Test 1 Flashcards
A “SPDR” is a(n):
A. ETF
B. ADR
C. ARS
D. VRDO
The best answer is A.
The “SPDR” is the Standard and Poor’s Depositary Receipt, one of the first index-ETFs. It is based on the composition of the Standard and Poor’s 500 Index. An ADR is an American Depositary Receipt. This is the vehicle for trading foreign stocks in the U.S. An ARS is an Auction Rate Security and a VRDO is a Variable Rate Demand Obligation.
When comparing fixed annuity contracts to variable annuity contracts, the customer should be made aware that:
I fixed annuities guarantee a rate of return that is not affected by investment risk
II variable annuities guarantee a rate of return that is not affected by investment risk
III fixed annuity payments depend on the performance of the securities held in the underlying separate account
IV variable annuity payments depend on the performance of the securities held in the underlying separate account
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is B.
Fixed annuities are an insurance product that guarantee a fixed return to the purchaser - here the insurance company bears the investment risk. On the other hand, variable annuities do not guarantee a fixed return - the annuity payment will vary with the performance of the underlying mutual fund investments that fund the annuity.
An option contract that is exercisable only on the expiration date is a(n):
A. spot contract
B. American contract
C. European contract
D. cash contract
The best answer is C.
“American” style options are exercisable at any time until expiration. “European” style options are only exercisable on the expiration date, not before.
In November, a customer buys 1 ABC Jan 70 Call @ $4 when the market price of ABC is $71. If the customer closes out the position prior to expiration by selling the call at $3, the gain or loss is?
A. $100 gain
B. $100 loss
C. $300 gain
D. $400 gain
The best answer is B.
The customer bought the call (opening purchase) for a $4 premium and then closed with a sale of the contract at $3 for a $100 loss.
Under Keogh rules, distributions from a Keogh Plan must commence the year after the individual turns age:
A. 55
B. 59 1/2
C. 60 1/2
D. 70 1/2
The best answer is D.
Under the Keogh rules, any distributions from a Keogh Plan must start no later than April 1st of the year following the year that the individual reaches the age of 70 1/2.
A bond trade takes place at 10:00AM on Monday, July 10th for “cash”. Settlement takes place:
A. before 2:30 PM on July 10th
B. before 2:30 PM on July 11th
C. during business hours on July 15th
D. during business hours on July 17th
The best answer is A.
Cash settlement is same day settlement, before 2:30 PM.
To sell variable annuities, salespersons must be registered with (the):
I FINRA
II State Insurance Commission
III State Banking Commission
IV State Securities Commission
A. I and IV only
B. II and III only
C. I, II and IV
D. I, II, III, IV
The best answer is C.
To sell a variable annuity, a salesperson must be registered with FINRA with either a Series 6 (mutual funds and variable annuities only) license or Series 7 (general securities) license. The salesperson must also be registered in the state to sell this non-exempt security under the state’s “Blue Sky” laws. In addition, the salesperson must be registered with the State Insurance Commission (since these products are sold by insurance companies; and insurance companies are regulated only at the state level). Banking regulators have nothing to do with securities.
Monetarist Theory states that the economy is stimulated by:
A. the actions of the Federal Reserve
B. increased Government spending
C. tax rate reductions
D. decreased Government spending
The best answer is A.
Monetarists claim that the actions of the Federal Reserve Board to tighten or loosen credit are the driving force behind economic cycles.
Which of the following option positions is used to hedge a short stock position?
A. long call
B. short call
C. long put
D. short put
The best answer is A.
When one has a short stock position, borrowed shares have been sold with the agreement that the customer will buy back the position at a later date. If the market rises, the loss potential is unlimited. The purchase of a call allows the stock to be bought in at a fixed price, limiting upside risk.
A non-durable power of attorney signed by a customer:
I remains in force upon the death of the customer
II is terminated upon the death of the customer
III remains in force upon the mental incapacitation of the customer
IV is terminated upon the mental incapacitation of the customer
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is D.
Any power of attorney, durable or non-durable, is terminated when a customer dies. The distinction between a durable and a non-durable power of attorney is that a non-durable power of attorney terminates if the grantor is mentally incapacitated whereas durable power of attorney remains in force if the grantor is mentally incapacitated.
At issuance, the exercise price of a warrant is set at:
A. a discount to the current market price of that issuer’s common stock
B. the current market price of that issuer’s common stock
C. a premium to the current market price of that issuer’s common stock
D. any of the above, depending on market conditions
The best answer is C.
At issuance, the exercise price of a warrant is set higher than the current market price of the stock. The stock’s price must appreciate for the warrant to have any intrinsic value. Stock warrants can be attached to preferred stock and bond offerings to make them more attractive to potential purchasers.
Which of the following would be described as an oil and gas program overriding royalty interest arrangement?
A. The general partner bears no costs; and gets a percentage of oil revenue from the first barrel sold
B. The general partner bears the tangible costs; and the limited partner bears the intangible drilling costs
C. The general partner bears the intangible drilling costs; and the limited partner bears the tangible costs
D. The general partner defers taking a percentage of oil revenues until all costs laid out by the limited partners are recovered
The best answer is A.
Choice A describes an overriding royalty interest. In such a sharing arrangement, the limited partners bear all costs and the general partner puts up nothing. The general and limited partners share oil revenue from the first barrel sold.
Choice B describes a functional allocation sharing arrangement. In such a sharing arrangement, the limited partners bear the immediately deductible intangible drilling costs, while the general partner bears the tangible costs (recovered through depreciation over a period of time).
Choice C doesn’t exist.
Choice D describes a “reversionary working interest” sharing arrangement, where the general partner puts up nothing, and the limited partners pay for everything. However, the general partner defers taking his or her percentage of oil revenue until all limited partner costs are recovered.
Underwriting selling group members act as:
A. agent for the syndicate, selling the new issue and take liability for any unsold portion of the new issue
B. agent for the syndicate, selling the new issue but take no liability for any unsold portion of the new issue
C. principal for the syndicate, selling the new issue and take liability for any unsold portion of the new issue
D. principal for the syndicate, selling the new issue but take no liability for any unsold portion of the new issue
The best answer is B.
Selling group members in a new issue underwriting group act as agent for the syndicate, helping the syndicate to sell the new issue, earning a selling concession on each share (or bond) sold. However, unlike the syndicate members, they take no liability for unsold shares.
Which rollovers are permitted without tax due?
I Exchange of one variable annuity contract for another variable annuity contract
II Exchange of a life insurance contract for a variable annuity contract
III Exchange of a variable annuity contract for a life insurance contract
IV Exchange of a life insurance contract for another life insurance contract
A. I and II only
B. III and IV only
C. I, II, IV
D. I, II, III, IV
The best answer is C.
Section 1035 “tax-free” exchanges permit “like-for-like” exchanges without tax due. Thus, Choices I and IV are tax free. It also permits a life insurance policy to be exchanged for a variable annuity without tax due, making Choice II true. Of course, the IRS is happy about this because the taxable annuity payments will start earlier than the payment of the taxable death benefit.
However, a variable annuity cannot be exchanged tax-free for an insurance policy under this tax rule, making Choice III false. If there is a gain in the separate account, it would be taxed upon exchange for a life insurance policy.
OEX index LEAPs are issued:
A. American style
B. European style
C. Asian style
D. Either American or European style
The best answer is A.
Regular stock options, LEAPs on these issues, OEX index options, and OEX LEAPs, are all American style options that are exercisable by the holder at any time.
Almost all other index options, on the other hand, are European style options. Such an option is only exercisable at expiration, not before. Prior to expiration, the contract can be traded; but cannot be exercised.
When a variable annuity contract is “annuitized,” which statements are TRUE?
I The number of annuity units is fixed
II The number of annuity units is variable
III The annuity unit value is fixed
IV The annuity unit value is variable
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is B.
When a variable annuity contract is annuitized, the accumulation units are converted into a fixed number of annuity units. This calculation is based on the dollar value of the accumulation units, the annuity option chosen, and the customer’s expected mortality. The fixed number of annuity units times the unit value (which varies with the performance of the mutual fund held in the separate account) determines the monthly payment.
Which of the following securities deliveries are “good”?
I Guardian securities with an assignment performed by the legal guardian
II Trust securities with an assignment performed by the Trustee
III Partnership securities with an assignment performed by a partner designated in the Partnership Agreement
IV Custodian securities with an assignment performed by the recipient of the gift
A. II, III, IV
B. I, II, III
C. I, II, IV
D. I, III, IV
The best answer is B.
Custodian account securities cannot be assigned by the minor. The minor has no legal authority. Any assignment must be made by the custodian. Guardian account securities are assigned by the legal court appointed guardian; partnership securities are assigned by a partner designated in the partnership agreement; and trust account securities must be assigned by the designated trustee.
An order ticket is filled out and sent for execution to the NYSE. After being executed on the NYSE, it is discovered that the account number is incorrect. Under FINRA rules, the account number may be changed to the correct one by the:
A. Registered Representative
B. Specialist (DMM)
C. Branch office manager
D. Floor Governor
The best answer is C.
Under FINRA rules, alterations to order tickets are prohibited, unless the alteration is approved in writing by a “designated person” such as a branch office manager. This person must understand all of the facts surrounding the alteration before approving of the change, and is responsible for the change.
A customer buys 2 ABC Jan 60 Puts @ $4 when the market price of ABC is $59. The breakeven point is:
A. $52
B. $56
C. $64
D. $68
The best answer is B.
The holder of the put paid a $4 premium per share for the right to sell ABC stock at $60. The customer’s net sale proceeds upon exercise equals $56 per share. To breakeven, the customer must buy the stock in the market at this price. To summarize, the formula for breakeven on a long put is:
Long put breakeven = strike price - premium
Which individuals can join together and qualify for a breakpoint on their aggregate purchases of mutual funds?
A. Family members in the same household
B. Members of an investment club
C. Limited partners who form a partnership to make the purchase
D. All of the above
The best answer is A.
Unrelated investors cannot “join together” to aggregate their purchases and get the benefit of a breakpoint. However, mutual fund companies will aggregate purchases of immediate family members in the same household and give them the benefit of the breakpoint.
Which statements are TRUE about Eurodollar bonds?
I The bonds are issued in bearer form
II U.S. corporate issuers are not subject to foreign currency risk
III Foreign corporate issuers are not subject to foreign currency risk
IV Trading is centered in the European market
A. I and II only
B. II and III only
C. I, II, IV
D. I, II, III, IV
The best answer is C.
Eurodollar bonds are issued in bearer form outside the U.S. Trading is centered in London. Because the bonds are payable only in dollars, U.S. based issuers do not run any foreign currency risk. If foreign currency values rise, it has no effect on the issuer who pays in dollars. On the other hand, foreign issuers of Eurodollar bonds are subject to foreign currency risk. For example, if a British corporation issues Eurodollar bonds, and the British Pound declines in value relative to the dollar, then it will cost the British company more (in Pounds) to pay the debt service on the bonds.
In a municipal bond contract, a “covenant of defeasance” would allow the issuer to:
A. redeem the issue in part or full at predetermined date(s) and prices
B. advance refund the issue under the terms specified in the bond contract
C. omit interest or principal repayments if coverage ratios decline below specified limits
D. reset interest rates periodically at predetermined dates based upon recognized interest rate indices
The best answer is B.
A municipal “covenant of defeasance” allows the issuer to “advance refund” the bond issue under the terms specified in the bond contract. An issuer will take advantage of this covenant if interest rates have dropped and the issue is not currently callable. To advance refund the issue, the issuer buys enough U.S. Government securities to meet the debt service requirements on the issue and places then in escrow with a trustee. The maturity on the U.S. Governments matches the maturity (or first call date) of the outstanding bonds. The interest payments received from the U.S. Governments are used to meet the debt service requirements. When the U.S. Governments mature, the proceeds are used to retire the issuer’s debt. By advance refunding, the issuer removes the existing debt as its own liability, freeing it to issue new debt at lower current interest rates.
A customer contributed $50,000 to a variable annuity contract. The account value has grown over the years and the NAV is now $70,000. The customer is now age 60, and takes a lump-sum distribution of $25,000 to pay for expenses. Which statement is TRUE?
A. The entire $25,000 distribution is not taxable
B. $5,000 of the distribution is taxable and $20,000 is not taxable
C. $20,000 of the distribution is taxable and $5,000 is not taxable
D. The entire $25,000 distribution is taxable
The best answer is C.
Variable annuity contributions are not tax-deductible. Earnings in the account build tax-deferred. When distributions are taken, tax is due on the portion that represents the tax-deferred build-up. The portion that represents the original contribution (already taxed dollars) is returned without any further tax due. If a lump-sum distribution is taken, the IRS uses LIFO (Last-In; First-Out) accounting. The Last-In Dollars are the tax-deferred build-up, so these are the First-Out dollars and they are 100% taxable! Any distribution above and beyond the build-up amount is a tax-free return of original capital.
In this example, the customer contributed $50,000 and this has grown, tax-deferred, to $70,000. If a lump sum distribution of $25,000 is taken, the first dollars out are the $20,000 of never taxed build-up and this amount is taxable. The remaining $5,000 is a partial tax-free return of the original $50,000 investment (which was not tax deductible).
If a couple that is not covered by another qualified retirement plan makes over $118,000 in year 2016, IRA contributions are:
I permitted
II not permitted
III tax deductible
IV not tax deductible
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is A.
Anyone can contribute to an IRA, whether covered by a pension plan or not. If a couple is not covered by a qualified plan, the contribution is tax deductible and the maximum that can be contributed is $5,500 each ($11,000 total). However, the contribution is not tax deductible for couples, where both are covered by qualified plans, who earn over $118,000 in year 2016 (the deduction phases out between $98,000 - $118,000 of income).
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
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.
During periods when interest rates are rising, which of the following statements are TRUE?
I Bonds with low coupon rates exhibit the greatest price volatility
II Bonds with high coupon rates exhibit the greatest price volatility
III To minimize price volatility, low coupon bonds are appropriate investments
IV To minimize price volatility, high coupon bonds are appropriate investments
A. I and III
B. I and IV
C. II and III
D. II and IV
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.
All of the following statements are true about SEP IRAs EXCEPT:
A. the plan is established by the employer
B. the plan allows for flexible contribution amounts
C. the amount that can be contributed is significantly greater than for a Traditional IRA
D. the contributions made are not deductible
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.
Which of the following statements are TRUE regarding the taxation of a municipal security?
I Capital gains from selling municipal bonds are exempt from Federal and State tax if the bond is owned by a resident of that State
II Capital gains from selling municipal bonds are subject to Federal and State tax
III Interest income received from municipal bonds is exempt from Federal and State tax if the bond is owned by a resident of that State
IV Interest income received from municipal bonds is subject to Federal and State tax
A. I and III
B. I and IV
C. II and III
D. II and IV
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.
On the same day in a margin account, a customer buys 5 ABC January 40 Calls @ $6 and sells 15 ABC January 50 Calls @ $1 when the market price of ABC is at $43. The maximum potential loss is:
A. $1,500
B. $2,000
C. $3,000
D. unlimited
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.
Which SEC rule gives a simplified registration process to offerings of no more than $50 million within a 12 month time frame?
A. Rule 144
B. Rule 144A
C. Regulation A
D. Regulation D
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.
Regarding the flow of funds set forth in a municipal bond contract, collected monies would FIRST be deposited to the:
A. Operations and Maintenance Fund
B. Debt Service Reserve Fund
C. Revenue Fund
D. Reserve Maintenance Fund
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.
A customer in the 28% tax bracket has $6,000 of capital gains and $9,000 of capital losses. How much unused loss is carried forward to the next tax year?
A. 0
B. $3,000
C. $6,000
D. $9,000
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.
All of the following are considered to be “insiders” EXCEPT:
A. an investor holding 11% of ABC preferred stock
B. the in-house counsel of ABC Corporation
C. the spouse of ABC Corporation’s President
D. ABC Corporation’s Chief Executive Officer
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.
A corporation has issued 10% AA rated sinking fund debentures at par. Three years later, similar issues are being offered in the primary market at 12%. Which of the following are TRUE statements about the outstanding 10% issue?
I The current yield will be higher than the nominal yield
II The current yield will be lower than the nominal yield
III The dollar price of the bond will be at a premium to par
IV The dollar price of the bond will be at a discount to par
A. I and III
B. I and IV
C. II and III
D. II and IV
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.
Which of the following procedures are required to open a Portfolio Margin account?
I The account must be approved by the designated ROP for uncovered options writing
II The customer must receive a copy of the risk disclosure document, at or prior to, account opening
III The customer must sign an acknowledgment that he or she has read and understands the risk disclosure document
IV The account must be approved by the CBOE or FINRA for exemption from Regulation T margin requirements
A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV
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.
A registered representative writes a letter to be sent as a general mailing to prospective customers, that recommends the purchase of a specific mutual fund. Which statements are TRUE?
I Each letter must include a copy of the fund prospectus
II The letter must be approved in advance by the principal
III The prospectus must be approved in advance by the principal
A. I only
B. I and II only
C. II and III only
D. I, II, III
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.
A customer account holds the following:
20% U.S. Stock Fund
20% International Stock Fund
40% Emerging Markets Stock Fund
20% Investment Grade Corporate Bonds
This portfolio is MOST susceptible to:
A. market risk
B. political risk
C. credit risk
D. liquidity risk
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.”
All of the following are coincident economic indicators EXCEPT:
A. Personal Income
B. Employment Duration
C. Employment Levels
D. Industrial Production
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.
A customer buys $10,000 of 30 year corporate bonds with 10 years left to maturity at 92. The customer elects not to accrete the discount annually. At maturity, the customer will have:
A. no capital gain or loss
B. an $800 taxable capital gain
C. $800 of taxable interest income
D. a $9,200 taxable capital gain
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).
A registered representative wishes to give a speech about investments in growth stocks versus value stocks to a group of 50 retail attendees. Which of the following statements are TRUE regarding the speech?
I The speech must be approved in writing by a compliance officer or principal
II The speech should be informational, not promotional in nature
III The speech can contain comparisons of past performance of recommended investments to that of recognized market indices
IV A written copy of the speech must be retained by the member firm for 3 years
A. I and II only
B. III and IV only
C. I, II, and IV
D. I, II, III, IV
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.
Interest income from all of the following municipal issues would likely be included as a tax preference item in the Alternative Minimum Tax computation EXCEPT:
A. Private Purpose Bonds
B. School District Bonds
C. Industrial Revenue Bonds
D. Redevelopment Bonds
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.”
A customer buys 100 shares of XYZ stock at $36 and buys 1 XYZ Jan 35 Put @ $6 on the same day. For tax purposes, what is the cost basis of the stock?
A. $30
B. $36
C. $41
D. $42
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.
Which statements are TRUE about structured products?
I The bond component pays interest based on an index rate such as the performance of the NASDAQ 100 Index
II The interest rate paid is typically capped to an annual maximum rate
III The derivative component establishes the payment at maturity and protects principal
IV The security may be listed on a national securities exchange, but trading is typically very thin
A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV
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.
ABC Corporation has declared a rights offering to stockholders of record on Friday, December 10th. Under the offer, shareholders need 10 rights to subscribe to 1 new share at a price of $19. Fractional shares can be rounded up to purchase 1 full share. As of the ex date, the stock is trading at $24. The value of the right is:
A. $.45
B. $.50
C. $.55
D. $1.00
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!
A customer has an existing margin account with the following positions:
Long: 1000 XYZ Cmn
Mkt Value: $20,000
Debit Bal: $15,000
SMA: $1,000
How much cash can the customer withdraw (borrow) from the account?
A. 0
B. $500
C. $1,000
D. $2,000
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.
SEC Rule 10b-5-1:
A. is the “catch all” fraud rule that makes any deceptive or manipulative practice in connection with the sale of a security potentially fraudulent under the Securities Exchange Act of 1934
B. gives officers of publicly held companies a safe harbor from being charged with an insider trading violation if they establish a pre-arranged trading plan for that issuer’s securities
C. prohibits the purchase or sale of an issuer’s securities based on material nonpublic information in breach of duty of trust owed to the issuer or shareholders of that security
D. prohibits any person, in connection with a tender offer for securities, to bid for or purchase the security which is subject of the tender offer through any means other than via the offer
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.
An investor has sold short 500 shares of ABC at $60. The stock has since declined to 38. All of the following can be used to protect the gain EXCEPT:
A. place a buy stop order at $40
B. buy 5 ABC 40 puts
C. buy 5 ABC 40 calls
D. sell 5 ABC 40 puts
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.
A growth investor would consider a company’s:
A. Price / Earnings ratio
B. Price / Book Value ratio
C. Stock price appreciation rate
D. Market share
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.
When the market price of ABC stock is $54 per share, which of the following choices would create a “strangle”?
A. Short 1 ABC Jan 50 Call; Short 1 ABC Jan 50 Put
B. Long 1 ABC Jan 50 Call; Long 1 ABC Jan 60 Put
C. Long 1 ABC Jan 50 Call; Long 1 ABC Jan 50 Put
D. Short 1 ABC Jan 60 Call; Short 1 ABC Jan 50 Put
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.
A customer buys 10 Allied Corporation 8% debentures, M ‘35, at 90 on Wednesday, April 19th in a regular way trade. The interest payment dates are Mar 1st and Sept 1st. How many days of accrued interest must be paid from buyer to seller on settlement?
A. 50
B. 51
C. 52
D. 53
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.
Which of the following securities are typically exempt from state registration requirements?
I U.S. Government issues
II Municipal issues
III Securities listed on a national stock exchange (“blue chips”)
IV New securities for an issuer who has filed registration statements previously in the state
A. I and II
B. II and IV
C. I, II, III
D. I, II, III, IV
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!)
Which of the following individuals trades on the New York Stock Exchange Floor?
I Specialist (DMM)
II Floor Broker
III Two Dollar Broker
IV Competitive Trader
A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV
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).
The Master Manufacturing Company has just announced a tender offer for its own common stock. Master is offering to buy up to 100% of the company’s stock at $20 per share contingent on at least 64% of the outstanding shares being tendered. After the announcement of the offer, the stock closed on the NYSE up 2.50 at $18.75. A customer has 100 shares of Master stock in his cash account. The customer tells you that he wishes to “cash out” his position. You should recommend that the customer:
A. tender the shares
B. sell long
C. sell short
D. hold the shares for a better offer
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.
A member firm receives a large block order to buy 100,000 shares of XYZ stock, which is not actively traded. Which customer(s) of the firm can buy XYZ stock prior to the filling of the block trade?
A. The registered representative who received the order
B. Other customers of the firm who place buy orders, if the firm has information barriers in place
C. Any customer of the firm who places an unsolicited order
D. No customer can buy the stock until the block order to buy is filled
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.
FINRA/NASD member firms are required to follow special procedures when opening accounts for which of the following?
I An employee of a FINRA/NASD member firm who wishes to open a securities account at that firm
II An employee of a FINRA/NASD member firm who wishes to open a securities account at another NASD member firm
III An employee of a FINRA/NASD member firm who wishes to open a securities account at a non-member bank
IV An employee of a FINRA/NASD member firm who wishes to open a securities account at a non-member investment adviser
A. II only
B. I and III
C. II, III, IV
D. I, II, III, IV
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.
A municipal issuer has sold housing bonds to build subsidized housing, where the homeowners make the mortgage payments to the municipal authority. The homeowners begin to prepay their mortgages at a faster than expected rate. If this occurs, the issuer will retire outstanding bonds by making a(n):
A. mandatory call
B. extraordinary mandatory call
C. optional call
D. extraordinary optional call
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.
A customer that owns stock and that is bullish on the market would sell covered calls on that stock above the market instead of buying calls on that stock for all of the following reasons EXCEPT to:
A. increase income from the stock position
B. maximize upside price appreciation
C. minimize the capital commitment
D. reduce loss potential on the stock position
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.
Which statements are TRUE when comparing UTMA Custodian Accounts to Coverdell Education Savings Accounts?
I Contributions to UTMA accounts are deductible for Federal income tax purposes
II Contributions to UTMA accounts are not deductible for Federal income tax purposes
III Contributions to Coverdell Education Savings Accounts are deductible for Federal income tax purposes
IV Contributions to Coverdell Education Savings Accounts are not deductible for Federal income tax purposes
A. I and III
B. I and IV
C. II and III
D. II and IV
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.
Which statement is FALSE about DVP transactions?
A. DVP transactions are used by institutional clients
B. DVP transactions are subject to Regulation T
C. Funds to pay for a DVP transaction must be deposited promptly
D. The securities delivery must take place within 35 days of trade date
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.
All of the following terms are synonymous EXCEPT:
A. agent
B. broker
C. dealer
D. middleman
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.
A 60 year old customer desires an investment that will provide for retirement income when she reaches age 65. The customer is able to invest $1,000 per month over that time period. Which of the following recommendations is most suitable?
A. The purchase of income bonds
B. The purchase of a variable annuity contract
C. The purchase of government bonds in an IRA account
D. The purchase of high yield bonds
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.
Which of the following insures municipal bonds?
A. Securities Investor Protection Corporation
B. Federal Deposit Insurance Corporation
C. Private Insurance Companies
D. Private Placement Investors
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.
Which of the following statements regarding collateralized mortgage obligations are TRUE?
I Each tranche has a different level of market risk
II Each tranche has a different level of credit risk
III Each tranche has a different yield
IV Each tranche has a different expected maturity
A. I and II only
B. III and IV only
C. I, III, IV
D. I, II, III, IV
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.
All of the following would be considered to be a “retail communication” EXCEPT a(n):
A. direct mailing sent to 30 existing retail clients
B. password-protected website maintained by a broker-dealer
C. institutional communication
D. internet bulletin board
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.
Which of the following sources of income are used to back revenue bond issues?
I Excise taxes
II Lease rentals
III Ad valorem taxes
IV Enterprise activity income
A. I and III only
B. II and IV only
C. I, II, IV
D. I, II, III, IV
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.
Many years ago, a customer bought 100 shares of ABC stock at $15. The customer makes a single gift to his daughter this year of the stock when it is valued at $30. The stock is sold by the daughter when it is worth $60. For tax purposes, the daughter’s cost basis in the security is:
A. $15 per share
B. $30 per share
C. $45 per share
D. $60 per share
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.
A corporation can redeem its debt securities prior to their maturity date by all of the following methods EXCEPT:
A. purchasing outstanding debt securities in the open market
B. tendering for outstanding debt securities at a price determined by the issuer
C. calling outstanding securities at pre-established dates and prices
D. issuing new bonds and using the proceeds to prepay the bondholders
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.
When interest is charged on a margin account, which statements are TRUE?
I The debit balance increases
II The debit balance decreases
III Equity changes
IV Equity remains the same
A. I and III
B. I and IV
C. II and III
D. II and IV
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).
Which statements are TRUE?
I OATS intakes orders for NASDAQ issues
II ACT intakes orders for all NASDAQ issues
III OATS matches and reports completed trades of NASDAQ issues
IV ACT matches and reports completed trades of NASDAQ issues
A. I and III
B. I and IV
C. II and III
D. II and IV
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.
Trading in the Interbank market will affect all of the following directly EXCEPT:
A. foreign currency prices in terms of U.S. dollars
B. American Depositary Receipt prices in terms of U.S. dollars
C. future economic growth
D. future trade deficit or surplus figures
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).
Issuers of securities are prohibited from:
A. buying calls on their own stock
B. selling calls on their own stock
C. buying puts on their own stock
D. selling puts on their own stock
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.
A customer asks about ratings services that rate stock performance. The registered representative should refer the customer to:
I Morningstar
II Standard and Poor’s
III Lipper Analytical Services
IV Member Firm In-House Research Reports
A. I and III
B. I and IV
C. II and III
D. II and IV
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.
In a period of deflation, all of the following statements about fixed income securities are true EXCEPT:
A. holders receive payments on fixed income securities that buy more in real terms
B. holders are likely to realize capital appreciation on fixed income securities that are not close to maturity
C. issuers are less likely to sell fixed income securities because interest rates will rise
D. issuers are likely to sell non-callable issues
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.
Which statements are TRUE regarding money market funds?
I Money market funds are typically sold with a sales charge
II Money market funds are typically sold without a sales charge
III Fund dividends are taxable, whether or not reinvested in additional shares
IV Fund dividends are not taxable if reinvested in additional shares
A. I and III
B. I and IV
C. II and III
D. II and IV
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.
The Options Clearing Corporation is responsible for all of the following EXCEPT:
A. standardization of listed options contracts
B. trading of listed options contracts
C. issuance of listed options contracts
D. assignment of exercises of listed options contracts
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.
Speculators in foreign currencies would NOT be subject to which of the following risks?
A. interest rate risk
B. exchange rate risk
C. market risk
D. political risk
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.
The amount of the good faith check is:
I determined by the issuer
II determined by the underwriter
III typically 1% or 2% of the par value of the bonds
IV typically 50% of the par value of the bonds
A. I and III
B. I and IV
C. II and III
D. II and IV
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.
A customer who is short 1 ABC Jan 40 Put wishes to create a “short put spread.” The second option position that the customer must take is:
A. long 1 ABC Jan 30 Call
B. long 1 ABC Jan 30 Put
C. long 1 ABC Jan 50 Call
D. long 1 ABC Jan 50 Put
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.
Which of the following statements are TRUE about the acceptance of an “indication of interest” for a registered offering during the 20 day cooling off period?
I The indication cannot be canceled by the customer
II The indication cannot be canceled by the brokerage firm
III The indication can be canceled by the customer
IV The indication can be canceled by the brokerage firm
A. I and III
B. I and IV
C. II and III
D. III and IV
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.
Which statements are TRUE regarding the weekly Treasury Bill auction?
I The minimum non-competitive bid has no dollar limit
II The minimum non-competitive bid amount is $100
III The maximum non-competitive bid has no dollar limit
IV The maximum non-competitive bid amount is $5,000,000
A. I and III
B. I and IV
C. II and III
D. II and IV
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.
Under the requirements of the USA PATRIOT Act, when opening an account for a non-resident alien, the registered representative must obtain which of the following from the customer?
I United States Passport Number
II Foreign Country Passport Number
III United States Tax Identification Number
IV Foreign Country Tax Identification Number
A. I and III
B. I and IV
C. II and III
D. II and IV
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.
Which of the following terms are synonymous when talking about open-end funds?
I Underwriter / Sponsor
II Underwriter / Dealer
III Public Offering Price / Ask Price
IV Public Offering Price / Bid Price
A. I and III
B. I and IV
C. II and III
D. II and IV
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.
Under the circuit breaker rule, a trading halt in NMS stocks will be INITIATED if the Standard and Poor’s Index drops by:
A. 7% prior to 3:25 PM (EST)
B. 13% prior to 3:25 PM (EST)
C. 20% prior to 3:25 PM (EST)
D. 25% prior to 3:25 PM (EST)
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.
In order to recommend a fee based account to a customer, under FINRA rules, the customer must be provided with a(n):
A. disclosure document, at or prior to, account opening
B. disclosure document within 15 days of account opening
C. investment adviser brochure, at or prior to, account opening
D. investment adviser brochure within 15 days of account opening
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.
Which statements are TRUE?
I Regular way trades of listed stocks settle on the business day after trade date
II Regular way trades of listed stocks settle 3 business days after trade date
III Regular way trades of listed stock options settle on the business day after trade date
IV Regular way trades of listed stock options settle 3 business day after trade date
A. I and III
B. I and IV
C. II and III
D. II and IV
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.
If a customer sells securities and fails to deliver on settlement date, the position must be bought in how many business days later?
A. 3
B. 5
C. 10
D. 30
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.
If the price of the underlying security remains unchanged until expiration, which of the following options investors may have a profit?
I Buyer of an “at the money” Put
II Seller of an “at the money” Put
III Buyer of a Straddle
IV Seller of a Straddle
A. I and III
B. I and IV
C. II and III
D. II and IV
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.
Listed options are traded on which of the following?
I American Stock Exchange
II Philadelphia Stock Exchange
III Pacific Stock Exchange
IV NASDAQ Stock Market
A. I and III only
B. II and IV only
C. I, II, III
D. I, II, III, IV
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.
The requirement for broker-dealers to disclose their privacy policies to customers, and to permit customers to “opt out” of having their information disclosed to third parties, is outlined under SEC:
A. Regulation SB
B. Regulation FD
C. Regulation SK
D. Regulation SP
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.
A customer enters an order that is “Good Through the Week.” How will it appear on the Specialist’s (DMM’s) book?
A. Day
B. GTC
C. GTW
D. AON
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.
Rule 103 of Regulation M requires that a market maker in a stock that is also a syndicate member in an “add-on” offering of that issue, during the 20-day cooling off period:
I can continue to act as a market maker
II must resign as a market maker
III can act as a passive market maker
IV can act as an active market maker
A. I or III
B. I or IV
C. II or III
D. II or IV
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.
A customer places an order to sell 100 shares of ABC stock that he cannot deliver by settlement date. The order ticket should be marked:
A. Sell - MKT
B. Sell - GTC
C. Sell - Long
D. Sell - Short
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.
A customer buys 100 shares of ABC stock at $48 and buys 1 ABC Jan 50 Put @ $5. The breakeven point is:
A. $43
B. $53
C. $55
D. $60
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.
A customer sells short 100 ABC @ $37 and sells 1 ABC Jan 35 Put @ $4. The customer would NOT make money if the market price for ABC was at:
A. $42
B. $40
C. $37
D. $35
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.
A customer has a margin account at a failed broker-dealer. The securities were purchased for $50,000. As of the date that SIPC filed in court to be the trustee in the bankruptcy, the securities were worth $30,000. The account has a debit balance of $10,000. SIPC coverage will be:
A. $20,000
B. $30,000
C. $40,000
D. $50,000
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.
Which of the following statements are TRUE about Rule 147?
I The rule exempts intrastate issues from Federal registration
II The rule exempts intrastate issues from State registration
III Both the issuer and all purchasers must be state residents
IV Resale is permitted to state residents only, for the 270 day period following the offering
A. I and II only
B. I, III, IV
C. II, III, IV
D. I, II, III, IV
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.”
All of the following statements are true about Auction Rate Securities EXCEPT:
A. Auction Rate Securities have an interest rate that steps up or steps down with the market
B. The Dutch Auction method is used to set the interest rate
C. Failure of an auction is not possible because of broker-dealer bidding
D. Auction Rate Securities are issued by corporations and municipalities
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.
All of the following statements are true regarding municipal advertising EXCEPT:
A. all municipal advertising must be approved by either the Municipal Principal or General Principal prior to use
B. copies of municipal advertising must be retained by the member for 4 years
C. municipal advertising cannot be materially false or misleading
D. form letters are exempted from the advertising rules
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.
Which statements are TRUE about stabilizing bids?
I A stabilizing bid is placed by the syndicate manager
II A stabilizing bid is placed by each syndicate member
III Only 1 stabilizing bid is permitted at any time
IV Any number of stabilizing bids can be placed at any time
A. I and III
B. I and IV
C. II and III
D. II and IV
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.
The selling concession in a municipal offering is the discount given to:
A. syndicate members
B. selling group members
C. non members of the underwriting group
D. financial institutions
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.
When opening an options account, the customer must return the signed Options Agreement:
A. 15 days prior to opening the account
B. 5 days prior to opening the account
C. at or prior to opening the account
D. 15 days after opening the account
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.
Under MSRB rules, any claim, dispute, or controversy shall be submitted to arbitration at the instance of all of the following EXCEPT a:
A. clearing corporation against a broker-dealer
B. broker-dealer against a customer who has previously signed an arbitration agreement
C. broker-dealer against a customer who has not previously signed an arbitration agreement
D. broker-dealer against another broker-dealer
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).
Which of the following statements are TRUE regarding a registered individual who recently left the employment of a FINRA member firm?
I The individual is allowed to maintain his license at another member firm without being employed by that firm
II The individual cannot maintain his license at another member firm without being employed by that firm
III The license remains active for an indefinite time period if the individual does not affiliate with another member firm
IV The license lapses if the individual remains unaffiliated for 2 years
A. I and III
B. I and IV
C. II and III
D. II and IV
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.
The “AIR” shown in a variable annuity prospectus is the:
A. minimum guaranteed rate of return on investment
B. maximum guaranteed rate of return on investment
C. conservative illustration of the rate of return on investment
D. aggressive illustration of the rate of return on investment
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.
In order to recommend a structured product to a customer, all of the following statements are true EXCEPT:
A. The member firm must perform a “reasonable basis” suitability determination evaluating the characteristics of the product to be recommended against competing products
B. Completion of the “reasonable basis” suitability determination means that the structured product can be recommended to all the firm’s customers
C. The member firm must perform a “customer specific” suitability determination prior to recommending a structured product to a customer
D. The registered representative offering the product must understand the product’s features and risks and be able to communicate these to the customer
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.
