Series 7 Q&A 8 Wrong Answers

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

1%
5%
10%
15%

A
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. (20-3

What type of options would be used to hedge a portfolio of computer stocks?

Interest-rate options
Narrow-based index options
Broad-based index options
Yield-based options

B
A portfolio containing only computer stocks represents just one segment of the market. A narrow-based index also contains stocks from only one segment of the market. (15-36

Someone who wishes to hedge a portfolio of preferred stocks would buy:

Yield-based option calls
Yield-based option puts
Interest-rate option calls
Interest-rate option puts

I and III
I and IV
II and III
II and IV

B
The prices of preferred stocks are inversely related to the movement of interest rates, as are bonds. Therefore, if the investor was concerned that rising interest rates would erode the value of the preferred stock portfolio, the purchase of an option that does well when interest rates rise would provide an effective hedge. Interest-rate puts (which are price-based options) would gain value when interest rates rise and would be a reasonable choice. Yield-based calls (which are yield-based options) would increase in value when interest rates rise, also creating a viable hedge. (15-48, 15-50)

A client buys 100 shares of XYZ Corporation at $27 per share and writes an XYZ October 30 call at a $3 premium.
The XYZ Corporation 30 call option will expire on:

October 30th
The first day of November
The Saturday following the third Friday of October
The Saturday following the fourth Friday of October

C
Listed equity options expire on the Saturday following the third Friday of the month at 11:59 p.m. Eastern Time. (16-2)

A client buys 100 shares of XYZ Corporation at $27 per share and writes an XYZ October 30 call at a $3 premium.
What is the breakeven point for the writer?

$24
$27
$30
$33

A
To find the breakeven point for the covered call writer, subtract the premium from the cost of the stock. The cost of the stock ($27) minus the premium ($3 per share), equals a breakeven point of $24. (15

An investor is told that the cost basis of a municipal bond purchased at a discount will be adjusted each year until maturity. This adjustment is due to:

Amortization
Accretion
Depreciation
Appreciation

B
When the basis of a discount bond is adjusted upward over time, the process is called accretion. When the basis of a premium bond is adjusted downward over time, the process is called amortization. (21-11)

A woman invested $200,000 in a real estate limited partnership. Her portion of the income and expenses are as follows:

Gross project revenues $ 180,000
Operating expenses $ 110,000
Interest paid on mortgage $ 45,000
Depreciation $ 40,000

Assuming she has $55,000 in passive income and is in the 28% tax bracket, how much of the passive loss can she utilize against the passive income?

$15,000
$40,000
$45,000
$55,000

A
The calculation for the project is as follows:

$180,000 gross revenue
- $110,000 operating expenses
- $40,000 depreciation
=
$30,000 earnings before interest
- $45,000 interest on mortgage
=
(-$15,000 ) taxable income

The investor may declare a loss of $15,000 against passive income. (20-5)

Which of the following would qualify for a sales breakpoint on large purchases of mutual fund shares?

A partnership formed to buy the securities
A joint account formed between two unrelated individuals
A husband and wife who are joint tenants with rights of survivorship
An investment club coordinated by a registered representative

C
Quantity discounts are only allowed for individuals and individual entities such as corporations. Partnerships and investment clubs are not entitled to a quantity discount. Joint accounts normally do not qualify for breakpoints except in cases where there is a dependency relationship in the account (e.g., husband and wife). (18-23

An underwriting syndicate that offered a new issue at $21 could NOT stabilize the offering at:

20.88
21
21.50
21.75

I only
I or II only
III or IV only
I, II, III, or IV

C
An underwriter can stabilize a new issue at or below the offering price. The underwriter could stabilize at 21 or 20.88, but could not stabilize at 21.50 or 21.75. (9-7)

Which TWO of the following would NOT be permitted to purchase shares of an IPO of KMF?

An attorney involved in the new issue of KMF
A portfolio manager of an investment company buying for his personal account
An investment company registered under the Act of 1940 which has some restricted persons as shareholders
The general account of an insurance company

I and II
I and IV
II and III
III and IV

A
Restricted persons include finders and fiduciaries (such as attorneys and accountants) involved in the new issue and portfolio managers who buy and sell securities on behalf of institutional investors. The New Issue Rule also provides a number of general exemptions.

The exemptions allow a new issue defined under the rule to be sold to the following accounts.

Investment companies registered under the Investment Company Act of 1940
The general or separate account of an insurance company
A common trust fund
An account in which the beneficial interest of all restricted persons does not exceed 10% of the account. (This is a de minimis exemption that allows an account owned in part by restricted persons to purchase a new issue if all restricted persons combined own 10% or less of the account.)
Publicly traded entities other than a broker-dealer or its affiliates that engage in the public offering of new issues
Foreign investment companies
ERISA accounts, state and local benefit plans, and other tax-exempt plans under IRS Code 501(c)(3) (9-5)

Interest earned on which of the following would be added to income when calculating the alternative minimum tax?

Limited tax bonds
School bonds
Private activity bonds
Public housing bonds

C
The computation of the alternative minimum tax involves adding tax preference items back to a taxpayer's income. In some cases, interest earned on a private activity bond may be considered a tax preference item. A private activity bond, also called an AMT bond, is a municipal bond with 10% or more of the proceeds generated from the bond going to a project financed by a private entity (e.g., a corporation). (21-3, 8-

An investor purchases a Canadian dollar September 80 call and writes a Canadian dollar September 82 call. This position is a:

Bullish spread
Bearish spread
Long straddle
Credit combination

A
A spread is the simultaneous purchase and sale of options of the same class (both calls or puts), on the same underlying security, with different strike prices and/or expiration months. A debit spread is created when the premium of the option purchased is greater than the premium of the option sold. The September 80 call, which is the right to buy the Canadian dollar at 80, is more valuable than an option that provides the right to buy at 82. Therefore, the call purchase will be the controlling factor in the spread. Since buying calls is bullish, a call debit spread is a bullish strategy. (15-22, 15-29)

Mr. Green, a new client, decides to short 100 shares of TANDY at $18 per share. What is the initial margin requirement for this trade?

$2.50 per share
30% of current market value
$1,800
$2,000

D
Industry rules require a minimum deposit of $2,000 on a short sale when it is the initial transaction in the account. For a purchase, the initial requirement is $2,000 or 100% of the purchase price, whichever is less. (13-15)

A customer owns an AMF October 30 call option. If AMF should split 2 for 1, the customer would own:

1 AMF October 30 call for 100 shares
1 AMF October 15 call for 200 shares
2 AMF October 15 calls each for 100 shares
2 AMF October 30 calls each for 100 shares

C
When a stock splits 2 for 1 (an even split), the number of contracts increase and the strike price is reduced proportionately. The number of shares representing each listed option remains at 100 shares. The customer would now have 2 calls for 100 shares each at the adjusted strike price of $15 or 2 AMF October 15 calls for 100 shares each of AMF. Listed options are adjusted for stock splits, stock dividends, and rights offerings but are not adjusted for cash dividends. (16-9)

A client wishes to make a purchase based on his belief that interest rates will decline over the next fifteen years. The recommendation of which of the following securities would NOT be consistent with the client's belief?

A 5-year noncallable bond
A TAN
Floating rate notes
A 15-year bond with a 5-year put feature

I and IV only
II and III only
I, III, and IV only
II, III, and IV only

B
Since the client believes interest rates will decline, he wants to lock in a high yield for the next 15 years. A TAN is a short-term security and a floating rate note's interest rate would be adjusted downward with prevailing interest rates. Neither would lock in the high return. The 5-year noncallable bond would lock in a high return without the possibility of being redeemed prior to maturity. The 15-year bond locks in the high return and the 5-year put feature permits the investor to redeem the bond after 5 years or keep it to maturity. This decision would depend on the prevailing rates in 5 years. (8-18, 5-18, 8-20)

Which of the following orders is a specialist prohibited from accepting on his book?

An open (GTC) order
A day order
A market order
A not-held order

I and III
I and IV
II and III
III and IV

D
A specialist may accept open GTC orders and day orders on his book. The specialist may not accept market orders and not-held orders on his book. A not-held order allows a floor broker to use his expertise with regard to the proper time and price for execution of the order. The term "not-held" means the floor broker is not held to a specific price for the stock. The specialist is not involved with not-held orders. Market orders would not be placed on the specialist's book, as the specialist would immediately execute any market order. (11-25)

A corporation has $10,000,000 of a 5% preferred stock issue outstanding. If the corporation were able to replace the preferred stock with $10,000,000 of 5% subordinated debentures, what effect would it have on earnings per share?

Increase
Decrease
Remain the same
Cannot determine

A
The company would pay the same amount ($500,000) whether it was interest on the subordinated debentures or dividends on the preferred stock. However, interest is deducted before taxes while dividends are taken from net income. (22-23)

A bond counsel would issue an unqualified legal opinion for a municipal bond issue to state that:

The issuer has defaulted on previous issues of bonds
The official statement has not been filed with the SEC
The bonds are very risky and are not a qualified investment for some investors
There are no limitations or pending lawsuits that hinder the issuance of the bonds

D
A bond counsel would render an unqualified legal opinion if there were no situations in existence that could adversely effect the legality of the issue. (10-3)

Which of the following statements best defines the term duration?

A measure of a fixed-income security's relative interest rate risk
A measure of a fixed income portfolio's average yield
The period of time before a fixed-income security will be called
The measure of volatility that compares an equity security to the S&P 500 index

A
Duration measures price sensitivity for fixed-income securities given changes in interest rates. For example, a bond with a 7-year duration would experience a 7 percent change in price for every one percent change in market interest rates. (22-44

An investor buys an 8% New York City bond at a 10.00 basis. If the bond is held to maturity, the investor's net yield will be:

8%
Between 8% and 10%
10%
Greater than 10%

B
Since the yield (10%) is higher than the coupon (8%), the bond was purchased at a discount. The interest on the bond is exempt from taxation but the discount will represent ordinary income at maturity. Since the investor must pay tax on the ordinary income, the net yield will be between 8% and 10%. (21-11, 5-9)

Four municipal bonds have the same maturity date. Which of the following would cost an investor the greatest dollar amount when purchased?

A 4 3/4% coupon bond offered on a 5.10 basis
A 5 1/4% coupon bond offered on a 5.00 basis
A 5 3/4% coupon bond offered on a 6.00 basis
A 6 1/4% coupon bond offered on a 6.50 basis

B
When bonds are purchased at a discount (below the $1,000 par value) the yield-to-maturity (basis) will be greater than the coupon rate (nominal yield). This is the case in all of the choices listed except where the coupon rate of 5 1/4% is greater than the yield-to-maturity of 5%. This would mean that an investor purchased the bond at a premium (above the $1,000 par value) and paid the greatest dollar amount. (5-10)

A tombstone ad states that Southern California Gas is issuing 8 3/4% first mortgage bonds at a price of 96.35% of their par value.
Which of the following are true?

The bonds are being sold to yield 9.635% annually.
The bonds will pay interest of $87.50 annually.
The bonds are subject to the Trust Indenture Act of 1939.

I and II only
I and III only
II and III only
I, II, and III

C
The rate of interest stated in the tombstone is 8 3/4%. This means the company will pay 8 3/4% of $1,000 or $87.50 per year in interest. The bonds are corporate bonds being issued by Southern California Gas Company (not the State of California) and would be subject to the Trust Indenture Act of 1939. (6-1, 5-7)

Collateralized mortgage obligations can be backed by securities issued by:

FNMA
GNMA
FHLB
FFCB

I and II only
II and III only
I, II, and III only
I, II, III, and IV

A
CMOs can be backed by securities issued by FNMA, GNMA, and FHLMC. Federal Farm Credit Bank (FFCB) arranges loans for agricultural purposes. The Federal Home Loan Banks (FHLB) issues securities and uses the funds to provide liquidity for savings and loan institutions. (7-17)

A customer requests that a broker-dealer sell stock that he owns and use the proceeds of the sale to purchase a different stock. In determining the amount of markup that he will charge, the broker-dealer:

Must consider each transaction separately
May charge a markup on the sale only
Should only consider the amount of money involved in the sale to the customer
Is prohibited from charging a markup under these circumstances

C
When the proceeds of the sale of one stock are used to purchase another stock from the same broker-dealer, the transaction is called a proceeds transaction. In determining the markup the broker-dealer will charge, industry rules state that the firm should consider only the amount of money involved in the sale to the customer. (12-4)

If a municipal bond is selling at a premium and is callable at par, how is the yield calculated?

As a percentage of the par value
By dividing the annual income by the current price
To the final maturity date
To the call date

The yield for a municipal bond that is selling at a premium and is callable at par is calculated to the call date. The yield-to-call measures the yield that would be earned if the bonds were called at the call price and not held to the maturity date. MSRB rules require dealers to quote the lower of the yield-to-call or the yield-to-maturity. If the bond is selling at a discount, the bond is quoted on a yield-to-maturity basis. If the bond sells at a premium and is callable at a premium, the yield may be to the final maturity or the call date, whichever is lower. (12-31, 5-17)

An investor buys a 5% municipal bond at 102 1/2. The bond has a yield-to-maturity of 4 1/2%. If the investor holds the bond to maturity, he will have a loss for tax purposes of:

0
$25
$50
$100

A
The IRS requires that a premium paid for a municipal bond be amortized over the life of the bond. At maturity, the investor would have an adjusted cost (after amortization) of par ($1,000). Since this is the amount received at maturity, there is no loss for tax purposes. (21-12)

The Federal Reserve would most likely take measures to ease the money supply in all of the following cases EXCEPT if:

Unemployment is high
The economy is in a recession
The gross national product has been declining
There is high inflation

D
The Fed is likely to ease money supply if the economy is sluggish (decrease in GDP), providing inflation is not a problem. If unemployment is high, the economy is probably either in a recession, a trough, or in the early stages of an expansion. Therefore, stimulating the economy through the easing of credit would be advisable. A high rate of inflation is normally indicative of too much money in circulation chasing a limited supply of goods and services. To combat high inflation, the Fed would normally take measures to reduce (tighten) the money supply. (22-12)

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

Commercial paper
Treasury bills
Treasury notes
Treasury bonds

Treasury bonds would have the greatest fluctuation in price. They have the longest maturity and would be exposed to the risks of the marketplace for the longest period of time. (5-11, 7-1)

A registered representative is discussing the investment merits of ABC stock with a customer. The registered representative may say:

"Let's buy ABC stock because we expect it to go up 4 points in the next two weeks."
"Our mergers department is working on a leveraged buyout for ABC Corporation. Let's buy it now before it is announced to the public."
"One of our analysts just issued a favorable research report for public use on ABC stock which estimates a 10% growth in earnings over the next three years. It appears to be a good situation for you."
"Let's buy ABC stock because we are in a bull market and all stocks go up in a bull market."

C
This is the only statement that would not be a violation since it is a statement of fact, coupled with an opinion or estimate of what should happen in the future. The other statements are violations because they definitely state an event (the stock will go up) will occur, which cannot be known in advance. Spreading rumors is also a violation. (11-5)

Municipal securities dealers would consider all of the following when determining a markup EXCEPT the:
Dollar amount involved in the transaction
Availability of the securities
Expenses incurred in doing the trade
5% markup policy

D
All of the choices listed would have to be considered except the 5% markup policy. This is due to the fact that municipal bond transactions are exempt from the 5% Policy. MSRB rules require a broker-dealer to obtain a price that is fair and reasonable based upon prevailing market conditions. (12-30, 12-4)

An investor has purchased two municipal bonds. Bond A is bought at a discount and Bond B is bought at a premium. If the investor holds both bonds to maturity, the tax consequences will be:

Ordinary income on A, no capital loss on B
A capital gain on A, a capital loss on B
A capital gain on A, ordinary income on B
A capital loss on A, a capital loss on B

A
The tax consequences will be ordinary income on Bond A since it was purchased at a discount. No capital loss will be allowed on Bond B because it was the investor's choice or preference to buy the municipal bond at a premium. According to IRS rules, the loss on the premium bond cannot be taken as a loss for tax purposes. (21-11)

What is meant by 4.50% less 3/4 for a municipal bond selling in the secondary market?

$1,000 bond at 4.50 yield - $0.75
$1,000 bond at 4.50 yield - $7.50
$5,000 bond at 4.50 yield - $0.75
$5,000 bond at 4.50 yield - $7.75

B
Quotes for serial municipal bonds are usually per $1,000 and on a yield-to-maturity basis. The "less 3/4" represents the concession or discount offered to another dealer (3/4 point = $7.50). (12-31)

In a new municipal issue, what is a group order?

An order placed by 3 or more members
An institution purchasing bonds from a syndicate
All members will benefit from the order
A dealer buying for a group of investors

C
There are four types of orders that can be placed with a syndicate.

A pre-sale order is any order placed before the syndicate actually purchases the issue from the issuer.
A group order is when all members of the syndicate share in the profit.
A designated order is usually placed by a large institution which designates two or more members to receive credit for the sale.
A member order is any order placed by members for their customers. (10-9)

A floor broker goes to a trading post to execute an order. When told of the floor broker's order, the specialist replies "you're stopped at 21." This means:

The floor broker cannot trade the stock until it hits 21
The floor broker is guaranteed a price of 21
The stock stopped trading at 21
The floor broker will enter a limit order at 21

B
When a specialist stops stock, she is guaranteeing a price. Stopping stock may only be done for a public order. (11-16)

All of the following statements are TRUE regarding yield curves EXCEPT:

In an ascending curve, short-term rates are lower than long-term rates
They are fixed and may only be changed by commercial banks
In a descending curve, short-term rates are greater than long-term rates
In a flat yield curve, both short-term and long-term rates are equal

B
Yield curves are ascending (upward sloping from the shorter to longer maturities) when money is "easy." When this occurs, short-term rates are lower than long-term rates. A descending yield curve, which is indicative of a tight money situation, will show short-term rates higher than long-term rates. A flat yield curve will indicate that short-term and long-term rates are approximately the same. (5-14)

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

European style, next business day settlement
European style, three business days settlement
American style, next business day settlement
American style, three business days settlement

D
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. (16-3)

Which of the following terms relates to the graph of optimal portfolios resulting from a comparison of risk and return?

CAPM
Efficient frontier
Duration
Alpha

B
According to modern portfolio theory , a graph of optimal portfolios may be created known as an efficient frontier. (22-42)

The market price of XYZ Company's stock is $60. The price-earnings ratio is 10 and earnings per share is $6.00. If the stock were to split 2 for 1, which of the following are true?

The price-earnings ratio will be reduced to 5.
The price-earnings ratio will remain at 10.
The earnings per share will be reduced to $3.00 per share.
The earnings per share will remain at $6.00 per share.

I and III
I and IV
II and III
II and IV

C
A stock split will increase the number of shares outstanding while decreasing the market price of the stock. The split will also have the effect of reducing earnings per share since the number of shares outstanding will increase. The 2-for-1 split will reduce the market price to $30 ($60 x 1/2) and the earnings per share to $3.00 ($6.00 EPS x 1/2). However, the price-earnings ratio (market price/EPS), which was 10 before the split, will remain the same since both the market price and the earnings per share were reduced by the same percentage ($30/$3.00 EPS = 10). (22-28, 4-8)

The transfer of bonds from one party to another may be accomplished by an endorsement on the back of the bond certificate or through a:

Letter of credit
Letter of notification
Power of attorney
Bond power

D
A bond power may be attached to the bond certificate and used to transfer ownership in lieu of completing (endorsing) the assignment form on the back of the bond certificate. (12-13)

A specialist has an order on its book from a public customer to buy stock at $34.70 and another order from a public customer to sell stock at $34.90. The specialist may:

Buy stock for its own account at $34.65
Buy stock for its own account at $34.75
Sell stock from its own account at $34.90
Sell stock from its own account at $34.95

B
A specialist is not permitted to compete with public orders when trading for its own account. The specialist may buy stock at a higher price or sell stock at a lower price. In doing so, the specialist has narrowed the spread (the difference between the bid and ask). The specialist, buying stock at $34.75, is permitted since this price is higher than the price of the public order ($34.70). The other choices would result in the specialist buying lower or selling at a price equal to or higher than the public customer's order. (11-16)

Which of the following is subject to the Penny Stock Rule?

Unsolicited orders for a non-Nasdaq stock trading at $3.00 per share
Solicited orders for a non-Nasdaq stock trading at $3.00 per share
Unsolicited orders for a Nasdaq stock trading at $3.00 per share
Solicited orders for a Nasdaq stock trading at $3.00 per share

B
Listed stocks and Nasdaq securities are not penny stocks under SEC rules. Unsolicited orders are exempt from the penny stock regulations. (12-20)

Which two of the following conditions are generally TRUE when the yield curve inverts?

Interest rates are relatively low.
Interest rates are relatively high.
Interest rates are expected to fall.
Interest rates are expected to rise.

I and III only
I and IV only
II and III only
II and IV only

C
The yield curve often inverts when interest rates are relatively high but are expected to fall in the near future. In such an environment, investors prefer to lock in relatively high long-term rates. The increased demand for long-term debt drives these prices up (and their yields down), as compared to short-term debt, causing the yield curve to invert. (5-14)

Why is the maturity of commercial paper 270 days or less?

Because it coincides with the historical 9-month business cycle
It is an attractive alternative to 6-month Treasury bills
Because short-term corporate debt of 270 days or less is exempt from registration
All of the above

C
Commercial paper has a maximum maturity of 270 days so that it will be exempt from the registration requirements of the Securities Act of 1933. (9-19, 7-21)

A T-bond put option is quoted at 3-28. The purchase of one option at this price would require payment of:

$328.00
$387.50
$3,280.00
$3,875.00

A purchase of a put option at 3-28 is $3,875. Three (3) points equals $3,000 and 28/32 equals $875. Each 1/32 of a point equals $31.25. Therefore, 28 x $31.25 equals $875. (15-47)

An investor has purchased 1,000 shares of XYZ stock. Which of the following option transactions would provide the most effective means of reducing the cost of the stock?

Buying 10 XYZ puts
Selling 10 XYZ puts
Buying 10 XYZ calls
Selling 10 XYZ calls

D
The investor would take in additional income by selling a call option. If the investor sold puts, she would be obligated to purchase XYZ stock if the price fell. The most effective means of reducing the price of a stock purchase is to write a covered call. (15-2)

Volume and holding period restrictions do not apply to the resale of private placements (Reg D offerings) when:

Purchasers' representatives assist investors
Both parties are accredited investors
The transaction is initiated by a registered principal
The purchaser is a qualified institutional investor

D
Under Rule 144A of the Securities Act of 1933, the owner of securities obtained through a private placement may resell those securities to a qualified institutional buyer without the volume and holding period restrictions of Rule 144. (9-21)

A corporation has $7,000,000 in income after paying preferred dividends of $500,000. The company has 1,000,000 shares of common stock outstanding. The market price of the stock is $56. What is the price-earnings ratio?

6.5 times
7.5 times
8 times
8.6 times

C
The price-earnings ratio is the market price ($56) of the stock divided by the earnings per share ($7) which equals 8 times. The earnings per share of $7.00 is found by dividing the $7,000,000 of available income to the common stockholders by the 1,000,000 shares of common stock outstanding. (22-28)

The current market price of XYZ Corporation stock is $52. A customer enters an order to sell 100 shares of XYZ Corporation at $50 stop but will not accept less than $49. He has entered a:

Stop order
Limit order
Market order
Stop-limit order

D
A sell order with a stop at one price (to sell at $50) and also with a limit price ($49), is called a stop-limit order. A round lot sale at or below $50 would activate the order, but then the stock would have to be sold at the limit price of $49 or better for the order to be executed. Sell stop-limit orders are entered below the market. (11-23)

A member of a municipal new issue syndicate is entering an order for an accumulation account being used for a unit investment trust that the firm underwrites. This order must be entered as a(n):

Pre-sale order
Related portfolio order
Contingency order
AON order

B
MSRB rules require a syndicate member to disclose to the syndicate an order for a unit investment trust or an accumulation account to be used for a unit investment trust. The disclosure is accomplished by entering the order as a related portfolio order. (10-11)

According to MSRB rules, which of the following is TRUE regarding a secondary market joint account?

It is a violation of the rules if it contains less than three members.
Its members are not permitted to disseminate more than one quote relating to the account's securities.
It needs to submit an underwriting fee to the MSRB.
It would be considered to have a control relationship with the issuer.

B
Members of a secondary market joint account must publish the same offering (quote). (12-32)

Mr. Thomas calls his registered representative with an order to buy up to 2,000 shares of XYZ at $35 per share right now and do not leave the unexecuted portion on the specialist book. Mr. Thomas has entered
a(n):

Order that cannot be accepted
Immediate-or-cancel order
Limit order
Day order

B
An order that dictates to fill as much of the order as you can right now and cancel the rest is called an immediate-or-cancel order. Limit orders are placed as either day or GTC orders and the unexecuted portions are placed on the specialist book. Mr. Jones entered this kind of order when he said he wanted by buy 2,000 shares of XYZ. (11-25)

According to MSRB rules, which of the following is FALSE regarding written complaints?

A report must be sent immediately to the MSRB
The complaint must be properly recorded and retained by the firm for six years
The firm must send a copy of the MSRB investor brochure
A principal must take appropriate action

Any written complaint must be administered to by a principal and be retained for six years along with a record of what the principal did to rectify the complaint. In addition, MSRB rules mandate that an MSRB investor brochure be sent to the complainant. A report does not need to be immediately sent to MSRB. (12-33)

An option contract for RFQ is for 108 shares. This would most likely be a result of which of the following circumstances?

Never, since an option contract always represents 100 shares
If there had been a stock split
If there had been a stock dividend
If there had been a cash dividend

The number of shares would be adjusted for a stock dividend or an odd stock split. 108 shares would most likely represent an 8% stock dividend. (16-10

An investor has been making payments into a variable annuity for the last 20 years. The investor decides to annuitize and selects a straight-life payout. Which TWO of the following statements are TRUE?

The investment risk is assumed by the insurance company.
The investment risk is assumed by the customer.
The amount of the payment to the customer is guaranteed by the insurance company.
The amount of the payment to the customer is not guaranteed.

I and III
I and IV
II and III
II and IV

d
Unlike a fixed annuity, the customer assumes the investment risk in a variable annuity. The amount of the payment depends on the performance of the separate account. The payment could increase, decrease, or remain the same, since the amount of the payment is not guaranteed. (19-2)

Which of the following best describes painting the tape?

A market maker's failure to honor a firm quote
Individuals entering into transactions in which ownership does not actually change, in order to give the impression of trading volume in a security
Employees of a broker-dealer purchasing shares of a hot new issue at the public offering price for their own account
A registered representative with discretion over a client's account conducting excessive trading to generate commissions

B
Painting the tape is a technique whereby individuals acting in concert repeatedly sell a security to one another without actually changing ownership of the securities. This is intended to give an impression of increased trading volume. The regulators considered this to be a type of manipulation. (11-5)

If the FOMC enters into a repurchase agreement, what is the immediate effect on the amount of money in the banking system?

Has no effect on the amount
Decreases the amount
Increases the amount
May increase or decrease the amount

C
In a repurchase agreement (Repo) , the Federal Open Market Committee would first buy the government securities. This action adds money to the banking system. A short time later the dealer would repurchase the securities from the Fed. (22-11)

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

The reserve requirement
Margin requirements
The discount rate
Its open market policy

A
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. (22-9)

Wireless Communications is offering 2,000,000 common shares (par value $.10) at $15. Which two of the following describe the financial impact on the company?

An increase in paid-in capital
A reduction in the long-term debt ratio
A reduction in liquidity
An increase in fixed assets by $30,000,000

I and II
I and IV
II and III
III and IV

A
The company will receive cash from the sale of the stock, so liquidity will increase. The common stock account and the paid-in capital account, which are part of stockholders' equity, will also increase. The long-term debt ratio will fall as the equity capital rises and since the company is raising cash, current assets will increase. Finally, fixed assets will be unchanged. (22-26, 22-30)

The 5% markup policy would apply to a:

Municipal bond trade
Transaction on the NYSE
Proceeds transaction
Purchase of mutual fund shares

C
The 5% markup policy does not apply to any trade requiring a prospectus (new issues, registered secondaries, and mutual funds) or a transaction involving an exempt security (municipal bond) or transaction effected on an exchange. The 5% policy applies to secondary market OTC trades, which include proceeds transactions (using sale proceeds to buy another security) and riskless or simultaneous transactions. (12-4)

An investor purchases 200 shares of STC at $35 and subsequently purchases 2 STC Jan 35 puts at 2.
At what market price must STC trade for the investor to have a profit?

32
34
36
38

D
If an investor is long stock and long a put, he will have a profit if the market price exceeds the cost of his stock plus the premium for the option. The stock must trade above 37 (35 cost + 2 premium). (15-4)

The Board of Directors of a corporation is responsible for establishing all of the following EXCEPT the:

Declaration date
Payable date
Ex-date
Record date

C
The ex-dividend date is standardized in the securities industry and is normally two business days prior to the record date. (4-7)

Mrs. Jones is interested in selling 500 shares of her REIT. The sale would be handled in a manner similar to the:

Redemption of an open-end fund
Sale of a fund listed on the NYSE
Liquidation of a real estate limited partnership
Redemption of EE bonds

B
There is a secondary market for REITs (Real Estate Investment Trusts); the vast majority trade on the NYSE with prices determined by supply and demand. Closed-end funds are funds that are often bought and sold on the NYSE that trade in a similar manner. (18-30)

An investor who sells a July 50 put and buys a July 60 put on the same stock is establishing:

A bull spread
A bear spread
A long straddle
A short straddle

B
A bear spread always involves buying the higher exercise price and selling the lower exercise price. This applies to both call spreads and put spreads.

A bull spread always involves buying the lower exercise price and selling the higher exercise price. This applies to both call spreads and put spreads. (15-29)

Supplemental documentation would be required when opening all of the following types of accounts EXCEPT:

Guardian
Partnership
Uniform Transfers to Minors
Account for an estate

A copy of the court appointment of the guardian is necessary for choice (A). To open a partnership account, a copy of the partnership articles should be obtained. In the case of an account for an estate, documentation should be obtained that shows the executor or administrator is properly authorized. Many new account forms contain UTMA/UGMA as one of the standard ownership choices, making additional documentation unnecessary. (2-8)

A type of new municipal issue sale where the underwriter is appointed by the issuer is a(n):

Eastern Account
Western Account
Negotiated Issue
Competitive Issue

C
For a negotiated issue, the underwriter is appointed by the issuer. Eastern and Western accounts are types of syndicates formed by underwriters. (10-2, 9-4)

Which two of the following are normally TRUE of money market mutual funds?

They are load funds.
They are no-load funds.
Dividends are computed daily and credited monthly.
Dividends are computed weekly and credited monthly.

I and III
I and IV
II and III
II and IV

C
Money market funds are normally no-load, open-end investment companies . Their portfolio consists of short-term fixed income securities such as Treasury bills, commercial paper, and bankers' acceptances. Dividends on money market fund shares are usually computed daily and credited monthly. Investors may elect to reinvest the dividends each month, thereby buying more shares. (18-8)

A municipal bond with an 8% coupon and eight years to maturity is purchased for 106. If sold six years later, what would be the cost basis?

100
101.50
104.50
106

B
When a bond is purchased at a premium (above par value), the premium must be amortized (reduced) over its life. The premium in this example is six points which must be amortized over its eight-year life. It must be amortized 3/4 point each year (6 points divided by 8 years to maturity). After six years, it would be reduced by 4 1/2 points (3/4 x 6). Its cost basis would therefore be 101 1/2 (106 original cost - 4 1/2 points amortized premium). (21-12)

A broker-dealer has a financial advisory relationship with an issuer of municipal securities. Under MSRB rules, which TWO of the following statements are TRUE?

The broker-dealer is permitted to act as a syndicate member on securities issued by this municipality.
The broker-dealer is not permitted to act as a syndicate member on securities issued by this municipality.
The financial advisory relationship between the broker-dealer and the municipality must be in writing.
The financial advisory relationship between the broker-dealer and municipality is not required to be in writing.

I and III
I and IV
II and III
II and I

C
Under MSRB rules, a financial advisory relationship exists when a municipal securities broker or dealer gives, or enters into an agreement with an issuer to give, financial advisory or consultant services regarding the issuance of municipal securities. There must be a written agreement between the two parties evidencing the fact that a financial advisory relationship exists. A broker-dealer that has a financial advisory relationship is prohibited from acting as an underwriter with respect to the same issuer of municipal securities. The rule applies whether the issue is sold on a negotiated or competitive bid basis. (12-28)

Gross Domestic Product (GDP) has declined for two consecutive quarters in the U.S. Which of the following industries would most likely be negatively affected by this downturn in the economy?

Cosmetics
Transportation
Food
Medical

Two consecutive quarters of declining GDP figures would be considered recessionary by most economists. Transportation stocks (e.g., railroads, trucking, airlines) are cyclical and the performance of these companies would be directly affected by this event. (22-2)

What is the maximum allowable percentage that can be sold above the original size of the offering through a green shoe option?

10%
15%
20%
25%

The overallotment provision of an underwriting agreement may contain a green shoe clause, which allows the syndicate to increase the number of shares sold by 15% over the original number of shares in the offering. (9-7)

Fred's Auto Centers is looking to raise $10 million to expand its business. The company has entered into an agreement to raise the capital through Winco Securities, a local investment banking firm. Winco Securities has made no guarantee that it will be able to raise the full amount of the offering. Which of the following statements regarding this scenario is/are true?

This is an example of a firm commitment underwriting.
This is a best-efforts underwriting.
Winco is acting as an agent for Fred's Auto Centers.
Winco is acting as principal in this underwriting.

II only
I and III only
I and IV only
II and III only

The underwriting is being done best-efforts, since no guarantee to raise the $10 million has been made by Winco Securities. Winco is acting as an agent in the transaction because any unsold shares will be retained by Fred's Auto Centers. Winco will be compensated only for the shares it sells and assumes no liability in the deal. (9-2)

What department or section of the brokerage firm would be responsible for tendering stock?

P&S Department
Margin Department
Cashier's Department
Reorganization Department

D
The Reorganization ("Reorg") department handles the exchange of one security for another (i.e., tender offers or converting rights into stock). The P&S Department normally handles the function of computing and comparing trades. The Margin Department handles the enforcement of Regulation T. The Cashier's Department is concerned with the handling and protection of securities. (11-18)

Concerning mutual funds, what is meant by net investment income?

Interest only
Dividends only
Interest + dividends - expenses
Dividends + capital gains - expenses

C
Net investment income of a mutual fund is derived from the total interest and dividends earned by the fund's portfolio minus the expenses of the fund. (18-29)

Which of the following statements are TRUE regarding a limited partnership?

There may only be one general partner.
There must be more than one limited partner.
The partnership does not pay income taxes.
It is a form of ownership that passes its profits and losses through to its participants.

III and IV
I, II, and III
I, II, and IV
II, III, and IV

A
Limited partnerships provide a form of ownership in which there is undivided interest in equity that does not pay income taxes and passes its profits and losses through to its participants. There are no rules, however, regulating the number of limited and general partners that a limited partnership must contain as long as there are at least one of each. (20-1)

What is the basic balance sheet equation?

Total Assets + Total Liabilities = Stockholders' Equity
Total Liabilities = Total Assets + Stockholders' Equity
Total Assets = Total Liabilities - Stockholders' Equity
Total Assets = Total Liabilities + Stockholders' Equity

D
The balance sheet equation is Total Assets = Total Liabilities + Stockholders' Equity. (22-20)

ABC Brokerage, a broker-dealer, sells 200 shares of stock to a customer from its own inventory. In this transaction, ABC acted as
a(n):

Agent
Broker
Principal
Underwriter

C
When a broker-dealer sells securities to a customer from its own account (inventory) or buys securities from a customer for its own account, it is acting as a principal or dealer. If the firm matched up a buyer and a seller without involving its own account, it would be acting as an agent or broker. (11-2)

A 6% bond is selling at a 6.25% basis. The bond will mature in 25 years and has 3 call dates. Which of the following would give the investor the best return?

If the bond is called after 10 years at 103
If the bond is called after 15 years at 102
If the bond is called after 20 years at 101
If the bond is held to maturity

C
The bond is selling at a discount. The first call in 10 years at 103 would give the investor the best return. The investor receives the highest call price in the shortest number of years. (5-17, 5-9, 5-10)

Interest rates had been very high. During the past three years rates have decreased dramatically, reaching historically normal level. The present yield curve would most likely be:

Ascending
Positive
Inverted
Negative

I and II
I and III
II and III
III and IV

A
If rates have declined for the past three years and reached a normal level, the present yield curve would most likely be ascending which is also referred to as positive or upward sloping. (5-14)

Which of the following could not be accomplished in a cash account?

Covered call or put writing
The sale of preferred stock
Selling short
The purchase of options

C
Selling short can only take place in a margin account. (2-10)

Which of the following is another way of expressing the earnings multiple?

Debt-to-equity ratio
Dividend payout ratio
Price-earnings ratio
Operating profit ratio

C
The earnings multiple is called the price-earnings ratio. (22-28)

Duties of the specialist on the NYSE include which of the following?

Maintaining a fair and orderly market in selected securities
Appointing floor brokers
Resolving trade imbalances
Arbitrating disputes between member firms

I and II only
I and III only
I, III, and IV only
I, II, III, and IV

B
The responsibilities of the specialist include resolving trade imbalances, which may result from a temporary lack of supply or demand in a particular security. The specialist's role also includes maintaining liquidity and a fair and orderly market. Floor brokers are not appointed by the specialist. Arbitration disputes between member firms are handled under the Arbitration Code. (11-16)

What type of risk do zero-coupon bonds eliminate?

Credit risk
Purchasing power risk
Reinvestment risk
Market risk

C
Zero-coupon bonds are issued at a discount and do not pay semiannual interest. Therefore, there are no interest payments to reinvest, eliminating reinvestment risk. When investing in fixed-income investments, one of the uncertainties is whether interest rates will allow an investor to realize the total return that was calculated at the time of the investment (yield to maturity). Zero-coupon bonds do not have reinvestment risk, but they do have extreme interest-rate risk because the bonds' duration will equal the years to maturity. (5-4, 5

Where could a broker-dealer find bidding details for a new municipal bond issue?

Bond Buyer New Issue Worksheets
OTCBB
Munifacts
Official Statement

A
The Bond Buyer New Issue Worksheets are a service of the Bond Buyer and show details of the issue and bidding requirements. The Official Statement is prepared after the issue is sold and contains a description of the issue and financial information of the issuer. (12

An investor has sold a stock short. If the present market value is $2.00 per share, the minimum maintenance requirement would be:

50%
$2.50 per share
$2.00 per share
30%

B
When selling short securities that have a market value less than $5 per share, a minimum maintenance requirement of $2.50 per share or 100% of the market value, whichever is greater, applies. Since $2.50 a share is greater than $2.00 per share, this is the correct answer. (13-16)

Which of the following represents the percentage of new municipal issues brought to market during a particular week that has already been sold?

The Bond Buyer Index
The Blue List
The Visible Supply
The Placement Ratio

D
The placement ratio represents the percentage of new municipal bond issues of $5,000,000 or more

Which bond has the most interest-rate risk?
A 3-month Treasury bill
A zero-coupon 30-year Treasury STRIPS
A 6%-coupon 30-year Treasury bond
A 3%-coupon 5-year Treasury note

B\The bond with the most interest-rate risk or price volatility is the one with the longest maturity and lowest coupon. (5-11)

To compute equity in both a short and long margin account, the formula would be:

The long market value plus the credit balance minus the short market value minus the debit balance
The long market value minus the credit balance minus the short market value minus the debit balance
The long market value plus the debit balance minus the short market value minus the credit balance
The long market value plus the credit balance plus the debit balance minus the short market value

A
The long market value plus the credit balance minus the short market value minus the debit balance equals the equity in both a long and short margin account. (13-19)

An investor sells uncovered calls and, just prior to their expiration, sells short the underlying stock. The intent is to keep the price from rising above the exercise price. Such an action is called:

Pegging
Supporting
Capping
Frontrunning

C
Writers of uncovered calls will benefit if they can prevent the price of stock from rising above the exercise price. They could accomplish this by capping the stock (entering sell orders to prevent the price from rising above a certain level). Capping is considered a manipulative activity and is a violation of securities law. (11-5

Where are the priority provisions for allocating bonds listed for a new municipal bond offering?

Official statement
Underwriters agreement
Offering circular
Settlement letter

B
The priority provisions of how bonds will be allocated to members of the municipal bond syndicate will be indicated in the underwriters agreement (syndicate letter). The usual priority of orders is pre-sale, group net, designated, and member orders at the takedown. (10

An investor purchases a $100m face value municipal bond with a 5-year maturity at 105. After two years, the bond is sold at 95. For tax purposes, the investor has a(n):

$2,000 loss
$4,000 loss
$8,000 loss
$10,000 loss

When a municipal bond is purchased at a premium, the bond's premium must be amortized to find an adjusted cost basis. If the bond is sold above the adjusted cost basis, the result is a capital gain. If the bond is sold below the adjusted cost basis, the result is a capital loss. If the bond is held to maturity, there is neither a loss nor a gain for tax purposes. This is because the adjusted basis would equal the par value after the premium is amortized.

This bond is purchased at $105,000 with a 5-year maturity. The premium of $5,000 ($105,000 - $100,000 = $5,000) must be amortized over a 5-year period ($5,000 divided by 5 years equals $1,000 per year). Therefore, each year the original cost of the bond is reduced by $1,000.

If the bond is sold after 2 years, the adjusted cost basis is $103,000 ($105,000 - $2,000 = $103,000). Since the bond is sold at $95,000, there is a capital loss of $8,000 ($103,000 - $95,000). (21-12

Roundville Bank is considering an investment in Roundville County bonds. The bonds contain a provision which permits banks to deduct 80% of the interest cost being paid to depositors on the funds used to purchase the bonds. These securities are known as:

Alternative minimum tax bonds
Bank qualified bonds
Private activity bonds
Moral obligation bonds

B
Bank qualified municipal bonds allow banks to deduct 80% of the interest cost paid to depositors on the funds used to purchase the bonds. This is done to encourage banks to invest in municipal securities. To qualify, a municipality may only issue up to $10,000,000 annually. (8-5)

Which of the following would give the best indication of current interest rates on revenue bonds?

Visible supply
Placement ratio
List of 20 bonds
List of bonds with 30 year maturities

D
The Bond Buyer computes the Revenue Bond Index which is the average yield of 25 revenue bonds with 30-year maturities. (12-27)

An investor is interested in purchasing an interest in a real estate limited partnership. To exhibit suitability, the investor could provide:

Past tax returns
Notarized document attesting that the investor is an expert in managing real estate
Executed copies of subscription agreements from other programs in which he is a limited partner
A completed subscription agreement

A.
When investing in a DPP the customer must verify that he meets all suitability standards. This can be accomplished by furnishing documents such as past tax returns and a statement of net worth. (20-3)

An insider of XYZ Corp. buys company stock in the open market at $63/share. Ten months later, the insider wishes to sell the stock at the current market price of $68/share. Which two of the following statements are TRUE regarding this transaction?

The sale is subject to the six-month holding period under Rule 144.
This sale is not subject to the six-month holding period under Rule 144.
The sale is subject to the volume limitations under Rule 144.
The sale is not subject to the volume limitations under Rule 144.

I and III
I and IV
II and III
II and IV

C
Rule 144 requires that restricted (unregistered) stock be held for six months before it can be resold. Control stock (registered stock purchased by insiders) is not subject to a holding period requirement under Rule 144. Both restricted and control stock are subject to the volume limitations under the Rule. (9-21)

An investor purchasing $1,000,000 par value of Treasury notes at a price of 101-03 would pay:
$1,010,300
$1,010,937.50
$10,101,300
$10,109,375

Treasury notes are quoted as a percentage of par in 32nds of a percent. A quote of 101-03 equals 101 3/32% or 101.09375% (3/32 = .09375). 101.09375% x $1,000,000 = $1,010,937.50. (7-2)

XYZ Corporation has 4,000,000 shares of common stock authorized and 2,500,000 shares issued of which 100,000 are treasury stock. The corporation is issuing an additional 1,000,000 shares through a standby underwriting. If only 600,000 shares are subscribed to in the corporation's offering, the number of outstanding shares will:

Remain the same since the entire issue was not fully subscribed
Increase by 600,000 to 3,000,000 shares
Increase by 600,000 to 3,100,000 shares
Increase by 1,000,000 to 3,400,000 shares

D
Since 100,000 shares of the 2,500,000 shares issued is treasury stock (repurchased by corporation), there are 2,400,000 shares outstanding prior to the new issue. On a standby underwriting, the underwriting syndicate agrees to purchase any shares which the corporation does not sell. Since the corporation only sold 600,000 shares, the underwriters would purchase the remaining 400,000 shares. After the new issue, there would be 3,400,000 shares outstanding (2,400,000 + 1,000,000). (9-2, 4-6)

A registered representative writes a letter to see if his clients have any interest in trading options. The letter is generic and describes the advantages and disadvantages of options trading. This letter:

Must be approved prior to use by a ROP
Need not be approved prior to use so long as it does not contain recommendations
Must be accompanied by a risk disclosure document
Need not be accompanied by a risk disclosure document

I and III only
I and IV only
II and III only
II and IV only

B
All advertising, sales literature, and educational material must be approved by a ROP prior to being sent to a customer. Since there are no specific recommendations, the OCC disclosure document does not need to precede or accompany the letter. However, the customer must receive the risk disclosure document at or before the account is approved for options trading. (16-12)

A customer contends that his registered representative made unauthorized trades in his account, and will take this matter to an arbitration panel. Regarding the makeup of this panel, which of the following statements is TRUE?

A majority of the arbitration panel must come from outside the securities industry.
A majority of the arbitration panel will come from within the securities industry.
All arbitrators must come from inside the securities industry or must be attorneys.
All arbitrators must come from outside the securities industry.

A
Under the Code of Arbitration, if a public customer takes a member firm to arbitration to resolve a dispute, the majority of the panel must come from outside of the securities industry unless the customer requests a panel with a majority of industry arbitrators. Neither the broker-dealer nor the customer may actually pick the arbitrators and arbitrators do not have to be attorneys. (1-14)

Mr. Jones bought an 8% debenture at a 7.20 basis. If the bonds are currently trading 15 basis points higher:

Mr. Jones' yield-to-maturity has increased to 7.35%
The bond's coupon has increased to 8.15%
The bond's market price has decreased
Mr. Jones' investment has not been affected

C
When the investor bought the bond, he established a yield-to-maturity of 7.20%. This will remain the same over the life of his investment. The coupon rate was established when the bonds were issued and will never change. However, when yields in the market increase, the market price of outstanding bonds will decrease. (5-7)

Mr. Blue's margin account has a market value of $20,000 and a debit balance of $9,000.

If Mr. Blue purchases $2,000 of options, he would have to deposit:

0
$1,000
$2,000
$3,000

B
The margin requirement when purchasing options is 100% of the purchase price (premium). Since the purchase price of the options is $2,000, Mr. Blue may use the $1,000 SMA and would be required to deposit an additional $1,000. The SMA is found by subtracting the required equity, $10,000 ($20,000 x 50%) from the current equity in the account ($11,000). (13-20, 16-5)

If ABC Corporation pays a $0.25 dividend to its shareholders, all of the following would result EXCEPT:

Retained earnings remain the same
Working capital is decreased
Current assets are decreased
Current liabilities are decreased

B
When a corporation pays a dividend, cash (a current asset) is reduced and the dividend is no longer a current liability (liabilities are reduced). Since current assets (CA) and current liabilities (CL) are reduced by the same amount, working capital (CA - CL) remains the same. The total assets and total liabilities are also reduced by the same amount and therefore retained earnings (which is part of stockholders' equity) will not be affected. Retained earnings are reduced when the corporation declares the dividend. (22-29)

A registered representative receives an order from the President of XYZ Corporation to sell unregistered XYZ shares. The client purchased the shares in a private placement 90 days ago. This order:

Will require the filing of Form 144 with the SEC
May be executed without any restrictions
Must be approved by a principal prior to execution
Is a violation of Rule 144 if executed

According to Rule 144, an affiliated person (e.g., the president of a company) must hold unregistered (restricted) stock for at least six months before it may be sold. Since the President of XYZ Corporation only owned the stock for 90 days, the order to sell would violate Rule 144 if executed. (9-20)

A customer's account does not require approval to trade penny stocks if the:

Trade is recommended
Trade is not recommended
Account is established
Account is new

I and III
I and IV
II and III
II and IV

The approval of an account to trade penny stocks is not required if the account has been in existence for more than one year or if all transactions in penny stocks are non-recommended. (12-21)

To calculate the total interest cost to the issuer for a competitive bid, the syndicate would need:

The total par value of the offering
The maturity schedule and coupon rates
Whether the bid includes any discounts or premiums
The dated date for the bonds

I and II only
III and IV only
I, II, and III only
I, II, III, and IV

D
When computing a competitive bid, the broker-dealer must calculate the total interest cost to the issuer. To calculate total interest cost, the coupon (interest rate), par value, maturity schedule, amount of any discount or premium, and dated date are required. (10-7)

Kyle, a client at TLC brokerage firm, anticipates a decline in the earnings of LPOP. LPOP is a thinly traded issue. Which of the following statements BEST describes what the RR should disclose to Kyle?

The stock may be difficult to sell short because the shares may not be available to borrow.
All securities may be sold short provided the client has a margin account.
As long as the order ticket is marked sell long, the stock could be sold short.
Exchange-traded put options are available on all securities and would be a less risky method to profit.

A client may sell short or buy a put to profit from a decline in the value of a security is anticipated. In order to sell short, the broker-dealer is required to borrow the security. Although short sales may only be executed in a margin account, if an issue is thinly traded, it may be difficult or impossible to borrow the security. A put option may be an attractive alternative to selling short; however, put options are unlikely to be available on a thinly traded security. (11-4, 12-15, 13-14, 14-15)

In an oil and gas drilling program, a sharing arrangement where the sponsor pays a small amount of all of the program's costs in return for a larger amount of the revenues is known as:

Functional allocation
Overriding royalty
Reversionary working interest
Disproportionate

In a disproportionate sharing arrangement, the sponsor (general partner) shares in the costs of the program and receives a portion of the profits. It is disproportionate because the percentage share of profits is much larger than the percentage share of costs. (20-17)

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

It must be opened by the time he files his tax return
It must be opened by the end of the tax year
A maximum deductible contribution of $24,000 is permitted
A maximum deductible contribution of $51,000 is permitted

I and III
I and IV
II and III
II and IV

C
A Keogh plan must be opened by the end of the tax year (December 31st). However, contributions are permitted until the filing deadline for the tax return (April 15th). A self-employed individual may deduct 20% of self-employed income or $51,000, whichever is less, to a Keogh. 20% of $120,000 is $24,000 and would be the maximum allowable deductible contribution. (17-10)

Which TWO of the following persons would be permitted to purchase an equity IPO?

An employee of a FINRA member whose sister is a director of the issuer
A portfolio manager of a mutual fund purchasing for his personal account
Employees of the issuer if the issuer is a FINRA member
An attorney hired by the issuer to assist in the IPO

I and II
I and III
II and III
II and IV

Issuer-directed securities provide an exemption for certain individuals under the New Issue Rule. Under this provision issuers may direct securities to the parent company of an issuer, the subsidary of an issuer, and employees and directors of an issuer. The issuer-directed provision also permits immediate family members to participate in the offering, provided they are employees or directors of the issuer. Registered representatives are also allowed to purchase shares of an equity IPO if the issuer is that person's employing broker-dealer or is the parent or subsidary of the broker-dealer.

An attorney hired to assist in the IPO has a restricted status because he is not employed by the broker-dealer. A portfolio manager of a fund may not purchase for his personal account. A purchase could be made on behalf of the fund. (9-7)

An XYZ Corporation convertible bond is selling in the market at $1,248.75. It is convertible at $30. XYZ common stock's market price is 37.50. The bond has been called at 103. Which of the following is the least attractive alternative for a holder of the bond?

Sell the bond
Convert to common and sell the common
Allow the bond to be called
Convert common stock to a bond

The holder could sell the bond and receive $1,248.75. If he converted, he would receive 33 1/3 shares ($1,000 par divided by $30 per share conversion feature) with a total value of $1,249.88 (33 1/3 times $37.50). The least attractive alternative is to allow the bond to be called and receive $1,030. (6-6)

The Trust Indenture Act of 1939 regulates:

A purchase of $5,000,000 of Treasury bonds
A private placement of $3,000,000 of corporate notes
A $20,000,000 sale of corporate bonds sold interstate
A sale by a brokerage firm throughout the country of $25,000,000 of corporate debentures

I and II only
I and III only
III and IV only
I, II, III, and IV

The Trust Indenture Act of 1939 regulates the public issuance of corporate securities that are sold interstate. It does not cover U.S. government securities or private placements. A $20,000,000 sale of corporate bonds sold interstate and a sale by a brokerage firm throughout the country (also interstate) of $25,000,000 of corporate debentures would be covered under the Trust Indenture Act of 1939. (6-1)

A Treasury bond is quoted 105.04 - 105.24. The purchase price that a customer would expect to pay would be:

$1,051.25
$1,052.40
$1,054.00
$1,057.50

U.S. Treasury notes and bonds are quoted in 32nds of a point. When purchasing the bond, the customer would pay the offering price of 105.24. To convert 105.24 into a dollar price:

step 1: 105.24 is equal to 105 24/32

step 2: convert 24/32 into a decimal, which is .75

step 3: convert 105.75% into a dollar price
(105.75% x $1,000 = $1,057.50)

The customer would pay $1,057.50. (7-2)

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:

Buy 5 bonds
Buy 100 shares of stock
Sell 5 bonds short
Sell 100 shares of stock short

I and III
I and IV
II and III
II and IV

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 - 60 parity price).

An investor would 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). (6-6)

Keystone Chocolate Co. plans to sell shares of a new issue only in the state of Pennsylvania. In order to qualify for a registration exemption under Rule 147, what percentage of the corporation's assets must be located in Pennsylvania, and what percentage of its revenues must be derived from Pennsylvania sources, at the time of the offering?

70%
80%
90%
100%

Keystone is eligible to offer shares in Pennsylvania (PA) under the intrastate exemption (Rule 147) if 80% of its assets are located in PA, 80% of its revenues are derived from PA sources, and 80% of the proceeds from the sale are used in PA. In addition, to qualify for the exemption, 100% of the purchasers of the offering must be residents of PA. (9-19)

Which of the following orders would you place for a customer who wants to hold her auction rate security if the interest rate is set at 3.4% or higher:

Hold order
Limit order
Bid order
Sell order

A current holder of an auction rate security may indicate the desire to continue to hold the security only if the rate is set at or above a specified rate. If the clearing rate sets below the interest or dividend rate that the holder or prospective holder specifies in her bid, the holder will be required to sell the securities subject to her bid, and the prospective buyer will not acquire the securities. Auction dealers refer to bids by prospective holders as "buy" orders and bids by holders as "roll-at-rate" orders. (8-19)

A municipal dealer purchased $100,000 face value of 6.00% bonds at a 6.00 basis. If the dealer reoffered the bonds, which of the following could be considered reasonable?

101
108
5.80 basis
4.00 basis

I and II only
I and III only
III and IV only
I, III, and IV only

The dealer purchased the bonds at par (6% coupon at a 6.00 basis). When reoffering the bonds, the dealer's markup should be reasonable. A one point markup (101) would be considered reasonable whereas an eight point markup (108) would not. An offering of 5.80 represents a reduction in yield of 20 basis points and would be considered reasonable. A reduction in yield of 200 basis points (6.00 basis minus 4.00 basis reoffering) would be excessive. (12-30)

An individual with $10,000 to invest would not usually be able to purchase:

Money-market fund shares
Dealer-placed commercial paper
Municipal bonds
Treasury STRIPS

The minimum requirement for an investment in dealer-placed commercial paper is normally $100,000. The minimum requirement for investment in Treasury STRIPS is usually $1,000 and the minimum denomination for municipal bonds is $1,000. (7-21)

Which of the following option orders may be accepted by an order book official?

Discretionary
Limit
Spread
Not held

An order book official on the floor of an options exchange is only permitted to accept limit orders. (16-3)

Approval by a principal is required when sending a customer all of the following EXCEPT a(n):

Abstract from an official statement
Form letter
Research report
Red herring

An abstract from an official statement, a form letter, and a research report are considered advertising or sales literature and must be approved. A red herring (preliminary prospectus) is used to provide a potential investor with information and is regulated by the SEC. (12-32, 9-13)

A broker-dealer owns 100 shares of ABCO stock which it purchased at 28. If the stock is sold to a customer, the broker-dealer will base a markup on:

The inventory cost of 28
The highest bid on the Nasdaq system
The lowest offer on the Nasdaq system
A price that is fair and reasonable

When selling stock to a customer, a markup should be based upon the lowest offer on the Nasdaq system, not the price the dealer paid to purchase the stock (dealer's inventory cost). (12-3)

When an investor sells an interest in a limited partnership, his or her cost basis for tax purposes is the:

Original investment
Adjusted basis
Accredited value
Original investment plus accretion

An investor's basis will be reduced by any claimed losses and any cash distributions. This reduced (adjusted) basis is the cost basis at the time of sale. (20-6)

The strike price of a T-bond option contract is expressed as a percentage of the:

Total premium
Face amount of the underlying bonds
Underlying market value
Discount yield

Both the strike price and premium for a T-bond option are expressed as a percentage of the face value of the underlying bonds. (15-47)

Which of the following persons control positions in secondary market municipal bonds for a broker-dealer?

Underwriter
Trader
Agent
Principal

A trader is responsible for positioning (carrying inventory) secondary market municipal bonds. An underwriter is involved in new issues. (12-1, 10-1)

Which of the following communications must be filed with FINRA ten days prior to use?

Options advertising
Mutual fund advertising
CMO advertising
Unit Investment Trust advertising

I and II only
I and III only
II, III, and IV only
I, II, III, and IV

Advertising for most products, including options and CMOs, must be filed with FINRA 10 days prior to use. However, investment company ads, including ads for mutual funds and unit investment trusts, must be filed within 10 days following initial use. (2-1, 7-19, 16-12)

A customer's margin account has a long market value of $30,000 and a debit balance of $12,000. FRB initial margin requirement is 50%.

What is the purchasing power in the account?

0
$3,000
$6,000
$18,000

The account has $18,000 equity which is $3,000 more than the FRB initial requirement of $15,000 ($30,000 market value x 50% requirement). This excess equity is journaled to SMA and creates buying (purchasing) power of $6,000 (2 x SMA). (13-9)

Which of the following is not used to determine the winning bid in a competitive bond offering?

Reoffering Yields
Bond years
NIC
TIC

Reoffering yields are based on the price paid by purchasers and are not a part of the underwriters bid. Bond years are calculated by multiplying the number of $1,000 par value bonds by the years to maturity. When the bond years of each maturity are multiplied by the respective coupon rate and then totaled, the result is the net interest cost for this issue. NIC and TIC are used to determine the cost of the bid to the issuer. (10-7)

Mrs. Ima Holder purchased 10 RFQ July 60 calls. RFQ declares a 50% stock dividend. After the dividend has been distributed, Mrs. Holder would now own:

10 contracts for 100 shares each
10 contracts for 150 shares each
15 contracts for 100 shares each
15 contracts for 150 shares each

When the underlying stock has a stock split or stock dividend, the option contract must be adjusted. For a stock dividend or an odd split, the number of contracts is kept constant while the number of shares per contract is increased. Therefore, Mrs. Holder would still have 10 contracts but the number of shares per contract would be increased by 50% to 150. (16-9)

A GNMA pass-through is quoted 98.10 to 98.18. This quote represents a spread per $1,000 face value of:

$0.08
$0.80
$2.50
$8.00

GNMA pass-through certificates (like T-notes and T-bonds) are quoted in 32nds. The spread of .08 represents 8/32 or 1/4 (.25) and has a value of $2.50 per $1,000. (7-11, 7-2)

The major disadvantage to a limited partner in a DPP is:

Lack of control
Lack of liquidity
Flow through of income and expense
Limited liability

An investor has limited control (management) in equity investments and no control (management) in bond or DPP investments. The major disadvantage of a DPP is the lack of liquidity meaning that the investor cannot easily sell his portion of ownership. (20-1)

A customer's margin account has a current market value of $10,000, debit balance of $8,000, and SMA of $1,000. The customer could meet a maintenance call with:

$100 cash
$500 SMA
$500 cash
$1,000 SMA

A long margin account must maintain an equity equal to 25% of the market value. The account is $500 below the minimum ($2,500 required minus $2,000 equity). Using SMA will increase the debit balance and therefore reduce equity.

An investor purchased a T-bond 96 call at a premium of 0.24. If the underlying security is $100,000 face value of T-bonds, what was the investor's total cost for the option contract?

$240
$750
$7,500
$24,000

The premium on a T-bond option is expressed in percentage of face value using points (whole percent) and 32nds of a point (1/32%). A premium of 0.24 represents 24/32 of a percent or 3/4 of a percent (0.75%). To determine the total cost, multiply the face value ($100,000) by 0.75%. The total cost is therefore $750. (15-47)

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