SIE Part 1: Understanding Products and Their Risks Flashcards
For preferred shares, the annual dividend payment is
A)
fixed and stated as a percentage of its current market value (CMV).
B)
subject to variation and stated as a percentage of its par value.
C)
fixed and stated as a percentage of its par value.
D)
subject to variation and stated as a percentage of its current market value (CMV).
fixed and stated as a percentage of its par value.
A preferred stock’s annual dividend payment is its fixed rate of return, unlike that of common shares where the dividend is subject to variation.
When investing in overseas markets in foreign securities, investors should be aware of and understand
A) business risk. B) market risk. C) currency risk. D) reinvestment risk.
currency risk.
Whenever investing in securities issued in non-U.S. markets, investors need to be sensitive to the different risks that might apply to foreign investments. Of those listed here, currency risk should be of concern. Currency risk is the possibility that an investment denominated in a foreign currency could decline for U.S. investors if the value of that currency declines in its exchange rate with the U.S. dollar.
LO 6.d
Which of the following sell transactions is not subject to the holding period restriction specified in SEC Rule 144?
A)
Unregistered stock acquired by a corporate affiliate in a stock option program
B)
Stock acquired in the OTC market by a corporate affiliate
C)
Stock acquired by a corporate affiliate in a private placement
D)
Unregistered stock acquired by a nonaffiliate under an investment letter
Stock acquired in the OTC market by a corporate affiliate
The holding period rule applies only to unregistered stock, which may or may not be control stock. Unregistered stock results from either private placements or the exercise of a corporate stock option. Because this question asked which securities were not subject to the Rule 144 holding period, only stock acquired in the OTC market by a corporate affiliate is the correct answer. However, the affiliated person is subject to volume restrictions.
LO 1.g
A bond having an 8% coupon is selling with an 8.25% yield to maturity. Which of the following statements are true?
- Nominal yield is higher than yield to maturity (YTM).
- Current yield is higher than nominal yield.
- Nominal yield is lower than yield to maturity (YTM).
- Current yield is lower than nominal yield.
A) II and III B) I and III C) II and IV D) I and IV
2 & 3
The bond is offered with a YTM of 8.25%. Because the YTM is higher than the 8% coupon, the bond is trading at discount to par. For discount bonds, the nominal yield is lower than both the current yield and the YTM.
LO 2.b
All of the following are types of maturities for debt instruments except
A) balloon. B) serial. C) series. D) term.
Series
The three types of maturities for debt instruments are term, serial, and balloon.
LO 2.a
T-bonds and T-notes
A) have interest paid on an annual basis. B) are both priced as a percentage of par. C) are both priced at a discount to par. D) have interest that accrues until paid at maturity.
Are both priced as a percentage of par
Both Treasury notes and bonds are priced as a percentage of par. Interest on these is paid semiannually. Comparatively, T-bills are priced at a discount to par with the interest not paid until maturity (the difference between the discount paid and par value received).
LO 2.j
A change to tax rates on dividends would be an example of
A) purchasing power risk. B) liquidity risk. C) legislative risk. D) currency risk
Legislative Risk
When legislation is passed that affects the income received on an investment, the investor is exposed to legislative risk. Only a legislature can change tax rates.
LO 6.d
All of the following are examples of legislative risk except
A)
a luxury tax imposed on high-priced amenities such as automobiles or yachts.
B)
a law that would either allow or eliminate a tax deduction.
C)
an environmental regulation enacted to require certain precautions be taken.
D)
changes made to the tax code regarding income tax.
an environmental regulation enacted to require certain precautions be taken.
Legislative risk results from a change in the law. Changes to the tax code are the most common legislative risks. Regulatory risk comes from a change to regulations that might impact certain individuals or businesses. The imposition of environmental regulations is one such example.
LO 6.d
When selling a bond, the issuer is taking
A) a loaners position. B) a borrower's position. C) an equity position. D) a creditors position.
a borrower’s position.
Issuers of bonds are borrowing money from the purchaser of the bond.
LO 2.a
When speaking to a customer about exchange-traded funds (ETFs), a registered representative could make which of the following correct statements?
A)
ETFs have different potential tax consequences than mutual funds.
B)
ETFs can be purchased only by paying a sales charge added to the NAV.
C)
ETFs cannot be purchased using traditional limit or stop orders.
D)
ETFs cannot be bought on margin.
ETFs have different potential tax consequences than mutual funds.
The potential tax consequences of owning an ETF can be different than those experienced when owning mutual funds. While an ETF can make a capital gains distribution, they generally do not—unlike a mutual fund, which generally would make such distributions on an annual basis. ETFs can be traded like other exchange products using traditional stock-trading techniques and order types and are priced by supply and demand. Customers pay commissions, not sales charges.
LO 5.k
All investors and investments are different. Recognizing this, it is true that
A)
all investments can be deemed suitable for every investor.
B)
most investments are not deemed suitable for any investor.
C)
no investment should be deemed suitable for every investor.
D)
some investments can be suitable for all investors.
no investment should be deemed suitable for every investor.
Because all investments are different, carrying different levels of risk and reward, no investment can ever be assumed as being suitable for all investors. Each investment type and/or strategy will be suitable for some investors but not all.
LO 6.a
Municipal bonds are issued by all of the following government entities except
A) agencies. B) territories. C) states. D) districts.
agencies.
Municipal bonds can be issued by any government entity except the federal government.
LO 2.h
What is the tax status of a dividend paid to a U.S.-based American depositary receipts (ADR) investor?
A) These dividends may be taxed by both the foreign country and the United States. B) These dividends are tax free. C) These dividends are tax deferred. D) These dividends are only taxable to foreign buyers.
These dividends may be taxed by both the foreign country and the United States.
Dividends paid to a U.S. investor may be subject to a withholding tax by the home country of the underlying foreign stock issuer. In many cases, the amount of tax withheld by the foreign government is applied as a credit against the investor’s U.S. tax liability. Note: Any trading profits (capital gains) from the ADR would only be taxable here in the United States.
LO 1.h
A corporation has issued debt securities backed by the shares of another corporation that it owns. These debt securities are known as
A) mortgage bonds. B) collateral trust bonds. C) equipment trust certificates. D) debentures.
collateral trust bonds.
A corporation can deposit securities it owns into a trust to be used as collateral to back its debt issues. When this is done, the securities issued are known as collateral trust bonds.
LO 2.f
An investor purchases 1 KLP October 95 put at 6.50. What is the investor’s maximum potential gain with this position?
A) $9,500 B) $9,650 C) $8,850 D) $10,150
C)
$8,850
The maximum gain on a long put is calculated by subtracting the premium from the strike price (95 − 6.50 = 88.50 per share). Because one contract represents 100 shares, the owner’s maximum gain is $8,850 and would occur if the stock falls to zero. Remember, put buyers are bearish; therefore, they will make money if the stock falls below the breakeven point—in this case, below 88.50.
LO 3.g
The coupon rate on a debt security represents
A)
the principal amount due to the investor at maturity.
B)
the interest rate the investor has agreed to pay the issuer.
C)
the principal amount loaned to the issuer.
D)
the interest rate the issuer has agreed to pay the investor.
the interest rate the issuer has agreed to pay the investor.
The coupon rate on a debt security represents the interest rate the issuer has agreed to pay the investor for use of the funds loaned to the issuer.
LO 2.a
For Treasury bills, which of the following are true?
- T-bills are issued at a discount to par.
- T-bills have maturities of 1–10 years
- Most T-bill issues are callable and convertible.
- T-bills are a direct obligation of the U.S. government.
A) II and III B) I and III C) I and IV D) II and IV
I and IV
T-bills are issued at a discount to par, are six months or less to maturity, and are a direct obligation of the U.S. government. Callable and convertible features are those that should be associated with corporate issues not government issues.
LO 2.j
XYZ Corporation is guaranteeing a debt issue for the IHG Company. Regarding these bonds, which of the following is true?
A)
These bonds are secured, with the value of the guarantee being as good as the strength of XYZ.
B)
These bonds are unsecured, with the value of the guarantee being as good as the strength of IHG the issuer.
C)
These bonds are unsecured, with the value of the guarantee being as good as the strength of XYZ.
D)
These bonds are secured, with the value of the guarantee being as good as the strength of IHG issuer.
These are guaranteed bonds where the value of the guarantee is only as good as the financial strength (good faith and credit) of the company making the guarantee—in this case, XYZ Corporation. Because these bonds are backed by the good faith and credit of XYZ and not by any tangible asset, they are unsecured debt instruments. Always remember that even though the word “guaranteed” is used to describe such issues, the bonds are unsecured debt.
LO 2.f
A put will have intrinsic value if, just before expiration, the price of the underlying stock is
A) less than the exercise price. B) greater than the exercise price. C) anywhere near the exercise price, above or below. D) equal to the exercise price.
less than the exercise price.
Put buyers are bearish. Puts have intrinsic value if the price of the underlying stock falls below the exercise price of the option, The client will be profitable if the price decline (below the strike) exceeds the amount of the premium paid. If the price of the stock rises above the exercise price or is the same as the exercise price, the put will expire worthless.
LO 3.d
For those owning preferred classes of stocks, priority of asset dissolution refers to
A)
the order in which preferred shareholders receive dividend payments and the order in which preferred shareholders are paid in the event of a bankruptcy liquidation.
B)
the order in which preferred shareholders are paid in the event of a bankruptcy liquidation.
C)
the order in which the board of directors (BOD) declares dividend payments.
D)
the order in which preferred shareholders receive dividend payments when declared.
the order in which preferred shareholders are paid in the event of a bankruptcy liquidation.
Priority at dissolution refers to the priority that preferred stockholders have over the claims of common stockholders on any assets remaining after creditors have been paid when assets are being liquidated.
LO 1.i
Systematic risk would include all of the following except
A) market risk. B) inflation risk. C) business risk. D) interest rate risk.
business risk.
Nonsystematic risks are those associated with the issuer (like a bad business strategy). Systematic risks impact large portions of the market and are difficult to reduce by diversification.
LO 6.c
Treasury bonds mature in
A) 1 year or more. B) 2 years or more. C) 10 years or more. D) less than 2 years.
10 years or more.
Treasury bonds (T-bonds) are the U.S. government’s long-term debt instrument having maturities of 10 years and up to 30 years.
LO 2.j
Treasury bills pay
A) annual interest payments. B) all interest at maturity. C) semiannual interest payments. D) monthly interest payments.
all interest at maturity.
Treasury bills (T-bills) are the only Treasury security issued at a discount to par value. At maturity, par value is received. The difference between what was paid and the par value received would be considered the interest income.
LO 2.j
A bank issues and guarantees certificates of deposit, and those that are negotiable are considered money market instruments. What makes a CD negotiable?
A) A fixed interest rate B) Backing by the banks good faith and credit C) Short-term maturity D) Secondary market trading
Secondary market trading
While all of these are characteristics of negotiable certificates of deposit issued by banks, it is the ability to trade the CDs in the secondary market that makes them negotiable.
LO 2.m
If a preferred shareholder received a $3.50 annual dividend each year, it could be assumed that
A) this is a 3.5% preferred class. B) these shares are trading at $35.00. C) the shares had increased by 3.5% each year. D) the common shareholders receive the same $3.50 annual dividend.
this is a 3.5% preferred class.
An annual dividend of $3.50 simply tells you that this is a 3.5% preferred class of stock (3.5% × par ($100) = $3.50) or ($3.50 ÷ par ($100) = 0.035). The current market value is not used to calculate the fixed dividend, nor does this dividend amount tell us what common shareholders received.
LO 1.i
Regarding bankruptcy proceedings,
A)
the procedure is only available to individuals seeking protection from creditors and not business entities.
B)
courts protect both corporate and individual filers from creditors.
C)
a plan for reorganization must be submitted first before the courts can offer protection from creditors.
D)
liquidation of assets must occur first before the courts can offer protection from creditors.
courts protect both corporate and individual filers from creditors.
Bankruptcy is a general term for court procedures available to both individuals and businesses. During the proceedings, filers are protected by the court from creditors. Protection is granted independent of any actions to liquidate or file a plan for reorganization.
LO 2.f
How often may funds be rolled over from one state’s Section 529 plan to another’s?
A) No more than twice per calendar year B) Once per semester C) As often as necessary D) Once every 12 months
Once every 12 months
A rollover involves actually withdrawing funds from one account for reinvestment in another. The investor thus has constructive receipt of the money and could be liable for taxes on any growth or earnings withdrawn if the rollover is not completed. The rollover procedure, when completed, protects from tax liability but may only be done once every 12 months.
LO 5.a
Which of the following positions will mitigate the risk of a short call position?
A) Long calls B) Short stock C) Long puts D) Short puts
Long Calls
A short call has unlimited risk unless the investor owns the stock (long position) or has another way to purchase the shares at a set price (warrants, stock rights, or long calls, for example).
LO 3.h
Different categories of preferred shares offered by an issuer
A) must all be convertible shares. B) all have preference over the issuer's common shares. C) must all be callable shares. D) all must have the same fixed dividend rate.
all have preference over the issuer’s common shares.
Separate categories of preferred shares may differ in several ways, including dividend rate and profit participation privileges. However, all maintain preference over common stock shares issued.
LO 1.i
A bond having a call feature
A)
can be redeemed before maturity at the issuer’s option.
B)
can be redeemed before maturity at the bond holder’s option.
C)
is guaranteed not to be redeemed before maturity.
D)
must be redeemed before the bond matures.
can be redeemed before maturity at the issuer’s option.
A bond with a call feature may be redeemed before maturity at the issuer’s option. There is no guarantee that it will or will not be called, nor is there a requirement that it must be called.
LO 2.b
T-notes pay interest
A) monthly. B) quarterly. C) semiannually. D) annually.
semiannually.
Treasury notes (T-notes) and bonds (T-bonds) pay interest on a semiannual basis.
LO 2.j
An investor lending money to an entity receives back the principal amount of the loan on
A) the maturity date. B) the payable date. C) the interest payment date. D) the record date.
the maturity date.
The date that the principal amount of a loan is due to be paid back to an investor is known as the maturity date.
LO 2.a
All of the following are corporate secured bonds except
A) mortgage bonds. B) equipment trust certificates. C) collateral trust certificates. D) debentures.
debentures.
Debentures are unsecured. Mortgage bonds are backed by property. Equipment trust certificates are backed by equipment. Collateral trust certificates are backed by securities.
LO 2.b
T-bonds are delivered in
A) book entry. B) registered form to principal only. C) bearer form. D) physical certificates.
book entry.
All U.S. government issues are delivered in book entry.
LO 2.f
A customer purchased 1 MNO Jan 50 call at 2. What is the breakeven point for both the purchaser and the seller?
A) 50 and 48 B) 50 C) 52 D) 52 and 48
52
Whether long or short the call, the breakeven for a call is found by adding the premium to the strike price. For the call buyer, the contract is profitable above the breakeven. For a call seller, the contract stands to lose money if the price of MNO rises above breakeven.
LO 3.g
Regarding the decision to dissolve a LP before its scheduled predetermined dissolution date, it would need to be
A)
ratified by the IRS because of the tax implications to dissolve earlier than planned.
B)
made by the general partner with the largest capital contribution with no vote required.
C)
voted on by the limited partners holding a majority interest.
D)
voted on by the general partner(s) only.
voted on by the limited partners holding a majority interest.
In instances where a decision to dissolve a limited partnership before its predetermined date is made, an affirmative vote to do so must be taken by the limited partners.
LO 5.e
All of the following are issuer transactions where the proceeds of the offering go to the issuing company except
A) an initial public offering (IPO). B) a repurchase agreement (REPO). C) an additional public offering (APO). D) a subsequent public offering (SPO).
a repurchase agreement (REPO).
APOs, IPOs, and SPOs all result in funds going to the issuer and are, therefore, issuer transactions. A REPO is a money market instrument where money changes hands between the buyer and the seller.
LO 2.m
A company has issued bonds (debt securities) to investors. For these investors, these securities represent
A) a loan to the issuing company. B) liability for the issuing company's debt. C) ownership in the existing company. D) equity in the issuing company.
a loan to the issuing company.
Purchasers of bonds have essentially given the issuer a loan for which they will receive repayment plus interest.
LO 2.g
A general partner would be considered to have a conflict of interest with the limited partnership if the GP
A) manages the day-to-day business. B) is compensated for managing the partnership. C) borrows money from the business. D) acts as agent making decisions for the business.
borrows money from the business.
The general partner manages the business and acts as agent for the business for which they may receive compensation. They may not borrow from the partnership because this would be considered a conflict of interest.
LO 5.e
The United States Congress has authorized all of the following enterprises to issue securities except
A)
Government National Mortgage Association (GNMA).
B)
Federal Deposit Insurance Corporation (FDIC).
C)
Federal National Mortgage Association (FNMA).
D)
Federal Home Loan Mortgage Corporation (FHLMC).
Federal Deposit Insurance Corporation (FDIC).
In addition to U.S. Treasury securities, the U.S. Congress authorizes certain agencies of the federal government to issue debt securities. These would include GNMA, FNMA, and FHLM. The Federal Deposit Insurance Corporation (FDIC) does not issues securities but is set up to insure bank deposits in the event of bank failure.
LO 2.j
For a real estate DPP, which of the following is true?
A)
Neither income nor capital growth would come from rents received.
B)
Income can be derived from rents received for the properties.
C)
Capital growth can be derived from rents received.
D)
Income will come from appreciation of the portfolio properties.
Income can be derived from rents received for the properties.
For real estate DPPs, both income and capital growth are possible. Income comes from the property rents received, and capital growth would come from the appreciation of the properties.
LO 5.e
