series 7 pt. 3
A major risk associated with investing in DPPs is the lack of liquidity. What steps could the program sponsor take that could have the effect of increasing the liquidity of an existing program?
A DPP rollup -- A DPP rollup is a transaction involving the combination or reorganization of one or more limited partnerships into securities of a successor corporation. The securities of the successor corporation would likely have greater liquidity. This would have the effect of turning the illiquid DPP into more liquid securities. Disclosure documents must be provided to investors prior to the transaction disclosing risk, the GPs opinion regarding fairness of transaction, and reports and appraisals in connection with the transaction.
Which of the following individuals could most likely open an account at a FINRA member firm without notifying or receiving permission from her employer?
A bank employee selling fixed annuities only -- Whenever an employee of a FINRA member wants to open a securities account with another FINRA member firm or financial institution, the employee must give prior written notice to her employer and receive prior written consent from her employer before the account can be opened. Someone selling fixed annuities only (not a security like variable annuities) is most likely not associated with a member.
Which of the following statements regarding yield shown on a bond confirmation for a bond that has been called is true?
A bond confirmation will show YTC if the bond has been called under an in-whole call provision. -- A bond confirmation for a bond called under an in-whole call provision will show yield to call (YTC), as the bond being called away is certain. However, in the event of an in-part call, there is uncertainty as to whether that particular bond will be called. Therefore, the lower of the YTC or yield to maturity would be shown on the confirmation.
Which of the following municipal issues would least likely involve overlapping debt?
An airport district -- Overlapping debt refers to property tax districts (areas). Airport issues are usually revenue issues of an authority that has no property taxing powers.
A customer enters an order to buy 1,000 ABC at 50, good for the week only. How will this order appear on the order book?
Buy 1,000 ABC 50 GTC -- Limit orders and stop orders are entered on the order book as either good til canceled (GTC) or day orders. Orders that are good for only a particular time frame (good for the week) will appear as GTC. It is the responsibility of the broker-dealer that entered the order to cancel it at the end of the week, if unexecuted.
If a customer believes the market price of a stock will sharply rise or fall in the near future, which of the following is the best strategy?
Buy a straddle -- If the stock goes either up or down sharply, the investor will profit from owning a straddle.
The syndicate manager in a firm commitment underwriting takes which of the following actions in a divided municipal syndicate account that does not sell out?
Confirms the bonds to the member that did not sell its share -- Because this offer is a divided, or Western, syndicate, each member is responsible for selling a specific number of securities. If a member does not sell its share, it receives the bonds for its inventory.
Which of the following regarding the Bond Buyer Revenue Bond Index (Revdex) are true? 1. It includes 30-year bonds. 2. It includes 20 bonds. 3. It is compiled weekly. 4. It is compiled monthly.
I and III -- The Bond Buyer Revdex is computed weekly just like The Bond Buyer's general obligation (GO) index. Revdex consists of 25 revenue bonds with 30-year maturities. The GO index includes 20 bonds, each with approximately 20 years to maturity.
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? 1. Conversion ratio is 25:1 2. Conversion ratio is 28:1 3. Parity price of the common stock is $42 4. Parity price of the common stock is $45
I and IV -- 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.
Which of the following statements regarding margin calls are true? 1. Customers are entitled to an extension of time. 2. Customers are not entitled to an extension of time. 3. Firms can sell securities without first contacting the customer. 4. Firms cannot sell securities without first contacting the customer.
II and III -- Some customers mistakenly believe that a firm must contact them for a margin call to be valid, which is not the case. Most firms will attempt to notify their customers of margin calls but are not required to do so. Also, there is no entitlement when it comes to an extension of time.
Which of the following are characteristics of the volatility market index (VIX)? 1. It is a bullish or bearish measure. 2. It is a measure of implied expectations of market volatility. 3. It is often referred to as the Chicago Board Options Exchange (CBOE) index. 4. It is often referred to as the fear index.
II and IV -- The VIX is a measure of investors' expectations regarding market volatility. High or low readings are neither bullish nor bearish, but instead, reflect expectations of volatility in the S&P 500 over the next 30 days. This index is referred to as the fear index, and VIX options are traded on the CBOE.
An investor opens the following options position: Sell 1 RIF Sep 70 call @ 6; sell 1 RIF Sep 70 put @1. What is the investor's maximum gain, maximum loss, and breakeven point?
Maximum gain is $700; maximum loss is unlimited; breakeven points are $63 and $77. -- The first step is to identify the position. This is a short straddle—a short put and a short call with identical terms. That means we are going to have two breakeven points. The maximum loss is unlimited because one of the positions is an uncovered call. The maximum profit is the premiums (credit) received of $700. Breakeven points follow the call-up and put-down rule. That is, add the premiums of $7 to the strike price of the call ($7 + $70 = $77) and subtract the premiums of $7 from the strike price of the put ($70 ‒- $7 = $63). Please note: In any options question, short positions are always uncovered (naked) unless something in the question indicates they are covered.
An investor opens the following options position: Buy 1 FOZ Mar 40 call @3; buy 1 FOZ Mar 40 put @2. What is the investor's maximum gain, maximum loss, and breakeven point?
Maximum gain is unlimited; maximum loss is $500; breakeven points are $35 and $45. -- The first step is to identify the position. This is a long straddle—a long put and a long call with identical terms. That means we are going to have two breakeven points. The maximum gain is unlimited because one of the positions is a long call. The maximum loss is the amount paid for the straddle (the two premiums totaling $500). Breakeven follows the call-up and put-down rules. Add the premium to the strike of the call ($40 + $5 = $45) and subtract the premium from the strike of the put ($40 ‒ $5 = $35).
An investor purchased a single premium deferred variable annuity 20 years ago. The premium deposit was $50,000. The account is now worth $200,000 and the investor is still working. When does the investor have to begin taking required minimum distributions?
Never with a nonqualified annuity -- On the exam, unless stated to the contrary, every annuity is nonqualified. One of the benefits of nonqualified annuities is that there is no age at withdrawals must commence. In general, earnings withdrawn prior to age 59½ are subject to the additional 10% penalty on top of tax at ordinary rates.
Proponents of which of the following technical theories assume that small investors are usually wrong?
Odd lot -- Odd lots are usually traded by small investors; some analysts believe small investors are generally wrong.
Which of the following positions does not expose a customer to unlimited risk?
Short 2 XYZ uncovered puts -- The maximum potential loss on a short put position is the market price declining to zero reduced by the premium. Remember, a stock's price can never go below "worthless." For example, if the investor sold 2 XYZ 90 puts and received a premium of 4 point each, the maximum loss would be $8,600 (worthless stock is put to the writer for $9,000 but the writer received the $400 premium) per contract or $17,200. That is a significant loss, but all of the other positions expose the client to unlimited risk because a loss will occur if the stock price rises and there is no upper limit to a stock's price.
Which of the following is not a requirement to be included on a customer confirmation by the Municipal Securities Rulemaking Board (MSRB)?
The accrued interest on a when issued security -- Because the settlement date on a when issued security is unknown, it is impossible to compute the accrued interest. MSRB rules require that all confirmations include the firm's capacity in the trade (agent/principal). The amount of the dealer's markup or markdown on a principal trade must be disclosed. The commission on an agency trade must be disclosed.
An individual with $100,000 to invest will require these funds in six months for the purchase of a house. In which of the following circumstances did the registered representative act correctly?
The registered representative convinced the client to invest in a Treasury bill on the basis of its safety. -- Investment in a Treasury bill is the only suitable investment among the choices listed. Purchase of annuities and a REIT are long-term investments not suitable to an individual who wants to invest funds on a short-term basis. Although an IPO may be liquid, it is not suitable for short-term funds earmarked for the purchase of a house because there is too much risk to the principal.
An investor wants to invest $20,000 but anticipates needing those funds in five years for a business investment. Currently, with inflation rising, the government is expected to take action to push interest rates up to reduce the money supply. Given these conditions, which of the following securities would be the least suitable for this investor who needs a specific amount of money in five years?
Zero-tranche collateralized mortgage obligation (CMO) with an estimated five years of life -- A zero-tranche CMO is subject to interest rate risk as well as extension risk when interest rates rise, and therefore, it would not be suitable for a customer that needs her investment back at a specific point in the future. By contrast, a four-year zero coupon bond will mature within the anticipated time frame for needing the funds and would be the most suitable choice of the answers given.
All of the following documentation is necessary for a publicly subscribed limited partnership except
a cash flow analysis. -- The certificate gives public information about the partnership and is filed in the home state. The partnership agreement spells out the roles of the general and limited partners. The subscription agreement is the instrument by which the limited partners invest.
If a customer buys 1 XYZ Jan 40 call and 1 XYZ Jan 40 put, paying total premiums of $650, and XYZ becomes worthless, the result is
a gain of $3,350. -- This is a long straddle in which breakeven points are established by adding and subtracting the combined premiums (6½ points) from strike (breakeven points are 46½ and 33½). The customer makes money if the stock moves above 46½ or below 33½. As the stock becomes worthless, the customer earns a 33½ point gain on 100 shares, or $3,350.
All of the following must register as an investment company under the Investment Company Act of 1940 except
an initial public offering for common shares of Amalgamated Investments, a holding company. -- Holding companies are not included in the definition of investment company under federal law. Amalgamated Investments would register with the SEC, just as any other offering of common stock. Investment companies, such as management companies (open-end or closed-end), unit investment trusts (UITs), and face amount certificate companies (FACs) all register under the Investment Company Act of 1940 as investment companies.
An investment company registered with the SEC under the Investment Company Act of 1940 that allows investors to sell their shares back to the company at net asset value on a quarterly basis is
an interval fund. -- The unique feature of interval funds is that at certain intervals, which may be anything from monthly to annually, investors are allowed to sell a portion of their shares back to the fund at net asset value (NAV). In the case of open-end funds and UITs, shareholders can redeem their holdings at NAV at all times, not just specified intervals. Aren't interval funds closed-end investment companies? Yes they are, but as covered many times in the course, when there are two choices that could be true statements, the correct answer is the one that more specifically answers the question. Use this logic: Are all interval funds closed-end funds? Yes. Are all closed-end funds, interval funds? No. That makes interval fund the best choice.
Mutual fund shareholders are often advised to enroll in automatic dividend reinvestment programs. In those programs, the investor can elect to have all distributions, or just those from income or just those from capital gains, automatically reinvested in additional shares of the fund. Among the advantages to the investor would be
automatic compounding of the investment. -- Similar in concept to the compounding of interest in a savings account, when distributions are reinvested rather than withdrawn, the capital has an opportunity to compound. Taxes are due in the year for which the distribution is paid (no tax break here). The shares are purchased at NAV; there are never cases where mutual fund shares are purchased below the NAV. If the fund has a 12b-1 charge, it would apply to the reinvested shares just as any other shares.
A customer has an order to buy 400 ABC at 60. ABC declares a 25% stock dividend. On the ex-date, the order on the order book will read
buy 500 shares at 48. -- For stock dividends, all buy limit orders on the book are adjusted and the order value must be the same before and after the adjustment. Before the adjustment, 400 ABC at 60 stop = $24,000 total value. After the adjustment, total shares on the buy order will be 500 (400 × 25% = 100 new shares, 400 + 100 = 500). To arrive at the new price, divide the total order value by the new number of shares ($24,000 ÷ 500 shares = 48). After the adjustment the new order will read; buy 500 shares at 48.
Bond trust indentures are required for
corporate debt securities. -- Municipal and government bonds are exempt from the trust indenture requirement of the Trust Indenture Act of 1939. Revenue bonds are frequently issued with a trust indenture, but no legal requirement to do so exists. The Trust Indenture Act of 1939 requires that corporate bond issues of $50 million or more sold interstate must be issued with a trust indenture.
The primary tax benefit of an income oil and gas program is
depletion. -- In an income program, the partnership is buying oil and gas wells that produce. There are no drilling costs involved in these programs. While there may be a small amount of depreciation as a tax benefit, the primary benefit is depletion, which is taken once the oil and gas have been sold.
Regulation T permits borrowing money for the purchase of each of the following except
listed options with expirations of less than nine months. -- Options with expirations of less than nine months must be fully paid without exception. With some exceptions, warrants, stocks, and bonds may be purchased on margin.
All of the following deal with the secondary market except
notice of sale. -- A notice of sale is published to provide syndicates with information on proposed new (primary market) issues. Dealers are selling out of inventory (secondary trading). A broker's broker executes trades in municipal securities for or on behalf of another Municipal Securities Rulemaking Board member firm. Transactions by a broker's broker could be in both the primary and secondary markets.
The call premium on a municipal bond trading above par is best described as the difference between
par and the call price. -- The call premium represents the difference between the call price and par. The farther away a call date, the lower the call premium.
When a bond is issued by a national government, it is called
sovereign debt. -- 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.
All of the following would be found in a bond resolution for a new municipal issue except
the costs to be incurred by the issuer in connection with the offering. -- The bond resolution (or the bond contract) spells out the characteristics of the issue (maturities, call features, etc.), the issuer's responsibilities to bondholders, and any restrictive covenants to which the issuer must adhere. Costs to be incurred by the issuer have no impact on bondholders.
A front-end sales load is defined as
the difference between the public offering price and the net asset value of a mutual fund share. -- A sales load is the difference between the public offering price and the net asset value per share of the fund.
Revenue bond rate covenants require the user fees to be high enough to cover all of the following obligations of the issuing authority except
the optional call provisions. -- Optional call provisions are at the option of the issuer. Rate covenants of an issue will not require enough to be collected to cover a call on the bonds.
A municipality's net total debt is calculated as
the total debt minus self-supporting debt minus sinking fund accumulations plus overlapping debt. -- The net total debt of a municipality is the net overall debt (total debt minus self-supporting debt minus sinking fund accumulations) plus overlapping debt (shared with other municipalities). States cannot have overlapping debt; it is their municipalities that can.
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?
$0 -- Until the customer realizes the loss by selling, there is no tax deduction.
A customer buys 200 ABC at 76 and simultaneously writes 2 ABC Mar 80 calls at 2. If the stock rises to 83, and the customer is assigned on the short calls, the customer has a gain of
$1,200. -- The customer bought 200 shares at 76 and was forced to sell those shares at 80 for a gain of $800. In addition, the customer received $400 for writing the calls, so the overall gain is $1,200. The price of 83 is irrelevant. It only explains why the customer was exercised (the 80 calls are in the money). Breakeven for covered call writing is the cost of stock (76) less premiums (2). The breakeven point is 74, and the customer sold at 80 (6 points × 200 shares = $1,200).
An Eastern account underwriting of $100 million in municipal bonds is established. ALFA Securities agrees to underwrite 10% of the issue and sells out its allotment of $10 million. However, some of the other firms participating in the deal are not as successful, and $15 million worth of bonds remain unsold. What is ALFA Securities' financial obligation?
$1.5 million -- Undivided liability in an Eastern account means this member is liable for 10% of the unsold bonds (10% × $15 million = $1.5 million).
If an investor with no other positions buys 2 DWQ Jun 45 calls at 3, and he exercises the calls when the stock is trading at 47.25 and immediately sells the stock in the market, what is the investor's profit or loss?
$150 loss -- The investor exercised the right to buy the stock for 45, and can sell the stock in the market for 47.25 for a gain of 2.25. The gain of 2.25 minus the premium of 3 gives the investor a loss of 0.75 per share. Multiplying the 0.75 loss by 200 (the number of shares) results in a loss of $150.
An investor purchases 1,000 shares of PLEX common stock at a price of $153 per share. Shortly afterward, with PLEX selling for 149 per share, a purchase of 10 PLEX 150 puts at 4 takes place. What is the investor's breakeven point?
$157 per share -- This investor is looking for the price to go up. The purchase price was $153 and the cost of the "insurance" (the put option) was 4. That means that the investor will not start making money until the stock rises above the cost of the stock plus the cost of the put ($153 plus $4 = $157). In a question like this, the current market price of the stock and the exercise price of the option are irrelevant. Breakeven on long stock and long put is the cost of the stock plus the cost of the put. As is always the case when computing breakeven, the number of shares and number of option contracts is meaningless−breakeven is the same price for one or one thousand.
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?
10 -- 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.
Listed options expire at
11:59 pm ET on the third Friday of the expiration month. -- Options expire on the third Friday of the expiration month at 11:59 pm ET.
