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Series 7- Passed with 83% > Chapter 15- Ethics, Recommendations And Taxation > Flashcards

Chapter 15- Ethics, Recommendations And Taxation Flashcards

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Series 7 Top-off Exam flashcards
1
Q

Rule makers for Securities industry

A

SEC, FINRA and other regulatory bodies

Duty of broker/dealers to regulate each other

Written procedures manual and at least one supervisor of the rule book per firm

Principal must review and approve all correspondence and review transactions

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2
Q

Customer ethics and responsibilities

A

Must provide accurate information

Full and honest disclosure

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3
Q

Ethical business practices

A

Maintain written supervisory procedures

Principal enforces the rules

Must be at least as stringent as self-regulatory organization

Conduct rules deal with ethical treatment of customers

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4
Q

Manipulative and fraudulent devices

A

Manipulative/fraudulent devices- cannot use manipulation to induce sales

Act of 1934 gives 3 year period of statue of limitations and 1 year from discovery

No dollar limit on penalty

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5
Q

Outside business activity

A

Associated persons cannot work for any other company other than member firm without disclosing

Must provide written notice

Member firm can restrict or reject if a conflict arrises

Includes serving as office or director of a company or owning an interest in another financial firm

May make a passive investment without disclilosing

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6
Q

Private securities transactions

A

Selling outside of regular business

Known as Selling away

To do so a person must:
Provide notice to employer
Describe the transaction in detail
Describe role in transaction
Disclose whether he may or has received compensation

If there is compensation attached, the employing member either has to treat the transaction as if it were happening on own books or ban the transaction

If no compensation then the employing member must acknowledge he was asked for permission and may require adhearance to procedures

No compensation and for a family member is excluded from this rule

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7
Q

Investment recommendations

A

Must be in customers best interest, be consistent with risk tolerance and objectives

Investments should be explained fully

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8
Q

Paying for referrals

A

FINRA prohibits reps from paying for referrals

Even if gift was given first and a referral was given upon receipt

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9
Q

Activities violation fair dealing conduct rules

A

Recommending investments not suitable for customers financial position or risk tolerance

Short term trading of mutual funds

Setting up fictitious accounts that other worlds would be prohibited

Making unauthorized transactions or use of funds

Committing forgery or misstating facts
Guaranteeing against loss

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10
Q

Churning

A

Excessive trading to generate commissions

Excessive frequency or excessive size abnormal from customer trait

Self regulatory orgs take deeper looks into discretionary accounts

Discussion with registered rep should take place

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11
Q

Reverse churning

A

Placing clients in expense accounts who don’t trade often

Fee based accounts have a flat fee each year

Must be an appreciably greater amount

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12
Q

Gratuities to other firms

A

May not distribute business related compensation to other firms

Allowed to extend gift if:
Not conditional on sales
Employing member prior approval
Does not exceed $100 per year

Vacations/season tickets are always violations

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13
Q

Employment contracts

A

Leasing of employees is acceptable if there is written consent between all parties

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14
Q

Borrowing and lending to clients

A

Written notice of agreement

And one of following has to be present:
Immediate family member (no notice needed)

Customer is in business of lending (no APPROVAL needed, need notice)

Both registered persons with firm

Personal relationship outside of client relations

Business relationship outside of broker-consumer

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15
Q

Misrepresentations

A

May not misrepresent education, services offered, fees to be charge

Misrepresentation to inaccurately state or fail to state a material fact

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16
Q

Research reports

A

Adviser or broker dealer is prohibited from presenting info prepared by other persons without disclosing name of said person or firm

Soft dollar arrangements- client pays a higher commissions for research done by firm before a trade occurs

Security Exchange Act of 1934 on Soft Dollars- must meet the following requirements for it to be legal:

  1. Eligibility of the research being charged
  2. Lawful and appropriate assistance in investment decision
  3. Reasonableness of commission paid
  4. Disclosed to client
Would not include:
Telephone lines
Office furniture
Rent for office space
Software not used for analysis
Training services
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17
Q

Safe Harbor Rules gor soft dollar: what qualifies and what doesn’t

A 
Qualifies:
Research reports
Financial newsletter/trade journal
Quantitative analytical software
Seminars and conferences with appropriate content
Not qualified:
Providing computers and equipment 
Travel expenses to seminars
Rent for office space
Internet services
Training services
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18
Q

Guarantees and sharing in customer accounts

A

May not guarantee against loss

May not share in profit/loss of accounts

Exception: Joint account in which registered rep only gets his share and the account must be approved

If with a family member, proportion does not apply

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19
Q

Painting the tape

A

Selling same shares twice in a day with the idea that shares will be sold at same price

Intent to boost activity

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20
Q

Marking the close

A

Effecting trades or falsely reporting trades to influence closing price

Also can’t pay for favorable reviews of companies

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21
Q

Front running

A

Placing individual trades due to prior knowledge of a block order (10,000 shares)

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22
Q

Interpositioning

A

Adding another broker/dealer when there is no benefit to the client

Generally a reciprocal relationship

Both receive commission from client

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23
Q

Where to file tips

A

FINRA via the regulatory tip line in Washington DC

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24
Q

To know your customer you must

A

Understanding a customers financial status
Net worth and net income
Investment objective
All facts essential in making recommendations

FINRA and SROs mandated

Does not include non security items

FINRA definition does not include other brokers and certain potential investors

If not a client and no compensation for the advice was received, then Rule would not apply

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25
Q

Non-financial considerations

A 
Customers age
Marital status
Number and ages of dependents
Customer employment status
Employment of customer family members
Customers current and future financial needs
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26
Q

Risk tolerance and investment goal questions

A

What kind of risks can you afford

How liquid must Investments be

How important are tax considerations

Long term or short term investments

What is your investment experience

What investments do you currently have

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27
Q

Current income generation

A

Short term debt, income oriented mutual funds, money market funds and annuities

Investment pyramid goes safety, growth and speculation

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28
Q

Capital growth

A

Most common growth investments are common stock and common stock mutual funds

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29
Q

Investment retirement accounts

A

Allow earnings to accumulate tax deferred (pay money on withdrawls)

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30
Q

Diversification

A

Objective to move away from having a single asset for retirement

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31
Q

Investment objectives and recommendations

A

Preservation of capital= Gov securities/Ginnie MAEs

Growth= common stocks or common stock mutual funds

Balanced or moderate growth= Blue chip stock

Aggressive growth/sepculation= tech stocks or sector funds

Income- bonds, but not zero coupons

Tax free income- munis or muni bond funds

High yield income- corp bonds or corp bond funds

Income oriented stock portfolio- preferred stock and utilities

Liquidity- money market funds

Keep pace with inflation- stock portfolio

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32
Q

Unsuitable trade

A

Investor wants to partake in a trade deemed by rep as unsuitable

Reg rep must explain why and would mark the trade unsolicited if customer went forward

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33
Q

Inflation risk

A

Purchasing power risk

Rising prices past investor return such as a bonds yield going lower than inflation

34
Q

Capital risk

A

Potential to lose some or all money

Unrelated to an issuers financial strength

35
Q

Timing risk

A

Investing at the wrong time and incurring loss or lower gains

36
Q

Interest rate risk

A

Sensitivity of investment value to fluctuations in interest

37
Q

Reinvestment risk

A

Difficulty to reinvest proceeds when interest rates decline during time period

Mortgage backed securities are susceptible due to refinancing of loans

Best answer for not susceptible to reinvestment risk is a zero coupon bond

38
Q

Call risk

A

Risk a bond might be called before maturity and the investor will not be able to reinvest at a similar rate

Call protection can be bought to defend against that and most issues come with some years of it

39
Q

Market risk

A

Systematic risk

Losing principal to price volatility in a security

Cannot be diversified away, rather it can only be minimized

40
Q

Credit risk, financial or default risk

A

Danger of losing Principal through an issuers failure

41
Q

Liquidity (marketability) risk

A

May not be able to sell

Municipals may be less marketable outside of local areas

42
Q

Legislative risk

A

Congress changing laws affecting securities

Reps should warn about impending law changes

43
Q

Alpha

A

Measure of performance that adjusts risk relative to a known benchmark

Basically excess return from predictions of benchmark

44
Q

Beta

A

Measure of volatility in relation to entire market

1 moves inline with market

1+ are more volatile in relation to overall market

Higher beta means the stock will return better than its pears by whatever it is over 1

Measures systematic risk, usually considered aggressive if over 1

High beta= Tech and automobile
Low= utilities and drug

45
Q

Nonsystematic risk

A

Risks specific to a stock instead of the market

46
Q

Duration

A

Measures time in years a bond takes to mature

Lower coupon generally signals higher duration

Interest bearing bonds usually have a shorter duration than maturity

Zero coupon are exactly maturity

Knowing duration means you can predict what an interest rate decrease would do to return

9 year duration and 1% decrease in rates would be a 9% increase in bond

47
Q

Defensive investment strategy

A

May have growth or income as objective but will be mostly invested in:
Blue chip stocks and AAA bonds

Examples include: food, utility and drug companies

48
Q

Aggressive strategy

A

Assume higher risk by investing in:
Highly volatile or Beta stock

Buying securities on margin

Using put and call option strategies

Most investors fall somewhere in between

49
Q

Modern portfolio theory

A

Emphasizes relationship between risk and reward

Derived from Capital Asset Pricing Model which states a stock price takes into account systematic and non systematic risk

50
Q

Ways to diversify

A

Type of instrument

Industry

Companies in an industry

Length of maturity

Investment rating and geography

51
Q

Dollar cost averaging

A

Periodic purchasing of a fixed dollar amount in one or more common stocks or mutual funds

Fluctuating market average prices would be lower than average price bought

52
Q

Constant Rationplan

A

Buy and sell in a way to keep equity and debt balanced

Usually start at 60 equity -40% debt

53
Q

Constant Dollar plan

A

Buy and sell to keep a set dollar amount invested at all times

Sell as prices rise and buys when markets fall

54
Q

Asset allocation

A

Balancing of different asset classes

Primary factor in performance is allocation

55
Q

Strategic asset allocation

A

Proportion of investments that should compose long term investment portfolio

Subtract age by 100 to find stock bond split

56
Q

Tactical asset Allocation

A

Short term portfolio adjustment that adjusts portfolio mix between asset classes in consideration of current market conditions

Try to time market instead of having set boundaries

57
Q

Active management vs passive

A

Relies on managers stock picking and market timing ability

Passive- belief that no particular management style will consistently outperform the market

Usually will try to mirror a specific index and seek a low cost means of generating return

58
Q

Growth portfolio

A

Focus on companies that outpace earnings of other companies

Will often buy companies at the high end of 52 week price range as growth is usually priced into stocks

59
Q

Value

A

Undervalued and out of favor Stock whose prices are low relative to company’s earnings or book value

Bottom of 52 week high/low

60
Q

Regressive taxes

A

Sales, excise, payroll, property, and gasoline

Levied equally regardless of income

Low income families pay higher percentage because a greater majority of their incomes than they do save

61
Q

Progressive taxes

A

Estate and income taxes

Increase with income

62
Q

Three types of income

A

Earned income- salary, bonuses and income derived from active participation in a business (GP)

Passive income- rental property, LPs, and enterprises in which someone is not actively involved. Passive loses are only allowed to be used against passive income

Portfolio income- dividends, interest, and net capital gains, taxed during year of receipt

63
Q

Capital loss usage

A

Can only offset earned income by 3000 in a particular year

Can carry forward indefinitely

64
Q

Interest income

A

Interest paid on debt securities, tax differs

Corporate bonds- taxable by fed, state and local gov

US Gov securities- Tbill, Tnote, and bonds are not taxable at state and local levels but taxed at fed

Agency issues- Similar to US gov securities except when mortgage backed securities. These are taxed at all levels.

Fannie Mae and Freddie Mac- taxed at all levels because they are corporations

Accrued Interest- When a bond is sold between interest payments, the trade confirmation will confirm how much accrued interest was received. Buyer deducts the interest paid to seller from total interest received

65
Q

Municipal securities

A

Interest from municipal securities is exempt from federal state and local taxes

May not be exempt if not a resident of the state in which the bond or note is issued

Private purpose bonds (industrial revenue bonds) issued by states or municipalities are a tax preference item in the Alternative minimum tax

66
Q

Qualified dividend income

A

Must be held more than 60 days during a 121 day period beginning 60 days before ex dividend day

Tax rate is specified by the IRS tax code

Nonqualified dividends are taxed as ordinary income

67
Q

Dividends from mutual funds tax

A

Corporate bonds- taxed at ordinary income rate

Stock funds- in accordance with IRS not ordinary income

Taxed regardless of whether funds are reinvested into additional shares or taken as cash

68
Q

Foreign security taxes

A

Taxed by country the investor is a citizen of

Us investor would be Federal, State and local (if applicable) taxes on foreign securities

Any withheld amount by foreign government can be used as a tax credit

69
Q

Adjusting cost basis

A

Cost basis is increased by commissions paid to buy a security

Proceeds are reduced by commission paid

Buy at 90 but pay $1 in commission, 91 base

Sell for 92 but pay $1 commission, 91 basis no gain

70
Q

Determination of which shares are sold

A

First in first out (FIFO)- assumed by IRS because it causes largest gain recognition

Share identification- must do before the transaction settles (Trade date + 3 business days)

Average basis- Usually used by mutual fund investors because its simplest with fractional shares

71
Q

Wash Sales

A

May not use losses if selling a security and then repurchasing securities 30 days before or after trade date

Buying calls, rights, warrants and convertible bonds is considered repurchasing

Writing deep in the Money puts also included

Allowed to adjust the cost basis of reacquainted stock by amount of disallowed loss

Applies to short selling as well

72
Q

Avoiding wash sale with Municipals

A

Change 2 of 3 factors

Issuer
Coupon
Maturity

73
Q

Pre tax yield

A

Municipal bonds would have the lowest pre tax yield compared to us gov bonds

74
Q

Bond premium Amortization

A

Bonds purchased at premium must amortize their loss

Reduces reported interest income during the year

Negative benefit for municipal bonds because it’s income is not taxed

75
Q

Bond discounts accretion

A

Accretion depends on whether it was purchased as an original issue discount (new issue) or on secondary market

Beneficial for municipal bonds if buying at original issue

If bought on secondary, the accretion is taxable

76
Q

Adjusting cost basis of corporate bond

A

Bond accretes if bought at discount

Investor has option to amortize or not

If the investor decides not to, his cost basis remains the same

77
Q

Cost basis for donations

A
  1. Donation to charity- Donor receives a tax deduction equal to market value on date of donation, no tax liability if held for more than one year. Tax is due if not held for one or more years
    Recipient cost basis is higher market value
  2. Donations to others- no deduction, cost basis to recipient is original cost basis, subject to gift tax
  3. Inherited securities- Recipient cost basis is FMV as of date of death
78
Q

Estate taxes

A

Paid by estate not the heirs, likewise for gifts

Both are progressive taxes

Married couples are allowed to transfer entire estate to surviving spouse tax free

79
Q

Margin interest

A

Tax deductible expense except if used to purchase Municipals

Deductions can not exceed interest income, dividends and cap gains

Banks can deduct 80% of costs for financing

80
Q

Short against the box

A

Selling shares short instead of selling a long position.

5% margin requirement applies on proceeds and firm may release 95% of proceeds

Cannot be used to stretch a short term gain to long term

Must be closed in 30 days and long for additional 60

81
Q

Alternative minimum tax

A

Makes certain high income tax payers pay taxes

Adds back:
Accelerated depreciation on investment property
Certain DPP costs
Local tax and interest on investments that do not generate income
Incentive stock options exceeding FMV

82
Q

Corporate dividend exclusion rule

A

Dividends received from other corporations are 70% exempt from taxation

Series 7- Passed with 83% (19 decks)

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