Final 2 Flashcards
Which of the following activities are prohibited during “cooling off” period?
1 sale of the issue to the public
2 acceptance of an indication of interest
3 distribution of a preliminary prospectus
4 distribution of an advertisement
A) 1 and 2
B) 3 and 4
C) 2 and 3
D) 1 and 4
The best answer is D. During the cooling off period, an offer or sale of the issue is prohibited, as are recommendations of the issue or the advertising of the issue. Sending a preliminary prospectus or accepting an indication of interest does not constitute an “offer” under the Securities Act of 1933 and thus is permitted.
Distributions from Roth IRAs are subject to a penalty if withdrawals are made within:
A) 1 year of original contribution
B) 3 years of original contribution
C) 5 years of original contribution
D) 10 years of original contribution
The best answer is C. Contributions to Roth IRAs are not tax deductible. If the monies remain invested in the Roth IRA for at least 5 years, they can be withdrawn with no tax due (assuming that the beneficiary is at least age 59 1/2 when distributions commence).
The O.C.C. assigns exercise notices on a:
A) fist in; first out basis
B) last in; first out basis
C) random order basis
D) method of reasonable fairness
The best answer is C. If an option contract is exercised by a holder, a writer is selected by the Options Clearing Corporation to perform on the contract on a random order basis.
A customer sells short 100 shares of ABC at $36 and buys 1 ABC Jul 35 Call @ $3. The stock falls to $30 and the customer closes the option contract at $1 and buys the stock at the current market price. The customer has a:
A) 200 loss
B) 300 loss
C) 300 gain
D) 400 gain
The best answer is D. The customer sold the stock for $36 and bought a call, paying a premium of $3 per share, for net proceeds of $33. The customer closes the positions by purchasing the stock at $30 and selling the call contract for $1, for a net payment of $29 per share. The net profit is $33 - $29 = $4 or $400 on 100 shares.
A customer buys an oil and gas limited partnership interest by contributing $20,000 and signing a $20,000 non-recourse note. The customer’s tax basis is:
A) 0
B) 10,000
C) 20,000
D) 40,000
The best answer is C. Investors are not at risk for non-recourse financing so it is excluded from the basis (with the exception of real estate programs which are exempt from the at risk rule). Only the $20,000 cash contribution is included in the basis, so potential tax deductions are reduced.
All of the following callable municipal bonds are trading at an 8% basis. Which is LEAST likely to be called?
A. 6 3/4% coupon rate callable at 100 in 2018
B. 7 1/2% coupon rate callable at 100 in 2018
C. 8% coupon rate callable at 100 in 2018
D. 8 3/4% coupon rate callable at 100 in 2018
The best answer is A. An issuer is least likely to call bonds which have low interest rates (low financing cost to the issuer) and high call premiums (the least expensive for the issuer to call in these bonds) - all of these issues are callable at par. The issuer will want to refinance the one with the highest coupon. The issuer would call these bonds and sell new bonds at lower current rates.
All of the following are true regarding corporate bonds which are purchased in the secondary market at a discount and accreted EXCEPT:
A. the interest income is subject to Federal Income tax
B. the interest income is subject to State and Local tax
C. if the bond is held to maturity, there is no taxable capital gain
D. if the bond is held to maturity, there is a taxable capital gain which is taxed as ordinary income
The best answer is D. Corporate bonds bought in the secondary market at a discount are termed “market discount bonds.” There is an option of accreting the discount and paying tax annually on the accretion amount at full tax rates; or of waiting until the bond is redeemed or sold to pay the tax on the earned market discount at full tax rates. If the holder accretes the bond and holds it until maturity, there is no capital gain or loss, since the entire discount has been accreted and taxed over the bond’s life. If the holder opts not to accrete the bond, the bond will be redeemed at par and the entire market discount is taxed as interest income received at maturity (not as capital gains).
Customer Name: Charlie Customer Age: 69 Marital Status: Single - Widowed Dependents: None Occupation: Retired Household Income: $31,000 (Social Security and Pension) Net Worth: $130,000 (excluding residence) Own Home: Yes $220,000 Value, No Mortgage Investment Objective: Current Income Risk Tolerance: Low Investment Time Horizon: 20 years Investment Experience: 0 years Current Portfolio Composition: Cash in Bank: $130,000 After reviewing this customer's profile sheet, which recommendation would be most appropriate?
A. The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20-year TIPS to meet the customer’s desire for current income and his low risk tolerance requirements
B. The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20-year STRIPS to meet the customer’s desire for current income and his low risk tolerance requirements
C. The customer should mortgage his house for $100,000 at current market interest rates and use the proceeds to buy 20 year income bonds to provide current income
D. The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20-year Treasury Bonds to meet the customer’s desire for current income and his low risk tolerance requirements
The best answer is D.
This customer is age 69, with no current investments or investment experience. The customer has a fairly low retirement income and needs additional current income to live comfortably. This customer really only has 2 assets to tap for potential current income. He owns a fully paid house worth $220,000; and has $130,000 of cash in the bank.
One way to supplement income is for the customer to get a reverse mortgage on the house, but this is not a banking exam, so we will not go near that possibility! The other way to supplement income is to invest the cash in the bank in an investment that is safe and that gives current income. Treasury Bonds pay interest semi-annually at a higher rate than that earned on bank deposits, and are really safe, so these would be the best recommendation. STRIPS do not provide current income since they are a zero-coupon Treasury obligation so these will not work. TIPS give a lower current interest rate than regular Treasury bonds, in return for protecting the investor against inflation - however the inflation protection is not “paid” until maturity, so again, these will not give the greatest additional current income.
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?
1) 104
2) 112
3) 5.75 Net
4) 4.00 Net
A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4
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!
Customer Name: John Doe Age: 41 Marital Status: Married Dependents: 1 Child, Age 13 Occupation: Engineer Household Income: $140,000 Net Worth: $240,000 (excluding residence) Own Home: Yes Investment Objectives: Total Return / Tax Advantaged Investment Experience: 12 years Current Portfolio Composition: 8% Common Stocks 62% Corporate Bonds 30% Money Market Fund This client has just been informed that he has been promoted and will be earning $190,000 per year instead of $140,000 per year. The customer intends to use this extra income to fund his 13-year old child's college education. Based on the customer's existing asset mix, the best recommendation would be for the customer to invest the extra $50,000 per year into a(n):
A) money market fund
B) income fund
C) growth fund
D) inflation protected fund
The best answer is C. This customer’s portfolio is 92% invested in cash and bonds with only 8% in equities. Since he has 6 years to fund the child’s education, growth stocks would help balance the portfolio and enhance the overall return.
Ten basis points are equal to:
1) .10 per 1,000
2) 1.00 per 1,000
3) .10%
4) 1.0%
A) 1 and 3
B) 1 and 4
C) 2 and 3
D) 2 and 4
The best answer is C. One basis point is .01% of interest. 10 basis points equals .10% of interest. 10 basis points equals .10%, which is the same as $1.00 per $1,000 face amount on a bond.
A registered representative wants to speak to a group of clients about a private placement in a 2-year old company. The invited clients have a stated minimum net worth of $1 million. The representative is soliciting them to buy privately placed shares of the company because it is in a growth business due to the aging of the population in the U.S. - the company’s business is the refurbishment of medical equipment in hospitals. In the Private Placement Memorandum (PPM), the company states that investors are expected to receive a 15% annual cash dividend and could also enjoy capital appreciation. What should the representative do before offering the security to these clients?
A. Nothing, because they all receive protection under anti-fraud Rule 10b-5 under the Securities Exchange Act of 1934
B. Nothing, because all of the investors are accredited under Regulation D of the Securities Act of 1933
C. The registered representative should review the revenue and expenses as detailed in the PPM to see if it is feasible for the company to pay a 15% cash dividend
D. The registered representative must get a signed attestation from each attendee that they received the PPM
The best answer is C. FINRA requires that when a private placement is offered, the broker-dealer or its representatives must conduct a reasonable investigation concerning that security and the issuer’s representations about it. FINRA states that a broker-dealer “may not rely blindly upon the issuer for information concerning a company and it cannot rely on information provided by the issuer in lieu of its own reasonable investigation.” The fact that a BD’s customers are accredited does not obviate this investigation. The BD must conduct a reasonable investigation concerning the:
issuer and its management;
business prospects of the issuer;
assets held by the issuer;
claims being made; and
intended use of the proceeds of the offering.
Note that if registered securities are being offered, this detailed “due diligence” investigation by the BD offering the investment is not required - it is only a requirement for private placement offerings (because in a registered securities offering, the issuer and underwriters perform the required due diligence). Also note that there is no requirement for a signed receipt that each attendee received a Private Placement Memorandum.
A customer enters an order to sell 100 ABC at $80.25 Stop Limit. After the order is entered, the tape shows the following trades: 80.25..80.13..80.13..80.50 The order is: I elected at 80.13 II elected at 80.25 IIIexecuted at 80.13 IV executed at 80.50
The best answer is D. Sell stop orders are placed lower than the current market and are elected (or triggered) at or below the stop price - here, the stop price is at 80.25. The very first trade is at 80.25 - this is at the stop price and elects the order.
Then the order becomes a limit order to sell at 80.25 or better (or higher). The next trade is at 80.13 - this does not meet the limit price of 80.25 needed to sell. The next trade is at 80.13 - this also does not meet the limit price of 80.25 needed to sell. The next trade is at 80.50 and the order can be executed, as this is the first trade “at or above” the limit of 80.25.
A customer owns 1,000 shares of XYZZ stock, purchased at $40 per share. The stock is now at $45, and the customer has become neutral on the stock, but believes that the stock still has good long term growth potential The client asks her representative for a “conservative recommendation” that will give her a positive portfolio return. The client should be told to:
A. sell 10 XYZZ 45 Call Contracts
B. sell 10 XYZZ 45 Put Contracts
C. sell 1,000 shares of XYZZ and sell 10 XYZZ 45 Call Contracts
D. sell 1,000 shares of XYZZ and sell 10 XYZZ 45 Put Contracts
The best answer is A.
The customer purchased the stock at $40 and it is now trading at $45. The customer is now neutral on the stock, but thinks it is a good long term investment. So the stock should not be sold (eliminating Choices C and D). If the customer sells calls against the stock position (covered call writer), the customer will generate extra premium income in the portfolio. This is a conservative income strategy. The risk here is that if the stock rises immediately, the stock will be called away and the customer will not enjoy the upside gain. If the stock falls, the customer loses on the stock (same as before), reduced by the collected premiums.
The sale of puts will also produce premium income. If the stock rises, the puts expire and the customer still owns the stock, but if the stock drops, the short puts will be exercised, obligating the customer to buy the stock (in addition to the shares already owned). Thus, in a falling market, the customer will lose twice as fast! This is not a “conservative” strategy.
An elderly female client has income from her pension plan and social security that meets her needs. She has extra money available that she would like to use to help fund her favorite 8-year old grandson’s college education. Which investment would be the best recommendation?
A) 10 year Treasury notes
B) growth stocks
C) S&P 500 index fund
D) income bonds
The best answer is B.
Since the child will be starting college in 10 years, growth stocks would be the best recommendation. These will grow the greatest amount over 10 years and this is sufficient time for the portfolio to absorb market volatility and recover. The second best choice would be the S&P 500 Index fund, but this would provide a lower return (and lower risk). Treasury notes and bonds give a much lower yield in return for absolute safety. Income bonds are corporate bonds that only pay interest if the corporation has enough “income.” These are risky investments.
Don’t confuse the female client’s needs with the child’s needs in this question. The female client’s needs are covered. This question asks what is appropriate for the child.
