Chapter Test Questions Flashcards
The record date for ABC Growth Fund’s quarterly dividends is Thursday, December 20. When is the ex-dividend day?
A. December 17
B. December 18
C. December 20
D. December 21
D. December 21
For mutual funds, the ex-dividend date is the first business day AFTER the record date.
Which of the following best describes the formula for current yield?
A. Annualized dividend / last reported trade price
B. Annualized dividend / annualized market value
C. Most recent dividend / book value per share
D. Quarterly dividend / par value
A. Annualized dividend / last reported trade price
The formula is annual dividend / current market value. Current market value is the price at which the most recent trade was executed, or the price at the close of the trading day.
Jack owns 300 shares of cumulative, convertible preferred stock. All of the statements below are true EXCEPT:
A. Jack can convert his shares to common stock at any time.
B. Jack will receive any deferred or omitted dividends before common shareholders can receive a dividend.
C. Jack receives dividend payments before common shareholders.
D. The issuing company could call the stock at par value.
D. The issuing company could call the stock at par value.
Jack owns cumulative, convertible shares. There is no call provision mentioned; therefore, the company could not call the stock.
ADRs are used to facilitate which of the following?
A. Domestic trading of foreign securities
B. Domestic trading of U.S. government securities
C. Foreign trading of U.S. government securities
D. Foreign trading of domestic securities
A. Domestic trading of foreign securities
American depositary receipts (ADRs) are certificates issued by a bank in the United States to represent a certain amount of shares of a foreign company. Since ADR transactions are regulated under the U.S. securities regulations, they also enjoy the same protection as domestic transactions.
Which of the following laws requires the full disclosure of all material information about a new issue security?
A. Securities Act of 1933
B. Securities Exchange Act of 1934
C. Glass Steagall Act
D. Regulation T
A. Securities Act of 1933
The Securities Act of 1933 is dedicated to the regulation of the new issue market. The SEC will not declare the issue to be in compliance if all material facts are not disclosed. If it is discovered that all material facts have not been disclosed, investors would have the right to file a claim against all parties based on disclosure requirements of the Act of 1933. The Glass Steagall Act pertains to the distinction between commercial banking and investment banking. As for Regulation T, it is a regulation, not a law. And the Securities Exchange Act of 1934 regulates the trading of securities in secondary markets, not new issue markets.
Which of the following is FALSE regarding warrants?
A. Warrants typically have a long life, perhaps even perpetual; the subscription price is above the stock’s current market value.
B. Warrants can trade separately from the common stock.
C. Warrants have a longer life than rights.
D. Warrants are issued at a discount to the underlying equity in order to make security offerings more attractive to the investor.
D. Warrants are issued at a discount to the underlying equity in order to make security offerings more attractive to the investor.
Warrants are long-term and at issue, their subscription price is at a premium to the underlying stock price. Rights are short-term, with a subscription price that is at a discount to the underlying stock price.
The main function(s) of FINRA include I. Self-regulation for the securities market. II. Governing member firms and associated persons. III. Monitoring compliance with securities regulations. IV. Approve and monitor SEC rules and regulations.
A. II and IV only
B. I, II, III, and IV
C. I only
D. I, II, and III only
D. I, II, and III only
FINRA oversees the securities markets, member firms, and associated persons, as well as monitoring compliance with securities regulations. The SEC has authority over FINRA, not the other way around.
Investors who own shares of XYZ Corp. have limited liability. Which of the following statements best describes this feature?
A. They would be liable for the amount they’ve invested, and any debt incurred by the corporation.
B. If the corporation went under, they would receive their original investment back in full.
C. They would be liable for judgments against the company in direct proportion to their ownership in the stock.
D. They would only be liable for the amount they’ve invested to purchase the shares.
D. They would only be liable for the amount they’ve invested to purchase the shares.
Limited liability means that investors are only liable for the amount they invested, and not for any other debts incurred by the corporation.
A corporation has issued 10 million shares of common stock that are currently trading for $5 per share. There are 2 million shares of treasury stock. What is the total value of outstanding common stock shares?
A. $8 million
B. $10 million
C. $40 million
D. $60 million
C. $40 million
Ten million issued shares minus 2 million treasury shares equals 8 million shares outstanding. Eight million outstanding shares x $5 / share = $40 million. Remember: Outstanding Stock = Issued Shares - Treasury Stock
XYZ Corporation has been experiencing some financial difficulty in the last few years. However, they are confident that the company will be profitable again in the next few years. XYZ would like to borrow some money from investors by issuing bonds, but they are concerned that the interest rate they will have to pay will be too high based on their most recent financial report. If XYZ would like to reduce the interest rate on the bonds and increase the marketability of their bonds, which of the following could XYZ do?
A. Issue bonds and stock together in a unit
B. Attach preemptive rights to the bond
C. Attach warrants to the bond
D. Issue treasury stock
C. Attach warrants to the bond
By issuing warrants with their new bond offering, XYZ would reduce its interest rate and also increase the marketability of the new bonds.
The quick ratio is:
A. An inferior measure because it fails to consider inventory.
B. A more stringent measure than the current ratio.
C. A more lenient measure than the current ratio.
D. Less accurate than the current ratio because it does not consider the time value of money.
B. A more stringent measure than the current ratio.
The quick ratio (acid test ratio) is a more stringent measure because it uses only cash equivalents (inventory is deducted), which are divided by current liabilities.
An American investor that would like to purchase the shares of a foreign company’s stock with the same regulatory protection given a domestic security could:
A. Purchase American depositary receipts on the foreign company.
B. Use foreign currency exchange markets.
C. Purchase domestic shares and convert them to foreign shares in the open markets.
D. Set up a domestic trading account with a foreign brokerage firm
A. Purchase American depositary receipts on the foreign company.
American depositary receipts, or ADRs, are certificates that trade on a stock market in the United States but actually represent a foreign stock. This allows American investors to purchase shares of non-American companies on an American exchange, as opposed to a foreign exchange, which would involve additional costs and complications. Because they trade on domestic exchanges, ADRs have the same regulatory protection as U.S. domestic securities.
A corporation pays a stock dividend to:
A. Promote its stock.
B. Reduce the price of its stock.
C. Reduce accounts payable.
D. Conserve cash.
D. Conserve cash.
A corporation pays a stock dividend to reward the shareholders while saving cash.
ABC Corporation has earnings of $5 per share and has paid a quarterly dividend of $.75. If ABC is currently trading at $30 a share, what is the current yield for ABC’s stock?
A. 2.5%
B. 7%
C. 10%
D. 17%
C. 10%
Current yield is determined by dividing the annual dividend by the current market price. Since ABC has paid a $.75 quarterly dividend, multiply $.75 times four to get annual dividend income of $3 per share. Then, divide $3 per share by the current market price of $30 per share to get the yield of 10%.
Joe received a certificate from a commercial bank that represents his interest in shares of a foreign company on a foreign exchange. What is this certificate called?
A. Application
B. Certificate of authenticity
C. American depositary receipt
D. Warrant
C. American depositary receipt
American depositary receipts are issued by banks in the U.S. to represent a certain amount of shares of a foreign company on a foreign exchange.
Which of the following preferred shares has the highest yield?
A. Participating
B. Cumulative
C. Convertible
D. Callable
D. Callable
Callable stocks have the highest yield. The highest yielding stock has the lowest price, and participating, cumulative and convertible are attractive features that add to the price and thus lower the yield. The call feature is undesirable to an investor. It adds risk and uncertainty to the stock. Therefore, investors demand a lower price and consequently higher yield when they buy callable preferred stock.
A convertible preferred is convertible at $20 per share. The stock is currently selling on the market at $120. Which of the following are correct statements is correct?
A. The common stock must be selling at $24 to be at parity with the preferred stock.
B. The common stock must be selling at $20 to be at parity with the bond.
C. The preferred stock’s conversion ratio is 1:6.
D. It makes sense to convert at $22.
A. The common stock must be selling at $24 to be at parity with the preferred stock.
The conversion ratio is the par value of the preferred stock divided by the conversion price, or in this case, 1:5. It identifies the number of common shares received upon conversion. The parity price of the common stock is determined by dividing the conversion ratio into the market value of the preferred stock, or 120/5 = $24. It only makes sense to convert at a price above the parity price.
Which will receive dividends?
A. Preemptive rights
B. ADR
C. Warrant
D. Treasury stock
B. ADR
ADRs receive dividends. Both warrant and rights are used to purchase the underlying stock but they are not stock themselves and do not receive dividends. Treasury stock is stock that has been bought back by the corporation; it does not receive dividends nor does it vote.
Preferred stock has priority over common in which of the following ways? I. Payment of dividends II. Voting status III. Bankruptcy priority IV. Receipt of stock rights
A. I and II
B. I and III
C. II and III
D. II and IV
B. I and III
Preferred stock does not vote, nor does it receive stock rights in a rights offering.
Which of the following is true about treasury stock?
A. It has been issued and repurchased by the company.
B. It is authorized, but unissued.
C. It is entitled to a dividend.
D. It has voting rights.
A. It has been issued and repurchased by the company.
Treasury stock has been issued (sold to the public) and subsequently bought back by the corporation; shares of treasury stock have no voting rights and receive no dividends.
ABC Corp paid the following dividends to its 6% noncumulative preferred stock: year one, $4; year two, $3. In year three, if ABC wishes to distribute a dividend to the common stockholders, ABC must first pay what to the preferred stockholders?
A. $0
B. $5
C. $6
D. $11
C. $6
ABC must pay the preferred stockholders its full dividend of $6 in year three before it may pay a dividend to the common. If this were cumulative preferred, the correct answer would be $11 – the delinquent dividends totaling $5 plus the current dividend of $6.
Which of the following is true of the organizational structure of a balance sheet? I. It is arranged from current items at the top to long term items at the bottom. II. Liquid items appear on the left and illiquid and fixed items appear on the right. III. It follows an equation. IV. Leverage items follow equity items.
A. I and II
B. I and III
C. II and III
D. II and IV
B. I and III
The balance sheet follows the balance sheet equation, and it starts with current items at the top and flows to long term items below. Leverage (bonds) comes before equity (stock.)
A corporation is issuing additional shares of stock through an APO (additional public offering). Which of the following would not be affected?
A. Interest owed
B. Outstanding shares
C. Working capital
D. Earnings per share
A. Interest owed
Working capital would increase because of cash receipts from the stock sale. EPs would decline because earnings are now dividend among a greater number of outstanding shares.
Which of the following securities is considered to be a long-term instrument?
A. Options
B. T-bills
C. Rights
D. Warrants
D. Warrants
Like rights, warrants provide an investor with an opportunity to purchase securities at a specified price for a set period of time. However, warrants are long-term, while rights are short-term.
Settlement for government securities is:
A. Same day.
B. Next day.
C. 4 business days.
D. 7 business days.
B. Next day.
Government trades settle the next business day, or T.
Warrants are issued along with a bond offering. The principal reason is:
A. To raise the price of the securities being sold.
B. To raise the coupon interest cost.
C. To improve marketability.
D. To increase the yield.
C. To improve marketability.
An attached warrant increases the attractiveness of a bond, enhancing its marketability. Consequently, the issuer can structure the bond with a lower nominal yield (stated interest rate). Investors will accept a lower stated interest rate in exchange for the warrant.
The term for active stock that represents the number of shares owned by the public is:
A. Treasury stock.
B. Issued stock.
C. Authorized stock.
D. Outstanding stock.
D. Outstanding stock.
“Outstanding stock” is the term for issued stock less any treasury stock reacquired by the corporation.
The date the board of directors authorizes a dividend is the:
A. Ex-dividend date.
B. Record date.
C. Declaration date.
D. Payable date.
C. Declaration date.
The dividend is authorized on the declaration date.
A shareholder owns 200 shares of stock with cumulative voting rights. If there are five vacancies being voted upon, what is the maximum number of votes the shareholder may cast for any one vacancy?
A. 1
B. 25
C. 200
D. 1,000
D. 1,000
The number of votes controlled by the shareholder is always calculated using the same formula: number of shares × number of vacancies. Under the cumulative method, the shareholder may allocate those votes among the vacancies in any way he desires. In this example, the investor might choose to concentrate all 1,000 of his votes on one vacancy. Consequently, he would forfeit any vote on the remaining four vacancies.
In order for a corporation to qualify for the 50% corporate dividend exclusion when they own stock of another corporation, they must own less than what percentage of that corporation’s outstanding stock?
A. 5%
B. 10%
C. 15%
D. 20%
D. 20%
To qualify for the corporate dividend exclusion, the shareholding corporation must own less than 20% of the dividend-paying corporation’s outstanding stock.
A heavily leveraged corporation has which of the following?
A. High bond ratio
B. Low rate risk
C. Low debt/equity ratio
D. High debt/equity ratio
D. High debt/equity ratio
A corporation with more debt has a higher debt/equity ratio and is more vulnerable to interest rate increases.
A client calls his registered representative (RR) to ask her to buy 500 shares of XYZ Corp because he heard a dividend has been declared, but not paid yet, and he wants to receive the dividend. How should the RR respond to the client?
A. Inform the client of the consequences and refuse the order
B. Place the order as an unsolicited order
C. Place the order at a date to settle after the record date and accept the consequences for going against the client’s instructions.
D. Place the order according to the client’s instructions
A. Inform the client of the consequences and refuse the order
This question is about a prohibited practice known as “selling dividends”. Registered representatives are prohibited from advising an investor to purchase a stock for the sole purpose of receiving the dividend. The registered representative must inform the client of the consequences of buying a stock just before a dividend is paid. If the client were to purchase the stock just before the ex-dividend date, he would have an unrealized loss on the stock when the price drops on that date and he would have a tax liability because dividends are taxable.
A company has been in arrears on dividend payments for three quarters. Who must get paid before common shareholders can receive a dividend? I. Callable preferred; II. Convertible preferred; III. Cumulative preferred:
A. I and II only
B. II only
C. III only
D. I, II and III
D. I, II and III
All dividend payments must be made to owners of all classes of preferred stock before common shareholders may receive a dividend. The cumulative feature also entitles the owner to any dividends in arrears.
What is the key difference between straight preferred stock and participating preferred stock shares?
A. Participating preferred offers the investor the potential to receive dividends in addition to the stated dividend.
B. There is no difference as both terms describe the same type of security.
C. Straight preferred shares enjoy an additional catch up provision for unpaid past dividends
D. Participating preferred shares may be converted to either common stock or corporate bonds
A. Participating preferred offers the investor the potential to receive dividends in addition to the stated dividend.
Participating preferred offers the stock the potential to receive a larger dividend in a year with exceptional corporate earnings.
Which of the following is FALSE regarding all preferred stock?
A. Preferred stock is often convertible to common shares.
B. Preferred stock is cumulative for past dividends and allows for a dividend catch up at some point in the future.
C. Preferred shares are senior to common shares.
D. Preferred shares receive dividends prior to common stock when dividends are declared.
B. Preferred stock is cumulative for past dividends and allows for a dividend catch up at some point in the future.
Although most preferred stock is cumulative, the cumulative feature is optional. Straight preferred (or noncumulative) also pays a stated dividend but does not “catch up” dividends which may have gone unpaid during any prior period.
Corporations generally issue warrants in connection with which of the following?
A. Convertible bond issues, in order to secure a higher interest rate
B. Common stock, in order to obtain an increase in par value
C. Preferred stock, in order to obtain a lower par value
D. Bonds, in order to secure a lower interest rate
D. Bonds, in order to secure a lower interest rate
Warrants are generally sweeteners attached to bonds to lower the interest rate the issuing corporation has to pay. But primarily, the warrants increase the marketability of the bond.
Which type of preferred stock may be exchanged for shares of common stock?
A. Callable preferred
B. Convertible preferred
C. Cumulative preferred
D. Participating preferred
B. Convertible preferred
The convertible preferred provision allows a shareholder to exchange preferred stock for common stock. The conversion price is determined at the time of issue.
Which of the following components reconcile cash flow to net income?
A. Convertible bond interest
B. Amortization
C. Depreciation and amortization
D. Depreciation
C. Depreciation and amortization
Amortization and depreciation are noncash deductions which are added back to net income to determine cash flow.
What type of preferred stock would a corporation issue if it wants the right to repurchase the shares at a specified price in the future?
A. Participating preferred
B. Convertible preferred
C. Callable preferred
D. Cumulative preferred
C. Callable preferred
The call feature of a stock allows the issuing corporation to repurchase the stock in the future at a specified price. The call price is established at issuance and is usually above par to make the stock more attractive to investors.
Which of the following would ensure that the numbers of shares printed on the stock certificates are equal to the number of shares that are outstanding for the corporation?
A. Registrar
B. Investment banker
C. Underwriter
D. Transfer agent
A. Registrar
It is the registrar’s job to make sure that the number of shares printed on the certificates is equal to the number of shares outstanding for the corporation. The transfer agent’s job is to physically transfer the ownership of the shares.
Which of the following is NOT a component of the balance sheet?
A. Assets
B. Liabilities
C. Net worth
D. Net revenue
D. Net revenue
This balance sheet formula (also known as the balance sheet equation) is expressed as “Assets = Liabilities + Net Worth.” Revenue and expense items are found on the income statement.
An investor owns 1,000 shares of XYZ Corporation, which just declared a stock dividend of 6%. The stock was selling for $10 just before the dividend was declared. The dividend announcement will have what effect?
A. Increase the number of shares the investor owns to 1,060 shares, but will not impact the total value of the stock holding.
B. Increase the cash in the account and decrease the number of shares owned.
C. Increase the number of shares outstanding and lower the investor’s proportional ownership of the company.
D. Increase the number of shares the investor owns to 1,060 shares and increase the share price to $10.60 in the market.
A. Increase the number of shares the investor owns to 1,060 shares, but will not impact the total value of the stock holding.
A stock dividend is used by the company to gradually lower the price of the stock in the marketplace and save cash for future growth. It does this by paying dividends in shares rather than in cash. In this scenario, the investor will have more shares, but at a lower price. Therefore, the market value of the stock holding remains the same.
Which of the following best describes cash settlement?
A. The trade involves a very liquid money market security with a maturity of less than 30 days.
B. The customer pays for the securities on trade date.
C. The customer must pay for the securities with cash or a cashier’s check.
D. Cash settlement may not be done in a margin account.
B. The customer pays for the securities on trade date.
For cash settlement trades, trade date and settlement date are the same. The entire transaction takes place on the same day.
Stock rights are:
A. Issued with a subscription price above current market value.
B. Required to be exercised.
C. Short term.
D. Long term.
C. Short term.
Stock rights are short-term instruments issued with a subscription price below the stock’s current market value. Because they enable the holder to purchase stock at a discount, rights have value. They trade briefly in the secondary market, because they expire in 30 to 60 days. Rights can be left to lapse or expire.
A corporation has a $4 million profit. The corporation is in the 34% tax bracket. What is pre-dilutive EPS? Common stock: 1,000,000 shares ($10 par) = $10,000,000; 5% preferred: 50,000 shares ($100 par) = $5,000,000; 7% debentures: 5,000 bonds ($1,000 par convertible at $10) = $5,000,000
A. $2.59
B. $2.16
C. $2.41
D. $2.66
B. $2.16
$4,000,000 (profit) minus $350,000 (interest 7% X $5 million) = $3,650,000 (pre-tax profit) X .66 (converse of 34% tax bracket) = $2,409,000 (post-tax profit) minus $250,000 (preferred dividends) = $2,159,000 earnings divided by 1,000,000 shares = $2.16 EPS
Which of the following does NOT affect a corporation’s reported net income per share?
A. A declaration of the dividend
B. A change in accounting method for valuing inventory
C. The discontinuance of operations of a company plant or division
D. The decrease in the number of shares outstanding
A. A declaration of the dividend
A declaration of a dividend has nothing to do with income per share. A dividend is the portion of earnings that the board of directors decides to distribute to the shareholders. The remainder is retained by the corporation in retained earnings.
A corporation’s capitalization consists of: Debenture - 7% - $1,000 par, maturity 2022: $4,000,000; Common Stock - $1 par, 200,000 shares outstanding: $200,000; Capital in excess of par: $800,000; Retained earnings: $5,000,000. The corporation, for the year 2010, earns $1,500,000 before interest and taxes and is in the 50% tax bracket. What is the return on common equity?
A. 6.1%
B. 10.2%
C. 30.5%
D. 61%
B. 10.2%
Net income = $1,500,000 gross earnings – $280,000 bond interest (7% x $4m) = $1,220,000 x 50% tax = $610,000 net income. Common shareholder equity = $5,000,000 retained earnings + $800,000 capital excess par + $200,000 par value outstanding shares = $6,000,000 total common equity. $610,000 / $6,000,000 = 10.16%
A corporation has a $4 million profit. The corporation is in the 34% tax bracket. What is post-dilutive EPS? Common stock: 1,000,000 shares ($10 par) = $10,000,000; 5% preferred: 50,000 shares (100 par) = 5,000,000; 7% debentures: 5,000 bonds ($1,000 par convertible at $10) = $5,000,000
A. $2.16
B. $2.41
C. $1.44
D. $1.59
D. $1.59
The convertible bonds all converted ($5,000,000/$10 = 500,000 shares of common). More shares are created, but interest cannot be deducted. Therefore, taxable earnings increase and net income also increases; however, because the number of shares outstanding goes up, the earnings-per-share goes down or dilutes. $4,000,000 (profit) X .66 (converse of 34% tax) = $2,640,000 (post-tax profit) minus $250,000 (preferred dividends) = $2,390,000 earnings divided by 1,500,000 shares = $1.59 EPS.
Once the dividend is declared by a corporation, which of the following will occur?
A. Retained earnings will decrease.
B. Working capital will increase.
C. Current liabilities will decrease.
D. Retained earnings will increase.
A. Retained earnings will decrease.
When a corporation declares a dividend, it becomes a current liability and must be paid. Retained earnings will decrease and current liabilities will increase by the total dollar amount of the dividend to all stockholders. An increase in current liabilities result in a decrease in working capital (which is equal to current assets minus current liabilities).
The capital structure is the total of all securities issued by a corporation. Which of the following statements is INCORRECT concerning corporate securities?
A. Treasury stock has voting rights.
B. Outstanding stock may receive dividends.
C. Most corporations will issue fewer shares than authorized in order to keep stock available for future use.
D. The amount of stock actually sold is referred to as issued shares.
A. Treasury stock has voting rights.
Owners of treasury stock have no voting rights and do not receive dividends.
Which type of stock would an investor own for the best assurance of receiving dividend income?
A. Participating preferred
B. Callable preferred
C. Convertible preferred
D. Cumulative preferred
D. Cumulative preferred
Cumulative preferred stocks give the best assurance of dividend income because no dividends can be paid to common stockholders if any preferred stock dividends are in arrears (not paid).
Which of the following indicates the generosity of the board of directors?
A. Preferred dividend ratio
B. P/E ratio
C. Dividend payout ratio
D. EPS
C. Dividend payout ratio
The dividend payout ratio expresses the portion of earnings which the board chooses to distribute to the shares.
Which of the following is NOT part of a corporation’s capital structure?
A. Paid in capital surplus
B. Accounts payable
C. Debentures
D. Preferred stock
B. Accounts payable
Accounts payable includes short-term (30- to 60-day) liabilities. It is not part of a corporation’s long-term capital structure.
When current stockholders have preemptive rights, they are entitled to:
A. The opportunity to purchase new shares before the shares are offered to the public.
B. Voting rights.
C. A special purchase price when they buy bonds from the same company.
D. A special discount on new issues.
A. The opportunity to purchase new shares before the shares are offered to the public.
Preemptive rights allow current shareholders the first opportunity to purchase a sufficient number of the new shares to maintain their current percentage of ownership in the company. The stock is offered to the general public only after current shareholders exercise their preemptive rights.
A corporation declares a dividend. This causes I. Stockholders’ equity to increase. II. Stockholders’ equity to decrease. III. Liabilities to increase. IV. Liabilities to decrease.
A. I and III
B. I and IV
C. II and III
D. III and IV
C. II and III
When a corporation declares a dividend, it is deducted from retained earnings in the equity section of the balance sheet and added to current liabilities in the liabilities section.
Which of the following statements is INCORRECT concerning convertible preferred stock?
A. It can be converted into common stock.
B. It has a higher claim than common in a corporate bankruptcy.
C. It can be called by the corporation.
D. Dividends must be paid before common stock dividends.
C. It can be called by the corporation.
Only callable preferred stock can be called by the corporation.
Companies have a net worth, which can be calculated using a method called the
A. Asset to Liability Cost Basis Method.
B. Corporate cash flow method.
C. Business modeling method.
D. Balance sheet equation.
D. Balance sheet equation.
The balance sheet equation works much the same for businesses as a net worth statement does for individuals. In both instances, net worth is calculated by subtracting liabilities from assets. One key difference is that companies often have inventory as an asset and bond obligations as a liability while individuals do not.
Which of the following best defines treasury stock?
A. Issued shares minus outstanding shares
B. Authorized shares minus outstanding shares
C. Nonvoting shares, authorized and issued
D. Nondividend paying shares, issued and outstanding
A. Issued shares minus outstanding shares
Treasury stock was previously outstanding. It has been bought back by the corporation and placed in the corporate treasury. Total shares issued minus shares currently outstanding equals the number of shares bought back by the corporation.
What are the two types of voting processes used by corporations?
A. Preemptive and proxy
B. Proxy and statutory
C. Statutory and cumulative
D. Proxy and cumulative
C. Statutory and cumulative
There are two types of voting processes used by corporations: statutory voting and cumulative voting. With statutory voting, shareholders are permitted one vote for each share owned to be voted for each director. With cumulative voting, shareholders can multiply the number of shares owned by the number of directorships and cast the votes in any manner desired.
To determine a corporation’s profitability year-over-year, which of the following is most suitable?
A. Price/earnings ratio
B. Profit ratio
C. Earnings per share
D. Fully diluted earnings per share
B. Profit ratio
The profit ratio measures how much of each revenue dollar is net income (Net income ÷ revenue).
The board of directors declares a dividend on Wednesday, Oct. 5, to shareholders of record as of Thursday, Oct. 20. If an investor purchased the stock on Thursday, Oct. 20, in a cash transaction, which of the following statements would be true?
A. The investor is entitled to the dividend as long as the shares are purchased on or before the record date regardless of the type of settlement used.
B. The investor would not be entitled to the dividend because the shares were purchased after the ex-dividend day which would have been Tuesday, October 18.
C. The investor would not be entitled to the dividend because the stock was purchased on the record date.
D. The investor would be entitled to receive the dividend because the stock was purchased using cash settlement.
D. The investor would be entitled to receive the dividend because the stock was purchased using cash settlement.
An investor that purchases the shares on the record date for cash settlement is the owner of record as of that date. The investor is therefore entitled to the dividend. For cash transactions, the ex-dividend date is the day after, not the day before, the record date. The way to remember this is to remember the acronym DREP (Declaration, Record, Ex-date, Payable).
The current ratio formula is
A. Current assets ÷ current owners’ equity.
B. Current assets ÷ current liabilities.
C. Quick assets ÷ current liabilities.
D. Current assets ÷ total liabilities.
B. Current assets ÷ current liabilities.
Current ratio measures the entity’s ability to pay its short-term debts. A number less than one means that the entity has insufficient funds to meet current liabilities.
Which of the following reflects a company’s profits and losses for a fiscal year?
A. Revenue report
B. Income statement
C. Cash flow analysis
D. Balance sheet
B. Income statement
An income statement shows a company’s performance over a specific period of time in terms of the company’s profits and losses.
An American corporation receiving which of the following is entitled to a 50% exclusion?
A. Dividends of preferred stock, but not common stock, of a domestic corporation
B. Dividends from common and preferred stock of another domestic corporation
C. Dividends from common stock only of a domestic corporation
D. Dividends and interest from a domestic corporation
B. Dividends from common and preferred stock of another domestic corporation
Under current tax law, corporations may exclude from taxation 50% of common and/or preferred dividends they receive from stock owned in a U.S. corporation. In order to qualify, they must own less than 20% of the dividend-paying corporation’s outstanding stock.
Authorized stock that has not been sold or distributed is referred to as:
A. Unissued shares.
B. Treasury stock.
C. Issued shares.
D. Outstanding stock.
A. Unissued shares.
Unissued shares are authorized but have not been sold or distributed. Treasury stock has been issued and repurchased by the corporation.
From a fundamental analyst’s point of view, which of the following is least significant?
A. Inventories
B. Assets
C. Trading volume
D. Sales
C. Trading volume
A fundamentalist looks at the company, not the market. Trading volume is a market characteristic and is examined by a technical analyst.
A corporation may distribute dividends in the form of:
A. Cash, company stock and stock of another corporation.
B. Cash only.
C. Cash and stock only.
D. Company stock and stock of another corporation only.
A. Cash, company stock and stock of another corporation.
Dividends may be distributed as cash, company stock, or stock in a related or subsidiary corporation.
An investor has a net worth of $500,000. If the investor takes $2,500 out of savings to invest in an IRA and $3,000 to pay off a credit card, and buys a $5,000 stereo on store credit, the investor’s net worth will then be:
A. $492,000
B. $495,000
C. $497,000
D. $500,000
D. $500,000
Here is how to work through these transactions to see how they affect the investor’s net worth. First, by moving $2,500 out of savings to invest in an IRA, the investor has simply moved a current asset to a long-term asset, so total assets remain unchanged. Second, when the investor uses $3,000 from savings to pay off a credit card, he has reduced both current assets and current liabilities by the same amount so net worth remains unchanged. Third, when the investor buys a $5,000 stereo on credit, both assets and liabilities have increased by the same amount; therefore, after all of this, the total net worth remains unchanged at $500,000. Remember, the formula for calculating net worth is total assets minus total liabilities.
Tim is an investor in Ajax Corporation, a publicly traded corporation. As an owner of common stock, Tim has the right to
A. Choose where Ajax locates its corporate headquarters.
B. Make day-to-day management decisions at Ajax Corporation.
C. Inspect the financials of Ajax Corporation.
D. Hire mid-level managers for Ajax Corporation.
C. Inspect the financials of Ajax Corporation.
As a common shareholder of Ajax Corporation, Tim would have the right to inspect the books, meaning Ajax financial statements. Tim would have access to these financial statements through Ajax filings of their 10K annual reports and 10Q quarterly reports.
Which of the following is the quick ratio?
A. P/E ratio
B. The acid test
C. EPS
D. EPS vs. P/E ratio
B. The acid test
The acid test is the same as quick ratio: current assets minus only inventory divided by current liabilities.
ABC Corporation originally authorized 1 million shares and has issued 600,000 shares. ABC Corporation has decided to buy 50,000 of their shares back and place them in treasury. How many shares are currently outstanding?
A. 400,000 shares
B. 550,000 shares
C. 600,000 shares
D. 1 million shares
B. 550,000 shares
The formula to calculate the number of outstanding shares is as follows: Total issued shares - Treasury stock = Number of outstanding shares (or in this scenario, 600,000 - 50,000 = 550,000 outstanding shares).
Individuals holding shares of common stock have the right to participate in the underlying corporation’s earnings. Which of the following statements is true?
A. Lower earnings yield lower dividends.
B. Higher dividends result in higher earnings.
C. Shareholders pay dividends in order to receive the payouts.
D. Earnings do not affect the payouts.
A. Lower earnings yield lower dividends.
Those holding shares of common stock have the right to participate in the earnings of the issuing company in the form of stock dividends. Dividends are usually paid quarterly by the issuing company, and as earnings fluctuate, so does the amount of payout per share issued by the company.
Preemptive rights allow a stockholder to
A. Purchase warrants and call options.
B. Serve as a board member.
C. Maintain proportionate interest in the company.
D. All of the above are correct.
C. Maintain proportionate interest in the company.
Preemptive rights allow the stockholder to maintain proportionate ownership in the company by having the first opportunity to buy new shares.
A cash purchase of heavy equipment will affect which of the following? I. Current Assets; II. Working capital; III. Shareholder’s equity; IV. Liabilities
A. I and II
B. I and IV
C. II and III
D. II and IV
A. I and II
Working capital is reduced because the heavy equipment is purchased with cash, a current asset. Fixed assets are affected because the value of long-term assets increases. (Heavy equipment is increased.) Total assets, however, do not change.
What ratio would an analyst consider when evaluating a corporation’s ability to service its debt?
A. Working capital ratio
B. Debt/equity ratio
C. Interest coverage ratio
D. Leverage ratio
C. Interest coverage ratio
The interest coverage ratio measures how easily the entity can pay interest on its outstanding bonds. A higher number is better.
ABC Corp., a newly formed corporation, is developing a machine to harness wind power to create energy. Because ABC currently has no earnings and is still in the growth phase, it is unable to pay cash dividends to its investors. However, ABC is very optimistic about its new product and wants to provide some sort of dividend to its current shareholders. ABC’s board of directors declares a 20% stock dividend to its current shareholders. An investor who currently owns 1,000 shares valued at $50 per share would own what after the stock dividend?
A. 1,200 shares at $50
B. 1,200 shares at $41.67
C. 1,000 shares at $50
D. 1,000 shares at $41.67
B. 1,200 shares at $41.67
When a corporation declares a stock dividend, the number of shares goes up while the price per share goes down. The aggregate or total value of the investment stays the same. In the case of ABC Corp. declaring a 20% stock dividend, an investor who owned 1,000 shares will now own 1,200 shares. However, the value of $50 per share will be reduced to $41.67 per share (50/1.20). The total value of the investment remains $50,000.
The amount of stock that a corporation is allowed to issue is called:
A. Treasury stock.
B. Authorized stock.
C. Outstanding stock.
D. Issued stock.
B. Authorized stock.
Authorized stock is specified in the corporate charter and is the total number of shares that the corporation may ultimately issue to the public.
The ex-dividend date is:
A. The first date on which the stock trades without the dividend.
B. Two business days after the record date.
C. The date the corporation distributes the dividends to shareholders.
D. The last date to purchase the stock for cash settlement and receive the dividend.
A. The first date on which the stock trades without the dividend.
The ex-date is the first day that the stock trades without the legal right to receive the dividend. On the ex-date, the stock price drops by the amount of the dividend.
A customer instructs his broker/dealer to purchase 200 shares of Dunham Corporation. Two days after trade date, the customer decides that he no longer wants the shares. Which statement is correct?
A. The customer has entered into a legally binding contract and is obligated to pay for the stock.
B. A trade may be canceled any time up to settlement date.
C. Because it is before settlement date, the customer is not obligated to pay for the trade.
D. Because the 24-hour grace period has expired, the customer must pay for the purchase.
A. The customer has entered into a legally binding contract and is obligated to pay for the stock.
On trade date, the terms of the trade are set, and the customer has entered into a legally binding contract.
A corporation with a low common stock ratio is:
A. Conservatively managed.
B. Financed more by preferred stock than common stock.
C. Less vulnerable to interest rate changes.
D. More vulnerable to interest rate changes.
D. More vulnerable to interest rate changes.
A low ratio indicates a large portion of the corporation’s capitalization is debt; it is highly leveraged. This makes the corporation vulnerable to rate changes. A low ratio indicates aggressive, not conservative financial management.
If a U.S. corporation was looking for maximum tax relief, which of the following investments should the registered representative recommend?
A. Common stock issued by another U.S. corporation
B. Common stock issued by a foreign corporation
C. Treasury stock
D. Bond
A. Common stock issued by another U.S. corporation
Of these choices, a U.S. corporation would achieve the best tax relief by purchasing shares in another U.S. corporation. Dividends received from another domestic corporation qualify for the 50% exclusion from taxes. The investing corporation would only pay taxes on 50% of the dividend distribution.
The ex-dividend date for XYZ is Monday, March 23. Under which of the following conditions would an investor purchasing XYZ receive the dividend?
A. Buys XYZ Monday, March 23 in a regular way trade
B. Buys XYZ Wednesday, March 25, for cash settlement
C. Buys XYZ Friday, March 27, for cash settlement
D. Buys XYZ Friday, March 20 in a regular way trade
D. Buys XYZ Friday, March 20 in a regular way trade
If Monday, March 23 is the ex-date, then Tuesday, March 24 is the record date. Therefore, a regular-way purchase on Friday, March 20 would buy (or receive) the dividend because settlement occurs on Tuesday, March 24 (or T+2) meeting the requirement that settlement must occur on or before the record date.
The amount of money that an investor pays for newly issued common stock in excess of its par value is called
A. Excess par value.
B. Book value.
C. Retained earnings.
D. Paid in capital surplus.
D. Paid in capital surplus.
When a corporation first issues stock to the public, any amount the investor pays for the new shares above par value is called “paid in capital surplus.”
A corporation’s capital structure consists of the following: Debenture - 7% - $1,000 par, maturity 2022: $4,000,000; Common stock - $1 par, 200,000 shares outstanding: $200,000; Capital in excess of par: $800,000; Retained earnings: $5,000,000. The corporation, for the current year, earns $1,500,000 before interest and taxes and is in the 50% tax bracket. What are the company’s earnings per share?
A. $0.25
B. $3.05
C. $3.75
D. $7.50
B. $3.05
Corporate profit of $1,500,000 minus $280,000 interest (7% X 4 million) = $1,220,000 X 50% = $610,000 divided by 200,000 shares = $3.05.
The bond ratio measures:
A. The portion of debt which matures in the next 12 months.
B. Short-term debt compared to long-term debt.
C. Total debt to common stock.
D. The amount of corporate capitalization that comes from long-term debt.
D. The amount of corporate capitalization that comes from long-term debt.
The bond ratio equals total bond par value ÷ total long-term capitalization.
Which measures a corporation’s solvency?
A. Working capital
B. Profit margin
C. Cash flow
D. Debt/equity ratio
A. Working capital
Working capital = current assets - current liabilities. It measures a corporation’s ability to meet current debt obligations.
One way an analyst evaluates management efficiency is by reviewing the
A. Return on common equity.
B. Debt/equity ratio.
C. P/E ratio.
D. Fully diluted EPS.
A. Return on common equity.
Return on common equity measures the return which management achieves on common stockholders’ equity. A higher ratio is better.
A corporation has the following: Revenue: $200,000. Operating expenses: $180,000 (includes $4,000 depreciation). Interest on notes: $11,000. Taxes (34%): $3,060. What is cash flow?
A. $5,940
B. $9,000
C. $9,940
D. $16,940
C. $9,940
Revenue minus the total of all expenses, including interest and taxes = $5,940. Then add depreciation, a non-cash expense for $9,940.
Which of the following best describes the purpose of a balance sheet?
A. It helps investors understand the company’s solvency.
B. It summarizes what the company owns and owes.
C. It demonstrates the company’s profits and losses.
D. It only shows the company’s assets.
B. It summarizes what the company owns and owes.
A balance sheet is a financial statement that summarizes a company’s assets, liabilities and shareholders’ equity at a specific point in time; in other words, it demonstrates what the company owns and owes.
The equation for outstanding stock is
A. Issued shares minus unissued shares.
B. Authorized shares minus unissued shares.
C. Issued shares minus treasury stock.
D. Authorized shares minus treasury stock.
C. Issued shares minus treasury stock.
Outstanding Stock = Issued Shares – Treasury Stock. Remember that treasury stock, which is stock that has been issued (sold to the public) and subsequently bought back by the corporation, must be subtracted from the shares that have been issued.
In order of liquidation, which of the following has a residual claim to the assets of the corporation?
A. General creditors
B. Secured bondholders
C. Preferred shareholders
D. Common shareholders
D. Common shareholders
Common shareholders are said to have a residual claim to assets. This means that common shareholders are the last to be paid per the order of bankruptcy liquidation. As owners, common shareholders take the most risk and also receive the greatest benefit if the company prospers.
All of the following types of stocks would be eligible for dividends EXCEPT:
A. Outstanding stock.
B. Treasury stock.
C. Preferred stock.
D. Common stock.
B. Treasury stock.
Treasury stock has no voting rights and does not receive dividends since the corporation holds these shares.
A corporation uses the statutory voting method. The shareholder owns 200 shares and there are five vacancies up for re-election. What is the maximum number of votes the shareholder may cast for any one vacancy?
A. 1
B. 5
C. 200
D. 1,000
C. 200
Statutory voting rights allow for one vote per share per vacancy. No matter what the number of vacancies is, the maximum limit of votes per vacancy is one per share. In this case, 200 shares owned = 200 votes per vacancy.
Which of the following will not affect a corporation’s reported net income?
A. Payment of a cash dividend to common shareholders
B. The carry forward of a loss from a prior tax year
C. A reduction of the company’s effective tax rate
D. A change of inventory procedure from FIFP to LIFO
A. Payment of a cash dividend to common shareholders
Payment of a dividend affects shareholder income but is after-tax to the corporation, having no effect on its net income.
Which of the following is not affected by the sale of debentures?
A. Working capital
B. Shareholders’ equity
C. Total assets
D. Liabilities
B. Shareholders’ equity
Receipt of cash from sale of bonds increases assets, working capital (current assets vs. current liabilities), and liabilities. There is no effect on a shareholder’s equity.
EPS measures:
A. Earnings after interest but before taxes.
B. Earnings available to common stockholders.
C. Earnings paid to stockholders.
D. Earnings available to stockholders.
B. Earnings available to common stockholders.
EPS is net income available to common stock after the preferred dividend is paid.
An analyst comparing the stock prices of two similar market competitors would most be interested in their:
A. P/E ratio.
B. Fully diluted EPS.
C. Debt ratio.
D. EPS.
A. P/E ratio.
The P/E ratio measures the value of a stock at its current price, and is one of the most commonly used tools when comparing similar stocks.
A stock dividend affects which of the following? I. Assets; II. Liabilities; III. Shareholder’s equity; IV. Net worth
A. I and IV
B. II and III
C. III and IV
D. I and III
C. III and IV
A stock dividend reduces retained earnings and increases shares outstanding proportionately.
ABC Corporation shares are currently trading at $50 per share. ABC is about to perform a two-for-one stock split. After the split, an investor who currently owns 100 shares of ABC stock would own:
A. 200 shares at $25.
B. 100 shares at $50.
C. 100 shares at $25.
D. 200 shares at $50.
A. 200 shares at $25.
200 shares at $25 a share is what the investor would own after the two-for-one split. It is important to remember that the aggregate value remains the same; however, the number of shares goes up and the price per share goes down proportionately. In this case, 2/1 × 100 shares before = 200 share after ½ × $50 per share before = $25 price per share after.
Fully diluted earnings per share:
A. Assumes interest and preferred dividends have been paid.
B. Is reported to the IRS.
C. Is a larger number than EPS.
D. Is a smaller number than EPS.
D. Is a smaller number than EPS.
Fully diluted EPS is a theoretical number. It is the earnings which would be available to commons shares if all convertible securities were converted to common stock. Fully diluted EPS assumes interest and dividends on convertible bonds and convertible preferred stock has NOT been paid. Because the total number of common shares significantly increases, fully diluted EPS is a smaller number than EPS.
Which of the following is NOT affected by the declaration of a dividend?
A. Working capital
B. Net worth
C. Assets
D. Liabilities
C. Assets
The declaration of a dividend increases current liabilities and reduces retained earnings. There is no impact on cash (assets) until the dividend is paid. When current assets are unchanged and current liabilities increase, working capital decreases.
Shares of stock that have actually been sold to the public are known as:
A. Issued stock.
B. Treasury stock.
C. Outstanding stock.
D. Authorized stock.
A. Issued stock.
Issued shares are the amount of stock that has been sold to the public.
Most stockholders vote by proxy. What does this mean?
A. They waive their right to vote.
B. They send their ballot by certified mail.
C. They grant limited power of attorney to someone to vote on their behalf.
D. They vote for the most popular candidate.
C. They grant limited power of attorney to someone to vote on their behalf.
Because attendance is usually inconvenient, most stockholders vote by proxy. A proxy is a limited power of attorney that the stockholder grants to someone to vote the stock either at his or her own discretion or at the instruction of the stockholder.
What is regular-way settlement for Treasury bonds?
A. T
B. T+1
C. T+2
D. Same day
B. T+1
Government notes and bonds, including treasury bonds, settle regular way, which is the next business day (also known as T+1).
For stock dividends, which of the following dates is NOT chosen by the board of directors?
A. Ex-dividend date
B. Declaration date
C. Record date
D. Payable date
A. Ex-dividend date
The ex-dividend date is dictated by the SRO. The other three dates are chosen by the corporation’s board of directors.
Which of the following discloses the assets available to common stock?
A. Book value per share
B. Fully diluted EPS
C. EPS
D. Debt/equity ratio
A. Book value per share
The book value per share is the residual value of assets left after all other parties are paid, including preferred stock.
Your client owns stock in a company that has announced a stock rights offering. If the client does not subscribe to the offer, his percentage of ownership interest in the company will:
A. Be worth more.
B. Increase.
C. Decrease.
D. Remain the same.
C. Decrease.
If a client does not subscribe to the shares entitled by his preemptive rights during a stock rights issue, his proportionate ownership will decrease because there will be an increase in outstanding shares owned by others after the offer.
Which of the following is not included in the current assets section of a balance sheet?
A. Inventory
B. Cash
C. Goodwill
D. Accounts receivable
C. Goodwill
Goodwill appears in the intangible assets section, below fixed assets.
A corporation offers its shareholders the privilege of obtaining its shares at a fixed price. What type of product is the corporation issuing?
A. Rights
B. Puts
C. Calls
D. Cumulative preferred stock
A. Rights
Corporations issue rights to allow shareholders to maintain their same ownership percentage in a corporation when new shares are issued. These shares are purchased at a fixed price (subscription price), which is lower than the public offering price.
Which of the following types of preferred stock might have regular changes in the dollar amount of its dividend?
A. Cumulative
B. Adjustable rate
C. Convertible
D. Participating
B. Adjustable rate
Adjustable rate preferred stock has a dividend that changes based on the performance of a benchmark security, and typically adjusts quarterly. Participating preferred stock might occasionally receive a dividend in excess of the normal stated divided, but this is an infrequent occurrence. Both participating and convertible preferred stock have fixed dividends.
A small corporation is raising $7,500,00 through a private placement of common stock. According to Regulation D, they can sell stock to all of the following groups of investors EXCEPT:
A. Unlimited number of accredited investors.
B. An insurance company and 20 non-accredited investors who are all represented by a purchaser representative.
C. An amateur investment club consisting of 25 investors with incomes of less than $75,000 per year, all represented by a purchaser representative.
D. A group of 40 individuals with annual incomes of $100,000 to $150,000 a year for 5 consecutive years. Two of the 40 investors have a net worth in excess of $1,000,000.
D. A group of 40 individuals with annual incomes of $100,000 to $150,000 a year for 5 consecutive years. Two of the 40 investors have a net worth in excess of $1,000,000.
Choice D is incorrect because under Regulation D, the company may sell securities to up to 35 non-accredited investors, and 38 investors in this example are non-accredited. All 40 have incomes less than $200,000 a year. Two of the 40 are accredited regardless of their incomes because they have a net worth of $1,000,000 or more.
An officer of ABC Corporation wants to sell some of the ABC stock in the secondary market to purchase a vacation home. He calls his registered representative and asks how many shares he can sell and stay within the requirements of Rule 144. The registered representative tells the officer that he will need to:
A. Call the SEC and ask them how many shares he will be allowed to trade.
B. Look at the number of outstanding shares of ABC And the average trading volumes for the previous 4 weeks.
C. Call the Exchange and ask them how many shares he will be allowed to trade.
D. Determine the number of shares he sold in the last trade and he is able to sell an equal amount of shares this time.
B. Look at the number of outstanding shares of ABC And the average trading volumes for the previous 4 weeks.
The officer would be able to sell the greater of 1% of the outstanding shares or the average trading volume for the previous four weeks. Form 144 is filed concurrently with the sale and the volume limitation applies during a 90-day period applicable to the Form 144.
The investment banker bears all the risk of unsold shares of a new issue security in which situation?
A. Firm commitment underwriting
B. The investment banker is never exposed to that type of risk.
C. All-or-nothing commitment
D. Best efforts underwriting
A. Firm commitment underwriting
In a firm commitment underwriting, the investment banker pays the issuer the value of all the shares, less the agreed upon compensation to the underwriting syndicate. If the issue is slow to sell or doesn’t sell, the investment banker selling the issue assumes the risk.
The purpose of a Rule 144 filing is to:
A. Announce a secondary offering.
B. Provide historical performance data.
C. Identify corporate insiders.
D. Alert the SEC that a control person is offering securities for sale.
D. Alert the SEC that a control person is offering securities for sale.
Rule 144 is a filing with the SEC concerning the sale of controlled securities.
A customer receives a red herring from his registered representative and has indicated interest in the offering. Which two of the following are true? I. The customer is obligated to buy the stock. II. The customer is not obligated to buy the stock. III. The broker/dealer is allowed to accept a deposit to secure the customer’s indication of interest. IV. The broker/dealer is not allowed to accept a deposit to secure the customer’s indication of interest.
A. II and III
B. II and IV
C. I and III
D. I and IV
B. II and IV
During the 20-day cooling-off period, deposits may not be accepted, and customers are not obligated to buy.
All of the following are required to register under Rule 145 for mergers and acquisitions EXCEPT:
A. A leveraged buy-out.
B. Stock splits or stock dividends.
C. An acquisition in which the acquirer is using both cash and securities.
D. A merger involving a stock offering.
B. Stock splits or stock dividends.
Rule 145 does not require the filing of a registration statement when a company declares a stock dividend or engages in a stock split.
The legislation that regulates the sale of securities at the state level is known as the:
A. Securities Act of 1933.
B. Investment Company Act of 1940.
C. Securities Act of 1934.
D. Blue Sky laws.
D. Blue Sky laws.
State securities laws are known as Blue Sky laws. These laws are tested under the Series 63 examination.
XYZ Corporation Primary Distribution Total issue: 1,000,000 shares; Retained for sale by underwriters: 800,000 shares; Reserved for distribution to selling group: 200,000 shares. PER SHARE: Public Offering Price: $10.00; Manager’s fees and expenses: .10; Underwriter’s allowance: .70; Selling Concession: .50; Proceeds to Issuer: 9.20. The underwriting spread is:
A. $0.10
B. $0.70
C. $0.80
D. $1.30
C. $0.80
By definition, the “underwriting spread” is the difference between the public offering price per share ($10) and the proceeds to the issuer (9.20).
Which of the following is NOT an exempt transaction?
A. An issue sold to 800 accredited investors
B. An issue of 5-year Treasury notes
C. An issue of $3.5 million over 1 year
D. An issue sold in one state
B. An issue of 5-year Treasury notes
Treasuries are an exempt security. The other three are exempt transactions.
The agreement among underwriters, also known as the syndicate letter, is a document that:
A. Is an agreement between participating broker/dealers who assume liability for any unsold shares and specifies the underwriters’ responsibilities and participation percentages.
B. Is an agreement that is provided to the investor for full and fair disclosure purposes.
C. Is between the issuer and the underwriters and specifies the offering price of the securities.
D. Is delivered to the issuer and defines the underwriting spread.
A. Is an agreement between participating broker/dealers who assume liability for any unsold shares and specifies the underwriters’ responsibilities and participation percentages.
The agreement among underwriters, also known as the syndicate letter, is between the broker/dealers who have formed the underwriting syndicate. It spells out the responsibilities of each syndicate member and each member’s percentage liability. It is important to differentiate the agreement among underwriters from the underwriting agreement. The agreement among underwriters is between syndicate members. The underwriting agreement is between the managing underwriter and the issuer.
XYZ Corporation is planning an add-on offering. XYZ currently has outstanding shares and is now raising additional capital to build a new manufacturing plant. The quiet period in which no research may be published on XYZ will last for how many days?
A. 3 days from the effective date
B. 5 days from the effective date
C. 12 days from the effective date
D. 40 days from the initial filing of the registration statement
A. 3 days from the effective date
The quiet period for a subsequent primary or add-on offering is 3 days from the effective date. This is the time period during which no research may be published on XYZ to prevent influencing the market value of XYZ outstanding stock.
Which of the following is exempt from FINRA Rule 5130, which prohibits the purchase of IPOs by member firms and associated persons?
A. An associated person who works for a member firm in the selling group
B. An associated person whose limited registration permits selling only investment company products
C. An associated person who works for a member of the syndicate, but does not plan on selling the IPO to customers
D. An associated person who works for a member firm not involved in the syndicate
B. An associated person whose limited registration permits selling only investment company products
An associated person with a limited registration is not a restricted person. The other associated persons are restricted. Whether an associated person plans to sell the IPO and whether the member firm is involved with the offering is irrelevant.
After a registered representative sends a red herring (preliminary prospectus) to a customer, each of the following activities is permissible EXCEPT:
A. Discussing the information in the preliminary prospectus with the customer.
B. Sending the final prospectus to the customer once the registration is effective.
C. Obtaining an indication of interest in the issue from the customer.
D. Guaranteeing the offering price of the issue to the customer.
D. Guaranteeing the offering price of the issue to the customer.
Since the offering price has not yet been determined, it cannot be guaranteed. The word “guarantee” should always be treated cautiously on the Series 7 exam.
Which act is most concerned with disclosure?
A. Securities Act of 1933
B. Securities Act of 1934
C. Maloney Act of 1938
D. Trust Indenture Act of 1939
A. Securities Act of 1933
The ’33 act requires SEC registration and prospectus disclosure.
XYZ Corporation Primary Distribution: Total issue: 1 million shares; Retained for sale by underwriters: 800,000 shares; Reserved for distribution to selling group: 200,000 shares. PER SHARE: Public Offering Price: $10.00; Manager’s fee and expenses: .10; Underwriter’s allowance: .70; Selling concession: .50; Proceeds to issuer: 9.20. Subsequent to the public offering, XYZ Corporation will receive a check from the underwriting syndicate for:
A. $8.7 million.
B. $9.2 million.
C. $9.5 million.
D. $10 million.
B. $9.2 million.
The proceeds to the issuer will be $9.20 per share for 1 million shares.
All of the following are true regarding indications of interest received by an underwriter of a new public offering during the 20-day cooling off period EXCEPT I. Indications cannot be canceled by the customer. II. Indications can be canceled by the customer. III. Indications can be canceled by the underwriting firm. IV. Indications cannot be canceled by the underwriting firm.
A. II and IV
B. I and III
C. I and IV
D. II only
C. I and IV
I and IV are the answers to this question (note the word “EXCEPT”) since indications are binding on neither the customer nor the underwriter.
Which of the following must be sold by prospectus?
A. Illinois 5% bond
B. ABC Bank 6% debenture
C. ABC Bank Corp 6% debenture
D. LMN County 4% bond
C. ABC Bank Corp 6% debenture
Securities issued by bank holding companies are not exempt.
If certain requirements are met, a corporation can offer securities sold within the borders of one state using the intrastate offering exemption, also known as:
A. Rule 147.
B. Regulation A+.
C. Regulation D.
D. Rule 144.
A. Rule 147.
SEC Rule 147 is the intrastate offering exemption. Certain requirements must be met with regard to the company’s assets, revenues, and proceeds. Also, 100% of the purchasers must be principal residents of the state.
Under Rule 144A, a qualified institutional buyer has:
A. At least $150 million in public float.
B. $50 million in public float and has not missed an interest or dividend payment in 3 years.
C. At least $100 million in assets under discretionary management.
D. At least 80% of its assets in one state.
C. At least $100 million in assets under discretionary management.
A QIB has at least $100 million in assets under discretionary management.
An analyst publishes a quarterly newsletter on technology stocks. The analyst regularly follows 15 young tech companies in this report. One of these companies is issuing stock through an APO. Which of the following is true?
A. The analyst must suspend the newsletter during the offering period.
B. During the offering period, the analyst must omit this company from the report.
C. During the offering period, the analyst must feature this company individually in the report.
D. During the offering period, the analyst may include this company but give it no special recognition.
D. During the offering period, the analyst may include this company but give it no special recognition.
The analyst may include the company if it is not highlighted or if past recommendations about the company are not changed.
Which of the following is designed to prevent fraud in the issue of securities?
A. Securities Act of 1934
B. Rule 144
C. Regulation A
D. The Securities Act of 1933
D. The Securities Act of 1933
The primary purpose of the Securities Act of 1933 is to provide purchasers of new issues fraud prevention in the sale of securities.
A tender offer is:
A. An offer to buy stock at a price above current market value.
B. An offer to sell stock at a price below current market value.
C. An offer extended to convertible securities at a parity exchange rate.
D. An offer to exchange stock at current market value on a specified date.
A. An offer to buy stock at a price above current market value.
A tender offer is a formal offer made by the corporation to existing shareholders to purchase their shares at a price above current market value.
ABC is a broker/dealer underwriting its own IPO. ABC is required to hire an independent underwriter to facilitate the IPO. What are the qualifications for the independent underwriter?
A. The underwriter must have done at least three offerings in the last 3 years. These three offerings must have been at least 50% of the size and type of ABC’s offering.
B. The independent underwriter must be owned by or affiliated in some manner with ABC brokerage firm.
C. The underwriter must have brought at least three other broker/dealers public in the last 5 years.
D. The underwriter must be a publicly traded company.
A. The underwriter must have done at least three offerings in the last 3 years. These three offerings must have been at least 50% of the size and type of ABC’s offering.
When ABC goes public, it must employ at least one qualified independent underwriter. The qualification of this underwriter is that it has done at least three offerings of this type that are at least 50% of this offering’s size in the last 3 years. The independent underwriter’s function is to help price the security.
According to the Securities Act of 1933, when new securities are sold in an IPO of a company that qualifies for listing on the NYSE, the final prospectus is to be delivered:
A. Only at the investor’s request.
B. Right after purchase of new securities.
C. Within 25 days of the effective date.
D. Whenever the representative thinks is best.
C. Within 25 days of the effective date.
In a sale of IPO securities, the final prospectus must be delivered to any customer within 25 days of the effective date if it qualifies to be listed on the exchange. If the IPO does NOT qualify for listing, the prospectus delivery requirement is 90 days.
ABC Corporation owns a division that manufactures a niche product used in the automotive industry. ABC feels that this division would be better served as its own entity, separate from the parent company. If ABC chooses to separate this portion of its manufacturing business, the process is a:
A. Secondary offering.
B. Merger.
C. Spinoff.
D. Stock distribution.
C. Spinoff.
When a company decides to separate a division into its own entity, the process is called a spinoff. Sometimes it is advantageous for a division to operate independently.
An issuer can avoid registration by engaging in a private placement of securities under Regulation D if certain requirements are met. Which of the following statements is CORRECT?
A. No more than 35 non-accredited investors may be involved in the sale.
B. The buyer must be given access to the financial information that would be found in a prospectus of a public offering.
C. The issuer needs assurance that the buyer has no intentions of making a quick sale of the investment.
D. All of the above are correct statements.
D. All of the above are correct statements.
All of the statements are correct regarding Regulation D conditions.
Who of the following are restricted persons associated with an IPO? I. An uncle of a registered representative; II. The father-in-law of a registered representative; III. A broker/dealer not involved in the syndicate; IV. A new registered representative’s grandparents
A. I and III
B. II and III
C. II and IV
D. III and IV
B. II and III
FINRA Rule 5130 states that broker/dealers and associated persons are not allowed to purchase IPOs from a syndicate. The broker/dealer’s involvement in the syndicate is irrelevant. This restriction extends to a registered representative’s in-laws, siblings, children, parents and spouses. Aunts, uncles, cousins and grandparents are excluded. Additionally, anyone financially supported by the registered representative or associated person is also a restricted person.
SEC stands for:
A. Secret Exchange Commission.
B. Securities Exchanging Committee.
C. Securities and Exchange Commission.
D. Secret and Exclusive Committee.
C. Securities and Exchange Commission.
SEC stands for Securities and Exchange Commission.
An issuer that currently has $150 million in outstanding capitalization and has an average daily trading volume of $1 million would have a restriction period for their add-on offering of:
A. 0 days.
B. 1 day prior to the effective date.
C. 5 days from the effective date.
D. 40 days from the effective date.
A. 0 days.
Issuers with a public float of at least $150 million and an average daily trading volume of $1 million would have no restrictions prior to the effective date. Issuers with an average daily trading volume of at least $100,000 and $25 million in public float are subject to a restricted period of 1 day before the effective date. Tier 3 companies – companies that do not qualify for Tier 1 or Tier 2 (smaller companies) – have a 5-day restricted period.
Which of the following falls under the category of an exempt security?
A. U.S. government bond
B. Common stock
C. Corporate bond
D. Mutual fund
A. U.S. government bond
Only the U.S. government bond is an exempt security; the rest are considered nonexempt securities and must be registered under the Securities Act of 1933.
When material deficiencies are discovered in the registration statement, the SEC will
A. Hire an underwriter to correct the registration statement.
B. Notify the appropriate state securities administrator.
C. Refer to the SRO.
D. Issue a deficiency letter or a stop order.
D. Issue a deficiency letter or a stop order.
The SEC will issue a deficiency letter, which suspends the cooling-off period until the deficiency is corrected, or a stop order, to prohibit sale until the deficiency is corrected.
Which of the following is true of restricted stock?
A. Shares are registered with the SEC.
B. A broker/dealer cannot act as an agent.
C. It must be held for 2 years before resale.
D. The purchase must be paid for in its entirety.
D. The purchase must be paid for in its entirety.
If a selling company is subject to the SEC reporting requirements, the securities must be held at least 6 months. Otherwise, they must be held at least 1 year. The holding period begins when the securities are bought and fully paid for. A broker/dealer can act as an agent, but restricted stock is not registered with the SEC.
Under Rule 144, when does an affiliate need to file a Notice of Proposed Sale with the SEC?
A. Every 3 months
B. If the sale involves more than 5,000 shares
C. If the sale adds up to $5,000
D. Every time there is a sale of restricted securities
B. If the sale involves more than 5,000 shares
If the sale involves more than 5,000 shares, or if the aggregate dollar amount is greater than $50,000 in any 90-day period, affiliates must file a notice with the SEC.
A research analyst has a meeting with an employee from investment banking. This is:
A. Prohibited until after the cooling-off period.
B. Prohibited under all circumstances.
C. Permissible if the meeting is attended by a compliance officer.
D. Permissible only when they are working on the same underwriting.
C. Permissible if the meeting is attended by a compliance officer.
An employee from the legal or compliance department must be present if the analyst is speaking with the investment banking department.
An analyst includes ABC’s 6% debenture in his newsletter. The analyst’s employer is currently underwriting an ABC stock offering. This is permissible:
A. Only with advance SRO approval.
B. If the analyst’s employer is not the managing underwriter.
C. If the bonds are not convertible.
D. Under no circumstances.
C. If the bonds are not convertible.
Because the bond is a different security than the stock, including it in the newsletter is permissible if it is not convertible into stock.
A director of a public corporation wishes to sell some of his stock in the company. Under SEC Rule 144, how long is the holding period?
A. 3 months
B. 6 months
C. 12 months
D. 24 months
B. 6 months
Before restricted securities may be sold in the marketplace, they must be held for a specified period of time. If a selling company is subject to the SEC reporting requirements, the securities must be held at least 6 months; otherwise, at least 1 year.
In order to be considered an accredited investor, in each of the past 2 years the investor’s income must exceed:
A. $200,000.
B. $300,000.
C. $400,000.
D. $500,000.
A. $200,000.
An individual natural person is an accredited investor if his or her income in each of the past 2 years exceeded $200,000 and it is reasonable to expect the same income level in the current year. If it is a joint account, the income test increases to $300,000.
ABC Corporation has issued a tender offer to the shareholders of XYZ Corp. Which of the following is a permissible way for a shareholder to sell into the offer?
A. Deliver 2 warrants, each representing one round lot of the stock
B. Deliver 1 warrant, representing one round lot of the stock
C. Deliver one round lot of the stock
D. Deliver an option on 100 shares of the stock
C. Deliver one round lot of the stock
A shareholder who sells into a tender offer must deliver shares net long. This means that the actual shares must be delivered. Options and warrants must be exercised first, then the resulting shares may be delivered into the tender. An investor may not sell short into the tender.
An issuer who has at least $100,000 in average daily trading volume and $25 million in public float is planning to bring additional shares to market. What would the restriction period be?
A. 1 day prior to the effective date
B. 3 days prior to the effective date
C. 10 days prior to the effective date
D. 20 days prior to the effective date
A. 1 day prior to the effective date
For issuers offering additional shares who currently have an average daily trading volume of at least $100,000 and $25 million in public float, the restriction for offering participants is 1 day prior to the effective date.
All are true about a red herring EXCEPT
A. It includes the price of the security.
B. It helps to determine demand for a new issue.
C. It’s also known as a preliminary prospectus.
D. It’s given to investors before the prospectus is finalized.
A. It includes the price of the security.
The red herring does not include the price of the security. The red herring, or preliminary prospectus, is often used to gauge subsequent market interest on the effective date.
Once a shelf registration is filed by the issuer, for how long may the issuer delay selling all or part of the new issue?
A. 270 days
B. 1 year
C. 18 months
D. 2 years
D. 2 years
In general, shelf registration gives the issuer 2 years to complete the issue. It may be as long as 3 years for seasoned (SIs) and well-known seasoned investors (WKSIs).
Which of the following is not a method to register a security at the state level?
A. Qualification
B. Application
C. Coordination
D. Notification
B. Application
The three methods used to “blue sky” a security are notification, coordination, and qualification.
Under Reg D rule 506, how much money can be raised within 12 months?
A. $1 million
B. $5 million
C. $10 million
D. An unlimited amount
D. An unlimited amount
Under Reg D rule 506, there is an unlimited amount of money that can be raised.
XYZ Corporation Primary Distribution: Total Issue: 1 million shares; Retained for sale by underwriters: 800,000 shares; Reserved for distribution to selling group: 200,000 shares. PER SHARE: Public Offering Price: $10.00; Manager’s fee and expenses: .10; Underwriter’s allowance: .70; Selling concession: .50; Proceeds to issuer: 9.20. Each underwriter will receive what fee per share for the stock he gives up to the selling group?
A. $0.20
B. $0.30
C. $0.50
D. $0.70
A. $0.20
The syndicate underwriter’s allowance (take-down) is $0.70, but on sales made by the selling group, the syndicate members are conceding $0.50 of the $0.70 to the selling group. The syndicate is, in effect, receiving a $0.20 override on sales made by the selling group.
After a company has streamlined its operations, one of its peripheral operations no longer fits in this newer business mode, so the company plans to sell it. This is called a:
A. Spinoff.
B. Registered secondary offering.
C. Tender offer.
D. Rule 147 offering.
A. Spinoff.
Selling or separating a portion of a corporation is called a spinoff.
A $200 million new issue is being underwritten by a syndicate. A “tombstone” ad has been placed in the Wall Street Journal listing the manager of the syndicate and the syndicate’s members. The placing of the ad was required by the:
A. SEC.
B. NYSE.
C. State Securities Commission.
D. None of the above.
D. None of the above.
No one requires an underwriter to publish a tombstone ad.
Under Reg D rule 504, how much money may be raised within 12 months?
A. $3 million
B. $5 million
C. $10 million
D. An unlimited amount
B. $5 million
Under Reg D rule 504, the maximum amount that can be raised in any 12 months would equal $5 million. Additionally, all investors must be accredited investors.
Jack owns a small manufacturing company in the Northeast. The company is publicly traded; however, its capitalization is very small. Jack would like to expand his operations over the next 2 years. Which of the following types of offerings will best suit the manufacturing company’s needs?
A. A registered secondary offering
B. An immediate offering at the market
C. An initial public offering, or IPO
D. A shelf offering
D. A shelf offering
The best answer is a shelf offering, since the issuer will need the money in stages over the next 2 years. Because the issuer is small, it only qualifies for a 2-year offering period. IPO is not the answer because an issuer only has one initial public offering. In a registered secondary offering, the offering proceeds go to a party other than the issuer. An immediate offering at the market is a possible choice. However, since the issuer will need the capital in stages, shelf offering is the better answer.
A corporation can avoid registration requirements in the issuance of securities by engaging in a private placement under:
A. Regulation A.
B. Rule 144.
C. Rule 147.
D. Regulation D.
D. Regulation D.
Private placement conditions are covered under Regulation D.
A guaranteed bond is one that is guaranteed by another company or entity. We would typically see a guaranteed bond used in which of the following situations?
A. Competitive bid underwriting
B. Merger
C. Spinoff
D. Registered secondary offering
C. Spinoff
A spinoff occurs when a division of the company is separated into a new entity. Often this new entity will issue bonds that are guaranteed by the company it was formerly associated with to reduce interest costs. The spinoff entity is sometimes held as a subsidiary. In other instances, it is sold to another company.
A “Chinese Wall” is:
A. A separation between the managing underwriter and the syndicate members.
B. A separation between the issuer and the syndicate.
C. A separation between investment banking and the other functions inside a broker/dealer.
D. A separation between the trading department and the back office inside a broker/dealer.
C. A separation between investment banking and the other functions inside a broker/dealer.
The Chinese Wall separates the investment banking department (also called the underwriting department), which handles inside information, from other departments of the broker/dealer.
Which of the following transactions requires distribution of an offering circular to prospective investors?
A. Rule 147
B. Reg A+
C. Rule 144A
D. Reg D
B. Reg A+
Regulation A+ or small issue exemptions, use an offering circular for disclosure instead of a prospectus. It must be sent to the prospective buyer either 48 hours prior to the purchase, or at the time of purchase, with a 5-day right of rescission.
Most restricted stock is acquired through which of the following types of offerings?
A. Private placement
B. Direct participation program
C. Registered secondary
D. Regulation A
A. Private placement
Unregistered securities purchased through a private placement are governed by Reg D. These securities are restricted from resale for 6 months for SEC-reporting companies, or for 1 year for nonreporting companies. Securities accumulated through Reg A are not restricted securities.
Which of the following is true about a stabilizing bid?
A. It is available to syndicate members, but not selling group members.
B. It is only visible on NASDAQ Level III.
C. The market maker must honor this bid by purchasing at least 100 shares at this price.
D. It must be disclosed in the prospectus.
D. It must be disclosed in the prospectus.
The right of the managing underwriter to enter a stabilizing bid in association with a primary offering must be disclosed in the prospectus.
Which of the following may an analyst do in connection with a public offering?
A. Receive compensation on investment banking activity
B. Include the stock in a quarterly research report only if it has been included previously
C. Participate in road shows
D. Publish research on the security
B. Include the stock in a quarterly research report only if it has been included previously
The stock may be included if it has previously been included in a list with several similar companies and the recommendation is not more favorable than it had been previously. Additionally, the company cannot be given any special recognition.
A coffee producer, an OTC traded company, did an add-on offering to update its roasting facility and expand into the tea market. The prospectus must be delivered within:
A. 25 days of the effective date.
B. 40 days of the effective date.
C. 30 days of the registration date.
D. 90 days after the effective date.
B. 40 days of the effective date.
Non-NASDAQ OTC issuers must deliver a prospectus for 90 days after the effective date in an IPO, and 40 days from the effective date for APOs.
Regarding underwriting compensation, rank the following in order of size from greatest to least. I. Reallowance II. Spread III. Concessions
A. I, III, II
B. II, I, III
C. II, III, I
D. III, II, I
C. II, III, I
The correct answer must show II (spread) as first in order, so the first and last answer choices can be eliminated. The reallowance is the smallest part of underwriting compensation; it is paid to another member whose only interest in the underwriting is filling a few customer orders.
Under Reg A+ Tier 2, what is the maximum amount of money that may be raised?
A. $5 million with no more than $1.5 million by affiliates
B. $20 million
C. $50 million with no more than $15 million by affiliates
D. Unlimited amount of money
C. $50 million with no more than $15 million by affiliates
Under Reg A+ Tier 2, the maximum amount of money that can be raised is $50 million with no more than $15 million by affiliated persons. This is to allow emerging growth companies to raise money.
Under Reg A+ Tier 1, the maximum amount of money that can be raised is $20 million with no more than $6 million by affiliated persons.
XYZ Corporation is a well-known seasoned issuer (WKSI) and is planning to expand operations. XYZ will need additional capital in stages to for this expansion. If XYZ does a shelf offering, how much time will it have to issue additional shares before it has to refile?
A. Ninety days to bring the shares to market and place the money in escrow for use at a later date
B. One year from the effective date of the shelf offering
C. Three years from the effective date of the shelf offering
D. Two years from the effective date of the shelf offering
C. Three years from the effective date of the shelf offering
Because XYZ is a WKSI, it may spread the offering over a 3-year period through a shelf offering. If XYZ was an unseasoned issuer (a smaller company), the shelf offering period would last only 2 years.
What is the most common method of acquiring restricted stock?
A. Rights offering
B. Private placement
C. Employee profit sharing plan
D. Merger
B. Private placement
Private placements are more commonly used to acquire restricted stock. Rights offerings (registered offerings), Employee Stock Ownership Plans (ESOP), and mergers are less common.
The announcement that must be filed in connection with a Regulation D offering is:
A. An offering memorandum.
B. An offering circular.
C. An official statement.
D. An official notice.
A. An offering memorandum.
The announcement that must be filed in connection with a Regulation D offering is an offering memorandum.
A well-known seasoned issuer is issuing securities in an APO. To meet Act of ‘33 disclosure requirements, the issuer may use a/an:
A. Free-writing prospectus.
B. S-1.
C. Offering circular.
D. Offering memorandum.
A. Free-writing prospectus.
WKSIs may use a free-writing prospectus for additional primary offerings (APOs) or add-on offerings.
A Rule 144 filing for the sale of restricted securities by control persons is subject to which of the following time limitations?
A. 30 days
B. 60 days
C. 90 days
D. 120 days
C. 90 days
A filing for sale under Rule 144 has a 90-day time restriction. If the security is not sold within 90 days of filing the Form, the affiliate must file an amended notice.
Upon filing a registration statement with the SEC, at what point would the issuer be required to provide additional information?
A. In the event of material changes in the underwriter’s circumstances
B. In response to an SEC deficiency letter
C. When accounting for offering amendments following commencement of sales
D. When accepting indications of interest
B. In response to an SEC deficiency letter
Additional information is required when responding to SEC deficiency letters. The SEC verifies that full and proper disclosure is made to the investors or potential investors. If something is inherently fraudulent or missing in the registration documents, the SEC will send out a deficiency letter and issue a stop order. The registration process will continue once the issuer provides the additional information to the security and exchange commission.
Which of the following is FALSE regarding a Rule 147 offering?
A. 80% of the issuer’s revenues must be generated in the state.
B. 100% of the purchasers must reside in the state.
C. 100% of the proceeds must be invested in the state.
D. 80% of the issuer’s assets must be in the state.
C. 100% of the proceeds must be invested in the state.
Under Rule 147, 80% of the proceeds must be invested in the state.
The underwriting agreement is between whom?
A. The syndicate members and the selling group
B. The underwriters and the public customers purchasing the new offering
C. The issuer and the managing underwriter
D. The syndicate members
C. The issuer and the managing underwriter
The underwriting agreement is between the issuer and the managing underwriter. It is the document that spells out the duties and responsibilities of each party, including who has liability for any unsold shares.
Some securities are exempt from the registration and prospectus requirements of the Securities Act of 1933. All of the following securities are among this exempt class EXCEPT:
A. Commercial paper that has a maturity not exceeding 270 days.
B. A security issued by a nonprofit organization.
C. A security offered for sale in only one state.
D. U.S. government securities.
C. A security offered for sale in only one state.
Offering all the securities in one state is an exempt transaction (Rule 147). The security offered through the exempt transaction is NOT an exempt security. The other securities listed are exempt securities. Municipal securities are also exempt.
Rule 144A allows:
A. Orderly distribution of insider shares.
B. Sale of insider shares along with an APO.
C. Domestic purchase of foreign securities.
D. Foreign purchase of domestic securities.
C. Domestic purchase of foreign securities.
Rule 144A allows domestic QIBs to purchase securities outside the US if done through a broker/dealer.
Which of the following terms would be used to describe a pre-offering solicitation under Reg A+?
A. A preliminary prospectus
B. Testing the waters
C. Statement of additional information
D. An omitting prospectus
B. Testing the waters
Testing the waters is a term that is used when the issuer is gauging marketability of their offering. A preliminary offering circular is sent to prospective investors to determine the viability of the offering. This is done prior to the offering statement being filed. The other three statements are incorrect because a prospectus is used for a public offering and an omitting prospectus and statement of additional information are both used for an open-end investment company.
XYZ is a publicly traded company and its stock has been doing well for the last several years. XYZ is planning to expand into new markets and would like to raise additional capital to finance this expansion. How may this be done?
A. After the IPO, XYZ can no longer raise capital in the primary markets
B. Registered secondary offering
C. Initial public offering or IPO
D. Add-on offering
D. Add-on offering
In an add-on, or subsequent primary offering, a publicly traded company increases its capitalization by issuing additional shares in the primary market. In a registered secondary offering, a party other than the issuer (usually a large shareholder) sells unregistered shares through a process of registration. In a registered secondary offering, the issuer does not receive the sale proceeds.
Regulation S addresses:
A. Off-shore sales of restricted stock.
B. Extension of credit.
C. Boundaries between underwriting and sales departments.
D. Private issuance of unregistered securities.
A. Off-shore sales of restricted stock.
Regulation S addresses off-shore sales of restricted stock and requires a 1-year holding period. Debt instruments sold under Reg S have a holding period of 40 days. Regulation M requires that broker/dealers establish a Chinese wall between underwriting and sales/trading departments. Regulation D relates to the issuance of unregistered, nonexempt securities. Regulation T governs the extension of credit from a broker/dealer to its customers.
Utilizing stabilization efforts on a new stock issue:
A. Can only be done using sell orders.
B. Must be done before the issue is sold in the marketplace as new issue.
C. Is prohibited under the Securities Act of 1933.
D. Is permitted if reported in the prospectus of the new stock issue.
D. Is permitted if reported in the prospectus of the new stock issue.
Stabilization is a one-sided bid by the underwriter to stop the decline in the price of a new issue of stock. If the syndicate has the ability to utilize stabilization, it must be disclosed in the prospectus.
When selling a new issue of securities within a given state, which of the following would potentially be governed under the state Blue Sky Laws? I. Registered representative; II. Broker/dealer; III. Security
A. I and II
B. I and III
C. II and III
D. I, II and III
D. I, II and III
All three are governed by that state. Generally, all three must be registered in that state. The Blue Sky laws under the Uniform Securities Act are tested in the Series 63 exam.
Under a Regulation S offering, when can the securities be resold to the investors in the United States? I. 40 days for equity securities II. 1 year for equity securities III. 40 days for debt securities IV. 1 year for debt securities
A. I and III
B. I and IV
C. II and III
D. II and IV
C. II and III
The resale in the secondary market of Reg S offerings is restricted for U.S. investors for a period of 1 year or 12 months for equities and 40 days for debt securities.
The investor places a sell stop at $45-limit $43 when the market is currently trading at $46. The following trades have occurred: $45.67, $45.23, $44.32, $42.98. At which price will the customer trade?
A. $45.23
B. $44.32
C. $42.98
D. There was no resulting trade for the customer.
D. There was no resulting trade for the customer.
The sell stop was placed at $45, so once the stock price hit $44.32, the stop was erased, then the limit order was in effect at $43. So the customer was only willing to sell at a price of $43 or better, which would be higher. However, the next trade was at $42.98, which was below the limit price of $43. Therefore, the customer’s trade did not occur.
How do OTC market makers make a profit?
A. By charging commission
B. By acting as agents
C. On the spread between the bid and the ask
D. By buying at the ask and selling at the bid
C. On the spread between the bid and the ask
OTC market makers make a profit on the spread between the bid and the ask in the securities that they trade.
Which system is used to report corporate bond trades?
A. TRACE
B. RTRS
C. TRF
D. OATS
A. TRACE
Trade Reporting and Compliance Engine is used by broker/dealers to report corporate bond trades. OATS is used to monitor for front running and best execution. RTRS tracks municipal bonds. All three systems are TRFs, or Trade Reporting Facilities.
Which of the following most closely expresses FINRA’s Five Percent Policy?
A. Markups/markdowns carry more risk and can be larger than commissions, but should never exceed 5%.
B. Markups/markdowns and commissions should be fair under the circumstances and should probably not exceed 5%.
C. Commissions should be fair and reasonable, and generally not exceed 5%.
D. Markups/markdowns and commissions should never exceed 5%.
B. Markups/markdowns and commissions should be fair under the circumstances and should probably not exceed 5%.
The policy applies to markups, markdowns, and commissions. Five Percent is a guideline, not a firm maximum.
Trade tickets must be time stamped:
A. When the order is received.
B. When the ticket arrives at the trading desk.
C. When the trade is executed.
D. All of the above.
D. All of the above.
All three are required so that there is an audit trail for the trade.
An investor with a short position is:
A. Bearish.
B. Accredited.
C. Closed.
D. Bullish.
A. Bearish.
A short position is an open, not a closed, position. Accredited and non-accredited investors may establish short positions. Long positions are bullish; short positions are bearish.
All of the following are forms of arbitrage EXCEPT:
A. Arbitration arbitrage.
B. Convertible securities arbitrage.
C. Market arbitrage.
D. Risk arbitrage.
A. Arbitration arbitrage.
Arbitration arbitrage is not a form of arbitrage. Arbitration is used for dispute resolution.
Which of the following is shown at NASDAQ Level 2? I. Highest bid; II. Lowest bid; III. Highest offered; IV. Lowest offered
A. I and III
B. I and IV
C. II and III
D. I, II, III, and IV
D. I, II, III, and IV
Level 2 is the trading desk and sees all quotes entered. Level 3 is where the market maker enters quotes, while Level 1 is where the R/R and/or customer can see inside asked and bid, or lowest asked and highest bid.
Which of these sequences accurately describes the flow of an order to purchase a stock on the NYSE in a margin account? I. Margin department; II. Wire room (order department); III. Cashiering; IV. P&S
A. III, II, IV, I
B. IV, II, I, III
C. II, I, IV, III
D. II, IV, I, III
D. II, IV, I, III
After the RR receives the order from the customer, it is submitted it to the wire room. The order is “wired” to the floor of the NYSE, where the firm’s commission broker executes the trade. The execution is reported to the P&S (purchase and sales) department; from there it goes to the margin department, where the required margin is calculated; the last step in the sequence is the cashiering department, which is responsible for sending out the “bill.”
A market order to sell at the close is placed with a registered representative. The resulting trade is executed and later confirmed to the customer at 14. The trade actually occurred at 13. What price does the customer receive?
A. 14
B. 13, but the customer can pursue arbitration as recourse.
C. 14, if a mediator is appointed.
D. 13
D. 13
The market order was filled at 13, and the customer will receive this price in spite of the confirmation error.
Your customer enters a buy order for 100 shares at 16 when the market is 15 - 15.50. An order is filled at 15.75. This means:
A. 15.50 plus markup.
B. 15 plus spread.
C. 15 plus commission.
D. 15.50 plus commission.
A. 15.50 plus markup.
Since the price is above the ask, it must be a customer purchase including a markup, because customer purchases are executed at the ask plus a markup. Conversely, customer sales are executed at the bid (in this case 15) less a markdown.
You have been watching two OTC stocks for a period of time and have noted that the spreads between the bid and ask prices are quite different. What could you likely assume from this finding?
A. The stock with the wider spread is more active.
B. The stock with the more narrow spread will be a better long-term performer.
C. No conclusion should be drawn from this finding.
D. The stock with the more narrow spread is more active.
D. The stock with the more narrow spread is more active.
Generally, the more actively traded stock will have a narrower spread between the bid and ask price.
One of your clients bought 100 shares of TBS at 20. The stock has now risen to 55, and the client would like to protect her profit. Which of the following orders should be entered?
A. Sell limit at 55.50
B. Sell limit at 55
C. Sell stop at 54.88
D. Sell stop at 55.13
C. Sell stop at 54.88
When an investor is long stock and wishes to protect against a loss or to lock in a profit on the position, the investor enters a sell stop order below the current market. The current market value of the stock is at 55 and the client wishes to protect the profit, so a sell stop order at 54.88 could be entered. If an investor has a short position in the stock and wishes to protect or lock-in a profit, a buy stop order would be entered above the market.
Regarding a broker/dealer retail sale to a customer, how can an order be filled? I. From inventory; II. Sell short to customer; III. Simultaneous or riskless transaction; IV. As an agent:
A. I and II
B. I and IV
C. II and III
D. I, II, III and IV
D. I, II, III and IV
The first three of these are principal transactions (as a dealer). The last is an agent or broker transaction.
What is the lowest price that a seller is willing to accept for a security from a customer?
A. Ask price
B. Bid price
C. Bottom price
D. Strike price
A. Ask price
The asked, or offering price, is the lowest price that a seller is willing to accept for a security from a customer.
The major objective for requiring the reporting of transactions in NASDAQ National Market System issues within 10 seconds is to provide current information to:
A. Institutional investors only.
B. Investors.
C. The SEC.
D. FINRA.
B. Investors.
The purpose of any trade or quote reporting system is to provide current information to investors, not regulators, and not just institutional investors.
FINRA Rule 4320 provides guidelines on the regulation of short sale delivery requirements. If a broker and the short selling client fail to deliver on a demand for the shorted security, what are the consequences imposed by the law?
A. The client and broker/dealer are restricted in trading and must deliver or face license suspension and account closure.
B. The client’s account is frozen and will not be released until the securities are delivered to the original owner.
C. The broker/dealer, client, and clearing firm are restricted from transacting in that security until the securities that are sold short are delivered in good delivery form.
D. The client has T+2 to deliver the securities after a second demand for the securities.
C. The broker/dealer, client, and clearing firm are restricted from transacting in that security until the securities that are sold short are delivered in good delivery form.
A short sale is the sale of an asset that the seller does not own. Short sale securities are securities that are borrowed. The original owner of the securities has every right to transact anytime they deem appropriate for their account. If securities are not returned, the original owner may also be in breach of failure to deliver. For this reason and others, FINRA has established delivery requirements and since amended the rules to include this amendment which places strong performance requirements and responsibilities on the broker/dealer and the clearing firm. Also included in the rule is the declaration that the broker/dealer effecting the short sell transaction and the client are restricted from transacting in the securities until the shorted securities are delivered in good delivery form.
What is the description of the industry’s Five Percent Policy?
A. Charges must be fair and reasonable.
B. There is a maximum markup of 5%.
C. No transaction charge can exceed 5%.
D. 5% is a sales charge rule
A. Charges must be fair and reasonable.
The Five Percent Policy is a guideline for determining fair and reasonable markups, markdowns and commissions. It states that such charges must always be reasonable given the circumstances. It is not a rule establishing 5% as a maximum.
The responsibility of a broker/dealer’s cashiering department is all of the following EXCEPT:
A. Handling the execution of a customer’s orders.
B. Transferring customers’ securities.
C. Delivering and receiving securities from other broker/dealers.
D. Handling loans from banks on hypothecated securities.
A. Handling the execution of a customer’s orders.
A cashier handles money and securities for the firm and does not handle the execution of a customer’s orders.
Sell ABC short 20 stop 20.50. The ticker tape shows: 19, 20, 21, 20.50, 20.25. At what price was the trade executed?
A. 19
B. 20
C. 20.50
D. 21
D. 21
Sell short 20 stop 20.50 (limit) is triggered or elected at 20 or below, and executed at or above 20.50. The order is triggered at 19 (20 or below), and execution occurs at 21 (the next price that is 20.50 or above).
A specialist receives an order to buy XYZ 200 shares 20 stop 19. This means that:
A. The specialist is prevented from buying, unless the market is at or below 19.
B. The order is stopped at or below 20 and filled at or above 19.
C. The order is triggered at or above 20 and filled at 19 or lower.
D. The order will be filled if the market moves successively lower from 20 to 19.
C. The order is triggered at or above 20 and filled at 19 or lower.
Buy stop limit order: stop at 20 or above, execute at 19 or below.
When a firm effects trades for its own account, it is acting in a principal capacity and is considered to be a/an:
A. Dealer.
B. Agency.
C. Financial institution.
D. Broker.
A. Dealer.
A firm transacting trades for its own account is acting in the capacity of a dealer.
A firm is acting in the capacity of a broker and receiving a commission. The firm is performing as:
A. An agent.
B. An investment adviser.
C. A dealer.
D. A principal.
A. An agent.
A firm that brokers and charges a commission is acting as an agent.
An investor who is bullish on a stock establishes a:
A. Straddle.
B. Long position.
C. Short position.
D. Spread.
B. Long position.
A bullish investor establishes a long position in (buys) a stock. A bearish investor establishes a short position in (sells) a stock. Spreads and straddles may be bullish or bearish, depending on whether they are net debit or credit positions.
A customer placed a market order. This means:
A. The order may not be executed because the customer has not specified a price.
B. The customer has specified a price, and the order will not be filled unless the market reaches that price.
C. The customer has stated the price he is willing to pay.
D. No price is set, and the order is to be filled at the best available market price.
D. No price is set, and the order is to be filled at the best available market price.
A market order has no specified price and is filled at the best available market price when executed.
Which of the following are concerns about dark pools of liquidity?
A. A large volume of shares trade
B. These are liquid trades.
C. These are trades by institutional investors.
D. These trades are neither reported nor visible to the public.
D. These trades are neither reported nor visible to the public.
Because of the lack of transparency with dark pool trades, they are considered unfair by some because the true volume and price of the security being traded is not displayed to the public.
When must a trade confirmation be sent to a customer?
A. T + 1
B. No later than the Reg T deadline
C. No later than settlement date
D. By the second day of the following week
C. No later than settlement date
The confirmation must be sent no later than completion of the trade or settlement date.
The 5% markup applies to which of the following?
A. Nonexempt securities
B. New issues
C. Government securities
D. Mutual funds
A. Nonexempt securities
Nonexempt (corporate) securities in secondary trades are under the policy.
The highest price a buyer is willing to pay for a security is known as the:
A. Asked price.
B. Bid price.
C. Net asset value.
D. Offering price.
B. Bid price.
A customer selling a secondary market security will receive the bid price, which is the highest price a dealer is willing to pay.
Which of the following represents the order in which market orders are filled?
A. Precedence, priority and parity
B. First in first out (FIFO)
C. Last in first out (LIFO)
D. Priority, precedence and parity
D. Priority, precedence and parity
Priority (time), precedence (size) and parity (coin toss). Priority means orders that get there first get filled first. Precedence means the larger order will get filled first. If the orders are entered at the same time and the orders are the same size, the exchange will toss a coin; this is called parity.
Which of the following statements is INCORRECT in regard to broker/dealers?
A. A principal is a dealer and sells securities from its own inventory.
B. A dealer makes a profit by charging a commission on the security transaction.
C. An agent is a broker and trades securities for a customer. As an agent, a firm does not own the security.
D. Securities firms may act in the capacity of both a principal and an agent and are referred to as broker/dealers.
B. A dealer makes a profit by charging a commission on the security transaction.
Dealers do not profit by charging a commission; they make their profit by charging markups on sales and markdowns on purchases.
Your client is interested in XYZ Company, a stock on Nasdaq; however, the client is not certain if it is better to buy the stock or sell it short. In a communication with a market maker in the security, you receive the following quotes: 500/54 bid – 200/54.17 ask. What does this series of quotes represent for your client?
A. Your client is given the opportunity to take both positions in the stock, selling at $54 and buying at $54.17.
B. Your client can take either position and buy or sell the full amount of shares provided in the quote.
C. Your client can buy up to 200 shares at $54.17 or sell up to 500 shares of the stock at $54 to the market maker.
D. Your client can sell short 200 shares through the broker @ $54.17 or buy 500 shares at $54.
C. Your client can buy up to 200 shares at $54.17 or sell up to 500 shares of the stock at $54 to the market maker.
First, an explanation of the quote provided: The market maker is willing to sell up to 200 shares at $54.17 or buy up to 500 shares at the price of $54. Those are the market maker’s positions; your client is on the other side of the trade. Your client is not obligated to buy or sell the full amount of shares. The quote is simply stating the market maker’s trade limits at that price. The market maker’s BID is what the client will receive if the client sells and the ASK is what the client will pay if the client buys.
An order is entered “buy XYZ 35 stop limit.” The tape shows 35.50; 36; 34.50; 35. The order was most likely executed at which price?
A. 34.50
B. 35
C. 35.50
D. 36
A. 34.50
A buy stop limit is placed above current market value. This order was triggered on 35.50, and executed at 34.50.
A customer places an order to buy 100 ABC @ 35 stop, but not for more than 36. This is a:
A. Buy stop limit order.
B. Buy market order.
C. Buy stop order.
D. Buy limit order.
A. Buy stop limit order.
This is a buy stop limit. The first price is the stop or trigger price, and the second is the price limit. Therefore, the order will be triggered at 35, and then become a live limit order to buy at 36 or better (less).
What type of order can a specialist keep on his books?
A. Limit
B. Market order
C. Market not public
D. Not held
A. Limit
A specialist can hold limits, stops, and stop limits away from the market, but not market orders (whether public or private). A “not held” is a market order.
A broker/dealer receives a confirmation from a trade that it does not recognize. Which of the following steps should be taken by the member firm?
A. Look for a customer who would be interested in purchasing the stock for a higher price
B. Send a DK notice to the contra broker
C. Complete the transaction and update the firm’s records
D. Block the sending member firm from trading with your firm in the future
B. Send a DK notice to the contra broker
DK stands for Don’t Know and is used when the member firm does not recognize the trade or when the terms of the transaction were not what the member firm agreed to.
Which of the following large block transactions appears on the exchange tape prior to execution on the exchange floor?
A. Special offer
B. Specialist’s block
C. Secondary distribution
D. Exchange distribution
A. Special offer
A “special offer” is an attempt to stabilize a declining stock. It appears prior to execution.
All the following receive copies of an order ticket, buy or sell, EXCEPT:
A. Operations department.
B. Margin department.
C. Purchase and sales.
D. Order or wire department.
A. Operations department.
The operations department is back office and issues, confirms, but does not receive order tickets, which are front office.
A customer that sells a security in the secondary market will receive the:
A. Net asset value.
B. Offering price.
C. Bid price.
D. Asked price.
C. Bid price.
The highest price a buyer will pay for a security is the bid price, which is the price the seller (customer) will receive.
Which of the following does NOT describe the OTC market?
A. A decentralized market
B. An auction market
C. A market where shares of the largest corporations are traded
D. A negotiated market
B. An auction market
The OTC is negotiated and competitive, involving dealers and traders processing orders and automatic quotes. Shares of the largest corporations trade OTC. The stock exchange, like the NYSE, is an auction market.
XYZ 25.25 + .25; Bid 25; Ask 25.12. If an investor wishes to purchase 1,000 shares of XYZ, excluding commission or markup, what price would be paid per share?
A. 25.12
B. 25.25
C. +25
D. 25
A. 25.12
Customers buy at the offer and sell at the bid.
Quotations provided by the National Quotation Service on the pink sheets are:
A. Published monthly.
B. Interdealer quotes.
C. For completed trades.
D. For corporate bonds.
B. Interdealer quotes.
“Pink Sheets” are compilations of all OTC common stocks with inter-dealer quotes (if available).
An interdealer quotation system (IQS) is a system for organizing the dissemination of price quotes and other securities information by broker and dealer firms. IQSs are intended to provide investors with timely and relevant information on which to base their investment decisions.
Which of the following is NOT required on confirmations?
A. Broker/dealer capacity
B. Delivery and payment instructions
C. Complete security description
D. CUSIP
D. CUSIP
CUSIP is not required on the trade ticket or confirmation.
CUSIP refers to the Committee on Uniform Securities Identification Procedures which oversees the entire CUSIP system. The CUSIP number is a unique identification number assigned to all stocks and registered bonds in the United States and Canada, and it is used to create a concrete distinction between securities that are traded on public markets.
When a customer effects a proceeds transaction, the Five Percent Policy states:
A. The markup is computed as two separate trades.
B. The combined proceeds to the broker/dealer on the sale and purchase should not exceed the 5% guideline based on the inside ask on the buy side.
C. The markup that is charged must be 5% on both the sale and the purchase.
D. The markup or commission charged must bear a reasonable relationship to the prevailing interdealer quotations.
B. The combined proceeds to the broker/dealer on the sale and purchase should not exceed the 5% guideline based on the inside ask on the buy side.
A proceeds transaction is one in which the proceeds of a sale are used to make an immediate purchase. FINRA states that the fairness of the markup is based on the combined proceeds to the broker/dealer divided by the inside ask on the buy side, and the broker/dealer should NOT consider these as separate trades but as one combined trade.
A Third Market trade involves:
A. Listed stocks traded over the counter.
B. Listed or unlisted stocks traded between institutional investors without the services of a brokerage firm.
C. The trading of unlisted stocks between institutional investors.
D. The trading of NYSE stocks on regional exchanges.
A. Listed stocks traded over the counter.
When stocks that are listed on any exchange are traded away from that exchange in the OTC market, such trading is described as third market.
Your client is long 100 shares of XYZ at $20. You enter a sell stop limit at 20. The tape indicates the following trades: 19, 19.75, 20.13, 20. At what price is the order executed?
A. 19.75
B. 20
C. 20.13
D. No execution
C. 20.13
Sell stop limits are placed below current market value. Therefore, XYZ must be currently trading above 20. The sell stop limit will be triggered when XYZ declines to or below 20. Therefore, at 19 the order is triggered and becomes a live limit order to sell at 20 or better; the first tic or trade at or above 20 is 20.13.
An investor purchases shares on one exchange and simultaneously sells those shares on another exchange. This is an example of:
A. Backing away.
B. Arbitrage.
C. Trading ahead.
D. Front running.
B. Arbitrage.
Arbitragers make their money by buying on one exchange and simultaneously selling on another exchange taking advantage of small price deviations. It’s important to remember that arbitragers need to move large blocks of securities in order for arbitrage to be profitable.
The return by the receiving party of securities previously accepted for delivery or a demand by the delivering party for return of securities that have been delivered is called:
A. Close-out.
B. Rejection.
C. Reclamation.
D. Re-delivery.
C. Reclamation.
Reclamation means literally “to reclaim or take back,” as the question describes. When a security is refused at settlement, it is known as a “rejection.”
NASDAQ Market Makers are required to report each trade within how many seconds of execution?
A. 3
B. 10
C. 30
D. There is no reporting requirement for the market makers.
B. 10
While many regulations also state immediately, the required deadline is stated as 10 seconds. It is a reasonable time after the trade.
An investor is interested in selling her shares of ABS Corp., which trades over-the-counter. The best bid price is $3.15 from the market maker Donaldson. The best ask price is $3.30 from market maker Williamson Investments. The investor trades listed stocks on the NYSE through her broker/dealer, STAT Investments. She can sell her ABC Corp shares:
A. At the ask price of $3.30 by directly contacting Williamson Investments.
B. By contacting her broker/dealer STAT Investments; she will get the bid price of $3.15.
C. By contacting her broker/dealer STAT Investments; she will get the ask price of $3.30.
D. At the bid price of $3.15 by directly contacting Donaldson.
B. By contacting her broker/dealer STAT Investments; she will get the bid price of $3.15.
While it would be advantageous for the investor to contact Donaldson directly, this can only be done with LEVEL III Nasdaq access, which her broker/dealer has. So, she needs to contact her broker. She will get the $3.15 price less a commission charge. The investor has access to Level I Nasdaq, which shows the best pricing, but not the name and contact information.
When a stock is crossed on the NYSE floor and then appears on the tape after execution, the transaction is a:
A. Special offer.
B. Exchange distribution.
C. Specialist block.
D. Secondary offering.
B. Exchange distribution.
A “stock cross” is an exchange distribution, crossing a huge buy order with a sell order, the specialist acting as a broker’s broker. A “secondary” is a spin-off distribution with a prospectus filed with the SEC, the largest of the blocks. A “special order” is a stabilizing bid reported on the tape prior to execution to support a falling stock. The “specialist block” is done quietly in the Third Market.
An order for a security trade that directs the broker to buy or sell “at the market” but only when a certain price level has been reached is known as:
A. A market order.
B. A limit order.
C. Selling short or “shorting.”
D. A stop order.
D. A stop order.
With a stop order, when the specified price level (trigger) is reached, it is triggered. Then it becomes a live market order, executed immediately at the next price.
Which of the following orders are reduced by the specialist of the NYSE on the ex-dividend date of a listed stock? I. Open buy limits; II. Open sell stops; III. Open sell limits; IV. Open buy stop limits:
A. II and IV
B. III and IV
C. I and II
D. I and III
C. I and II
Only orders that are placed at or below current market price are adjusted: these include buy limits, sell stops, and sell stop limits. On the other hand, sell limits, buy stops and buy stop limits are placed ABOVE the current market value, and therefore are not adjusted.
A listed stock trading in the OTC market is referred to as the:
A. Fourth Market.
B. Third Market.
C. Instinet.
D. Composite.
B. Third Market.
A listed stock trading in the OTC market is referred to as the Third Market. These trades are reported to FINRA, and quotes can be found on the Consolidated Quote System (CQS).
A large corporation places an order to purchase a block of its own stock. The order is placed with a floor broker who enters the order with a specialist. The order is taken off the floor and filled. The block order is:
A. A special offer.
B. A secondary offering.
C. A specialist block.
D. An exchange acquisition.
C. A specialist block.
Only one specialist is involved; the order is booked and taken off the floor, hence the term “specialist block.”
In the secondary market, which of the following can take a position?
A. Issuer
B. Trader or dealer
C. Underwriter
D. Agent
B. Trader or dealer
A trader can be a market-maker, a dealer, a firm acting as principal, or a taker of long or short positions, but not an agent or broker.
Which of the following statements are true regarding the over-the-counter market? I. The Federal Reserve Board regulates which OTC securities are marginable. II. FINRA regulates trading practices in the OTC market. III. The SEC does not have regulatory authority over OTC margin transactions. IV. The FRB governs trading practice on margin trades.
A. II and III
B. II and IV
C. I and II
D. I and III
C. I and II
The Fed regulates OTC margin, FINRA regulates OTC trading, and the SEC has an overview of FINRA, whether a trade was done for cash or on margin. The FRB does not regulate trade practices.
A client places an order to sell short 100 shares of XYZ at 35.50 stop limit. At which trade was the order elected? 36, 35.75, 35.13, 34.88, 35, 35.62
A. 34.88
B. 35.00
C. 35.13
D. 35.62
C. 35.13
Sell stop and sell stop limit orders are triggered (elected) when the stock price trades at or through (below) the trigger price, which is 35.50 in this example. This stop limit order then becomes a live limit order to sell at 35.50 or better. This order is triggered at 35.13. Then it becomes a live limit order to sell at 35.50 or better. Therefore, it would be executed at 35.62.
A customer places a buy limit order at $36.50. This means that the order:
A. Is held in the specialist’s book.
B. Can only be executed at $36.50.
C. Cannot be executed and is terminated.
D. Is executed at or above $36.50.
A. Is held in the specialist’s book.
The order is guaranteed to be executed at $36.50. Awaiting execution, the order is held in the specialist’s book.
Relative to a DMM “stopping stock” on the NYSE, it can be done if I. It is for a public order. II. Permission of a floor governor is granted. III. The designated market maker is guaranteeing a price. IV. It is bought for another member’s account.
A. II and IV
B. III and IV
C. I and II
D. I and III
D. I and III
The designated market maker (DMM) may guarantee a floor broker a price for one of the broker’s public orders, as long as, in the DMM’s judgment, it would not adversely affect the market in the stock.
In order to make sure that the trader received the best execution, the trader should seek the:
A. NBBO.
B. Last trade in the security.
C. Lowest bid.
D. Highest ask.
A. NBBO.
The NBBO, which stands for the National Best Bid and Offer, will be determined by looking at all the different markets where the security trades to determine the highest bid and the lowest ask price.
Where do municipals trade?
A. On short
B. On the NYSE
C. On Munifacts
D. OTC
D. OTC
Municipal bonds trade in the OTC market, which is a negotiated market.
Which of these statements is INCORRECT concerning broker/dealers?
A. A dealer sells securities from its own inventory.
B. A broker is an agent who purchases or sells securities for a customer and charges them a commission.
C. A dealer earns a profit by marking up the security above the ASK price.
D. A firm can act in both the capacity of a broker and a dealer when selling securities from its own inventory.
D. A firm can act in both the capacity of a broker and a dealer when selling securities from its own inventory.
Acting as broker and acting as dealer are mutually exclusive. In each trade, the firm acts as one or the other, but never both. When a firm acts as a broker, it is acting in an agent capacity and does not use its inventory account.
CQS transactions involve all the following, EXCEPT:
A. BSE listed.
B. NYSE listed.
C. CSE listed.
D. OTCBB.
D. OTCBB.
OTCBB consists of unlisted over-the-counter stocks. The OTCBB is not an exchange.
The Consolidated Quotation System (CQS) is the electronic service that provides quotation information for stock traded on the American Stock Exchange, New York Stock Exchange, and other regional stock exchanges in the United States and also includes issues traded by FINRA member firms in the third market.
BSE = Bombay Stock Exchange (India) NYSE = New York Stock Exchange CSE = Canada's New Stock Exchange
One of your customers enters a limit order good for one month. Your firm has entered the order as a GTC order. The responsibility for canceling the order, if not executed by the end of that month, is that of the:
A. Firm’s commission broker.
B. Firm.
C. Customer.
D. Specialist.
B. Firm.
When a member firm accepts an order of this type, it accepts ultimate responsibility for follow-through. The firm’s commission broker is commonly known as the “floor broker” and is on the floor of the exchange. The specialist has no responsibility in this case because the specialist doesn’t know that the order was only good until the end of the month.
A broker/dealer tells a customer that an order was not executed because of a stock order that was placed ahead. The order was probably a:
A. Short sale.
B. Margin order.
C. Limit order.
D. Market order.
C. Limit order.
When there are many limit orders entered at the same price, they are filled in the order in which they are entered, a time priority. It is possible that those orders entered last are not executed because the other orders (stock ahead) may not be executed before the stock price moves beyond the stipulated limit price.
Concerning the reporting of last-sale price information for OTC stocks, which of the following is true?
A. Last-sale price information is available on NASDAQ National List OTC stocks.
B. No last-sale price information is available on any NASDAQ OTC stocks.
C. Last-sale price information is available on all NASDAQ and OTC stocks.
D. Last-sale price information is available on OTC transactions in the National Market System.
D. Last-sale price information is available on OTC transactions in the National Market System.
Last-sale information is available for OTC transactions in NASDAQ National Market System, not on NASDAQ small caps or emerging companies.
Which of the following orders are placed BELOW the current market value? I. Sell limits; II. Buy limits; III. Buy stops; IV. Sell stops:
A. II and III
B. II and IV
C. I and III
D. I and IV
B. II and IV
Buy limits, sell stops, and sell stop limits are placed below current market value. Sell limits, buy stops, and buy stop limits are placed above current market value.
A designated market maker (DMM) can act as all of the following EXCEPT:
A. Underwriter.
B. Agent.
C. Broker.
D. Principal.
A. Underwriter.
A broker is an agent. The DMM is also a principal but does not underwrite new issues.
An order reaches the floor, and the designated market maker says you are stopped at 38.50. This means:
A. You are guaranteed a price of 38.50 or less.
B. Your execution will be 38.50 or better.
C. You can’t trade until the stock hits 38.50.
D. You must enter a new order at 38.50.
B. Your execution will be 38.50 or better.
A DMM stopping the stock guarantees a price that is equal to or better (usually subject to only one attempt by a broker to get a better price).
Which of the following orders is NOT kept in the specialist’s book?
A. Stop
B. GTC
C. Limit
D. Not held
D. Not held
A “not held” order is held by the floor broker until the floor broker judges the best time to submit the order to the specialist. Market public orders are executed without delay unless specifically designated as “not held” (“hold for a better time or price”) or “not public” (“execute away from the trading pit”).
A broker receives a buy and a sell order on the same security from two customers. Which must he do to execute the orders?
A. Utilize another dealer to complete the trade
B. Fill both from inventory
C. Riskless and simultaneous principal
D. Agency cross
D. Agency cross
The broker would act as an agent (not principal) and cross both customers at one price (usually between bid and asked) with the commission due from each customer.
A large corporation places an order to purchase a block of its own stock. The order is placed with a floor broker who enters the order with a specialist. The order is taken off the floor and filled. The announcement of the order is to:
A. Only the specialist.
B. All FINRA members.
C. All NYSE members.
D. All NYSE and FINRA members.
A. Only the specialist.
An order from the public is represented on the trading floor of the New York Stock Exchange by a:
A. Floor broker.
B. DMM.
C. Floor clerk.
D. Floor trader.
A. Floor broker.
A public order that is transmitted to the New York Stock Exchange Floor is represented on the floor by a floor broker who competes for execution of the order.
An investor purchases a 6% convertible corporate bond at 105. The conversion price on the bond is $25 and the bond is currently trading at $26.50. The bond has been called at 103. Which of the following situations would benefit the investor the most?
A. Sell the bond at 105.
B. Keep the bond and continue to receive interest.
C. Allow the bond to be called.
D. Convert the bond and sell the stock in the market.
D. Convert the bond and sell the stock in the market.
The investor should convert the bond and sell the stock in the open market. This is a form of convertible securities arbitrage. Both the conversion price and conversion ratio are based on the par value. Because we know the conversion price is $25, we simply take the par value of $1,000 divided by $25 and we get the ratio of 40:1. The bond is currently trading at $1,050. To come up with the parity of the common stock, take the $1,050 divided by 40 which would equal a parity price of $26.25. The stock is currently trading at $26.50 so therefore, if the investor purchased the bond and converted it at $26.25 and simultaneously sold in the market, it would make $0.25 per share or $1,060 per bond (which would be $26.50 times 40 equals $1,060).
If the investor allowed the bond to be called, they would only make $1,030 and if they sold it in the market, they’d only make $1,050. The investor would not be allowed to keep the bond and continue to receive interest after it’s been called.
A dealer has an average cost of 6.50 on the inventory position of an OTC stock the firm is trading. The NASDAQ Level 1 quote for the stock is 5 - 5.50. According to the FINRA conduct rules, what price would be used when figuring the mark-up to a prospective customer?
A. 5
B. 5.50
C. 6
D. 6.50
B. 5.50
Dealers must sell to customers at a price based upon current market value. Because the question identifies this transaction as a sale (the dealer is figuring MARK-UP), the mark-up will be based upon the best available ASK price, which is 5.50.
All of the following are true regarding Electronic Communications Networks (ECNs) EXCEPT:
A. ECNs cannot execute mutual fund trades.
B. They are used for Fourth Market trades.
C. They facilitate trades between institutions.
D. Transactions are executed without the broker.
A. ECNs cannot execute mutual fund trades.
Institutional investors, including mutual funds, use ECNs to execute trades on an agency cross basis.
A broker goes to a designated market maker (DMM) to sell 100 XYZ. The DMM stops the broker at 31. Which of the following is true?
A. The DMM has halted trading at 31.
B. The broker cannot obtain a price higher than 31.
C. The broker is assured of 31 or a better price.
D. The DMM has guaranteed the broker a price of 31.
D. The DMM has guaranteed the broker a price of 31.
The DMM stopping the stock is guaranteeing a price. The broker now has one chance of doing better. The DMM will only stop the order for public orders, not for institutional orders.
Which of the following is NOT considered by a NASDAQ dealer when determining the mark up or mark down to charge in a principal trade?
A. Availability of the security
B. Cost involved in trade execution
C. Cost of the security held in inventory
D. Dollar price of the security
C. Cost of the security held in inventory
The dealer’s cost cannot be considered since every trade must be based on current market price at the time of that trade.
Which of the following statements regarding limit orders is true?
A. A limit may never be executed.
B. A buy limit is placed above current market value.
C. A limit order may not be left with the specialist.
D. A limit is executed immediately.
A. A limit may never be executed.
Because a limit order is dependent on market movement in a certain direction, it may never be executed. Buy limits are placed below, and sell limits above, current market value. Market orders are executed immediately; limit orders are left with the specialist for possible future execution.
All of the following are correct about corporate bond trade reporting EXCEPT:
A. Sell side reports through TRACE within 10 seconds.
B. Buy side reports through TRACE within 15 minutes.
C. FINRA reports the trade immediately.
D. Sell side reports through TRACE within 15 minutes.
A. Sell side reports through TRACE within 10 seconds.
Corporate Bond transactions are reported through TRACE. Both the buy side and the sell side are required to report within 15 minutes of the transaction. Once the trade report is in from both the buy side and the sell side, FINRA is required to release the information to the public immediately.
An investor purchased a bond with a 3% coupon at $1,050. All of the following statements are correct EXCEPT:
A. The current yield is 2.86%.
B. The bond was purchased at a discount.
C. The bond was purchased at a premium.
D. The current yield is lower than the coupon rate.
B. The bond was purchased at a discount.
This is not a correct statement; the bond’s purchase price is higher than par, so it was purchased at a premium, not a discount.
Which of the following would be required to quote on a yield to call basis?
A. Nominal rate of 5% with a basis of 5.5%
B. Nominal rate of 5.5% quoted at 100
C. Nominal rate of 6% with a basis of 5.5%
D. Nominal yield of 5.25% with a basis of 5.5%
C. Nominal rate of 6% with a basis of 5.5%
The basis of 5.5 is lower than the stated or nominal rate of 6%, so therefore the bond is trading at a premium. If we follow the YMCA technique, this would indicate that the lowest rate is yield to call on a premium bond.
All of the following statements are true concerning revenue bonds EXCEPT:
A. They often have an indenture, which includes protective covenants.
B. A feasibility study will be used to determine the viability of the project.
C. They’re considered self-supporting.
D. They require voter approval.
D. They require voter approval.
Voter approval is only required for general obligation bonds because they are backed by the full faith and credit of the state or local taxing authorities.
Ted and Carol opened a 529 plan for their granddaughter. For their initial contribution, they want to contribute the largest amount permitted without paying gift tax. The maximum contribution allowed without paying gift tax is:
A. $15,000.
B. $30,000.
C. $75,000.
D. $150,000.
D. $150,000.
Ted and Carol could make an accelerated gift of $150,000 ($75,000 each) without paying gift tax. They would not be able to make another contribution for 5 years.
What does it mean when a market maker has a quote that is out firm with the recall?
A. That they can recall the quote and change the price randomly during the outfirm period.
B. That it is a nominal quote and does not need to be honored.
C. That it locks in a price for a specified period of time and the period of time can be accelerated by the recall.
D. That is a workable indication that provides a range in which the bonds will sell.
C. That it locks in a price for a specified period of time and the period of time can be accelerated by the recall.
An outfirm quote with a 5-minute recall locks in a price at which the bonds can be purchased for a specific period of time. This way, the other firm is able to market those bonds without having to purchase them first and placing them in their inventory. The recall will accelerate the period of time in which the quote is out firm.
When comparing a convertible bond to a similar callable debenture, which of the following statements is true?
A. The similar bonds will have similar interest rates.
B. The callable debenture will be sold on a yield-to-call basis.
C. The convertible bond will have a lower stated interest rate.
D. The callable debenture will have a lower stated interest rate.
C. The convertible bond will have a lower stated interest rate.
Because the convertible feature is attractive to investors, they will accept a lower yield than on comparable bonds without this feature. Because callable bonds carry more risk, investors demand a higher yield than similar noncallable bonds. Because bonds are always sold on a “yield-to-worst” basis, a premium-priced callable bond would be sold on a yield-to-call basis. However, a discount-priced callable bond is sold on a yield-to-maturity, never a yield-to-call basis.
Which of the following municipal bonds would not be tax exempt?
A. New Orleans Convention Center bonds
B. Cedar Rapids Sewer and Water bonds
C. Tampa Bay Control bonds
D. Charlotte Transportation bonds
A. New Orleans Convention Center bonds
Convention center bonds are not designated for a public purpose; therefore, they are not tax exempt.
Which of the following have an active secondary market?
A. Eurodollar CDs
B. Federal funds
C. Commercial paper
D. Repurchase agreements
A. Eurodollar CDs
There is no secondary market for fed funds. There is not much of a secondary market for commercial paper or repurchase agreements, but there’s an active secondary market in Eurodollar CDs, especially in New York and London.
Your broker/dealer is a member of the underwriting syndicate and re-offers 100,000 M of bank-qualified municipal debt at 99.75 net. There’s a .75 point selling concession, .25 point re-allowance, and 1 point additional takedown. What’s the member’s profit?
A. $750,000
B. $2 million
C. $1 million
D. $1.75 million
D. $1.75 million
The takedown or member’s profit is selling concession (including re-allowance) plus additional takedown. The total takedown is 1.75 points or percent of $100 million or $1.75 million (times the member’s bracket). “99.75 net” simply indicates a dealer/syndicate re-offering or no commission charged.
Which of the following is not a characteristic of money market instruments?
A. They are investment grade.
B. They freely trade.
C. They are equity positions.
D. They have maximum maturities of 1 year.
C. They are equity positions.
All money market instruments are debt, not equity securities. All money market securities share three characteristics: They are short-term, safe, and liquid.
Long-term unsecured corporate debt offerings are defined as:
A. Commercial paper.
B. Preferred stock.
C. Debentures.
D. Bills.
C. Debentures.
Debentures are unsecured corporate debt offerings, or nonsecured bonds.
Which of the following trade with accrued interest?
A. Certificates of deposit
B. Banker’s acceptances
C. Zero coupon Treasury obligations
D. Treasury bills
A. Certificates of deposit
Only negotiable CDs pay interest. The rest of these instruments just pay par at maturity.
Which of the following corporate bonds is considered safest for an investor?
A. A-rated unsecured bond
B. A-rated secured bond
C. AAA-rated unsecured bond
D. BB-rated unsecured bond
C. AAA-rated unsecured bond
The rating takes into account all information about the bond. Even though this bond is unsecured, it is considered safer than bonds that are fully secured from other issuers.
A municipal “workable indication” is the same as a:
A. Likely bid.
B. Firm bid and offer.
C. Firm bid.
D. Likely ask.
A. Likely bid.
A workable quote is a likely bid.
What is the backing for a secured bond?
A. Guarantee from the issuer’s bank
B. Full faith and credit of the issuer
C. Assets held in an escrow account
D. Guarantee from the issuer’s parent company
C. Assets held in an escrow account
Every bond is backed by the full faith and credit of the issuer, which is simply the issuer’s promise to repay. In addition, a secured bond is also backed by assets held for the bondholders.
Which of the following is related to the additional bonds test in the bond indenture?
A. Dilution of tax revenue
B. Limitation on future bond issues
C. Junior lien
D. Subordinated debenture
B. Limitation on future bond issues
The additional bonds test is a requirement of a secured bond issue having an open end indenture. If the corporation issues additional bonds, both the original and the new bondholders have equal claim to the collateral. To protect the original bondholders, the number of bonds issued using the same collateral is limited. This total number of permissible bonds is calculated using the additional bonds test. This test is used for net lien municipal revenue bonds.
A Treasury bond with a 10 1/4% coupon due on July 1, has interest payment dates of Jan. 1 and July 1. It is traded for settlement on Feb. 24. What is the number of days of accrued interest?
A. 54
B. 55
C. 56
D. 57
A. 54
Governments notes and bonds use “actual over actual” (days in month over days in the year) and settle next day. 31 days in January plus 23 in February = 54 days. The settlement date does not count.
A municipality has issued a double-barreled revenue bond where the net revenues generated by the facility have proven to be insufficient to service the debt. Which of the following income sources may be used by the municipality to satisfy the obligation? I. Ad valorem tax collections; II. Fines; III. Assessments of additional taxes; IV. Collected back-due ad valorem taxes
A. I and III
B. I and IV
C. II and IV
D. I, II, III, and IV
D. I, II, III, and IV
“Double-barreled” means general obligation, and GO Bonds can be backed by all of the taxes mentioned in addition to fines.
A bond whose fixed nominal rate increases to a higher fixed rate in its latter years is called a(n):
A. VRN
B. CMO
C. ETN
D. Step coupon bond
D. Step coupon bond
An ETN’s accreted interest is based on an underlying index, and is only paid at maturity. VRNs have a fluctuating rate; not a one-time increasing rate. CMOs are not structured as step-ups.
A municipal dealer has bonds out firm to another dealer. Which is true? I. The bonds are tied up for a specified period of time. II. The dealer is locked into a quote. III. This is a type of AON. IV. The price can be re-negotiated.
A. I and II
B. I and IV
C. II and III
D. II and IV
A. I and II
An “out firm” is a bid price guaranteed to a dealer by another dealer for a period of time.
All or none (AON) is a directive used on a buy or sell order that instructs the broker to fill the order completely or not at all.
An asset-backed security is backed by:
A. Short-term loans on credit cards or automobiles.
B. Equipment owned and operated by the issuer.
C. Securities of a different issuer.
D. Real estate mortgage pools.
A. Short-term loans on credit cards or automobiles.
Asset-backed securities are backed by short-term loans on assets other than real estate, such as autos or credit cards.
On a discount bond, which of the following correctly states highest to lowest yield?
A. Nominal yield, current yield, yield to maturity
B. Yield-to-maturity, current yield, nominal yield
C. Nominal yield, yield to maturity, current yield
D. Current yield, nominal yield, yield to maturity
B. Yield-to-maturity, current yield, nominal yield
On a discount bond, the highest yield is the yield-to-maturity, followed by the current yield. The nominal yield, or coupon rate, is the lowest yield.
Which of the following bonds is affected by the price of the common stock?
A. Guaranteed bond
B. Convertible bond
C. Surety bond
D. Income bond
B. Convertible bond
Because it converts into the common stock, the convertible bond’s price is affected by the price of the common stock.
Which of the following statements regarding Eurodollar bonds is false?
A. The issuer of Eurobonds may be domestic or foreign.
B. Payment of interest and principal may be made in U.S. dollars or designated foreign currencies, at the option of the issuer.
C. Payment of interest and principal may be made only in U.S. dollar-denominated deposits.
D. The bonds are issued outside the United States.
B. Payment of interest and principal may be made in U.S. dollars or designated foreign currencies, at the option of the issuer.
Payment is made only in U.S. dollars, not foreign currencies.
A bond with a C rating is considered:
A. To have financial risk.
B. To have high credit risk.
C. To be lowest of investment grade.
D. Medium grade.
B. To have high credit risk.
A C rating is the lowest speculative rating before a bond has defaulted.
What is the most common type of corporate bond issued?
A. Secured.
B. Unsecured.
C. Open-end.
D. Closed-end.
B. Unsecured.
Debentures (the most common type of bond issued) are issues that are not secured by a pledged asset, but secured only by the good faith of the issuer.
Which of the following issues equipment trust certificates?
A. A regional airline
B. A company that builds boats
C. A company that leases planes
D. An airline manufacturer that manufactures jet engines
A. A regional airline
An equipment trust certificate is issued by the owner/operator of the equipment, not the manufacturer. The correct answer is the regional airline, which actually flies the planes and will use the airplanes as collateral for the equipment trust certificate.
An investment with a stated interest rate that matures in 2 to 10 years is a:
A. Treasury stock.
B. Treasury strip.
C. Treasury note.
D. Treasury bond.
C. Treasury note.
T-Notes mature in 2 to 10 years and pay a stated rate of interest.
The least-active secondary market exists in:
A. Banker’s acceptances.
B. Commercial paper.
C. T-bills.
D. CDs.
B. Commercial paper.
This is just a fact you need to know.
All of the following are agency issues backed by government-guaranteed or insured mortgages, EXCEPT:
A. Federal Home Loan.
B. SLMA.
C. FNMA.
D. GNMA.
B. SLMA.
Sallie Mae is Student Loan Marketing Association (SLMA) and does not deal in mortgages. The rest do.
Which of the following is not AAA-rated?
A. STRIPs
B. LYONS
C. TIGRS
D. CATS
A. STRIPs
STRIPs are issued by the U.S. Treasury and are full faith and credit of the U.S. government. The others are different treasury receipts, which are broker/dealer products and are AAA-rated.
Liquid yield option notes (LYONs), introduced by Merrill Lynch in 1985, are a form of zero-coupon convertible bonds with a predetermined conversion feature that allows either the holder or issuer to convert them to a fixed number of shares of common stock.
Treasury Investment Growth Receipts (TIGRs), issued from 1982 until 1986, were zero-coupon bonds based on U.S. Treasury bonds held by Merrill Lynch.
Certificates of Accrual on Treasury Securities (CATS) were a type of bond invented by the bank Salomon Brothers. Issued by private banks from 1982 – 1986, these bonds were backed by the U.S. Treasury through the creation of special purpose entities (SPV/SPEs).
Commercial paper I. Can be issued to the public. II. Is generally issued at a discount. III. Can be traded. IV. Has maturity of more than 270 days.
A. I and II
B. II and III
C. II and IV
D. III and IV
B. II and III
Commercial paper is issued to dealers only and matures in less than 270 days. It also trades and, if issued by nonfinancial corporations, is sold at discount.
Funded debt of a corporation can include:
A. Common stock with warrants.
B. Preferred stock.
C. Short-term bank loans.
D. Long-term loans.
D. Long-term loans.
“Funded debt” refers to long-term debt or bonds.
What is the security for senior subordinated debentures?
A. General assets
B. Real estate
C. Mortgages
D. Equipment
A. General assets
A debenture is full faith + credit or general, NOT particular assets.
Which of the following securities has the lowest credit risk?
A. COAGRS
B. TIPS
C. LYONs
D. PANTHERS
B. TIPS
TIPS, or Treasury Inflation Protected Securities, are issued and backed by the U.S. Treasury. The other debt instruments are proprietary names of various treasury receipts, which are issued and backed by broker/dealers.
A Certificate of Government Receipts (COUGR) is a U.S. Treasury bond that was marketed by A.G. Becker Paribas stripped of its coupon payments. COUGRs only pay an investor their face value at maturity.
Liquid yield option notes (LYONs), introduced by Merrill Lynch in 1985, are a form of zero-coupon convertible bonds with a predetermined conversion feature that allows either the holder or issuer to convert them to a fixed number of shares of common stock.
If a 10-year bond has a coupon or interest rate of 8%, how much interest does the bond pay?
A. $80 twice a year
B. $40 twice a year
C. $80 once a year
D. $40 once a year
B. $40 twice a year
An 8% bond pays $80 each year (1,000 x 8%). Bonds pay interest semi-annually, so the bond pays $40 twice a year.
In a government yield auction of U.S. Treasury bills, which of the following orders will always be filled?
A. Commercial lenders
B. The FOMC account
C. Primary market makers
D. Noncompetitive bid
D. Noncompetitive bid
Non-competitive bids, which are submitted to the Federal Reserve prior to a government yield auction of U.S. Treasury bills, are certain to be filled because T-bills in the amount of the order have been set aside for the non-competitive bidder prior to the auction market. The noncompetitive bidder is guaranteed to receive the designated amount of T-bills at the average yield (the average price) of the actual auction market.
New issue municipal “group” orders are submitted:
A. For a particular syndicate member to be retailed to its clients.
B. For the benefit of the syndicate account as a whole in proportion to each member’s bracket.
C. By municipal specialists or broker’s brokers for their institutional clients.
D. By a joint account which is in the process of underwriting those securities.
B. For the benefit of the syndicate account as a whole in proportion to each member’s bracket.
Group net orders are for the benefit of the syndicate as a whole and normally have highest priority, unless the manager allows presale.
Systematically increasing cost basis on an OID is called:
A. Accretion.
B. Depletion.
C. Appreciation.
D. Amortization.
A. Accretion.
Bond premiums are amortized down to par. Bond discounts are accreted up to par.
The original issue discount (OID) is the difference between the original face value amount and the discounted price paid for a bond. OID bonds have the potential for gains since investors can buy the bonds for a lower price than their face value.
A step coupon bond: I. Has a nominal rate which increases at a specified point during its life. II. Has a nominal rate which fluctuates based on an underlying index. III. Pays periodic interest. IV. Accretes interest and pays at maturity.
A. III and IV
B. I and III
C. II and III
D. II and IV
B. I and III
A step coupon, or step-up bond, has a fixed coupon rate which increases to another fixed rate at a specified year during its life. Step-ups pay periodic interest; they are not OIDs.
Municipalities typically issue short-term notes for:
A. Permanent financing.
B. Long-term financing.
C. Project financing.
D. Interim financing.
D. Interim financing.
Municipalities use short-term municipal notes to provide interim financing in anticipation of receiving money from taxes, revenues collected from a municipal facility, or new bonds being issued.
Interest income from U.S. government bonds is:
A. Subject to federal income tax but exempt from state income tax.
B. Subject to federal and state income tax.
C. Exempt from federal and state income tax.
D. Subject to state income tax but exempt from federal income tax.
A. Subject to federal income tax but exempt from state income tax.
U.S. government bonds are taxable by their issuing entity, the federal government, but exempt from state taxation.
A bond that sells above par is known as a premium bond. Which of the following statements are true?
A. Current yield is the lowest.
B. All yields are the same.
C. Yield-to-maturity is higher than current yield.
D. Nominal yield is the highest yield.
D. Nominal yield is the highest yield.
The nominal yield will always be the highest yield on a premium bond. The nominal yield is the same as the coupon rate.
On a discount bond, which of the following lists is correct from lowest to highest yield?
A. Nominal yield, current yield, yield-to-maturity
B. Yield-to-maturity, current yield, nominal yield
C. Nominal yield, yield-to-maturity, current yield
D. Current yield, nominal yield, yield-to-maturity
A. Nominal yield, current yield, yield-to-maturity
On a discount bond, the lowest yield is nominal yield, followed by current yield, then yield-to-maturity.
All of the following are agency issues backed by government-guaranteed or insured mortgages EXCEPT:
A. Federal Home Loan.
B. SLMA.
C. FNMA.
D. GNMA.
B. SLMA.
SLMA, or Sallie Mae, is the Student Loan Marketing Association (SLMA) and does not deal in mortgages. The rest do.
Which of the following are true of negotiable certificates of deposit? I. The issuing bank guarantees the instrument. II. Certificates of deposit are callable. III. Minimum denominations are $1,000. IV. They can be traded in the secondary market.
A. I and II
B. I and IV
C. II and III
D. III and IV
B. I and IV
Denominations of a negotiated CD are $100,000 minimum, and they are too short-term to be callable.
Which of the following can issue Eurodollar bonds? I. Sovereign governments; II. State and local governments; III. U.S. corporations; IV. Foreign corporations
A. I and II
B. I and III
C. III and IV
D. I, II, III and IV
D. I, II, III and IV
All of these entities can issue Eurodollar bonds. The U.S. government, however, cannot.
An example of a non-marketable type of Treasury issue is a:
A. T-Bond.
B. Series EE bond.
C. T-Bill.
D. T-Note.
B. Series EE bond.
A Series EE savings bond is a non-marketable savings bond issued by the Treasury. It is not traded in the secondary market and must be redeemed by the issuer. T-bills, T-notes, and T-bonds are all marketable securities.
Which of the following statements regarding overnight repurchase agreements is incorrect?
A. The seller loses control of securities.
B. There is no liquidity risk.
C. There is no interest rate risk.
D. Interest rates most closely follow the fed funds rate.
C. There is no interest rate risk.
An overnight repo is still debt, and all debt has interest rate risk.
The investment risk that impacts buying power and results in devaluation of fixed income securities is called:
A. Market risk.
B. Financial risk.
C. Commerce risk.
D. Inflation risk.
D. Inflation risk.
Inflation risk is also known as “purchasing power risk.” As inflation erodes money’s purchasing power, the value of a bond’s fixed interest payments will decline, reducing the market value of the bond. All fixed income securities are subject to inflation risk.
Funds are escrowed to retire a bond on its next call date. This bond is I. Prerefunded. II. Extinguished. III. Defeased. IV. Defunded.
A. I and II
B. I and III
C. II and III
D. II and IV
B. I and III
A new bond has been issued and the resulting funds have been escrowed for calling a prerefunded bond on its next call date. This bond is said to be defeased and will trade on a YTC basis.
Which of the following have the highest monthly payment guaranteed by the government?
A. T-note
B. GO
C. T-bond
D. GNMA
D. GNMA
T-bonds and notes pay semiannually, as does a General Obligation municipal bond. GNMA is a monthly pass-through of interest and principal with payment that is government-guaranteed.
One method that the Securities and Exchange Commission has incorporated into the yield reporting standards that provides for greater clarity of income results is called:
A. Current yield analysis.
B. Annual yield standardization.
C. Current month yield adjustment.
D. Standardized yield reporting.
D. Standardized yield reporting.
Standardized yield (SEC yield) is the measure of the current net market yields on a mutual fund’s investment portfolio. It is based on the net investment income for the 30-day period ending on the last day of the previous month divided by the highest offering price on that last day. It helps make it easier for investors to compare fund performance.
A U.S. government bond quoted at 94.20 - 95.08 has a bid price of:
A. $942.00.
B. $946.25.
C. $952.50.
D. $958.00.
B. $946.25.
Bonds are quoted at $1,000 par in 32nds, with each point worth $10. The bid price (the first price listed) would be $940 + (20/32 X $10), which converts to $940 + $6.25 for a price of $946.25.
The key difference between a T-Note and a T-Bond is:
A. T-Notes are always sold at a discount and redeemed for the face amount.
B. T-Notes are issued with maturities of less than 10 years.
C. T-Notes are only sold for amounts less than $1,000.
D. T-Notes are issued with maturities of 10 years or more.
B. T-Notes are issued with maturities of less than 10 years.
The only difference between a T-note and a T-bond is the length of the maturity of the original issue. T-Notes have maturities ranging from 2 to 10 years while T-Bonds have maturities of 30 years. Both have a starting denomination of $1,000 and can be purchased at a discount or a premium depending on the interest rate environment in the market.
How are Eurodollars denominated?
A. In euro
B. By the European government
C. In American dollars
D. By both American and European companies
C. In American dollars
Eurodollar securities, whether notes, bonds, or CDs, are based on U.S. dollars in foreign repositories, mostly European.
Alicia purchased a 10-year Treasury bond from the Federal Reserve Bank last year to secure her daughter’s college funds. Which of the following is NOT true regarding this type of security?
A. Alicia has physical possession of the bond itself, so she can sell it to anybody for any price.
B. The bond has a set maturity date.
C. This type of bond is considered a marketable security.
D. The bond is considered a form of “lending” money to the government.
A. Alicia has physical possession of the bond itself, so she can sell it to anybody for any price.
Since 1986, all securities issued by the Treasury Department have been book-entry, meaning they exist only as electronic records in computers.
Which of the following is NOT a secured bond?
A. Mortgage bond
B. Equipment trust certificate
C. Guaranteed bond
D. Collateral trust certificate
C. Guaranteed bond
A guaranteed bond is a debenture (unsecured). It is backed not only by the issuer’s promise, but by an additional promise, usually from a parent or affiliate.
Which of the following statements about series bonds is TRUE?
A. They are considered to be very risky.
B. They are volatile.
C. They may only be redeemed by the Treasury.
D. They trade in the secondary market.
C. They may only be redeemed by the Treasury.
Series bonds are savings bonds that offer stability and low risk. Series bonds are issued by the Treasury and may only be redeemed by the Treasury. They do not trade in the secondary market.
A corporation issues bonds which will mature over several years. These bonds are known as:
A. Serial bonds.
B. Term bonds.
C. Successive bonds.
D. Ladder bonds.
A. Serial bonds.
Serial bonds are issued together but mature in increments over a series of years. Term bonds are issued together and all mature at the same time. A laddered portfolio of bonds is a portfolio of various bonds from different issuers that mature at intervals to match an investor’s cash flow needs.
An 8.5% CMO yielding 9.55% does NOT have which of the following risks?
A. Extended maturity
B. Resale
C. Loss of principal
D. Refinance
D. Refinance
Refinance risk is a threat only when bonds are trading at a premium. CMO refinancing risk occurs when rates are falling. Extended maturity, resale, and loss of principal occur when rates are rising.
Which of the following Treasuries trades in the secondary market?
A. II bonds
B. HH savings bonds
C. T bills
D. EE bonds
C. T bills
EE, HH, and II savings bonds do NOT trade in the secondary market. They must be redeemed by the U.S. Treasury.
The primary responsibility for the payment of principal and interest on an industrial revenue bond issue rests with the:
A. Bond counsel.
B. Issuer.
C. Trustee.
D. Corporate lessee.
D. Corporate lessee.
The corporate lessee pays debt service on a facility lease from the municipality.
The main difference between the 30-day visible supply and the placement ratio is:
A. The 30-day visible supply looks forward and the placement ratio records historical information.
B. The placement ratio considers only revenue bonds.
C. The 30-day visible considers only GO bonds.
D. The placement ratio considers the time value of money.
A. The 30-day visible supply looks forward and the placement ratio records historical information.
The 30-day visible supply reports the total number of municipal bonds coming to market in the next month. The placement ratio reports the number of bonds sold compared to total bonds offered for the previous week.
When comparing long-term bonds to short-term bonds, which of the following statements is incorrect?
A. Long-term bonds are usually more liquid than short-term bonds.
B. Long-term bonds usually have higher yields than short-term bonds.
C. Long-term bonds tend to be more callable than short-term bonds.
D. Long-term bond market prices react to a change in interest rates with a greater price change than short-term bonds.
A. Long-term bonds are usually more liquid than short-term bonds.
In a positive yield curve, which is normal, long-term bonds have higher yields than short-term bonds. Generally speaking, issuers attach call provisions to long-term bonds more frequently than short-term bonds. When interest rates fluctuate, long-term bonds experience a greater price change than short-term bonds. But short-term bonds are generally considered to be more liquid than long-term maturities.
To determine the current yield of a bond,
A. Multiply the current market value by the nominal yield.
B. Multiply the par value by the nominal yield.
C. Divide the annualized dollar yield by the face value.
D. Divide the annualized dollar yield by the current market value.
D. Divide the annualized dollar yield by the current market value.
The current yield is the annualized dollar yield (also called interest rate or coupon rate) expressed as a percentage of the current market value of the bond.
If the last transaction in a bond is XYZ 4.50s 2025 at 98, it is selling at:
A. Asset value.
B. A premium.
C. A discount.
D. Par.
C. A discount.
This bond is selling at a discount or less than par ($1,000). Multiply the quoted price of 98 by 10 to calculate the price ($980).
Which of the following is the most secure?
A. Moral Obligation
B. IDR
C. TAN
D. GO
C. TAN
A TAN (Tax Anticipation Note) is GO, anticipates property tax proceeds, and is short-term. It is the safest of the Muni notes.
Mortgage-backed issues are considered to be safe instruments. Which statement is INCORRECT concerning these securities?
A. GNMA, FNMA, and FHLMC are all fully backed by the federal government.
B. Interest received is subject to federal, state and local taxation.
C. GNMA (Ginnie Mae) is a government-owned corporation.
D. GNMA, FNMA (Fannie Mae), and FHLMC (Freddie Mac) will all hold FHA and VA loans in their portfolios.
A. GNMA, FNMA, and FHLMC are all fully backed by the federal government.
Only GNMA is fully backed by the full faith and credit of the U.S government guaranteed agency. FNMA and FHLMC are government-sponsored enterprises that may borrow from the Treasury.
An investor has some bonds that are callable. She is wondering what the yield on her bonds will be if they are in fact called by the issuer. Which of the following is true regarding this investor’s bonds?
A. She would not be affected by the call unless she opts to redeem the bonds at the current market value.
B. The investor would receive the face value of the bond once it is called.
C. She would receive all future interest in one lump sum when the bond is called.
D. The investor would have a yield on the bond based on the call premium at the time that the bond is called.
D. The investor would have a yield on the bond based on the call premium at the time that the bond is called.
The yield that this investor would realize in the event that the bond was redeemed by the issuer on the next available call date would be the yield-to-call. This yield would be based on the call premium paid by the issuer.
Which of the following statements is true when a bond is trading at a premium?
A. All yields are the same.
B. Yield-to-maturity is higher than current yield.
C. Nominal yield is the highest yield.
D. Current yield is the lowest.
C. Nominal yield is the highest yield.
The nominal yield will always be the highest yield on a premium bond. The nominal yield is the same as the coupon rate.
Treasury notes have stated (fixed) interest payments that are paid:
A. Monthly.
B. Quarterly.
C. Semiannually.
D. Annually.
C. Semiannually.
Treasury notes pay interest semiannually.
Which bond would be the safest credit risk?
A. Guaranteed bond
B. Step coupon bond
C. Convertible bond
D. Income bond
A. Guaranteed bond
Unlike the other debentures, a guaranteed bond is backed by not just one, but two promises.
The risk of not being able to sell a security in a timely manner is:
A. Marketability risk.
B. Business/credit risk.
C. Purchasing power risk.
D. Reinvestment risk.
A. Marketability risk.
Marketability risk is the risk of not being able to sell the investment in a timely manner.
Which of the following is a U.S. government agency backed by the full faith and credit of the U.S government?
A. SLMC
B. FHLMC
C. FNMA
D. GNMA
D. GNMA
Government National Mortgage Association (also known as Ginnie Mae, or GNMA) is the only U.S. government agency fully backed by the U.S. Government. The others are quasi-governmental agencies that have an implied backing in the form of a line of credit from the U.S. Treasury, but not full backing.
A portfolio manager purchases a bond on a yield-to-call basis. This bond is trading at:
A. A premium
B. A series
C. A discount
D. Par
A. A premium
Bonds are always quoted on a “yield-to-worst” basis. This means that discount bonds are sold on a yield-to-maturity basis and premium bonds are sold on a yield-to-call basis. When a bond is issued at par, all yields are the same.
General obligation bonds issued by states are not secured by what form of taxes?
A. Gasoline taxes
B. Property taxes
C. Sales taxes
D. Income taxes
B. Property taxes
Only local subdivisions, such as cities and counties, levy property taxes. Thus, GO bonds issued by the state will not be secured by property taxes.
Which of the following have currency risk? I. American Depository Receipts; II. Eurobonds; III. Income bonds; IV. Treasury Receipts
A. I and II
B. I and III
C. II and III
D. III and IV
A. I and II
ADRs facilitate domestic investment in foreign securities. Because the dividends and principal are denominated in a currency of the foreign issuer, ADRs have currency risk, even though the custodial bank performs all currency exchange services.
Which of the following is an example of an unsecured corporate bond?
A. Mortgage bond
B. Debenture
C. Equipment trust certificate
D. Collateral trust bond
B. Debenture
A debenture is a bond secured only by the full faith and credit of the corporation.
When comparing two similar bonds,
A. The secured bond’s yield will be comparable to the unsecured bond yield.
B. The income bond’s yield will be lower than the secured bond’s yield.
C. The secured bond’s yield will be higher than the unsecured bond yield.
D. The unsecured bond’s yield will be higher than the secured bond.
D. The unsecured bond’s yield will be higher than the secured bond.
Because the debenture is riskier than the secured bond, investors will demand a higher yield. Income (adjustment) bonds are very risky and therefore trade at a significant discount, resulting in a higher potential yield than a secured bond.
Rising prices over time will erode the value of a dollar. This is known as:
A. Purchasing power risk.
B. Market risk.
C. Business risk.
D. Timing risk.
A. Purchasing power risk.
Sustained inflation will erode the value of a dollar causing a decline in the purchasing power of future dollars.
An investor who wants to purchase mortgage-backed securities fully guaranteed by the U.S. government should purchase:
A. Federal National Mortgage Association (Fannie Mae).
B. Federal Home Loan Mortgage Corporation (Freddie Mac).
C. Government National Mortgage Associations (Ginnie Maes).
D. Collateralized Mortgage Obligations (CMOs).
C. Government National Mortgage Associations (Ginnie Maes).
Of these issues, Ginnie Maes are the only ones with both principal and interest payments fully guaranteed by the U.S. government.
Which of the following best illustrates “marketability risk?”
A. A security has “gone out of style” and is no longer attractive in the market.
B. A security has been promoted through false advertising.
C. An advertiser creates a TV commercial that ultimately deters viewers from buying the product.
D. A person selling a security at an inappropriate time sustains a loss.
D. A person selling a security at an inappropriate time sustains a loss.
Marketability or redeemability risk is the risk of selling or redeeming a security at an inappropriate time, thus sustaining a loss or mitigating a profit.
Which of the following are characteristics of TIPS? I. Fluctuating interest rate; II. Fixed interest rate; III. Fluctuating principal; IV. Fixed principal
A. I and III
B. I and IV
C. II and III
D. II and IV
C. II and III
TIPS have a CPI-adjusted, fluctuating principal and a fixed interest rate. Because this fixed rate is applied to a fluctuating principal each semiannual interest period, the interest payment fluctuates.
Assuming a face value of $1,000, a 10% bond quoted at 820 has a current yield of:
A. 8.6%.
B. 10%.
C. 12.2%.
D. 14.5%.
C. 12.2%.
The nominal yield is 10%; the face value of the bond is $1,000. The annual interest is $100 (10% of $1,000). Therefore, the current yield is $100 / $820 = 12.2%.
In the analysis of a general obligation bond, an increase in which of the following is NOT considered a negative event?
A. Assessed valuation of property
B. Expenses of the municipality
C. Delinquent taxes
D. Tax rates
A. Assessed valuation of property
An increase in assessed valuation indicates that the value of local property is rising which will result in higher tax collections.
An investor buys a 4% 10-year municipal bond at 96. Six years later, the investor sells at 99. What is the investor’s gain or loss?
A. $100 loss
B. No gain or loss
C. $30 gain
D. $6 gain
C. $30 gain
Only municipal OIDs are accreted. The discount on a conventional interest paying municipal bond purchased in the secondary market is not accreted.
99 points x $10/point = $990
96 points x $10/point = $960
$990 (sold) - $960 (bought) = $30
Which of the following is NOT required to meet the educational requirements for selling a CMO to a retail client?
A. Discussion stating the fact that two CMOs with the same collateral backing may be retired on different dates
B. Suitability requirements for buying CMOs
C. Glossary
D. Discussion of characteristics and risks involved
B. Suitability requirements for buying CMOs
Brokers who sell CMOs to retail clients are required to offer educational materials to retail buyers, which must a glossary, a discussion of the characteristics and risks involved, and a discussion stating that two CMOs with the same collateral backing may be retired on different dates. Although a broker must always consider suitability when recommending an investment to a client, this is not an educational materials requirement for selling a CMO. However, the required discussion about the characteristics and risks associated with CMOs will serve to educate the investor about this type of security.
Which has the best rating? A. A-3 10 years to maturity B. A-2 15 years to maturity C. A-1 20 years to maturity D. Aaa 5 years to maturity
D. Aaa 5 years to maturity
Moody’s Aaa or S&P’s AAA is top investment grade.
Which of these issues one type of security only that pays monthly interest?
A. T-Bond
B. T-Note
C. Fannie Mae
D. Ginnie Mae
D. Ginnie Mae
The best answer is the GNMA certificate which pays monthly interest. Fannie Mae also issues stock.
A guaranteed bond:
A. Is backed by the full faith and credit of another entity.
B. Has a higher nominal rate than other debentures.
C. Is the best type of secured bond.
D. Has priority over other secured bonds in bankruptcy priority.
A. Is backed by the full faith and credit of another entity.
All bonds are backed by the faith and credit of the issuer. In addition, the guaranteed bond is also backed by the promise of a second entity, usually a parent corporation or subsidiary. Consequently, it has a lower coupon than comparable debentures which are not guaranteed. A guaranteed bond is not a secured bond. Like all other debentures, a guaranteed bond is subordinate to secured bonds in bankruptcy priority.
The last quotation of a U.S. government bond is 98.08. An investor purchasing the bond would pay:
A. $98.80.
B. $980.80.
C. $982.50.
D. $988.00.
C. $982.50.
Bond prices are quoted at par in 32nds. The quote of 98.08 means $980.00 + 8/32, which equals $2.50, making the bond price $982.50.
Which of the following statements are true regarding income bonds? I. They do not pay semiannual interest. II. Their steady income makes them attractive to retired investors. III. They may not return 100% of principal at maturity. IV. They are typically issued by utility companies.
A. I and II
B. I and III
C. II and III
D. II and IV
B. I and III
Income (adjustment) bonds result from a debt renegotiation. The issuer will not pay interest again unless it returns to profitable financial condition. Because they may not return 100% of principal they are very risky and not suitable for most investors. The other answer choices are distractors.
Overlapping debt includes which of the following?
A. School district
B. Port authority
C. Housing authority
D. Hospital board
A. School district
Overlapping debt is general obligation debt. Of these municipal issuers only the school district debt is general obligation. It is backed by taxes.
When the government places an embargo on a foreign source of goods and services, this is considered a form of:
A. Regulatory risk.
B. Business risk.
C. Inflation risk.
D. Import risk.
A. Regulatory risk.
Regulatory risk is associated with changes in law that can potentially affect a security, an industry or a country. This issue may also be referred to as legislative or political risk.
If a bond investor wants to know the rate of return measuring the total performance on a bond held from purchase through maturity, the investor should calculate the:
A. Internal rate of return.
B. Tax-adjusted yield of the bond.
C. Yield-to-maturity.
D. Annualized yield for the bond.
C. Yield-to-maturity.
The yield to maturity is a rate of return measuring the total performance of a bond (coupon payments as well as capital gain or loss) from the time of purchase until maturity.
Which of the following best describes regulatory risk?
A. Currency exchange rates affecting foreign investments
B. Changes in law that can potentially affect a security
C. Purchase of a security at an inappropriate time
D. Security falling out of political favor
B. Changes in law that can potentially affect a security
Regulatory risk, also known as legislative or political risk, is associated with changes in law that can potentially affect a security, an industry or a country.
Which of the following is true of GNMA?
A. It issues $25,000 bonds.
B. It lends funds to savings institutions.
C. It is a direct obligation of the government.
D. Interest payments are semi-annual.
A. It issues $25,000 bonds.
GNMA is a serial, pass-through certificate making monthly payments of principal and interest. It is also a government agency which buys only government-guaranteed mortgages.
Which of the following statements regarding commercial paper is false?
A. Any discount is taxable as ordinary income.
B. It is issued by corporations.
C. It can be issued either at a discount or with a coupon rate.
D. Registration is required by the SEC.
D. Registration is required by the SEC.
Commercial paper that matures in 270 days or less is exempt from SEC registration.
Which of the following corporate bonds is secured by real estate?
A. Mortgage bond
B. Equipment trust certificate
C. Debenture
D. Collateral trust bond
A. Mortgage bond
Mortgage bonds are backed or secured by real estate so if the corporation defaults on the bonds the real estate will be sold to satisfy the bond holder’s claims.
Which of the following investments would be least suitable for a retired individual with limited savings?
A. Income bond
B. CD
C. Money market mutual fund
D. T-bill
A. Income bond
An income bond is the product of a bankruptcy proceeding or debt renegotiation. It is very speculative and not suitable for an investor with a low risk tolerance.
Which of the following would NOT issue overlapping debt?
A. Water district
B. Library district
C. School district
D. State
D. State
The state has no direct role in the property tax.
Which of the following best describes a double-barreled bond?
A. General obligation
B. Contingent liability
C. Moral obligation
D. Section 8-assisted
A. General obligation
A double-barreled bond is a general obligation bond, but it possesses a revenue source which may or may not be adequate for debt service payments.
Geographical diversification of municipal investments can protect against all of the following EXCEPT:
A. Default by one particular issuer.
B. Adverse legislation in one area.
C. Economic decline in one region.
D. Increasing interest rates.
D. Increasing interest rates.
Increasing interest rates affect all long-term debt negatively and can’t be diversified away by investing in municipal bond issues in different regions.
A retired investor is reinvesting the proceeds from a mature municipal bond. Which of the following would best suit her objectives?
A. A toll road bond
B. A G.O. issued by a city with a rising tax rate
C. A pre-refunded bond
D. An airport bond
C. A pre-refunded bond
A pre-refunded bond is AAA and trades to an established call date. It is the best of the four choices. Airport and toll road bonds are revenue bonds which are generally not as safe as G.O.s. A rising tax rate is viewed negatively since it can result from falling assessed values, rising delinquency rates, or municipal budget deficits. Therefore, a G.O. issued by a city with a rising tax rate is not the best choice for this retired conservative investor.
Benefits of Local Government Investment Pools (LGIPs) include all of the following EXCEPT:
A. High investment returns.
B. Protection of capital.
C. Cash management.
D. Liquidity.
A. High investment returns.
LGIPs are established by state or local governmental entities to invest public funds for their own benefit. Among the benefits they offer are cash management, liquidity and protection of principal. Designed to satisfy short-term cash needs, they offer low volatility and modest returns.
If a municipal securities dealer, as a member of a syndicate, enters an order for its own account, which priority would it have, if normal priority were followed?
A. Member
B. Group
C. Designated
D. Pre-sale
A. Member
An order for its own (retail) account would be a member order.
A bond rated A by Moody’s is considered to be:
A. High or medium investment grade.
B. Speculative.
C. Not suitable for investment.
D. Highest-quality investment grade.
A. High or medium investment grade.
Medium investment grade is A. Aaa and AAA are highest investment grade.
The cyclical and constantly fluctuating nature of interest rates has the most direct impact on:
A. No one type of security more than another since all markets are equally affected.
B. The value of growth mutual funds.
C. Market values of fixed income securities.
D. Corporate stock pricing.
C. Market values of fixed income securities.
Interest rates fluctuate constantly and directly affect the market value of fixed income securities. The threat of suffering a loss due to a change in the interest rate is called interest rate risk. All fixed income securities are subject to interest rate risk.
A U.S. government bond quoted at 108.06 - 109.09 has an ask price of:
A. $108.60.
B. $1,081.88.
C. $1,092.81.
D. $1,099.00.
C. $1,092.81.
Bond prices are quoted at $1,000 par in 32nds, with each point worth $10. The ask price (the last price quoted) would be $1,090 + (9/32 X $10) for a price of $1,092.81.
An investor had a series of bonds in his portfolio “called” by the issuer. What “value” can he expect to receive for the bonds when he redeems them with the issuer?
A. Inflation-adjusted value
B. Face value
C. Market discounted value
D. Call premium value
D. Call premium value
When a bond is called, the issuer often pays a call premium for the privilege of calling the bonds early.
Which of the following entities does NOT issue Eurodollar bonds?
A. A local government
B. Foreign corporations
C. U.S. government
D. U.S. corporations
C. U.S. government
The U.S. government cannot issue Eurodollar bonds; however, local and state governments may.
Which of the following is an appropriate investment for a LGIP?
A. Commercial paper
B. Private equity fund
C. International mutual fund
D. Sector fund focused on technology
A. Commercial paper
Of the choices listed, only commercial paper would meet the low volatility and short-term liquidity requirements of a Local Government Investment Fund. Technology sector funds and international mutual funds would be too volatile and risky to meet the everyday cash needs of the participating government entities. Private equity funds are also not appropriate; they are illiquid, long-term investments with a high degree of risk.
Moody’s MIG rating would apply to which of the following?
A. Noncallable industrial revenue bonds
B. Bond anticipation notes
C. Project notes
D. Advanced refunded utility bonds
B. Bond anticipation notes
MIG or Moody’s Investment Grade applies only to municipal notes. It does not apply to project notes which have not been issued since 1984 and were not rated.
Which of the following is the risk that an issuer may not be able to meet interest or principal payments on fixed income securities?
A. Interest rate risk
B. Purchasing power risk
C. Fixed income risk
D. Business/credit risk
D. Business/credit risk
Business/credit risk is the risk that an issuer may not be able to meet interest or principal payments on fixed income securities.
The terms for systematically recognizing the premium or discount associated with a municipal bond’s price are I. Amortization II. Absorption III. Accretion IV. Alliteration
A. I and II
B. I and III
C. II and III
D. II and IV
B. I and III
A bond purchase premium is amortized and a bond purchase discount is accreted. These are mathematical calculations used to systematically recognize the premium or discount over the life of the bond. The other choices are distractors.
Which risk is the risk that an investor may sustain a loss if a security must be sold quickly?
A. Purchasing power risk
B. Business/credit risk
C. Market risk
D. Liquidity risk
D. Liquidity risk
An investment of low liquidity could expose an investor to a risk of loss should the security need to be liquidated quickly.
A bridge authority issues a revenue bond through a competitive bid underwriting. Twenty years after construction is finished, the bridge is condemned due to weather damage and faulty construction. What provision is in place to protect the bond holders?
A. Errors and Omissions refund under the insurance covenant
B. Sinking fund required by the bond indenture
C. Catastrophic call under the insurance covenant
D. Additional bonds test
C. Catastrophic call under the insurance covenant
The insurance covenant in the bond indenture requires that the project is insured against future catastrophe. In this event, the insurance proceeds are used to call the bonds.
Which of the following is false regarding bond anticipation notes?
A. Interest is paid semi-annually.
B. Interest on the notes is exempt from federal income tax.
C. Maturity of the notes is under 5 years.
D. Notes are repaid from general tax collections and direct government obligations.
D. Notes are repaid from general tax collections and direct government obligations.
Bond anticipation notes, or BANSs, are interim financing that is repaid from the proceeds of an upcoming bond issue.
A city and county are coterminous. When evaluating the debt issue of the city, the debt of the county would be considered:
A. Direct debt.
B. Overlapping debt.
C. Commingled debt.
D. Double-barreled debt.
B. Overlapping debt.
If a city and county are coterminous, this would mean that they have overlapping boundaries. In such cases, a portion of the county’s debt would be overlapping on the city.
In a municipal offering, “group net” orders are treated by the manager:
A. For the benefit of the syndicate as a whole.
B. For the benefit of the institution placing the order.
C. And by municipal brokers’ brokers for anonymous clients.
D. To benefit a joint account established in order to reoffer the bonds.
A. For the benefit of the syndicate as a whole.
Group net benefits each member of the syndicate according to bracket.
The type of risk that includes influences such as competitive pressures, market share and competence of management and is usually managed with a long-term focus is called:
A. Market risk.
B. Inflation risk.
C. Management risk.
D. Business risk.
D. Business risk.
Business risk is the risk associated with the specific circumstances of any particular company. It includes many influences associated with business success or failure such as competitive pressures, market share and competence of management. Business risk is usually managed with a long-term focus.
Assuming that a bond is purchased at a discount, then:
A. CY is greater than YTC.
B. CY is greater than YTM.
C. Nominal yield, or stated rate, is less than YTC.
D. Nominal yield is greater than YTC.
C. Nominal yield, or stated rate, is less than YTC.
If a bond is selling at a discount, the current yield (CY) will be higher than the nominal (coupon) yield. The yield-to-maturity (YTM) will be even higher than the current yield, since the discount represents a profit earned at maturity. The yield-to-call (YTC) is the highest yield on a callable bond traded at a discount.
TIPS are NOT issued in which of the following maturities?
A. 5 year
B. 10 year
C. 20 year
D. 30 year
C. 20 year
TIPs are issued in 5-, 10-, and 30-year maturities only.
When comparing business risk and market risk, which of the following is true?
A. The market value of substandard business operation is subject to market risk but the value of a well-run business is not.
B. Business risk is illustrated by the concept that “a rising tide raises (or lowers) all boats.
C. Business risks are those relating to the operational success of the particular business in question as opposed to the influence of trends in the broad securities markets.
D. Market risk has to do with how the successes or failures in the day-to-day operations of a business influence the market value of its securities.
C. Business risks are those relating to the operational success of the particular business in question as opposed to the influence of trends in the broad securities markets.
Business risk is tied to the fortunes of the particular business. Market risk is the influence that general market sentiments and pressures can have on the value of even the more prosperous business operation.
Accrued interest on a new issue municipal bond is calculated from:
A. Dated date to first coupon date.
B. Settlement date to trade date.
C. Dated date to settlement date.
D. Settlement date to first coupon date.
C. Dated date to settlement date.
New issue municipals calculate interest from the dated date up to but not including the settlement date. This interest accrues to the issuer and is factored into the re-offered price of the bond.
The dated date is the date on which interest begins to accrue on a fixed-income security.
Which of the following is a contract between the issuer and the trustee who acts on behalf of the bondholders?
A. Offering circular
B. Trust indenture
C. Prospectus
D. Official statement
B. Trust indenture
A trust indenture is a contract between the issuer and the trustee who acts on behalf of the bond holder. It is designed to protect the bond holder and the indenture will often have covenants that will protect the bondholders’ interest. Further, the indenture will either be open-end or closed-end.
Which of the following are characteristics of auction rate securities? I. They are money market debt instruments. II. They have regularly resetting interest rates. III. They are extremely liquid. IV. They are issued by corporations and municipalities.
A. I and II
B. I and IV
C. II and III
D. II and IV
D. II and IV
ARSs may have limited marketability, and cannot be presented as money market securities. They have regularly resetting interest rates and are issued by certain government agencies, corporations and municipalities.
If interest rates are trending downward, which of the following are true? I. The market value of preferred stocks will increase. II. The market value of all types of fixed income securities will likely decrease. III. Values of U.S. Treasury securities will increase. IV. Values of municipal bonds will decrease.
A. I and II
B. I and III
C. II and IV
D. III and IV
B. I and III
The relationship between bond prices and interest rates is inverse. As interest rates trend down, bond prices will generally go up.
Linda inherited a 20-year Treasury bond from her grandfather. The bond has 5 more years to maturity, so which of the following is true regarding the volatility of the bond based on interest rate fluctuations?
A. As interest rates go down, the bond will go down in market value.
B. The bond will fluctuate more than a 20-year bond with a longer maturity.
C. The bond will not fluctuate with interest rates since it has a set “coupon” interest rate.
D. The bond will fluctuate with interest rates, but less than a similar bond with a longer maturity.
D. The bond will fluctuate with interest rates, but less than a similar bond with a longer maturity.
It is important to remember that the value of a marketable debt security is affected by changes in interest rates. As interest rates go down, for example, the market value of an existing debt security increases. Also, the shorter the maturity, the less volatile a bond is to current interest rate fluctuations.
The lowest bank-qualified rating is:
A. AA.
B. Baa.
C. BB.
D. A-1.
B. Baa.
“Bank-qualified” bonds are investment grade. The lowest investment grade rating is Baa (Moody’s) or BBB (Standard and Poor’s).
Atlanta has $100 million of existing debt and makes up 60% of Fulton County’s assessed valuation. Fulton County has $20 million of debt. What is Atlanta’s direct debt per capita (assuming a population of 2 million)?
A. $30
B. $50
C. $56
D. $60
B. $50
The key here is that the question is asking for DIRECT DEBT PER CAPITA, which includes ONLY the debt of Atlanta, not including any of the Fulton County debt. $100 million divided by 2 million = $50 of direct debt per capita. The overlapping debt is $6 ($12 million divided by 2 million people). The net overall debt for the city is $112 million (the direct debt of $100 million plus the overlapping debt of $12 million), or $56 per capita.
The priority for acceptance of orders for an over-subscribed municipal bond offering will be established by the manager in the:
A. Agreement among underwriters.
B. Official notice of sale.
C. Bid form.
D. Official statement.
A. Agreement among underwriters.
The agreement among underwriters conveyed through the syndicate letter or account summary specifies over-allocation priority.
Which of the following are issued with a specified, fixed rate of interest?
A. U.S. government bonds and notes
B. U.S. government bills and notes
C. U.S. government bills and bonds
D. All of the above
A. U.S. government bonds and notes
Treasury notes and Treasury bonds are issued with specified or fixed interest rates. Treasury bills are dependent on the amount purchased, as they are always purchased at discount. T-Notes and T-Bonds can be purchased at a discount and/or a premium.
Which of the following are characteristics of BABs? I. Their interest is taxable. II. Their proceeds fund debt refinancing. III. Their proceeds fund public projects. IV. Capital gains on BABs are tax-free.
A. I and III
B. I and IV
C. II and III
D. III and IV
A. I and III
BABs are issued by municipalities to finance public projects, such as bridges and highways. BAB interest is taxable. Capital gains on ALL municipal bonds, including BABs, are taxable.
In pricing a new issue, a municipal bond underwriter would most likely check:
A. The 30-day visible supply.
B. SHORT.
C. Munifacts.
D. EMMA.
A. The 30-day visible supply.
The 30-day visible supply indicates how much competition a bond issue will have in the next 30 days. This influences an underwriter’s pricing decision on a new bond offering. The other three are information sources for the secondary market.
Which of the following bonds has the most call risk?
A. 4% corporate bond trading at a premium, callable at a premium
B. 3% corporate bond trading at a discount, callable at par
C. 2% general obligation municipal bond, callable at a premium
D. 4% corporate bond trading at a premium, callable at par
D. 4% corporate bond trading at a premium, callable at par
Generally, bonds with higher stated interest rates are more likely to be called than those with lower stated rates because the issuer has more incentive to eliminate high semiannual interest payments. Also, bonds callable at par are more likely to be called than bonds with a premium call price, because there is less call cost to the issuer.
Qualified disability-related expenses for an ABLE account include all of the following EXCEPT:
A. Wheelchair.
B. Doctor’s visits.
C. Rent.
D. College textbooks for a sibling.
D. College textbooks for a sibling.
Qualified disability-related expenses for an ABLE account must be related to satisfying the needs of the disabled person and include expenses for education, housing, transportation, assistive technology, employment training and support, financial management and health care.
The lowest yielding CMO tranche is the:
A. Inverse floater.
B. Z-tranche.
C. TAC.
D. PAC.
D. PAC.
The PAC has the lowest prepayment and extension risk, and therefore the lowest yield. The Z-tranche is the riskiest tranche. Consequently, the Z-tranche has the highest potential yield.
A pre-refunded bond is sold on a:
A. Current yield basis.
B. YTM basis.
C. YTC basis.
D. Nominal yield basis.
C. YTC basis.
Because the bond will definitely be called on the next available call date, it is quoted and traded on a YTC basis.
Which of the following does NOT affect the secondary market price of a bond?
A. Yield
B. Dated date
C. Settlement date
D. Coupon
B. Dated date
The dated date, first day of interest accrual, would affect price only on new issues, not on secondary market transactions.
When a member is liable for its percentage of any unsold securities, the syndicate is a(n) I. Eastern syndicate. II. Divided syndicate. III. Western syndicate. IV. Undivided syndicate.
A. I and II
B. I and IV
C. II and III
D. III and IV
B. I and IV
In an undivided syndicate, each member is liable for unsold securities regardless of its sales performance in the issue.
The form of risk that affects purchasing power is called:
A. Inflation risk.
B. Consumption risk.
C. Supply and demand risk.
D. Regulatory risk.
A. Inflation risk.
Inflation reduces purchasing power over time.
A South American country nationalizes all foreign business assets within its borders. This is an example of:
A. Inflation risk.
B. Diplomacy risk.
C. Legislative risk.
D. Currency risk.
C. Legislative risk.
Legislative risk, also known as regulatory or political risk, comes from the actions of foreign governments as well as the U.S. government.
A debenture is an example of a:
A. Nonsecured bond.
B. Convertible bond.
C. Zero-coupon bond.
D. Secured bond.
A. Nonsecured bond.
Debentures are corporate issues of unsecured debt; they are backed only by the good faith of the issuer.
Which bond has the greatest market risk?
A. 6 1/2%, 15-year noncallable, rated A
B. 6%, 30-year callable, rated Baa
C. 7%, 15-year noncallable, rated BBB
D. 7%, 30-year callable, rated A-1
B. 6%, 30-year callable, rated Baa
The 30-year has lowest coupon and is lowest of the investment grade rating. Although the rating is equal to the rating of the 7%, 15-year noncallable BBB bond, the bond with the lower coupon/higher price has greater market risk.
Credit analysis of an airport authority revenue bond would include all of the following EXCEPT:
A. Debt coverage ratios.
B. Flow of funds.
C. Competing facilities.
D. Overlapping debt.
D. Overlapping debt.
Overlapping debt is for GO (general obligation), not revenue bonds.
What type of risk involves owning bonds in a declining interest rate environment?
A. Reinvestment risk
B. Interest risk
C. Market risk
D. Inflation risk
A. Reinvestment risk
Reinvestment risk occurs when interest rates have fallen and bond interest income must be reinvested at lower rates. The income produced by the currently available bond yields may be much less.
Which of the following correctly describes a bond’s interest accrual period?
A. The last payment date up to but not including settlement date.
B. The last settlement date up to but not including interest payment date.
C. The dated date up to but not including trade date.
D. The last settlement date up to but not including trade date.
A. The last payment date up to but not including settlement date.
The bond purchaser owes part of the next semiannual interest payment (accrued interest) to the bond seller. The seller is entitled to the first portion of the interest payment (from the last payment date up to but not including settlement date) and the buyer will earn the second portion (from settlement date until the next semiannual payment date).
XYZ Corp’s debentures are convertible into its common stock at $50 per share. The stock has risen to $70. What is the parity price of the bond?
A. $150
B. $900
C. $1,200
D. $1,400
D. $1,400
An increase from $50 to $70 is 40% per share. To be at parity, the bond must also rise 40%. Therefore, the parity price of the bond is $1,400.
$1,000 (par) / $50 (convertible price) = 20 conversion ratio
$70 stock price x 20 conversion ratio = $1,400
If the prime interest rate increases, bond prices will generally:
A. Decrease.
B. Remain the same.
C. Move in parity with the prime rate.
D. Increase.
A. Decrease.
Bond prices are inversely proportionate to interest rates; therefore, a rise in the prime rate will generally cause high-grade bond prices to fall.
Sam was having difficulty selling his investments due to a lack of demand in the secondary market. What does that say about his investments?
A. They may be subject to legislative risk.
B. They were fixed income securities.
C. Their market value was lower than their book value.
D. They have a high liquidity risk.
D. They have a high liquidity risk.
Liquidity Risk is the risk that an asset may not quickly convert to cash at a fair price. Illiquid investments might not sell quickly or at a fair price due to low trading activity in the secondary market.
The best definition of “current yield” is:
A. The most recent annualized dollar amount of income divided by the security’s purchase price and expressed as a percentage.
B. A debt security’s annualized dollar amount of income divided by the face (or “par”) value.
C. The most recent annualized dollar amount of income divided by the security’s current market value and expressed as a percentage.
D. The most recent annualized dollar amount of income, as opposed to any past payout or an anticipated future payout.
C. The most recent annualized dollar amount of income divided by the security’s current market value and expressed as a percentage.
The term “current” always implies a yield figure based on current market value rather than the price paid for a security or its anticipated value at maturity. For a bond, annualized dollar yield is always the same because it is the nominal yield expressed in dollars. For a stock or mutual fund, the most recent annualized dollar yield is the sum of the most recent four dividends.
Which of the following is NOT a risk of Eurodollar bonds?
A. Credit risk
B. Interest rate risk
C. Exchange rate risk
D. Systematic risk
C. Exchange rate risk
Because Eurodollar bonds are traded in, and pay interest in U.S. dollars, they do not have currency or exchange rate risk. Like other bonds, Eurodollar bonds are subject to the other listed risks.
An investor buys bonds which are priced in basis points. These bonds are:
A. Convertible bonds
B. Adjustment bonds
C. Serial bonds
D. Term bonds
C. Serial bonds
Serial bonds are priced at a yield percentage or in basis points. Term bonds are priced in points as a percentage of par value (a dollar price). Convertible bonds are typically term bonds. Adjustment bonds are a result of a debt renegotiation.
Which of the following are characteristics of BABs? I. They provide tax-free interest. II. They may provide a federal subsidy to the issuer III. They may provide a tax credit to the investor. IV. They provide tax-free capital gains.
A. I and II
B. I and IV
C. II and III
D. III and IV
C. II and III
Interest on BABs is taxable, and capital gains from trading ALL bonds is taxable.
All of the following are used to properly evaluate the yield-to-maturity of a bond investment EXCEPT:
A. Number of years to maturity.
B. Par value realized at maturity.
C. Current price of the bond.
D. Annual interest paid in dollars.
C. Current price of the bond.
The factors taken into account when calculating yield-to-maturity of a bond are annual coupon payment in dollars; number of years to maturity; par (or face) value realized at maturity; initial price paid. The current price of the bond is not taken into account.
Which of the following is the highest yield when a bond is trading at a discount?
A. Current yield
B. Yield-to-maturity
C. Coupon rate
D. Nominal yield
B. Yield-to-maturity
Since the yield-to-maturity represents the overall yield received on a bond, it is the highest yield on a discount bond. The calculation incorporates the coupon rate plus the par value received at maturity, which is greater than the discounted price paid.
If a bond is bought at a discount, the yield-to-maturity is:
A. Higher than the nominal yield.
B. Lower than the nominal yield.
C. The same as the nominal yield.
D. None of the above.
A. Higher than the nominal yield.
On a discount bond, YTM is higher than nominal yield. In addition to earning interest, the investor pays less than par value for the bond and receives full par value at maturity.
Liquidity of an investment is best described as:
A. Whether the investment can be traded on an exchange (auction market) or must be negotiated over the counter.
B. Whether trading activity is heavy or light on a given trading day.
C. The extent to which the investment is composed of cash or cash equivalents.
D. Whether the investment can be sold quickly at a fair price.
D. Whether the investment can be sold quickly at a fair price.
To liquidate is to sell an investment and turn it into cash. A security is liquid if it can be quickly converted to cash at a fair price.
Which of the following municipal entities would NOT issue overlapping debt?
A. School district
B. Turnpike authority
C. Park district
D. Library district
B. Turnpike authority
The turnpike authority issues self-supporting revenue debt, not general obligation.
Which of the following factors will most likely create reinvestment risk?
A. Opportunity cost
B. Falling interest rates
C. Short-term investments
D. Decreasing asset values
B. Falling interest rates
Reinvestment risk is the risk that, upon maturity, if interest rates have fallen, the investor must reinvest the bond principal at a lower yield. Also, in a falling rate environment, bond holders must reinvest the bond interest income they receive at lower rates.
The last transaction in ABC 6.00s 2025 was 103. This bond is selling at:
A. Net asset value.
B. Par.
C. A premium.
D. A discount.
C. A premium.
This bond is quoted at 103, which is equal to a price of $1,030. (Remember to multiply 103 x 10 to arrive at the price of the bond). The bond is selling at a premium because the price of $1,030 is greater than its par value (or $1,000).
Which of the following is NOT correct regarding 529 plans?
A. They allow for an accelerated gift per donor.
B. Qualified withdrawals are taxed as ordinary income.
C. Rules and provisions may vary by state.
D. Contributions grow tax deferred.
B. Qualified withdrawals are taxed as ordinary income.
Qualified withdrawals are not taxed as ordinary income. Rather, withdrawals are tax-free when used for qualified education expenses. 529 plans are state-specific, and some rules may vary. Most plans allow for a 5-year “accelerated gift” equal to five times the allowable annual amount per donor with no gift tax liability if no other contributions are made for 5 years. This amount increases periodically for inflation. Contributions grow tax-deferred.
XYZ Industries: 6% noncumulative preferred; 9% debentures convertible at $25. The trust indenture for the debentures contains an “anti-dilution” clause. If the company distributes a 10% stock dividend on the common stock, an investor who owns 10 XYZ Industries debentures would receive:
A. A certificate for one additional bond.
B. A certificate for 10 shares of common stock.
C. A check for $50, representing the adjustment for the conversion ratio.
D. A notice that the conversion price of his bonds has been reduced to $22.73.
D. A notice that the conversion price of his bonds has been reduced to $22.73.
A debenture convertible at 25 would convert into 40 shares ($1,000/25 = 40). A 10% stock dividend would adjust the number of shares to 44. $1,000/44 = 22.73, the new conversion price.
An investor’s eldest child is about to graduate from high school and is not planning on attending any higher education program. What options does the investor have regarding the 529 plan which was established for this child?
A. The parent may use the funds to purchase a primary residence.
B. The funds will be forfeited.
C. The funds may be transferred to a sibling without penalty.
D. The balance may be withdrawn without penalty.
C. The funds may be transferred to a sibling without penalty.
With 529 plans, the donor may roll over the money and transfer it at any time, without penalty, to any beneficiary in the same family as long as it will be used for qualified educational expenses.
Smith Co is a member of an eastern municipal underwriting syndicate. Smith is committed to sell 25% of the issue, or 50,000 bonds. Smith sells 62,000 bonds, and at the end of the offering there are 8,000 unsold bonds. Smith:
A. Must continue selling until the full issue is placed.
B. Fulfilled its commitment in the offering and has no further obligation.
C. Exceeded its obligation and qualifies for the additional takedown.
D. Owns 2,000 of the unsold bonds.
D. Owns 2,000 of the unsold bonds.
In an eastern syndicate, each member is liable for any unsold bonds according to its original commitment percentage. The member’s performance is irrelevant. In this case, though Smith exceeded its commitment by 12,000 shares, it is still liable for 25% of any unsold shares. If this were a western syndicate, it would have fulfilled its commitment in the offering and would have no further obligation.
Which of the following is NOT used to calculate the price of a bond?
A. Coupon
B. Yield to maturity
C. Dated date
D. Accrued interest
C. Dated date
The dated date is relevant only on a new issue bond. It is not relevant to the accrued interest calculation on a bond traded in the secondary market.
Which of the following needs voter approval?
A. GO
B. Sewer revenue bond
C. Special assessment bond
D. IDB
A. GO
Only GO bonds (general obligation) require voter referendums.
IDB = Industrial Revenue Bond
A common fund found in the indenture of a revenue bond that provides money for additions, expansions, and improvements is the:
A. Replacement and renewal fund.
B. Sinking fund.
C. Operations and maintenance fund.
D. Construction fund.
A. Replacement and renewal fund.
Of the common funds that are found in the indenture of revenue bond, an operations and maintenance fund provides for monies to operate and maintain the facility. A debt service fund provides for service of the principal and interest payments. A replacement and renewal fund provides monies for additions, improvements, or expansions to the current facility if these would be considered beneficial.
Which of the following is measured by the yield-to-maturity?
A. The return on a bond up to the call date
B. The return of an investment in relation to the degree of risk
C. The total return of a bond from the time of purchase until maturity
D. The return on a bond based on its current market value
C. The total return of a bond from the time of purchase until maturity
The yield-to-maturity measures the total return of a bond from the time of purchase until maturity. The return of an investment in relation to the degree of risk taken is called the risk-adjusted return. The current yield measures the interest rate that a security with a fixed income is generating to the holder based on its current market value. The yield-to-call measures the return on a bond similar to the yield-to-maturity, except that the ending period is not the maturity date but the call date.
The credit rating of a pre-refunded bond is:
A. Determined by Fitch.
B. AAA.
C. Never above BBB.
D. Based on the financial condition of the issuer.
B. AAA.
An advance-refunded bond has been called and therefore trades on a YTC basis. The issuer pre-refunded this bond by issuing a new bond (with a lower interest rate). The issuer places this refund money into an escrow account to retire the advance-refunded bonds at their next call date. Since money is safely escrowed to retire the old bonds on their next call date, they are automatically reclassified as AAA and they trade to this known call date.
A registered representative of a managing underwriter enters an order for the broker/dealer’s customer’s account. What priority will it have?
A. Pre-sale
B. Member-related
C. Member
D. Designated group
C. Member
Customers of member dealers are given member priority.
What should an investor consider before establishing a 529 plan in a neighboring state?
A. Whether or not the child will attend college as the plan cannot be transferred after it is established
B. Tax consequences for establishing the plan while the child is so young
C. The possible tax consequences of investing in an out-of-state plan
D. Which university the child would have to attend based on this particular 529 plan
C. The possible tax consequences of investing in an out-of-state plan
When an investor establishes a 529 plan outside of his or her state, there could be tax consequences that would make the plan less attractive, including the loss of state income tax deductions. 529 plans do not limit a student’s choice of universities. If the child for whom a 529 plan is established decides not to attend college, the beneficiary can be changed to another person in the same family. Tax consequences are of no concern since earnings grow tax-deferred and withdrawals are tax-free when used for qualified education expenses. In fact, establishing a plan when a child is very young allows funds to grow for a longer period of time.
An investor buys a 10-year municipal bond at 107. The investor sells the bond after 3 years at 102. What is the investor’s gain or loss?
A. $35 loss
B. $29 loss
C. $19 gain
D. No gain or loss
B. $29 loss
The investor reduces bond cost basis by $7 per year ($70 premium / 10 years) After 3 years, the investor’s cost basis is $1,049 (1,070 – 21) Cost basis minus sale price = 1,049 – 1,020 = $29 loss
Qualified higher education expenses in a 529 plan include which of the following expenses for elementary and secondary public school?
A. Unlimited expenses
B. $10,000 in tuition
C. Books and supplies
D. None; only postsecondary education expenses are allowed.
B. $10,000 in tuition
In addition to specified expenses for postsecondary schools (colleges and universities), qualified higher education expenses also include $10,000 in annual expenses for tuition for elementary and secondary public, private, and religious schools.
The term “double-barreled” is used to refer to which of the following?
A. Certain municipal bonds where the source of revenues is a special tax levied on the sale of such items as alcoholic beverages, tobacco, and firearms
B. Certain municipal bonds where a taxing authority guarantees debt service payments in the event that pledged revenues are insufficient
C. The arrangement whereby municipalities issue bonds to finance the construction of industrial plants which are leased to private companies
D. A municipal authority or commission created to finance a project for which the debt service is funded by legislative appropriations
B. Certain municipal bonds where a taxing authority guarantees debt service payments in the event that pledged revenues are insufficient
“Double-barreled” refers to general obligation municipal debt that has a possible unstable revenue source. The final backing if revenues fall short is the general tax revenues of the issuer.
The provision in the indenture of a municipal revenue bond that would be invoked in the case of condemnation of the building constituting the primary revenue source is the:
A. Defeasement provision.
B. Catastrophe call provision.
C. Extraordinary call provision.
D. Sinking fund provision.
B. Catastrophe call provision.
Protective covenants in revenue bonds include the Insurance Covenant. In the event the facility becomes condemned or damaged to the extent that it cannot generate revenues, an insurance policy enables the issuer to call in the bonds. This is known as a “catastrophe call.”
A bond is considered to be speculative (a “junk bond”) when its Standard and Poor’s rating is no higher than:
A. C.
B. B.
C. BB.
D. BBB.
C. BB.
Bonds with a rating of BBB and higher are considered to be “investment grade,” while bonds rated BB or lower are speculative or high yield, also known as junk bonds.
The G.O. index contains:
A. 20 GO bonds with 20 year maturities.
B. 20 GO bonds with 25 year maturities.
C. 25 GO bonds with 25 year maturities.
D. 25 GO bonds with 30 year maturities.
A. 20 GO bonds with 20 year maturities.
The GO index contains 20 GOs with 20 year maturities.
Which of the following would be least suitable for a very wealthy investor seeking tax relief?
A. Limited partnership
B. G.O.
C. Revenue
D. IDR
D. IDR
IDRs are subject to the alternative minimum tax (AMT). Since very wealthy investors are generally subject to the AMT, the other three choices are probably better for this investor.
A parent has been using distributions from a 529 plan to pay for her son’s college education. In his spare time and unrelated to his college curriculum, the son decides to start a business and needs $15,000 in seed money. If $15,000 is withdrawn from the 529 plan to cover this business venture, what are the implications?
A. No penalty, but ordinary income taxes on earnings
B. 10% penalty and ordinary income taxes on earnings
C. 10% penalty, but no tax implications
D. No penalty, no tax implications
B. 10% penalty and ordinary income taxes on earnings
This is not a qualified higher education expense. Therefore, there would be a 10% penalty on the earnings portion of the withdrawal, which would also be subject to ordinary income taxes at the state and federal levels.
The priority accorded to municipal orders taken for a new issue would be found in the:
A. Offering circular.
B. Agreement among underwriters.
C. Official statement.
D. Settlement letter.
B. Agreement among underwriters.
The order priority of a municipal underwriting may be found in the agreement among underwriters. It would not be in the official statement.
Which of the following statements is true about a municipal dealer who has an outfirm quote from another municipal dealer? I. The dealer has the right to buy the bonds at a fixed price for a certain period of time. II. The dealer must buy the bonds before the stated time period expires. III. The dealer can sell the bonds before buying them. IV. The dealer may renegotiate the price prior to the sale.
A. I and III
B. I and IV
C. II and III
D. II and IV
A. I and III
The dealer has received an out firm bid, which is a stated price for a fixed time subject to fill or kill recall. The dealer can sell the bonds prior to buying them. No renegotiate is available, and the dealer is not obligated to buy.
Which of the following are true regarding municipal offerings? I. Revenue bonds are usually offered through competitive bidding. II. Revenue bonds are usually offered through a negotiated process. III. General obligation bonds are usually offered through competitive bidding. IV. General obligation bonds are usually offered through a negotiated process.
A. I and IV
B. II and III
C. II and IV
D. I and III
B. II and III
II and III are correct. A “competitive bid” process is often required for GO bonds; revenue bond issues are typically negotiated.
The responsibility for the payment of principal and interest on an industrial development revenue bond issue rests with the:
A. Municipal issuer.
B. Trustee.
C. Corporate guarantor.
D. Bond counsel.
C. Corporate guarantor.
The corporation is the guarantor of industrial development revenue bonds. The corporation guaranteeing the IDR must be disclosed on the municipal bond confirmation.
Bond premium amortization I. Reduces the investor’s cost basis. II. Increases the investor’s cost basis. III. Reduces YTM and YTC. IV. Increases YTM and YTC.
A. I and III
B. I and IV
C. II and III
D. III and IV
A. I and III
Amortizing the bond’s premium systematically reduces the investor’s cost basis to par at maturity. It also reduces the yield realized by the investor.
Which of the following would be quoted on a bond confirmation when an investor purchases a bond that has been advance refunded?
A. Yield call or yield to maturity whichever is lower
B. Yield to call
C. Yield to maturity
D. Yield to call or yield to maturity whichever is higher
B. Yield to call
Because these bonds have been advance refunded to the call date, the investor will receive yield to call and that is what must be quoted on the investor confirmation. Under normal circumstances the investor confirmation must show yield to maturity or yield to call whichever is lower. But because the bond has been advance refunded, we know that the bond will be called at the first call date. Therefore, in this situation, yield to call is required to be on the confirmation because it will be the effective yield for the investor.
With regard to 529 plans, all of the following are considered qualified higher education expenses EXCEPT:
A. Computers.
B. Extracurricular activity fees.
C. Tuition.
D. Room and board.
B. Extracurricular activity fees.
This is an EXCEPT question. Qualified higher education expenses do not include extracurricular activity fees. They are limited to tuition, mandatory fees, room and board, computers (and related equipment), and required books and supplies.
Advance refunding is:
A. Issuing new debt to extinguish old debt at the first opportunity.
B. Rolling principal over before its maturity to take advantage of higher rates.
C. Making regular deposits to an escrow account to be used only for debt retirement.
D. Escrowing sufficient collateral to extinguish debt at maturity.
A. Issuing new debt to extinguish old debt at the first opportunity.
Advance refunding is issuing a new, lower coupon bond to lock in a low interest rate, escrowing the funds, and using them to pay off an outstanding, higher coupon bond at the next call date.
Where can retail investors find information on municipal bond issuers?
A. Local newspaper
B. The daily bond buyer
C. Munifacts
D. EMMA
D. EMMA
EMMA (Electronic Municipal Market Access) is an electronic system which provides muni bond issuer information to the public and to professionals.
An engineering report would be used for which of the following?
A. Hospital revenue bond
B. School bond
C. Project note
D. General obligation bond
A. Hospital revenue bond
An engineering report or feasibility study would only be used in the analysis of a municipal revenue bond issue. School bonds, general obligation bonds, and project notes do not require feasibility studies.
Prepaid tuition plans allow the purchase of units or credits at participating colleges or universities. Which of the following statements is TRUE?
A. Residency is never required.
B. Future tuition can be secured at current prices.
C. Room and board are covered.
D. Tuition for elementary and secondary schools can be prepaid.
B. Future tuition can be secured at current prices.
Prepaid tuition plans allow the purchase of units or credits at participating colleges/universities for future tuition at current prices. They offer a significant benefit considering the escalating costs associated with college tuition. Room and board are not covered , nor is tuition for elementary and secondary schools. Most prepaid tuition plans are sponsored by state governments and have residency requirements.
The Revdex is found in which publication?
A. EMMA
B. Daily Bond Buyer
C. SHORT
D. Munifacts
B. Daily Bond Buyer
The Revdex is found in the Daily Bond Buyer. It is relevant to the primary municipal market. The other three sources service the secondary municipal market.
What is the cost of a March 120 T-Bond call with a premium of .20?
A. $625
B. $1,000
C. $2,000
D. $6,250
A. $625
Treasury notes and bonds are quoted in 32nds. Therefore, .20 = 20/32 (.625) of 1% of $100,000 (1 point) or $625.
Equity options expire:
A. At 11:59 p.m. ET on the Saturday following the third Friday of the month.
B. At 4:05 p.m. on the third Friday of the month.
C. At noon on the Saturday following the third Friday of the month.
D. At 11:59 p.m. ET on the third Friday of the month.
D. At 11:59 p.m. ET on the third Friday of the month.
Equity options expire on the third Friday of the month at 11:59 p.m. ET.
If an investor is very bullish on a stock, which of the following actions would provide the greatest potential short-term gain?
A. Buy one call on the stock
B. Short 100 shares of the stock
C. Sell one put on this stock
D. Buy 100 shares of the stock
A. Buy one call on the stock
Buying 100 shares of the stock and buying one call on the stock offer theoretically unlimited upside potential. However, a call is cheaper than 100 stock shares and therefore offers the same unlimited upside for a smaller investment. This is the concept of leverage. Selling a put offers a finite, not a theoretically unlimited, potential gain. Shorting stock is a bearish move and is contrary to this investor’s bullish opinion.
An option contract that gives the holder of the contract the right to sell the underlying security at the strike price is a:
A. Short stock position.
B. Call option.
C. Put option.
D. Strike option.
C. Put option.
A put option contract gives the holder of the contract the right to sell the underlying security at the strike price.
The manager of a bond fund has used the strategy of writing covered T-bond calls as a means of increasing the fund’s yield. Distributions to shareholders from this source of income will be treated, for tax purposes, as:
A. Capital gains.
B. Interest.
C. Interest and capital gains.
D. Ordinary income.
A. Capital gains.
Any income derived from writing options is considered to be capital gain. Therefore, any distributions (Remember: a regulated investment company distributes at least 98% of its net capital gains.) would be considered to be capital gains to the shareholder of the fund. However, interest received on the bonds in the portfolio would be distributed (after expenses) to the shareholder in the form of dividends, taxed as ordinary income.
If you anticipate interest rates to decline, you would recommend a I. T-Bond yield call. II. T-Bond yield put. III. T-Bond call. IV. T-Bond put.
A. II and IV
B. I and III
C. I and IV
D. II and III
D. II and III
Rates declining would favor a T-Bond yield put, which follows declining yields and a T-Bond call, which appreciates along with bond prices.
ABC shares are trading at $29. An investor buys 10 ABC Oct 30 calls at $2 and 10 ABC Oct 30 puts at $3.50. At expiration, ABC is trading at $34 and the investor closes the position at intrinsic value. What is the gain or loss, not including commission?
A. $150 loss
B. $1,500 loss
C. $400 gain
D. $4,000 gain
B. $1,500 loss
Credit: ($34 - $30) (call buy)
Debit: $2.00 (premium), $3.50 (premium)
$34 - $30 - $2.00 - $3.50 = -$1.50 x 1,000 shares = -$1,500
The investor purchased 10 calls at $2 for a total cost of $2,000 and 10 puts at $3.50 for a total cost of $3,500. At expiration, ABC is $34, so the Oct 30 calls are in-the-money by four points and the investor’s calls have intrinsic value of $4,000 ($4 x 100 x 10 = $4,000). The Oct 30 puts are out-of-the-money and have zero intrinsic value. The investor made $2,000 profit on the calls but lost $3,500 (the entire premium paid) on the puts; $2,000 - $3,500 = $1,500 loss.
Bob wrote one XYZ July 45 put for $4.50 and one XYZ July 40 call for $2 with the market price of XYZ at 41. XYZ appreciates to 43, and Bob makes closing purchases of the put for $2.50 and the call for $3.75. What is the gain or loss?
A. $250 loss
B. $250 gain
C. $25 loss
D. $25 gain
D. $25 gain
Credit: $4.50 (premium), $2.00 (premium)
Debit: $2.50, $3.75 (closing purchases)
$4.50 + $2.00 - $2.50 - $3.75 = $0.25
The position is a short combination. Bob wrote the put and call for a combined premium of $6.50 ($4.50 + $2). He purchased them back for a combined premium of $6.25 ($2.50 + $3.75 = $6.25. $6.50 - $6.25 = $0.25 X 100 = $25.
If a call holder chooses to exercise the call, the writer must:
A. Buy 100 shares of the underlying security at the strike price.
B. Assign a call.
C. Give notice to the OCC.
D. Sell 100 shares of the underlying security at the strike price.
D. Sell 100 shares of the underlying security at the strike price.
Call holders have the right to buy. Therefore, the writer of the call option would be obligated to sell 100 shares at the strike price if the contract was exercised.
Long-term equity appreciation participation securities or LEAPS have expirations as long as:
A. 9 months.
B. 12 months.
C. 24 months.
D. 39 months.
D. 39 months.
LEAPS can run as long as 39 months. However, when leaps are in the last 9 months prior to expiration, they are considered regular options.
You buy a put. Four months later, you sell for a gain. Which is true? I. Short-term capital gain; II. Long-term capital gain; III. Closing sale; IV. Closing purchase
A. I and III
B. I and IV
C. II and III
D. II and IV
A. I and III
Short-term and closing sale.
Which of the following applies to a call option contract?
A. The call writer has the obligation to buy at the strike price.
B. The call holder has the obligation to buy at the strike price.
C. The call writer has the right to sell at the strike price.
D. The call holder has the right to buy at the strike price.
D. The call holder has the right to buy at the strike price.
A call option is a contract that gives the call holder the right to purchase 100 shares of the underlying security, at the strike price (also called the exercise price), until expiration. The call writer has the obligation to sell 100 shares of the underlying security at the strike price. Long call – right to buy. Short call – obligation to sell.
On behalf of a client, you enter an order to write 5 ABC Jan 30 puts. This order is a(n)
A. Closing buy order.
B. Opening buy order.
C. Opening sell order.
D. Closing sell order.
C. Opening sell order.
Opening sell, the investor is establishing a short position.
A financial institution has a large portfolio of U.S. Treasury notes and is concerned that interest rates are about to increase. Rather than selling off the notes, thereby creating portfolio volatility, the institution could attempt to offset the portfolio’s unrealized losses by:
A. T-note options could not be used in this situation.
B. Buying T-note calls.
C. Buying T-note puts.
D. Writing either T-note calls or T-note puts.
C. Buying T-note puts.
If interest rates go up as expected, the T-note portfolio will decline in price. The purchase of T-note puts would offset this unrealized loss, since their value would increase as prices decrease.
An investor is long XYZ stock at 50 and writes a 55 call for 3. What is the result when the investor closes this position at the current market price of 57?
A. $400 gain
B. $600 gain
C. $800 gain
D. $1,000 gain
C. $800 gain
Credit: $3 (premium), $55 (short call)
Debit: $50 (long stock)
$3 + $55 - $50 = $8 x 100 shares = $800
The investor bought stock at $50 (debit), sold a call @$3 (credit) and sold stock at $55 (credit). Total credits $58 - $50 debit = $8 X 100 = $800.
An investor is short 20 DEF April 70 puts. He enters an order to buy 10 DEF April 70 puts. This order is:
A. An opening sell order.
B. A closing buy order.
C. A closing sell order.
D. An opening buy order.
B. A closing buy order.
This is a closing buy order. The investor is reducing an existing options position.
If a call holder chooses to exercise the call, the writer must:
A. Give notice to the OCC.
B. Sell 100 shares of the underlying security at the strike price.
C. Buy 100 shares of the underlying security at the strike price.
D. Assign a call.
B. Sell 100 shares of the underlying security at the strike price.
Call holders have the right to buy. Therefore, the writer of the call option would be obligated to sell 100 shares at the strike price if the contract was exercised.
The strike price and premium of Treasury bond options are stated as a percentage of the:
A. Face amount of the underlying bonds.
B. Aggregate call premium.
C. Accrued interest.
D. Current market value of the underlying bonds.
A. Face amount of the underlying bonds.
The par value, or face amount of T-bonds, is basis for bond and option quotes.
Your customer writes an S & P 100 (OEX) May 320 put for .50. With the OEX at 340, what is her maximum gain?
A. $34
B. $50
C. $510
D. $515
B. $50
$0.50 (premium) x 100 shares = $50
When you write a put, your maximum gain is the premium you received - $50 or .50 point X 100.
The holder of a call option on a T-bond will profit under all of the following circumstances, EXCEPT I. Yields on T-bonds decrease. II. Yields on T-bonds increase. III. Prices of T-bonds decrease. IV. Prices of T-bonds increase.
A. I and III
B. I and IV
C. II and III
D. II and IV
C. II and III
The buyer or holder of a call will profit, EXCEPT when yields increase and prices decrease. Under this circumstance the holder will lose.
A U.S. corporation imports goods from Switzerland. Which of the following option positions should it choose to best protect itself?
A. Buy Swiss francs puts
B. Sell Swiss franc calls
C. Sell Swiss franc
D. Buy Swiss franc calls
D. Buy Swiss franc calls
Remember that “importers buy calls.” An easy way to remember this is EPIC: Exporters buy Puts, Importers buy Calls.
A client has both a cash and margin account, and actively trades stocks in both. He does not own stock ZZZ at the moment, but has been following it for some time and is convinced it is going to steeply decline in price. He plans to short sell the stock, but wants to know any advantages to buying puts on the stock instead. All of the following are correct EXCEPT put buying:
A. Does not require that securities be located for borrowing.
B. Returns are enhanced by the gradual erosion of the option’s time value.
C. Is less risky.
D. Involves a smaller capital commitment.
B. Returns are enhanced by the gradual erosion of the option’s time value.
Both strategies allow investors to capitalize on a stock’s decline, but with very different risk/reward profiles. Short sales have an unlimited loss potential in a rising market, while the maximum loss on a long put is limited to the premium paid. Short sales must be done in a margin account, and 50% of the short market value is required to be deposited by the investor. Long puts require a much smaller capital outlay - the option premium. Short sales can also be more cumbersome since the securities to be borrowed must be located. The eroding time value of options does not constitute an advantage, however, because it works to reduce premiums over time, thereby inhibiting options returns.
A customer buys an 8 1/2% T-bond maturing in 2015. He also buys a T-bond put. Interest rates appreciate to 10%. Which of the following will occur upon sale of the bond and exercise of the put?
A. Put will be exercised for a gain.
B. Position will be closed for a loss.
C. Position will be closed without gain or loss.
D. Bond yields will rise for a gain.
B. Position will be closed for a loss.
If you buy a T-bond and a T-bond put, then interest rates rise; you cut your losses in bond price by exercise. Your loss becomes mostly premium.
The contract size for equity mini-options is:
A. 10 shares of the underlying stock.
B. 25 shares of the underlying stock.
C. 50 shares of the underlying stock.
D. 100 shares of the underlying stock.
A. 10 shares of the underlying stock.
The contract size for equity mini-options is 10 shares of the underlying stock.
A domestic company is exporting goods to Europe. Which of the following option strategies would it use?
A. Sell euro puts
B. Buy euro calls
C. sell euro calls
D. Buy euro puts
D. Buy euro puts
The U.S. exporter would buy puts. An easy way to remember this is EPIC, meaning Exporters buy Puts, Importers buy Calls.
Which one of the following parties to an options contract receives the premium and has the obligation to sell the underlying security at the strike price if the option is exercised?
A. Put writer
B. Call holder
C. Call writer
D. Put holder
C. Call writer
The call writer is short the call and has the obligation to sell the underlying security at the strike price if the options contract is exercised by the call holder. The call writer collects the premium.
Which of the following is true concerning option sales literature?
A. It must show past performance.
B. It must be preceded or accompanied by an OCC disclosure document.
C. It must disclose the firm’s past experience based on the firm’s recommendations.
D. It may not project future performance.
B. It must be preceded or accompanied by an OCC disclosure document.
Sales literature in options may portray past performance of representative and B/D and may project future performance if hedged and currency dates are given, but it must be preceded or accompanied by a disclosure document.
Triple witching involves the expiration of which of the following four times a year? I. Equities; II. Equity options; III. Equity option indexes; IV. LEAPs
A. I and II
B. I and IV
C. II and III
D. II and IV
C. II and III
Equities don’t expire; therefore, any choices containing “I” are incorrect. “Triple witching” is the expiration of options on equities, equity indexes, and equity index futures, but futures are for another test; not covered here on the Series 7.
A customer buys 1 Euro April 98 call and sells 1 Euro July 98 call. The position is profitable under all circumstances, EXCEPT:
A. Premiums widen.
B. Premiums narrow.
C. Both contracts expire.
D. Both contracts are exercised.
A. Premiums widen.
The position is credit; the July being sold is more valuable. Credit will gain, except if premiums widen.
A customer with a short equity put option is assigned an exercise notice by his firm. How should he handle this?
A. He can avoid buying the underlying stock by closing out his short put within 24 hours of receiving the exercise notice.
B. He must accept the exercise notice and buy the underlying stock.
C. He can ask the firm to reassign the notice.
D. He can refuse the exercise notice.
B. He must accept the exercise notice and buy the underlying stock.
The exercise of options contracts is backed by the Options Clearing Corp., which is the clearing agent for listed options contracts and is responsible for standardizing, issuing and guaranteeing the performance of these contracts. If the holder of an option wishes to exercise, his broker/dealer notifies the OCC, which, in turn, randomly assigns the exercise notice to a broker/dealer that can fulfill the notice. That broker/dealer then assigns the exercise notice to a short customer on a random, first in/first out or any other basis that is fair and reasonable. Once a customer receives an exercise notice, he must fulfill his obligations under the contract. If a customer defaults on this obligation (which is rare), the OCC, as the guarantor of last resort, stands ready to fulfill it.
A customer purchases one XYZ July 50 put for $2.50 with the price of XYZ stock at 55. The following week, XYZ reports disappointing earnings and the stock drops to 43.50. If the customer simultaneously exercises the long put and purchases 100 shares of XYZ stock at 43.50, the resulting profit or loss would be
A. $0.
B. $400 profit.
C. $400 loss.
D. $650 profit.
B. $400 profit.
[ $50 - $43.50 - $2.50 ] x 100 shares = $400 profit
The customer purchases the put for $2.50 (a debit). He exercises the put and sells stock at $50 (a credit) and purchases the stock at $43.50 (a debit). $6.50 profit on stock - $2.50 premium paid= $4 X 100 = $400 profit
The options position with the most risk is:
A. Uncovered put.
B. Long call.
C. Uncovered call.
D. Long put.
C. Uncovered call.
Short calls have unlimited risk. Naked or uncovered calls are short calls.
A customer has a portfolio of Treasury securities. In order to increase investment income,
A. Buy calls.
B. Write puts.
C. Buy puts.
D. Write calls.
D. Write calls.
If an investor is long Treasury securities, writing T-Bond calls would increase income through receiving premiums.
A newspaper advertisement lists only the name, address, and phone number for information on options. Which of the following is required?
A. Approval of the CBOE
B. Permission of the broker/dealer
C. Approval of the ROP
D. Nothing, not an ad
C. Approval of the ROP
Approval of the ROP is always required, whether the material is sales literature, advertising, or personal correspondence. Approval of the CBOE is required for any but blind ads. This is a blind ad.
A Registered Options Principal (ROP) designation qualifies the holder to supervise options trading activities.
Buy one ABC Jan 40 call and write one ABC Jan 30 call. This position I.is a Debit spread. II is a Credit spread. III. Loses money if premiums widen. IV. Loses money if premiums narrow.
A. I and III
B. I and IV
C. II and III
D. II and IV
C. II and III
Write a 30 call, buy a 40 call is a vertical (price) spread. The short call with lower strike price will have the higher premium, so the spread is established for a credit. You make money on this position if the spread narrows (becomes less expensive) if it widens (becomes more expensive) you lose money. This is a bear call spread.
A company is building a plant in Japan using Japanese labor. The company will pay the labor force in Japanese yen in approximately 3 months. The company believes the dollar will decline against the yen. In order to best protect itself, what option position should the company choose?
A. Sell a Japanese yen put
B. Sell a Japanese yen call
C. Buy a Japanese yen put
D. Buy a Japanese yen call
D. Buy a Japanese yen call
If the U.S. company wishes to protect its payroll, it would buy Japanese yen calls to hedge against the currency.
Which of the following is the most widely used index for option contracts?
A. S & P 100
B. National OTC
C. Major market
D. S & P 500
A. S & P 100
The S & P 100, or OEX, has the greatest volume by far.
How often can an investor purchase the maximum number of option contracts?
A. 5 business days
B. 7 business days
C. 30 calendar days
D. 9 months
A. 5 business days
The option position limits apply every 5 business days.
XYZ stock has a market price of $55 per share. John thinks the price of XYZ stock is going to remain stable over the next 3 months, so he decides to write 10 XYZ July 55 calls @ 3. What is the maximum gain?
A. $300
B. $1,000
C. $3,000
D. Unlimited
C. $3,000
The maximum gain in writing/selling options is the premium received.
You are long 200 shares of ABC at 54 and simultaneously buy 2 ABC Aug 55 puts for 3. The puts are exercised with the market at 52. What is your gain or loss?
A. $100 gain
B. $300 gain
C. $200 loss
D. $400 loss
D. $400 loss
Premium is -3 (200). Market is a long position hedge. -54 + 55 = +1 - 3 = -2 X 200 = $400 loss. Note that the market value (market at 52) is irrelevant for this calculation.
Credit: $55 (put)
Debit: $54 (own), $3 (put premium)
$55 - $54 - $3 = -2 x 200 = -$400
A client purchases 100 XYZ at 47 and later writes a Nov 50 call at 4. The client will break even when the underlying stock is at:
A. $40.
B. $43.
C. $51.
D. $54.
B. $43.
Price paid for stock $47 - $4 premium received = $43.
Your customer writes an OEX 250 put for 2.50 when the S & P 100 is at 252. What is the maximum loss?
A. $250
B. $24,750
C. $25,000
D. $25,200
B. $24,750
Credit: $2.50 (premium)
Debit: $250 (strike)
$2.50 - $250 = -$247.50 * 1000 = -$24,750
The maximum loss is the strike price of 250 minus 2.50 X 100 = 24,750.
A customer purchases one XYZ July 50 put for $2.50 with the price of XYZ stock at 55. What is the maximum profit the customer could realize?
A. $250
B. $4,750
C. $5,000
D. Unlimited
B. $4,750
$50 - $2.50 = $47.50 x 100 = $4,750
50 strike price - $2.50 premium= 47.50 X 100 = $4,750 gain
If a customer is short a stock, which of the following would lower risk and increase income?
A. Buy puts
B. Buy calls
C. Sell puts
D. Sell calls
C. Sell puts
A short stock position is bearish. You would sell puts, which is bullish and would give a partial hedge and income.
The options position limit on XYZ stock is 200,000 contracts. Bob (a high roller) is short 150,000 XYZ Dec 50 puts. Which of the following trades would put Bob in violation of position limits?
A. Buy 100,000 XYZ Mar 60 puts.
B. Buy 60,000 XYZ Dec 50 puts.
C. Buy 60,000 XYZ Mar 60 calls.
D. Write 100,000 XYZ Dec 60 calls.
C. Buy 60,000 XYZ Mar 60 calls.
Bob is short puts, a bullish position. If he buys 60,000 calls, he will have 210,000 contracts on the same side of the market. Buying 60,000 XYZ Dec 50 puts will reduce his position. Writing calls and buying puts are bearish positions.
George bought 500 shares of ABC at 41 and wrote 5 ABC June 40 straddles. At expiration, ABC closes at 37.50 and George is exercised on his short puts. After being exercised, what is George’s stock position?
A. Long 500 shares ABC
B. Short 500 shares ABC
C. Long 1,000 shares ABC
D. Short 1,000 shares ABC
C. Long 1,000 shares ABC
A put writer has the duty to buy stock at the strike price. George already owned 500 shares and had to buy another 500 shares of ABC at the 40 strike price.
Your client has a portfolio of Treasury bonds. You are concerned about a rise in interest rates. Which of the following would you recommend?
A. Sell T-Bond puts
B. Buy T-Bond calls
C. Buy T-Bond puts
D. Sell T-Bond calls
C. Buy T-Bond puts
A rise in interest rates would cause bond values to fall. Therefore, a hedge would involve buying puts on long bond positions.
If XYZ stock is trading at 27.50, which of the following options are in-the-money?
A. XYZ August 25 put
B. XYZ July 30 call
C. XYZ July 25 call
D. XYZ August 27 put
C. XYZ July 25 call
The July 25 call is in the money by 2.50. A call is in the money when the price of the underlying security is higher than the strike price. A put is in the money when the price of the underlying security is lower than the strike price.
An investor has a portfolio of stocks that has appreciated from an original value of $38,000 to a current value of $44,000. The portfolio has a beta factor of 1.00. If the investor wishes to hedge the portfolio through the use of OEX SEP 220 options, the investor should:
A. Buy 1 put.
B. Buy 2 puts.
C. Write 1 call.
D. Write 2 calls.
B. Buy 2 puts.
$44,000 (portfolio) / [ 220 (strike) x 100 (contract multiplier) ] = 2 puts
2 puts x 1.00 (beta) = 2 puts
The best way to hedge a portfolio of stocks is to purchase a put option. Since the investor wishes the use OEX 220’s and since each option has a multiplier of 100, the market value of the OEX 220 is 100 X 220, or $22,000. Hedging a portfolio of $44,000 would require two puts.
With the underlying stock at $120, an investor writes a naked 120 put for a premium of $200. The maximum the writer can lose is:
A. $200.
B. $11,800.
C. $200 to $12,000.
D. $200 to infinity.
B. $11,800.
$120 (strike) x 100 = $12,000, if stock goes to zero.
$12,000 - $200 (premium) = $11,800 loss
The maximum loss for a short put occurs if the stock goes to zero. The writer is exercised, and is forced to buy worthless stock for $120 per share. Keeping the $200 premium, the maximum loss is $11,800.
Option orders are transmitted to the CBOE trading floor via:
A. ECN.
B. OSS.
C. SLP.
D. EMMA.
B. OSS.
The CBOE’s Order Support System is an automated execution system that allows member firms to transmit option orders directly to the trading post.
Short 200 shares of ABC at 56. Which would lower or offset your market risk? I. Buy ABC July 55 put; II. Sell ABC July 55 put; III. Buy ABC July 55 call; IV. Sell ABC July 55 call
A. I and III
B. I and IV
C. II and III
D. II and IV
C. II and III
For short stock, selling puts provides a partial hedge (and income) and buying calls is a hedge.
Your client purchased one XYZ Sept. 120 straddle @ $9 ($3.75 for the call and $5.25 for the put). Assuming intrinsic value only, what are the breakeven points for the straddle?
A. 111 and 129
B. 120 and 129
C. 102 and 138
D. 111 and 138
A. 111 and 129
$120 + $9 = $129
$120 - $9 = $111
Breakeven is 111 and 129. Call strike price + total premium on the upside. Put strike price – total premium on the downside. Your client makes a profit if XYZ falls below 111 or rises above 129. He loses money at expiration if XYZ closes between 111 and 129.
You buy/hold an ABC Sept 50 put. Which of the following would create a straddle?
A. Sell ABC Sept 60 call
B. Buy ABC Sept 50 call
C. Sell ABC Sept 50 call
D. Buy ABC Sept 40 call
B. Buy ABC Sept 50 call
A straddle is either buying or selling a call and put on the same underlying security, with the same strike price and expiration date. You buy/hold an ABC Sept 50 put, so to create a straddle, you buy/hold an ABC Sept 50 call.
In closing a discretionary account trading in options, you would need the permission of which of the following?
A. General securities principal
B. Client
C. Supervisory manager
D. Registered options principal
D. Registered options principal
The registered options principal must approve both the opening and closing of discretionary accounts in options and closely review their transactions.
All of the following are advantages of buying calls EXCEPT:
A. Potential for unlimited gains.
B. Collecting dividends on the underlying stock.
C. Liquid secondary market.
D. Leverage.
B. Collecting dividends on the underlying stock.
Call holders don’t collect dividends; they don’t own the stock.
Your customer buys one XYZ 160 put at 10 and shorts one XYZ 150 put at 3. Which two words describe this spread? I. Debit; II. Credit; III. Bullish; IV. Bearish
A. I and III
B. I and IV
C. II and III
D. II and IV
B. I and IV
This is a debit spread, since the customer purchased one put for 10 and sold the other for 3, which resulted in a debit of $700. Further, this is a bear spread, since the customer bought a put with the high strike of 160 and sold a put with a strike price of 150. If the investor had sold the option with the lower strike price, it would have been a bull spread and credit.
In early May, a customer buys 100 SOP at 27 and writes one SOP Oct 30 call for 3. This is his first option transaction and takes place in his cash account. Which of the following statements is TRUE if the call is exercised?
A. Breakeven at 24, maximum profit of $300
B. Breakeven at 24, maximum profit of $600
C. Breakeven at 30, minimum profit of $300
D. Breakeven at 30, minimum profit of $600
B. Breakeven at 24, maximum profit of $600
$27 - $3 = $24 breakeven
$30 - $27 = $3 x 100 = $300 from sale
$3 x 100 = $300 from premium
Since the investor purchased 100 shares for $27 a share and sold the call for $300, the investor is out a net of $2,400; therefore, the breakeven point is $2,400 or $24 per share. If the market increases and the option is exercised, the owner of the stock makes the maximum profit of $600. Premium = +3; Market = -27 + 30 = +3 = -24 breakeven = +6 X 100 = $600
The portfolio manager of a U.S. large-cap equity mutual fund is worried that an escalating trade war may negatively impact his fund by causing a general market decline. Which of the following hedging strategies would best protect the fund portfolio in a down market?
A. Buy Russell 2000 Index puts
B. Buy puts on the portfolio’s major holdings
C. Buy S&P 500 Index puts
D. Sell S&P 500 Index calls
C. Buy S&P 500 Index puts
Given the nature of the fund, the most effective hedge is to buy puts on a broad U.S. market index whose composition closely resembles that of the portfolio. The S&P 500 Index is a better match for the fund portfolio than the Russell 2000 Index, which tracks small- and medium-cap U.S. stocks. Long puts would provide a good hedge because they will increase in value if the market, and therefore the fund, declines in value. Selling calls on the S&P 500 Index is a less effective hedge than buying puts because it would limit the portfolio’s downside protection to the premiums collected. Buying puts on the fund’s major holdings would be costly and, in any event, would not succeed in protecting the portfolio as a whole.
A customer buys 100 shares of XYZ stock for $40 a share and sells one July 45 call for a premium of $2. What is the maximum loss that the customer would sustain?
A. $3,800
B. $4,000
C. $4,200
D. $4,500
A. $3,800
If stock goes to zero, customer would lose [ $40 (purchase price) + $2 (premium) ] x 100 shares = $3,800
Premium = +2 Market = -40 (stock price) = 38 breakeven X 100 = $3,800
A mutual fund portfolio manager expects interest rates to increase. He wishes to protect his Treasury bond portfolio but also wishes to generate some additional income. What would be the most appropriate action for the portfolio manager to take?
A. Sell T-bond puts
B. Sell T-bond calls
C. Buy T-bond puts
D. Buy T-bond calls
B. Sell T-bond calls
Because the manager wishes to generate income and have the income protect against temporary declines in bond prices, he should sell calls, not buy puts.
An investor is bullish on a stock and wants to leverage the maximum potential gain on that stock. However, she is uncomfortable with the short-term nature of options. Which of the following might her registered representative suggest?
A. Maxi-options
B. LEAPS
C. STAGS
D. Mini-options
B. LEAPS
Unlike conventional options and which expire nine months after issue, LEAPS are issued with expirations out to 39 months and might appeal to this investor. Mini-options represent an underlying 10 shares (instead of 100) but still have nine month expirations. “STAGS” is a distractor.
An investor buys one DEF May 60 call for a premium of 6 and sells one DEF May 70 call for a premium of 3. The investor will break even at expiration of LDEF if trading at which of the following prices?
A. $60
B. $63
C. $66
D. $67
B. $63
Premium = -6 + 3 = -3 Market = -60 (call = right to buy) = 63
With XYZ trading at 72.75, a customer buys one XYZ May 75 put for $4.50. What’s the maximum gain?
A. $450
B. $7,050
C. $7,275
D. $7,500
B. $7,050
[ $75 (strike) - $4.50 (premium) ] x 100 shares = $7,050
Maximum gain is $7,050, 75 strike price - $4.50 premium paid = $70.50 X 100 shares. The put holder will realize the maximum gain if XYZ is 0 at May expiration.
Buy 200 shares of XYZ at 35. Sell 2 XYZ June 40 calls for 2. Sell 2 XYZ June 30 puts for 1.50. What is the maximum loss?
A. $6,700
B. $7,000
C. $12,300
D. $13,000
C. $12,300
Credit: $2 (premium), $1.50 (premium)
Debit: $35 (purchase), $30 (short put)
The position should be treated as a covered call, long the stock, short the call, and a short put X 200. Long the stock at 35 = -35. Duty to buy on short put = -30 Market = -65. Premium received = +3 1/2 Breakeven is -61.50 X 200 = $12,300 loss
On April 25, a customer buys 100 XYZ at 62.25 and, on the next day, buys one XYZ July 60 put at 1.50. At expiration, XYZ is selling at 68.38. The customer allows the put to expire and sells the XYZ shares at 68.38. What would be his profit on the overall transactions?
A. $350.50
B. $463
C. $612.50
D. $762.50
B. $463
Credit: $68.38
Debit: $62.25, $1.50
$68.38 - $62.25 - $1.50 = $463
Paid $6,225 for the long position in XYZ (100 X 62.25), also paid $150 for the put option, for a total of $6,375 paid. Put option expires unexercised, and receives $6,838 for the sale of XYZ (100 X 68.38). $6,838 – $6,375 = $463 profit.
Prior to writing an option in a newly-opened account, which of the following must be completed and delivered? I. Options agreement; II. Margin agreement; III. Options disclosure; IV. Margin disclosure
A. I and II
B. I and III
C. II and III
D. II and IV
C. II and III
The hypothecation (margin) agreement must be completed prior to the first margin trade, and writing an option is a short sale on margin. The options disclosure document must also be sent. The options agreement needs to be signed only after 15 days of account opening, and margin disclosure is with the opening of the margin account, not the first trade.
Sandy holds 2 XYZ Dec 60 calls. XYZ split 3:2. After the split Sandy holds 2 XYZ Dec 40 calls. A week later, she sold her calls for $3. What is the total premium she received?
A. $45
B. $450
C. $600
D. $900
D. $900
After a 3:2 split, the new contract size is 150 shares. $3 X 150 = $450 X 2 contracts = $900.
When an option writer covers a position by purchasing an option, it is a(n):
A. Closing sale.
B. Opening purchase.
C. Closing purchase.
D. Opening sale.
C. Closing purchase.
If the investor is the writer of an option, which is the same as being short, he can close his position by buying an options contract.
All of the following statements refer to European style options EXCEPT:
A. Can be exercised at any time.
B. Can only be exercised during a specific time period.
C. Are less risky than American style options.
D. Often apply to stock index options.
A. Can be exercised at any time.
Unlike American style options, European style options can only be exercised during a specific time period, usually the last trading day before expiration, making them less risky. Options on stock indexes are generally European style.
A customer writes 10 ABC April 40 puts at $4.75 when the market price of ABC is $42. What is the maximum possible gain for the investor?
A. $2,750
B. $4,750
C. $35,250
D. $40,000
B. $4,750
Maximum gain for an option writer is the premium received. Therefore, 4.75 X 100 = 475 X 10 = $4,750.
Bob sold one XYZ March 60 call for 3.50. What is the maximum gain?
A. $350
B. $600
C. $6,000
D. Unlimited
A. $350
The maximum gain when selling options is the premium received.
A customer buys 100 shares of XYZ common stock at $52 and, on the same day, buys one XYZ April 50 put at 1.50. What is the maximum possible gain to the customer upon expiration of the option?
A. $4,850
B. $5,050
C. $5,350
D. Unlimited
D. Unlimited
The gain is up and unlimited.
For the purposes of establishing option position limits, which of the following pairs of positions shall be considered on the same side of the market? I. Long calls and long puts; II. Long calls and short puts; III. Short calls and short puts; IV. Short calls and long puts
A. I and III
B. I and IV
C. II and III
D. II and IV
D. II and IV
Long calls and short puts (II) are both on the upside of the market (bullish) while short calls and long puts (IV) are both on the downside of the market (bearish).
The market price of ABC stock is $17.25. The ABC June 20 call:
A. Has intrinsic value.
B. Is at the money.
C. Is in the money.
D. Is out of the money.
D. Is out of the money.
The ABC June 20 call is out of the money. The market price of the stock is lower than the strike price. Calls are in the money when the market price is above the strike price.
Long the stock. Sell a call. The call is exercised. The seller will receive the dividend if the call is exercised after the:
A. Record date.
B. X-dividend date.
C. Settlement date.
D. Payment date.
B. X-dividend date.
The covered call writer is long the stock and entitled to the dividend if ownership continues up through the x-dividend date. Exercise would call the stock away.
The purchase of a put has all the following advantages over selling short, EXCEPT:
A. Decreasing time value.
B. No requirement to make dividend payments.
C. Liquidity.
D. Lower capital commitment.
A. Decreasing time value.
Decreasing time value is not an advantage for premium buyers. Loss for the purchase of a put is limited to the premium paid.
Sell an ABC May 55 call and buy an ABC May 60 call. At what market price will every dollar of loss on the 55 call be offset by a dollar of gain on the 60 call?
A. Below 55
B. 60
C. 55
D. Above 60
B. 60
At 60, this credit spread reaches maximum loss. The gain is narrowing around 55 with a maximum loss at 60.
Purchase an ABC May 60 call for 5. Sell an ABC May 70 call for 1. When ABC is at 72, the 60 call is at 13, and the 70 call is at 3, you close your position. What is your gain or loss?
A. $600 gain
B. $800 gain
C. $1,000 gain
D. $800 loss
A. $600 gain
Credit: $1, $13
Debit: $5, $3
Premium Open: -5 and +1 = -4 Close: +13 and -3 = +10 +6 gain X 100 = $600 gain
XYZ stock has a market price of $62. Your client writes an XYZ Sept 60 call for $5. A month later, XYZ stock has a market price of $68 and your client makes a closing purchase of the XYZ Sept 60 call at $10. What is his gain or loss?
A. $500 loss
B. $100 gain
C. $700 gain
D. $200 loss
A. $500 loss
$5 - $10 = -$5 x 100 = -$500
He wrote/sold the call for $500 (credit) and made a closing purchase for $1,000 (debit), for a loss of $500.
ABC stock is trading at $18.30 a share. The ABC June 20 put has a premium of $2.60. It has a time value of:
A. $0.90.
B. $1.30.
C. $2.60.
D. 0; it only has intrinsic value.
A. $0.90.
$20 - $18.30 = $1.70 intrinsic value
$2.60 (premium) - $1.70 (intrinsic) = $0.90 (time value)
The June 20 put is in the money. To determine the time value, you have to determine how much of the premium is intrinsic value (in the money), 20 (strike price) – 18.30(market price of ABC) = $1.70 (intrinsic value). Premium – intrinsic value = time value, so $2.60 - $1.70 = .90.
An investor holds 2 July 60 calls. If a 25% stock dividend is declared, the investor will hold:
A. 2 July 48 calls with 100 shares each.
B. 2.5 July 45 calls with 100 shares each.
C. 2 July 48 calls with 125 shares each.
D. 2.5 July 45 calls with 120 shares each.
C. 2 July 48 calls with 125 shares each.
The number of contracts stays the same with a stock dividend, but the shares increase and the strike price declines. The calculation for the stock would be taking the initial 100 shares X 1.25 = 125 shares. The calculation for the adjusted strike-price would be taking the initial 60 / 1.25 = 48.
A customer buys 100 shares of XYZ common stock at $52 and, on the same day, buys one XYZ April 50 put at 1.50. A customer will break even with this position when the market price of the stock is:
A. 48.50.
B. 50.50.
C. 52.
D. 53.50.
D. 53.50.
Premium is -1.50 and market is -52. Therefore, breakeven is 53.50.
Customer bought at $52 and paid $1.50 for the put. $52 + $1.50 = $53.50, which is upside breakeven. The put is not exercised.
Downside, I think would be $50 (strike price) - $2 (net between purchase price and strike price) - $1.50 (premium) = $46.50, which is not an answer.
You bought an XYZ March 50 call for $3. The day before March expiration, XYZ is trading at $65 and you sell the call for intrinsic value. You have:
A. Loss of $300.
B. Gain of $1,200.
C. Loss of $1,200.
D. Gain of $300.
B. Gain of $1,200.
Intrinsic value for a call is stock price – strike price = 15. You paid $3 (a debit) for the call and sold it for $15 (a credit) for a gain of $1,200.
Short 1 ABC May 45 call at 1.50 and buy 1 ABC May 40 call at 3.50. This position is I. Debit. II. Bear. III. Bull. IV. Credit.
A. I and II
B. I and III
C. II and IV
D. III and IV
B. I and III
Buying the lower strike price on a call spread means that your position is debit. You pay more premium than you receive. Debit call is bullish.
A customer has been approved for a margin account. The customer wishes to sell options. The first trade can occur:
A. Fifth business day.
B. Today.
C. Within 15 days.
D. Next day.
B. Today.
The customer may immediately trade once his margin account is approved.
Your client is bearish on ABC stock. Which of the following option spreads might you recommend? I. Buy 1 ABC July 50 call, sell 1 ABC July 55 call. II. Buy 1 ABC July 55 call, sell 1 ABC July 50 call. III. Buy 1 ABC July 55 put, sell 1 ABC July 50 put. IV. Buy 1 ABC July 50 put, sell 1 ABC July 55 put.
A. I and IV
B. II and III
C. II and IV
D. III and IV
B. II and III
II and III are both bearish. II is a credit call and III a debit put spread.
XYZ Corporation declares a 20% stock dividend. What effect will this have on XYZ options contracts?
A. Contract size will increase and strike prices will be adjusted lower.
B. Contract size will increase and strike prices will remain the same.
C. The number of contracts will increase and strike prices will be adjusted lower.
D. The number of contracts will increase and strike prices will remain the same.
A. Contract size will increase and strike prices will be adjusted lower.
Fractional stock splits and stock dividends increase contract size. Strike prices are adjusted proportionately lower.
A customer writes an XYZ Dec 15 put for $2. At expiration the market price of XYZ is $12 and the put is exercised and the customer immediately sells 100 shares at $12. What is gain or loss?
A. Profit of $100
B. Loss of $100
C. Profit of $200
D. Loss of $200
B. Loss of $100
Credit: $2, $12
Debit: $15
The market price of XYZ is $12. The put was exercised and the customer has to buy 100 shares of stock at $15 (debit) that was sold for $12 (credit), so $300 was lost on the stock. However, the premium of $200 (credit) was received when the put was written, so the loss is $100.
Sarah wrote/sold the following straddle: 1 XYZ Oct 20 put for 5 and 1 XYZ Oct 20 call for 3. At October expiration, XYZ stock is at 29. The Oct 20 put expires and the Oct 20 call is exercised with XYZ at 29. Sarah buys stock at $29 and closes her position. What is the profit or loss?
A. Profit $400
B. Loss $400
C. Profit $100
D. Loss $100
D. Loss $100
Credit: $5 (premium), $3 (premium), $20 (call strike)
Debit: $29 (purchase)
$5 + $3 + $20 - $29 = -$1 x 100 = -$100
A customer shorts one ABC Jan 65 call for a premium of 4 and holds one ABC Apr 70 call for a premium of 1. If the market price of the underlying security is 62, what is the probable result?
A. $300 loss
B. $300 gain
C. $800 gain
D. $800 loss
B. $300 gain
Credit: $4 (premium)
Debit: $1 (premium)
$4 - $1 = $3 x 100 = $300
If the market price remains at 62, the options should expire since they’re both out-of-money. This would give the customer a $300 profit.
In early October, a customer buys 100 shares of XYZ stock at $50 per share and, at the same time, writes an XYZ April 50 call option for a premium of $8 per share. What is the term used to describe this position?
A. A covered write
B. Either an uncovered writer position or a naked position
C. An uncovered writer’s position
D. A naked position
A. A covered write
An investor who buys stock and then writes a call option on those shares is writing a covered call option. This position is known as a covered write.
Which of the following are combined with a long call position in XYZ in order to determine compliance with the exchange position limit rules? I. Long XYZ puts; II. Short XYZ calls; III. Short XYZ puts
A. I only
B. II only
C. III only
D. II and III only
C. III only
The position limit rules were developed to prevent investors from putting an excessive “bet” on a specific directional move in the market price of a security. Investors bet that market prices will either rise or fall. Here the investor with a long call position is betting that the market price will go up. An investor who takes a short position in XYZ puts also stands to benefit if the market price goes up since the put will expire and he will keep his premium.
The husband of an options clients also trades options, but does so in a separate account at another brokerage firm. Both of them are currently hedging short sale positions in stock VVV with options. However, the options client is long 32,000 VVV calls, while her husband is short 30,000 VVV puts. The current contract position limit for VVV stock is 60,000 contracts. Which of the following applies to this situation?
A. This couple’s current options positions are in violation of the position limit rules.
B. The position limit rules apply to institutional but not individual investors.
C. The position limit rules do not apply to this couple because they trade options in separate accounts at different firms.
D. This couple’s current options positions are not in violation of the position limit rules.
A. This couple’s current options positions are in violation of the position limit rules.
The options exchanges impose limits on the maximum number of puts and calls on a given security that may be held or written on the same side of the market by a single investor or group of investors acting in concert or under common control. These limits apply to all investors, including institutions. Married couples are viewed as acting in concert or under common control, and as such are subject to the limits even if they maintain options accounts at different brokerage firms. In this case, a violation would occur if the couple exceeded the 60,000 contract position limit for VVV stock with combined positions on the same side of the market - that is, on the bull or bear side of the market. The long calls and short puts they own are both bullish. And since they have a combined 62,000 contracts on the bull side of the market, they are in violation of the position limit rules.
A customer has requested that an account be opened for trading options. Which of the following would the registered representative do in addition to mailing out the options agreement form?
A. Send an options disclosure document
B. Obtain the approval of a manager or principal
C. Complete a customer suitability form
D. Consult the ROP
A. Send an options disclosure document
Suitability is already determined at account opening, and the ROP (registered options principal), upon approving the account, would instruct you to send out the options disclosure document.
A client owns 100 shares of ABC stock purchased 2 years ago at $28 per share. The stock is now trading at $42 and is widely predicted to be headed for a decline. What options strategy could the client use that would protect her gain yet still allow her to benefit from an upward move in the stock if current predictions are incorrect?
A. Sell a put on ABC
B. Buy a call on ABC
C. Buy a put on ABC
D. Sell a call on ABC
C. Buy a put on ABC
This is a classic hedging question. It is important to remember that hedges always have the opposite market attitude of the underlying primary investment position. In this case, the client’s primary investment position is that she owns the stock, which means she is bullish on the stock. To hedge that long position, she must use options positions that are bearish. Of the four potential answers, buying a call and selling a put can immediately be eliminated because they are bullish in nature. By contrast, long puts and short calls are both bearish in nature, and both could be used to hedge a long stock position. However, only the long put position would allow the client to achieve both objectives noted in the question. If the stock declines, she can exercise her right to sell it and preserve her gain, or the gain in the option’s value will offset the losses on her stock position; if the stock goes up, she is out her put premium but will fully participate in the price gain. If, on the other hand, she sells a call on the stock, her downside protection is limited to the premium she collects, and on the upside, the stock could be called away from her, preventing her from benefiting from further appreciation.
The options position limit on ABC stock is 75,000 contracts on the same side of the market. Which of the following positions would violate the position limit?
A. Short 50,000 ABC June 60 calls, Long 50,000 ABC June 70 calls
B. Long 20,000 ABC June 50 calls, Long 70,000 June 50 puts, Long, 40,000 ABC Sept 55 calls
C. Long 50,000 ABC June 60 calls, Long 25,000 ABC June 50 puts, Long 10,000 ABC Sept 40 puts
D. Long 50,000 ABC June 60 calls, Long 25,000 ABC Sept 55 calls, and Short 10,000 ABC June 50 puts
D. Long 50,000 ABC June 60 calls, Long 25,000 ABC Sept 55 calls, and Short 10,000 ABC June 50 puts
Long calls and short puts are on the same side of the market (bullish). Different expiration dates and strike prices are irrelevant.
An investor wants to purchase ABC stock, which is currently trading at $38 per share, because he believes it has excellent long-term appreciation potential. Near-term, however, he expects the stock to decline in price due to general market weakness. If he wants to purchase the stock below its current market value and generate additional income, he could:
A. Write a put at $35.
B. Buy a $40 call and exercise the option.
C. Write a call at $35.
D. Buy a $40 put and exercise the option.
A. Write a put at $35.
The two responses that have the investor exercising the option can immediately be eliminated because the investor is looking to generate (collect) premium income, not pay it out by buying options. Writing a call and writing a put would both generate premium income, but only the short put position would achieve the additional objective of potentially enabling him to acquire the stock below its current market price of $38. The reason: If the stock does indeed decline in price near-term, the put would likely be exercised, allowing the put writer (the investor) to buy the stock at $35 per share. Writing a call, by contrast, would obligate the investor to sell, not to buy, the stock, and since he does not own the stock, would expose him to potentially unlimited losses if the stock rose in value. Another clue to correctly choosing between the writing a call and writing a put answers is to look at the market attitude of the two strategies. Put writing is a bullish strategy that is in keeping with the investor’s long-term view of the stock, while call writing is a bearish strategy that conflicts with that view.
In an options contract, which party receives the premium and is obligated to buy the underlying security at the strike price?
A. Put holder
B. Put writer
C. Call holder
D. Call writer
B. Put writer
In an options contract, the put writer collects the premium and is obligated to buy the underlying security at the strike price. Remember that the option writer – for calls or puts – always has the obligation to sell or buy the underlying security and receives the premium.
In an effort to maintain orderliness when taking option orders and transactions, the specialist/order book official uses a/an:
A. First come/first serve rule (FIFO).
B. Intrinsic value method.
C. Random selection process.
D. Trading rotation.
D. Trading rotation.
The specialist/order book official always starts the taking of orders, in the series of options assigned to him, with an opening rotation. When the market closes, the system implemented to take orders is the closing rotation.
A simultaneous investment in different types options on the opposite side of the market is a:
A. Credit spread.
B. Straddle.
C. Horizontal spread.
D. Hedged position.
B. Straddle.
A straddle involves the purchase or sale of a call and a put (different types of options) that are on the opposite sides of the market.
An investor writes one ABC Oct 50 straddle, receiving 3.25 for the call and 2.25 for the put. What is the maximum gain?
A. 2.50
B. 3.50
C. 4.50
D. 5.50
D. 5.50
The maximum gain is total premium received is 3.25 + 2.25 = 5.50.
Which of the following identifies uncovered put writing? I. Unlimited loss; II. Bearish on the stock; III. Bullish on the stock; IV. Unlimited gain
A. III and IV
B. I and II
C. II only
D. III only
D. III only
Selling a put uncovered gain is premium; loss is breakeven down to zero. The position is bullish because there is downside risk.
Which TWO of the following are used to determine position limits? I. Debit puts and credit puts; II. Credit calls and debit puts; III. Debit calls and credit puts; IV. Debit calls and credit calls
A. I and III
B. I and IV
C. II and III
D. III and IV
C. II and III
Credit calls and debit puts are on the same side of the market (bearish). Debit calls and credit puts are on the same side of the market (bullish).
An option trader sells 1 ABC Apr 50 put for 1 and buys 1 ABC Apr 60 put for 8 with the market in ABC at 54. What are the trader’s maximum profit, maximum loss, and breakeven point?
A. $600, $400, 54
B. $700, $300, 57
C. $300, $700, 53
D. $700, $700, 67
C. $300, $700, 53
Credit: $1, $60-$50=$10
Debit: $8
The position is a debit put spread. Premium (max loss -7(00), max gain +3(00) and 60 minus 50 strike price equals 10. Breakeven is net premium of 7 subtracted from the higher strike price.
An options client owns 1 ABC July 30 call contract. ABC announces a 50% stock dividend. How will this development impact the client’s contract?
A. The ABC call will be adjusted to contain 150 shares with an exercise price of 20.
B. The current contract will remain unchanged and an additional contract will be issued containing 50 shares with an exercise price of 30.
C. Don’t worry about it; stock dividends do not impact options contracts.
D. The ABC call will be adjusted to contain 150 shares with an exercise price of 45.
A. The ABC call will be adjusted to contain 150 shares with an exercise price of 20.
Options contracts are adjusted in response to corporate actions or events such as even and uneven stock splits, reverse stock splits, stock dividends, rights offerings, mergers and acquisitions and spin-offs. Specifically, the underlying terms of the contract are adjusted to ensure that the valuation and total equity/obligation of the contract remain unchanged. When a company pays a stock dividend, the number of contracts remains the same, but the number of shares represented by the contract rises. In addition, the strike price is adjusted down so that the total exercise value remains unchanged. In this example, the exercise value of the original contract was $3,000 (100 shares x $30 strike price). After the 50% stock dividend payout, the contract is adjusted to contain 50% more shares, or 150 shares in total, and the strike price is reduced to $20 so that the total exercise price remains $3,000. It is important to note that options contracts are typically not adjusted for ordinary cash dividends.
What is the maximum loss for selling an XYZ 60 call for 3.50 when XYZ is at 70 and the call is at 11?
A. 350
B. 1,100
C. 2,250
D. Unlimited
D. Unlimited
A naked call has unlimited loss.
An option trader sells 1 ABC Apr 50 put for 1 and buys 1 ABC Apr 60 put for 8 with the market in ABC at 54. The trader will profit if I. Both options expire unexercised. II. Both options are exercised. III. The difference in premiums widens to more than 7 points. IV. The difference in premiums narrows to less than 7 points.
A. II or IV
B. I or III
C. I or IV
D. II or III
D. II or III
The position of debit will profit if options are exercised and premiums widen.
A customer gives a registered representative an order for the sale of an option position. The order is:
A. Discretionary.
B. Authorized only if approved by the registered options principal.
C. Unauthorized unless done in a margin account.
D. Unsolicited.
D. Unsolicited.
A customer giving the representative an order is unsolicited.
Sell a 15 put for 2. What is the maximum loss?
A. $200
B. $500
C. $1,300
D. $1,500
C. $1,300
Premium is -2, and market is -15 = -13 X 100 = $1,300. Strike price 15 minus – 2 premium received = 13 X 100 = $1,300
ABC stock is trading at $29. Jan thinks that ABC stock is going lower so she buys 10 ABC Feb 30 puts @ $2.25. The following week ABC rallied to $35 and Jan sold her puts for $0.75. What is gain or loss?
A. A loss of $600
B. A loss of $1,500
C. A loss of $150
D. A gain of $1,500
B. A loss of $1,500
$0.75 - $2.25 = -$1.50 x 10 x 100 = -$1,500
Jan paid $2.25 (a debit) and sold for $0.75 (a credit) = ($1.50) X 100 X 10 contracts = $1,500 loss
The disclosure document of the options clearing corporation must be sent:
A. 30 days after the account opening.
B. At or prior to the first trade approval.
C. Within 15 days before first trade.
D. Within 15 days after first trade.
B. At or prior to the first trade approval.
The disclosure document of the options clearing corporation must be sent to the customer prior to the account approval by a registered option principal, or ROP.
When must a client receive an option’s disclosure document?
A. Before the customer’s first statement
B. At confirmation of the trade
C. At or before the account is approved for trading
D. At or before account approval
D. At or before account approval
A client receives an option’s disclosure document at or before account approval.
What is the meaning of the term “strike” price as used in an options contract?
A. The strike price is the value at which the option can be exercised throughout the option period.
B. It is the price the seller of the option pays if the option contract expires.
C. This is the price any investor will be willing to pay for the security during the option period.
D. It is the cost of the option in dollars at the time it is sold by the option “writer.”
A. The strike price is the value at which the option can be exercised throughout the option period.
An option denotes the right (but not the obligation) to buy or sell an underlying security at a designated price, known as the strike or exercise price, at any time throughout the option period. Option contracts are written with a definite start and expiration time.
The writer of a call option opens with a premium of 8 and closes his option position at ¼. What is the loss or gain?
A. $775 gain
B. $750 gain
C. $750 loss
D. $775 loss
A. $775 gain
$8 - $0.25 = $7.75
The answer is $775 gain, calculated as $800 (credit received by the writer) minus $25 (debit paid by the writer when the position is closed out).
You buy 100 shares of XYZ at 48 and buy an XYZ May 50 put for 5. The stock is sold at 59 and the put for 1. What is your gain or loss?
A. $400 loss
B. $700 profit
C. $700 loss
D. $1,500 profit
B. $700 profit
Credit: $59, $1
Debit: $48, $5
$59 + $1 - $48 - $5 = $7 x 100 = $700
If premium is -5 and stock/strike price is -48 = -53. If premium is +1 and stock/strike price is +59 = +60. Profit is -53 + 60 = +7(00)
Sell short 100 shares of XYZ at 46 in a margin account. Buy an XYZ July 45 call for 4. XYZ is at 50 when the call is exercised. What is your gain or loss?
A. $300 loss
B. $500 loss
C. $400 gain
D. $500 gain
A. $300 loss
Credit: $46
Debit: $4, $45
$46 - $4 - $45 = -$3 x 100 = -$300
Paid premium of $400, then paid $4,500 when call exercised, $4,900 total paid. Received $4,600 when sold stock. So $4,600 received minus $4,900 paid = $300 loss
Buy 100 shares of LMN at 44 Sell LMN May 45 call. At what market price could there be a loss?
A. Above 44
B. Above 45
C. Below 44
D. Below 45
C. Below 44
Loss is in the stock market price going down below the purchase price of the long stock, so below 44 is the price point there could be a loss, depending on the premium received for the 45 call.
A customer purchases one XYZ July 50 put for $2.50 with the price of XYZ stock at 55. The maximum loss the customer could sustain is:
A. $250.
B. $5,000.
C. $5,500.
D. Unlimited.
A. $250.
The buyers of options lose only their premium (2.50 X 100 = $250).
A customer buys an XYZ Aug 50 put for 2.50. With XYZ trading at 52.50, what is the customer’s maximum loss?
A. $250
B. $1,050
C. $5,250
D. Unlimited
A. $250
The customer bought a put. Maximum loss when buying options = premium, $250.
A client wants to discuss the assignment of his short call option on XYZ. The market price is $1.00 out of the money but the market price has been increasing steadily. He asks when he is required to deliver the stock. Which of the following is the correct means of option assignment for his call?
A. The Options Clearing Corporation decides which broker/dealer will deliver the securities. Then the broker/dealer will assign one of their clients by random selection. The client might not be assigned.
B. FINRA makes the random selection and assigns the investor through notice to the broker/dealer.
C. The Options Clearing Corporation will notify the client that he must arrange delivery with his broker/dealer.
D. The client must deliver the stock to the Options Clearing Corporation when the security is in-the-money. They will decide whose securities will be delivered when exercised.
A. The Options Clearing Corporation decides which broker/dealer will deliver the securities. Then the broker/dealer will assign one of their clients by random selection. The client might not be assigned.
The process of assignment for options is random on the part of both the Options Clearing Corporation (OCC and the broker/dealer. When an investor wishes to exercise his option, he notifies the broker/dealer. The broker/dealer notifies the OCC and then the OCC randomly selects a broker/dealer that has an open position to be exercised. That broker/dealer then randomly selects one of their clients to deliver securities to or to buy the securities when assigned a put option. FINRA is not involved.
Which of the following options is trading at parity?
A. 40 call with a $3 premium when the current market value of the underlying stock is trading at $40
B. 40 call with a $3 premium and the current market value of the underlying stock is trading at $43
C. 50 put with a $3 premium when the current market value of the underlining stock is at $53
D. 50 put with a $3 premium when the current market value of the underlining stock is at $50
B. 40 call with a $3 premium and the current market value of the underlying stock is trading at $43
Parity exists when the underlying stock is trading at the same value as the breakeven of the option. If the stock’s current market value is $43, a $40 call with a premium of $3 is at parity. This usually happens just prior to expiration because there’s no longer any time value associated with the option.
A customer writes 10 ABC April 40 puts at 4.75 when the market price of ABC is $42. ABC stock rises to 63.38, and the customer closes the position at .12. What is the gain or loss?
A. $19,625 loss
B. $4,750 loss
C. $4,630 gain
D. $125 gain
C. $4,630 gain
Credit: $4.75
Debit: $0.12
$4.75 - $0.12 = $4,630
The customer wrote 10 puts @ 4.75 (credit), for a total of 4.75 X 100 (shares per option contract) X 10 (put contracts) = $4,750. The customer then purchased them back @ .12 (debit), for a total of .12 X 100 X 10 = $120. $4,750 – $120 = $4,630 gain.
The exchange halts trading in a stock on which listed options are traded. Who halts trading in the options on that stock?
A. The specialist
B. The SEC
C. The options exchange
D. The issuer
C. The options exchange
The options exchange, by agreement with the stock exchange, honors trading halts.
Your client wrote 5 XYZ June 60 straddles @ $8.25. What is the potential maximum gain and loss?
A. Maximum gain is $4,125 and maximum loss is $30,000.
B. Maximum gain is $4,125 and maximum loss is unlimited.
C. Maximum gain is unlimited and maximum loss is $4,125.
D. Maximum gain is $4,125 and maximum loss is $25,875.
B. Maximum gain is $4,125 and maximum loss is unlimited.
On a short straddle, the maximum gain is the premium received, $8.25 X 100 = $825 X 5 = $4,125, and the maximum loss is unlimited.
Which of the following applies to put option contracts?
A. The put writer has the obligation to sell at the strike price.
B. The put writer has the right to sell to sell at the strike price.
C. The put holder has the obligation to buy at the strike price.
D. The put holder has the right to sell at the strike price.
D. The put holder has the right to sell at the strike price.
A put option is a contract that gives the put holder the right to sell 100 shares of the underlying security at the strike price (also called the exercise price), until expiration. Long put – right to sell. Short put – obligation to buy.
Your customer buys an XYZ September 60 put at 6 and sells one XYZ September 50 put for 1. When the market is at 56 and the options are trading at intrinsic value, what is your gain or loss?
A. $100 loss
B. $400 gain
C. $500 loss
D. $500 gain
A. $100 loss
Credit: $1, ($60 - $56 = $4)
Debit: $6
$4 + $1 - $6 = -$1 x 100 = -$100
Premium is -5 Market is +60 minus premium = +55 and -56 = +4 -5 (premium) +4 (market) = -1 X 100 = $100 loss
An investor is long 1 July 50 put. After writing 1 July 45 put, this position is a I. Credit spread. II. Debit spread. III. Horizontal spread. IV. Vertical spread.
A. I and III
B. I and IV
C. II and III
D. II and IV
D. II and IV
The spread is debit (buy the higher put) and vertical (difference in strike price).
A registered representative wants to increase his sales and decides to increase his option business. He sends a letter to all of his customers discussing covered call writing, but he makes no specific recommendations. When must the OCC Disclosure Statement be delivered?
A. Within 15 days after the account has been approved for option writing
B. At or prior to the time the client receives the letter
C. At or prior to the opening of the account
D. At or prior to account approval
B. At or prior to the time the client receives the letter
The options disclosure document must be sent prior to or upon sales literature being sent.
A customer buys a June 30 put for 1 after having purchased 100 shares of the same stock for $34 per share. What is the maximum possible gain?
A. $2,900
B. $3,300
C. $3,500
D. Unlimited
D. Unlimited
Since the customer owns stock and the stock may rise infinitely, there is an unlimited gain potential.
In opening an options account, all the following must be completed, EXCEPT:
A. Delivering the options disclosure document to the customer.
B. Completing the new account form.
C. Reviewing and approving the first transaction.
D. Receiving a signed options agreement from the customer.
D. Receiving a signed options agreement from the customer.
The customer has a 15-day free look on the account agreement beginning on the date the agreement is given.
Which of the following would be reviewed in accordance with SEC position limits?
A. Long puts and short calls
B. Short puts and long puts
C. Long puts and long calls
D. Short puts and short calls
A. Long puts and short calls
Position limits place restrictions on the number of positions on the same side of the market, either both bullish or both bearish. Both long puts and short calls are bearish.
Unless instructed to the contrary, the Options Clearing Corporation (OCC) will automatically exercise all options that are:
A. At-the-money.
B. Out-of-the-money.
C. In-the-money by $50 or more.
D. At least $0.01 in-the-money.
D. At least $0.01 in-the-money.
If a long option expires, the client will lose the full premium paid. To help minimize these losses, if an option is in-the-money by 0.01 or more the option will be automatically exercised by the OCC, unless the holder instructs the OCC to let it expire unexercised.
Randy bought 500 shares of ABC stock @ 34. He wrote 5 ABC Aug 35 straddles @ $6.15. At August expiration, ABC closes at 37.50 and Randy is exercised on his short calls. What is his profit or loss?
A. $3,575 profit
B. $3,075 loss
C. $1,250 loss
D. $500 profit
A. $3,575 profit
Credit: $6.15, $35
Debit: $34
Randy’s profit is $3,575. At expiration, he was assigned and had to sell his long stock @ 35 for a one point profit plus the premium received for the short straddle. $1 + $6.15 = $7.15 X 100 = $715 X 5 (straddles & stock) = $3,575.
What is the maximum potential loss when a client holds a long straddle on a common stock?
A. Premium paid
B. Unlimited
C. Strike price of long put – Net Premium
D. Strike price of long call + Net premium
A. Premium paid
When you are long you are the buyer. In a straddle, you buy both a put and a call. The maximum loss is the premium paid. In this case, both options expire worthless, which occurs if the straddle expires with the market price at the strike price.
If you buy a XYZ July 50 put for 7 and sell a XYZ July 40 put for 1, your position is I. Bullish. II. Bearish. III. Debit. IV. Credit.
A. I and III
B. I and IV
C. II and III
D. II and IV
C. II and III
You buy the higher, more valuable strike price of the put spread, so you establish the spread for a debit. A debit put spread is bearish.
Rich holds one XYZ May 30 call. XYZ splits 3:1. What is Rich’s new option position?
A. 3 XYZ May 10 calls
B. 1 XYZ May 10 call
C. 3 XYZ May 15 calls
D. 2 XYZ May 15 calls
A. 3 XYZ May 10 calls
Remember: Whenever you have a stock split that is even, such as a 3-for-1, the number of contracts goes up and the strike price goes down, accordingly. In this case, Rich owns one contract with the strike price at 30. After a three-for-one stock split, Rich will own three contracts with the strike price of $10. It’s important to remember that the aggregate value and exercise will remain at $3,000.
A customer shorts one ABC Jan 65 call for a premium of 4 and holds one ABC 70 call for a premium of 1. What is the customer’s maximum potential loss?
A. $0
B. $200
C. $300
D. Unlimited
B. $200
$65 - $70 = -$5 (net spread @ $70 CMV) + $4 (put premium) - $1 (call premium) = -$2 x 100 shares = -$200
On this credit spread, if the option is exercised, the customer will lose $200. This is equal to the difference in the strike prices minus the net premiums. BUY 70 call for 1 minus SELL 65 call for 4 = 5 market minus 3 premium = 2 OR Premium = +4 minus 1 = +3 Market = +65 minus 70 = -5 = -2 loss
