UNIT 18 QBANK

Question 1

A client calls a registered representative and states that she lives in New York City and is looking for a bond that would be triple tax free in New York. The registered representative tells the client that his firm has some bonds in inventory that are from the Albany New York School District that would be triple tax free for the client. Which of the following would be the registered representative’s best course of action?

A) Determine suitability prior to placing the trade and mark the trade solicited.
B) No suitability determination is required because the bonds will be tax free for the client and mark the trade solicited.
C) No suitability determination is required because these bonds will be tax free for the client and mark the trade unsolicited.
D) Determine suitability prior to the trade and mark the trade unsolicited.

Answer 1

A) Determine suitability prior to placing the trade and mark the trade solicited.

Explanation
For a trade to be unsolicited, the client would need to specifically identify the bonds he wanted to purchase; instead the registered representative is the one who recommended these bonds, making the trade solicited. Suitability must be determined on solicited trades.

Question 2

Blaine Smith has owned XYZ stock for several years and believes it is time to take his profit and invest that money in another stock. He should

A) sell XYZ to close.
B) sell XYZ to open.
C) buy XYZ to open.
D) buy XYZ to close.

Answer 2

A) sell XYZ to close.

Explanation
When a client owns a stock and wants to get out of that position, he should sell the stock in a closing transaction.

Question 3

Which of the following is true regarding short sales?

A) Selling short means selling less shares than were purchased.
B) Selling short involves selling shares not yet owned.
C) Selling short involves purchasing the shares first.
D) Selling shares not yet owned is prohibited.

Answer 3

B) Selling short involves selling shares not yet owned.

Explanation
Short sales involve selling shares not yet owned. This is permitted. When selling short, investors are borrowing the shares to be sold, which must be replaced later by buying them. Investors who sell short are bearish, hoping the shares go down in value so that they can be purchased later at a lower price than they were initially sold for.

Question 4

Your customer opens a position at 45 and then closes it later at 47. This represents

A) a 47-point gain.
B) a 2-point gain or loss.
C) a 2-point gain.
D) a 2-point loss.

Answer 4

B) a 2-point gain or loss.

Explanation
Because we do not know if the opening transaction was a buy or a sell from what we are told, this could be either a 2-point gain or loss. If the opening transaction was a buy, this represents a gain (bought at 45, sold at 47). But if the opening transaction was a sell, this represents a 2-point loss (sold at 45, bought back at 47).

Question 5

All of the following are required for a discretionary account except

A) the account must receive FINRA approval prior to the first trade.
B) a principal at the firm must authorize discretion.
C) the customer must authorize discretion.
D) all trades must be promptly approved by a principal at the firm.

Answer 5

A) the account must receive FINRA approval prior to the first trade.

Explanation
FINRA approval is not required for opening accounts.

Question 6

A customer who is short against the box may close the position by all the following except

A) combining purchases of stock with stock already owned by the customer.
B) depositing the fair market value of the shorted stock into his account.
C) purchasing twice the stock in the open market.
D) covering the short with the stock in his account.

Answer 6

B) depositing the fair market value of the shorted stock into his account.

Explanation
A customer who is short against the box owns the stock he shorted. As a result, the customer may use his owned stock to cover the short position, buy back the short position in the open market, or any combination of the two. The customer cannot simply deposit funds into his account.

Question 7

Selling shares not yet borrowed or located to be borrowed is

A) known as a short sale and is prohibited.
B) known as closing a position with a sale and is prohibited.
C) known as closing a short sale with a purchase.
D) known as a naked short sale and is prohibited.

Answer 7

D) known as a naked short sale and is prohibited.

Explanation
In order to open a position with a short sale, the shares to be sold must be borrowed or located to be borrowed first. Not doing so is known as selling short naked (naked short sale) and is prohibited.

Question 8

The locate requirement is an element of which of the following transactions?

A) Sell to close
B) Buy to close
C) Buy to open
D) Sell to open

Answer 8

D) Sell to open

Explanation
When selling short (selling to open), shares must be borrowed from the dealer. The dealer finding those shares that can be loaned to the seller is part of the locate requirement.

Question 9

A registered representative suggests a trade to a customer which the customer agrees is suitable given their investment objectives. The order is entered. This transaction is

A) neither solicited or unsolicited and the order ticket should be marked as neither.
B) solicited and the order ticket must be marked solicited.
C) unsolicited and the order ticket should be marked unsolicited.
D) solicited but the order ticket need not be marked in any special way.

Answer 9

B) solicited and the order ticket must be marked solicited.

Explanation
A transaction initiated by an agent or registered representative is known as a solicited transaction. Unsolicited transactions are those initiated by the customer. Order tickets should always be marked solicited or unsolicited.

Question 10

With a discretionary account

A) a full power of attorney is needed on file to grant discretion.
B) churning is permitted by the party given the discretion.
C) the customer may refuse any trades done by the party given the discretion.
D) the customer may still enter orders.

Answer 10

D) the customer may still enter orders.

Explanation
With a discretionary account the customer can continue to enter orders themselves. A trading authorization or limited power of attorney, not full power of attorney is required. The customer is bound to accept all trades done by the party given the discretion and churning, trades done only for the purpose of generating commissions, is never permitted.

Question 11

Meeting the location requirements and the borrowing of securities when a customer wants to sell short is done by

A) the customer who wants to sell short.
B) the customer or entity that the shares will be borrowed from.
C) the broker-dealer on behalf of the short-selling customer.
D) the purchaser of the securities being sold short.

Answer 11

C) the broker-dealer on behalf of the short-selling customer.

Explanation
Meeting the location requirements and the borrowing of securities is done by the back office of the broker-dealer on behalf of the short-selling customer. Meeting these requirements is not something the short-selling customer would undertake without a broker-dealer.

Question 12

A customer called his registered representative to place a trade to buy 100 shares of ABC. The customer wants to put a limit on the order, but is unsure what would be an appropriate price. At the suggestion of the registered representative, the customer enters the order with a limit of $30. This trade was

A) unsolicited.
B) discretionary.
C) solicited.
D) not held.

Answer 12

A) unsolicited.

Explanation
The customer, independent of the registered representative, placed the order, making it unsolicited. While the rep did advise on what an appropriate limit price would be, the customer ultimately placed the order instructions with the limit, and would not be considered discretionary.

Question 13

Which of the following transactions has the least risk?

A) Short against the box
B) Selling short
C) Selling to open
D) Buying to open

Answer 13

A) Short against the box

Explanation
Short against the box is when a customer owns the shares she wants to sell but borrows some additional shares, sells the borrowed shares, and then covers the short position with shares already owned. Historically it was a tax strategy, but it doesn’t work as well anymore with the tax law change. There is no loss potential. Buying to open can cause a loss of the amount invested; selling short and selling to open have unlimited loss potential.

Question 14

Potential risks of owning common stock include all of the following except

A) unlimited liability.
B) low priority in liquidation.
C) business risk.
D) market risk.

Answer 14

A) unlimited liability.

Explanation
As a common stockholder, an investor cannot lose more than she invested.

Question 15

Shares must be borrowed in order to

A) sell short to close a position.
B) buy to open a position.
C) sell short to open a position.
D) buy to close a position.

Answer 15

C) sell short to open a position.

Explanation
When selling short, an investor is opening a position (a short position). Selling short means selling shares not yet owned. In order to do so, the shares must be borrowed first.

Question 16

A customer called his registered representative to place a trade to buy 100 shares of ABC. The customer wants to put a limit on the order, but is unsure what would be an appropriate price. At the suggestion of the registered representative, the customer enters the order with a limit of $30. This trade was

A) solicited.
B) unsolicited.
C) discretionary.
D) not held.

Answer 16

B) unsolicited.

Explanation
The customer, independent of the registered representative, placed the order, making it unsolicited. While the rep did advise on what an appropriate limit price would be, the customer ultimately placed the order instructions with the limit, and would not be considered discretionary.

Question 17

A registered representative enters a discretionary order for her clients account. All of the following are required except

A) the order must be approved by a principal prior to entry.
B) the order should be included in those required to be reviewed frequently.
C) the order must be identified as or marked discretionary.
D) a record of the order must be maintained.

Answer 17

A) the order must be approved by a principal prior to entry.

Explanation
Each discretionary order must be identified as such at the time it is entered for execution, a principal, officer or a partner of the BROKER-DEALER must approve each order promptly and in writing, but not necessarily before order entry, a record must be kept of all transactions including discretionary ones, and as with all trading activity, it is subject to frequent and systematic review by a designated supervisor or manager.

Question 18

Short sellers have

A) unlimited profit and loss potential.
B) unlimited profit potential and limited loss potential.
C) limited profit potential and an unlimited loss potential.
D) limited profit and loss potential.

Answer 18

C) limited profit potential and an unlimited loss potential.

Explanation
Short sellers are bearish—wanting to see the stock go down in value. Because stock could only go down as far as zero, the profit for a short seller is limited to the difference between the price the stock was shorted at and zero. By contrast, the risk for a short seller is that the stock goes up in value and there is no limit to how high the stock might rise, giving the short seller potentially unlimited losses.

Question 19

An investor who has a short position in 500 shares of JKH common stock would eliminate that position by

A) entering a closing sale order for 500 shares of JJK.
B) entering a closing purchase order for 500 shares of JKH.
C) entering a closing purchase order for 500 shares of ABC.
D) entering an opening purchase order for 500 shares of JKH.

Answer 19

B) entering a closing purchase order for 500 shares of JKH.

Explanation
In order to eliminate a position, long or short, the investor always takes an action opposite that of the one that began (opened) the position. Therefore, we always close the position with a closing order. In the case of a short position, we began with a sale, so we close with a purchase of the same security that was initially sold short—in this case, 500 shares of JKH.

Question 20

Which of the following transactions has the least risk?

A) Selling to open
B) Buying to open
C) Short against the box
D) Selling short

Answer 20

C) Short against the box

Explanation
Short against the box is when a customer owns the shares she wants to sell but borrows some additional shares, sells the borrowed shares, and then covers the short position with shares already owned. Historically it was a tax strategy, but it doesn’t work as well anymore with the tax law change. There is no loss potential. Buying to open can cause a loss of the amount invested; selling short and selling to open have unlimited loss potential.

Question 21

Shares must be borrowed in order to

A) sell short to open a position.
B) sell short to close a position.
C) buy to open a position.
D) buy to close a position.

Answer 21

A) sell short to open a position.

Explanation
When selling short, an investor is opening a position (a short position). Selling short means selling shares not yet owned. In order to do so, the shares must be borrowed first.

Question 22

A customer wishes to sell short 1,000 shares of ABC. Prior to executing the order, the registered representative must

A) receive principal permission to execute the trade.
B) have the customer pledge personal collateral to cover the sale.
C) locate shares that can be lent to effect the sale.
D) receive permission from the customer to borrow shares.

Answer 22

C) locate shares that can be lent to effect the sale.

Explanation
Regulation SHO requires that prior to executing any short sale, the broker-dealer must locate the shares borrowed. Shorting stock uncovered is a violation of Regulation SHO and may result in disciplinary action against the member firm.

Question 23

The trade would need to be placed in a discretionary account if the registered representative chooses which of the following?

I. The time of execution of the trade
II. Which security to buy
III. How much of the security to buy
IV. At what price to execute the trade

A) I and II
B) II and IV
C) II and III
D) I and IV

Answer 23

C) II and III

II. Which security to buy
III. How much of the security to buy

Explanation
If the registered representative chooses the asset, the action, or the amount, it must be placed in a discretionary account. The registered representative can choose the time or price without the needing to place the trade in a discretionary account.

Question 24

Your customer opens a position at 45 and then closes it later at 47. This represents

A) a 47-point gain.
B) a 2-point loss.
C) a 2-point gain or loss.
D) a 2-point gain.

Answer 24

C) a 2-point gain or loss.

Explanation
Because we do not know if the opening transaction was a buy or a sell from what we are told, this could be either a 2-point gain or loss. If the opening transaction was a buy, this represents a gain (bought at 45, sold at 47). But if the opening transaction was a sell, this represents a 2-point loss (sold at 45, bought back at 47).

Question 25

Shares to sell short have been located in order to be borrowed. Once sold short, these shares will be known as

A) covered.
B) uncovered.
C) naked.
D) closed.

Answer 25

A) covered.

Explanation
Selling short requires borrowing or locating the shares to be borrowed first. These shares, because they have already been located to be borrowed, are known to be covered.

Question 26

A closing transaction can be

A) either a buy or a sell.
B) a sell only.
C) a short sale.
D) a buy only.

Answer 26

A) either a buy or a sell.

Explanation
A closing transaction can be either a buy or a sell, depending on what the opening (initial) transaction was. The closing transaction will always be the opposite of the opening one—buy to open, sell to close or sell to open, buy to close.

Question 27

Selling shares not yet borrowed or located to be borrowed is

A) known as closing a short sale with a purchase.
B) known as closing a position with a sale and is prohibited.
C) known as a short sale and is prohibited.
D) known as a naked short sale and is prohibited.

Answer 27

D) known as a naked short sale and is prohibited.

Explanation
In order to open a position with a short sale, the shares to be sold must be borrowed or located to be borrowed first. Not doing so is known as selling short naked (naked short sale) and is prohibited.

Question 28

Which of the following transactions has the most risk?

A) Buying to open
B) Selling short
C) Short against the box
D) Selling to close

Answer 28

B) Selling short

Explanation
Short against the box is when a customer owns the shares she wants to sell, but borrows some additional shares, sells the borrowed shares, and then covers the short position with shares already owned. Historically it was a tax strategy, but it doesn’t work as well anymore with the tax law change. There is no loss potential. Buying to open can cause a loss of the amount invested; selling short has unlimited loss potential.

Question 29

When investors open a position by going long the security, they can close the position by

A) buying the security.
B) selling the security.
C) selling the security short.
D) opening a new position in the security.

Answer 29

B) selling the security.

Explanation
Going long a security means that it was purchased. If a position was opened by purchasing the security, it would be closed by selling it.

Question 30

With a discretionary account

A) the customer may still enter orders.
B) the customer may refuse any trades done by the party given the discretion.
C) churning is permitted by the party given the discretion.
D) a full power of attorney is needed on file to grant discretion.

Answer 30

A) the customer may still enter orders.

Explanation
With a discretionary account the customer can continue to enter orders themselves. A trading authorization or limited power of attorney, not full power of attorney is required. The customer is bound to accept all trades done by the party given the discretion and churning, trades done only for the purpose of generating commissions, is never permitted.