Study Cards

Question 1

Put Debit spread on options is:

Answer 1

Investor purchased the one with the higher strike price (higher premium)

Question 2

Put Credit spread on options is:

Answer 2

investor sold the one with the higher strike price

Question 3

Call Debit spread on options is:

Answer 3

investor purchased the one with the lower strike price (higher premium)

Question 4

Call Credit spread on options is:

Answer 4

investor sold the one with the lower strike price (higher premium)

Question 5

Company is going public for the first time. Proceeds from an offering are paid to the issuer.

Answer 5

I.P.O. (initial public offering)

Question 6

Company has already gone public and is issuing additional shares. Proceeds from the offering are paid to the issuer.

Answer 6

Additional Public Offering (A.P.O.)

Question 7

Covered put writing is a strategy where an investor

A)
sells a put and buys a call on the same stock.

B)
sells a put on a stock that he owns.

C)
sells a put and sells a call on the same stock.

D)
sells a put on a stock he has sold short.

Answer 7

D) sells a put on a stock he has sold short.

Explanation
The first thing to remember is that option sellers have an obligation. In the case of a call writer, the obligation is to deliver the underlying stock. However in the case of a put (our question), the obligation is to pay for stock delivered. A seller of an option would be covered if he has whatever it is he is obligated for.

If you sell a put and the option is exercised by the holder, meeting the obligation requires having sufficient cash to purchase the stock being put to you. Owning the shares would not help you meet your obligation; you need cash. You would be covered if you have cash available to cover the purchase. One way is a deposit of cash at the time the put is written. Alternatively, if you sell 100 shares short for each put sold, you would have cash from the short sale that could be used to cover the obligation to buy the stock at the strike price. Notice that selling a put is bullish; the short stock position is bearish.

An easy way to eliminate answer choices is to remember that hedging involves a stock position and an option position that are opposite in sentiment. Notice that the sentiments associated with the answer choice “sells a put on a stock that he owns” doesn’t work because a long stock position is bullish and selling a put is bullish. Therefore, this answer can be eliminated.

To prove the point, let’s look at the other side. If you sell a call, you are obligated to sell shares of stock. You would be covered if you already owned the shares. Notice that selling a call is bearish and owning the stock is bullish.

LO 9.f

Question 8

An investor buys 2 LMN 40 calls and pays a premium of 4 each. The investor also buys 2 LMN 40 puts and pays a premium of 2.50 each. At the time of purchase, LMN is trading at $40.75. On the expiration date, LMN is trading at $32.50. If the investor closes her position for its intrinsic value, excluding commissions, the investor realizes

A)
a $100 profit.

B)
a $100 loss.

C)
a $200 profit.

D)
a $200 loss.

Answer 8

C.) $200 profit

Explanation
Closing out a position is the opposite of the opening transaction. In this situation, the investor opened by buying two calls for a total of $800 and closed them out by selling for their intrinsic value. (Calls have intrinsic value when the market value is above the strike price; in this situation, there is no intrinsic value.) The investor also bought two puts for a total of $500 and closed them out by selling for their intrinsic value of $1,500. (Puts have intrinsic value when the market value is below the strike price; in this situation, the intrinsic value is $7.50 per contract, or 40 − 32.50 = 7.5 × 2 = 15 × 100 shares = $1,500.) The resulting profit on the position is $200 ($1,500 − $1,300), the total of the premiums paid for all of the options.

LO 9.i

Question 9

If a registered options principal is asked to approve a discretionary order to buy 1 XYZ Oct 60 put and sell 1 XYZ Oct 55 put for a net debit of $5, he should

A)
approve the order if the customer has sufficient funds in her accounts.

B)
not approve the order.

C)
approve the order in writing.

D)
obtain the best execution for the order.

Answer 9

B.) Not approve the order

Explanation
Because this is a debit spread, the maximum gain occurs if both sides are exercised. If this occurs, the investor earns $5 (buys stock at 55 when the short put is exercised and sells stock at 60 by exercising the long put). Because the net premium paid for the spread is $5, there can never be any gain. This spread is not economical.

Question 10

A customer wrote 1 XYZ Sep 45 put at 6 and 1 XYZ Sep 35 call at 6 when XYZ was at 40. Before expiration, if XYZ was at 43, and the customer closed her positions at intrinsic value, the customer has

A)
a $600 loss.

B)
a $200 loss.

C)
a $200 gain.

D)
a $600 gain.

Answer 10

C) a $200 gain.

Explanation
We first identify the position. This is a short combination. The investor sold a put and sold a call on the same stock, but at different strike prices. If the prices and expiration dates were the same, it would be a straddle. When the customer begins the position by selling options, the action is an opening sale. That is, the position was opened by selling an option (in this case, two options). The customer collects $1,200 in premiums for writing the options (6 + 6). The question says the positions were closed at the intrinsic value. You close an opening sale with a closing purchase. That is, the customer buys back the option(s) that were sold. In this case, the price is $200 (45 − 43) to close out the put and $800 to close out the call (43 − 35). Determining gain or loss is simply comparing the $1,200 received to the $1,000 paid and that results in a gain of $200.

The T-chart looks like this:

Debit ($ out) Credit ($ in)

$200 (put) $600 (Sep 45 put)

$800 (call) $600 (Sep 35 call)

$1,000 $1,200

LO 9.b

Question 11

Several months ago, one of your customers purchased one RMBN Apr 130 put at a premium of 5. If the common stock of RMBN is currently trading at 123 and the RMBN Apr 130 put is trading at 9, it would be correct to state that the premium represents

A)
no intrinsic value and time value of 4.

B)
intrinsic value of 4 and no time value.

C)
intrinsic value of 2 and time value of 7.

D)
intrinsic value of 7 and time value of 2.

Answer 11

D) intrinsic value of 7 and time value of 2.

Explanation
The option is in the money by 7 points because the strike price is 130 and the market price is down to 123. The difference between that intrinsic value of 7 and the actual premium of 9 represents the time value of 2. The price the customer paid for the option has nothing to do with the question. It would be relevant if the question stated that the customer sold the option and asked for the gain or loss.

LO 9.b

Question 12

If a customer buys 1 XYZ Aug 50 put at 1 and sells 1 XYZ Aug 65 put at 10 when XYZ is at 58, what is the maximum risk?

A)
$900

B)
$1,500

C)
$600

D)
$100

Answer 12

C) $600
This is a credit spread. The maximum loss is the difference between the strike prices and the net credit. In this example, the strike price difference is 15 (65 – 50) and the net premium is 9 (10 − 1), or 15 − 9 = 6 × $100 = $600 maximum loss. The maximum gain is the net credit of $900. Credit put spreads are bullish (buy the low strike, sell the high strike). If the stock’s price should rise above $65 per share, both options expire worthless (who wants to sell stock at $50 or $65 when the price is above that). If the investor is wrong and the stock price falls below $50, the short put will be exercised and the investor will have to buy the stock at $65 per share. Now that the stock is owned, it can be used to exercise the long put and be sold at $50 per share. That $15 difference between the 50 and 65 strikes is the largest spread possible. Comparing the loss of $1,500 to the initial credit of $900 proves that the maximum risk of loss is $600.

LO 9.f

Question 13

Your customer sells short FGH at 79 and pays $3 for an FGH 80 call. What is the breakeven and maximum loss?

A)
The breakeven is $83, and the maximum loss is $300.

B)
The breakeven is $82, and the maximum loss is $300.

C)
The breakeven is $76, and the maximum loss is $400.

D)
The breakeven is $77, and the maximum loss is $400.

Answer 13

C) The breakeven is $76, and the maximum loss is $400.

Explanation
The breakeven point for the short stock, long call position is the short sale price minus the premium paid ($79 – $3 = $76). The maximum loss will occur at the strike price for the long calls and the short stock. If the stock rises to $80, the customer loses $1 on the short sale and loses $3 on the option for a total of a $400 loss.

LO 9.e

Question 14

If a customer buys 1 XYZ Aug 50 put at 1 and sells 1 XYZ Aug 65 put at 10 when XYZ is at 58, the maximum potential gain is

A)
$900.

B)
$1,500.

C)
$600.

D)
$1,100.

Answer 14

A) $900.

Explanation
The maximum gain on any credit spread is the net credit. In this case, $1,000 was received, and $100 was paid out, so the net credit is $900.

LO 9.f

Question 15

In a bull call spread, an investor

buys the lower exercise price and sells the higher exercise price.
buys the higher exercise price and sells the lower exercise price.
anticipates the spread will narrow.
anticipates the spread will widen.
A)
I and IV

B)
I and III

C)
II and IV

D)
II and III

Answer 15

A) I and IV

Explanation
In a bull call spread (debit spread), a call with a lower strike price is purchased and a call with a higher strike price is sold. Because the long call has a lower strike price than the short call, it is more expensive, resulting in a net debit. In a bull call spread, the investor hopes the market prices rise. Maximum profit occurs if both calls are exercised, and because this is a debit spread, the spread is profitable if it widens.

LO 9.f

Question 16

Intrinsic value calculation:

Answer 16

CMV-strike price (As long as it is >0)

Question 17

If MCS is trading at 43 and the MCS Apr 40 call is trading at 4.50, what is the intrinsic value and the time value of the call premium?

A) Intrinsic value 4.50, time value 0

B)
Intrinsic value 3, time value 1.50

C)
Intrinsic value 1.50, time value 3

D)
Intrinsic value 3, time value 4.50

Answer 17

B)
Intrinsic value 3, time value 1.50

Explanation
The option is in the money by three points (the strike price on the call is 40 and the market price is 43). Because the actual premium is 4.50, the balance of 1.50 represents time value. Remember P – I = T (Premium minus intrinsic value equals the time value).

LO 9.b

Question 18

Which of the following securities underlies a yield-based option?

A)
Income bonds

B)
Treasury securities

C)
Revenue bonds

D)
Debentures

Answer 18

B)
Treasury securities

Explanation
Yield-based interest rate options are based on the yields of Treasury bills, notes, and bonds.

LO 9.h

Question 19

investors want a debit spread to __________

Answer 19

widen

Question 20

investors want a credit spread to __________

Answer 20

narrow

Question 21

If an investor buys a Jan 30 XYZ call for 4 and sells a Jan 35 call for 2, to become profitable, the spread between the prices of the two options must

A)
narrow.

B)
remain the same.

C)
widen.

D)
fluctuate.

Answer 21

C) widen

Explanation
This is a debit spread. A debit spread is profitable when the difference between the premiums widens. A debit spread is closed as a credit, and to be profitable, the credit must be larger than the opening debit.

LO 9.f

Question 22

If a customer is long 1 ABC Oct 50 call at 11 and short 2 ABC Oct 60 calls at 5, the maximum loss potential is

A)
unlimited.

B)
$1,100.

C)
$100.

D)
$1,000.

Answer 22

A)
unlimited.

Explanation
The customer is short two calls and long one call, leaving one of the short calls uncovered. The loss potential for a naked call writer is unlimited on the upside. If exercised, the writer must buy the stock at the current market price so it will be delivered at the strike price.

LO 9.c

Question 23

If a Japanese exporter wants to hedge a recent sale of stereo equipment to a U.S. buyer, and the exporter will be paid in U.S. dollars upon delivery of the goods, the best hedge would be to

A)
sell Japanese yen calls.
r
B)
buy Japanese yen calls.

C)
buy Japanese yen puts.

D)
sell Japanese yen puts.

Answer 23

B)
buy Japanese yen calls.

Explanation
The Japanese exporter will be paid in U.S. dollars upon delivery of the equipment. He would be adversely affected if the dollar dropped in value in relation to the yen. To protect his position, he should buy calls on his own currency—the yen. Then if the yen appreciates, his loss on the dollar is offset by his gain on the calls. Exporters buy puts on foreign currency to hedge, but there are no options on the U.S. dollar. The next best strategy is to buy calls on the home currency.

LO 9.h

Question 24

Safest hedging method for a short sale:

Answer 24

Buying a call

Question 25

An ABC 40 call is quoted at 4.25 - 4.50, and an ABC 45 call is quoted at 1.50 - 2.00. What is the cost of establishing a debit spread? A) $300 B) $250 C) $275 D) $225

Answer 25

A) $300 Explanation To establish a debit spread, an investor buys a 40 call at the ask price of 4.50 and sells a 45 call at the bid price of 1.50. The net premium paid is (4.50 minus 1.50) times 100 shares, which equals $300. LO 9.f

Question 26

Without any position in the stock, an investor wrote an ABC Jul 60 call for 6. On the expiration date, ABC is selling for 66, and the investor closes the position at the intrinsic value. For tax purposes, the investor has A) realized a short-term capital loss of $600. B) realized a short-term capital gain of $600. C) realized ordinary income of $600. D) broken even.

Answer 26

D) broken even Explanation With the stock at 66, the call is 6 points in the money (call-up rule). That means the option will cost 6 points to close the position. The writer sold the option for 6 points and bought it back for 6 points. That results in breaking even. LO 9.i

Question 27

VIX (volatility market index) is also known as:

Answer 27

Fear gauge or fear index

Question 28

A spread involves:

Answer 28

two simultaneous positions in related options of the same type—one long and the other short of the same underlying security.

Question 29

A customer who is long 1 XYZ Sep 50 call could create a spread by combining it with which of the following positions? A) Long 1 XYZ Sep 50 put B) Short 1 XYZ Sep 60 call C) Long 1 XYZ Sep 60 call D) Short 1 XYZ Sep 50 put

Answer 29

B) Short 1 XYZ Sep 60 call. Explanation A spread involves two simultaneous positions in related options of the same type—one long and the other short of the same underlying security. LO 9.g

Question 30

A customer purchases 2 QRS Jul 30 calls at 2 and 2 QRS Jul 30 puts at 2.50. She will break even when the price of the underlying stock is I $25.50. II $27.50. III $32.00. IV $34.50. A) I and II B) III and IV C) I and IV D) II and III

Answer 30

C.) I and IV Explanation The customer has purchased calls and puts with the same strike price and expiration date, so the position is a long straddle. Straddles have two breakeven points: the strike price plus the sum of the two premiums, and the strike price minus the sum of the two premiums. The customer profits in a long straddle when the stock price is outside the breakeven points (i.e., higher than 34.50 or lower than 25.50). Remember, when we find the breakeven point, we ignore the number of contracts. Breakeven is the same whether it is one or 1,000 contracts. LO 9.d

Question 31

One of your customers is speaking to you about spread strategies for equity options and makes several statements about spreads. Which of her statements is false? A) “With a time or horizontal spread, both options expire at the same time, which means the position expires simultaneously.” B) “No spread can ever have an unlimited maximum loss potential.” C) “With spreads, I always know exactly how much I can lose or gain once the position is established.” r D) “If a position, whether long or short, begins to move against me, I can always close it out in the market.”

Answer 31

A) “With a time or horizontal spread, both options expire at the same time, which means the position expires simultaneously.” Explanation Spreads have a defined maximum gain and loss, and neither can ever be unlimited. Spreads like single option positions can be closed in the market before expiration. Time or horizontal spreads have contracts that expire in different months, not the same time. LO 9.d

Question 32

If your client expected short-term interest rates to fall, you might recommend that the client A) buy a Treasury bond yield-based put. B) buy a Treasury bill yield-based put. C) write a Treasury bill yield-based call. D) buy a Treasury bill yield-based call.

Answer 32

B) buy a Treasury bill yield-based put. Explanation The key to debt options is that the investor is betting on the movement of interest rates, not the price of the security. As with any other investment based on downward movement (put down), the strategy called for here is buying a U.S. Treasury bill put option. Why not the Treasury bond put? Because the question refers to short-term rates and Treasury bonds are a play on long-term ones. LO 9.h

Question 33

A transaction that will create or increase a long position in an option contract is A) a covered writing transaction. B) a closing purchase transaction. C) an opening purchase transaction. D) an opening writing transaction.

Answer 33

C) an opening purchase transaction. Explanation One takes a long position by buying an option. Creating or increasing the position is opening not closing. A closing purchase transaction eliminates the position. An open writing transaction creates or increases a short, not long, position. LO 9.a

Question 34

All of the following positions have limited loss potential except A) long stock/short call. B) short stock/long call. C) short stock/short put. D) long stock/long put.

Answer 34

C) short stock/short put. Explanation If the stock rises, the put will expire, leaving the customer short stock with an unlimited loss potential. LO 9.c

Question 35

If a customer buys 1 ABC Jan 50 call at 2 and 1 ABC Jan 50 put at 4 when ABC is at 49, the maximum potential gain is A) unlimited. B) $200. C) $600. D) $400.

Answer 35

A) unlimited. Explanation Maximum gain in a long straddle is unlimited if the market moves up. If the market moves to zero, the gain is $4,400 (50 − 6 = 44). LO 9.g

Question 36

In a rising market, all of the following strategies are appropriate except A) long calls. B) short puts. C) debit call spreads. D) short stock/short put.

Answer 36

D) short stock/short put. Explanation Investors who short stock have sold borrowed shares and profit when the market price declines. LO 9.

Question 37

If a customer buys 2 Canadian dollar 78 calls and writes 2 Canadian dollar 80 calls, this position is A) a diagonal call spread. B) a credit call spread. C) a bull call spread. D) a horizontal call spread.

Answer 37

C) a bull call spread. Explanation Bull positions in options spreads are established by buying the option with the lower strike price. LO 9.h

Question 38

A client buys 1 Jul 50 call and writes 1 Jul 60 call. This is A) a debit bull spread. B) a credit bear spread. C) a credit bull spread. D) a debit bear spread.

Answer 38

A) a debit bull spread. Explanation We have to answer two questions: is this a bull or bear spread, and is it a debit or credit spread? Looking at the first question, the goal of a bull is to always buy low and sell high. In the case of options, that refers to the strike prices (not the premiums). In this question, the purchased option has a 50 strike, and the sold option has a 60. That looks like buy low/sell high, so this is a bull call spread. But how can we determine if this is a debit (more money out than in) or a credit spread (the reverse) when the premiums are not shown? Simple. What would you pay more for? The option to buy stock at $50 per share or buy it at $60 per share? When it comes to a call option, the cheaper it can be exercised, the more valuable the option. So, the premium for the $50 call must be higher than the $60. If that is so (as it must be), then the investor is spending more to buy the 50 than is being received when selling the 60. More money out than in is a debit spread. LO 9.f

Question 39

The market attitude of a customer who establishes a debit put spread is A) bearish. B) bullish. C) speculative. D) neutral.

Answer 39

A) bearish. Explanation In a put spread, a customer is buying one put and selling another with different strike prices and/or expirations. In any spread, one of the options is dominant. In a long put spread, the long put position is dominant because it has the higher premium. Buying puts is bearish. LO 9.f

Question 40

Your client currently holds XYZ stock in her portfolio. You notice that the put-call ratio for options trading on XYZ stock has been increasing over the past several days. The increase in the ratio would indicate that A) for the underlying XYZ stock, more calls than puts are being traded. B) investors are becoming more and more bullish on XYZ stock. C) for the underlying XYZ stock, more puts than calls are being traded. D) for the underlying XYZ stock, straddles are being purchased.

Answer 40

C) for the underlying XYZ stock, more puts than calls are being traded. Explanation The ratio is a measure of puts traded to calls traded and is calculated by dividing the number of traded puts by the number of traded calls (puts ÷ calls). As the ratio increases, it reflects that more puts than calls are being traded and is therefore a more bearish indicator of investor sentiment. LO 9.c

Question 41

put/call ratio is:

Answer 41

of puts traded divided by the number of calls traded. More puts than calls indicates a bearish market More calls than puts indicates a bullish market

Question 42

The writer of a combination expects the market to be A) stable. B) bearish. C) volatile. D) bullish.

Answer 42

A) stable. Explanation 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. LO 9.g

Question 43

What is the breakeven point for a person who bought 500 shares of JKL stock at $71.25 and sold 5 JKL July 75 calls at 3.75? A) $71.25 B) $67.50 C) $78.75 D) $75

Answer 43

B) $67.50 Explanation The breakeven point is the stock price purchased minus the premium ($71.25 – $3.75 = $67.50). One of the drawbacks of writing calls against a long stock position is that it limits upside potential. Therefore, covered call writing is typically done in a stable market. LO 9.e

Question 44

A customer of a FINRA member firm called to ask about closing 10 MNO Dec 60 puts. Each contract was purchased at $300. The underlying stock's price is currently 63, with 20 business days until the options expire. What is the breakeven price? A) 63 B) 63 & 57 C) Unlimited D) 57

Answer 44

D) 57 Explanation Not considering commissions and other fees, $57 is the break even on this investment. A simple way to remember how to handle a question like this is "puts subtract" the premium from the strike price, whether long or short. LO 9.d

Question 45

An ABC 40 call is quoted at 4.25 - 4.50, and an ABC 45 call is quoted at 1.50 - 2.00. What is the cost of establishing a debit spread? A) $250 B) $225 C) $300 D) $275

Answer 45

C) $300 Explanation To establish a debit spread, an investor buys a 40 call at the ask price of 4.50 and sells a 45 call at the bid price of 1.50. The net premium paid is (4.50 minus 1.50) times 100 shares, which equals $300. LO 9.f

Question 46

Types of REITS:

Answer 46

- Mortgage/Debt: issue secured loans that are backed by real estate purchases - Equity: own and operate income-producing real estate - Hybrid: combination of mortgage and equity REITs

Question 47

REITS pass through __________ but not pass through ___________

Answer 47

income and cannot pass through losses

Question 48

REITS have no taxation on income if

Answer 48

90% of it is distributed: - doesn't pass through losses (unlike limited partnerships) - 20% of distributed income is tax-deductible (example: you receive $100 dividend, $20 will be tax deductible, the other $80 will be taxed as ordinary income)

Question 49

REITs shares trade:

Answer 49

on the secondary market and they are marginable. REITs are attractive for investors seeking current income

Question 50

Methods of Offering REITs:

Answer 50

- Registered, exchange-listed, and publicly traded (liquid) - Registered, but not exchange-listed (non-traded) - often have a lack of liquidity - Unregistered; offered through a private placement (illiquid)

Question 51

DPP:

Answer 51

a business venture that's designed to pass through both income and losses to investors. Examples: - Subchapter S Corporations - Joint Ventures - General Partnerships - Limited Partnerships (typical DPP) - An LP is formed by filing a Certificate of Limited Partnership with the state - owned by general and limited partners - limited partnership agreement defines the relationship between the partners

Question 52

Advantages of limited partnerships:

Answer 52

An LP (limited partnership) is a business venture that's designed to pass through both income and losses to investors. Flow-through of income (no double taxation) and expenses: - Income flows through as passive income - A portion is taxed as ordinary income (20% deductible, just like the REIT) Limited Liability - Limited partners are only liable for the amount invested and any loans assumed (i.e., the amount they have at risk)

Question 53

Disadvantages of limited partnerships:

Answer 53

Illiquidity: - typically not publicly traded - GP's approval may be required to sell Lack of Control: - Limited partners have limited voting power and no managerial authority Effect of Tax Law changes: Tax law can change all the time Increased Tax Complexity Calls to contribute additional funds

Question 54

General and Limited Partners characteristics:

Answer 54

General Partner: - Day-to-day manager with unlimited personal liability - must have at least a 1% interest - fiduciary toward limited partner - Last at liquidation: - Secured Lender - General Creditor - Limited Partner - General Partner Limited Partner: - Passive investor with limited liability - Contributors of capital - Have certain rights: - Lend money to the partnership, inspect books, and compete - Ways to endanger "limited" status: - Negotiate contracts, hire/fire employees, or lend name *Limited Partners can be in 2 categories for liquidation: If limited partners lend money they will become an unsecured lender (up to the amount lent) and then under the limited partner

Question 55

Limited Partnership offering Practices:

Answer 55

Public Offering: - If a sponsor (GP) conducts a public offering of securities: - Registration is required under the Securities ACt of 1933 - An underwriter is used to facilitate the offering - A prospectus is used as the disclosure document Private Placement: - If a sponsor (GP) conducts a private placement of securities: - Securities qualify for an exemption from registration through Reg. D

Question 56

Main types of Limited Partnerships:

Answer 56

Real Estate Programs: Category: - Raw Land: Purely speculative. Speculation on land appreciation; no positive cash flow or depreciation - New Construction: Risks of overbuilding, cost overruns, long duration, etc. - Existing: Existing cash flow, but potential problematic tenant issues (e.g., long- term leases) - Low Income (Government Assisted): Beneficial potential tax credits; little chance of appreciation; high maintenance costs Riskiest to least risk: - Raw Land - New Construction - Existing Property - Low Income Oil and Gas Programs: - Exploratory (wild-catting): High risk with high potential reward - Developmental: Drilling near an existing field (step out wells) - Balanced: Combination of exploratory and developmental - Income: Purchase of existing wells; creates immediate cash flow Riskiest to least risk: - Exploratory - Balanced - Developmental - Income Equipment Leasing Programs (used for income): - Used to lease equipment such as: - Computers - Transportation Equipment (airplanes and railroads) - Construction Machinery Equipment is purchased from manufacturers and then leased to end users Advantages: Investors receive consistent income as well as depreciations tax benefits Disadvantages: No appreciation of underlying assets Public Equity and Debt Programs: DPPs may invest in the public equity or debt of existing issuers: - Small Capitalization Debt: - Many of these bonds are illiquid - Many issues are unrated - Above average yields - Small Capitalization Equity: - Publicly Traded, but may be illiquid - These programs are often concentrated in a specific industry in which the GP has expertise

Question 57

Business Development Companies (BDCs):

Answer 57

Riskier investment. Closed end funds, but elect to be treated as business development companies. Invest in equity/debt of typically non-public companies, including: - Small and developing companies - Financially troubled companies - Private companies Income and net worth requirements are avoided since BDCs are public offerings Most trade on exchanges providing liquidity. Investors combined capital making a capital investment into the company. They receive earnings or interest payments. 90% of taxable income distributed

Question 58

DPPs Risk Summary:

Answer 58

Investors should be aware of the following risks of DPP investments: - Illiquid nature and potential loss of capital (main risk) - Management Ability of the general partner(s) - Unpredictable income - Potential future mandatory assessments - Rising operating costs - Changes in tax laws and government regulations - Economic and environmental occurrences Successful investing is about managing risk, not avoiding it.

Question 59

DPPs - Evaluation:

Answer 59

What do we need to look at to evaluate? Investors and RRs should use the following factors when evaluating the potential and merits of a given program: - Managerial track record - Start-up costs (typically are very high) - Time to crossover - Use of leverage - Competitive landscape - GP exit strategies (i.e., ultimate asset sale) - Economic soundness of the program DPPS are complicated products. The focus should be on finding the best fit for the client.

Question 60

DPPs Investor Considerations:

Answer 60

Investor Certification: - Registered Representatives are required to certify they have informed their customers of all relevant facts and lack of marketability - Investors must have sufficient net worth and income to absorb a loss of the entire investment Discretionary Accounts: - Registered Representatives are not permitted to exercise discretion involving client investments in DPPs.

Question 61

DPPs - Suitability Issues:

Answer 61

Those considering DPPs as a potential investment should: - Have liquidity in other investments: - There may be an extended time required to reach the crossover point (i.e., the beginning of positive cash flow) - Have a need for both present and future tax benefits - Be aware of the risks involved - Be able to tie up funds for a long period of time *These products are often only suitable for sophisticated investors who are seeking performance that's not correlated to the stock market

Question 62

Hedge Fund:

Answer 62

- Investment fund generally for wealthy investors - Offered under Reg. D exemption to accredited investors - Not considered a registered investment company under the act of 1940 - Uses exotic strategies involving derivatives, leverage, and selling short - Investors are seeking over-sized performance that's often uncorrelated to stock market Fund of Hedge Fund (fund of funds): - Fund which allocates money to hedge fund managers - Generally suitable for wealthy investors - May place restrictions on withdrawing money Interval Funds: - A type of closed-end fund - Unliked most closed-end funds, their shares are continuously offered, buy don't trade in the secondary market at prices that are above or below their current NAV - Investors are able to sell a portion of their shares back to the fund at preset intervals - Their fees and expenses tend to be higher than other closed-end funds and mutual funds - Offer limited liquidity and are most suitable for long-term investors

Question 63

Compensation disclosures:

Answer 63

Agent: Commission is disclosed on the confirmation (acting as a broker) Principal (dealer): - Markups on NMS (National Market System, meaning it is listed) securities are disclosed on client purchases - Markdowns on NMS securities are disclosed on client sales - Compensation calculation is based on NBBO (inside market for the stock, highest bid and lowest ask, national best bid best offer) Dual Agency Cross (cross the stock, highest bid and lowest stock): - Internal trades that are executed between the bid and offer - Commissions charged to both the buyer and seller - Commissions must be disclosed on the confirmation Riskless Principal: - Firm's purchase and resale to its client is reported as one trade - Markup must be disclosed on confirmation Net Basis (typically for institutional clients): - Firm's purchase and resale to its client is reported as two trades - markup is NOT disclosed - retail client must provide prior written consent - Institutional clients may provide both oral and written consent or use a negative consent letter

Question 64

Soft-dollar Arrangements:

Answer 64

This practice involves an investment adviser (IA) receiving research or other services from a B/D in exchange for order flow: - The services received from the B/D must benefit its clients Acceptable: - Research reports (in-house and third-party) - Access to analysts - Portfolio analysis software - Subscription to industry trade publications - Attendance cost for a securities conference or seminar - IA software Unacceptable: - Office space - Accounting Fees - Advertising/marketing expenses - Travel reimbursement - Professional licensing fees - Subscription to mass-marketed publications - Bloomberg hardware

Question 65

What's on a confirmation:

Answer 65

Confirmations are sent on, or before, settlement and include the following: - Execution details - Name of Customer - Buy/sell - Price and Quantity - Trade and settlement dates - Firm Capacity (agent or principal, this disclosure is not on an order ticket) - For bonds, dollar price and yield information (the lower of the YTC or YTM) - Name of the contra party or a statement of the availability of the information upon written request

Question 66

How often must b/ds send customer statements:

Answer 66

At least quarterly (inactive accounts). For active accounts (monthly) Information on statements include: - Summary of the total value of investments and cash - Unrealized and realized gains and/or losses - Detailed information on the specific investments in the portfolio - Income generated from investment for the statement period and year-to-date - Daily activity for the statement period - Required disclosures

Question 67

SEC requires the updating of customer information at least ______________

Answer 67

Every 3 years. Failure to update client information on a timely basis may result in the execution of unsuitable transactions or regulatory issues - If a client moves to a new state, both the firm and the RR must be registered in that state in order to continue conducting business with the client - Changes in the financial background of a client (for better or worse) must be documented - A different patter of transactions may indicate a change - Objectives are typically adjusted as customers age *FINRA rules require firms to send a copy of updated changes to a customer within 30 days or at the time the next statement is mailed.

Question 68

Acceptable reasons to protest the transfer:

Answer 68

- Additional documentation is required (death certificate) - Account is flat; reflects no assets - Invalid account number - Social security number or account title does not match - Existing court order or tax liens - Written instructions to rescind the transfer are received from the client *A Client can do a "partial transfer" versus a whole transfer * But not due to a dispute over securities positions or money balances *If discrepancy claim occurs after transfer, carrying B/D must resolve it within 5 business days

Question 69

Systematic Risks:

Answer 69

Are risks that affect the value of ALL securities and cannot be avoided through diversification, including: - Market Risk: Risk inherent in all securities due to market fluctuation - Interest-rate Risk: Risk that the value of a fixed income (bond, munis, corp, treasuries) will decline due to a rise in interest rates - Inflation Risk: Risk that an asset or the purchasing power of income may decline over time, due to the shrinking value of the country's currency: - To find a bond's real interest rate, the formula is: nominal yield-inflation rate - Event Risk: Risk that a significant event will cause a substantial decline in the market

Question 70

Unsystematic Risk:

Answer 70

These risks are unique to a specific security and can be managed through diversification: - Business Risk: Risk that a company may perform poorly causing a decline in the value of the stock - Regulatory Risk: Risk that new regulations may have a negative impact on an investments value - Political Risk: Risk that a political event outside of the U.S. could adversely affect the domestic markets - Liquidity Risk: Due to a lack of marketability, this is the risk that an investment cannot be bought or sold quickly enough to prevent or minimize a loss (DPPs, Unregistered (OTC), structured products). - Capital Risk: Risk of investors losing their invested capital (lower for bonds) - Credit Risk: Risk that a bond may not repay its obligation - Currency Risk: Risk of loss when converting an investment that's made in foreign currency into U.S. dollars - Legislative Risk: Risk that new laws may have a negative impact on an investment's value (e.g., tax code changes) - Opportunity Risk: Risk of passing on the opportunity of making a higher return on another investment - Reinvestment Risk: Risk that interest rates will fall and semiannual coupons will be reinvested at a lower rate (zero coupon bonds eliminate this risk, since there are no semiannual interest payments) - Prepayment Risk: Risk that mortgages will be paid off early due to lower interest rates, resulting in reinvestment in lower yielding investments

Question 71

Investment Returns:

Answer 71

The following return measures are based on the different types of investments: - Equity: Current Yield ( Annual Dividend divided by Current Market Price) example: Stock is giving a annual dividend of a $1 and is trading at $20 a share. This will give you a 5% CY. (BE ONE THE LOOKOUT FOR QUESTIONS GIVING YOU A QUARTERLY DIVIDEND) - Debt (bonds): - Nominal Yield (coupon) - Current Yield (based on annual interest divided by the price) - Yield-to-maturity (YTM) - Yield-to-call (YTC) - same as YTM except at the call date - Municipal Bonds: - Tax-equivalent Yield ( Tax-Free Yield divided by (100% - tax bracket) - Capitial Gains and Capital Losses: - Gain - realized when sales proceeds exceed cost basis - Loss - realized when sales proceeds are below cost basis - Return of capital - return of investor's original investment (not a gain or loss)

Question 72

Tax Considerations when giving or receiving securities the tax implications must be taken into account:

Answer 72

- Unified Gift and Estate Taxes: The amount of assets that can be left in an estate without incurring estate taxes - Annual Gift Limit: - $18,000 can be gifted each year to as many as desired without tax to the donor ($36k for a married couple) - Amounts in excess reduce the lifetime exclusion - Unlimited amounts can be gifted between spouses Securities Received as a Gift: - (testable question) If fair market value (FMV) exceeds donor's (original) cost basis: - Use original basis (OB) - Use donor's holding period Example: client buys a stock at $20 and the FMV goes up to $30. The client gifts this to someone. They would use the $20 (original basis) and if the new owner sells they pay taxes based off of the $20 cost basis. And the holding period of the stock for the new owner is what determines short or long capital gain or loss - FMV less than donor's cost basis and sold for: - More than OB, use OB - Less than OB, use FMV Inherited Securities (someone passed away and the recipient inherited the securities): - Cost basis is the value at the time of death: - Stepped up if deceased's cost basis is lower Example: original buyer bought the stock at $20. Stock is now up to $30 and the buyer passed away. The inherited would receive a $30 cost basis. So if the new owner sells it when the MV is up to $32 then they would only have a $2 capital gain. - Stepped down if deceased's cost basis is higher

Question 73

What is Beta?

Answer 73

Beta measures the volatility of an asset (typically an equity) relative to the entire market. - A stock's beta is compared to the beta of the S&P 500, which is fixed at 1.00 - If a stock's beta is more than 1, it's expected to outperform when the market is up and underperform when the market is down - If a stock's beta is less than 1, it's expected to underperform when the market is up and outperform when the market is down

Question 74

What is the measurement of unsystematic risk?

Answer 74

Alpha, measures an investment's risk-adjusted performance against a benchmark index. Outperforming the benchmark results in a positive alpha; underperforming results in a negative alpha

Question 75

Technical Analysis:

Answer 75

Basic Chart patterns and terms used to indicate the direction of prices: Trend lines: Straight lines that show direction and speed of price movements Saucer/inverted Saucer: Chart formations showing that an upward trend has come to an end (inverted saucer), or a downward trend has come to an end (saucer) Moving Averages: Provide a current direction of prices, removing random price fluctuations (e.g., 50-day, 200-day, etc.) Overbought/oversold: Overbought - buying has pushed the price to high and a pullback is expected; Oversold - selling has pushed the price to low and a bounce is expected