Series 7 - Closed Book 6

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The fluctuations in the value of a variable annuity will correspond with the fluctuations in the:

Dow Jones Industrial Average
Value of the index or average on which the payout is based
Value of the securities held in the separate account of the annuity
Cost of living index

C.
The fluctuations in the value of a variable annuity will correspond with the fluctuations in the value of the securities held in the separate account of the annuity. This is the securities portion of the annuity. (19-2)

Where would a listing of the allocation of bonds for a new municipal issue be found?
Notice of Sale
Underwriting Agreement
Account Summary Report
Official Statement

C.
After the sale of a new issue, the syndicate manager must distribute a summary of the account to the members of the syndicate. This summary statement will include the allocation of bonds. (10-11)

Tax-free municipal bonds would be least attractive to a(n):
Pension fund
Insurance company
Individual who has just inherited $1,000,000
Officer of a corporation who is in the 28% tax bracket

A.
A pension fund does not pay tax on its investments. Therefore, it would not find municipal bonds as attractive an investment as it would other higher yielding investment instruments. (8-25)

Which of the following would be characteristic of a call protection provision?

Money is required to be deposited in a sinking fund to call the bond.
It is a provision prohibiting the calling of the bond during its early years.
It is a provision requiring the issuer to call the bond at a specific premium.
It is a provision requiring the issuer to call the bond.

B.
A provision prohibiting the calling of the bond during the early years would be characteristic of a call protection provision. (5-17)

Relative to a convertible bond, which of the following would produce a desirable arbitrage situation?
Stock at parity with the bond
Stock at a premium to parity and the bond is trading at par
Stock at a discount to parity and the bond is trading at par
Yield on the bond equals the yield on the stock

B.
An arbitrage situation occurs when there is a price difference in comparable securities. If stock is selling above parity, the value of the stock received from converting the bond would be more than the value of the bond. An investor could sell short the stock and buy the bond and then convert the bond and use the stock to cover the short position. (6-9)

All of the following would be found in a municipal revenue bond resolution EXCEPT:
Restrictions on the sale of additional bonds
Rate covenants
Sinking fund provisions
The yields-to-maturity of the bonds

D.
The indenture or resolution is basically the contract between the issuer and the bondholder. It will specify the rights of the bondholders and the provisions to protect the bondholders' interest. One of the provisions included is a rate covenant in which the issuer pledges to charge rates that are sufficient to cover expenses and debt service. An additional bonds test is included which sets requirements that must be met before additional bonds could be issued. The method of funding and the operation of the sinking fund (used to retire some bonds prior to maturity) would also be included. Another important provision is flow of funds which states how the income generated by the project will be utilized. (8-12)

An investor purchases a 20-year 5% bond at par value which will yield 5 3/4% if called at the first call date in five years. The yield-to-maturity on bond is:
5%
More than 5%
Between 5% and 5 3/4%
5 3/4%

A.
The bond has a coupon rate of 5%. If the bond is purchased at its par value and is not called but held to maturity, the bond yield will be the same as the coupon rate, which is 5%. (5-9)

Various tranches of a long-term speculative bond issue are called by the issuer. The effect on the remaining outstanding bonds is likely to be:

Improved quality
Decreased quality
Making them eligible for investment by banks
Increased interest payments

A.
When part of an issue of long-term speculative bonds is called, the effect on the remaining outstanding bonds will be an improvement in their quality. The issue will have less debt outstanding and there will be less interest charges to pay, which improves the quality of the issue. (22-30)

The number of times the earnings of a municipal facility exceeds the interest charges and principal payments of a revenue bond for a period of time is called the:
Working capital ratio
Dividend payout ratio
Debt service coverage ratio
Price-earnings ratio

C.
The number of times the earnings of a revenue bond of a municipal facility exceeds the interest charges and principal payments (debt service) for a period of time is called the debt service coverage. (8-12)

A municipality would refund a revenue bond issue for all of the following reasons EXCEPT to:
Reduce interest charges
Issue new bonds at lower interest rates
Reduce the market value of outstanding bonds that are not refunded
Eliminate restrictions in the bond resolution

C.
A municipality would refund a revenue bond issue if interest rates declined to reduce interest charges, to issue new bonds at lower interest rates, and to eliminate restrictions in the bond resolution. The municipality would not refund an issue to reduce the market value of the outstanding bonds. The market value of the outstanding bonds will be determined by supply and demand and by the general level of interest rates. (5-17)

Which of the following are true about SIPC?
It was created by an Act of Congress and is considered a U.S. government agency.
It is a nonprofit organization that only broker-dealers may join.
It provides insurance for customer accounts in the event of bankruptcy by a broker-dealer.
It provides insurance for customer accounts for fraud, embezzlement, and counterfeiting.
I and II
I and IV
II and III
III and IV

C.
SIPC can borrow from the U.S. government, but it is not an agency of the U.S. government. SIPC provides insurance coverage for customer accounts in the event of a brokerage firm's failure. Each brokerage firm must take out a separate insurance policy (known as a fidelity bond) to insure itself for fraud, embezzlement, and counterfeiting. This bonding is not provided by SIPC. (3-8)

The MSRB does all of the following EXCEPT:
Regulate municipal securities dealers
Regulate municipal securities salesmen
Regulate municipal securities advertising
Regulate municipal securities issuers

D.
The MSRB has the power to regulate broker-dealers, their personnel, and their communications with the public. It does not, however, have the power to regulate municipal issuers. (10-9)

A municipal broker-dealer would be acting as a principal in which of the following scenarios?
Selling bonds from inventory to an individual
Selling bonds from inventory to a broker's broker
Buying bonds from another broker-dealer for inventory
Buying 500 bonds to fill an insurance company's order for 250 bonds
I and III only
II and III only
I, II, and III only
I, II, III, and IV

D.
A broker-dealer is acting as a principal when buying for or selling from inventory. In choice (IV), the broker-dealer is buying 500 bonds to fill an order for 250 bonds. The remaining 250 bonds would be for inventory. (11-2)

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 of the following is (are) correct?
The rep must follow all instructions from the trader's employer.
The MSRB must be notified.
The carrying broker-dealer must send written notification of each transaction to the trader's employer.
I only
II only
I and III only
I, II, and III

C.
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 (interpretation is to get 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. (12-30)

ABC Brokerage, a broker-dealer, purchases 600 shares of stock from a market maker to fill a customer's buy order. ABC has acted as a:
Dealer
Specialist
Agent
Underwriter

C.
When a broker-dealer buys a security from a market maker (dealer) on behalf of its customer; it has acted as a broker (agent).The client would be charged a commission on the transaction. If the firm bought the security for its own account, or sold the security to a client from its inventory, it would be acting as a dealer (principal). The client in this case would be charged a markup or markdown. (11-2)

A customer sells a Brunswick April 20 straddle and receives a premium of $800. The put side of the straddle expires unexercised but the call is exercised. The customer is uncovered on the call and must purchase the stock in the market to effect delivery to the buyer of the call. The current market price of Brunswick Corporation is $29. The net result to the customer will be a:
$100 loss
$100 profit
$2,100 profit
$2,100 loss

A.
The customer received $800 from the sale of the straddle. The customer is required to buy 100 shares of Brunswick at the current market price of $29 for $2,900. He delivers the stock to the option buyer for the call price of $20, receiving $2,000. The customer sustained a $900 loss from the exercise of the uncovered call option position but received $800 from the sale of the straddle resulting in a net loss of $100. (15-16)

From the issuer's perspective, when comparing term bonds and serial bonds, serial bonds have:
Declining interest payments and declining principal amounts
Increasing interest payments and increasing principal amounts
Stable interest payments and stable principal amounts
None of the above

A.
Serial bonds have different maturity dates with lesser amounts of debt outstanding as time goes by. The bonds will have declining interest payments and principal amounts. Term bonds, by comparison, mature at the same time and would have stable interest payments with the principal paid on one maturity date. (5-3)

Advertisements regarding options:
Must be submitted to the exchange 15 days prior to initial use
Must be submitted to the exchange 10 days prior to initial use
Must be kept on file by the member firm for six years
Must be kept on file by the member firm for three years
I and III
I and IV
II and III
II and IV

D.
Advertisements must be submitted to the exchange for approval at least 10 days prior to initial use. All advertisements must be maintained on file by the member firm for three years. (2-1, 16-12)

Which of the following securities would provide an investor with protection against purchasing power risk?
Treasury Bills
Treasury Notes
TIPS
STRIPS

C.
Treasury Inflation-Protected Securities (TIPS) are U.S. government securities that are inflation-adjusted based on the Consumer Price Index (CPI). With TIPS the rate of interest is fixed; however, the principal amount on which that interest is paid will vary based on the CPI. They are usually purchased as protection against inflationary or purchasing power risk. The other choices are U.S. government securities that either pay an investor a fixed rate or amount. (7-2)

A brokerage firm is holding $600,000 of securities for a customer. The securities are registered in the name of the customer. If the firm was being liquidated by SIPC, the customer would:
Be insured for $500,000 of securities
Receive the entire $600,000 of securities
Be insured for $100,000 of securities
Lose the entire $600,000

B.
Securities registered in the names of customers are not part of SIPC coverage and are returned to the appropriate individuals. (3-8)

When a municipality is allocating funds for a net revenue issue, the first priority will be to satisfy the:
Operation and maintenance of the facility
Debt service
Reserve for retirement of the bonds
Surplus for expansion of the facility

A.
The first priority for a net revenue issue will be for the operation and maintenance of the facility. It indicates how a municipality distributes revenues received. The order will be as follows:

Operation and maintenance
Debt service
A reserve for retirement of bonds
A surplus for expansion of the facility (8-14)

All of the following are true regarding the role of a transfer agent EXCEPT that the transfer agent:
Keeps a record of each stockholder's name and shares owned
Issues and cancels stock certificates
Resolves problems due to mutilated certificates
Makes sure that outstanding shares do not exceed authorized shares

D.
The transfer agent is responsible for issuing new certificates, cancelling old certificates, keeping a record of shareholders and the number of shares each owns, and handling problems that come about in cases of missing, lost, stolen, or mutilated securities. The registrar makes sure that outstanding shares do not exceed authorized shares. (4-6)

An investor who sells index straddles or combinations is anticipating the market will be:
Bullish
Bearish
Neutral
Volatile

C.
An investor who sells straddles or combinations is selling both calls and puts on the same underlying security. This type of investor is neither bullish or bearish, but is anticipating the price of the underlying security (in this case an index) will remain relatively stable or neutral. (15-16)

Which one of the following will NOT result in a profit to an uncovered call writer?
The price of the underlying security falls below and remains below the exercise price of the option.
The call is exercised and the underlying security price is greater than the exercise price plus the premium received.
The price of the option contract declines.
The option contract expires without being exercised.

B.
An uncovered call writer does not own the underlying stock. If the market price of the underlying stock rises above the exercise price, the stock will be called away. If the market price rises above the exercise price by an amount exceeding the premium, the difference in prices will represent the loss to the writer. For example, if an individual writes 1 XYZ July 50 call for 5 and the market price rises to 60, the stock will be called away. The writer will be required to buy the stock at 60. Since the investor received only 55 (exercise price of 50 plus premium of 5), there will be a 5-point loss. (14-14)

Mr. Smith is short 1,000 shares of ABC Corporation at $100. Mr. Smith enters GTC orders to either buy 1,000 shares of ABC at $95 if it declines or buy 1,000 shares at $105 stop if it should go up. ABC Corporation declines to $95 but Mr. Smith is only able to buy 300 shares. The order should be revised to:
Buy 700 at $95 and buy 700 at $105 stop
Buy 700 at $95 and buy 1,000 at $105 stop
Buy 1,000 at $95 and buy 700 at $105 stop
Buy 1300 at 95 and 1300 at $105 stop

A.
Mr. Smith covered 300 shares of ABC Corporation at $95 when the stock declined, leaving 700 shares left uncovered. The GTC orders left on the specialist's book will now be: buy 700 at $95 and buy 700 at $105 stop. The floor broker will have the specialist change the order so the specialist does not execute an order on his book with an incorrect number of shares. (11-23)

Which best describes the Revenue Bond Index?
Average yield on a list of bonds with 30 year maturities
Average yield on a list of 11 bonds
Average yield on a list of 20 bonds
Average yield on a list of new revenue issues

A.
The Bond Buyer publishes different indexes. They include:

The 20-Bond Index -- The average yield-to-maturity on a particular day of 20 specific GO bonds with 20-year maturities.
The 11-Bond Index -- The average yield-to-maturity on a particular day of 11 of the 20 specific GO bonds from the 20-Bond Index.
The Revenue Bond Index -- The average yield-to-maturity on a particular day of 25 specific revenue bonds with 30-year maturities. (12-27)

Which two of the following are TRUE regarding the buyer and writer of a straddle?
The buyer of a straddle expects the market to fluctuate.
The writer of a straddle expects the market to fluctuate.
The buyer of a straddle expects the market to remain stable.
The writer of a straddle expects the market to remain stable.
I and II
I and IV
II and III
III and IV

B.
The writer (seller) of a straddle (call and put) believes the stock's price will remain stable. The buyer of a straddle expects that the market price of the underlying stock will be volatile. (15-13)

All of the following statements are true about closed-end investment companies EXCEPT that the:
Number of outstanding shares is constant
Shares are sold at the current market price
Shares may not sell below the current net asset value
Shares may be listed on the NYSE

C.

Closed-end investment companies are bought and sold in the same manner as common stocks. If a customer wanted to sell a closed-end fund at the market, he would receive the current bid price (the market quote, not the net asset value). If a customer wanted to buy a closed-end investment company at the market, he would buy it at the current offering or asked price. The market price of the shares can be at, above, or below the net asset value. Closed-end investment companies have only one issue of shares. Once sold, no new shares are issued. The amount of outstanding shares will remain constant. The shares may be listed on an exchange or trade in the OTC market. (18-2)

A customer makes an initial purchase of 100 shares of XYZ on the NYSE at $30 per share. The Federal Reserve margin requirement according to Regulation T is 50%. The customer will have to deposit:
$1,500
$2,000
$2,500
$3,000

B.
Industry rules require minimum equity in a margin account of $2,000, unless the securities are paid in full. If the customer already had an account with enough equity in it, the call would be for $1,500 (50% of $3,000). However, the question states that it is an initial purchase and we must assume that this is a new margin account. Therefore, $2,000 must be deposited. (13-6)

A MIG rating applies to a:
Convertible bond
Pre-refunded utility bond
ADR
BAN

D.
MIG (Moody's Investment Grade) ratings apply to municipal notes. A BAN (Bond Anticipation Note) is the only municipal note given. (8-18)

An investor purchased $100,000 face value of a 12% municipal bond that matures December 1, 2010. The transaction settled on August 1st. The investor owed accrued interest of:
$200
$800
$2,000
$8,000

C.
The bonds purchased by the investor will generate yearly interest of $12,000 ($100,000 par multiplied by 12%). The fact that the bonds mature on December 1, 2010 signifies that interest payments are made every December 1st and June 1st. The investor would therefore owe 60 days of accrued interest (from June 1st, the last coupon, up to but not including the settlement date of August 1st). Since the yearly interest is $12,000, accrued interest would be $2,000 (60/360 x $12,000). (8-24)

Which of the following may be reasons for a revenue bond issue to be called?
A change in the tax status of the issuer
Surplus funds are available
Interest rates rise dramatically
Destruction of the facility by fire
III and IV only
II, III, and IV only
I, II, and IV only
I, II, III, and IV

C.
Destruction by fire would be included in a catastrophe call provision and permit the issue to be called. Any surplus monies may typically be used to retire a portion of outstanding bonds. If the tax status of an issuer is in doubt at the time of issuance, there is usually a provision requiring that the issue be called if the tax status of the issuer changes and the bonds become taxable. An issuer may refund an outstanding issue if interest rates are declining, not rising. (8-13, 5-17)

The State of North Carolina is offering $50,000,000 5 1/2% sewer improvement bonds.
The bonds are:

Exempt from the margin requirements of Regulation T
Exempt from the Securities Act of 1933
Exempt from the Trust Indenture Act of 1939
I only
I and II only
II and III only
I, II, and III

D.
The bonds are municipal revenue bonds which are exempt from all federal acts and regulations except antifraud provisions. (8-1)

A British company expecting payment from a customer in U.S. dollars is fearful that the dollar will decline in value. To hedge against a decline in the U.S. dollar, the British company should:
Buy British pound puts
Buy British pound calls
Write British pound calls
Write British pound straddles

B.
If the value of the U.S. dollar declines, the value of the British pound increases. The company should buy British pound calls since it would profit on the calls if the U.S. dollar declined (British pound increased). The profit on the call could help to offset the loss on the U.S. dollars it is expecting as payment. (15-45)

An investor purchases an ABC Jan 40 call @ 4 and sells an ABC April 30 call @ 9. This is an example of a:
Variable hedge
Vertical spread
Horizontal spread
Diagonal spread

A spread involves the purchase and sale of the same type of options (calls or puts). If the contracts differ in expiration, it is a horizontal spread. If the contracts differ in exercise (strike) price, it is a vertical spread. If both expiration and exercise price are different, it is a diagonal spread. (15-22)

The 5% policy applies to which of the following?
Shares of a mutual fund purchased with a sales charge
A registered secondary distribution requiring a prospectus
Securities found on Nasdaq
Municipal securities

C.
The 5% policy does not apply when a security is being issued with a prospectus or for municipal securities. In this example, a prospectus would be required for a primary distribution as well as a registered secondary distribution. Securities traded on Nasdaq would be the only choice given for which the 5% guideline would apply. (12-4)

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