Practice Exam 2

Question 1

A customer purchases an ABC 6-½% convertible preferred stock at $80. The conversion price is $20. If the common stock is trading 2 points below parity, the price of ABC common is:

A) $14.
B) $12.
C) $16.
D) $18.

Answer 1

$14;
The conversion ratio is computed by dividing par value by the conversion price ($100 par / $20 = 5). Parity price of the common stock is computed by dividing the market price of the convertible by the conversion ratio ($80 / 5 = $16). $16 − 2 = $14.

Question 2

A primary dealer has its bid on Treasury bills filled at the weekly auction. Settlement between the dealer and the Treasury will be:

A) next business day.
B) Thursday of that week.
C) same day.
D) regular way.

Answer 2

Thursday of that week;

Settlement for the weekly Treasury bill auction normally occurs on the Thursday of the same week as the auction.

Question 3

Under MSRB rules, which of the following statements regarding a fidelity bond is TRUE?

A) It insures brokerage firm customers in the event the brokerage firm must liquidate.
B) It insures against loss due to theft.
C) It will insure against the price decline of a security.
D) It is contained in the trust indenture.

Answer 3

It insures against loss due to theft;

MSRB members are required to have a fidelity bond which protects against loss due to employee theft.

Question 4

Which of the following would have the least market risk?

A) AAA corporate debentures.
B) Fannie Maes.
C) Revenue anticipation notes.
D) Corporate or municipal bonds with long-term maturities.

Answer 4

Revenue anticipation notes;
Anticipation notes are the shortest term, which gives them the least market risk (the risk that price will fluctuate during the time left to maturity).

Question 5

A working interest in an oil and gas partnership entitles the holder to:

I. a portion of the revenue.
II. responsibility for part of the expense of extraction.
III. royalty interest in the revenue.
IV. royalty interest in revenue after deducting certain expenses.

Answer 5

I. a portion of the revenue.
II. responsibility for part of the expense of extraction;

A working interest is a right to revenues from production, but it also carries the responsibility for extraction costs. A royalty interest carries no responsibility for extraction costs.

Question 6

Who signs the agreement among underwriters for a municipal bond issue?

A) All members of the underwriting syndicate.
B) Managing underwriter and bond counsel.
C) Managing underwriter and issuer.
D) Managing underwriter and trustee.

Answer 6

All members of the underwriting syndicate;

All members of the syndicate, including the managing underwriter, sign the agreement among underwriters. It is not signed by the issuer, bond counsel, or trustee.

Question 7

Once a broker/dealer receives an enrollment notification for an employee to test for the Series 7 licensing exam, the employee will have how long to successfully complete (pass) the exam?

A) 6 months.
B) 2 months.
C) 3 months.
D) 4 months.

Answer 7

4 months;

Once notification of enrollment for testing has been received by the broker/dealer the candidate will have 120 days (4 months) to successfully complete (pass) the exam. This is commonly referred to as the “testing window”.

Question 8

If IDBs are called because of condemnation, this would be covered under which of the following clauses in the bond indenture?

A) Defeasance.
B) Refinancing.
C) Refunding.
D) Catastrophe.

Answer 8

Condemnation is considered a catastrophe and only applies to revenue bonds.

Question 9

If XYZ Corporation intends to offer stock in a public offering, it must do all of the following EXCEPT:

A) publish a tombstone advertisement.
B) file a registration statement.
C) register the securities with the SEC.
D) issue a prospectus.

Answer 9

publish a tombstone advertisement;

Tombstones are advertisements often appearing in business newspapers to publicize new issues and are generally placed by a syndicate manager. They are not required.

Question 10

If a municipal bond maturing in 10 years is bought for 110, its cost basis at the end of the sixth year is:

A) 104.
B) 101-½.
C) 106.
D) 100.

Answer 10

$104
To establish the new cost basis, determine the amount of the premium to be amortized yearly. For this bond, the $100 premium is amortized over 10 years: $100 ÷ 10 = $10. Then, multiply the annual amortization amount by the number of years the bond is held ($10 × 6 = $60). Finally, subtract the amount of the amortized premium from the original cost of the bond ($1,100 − $60 = $1,040, or 104).

Question 11

Through its open market operations, the Federal Reserve trades all of the following EXCEPT:

A) Grant anticipation notes.
B) Ginnie Maes.
C) Treasury notes.
D) Treasury bills.

Answer 11

Grant anticipation notes;

The Federal Open Market Committee (FOMC) trades U.S. government and agency securities in the secondary market. Grant anticipation notes (GANs) are municipal securities.

Question 12

Which of the following statements regarding a red herring is NOT true?

A) A red herring is used to accept indications of interest from investors.
B) Additional information may be added to a red herring at a later date.
C) The final offering price does not appear in a red herring.
D) An agent may accept funds to be placed in escrow until the effective date if the request to do so is made by a potential purchaser.

Answer 12

An agent may accept funds to be placed in escrow until the effective date if the request to do so is made by a potential purchaser;

An agent is not permitted to accept funds from potential purchasers of a new issue before the effective date.

Question 13

Which of the following are considered sources of debt service for GO bonds?

I. Tolls on roads
II. Real estate taxes
III. Revenue generated by a hospital
IV. Liquor license fees

Answer 13

II. Real estate taxes
IV. Liquor license fees;

General revenues of the municipality such as real estate taxes or licensing fees may be used to pay the debt service on a general obligation bond. Usage revenue such as that generated from toll roads or hospitals would be associated with funding revenue bonds.

Question 14

When investor confidence in the economy is increasing, a technical analyst would anticipate that:

I. yields on AAA-rated bonds will be higher than those on BBB-rated bonds.
II. yields on BBB-rated bonds will be higher than those on AAA-rated bonds.
III. the spread between yields on AAA-rated and BBB-rated bonds will increase.
IV. the spread between yields on AAA-rated and BBB-rated bonds will decrease.

Answer 14

II. yields on BBB-rated bonds will be higher than those on AAA-rated bonds.
IV. the spread between yields on AAA-rated and BBB-rated bonds will decrease;

When investor confidence in the economy is increasing, yield spreads between the safest bonds and more speculative bonds decrease because investors are willing to take on greater risk. Yields on less safe bonds remain higher than those of AAA bonds. When investor confidence is declining the yield spreads will increase.

Question 15

Underwriters that reserve the right to stabilize the price of securities distributed to the public under an SEC registration statement may do so:

A) without restriction.
B) only if notice is given in the prospectus.
C) under no circumstances.
D) only if the securities being distributed will be immediately listed for trading on the NYSE or other exchange.

Answer 15

only if notice is given in the prospectus;

Stabilizing transactions are permitted if the SEC is notified in the registration statement and the investing public is notified in the prospectus.

Question 16

Information found in the Bond Buyer would include all of the following EXCEPT

A) the placement ratio
B) secondary market volume
C) REVDEX
D) the 30-day visible supply

Answer 16

secondary market volume;

The Bond Buyer is a source of information for new (primary market) municipal bond issues. It contains REVDEX, an index for revenue bonds as well as GO bond indexes. Additionally it includes the 30-day visible supply and the placement ratio.

Question 17

The amount paid in excess of par value on the sale of common shares by an issuer is reflected in which of the following accounts on the corporate financial records?

A) In the capital stock.
B) In the earned surplus.
C) In the retained earnings.
D) In the paid-in surplus.

Answer 17

In the paid-in surplus;

Paid-in surplus, or capital surplus, is the excess over par value that investors pay for stock on its original issue. Generally, par value on common stock is a matter of record for accounting purposes.

Question 18

Private placements

A) may be advertised if all of those solicited are accredited investors
B) can only be advertised when 35 or fewer of the investors are nonaccredited
C) may be advertised under all circumstances
D) may never be advertised under any circumstance

Answer 18

may be advertised if all of those solicited are accredited investors;

In order to solicit or advertise private securities offerings, all purchasers of the advertised securities must be accredited investors or the business must reasonably believe that the investors are accredited investors at the time of the sale.

Question 19

A customer buys 100 XYZ at $30. Two years later, with the stock trading at $70, the customer makes a gift of the securities to his son. Which of the following statements are TRUE?

I. For gift-tax purposes, the value of the gift is $3,000.
II. For gift-tax purposes, the value of the gift is $7,000.
III. The son’s cost basis on the stock is $3,000.
IV. The son’s cost basis on the stock is $7,000.

Answer 19

II. For gift-tax purposes, the value of the gift is $7,000.
III. The son’s cost basis on the stock is $3,000;

When making a gift of securities, the market value at date of gift is used to determine if any gift taxes are due. However, when making a noncharitable gift of securities, the donor’s cost basis is passed to the recipient.

Question 20

Which of the following would be found in the agreement among underwriters for a municipal bond offering?
I. Legal opinion.
II. Amount of the concession.
III. Appointment of the bond counsel.
IV. Establishment of the takedown.

Answer 20

II. Amount of the concession.
IV. Establishment of the takedown;

The agreement among underwriters describes the rights, duties, and commitments of the syndicate members regarding the securities being underwritten. It appoints the syndicate manager to act on behalf of the syndicate and includes provisions dealing with underwriting compensation (takedown and concession). The legal opinion is a document prepared by the bond counsel, and the appointment of the bond counsel is the issuer’s responsibility.

Question 21

Of the following system characteristics which can be associated with TRACE (Trade Reporting and Compliance Engine)?
I. Both sides of the transaction must report.
II. Only the buyer is required to report .
III. Municipal securities are excluded from the reporting system.
IV. It is an execution and trade reporting system.

Answer 21

I. Both sides of the transaction must report.
III. Municipal securities are excluded from the reporting system;

TRACE requires that both sides of the transaction report corporate bond trades that occur in the OTC secondary market. Municipal securities are one of the specific exclusions from the trade reporting system. Trace is not an execution system.

Question 22

TANs, RANs, GANs, and BANs are issued by municipalities seeking:

A) bond insurance.
B) special tax assessments for GO bonds.
C) financing for low-cost housing.
D) short-term financing.

Answer 22

short-term financing;

Municipal short-term notes (tax anticipation notes, revenue anticipation notes, grant anticipation notes, and bond anticipation notes) are used as interim financing until a permanent long-term issue is floated or until tax receipts increase or revenue flows in.

Question 23

All of the following sources of revenue could be used to service general obligation debt EXCEPT:

A) ad valorem taxes.
B) fines.
C) sales taxes.
D) user charges.

Answer 23

user charges;

Historically, municipalities get most of their revenues from property taxes (ad valorem taxes). Other sources of revenue include sales taxes, income taxes, gasoline taxes, license fees, fines, and assessments. User charges would be used to service revenue bonds.

Question 24

If a stock is sold on November 30 when the record date for a dividend distribution is December 1, the seller is:
I. entitled to the dividend if the trade is done regular way.
II. not entitled to the dividend if the trade is done regular way.
III. entitled to the dividend if the trade is done with cash settlement.
IV. not entitled to the dividend if the trade is done with cash settlement.

Answer 24

I. entitled to the dividend if the trade is done regular way.
IV. not entitled to the dividend if the trade is done with cash settlement.;

Anyone who owns the stock on the record date will receive the dividend. In a regular way trade, the seller will still be owner of record on record date, as the trade will settle after the record date. In a cash settlement transaction, the buyer will be owner of record on record date.

Question 25

Which of the following investor profiles would a principal protected equity-linked exchange-traded note best be suited for?

A) An investor wanting to avoid credit risk
B) An investor wishing to be able to get into and out of the investment easily
C) An investor wanting a fixed return at maturity
D) An investor seeking current interest income

Answer 25

An investor wishing to be able to get into and out of the investment easily

Question 26

A stock mutual fund wishes to advertise itself as diversified. To be able to do so, the fund must invest:

A) All of these.
B) at least 75% of its assets in securities other than its own.
C) no more than 5% of its assets in any one target company.
D) so that it holds no more than 10% of the voting stock of any one company.

Answer 26

All of these;

All of these choices comprise the 75-5-10 rule for diversified investment companies under the Investment Company Act of 1940. At least a minimum of 75% of the total assets must be invested in securities other than those of the investment company. Of the assets invested, no more than 5% of the fund’s total assets can be in any one company nor can the percentage ownership of any one company be more than 10%.

Question 27

Exchange-traded notes (ETNs)

I. are unsecured debt securities
II. are unsecured equity securities
III. are issued by financial institutions such as banks
IV. have no credit risk associated with them

Answer 27

I. are unsecured debt securities
III. are issued by financial institutions such as banks;

Exchange-traded notes (ETNs) are unsecured debt securities issued by financial institutions such as banks. Their prices can be impacted by changes in the credit rating of the issuer.

Question 28

In a proceeds transaction for a customer where the proceeds from the liquidation of one stock are used to purchase another stock, the 5% markup policy is computed on the basis of:

A) the markup on the buy side only.
B) each side of the transaction separately.
C) a combination of both the buy side and the sell side.
D) the markdown on the sell side only

Answer 28

a combination of both the buy side and the sell side;

In a proceeds transaction (sell one position; take the proceeds and buy another), the 5% markup is computed by adding the compensation made by the dealer on the sell side to that made by the dealer on the buy side and applying the total to the inside market on the buy side.

Question 29

Which of the following activities are characteristic of a primary offering?
I. Raising additional capital for the company.
II. Selling previously issued securities.
III. Increasing the number of shares outstanding.
IV. Buying previously issued securities.

Answer 29

I. Raising additional capital for the company.
III. Increasing the number of shares outstanding;

A primary offering involves the sale of previously unissued securities. The issuing company receives the proceeds from the sale; once the securities are sold, more securities will be outstanding.

Question 30

A client is trying to decide between a par value corporate bond carrying a coupon rate of 6.25% per year and a par value municipal bond that pays an annual coupon rate of 4.75%. Assuming all other factors are equal and your client is in a 28% marginal income tax bracket, which bond do you tell the client to purchase and why?

A) The corporate bond because the after-tax yield is 6.25%.
B) The corporate bond because the after-tax yield is 4.5%.
C) The municipal bond because its equivalent taxable yield is 6.3%.
D) The municipal bond because its equivalent taxable yield is 6.6%.

Answer 30

The municipal bond because its equivalent taxable yield is 6.6%;

This is calculated using the tax-equivalent yield formula; Municipal yield / (100% − investors tax bracket) 4.75 / (1 − .28) = 6.6%. By comparison, the 6.6% tax-equivalent yield of the municipal bond is higher than the 6.25% yield of the taxable corporate bond making the municipal bond the higher yielding investment given the investors 28% tax bracket.

Question 31

A customer buys XYZ Oct 75 put at 7 when XYZ is trading at 72. The stock falls to 69 and the customer exercises the put. For tax purposes, sales proceeds are:

A) 6800.
B) 6500.
C) 6200.
D) 7500.

Answer 31

6800;

When a put is exercised, the holder is selling stock at the strike price (75). However, the tax rules require that, if exercised, the cost basis of stock purchased or sales proceeds of stock sold, is adjusted to the breakeven point of the option. For puts, breakeven is strike price minus premium (75 − 7 = 68).

Question 32

If an XYZ Aug 80 put is trading at 2, at which price would the option be at parity with the stock?

A) 78.
B) 82.
C) Any of the above.
D) 80.

Answer 32

78;

The term “at parity” means the premium equals the intrinsic value that occurs for an in-the-money option prior to expiration when the time value has eroded. An 80 put is in-the-money by 2 points (the premium) when the underlying stock is trading at 78.

Question 33

Last-sale information is always available for all of the following securities EXCEPT

A) OTC, non-Nasdaq
B) CBOE listed option contracts
C) NYSE-listed
D) Nasdaq

Answer 33

OTC, non-Nasdaq;

Last-sale information is available for listed

Question 34

If a customer wants to buy shares of ABC on margin, while ABC is engaged in an initial public offering, how many days must the customer wait after the public offering date?

A) 40.
B) 25.
C) 90.
D) 30.

Answer 34

30;

According to Regulation T, a new issue may not be purchased on margin for the first 30 calendar days following the public offering date.

Question 35

Which of the following is TRUE about a sales agreement between a principal underwriter and a member, which enables the member to receive a discount from the public offering price?
I. It must be in writing.
II. It must provide for a 45-day right of refusal.
III. It must provide that the member will sell at NAV only when selling to the public.
IV. It must provide for a refund of the concession by the member to the underwriter if the shares are redeemed within 7 business days of the sale.

Answer 35

I. It must be in writing.
IV. It must provide for a refund of the concession by the member to the underwriter if the shares are redeemed within 7 business days of the sale.

I and IV;

All sales agreements must be in writing, provide for a 7-day refund of the concession, and include a stipulation that the member will maintain the public offering price, not the NAV.

Question 36

Which of the following statements regarding a bond trading flat is NOT true?

A) It may be a bond in default.
B) It may be traded with accrued interest.
C) It may be an income bond.
D) It may have interest in arrears.

Answer 36

It may be traded with accrued interest.

A municipal or corporate bond trading flat is trading without accrued interest. The bond may be an income bond, which normally pays no interest, or it may be a bond currently paying no interest because it is in default.

Question 37

In a negotiated municipal bond underwriting all of the following are true EXCEPT:

A) the underwriter works with the issuer to establish the interest rate.
B) the municipality appoints an investment banker or broker/dealer to underwrite the offering.
C) the underwriter works with the issuer to establish the offering price.
D) the underwriters may also be financial advisors to the municipality and receive both advisory fees and underwriting fees.

Answer 37

the underwriters may also be financial advisors to the municipality and receive both advisory fees and underwriting fees;

In a negotiated underwriting, the municipality appoints an investment banker or broker/dealer to underwrite the offering. The underwriter works with the issuer to establish the interest rate and the offering price in light of the issuer’s financial needs and market conditions. Generally those acting in the capacity of financial advisor to a municipality may not simultaneously act as underwriters. This is true of both negotiated and competitive bid underwritings. While the MSRB rules do allow for certain exceptions, the fees collected would be limited to only those already agreed to for the advisory services and not include any additional fees for performing underwriting functions or services.

Question 38

A sharing arrangement in which only deductible costs are apportioned to the investor with the sponsor bearing all capitalized costs is called a(n):

A) overriding royalty arrangement.
B) reversionary sharing arrangement.
C) functional allocation.
D) carried interest.

Answer 38

functional allocation;

Functional allocation is a sharing arrangement in which the general partner pays for all tangible drilling costs (capitalized costs) and the limited partners pay for all intangible drilling costs (deductible costs).

Question 39

For which of the following would the net revenue to debt service ratio be applicable?

A) Hospital bonds.
B) GO bonds.
C) Tax anticipation notes.
D) School bonds.

Answer 39

Hospital bonds;

This is the Coverage ratio. Because revenue bonds are only backed by funds generated by a specific source, it is important that net revenues exceed debt service requirements. Hospitals are often built with the proceeds of revenue bond issues.

Question 40

After a mutual fund’s tenth year, performance statistics must show results for each of the following periods EXCEPT:

A) 3 years.
B) 5 years.
C) 10 years.
D) 1 year.

Answer 40

3 years;

Mutual fund performance statistics must show results for 1, 5, and 10 years, or the life of the fund, whichever is shorter.

Question 41

The dividend payout ratio of common stock is found by dividing the annual dividend per share by:

A) the book value.
B) the market price.
C) the earnings per share.
D) the capitalization per share.

Answer 41

the earnings per share;

The key to the question is ratio, which in this case is the relationship between dividends per share and their source of earnings per share.

Question 42

A due diligence meeting occurs between:

A) All of these.
B) the underwriter and the SEC before the issuance of a final prospectus to insert the public offering price and make any last minute changes at the SEC’s request.
C) the issuing corporation and the underwriters to review and reexamine the full details of the pending underwriting and negotiate final terms to be included in the formal underwriting contract.
D) the FINRA member firm and FINRA’s Corporate Finance Department to discuss the fairness of the underwriting spread on a pending public offering.

Answer 42

the issuing corporation and the underwriters to review and reexamine the full details of the pending underwriting and negotiate final terms to be included in the formal underwriting contract;

A due diligence meeting is held between the issuer and the underwriter before the effective date and is one of the final meetings held before the sale of the security so that each party may review all aspects of the issue.

Question 43

Payments received by the owner of a 403(b) plan are:

A) not taxable.
B) taxable only to extent of the owner’s cost basis .
C) 100% taxable.
D) taxable only to extent of earnings.

Answer 43

100% taxable;

When TSA funds are withdrawn, they are fully taxed at ordinary income rates. Funds were contributed pretax and earnings accumulate tax deferred. Because no taxes were ever paid, the full withdrawal is taxable.

Question 44

Which of the following is a third-market trade?

A) 10,000 shares of LMNO, a stock listed on Nasdaq, are traded between two financial institutions via an electronic communications network (ECN).
B) 12,000 shares of PQ, a stock listed on the Philadelphia Stock Exchange are sold on the Chicago Stock Exchange floor.
C) 10,000 shares of XYZ, a stock listed on the New York Stock Exchange, are sold on the Chicago Stock Exchange floor.
D) 12,000 shares of XYZ, a stock listed on the New York Stock Exchange, are sold over the counter.

Answer 44

12,000 shares of XYZ, a stock listed on the New York Stock Exchange, are sold over the counter;

A third-market trade occurs when exchange-listed securities are traded over the counter.

Question 45

The writer of a combination expects the market to be:

A) volatile.
B) bearish.
C) bullish.
D) stable.

Answer 45

stable;

The writer, or seller, of a combination expects the market to be stable. The buyer of a combination expects the market to be volatile. Combinations and straddles are never bullish or bearish, as there are always both calls and puts involved in the strategy, which are both bullish and bearish. Remember, the definition of a combination is a put and a call on the same underlying security with the strike prices and/or the expiration months being different.

Question 46

A customer buys a municipal bond at 106 with 8 years to maturity. What is the amount of unamortized premium at the end of 4 years?

A) $36.
B) $50.
C) $40.
D) $30.

Answer 46

$30;

The original premium was $60 for 8 years, which means that after 4 years the remaining premium is half that amount.

Question 47

All of the following are purchasers of Treasury securities in the primary market EXCEPT:

A) commercial banks.
B) investment companies.
C) the Federal Reserve Board.
D) financial institutions.

Answer 47

the Federal Reserve Board;

The FRB trades in governments in the secondary market; they are not primary purchasers.