practice questions from kaplan Flashcards
A corporation plans to issue stock to the public at $10 per share. If the manager’s fee is $0.10 per share, the underwriting fee is $0.25 per share, the concession is $0.45 per share, and the reallowance is $0.20 per share, the spread is
.80
In a corporate offering, the spread has three components: the manager’s fee, the underwriting fee, and the concession. The math here is $0.10 plus $0.25 plus $0.45 = $0.80. The reallowance is not a separate item; rather, it is part of the $0.45 concession and represents a give-up if a member of the selling group sells to a FINRA member firm that is not a member of the selling group.
A bond with 25 years to maturity, 7% coupon, quoted on a 6.25% basis is callable in 10 years at 103, 15 years at 102, and 20 years at par. On the customer’s confirmation, the dollar price quoted must be based on
10 years to call.
This is a premium bond. With premiums, the years to call will be lower than the years to maturity. The question becomes which call date should be used. As a rule of thumb, always use the near-term (first) in-whole call date.
An investor takes a short position in one XYZ Nov 140 put @7. Disregarding any commissions, on settlement date the investor
receives $700.
When an investor takes a short position in an option, it means the investor has sold, or written the option. As a seller, the investor receives the premium on the settlement date.
Which of the following legislative acts exclusively regulates debt securities?
The Trust Indenture Act of 1939 protects investors in corporate bonds should the issuing company default. While the Securities Act of 1933 and the Securities Exchange Act of 1934 both have provisions dealing with corporate debt securities, the Trust Indenture Act of 1939 is the only act that affects them exclusively.
An order designated fill-or-kill (FOK) means that the order must be executed
FOK orders must be executed immediately in their entirety or they are canceled.
If a customer sells $5,000 worth of stock in a restricted margin account, the special memorandum account (SMA) will be
credited by $2,500.
When securities are sold in a restricted account, 50% of the proceeds are credited to SMA. In other words, the customer is permitted to remove 50% of the proceeds from the account, but the balance must remain in the account to reduce the debit balance.
The Nasdaq quotation system offers three different levels of service depending on the needs of the user. The information generally available to the retail investor is found on Level 1, and the quote represents
the inside market.
The Nasdaq Level 1 service shows the inside market. That quote is the highest bid and the lowest offer of all of the current market makers in the stock. Traders generally refer to that as the NBBO (national best bid and offer). Firm quotes are only available on Levels 2 and 3. Level 1 will display the most recent trade, but that is not a quote because it only shows one side, not a bid and ask.
A customer buys 1 LMB Aug 70 put for 4 and 1 LMB Aug 70 call for 4. The customer will break even at
$62
$66
$74
$78
78 or 62 / call up or put down
This is a straddle (a put and a call on the same stock with identical terms). There are two breakeven points solved by using the “call up” and “put down” rule. To break even, the customer must recover $800 total paid in premiums. On the long 70 call, this occurs if the market price rises to 78 (“call up” 8 points from 70). On the long 70 put, this occurs if the market price falls to 62 (“put down” 8 points from 70).
What is the following position?
Buy 1 QRS May 40 call
Sell 1 QRS May 50 call
A price spread is composed of a long and short option of the same type with the same expiration but different strike prices. A price spread is also termed a vertical spread.
A margin account customer buys 100 shares of HEX at $70 and writes a HEX Oct 70 call for a premium of 8. What must he deposit? (Regulation T is 50%.)
$2,700
The normal call would be 50% of $7,000, or $3,500. In this example, subtract the premium of $800 that the customer received. (Remember, in a covered call situation, no margin is required for the call.)
A municipality has an ad valorem tax rate of 10 mills. A piece of real property is assessed at $100,000 and has a market value of $125,000. The annual taxes paid on the property are
$1,000.
Ad valorem tax rates are based on mills with one mill being equal to $0.001 (1/10th of a cent). The amount of taxes to be paid on the property is determined by multiplying the millage rate—in this case, one cent (10 mils at $0.001 = $0.01)—times the assessed property value ($100,000). The market value is irrelevant. For those who have difficulty determining where the decimal point goes, on any question like this, drop the last three 000s from the assessed value and multiply by the millage rate. In this question, that would be $100 times 10 and that equals the correct answer of $1,000.
The writer of a combination expects the market to be
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.
On February 13, your customer buys an 8% Treasury bond maturing in 2019 for settlement on February 14. If the bonds pay interest on January 1 and July 1, how many days of accrued interest are added to the buyer’s price?
44
Accrued interest for government bonds is figured on an actual-days-elapsed basis. The number of days begins with the previous coupon date and continues up to, but not including, the settlement date. The bonds pay interest on January 1. There are 31 days of accrued interest for January. The bonds settle February 14. There are 13 days of accrued interest for February. Do not count the settlement date (31 + 13 = 44 days).
FINRA Rule 2310 defines a direct participation program as “a program which provides for flow-through tax consequences regardless of the structure of the legal entity or vehicle for distribution including, but not limited to, oil and gas programs, real estate programs, agricultural programs, cattle programs, condominium securities, Subchapter S corporate offerings and all other programs of a similar nature, regardless of the industry represented by the program, or any combination thereof.”
The rule places limits on the amount of broker-dealer sales compensation considered fair and reasonable. That limit is
10% of the gross proceeds.
FINRA limits the amount of the sales compensation to 10% of the gross proceeds of the offering. If the organization and offering expenses exceed 15% of the gross proceeds, FINRA considers that too high. The 2% is the maximum charge in a DPP rollup if the firm wishes to solicit votes from the limited partners. The 5% is the FINRA markup policy and that does not apply to DPPs.
U.S. Treasury notes are issued with maturities of
2, 3, 5, 7, and 10 years.
SEC rules require that customers be given a copy of the risk disclosure document before their first transaction in a penny stock. The member firm must receive a signed and dated acknowledgment from the customer that the document has been received. In addition to obtaining the client’s signature, the SEC requires the firm to wait at least
two business days after sending the statement before executing the first trade.
It is SEC Rule 15g-2 that requires the firm wait at least two business days after sending the risk disclosure document before executing the first penny stock trade for a new customer.
The writer of a combination expects the market to be
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.
Which of the following acts requires full and fair disclosure of all material information about nonexempt securities and debt securities offered to the public for the first time?
Securities Act of 1933
A corporation is likely to call eligible debt when interest rates are
A corporation generally calls in its debt when interest rates are declining to replace old, higher interest rate debt with new, lower interest rate issues.
The manager of a portfolio that consists predominately of large- and mid-cap stocks could hedge against a market downturn and generate additional income by
selling broad index calls.
The only way to generate income through the use of options is to sell them. If concerned that the market may fall, selling calls is the appropriate strategy.
In a discussion with one of your customers, the topic of alternative debt instruments is brought up. It seems that the customer was competing in a duplicate bridge tournament in town and one of the other competitors mentioned that they have been obtaining higher income returns from ELNs. When the customer asks you for the meaning of that abbreviation, you would reply
An ELN is an equity-linked note. That is a strange name for a debt product. The equity refers to the specific stock, a basket of stocks, or an equity index upon which the return is based. Therefore, the return is not fixed and can be higher or lower than anticipated depending on the selected equity’s performance. There are foreign exchange-linked notes where the performance is based on currency rates, but that is unlikely to ever be a topic covered on the exam. There are no such products as exchange or equity-leveraged notes.
Which of the following ratios is normally considered adequate coverage of interest and principal charges for a municipal revenue bond?
2:1
Generally, a sound debt service (interest and principal) coverage ratio for municipal revenue bonds is 2:1. In other words, $2 of revenue is collected for every $1 of debt service.
A municipal finance professional (MFP) is
an associate of a broker-dealer engaged in municipal securities representative activities other than retail sales.
An MFP is an associate of a broker-dealer engaged in municipal securities representative activities other than retail sales. Those activities can include the solicitation of municipal bond business. MFPs are subject to the MSRB reporting rules regarding gifts to elected officials and political parties (MSRB Rule G-37).
Which of the following statements regarding Treasury receipts are true?
Interest is paid annually.
Interest is paid at maturity.
Interest is taxed annually.
Interest is taxed at maturity.
II and III
Treasury receipts are zero-coupon bonds issued by broker-dealers. Zero-coupon bonds pay all of their interest at maturity. They are issued at a discount and redeemed at par, and the difference represents the interest earned. For zeroes with a maturity of more than one year, the interest (or discount) must be accreted each year—and is taxable that year as income. This is called imputed interest.
Government agency securities settle
the second business day following the trade date.
An investor opens the following positions: Sell short 100 shares of ROC @90; sell 1 ROC May 90 put @3. What is the customer’s maximum gain, maximum loss, and breakeven point?
Maximum gain is $300; maximum loss is unlimited; breakeven point is $93.
The first step is to identify the position. This is a short sale of stock and a sale of a put option. The sale of the put provides some income and offers protection only to the extent of the premium. Short sellers want the stock’s price to decline. They lose when it rises. The investor has received $9,300 ($9,000 from the sale of the stock and $300 from the sale of the option). That makes the breakeven point $93 per share. Once the price of the ROC stock goes above that, the investor loses money. Because there is no limit as to how high the stock’s price can go, the maximum loss is unlimited. If, on the other hand, the stock’s price declines into the 80s or lower, the owner of the 90 put will exercise and our investor will pay $9,000 to purchase the stock. That stock will be used to cover the short sale. That means the investor sold the stock (short) at $90 and bought it back at $90 for no gain. At that point, the investor’s only profit is the $300 from the premium on the sale of the put. Why doesn’t the breakeven follow the “put-down” rule? That rule applies when the only positions are options. Once there is a long or short stock position along with an option position, it is the stock controlling the breakeven
Which of the following statements regarding index options are true?
Exercise is settled in cash.
Exercise settlement value is based on the value of the index at the time exercise instructions are received.
Exercise settlement value is based on the closing index value on the day exercise instructions are tendered.
Exercise settlement is T+2.
I and III
All index option exercises are settled in cash. The amount a writer owes the holder is known as the intrinsic value of the option, and the settlement value is based on the closing index value on the day exercise instructions are tendered. Exercise settlement is the next business day.
An investment company registered under the Investment Company Act of 1940, whose specific purpose is to aid in the promotion and development of small businesses, is
Business development companies (BDCs) were created in 1980 by an act of Congress. Their purpose is aiding small businesses. As you can tell, they are appropriately named. Although private equity funds and venture capital funds may do that, neither of them are registered investment companies under the Investment Company Act of 1940.
A customer opens the following positions: Buy 100 shares of CDL @$40; sell 1 CDL Apr 40 call @2. What is the customer’s maximum gain, maximum loss, and breakeven point?
Maximum gain is $200; maximum loss is $3,800, breakeven point is $38.
The first step is to identify the position. This long stock with a short call (i.e., a covered call position). Breakeven is the customer’s net cost. The price of the stock ($40) minus the premium ($2) received equals the $38 per share breakeven point.
The strategy is to generate some income with a little protection against a decline in the price of the CDL stock. The premium income is the most this client can make. If the stock should rise well above the cost of $40 per share, the short call will be exercised and the customer will deliver the stock purchased at $40 and receive $40. Regardless of how high the stock price rises, this customer can never make more than the $2 premium. If the stock’s price should decline, the call will expire unexercised. That 2-point premium protects the long stock, but only for those 2 points. Once the market price falls below $38 (the breakeven point), it is all a loss for the customer, down to a maximum $3,800 if the price drops to zero. Why doesn’t the breakeven follow the “call-up” rule? That rule applies when the only positions are options. Once there is a long or short stock position along with an option position, it is the stock controlling the breakeven.
The public offering price for a mutual fund, as quoted in the financial press, reflects
The public offering price for a quoted mutual fund includes the maximum sales charge the fund distributor can assess.
A client of yours wishes to sell 400 shares of LMNO common stock. You contact your trading desk and receive the following quote: “We are currently quoting LMNO at 42-42.15, 6 by 4.” You report this to the client who says, “Do it.” The customer will receive
16,800
The statement from the trading desk indicates a firm quote. When the client is selling, the price received is the dealer’s bid price. This quote indicates that the firm is willing to buy up to 600 shares at the bid price. Multiply 400 shares times the bid of $42 per share to arrive at $16,800. If the client was a buyer, the cost would be the ask price of $42.15 ($16,860). The other two choices are for students who didn’t notice the client had 400 shares.
A planned amortization class (PAC) collateralized mortgage obligation (CMO) offers
protection from both prepayment and extension risk.
A PAC offers protection from both prepayment and extension risk. This protection is greater than that offered by a targeted amortization class CMO, which protects against prepayment risk only.
A customer buys a municipal bond in the secondary market at 96 that has four years to maturity. Two years later, the customer sells the bond at 99. The tax consequences of this investment are
two points of ordinary income and one point of capital gain.
When a municipal bond is purchased in the secondary market at a discount, the annual accretion is taxed as ordinary income. The annual accretion is one point per year (four points divided by four years to maturity). Therefore, when the bond is sold two years later, its cost basis is 98. If the bond is sold at 99, there is a long-term capital gain of one point per bond. Also, there is ordinary income taxation on the accretion of two points.
A mutual fund has a net asset value (NAV) of $7.80 per share, and the fund pays its underwriter a concession of $0.12 per share. If the fund has a sales load of $0.50 per share and an administrative fee of $0.15 per share, how much does the investor pay per share to purchase a Class A share of this fund?
$8.30
The investor pays the public offering price (POP) when purchasing mutual fund shares. For a Class A share upon purchase, the POP is the NAV plus the sales charge. In this case, the NAV is $7.80 and we are told the sales load is $0.50. Adding the two numbers together equals the public offering price of $8.30. The underwriter’s concession of $0.12 is part of the $0.50 as is the $0.15 administrative fee.
A customer buys a newly issued municipal zero-coupon original issue discount bond for 85. If the bond is held until maturity, the tax consequence
0
Municipal original issue discount bonds must be accreted. At maturity, the entire discount will be accreted, and the cost basis will be equal to the par value. No gain or loss will occur at maturity.
If a customer wants to place an order for a specific municipal bond and provides the bond’s issuer, coupon, maturity date, and CUSIP number, but she has not disclosed her financial objectives or tax status, the representative must
When a customer wants to buy a specific municipal bond and possesses all of the bond’s material information, Municipal Securities Rulemaking Board Rule G-19 allows the representative to execute the order and mark it unsolicited. The representative may not recommend any municipal bond without first knowing the customer’s financial objectives and tax status
A broker-dealer can rehypothecate (repledge) up to
140% of the debit balance in a customer’s margin account.
In a margin account, hypothecation is the pledging of customer securities as collateral for the margin loan the customer will receive. The broker-dealer repledges (rehypothecates) the securities as collateral to the lending bank. Broker-dealers are permitted to pledge up to 140% of the debit balance in the customer’s account.
When a corporation issues a debt security, the terms of the loan are expressed in a document known as the bond’s indenture. The indenture is sometimes referred to as
The indenture, sometimes also referred to as the deed of trust, states the issuer’s obligation to pay back a specific amount of money on a specific date. A debenture is a debt security containing an indenture. The bond resolution is a term used for municipal bonds not corporate debt.
Which of the following is the computation for the coverage ratio for a municipal revenue bond issue?
Net revenue divided by annual interest and principal expense
On Monday, John bought and sold 1,000 shares each of MEDX and CETN stock. On Wednesday, he purchased an additional 500 shares of CETN and 1,600 shares of KRS, which he closed in two trades of 800 shares each, later that day. On Friday, John executed a trade to purchase 2,000 shares of BUV and sell 300 shares of the CETN he purchased on Wednesday. Under FINRA rules, John meets the definition of
a pattern day trader.
A day trader buys and sells the same security on the same day. Pattern day trading is a regulatory designation for a day trader who executes four or more day trades in a five-business-day period. And, yes, the exam can be this specific.
Which of the following is a short-term money market instrument with a bank guarantee that is used to provide capital for exporters to foreign countries?
Bankers’ acceptance
One member of a municipal syndicate is opposed to bidding on a particular issue because of some of the restrictions outlined in the official notice of sale. The other eight members of the syndicate have agreed on a price and vote to submit their bid. In this situation, the syndicate manager can do all of the following except
require the dissenting member to accept its prorated share of the offering.
Closed-end investment company shares can be purchased and sold
in the secondary market.
In its notice of sale in The Bond Buyer, an issuer states that it will take into consideration the timing of interest payments when evaluating bids. The issuer will be using which of the following methods in its bid selection?
The true interest cost (TIC) method takes into consideration the time value of money. The issuer discounts future interest payments to arrive at a present value.
A customer asks his registered representative to purchase $10,000 worth of shares in any pharmaceutical company that looks promising. Which type of account allows the registered representative to act in accordance with this instruction?
Discretionary
If the registered representative may decide the specific security, the transaction requires discretionary authority, and therefore, must be done in a discretionary account. Determining the time or price does not require discretionary authority.
A foreign currency investor is long 40,000 Swiss francs at $0.81. If the investor buys 4 Jul 80 SF puts at 1.25 to hedge, the breakeven point is
0.8225
When hedging with puts, the breakeven point is the cost of the underlying investment plus premium paid ($0.81 plus $0.0125 equals $0.8225, or 82.25 cents).
A $50,000 20-year 7% municipal bond with semi-annual M/S coupon payments is issued on March 1, 2020. The full price for a trade of this bond, with a 7% yield to maturity to settle on June 30, 2020, is
$51,156.94.
The full price of a bond includes the accrued interest. First, we calculate the number of days of accrued interest. Because this is a municipal bond, each month has 30 days. Accrued interest is always paid up to, but not including, the settlement date. That means 30 days each for March, April, and May (90 days). Because we do not pay accrued interest for June 30, (on settlement date, the new owner is entitled to the entire six months of interest), there are 29 more days, giving us a total of 119 days. You can set it up like this: 6/30 minus 3/01 = 3 months, 29 days = 119 days.
The next step is computing the amount of accrued interest in dollars and cents. With a coupon of 7% and semi-annual payments, each payment is 3.5% of the $50,000 par value. That is $1,750 each six months. We are going to solve for 119/180 days’ worth of accrued interest. With the test center calculator, multiply $1,750 times 119 and divide the product by 180. The result is accrued interest of $1,156.94. Alternatively, you could find the interest for each day by dividing the semiannual interest of $1,750 by 180 days = $9.72222 per day. Multiply that times 119 days and the product is $1,156.94.
Finally, when a bond with a 7% coupon has a yield to maturity of 7%, that tells us the bond is selling at par. All we need to do now is add the accrued interest to the $50,000 par value to arrive at $51,156.94.
A municipal revenue bond indenture contains a net revenue pledge. The following are reported for the year: $30 million of gross revenues, $18 million of operating expenses, $4 million of interest expenses, and $2 million of principal repayment. What is the debt service coverage ratio?
2:1
Under a net revenue pledge, bondholders are paid from net revenue, which equals gross revenue minus operating and maintenance expenses. In this example, net revenue is $12 million ($30 million − $18 million). Debt service is the combination of interest and principal repayment. Here, debt service is $6 million ($4 million + $2 million). To compute the debt service ratio, divide net revenue by debt service: $12 million divided by $6 million equals a ratio of 2:1.
A variable-rate municipal bond investment’s main advantage is that
its price should remain relatively stable.
A variable-rate bond has no fixed coupon rate. The coupon is tied to a market rate (e.g., T-bond yields) and subject to change at regular intervals. Because the interest paid reflects changes in overall interest rates, the bond price remains relatively close to its par value. Its coupon is always representative of the current market rate. As rates rise, the coupon is adjusted upward. As rates fall, the coupon is adjusted downward.
When an underwriting syndicate commits to distribute an entire offering, it may enlist other FINRA member firms to help in the offering. These member firms are known as
selling group members.
Your firm has just assigned you a new client. Wanting to do the best job you can, you review the current investment holdings of the client. Included are the following mutual fund accounts:
$50,000 in Class B shares of the STU Growth Fund
$25,000 in Class A shares of the STU International fund
$15,000 in Class A shares of the TUV Utility Fund
STU and TUV offer rights of accumulation and breakpoints at $25,000, $50,000, and $100,000. If the client wishes to invest $20,000 into the Class A shares of the STU Technology Fund, the sales charge would be based on
the $25,000 breakpoint.
There are several important points in this question. Rights of accumulation provide that a new purchase is added to the value of existing accounts to determine the breakpoint reached. However, only Class A shares count because the Class B shares never paid a front-end load. Of course, only shares in the same fund family are used – we cannot combine STU shares with TUV shares. As far as the math, we have $25,000 in one STU fund and are adding another $20,000. That brings the investor’s account in STU funds to $45,000, which is enough to meet the $25,000 breakpoint, but not the breakpoint at $50,000. Finally, the sales charge is computed as a percentage of the public offering price (POP), not the NAV.
Pursuant to Regulation T, cash dividends received in a customer’s margin account
can be withdrawn anytime within the first 30 days of receipt.
If a customer wishes to withdraw cash dividends, the customer must do so within 30 days of receipt. Otherwise, they become a permanent reduction of the debit balance. The customer does not lose the dividend; rather, the dividend amount is now reflected as increased equity in the account. As the debit balance falls, equity in the account goes up dollar for dollar.
An investor purchased a new issue corporate zero-coupon bond for $600. The bond has a maturity of 20 years. Six years later, the investor sells the bond for $740. For tax purposes, this would result in
a capital gain of $20.
The $400 discount is accreted over the 20 years to maturity. That is an annual accretion of $20. After 6 years, that is $120, making the tax basis of the bond $720. Because the sale at $740 is $20 more than the basis, the investor has a long-term capital gain.
Which of the following positions meets the IRS definition of a married put?
Buy 100 shares of ABC at $50 per share and simultaneously buy one ABC 50 put
A married put is a specific type of protective put. Anytime a put option is purchased while the investor is long the underlying stock, it is considered a protective put because it is a hedge against a move to the downside. When the put and stock are bought at the same time, the strategy is known as a married put and has a special tax benefit. Normally, purchasing a put option on stock held less than the long-term holding period causes the existing holding period on the stock to be erased. In the case of the married put, the holding period of the stock is not affected.
ADJ Corporation’s charter has authorized 10,000,000 shares of common stock. It has issued 5,000,000 shares and has 1,000,000 shares in its treasury. How many shares of common stock are currently outstanding?
4,000,000 shares
Shares outstanding are those that are in the hands of the public. To determine the number of outstanding shares, take the number issued minus the number in the treasury. In this question, that is 5 million minus 1 million = 4 million. If, at a later time, ADJ should decide to issue some of the authorized, but unissued shares, the number of outstanding shares will obviously increase. The same would happen if the company sold some of the treasury stock in the open market or used it to pay stock dividends to current shareholders.
If a customer buys 1 FLB Oct 50 call at 3 and she exercises the option to buy 100 shares when the market is at 60, what is the cost basis of the 100 shares?
$5,300
The cost basis of the 100 shares is the total amount the investor spent to acquire them. She paid $300 to purchase the call option. When she exercised the call, she purchased 100 shares of FLB at $50 per share for $5,000, so the cost basis is $5,300.
A U.S. company that sells stereo equipment places an order for Japanese stereo components for its inventory. Payment must be made in Japanese yen in three months. The U.S. company thinks that the U.S. dollar may weaken against the yen. Which of the following foreign currency option transactions would best protect the U.S. company from a weakening of the U.S. dollar against the yen?
Buy calls on Japanese yen
The U.S. company is concerned that the value of the Japanese yen will rise. Therefore, the company should buy calls on the yen to lock in the lowest possible price to buy yen for payment of the contract. Importers buy calls to hedge.
Which of the following statements are true?
Build America Bonds (BABs) are tax exempt at all levels.
Direct-payment BABs provide the municipal issuer with payments from the U.S. Treasury.
BABs are issued by the U.S. Treasury.
Tax credit or issuer BABs provide the municipal bondholder with a federal income tax credit.
II and IV
Created under the Economic Recovery and Reinvestment Act of 2009 to assist in reducing costs to issuing municipalities and to stimulate the economy, BABs are taxable municipal securities. There are two types: direct payment BABs that provide the municipal issuer with payments from the U.S. Treasury and tax credit or issuer BABs that provide the bondholder with a federal income tax credit.
To be defined as a pattern day trader, the customer must execute at least
four day trades in five business days.
Securities transactions take place in the primary and secondary markets. Which of the following investment companies can trade in both?
All of these can have primary market transactions. In the case of the closed-end investment company (CEF), it is the initial public offering and, if desired, an additional public offering. The CEF is the only one of these choices where shares trade in the secondary markets. Investors holding shares of a CEF can trade the shares freely, just like any other stock. However, owners of the other types of investment companies will find there is no market for their shares if they wish to sell. That is not a problem, though, because these investment companies stand ready to redeem shares continuously. Technically, when the UIT buys back its shares, it is considered a secondary market transaction. However, for exam purposes, because the trust is the only buyer in the marketplace and the price is not subject to negotiation, it is not a true secondary market transaction.
Stabilizing bids may be entered at
a price no higher than the public offering price.
Stabilizing bids cannot be used to raise the market price of an issue. Stabilization may only be used to support a new issue security at or below the public offering price
The holder of a foreign currency call option has the right to
buy the specified foreign currency for a fixed U.S. dollar amount.
The holder of a call option has the right to buy the underlying asset. The asset in the case of foreign currency options is the specified foreign currency. Therefore, a foreign currency call option gives the holder the right to buy the specified foreign currency at the strike price. That strike price is expressed in U.S. dollars. For example, one BP 1.30 call option gives the holder the right to buy 10,000 British pounds at a price of $1.30 per pound, or $13,000.
A customer who owns a portfolio of blue-chip stocks believes the securities will provide long-term appreciation but fears that the market will decline over the short term. Which options strategy would likely offer some protection against the expected decline while allowing the customer to generate additional income?
Sell covered calls
Selling calls will generate income and protect the downside to the extent of the premiums received.
The official statement for a new revenue bond indicates that the flow of funds is based on a net revenue pledge. This means the first payments go to
pay current operating and maintenance expenses.
When the flow of funds is described as a net revenue pledge, it means the operating and maintenance expenses are paid first. Following that is the debt service (interest and this year’s principal). In a gross revenue pledge, the order is reversed.
What is the profit to a syndicate member if a syndicate is offering an 8.5% bond at 100, the syndicate manager is giving a 0.75 concession and a 1-point total takedown, and the syndicate member sells 1,000 bonds?
$10,000
When a member of the syndicate sells a bond, the member is entitled to the total takedown. In this case, one point ($10) per bond (1,000 bonds sold × $10 per bond = $10,000 profit). Remember that the concession would only go to those who are not members of the syndicate but are part of the selling group instead.
Flow-through of income and loss is a feature of
direct participation programs (DPPs).
If a member firm suspects exploitation in the account of a specified adult, proceeds from sales may be put on temporary hold
for a maximum of 55 business days.
One of your new customers indicates that he does not want the securities transferred into the name of the brokerage firm nor does he want the securities held in his name at the firm. At the same time, he wants to be able to make trades easily without delivery issues. What would you recommend?
DRS stands for the Direct Registration System. DRS provides a book-entry service. The issuer keeps the records of ownership with no certificates issued. When there is a sale of securities in the account, the customer tells the DRS to deliver to the broker-dealer and there are no hassles with signature guarantees or mutilated certificates. Transfer and ship creates potential delivery issues because the customer will have to be sure to have everything in good deliverable form to the broker-dealer by T+2. DVP and RVP are for institutions and street name means in the name of the brokerage firm, something the customer specifically does not want. **This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback.
Which of the following describes the position in a call option on a Swiss franc with a strike price of 120, a premium of 7, and a current market of 126?
In the money
In this case, the strike price is less than the market price, so a call option would be in the money by the difference between the strike price and the market price (six points, in this case). At the money means the strike price and the market price are the same. At parity means the premium equals the intrinsic value.
An investor purchases $10,000 worth of Treasury bills on November 27 and holds them until they mature on March 30 of the following year. For purposes of taxation, the interest from those Treasury bills is treated as
ordinary income subject to federal income tax.
Interest on Treasury bills, notes, and bonds is taxable as ordinary income at the federal level. It is exempt from state and local taxation.
A major risk associated with investing in DPPs is the lack of liquidity. What steps could the program sponsor take that could have the effect of increasing the liquidity of an existing program?
A DPP rollup
A DPP rollup is a transaction involving the combination or reorganization of one or more limited partnerships into securities of a successor corporation. The securities of the successor corporation would likely have greater liquidity. This would have the effect of turning the illiquid DPP into more liquid securities. Disclosure documents must be provided to investors prior to the transaction disclosing risk, the GPs opinion regarding fairness of transaction, and reports and appraisals in connection with the transaction.
In a new municipal offering, who is responsible for hiring bond counsel?
The issuer
The issuer hires a bond attorney to render an opinion on the prospective municipal offering.
The market price of fixed-income securities, especially bonds, is highly sensitive to changes in market interest rates. Based on that knowledge, which of the following bonds will have the greatest price change when market interest rates increase?
20-year maturity, 4% coupon
The longer the duration, the greater the decrease in price when interest rates go up. The bond with the longest duration will have the longest term to maturity and lowest coupon. Without getting into complicated math, assume that interest rates rose to 8%. Those investors holding a bond with a 4% coupon are going to be earning half of the going rate while those with the 6% coupon are earning 75% of the going rate of 8%. Presented with that information, you can ask what would be worth more to an investor: the 4% bond or the 6% bond? I think most would rather earn 6% and would pay a higher price for that bond. The next step is thinking about how long the investor will be stuck with that lower-than-market rate. Would you rather receive half the going rate for 10 years or for 20 years? Clearly, the sooner you can get your principal back and reinvest at the higher rates, the more attractive the bond. That makes the 4% bond with a 20-year maturity the least attractive investment, and its price will decline more than the others. That relates to our first two statements: the longer the duration, the more the price decline, and the longest term to maturity with the lowest coupon rate will have the longest duration.
The portion of a municipal bond underwriting spread that remains after the syndicate manager subtracts the management fee is
the total takedown.
The total takedown is that portion of the municipal underwriting spread that remains after the underwriting manager takes the management fee. The total takedown consists of the additional takedown and the concession.
Three family members each hold sizable call option positions with the same underlying equity security in their individual accounts. Over the course of three days (Monday through Wednesday), each of the customers calls your broker-dealer and gives instructions to exercise all of their call options in that security. You recognize this as a potential violation of
Options Clearing Corporation (OCC) exercise limit rules.
OCC exercise rules limit the maximum number of contracts in the same underlying security that can be exercised within a five-business-day period. Three customers—all related and all giving instructions to exercise their long calls in the same underlying security within three business days—should, at a minimum, raise the question of whether or not they are acting in concert to circumvent the OCC exercise limit rules.
One of your existing cash account customers opens a new margin account. The initial activity in the account is the purchase of $12,000 CMV of ABC and the short sale of $10,000 CMV of XYZ. With Regulation T at 50%, what is the amount of the initial margin call?
$11,000
A margin account containing long and short positions is known as a combination or mixed margin account. In a mixed-margin account, it is generally easiest to figure the transactions separately. Whether a long purchase or a short sale, the initial margin requirements are the same: 50% of the transaction. The investor needs $6,000 ($12,000 times 50%) for the purchase and $5,000 ($10,000 times 50%) for the short sale.
PDQ Corporation has a 6.25% $100 par value convertible preferred stock (conversion ratio of 4) outstanding. The stock has an antidilution covenant. If PDQ declares a 10% stock dividend, the antidilution covenant will adjust
the conversion price to approximately $22.73.
When a $100 par value preferred stock is convertible into four shares of common stock, the conversion price is $25 per share, ($100 ÷ 4 = $25). The antidilution covenant means the investors will have the same conversion rights after a stock split or stock dividend as they had before. After a 10% stock dividend, each share of preferred stock will be convertible into 4.4 shares (4 shares x 110% = 4.4). The par value of the preferred stock does not change. Divide that $100 par value by the new number of shares to get the new conversion price. It looks like this: $100 ÷ 4.4 = 22.73. Alternatively, you can divide the original conversion price of $25 by 110% arrive at the same answer.
An investor purchased 100 shares of RIK common stock at $150 per share on June 17, 2019. On July 11, 2020, with the RIK selling at $180, the investor hedges by purchasing one RIK Oct 165 put at 2.50. Immediately prior to the expiration date, RIK is selling for $145 per share and the put option is exercised using the long stock for delivery. This would result in
a long-term capital gain of $1,250.
The investor purchased a protective put against a long position that had a long-term holding period (almost 13 months). That means that the holding period of the stock is not affected by the purchase of the put. Therefore, this investor’s gain will be long term. The gain is the difference between the cost and the proceeds. When exercising a put, the cost of the stock is the investor’s cost basis. The exercise price minus the option premium paid is the sale price. In our question, the cost is the $150 initial purchase price ($15,000 total). The sale price is the 165 strike minus the $2.50 premium, or $162.50 per share ($16,250). That results in a long-term capital gain of $1,250.
Which of the following is defined as profits after taxes and interest paid, less preferred dividends, divided by the number of shares of outstanding common stock?
Earnings per share (EPS)
Dividing net income after taxes, interest, and payment of preferred dividends by the number of common shares outstanding determines EPS.
A dealer that quotes a concession of half to another dealer means
$5 per $1,000 of par.
A concession between broker-dealers on secondary market transactions is a discount from the yield that the broker-dealer is quoting. It is common for a broker-dealer to offer bonds to other broker-dealers at a price, less the concession. The net price becomes the purchase price for the buying broker-dealer. If simultaneously sold to a retail account, the markup is from the net price paid. If not simultaneously retailed but held in the broker-dealer’s inventory, it is fair for the broker-dealer to market her inventory and mark up from there for retail sale.
A convertible preferred stock issue (par value $100) is selling at $125 and is convertible into five shares of common stock. The conversion price of the common stock is
$20.
Par value divided by conversion price equals the number of shares into which the security is convertible. If this security is convertible into five shares, we need to know what number goes into $100 five times. That number is $20. The current market value of the preferred stock is unnecessary information.
An investor is following the new issue municipal bond market. The primary source material is found in the Daily Bond Buyer. This publication is distributed on
a daily basis.
The FINRA 5% policy deals with markups, markdowns, and commissions. When acting as a dealer, what prices are used to compute the member firm’s markup or markdown?
The highest bid and lowest ask for all market makers
The basis of the fairness of markups and markdowns under the 5% markup policy is the highest bid and the lowest ask shown for all market makers making a market for that security. This is the inside quote or inside market price because it shows the narrowest spread. Comparing the inside market to the price charged (or paid) to the retail customer determines the actual percentage. Depending on the circumstances, it may be 5%, more than 5%, or less than 5%.
A broker’s broker does all of the following except
makes a market in securities.
A broker’s broker acts as the agent in transactions by facilitating the movement of blocks of bonds. The broker’s broker is allowed to conceal the identities of the contra-parties, thus protecting investment strategies. A broker’s broker does not make a market in securities.
Dale Wells, a British citizen temporarily working in the United States, wants to form a business venture with other investors. Wells is looking for favorable tax treatment of earnings and losses. Wells also wants to limit the number of investors but is willing to share control of the enterprise with others to attract them. What business form would you advise?
General partnership
Limited partnerships would not work because the other investors have limited say in how the enterprise is run. C corporations do not provide favorable tax treatment of gains or losses. Although an S corporation appears to be the right answer, only U.S. citizens or resident aliens can own one.
There are a number of different types of orders that a registered representative can enter for a client. Of the following, which one would be most appropriate for a client wishing to protect a profit on a long stock position?
A sell stop order
Protecting a profit on a long position means getting out of the stock before its price declines below the original purchase price. That means selling the stock. The investor would enter the sell stop order with a stop price below the current market, but above the original cost. A sell limit order is placed above the market and that is of no help if the price drops. A market order is executed at once and buying the stock is not appropriate when the investor already owns it.
A company has filed for an IPO at $20 par value. The IPO is priced at $30 per share. Where on the balance sheet is the extra $10 recorded?
Capital surplus
When new stock is issued, any funds paid for the stock in excess of the par or stated value is called capital surplus. In this case, it is the $10 above the $20 par. It might also appear on your exam as paid-in surplus.
A company’s dividend on its common stock is
determined by its board of directors.
A customer’s restricted margin account shows the following:
LMV $30,000
DB $16,000
SMA $0
If the customer sells $2,000 of securities, how much could be withdrawn from the account?
$1,000
In this restricted account, half of the sales proceeds will be used to reduce the DB balance to $15,000 and half of the sales proceeds are released to the special memorandum account (SMA). Therefore, when $2,000 of stock is sold, $1,000 is credited to SMA. This is the amount that can be withdrawn from the account.
A customer holds 10 TRG May 60 calls. The stock splits 3:2. What is the number of contracts, adjusted strike price, and the adjusted number of shares per contract?
10 contracts @$40 for 150 shares
The number of contracts is not adjusted—there are still 10. However, with a 3:2 split, the number of shares per contract increases to 150. Because the aggregate exercise price must remain the same as before the split ($6,000 per contract), the price per share is reduced to 2/3rds of the original, or $40 per share. We check that by multiplying the new contract size (150) by the new contract price ($40) and the result is the original $6,000 per contract.
An investor who is bearish on the outlook for Fernweh Travel Services (FTS) sells 400 shares short at $52 per share. Three months later, the market price of FTS shares is $58. Under FINRA rules, a maintenance call will be issued when the price of FTS shares
rises above $60.
The calculation to find the short margin account maintenance level is credit balance ÷ 130% (or 1.3). The price per share level will be the same whether it is 100 shares or 400 shares so we’ll use 100 shares in our calculation. Keeping the math simple, the credit balance in a short account is the sale proceeds ($5,200 in our question) plus the 50% Regulation T requirement ($2,600) for a total of $7,800. Divide that credit balance by 1.3 and the quotient is $6,000 (or $60 per share). In a short margin account, things start turning bad as the price of the stock rises. This account will receive a maintenance call if the market price of FTS increases by more than $2 per share from its current trading level of $58.
For those who find it easier to view the calculation using the full 400 shares, the math goes like this:
The credit balance is the sales proceeds of $20,800 (400 shares times $52 per share) plus the 50% Regulation T requirements ($10,400) for a total of $31,200. Divide that credit balance by 1.3 and the quotient is $24,000. Because the question asks for the per-share price at which a maintenance call is issued, divide the $24,000 by 400 shares and the result is the same $60 per share we arrived at using 100 shares. Use whichever is easier for you to follow; the correct answer will always be the same.
Which of the following items appears on the confirmation statement for a when-issued trade of municipal bonds?
Principal or agency trade
The capacity of the firm, principal or agent, must be disclosed on all confirms. The settlement date, accrued interest, and total price would not appear on a when-issued confirm.
A technical analyst would be most interested in
support levels.
Technical analysts care about price and volume trends in the marketplace, such as support levels. A corporation’s earnings, P/E ratio, and current ratio would be of most interest to a fundamental analyst who reviews a company’s financial statements in more detail.
LO 13.e
Pass-through securities are issued by all of these except
The Farm Credit System (FCS) is a national network of lending institutions that provides agricultural financing and credit. The federal FCS issues discount notes, floating rate bonds, and fixed-rate bonds. The maturities range from one day to 30 years. Unlike the mortgage agencies, these are not pass-through investments.
When the broker-dealer is acting in a principal capacity, which of the following does the Municipal Securities Rulemaking Board (MSRB) require on customer confirmations?
Amount of markdown or markup
MSRB rules require that customer confirmations provide the name, address, and telephone number of the broker-dealer and the capacity of the firm in the trade (agent or principal). The amount of commission is required if the firm acted as agent, and the markup or markdown if the firm acted as principal.
A municipal bond is purchased in the secondary market at 102½. The bond has five years to maturity. Two years later, the bond is sold for 102. The tax consequence to the investor is
a capital gain of $5 per bond.
Municipal bonds bought at a premium, either in the new issue or secondary market, must be amortized. The amount of the premium is 2½ points, or $25. As the bond has five years to maturity, the annual amortization amount is $5 per bond. After two years, the bond’s basis has been amortized down to 101½. At that point, a sale at 102 generates a capital gain of $5 per bond.
