there would be no current taxation, and upon maturity, if desired, the funds could be distributed without the 10% penalty. Zero-coupon bonds are one way to guarantee funds for college education. However, with no current income, they would not be suitable for the 65-year-old and would not offer any tax shelter to the 20-year-old.

The ELLA Distributing Company issued a bond with a nominal yield of 5%. The bond matures in 12 years and is currently trading at 94. The bond's yield to maturity is closest to A) 5.00%. B) 5.67%. C) 4.64%. D) 5.32%.

B The yield to maturity computation is tricky, but current yield is not. It is simply the coupon divided by the current market price. In our question, that is 5% divided by 94 equals 5.32% (or $50 divided by $940). We know the yield to maturity for a bond selling at a discount is higher than its current yield. That means the correct answer must be greater than 5.32%. YTM calculation goes like this: [annual interest + (discount divided by the number of years to maturity)] divided by the average price of the bond

Minority stockholders are more likely to be able to elect directors through which form of voting? A) Progressive B) Statutory C) Cumulative D) Regular

C Explanation Minority stockholders are more likely to be able to elect representatives to the board of directors through cumulative voting. Small stockholders may cast all of their votes on one position rather than spread them out, and thus dilute them over two or three positions.

A DMF convertible bond (convertible into 25 shares) has increased 20% above par in market value. Which of the following would you expect the price of the DMF's common stock to be? A) $42 B) $32 C) $48 D) $40

C Explanation $1,000 (par) + 20% = $1,200 / 25 shares = $48. Alternatively, it is ordinarily the 20% increase in the value of the common stock that has caused the bond to increase 20% in value. $1,000 divided by 25 shares equals $40 plus 20% equals $48.

The following dividends were received by a husband, his spouse, and both of them jointly: husband, $160; spouse, $160; joint, $100. What amount of dividends that would be subject to taxation if they filed a joint tax return? A) $200 B) $0 C) $420 D) $220

C Explanation $160 + $160 + $100 = $420. This would all be taxable as ordinary income.

Moody's Investment-Grade (MIG) rating would be applicable to A) a New York state university bond. B) a New York state general obligation bond. C) a New York state revenue anticipation note. D) a New York state revenue bond.

C Explanation A MIG rating is provided for short-term municipal debt commonly referred to as notes (revenue anticipation notes).

The basis of a bond with a 5% nominal yield maturing in twenty years and selling at 115 is approximately A) 4.65%. B) 4.35%. C) 3.95%. D) 5.75%.

C Explanation A bond's basis is its yield to maturity (YTM). It is not necessary to do the YTM calculation because it could only be one choice. We can easily compute the current yield by dividing the $50 annual interest by the $1,150 current market price. That is about 4.35%. The YTM must be lower than that because it includes the eventual loss realized when the bond matures at par. There is only one selection that is lower than 4.35%. The calculation would follow our formula of: Annual interest - (premium ÷ number of years to maturity) (Current market price + par) ÷ 2) Plugging in the numbers, we have: ($50 - $7.50) divided by $1,075. That is 3.95%

One of your customers owns five JLO 5s of 2042. The debentures have a conversion price of $15. When the market price of the convertible is 80, the parity price of the stock is A) $18.00. B) $5.33. C) $12.00. D) $15.00.

C Explanation A debenture with a conversion price of $15 is convertible into 66.66 shares ($1,000 ÷ $15). It is always the par value that is used, not the market price. To determine the parity price of the stock, divide the current market price of $800 by 66.66 and the answer rounds off to $12. Some students find it easier to recognize that the bond is 20% below its par value. To be equal (and that is what parity means), the stock must be 20% below the $15 conversion price (or 80% of it). Reducing $15 by 20% is a $3 reduction to $12 or taking 80% of $15 equals $12.

A member of the investment banking department of ABC Securities is explaining some of the advantages and disadvantages of rights and warrants to the board of directors of XYZ Corporation. Which of the following statements could he make? The exercise prices of stock rights are usually below current market value (CMV) of the underlying security at time of issue. The exercise prices of warrants are usually above CMV of the underlying security at time of issue. Both rights and warrants may trade in the secondary market and may have prices that include a speculative (time) value. Warrants are often issued attached to a bond issue to reduce the interest costs to the issuer. A) I and II B) I, II, and III C) I, II, III, and IV D) I only

C Explanation All are true statements. The exercise prices of stock rights are usually below CMV of the underlying security at the time of issue. The exercise prices of warrants are usually above CMV of the underlying security at the time of issue. Both rights and warrants may trade in the secondary market and have prices that include a speculative (time) value. Warrants are often issued attached to a bond issue to reduce the interest costs to the issuer.

Which of the following money market instruments is most often used by those in the import/export business? A) Commercial paper B) Variable rate demand notes C) Bankers' acceptances D) Negotiable CDs

C Explanation Bankers' acceptances are loans guaranteed by a commercial bank that are typically used to finance international transactions. Although all of the choices are money market instruments, it is the BAs that are primarily used by those engaged in international business.

Which of the following is a short-term money market instrument with a bank guarantee that is used to provide capital for exporters to foreign countries? A) World Bank drawing rights B) American depositary receipt C) Bankers' acceptance D) Commercial paper

C Explanation Bankers' acceptances are money market instruments used to finance international trade. A banker's acceptance is a time draft drawn on a bank by an importer or exporter of goods, and it represents the bank's conditional promise to pay the face amount of the note at maturity (normally less than three months).

A corporation is having a rights offering. The terms of the offering require four rights plus $40 to purchase one share. With the stock's current market price at $50 per share, the theoretical value of one right before the ex-rights date is A) $0.25. B) $2.50. C) $2.00. D) $0.20.

C Explanation Because the question is asking about the value before ex-rights, it means we use the cum-rights (with rights) formula. That is, the (market price minus the subscription price) divided by the (number of rights it takes to buy one share plus one). Plugging in the numbers gives us ($50 - $40) ÷ (4+1) = $10 ÷ 5 = $2.00

All of the following statements regarding commercial paper are correct except A) it is unsecured. B) interest is received at maturity. C) it is quoted as a percentage of par. D) it is quoted on a discount yield basis.

C Explanation Commercial paper is short-term, unsecured corporate debt. It is issued and traded at a discount of face value and does not pay periodic interest. Like all zeroes, it is quoted on a discounted yield basis.

Which of the following statements is true regarding dividend payments on common stock? A) Dividends on common stock are paid at the discretion of the board of directors and may be paid ahead of preferred stock when necessary to allow the company to remain listed on the exchange. B) Dividends on common stock are paid at the discretion of the board of directors and are paid as a stated percentage of the corporation's net income. C) Dividends on common stock are paid at the discretion of the board of directors and may be paid even where there are no earnings. D) Dividends on common stock are paid at the discretion of the board of directors and can be paid only when there are sufficient earnings.

C Explanation Dividends on common stock are paid at the discretion of the corporation's board of directors. Although each stockholder receives an amount proportionate to their holdings, the dividend can be any proportion of the company's earnings. In fact, a corporation can pay a dividend even when there are no earnings. However, no dividend on common stock can ever be paid before payment of the dividends due on preferred stock.

A corporate bond with a nominal yield of 6% is currently trading at a yield to maturity (YTM) of 5.8%. It would be accurate to state that this bond is trading at A) a discount. B) par. C) a premium. D) parity.

C Explanation If YTM is less than the nominal or coupon yield, the bond is trading at a premium.

One of your customers has asked you about trading penny stocks. After discussing the risks, the customer decides to go ahead. The firm sends the individual a copy of the special penny stock risk disclosure document. The firm needs the customer's signed and dated acknowledgment of receipt of the document. Trading in penny stocks may not begin in that account until A) the day the signed acknowledgment has been received. B) at least two business days after receiving the statement. C) at least two business days after sending the statement. D) at least $25,000 in equity is in the account.

C Explanation It is SEC Rule 15g-2 that requires the firm to wait at least two business days after sending the risk disclosure document before executing the first penny stock trade for a new customer. The $25,000 is the minimum equity in a pattern day trading account.

In recent years, much publicity has surrounded the rapid growth of start-up businesses. In most cases, the early financing was done privately. When private debt is used at the intermediate stage of a company's development, it is called A) intermediate debt. B) middle-risk debt. C) mezzanine debt. D) mid-term debt.

C Explanation Just as the mezzanine in a theater is between the balcony and the orchestra levels, mezzanine debt represents financing supplied at the intermediate point in a new company's development. The funds are provided on a private basis and the investment carries a high degree of risk. As an alternative investment, it will be suitable for a very narrow range of customers. **This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback.

Under the 5% markup policy, which of the following determines the amount of markup in a principal transaction? A) Highest bid B) Highest ask C) Lowest ask D) Lowest bid

C Explanation Markups are always based on the inside offer, which is the lowest ask price in a particular security. Markdowns are based on the inside bid, which is the highest bid price for a particular security.

A convertible preferred stock issue (par value $100) is selling at $125 and is convertible into five shares of common stock. The conversion price of the common stock is A) $100. B) $25. C) $20. D) $1,200.

C Explanation Par value divided by conversion price equals the number of shares into which the security is convertible. If this security is convertible into five shares, we need to know what number goes into $100 five times. That number is $20. The current market value of the preferred stock is unnecessary information.

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) cumulative preferred stock. B) senior claim preferred stock. C) subordinated debentures. D) callable preferred stock.

C Explanation Regardless of the level of seniority of a preferred stock, it comes behind any debt security. More importantly, interest on a debenture, subordinated or not, is a contractual obligation. Unlike the dividends on stock, the decision to pay or not to pay interest is not an optional one. Failure to pay interest on a debt security can lead to foreclosure and bankruptcy proceedings.

All of the following statements regarding the 5% markup policy are true except A) the type of security is a factor to consider. B) the markup policy does not apply to securities sold at a specific price and with a prospectus. C) a riskless transaction is not generally covered by the 5% markup policy. D) a transaction in common stock customarily has a higher percentage markup than a bond transaction of the same size.

C Explanation Riskless transactions are covered by the 5% markup policy.

When part of an issue of speculative bonds with a 25-year maturity are called, the effect on the remaining bonds will be to A) increase their coupon rate. B) decrease their quality. C) improve their quality. D) decrease their coupon rate.

C Explanation Speculative bonds are those with lower ratings. They are considered to be of lower quality because the risk of timely payment and principal are higher than investment-grade bonds. When a company shows its determination to honor its debt by paying off some of it in advance, the rating associations take note of that and invariably increase the rating. Compare this to your personal credit score. Your score might be relatively low because you have a lot of outstanding debt. As you pay down that debt, your credit score is likely to increase. It is the same logic here.

The 5% markup policy applies to A) new issues. B) mutual funds. C) principal over-the-counter (OTC) trades. D) all of these.

C Explanation The 5% markup policy applies to agency and principal nonexempt securities and transactions, both exchange and OTC traded. It does not apply to prospectus offerings (mutual funds and new issues).

Stock prices in the over-the-counter (OTC) market are determined by A) the 5% markup policy. B) an auction. C) negotiation. D) a competitive bid.

C Explanation The OTC market is considered to be a negotiated market in contrast to a stock exchange, which is an auction market. The 5% markup policy regulates commissions and markup, not prices. Competitive bids are a type of underwriting agreement for new issues.

The board of directors of DMF, Inc., announces a 5, for-4 stock split. The market price of DMF after the split should decrease in value by A) 25%. B) 30%. C) 20%. D) 10%.

C Explanation The easy way to handle questions about stock splits is to turn the split into a fraction. You know that after a split, which increases the number of shares outstanding, the market price per share will be reduced. With a 5-for-4 stock split, the new price should be about four-fifths of the old price. A one-fifth change equals 20% (100% / 5 = 20%).

The DERP Corporation has a rights offering. The common stock is currently selling at $45.50. DERP is issuing one new share of stock at $40 per share for each 10 shares owned. What is the theoretical value of one right when the stock is traded ex-rights? A) $0.50 B) $0.40 C) $0.55 D) $0.45

C Explanation The formula for the theoretical value of a right when it is ex-rights (the buyer doesn't get the rights) is (M ‒ S) ÷ N where M = market price of the stock, S = the subscription price, and N = number of rights needed. Plug in the numbers and you have ($45.50 ‒ $40) divided by 10. That is $5.50 divided by 10 or $0.55 each

Which of the following statements regarding corporate zero coupon bonds are true? Interest is paid semiannually. The discount is in lieu of periodic interest payments. The discount must be accreted and is taxed annually. The discount must be accreted annually with taxation deferred until maturity. A) I and IV B) I and III C) II and III D) II and IV

C Explanation The investor in a corporate zero coupon bond receives the return in the form of growth of the principal amount over the bond's life. The bond is purchased at a deep discount and redeemed at par at maturity. That discount from par represents the interest that will be earned at maturity date. However, the discount is accreted annually, and the investor pays taxes yearly on the imputed interest.

ABC Corporation has an outstanding 8% convertible bond that is callable at 102. Currently, the bond is trading at 101. The conversion price is $40, and the common stock is currently trading at $39.50. ABC announces a call at 102. To realize the greatest profit, a bondholder should A) continue to hold the bonds and receive interest payments. B) sell the bonds at the current market price. C) tender the bonds. D) convert the bonds into common and sell the converted shares.

C Explanation The investor would realize the greatest sales proceeds by tendering the bond to the corporation for 102. Selling the bond at its current market value of 101 is not an attractive option. Converting the bond to common stock would result in 25 shares ($1,000 par converted at $40 = 25 shares) sold at $39.50 per share ($39.50 × 25 = $987.50). Once the call date passes, the issuer ceases interest payments making it unattractive to continue to hold the bonds.

Gargantuan Computers, Inc., (GCI) conducts a rights offering to its current shareholders at $50 per share, plus one right. If the current market price of GCI is $70, what is the value of one right before the stock trades ex-rights? A) 3 B) 15 C) 10 D) 5

C Explanation The stock is trading cum rights (before the ex-date). The formula to calculate the value of one right before the ex-date is follows: CMV minus subscription price divided by the number of rights to purchase one share plus 1. Therefore, one right is valued at $10, computed as ($70 − $50) / 2 = $10.

One of your customers calls and asks you about a security with an S&P rating of SP-2. The customer is most likely asking about which of the following? A) A municipal bond B) Commercial paper C) A municipal note D) Your firm's privacy notice

C Explanation The three major rating services each have their own rating system for short-term municipal debt (notes). In the case of Standard and Poor's, the ratings are SP-1, SP-2, and SP-3 in declining order of quality. Regulation S-P (with the hyphen between the S and P) deals with privacy notices. Although it is unlikely to be tested, commercial paper is rated A-1, A-2, A-3, and then into the "Bs."

A bond investor who is looking for capital gains should invest in bonds when interest rates are A) low and expected to decline. B) low and expected to rise. C) high and expected to decline. D) high and expected to rise.

C Explanation This is about the inverse relationship between interest rates and bond prices. As interest rates rise, bond prices fall. Conversely, when interest rates decline, bond prices increase. If an investor buys bonds when the current interest rates are high, a future decline in those interest rates will cause the price of the bonds to increase.

An investor purchases a newly issued convertible bond at par. The bond is convertible at $40. Three years later, the underlying common stock is trading at $50 per share. If the investor sells the bond at a $50 premium over the parity price, there is A) a long-term capital gain of $1,050. B) a long-term capital gain of $10 per share. C) a long-term capital gain of $300. D) a long-term capital gain of $200.

C Explanation This question involves several steps. The first is to determine the conversion ratio in shares. A bond convertible at $40 per share has a share conversion rate of 25 shares ($1,000 ÷ $40). The second step is to compute the parity price. That is, what are those 25 shares worth? Multiply 25 shares times $50 per share and that equals $1,250. When the bondholder sells the bonds at parity plus a $50 premium, $1,300 is received. The $300 profit over the $1,000 initial cost is a long-term capital gain. An alternative that might be easier for some is to look at the appreciation of the stock. It is $10 per share higher than the conversion price of $40. That represents an increase of 25% (10 ÷ 40). If the bond is at parity with the stock, its price must be 25% higher and that brings us again to the $1,250 parity price. Add the $50 premium to get to $1,300, $300 above the initial cost.

If a customer buys $28,000 of ABC stock in April 20XXand at year end, the stock is worth $23,000, how much may the customer deduct on his 20XX tax return? A) $2,000 B) $3,000 C) $0 D) $5,000

C Explanation Until the customer realizes the loss by selling, there is no tax deduction.

Which of the following securities cannot pay a dividend? A) Class B common stock B) American depositary receipt C) Warrant D) Convertible preferred stock

C Explanation Warrants represent long-term options to buy stock at a fixed price, and, like options, cannot pay dividends.

A customer owns a 7.5% ABC convertible bond currently trading at 115. The conversion price is $40. What is the parity price of the common? A) $44.00 B) $28.75 C) $46.00 D) $34.00

C Explanation What does parity price mean? Here is what it says in the LEM: Calculating Conversion Parity Parity means that two securities are of equal dollar value (in this case, a convertible bond and the common stock into which it can be converted). The question is looking for the parity price of the common stock. That is the market price per share, where the total value of the stock received upon conversion equals the market price of the bond. There are two ways to do this. The first is generally the easiest to understand. We are told that the bond has a conversion price of $40. That means you can get 25 shares if you wish to convert. That is because the issuer is basically saying, "We owe you $1,000 and will let you spend it on our stock at $40 per share." Now that we know we can get 25 shares, what does each share have to be worth to equal $1,150? If you divide $1,150 by 25 shares, the result is $46. The other method to do this is as follows: The bond is selling at a 15% premium. To be equal to that, the stock must be selling at a 15% premium over the conversion price. $40 times 115% equals $46. If that makes sense to you, it is much faster than the first method.

A corporation has $25 million of 5% bonds outstanding. The bonds are callable at 102. Current market interest rates are 6%. If the company would like to retire $10 million of the debt, it might be smart to A) issue $10 million of new bonds at current rates and use the proceeds to call in outstanding ones. B) issue $10 million of treasury stock and use the proceeds to retire the bonds. C) make a tender offer to purchase $10 million face amount of the bonds. D) exercise the call provision for $10 million face amount of the bonds.

C Explanation When current market interest rates are 6%, bonds with a 5% coupon are selling at a discount. That means the company could make a public offer to buy the bonds back at a price somewhat below par value. In simple terms, they could retire $10 million of debt for less than $10 million. It would make no sense to call the bonds at 102 ($1,020) when they can be purchased for less than $1,000 each in the open market. Issuing new bonds to retire old ones, a practice known as refunding, is done when interest rates have fallen. In this question, interest rates have gone up making that plan incorrect. A company cannot issue treasury stock. Issued and outstanding stock becomes treasury stock when it is reacquired by the issuer.

Market interest rates have been rising, which means the price of bonds traded in the secondary market has A) increased. B) not changed because bond prices are not affected by interest rates. C) decreased. D) not changed because only new bond prices are impacted by changes in interest rates, not the price of bonds already trading in the secondary market.

C Explanation When interest rates rise, bond prices fall.

An investor purchases zero-coupon bonds issued by the U.S. Treasury due to mature in 18 years at $100,000. Which of the following might describe the primary reason for selecting that investment vehicle? The investor is 65 years old and needs the reliability of current income. The investor is 45 years old and has purchased these in an IRA rollover account and wants the assurance of funds for retirement. The investor is 30 years old and has a newborn child and wishes to assure funds for a college education. The investor is 20 years old, has just received an inheritance, and wishes to shelter income for as long as possible. A) I and IV B) III and IV C) II and III D) I and II

C Explanation Zero-coupon bonds maturing in 18 years would assure the 45-year-old of the face value at age 63. Being in an IRA, there would be no current taxation, and upon maturity, if desired, the funds could be distributed without the 10% penalty. Zero-coupon bonds are one way to guarantee funds for college education. However, with no current income, they would not be suitable for the 65-year-old and would not offer any tax shelter to the 20-year-old.

Formula for conversion ratio Formula for parity price of common stock

CR: dividing par value by conversion price ($100 par) PP: dividing the market price of the convertible by conversion ratio.

The basis of a bond with a 5% nominal yield maturing in twenty years and selling at 85 is approximately A) 5.88%. B) 4.59%. C) 5.75%. D) 6.22%.

D Explanation A bond's basis is its yield to maturity (YTM). It is not necessary to do the YTM calculation because it could only be one choice. We can easily compute the current yield by dividing the $50 annual interest by the $850 current market price. That is about 5.88%. The YTM must be higher than that because it includes the eventual profit realized when the bond matures at par. There is only one selection that is higher than 5.88%. The calculation would follow our formula of: Annual interest + (discount ÷ number of years to maturity) ÷ (Current market price + par) ÷ 2) Plugging in the numbers, we have: ($50 + ($150 ÷ 20 years) = ($50 + $7.50) divided by ($850 + $1,000 ÷ 2) = $57.50 ÷ $925 = 6.22%

Which of the following instruments is essentially a letter of credit? A) Margin loans B) Negotiable CDs C) Commercial paper D) Bankers' acceptances

D Explanation A letter of credit (LOC) is a commitment, usually made by a commercial bank, to honor demands for payment of a debt upon compliance with conditions and/or the occurrence of certain events specified under the terms of the letter of credit. Those in the import/export business use these LOCs in the form of bankers' acceptances

During a period of sustained low interest rates, many investors, particularly institutions, look to increase their return through alternative debt investments. Examples of those would include all of the following except A) equity-linked notes. B) exchange-traded notes. C) private placement debt. D) leveraged ETFs.

D Explanation Although leveraged ETFs (exchange-traded funds) are certainly an alternative investment, they represent an equity investment rather than debt. Despite the misleading name, equity-linked notes are, in fact, debt instruments.

Dividends from American depositary receipts (ADRs) held by U.S. investors are declared in A) U.S. dollars and paid in U.S. dollars. B) the foreign currency and paid in the foreign currency. C) U.S dollars but paid in the foreign currency. D) the foreign currency but paid in U.S. dollars.

D Explanation Although the dividends paid by ADRs held by U.S. investors are declared in the foreign currency, they are paid in U.S. dollars. This is one reason currency risk is a factor for ADR holders.

Which of the following describe a securities exchange? Prices are set by negotiation between interested parties. The highest bid and the lowest offer prevail. Only listed securities can be traded. Minimum prices are established at the beginning of the day. A) II and IV B) I and III C) I and IV D) II and III

D Explanation An exchange is not a negotiated market but an auction market in which securities listed on that exchange are traded. No minimum price is set for securities. Rather, the highest bid and the lowest offer prevail.

Which of the following is true with respect to excess capital losses realized by an individual taxpayer? A) They may be carried back up to three years and carried forward indefinitely until exhausted. B) They may be carried forward with a time limit of five years. C) No more than $3,000 per year may be used against capital gains. D) They may be carried forward indefinitely until exhausted.

D Explanation Any taxpayer is permitted to reduce capital gains with realized capital losses. If the capital losses exceed the capital gains, up to $3,000 may be deducted against taxable income. Anything in excess of that is carried forward and used against gains, or, if there are no gains, taxable income, again with a $3,000 annual limit. Those losses can be carried forward with no time limit until they are all used against gains or income.

XYZ Corporation, whose common stock is currently selling for $40 per share, is having a rights offering. The terms of the offering require 10 rights plus $35 to subscribe to one share of stock. Compute the theoretical value of a right before the ex-rights date. A) $0.55 B) $3.50 C) $0.50 D) $0.45

D Explanation Because the stock is trading with rights (before the ex-rights date), the formula is (M ‒ S ) divided by (N + 1). Plugging the numbers in, we have ($40 ‒ $35) divided by (10 + 1) = $5.00 ÷ 11 = $0.45.

KLM Company has 10 million convertible bonds outstanding that are convertible at $25. The bonds contain an antidilution feature. If KLM declares a 10% stock dividend, the new conversion price will be A) $22.50. B) $50.00. C) $45.45. D) $22.73.

D Explanation Before the stock dividend, an investor would have received 40 shares of stock for each $1,000 bond ($1,000 / $25). A 10% stock dividend would now give an investor 44 shares on conversion (40 shares + 10% = 4 shares more). $1,000 / 44 shares = $22.73 per share for the new conversion price.

An investor has received a cash dividend on a stock that they have owned for over 10 years. It is the first dividend the company has paid. The cash dividend would be taxable to the investor as A) a return of principal. B) a short-term capital gain in the year in which it is received. C) a long-term capital gain in the year in which it is received. D) income in the year in which it is received.

D Explanation Cash dividends are always treated as income and are taxable to the investor in the tax year in which they are received by the investor. In those cases where the dividend is qualified, it will be taxed at a lower rate than the investor's ordinary income. That does not affect this question because the answer is the same if the dividend is qualified or not. A capital gain occurs when an investor sells an asset for more than its cost basis.

Which of the following debt instruments is unsecured? A) Equipment trust certificates B) Junior lien mortgage bonds C) Collateral trust certificates D) AAA/AAA-rated debentures

D Explanation Corporate debentures are unsecured bonds backed by the credit of the issuing corporation; they are not secured by underlying collateral. Mortgage bonds are secured with real estate serving as collateral. Collateral trust bonds are secured by securities that a corporation owns in other companies or bonds. Equipment trust certificates are secured by transportation equipment owned by the corporation.

A customer of your broker-dealer is questioning the timeliness in which one of her equity orders for a stock listed on Nasdaq was handled and executed. A source providing the most complete order entry and execution details for the customer's order could be found A) at the broker-dealer's order entry desk. B) on FINRA's website. C) on the SEC's website. D) with the Order Audit Trail System (OATS).

D Explanation For an equity stock listed on Nasdaq, the source that would provide the most complete information regarding the handling of the order and its execution, including a timeline of all relevant entry and execution events, would be the OATS.

An investor might expect to receive the greatest gain on an investment in a corporate bond by purchasing A) long-term bonds when interest rates are low. B) short-term bonds when interest rates are low. C) short-term bonds when interest rates are high. D) long-term bonds when interest rates are high.

D Explanation If an investor purchases bonds when market interest rates are high, a drop in interest rates will lead to a corresponding increase in bond value. Long-term debt instruments will fluctuate to a greater degree than those with short-term interest rates. Thus, long-term debt offers the greater chance of gain.

An investor who purchased 100 shares of REDP common stock on February 28, 2019, would receive long-term capital gain treatment if the stock is sold at a profit starting A) February 28, 2020. B) March 2, 2020. C) February 29, 2020. D) March 1, 2020.

D Explanation Investors must own a security for more than 12 months before it becomes long term for tax purposes. The first day after February 28, 2019, is March 1, 2019. Twelve months later is March 1, 2020. Always count 1 day and then add 12 month so that, in this case, you don't come up with February 29 because 2020 is a leap year.

A corporate bond is quoted at 102⅝. A customer buying 10 bonds would pay A) $10,025.80. B) $10,285.00. C) $10,258.00. D) $10,262.50.

D Explanation Par ($1,000) × 102% = $1,020. Five-eighths of one bond point ($10) equals 0.625 times $10 equals $6.25. Therefore, the quote reading 102⅝ equals $1,026.25 per bond ($1,020 + $6.25). Because we are told the customer is buying 10 bonds, we multiply $1,026.25 by 10 bonds, which equals the amount the customer will need to pay to make the entire purchase: $10,262.50.

Preferred stock comes with many different options. What type of preferred stock would be most advantageous to the investor if the issuing company had strong revenue and earnings that exceeded industry estimates? A) Adjustable-rate B) Callable C) Cumulative D) Participating

D Explanation Participating preferred stock may receive an additional amount paid to shareholders based on superior performance of the issuer. Cumulative refers to unpaid dividends that accrue on a preferred issue. Those must be paid before common stockholders receive a dividend. That could be a benefit if the company had dividends in arrears and these higher earnings made it possible to pay them. However, unless something in the question indicated that these higher earnings followed several years of losses, there is no way to infer that the company is behind on its dividends. As you hear us say many times, do not read something into the question that is not there. Adjustable-rate preferred stocks adjust their dividends based on market interest rates, not on the company's earnings. Although it is possible that higher earnings could encourage the company to call in some of the outstanding callable preferred stock, doing so would be considered a benefit to the issuer rather than the investor.

With the advent of the horseless carriage (a.k.a. the automobile), the Acme Buggy Whip Corporation's revenues fell to the point where it could no longer cover expenses. This led to an involuntary bankruptcy. The priority of payout was A) general creditors, senior notes, preferred stock, common stock. B) common stock, preferred stock, general creditors, senior notes. C) senior notes, preferred stock, common stock, general creditors. D) senior notes, general creditors, preferred stock, common stock.

D Explanation Senior debt refers to obligations that have priority in the event of default. It parallels the use of senior when comparing preferred stock to common stock, the most junior of all securities.

All of the following considerations apply to the 5% markup policy except A) the availability of the security. B) the cost of executing the transaction. C) the services rendered by the broker-dealer. D) the customer's ability to pay.

D Explanation The 5% policy is a guideline for markups and commissions for exchange and over-the-counter trades. A firm cannot charge a higher commission or markup to a customer on the basis of the customer's ability to pay. Factors relevant in determining the fairness of a commission or markup include the type of security, the services rendered by the firm, and the expenses and difficulty of executing a particular trade.

Which of the following is not a characteristic of certificates of deposit (CDs)? A) A CD may be payable to the bearer or registered in the name of the investor. B) A CD is often issued by a bank. C) A CD can be negotiable or nonnegotiable. D) The Federal Deposit Insurance Corporation (FDIC) provides insurance for CDs to $500,000.

D Explanation The FDIC provides insurance for CDs up to $250,000. All of the other characteristics are applicable to CDs.

All of the following statements regarding over-the-counter (OTC) markets are true except A) securities traded OTC include American depositary receipts (ADRs) and municipal bonds. B) a bid is the highest price a dealer will pay when buying. C) an offer is the lowest price a dealer will accept when selling. D) the OTC market is an auction market.

D Explanation The OTC market is a negotiated market in which market makers post their quotes to facilitate negotiating price. A bid is the highest price a buyer is willing to pay, and an offer is the lowest price a seller is willing to accept. Among the securities traded OTC, both ADRs and municipal securities would be included.

The over-the-counter (OTC) market is A) an auction market. B) the first market. C) all of these. D) a negotiated market.

D Explanation The OTC market is a negotiated market. Registered market makers compete among themselves to post the best bid and ask prices.

Rank the following from first to last in order of payment at liquidation of a corporation. General creditors Preferred stock Subordinated debentures Accrued taxes A) I, III, IV, II B) III, IV, II, I C) III, IV, I, II D) IV, I, III, II

D Explanation The complete order of liquidation is as follows: secured debt, debentures and general creditors, subordinated debentures, preferred stock, common stock.

The rate on an adjustable preferred stock may be indexed to A) the Producer Price Index. B) the Consumer Price Index. C) the Dow Jones Industrial Average. D) the Treasury bill rate.

D Explanation The dividend on an adjustable rate preferred stock is tied to a particular interest rate, and the Treasury bill rate is a common benchmark.

In order for an investor to be eligible to receive a previously declared cash dividend, the stock must be purchased A) the day after the ex-dividend date. B) on the ex-dividend date. C) the day before the record date. D) before the ex-dividend date.

D Explanation The ex-date (it can be ex-dividend, ex-rights, or ex-split) is the first day on or after which a purchaser is not eligible to receive the dividend (or the rights or the split). With regular way delivery at T+2, one would have to buy the security at least 2 business days before the record date (the day the issuer makes a record of all eligible owners). Therefore, in most cases, the ex-date will be one business day prior to the record date. Buying then or afterwards is going to be too late to get the purchaser's name on the record books.

When a corporation issues a debt security, the terms of the loan are expressed in a document known as the bond's indenture. The indenture is sometimes referred to as A) the loan agreement. B) the bond resolution. C) the debenture. D) the deed of trust.

D Explanation The indenture, sometimes also referred to as the deed of trust, states the issuer's obligation to pay back a specific amount of money on a specific date. A debenture is a debt security containing an indenture. The bond resolution is a term used for municipal bonds not corporate debt.

Which of the following statements regarding corporate zero coupon bonds are true? Interest is paid semiannually. The discount is in lieu of periodic interest payments. The discount must be accreted and is taxed annually. The discount must be accreted annually with taxation deferred until maturity. A) I and III B) I and IV C) II and IV D) II and III

D Explanation The investor in a corporate zero coupon bond receives the return in the form of growth of the principal amount over the bond's life. The bond is purchased at a deep discount and redeemed at par at maturity. That discount from par represents the interest that will be earned at maturity date. However, the discount is accreted annually, and the investor pays taxes yearly on the imputed interest.

A convertible corporate bond with an 8% coupon yielding 7.1% is available but may be called sometime this year. Which feature of this bond would probably be least attractive to your client? A) Convertibility B) Coupon yield C) Current yield D) Near-term call

D Explanation The near-term call would mean that no matter how attractive the bond's other features, the client may not have very long to enjoy them.

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) adjustable-rate preferred stock. B) common stock. C) callable preferred stock. D) cumulative preferred stock.

D Explanation 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.

When a bond is issued by a national government, it is called A) high-quality debt. B) national debt. C) treasury debt. D) sovereign debt..

D Explanation The term sovereign debt applies to securities issued by national governments. U.S. Treasuries are an example of sovereign debt issued here. Other countries have their versions. Not all are considered high quality, especially those issued by emerging economies

Two bonds currently quoted at a 5.50 basis mature in exactly 15 years. Their coupons are 6% and 7%, respectively. Which bond would experience the greatest appreciation in value if the yields dropped to a 5.20 basis? A) Neither because both would decline in value B) Both would appreciate the same amount C) The 6% bond D) The 7% bond

D Explanation These bonds are selling at a premium (their coupons are above their yield to maturity, or basis). If the YTM declines to 5.20, it means that the prices of the bonds went up. Without getting too deep into the mathematics, in order for both bonds to have the same basis (5.20), the one with the 7% coupon must have a higher price because the $10 per year additional interest has to be offset by a larger annual "loss." Here is a general rule that will apply to your exam questions. When interest rates are falling, bonds with higher coupon rates are going to appreciate in price at a greater rate than bonds with lower coupon rates. Conversely, when interest rates are rising, those bonds with higher coupons will decrease in price at a slower rate than bonds with lower coupons. In our specific question, the 7% bond will have a greater price increase than the 6% bond. If, however, our question showed the bond selling at a discount, e.g., the basis (YTM) is 8%, the 7% bond would be selling closer to par value than the 6% bond.

DJX Corporation's charter has authorized 10,000,000 shares of common stock. It has issued 5,000,000 shares and has 1,000,000 shares in its treasury. How many shares of DJX common stock are authorized but unissued? A) 6,000,000 B) 4,000,000 C) 9,000,000 D) 5,000,000

D Explanation This company has 10 million shares of common stock authorized. It has issued 5 million shares. The other 5 million are authorized, but unissued. Treasury stock is authorized and issued stock that is no longer outstanding.

An investor owns ten ABC 6s of 2045. The debentures have a conversion price of $50 with an anti-dilution provision. After ABC distributes a 20% stock dividend, the investor's position will be A) ten ABC 6s of 2045 convertible into 16.67 shares. B) twelve ABC 6s of 2045 with conversion price of $50. C) ten ABC 6s of 2045 convertible into 20 shares plus forty additional shares. D) ten ABC 6s of 2045 with a conversion price of $41.67.

D Explanation This question deals with the anti-dilution provisions of a convertible security. When there is a stock dividend or a stock split, the holder of the convertible maintains the same equity proportion as before. With a conversion price of $50, the debenture is convertible into 20 shares ($1,000 ÷ $50). After a 20% stock dividend, the holder should be able to acquire 20% more shares. That makes the security convertible into 24 shares. Divide the $1,000 par value by 24 shares and the conversion price is now $41.67.

A company has reverse split its common stock. The effect on the earnings per share will be A) none of these. B) no effect. C) a decrease. D) an increase.

D Explanation When a reverse split takes place, the number of outstanding shares is reduced. Because the split has no effect on earnings of the company, dividing those earnings by fewer shares will cause an increase to the earnings per share.

Elisha purchased 100 shares of RMBN common stock on June 6, 2019, at $60 per share. On February 11, 2020, RMBN paid shareholders a 20% stock dividend. Elisha sells the shares received as the stock dividend on December 5, 2020, at $55 per share. What are the tax consequences of this trade? A) $100 short-term capital gain B) $100 long-term capital loss C) $100 short-term capital loss D) $100 long-term capital gain

D Explanation When a stock dividend is paid, the cost basis of the shares is adjusted. In this case, Elisha now owns 120 shares and the total cost is still the original $6,000. That makes the adjusted cost basis per share $50 ($6,000 ÷ 120). With the new cost basis of $50 per share, when the sale of those 20 shares takes place at $55 per share, the result is a gain of $100 ($5 per share profit times 20 shares. Alternatively, $1,100 total proceeds [20 shares x $55 per shares] minus $1,000 cost basis [20 shares x $50 per share adjusted cost per share)). Even though these shares were acquired less than 12 months before the sale, their holding period is based on the original purchase date and that is clearly more than 12 months before the sale. That is why it is long term.

S&P Bond Guide: FLB Zr 37 87 87½. What do each variable represent?

FLB: issuer ZR: 0 coupon 37: Year of maturity 87: Bid price ($870) 87 1/2: asked price ($)875

An investor purchases a PQR convertible bond at 98 on June 18, 1994. The bond is convertible at $25, and on June 19, 1995, when the common stock is trading at $26 per share, the investor converts his bond into the stock. For tax purposes, these transactions will result in A) neither gain nor loss. B) a $40 capital loss. C) a $40 capital gain. D) a $60 capital gain.

a Explanation The process of converting a convertible bond into common stock is not a taxable event. When the stock is sold, the taxable event occurs.

Prices of bonds with ______ coupon rates tend to be more volatile than prices of bonds with _______ coupon rates.

Low, high lower=higher volatility

When interest rates are falling, bonds with __________ coupon rates are going to appreciate in price at a greater rate than bonds with ________ coupon rates. Conversely, when interest rates are rising, those bonds with __________ coupons will decrease in price at a slower rate than bonds with ___________ coupons

When interest rates are falling, bonds with higher coupon rates are going to appreciate in price at a greater rate than bonds with lower coupon rates. Conversely, when interest rates are rising, those bonds with higher coupons will decrease in price at a slower rate than bonds with lower coupons

A bond's basis is also referred to as the bond's __________

Yield to maturity

Corp Securities Qualified dividends are taxed at the same rate as long-term capital gains—a rate significantly lower than the ordinary income tax rate levied against nonqualified dividends. That lower rate ranges from __% to as high as __%, with an even higher effective rate for those with an extraordinarily high income. For most investors, the rate is __%, and that is the number you should use in any computations. benefit for most investors to receive (nonqualified/qualified) dividends?

low=0% High=20% Average test calculation is 15% benefit investors to receive qualified dividends

OTC market is a _________ market (not an ___________ market as is the case with an exchange)

negotiated - OTC Auction -Exchange

A _________ is a security that allows the holder to purchase shares of the underlying issue at a fixed price (above the current market price when issued) for an extended period (typically two years or longer). Call options are similar, except they are short-term securities (nine months at issue).

warrant