Series 7 Practice Exam 10

Flashcard maker : Lily Taylor
There are 2,600,000 shares of XYZ Corporation outstanding, which are listed on the NYSE. Mr. Smith owns 300,000 shares of restricted securities, which he has held for more than six months. He is not an affiliate of XYZ. Mr. Smith would like to sell some of his securities under Rule 144. The weekly trading volume for the last six weeks is:

1 week ago 25,000 shares
2 weeks ago 26,000 shares
3 weeks ago 27,000 shares
4 weeks ago 28,000 shares
5 weeks ago 27,000 shares
6 weeks ago 27,000 shares

According to Rule 144, Mr. Smith would need to file with the SEC a notice of intent to sell which is valid for:

90 days

Explanation: The notice of offering for a Rule 144 sale is valid for 90 days.

A broker-dealer appears on the Nasdaq system as a market maker for DCIR common stock. An employee of the firm responsible for maintaining the firm’s inventory in DCIR is known as a:
Position trader

Explanation: A position trader is responsible for maintaining a broker-dealer’s inventory as well as trading the firm’s account.

An established customer has purchased penny stocks through a broker-dealer on five occasions. When making future recommendations to the customer regarding these securities, the broker-dealer must:

a. Obtain a written statement from the customer for each trade
b. Have the customer sign a suitability statement for each trade
c. Have the trades preapproved by a principal
d. Be sure that the recommendations take into account the customer’s investment objectives

d. Be sure that the recommendations take into account the customer’s investment objectives

Explanation: The account approval requirements for penny stocks under SEC Rule 15g-9 do not apply to existing customers who have maintained an account with a broker-dealer for more than one year or have previously engaged in three or more transactions involving penny stocks. All recommendations to a customer should take into account the customer’s investment objectives.

A closed-end fund trading on the NYSE has a current bid price of $21.50 and an offer price of $21.70. A customer purchasing the fund would pay:
$21.70 plus a commission

Explanation: The customer would pay $21.70 plus a commission. A closed-end fund is purchased and sold like any other stock traded on the NYSE. The customer would pay the offer price plus a commission or receive the bid price less a commission when selling the security. The term sales charge refers to the built-in compensation charged by an open-end (mutual fund) company when a customer buys shares of the fund.

A bond is convertible into stock at $50 per share. The market price of the stock is 65. The market price of the bond is 120. To profit from this arbitrage opportunity, an investor should:

I. Buy 5 bonds
II. Buy 100 shares of stock
III. Sell 5 bonds short
IV. Sell 100 shares of stock short

I and IV

Explanation: Since the bond is convertible into 20 shares of stock ($1,000 par divided by $50) and the bond is priced at 120, the parity for the stock is $60 per share ($1,200 bond price divided by 20 shares). An arbitrage situation exists because the stock is selling at a 5-point premium to parity (65 market price versus 60 parity price).

An investor can profit from this situation by purchasing bonds at 120 and shorting the stock at 65. Each bond may be converted into 20 shares of stock at a cost of $60 per share. These shares may then be used to cover the short sale, establishing a 5-point profit (65 short sale price – 60 cost).

The Order Audit Trail System tracks the:
Entire life of an order that is accepted by a member firm

Explanation: The Order Audit Trail System (OATS) enables FINRA to effectively review market activity in regard to customer orders within a member firm, to conduct surveillance, and to enforce rules. OATS records the life of an order from receipt, to routing, to modification if applicable, and cancellation or execution.

An investor purchases 100 shares of XYZ at 60 and also writes an XYZ 65 call @ 3. If the call is exercised when the market price of XYZ is 70, what is the investor’s profit?
$800

Explanation: If the call is exercised, the investor will be required to sell his stock at the strike price of 65 (not the market price of 70). The proceeds of the sale will be $6,800 ($6,500 strike price plus $300 premium received). Since his original cost is $6,000, he will have a profit of $800.

A limited partnership would be LEAST suitable for which of the following accounts?

a. An institutional account
b. A trust account
c. A corporate account
d. A UTMA account

d. A UTMA account

Explanation: Of the choices listed, a UTMA (custodian or minor’s) account would be least suitable for a limited partnership. A limited partnership generally has limited marketability and a lack of liquidity. In addition, most custodian accounts would not be in a position to benefit from the tax advantages of a limited partnership or a DPP.

An investor purchased 100 shares of ABC stock at $53 and on the same day purchased an ABC June 50 put at 2. After the put expired, the investor sold the ABC stock at $60. The investor’s:

I. Cost basis for tax purposes was 53
II. Cost basis for tax purposes was 55
III. Profit was $500
IV. Profit was $700

II and III only

Explanation: When a married put (stock and put purchased on the same day) expires, the premium is added to the cost basis of the stock. The cost basis, therefore, will be $55 (53 + 2). The sale at $60 results in a profit of $5 per share (60 – 55), for a total of $500.

Municipal securities Dealer A quotes a price for a block of bonds to Dealer B for one hour with a five-minute recall. This means:
Dealer A may recall Dealer B within the one-hour period and demand a decision of Dealer B in five minutes

Explanation: When municipal bonds are offered on a firm basis to Dealer B for one hour with a five-minute recall, the offering dealer, Dealer A, may not offer the bonds to anyone but Dealer B without giving Dealer B the first opportunity to take the bonds. Since the recall period is five minutes, if Dealer A recalls Dealer B, Dealer B then has five minutes to take the bonds or else Dealer A is free to sell the bonds to someone else.

A customer opens a margin account and signs the basic customer agreement, which consists of a credit agreement, loan consent agreement, and hypothecation agreement. If the customer’s first order is to buy 100 shares of XYZ stock at a price of 36, the customer:
Will pledge stock in order to receive a loan to buy the stock

Explanation: Securities in a margin account are always held at the brokerage firm in street name to allow the firm to liquidate shares if necessary. Under the hypothecation agreement, the customer pledges securities as collateral for the loan. The loan consent agreement permits the firm to lend the securities to other customers or other broker-dealers. The credit agreement establishes the customer’s responsibility to pay interest on the debit balance. Since the initial trade was for $3,600, industry rules require that the customer deposit at least $2,000 and may borrow up to $1,600.

A company based in Europe with offices located in New Jersey would like to have its stock traded on the NYSE. This most likely will be accomplished through the issuance of:
American Depositary Receipts

Explanation: American Depositary Receipts (ADRs) facilitate U.S. investment in the stock of foreign corporations. When the foreign securities are deposited in a U.S. bank based in that country, a receipt for those securities is issued and traded in the U.S. as if it were the foreign security itself.

A broker-dealer is underwriting an initial public offering (IPO) for a company that is not eligible to be listed on an exchange. The broker-dealer is required to deliver prospectuses:
For 90 days after the effective date

Explanation: When a company that is the subject of an IPO is listed, on the effective date of the offering, prospectuses must continue to be delivered on all purchases in the aftermarket for 25 days. The prospectus delivery requirement for an IPO that will not be listed on an exchange continues for 90 days after the effective date.

Which TWO of the following choices BEST describe a gasoline tax?

I. Graduated taxes
II. Flat taxes
III. Progressive taxes
IV. Regressive taxes

II and IV

Explanation: A regressive tax is flat (i.e., the tax rate remains constant regardless of the taxable amount). Examples of regressive taxes are sales taxes and gasoline taxes. A progressive tax is graduated (i.e., the tax rate increases as the taxable amount increases). Income taxes, estate taxes and gift taxes are progressive.

Public orders on a designated market maker’s book show an inside market comprised of Broker A bidding for 100 shares of ABC Corporation at 42.25. Broker B is offering to sell 300 shares of ABC at 42.63. The size of the market would be:
100 by 300

Explanation: The amount of shares at the highest bid and the lowest offer on the designated market maker’s book is called the size of the market. The size of the market is 100 shares bid for at 42.25 and 300 shares offered at 42.63 or 100 by 300.

Foreign currency options:

I. Are quoted in U.S. dollars
II. Are quoted in the underlying foreign currency
III. Expire on the third Friday of the expiration month
IV. Expire on the last Friday of the expiration month

I and III only

Explanation: Foreign currency options are quoted in U.S. dollars (U.S. currency). Beginning February 15, 2015, the expiration date for foreign currency options is the third Friday of the expiration month, at 11:59 p.m. Eastern Time.

When reviewing a company, a fundamental analyst will look at which TWO of the following choices?

I. Financial reports
II. Trading volume
III. Management of the corporation
IV. Short interest

I and III

Explanation: A fundamental analyst is interested in the company, not technical factors relating to the stock. He would look at financial reports and the company’s management.

Which of the following methods is used by the Options Clearing Corporation in assigning exercise notices?

a. Random selection
b. First-in, first-out
c. To the member firm holding a long position that first requests an exercise
d. On the basis of the largest position

a. Random selection

Explanation: The OCC assigns exercise notices on a random selection basis only.

Penny stock rules apply under which TWO of the following conditions?

I. The stock is priced below $5.00 per share
II. The customer is an active trader of penny stocks
III. The broker-dealer is a market maker in the security
IV. The customer is an institutional investor

I and III

Explanation: A penny stock, according to SEC rules, is a stock that sells for less than $5.00 that is not listed on Nasdaq or the NYSE. A stock quoted on the OTC Bulletin Board or OTC Pink Market (Pink Sheets) that has a bid price of less than $5.00 is defined as a penny stock. Penny stock rules would not apply under the following conditions.

– The customer is defined as an existing customer, who is a person who has maintained an account with a broker-dealer for more than one year, or has previously engaged in 3 or more transactions involving penny stocks (i.e., an active trader of penny stocks)
– In nonrecommended or unsolicited transactions
– In transactions by a broker-dealer that is not a market maker in that security
– In transactions by an institutional accredited investor

If interest rates decline, which of the following securities will probably have the greatest increase in market value?

a. Treasury bills
b. Commercial paper
c. Treasury bonds
d. Treasury notes

c. Treasury bonds

Explanation: When interest rates decline, the securities with the longest maturities will most likely have the greatest price increase.

Which of the following statements is TRUE regarding dividend and capital gain distributions of mutual funds?

a. They may be combined to determine the total yield
b. The taxes may be deferred if they are invested in additional mutual fund shares
c. Dividends are taxed as long-term capital gains
d. They can be reinvested automatically in additional shares if the shareholder chooses to do so

d. They can be reinvested automatically in additional shares if the shareholder chooses to do so

Explanation: Of the choices listed, the only true statement regarding dividend and capital gain distributions from an open-end investment company (mutual fund) is that they can automatically be reinvested in additional shares if the fundholder chooses to do so. They may not be combined to determine yield. The taxes must be paid in the year that the distribution is realized, even if the distribution is reinvested. Qualified dividends are taxable at a maximum rate of 20% regardless of how long the fund is held and nonqualified dividends are taxed as ordinary income. Long-term capital gain distributions are taxable as long-term capital gains regardless of how long the fund shares are held.

Which of the following securities will probably have the greatest fluctuation in price when interest rates move up or down?

a. Commercial paper
b. Treasury bills
c. Treasury notes
d. Treasury bonds

d. Treasury bonds

Explanation: Treasury bonds have the longest maturity of the choices listed and will have the greatest fluctuation in price. Since they have the longest maturity, they will be exposed to the risks of the marketplace for the longest period.

Which TWO of the following types of securities may a municipal securities representative sell?

I. General obligation bonds
II. Treasury notes
III. Variable-rate demand obligations (VRDOs)
IV. Municipal unit investment trusts

I and III

Explanation: A municipal securities representative may sell municipal bonds. General obligation bonds and VRDOs are types of municipal securities. The municipal securities representative, according to the MSRB, is not properly registered to sell government bonds, municipal unit investment trusts, or any type of corporate securities.

Under the partnership democracy provisions of a limited partnership, the limited partners are NOT permitted to:

a. Petition the court to have the general partner removed
b. Petition the court to have the partnership dissolved
c. Sell assets owned by the partnership
d. Sue the general partner

c. Sell assets owned by the partnership

Explanation: Selling assets is a management decision and is, therefore, not the role of the limited partners. Democracy provisions would permit the other choices.

Which of the following statements is TRUE concerning a customer who purchases an out-of-state original issue discount (OID) general obligation bond?

a. Each year the customer will pay both federal and state income tax
b. Each year the customer will pay only federal income tax
c. Each year the customer will pay only state and local income tax
d. The customer will not pay any tax

c. Each year the customer will pay only state and local income tax

Explanation: The upward adjustment in the purchase price of an original issue discount bond is called accretion. The amount accreted each year is considered interest income, which may or may not be taxable depending on the type of security. The interest on an out-of-state municipal security is exempt from federal tax, but subject to state and local income tax. The tax rate is based on the state in which the customer maintains his primary residence.

XYZ Corporation borrows money at a rate of interest that is one point above LIBOR. Therefore, the rate is based on:

a. A long-term bond index
b. The U.S. prime rate
c. The London Interbank Offered Rate
d. A rate established by the Federal Reserve

c. The London Interbank Offered Rate

Explanation: LIBOR is the London Interbank Offered Rate. It is the average rate that banks charge each other on loans for London deposits of Eurodollars.

Which of the following statements is NOT TRUE about defined benefit plans?

a. Contributions are based on a predetermined distribution amount
b. The employee does not know the amount her employer will contribute each year
c. These plans provide tax-free distributions to participants
d. These plans are ERISA-qualified retirement plans

c. These plans provide tax-free distributions to participants

Explanation: An ERISA-qualified retirement plan is generally established as either a defined contribution or a defined benefit plan. In a defined contribution plan, a specific contribution is made each year and benefits are equal to the amounts provided by the total of contributions and earnings in the plan. A defined benefit plan promises specific benefits at retirement. Contributions to the plan are calculated to provide the promised benefits upon retirement and, therefore, the employee does not know the amount her employer will contribute each year. Distributions from a pension plan are not tax-free and are typically considered ordinary income.

An investor purchases a zero-coupon municipal bond maturing in 15 years that is callable in five years at 102. If the bond is called, the investor will receive:
102% of the compound accreted value

Explanation: The investor would receive 102% of the compound accreted value since the security is a zero-coupon bond or original issue discount (OID) bond. The compound accreted value is equal to the original value of the bond plus the annual accretion as of the call date. If the bond was not an OID bond and was called, the investor would receive 102% of par or $1,020.

A corporation with an excellent earnings record has several issues of bonds outstanding. During a period of stable interest rates, which of the following securities are expected to fluctuate the most?

a. Mortgage bonds
b. Commercial paper
c. Debenture bonds
d. Convertible bonds

d. Convertible bonds

Explanation: The convertible bonds will fluctuate the most because they are convertible into common stock. The price fluctuates with the price movements of the common stock. The fact that interest rates are stable is another reason why convertible bonds is the best answer. If the question had stated that interest rates were moving sharply upward or downward, then all other bonds would fluctuate sharply in price to bring yields in line with interest rates. However, the question asks what will happen in a period of stable interest rates. Given that statement, the best answer is that convertible bonds will fluctuate the most.

Which of the following choices is NOT a characteristic of a HOLDR?

a. Diversification
b. The right to vote
c. The ability to control when you are taxed
d. Once-a-day pricing

d. Once-a-day pricing

Explanation: Holding Company Depository Receipts (HOLDRs) are created by depositing securities of a certain sector (e.g., Biotech, Internet, Retail) into a trust and selling interests in the trust to investors. HOLDRs offer investors diversification similar to an Exchange-Traded Fund (ETF). Unlike ETFs, the owner of a HOLDR has an ownership interest in the shares of the companies that the HOLDR is invested in and would retain the right to vote. Once the portfolio has been created, the makeup of the portfolio will typically not change, although if a company included in the portfolio goes bankrupt or merges with another company, the makeup of the HOLDR may be altered.

Investors have the ability to control when they are taxed, since they determine when to hold or sell the HOLDR. An investor in a mutual fund does not have that benefit since the portfolio manager would determine when to hold or sell the securities in the fund. Benefits also include liquidity and pricing throughout the day (i.e., they are exchange-traded) as compared to an index or sector mutual fund, which has daily pricing and is purchased directly from the fund. HOLDRs have no management fees and are considered low-cost since there are only small transaction costs and custodian fees.

When a corporation goes bankrupt, which of the following would be the last to be paid?

a. Internal Revenue Service
b. Debenture holders
c. Preferred stockholders
d. Holders of warrants

d. Holders of warrants

Explanation: A holder of common stock is usually the last to be paid in a bankruptcy. A holder of a warrant has the right to purchase common stock and is paid after a holder of common stock. In practical terms, the common stock is worthless if a corporation declares bankruptcy.

An employee of a corporation is enrolled in a noncontributory pension plan. Relative to the plan, which of the following statements are TRUE?

I. Earnings in the plan accrue tax-deferred
II. Earnings in the plan are taxed each year
III. Benefits are taxed as a capital gain when received
IV. Benefits are taxed as ordinary income when received

I and IV

Explanation: In a noncontributory pension plan, the employee does not make contributions. Earnings in the plan accrue tax-deferred (are not taxed until received by the employee) and benefits received are taxed as ordinary income.

An investor who owns 1,000 shares of ABC informs you that he wants to sell short against the box. Which of the following statements is TRUE?

a. This type of transaction is only permitted by institutional investors
b. This type of transaction is permitted if the order ticket is marked short
c. This type of transaction is permitted if the order ticket is marked long
d. This type of transaction is only permitted in a cash account

b. This type of transaction is permitted if the order ticket is marked short

Explanation: In certain instances, a client (institutional or retail) that is long a security may want to sell the stock, but not deliver his long position. The client must borrow the security to effect delivery, requiring the order ticket to be marked short. This type of transaction is called selling short against the box. The term box is an old industry term referring to a safe deposit box. Short sales are permitted to be executed only in a margin account.

The Bond Buyer Revenue Bond Index is:

I. A 30-year index
II. A 20-year index
III. A 25-bond index
IV. A 30-bond index

I and III only

Explanation: The Bond Buyer Revenue Bond Index (commonly referred to as the Revdex) is an index of the yields on 25 revenue bonds. It is compiled on a weekly basis by The Bond Buyer and contains 30-year maturity bonds with an average rating on S&P of A+ and on Moody’s of A1.

It is most beneficial to the holder of a call if the price of the underlying security is:
Rising

Explanation: The holder (purchaser) of a call expects the market price of the underlying security to rise and, therefore, will profit from a rise in the security.

Which of the following companies is LEAST affected by changes in the business cycle?

a. A construction company
b. A machine tool company
c. An automobile manufacturer
d. A pharmaceutical company

d. A pharmaceutical company

Explanation: Changes in the business cycle will have the least effect on a defensive company (such as pharmaceuticals or utilities). The demand for the products produced by defensive companies will not be hurt by a downturn in the economy. The other choices are examples of cyclical companies. These companies tend to parallel the economy of the country. If the economy is expected to prosper, then you can expect a cyclical company to prosper. If the economy is expected to decline, then you can expect a cyclical company to be less prosperous.

An investor established the following positions.

Long 100 shares of XYZ at $37 per share
Long 1 XYZ 35 put at 1.75

This investor prefers XYZ to:

Appreciate significantly

Explanation: The investor purchased the stock at $37 per share and protected it by purchasing the right to sell XYZ at $35, paying a 1.75 premium (long XYZ 35 put). The investor loses money if the stock falls below the breakeven price of $38.75 ($37 purchase price of the stock + the 1.75 premium on the purchase of the put). The investor prefers XYZ to appreciate significantly since there is the potential for unlimited gains.

A 60-year-old individual has invested $30,000 in a nonqualified variable annuity. The annuity’s value is currently $40,000. If the individual withdraws $20,000 and is in a 28% tax bracket, his tax liability will be:
$2,800

Explanation: The amount invested in a nonqualified variable annuity may not be deducted from income. All earnings accrue tax-deferred. A withdrawal will be taxed on a LIFO method, meaning the earnings (last in) will be considered the first to be withdrawn. Earnings are taxed as ordinary income. Withdrawal of the invested amount is considered return of capital and is not taxed. The annuity has earnings of $10,000 and, therefore, $10,000 of the $20,000 withdrawn is taxable and the remaining $10,000 is considered return of capital. The tax liability is $2,800 ($10,000 taxable amount x 28% tax bracket). Had the individual been under 59 1/2 years of age when the withdrawal was made, the distribution also would have been subject to a 10% penalty on the taxable portion.

The official statement for a revenue bond issue states that the bonds are backed by a pledge of the project’s net revenues. This means that the:
Debt service is the first item paid after operating and maintenance expenses

Explanation: Most municipal revenue bonds are net revenue pledge bonds. This means that bond (debt) service is paid from net revenue (revenue after operating and maintenance expenses).

When evaluating two CMOs backed by GNMAs, one having a 6% yield and the other having a 10% yield, which TWO of the following statements are TRUE?

I. Prepayment risk is greater for the CMO with the 10% yield
II. Prepayment risk is greater for the CMO with the 6% yield
III. Credit risk is greater for the 10% CMO
IV. Credit risk is the same for both securities

I and IV

Explanation: Prepayment risk measures the possibility that homeowners will refinance (prepay) their mortgages. Historically, the speed of prepayment increases when interest rates fall. If this happens, payments will flow into the CMOs at an accelerated rate, forcing investors to reinvest these monies at lower-than-anticipated rates. Therefore, the CMO with the higher interest rate will have higher prepayment risk.

GNMA-backed CMOs are highly rated and, therefore, have little credit risk. Since both CMOs are backed by GNMAs, credit risk is minimal for both pools.

When opening a new account, what is the order in which the following actions should take place?

I. Obtain approval from the ROP
II. Obtain essential facts from the customer
III. Obtain a signed options agreement
IV. Enter the initial order

II, I, IV, and III

Explanation: When opening an account, the first step is to obtain the essential facts regarding the investor’s investment objectives and financial means. The account is then approved by the manager and the initial order can be entered. The member firm has 15 days to obtain the signed options agreement.

A husband and wife with children going to college in 2, 11, and 16 years are planning to set up an account to pay for their children’s college education. Which of the following investments are most suitable for this purpose?

a. Money-market funds
b. Certificates of deposit maturing every 12 months
c. Junk bonds with serial maturities coinciding with the children’s college attendance
d. Investment-grade corporate bonds with maturities coinciding with the children’s college attendance

d. Investment-grade corporate bonds with maturities coinciding with the children’s college attendance

Explanation: Given these choices, the investment-grade bonds with serial maturities of 2, 11, and 16 years appear to be the most suitable investment. Money-market funds are used more as a parking place for funds until an investment decision can be made. CDs may be used, but are not as attractive as choice (d) since the CDs mature in 12 months. Junk bonds carry too much risk for their intended purpose.

An investor is a limited partner in a direct participation program that the IRS has determined to be abusive. This investor:
May be subject to pay back taxes as well as penalties and interest

Explanation: If the IRS deems a direct participation program abusive, deductions previously claimed may be disallowed causing investors to pay back taxes as well as interest and penalties on the back taxes. A DPP may be considered abusive if it is based on a false assumption or if it overstated property values for the purpose of generating large deductions.

Which of the following statements about municipal revenue bonds is NOT TRUE?

a. There is no debt limitation set by the issuing municipality
b. The maturity of the revenue bond usually coincides with the useful life of the facility being built
c. They can be issued by states, political subdivisions, interstate authorities, and intrastate authorities
d. The interest and principal are paid from the revenue received from the facility

b. The maturity of the revenue bond usually coincides with the useful life of the facility being built

Explanation: Municipal revenue bonds do not have maturity schedules that coincide with the usefulness of the facility being built. They mature prior to the useful life of the facility. Municipal revenue bonds do not have debt limitations as do general obligation bonds. A debt limitation is the statutory or constitutional maximum debt that an issuer may legally incur. Revenue bonds can be issued by states, political subdivisions (such as counties or townships), interstate authorities and intrastate authorities. The interest and principal are paid from the revenue received from the facility.

The proceeds of the sale of a municipal bond issue are invested in U.S. government securities that are sufficient to cover interest, principal, and call premiums on an outstanding bond issue. The outstanding bonds are called:
Prerefunded bonds

Explanation: The outstanding bonds are called prerefunded or advance-refunded bonds. The new issue is called a refunding issue. This is usually done when the issuer can borrow funds at lower rates, thereby reducing its interest costs.

Which TWO of the following activities are typically performed during the cooling-off period of an initial public offering (IPO)?

I. A preliminary prospectus is prepared by the issuer
II. The issuer will publish research on the securities to be offered
III. The SEC reviews the issuer’s registration statement and evaluates the investment merit of the issue
IV. The issuer and underwriters hold a due diligence meeting

I and IV

Explanation: During the cooling-off period, the SEC will review the issuer’s registration statement for completeness. The SEC does not evaluate (pass on) the investment merits of the issue. Also, during the cooling-off period, the issuer will blue-sky the issue, send out a preliminary prospectus, and hold a due diligence meeting. Research is not permitted to be published by a broker-dealer until after the effective date of an IPO.

Which of the following option positions obligates the investor to sell shares if exercised?

a. Long a call
b. Long a put
c. Short a call
d. Short a put

c. Short a call

Explanation: A short call position obligates the investor to sell shares if the option is exercised.

A self-employed individual has total income of $120,000. If the individual wants to open a Keogh plan:

I. It must be opened by the time he files his tax return
II. It must be opened by the end of the tax year
III. A maximum deductible contribution of $24,000 is permitted
IV. A maximum deductible contribution of $53,000 is permitted

II and III

Explanation: A Keogh plan must be opened by the end of the tax year (December 31). However, contributions are permitted until the filing deadline for the tax return (April 15). A self-employed individual may deduct 20% of self-employed income or $53,000, whichever is less, to a Keogh plan.(For 2014, the limit was $52,000.) 20% of $120,000 is $24,000 and would be the maximum allowable deductible contribution.

A municipal bond issue is called due to an event beyond the control of the issuer that affects the use of property (e.g., earthquakes, hurricanes, condemnation of property). This is known as:
A catastrophe call

Explanation: A catastrophe call allows an issuer to call an entire issue in situations that are beyond its control, such as a condemnation.

A 60-year-old individual has been putting money in an annuity for 15 years and has been informed of another variable annuity that is offering higher returns. He is not in need of income at this time and is looking to defer income for several more years. Which of the following suggestions is most suitable in light of this individual’s circumstances?

a. He should use the provisions of a 1035 exchange to move the money from his current annuity to the new annuity offering higher returns
b. An exchange would be suitable if he hasn’t made an exchange within the last 36 months
c. He should maintain his existing variable annuity and not begin taking distributions until such time as he needs them
d. The individual can begin taking tax-free distributions from his existing annuity

c. He should maintain his existing variable annuity and not begin taking distributions until such time as he needs them

Explanation: In most situations, senior citizens should not be starting, or exchanging into, a new variable annuity since they are designed primarily as long-term investments. Contributions grow tax-deferred and the earnings are taxable only when the annuitant starts taking distributions. While a 1035 exchange allows a person to move from one annuity to another without the exchange being taxable, the new annuity is subject to its own sales charges and the benefits of the original annuity contract will be lost. Exchanges done within 36 months of a previous exchange can be viewed as churning and being unsuitable.

All of the following statements are TRUE concerning marketwide circuit breakers, EXCEPT:

a. They are based on the S&P 500 Index
b. The levels are calculated on a monthly basis
c. A trading halt on one exchange applies to all exchanges
d. A 7% decline will halt trading for 15 minutes

b. The levels are calculated on a monthly basis

Explanation: Marketwide trading halts are based on the S&P 500 Index and are calculated daily (not monthly). A trading halt on one exchange applies to all exchanges that trade the same security. A Level 1 Market Decline (7%) and a Level 2 Market Decline (13%) will halt trading for 15 minutes. For a Level 3 Market Decline (20%), trading will be halted for the remainder of the day.

Briana Corporation, an existing public company, is offering 500,000 shares of common stock to the public through an underwriting syndicate. The prospectus states that 250,000 shares are being offered by selling stockholders and 250,000 shares are being offered by Briana Corporation. Which of the following statements is TRUE regarding this offering?

a. It is an initial public offering
b. A registration statement is not required
c. It is a combined primary and secondary offering
d. It is a private placement

c. It is a combined primary and secondary offering

Explanation: Of the 500,000 shares being offered, 250,000 shares are being issued for the first time from authorized but unissued shares. This is considered a primary offering. The 250,000 shares being offered by the selling stockholders have already been issued by the corporation. This makes them a secondary offering. The offering is, therefore, a combined primary and secondary offering. A registration statement is required because the securities are being offered to the public.

When opening an account for a customer, MSRB rules do not require the dealer to obtain the customer’s:

a. Financial condition
b. Investment history
c. Investment objectives
d. Date of birth

Explanation: MSRB rules specifically state that a dealer should make every effort to obtain all of the information listed except the customer’s date of birth. The dealer should determine that the customer is not a minor, but not specifically his date of birth.
What is the SRO maintenance requirement on a $1 million purchase of a 2x Long Gold Index ETF?
$500,000

Explanation: Leveraged ETFs have maintenance requirements in excess of the typical SRO thresholds of 25% on long positions and 30% on short positions. The margin requirement on these securities can be computed by multiplying the portfolio leverage factor by the standard SRO maintenance requirement. In this case, the standard long requirement is 25% multiplied by a factor of 2, so the client must maintain a 50% margin. $1,000,000 x 25% = $250,000. $250,000 x 2 = $500,000.

Government-sponsored enterprise securities are comparable to direct government obligations with regard to all of the following statements, EXCEPT:

a. They trade in the over-the-counter market
b. All are government guaranteed
c. Short-term securities are quoted on a discount yield
d. Long-term securities are quoted as a percentage of par

b. All are government guaranteed

Explanation: Government-sponsored enterprise securities are not guaranteed by the government. The other statements are true.

How much margin must the purchaser of one RFQ Feb 60 call for a $3 premium deposit?
100%

Explanation: Options may not be purchased on margin. According to Regulation T, the full purchase price (the premium) must be deposited.

An individual who is short stock and wants protection against an upside move in the market will probably:
Buy a call option

Explanation: An individual who is short stock will buy a call option. If the market advances, the individual will exercise the call option to limit the loss if the market value of the short stock increases.

When examining an earnings report for National Corporation, a registered representative sees that earnings per share is reported on both a primary and fully diluted basis. This indicates that:

I. The company has convertible bonds or convertible preferred stock outstanding
II. The company has cumulative and participating preferred stock outstanding
III. Earnings per share is calculated using current shares outstanding and also assuming that all convertible securities were converted
IV. Earnings per share is calculated on a pretax and after-tax basis

I and III only

Explanation: The calculation for earnings per share on a primary basis (before the possible dilution of convertible bonds, convertible preferred stock, stock options, or warrants) is computed based on the number of outstanding common shares only. The calculation for earnings per share on a fully diluted basis includes the outstanding shares if convertible bonds and preferred stock are converted into common stock.

An investor is in the 35% tax bracket. Which of the following investments would afford him the BEST after-tax yield?

a. A 3.50% general obligation bond
b. A 4.10% Treasury bond
c. A 5.25% investment-grade corporate bond
d. A 5.75% non-investment-grade corporate bond

d. A 5.75% non-investment-grade corporate bond

Explanation: The 3.50% general obligation bond (municipal bond) is exempt from federal income taxes. The other investments are subject to federal income taxes and 35% of the income received would be taxable. The taxable equivalent yield of the 3.50% municipal bond is 5.38%. This is calculated by dividing the 3.50% municipal yield by the complement of the tax bracket which is 65%. The highest (best after-tax yield) would be found in the 5.75% non-investment-grade corporate bond.

A bank or brokerage firm is applying to become a primary dealer in government securities. Which government body appoints the financial institution as a primary dealer?

a. The Treasury Department
b. The SEC
c. FINRA
d. The Federal Reserve Board

The Federal Reserve Board

Explanation: The Federal Reserve Board appoints primary dealers in government securities.

When determining the position limit, the member firm will aggregate which TWO of the following positions?

I. Long calls and long puts
II. Long calls and short puts
III. Short calls and short puts
IV. Short calls and long puts

II and IV

Explanation: When determining a customer’s position in relation to the exchange’s position limit, the member firm will consider all positions on one side of the market. The position may not exceed the limit on either the long side of the market or the short side of the market.

When determining which is the long side of the market, it is NOT correct to aggregate long calls and long puts, or to aggregate short calls and short puts. Instead, the long side of the market is the side on which the investor acquires stock and the short side is the side on which stock is sold.

We will examine first the long side of the market. If investors are long calls, they have the option to call away stock. They would, therefore, acquire stock. If investors are short puts, they have the obligation to accept stock if the put is exercised. In both instances, they will acquire stock. Therefore, long calls and short puts are on the long side of the market and are aggregated to determine the total position.

In regard to the short side of the market, if investors are long puts, they have the option to sell stock by exercising the puts. If investors are short calls, they have the obligation to sell stock if the calls are exercised. In both instances, they will sell stock. Therefore, long puts and short calls are on the short side of the market and are aggregated to determine the total position.

If a customer’s objectives are safety of principal and income, you as the registered representative would NOT suggest:

a. AA-rated corporate bonds
b. High-grade preferred stocks
c. A bond fund which invests in investment-grade municipal bonds
d. An Exchange-Traded Fund that tracks the S 500 Index

d. An Exchange-Traded Fund that tracks the S 500 Index

Explanation: An ETF that tracks the S 500 Index invests in common stocks that will not pay a high dividend and will fluctuate in value with the general equity market. This customer wants income and safety of principal, which may be found in the other three investment choices.

All of the following statements are TRUE of covered call option writing, EXCEPT:

a. The writer can increase the overall yield on his portfolio
b. It is considered a conservative option strategy
c. The premium received guarantees the writer cannot have a loss on the underlying security
d. The writer will have a short-term capital gain if the option expires unexercised

c. The premium received guarantees the writer cannot have a loss on the underlying security

Explanation: All of the choices listed are true except the premium received guarantees the writer cannot have a loss on the underlying security. The security can decline in price below the breakeven point (cost price of the stock minus the premium), causing the writer to have a loss on the stock. If the option expires, the writer will always have a short-term capital gain from the premium received.

Dynasty Corporation is planning to acquire Regal Corporation. If a trader purchased 12,000 shares of Regal Corporation and sold short 4,000 shares of Dynasty Corporation, the trader is:
Engaging in a risk arbitrage

Explanation: When there is an acquisition or merger taking place, traders will try to take advantage of the activity between the common stocks of the two companies. The trader or risk arbitrageur will go long the company being acquired and sell short the shares of the acquiring company. This process is known as risk arbitrage. If the acquisition is successful, Regal Corporation’s stock will increase and Dynasty Corporation’s stock will decline.

Accrued interest for municipal bonds is computed on:
A 30-day month and a 360-day year

Explanation: Accrued interest for municipal bonds is computed in the same manner as for corporate bonds, which is based on a 30-day month and a 360-day year. Accrued interest for U.S. government bonds is figured on a 365-day year counting actual days elapsed. Accrued interest on all bonds is calculated from the last interest payment, up to but not including the settlement date.

An aunt wishes to give her niece securities as a gift. The niece’s parents have recently died and a court has appointed a guardian other than the aunt. The aunt:
May give the securities without the permission of the guardian

Explanation: The aunt may give securities to the minor as a gift. There are no restrictions on a donor giving a gift.

When a stock sells ex-dividend, which TWO of the following orders on a designated market maker’s (DMM’s or specialist’s) book will be reduced?

I. Buy-limit order
II. Sell-limit order
III. Buy-stop order
IV. Sell-stop order

I and IV

Explanation: When a stock sells ex-dividend, the DMM (specialist) will reduce those orders on his book that were entered below the market. A buy-limit order and a sell-stop order will be reduced by the amount the stock sells ex-dividend since these orders are entered below the market.

Which TWO of the following choices would be the most suitable purchasers of municipal zero-coupon bonds?

I. An investor who does not seek present additional cash flow
II. An investor who seeks the tax benefits of long-term capital gains
III. An investor who needs cash for living expenses
IV. A custodian account where the parent of the minor child is in the highest tax bracket

I and IV

Explanation: In a custodian account, the minor is technically liable for taxes. Depending on the amount of income generated in the account and the age of the minor, taxes are calculated at the parents’ rate. Therefore, parents may consider the purchase of municipal bonds in the custodian account for tax advantages. The zero-coupon bond will not produce cash flow during the holding period. This would be desirable for those who do not need cash income. (Funds are needed at a later date in the custodian account.) The zero-coupon municipal bond would be suitable for other accounts besides the custodian account, such as upper tax bracket earners during their peak earning years. Zero-coupon bonds are subject to annual accretion of the investor’s cost basis. As such, at maturity, the investor’s cost basis equals the par value of the bond. (There are no capital gains.) The accretion of the municipal bond is treated as interest income which, in the case of the municipal bond, is federally tax-free. This is a tax advantage, but it is not a long-term capital gain.

What is the SRO maintenance requirement on a $1 million short position of a 3x Inverse Gold Index ETF?
$900,000

Explanation: Leveraged ETFs have maintenance requirements in excess of the typical SRO thresholds of 25% on long positions and 30% on short positions. The margin requirement on these securities can be computed by multiplying the portfolio leverage factor by the standard SRO maintenance requirement. In this case, the standard short requirement is 30% multiplied by a factor of 3, so the client must maintain a 90% margin. $1,000,000 x 30% = $300,000. $300,000 x 3 = $900,000.

A municipal securities broker’s broker will complete transactions for a:

I. Retail customer
II. Dealer bank
III. Municipality
IV. Municipal broker-dealer

II and IV only

Explanation: A broker’s broker works only for other professionals in the industry, executing trades for dealer banks or other broker-dealers, but not for retail customers or municipalities. The purpose of a broker’s broker is to provide anonymity to market participants.

An investor purchases a two-year ABC call. Which of the following designations accurately describes the exercise of the option?

a. European style, next business day settlement
b. European style, three business days’ settlement
c. American style, next business day settlement
d. American style, three business days’ settlement

d. American style, three business days’ settlement

Explanation: Long-term anticipation securities (LEAPS) may be exercised on any day prior to expiration (American style). Exercise settlement is in the underlying stock, in three business days.

Because of its multiplier effect on the economy, the Federal Reserve Board is reluctant to change:
The reserve requirement

Explanation: Changing bank reserve requirements has a multiplier effect. This means that a small change in the reserve requirement can have a large effect on the money supply and the economy. This makes the results of changing the reserve requirement difficult to control, and the FRB is hesitant to use this tool.

Co. A Co. B Co. C Co. D
Earnings per Share $2.00 $6.50 $5.20 $7.80
Dividends $0.10 $2.50 $2.60 $6.00
Percentage of
Retained Earnings 95% 62% 50% 23%

An investor has decided to diversify her portfolio into a more defensive position by including utility stocks. Which of the above companies is probably a utility?

Company D

Explanation: Company D is probably a utility since utility companies usually have a high dividend payout ratio and a low percentage of retained earnings.

Which of the following choices best describes certificates of participation?

a. A form of equity financing for a corporation.
b. A type of REIT
c. A type of bond, typically created through a lease agreement
d. A type of bond based on payments from residential mortgages

c. A type of bond, typically created through a lease agreement

Explanation: Certificates of participation (COPs) are lease financing agreements, issued typically in the form of a tax-exempt or municipal revenue bond. COPs have been used traditionally as a method of monetizing existing surplus real estate. This financing technique provides long-term funding through a lease that does not legally constitute a loan, thus eliminating the need for a public referendum or vote.

A customer purchased a municipal bond with a 6.50% coupon rate that was priced at a 6.95 basis. If the bond is currently trading at $945, the current yield is:
6.88%

Explanation: The current yield is found by dividing the yearly interest payment of $65 by the market price of $945. This equals 6.88%. The fact that the bond was purchased at a 6.95 basis is not relevant.

Compared to selling short, buying a put option:
Explanation: Short selling requires the deposit of margin, whereas the premium on a put is usually substantially less than the Regulation T margin requirement. On a short sale, the seller’s risk is unlimited, whereas on a put purchase, the risk is limited to the premium. Although a short sale may be effected only if the stock can be borrowed under Regulation SHO, a put may be purchased at any time. Puts can be purchased in a cash account, while selling short requires a margin account.
A customer purchases a municipal bond for settlement on Tuesday, October 10. The bond pays interest on January 15 and July 15. The number of days of accrued interest the buyer owes to the seller is:
85 days

Explanation: Interest is figured from the last interest payment date, July 15, up to but not including the settlement date (which is given as October 10). Therefore, accrued interest is figured up to and including October 9.

The customer buying the bonds needs to pay accrued interest for 85 days. Corporate and municipal bond interest is computed on the basis of a 30-day month and a 360-day year. If interest is paid on the first of the month, there will be 30 days of accrued interest to calculate. If interest is paid on the fifteenth of the month, there will be 16 days of accrued interest to calculate for that particular month.

July 16 days
August 30 days
September 30 days
October 9 days
85 days

The tool most commonly used by the FRB to regulate the amount of money and credit in the banking system is:

a. Open market operations
b. The discount rate
c. Moral suasion
d. Reserve requirements

Open market operations

Explanation: Of all the tools of the Federal Reserve Board listed, the one most commonly used is open market operations. This is the most flexible tool and can be changed or fine-tuned very easily by buying or selling more or less U.S. government securities in the open market. The other choices are not as flexible, but are used to implement FRB policy. The margin requirement is another tool the FRB can use, but the margin requirement is the least likely tool the FRB would use since it affects only a small segment of the economy.

Super Entertainment Inc., a publicly traded firm on the NYSE, spins off its domestic syndication division, creating 1,000,000 new shares. To receive the new shares, investors must exchange 25% of their old shares. Investors who receive shares of the new company will:
Be required to receive a prospectus under the Securities Act of 1933

Explanation: This scenario is an example of an offering regulated by Rule 145. Rule 145 defines certain types of reclassifications of securities as sales subject to the registration and prospectus requirements of the Securities Act of 1933. Shares acquired through mergers, consolidations, and spinoffs involving exchanges of stock are all covered under the rule. The amount of shares is irrelevant.

Which of the following choices does NOT delegate power of attorney to a third party for the purpose of making securities transactions?

a. A husband
b. A wife
c. A corporation
d. A custodian

d. A custodian

Explanation: Of the choices given, the only one that does not delegate power of attorney to a third party for the purpose of making securities transactions is a custodian for a minor. The custodian acts as the fiduciary for a minor’s account and does not delegate a power of attorney.

Which of the following Moody’s ratings is the most speculative?

a. Aa
b. A
c. Baa
d. Ba

d. Ba

Explanation: Of the choices given, Ba is the most speculative. The highest Moody’s rating is Aaa.

In order to have an issuer of securities exempt from the provisions of the Securities Act of 1933 under Regulation D, which TWO of the following statements are TRUE?

I. The purchasers must sign an investment letter restricting the resale of the securities
II. The size of the offering must be limited
III. The number of accredited buyers is unlimited
IV. The issuer must file an offering document with the SEC

I and III

Explanation: According to Regulation D, certain conditions must be met for the securities to be exempt from the provisions of the Securities Act of 1933. The offering must be restricted to persons who are knowledgeable and experienced in business and financial matters and who are able to afford the economic risks involved. The issuer must provide the buyer with detailed financial information (this offering document does not need to be filed with the SEC). The number of nonaccredited purchasers must be limited to 35, and the offering must be made in direct negotiations between the issuer and the buyer or his purchaser representative. Also, the buyer must sign an investment letter stating that the purchase was made for investment and not for short-term trading purposes. The size of the offering is not limited and there is no limit as to the number of accredited investors.

The MSRB performs all of the following functions, EXCEPT:

a. Regulate municipal securities dealers
b. Regulate municipal securities representatives
c. Regulate municipal securities advertising
d. Set fixed commissions for municipal dealer agency transactions

d. Set fixed commissions for municipal dealer agency transactions

Explanation: The MSRB does not set fixed commissions for municipal dealer agency transactions. MSRB rules regarding commissions state that they shall be fair and reasonable and negotiated between buyer and seller.

Regulation NMS applies to which TWO of the following choices?

I. Listed equity trades
II. Listed debt trades
III. Quotes available for manual execution
IV. Quotes available for electronic execution

I and IV

Explanation: One of the provisions of Regulation NMS (National Market System) requires a broker-dealer to provide its clients with the best price available for listed equity trades available for electronic execution. The best price is defined as the highest bid or lowest offer (inside market) from all available market centers. Reg NMS does not apply to securities subject to manual execution. Nor does it apply to debt securities, whether electronically or manually executed.

When comparing an Albany, New York hospital revenue bond to a Buffalo, New York hospital revenue bond, you notice that they have similar maturities but the Buffalo bond has a higher yield. A possible reason for this is:
There are more hospitals located in Buffalo than in Albany

Explanation: Competing hospitals could affect the project’s revenue and, therefore, could reduce the bond’s security. Each of the other choices relates to taxes, which do not secure revenue bonds.

A buy stop order is entered:

I. Below a support level
II. Above a resistance level
III. To limit a loss on a long stock position
IV. To limit a loss on a short stock position

II and IV

Explanation: A stop order may be used to limit a loss or protect a profit on an existing position. If an investor is short stock, he can enter a buy stop order which, if activated, will cover his short position and protect the profit or limit the loss on the short position. A technical analyst may also place a buy stop above the resistance level to purchase the stock should there be a price breakout.

A woman wishes to open an account at a municipal securities firm. She identifies herself as the spouse of a trader at another municipal securities firm. Which TWO of the following are TRUE?

I. The representative must follow all instructions from the trader’s employer
II. The MSRB must be notified
III. The carrying broker-dealer must send written notification of each transaction to the trader’s employer
IV. The trader’s employer must approve all transactions of the spouse

I and III

Explanation: MSRB rules require that when opening an account for an employee of another municipal firm, a municipal registered representative must:

Notify the employer and follow all instructions (effectively receiving the employer’s permission)
Send duplicate confirmations to the employer

Included in the definition of employee is spouse, minor children, and anyone else dependent on the employee. The MSRB need not be notified and the trader’s employer is not required to approve each trade.

In a limited partnership, a general partner’s minimum participation in profits and losses is:
1%

Explanation: According to tax law, a general partner must have at least a 1% participation in profits and losses for a business to maintain limited partnership status.

A corporate bond has increased in value by 3/4 of a point. The bond has increased by:
$7.50 per $1,000 par value

Explanation: One point equals $10. An increase of 3/4 of a point in a corporate bond is $7.50 per $1,000 of par value.

A registered representative has limited discretion over a customer’s account. The registered representative may:
Place orders before the order has been approved by a principal

Explanation: Limited discretion does not permit free withdrawal of funds. The account owner must receive confirmations. Buy stop orders are permitted. The RR may place orders which can be approved promptly afterward.

Which of the following securities has prepayment risk?

a. Mortgage bonds issued by a utility company
b. Bonds issued by Freddie Mac
c. Collateralized mortgage obligations
d. Commercial paper

c. Collateralized mortgage obligations

Explanation: Many homeowners pay off their mortgages early. When interest rates fall, homeowners have an incentive to refinance and pay off their existing mortgages. These prepayments are passed through to the pools holding the old mortgages. The investors then need to reinvest this large amount of principal at a time when interest rates have declined. This is referred to as prepayment risk and it is associated with mortgage-backed securities such as CMOs. Although both Fannie Mae (FNMA) and Freddie Mac (FHLMC) issue mortgage-backed securities, in this question choice (b) covers the bonds of these issuers, which do not have prepayment risk.

A 3-month Treasury bill is issued at a discount to yield 9.5%, and a corporate bond is issued to yield 9.5%. The bond is to mature in 10 years. If both are offered on the same day on a bond equivalent yield basis, which of the following statements is TRUE?

a. The bill has a greater yield than the bond
b. The bond has a greater yield than the bill
c. The yield is the same for both
d. The bond equivalent yield and tax equivalent yield are equal

a. The bill has a greater yield than the bond

Explanation: T-bills are issued and quoted on a discount yield basis, whereas corporate bonds are quoted on a yield-to-maturity basis. These yields are calculated in different manners. The bond equivalent yield of a T-bill is always higher than its discount yield.

A customer has the following accounts with a brokerage firm.

Cash Account $20,000 securities (market value)
$10,000 cash

Long Margin Account $60,000 securities (market value)
$30,000 debit balance
$10,000 SMA

Short Margin Account $40,000 securities (market value)
$60,000 credit balance

The total amount of cash that may be withdrawn from all the accounts is:

$20,000

Explanation: The $10,000 in cash may be withdrawn from the cash account. The $10,000 SMA in the long margin position may also be withdrawn for a total of $20,000. The short margin position does not have SMA. Therefore, in this example, nothing can be withdrawn from that position.

A new municipal bond issue has a total par value of $80,000,000. A member of the underwriting syndicate has sold its entire commitment of $10,000,000. If the syndicate is organized as a divided (western) account and there is an unsold balance of $2,000,000, what is the member’s remaining liability?
0

Explanation: In a divided account, a member is responsible for selling only its participation. The member’s responsibility ends once the firm has sold its $10,000,000 commitment. In an undivided (eastern) account, a syndicate member retains liability for unsold bonds. Regardless of the amount of bonds sold, the member is still liable for an amount of bonds equal to its percentage participation.

A client is seeking a mutual fund that will maximize its return by limiting expenses. As a result, he wants to invest in a portfolio that is passively managed. Which TWO of the following choices will help achieve this goal?

I. A portfolio that invests only in fixed income securities
II. An exchange-traded fund based on the Nasdaq 100 Index
III. A mutual fund that tracks the S 500 Index
IV. An account managed by an investment adviser

II and III

Explanation: Passive investing or management is designed to minimize transaction costs and capital gains. This is accomplished by a portfolio manager trying to mirror an index, not outperfom an index. An exchange-traded fund or mutual fund that follows and is designed to replicate an index such as the S 500 or the Nasdaq 100 will accomplish this objective. Active management is a situation where the portfolio manager frequently trades the securities in a portfolio to achieve results that will outperform an index. The portfolio could be invested in equity or fixed-income securities.

Which of the following actions must a municipal dealer disclose on a confirmation?

I. The municipal dealer acted as a agent
II. The municipal dealer acted as a principal
III. The municipal dealer acted as an agent for a third party
IV. The municipal dealer acted as a bona fide market maker

I, II, and III only

Explanation: The MSRB requires a municipal dealer to indicate to a customer through a written confirmation the capacity in which the dealer acted. The municipal dealer must disclose if it acted as an agent for the customer, as a principal for its own account, or as an agent for a third party. If the municipal dealer acted as an agent for a third party, the municipal dealer must disclose the name or promise to provide the name of the third party. Also, the amount of money received from the third party by the municipal dealer is required. A bona fide market maker is one who makes a market in over-the-counter stocks.

For variable annuities, which of the following payout options provide the highest payout?

a. Joint and last survivor life annuity
b. Life annuity with period certain
c. Life annuity
d. Unit refund life annuity

c. Life annuity

Explanation: Annuitants will receive the greatest cash flow from the life annuity payout option. This option allows an annuitant to receive payments for his lifetime. At death, the payments cease since no beneficiary is designated and, therefore, the insurance company is relieved of its obligation to make payments. The annuitant assumes the greatest degree of risk with this type of payout. (89732)

Which of the following persons may not delegate power of attorney to a third party for the purpose of making securities transactions?

a. A husband
b. A wife
c. A corporation
d. A custodian for a minor

d. A custodian for a minor

Explanation: Of the choices given, the only one that may not delegate power of attorney to a third party for the purpose of making securities transactions is a custodian for a minor.

Which of the following descriptions characterizes inverse exchange-traded funds (ETFs)?

a. They are designed to deliver the same performance as an index or other benchmark
b. They are designed to deliver a multiple of the performance of an index or other benchmark
c. They are designed to deliver the opposite of the performance of an index or other benchmark
d. They are designed to deliver a multiple of the opposite performance of an index or other benchmark

c. They are designed to deliver the opposite of the performance of an index or other benchmark

Explanation: An inverse ETF is designed to deliver the opposite of the performance of an index or other benchmark. For example, an inverse ETF based on the DJIA seeks to deliver opposite performance of that index. So, if the DJIA rises by 1%, an inverse ETF would decrease by 1%, and if the DJIA falls by 1%, the inverse ETF would increase by 1% before fees and expenses. Choice (a) is a regular ETF, choice (b) a leveraged ETF that seeks to deliver a multiple of the performance of an index or other benchmark, and choice (d) is a leveraged inverse ETF.

For tax purposes, corporations may exclude a portion of the dividends received from:

I. Municipal bonds
II. Corporate bonds of other corporations
III. Preferred stocks of other corporations
IV. Common stocks of other corporations

III and IV only

Explanation: Corporations may exclude a portion of the dividends received from equity investments in other corporations. This includes common stock and preferred stock.

Which of the following objectives is the least suitable reason for investing in a mutual fund?

a. Diversification
b. Professional management
c. Short-term trading
d. Liquidity

c. Short-term trading

Explanation: Investors in mutual funds usually seek all of the objectives listed except short-term trading.

The call feature on callable bonds is most relevant when the economy is:
Experiencing a slowdown and the FRB is trying to stimulate growth

Explanation: The call feature on callable bonds is most relevant when the general level of interest rates is declining. Rates will tend to decline when the FRB is trying to stimulate the economy by increasing the money supply. The goal is to bring down interest rates to allow the economy to grow. Rising inflation usually causes the FRB to decrease the money supply in order to drive up interest rates. If the economy is growing and inflation is stable, this is a beneficial situation and the FRB may simply leave rates unchanged.

An individual invested $30,000 in an oil and gas balanced program as a limited partner. His portion of a recourse loan is $50,000. Assuming sufficient passive income, the maximum passive losses that a limited partner may claim is:
$80,000

Explanation: The maximum amount of losses that may be deducted by a limited partner is the extent of his basis (in this question, $80,000). Assuming sufficient passive income, the limited partner may deduct $80,000.

Which of the following statements is TRUE regarding a registered representative who has not completed the Continuing Education Regulatory Element training within 120 days of his registration anniversary?

a. The representative will be placed in inactive status
b. The broker-dealer must request an extension from an SRO
c. The representative will be suspended
d. The representative has 30 days to complete the requirement

a. The representative will be placed in inactive status

Explanation: FINRA will notify a representative within 30 days of the second anniversary date of initial registration, and every three years thereafter. If the representative then fails to complete the required training within 120 days of the anniversary date, that person’s registration will become inactive and any activity that requires registration, including receipt of commissions, will be prohibited.

A registered representative wants to take on a second job working part-time as a waiter in a restaurant. This is allowed as long as the individual notifies:
His employer

Explanation: Prior written notification must be provided to the registered representative’s employer.

Which TWO of the following statements regarding straddles are TRUE?

I. An investor who does not anticipate that the price of the stock will change may sell a straddle
II. An investor who anticipates a substantial advance in the price of a stock will buy a straddle
III. An investor who anticipates a substantial decline in the price of a stock will buy a straddle
IV. An investor who anticipates substantial fluctuations in the price of a stock will buy a straddle

I and IV

Explanation: If investors wish to generate premium income, they will consider selling a straddle in order to generate income on both the put and the call. They will sell the straddle only if they do not anticipate significant price changes in the market price of the underlying security.

The investor who anticipates significant changes in the price of a stock, but does not know if the price will advance or decline, will buy a straddle in order to be able to profit on both sides of the market.

An investor who anticipates a substantial advance in the price of a stock will buy a call. An investor who anticipates a significant decline in the price of a stock will buy a put. Neither investor will buy a straddle if they anticipate that a price will move in only one direction, since the premium will be lost (assuming they are right) on the other side of the market. For example, an investor anticipates that XYZ stock will advance from $50 to $80. If a straddle is bought and the price did advance, there would be a profit on the call but there would be a loss of the entire put premium.

Which of the following statements is TRUE concerning periodic payment variable annuities?

a. The number of a client’s annuity units never changes
b. The number of a client’s accumulation units never changes
c. They never have a beneficiary
d. The monthly payout is fixed by the inflation index

a. The number of a client’s annuity units never changes

Explanation: During the pay-in period of a variable annuity, the client is continually purchasing accumulation units. These accumulation units are then exchanged for a fixed number of annuity units when the payout period begins. The first monthly payout is determined actuarially and thereafter is based on the performance of the separate account.

Which of the following choices is Standard and Poor’s (S’s) lowest rating for a municipal note?
SP-3

Explanation: Standard and Poor’s best rating for notes is SP-1 and its worst rating is SP-3. AAA is S’s best rating for bonds and D is its lowest rating for bonds.

A pension fund manager is holding a large portfolio of common stock. Many of these securities are represented in an index that has listed options trading. If a general market downturn is anticipated, the pension fund manager can:

I. Buy stock index call options
II. Write stock index call options
III. Buy stock index put options
IV. Write stock index put options

II and III

Explanation: The pension fund manager can hedge against a decline in the market by writing stock index call options and buying stock index put options. If the market did decline, the stock index call option will expire unexercised and the fund will generate premium income. The put index option’s value increases as the index declines, and can be sold by the pension fund manager at a profit. This profit, along with the premium income received from writing call index options, can help offset the loss incurred by the common stock in the pension fund’s portfolio.

A Keogh Plan is a type of retirement plan that allows self-employed individuals to contribute 20% of their income with a maximum contribution of:
$53,000

Explanation: A Keogh Plan allows self-employed individuals to contribute 20% of their income with a maximum deductible contribution of $53,000. (For 2014, the limit was $52,000.)

When the economy is peaking, what will be the expected sequence of the next three stages of the business cycle?

I. Trough
II. Expansion
III. Contraction

III, I, II

Explanation: Historically, the business cycle has moved sequentially through four stages. An expanding economy will peak once the supply of goods and services surpasses demand. As the economy contracts, demand for products decreases causing a reduction in business activity. The economy will bottom out (forming a trough), leading the way to expansion and the beginning of a new cycle. Thus, if the economy is at its peak, the next three stages in succession will be contraction (recession), trough, and expansion.

A registered representative is provided with the following financial information concerning a company: Debt of $225 million, par value of the common stock $40 million, paid-in capital of $70 million, and retained earnings of $750 million. The common stock ratio is:
79%

Explanation: The common stock ratio is found by dividing total shareholder equity by a company’s total capital. Shareholder equity is equal to the par value of the common stock + paid-in capital + retained earnings, and the total capital is found by adding the debt to shareholder equity. The common stock ratio is 79% [par value of the common stock is $40 million + paid-in capital of $70 million + retained earnings of $750 million = $860 million / $1,085 million ($225 million + $860 million)]. The common stock ratio is used to analyze the capital structure of a company.

When a broker-dealer sells a security to a client and charges a commission on the transaction, it is acting as the client’s:

a. Market maker
b. Principal
c. Designated market maker
d. Agent

d. Agent

Explanation: A broker-dealer that buys securities from or sells securities to a client without owning the securities is acting as the client’s agent or broker. The broker-dealer does not have any risk and the client pays a commission on this type of transaction. When acting in a principal capacity, the client is charged a markup or markdown.

An investor purchased $200,000 of 6% general obligation bonds on margin. The customer has a debit balance of $50,000 and is paying interest of 10% yearly on the debit balance from the purchase of the municipal bonds. How much interest expense may the investor use as a deduction for federal income tax purposes?
None

Explanation: The investor may not use any of the interest expense as a deduction against ordinary income. Interest charges on money borrowed to purchase federally tax-exempt municipal securities may not be used as an interest expense deduction for federal income tax purposes. The investor is already receiving the benefit of tax-free interest income from the municipal bond and the IRS will, therefore, not allow the interest expense to be deducted as well.

A customer, who is going on vacation, enters a GTC order to buy a stock. The order is executed. The customer tells the registered representative that he wants the stock but will not return in time to pay for the security by the payment date. The customer states he will send in a check a few days late. The registered representative should:
Request an extension

Explanation: The customer has indicated that he wants to purchase the stock but will not be able to pay for it in time because he will be on vacation. The order was a good-until-cancelled (GTC) order, so the customer did not know if and when the order would be executed. The reason for the late payment is due to the customer being on vacation. This is a valid reason, and the registered representative should request an extension.

The 5% markup policy applies to:
Nonexempt securities

Explanation: The 5% markup policy does not apply to transactions requiring a prospectus (new issues, mutual funds, and registered secondaries) or transactions in certain exempt securities (such as municipal securities).

An investor has sold stock short at $60. The current market price of the stock is $40 and the investor believes the stock will recover somewhat before going lower. The investor should:
Buy a call

Explanation: The stock is currently trading at $40 and the investor is concerned that the price will rise. An investor who wants to limit the losses on an underlying short stock will buy a call.

FINRA disseminates bond transaction information for all these securities, EXCEPT:

a. Non-investment-grade corporate bonds
b. Rule 144A securities
c. Investment-grade corporate bonds
d. GSE bonds

b. Rule 144A securities

Explanation: TRACE is a reporting system that was created to provide greater transparency in the corporate bond market. It is not a quotation system or an execution system. Broker-dealers provide quotes and will execute transactions in corporate bonds. There is no regulatory quote or execution system as there is for equity securities. FINRA disseminates bond transaction information for publicly traded, TRACE-eligible securities (which include investment-grade and non-investment-grade bonds, and debt securities issued by a government-sponsored enterprise). Although transactions for securities issued under Rule 144A are reported to TRACE, the information is not disseminated.

A registered representative is preparing to leave her firm. Her clients will be assigned to another representative at the same firm. To accomplish this:
The account records must be amended to reflect the change

Explanation: Account records must be amended whenever an internal transfer of an account is made. This change does not require approval of the customer, the completion of a new account form, or the notification of any regulatory authority.

A registered representative discovers that one of her customers is on the Office of Foreign Assets Control (OFAC) list. The RR or someone else at her firm must notify:
The Treasury Department

Explanation: Firms are prohibited from transacting business with individuals and entities on the Office of Foreign Assets Control (OFAC) list. If a registered representative discovers that one of the owners or beneficiaries of an account is on the OFAC list (or if someone on the list tries to open an account with his firm), the RR or someone else from her firm should contact the U.S. Treasury Department immediately. The Financial Crimes Enforcement Network (FinCEN) and OFAC are part of the Treasury Department.

A registered representative is permitted to contact a person whose name is on the national Do Not Call List:
If the person has provided prior written consent to be contacted

Explanation: A person may register her number on the Federal Trade Commission (FTC) National Do Not Call Registry and have it remain on the list indefinitely. Broker-dealers are required to download the names on this list in order to prevent RRs from cold calling any of these persons. The following three exceptions exist which permit RRs to contact any person whose name is on this list.

1. The firm has obtained the person’s expressed prior written consent as evidenced by a signed written agreement. The agreement must state that the person agrees to be contacted and the telephone number to which calls may be made.
2. There is an established business relationship between the RR and the person.
3. There is a personal relationship between the RR and the person.

An investor whose portfolio consists of high-yield municipal bonds, equity securities, and futures and options MOST likely has an investment objective of:
Speculation

Explanation: An investor whose portfolio consists of high-yield municipal bonds, equity securities, and futures and options most likely has an investment objective of speculation.

On February 10, an investor sold 100 shares of ABC short at $50/share. The investor covers the position on November 1 by purchasing 100 shares of ABC at $58/share, establishing an 8-point loss. If, on November 15, the investor shorts 100 shares of ABC at $56/share:
The wash sale rule has been violated

Explanation: Reinstating a position within 30 days of realizing a loss is a violation of the wash sale rule. The November 15 short sale creates a new short position in ABC only 15 days after establishing a loss on an original short position in ABC. Therefore, the loss may not be claimed at this time.

Warrants will most likely be issued to:
Reduce the interest rate on an issue of debentures

Explanation: Debentures may be issued with warrants attached. This allows the corporation to pay a lower interest rate on the debentures.

Ms. Jones, a shareholder of XYZ Corporation, reads in the newspaper that XYZ Corporation intends to issue new shares through a rights offering. The terms of the rights offering are as follows:

1. 10 rights plus $10.50 are required to subscribe to one new share of stock
2. Fractional shares become whole shares
3. The record date is Friday, October 17
4. JPMorgan Chase and Bank of America are the transfer agents
5. Goldman Sachs and Morgan Stanley are the standby underwriters

Ms. Jones also owns 87 shares of the preferred stock of the XYZ Corporation. How many additional shares can she subscribe to and at what cost?

Preferred stockholders are not permitted to participate in a rights offering

Explanation: Preferred stockholders are not permitted to participate in a rights offering. Only the common stockholders are permitted.

An accountant earns $200,000 and wishes to make the maximum IRA contribution for himself and his nonworking spouse. He can contribute a maximum of:
$5,500 in her account plus $5,500 in his account

Explanation: An individual with earned income and a nonworking spouse may contribute a total of $11,000 for himself and his wife. However, the contribution must be made in two separate accounts, each housing $5,500.

If the S&P 500 has been increasing on high volume for several days, what term would BEST define this situation?

a. Market momentum
b. An efficient market
c. Market neutral
d. A resistance level

a. Market momentum

Explanation: The term market momentum is used to describe a situation where prices are moving in a certain direction and there is a high level of trading volume. There is also an expectation that this pattern will continue in the near future. For example, if the S&P 500 Index has been trading up or down significantly over a period of days along with heavy trading volume, some traders will anticipate this pattern may continue for a few more days. Market neutral is used to describe attempting to profit by buying some securities while at the same time selling short others. A resistance level is a point on a chart where the price of a security stops increasing. Efficient market is a term used to define that stock prices already represent all available information and there is no benefit that may be gained by using professional analysis.

In order to sell variable annuities to clients, a person must hold which of the following?
A life insurance license and securities registration

Explanation: Variable annuities are considered both insurance products and securities. As a result, an individual must be properly registered (Series 6 or 7) and hold a life insurance license.

A corporation has raised money to use for expansion of its plant within the next six months. In which of the following securities should the corporation invest the funds until they are used?

a. High-quality commercial paper
b. Long-term municipal zero-coupon bonds
c. U.S. Treasury bonds
d. High-quality preferred stocks

a. High-quality commercial paper

Explanation: The corporation intends to use the money in a short period and does not want to assume undue investment risks. Of the choices given, the most suitable investment is high-quality commercial paper since it is extremely safe and can be purchased with a short maturity to match the corporation’s needs.

The French economy is on the verge of a recession. The Swiss government announces that there was another quarterly increase in its GDP figures. An investor wanting to act on this information will buy:

I. Euro calls
II. Euro puts
III. Swiss franc calls
IV. Swiss franc puts

II and III only

Explanation: An increase in the Swiss GDP is a positive situation for the Swiss economy. This may cause the value of the Swiss franc to rise. If the Swiss franc rises, the holder of a Swiss franc call will profit. A looming recession in France may cause the euro to decrease in value. If the euro decreases, the holder of a euro put will profit.

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