Customer Disclosure and Settlement Rules

Question 1

An OTC confirmation that discloses the remuneration to be received by the member and which makes available to the customer the name of the contra-broker is required for:

A. Non-NASDAQ principal trades
B. Non-NASDAQ agency trades
C. position trades
D. primary trades

Answer 1

The best answer is B.

Commissions must be disclosed for agency trades; also the name of the contra broker and time of the trade must be made available to the customer upon written request. In a principal transaction, the mark-up is included in a net price and is disclosed for NASDAQ securities transactions (NOT disclosed for non-NASDAQ OTC securities transactions). The mark-up, or commission, must be fair and reasonable.

Question 2

Which of the following must either be disclosed or made available on an agency confirmation?

I The remuneration earned by the firm in the transaction
II The time of the transaction
III The identity of the other party in the transaction

A. I only
B. I and II
C. II and III
D. I, II, III

Answer 2

The best answer is D.

In an agency transaction, the commission (remuneration) must be disclosed on the confirmation (this is not required for principal transactions except for NASDAQ securities); the confirmation must also make available the name of the other party to the trade and the time of the trade.

Question 3

Which of the following information is disclosed on an options confirmation?

I Strike price
II Type of option
III Expiration date
IV Open interest

A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV

Answer 3

The best answer is C.

Disclosed on an options confirmation are the type of option; the expiration; the strike price; the execution price and any commission; the trade date and settlement date. Open interest figures (the number of contracts that remain open that have yet to be closed by trading or exercise) are not disclosed.

Question 4

All of the following information appears on a municipal bond trade confirmation EXCEPT:

A. Agency or principal capacity
B. Paying agent name
C. Broker-dealer name
D. Accrued interest

Answer 4

The best answer is B.

Paying agent name does not appear on a bond confirmation. The name of the broker-dealer, the accrued interest, and the capacity in which the transaction was executed, all appear.

Question 5

All of the following dates are needed to compute the total purchase price of a municipal bond traded in the secondary market that is quoted on a yield basis EXCEPT:

A. dated date
B. maturity date
C. settlement date
D. in whole call date

Answer 5

The best answer is A.

When a municipal dealer gives a basis quote, he is promising the purchaser a certain yield on the bond. MSRB rules require that when the actual dollar price is determined, that the dollar price be computed to the lowest dollar amount of yield to call or yield to maturity. The only calls that are considered are optional calls, meaning the issuer has the option of calling in the entire issue at preset dates and prices, as set forth in the bond contract. This is an “in whole” call. Settlement date is needed to compute the amount of accrued interest. The dated date has no meaning for pricing a bond trading in the secondary market. It is simply the legal date of issuance of the bond, and is the date from which interest started accruing on the issue.

Question 6

Under MSRB rules, yield to worst means that:

A. all municipal bonds quoted on a yield basis must be priced to the near-term in whole call date
B. municipal par bonds quoted on a yield basis must be priced to the near-term in whole call date
C. municipal discount bonds quoted on a yield basis must be priced to the near-term in whole call date
D. municipal premium bonds quoted on a yield basis must be priced to the near-term in whole call date

Answer 6

The best answer is D.

When municipal serial bonds are quoted on a yield basis, the dealer must compute the dollar price shown on the customer confirmation. This dollar price must assure, that at a minimum, the customer will receive the promised yield. This is known as pricing to the “worst case” scenario.

For a premium bond, the “worst case” scenario is having the bond called early (which is the likely case). Bonds trade at a premium because market interest rates have dropped, so the issuer can refund the issue at lower current market rates by calling in the bonds. In this case, the bond is priced based on giving the customer the promised yield using the near-term in whole call date as the redemption date. If the bond were not called, the customer’s actual yield would improve, because the annual loss of premium incorporated into the yield would be spread over a longer time frame.

For a discount bond, the “worst case” scenario is having the bond held to maturity (which is the likely case). Bonds trade at a discount because market interest rates have risen, so the issuer would not call these bonds. In this case, the bond is priced based on giving the customer the promised yield using the maturity date. If the bond were called early, the customer’s actual yield would improve, because the annual earning of the discount incorporated into the yield would be spread over a shorter time frame.

Question 7

Under MSRB rules, pricing of callable municipal premium bonds quoted on a yield basis is based upon:

A. best case scenario
B. worst case scenario
C. yield to maturity
D. nominal yield

Answer 7

The best answer is B.

When municipal serial bonds are quoted on a yield basis, the dealer must compute the dollar price shown on the customer confirmation. This dollar price must assure, that at a minimum, the customer will receive the promised yield. This is known as pricing to the “worst case” scenario.

For a premium bond, the “worst case” scenario is having the bond called early (which is the likely case). Bonds trade at a premium because market interest rates have dropped, so the issuer can refund the issue at lower current market rates by calling in the bonds. In this case, the bond is priced based on giving the customer the promised yield using the near-term in whole call date as the redemption date. If the bond were not called, the customer’s actual yield would improve, because the annual loss of premium incorporated into the yield would be spread over a longer time frame.

For a discount bond, the “worst case” scenario is having the bond held to maturity (which is the likely case). Bonds trade at a discount because market interest rates have risen, so the issuer would not call these bonds. In this case, the bond is priced based on giving the customer the promised yield using the maturity date. If the bond were called early, the customer’s actual yield would improve, because the annual earning of the discount incorporated into the yield would be spread over a shorter time frame.

Question 8

Which call covenant MUST be considered when computing the dollar price of a municipal premium bond quoted on a yield basis?

A. Catastrophe call
B. Extraordinary optional call
C. Sinking fund call
D. In whole call

Answer 8

The best answer is D.

MSRB rules require that if a premium bond is quoted on a yield basis, that the dollar price that is computed be the lower of the price computed to any call dates or maturity. This usually means that the price is computed to give the yield to the near term call date, since the premium is lost in the fastest time. The only calls that must be considered are those that have a “reasonable” certainty of occurring. An “in whole” call means the issue or maturity is callable in whole at predetermined dates. These call dates must be considered.

Sinking fund calls are chosen on a random order basis - since we don’t know which bonds will be selected for call, there is not a “reasonable” certainty.

Extraordinary optional calls, such as a mortgage revenue bond issue calling in bonds if mortgages are prepaid, also is not considered.

Finally, a catastrophe call (for example, bonds are called if a facility is destroyed) does not have a “reasonable” certainty and is not considered.

Question 9

Under MSRB rules, which of the following call provisions can affect the yield that is shown on a customer’s municipal bond confirmation?

I In-whole call
II Sinking fund call
III Extraordinary mandatory call

A. I only
B. III only
C. II and III
D. I, II, III

Answer 9

The best answer is A.

The MSRB requires that dollar prices of bonds quoted on a yield basis be computed to the lowest dollar amount of Yield to Maturity or Yield to Call. The only calls that must be considered are those where there is reasonable certainty that specified bonds will be called. Under an “in whole” call, the issuer establishes dates when the entire issue can be called. This meets the reasonable certainty test.

Sinking fund calls are handled by random choice. It is not known which bonds will be called - only that a preset dollar amount of bonds will be called at the call dates. This does not meet the reasonable certainty test. Extraordinary calls, such as a calamity call, also do not meet the reasonable certainty test.

Question 10

The only call provision that must be considered when determining the purchase price of a municipal bond trade effected on a yield basis is a(n):

A. extraordinary optional call
B. extraordinary mandatory call
C. optional call
D. mandatory call

Answer 10

The best answer is C.

When a municipal dealer gives a basis quote, he or she is promising the purchaser a certain yield on the bond. MSRB rules require that when the actual dollar price is determined, that the dollar price be computed to the lowest dollar amount of yield to call or yield to maturity. The only calls that are considered are optional calls, meaning the issuer has the option of calling in the entire issue at preset dates and prices, as set forth in the bond contract.

Mandatory calls are not considered - an example of a mandatory call is a “sinking fund” call. In such a call, the issuer is obligated to deposit monies annually to a sinking fund, and then use the funds to call in bonds on a random pick method at specified dates. It is the luck of the draw as to whether a given bond is called or not. Since there is no reasonable certainty of a specific bond being called, this type of call is not considered when pricing municipal bonds.

Extraordinary calls (such as catastrophe calls, or calls of bonds backed by mortgages due to mortgage prepayments) are not considered, again because of the lack of any certainty as to their actually happening.

Question 11

Which callable municipal bonds quoted on a yield basis would be priced to the near term “in whole” call date?

A. par bonds
B. discount bonds
C. premium bonds
D. zero-coupon bonds

Answer 11

The best answer is C.

Municipal bonds trading in the secondary market at a premium must be priced to give the customer the promised yield based upon yield to call - this is the worst case basis. Using the call date assumes that the premium will be lost over the shortest time period - if the bond is not called, then the customer’s yield improves.

If a par bond is called early, the customer’s yield stays the same (or improves, if there is a call premium paid). If a discount bond (or zero-coupon bond) is called early, then the customer’s yield improves. For both of these, the “worst case” is for the bonds to be held to maturity - earning the discount over the slowest period of time.

Question 12

If a municipal bond, callable at par, is quoted on a yield basis that is lower than the nominal yield, the price of the bond to a customer would be calculated based on:

A. nominal yield
B. current yield
C. yield to call
D. yield to maturity

Answer 12

The best answer is C.

If a bond is purchased at a premium, its yield to call will be the lowest effective yield. Under MSRB rules, bonds are priced on a worst case basis, meaning, in this case where the premium is lost in the shortest time period. This premium will be lost in the shortest period of time if the bonds are called early. Thus, under MSRB rules, premium bonds must be priced to the near term call date. Then, the customer gets, at a minimum, the yield promised. If the bonds aren’t called, the yield actually improves on the bonds.

Question 13

Under MSRB rules, if the yield to call is lower than the yield to maturity, the bond must be priced based on:

A. yield to maturity
B. yield to call
C. current yield
D. nominal yield

Answer 13

The best answer is B.

The MSRB requires that dollar prices of bonds quoted on a yield basis be computed to the lowest dollar amount of Yield to Maturity or Yield to Call.

Question 14

A 7% general obligation bond is issued with 20 years to maturity. A customer buys the bond on a 7.50% basis. The bond contract allows the issuer to call the bonds in 5 years at 102 1/2, with the call premium declining by 1/2 point a year thereafter. The bond is puttable in 5 years at par. The price of the bond to a customer would be calculated based on the:

A. 5 year call at 102 1/2
B. 5 year put at 100
C. 10 year call at 100
D. 20 year maturity

Answer 14

The best answer is D.

This is a very difficult question. Since the bond has a stated rate of interest of 7%, but is priced to yield 7.50%, the bond is being sold at a discount. The amount of the discount to which this equates is about $140 (you do not need to know how to do this, but you do need to understand the concept that follows). The dollar price of the bond would be $860 to yield 7.50% to maturity. Under MSRB rules, bonds are priced on a worst case basis, meaning in this case where the discount ($140 in this case) is earned over the longest period of time. This occurs if the bonds are held to maturity. If the bonds are called earlier, the yield actually improves on the bonds, since the customer earns the discount faster.

Question 15

For municipal transactions effected on a yield basis, how are these bonds generally priced?

I Discount bonds are priced to maturity date
II Discount bonds are priced to the near-term call date
III Premium bonds are priced to maturity date
IV Premium bonds are priced to the near-term call date

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 15

The best answer is B.

For transactions in callable issues effected on a yield basis, discount bonds are priced to maturity while premium bonds are priced to the near term call date. Thus, the customer is always given a dollar price that ensures he will, at a minimum, get the promised yield.

Question 16

A municipal term bond with 13 years remaining has been pre- refunded at 103 to a call date 3 years in the future. If a customer buys this bond, the yield shown on the confirmation will be computed to:

A. the call date including the 3 point call premium
B. the call date excluding the 3 point call premium
C. maturity including the 3 point call premium
D. maturity excluding the 3 point call premium

Answer 16

The best answer is A.

When a municipal bond is pre-refunded, the issuer escrows sufficient government securities to pay the interest on the bonds until the earliest call date, at which point the bonds are called (with any applicable call premiums being paid) and paid off with the escrowed governments. A customer who buys advance refunded bonds knows they will be called. Any yield that is shown must be computed to the call date, including any call premiums - in essence, the call date becomes the new maturity date for the issue.

Question 17

If a customer buys a pre-refunded bond, the yield shown on the confirmation will be computed based upon the:

A. current yield
B. yield to maturity
C. yield to call
D. yield to put

Answer 17

The best answer is C.

When a municipal bond is pre-refunded, the issuer escrows sufficient government securities to pay the interest on the bonds until the earliest call date, at which point the bonds are called (with any applicable call premiums being paid) and paid off with the escrowed governments. A customer who buys advance refunded bonds knows they will be called. Any yield that is shown must be computed to the call date, including any call premiums, if any. In essence, the call date becomes the new maturity date for the issue.

Question 18

A municipal term bond with 9 years remaining has been pre-refunded at 102 to a call date 2 years in the future. If a customer buys this bond, the yield shown on the confirmation will be computed:

I to the call date
II to maturity date
III including any call premium
IV excluding any call premium

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 18

The best answer is A.

When a municipal bond is pre-refunded, the issuer escrows sufficient government securities to pay the interest on the bonds until the earliest call date, at which point the bonds are called (with any applicable call premiums being paid) and paid off with the escrowed governments. A customer who buys advance refunded bonds knows they will be called. Any yield that is shown must be computed to the call date, including any call premiums - in essence, the call date becomes the new maturity date for the issue.

Question 19

Which callable municipal bond issue MUST be priced to a “refunding call” date?

A. premium bond callable in 5 years at 100
B. premium bond callable in 5 years at 105
C. discount bond callable in 5 years at 100
D. discount bond callable in 5 years at 105

Answer 19

The best answer is A.

Municipal bonds trading in the secondary market must be priced on a “worst scenario” basis. It would be inappropriate to quote a municipal customer a yield to maturity, and then have the bond called early, reducing the customer’s promised yield. This will always occur if a bond is priced at a premium, and is called early at par. In this case, the price computed must give the customer the promised yield computed to the call date.

If the premium bond is called early and there is a substantial call premium, the customer’s yield may be improved by that call premium. In this case, the bond would be priced to maturity.

If a bond is priced at a discount, it will always be priced to maturity. If the bond is called early, the customer earns the discount faster and the customer’s effective yield increases.

Question 20

Which municipal bond quoted on a yield basis MUST be priced to the “refunding call” date?

A. 6% coupon; 7% basis; callable at 100
B. 6% coupon; 7% basis; callable at 105
C. 8% coupon; 7% basis; callable at 100
D. 8% coupon; 7% basis; callable at 105

Answer 20

The best answer is C.

Municipal bonds trading in the secondary market must be priced on a “worst scenario” basis. It would be inappropriate to quote a municipal customer a yield to maturity, and then have the bond called early, reducing the customer’s promised yield. This will always occur if a bond is priced at a premium, and is called early at par. The question that you have to ask yourself is: “Which bond is the premium bond?” The only bonds listed with a basis lower than the nominal yield are Choices C and D. The worst case is for a premium bond to be called early, and for the issuer to pay no call premium. Therefore, Choice C is the worst case scenario; and this bond must be priced to the refunding call date. If the issuer is paying a large call premium to call in the issue early (Choice D); then this additional payment to the bondholder may raise the yield to call above the yield to maturity - thus, this is not the worst case scenario.
If the discount bonds (Choices A and B) are called early, their yield improves. These bonds would be priced as if held to maturity (the worst case scenario for discount bonds).

Finally, another way to look at this question is to ask “Which bond is an issuer most likely to call?” - because that is the one that must be priced to the call date. Issuers want to call bonds with high coupons trading at premium because market interest rates have fallen and they want to pay nothing or very little to call in the bonds in (no call premium) - Choice C!

Question 21

A bond trade takes place at 10:00 AM on Monday, July 10th for “cash.” Settlement takes place:

A. before 2:30 PM on July 10th
B. before 2:30 PM on July 11th
C. during business hours on July 15th
D. during business hours on July 17th

Answer 21

The best answer is A.

Cash settlement is same day settlement, before 2:30 PM.

Question 22

Regular way trades of U.S. Government securities settle:

I next business day
II in 2 business days
III in Clearing House funds
IV in Federal Funds

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 22

The best answer is B.

Regular way trades of U.S. Government securities settle next business day in Federal Funds.

Question 23

At the time of a “when, as and if issued” trade the:

I amount of accrued interest due to the underwriters is known
II amount of accrued interest due to the underwriters is not known
III settlement date is known
IV settlement date is not known

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 23

The best answer is D.

“When, as, and if issued” trades are used for new issues where the certificates are not as yet physically printed and delivered. At the time of the “when issued” trade, the final settlement date is not known. Therefore, the amount of accrued interest due to the underwriters is not known. Of course, the trade date is known and the trade price is known at the time of the “when issued” confirmation.

Question 24

Which information would be included on a When, As and If Issued trade confirmation for a bond trade?

A. Settlement date
B. Amount of accrued interest
C. Total transaction cost
D. Agent or principal transaction

Answer 24

The best answer is D.

A “When, As and If Issued” trade occurs without knowing the settlement date. When the securities are finally issued, a settlement date is set. If the settlement date is unknown, the amount of accrued interest due is unknown (interest accrues up to, but not including settlement). If the amount of accrued interest is unknown, the total transaction cost is unknown. The confirmation would state whether the trade was performed by the firm as agent or dealer.

Question 25

Which statements are TRUE regarding DK notices?

I They are sent to customers
II They are sent to contra-brokers
III They are used to confirm the details of the trade
IV They are used to reconcile unmatched trades

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 25

The best answer is D.

DK or “Don’t Know” notices are sent dealer to dealer to reconcile unmatched trades. The dealer knows that there is a problem when he or she receives a comparison from the contra broker that does not agree with the trading record.

Question 26

The regular way ex date for cash dividends is usually set at:

A. 2 business days before record date
B. 1 business day before record date
C. 1 business day after record date
D. 2 business days after record date

Answer 26

The best answer is B.

The regular way ex date (reduction date for a cash dividend) is set at 1 business day prior to the record date. If the stock is bought before this date in a regular way trade, settlement will occur on the record date or before (since regular way settlement is 2 business days) and the purchaser will be on the record books for the distribution.

Question 27

A corporation declares a cash dividend on Monday, November 8th, payable to holders of record on Monday, November 22nd. The local newspaper publishes the announcement on Tuesday, November 9th, while Standard and Poor’s reports the dividend on Thursday, November 11th. The ex date for regular way trades will be set at:

A. Wednesday, November 10th
B. Thursday, November 18th
C. Friday, November 19th
D. Monday, November 22nd

Answer 27

The best answer is C.

The regular way ex date for cash dividends is set at 1 business day prior to record date. Since the record date is Monday, November 22nd, the ex date is 1 business day prior and is Friday, November 19th.

Question 28

The record date to receive a dividend is set at Monday, June 13th. If a stockholder wishes to receive the dividend, he or she must sell the stock in a regular way trade no earlier than:

A. Thursday, June 9th
B. Friday, June 10th
C. Monday, June 13th
D. Tuesday, June 14th

Answer 28

The best answer is B.

If a person owns common stock and wishes to receive the dividend, that person cannot sell prior to the ex date. If the stock is sold prior to the ex date, the buyer pays for the dividend and would receive that dividend. If the stock is sold on the ex date or later, the buyer does not pay for the dividend and does not receive the dividend. Thus, if the stock is sold on the ex date or later, the seller would receive the dividend.

The ex date is 1 business day prior to record date - or Friday, June 10th. Thus, if the stock is sold on June 10th or later, the seller would receive the dividend.

Question 29

The record date to receive a dividend is set on Tuesday, June 14th. If a stockholder wishes to receive the dividend, he or she must sell the stock in a regular way trade no earlier than:

A. Thursday, June 9th
B. Friday, June 10th
C. Monday, June 13th
D. Tuesday, June 14th

Answer 29

The best answer is C.

If a person owns common stock and wishes to receive the dividend, that person cannot sell prior to the ex date. The ex date is 1 business day prior to record date - or Monday, June 13th. Thus, if the stock is sold on June 13th or later, the seller would receive the dividend.

Question 30

If a stockholder wishes to receive a common dividend, that person must sell the stock in a regular way trade no earlier than the:

A. business day prior to the ex date
B. ex date
C. business day following the ex date
D. record date

Answer 30

The best answer is B.

If a person owns common stock and wishes to receive the dividend, that person cannot sell prior to the ex date. If the stock is sold prior to the ex date, the buyer pays for the dividend and would receive that dividend. If the stock is sold on the ex date or later, the buyer does not pay for the dividend and does not receive the dividend. Thus, if the stock is sold on the ex date or later, the seller would receive the dividend.

Question 31

The ex date for a cash dividend is Wednesday, November 6th and the Record Date is Thursday, November 7th. Which statement is TRUE?

A. A buyer of the stock in a regular way trade on November 6th will receive the dividend
B. A buyer of the stock in a regular way trade on November 7th will receive the dividend
C. A seller of the stock in a regular way trade on November 6th will receive the dividend
D. A seller of the stock in a regular way trade on November 7th will not receive the dividend

Answer 31

The best answer is C.

To buy stock in a regular way trade in time to get a cash dividend, it must be bought before the ex date, making Choices A and B false. A purchase on November 5th will settle on November 8th while a purchase on November 7th will settle on November 11th (it goes over the weekend) and the purchaser will not be an owner of record as of November 7th.

To sell stock in a regular way trade and still retain the dividend, the stock cannot be sold until the ex-date or after. Thus, Choice C is true - if the stock is sold on November 6th, the trade will settle on November 8th and the seller will show as an owner of record on November 7th and will receive the dividend.

If the stock is sold on November 7th, the trade will settle on November 11th (it goes over the weekend) and the seller will be an owner of record as of November 7th and will receive the dividend - making Choice D false.

Question 32

The last day that a customer can buy stock and receive a dividend if he or she is willing to settle “for cash” is:

A. two business days prior to record date
B. three business days prior to record date
C. the record date
D. the payable date

Answer 32

The best answer is C.

If a customer buys the stock “cash settlement,” the stock is delivered and paid for that day. The customer is entitled to the dividend if he is on Record of owning the shares on record date. Therefore, a purchase settled for cash settles that day and places the buyer on the record books to receive the dividend as of the close of business. Note that customers pay more to buy stock in a cash settlement than in a regular way settlement, because the dividend amount deducted on the regular way ex date is added back to the trade price.

Question 33

The ex date for stock splits and stock dividends is set at:

A. 1 business day after the payable date
B. 1 business day after the record date
C. 2 business days prior to payable date
D. 2 business days prior to the record date

Answer 33

The best answer is A.

The ex date for stock splits and stock dividends is unusual because it is set at the business day after the payable date. The record date to receive the extra shares is typically a month before the payable date. Someone who buys the shares settling after the record date will not get the extra shares. Yet on ex date the price is reduced, and that customer has the same number of shares, now worth less. The customer can claim the extra shares he deserves with a due bill. As of the morning of the ex date, any new purchaser buys at the reduced price and a due bill is not needed.

Question 34

When a corporation splits its stock, which of the following statements are TRUE?

I The market price per share will be reduced
II The market price per share will be increased
III Individual investors are more likely to buy the stock
IV Individual investors are less likely to buy the stock

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 34

The best answer is A.

When a corporation declares a stock split, the market price per share will be reduced and the number of outstanding shares will be increased. Individual investors are more likely to buy a lower price stock than a higher priced one, since cheaper stocks are more affordable.

Question 35

When a corporation splits its stock, all of the following will occur EXCEPT:

A. the market price per share will be reduced
B. the number of outstanding shares will be increased
C. individual investors are more likely to buy the stock
D. each shareholder’s proportionate ownership in the corporation will be increased

Answer 35

The best answer is D.

When a corporation splits its stock, each shareholder’s proportionate ownership in the corporation remains the same. For example, if a customer owns 100 shares at $50 and the corporation splits its stock 2 for 1, the customer will now own 200 shares at $25 (in both cases, it’s a $5,000 investment). The other statements are true. Splitting the stock will cause the market price per share to be reduced and the number of outstanding shares will be increased. Also, individual investors are more likely to buy a $25 stock than a $50 one, since cheaper stocks are more affordable.

Question 36

XYZ Corporation announces a 10% stock dividend, followed by a 5% “spin off” of a subsidiary business. A customer who owns 200 shares of XYZ will receive:

A. 20 shares of XYZ and 10 shares of the spin-off
B. 10 shares of XYZ and 10 shares of the spin-off
C. 20 shares of XYZ and 11 shares of the spin-off
D. 20 shares of XYZ and cash equal to 5% of the value of the spin-off

Answer 36

The best answer is C.

Because the customer owns 200 shares of XYZ stock, the 10% stock dividend will give the customer 20 additional XYZ shares for a total of 220 XYZ shares.

The 5% spin off of the subsidiary that follows means that 5% of the 220 share holding = 11 shares will be spun-off to the shareholders as a separate company.

Question 37

A company decides to split its stock 5:4. Prior to the ex date, the stock is trading at $50 per share. The holder of 100 shares of stock, as of the ex date, will have:

A. 120 shares valued at $40 per share
B. 125 shares valued at $40 per share
C. 120 shares valued at $60 per share
D. 125 shares valued at $60 per share

Answer 37

The best answer is B.

After the split, the holder has 1.25 times (5 / 4 = 1.25 so this is a 1.25 to 1 split) the number of original shares or 1.25 X 100 = 125 shares. Since the stockholder has 1.25 times the number of shares after the split, the market price will be reduced on ex date by a factor of 1.25. The market price of the stock is $50 before the split. The new market price is $50 / 1.25 = $40 per share.

Question 38

A customer owns 500 shares of ABC preferred stock trading at $90 per share. Following a 3:1 common stock split, the customer will have:

I 500 shares
II 1,500 shares
III at $30 per share
IV at $90 per share

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 38

The best answer is B.

Be careful! Only common stock is affected by a stock split or stock dividend. The intent of a stock split or stock dividend is to reduce the price of the common stock to make it more marketable. It has NO effect on the preferred stockholder.

Preferred stockholders receive a fixed dividend rate based on par value. Just like a bondholder, the price moves inversely to market interest rates. When there is a stock split or stock dividend, the price of preferred stock and bonds of that company are unaffected.

Question 39

A customer owns 1,000 shares of ABC preferred stock trading at $120 per share. Following a 2:1 common stock split, the customer will have:

A. 1,000 shares at $60 per share
B. 1,000 shares at $120 per share
C. 2,000 shares at $60 per share
D. 2,000 shares at $120 per share

Answer 39

The best answer is B.

Be careful! Only common stock is affected by a stock split or stock dividend. The intent of a stock split or stock dividend is to reduce the price of the common stock to make it more marketable. It has NO effect on the preferred stockholder.

Preferred stockholders receive a fixed dividend rate based on par value. Just like a bondholder, the price moves inversely to market interest rates. When there is a stock split or stock dividend, the price of preferred stock and bonds of that company are unaffected.

Question 40

When a corporation declares a reverse stock split, which of the following statements are TRUE?

I The market price per share will be reduced
II The market price per share will be increased
III Institutional investors are more likely to buy the stock
IV Institutional investors are less likely to buy the stock

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 40

The best answer is C.

When a corporation declares a reverse stock split, the market price per share will be increased and the number of outstanding shares will be reduced. Institutional purchasers are often restricted by their investment policy guidelines from buying “cheap” stocks. Corporations will declare a reverse stock split so that the stock price increases to an acceptable level to institutional investors.

Question 41

A company whose stock price has declined greatly decides to reverse split its stock 1:5. Prior to the split, the stock traded at $1.00 per share. As of the ex date, the price per share will be:

A. $.20
B. $1.00
C. $5.00
D. $20.00

Answer 41

The best answer is C.

In a reverse split, the number of outstanding shares of the corporation is reduced. After the reverse split, each shareholder’s proportionate ownership interest remains the same. The only difference is that the shareholder’s ownership interest is represented by fewer shares. Thus, an individual who originally had 500 shares at $1, would now have 100 shares (1/5th of 500) at $5 (5 x $1).

Question 42

A company whose stock price has declined greatly decides to reverse split its stock 1:20. Prior to the split, the stock traded at $.50 per share. As of the ex date, the price per share will be:

A. $.50
B. $2.50
C. $10.00
D. $20.00

Answer 42

The best answer is C.

In a reverse split, the number of outstanding shares of the corporation is reduced. After the reverse split, each shareholder’s proportionate ownership interest remains the same. The only difference is that the shareholder’s ownership interest is represented by fewer shares. Thus, an individual who originally had 1,000 shares at $.50, would now have 50 shares (1/20th of 1,000) at $10 (20 x $.50).

Question 43

Which of the following orders will be reduced on ex date for a cash dividend?

I Buy 100 ABC @ 50
II Buy 100 ABC @ 60 Stop
III Sell 100 ABC @ 50 Stop DNR
IV Sell 100 ABC @ 60

A. I only
B. I and II
C. III and IV
D. II and III

Answer 43

The best answer is A.

The orders that are reduced on ex date are those placed below the market - Open Buy Limit and Open Sell Stop orders. The intent is to make sure that the order does not become executable due to the fact that the stock’s opening price is reduced by the dividend amount. However, an order with DNR on it (Do Not Reduce) will not be adjusted downwards on ex date.

Question 44

A customer places an order to sell 100 ABC at 12 Stop Limit, when ABC stock is trading at $13. The company is restructuring and has announced a special dividend of $2.85 to be paid to shareholders of record. On the ex date, the order will be:

A. canceled
B. reduced to $9.00
C. reduced to $9.15
D. executed at $12.00

Answer 44

The best answer is C.

On ex dividend date, all open orders placed lower than the current market are reduced for cash dividends (except for orders placed DNR - Do Not Reduce). The intent is to make sure that the order does not become executable due to the fact that the stock’s opening price is reduced by the dividend amount. The order was originally placed at $12. The adjusted order price is $12 - $2.85 reduction = $9.15 adjusted order price.

Question 45

An open order is on the member firm’s internal order entry system to sell 200 XYZ at 30 Stop GTC. The company has declared a 50% stock dividend. On the morning of the ex date, the order on the book will be:

A. Sell 300 XYZ at 20 Stop GTC
B. Sell 300 XYZ at 30 Stop GTC
C. Sell 300 XYZ at 40 Stop GTC
D. Sell 300 XYZ at 60 Stop GTC

Answer 45

The best answer is A.

To adjust the order for the 50% stock dividend, the number of shares is multiplied by a factor of 1.50 (since there are 50% extra shares) while the order price is divided by a factor of 1.50.

200 shares x 1.50 = 300

The price would change to:

$30 price / 1.50 = $20 adjusted order price

Question 46

An open order is on the member firm’s internal order entry system to sell 400 XYZ at 40 Stop GTC. The company has declared a 25% stock dividend. On the morning of the ex date, the order on the book will be:

A. Sell 400 XYZ at 32 Stop GTC
B. Sell 400 XYZ at 40 Stop GTC
C. Sell 500 XYZ at 32 Stop GTC
D. Sell 500 XYZ at 40 Stop GTC

Answer 46

The best answer is C.

To adjust the order for the 25% stock dividend, the number of shares is multiplied by a factor of 1.25 (since there are 25% extra shares) while the order price is divided by a factor of 1.25.

400 shares x 1.25 = 500 shares on the adjusted order (this is a round lot)

$40 price / 1.25 = $32 adjusted order price.

Question 47

An open order is on the member firm’s internal order entry system to sell 800 XYZ at 50 Stop GTC. The company has declared a 25% stock dividend. On the morning of the ex date, the order on the book will be:

A. Sell 800 XYZ at 40 Stop GTC
B. Sell 800 XYZ at 50 Stop GTC
C. Sell 1,000 XYZ at 40 Stop GTC
D. Sell 1,000 XYZ at 50 Stop GTC

Answer 47

The best answer is C.

To adjust the order for the 25% stock dividend, the number of shares is multiplied by a factor of 1.25 (since there are 25% extra shares) while the order price is divided by a factor of 1.25.

800 shares x 1.25 = 1,000 shares on the adjusted order

$50 price / 1.25 = $40 adjusted order price

Question 48

The record date for a cash dividend is Wednesday July 5th. A client buying the stock would receive the dividend in all of the following circumstances EXCEPT the stock is purchased in a:

A. regular way trade on Wednesday, June 28th
B. regular way trade on Friday, June 30th
C. regular way trade on Monday, July 3rd
D. cash trade on Wednesday, July 5th

Answer 48

The best answer is C.

If the stock is purchased in a regular way trade on Wednesday, June 28th, the trade will settle 2 business days later on Friday, June 30th. The customer will be on the record books on July 5th to receive the dividend.

If the stock is purchased in a regular way trade on Friday, June 30th, the trade will settle 2 business days later on Wednesday, July 5th (remember that July 4th is a legal holiday and the markets are closed!). The customer will be on the record books on July 5th to receive the dividend. (The list of owners to receive the dividend is taken the evening of the Record Date.)

If the stock is purchased in a regular way trade on Monday, July 3rd, the trade will settle 2 business days later on Thursday, July 6th (remember that July 4th is a legal holiday and the markets are closed!). The customer will NOT be on the record books on July 5th to receive the dividend.

If the stock is purchased in a cash trade on Wednesday, July 5th, the trade will settle the same day. The customer will be on the record books on July 5th to receive the dividend.

Question 49

A regular way municipal bond trade is performed on Wednesday, March 13th. The interest payment dates are March 15th and September 15th. All of the following statements are true EXCEPT:

A. settlement takes place on March 15th
B. the trade is “flat”
C. the seller must deliver the bonds to the buyer’s office
D. the buyer must pay accrued interest to the seller

Answer 49

The best answer is D.

If the municipal bond is traded on Wednesday, March 13th, the trade settles on the Friday, March 15th. Since the interest payment date is the 15th, the trade is settling on the exact cut off point where the seller gets the six month interest payment from the issuer and the buyer assumes ownership at the exact beginning of the next 6 month period. No accrued interest is due from buyer to seller - this trade will be “flat.” Also, note that this can only happen twice per year.

Question 50

Which of the following securities deliveries are “good”?

I Guardian securities with an assignment performed by the legal guardian
II Trust securities with an assignment performed by the Trustee
III Partnership securities with an assignment performed by a partner designated in the Partnership Agreement
IV Custodian securities with an assignment performed by the recipient of the gift

A. II, III, IV
B. I, II, III
C. I, II, IV
D. I, III, IV

Answer 50

The best answer is B.

Custodian account securities cannot be assigned by the minor. The minor has no legal authority. Any assignment must be made by the custodian. Guardian account securities are assigned by the legal court appointed guardian; partnership securities are assigned by a partner designated in the partnership agreement; and trust account securities must be assigned by the designated trustee.

Question 51

A customer has placed an order to sell 500 shares of XYZ stock, which the customer is holding in a safe deposit box. When the certificates are received by the brokerage firm, four 100 share certificates have been signed by the customer, and one 100 share certificate is unsigned. The proper procedure is to:

A. return all certificates to the customer by registered mail with instructions that they must all be signed
B. return only the unsigned certificate to the customer by registered mail with instructions that it must be signed
C. retain all the certificates and send the customer a stock power with instructions that it must be signed
D. retain and deliver all the certificates, since they are acceptable once they have been guaranteed by the broker-dealer

Answer 51

The best answer is C.

A stock power represents a legal transfer document, when accompanied by the stock certificate. The proper procedure is to send the customer a stock power for his signature. When this is returned to the broker-dealer, it is attached to the unsigned certificate, and makes that certificate a “good delivery.” While the customer could be returned the unsigned certificate (Choice B), this is not the best answer. It is imprudent to send stock certificates through the mail. This can be avoided by using a stock power instead.

Question 52

All of the following are considered to be a good delivery for a 400 share purchase of stock EXCEPT:

A. One 400 share certificate
B. Eight 50 share certificates
C. Ten 40 share certificates
D. Sixteen 25 share certificates

Answer 52

The best answer is C.

To be a good delivery dealer to dealer, stock certificates must be delivered in multiplies of 100 on one certificate or in certificates of less than 100, where the certificates can be added exactly to 100 share units. Choice C does not meet this requirement. Individual 40 share certificates cannot be added into 100 share units. 25 share certificates are good (Four 25 share certificates = 100), as are eight 50 share certificates or one 400 share certificate.

Question 53

Which is NOT a good delivery for a 150 share trade of stock?

A. One 100 share certificate and one 50 share certificate
B. Three 50 share certificates
C. Five 30 share certificates
D. Six 25 share certificates

Answer 53

The best answer is C.

To be a good delivery, certificates must be in round multiples of 100 shares on one certificate or must be delivered in certificates that add up to 100 share units. If there is an odd lot (a portion of the order that is less than 100 shares), it can be delivered in any form. Certificates of 30 shares each are not good because 30 + 30 = 60; 60 + 30 + 30 = 120. A round lot of 100 shares cannot be created from these units. The other choices either allow for the creation of 100 share units; or are in multiples of 100 on 1 certificate with the odd lot being handled separately.

Question 54

All of the following are considered to be a good delivery for a 500 share trade of stock EXCEPT:

A. Two 250 share certificates
B. Twenty 25 share certificates
C. Ten 50 share certificates
D. Fifty 10 share certificates

Answer 54

The best answer is A.

To be a good delivery dealer to dealer, stock certificates must be delivered in multiplies of 100 on one certificate or in certificates of less than 100, where the certificates can be added exactly to 100 share units. Choice A does not meet this requirement - two 250 share certificates are not in multiples of 100 on a certificate. Twenty 25 share certificates work because four 25 share certificates = 100. Ten 50 share certificates work because two 50 share certificates = 100. And fifty 10 share certificates work because ten 10 share certificates = 100.

Question 55

Which is NOT a good delivery for a 400 share trade of stock?

A. One 400 share certificate
B. Twenty 20 share certificates
C. Forty 10 share certificates
D. Ten 40 share certificates

Answer 55

The best answer is D. To be a good delivery, certificates must be in round multiples of 100 shares on one certificate or must be delivered in certificates that add up to 100 share units. Certificates of 40 shares each are not good because 40 + 40 = 80; 80 + 40 = 120. A round lot of 100 shares cannot be created from these units. The other choices either allow for the creation of 100 share units; or are in multiples of 100 on 1 certificate.

Question 56

A stock certificate that has been damaged with a large ink stain has been authenticated by the issuer. The next buyer of the stock receives that certificate and does not believe the authentication. Which statement is TRUE?

A. The customer can demand a new replacement stock certificate and will not be charged for this
B. The customer can demand a new replacement stock certificate and will be charged for this
C. The customer has no recourse since the certificate has been authenticated
D. The customer can break the trade since the certificate was not delivered in good form

Answer 56

The best answer is B.

This is a reality-based question. While the certificate is a good delivery because it has been authenticated by the issuer (it could also be validated/authenticated by the transfer agent, registrar or paying agent), the customer is concerned about the authentication. In the same manner as taking old money to a bank to replace it with new money, the stock certificate can be canceled by the transfer agent and a nice crisp new certificate issued. The only problem is that there is a not-so-small fee for this and the customer must pay the fee, since the securities were actually delivered in good form when they were authenticated.

Question 57

A broker-dealer receives fully paid stock certificates from a customer that are to be deposited to the customer’s margin account. Upon inspection, the cashier of the firm finds that some of the certificates are mutilated and the identification numbers cannot be discerned. The proper procedure is to:

A. reject all the certificates and return them to the customer
B. reject the mutilated certificates and return them with a “due bill” to the customer
C. hold the mutilated certificates and request a validation letter from the issuer or transfer agent before crediting the account
D. accept all the certificates and credit them to the customer’s account

Answer 57

The best answer is C.

The proper procedure when receiving mutilated certificates from a customer is to validate the certificates with the issuer or transfer agent. Once they are validated, they can be deposited to an account for the customer.

Question 58

A mutilated security is considered a good delivery if validated by:

A. customer who bought the stock
B. customer who sold the stock
C. contra broker
D. issuer

Answer 58

The best answer is D.

A mutilated security is a “good delivery” if it is accompanied by a letter of validation from the issuer or transfer agent. It is not acceptable to have the customer or delivering broker tell you that the mutilated security is “OK.”

Question 59

The proper procedure when receiving mutilated certificates from a customer is to:

A. hold the mutilated certificates and request a validation letter from the issuer or transfer agent before crediting the account
B. accept all the certificates and immediately credit them to the customer’s account
C. reject all the certificates and return them to the customer
D. reject the mutilated certificates and return them with a “due bill” to the customer

Answer 59

The best answer is A.

The proper procedure when receiving mutilated certificates from a customer is to validate the certificates with the issuer or transfer agent. Once they are validated, they can be deposited to an account for the customer.

Question 60

If a customer buys a security that is part of the DTC DRS program, the customer will receive:

A. physical stock certificates registered in customer name
B. uncertificated book-entry registration in customer name
C. physical stock certificates held in “street name”
D. any of the above as designated by the customer

Answer 60

The best answer is B.

DTC (Depository Trust Corporation) safekeeps almost all physical securities certificates for member firms. It is based in New York and has an underground, airtight bunker that goes 8 stories into the ground for this purpose. Computer systems keep track of the “transfer” of these certificates from one owner to another - they are no longer physically moved, unless the customer actually wants delivery of the physical certificate (for which DTC now imposes a substantial charge). Once DTC could track change of ownership by computer, the next step was to create a “book entry” registration system for stocks, where there are no more physical certificates (saves time and money).

This is called “DRS” - the Direct Registration System. Because the owner’s name is electronically recorded on the books of the transfer agent, payments of dividends and interest are made directly from the transfer agent to the customer/owner.

Question 61

A due bill is required when:

I a stock is purchased before the ex date in a regular way trade
II a stock is purchased after the ex date in a regular way trade
III the trade settles before the record date
IV the trade settles after the record date

Incorrect Answer A. I and III
Correct Answer B. I and IV
StatusC C. II and III
StatusD D. II and IV

Answer 61

The best answer is B.

A due bill is required when a stock is purchased in time to receive the dividend (that is, purchased prior to the ex date in a regular way trade); and for some reason, settlement is delayed beyond the normal regular way time frame of 2 business days (so that the trade settles after the record date). When this occurs, the buyer pays for the dividend in the price of the stock; but does not show on the record books to receive the dividend. Instead, the issuer sends the check to the seller - and the seller does not deserve the dividend! When the stock is delivered, a due bill check, payable from seller to buyer, is attached. This gives the dividend to the rightful owner.

Question 62

A due bill is used to:

A. reclaim a mutilated stock certificate
B. assign a stock certificate to a new owner
C. claim a dividend that is sent to the wrong person
D. claim against a brokerage firm in an arbitration proceeding

Answer 62

The best answer is C.

A due bill is required when a stock is purchased in time to receive the dividend (that is, purchased prior to the ex date in a regular way trade); and for some reason, settlement is delayed beyond the normal regular way time frame of 2 business days (so that the trade settles after the record date). When this occurs, the buyer pays for the dividend in the price of the stock; but does not show on the record books to receive the dividend. Instead, the issuer sends the check to the seller - and the seller does not deserve the dividend! When the stock is delivered, a due bill check, payable from seller to buyer, is attached. This gives the dividend to the rightful owner.

Question 63

The “right of reclamation” in a municipal bond sale refers to the:

A. refusal by a municipal dealer to accept a delivery of bonds tendered to that firm by another municipal securities dealer
B. return of municipal securities that have been previously accepted on a delivery
C. procedure where a municipal dealer that bought securities, but has not yet received them, can close-out the trade
D. settlement method where payment is made on delivery, or, if the dealer does not have the monies, the delivery may be rejected

Answer 63

The best answer is B.

When securities are delivered on settlement date, the buyer inspects the delivery to ensure that the proper securities are being delivered in “good form.” If the buyer finds that the wrong securities are being delivered, or that there is a problem, such as the securities’ not having a proper assignment; or a coupon bond missing coupons; then the buyer may reject the delivery. This is the right of rejection.

If the buyer has failed to detect an irregularity upon settlement, and accepts a delivery that later proves to have a problem, the buyer may use the “right of reclamation” to correct the problem. The buyer completes a “reclamation form” detailing the error; attaches it to the securities with the problem; and returns both to the seller. Upon receipt of the securities with the reclamation form, the seller must correct the problem within stated time periods.

Question 64

A municipal dealer purchases securities and accepts them for delivery on settlement date. The dealer later finds that the delivery of the securities should not have been accepted as there were missing coupons. The municipal dealer can correct this error through the right of:

A. rejection
B. reclamation
C. arbitration
D. reparation

Answer 64

The best answer is B.

If the buyer has failed to detect an irregularity upon settlement, and accepts a delivery that later proves to have a problem, the buyer may use the “right of reclamation” to correct the problem. The buyer completes a “reclamation form” detailing the error; attaches it to the securities with the problem; and returns both to the seller. Upon receipt of the securities with the reclamation form, the seller must correct the problem within stated time periods.

Question 65

The “right of rejection” in a municipal bond sale refers to the:

A. refusal by a municipal dealer to accept a delivery of bonds tendered to that firm by another municipal securities dealer
B. return of municipal securities that have been previously accepted on a delivery
C. procedure where a municipal dealer that bought securities, but has not yet received them, can close-out the transaction
D. settlement method where payment is made on delivery, or, if the dealer does not have the monies, the delivery may be rejected

Answer 65

The best answer is A.

When securities are delivered on settlement date, the buyer inspects the delivery to ensure that the proper securities are being delivered in “good form.” If the buyer finds that the wrong securities are being delivered, or that there is a problem, such as the securities’ not having a proper assignment; or a coupon bond missing coupons; then the buyer may reject the delivery. This is the right of rejection.

If the buyer has failed to detect an irregularity upon settlement, and accepts a delivery that later proves to have a problem, the buyer may use the “right of reclamation” to correct the problem. The buyer completes a “reclamation form” detailing the error; attaches it to the securities with the problem; and returns both to the seller. Upon receipt of the securities with the reclamation form, the seller must correct the problem within stated time periods.

Question 66

A municipal dealer purchases securities. The securities are delivered on settlement date and the dealer finds that the wrong securities were delivered. The municipal dealer refuses the delivery of the securities by what action?

A. Right of rejection
B. Right of reclamation
C. Right of arbitration
D. Right of reparation

Answer 66

The best answer is A.

When securities are delivered on settlement date, the buyer inspects the delivery to ensure that the proper securities are being delivered in “good form.” If the buyer finds that the wrong securities are being delivered, or that there is a problem, such as the securities not having a proper assignment, or a coupon bond missing coupons, then the buyer may reject the delivery. This is the right of rejection.

Question 67

An investor has 300 shares of stock that have split 3:1. Which statements are TRUE?

I The investor will receive an additional 600 shares
II The investor will receive an additional 900 shares
III The investor will receive a replacement certificate for his original 300 shares
IV The investor will receive a sticker with a reduced par value to place on his or her original 300 share certificate

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 67

The best answer is B.

Stock splits are mechanically handled by giving the stockholder a new certificate for the additional shares, as well as a sticker to place on his old shares reflecting the reduced par value per share. This is cheaper than having shareholders tender all old shares, canceling them, and issuing all new shares. Since this is a 3 for 1 split, for every share held, after the split, the investor will have 3 shares. Thus, for 300 shares held, after the split, the investor will have 900 shares. He or she will receive a new certificate for the 600 additional shares; and a sticker to place on the original 300 shares, reducing the par value per share.

Question 68

An investor has 300 shares of stock that have split 3:1. All of the following statements are true EXCEPT the:

A. investor will receive an additional 600 shares with a reduced par value
B. investor will receive a replacement certificate for his original 300 shares
C. investor will receive a sticker with a reduced par value to place on his or her original 300 share certificate
D. investor’s ownership interest in the corporation has not been diluted

Answer 68

The best answer is B.

Stock splits are mechanically handled by giving the stockholder a new certificate for the additional shares, as well as a sticker to place on his old shares reflecting the reduced par value per share. This is cheaper than having shareholders tender all old shares, canceling them, and issuing all new shares. Since this is a 3 for 1 split, for every share held, after the split, the investor will have 3 shares. Thus, for 300 shares held, after the split, the investor will have 900 shares. He or she will receive a new certificate for the 600 additional shares; and a sticker to place on the original 300 shares, reducing the par value per share.

Also note that the shareholder has not changed his or her proportionate ownership interest in the company. Each shareholder has proportionately more shares, with each share now worth proportionately less. Corporations split their stock when the price per share gets too high, making round lot trades too expensive for the average investor. By splitting the stock, round lot trades become more accessible to the smaller investor.

Question 69

Which of the following are considered in determining fair and reasonable compensation under the FINRA 5% Policy?

I Size of the transaction
II Level of service provided by the member firm
III Profit to the dealer on the transaction
IV Total dollar amount of the trade

A. I and IV only
B. II and III only
C. I, II, IV
D. II, III, IV

Answer 69

The best answer is C.

Under the FINRA 5% Policy, any dealer profit or loss on that transaction is not considered in determining fair and reasonable compensation. The size of the trade, total dollar amount, and level of service provided by the firm are all considered.

Question 70

All of the following are considered in determining fair and reasonable compensation under the FINRA 5% Policy EXCEPT:

A. Size of the transaction
B. Level of service provided by the member firm
C. Profit to the dealer on the transaction
D. Total dollar amount of trade

Answer 70

The best answer is C.

Under the FINRA 5% Policy, any dealer profit or loss on that transaction is not considered in determining fair and reasonable compensation for effecting an over-the-counter transaction. The size of the trade, total dollar amount, and level of service provided by the firm are all considered.

Question 71

The FINRA 5% Policy applies to:

I Trades on an Exchange Floor
IINew Issues
III Second Market trades of OTCBB and Pink Sheet stocks
IV Third Market trades of exchange listed stocks

A. I and II only
B. III and IV only
C. I, III, IV
D. I, II, III, IV

Answer 71

The best answer is C.

The FINRA 5% Policy applies to trades that take place in the secondary market. This means that it applies to trades or corporate stocks and bonds. It also applies to trades of government and agency bonds. However, it does not apply to trades of municipal bonds because these are covered under a similar MSRB rule.

The policy also does not apply to any transaction that requires a prospectus - meaning new issues, mutual funds, and initial offerings of limited partnerships.

Question 72

The FINRA 5% Policy applies to:

I offering of Mutual funds
II offerings of Direct Participation Programs
III trades of Municipal securities
IV trades of Over-the-counter securities

A. I and II only
B. III and IV only
C. IV only
D. I, II, III, IV

Answer 72

The best answer is C.

The 5% Policy applies to all over-the-counter and exchange transactions, except for transactions in municipal securities, which are covered by a similar MSRB rule. It only applies to secondary market transactions, not to primary market (new issue) transactions. Both mutual funds and limited partnership offerings are new issues and do not fall under the policy.

The 5% Policy is a guide, not a rule. Under this policy, depending upon the circumstances, a 1% mark-up can be considered excessive; while a 10% mark-up can be reasonable.

Question 73

The FINRA 5% Policy applies to:

A. the primary market
B. mutual fund offerings
C. trades of corporate securities
D. trades of municipal securities

Answer 73

The best answer is C.

The FINRA 5% Policy applies to trades that take place in the secondary market. This means that it applies to trades or corporate stocks and bonds. It also applies to trades of government and agency bonds. However, it does not apply to trades of municipal bonds because these are covered under a similar MSRB rule.

The policy also does not apply to any transaction that requires a prospectus - meaning new issues, mutual funds, and initial offerings of limited partnerships.

Question 74

A stock is quoted at $18 - $19. If a customer sells 100 shares to the dealer, under the FINRA 5% Policy, a fair and reasonable mark-down is based upon which price?

A. $17.50
B. $18.00
C. $18.50
D. $19.00

Answer 74

The best answer is B.

Under the 5% Policy, commissions and mark-up / mark-down percentages are computed from the inside market. If a customer buys, any mark-up is calculated from the inside ask price of $19. If the customer sells, any “mark-down” is computed from the inside bid price of $18.

Question 75

A simultaneous trade is performed on the OTC market. Under FINRA rules, the transaction is:

A. prohibited
B. allowed and must conform to the 5% Policy
C. allowed if a commission or mark-up is only charged on one side of the transaction
D. allowed if the combined mark-up does not exceed 8 1/2%

Answer 75

The best answer is B.

In a riskless or simultaneous trade, a dealer gets an order from a customer to buy a security, and then the dealer buys the stock into his inventory to sell to the customer. The dealer has no risk and in this case the mark-up must be disclosed to the customer. Of course, the amount of the mark-up must conform with the 5% Policy.

Question 76

An OTC trader receives an order from a customer to “Buy 1,000 XYZ at the Market” and simultaneously receives an order from another customer to “Sell 1,000 XYZ at the Market.” The trader crosses the orders at the current market price. Which statements are TRUE?

I The firm must act as an agent in the transaction, charging a commission on each side
II The firm must act as a principal in the trade, charging a mark-up on the buy side and a mark-down on the sell side
III When determining a price charged to the customer, the firm must comply with the FINRA 5% Policy
IV When determining a price charged to the customer, the firm must consider the customer’s financial condition

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 76

The best answer is A.

A riskless or simultaneous transaction, as performed in the “over-the-counter” market occurs when, at the same time, a broker-dealer receives an order to buy a stock from one customer; and receives another order to sell the same amount of that stock from another customer. The firm is permitted to “cross” those orders at the current market price. Under FINRA rules, such transactions must comply with the 5% Policy.

In this transaction, the firm is acting as an agent (since it is not buying or selling the securities from its inventory) and may only charge a commission on each side of the trade. These commissions must be “fair and reasonable” under the 5% Policy. Remember, 5% commissions (in agency trades) or mark-ups (in principal trades) are only “guidelines” - not rules. Each commission or mark-up must be “fair and reasonable,” taking into consideration all relevant factors surrounding that transaction.

Question 77

In a riskless or simultaneous transaction, which of the following statements are TRUE?

I The firm is acting as agent in the transaction
II The firm is acting as principal in the transaction
III The transaction must comply with the 5% Policy
IV The transaction does not have to comply with the 5% Policy

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 77

The best answer is C.

A riskless or simultaneous transaction, as performed in the “over-the-counter” market occurs when a broker-dealer receives an order to buy a stock from one customer; and then the firm buys the security into its inventory account to sell to that customer. Because the firm did not hold the position in advance, it has no “inventory risk” of falling prices - hence the term “riskless transaction.” Under FINRA rules, such transactions must comply with the 5% Policy. Any mark-up must be “fair and reasonable” under the 5% Policy.

Question 78

Riskless or simultaneous transactions performed in the over-the-counter market are:

A. permitted if they are effected with the prior approval of the registered principal
B. permitted if they comply with the provisions of the FINRA 5% Policy
C. permitted only if they are effected in an arbitrage account
D. a prohibited practice

Answer 78

The best answer is B.

A riskless or simultaneous transaction, as performed in the “over-the-counter” market occurs when a broker-dealer receives an order to buy a stock from one customer; and then the firm buys the security into its inventory account to sell to that customer. Because the firm did not hold the position in advance, it has no “inventory risk” of falling prices - hence the term “riskless transaction.” Under FINRA rules, such transactions must comply with the 5% Policy. Any mark-up must be “fair and reasonable” under the 5% Policy.

Question 79

A customer tells his broker “Sell my position in ABCD (a NASDAQ stock) and use the proceeds to buy EFGH (another NASDAQ stock).” Under the 5% Policy, the customer will be charged a commission or mark-up based on the:

A. purchase of EFGH only
B. sale of ABCD only
C. purchase of EFGH separately; and the sale of ABCD separately
D. purchase of EFGH and the sale of ABCD combined

Answer 79

The best answer is D.

This is known as an over-the-counter “proceeds transaction.” In such a transaction, the customer directs the firm to sell an existing position, and to use the proceeds to buy another position. Under the FINRA 5% Policy, proceeds transactions are subject to a “combined mark-up” that must be fair and reasonable. In a combined mark-up, the compensation earned for liquidating the existing position is added to the mark-up that the firm earns on the new purchase. This combined compensation must be “fair and reasonable.”

Question 80

All of the following are considered in determining a fair and reasonable price in a municipal principal transaction EXCEPT:

A. Price of the transaction
B. Dollar amount of the transaction
C. Best judgment of the dealer as to the value of the securities
D. The fact that the municipal dealer is entitled to a profit in this transaction

Answer 80

The best answer is A.

The MSRB Fair Pricing Rule states that the factors that should be considered when pricing a municipal bond for BOTH agency and principal transactions are the:

• best judgment of the fair market value of the security;
• expense of filling the order;
• fact that the firm is entitled to a profit;
• availability of the security;
• total dollar amount of the transaction - a larger dollar amount should result in a smaller mark-up percentage; and
• value of services rendered in effecting the trade

The factors to be considered ONLY for principal transactions are the:

• yield should be comparable to other similar securities available in the market;
• maturity, rating and call features of the security;
• nature of the dealer’s business; and
• existence of material information about the issuer.

The factors to be considered that ONLY apply to agency trades are the:

• price of the transaction;
• value of any other compensation received in connection with this transaction (for example, a customer directs a municipal dealer to sell one bond and use the proceeds to buy another in a “bond swap.” The dealer is performing 2 trades instead of 1, and so, should charge a bit less for each trade).

Question 81

Which of the following are considered in determining a fair and reasonable price in a municipal principal transaction?

I Best judgment of the dealer as to the value of the securities
II Dollar amount of the transaction
III Expenses incurred by the municipal dealer in effecting the transaction
IV The fact that the municipal dealer is entitled to a profit in this transaction

A. I and III only
B. II and IV only
C. I, II, III
D. I, II, III, IV

Answer 81

The best answer is D.

The MSRB Fair Pricing Rule states that the factors that should be considered when pricing a municipal bond for BOTH agency and principal transactions are the:

• best judgment of the fair market value of the security;
• expense of filling the order;
• fact that the firm is entitled to a profit;
• availability of the security;
• total dollar amount of the transaction - a larger dollar amount should result in a smaller mark-up percentage; and
• value of services rendered in effecting the trade

The factors to be considered ONLY for principal transactions are the:

• yield should be comparable to other similar securities available in the market;
• maturity, rating and call features of the security;
• nature of the dealer’s business; and
• existence of material information about the issuer.

The factors to be considered that ONLY apply to agency trades are the:

• price of the transaction;
• value of any other compensation received in connection with this transaction (for example, a customer directs a municipal dealer to sell one bond and use the proceeds to buy another in a “bond swap.” The dealer is performing 2 trades instead of 1, and so, should charge a bit less for each trade).

Question 82

All of the following are considered in determining a fair and reasonable price in a municipal agency transaction EXCEPT:

A. Availability of the security
B. Cost of the security
C. Expenses associated with effecting the transaction
D. Value of services rendered by the municipal broker

Answer 82

The best answer is B.

The MSRB Fair Pricing Rule states that the factors that should be considered when pricing a municipal bond for BOTH agency and principal transactions are the:

• best judgment of the fair market value of the security;
• expense of filling the order;
• fact that the firm is entitled to a profit;
• availability of the security;
• total dollar amount of the transaction - a larger dollar amount should result in a smaller mark-up percentage; and
• value of services rendered in effecting the trade

The factors to be considered ONLY for principal transactions are the:

• yield should be comparable to other similar securities available in the market;
• maturity, rating and call features of the security;
• nature of the dealer’s business; and
• existence of material information about the issuer.

The factors to be considered that ONLY apply to agency trades are the:

• price of the transaction;
• value of any other compensation received in connection with this transaction (for example, a customer directs a municipal dealer to sell one bond and use the proceeds to buy another in a “bond swap.” The dealer is performing 2 trades instead of 1, and so, should charge a bit less for each trade).

Question 83

Which of the following are considered in determining a fair and reasonable price in a municipal agency transaction?

I Availability of the security
II Expenses associated with effecting the transaction
III Value of services rendered by the municipal broker
IV Value of any other compensation received in connection with this transaction

A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV

Answer 83

The best answer is D.

The MSRB Fair Pricing Rule states that the factors that should be considered when pricing a municipal bond for BOTH agency and principal transactions are the:

• best judgment of the fair market value of the security;
• expense of filling the order;
• fact that the firm is entitled to a profit;
• availability of the security;
• total dollar amount of the transaction - a larger dollar amount should result in a smaller mark-up percentage; and
• value of services rendered in effecting the trade

The factors to be considered ONLY for principal transactions are the:

• yield should be comparable to other similar securities available in the market;
• maturity, rating and call features of the security;
• nature of the dealer’s business; and
• existence of material information about the issuer.

The factors to be considered that ONLY apply to agency trades are the:

• price of the transaction;
• value of any other compensation received in connection with this transaction (for example, a customer directs a municipal dealer to sell one bond and use the proceeds to buy another in a “bond swap.” The dealer is performing 2 trades instead of 1, and so, should charge a bit less for each trade).

Question 84

Under MSRB rules, all of the following are considered in determining a fair and reasonable commission in a municipal agency transaction EXCEPT:

A. Availability of the security
B. Expenses associated with the transaction
C. Nature of the dealer’s business
D. Value of services rendered

Answer 84

The best answer is C.

The MSRB Fair Pricing Rule states that the factors that should be considered when pricing a municipal bond for BOTH agency and principal transactions are the:

• best judgment of the fair market value of the security;
• expense of filling the order;
• fact that the firm is entitled to a profit;
• availability of the security;
• total dollar amount of the transaction - a larger dollar amount should result in a smaller mark-up percentage; and
• value of services rendered in effecting the trade

The factors to be considered ONLY for principal transactions are the:

• yield should be comparable to other similar securities available in the market;
• maturity, rating and call features of the security;
• nature of the dealer’s business; and
• existence of material information about the issuer.

The factors to be considered that ONLY apply to agency trades are the:

• price of the transaction;
• value of any other compensation received in connection with this transaction (for example, a customer directs a municipal dealer to sell one bond and use the proceeds to buy another in a “bond swap.” The dealer is performing 2 trades instead of 1, and so, should charge a bit less for each trade).

Question 85

A municipal dealer buys $100,000 of 8% General Obligation bonds, M ‘42, at par. The dealer immediately reoffers the bonds to customers. Which TWO of the following quotes would be considered “fair and reasonable” under MSRB rules?

I 102
II 110
III 6.00 Net
IV 7.50 Net

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 85

The best answer is B.

The dealer purchases 8% bonds at par. Any mark-up that he earns upon reselling the bonds must be fair and reasonable. A price of 102 equals a mark-up of 2% above par. This is certainly fairer than a price of 110, representing a 10% mark-up from par.

To get an “approximate” price for a long-term bond offered on a yield basis, divide the coupon by the basis (this only works for long term bonds). Thus, an 8.00% bond offered on a 6.00% basis would have an approximate price of 8.00/6.00 = 1.33333 x $1,000 par = $1,333.33. This is about a 33% mark-up over par, which is excessive.

In contrast, an 8.00% bond offered on a 7.50% basis would have an approximate price of 8.00/7.50 = 1.066666 x $1,000 par = $1,066.66. This is a 6.66% mark-up over par, which is a little high, but not as high as the other choice!

Question 86

A municipal dealer buys $100,000 of 6% General Obligation bonds, M ‘40, at par. The dealer immediately reoffers the bonds to customers. Which TWO of the following quotes would be considered “fair and reasonable” under MSRB rules?

I 104
II 112
III 5.75 Net
IV 4.00 Net

A. I and III
B. I and IV
C. II and III
D. II and IV

Answer 86

The best answer is A.

The dealer purchases 6% bonds at par. Any mark-up that he earns upon reselling the bonds must be fair and reasonable. A price of 104 equals a mark-up of 4% above par. This is certainly fairer than a price of 112, representing a 12% mark-up from par.

To get an “approximate” price for a long-term bond offered on a yield basis, divide the coupon by the basis (this only works for long term bonds). Thus, a 6.00% bond offered on a 5.75% basis would have an approximate price of 6.00/5.75 = 1.043478 x $1,000 par = $1,043.48. This is about a 4% mark-up over par, which is fair.
In contrast, a 6.00% bond offered on a 4.00% basis would have an approximate price of 6.00/4.00 = 1.50 x $1,000 par = $1,500. This is a 50% mark-up over par, which is really excessive!