EXAM 1 SERIES 65 10 CARDS - 2

Question 1

If a person violates the USA, there will not be any “civil penalties”. Why?

Answer 1

“Civil” court can result in “fines” but not “penalties”.

Liabilities = fines
Penalties = prison sentences

Question 2

If a company has issued “cumulative” preferred stock, and has not paid full dividends, “common dividends” would require the company to make up previous payments not made. Why?

Answer 2

When a company annonces a dividend to stockholder, the company must compensate cumulative preferred dividends for past dividends that were never paid.

Cumulative preferred stockholders have a priority claim on dividends, which must be fufilled brfore any payments can be made to common shareholders.

Preferred shareholders have a higher claim on dividends than common shareholders. They are usually paid a fixed dividend.

Cumulative preferred stock means that if the company misses any dividend payments, these unpaid dividends accumulate and must be paid out before any dividends can be given to common shareholders.

Question 3

After an advisory firm trminates its business, the IA must maintain required records for 3 years. True or False?

Answer 3

True. After an investment adviser terminates its business, the adviser must maintain required records for 3 years.

Question 4

If an investor buys a municipal bond at 110 with 5 years to maturity, what is the cost basis after the investor holds the bond for 3 years?

110
106
104
102
The answer is 104. Why?

Answer 4

If an investor buys a municipal bond at a premium, the bond must be amortized where the cost basis is reduced annually based on the amount of premium lost each year. Since the investor buys the bond at $1100 and the bond matures at $1000 in 5 years, the investor loses $100 in 5 years for $20 per year. Since the bond is held for 3 years, the investor loses $60 ($20 x 3). Therefore, the cost basis is reduced to $1040 ($1100 - $60).

Question 5

Regarding Municipal bonds, what is the formula for Annual Amortization?

Answer 5

Annual Amortization = Premium Paid / Yrs to Maturity

Question 6

What is usually the face value of a Municipal Bond (Par Value)?

Answer 6

Face Value (Par Value): This is the nominal value of the bond what will be repaid to the bondholder at maturity. For most bonds, this is standardized at $1,000.

Note:
Price Quotation: Bonds are often quoted as a percentage of thier face value (par value). For instance, a bond quoted at 100 is priced at 100% of its face value (par value). If the face value is $1,000, a bond quoted at 100 would cost $1,000.

Example:
Face value: $1,000
Quoted Price: 110 (which means 110% of the face value)

So, When we say a bond is bought at 110, it mean the investor paid 11% of the face value. For a bond with a $1,000 face value:

Purchase Price - 110% of (X) $1,000 = $1,100

Question 7

Regarding Municipal Bonds, what is the formula to calculate the Premium Paid?

Answer 7

Premium Paid = Purchase Price - Face Value (Par Value)

Example:
1. Purchase Price: $1,100
2. Face Value: $1,000

If the bond is purchased at a price above the face value, the difference is the premium paid. Here the premium paid is $100

Question 8

Regarding municipal bonds, what is the formula to calculate “total Amortization?

Answer 8

Total Amortization = Annual Amortization x Number of Yrs held

Example:
Total Amortiztion = 2 x 3 = 6 (or $20 x 3 = $60)

Question 9

Regarding municipal bonds, what is the formula for calculating “Adjusted Cost Basis”?

Answer 9

The cost basis is adjusted by subtracting the total amortization from the initial purchase price.

Adjusted cost basis = Initial purchase price - Total amortization

Adjusted cost basis = 110 - 6 = 104
(or $1,100 - $60 = $1,040)

Question 10

There are 7 Steps to determine the cost basis of a municipal Bond. Here are the Steps to determine the cost basis after 3 years:

1. Determine the Initial Purchase Price.
2. Determine the Face Value (Par Value)
3. Determin the Premium Paid
4. Determine Total Yrs to Maturity
5. Determine Annual Amortization
6. Determine Amortization The for Years (How long was the bond held, ex: 3 yrs)
7. Determine Total Amortization
8. Determine the Adjusted Cost basis

Answer 10

Steps to Determine the Cost Basis After 3 Years:

1. Initial Purchase Price: The bond is bought at 110 (or $1,100 if we assume a face value of $1,000).
2. Face Value: The face value of the bond is 100 (or $1,000).
3. Premium Paid: The premium is 110 - 100 = 10 (or $100).
4. Total Years to Maturity: The bond has 5 years to maturity.
5. Annual Amortization: The premium is amortized over 5 years.

Annual amortization = Premium / Years to maturity

Annual amortization = 10 / 5 = 2 (or $100 / 5 = $20 per year)

6. Amortization for 3 Years: After holding the bond for 3 years, the total amortization would be:
7. Total amortization = Annual amortization * Number of years held

Total amortization = 2 * 3 = 6 (or $20 * 3 = $60)

8. Adjusted Cost Basis: The cost basis is adjusted by subtracting the total amortization from the initial purchase price.

Adjusted cost basis = Initial purchase price - Total amortization
Adjusted cost basis = 110 - 6 = 104 (or $1,100 - $60 = $1,040)