a. A person who requires the discipline of forced savings
b. Parents with a modest income who have young children
c. A person who wants the assurance of a guaranteed cash value
d. A person with an understanding of investments who can tolerate market risk
Explanation: Similar to a variable annuity, the cash value of a variable life insurance policy increases or decreases in relation to the performance of the separate account. A person who is knowledgeable about investments may be a candidate for variable life insurance because common stock and bonds are the foundation of the policy. As the market values of the securities fluctuate, the cash value changes and is not guaranteed. Therefore, the insured must be able to tolerate market risk. There are other methods by which an investor may achieve forced savings and the product may not be suitable for parents with a modest income who have young children.
Explanation: An investor placing a market order will normally buy at the offer and sell at the bid. In this case, the investor purchased 10 contracts at the offer price of $5.15 and then closed out that position by selling 10 contracts at the bid price of $5.20. The investor’s cost basis for 10 contracts is $5,150 (10 contracts x $515 per contract) and the investor’s sales proceeds are $5,200 (10 contracts x $520 per contract). The investor’s capital gain of $50 is based on the difference between the cost basis and sales proceeds.
I. An attorney involved in the new issue of KMF
II. An investment company registered under the Act of 1940 that has some restricted persons as shareholders
III. A portfolio manager of an investment company buying for his personal account
IV. The general account of an insurance company
Explanation: Restricted persons include finders and fiduciaries (such as attorneys and accountants) involved in the new issue as well as 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)
a. The S&P 500 Index and the NYSE Composite Average
b. The Dow Jones Industrial Average and the Dow Jones Transportation Average
c. The Dow Jones Industrial Average and the Dow Jones Utility Average
d. The Dow Jones Composite and the NYSE Composite Average
Explanation: The Dow Theory holds that a confirmation of a bullish or bearish trend is made when the Dow Jones Industrial Average and the Dow Jones Transportation Average move in the same direction and reach new highs or new lows.
a. A taxable money-market fund
b. A tax-exempt money-market fund
c. A short-term Treasury fund
d. A balanced fund
Explanation: While all of these funds are somewhat conservative, the balanced fund will contain some equity investments and long-term bonds, which will expose the customer to market risk. Given the customer’s short-time horizon and objective of preservation of capital, the balanced fund would be the least suitable of the choices listed.
I. This is considered correspondence
II. This is considered a retail communication
III. This activity requires principal approval prior to use
IV. This activity should be reviewed
Explanation: This activity is considered a retail communication since the registered representative is sending the communication to more than 25 customers. A retail communication is any written or electronic communication that is distributed or made available to more than 25 retail investors within any 30-calendar-day period. If the communication is directed to 25 or fewer individuals, it is considered correspondence. If the retail communication does not make a recommendation, or promote a product or service, prior principal approval is not required. FINRA does not consider announcing the availability of online account statements as promoting a product or service. This activity should, however, be reviewed and supervised by the broker-dealer.
Explanation: Whoever is the stockholder of record on the record date (Nov. 1) will be credited with the additional shares resulting from the split. If that person liquidates the position prior to the ex-date (Dec. 1), the buyer must receive a due bill upon settlement of that trade. This is because on Dec. 1 the value of the stock will be cut in half. If the buyer does not receive the additional shares, then the position loses half its value on the ex-dividend date. The first day that the purchaser is not entitled to the additional shares is the ex-date, and this is the first day the stock will not trade with a due bill.
I. An exchange-traded fund
II. An initial public offering in which the RR’s firm is not an underwriter
III. A new issue of common stock in which the broker-dealer is the managing underwriter
IV. Convertible debt
Explanation: An employee of a broker-dealer is considered a restricted person and may not purchase new issues under FINRA rules. New issues under the rule are defined as initial public offerings (IPOs) of equity securities sold under a registration statement. Exemptions from the definition of an IPO include all debt offerings, investment company offerings such as mutual funds and exchange-traded funds, and preferred stock. Whether the broker-dealer is participating as an underwriter does not alter the restrictions.
Explanation: If a client is long a security that is convertible into an equal number of shares of a short position carried by the same client, the maintenance requirement is 10% of the current market value of the long position. This is an industry rule, not a Regulation T requirement. Each bond is convertible into 50 shares (the par value of $1,000 divided by the conversion price of $20). The client may convert the 40 bonds into a total of 2,000 shares (50 shares x 40 bonds), which is equal to the number of shares the client is short. The maintenance requirement is 10% of the long position, which is equal to $4,600 ($1,150 x 40 bonds x 10%).
a. The dollar amount of payments is guaranteed
b. Participants may not vote to change objectives
c. Payout is based on a number of annuity units, which remains fixed for the duration of the payout period
d. Annuity payments are of a constant dollar amount throughout the payout period
Explanation: A variable annuity does not give an annuitant a fixed-dollar return over a fixed number of years. Variable annuities give the annuitant a variable return based on the value of the securities in the separate account of the annuity. Payout is based on the number of annuity units that an investor receives upon annuitizing. The number of units remains fixed for the duration of the payout period. The investor takes on all investment risk since payments are not guaranteed. Investors are allowed to vote on certain issues.
a. Agricultural loans to farmers
b. Loans to finance residential mortgages
c. Business loans to veterans
d. Loans to utility companies
Explanation: The Federal Intermediate Credit Bank (FICB) makes agricultural loans to farmers.
a. A State Securities Commission
b. The Securities and Exchange Commission
c. The Federal Reserve Board
Explanation: Under Regulation T, the Federal Reserve Board is responsible not only for setting margin requirements but also for determining which securities may be sold on margin.
a. Written authorization from the customer
b. Oral authorization from the customer
c. Written authorization from the client for each trade the registered representative executes
d. The registered representative to send the client a letter detailing the proposed transaction
Explanation: Discretionary accounts require written authorization from the customer. In addition, each discretionary order must be approved on the day the order is entered by a manager, partner, or authorized person.
a. The director is permitted to sell the shares if the trade is reported
b. The director is permitted to sell the shares only if they are held for three additional months and the trade is reported
c. The director is permitted to sell the shares and no report is required
d. The director is permitted to sell the shares only if the transaction will result in a loss
Explanation: An insider, as defined by the Securities Exchange Act of 1934, is a director, officer, or owner of more than 10% of the voting stock of a corporation. Immediate family members of the insider are also subject to the same limitations. An officer or director is required to register with the SEC regardless of her ownership levels in the company. The director as an insider is required to report the transaction to the SEC within two business days. Insiders are not permitted to make short-swing profits (based on ownership of six months or less in their own company’s stock). Since the director owned the shares for nine months, there is no violation. Since the shares were purchased by the director in the secondary market, the shares are considered control, not restricted stock, and are not subject to the six months’ holding.
a. The bond is called after 10 years at 103
b. The bond is called after 15 years at 102
c. The bond is called after 20 years at 101
d. The bond is held to maturity
Explanation: The bond is selling at a discount. The first call in 10 years at 103 will give the investor the best return. The investor receives the highest call price in the shortest number of years.
a. Short-term bond prices
b. Long-term bond prices
c. The discount rate
d. Treasury bill prices
Explanation: The federal funds rate is the rate one bank charges another bank when loaning excess reserves. It is the most sensitive of all interest rates and affects all bond prices and other interest rates except the discount rate which is set by the Federal Reserve Board.
a. Contain the annualized rate of return
b. Disclose the representative’s trading performance for the past three years
c. Have an OCC risk disclosure document with it or be sent in advance
d. Contain a schedule of commissions and markups
Explanation: Options retail communications containing projections that is sent to a prospective customer must be accompanied by or preceded by a risk disclosure document. An annualized rate of return may be included under certain circumstances. Trading performance, if included, must cover a one-year period. There is no requirement to include a schedule of transaction costs.
a. Sell a call
b. Sell a put
c. Sell a straddle
d. Buy a straddle
Explanation: If the market price does not change, neither side of the straddle will be exercised. The premium on both the put and the call will be income to the investor.
a. It is designed to provide employees with a fixed monthly payout at retirement
b. The employer bears all the investment risk
c. Employees may deduct all employer contributions
d. Each employee has a separate account within the plan
Explanation: A defined contribution plan is one in which the employer makes contributions on behalf of employees, and the size of the retirement benefit depends on the amount of the contributions and the investment performance of the assets in the plan. In this type of plan, the employee assumes the investment risk and only the employer may deduct employer contributions. In addition, each employee has a separate account within the plan to easily track the growth of his retirement assets.
a. A raw land program
b. An existing properties real estate program
c. An oil and gas drilling program
d. An oil and gas exploratory program
Explanation: All of the choices provide potential for future cash flow and deductions except for a raw land program. In a raw land program, deductions are negligible and the profit potential comes in the form of capital appreciation, not cash flow.
a. Glossary of terms
b. Discussion on how changing interest rates may affect the prepayment rates
c. Discussion on how changing currency rates may affect the value of the securities
d. Discussion on the relationship between mortgage loans and mortgage securities
Explanation: Broker-dealers must offer customers educational material about the features of CMOs. This material must include:
A discussion of the characteristics and risks of CMOs. This includes: how changing interest rates may affect prepayment rates and the average life of the security, tax considerations, credit risk, minimum investments, liquidity, and transactions costs.
A discussion of the structure of a CMO. This includes the different types of structures, tranches, and risks associated with each type of security. It is also important to explain to a client that two CMOs with the same underlying collateral may have different prepayment risk and different interest-rate risk.
A discussion that explains the relationship between mortgage loans and mortgage securities
A glossary of terms applicable to mortgage-backed securities
Changing currency rates are not applicable to the risks associated with CMOs.
Explanation: Capital risk is the risk of an investor losing her principal, the amount of funds invested in a security. When compared to the other securities, bonds have the least amount of capital risk. At maturity, the investor would receive the principal amount of the bond, thus minimizing the capital risk.
c. Consumer electronics
Explanation: A leveraged company has a large amount of outstanding debt (bonds) and would be the most leveraged. Of the choices given, utilities are the heaviest users of debt and have the greatest amount of interest charges (fixed charges). The percentage of debt in a utility company’s capitalization is usually greater than that of the other companies listed.
Explanation: Securities purchased in a new margin account require a minimum equity of $2,000. If the securities are worth less than $2,000, then the securities must be paid for in full. In this example, the purchase is for $1,500, requiring the customer to deposit the full amount of the purchase.
a. Mutual funds are subject to more regulatory oversight than hedge funds
b. Mutual funds pool investors’ money and manage the portfolio, whereas hedge funds manage each investor’s assets separately
c. Hedge funds often use higher degrees of leverage than mutual funds
d. Mutual funds may be suitable for many customers, whereas hedge funds are generally suitable for sophisticated, wealthy investors only
Explanation: Mutual funds and hedge funds both pool investors’ money to manage the assets. Unlike mutual funds, hedge funds are often exempt from regulatory oversight, use leverage, and often employ aggressive financial strategies such as short selling and placing large bets on individual companies or sectors of the market. Hedge funds typically have high minimum investment requirements that make them suitable only for professional and wealthy investors.
I. Buy an ABC June 30 call at 5
II. Buy an ABC June 30 put at 3
III. Sell an ABC June 35 call at 2
IV. Sell an ABC June 35 put at 4
Explanation: The only choice given that will create a debit spread is the purchase of an ABC June 30 call at 5 and the sale of an ABC June 35 call at 2. This spread is executed for a net debit of 3. This is a debit spread because the option being purchased has a larger premium than the option being sold.
I. A self-employed doctor
II. A security analyst who made $2,000 giving public lectures on technical analysis
III. An engineer of a corporation who made $5,000 making public speeches on his specialization
IV. An executive of a corporation who received $5,000 in stock options from his corporation
Explanation: An individual with self-employed income may establish a Keogh. Of the choices given, a doctor may participate because he is self-employed. The security analyst and the engineer could set up a plan for the income they derive from outside, self-employed activities. An executive of a corporation who received $5,000 in stock options may not participate because he is not self-employed.
Explanation: A short position will be profitable if the market price of the security decreases. If the stock increases, the investor will have a loss. A buy stop order is placed above the market. If executed, stock will be purchased preventing further loss. There is no limit to the length of time that a short position may remain open. A portion of the short credit balance must always remain in the account to be used eventually to cover the short position. An investor who is short the stock does not receive dividends and does not have the right to vote.
Explanation: Eurodollars are defined as U.S. dollars on deposit in all foreign banks, not just banks in Europe.
Explanation: Inflation occurs when the money supply expands faster than the supply of goods and services. To combat inflation, the Federal Reserve will most likely sell securities in order to reduce the money supply.
I. Created the SEC
II. Provided for the regulation of credit
III. Provided for the regulation of exchanges
IV. Provided for the regulation of new issues
Explanation: The Securities Exchange Act of 1934 created the SEC and provided for the regulation of credit and exchanges. The Securities Act of 1933 provided for the regulation of new issues.
a. The RR is not permitted to pay a finder’s fee to the accountant
b. The RR is permitted to pay a maximum finder’s fee of 5% to the accountant
c. The RR is permitted to pay a maximum finder’s fee of 8.5% to the accountant
d. The RR is permitted to pay an annual referral fee to the accountant based on the amount of commissions generated by the referrals
Explanation: A broker-dealer is not permitted to compensate nonregistered persons in exchange for introducing clients to an RR or based on the amount of commissions or fees generated by the account. This would prohibit a firm from paying a finder’s fee, rebate, or bonus based on commissions to any person who is not employed by a broker-dealer (an accountant or attorney, for example) unless that person was registered with the broker-dealer.
Explanation: When a bond is prerefunded, the only applicable date is the first call feature. Therefore, the bond must be priced to the first call date.
1. An employee of a municipal securities firm may open a new account with another municipal securities firm without the employer being notified
II. An employee of a municipal securities firm may open a new account with another municipal securities firm as long as the employer is notified and duplicate confirmations are sent to the individual’s employer
III. A bond attorney may open a new account without restriction
IV. An officer of a municipal issuer may open a new account without restriction
Explanation: MSRB rules only place restrictions on opening an account for an employee of another MSRB member firm. When opening an account for an employee of another MSRB member firm, the employer must be notified and duplicate confirmations of all trades must be sent to the employer.
Explanation: If a corporation owns less than 20% of the distributing company, the corporation is required to pay tax on 30% of the dividends it receives on stock that it owns (70% is excluded). The company will have to add $30,000 (30% of $100,000) to its taxable income. The total taxable income will, therefore, be $2,030,000. The tax liability will be $690,200 ($2,030,000 times 34% tax rate). If the corporation owned at least 20% of the distributing company, only 20% of the dividends would be taxable.
Explanation: Sell stop orders are entered below the current market. The order will most likely be entered by a technical analyst (chartist) below a support level for the stock. If the price of the stock goes below the support level, it will be a breakthrough on the downside. This is a bearish indication. Once the stop price has been reached, the stock will be sold at the market.
b. Depreciation of equipment
d. Depreciation of land
Explanation: The most advantageous tax benefit that an investor will receive from an oil and gas program is the depletion deduction. These deductions normally last for as long as the program produces oil and gas. Depreciation of equipment lasts a limited number of years and land may not be depreciated.
Explanation: This is a debit spread since the investor is paying more (4) for the purchased calls than he receives (2) for the calls that were written. The maximum loss for a debit spread is the amount of the debit. A simple way to look at a debit spread is to focus in on the buy side of the spread. Approach the questions as if the investor purchased the 90 call at the net debit of 2 ($2,000 for 10 contracts). The maximum loss when purchasing an option is the premium (net premium).
Explanation: 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).
Explanation: When a broker-dealer buys a security from a market maker (dealer) on behalf of its customer, it is acting as a broker (agent).The client is 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 is acting as a dealer (principal). The client in this case is charged a markup or markdown.
Explanation: By issuing securities with long-term maturities, the municipality can lock in the rate of interest it needs to pay on the bonds. Therefore, if interest rates are expected to rise over a given period, the municipality would not be subject to these changes. This would provide the municipality with the capital it needs, without borrowing again at higher rates of interest, as it would need to do if it issued shorter-term or intermediate-term securities.
Explanation: In this question, the investor has two positions in ABC stock and each position was purchased at different times and at different prices. When an investor sells a portion of his holdings, unless his sell order ticket identifies the specific shares that he is selling, the IRS will assume that first-in, first-out (FIFO) will be the method to be used. Since the investor stipulated that the shares being sold were against the shares that were purchased in August and those shares were held for one year or less, the capital gain is short-term. The cost basis of the shares being sold is $55 and the proceeds per share on the sale is $59. Therefore, the gain of $4 per share is multiplied by the 400 share position, resulting in a $1,600 total gain.
Explanation: Net investment income of a mutual fund is derived from the total interest plus dividends earned by the fund’s portfolio minus the expenses of the fund.
Explanation: T + 3 in a municipal bond transaction means the bonds will settle regular-way in 3 business days from the trade date.
I. The investment risk is assumed by the insurance company
II. The investment risk is assumed by the customer
III. The amount of the payment to the customer is guaranteed by the insurance company
IV. The amount of the payment to the customer is not guaranteed
Explanation: 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 may increase, decrease, or remain the same, since the amount of the payment is not guaranteed. In addition, since a straight-life settlement option was chosen, payments will stop when the investor dies, regardless of the amount left in the contract.
a. A mutilated coupon
b. Lack of a legal opinion
c. No endorsement by the owner
d. Lack of a seal on the certificate
Explanation: A municipal bearer bond does not require endorsement (signature) by the owner.
a. An exchange-traded fund (ETF)
b. An equipment leasing direct participation program (DPP)
c. A private activity municipal revenue bond
d. The PAC tranche of a collateralized mortgage obligation
Explanation: Converting the preferred stock has a value of $55 ($110 per common share x 1/2 conversion ratio). Since the call price of $60 is more beneficial to the preferred stockholder, the market price of the preferred stock will most likely rise to near $60 (the call price).
a. Approval by a majority of legal age voters
b. Approval by the state legislature
c. Approval by the bond trustee
d. Approval by the appropriate state agency
Explanation: State legislative approval is required before a municipality can begin making payments on a moral obligation bond.
Explanation: MSRB rules require that an advertisement must be approved prior to its first use by a municipal securities principal.
Explanation: The bond is convertible at $25. This means the conversion ratio is 40 to 1 ($1,000 par value divided by the conversion price of $25 equals the conversion ratio of 40 to 1). To find parity for the stock, divide the market value of the bond by the conversion ratio. The market value of the bond $960, divided by the conversion ratio of 40 to 1 equals the $24 parity price for the stock.
a. An oil and gas company
b. A home appliance company
c. A utility company
d. A pharmaceutical company
Explanation: A cyclical company is one whose sales correspond to changes in the business cycle and, therefore, will be affected by a recession. Examples of cyclical stock includes the stock of household appliance companies, steel companies, and construction companies. A defensive company is one whose sales are not as affected by changes in the business cycle (i.e., it resists recession). Examples of defensive stock includes the stock of pharmaceutical, health care, tobacco, oil and gas, utility, and supermarket companies.
a. 20% in equities, 30% in Treasury bonds, and 50% in tax anticipation notes
b. 40% in equities, a 30% mixture of in-state and out-of-state municipal bonds, 15% in Treasury bonds, 15% in revenue anticipation notes
c. 30% in-state municipal bonds, 30% in out-of-state municipal bonds, 15% in Treasury bonds, 10% in revenue anticipation notes
d. 25% in-state municipal bonds, 25% in out-of-state municipal bonds, 25% in corporate bonds, and 25% in Treasury bonds
Explanation: Although this investor is in her late 40s and considers herself a conservative investor, equities should be a part of her asset allocation. Many strategists recommend taking 100% and subtracting the investor’s age as a guide to the percentage of the investor’s portfolio that should be allocated to equities. As such, a 40% allocation in equities is reasonable with the remainder in various fixed-income securities and cash. Prior to inheriting the funds, she would not have been a suitable candidate for tax-exempt or municipal securities due to her low tax rate. After investing in these funds, the income/dividends/potential capital gains would have the effect of increasing her tax rate, so that municipal bonds would be an attractive investment. In-state municipal bonds would offer a higher after-tax return to this investor. Due to the potential of credit risk with municipal bonds, having a portion of the funds in Treasury securities would be a good recommendation. In addition, the investor should invest a portion of the funds in cash or cash alternatives. This is satisfied by allocating a portion of the funds in short-term municipal securities such as tax or revenue anticipation notes. Choice (a) has only a 20% allocation in equities and a 50% allocation of funds in tax anticipation notes, offering no growth potential. Having 100% of the funds in fixed-income investments does not offer the customer a balanced approach and, therefore, the other choices would not be the best method of investing the funds.
Explanation: When a lump-sum withdrawal from a corporate pension plan, Keogh, or IRA is deposited into an IRA, it is referred to as a rollover. If the rollover is done within 60 days, the investor will avoid a taxable event. If the distribution is from a qualified plan other than an IRA, the distributing company must withhold 20% of the distribution for the IRS. Only one rollover is permitted each year.
I. The money supply will be increased
II. The money supply will be decreased
III. Interest rates will tend higher
IV. Interest rates will tend lower
Explanation: On a repurchase agreement, the Fed initially purchases securities. Therefore, money is added to the banking system. This tends to loosen credit and allows interest rates to decline.
Explanation: This is a debit spread since the investor is paying more (4) for the purchased calls than he receives (2) for the calls that were written. The maximum loss for a debit spread is the amount of the debit. A simple way to look at a debit spread is to focus in on the buy side of the spread. Approach the questions as if the investor purchased the 90 call at the net debit of 2 ($2,000 for 10 contracts). Therefore, look at the purchase of a 90 call at 2 (net debit). The breakeven point when buying a call is the strike price (90) plus the premium (net debit of 2). Any market price above the breakeven point of 92 will make the position profitable.
a. Credit risk
b. Inflationary risk
c. No risk
d. Capital risk
Explanation: Credit risk is the risk that the investor will not receive interest and/or principal when it is due. Capital risk is the risk that the investor will lose his investment. Since Treasury bonds are direct obligations of the U.S. government, there is no risk that the investor will not receive interest and/or principal when due, or lose his investment. Therefore, the investor is free of credit and capital risk. All fixed-income securities expose an investor to inflationary risk (purchasing-power risk).
a. No gain or loss
b. A 1-point capital gain
c. A 4-point capital gain
d. A 1-point capital loss
Explanation: When selling a zero-coupon security, if the bond is sold above the accreted value (not the original cost), it is considered a capital gain and, if sold below, a capital loss. According to IRS rules, the accretion added each year to the cost basis for a zero-coupon security is treated as interest income for that year. If a zero-coupon security is sold for its accreted value, the investor will have no gain or loss.
I. To finance the building of a high school
II. To finance the construction of a power plant
III. To pay the salaries of police and firefighters
IV. To pay the salaries of transit workers
Explanation: Revenue bonds are usually issued to construct and operate some type of revenue producing facility. Examples include power plants, transit systems, turnpikes, colleges, bridges and tunnels, hospitals, sewer systems, and stadiums. General obligation bonds are issued to finance public schools (elementary school and high school) and to pay the general expenses of running a municipality (e.g., police and firefighters).
a. Buy stock for its own account at $34.65
b. Buy stock for its own account at $34.75
c. Sell stock from its own account at $34.90
d. Sell stock from its own account at $34.95
Explanation: A designated market maker is not permitted to compete with public orders when trading for its own account. The DMM may buy stock at a higher price or sell stock at a lower price. In doing so, the DMM has narrowed the spread (the difference between the bid and ask). The DMM, 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 DMM buying lower or selling at a price equal to or higher than the public customer’s order.
a. Buying a put will require a smaller capital commitment
b. Buying a put has a larger potential loss than selling the stock short
c. The put has time value that gradually dissipates
d. Buying a put is not subject to the Regulation SHO requirement to borrow shares
Explanation: Choice (b) is not true. Buying a put has a smaller potential loss than selling the underlying stock short. The maximum loss when buying a put is limited to the premium paid. The loss when selling short is unlimited. All of the other statements are true. The cost for the premium of a put is substantially less than the Regulation T margin requirement for a short sale. The purchase of puts is not subject to the borrowing requirements of Regulation SHO, whereas short sales of equities are. An option’s premium consists of intrinsic value and/or time value. Time value gradually dissipates as an option nears its expiration.
a. Permits the tax-free exchange of one annuity contract for another
b. Forbids the tax-free exchange of an insurance policy for a new life insurance policy
c. Forbids the tax-free exchange of an insurance policy for a new annuity contract
d. Permits the tax-free exchange of an annuity contract for a life insurance policy
Explanation: 1035 exchanges permit an individual to exchange one variable annuity contract for another, during the accumulation period, without tax consequences.
a. Immediate sale within the U.S. market
b. Immediate sale in a designated offshore market
c. Regulatory approval from SROs
d. Waiting six months, then selling within the U.S. market
Explanation: An overseas investor who acquires securities pursuant to Regulation S may sell the securities overseas immediately through a designated offshore securities market. There is a distribution compliance period (holding period) of 40 days for debt securities and a one-year period before an equity security sold pursuant to Regulation S may be resold in the U.S.
a. Yield-based call options
b. Yield-based put options
c. VIX call options
d. VIX put options
Explanation: The prices of bonds are inversely related to the movement of interest rates. If the investor is concerned that rising interest rates will erode the value of the bond portfolio, the purchase of an option that does well when interest rates rise will provide an effective hedge. Yield-based call options increase in value when interest rates rise, creating a viable hedge. The VIX (volatility index) tends to move inversely with the S&P 500 Index. The VIX usually rises when the S&P 500 Index falls, and falls when the S&P 500 Index increases. An investor will buy VIX call options when he expects the market to decline and volatility to increase. An investor will buy put options on the VIX if he expects the market to rise and volatility to decrease. Many investors will buy VIX call options as a hedge against a possible decline in the stock market. VIX options can be used by investors who expect either an increase or a decrease in volatility. It is not used to hedge a bond portfolio.
I. The term collateralized mortgage obligation must be included within the name of the product
II. The basis point spread above a comparable Treasury security the client will receive in interest must be included
III. The lower of the yield to call or yield to maturity must be included
IV. The government agency backing only applies to the face value of the securities
Explanation: Retail communications (e.g., sales literature) and correspondence about collateralized mortgage obligations (CMOs) are subject to special rules. The term collateralized mortgage obligation must be included within the name of the product and it must disclose that the government agency backing only applies to the face value of the securities (not any premium paid). If the client paid a premium to purchase a CMO, only the par value would be backed by the entity backing the security. The actual coupon rate, not the spread above Treasuries, needs to be disclosed. Due to the prepayment risk of CMOs, the yield to average life would be disclosed, not the yield to maturity or yield to call.
a. A 6.25% in-state municipal bond
b. A 7.10% out-of-state municipal bond
c. A 11.65% investment-grade corporate bond
d. A 10.85% mortgage bond
Explanation: The major advantage of municipal bonds for most investors is that the interest received from the bond is exempt from federal taxes. In addition, most states also exempt interest from bonds issued within their state from a resident’s state and local income taxes. However, if a state resident earns interest from an out-of-state municipal security, that interest is usually subject to state and local taxation. If an investor in a particular tax bracket would like to compare the benefit of tax-free interest income to after-tax income of a taxable bond, it is necessary to find the equivalent taxable yield. The mortgage bond is a type of corporate bond and both are fully taxable. Since the investor can purchase an in-state municipal bond and out-of-state municipal bond, we use the combined rate of 42% for the in-state bond and the federal rate of 35% for the out-of-state bond. The formula is:
Municipal Bond Yield / (100% – Investor’s Tax Bracket) = Equivalent Taxable Yield
The customer is in the 42% combined tax rate. The municipal bond has a yield of 6.25%.
6.25% (Municipal Bond Yield) / 58% (100% – 42%) = 10.78% Equivalent Taxable Yield
The out-of-state municipal bond has a yield of 7.10% and the equivalent taxable yield is 10.92% (7.10% / 65%). The investment-grade corporate bond has the best or highest after-tax yield.
a. U.S. government and municipal securities
b. Securities of a publicly held finance company
c. Securities of a small business investment company
d. Securities of a nonprofit organization
Explanation: Nonexempt securities are those that are subject to the registration requirements of the Securities Act of 1933. Securities of a publicly held finance company are the only nonexempt securities. All of the other securities listed are exempt from the registration requirements of the Securities Act of 1933.
I. Tax-free interest if the bond is an OID
II. A capital gain if the bond is an OID
III. Ordinary income if the bond is not an OID
IV. Tax-free interest if the bond is not an OID
Explanation: For an OID (original issue discount), the discount is considered interest. Because this is a municipal bond, the interest is tax-exempt. For a non-OID (a secondary market discount), the discount is reported as ordinary income.
I. Deal with broker-dealers
II. Deal with dealer-banks
III. Underwrite new issues
IV. Trade from its own inventory
Explanation: A municipal broker’s broker is a broker (agent) that deals only with other municipal securities brokers or dealers. The broker’s broker never deals with individual investors or establishes an inventory position, and is not involved in the underwriting of a new issue.
I. An offering of municipal revenue bonds
II. An offering of convertible securities by a company listed on the NYSE
III. An offering of corporate notes with a maturity of three years
IV. A private placement of bonds issued by a corporation, sold by a broker-dealer
Explanation: The Trust Indenture Act of 1939 regulates the public issuance of corporate securities that are sold interstate. It does not cover exempt securities such as U.S. government securities, municipal securities, or private placements. A sale of corporate convertible securities and an offering of corporate notes are subject to the 1939 Act. Corporate debt with a maturity of 270 days or less (commercial paper) is exempt from the 1933 Act and the 1939 Act.
Explanation: The breakeven formula for call buyers is the strike price plus the premium. The strike price is 85 (0.8500) and the premium is .82 ($0.0082). Therefore, the spot rate for the Canadian dollar would need to be $0.8582 for Mr. Jones to break even.
a. The sharing arrangement between the limited and general partners
b. The amount of money that the general partner will contribute to the program
c. The provisions for dissolving the partnership
d. Who is required to sign this document
Explanation: In order to purchase an interest in a direct participation program, the investor must complete the subscription agreement. It will specify who is required to sign the agreement. The other choices given are found in the offering documents.
Explanation: The customer has received a total of $5 in premiums or $500 for the straddle. The call side of the straddle expires, but the put is exercised. The writer must buy the stock at $60 per share (the exercise price). The stock is then sold at the $50 market price, which results in a $1,000 loss ([$60 – $50] x 100 shares). However, since the customer initially received a premium when she wrote the straddle, the loss is only $500 ($1,000 loss from exercising the put – $500 premium).
Explanation: If the tax-exempt status were eliminated, yields on newly issued municipal bonds would need to increase to compete with the higher yields of non-tax-exempt bonds.
I. The earnings before interest and tax (EBIT)
II. The debt-to-equity ratio
III. The operating profit margin
IV. The amount of working capital
Explanation: The debt-to-equity ratio is found by dividing the dollar amount of debt (bonds) by the dollar amount of shareholder equity (common stock + paid-in capital + retained earnings). Working capital is found by subtracting current liabilities from current assets. All of these numbers may be found in a company’s balance sheet. EBIT and the operating profit margin can be calculated by examining the income statement.
Explanation: Municipal serial bonds are quoted on a yield-to-maturity basis. Municipal term bonds are quoted on the basis of a dollar price.
Explanation: The cost of a long-term equity option is found by multiplying the premium quote by $100. The cost of 10 puts quoted at 12.25 is, therefore, $12,250 (12.25 x $100 x 10 = $12,250).
a. Her broker-dealer is required to approve the loan
b. She is required to notify her firm of the loan
c. She is required to notify FINRA
d. She is not required to notify her firm about the loan
Explanation: Registered individuals may not borrow money from, or lend money to, a customer unless certain conditions are met. These conditions include implementing written procedures permitting such activity and satisfying one of the following provisions.
1. The customer and the registered person are immediate family members.
2. The customer is a financial institution regularly involved in the business of extending credit or providing loans.
3. Both parties are registered with the same firm.
4. The loan is based on a personal relationship between the customer and the registered person.
5. The loan is based on a business relationship independent of the customer-broker-dealer relationship.
If the loan is based on provision 1 (borrowing from family members), firm notification or firm approval is not required. If the conditions indicated in provisions 3, 4, or 5 apply, the firm must approve the lending activity prior to the execution of the loan.
Explanation: If interest rates are stable, most bond prices will have little movement. However, a convertible debenture could show significant price appreciation or depreciation if the underlying equity changes in value because of the potential to convert. This keeps the bond price in the vicinity of conversion parity. Parity is achieved when the value of the bond equals the value of the common stock derived from conversion.
Explanation: In order to take advantage of the anticipated increase in the value of the euro, Andrew is purchasing 10 euro calls at a premium of 1.30. Euro options are quoted in cents per unit, so the decimal must be moved two places to the left to convert the quote to dollars ($.0130). To calculate the cost of the euro call, multiply the contract size (10,000) times the dollar value of the premium ($.0130).
10,000 x $.0130 = $130
Since Andrew is purchasing 10 options, the total cost is $1,300.
a. Bankers’ acceptances (BAs)
b. Treasury bills
c. Eurodollar CDs
d. American Depositary Receipts (ADRs)
Explanation: Of the choices given, a banker’s acceptance (BA) is the only instrument that is used as a means of financing foreign trade. Do not confuse a BA with an ADR (American Depositary Receipt), which facilitates the trading of foreign securities in U.S. markets. Eurodollar certificates of deposit pay interest and principal in Eurodollars (U.S. dollars deposited in nondomestic banks) and are not used to finance importing and exporting operations.
Explanation: If a corporation owns less than 20% of the distributing company, the corporation is required to pay tax on 30% of the dividends it receives on stock that it owns (70% is excluded). The company would need to add $30,000 (30% of $100,000) to its taxable income. The total taxable income, therefore, is $2,030,000. The tax liability is $690,200 ($2,030,000 times 34% tax rate). If the corporation owned at least 20% of the distributing company, only 20% of the dividends would be taxable.
Explanation: SEC Rule 15c3-3 (the Customer Protection Rule) sets forth rules for broker-dealer reserve requirements and custody of securities. Under the custody of securities section, a brokerage firm must buy in securities within 10 business days from settlement when a customer has failed to deliver securities that were previously sold.
a. SMA is decreased
b. The debit balance is reduced
c. The market value is increased
d. The equity is reduced
Explanation: When a cash dividend is paid, the debit balance is reduced by the amount of the dividend. The SMA is also increased by the amount of the dividend. The market value changes due to fluctuations in the price of the security.
a. Independent brokers
b. Registered representatives
c. Floor brokers
d. Designated market makers
Explanation: Registered representatives of a broker-dealer are not permitted to trade on the floor of the NYSE.
Explanation: If an investor in a particular tax bracket would like to compare the benefit of tax-free interest income to after-tax income of a taxable bond, it is necessary to find the equivalent taxable yield. The formula is:
Municipal Bond Yield / (100% – Investor’s Tax Bracket) = Equivalent Taxable Yield
The customer is now in the 33% tax bracket. (The 15% rate is no longer relevant). The municipal bond has a yield of 3.75%.
3.75% (Municipal Bond Yield) / 67% (100% – 33%) = 5.60% Equivalent Taxable Yield
Explanation: The spread will widen as the market price rises. The maximum spread occurs at a market price of 95. If it rises above 95, the spread will not widen beyond 5 (the difference between the strike prices).
a. They offer investors the same amount of liquidity as exchange-traded REITs
b. They are not required to distribute the same percentage of taxable income as exchange-traded REITs
c. They are not required to make periodic disclosures that are required of exchange-traded REITs
d. They are not suitable for the same investors as exchange-traded REITs
Explanation: Most REITs are traded on an exchange, such as the NYSE, and offer investors a high degree of liquidity. Nontraded REITs do not have their shares listed on an exchange and offer very limited liquidity, similar to limited partnerships. They would not be suitable for investors seeking liquidity. Both invest in various types of real estate and are subject to the same tax consequences (90% distribution on taxable income). Since they are both registered, they are required to make the same disclosures to investors.
a. An NYSE MKT stock
b. An NYSE MKT warrant
c. An NYSE-listed bond
d. A non-Nasdaq stock
Explanation: The Consolidated Quotation System (CQS) displays quotations on all common stock, preferred stock, warrants, and rights that are listed on the New York Stock Exchange (NYSE) or the NYSE MKT (formally NYSE Amex), and trading in the OTC market (third market). While an NYSE MKT stock, an NYSE MKT warrant, and a NYSE-listed bond typically appear on CQS, a non-Nasdaq stock does not appear.
Explanation: Under industry rules, the following items MUST be obtained when opening an account.
1. The customer’s name and residence
2. Whether the customer is of legal age
3. The name of the registered representative introducing the account and the signature of the member or partner, officer, or manager who accepted the account
4. If the customer is a corporation, partnership, or other legal entity, the names of any persons authorized to transact business on behalf of the entity
The name of the beneficiary is not required when opening an account.
Explanation: The first coupon will be paid in 7 months. This is known as an odd (in this case, long) first coupon payment. The interest will begin to accrue from the dated date but will be paid on the first coupon date.
a. The corporation sends the proxy to the customer
b. The corporation sends the proxy to the NYSE, which then sends it to the customer
c. The corporation sends the proxy to the SEC, which then sends it to the customer
d. The corporation sends the proxy to the brokerage firm, which then sends it to the customer
Explanation: A publicly held company must provide a means for shareholders who cannot attend company meetings to vote on important matters. This is done through a proxy, which is a delegation of the shareholder’s vote. The corporation will send the proxy to all stockholders of record who can then cast their votes without attending the meeting. When stock is held in street name (i.e., in the name of the brokerage firm), the corporation sends the proxy to the brokerage firm, which is the stockholder of record on the corporate books. The brokerage firm sends the proxy to the customer and the corporation then pays the additional expenses. The SEC regulates the solicitations of proxy material.
Explanation: The current yield of a stock is found by dividing the yearly dividend by the market price of the stock. The market price is $56. The yearly dividend is $3 ($.75 x 4 = $3.00). Therefore, $3 divided by $56 equals 5.3%.
Explanation: The FRB requirement is 50%, which is the same for purchases as it is for short sales. Therefore, the required deposit is $750 (50% x $1,500). Since this trade is executed in an existing account, the only requirement is the FRB’s. If this had been the initial trade in the account, the required deposit under industry rules would be $2,000.
a. Request bids
b. Accept bids
c. Commit to underwritings
d. Negotiate settlement dates in the secondary market
Explanation: A municipal bond trader is not involved in underwritings of new issues.
Explanation: Social media sites that permit real-time communication or interactive, electronic forums fall under the guidelines of a public appearance, according to FINRA. Examples include Facebook, Twitter, and LinkedIn. Most firms do not permit their RRs to use these types of systems to communicate with customers to conduct business because they are not able to monitor the sites. Correspondence is any oral or written communication distributed or made available to 25 or fewer retail investors.
Explanation: The formula for computing current yield (also known as the dividend yield) is: Annual Dividend / Market Price of the Stock
Since the quarterly dividend is 32 1/2 cents, the annual dividend is $1.30 (32 1/2 x 4 = $1.30). $1.30 divided by the $24 market price equals 5.41%.
b. Efficient frontier
Explanation: According to modern portfolio theory, a graph of optimal portfolios can be created known as an efficient frontier.
a. Open-end investment companies
b. Closed-end investment companies
c. Unit investment trusts
d. Face amount certificate companies
Explanation: Investment companies with no management fee and low sales charges, which invest in a fixed portfolio of municipal or corporate bonds, are categorized as unit investment trusts (UITs). Investors can receive a reduced sales charge if they purchase a certain amount of a UIT.
Explanation: When a stock splits 2 for 1 (an even split), the number of contracts increases and the strike price is reduced proportionately. The number of shares representing each listed option remains at 100 shares. The customer will 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.
a. Contribute the maximum amount allowable to a 529 plan
b. 50% equities, 20% general obligation bonds, 15% utility revenue bonds, and 15% Treasury Inflation-Protected Securities (TIPS)
c. 20% high-yield corporate bonds, 20% airport revenue bonds, 20% general obligation bonds, 20% Treasury bonds, and 20% tax anticipation notes
d. 30% general obligation bonds, 20% high-yield municipal bonds, 20% hospital revenue bonds, 20% special tax bonds, and 10% housing revenue bonds
Explanation: This customer is seeking to maximize his tax-free income and would like to invest in different types of municipal securities. A portfolio of 30% general obligation bonds, 20% high-yield municipal bonds, 20% hospital revenue bonds, 20% special tax bonds, and 10% housing revenue bonds would be suitable for this investor. There is no reason why a small percentage (20%) cannot be invested in high-yield municipal bonds. Choice (b) contains equities and Treasury Inflation-Protected Securities (TIPS), which are taxable, fixed-income securities. Choice (c) also contains taxable, fixed-income securities (corporate bonds and Treasury bonds) as well as short-term municipal securities (tax anticipation notes). Since the customer’s children are already attending college, the tax-free growth available with a 529 plan would not be advantageous or a suitable investment when seeking tax-exempt income.
Explanation: A DK notice is sent to the contrabroker upon receipt of the confirmation for an uncompared trade. The broker-dealer sending the DK notice states that the trade does not appear on its records and, therefore, denies any responsibility for the settlement of the trade unless the contraparty can prove that the trade did indeed take place.
a. Official notice of sale
c. Bond indenture
d. Syndicate agreement
Explanation: All protective covenants for a revenue bond are found in the bond’s indenture. Also included in the indenture are the rights and obligations of the issuer and the bondholders. The official notice of sale contains the information and procedures necessary for syndicates that wish to bid on a competitive issue of bonds. The syndicate agreement is a contract among the underwriters that defines their working relationship and addresses such items as the priority of orders and sharing of the underwriting spread. A prospectus is a disclosure document for issues that are registered under the Securities Act of 1933. Municipal revenue bonds are exempt from that Act.
I. Investor in a variable annuity
II. Annuity company in a variable annuity
III. Investor in a fixed annuity
IV. Annuity company in a fixed annuity
Explanation: In a fixed annuity, the annuity company guarantees a fixed monthly payment. The company, therefore, must invest the monies and assume the investment risk. In a variable annuity, the annuity company makes no guarantee. The company will invest the investor’s money and the investor’s annuity benefits will depend on the value of the investments. The investor, therefore, assumes the investment risk.
Explanation: A leveraged buyout (LBO) is the acquisition of a company primarily using debt to finance the purchase. The assets of the acquired company are generally used as collateral for the borrowed funds. This type of acquisition allows the acquiring company, which is referred to as a private equity (PE) firm, to make the purchase without using much of its own equity. In many circumstances, since a large amount of borrowed funds are used to make the purchase, they are usually non-investment-grade.
Explanation: First, determine the amount of the debit balance. If the customer purchased $70,000 worth of stock at a 50% margin requirement and deposited $35,000, the debit balance is $35,000 ($70,000 market value – $35,000 margin requirement = $35,000 debit balance).
Depaul increased to $78 per share, making the market value $78,000. The equity increases to $43,000. The excess equity (SMA) is found by subtracting the FRB-required equity of $39,000 (50% of $78,000) from the actual equity in the account, $43,000. The SMA is, therefore, $4,000. The SMA remains in the account until it is used. The SMA balance will never decrease because of market movements. Securities held in a margin account that increases in value can create excess equity (SMA). However, if these securities later decline in value, this will not decrease SMA.
a. A real estate investment trust (REIT)
b. A collateralized mortgage obligation (CMO)
c. A direct participation program (DPP)
d. A business development company (BDC)
Explanation: A business development company (BDC) raises capital by selling securities to investors and is similar in structure to a closed-end investment company. A BDC will use the money it raises to invest mostly in private companies, small and developing businesses, and financially troubled companies that have difficulty raising capital in public markets. The objective is to help these companies by providing funding when they may not be able to raise capital for themselves. Most BDCs trade on an exchange and, therefore, provide an investor with liquidity and, since they are structured as regulated investment companies, they are not taxed if they distribute at least 90% of their income to investors. Most have an investment objective of providing current income and capital appreciation, and will invest their funds in both debt (e.g., loans, subordinated and mezzanine financing) and equity of private small and middle-market companies. Since some of the funds are invested in the equity of nonpublic companies, a customer purchase of a BDC is similar to buying a publicly traded investment in a private equity firm.
b. Institutional communication
c. Retail communication
d. Public appearance
Explanation: FINRA’s Communications with the Public Rule defines different types of communication.
– Correspondence, which is defined as any written or electronic communication that is distributed or made available to 25 or fewer retail investors within any 30 calendar-day period.
– Institutional communication, which is defined as any written or electronic communication that is distributed or made available only to institutional investors. This would not include any internal communication by the broker-dealer.
– Retail communication, which is defined as any written or electronic communication that is distributed or made available to more than 25 retail investors within a 30 calendar-day period.
– Public appearances are situations where employees associated with a broker-dealer or sponsor participate in a television or radio interview, seminar, or forum, or make a public appearance, or engage in speaking activities that are unscripted and are not otherwise considered retail communication. Social media sites, which permit real-time communication or interactive, electronic forums, fall under the guidelines of a public appearance (e.g., Facebook, Twitter, and LinkedIn).
Since the e-mail is being sent to 25 or fewer individual (retail) investors, it is defined as a correspondence. It makes no difference whether the investors have an account with the RR or the member firm.
Explanation: The highest Moody’s rating is Aaa followed by Aa, A, and Baa.
a. Syndicate letter
b. Account summary statement
c. Notice of sale
Explanation: The indenture contains all the agreements and covenants pertaining to a bond issue, and also contains the provisions for the application and allocation of funds of a revenue bond.
Explanation: A new issue will appear on the Nasdaq system on the effective date of the issue. The effective date, which is determined by the SEC upon completion of the registration process, is the first date that the securities may be sold to the public.
a. The retail salesperson would not be considered a municipal finance professional
b. The retail salesperson could not have made a $300 political contribution to a local elected official in the past two years
c. The retail salesperson is required to register as a municipal securities principal
d. The action by the retail salesperson would be a violation of MSRB rules
Explanation: Since the retail salesperson has helped his firm obtain negotiated municipal bonds business, he is defined as a municipal finance professional (MFP). A two-year look-back period applies to municipal finance professional contributions. If an individual has made contributions to a political candidate that would have resulted in a violation of MSRB Rule G-37 (contributing more than $250 to a candidate for whom he is entitled to vote for), the firm that employs the individual is subject to the underwriting ban if the individual was employed in the role of an MFP within two years of the contribution. A retail salesperson is not required to register as a principal and is permitted to solicit elected officials of municipal bond issuers, provided the retail salesperson does not contribute more than $250 for the official for whom he is entitled to vote.
Explanation: Registered representatives agree to arbitrate any disputes with their employer, with the exception of statutory discrimination and harassment claims.
I. Determining customer suitability
II. Obtaining a signed options agreement
III. Entering the initial order
IV. Obtaining approval from the ROP
Explanation: When opening an account, the first step is to obtain the essential facts regarding the customer’s investment objectives and financial means in order to determine suitability. The account is then approved by the ROP and the initial order is entered. The member firm has 15 days to obtain the signed options agreement.
a. Request a cancel and rebill without principal approval
b. Enter a new order
c. Cancel the order and take no other action
d. Request a cancel and rebill after receiving principal approval
Explanation: If a transaction is executed but the wrong account is used, the error can be corrected without placing a new order. This is done by transferring the transaction to the correct account number with the permission of a registered principal. This transfer process is sometimes referred to as a cancel and rebill. In some cases, an error is made using the correct customer but transferred to a different account (e.g., a wrong custodial account or a joint account instead of an individual account).
a. 50% in equities, 25% in-state municipal bonds, 15% in Treasury bonds, and 10% in a money- market fund
b. 100% in equities
c. 50% in-state municipal bonds, 25% in out-of-state municipal bonds, 15% in Treasury bonds, 10% in money-market funds
d. 25% in-state municipal bonds, 25% in out-of-state municipal bonds, 25% in corporate bonds, and 25% in Treasury bonds
Explanation: Although this investor is in her late 40s and considers herself a conservative investor, equities should be a part of her asset allocation. Many strategists recommend taking 100% and subtracting the investor’s age as a guide to the percentage of the investor’s portfolio that should be allocated to equities. As such, a 50% allocation in equities is reasonable with the remainder in various fixed-income securities and cash. Prior to inheriting the funds, she would not have been a suitable candidate for tax-exempt or municipal securities due to her low tax rate. After investing in these funds, the income/dividends/potential capital gains would have the effect of increasing her tax rate, so that municipal bonds would be an attractive investment. In-state municipal bonds would offer a higher after-tax return to this investor. Due to the potential of credit risk with municipal bonds, having a portion of the funds in Treasury securities would be a good recommendation. In addition, the investor should invest a portion of the funds in cash or cash alternatives. This is satisfied by allocating a portion of the funds to a money-market fund. Having 100% of the funds in equities or fixed-income investments does not offer the customer a balanced approach and, therefore, the other choices would not be the best mix of investing the funds.
Long Account Short Account
$150,000 Market Value $45,000 Market Value
$50,000 Debit Balance $75,000 Credit Balance
Explanation: The formula for calculating SMA is:
Actual equity – Reg T Requirement = SMA
The equity in the long account is $100,000 ($150,000 LMV
– $50,000 DR).
The equity in the short account is $30,000 ($75,000 CR
– $45,000 SMV).
Total equity is $130,000.
The Reg T requirement for the long account is $75,000 ($150,000 LMV x 50%).
The Reg T requirement for the short account is $22,500 ($45,000 SMV x 50%).
The total Reg T requirement is $97,500.
The combined SMA is, therefore, $32,500 ($130,000 Actual equity – $97,500 Reg T requirement).
a. A municipal revenue bond
b. A Treasury note
c. A hybrid REIT
d. An equity REIT
Explanation: Since this is a tax-deferred (retirement) account, the municipal security would not be suitable and, since the investor wants a higher return, the Treasury note would not be the best choice. Although either REIT may be suitable, the hybrid REIT is a better choice since the investor wants diversification. There are three types of REITs: mortgage REITs which provide funds to real estate owners in the form of lending them funds (i.e., a mortgage), equity REITs which own and operate income producing real estate (for example, apartment buildings, commercial property, shopping malls and other types of retail property, and vacation resorts), and hybrid REITs, which invest in both of these ventures. By purchasing a hybrid REIT, the investor can take advantage of buying a security that invests in actual equity ownership of real estate as well as investing in an interest-rate-sensitive security such as a mortgage REIT.
Explanation: SIPC will cover the customer’s equity in the margin account ($425,000). SIPC does not provide coverage for commodities or futures accounts.
I. The bid price is equal to the net asset value
II. The bid price is equal to the net asset value plus the redemption fee
III. The offer price is equal to the net asset value plus the sales charge
IV. The offer price is equal to the net asset value minus the sales charge
Explanation: The bid price of a mutual fund is also equal to the net asset value (NAV) and is the price a customer will receive if shares are sold. It does not include the redemption fee, which may be charged when the customer sells her shares. The offer price is equal to the NAV plus the sales charge, if any, and is the price a customer pays to purchase shares of a mutual fund.
Explanation: If a put or call option expires, the amount of the premium paid by the purchaser of the option is considered for tax purposes to be a capital loss at the time the option expires.
a. 30% corporate bond fund, 30% municipal bond fund, and 40% in a U.S. government bond fund
b. 20% in a blue-chip fund, 20% in a technology fund, 20% in an emerging markets fund, 20% in a municipal bond fund, and 20% in a U.S. government bond fund
c. 50% in an ETF that follows the S&P 500 and 50% in an equity foreign index fund
d. 30% in an ETF that follows the S&P 500, 20% in an emerging markets fund, 15% in a REIT fund, 15% in a biotechnology fund, and 20% in a U.S. government bond fund
Explanation: An investor seeking income and capital growth would want her assets allocated evenly between equity and fixed-income investments. Choice (b) has a 60%/40% mix of equity and fixed-income. Choice (a) is 100% fixed-income, choice (c) is 100% equity, and choice (d) is 80% equity and 20% in fixed-income.
a. Preferred stock of a financial services company
b. A mutual fund that invests in international markets
c. A real estate investment trust (REIT)
d. A hedge fund using leverage
Explanation: Of the choices listed, the hedge fund would be the least suitable since it does not offer liquidity. Hedge funds are not subject to the same regulations for requiring access to their funds as are mutual funds. The shares are not redeemable on a daily basis and are not suitable for an investor requiring a certain degree of liquidity. The preferred stock and REIT are exchange-traded and may be sold at any time.
a. A gift of basketball tickets to a customer valued at $100
b. A business dinner with a client costing $135
c. Reserving a hotel room for a client at a municipal bond seminar costing $150
d. A Christmas gift to a client valued at $125
Explanation: MSRB rules prohibit gifts in excess of $100 per year to a person other than an employee or partner of the gifting individual, if such payments or services are in relation to the municipal securities activities of the employer or the recipient. (Therefore, a Christmas gift to the client valued at $125 would not be allowed.) However, costs incurred for business lunches or hotel accommodations for clients at business seminars are business expenses and are allowed as long as they are not frequent or excessive.
I. Customer verification of the client’s personal information is not required if the customer was referred by an existing client
II. Customer verification of the client’s personal information is required under any circumstances
III. The client may have either a taxpayer identification number or a passport number and country of origin
IV. The client must have a taxpayer identification number to open the account
Explanation: If a non-U.S. citizen wants to open a new account, the member firm is required to obtain certain information as part of its AML procedures under its customer identification program (CIP). For non-U.S. citizens, the firm must obtain the client’s name, address, date of birth and one of the following: passport and country of issuance, taxpayer identification number, or any other government issued document with a photograph. An RR always needs to verify the client’s personal information regardless of whether the customer was referred by an existing client.
Explanation: A variable-rate demand obligation (VRDO) can be redeemed prior to maturity on any date the interest rate on the obligation is reset. Rates can be reset on a monthly, weekly, or daily basis. The obligation will be redeemed at par value plus accrued interest.
a. The order period
b. An account agreement
c. A good faith deposit
d. The takedown and concession
Explanation: Two or more municipal securities dealers might form a joint acount in order to purchase and distribute a large block of securities and spread the risk of the transaction. Both new issue and secondary joint accounts act according to an account agreement that will contain the takedown and concession. An order period will also be used for both. Good faith deposits relate only to a new issue, since that is the amount that the syndicate gives to the issuer along with the bid.
Explanation: The subscription agreement will specify the party to whom the check should be made payable.