Test 1 Flashcards

Question

Which of the following statements are TRUE about Treasury Receipts? I The underlying securities are backed by the full faith and credit of the U.S. Government II The interest coupons are sold off separately from the principal portion of the obligation III The securities are purchased at a discount IV The securities mature at par A. I and II only B. III and IV only C. I, II, IV D. I, II, III, IV

Answer 1

The best answer is D. Treasury Receipts are zero coupon Treasury obligations (which are directly backed by the full faith and credit of the U.S. Government) created by broker/dealers who buy Treasury Bonds or Treasury Notes and strip them of their coupons, keeping the corpus of the bond only. The bonds are put into a trust, and "units" of the trust are sold to investors. Treasury Receipts are purchased at a discount and mature at par. The discount earned over the life of the bond is the "interest income." Once the Federal government started "stripping" bonds itself (in 1986) and selling them to investors, this market evaporated. However, 30 year T-Receipts will trade until they all mature.

Answer 2

The best answer is B. Bonds with the lowest price volatility will be ones with the highest coupon rate. Bonds with low coupon rates exhibit greater price volatility, with the most volatile bond being a zero-coupon bond. Thus, to minimize price volatility due to interest rate movements ("interest rate risk"), high coupon bonds are more appropriate than low coupon bonds.

Answer 3

The best answer is D. A SEP IRA is a "Simplified Employee Pension" plan that must be set up by the employer, with deductible contributions made by the employer. They are easier to set up and administrate than regular pension plans and allow for a very large annual contribution (25% of income statutory rate; 20% effective rate, capped at $53,000 in 2016). The employer sets the actual contribution percentage, which must be the same for all employees. A major advantage of SEP IRAs is that there is flexibility regarding the annual contribution to be made - the employer can change the contribution percentage each year. So this plan is a good option for a small business that has variable cash flow.

Answer 4

The best answer is C. Capital gains on municipal securities are taxable at the Federal, State and Local levels. Only the interest income from municipal securities is exempt from Federal income tax; it is still subject to State and Local tax unless the bond is purchased by a resident of that State.

Answer 5

The best answer is D. This is a very difficult question. The customer is taking the following positions: Buy 5 ABC Jan 40 Calls @ $6 Sell 5 ABC Jan 50 Calls @ $1 $5 Debit Sell 10 ABC Jan 50 Calls @ $1 Credit The customer is creating 5 "long call spreads" and has 10 naked calls. In effect, he is writing 3 times the number of short calls needed to create the spread. Therefore he is "writing at a 3:1 ratio." This is termed a ratio spread. Long call spreads are used when a customer is moderately bullish, and wishes to reduce the cost of the long position by selling an equal number of "out the money" calls. This limits upside gain potential, but also reduces the cost of the positions. By writing three times the number of calls, the customer further reduces the cost of the positions, but also assumes unlimited upside risk on the 10 naked calls that are left.

Answer 6

The best answer is C. Regulation A is intended to make it easier for start-up companies to raise capital. It gives an "E-Z" registration method for offerings of up to $50 million within a 12 month period. The rule is split into Tier 1 and Tier 2. Tier 1 offerings, up to a maximum amount of $20 million, are given the easiest registration method and do not require audited financial statements. Tier 2 offerings allow a maximum of $50 million to be raised, but require audited financial statements. An abbreviated registration statement is filed with the SEC (Form S1-A) and the issue must go through a 20 day review period, similar to a regular registered offering. Disclosure to investors is made through an Offering Circular rather than a Prospectus.

Answer 7

The best answer is C. The trust indenture of a revenue bond issue includes a "flow of funds" - meaning how revenues will be applied by the issuer. As revenues are collected, they are deposited to a revenue fund, also called a general collection account. The monies are then applied, in sequence, to the operation and maintenance account; sinking fund; debt service reserve fund; reserve maintenance fund; renewal and replacement fund; and finally to the surplus fund.

Answer 8

The best answer is A. The customer has a capital gain of $6,000 and a capital loss of $9,000 for a net capital loss of $3,000. Since $3,000 of net capital losses can be deducted in a tax year, the entire loss can be deducted and there is no loss carryforward.

Answer 9

The best answer is A. An insider is defined as an officer, director, 10% common shareholder or "affiliated person." The Chief Executive officer of the corporation is an officer; the President's spouse is an "affiliated person." Court decisions have extended the definition of an insider to include almost anyone who has "material non-public information" about the company. Because of this, an in-house lawyer is considered an "insider." An investor who holds non-convertible bonds or preferred stock of the company is not an insider - he or she is not in a position to get non-public information.

Answer 10

The best answer is B. The bond was issued with a coupon of 10%. Currently, yield for a similar issue is 12%. Therefore, interest rates have risen subsequent to the issuance of the bond or the credit quality of the bond has deteriorated. When interest rates rise, yields on bonds already trading must also rise. What causes this is a drop in the dollar price of the issue - the bond now trades at a discount.

Answer 11

The best answer is C. FINRA requires that a portfolio margin account be opened as an options account that is qualified for naked options writing. This requires a more-detailed suitability determination and requires not only branch manager approval, but also separate approval of the designated Registered Options Principal (this is the "main office" ROP in charge of compliance as opposed to a regular branch manager-ROP). The customer must be provided with a portfolio margin risk disclosure document at, or prior to, the initial transaction in the account and must sign an acknowledgment that he or she has read and understands the disclosure document prior to the initial transaction in the account. There is no requirement for the member firm to get each customer account approved by the CBOE or FINRA.

Answer 12

The best answer is B. Prospectuses are required for any "offer" of a new issue that is not exempt from the provisions of the Securities Act of 1933. Every mutual fund share that is sold is "newly issued" by that fund, therefore mutual funds must be offered with a prospectus. A letter to customers that recommends the purchase of a mutual fund constitutes an "offer" of a new issue under the Securities Act of 1933. Any offer must be accompanied with, or preceded by, a prospectus. The prospectus need not be approved by the principal, since it is lawyer prepared and has been filed with the SEC; however, the solicitation letter to customers must be approved in advance by the principal.

Answer 13

The best answer is B. This portfolio is concentrated in Emerging Markets stocks (40% of the portfolio). These are stocks in fast-growing "Third World" countries that do not have strong political systems and legal protections. Say, for example, that the fund holds stocks of companies based in Pakistan, the government is overthrown, and the new government nationalizes the companies that are owned by the fund, giving no compensation to the ex-shareholders, so they lose their investment. This is called "political risk."

Answer 14

The best answer is B. Coincident indicators include personal income levels, employment levels and the index of industrial production. These all show how the economy is performing at the current time. Employment duration is a lagging indicator - it shows how long someone was employed before losing their job - so it shows past history.

Answer 15

The best answer is C. Corporate bonds bought in the secondary market at a discount are termed "market discount bonds." There is an option of accreting the discount and paying tax annually on the accretion amount at full tax rates; or of waiting until the bond is redeemed or sold to pay the tax on the earned market discount at full tax rates. If the holder accretes the bond and holds it until maturity, there is no capital gain or loss, since the entire discount has been accreted and taxed over the bond's life. If the holder opts not to accrete the bond, the bond will be redeemed at par and the entire market discount is taxed as interest income received at maturity (not as capital gains).

Answer 16

The best answer is D. FINRA defines communications with the public as either: * Correspondence: A communication made available to 25 or fewer existing or prospective retail clients * Retail Communication: A communication made available to more than 25 existing or prospective retail clients Retail communications must be approved by a principal prior to use and can be required to be filed with FINRA. In contrast, correspondence is only subject to "post use review and approval" (as long as the firm has appropriate supervisory procedures in place) and cannot be required to be filed with FINRA. A "Retail Communication" is a very broad definition that includes advertising (seen by the general public) and sales literature (seen by a specific audience). * Advertising: TV, radio, newsprint, billboards, websites, internet bulletin boards * Sales Literature: Research reports, market letters or form letters delivered to more than 25 existing or prospective retail clients, scripted speeches delivered to more than 25 existing or prospective retail clients, password-protected websites Since this speech is being given to 50 retail attendees, it falls under the "Retail Communication" definition and requires prior principal approval. There is no prohibition on comparing performance to that of a recognized benchmark, such as the Standard and Poor's 500 Average - this is the industry norm. What is not permitted is a projection or promise of future performance. All speeches are supposed to be informational, not promotional, in nature.

Answer 17

The best answer is B. The interest income from non-essential private use municipal bond issues is included as a "tax preference" item in the Alternative Minimum Tax. Both School District Bonds and Public Housing bonds are considered to be "essential public uses" and are not subject to AMT. Industrial Revenue Bond issues are used to finance construction of plants for corporate lessors and are "private use." Redevelopment bond issues are used to finance rehabilitation of plant and offices, typically for corporate use, and also are considered to be "private purpose."

Answer 18

The best answer is D. When a put is purchased on a stock on the same day that the stock is bought, the put is said to be "married" to the stock position. The only reason the option was purchased was to protect the customer against loss if the market for the stock fell. It was not purchased to speculate in the market. The IRS treats a "married" put as part of the cost basis of the stock. Notice that, therefore, the put premium cannot be deducted as a capital loss if the put expires worthless; instead, it has increased the stock's cost basis and will reduce any potential capital gain, when, and if, the stock is sold. As one would expect, this is the tax treatment that is most beneficial to the IRS and least beneficial to the investor. The cost of the stock is $36 + $6 premium = $42 per share. When the stock is sold the customer reports a capital gain or loss based on the sale price of the stock.

Answer 19

The best answer is D. Structured products are securities based on, or derived from, a basket of securities, an index, or other securities, commodities or currencies. There are many types of structured products, but generally they consist of a "bond" portion, which pays interest based on the performance of a well known index such as the S&P 500 Index or NASDAQ 100 Index. However, there is most often a cap on the maximum annual return. For example, if there is a 15% cap, and the NASDAQ 100 Index goes up by 18% that year, the structured product will only yield 15%. In addition, structured products have a derivative component (an embedded option) that allows the holder to sell the security back to the issuer (at par) at maturity, protecting principal. These are often marketed as debt instruments, but that is not really the case. Structured products are created by many different brokerage firms and each firm's version is somewhat different. They can be exchange listed, though trading is typically pretty thin.

Answer 20

The best answer is B. The value of a right "ex rights" is: (Adjusted market price - subscription price) / N (24 - 19) / 10 = 5 / 10 = $.50 Value "Ex Rights" Notice that the market price of $24 was already adjusted on the ex date by the exchange where the stock trades. Do not try and reduce the price again!

Answer 21

The best answer is A. This account sets up as: LMV - DR = EQ $20,000 - $15,000 = $5,000 (25%) This account is at minimum maintenance margin. If the SMA of $1,000 were borrowed from the account, the margin would go below 25% minimum maintenance. If the withdrawal causes the account to fall below minimum maintenance, no withdrawal is permitted. SMA can only be borrowed if the account is above minimum maintenance margin - and it can only be borrowed in an amount that brings the account to maintenance - not below maintenance.

Answer 22

The best answer is B. SEC Rule 10b-5-1 allows officers of publicly held companies (statutory insiders) to establish "pre-arranged trading plans" that set future transaction dates and amounts of that issuer's securities; or that specify algorithms that establish the transaction dates and amounts. As long as the officer does not deviate from the plan, the officer is given a "safe harbor" from being accused of insider trading based on those trades.

Answer 23

The best answer is B. The investor has a gain on the short stock position that will evaporate as the market rises. To protect the gain, the stock must be bought in if the market begins to rise. A buy stop order is executed in a rising market, and would be appropriate to close the short position if the market rises. The purchase of a call allows the stock to be bought in at the strike price if the market rises, protecting the gain. If a put is sold and the market rises, the put will expire worthless, and the writer will keep the premium received. This amount of premium received will reduce any loss on the short stock position if the market rises. The purchase of a put will not protect the gain, since it allows the stock to be sold at the strike price. If exercised, the long put will cause the customer to have sold the stock TWICE.

Answer 24

The best answer is C. Growth investors select investments based simply on growth in earnings or growth in market price; on the assumption that these will always be the best performing investments. Value investors invest in undervalued companies - as measured by low Price/Earnings ratios and low Price/Book Value ratios - that have good market prospects. Thus, they also consider product line, market share, management, etc.

Answer 25

The best answer is D. A "strangle" is a specific variation of a combination, where both contracts are "out the money." Choice A is a short straddle; Choice C is a long straddle. Straddles have the same strike price and expiration. Combinations have different strike prices and/or expirations. A long strangle is the purchase of an "out the money" call and an "out the money" put. The "idea" behind the strategy is to profit from a volatile market, just like a long straddle. Because both contracts are "out the money," the premium cost will be lower. However, the market must move more sharply (either up or down) in order for the position to be profitable. In Choice B, the 50 call is in the money by $4 (market = $54) and the 60 put is in the money by $6 (market = $54), so while this is a combination, this is not a strangle. A short strangle is the sale of an "out the money" call and an "out the money" put. The "idea" behind the strategy is to profit from a stable market, just like a short straddle. Because both contracts are "out the money," the premiums collected will be lower. However, the market must move more sharply (either up or down) in order for the position to become unprofitable. In Choice D, the 60 call is out the money by $6 (market = $54) and the 50 put is out the money by $4 (market = $54), so this is a short strangle.

Answer 26

The best answer is D. Interest accrues on a 30 day month / 360 day year for corporate bonds, with interest accruing up to, but not including settlement. The bonds were purchased on Wednesday, April 19th. Settlement takes place 3 business days after purchase on Monday, April 24th, thus interest accrues through the 23rd of April. Since the last interest payment was made on March 1st, 30 days are due for March; and 23 are due for April; for a total of 53 days of accrued interest due.

Answer 27

The best answer is C. State registration is not required for those securities that are exempt under the Federal Securities Acts, such as U.S. Government and Municipal debt. State laws typically exempt listed companies from registering in the state under what is known as a "blue chip exemption." The reasoning is that if the company is solid enough to be listed on an exchange and it is registered with the SEC, then that is sufficient. Because an issuer has filed registration statements previously in a state does not exempt that issuer from filing for a new proposed issue (the logic for this is that the State wants to collect a registration fee for that issue!)

Answer 28

The best answer is D. The Specialist (now renamed the DMM - Designated Market Maker) is the assigned market maker in a security on the NYSE floor. The Floor Broker handles orders as agent for retail member firms. The Two Dollar Broker executes orders for retail member firms, usually when its Floor Brokers are too busy. The name comes from the fact that they used to charge $2 per trade. A Competitive Trader is a person that trades for his own account (this really doesn't happen any more, but it is tested).

Answer 29

The best answer is B. If the customer wants to "cash out" the position, tender is not appropriate since the offer is contingent on 64% of the shares being tendered. The best procedure is simply to sell the long position at the new higher market price.

Answer 30

The best answer is B. In its "front running" rule, FINRA gives an exception to the prohibition on a member firm placing orders to trade a stock prior to the filling of a large block order if the firm has information barriers in place. If this is the case, the front running prohibition only falls on the people at the firm who know about the existence of the large block order. Persons placing orders to buy XYZ stock at the firm who have no knowledge of the impending block purchase are exempted from the "front running" rule because, with effective information barriers in place, they could not have known about the large trade that is about to be placed.

Answer 31

The best answer is C. If an employee of a FINRA/NASD member firm wishes to open an account at that firm, then no special procedures are required. However, if an employee of a FINRA/NASD member wishes to open an account at another member firm, or at a non-member bank or investment adviser, then prior notice must be given to the employer member; and duplicate confirmations must be made available to the employer member upon written request.

Answer 32

The best answer is D. Since the homeowners are prepaying their mortgages faster than expected, the issuer will use the excess monies to call in outstanding bonds, rather than continue to pay interest on them. This call results from an extraordinary event, and is at the option of the issuer. Hence, it is an extraordinary optional call.

Answer 33

The best answer is B. If a customer sells a call against stock that he or she owns, a premium is collected. This reduces the cost of the stock position (hence reducing the potential loss on the stock position) and gives the call writer premium income. In return for this, the call writer gives up any "upside" gain potential on that stock (above the strike price of the call). Therefore, upside price appreciation is limited.

Answer 34

The best answer is D. Custodian accounts opened under either the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA) can be opened by any adult for any minor, with no limitation on the dollar amount that can be donated into the account. There is no tax deduction for the donor for the contribution and earnings in the account are taxable annually to the minor. Because all of the funds in the account represent "after-tax" dollars, there is no tax liability when funds are withdrawn. Coverdell Education Savings accounts can be opened by any adult for a minor, with annual contributions into the account limited to $2,000. The contribution amount is not deductible. Earnings build tax-deferred; and when distributions commence, as long as they are used to pay for that minor's education expenses, the distribution is not taxable (a major tax benefit). Also note that high earning individuals cannot open Coverdell ESAs.

Answer 35

The best answer is B. Regulation T does not cover "delivery versus payment" transactions. These are specified by mutual funds when they purchase securities. The fund specifies that the securities be delivered to the fund's custodian bank, which is authorized to pay upon delivery. FINRA requires that the funds to pay be on deposit at the custodian bank "promptly" (the same as the wording of Regulation T) and also requires that the transaction be settled no later than 35 days from trade date.

Answer 36

The best answer is C. An agent is a broker who is middleman in a transaction, earning a commission. A dealer is a market maker, who is a principal in a transaction, earning a mark-up or mark-down.

Answer 37

The best answer is B. A variable annuity contract places no dollar limit on contributions; and the income earned on investments is tax deferred during the accumulation period. Thus, the customer would be allowed to contribute $12,000 per year; and would receive the benefit of the tax deferred build up. At age 65, she could annuitize and convert the value of the account into an annuity contract that would make payments for her life. This is the best choice offered. Income bonds only pay income if the corporation earns enough, so these are not suitable for retirement income. An IRA account only allows a $5,500 contribution for an individual in 2016, so this does not meet the customer's desire to invest $12,000 per year. Finally high yield bonds are speculative, and are not suitable for retirement income.

Answer 38

The best answer is C. Private insurers such as MBIA (Municipal Bond Insurance Association, Inc.), AMBAC (American Municipal Bond Assurance Corporation) and FGIC (Financial Guaranty Insurance Corporation), insure municipal bond issues.

Answer 39

The best answer is C. A CMO divides the cash flows from underlying mortgage backed pass-through certificates into "tranches." Each tranche, in effect, represents a differing expected maturity, hence each tranche has a different level of market risk. Since each tranche represents a differing maturity, the yield on each will differ. New CMOs have special classes of tranches called PAC (Planned Amortization Class) and TAC (Targeted Amortization Class) tranches. These tranches are given a greater certainty of repayment at the projected date, by allocating earlier than expected repayments to so-called "companion" tranches, before prepayments are applied to these tranches. Credit risk for CMO tranches is the same for all tranches, since it is based on the quality of the underlying mortgage backed securities held in trust.

Answer 40

The best answer is C. FINRA defines communications with the public as either: * Correspondence: A communication made available to 25 or fewer existing or prospective retail clients * Retail Communication: A communication made available to more than 25 existing or prospective retail clients Retail communications must be approved by a principal prior to use and can be required to be filed with FINRA. In contrast, correspondence is only subject to "post use review and approval" as long as the firm has appropriate supervisory procedures in place and cannot be required to be filed with FINRA. A "Retail Communication" is a very broad definition that includes advertising (seen by the general public) and sales literature (seen by a specific audience). A direct mailing to more than 25 existing or retail clients is a retail communication that is sales literature. A password protected website is a retail communication that is sales literature, since it is seen by a specific audience. An internet bulletin board is a retail communication that is advertising, since it is seen by the general public. Institutional communications are excluded from the "retail communications" definition, approval and filing rules because institutions are sophisticated investors who know what they are doing.

Answer 41

The best answer is C. Ad valorem taxes back general obligation bonds. Revenue bonds can be backed by any source of revenue other than ad valorem taxes. These sources include revenue from facility operations, grants, excise taxes, or other non-ad valorem taxes like sales and income taxes.

Answer 42

The best answer is A. If a person (other than a charity) receives a gift of property upon which no gift tax has been paid, the cost basis to the recipient is the original cost basis of that security - in this case $15 per share. We know that no gift tax was due, since the aggregate value of the securities at the time the gift was given was 100 x $30 per share = $3,000, which is under the annual gift exclusion of $14,000 in 2016.

Answer 43

The best answer is D. A corporation cannot retire its debt prior to maturity by prepaying the bondholders - there is no such thing for corporate debt securities. There are only four ways in which a corporation can redeem its debt prior to maturity. It can purchase outstanding debt securities in the open market, which it would do if the market price of the bonds was below the call price. It can make a formal tender offer to all bondholders to buy outstanding debt securities at a price determined by the issuer. It can call outstanding securities at pre-established dates and prices. Finally, it can force conversion of convertible bonds that have appreciated in the market by calling them. Rather than tender the bonds to the issuer at the lower call price; the convertible bondholders will convert into the more valuable equivalent number of shares of common stock.

Answer 44

The best answer is A. Interest is charged on the debit, just as interest is charged on a credit card loan. The interest is added to the loan amount, increasing the debit balance. As a result, equity falls by the same amount (Note: Changes in equity result from either a change in the market value; or a change in the debit balance).

Answer 45

The best answer is B. The ACT system takes the details of completed trades and reports the trade to the Network C (NASDAQ) Tape; to the contra-party to the trade for comparison; and to the clearing corporation for settlement. OATS is the Order Audit Trail System - which automates order entry for NYSE, NYSE-MKT (AMEX), NASDAQ and OTC issues.

Answer 46

The best answer is B. Foreign currencies trade in the "Interbank" market. If the dollar declines against foreign currencies, U.S. goods become cheaper to foreigners. This will stimulate exports and domestic economic growth. If the dollar rises against foreign currencies, foreign goods become cheaper in the U.S. This will stimulate imports, and shift production out of the U.S. to other countries. American Depositary Receipts are vehicles for foreign securities to be traded in the United States. ADRs are only traded in the United States, and are denominated in U.S. dollars, so there is no direct effect of foreign currency price movements on ADR prices (though an argument can be made that the foreign stock held in trust pays dividends in the foreign currency; and that these dividends are converted to U.S. dollars to be paid to ADR holders; that currency price movements have some impact on ADR values).

Answer 47

The best answer is B. Issuers are prohibited from selling call options against their underlying stock. If they were exercised, they could simply issue more shares to deliver on the exercise notice, diluting existing stockholder's equity. Furthermore, the issuance of the new shares would require a registration with the SEC. Thus, issuers are prohibited from selling calls against their own stock.

Answer 48

The best answer is D. Lipper and Morningstar are ratings services that rate mutual funds and ETFs. Standard and Poor's rates bonds mutual funds and individual stock issues. Finally, member firm research departments produce reports that rate individual stock issues.

Answer 49

The best answer is C. In a deflationary period, prices fall. Therefore, money buys "more" in real terms. As deflation occurs, interest rates will drop, causing long term debt prices to rise. Because interest rates will be lower, issuers are more likely to sell fixed income securities - it costs them less to finance. Issuers are likely to sell non-callable issues because interest rates are low, and there is no need to call in such issues when the financing rates are so favorable. Callable issues are generally sold in periods of high interest rates, so the issuer can call in the securities if interest rates fall subsequently.

Answer 50

The best answer is C. Money market funds usually do not impose sales charges. Fund dividends are taxable, whether or not they are automatically reinvested in additional fund shares.

Answer 51

The best answer is B. The Options Clearing Corporation is the technical issuer and guarantor of listed options contracts. The O.C.C. standardizes the options contracts that it will issue to increase potential investor participation. If there is an exercise of an option contract, it is the O.C.C. who assigns the exercise notice to a writer of that contract. Trading of listed options contracts takes place on exchange floors, under the rules of the exchange. The O.C.C. does not establish options trading rules - these are established by the exchanges.

Answer 52

The best answer is A. Interest rate risk only affects fixed income securities. As interest rates rise, the stream of future fixed interest payments and final principal repayment are devalued, reducing the current value of the bond. This risk would not affect foreign currencies, which do not give investors an income stream. Speculators in foreign currencies are simply placing bets on the future value of that currency. They assume political risk, exchange rate risk, and market risk. Market risk in this case is simply the risk of being on the wrong "side" of the market - e.g., being long the currency only to have its value fall; or short the currency only to have its value rise.

Answer 53

The best answer is A. The amount of the good faith check is determined by the issuer and this is set forth in the Official Notice of Sale. The good faith check amount that must be deposited by interested bidders is typically 1% or 2% of the par value of the bonds.

Answer 54

The best answer is B. A spread consists of the purchase and sale of the same type of option with a different strike price and/or expiration - therefore Choices A and C are incorrect. In a bull put spread (the same as a short put spread), the customer purchases the lower strike price (lower premium since the contract allows the holder to sell at a lower price) and sells the one with the higher strike (higher premium, since the contract allows the holder to sell at a higher price). The spread results in a credit received, which the customer wants to keep. If the market rises, then the contracts expire "out the money" and the net premium received is kept. This is the maximum gain. If the market falls, in this case below $30, then both contracts are exercised at a loss to the customer. If the market falls below $30, then the customer is obligated to buy stock at $40; that he sells at $30; for a 10 point loss (net of any premium credit received). This is the maximum potential loss.

Answer 55

The best answer is D. Indications of interest which are accepted prior to the effective date of an issue in registration are not binding. The customer or the firm can cancel the indication at any time without penalty. During the cooling off period, orders cannot be accepted (these are binding) because the final prospectus is not yet available. Under the Securities Act of 1933, an offer or sale can only be made with the final prospectus. The final prospectus is available and sales commence as of the effective date.

Answer 56

The best answer is D. The minimum non-competitive bid amount in the weekly Treasury Bill auction is $100; the maximum non-competitive bid amount is $5,000,000.

Answer 57

The best answer is C. When opening an account for a non-resident alien, the customer's current passport number (from their country) must be obtained, as well as a U.S. tax identification number for that person.

Answer 58

The best answer is A. When talking about mutual funds, the Fund Sponsor is the Fund Underwriter. Broker-dealers may join in a selling group to sell these funds, acting as agent only. Public Offering Price of a fund is the same as the fund's ask price.

Answer 59

The best answer is A. Under the circuit breaker rule, if the Standard and Poor's 500 Index moves down by 7% or more from the prior day's closing price, the listed equity markets will be shut down for 15 minutes. After reopening, if the index falls by a total of 13% or more from the prior day's closing price, the markets will close again for 15 minutes. This is intended to allow investors to calmly evaluate market conditions, so that a "domino effect" of panic selling does not occur. Finally, after reopening, if the index falls by a total of 20%, the markets will close until the next day. Also note that any 7% or 13% drop that occurs after 3:25 PM will not close the markets - they will stay open until the 4:00 PM close. This is the case because funds base their NAVs on closing prices, and it was felt that having a lack of pricing to investors would be overly disruptive. On the other hand, any 20% drop at any time will shut the markets until the next day, since such a dramatic price drop is usually caused by a major news event.

Answer 60

The best answer is A. FINRA requires that, if a fee based account is recommended to a customer, the customer must receive a disclosure document that details all services provided and costs involved, at, or prior to, account opening.

Answer 61

The best answer is C. Regular way trades of listed stocks settle 3 business days after trade date. In contrast, regular way trades of listed stock options settle 1 business day after trade date.

Answer 62

The best answer is C. If a customer fails to deliver on a sale, this is not known until settlement date. As of settlement, the customer has 10 business days to deliver the stock, or the position will be bought in by the brokerage firm.

Answer 63

The best answer is D. If the market price remains the same at expiration, "at the money" options contracts will expire. This means that the writer of the contract will earn the premium and the holder will lose the premium. Since a long straddle is the purchase of a call and a put on the same stock with the same strike price and expiration, the buyer of an "at the money" straddle will lose the premiums paid if the stock price remains unchanged because both positions will expire. On the other hand, the writer of that straddle, the sale of a call and a put on the same stock, will earn the premiums.

Answer 64

The best answer is C. All options trades are effected on exchange floors, with the CBOE - Chicago Board Options Exchange being the largest options exchange. The other exchanges that trade options are the American Stock Exchange (AMEX), Philadelphia Stock Exchange (PHLX); and Pacific Stock Exchange (PSE). No options are traded on NASDAQ.

Answer 65

The best answer is D. Regulation SP ("Statement of Privacy") requires financial institutions to provide retail customers with a copy of their privacy policies and procedures, including whether customer information is provided to third parties; and requires that customers be given the ability to "opt out" of any such disclosures.

Answer 66

The best answer is B. The Specialist (now called the DMM - Designated Market Maker) only accepts "Day" orders and "GTC" orders on his book. If a customer wants an order canceled at the end of a week, this is the responsibility of the member firm that entered the order. The ordered would be entered as "GTC" by the member, and if not executed by the end of the week, would be canceled from the Specialist/DMM's book by the member.

Answer 67

The best answer is C. Rule 103 of Regulation M covers the situation where a firm in the underwriting group for an add-on securities offering also happens to be a market maker in the stock. The worry of the SEC is that the market maker, during the 20-day cooling off period, would be tempted to aggressively buy the stock to push up the market price. This, in turn, would push up the POP when it is set just prior to the effective date, which would increase the underwriters' spread. To stop this, the SEC requires that either the market maker stop making a market until the effective date; or alternatively, the market maker must act as a "passive" market maker - meaning that it cannot buy the stock at a price higher than the current high bid.

Answer 68

The best answer is D. A long sale is the sale of shares which the customer owns and will deliver on settlement date. A short sale is the sale of shares which the customer does not own. Therefore, in order to effect delivery on settlement date, the short seller must borrow the shares. In essence, a short seller is selling borrowed shares.

Answer 69

The best answer is B. The customer paid $48 for the stock and $5 for the put, for a total outlay of $53. To breakeven, the stock must be sold for $53.

Answer 70

The best answer is A. A customer with a short stock / short put position loses if the market rises. The customer sold the stock at $37 and collected $4 in premiums, for a total of $41. To break even, the stock must be bought for this amount. If the stock is bought for more than $41, the customer loses. Therefore, a loss is experienced at $42.

Answer 71

The best answer is A. The "valuation date" for coverage purposes in an SIPC liquidation is the date that SIPC files in court to be the trustee in the bankruptcy of the failed broker-dealer. As of that date, the securities were valued at $30,000. However, because the customer had a $10,000 loan against the securities (debit balance), SIPC will cover the customer account only for $20,000 of equity.

Answer 72

The best answer is B. Rule 147 exempts "intrastate" issues from registration with the SEC. However, the issue is still subject to state (blue-sky) registration. To obtain the 147 exemption, both the issuer and the purchaser must be state residents. Resale is restricted to state residents for 9 months following the offering; thereafter, the issue can be sold interstate. Note, however, that because these securities were never registered with the SEC, they cannot be publicly traded. The only way to resell them is in a "private transaction."

Answer 73

The best answer is C. Auction Rate Securities are long-term bonds that have the interest rate reset weekly (or sometimes monthly) via a Dutch auction. This gives the issuer the benefit of lower short-term interest rates as compared to those of a traditional long-term bond. The interest rate "steps-up" or "steps-down" as market interest rates move. Unlike variable rate demand notes, these securities do not have an embedded put option, so they cannot be "put" back to the issuer at the auction reset date. Instead, a holder of an ARS needs to find a buyer at the auction if it wishes to sell. A lack of bidders at the auction means that holders cannot sell these securities - which is exactly what happened when the market "froze" in early 2008. Broker-dealers that acted as agents for corporations and municipalities that issued ARSs would typically bid at the weekly auctions, but they pulled out as credit conditions worsened and the market imploded. The future for ARSs is pretty bleak, but they are tested.

Answer 74

The best answer is D. All municipal advertising must be approved in advance of use by a municipal principal or general securities principal and copies must be retained for 4 years (note in contrast that FINRA's rule is 3 years). Advertisements cannot be materially false or misleading. Official Statements, prospectuses, and other similar "lawyer prepared" documents are exempted from the advertising rules. Such documents are exempted because their content is legally dictated and is not promotional in nature. Form letters are defined as advertising, as are notices, circulars, reports, market letters and reprints of these items.

Answer 75

The best answer is A. Only 1 stabilizing bid is permitted at any time. The manager of the syndicate places the stabilizing bid on behalf of the syndicate.

Answer 76

The best answer is B. The selling concession is the discount given by the manager to the selling group members who place orders for the bonds.

Answer 77

The best answer is D. A copy of the options new account form is part of the Options Agreement that is sent to the customer, to be signed and returned within 15 days of account opening. The Options Agreement is a recap of the customer new account profile including the suitability determination and it qualifies the customer for a level of options trading, detailing which options transactions are permitted. If the signed agreement is not returned, you are prohibited from accepting new orders - only closing transactions are allowed.

Answer 78

The best answer is C. MSRB rules require that arbitration be used to settle disputes where a claim is initiated from broker-dealer to another broker-dealer; or clearing corporation to broker-dealer (Choices A and D). If a dispute exists where a broker-dealer has a claim against a customer and that customer has signed an arbitration agreement, then the matter must be resolved by arbitration (Choice B). On the other hand, if a broker-dealer initiates a claim against a customer and the customer has not signed an arbitration agreement, then the customer cannot be forced to arbitration (Choice C).

Answer 79

The best answer is D. FINRA prohibits "parking" of licenses when an individual is not affiliated with a member firm. If that person remains unaffiliated for 2 years, all licenses lapse.

Answer 80

The best answer is C. The AIR - Assumed Interest Rate - shown in a variable annuity prospectus illustrates the annuity that will be available if the separate account performs at that interest rate. It is conservatively estimated, but is no guarantee of a specific return.

Answer 81

The best answer is B. Because of the complexity of structured products, this is where FINRA first came up with its "3 Level" suitability rule (Reasonable basis suitability; Customer-specific suitability; and Quantitative suitability). It proved so successful that FINRA applied the same rule to all recommendations, but, of course, they did not rescind the separate rule for this product! FINRA describes the typical structured product as a a zero-coupon "synthetic bond" that gives a return tied to a market index such as the NASDAQ 100 Index or the Standard and Poor's 500 Index; and which has a maturity based on an embedded option; FINRA requires that the member firm perform a "reasonable basis" suitability determination to evaluate the product's potential rewards and risks (relative to other similar structured products offered by other firms). Once a "reasonable basis" suitability determination has been completed, then the member firm can offer the structured product only to its customers that are suitable for that investment. This is "customer specific" suitability. It cannot be recommended to all customers, since a specific suitability determination is required for each recommendation. Furthermore, any representative recommending the product must understand the product's features and risks and be able to communicate these to customers.