Representative Sample Draft Series 7 Cards Flashcards
Retirement plan questions on the Series 7 exam will often focus on questions of suitability, or how appropriate a given investment vehicle or strategy is for a particular customer based on a variety of factors (age, risk tolerance, liquidity needs, etc.)
What types of accounts are some of the most commonly used for retirement planning?
- Traditional and Roth IRA
- 401(k) and 403(b)
- SEP and SIMPLE IRA
- Annuities
- Defined contribution
- Defined benefit
What are the differences between qualified and nonqualified retirement plan accounts?
- Contributions to a qualified plan are deducted from pretax income, and grow tax-free until withdrawal.
- Contributions to a nonqualified plan are ineligible for such advantageous tax treatment, and must come from after-tax income.
- Employees’ nonqualified plan assets can be at risk in the event of employer bankruptcy.
- A nonqualified plan is any plan that does not meet all of the ERISA and IRS requirements of a qualified plan.
What is the purpose of an IRA, and what are the contribution limits for the most popular IRA account types?
- IRAs were established to encourage long-term saving for retirement.
- For tax year 2014, the cap on individual contributions to Traditional and Roth IRAs combined is $5,500 per year for those under age 50, and $6,500 for those 50 or over.
- For tax year 2014, the cap on SEP IRA contributions is 25% of compensation or $52,000, whichever is less.
Until what date may a prior-year contribution to an IRA be made?
April 15 of the following year. For example, for tax year 2014, individuals can make a prior-year contribution until April 15th, 2015.
What is the penalty for excessive IRA contributions?
Contributions in excess of annual IRA plan limits are penalized at 6% annually for as long as they remain in the account.
What is the main difference between a Roth IRA and a Traditional IRA?
Roth IRA contributions are made using after-tax income. The main benefit of a Roth IRA is the ability to make tax-free withdrawals once eligible retirement age has been reached. This feature becomes especially valuable over longer time horizons.
Traditional IRA contributions are made using pretax income. While its earnings grow tax free, withdrawals are taxed as regular income.
What are the key features of municipal bonds (munis)?
- Muni interest is usually exempt from federal taxes; this is an important tax advantage for investors wanting to preserve income. They are subject to state and local taxation.
- Unlike stocks, munis are required to have a legal opinion (usually issued by a law firm that specializes in munis) that confirms the issuer has the legal right to issue the security in the issuer’s jurisdiction. It also declares whether the issue is exempt from federal taxes.
- Munis usually issue serial debt (multiple maturities) and pay interest semiannually instead of quarterly.
For what types of projects do municipalities use general obligation bonds (GOs)?
Non-revenue projects such as schools, utilities, parks, etc. GOs are supported by the taxing authority of the municipality issuing them and are repaid via tax revenue.
Where are the convenants of a revenue bond listed?
The trust indenture. This will contain all the obligations of the issuer as well as outlining specific protections that protect the investor. The indenture will also specify a trustee who will ensure compliance.
What is the primary characteristic of a negotiated muni offering?
It is carried out directly with a single institution of the issuer’s choice.
Most revenue bonds use this type of offering, while most GOs use a competitive offering, wherein multiple institutions bid to underwrite the issue.
What is the importance of the dated date?
It is the date when a new bond issue begins to accrue interest.
You would like to reduce a client’s exposure to WJT stock, currently trading at $15.00. Your client is the ex-CEO of the company and currently has $50M worth of the company’s stock.
The trading desk provides you with a quote of $2.25 on a put option on the stock. The put option has a strike price of $14.00 in one year’s time, at which point a large portion of your client’s stock will vest.
At expiration, the put option on WJT stock is at-the-money. Describe the relative magnitude of delta and gamma.
Gamma value will be large and any requirements to hedge the position should be based on gamma. Delta value of an at-the-money put at expiration is exactly 0.5.
The value of gamma is largest when an option is at-the-money and near expiration. This can lead to large swings in the price of an option for which delta hedging is not well suited. Thus, it is best to manage an option position that is near expiry and at-the-money by gamma hedging the position.
You would like to reduce a client’s exposure to WJT stock, currently trading at $15.00. Your client is the ex-CEO of the company and currently has $50M in the company’s stock.
The trading desk provides you with a quote of $2.25 on a put option on the stock. The put option has a strike price of $14.00 in one year’s time, at which point a large portion of your client’s stock will vest.
Given the price of the put option quoted by the desk, and a risk-free rate of 5%, calculate the value of a call option on WJT stock.
$3.92, based on the put-call parity relationship:
Call = Stock - Strike / (1 + Risk-free rate)Time + Put
Call = $15.00 - $14.00 / (1 + 5%)1 + $2.25
Call = $15.00 - ($14.00 / 1.05) + $2.25
Call = $15.00 - $13.33 + $2.25
Call = $3.92
The following options are quoted on a derivative exchange:
Stock price: $90
Volatility: 29%
Short-term interest rates: 3%
Dividend: none
Expiration: 1 year
Prices of European-style options: $85 strike put, price: $6.65
What is the expected price of a call with an $85 strike price?
$14.16, based on the put-call parity relationship:
Call = Put + Spot - Strike × exp(-Rate × Time)
Call = $6.65 + $90 - $85 × exp(-0.03 × 1)
Call = $14.16
Not discounting the strike, the wrong value of $6.65 + $90 - $85 = $11.65 is obtained.
Discounting the spot but not the strike, the wrong value of $6.65 + $87.34 - $85 = $8.99 is obtained.
Stock price: $60
Volatility: 23%
Short-term interest rates: 2.5%
Dividend: $0.06 after 3 months
Expiration: 4 months
Ask prices of American-style call options:
$55 strike, price: $0.95
$60 strike, price: $2.90
$65 strike, price: $6.25
How would the issuer of call options hedge this position?
Buying delta shares for each option. The issuer is short (not long) call options, which is equivalent to a delta short position in the stock. In order to hedge it, the issuer will have to buy delta shares for each option, resulting in a delta neutral position.
