Your FREE Series 7 Practice Test 2026 – 870+ Q&A

Series 7 Practice Questions

1. A registered representative of a FINRA member firm is going to present a seminar on retirement planning. It will be a slide show, and no specific advice will be given. The expected attendance is approximately 50 people. Under the FINRA rule on communications with the public,
   • The slides are considered a retail communication and need principal approval before first use
   • A registered principal is required to attend to ensure that the standards of ethical conduct are maintained
   • This seminar can take place only if the recommendations are tailored to the specific needs of the audience
   • This is a public appearance and no approvals are necessary

   Correct answer: The slides are considered a retail communication and need principal approval before first use

   Under the FINRA rule on communications with the public, it is only an unscripted presentation that needs no principal approval. The use of slides changes things, and once more than 25 individuals will see them within a 30-calendar-day period, those slides are retail communications. As such, principal approval is required. Because the question states that no specific advice will be given, suitability of recommendations is irrelevant. However, all presentations at seminars should consider the nature of the audience and keep the presentation at the appropriate level.

2. An increasing percentage of registered representatives of FINRA member firms are using social media to increase their business. When using social media to reach out to clients and prospects, compliance with FINRA rules requires
   • Member firm supervision over social media communication with prospects only
   • That social media not be used to prospect for clients
   • Member firm supervision over social media communication with clients only
   • Member firm supervision over social media communication with clients and prospects

   Correct answer: Member firm supervision over social media communication with clients and prospects

   Social media is a form of electronic communication. As communication with the public, it is subject to member firm supervision, including training of associated persons. In most cases, it fits the definition of retail communication but is generally exempt from the continuous approval requirements, as well as the need to file with FINRA. Remember that retail communication includes prospective customers, as well as existing ones.

3. FINRA Rule 2210 deals with communications with the public. The rule classifies these communications into three different categories. Which of the following is not one of those categories?
   • Advertisements
   • Retail communications
   • Institutional communications
   • Correspondence.

   Correct answer: Advertisements

   Advertising is not one of the three categories. When FINRA rewrote the old rule, it removed the term advertising and sales literature.

4. Which of the following statements is true?
   • Institutional communications material always requires prior principal approval.
   • All retail communications require submission to the FINRA Department of Advertising.
   • Institutional communications do not require prior principal review if associated persons receive training in the firm's procedures governing institutional communications.
   • All retail communications require prior principal approval.

   Correct answer: Institutional communications do not require prior principal review if associated persons receive training in the firm's procedures governing institutional communications.

   Member firms have a choice of procedures to follow when it comes to institutional communications. Review prior to use is the preferred option for many firms. The alternative is proper training of associated persons as to the firm's procedures governing institutional communications, documentation of such education and training, and surveillance and follow-up to ensure that such procedures are implemented and adhered to. Evidence that these supervisory procedures have been implemented and carried out must be maintained and made available to FINRA upon request. Not all retail communications must be filed with FINRA and not all retail communications must have prior principal approval. For example, any retail communication that does not make any financial or investment recommendation or otherwise promote a product or service of the member does not require prior principal approval or filing with FINRA

5. A registered representative is reading an article in a popular magazine about the advantages of tax deferral in retirement planning. There is a note that reprints of the article are available. In order to send these reprints to existing and prospective customers,
   • Member alterations to the contents are only to make it consistent with applicable regulatory standards or to correct factual errors
   • Approval by a principal is required within 10 days after first use
   • The name of the underwriter who commissioned the article must be prominently displayed
   • Filing a copy with FINRA is required

   Correct answer: Member alterations to the contents are only to make it consistent with applicable regulatory standards or to correct factual errors

   This is an example of an independently prepared reprint. It is a form of retail communications and can be used only if the preparer is independent of the member firm. In most cases, these are used "untouched." However, if there are factual errors or statements contrary to FINRA standards, they must be fixed. Preapproval by a principal is required and there is no filing necessary with FINRA. If the publisher is independent but received money from an issuer or underwriter for authoring the article, it may not be used.

6. After a mutual fund's 10th year, performance statistics must show results for each of the following periods except
   • 5 years.
   • 10 years.
   • 1 year.
   • 3 years.

   Correct answer: 3 years.

   Mutual fund performance statistics must show results for one, five, and 10 years, or for the life of the fund—whichever is shorter.

7. The latest issue of a newsletter your firm subscribes to is especially relevant to one of your firm's investment products. If you decide to send it to clients and prospects, you must disclose that
   • Future articles sent will provide similar discussions and information
   • The newsletter discusses only those products that you have available through your firm
   • The newsletter's purpose is to provide clients with a choice of products that are suitable for everyone's portfolios
   • The newsletter is written and produced by a third party

   Correct answer: The newsletter is written and produced by a third party

   If a third party is the creator of the newsletter, that fact must be disclosed, along with the name of the third party and the date of publication.

8. The FINRA rule on communications would consider communications that are posted on an online interactive electronic forum (i.e., a chat room) to be
   • Institutional communications
   • A public appearance
   • Retail communications
   • Correspondence

   Correct answer: Retail communications

   This type of communication is included in the definition of retail communications. FINRA Rule 2210 treats interactive electronic forum posts, such as social media status updates, as retail communications rather than public appearances. However, unlike most retail communications (and similar to public appearances), the rule specifically excludes these posts from both the principal pre-use approval requirements and the filing requirements. That does not mean member firms should not monitor the activities of their associated persons, but that is a real world situation and we're sticking with what the test covers.

9. A registered representative has been doing some research on his own. He would like to share the information with some of his clients and sends an email to 15 of them. He also has some prospects he's been working on and sends the email to 12 of them during the same week. Under the FINRA rule on communications with the public, this would be considered
   • Retail communication
   • Exempt from the principal approval requirements
   • Correspondence
   • An electronic communication

   Correct answer: Retail communication

   FINRA defines a retail communication as "any written (including electronic) communication that is distributed or made available to more than 25 retail investors within any 30-calendar-day period." It is important to understand that retail investors includes current and prospective customers. Because this report will be sent to 27 within the 30-calendar-day period, it fits the definition. Like virtually all retail communications, principal approval is necessary before it is used. Is this an electronic communication? Yes it is, but the exam will want the more specific response—retail communication.

10. FINRA Rule 2210, communications with the public, describes several different categories of communications. One of those categories is called
    • Email
    • Public appearances
    • Social media
    • Correspondence

    Correct answer: Correspondence

    The three categories of communications with the public are correspondence, institutional communications, and retail communications. The other choices shown here may fit into one of those categories but are not a distinctive category in the rule.

11. A registered representative reproduced a research report prepared by an independent research analyst on his broker-dealer's letterhead, with no mention of the party who prepared the report. If this literature is forwarded to a select group of clients only, the registered representative's action is
    • Allowed with the written approval of a principal of the broker-dealer
    • Allowed only if the research report has been filed with FINRA
    • Allowed
    • Not allowed

    Correct answer: Not allowed

    A broker-dealer is prohibited from presenting to a client research reports, analysis, or recommendations prepared by other persons or firms without disclosing that they were prepared by a third party.

12. Each of the following is a category of communication with the public designated by FINRA except
    • Market letters
    • Institutional
    • Retail
    • Correspondence

    Correct answer: Market letters

    The three categories of communication with the public designated by FINRA are retail, correspondence, and institutional. Market letters, as with other pieces of sales or advertising, can fall under any of the three communication categories, depending on to whom they are sent or made available to and the number of recipients.

13. Which of the following would not be considered institutional communications with the public?
    • An internal memo promoting a new product that will be offered to your firm's institutional customers only
    • A communication with an individual designated to act on behalf of your institutional customer
    • A letter to a municipality offering your firm's services as an underwriter
    • A letter to another broker-dealer

    Correct answer: An internal memo promoting a new product that will be offered to your firm's institutional customers only

    Institutional communications specifically exclude internal communications. Communications with another member firm, a government entity such as a municipality, or with someone designated to act on behalf of one of your firm's institutional customers would all fall within the definition of institutional communications.

14. All of the following would be considered either retail communications or correspondence except
    • An email to several municipalities sent out in a single day offering your firm's services for underwriting their municipal securities
    • A written communication to all of the firm's customers regarding a new mutual fund being offered
    • A letter to 10 individual investors within the past week regarding a new investment strategy
    • An electronic communication distributed through the firm's website regarding potential opportunities with the firm as a registered representative

    Correct answer: An email to several municipalities sent out in a single day offering your firm's services for underwriting their municipal securities

    Communications with government entities, which includes municipalities, fall under the heading of institutional communications. The others are all examples of either retail communications or correspondence, depending on how many recipients there are within a 30-calendar-day period. (Retail equals more than 25 retail investors within any 30-calendar-day period, and correspondence is 25 or fewer retail investors within any 30-calendar-day period.)

15. Correspondence—one of the three categories of communication with the public—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
    • Communication that is targeted only at individuals who currently maintain accounts with the broker-dealer
    • Electronic communication only that has been made available to 25 or fewer retail investors within the past six months
    • Written communications only that has been made available to 25 or fewer retail investors within the past six months

    Correct answer: Any written or electronic communication that is distributed or made available to 25 or fewer retail investors within any 30-calendar-day period

    Correspondence can be written or electronic and targeted at either a broker-dealer's account holders or nonaccount holders. The criteria that makes communication a correspondence is that it is distributed to 25 or fewer retail customers within any 30-calendar-day period.

16. Communications with the public include all of the following except
    • Informational material on a new mutual fund intended for sales personnel
    • Institutional sales material
    • Television appearances by an officer of the firm
    • Independently prepared reprints forwarded to your firm's customers

    Correct answer: Informational material on a new mutual fund intended for sales personnel

    Correspondence can be written or electronic and targeted at either a broker-dealer's account holders or nonaccount holders. The criteria that makes communication a correspondence is that it is distributed to 25 or fewer retail customers within any 30-calendar-day period.

17. All of the following are unlawful except
    • Selling new issues on margin
    • Giving written notification to a customer that the broker-dealer is acting as a principal for the trade
    • Representing that the SEC has approved of a broker-dealer or a security being sold
    • Omitting a statement of a material fact

    Correct answer: Giving written notification to a customer that the broker-dealer is acting as a principal for the trade

    New issues may not be sold on margin. The SEC does not approve or disapprove of securities, broker-dealers, or registered representatives. It is always unlawful to make a fraudulent communication in connection with the sale or purchase of securities; making a fraudulent communication includes failing to state a material fact.

18. A testimonial used by a member firm in connection with retail communications must state all of the following except
    • The qualifications of the person giving the testimonial if a specialized or experienced opinion is implied
    • That past performance is not indicative of future performance and that other investors may not obtain comparable results
    • The fact that compensation was paid to the person giving the testimonial if more than $100 in value was paid
    • The time period covered by the testimonial

    Correct answer: The time period covered by the testimonial

    The specific time period the testimonial is relating to is not a disclosure item. If a member uses a testimonial in its retail communications, the following rules apply: if more than $100 in value is paid for the testimonial, you must state the fact that it is a paid testimonial; the communication must not suggest that past performance (or the personal experience of the person making the testimonial) is an indication of future performance; and if the testimonial implies that the person is making the statement based on special knowledge or experience, the communication must state the person's qualifications. ** This question deals with material not covered in your study materials, but it relates to recent rule changes and/or student feedback.

19. FINRA's rule on communications allows member firms to use testimonials in retail communications as long as certain disclosures are made. Among those disclosures is
    • Indicating that if any compensation is paid for the testimonial, the fact that it is a paid testimonial
    • Indicating that if more than $100 in value is paid for the testimonial, the fact that it is a paid testimonial
    • Indicating that if $100 or more in value is paid for the testimonial, the fact that it is a paid testimonial
    • Indicating that if less than $100 in value is paid for the testimonial, the fact that it is a paid testimonial

    Correct answer: Indicating that if more than $100 in value is paid for the testimonial, the fact that it is a paid testimonial

    Retail communications or correspondence providing any testimonial concerning the investment advice or investment performance of a member or its products must prominently disclose that if more than $100 in value is paid for the testimonial, the fact that it is a paid testimonial. Would the exam ever want you to know that it is more than $100 rather than $100 or more? Yes. ** This question deals with material not covered in your study materials, but it relates to recent rule changes and/or student feedback.

20. A FINRA member firm sends a promotional piece to 35 individuals over a three-day period. Twenty of these individuals are current customers of the firm. The other 15 are prospects whose names came from a commercially available mailing list service. Under the FINRA rule on communications with the public, this promotional piece would be considered
    • Correspondence to the existing customers, retail communication to the prospects
    • Direct mail
    • Retail communication
    • Correspondence

    Correct answer: Retail communication

    Retail communication means any written communication that is distributed or made available to more than 25 retail investors, whether current or prospective customers within any 30-calendar-day period. The fact that some of the recipients are customers and others are prospects is irrelevant. It is simply the number of people during the 30-day period.

21. Which of the following do not represent communications with the public?
    • Research reports
    • Market letters
    • Billboards
    • Internal memos

    Correct answer: Internal memos

    Each of the terms qualifies as either a form of advertising or sales literature except internal memos, which are communication pieces intended only for use within the broker-dealer and not for public distribution.

22. A registered representative of a FINRA member firm uses her personal smartphone to send a client a text message about a security in the client's portfolio. This practice is
    • A personal message and does not come under the FINRA rules on communications with the public
    • Considered a retail communication and must have principal approval
    • Not permitted under FINRA rules; all electronic communications must be on company-owned devices
    • Considered an electronic communication and must be reviewed by a principal

    Correct answer: Considered an electronic communication and must be reviewed by a principal

    Although many member firms do not permit use of personal devices, that is a firm's decision, not a FINRA rule. When permitted, a single message like this is considered correspondence delivered electronically. As with all correspondence, review by a principal is required. This review may be on a pre- or post-use basis. A text message sent to more than 25 persons within a 30-day period becomes retail communication.

23. Lorne Walters is a registered representative with Pecuniary Profits Securities, PPS, a FINRA member firm. Walters has decided to conduct virtual meetings using a system called Xoom. Because he has never used the system before, Walters decides to make a trial run of his securities presentation to six family members who are PPS customers. All of these family members are accredited investors. Which of the following choices best describes this situation?
    • Prior approval of PPS may be required, but it is not mandated by FINRA for this public appearance.
    • Walters may not recommend securities during the presentation, unless a principal of PPS provides prior approval.
    • This constitutes an institutional communication to accredited investors and does not require preapproval by a principal of the firm.
    • The virtual meeting may not be archived for later viewing.

    Correct answer: Prior approval of PPS may be required, but it is not mandated by FINRA for this public appearance.

    The virtual meeting is defined as a public appearance. Prior approval of a broker-dealer is not mandated by FINRA but may be required by the broker-dealer. An associated person of a broker-dealer may make a recommendation of a security in a public appearance but must have a reasonable basis for the recommendation. Individual accredited investors are not institutional investors unless they have assets of at least $50 million, and there is nothing in the question to indicate that is the case with these customers. If such electronic presentations are recorded, the recording must be preserved for a minimum of three years.

24. A registered representative wants to place advertisements in his daughter's youth athletic league quarterly sponsorship booklet and in the weekly bulletin at his church describing that he specializes in retirement planning and 529 plans. Which of the following statements regarding these advertisements is true?
    • Preapproval by a principal of the broker-dealer is required.
    • The piece will be regulated as correspondence because it is only being forwarded to two organizations.
    • The advertisement is considered institutional communication because it is placed in literature being distributed by organizations such as the youth athletic league and the church organization, and therefore, no principal preapproval is required.
    • No approval is required because both the youth athletic league and the church would be recognized as bona fide nonprofit organizations by the IRS.

    Correct answer: Preapproval by a principal of the broker-dealer is required.

    Any piece promoting securities services and/or products intended to be received by more than 25 retail customers within any 30-calendar-day period must be preapproved by a principal before use. Given the intended placements of the piece, there is no way to determine the exact number of retail customers who will be exposed to it and within what time frames; therefore, it must be regulated as retail communication. It does not fit the definition of correspondence or institutional communication.

25. FINRA Rule 2210, communications with the public, has a number of filing requirements. Some communications are prefiled, others are postfiled, and some are excluded from filing with FINRA. Included in the list of exclusions would be retail communications
    • That do no more than identify a national securities exchange symbol of the member or identify a security for which the member is a registered market maker
    • That do no more than identify and recommend a specific registered investment company or family of registered investment companies
    • That do not make any financial or investment recommendation, but only promote a service offered by the member
    • Dealing with specific index funds that previously have been filed with FINRA and that are to be used, with the only change being a recommendation of index exchange-traded funds from the same sponsoring organization

    Correct answer: That do no more than identify a national securities exchange symbol of the member or identify a security for which the member is a registered market maker

    A communication limited to identifying the member's exchange or market-maker symbol is excluded from the FINRA filing requirements. A communication that identifies and recommends a specific investment company or companies must be filed. When previously filed material is used, no filing is necessary as long as there is no material change. However, changing from recommending specific funds to specific ETFs is a material change and would require filing. A retail communication promoting a service offered by a member firm is a communication that would likely need filing with FINRA.

26. A registered representative is preparing a PowerPoint slide presentation, to be delivered in a live seminar, for a group of invited institutional clients. To use the slides, they may have to be
    • Reviewed by a principal of the broker-dealer
    • Submitted to both FINRA and the SEC for preuse approval
    • Submitted to the SEC for review and approval
    • Approved by FINRA in writing

    Correct answer: Reviewed by a principal of the broker-dealer

    Communications material that is intended for use with institutional customers only need be supervised and reviewed by a principal of the member firm. Alternatively, if the member's procedures do not require review of institutional communications, they must include a provision for the education and training of associated persons so that they will understand the firm's requirements. Though FINRA can request spot checks of any material used to communicate with the public, submission of institutional communications to FINRA or the SEC for review or approval is not required.

27. If another member broker-dealer has already received clearance from FINRA for a retail communication, filing the piece with FINRA so that your broker-dealer can now use it
    • Must be done 10 days before your broker-dealer can use it, even if unaltered
    • Is not necessary if unaltered and used as originally intended
    • Must be done before publication by your broker-dealer, whether it is altered or unaltered
    • Must be done within three days after use by your broker-dealer, even if unaltered

    Correct answer: Is not necessary if unaltered and used as originally intended

    If unaltered and used as it was originally intended, refiling with FINRA is not required. If the piece had been altered or was intended to be used in a manner inconsistent with how it had been originally intended to be used, filing with FINRA would be required.

28. A principal of a member firm with the responsibility of supervising registered representatives would perform all of the following duties except
    • Approve each securities transaction, whether for retail or institutional customers
    • Approve the opening of all new accounts, whether for retail or institutional customers
    • Review a registered representative's correspondence with the firm's customers in accordance with the firm's written procedures
    • Write all sales material and advertising copy intended to be used as a means of communicating with the public

    Correct answer: Write all sales material and advertising copy intended to be used as a means of communicating with the public

    There is no industry requirement that sales or advertising material intended to be used to communicate with the public be written by a principal of the firm. A principal must approve all retail communications before use, new accounts, and each transaction. All correspondence must be reviewed by a principal, but FINRA rules state that principal review of correspondence can take place before or after use, in accordance with the member firm's written procedures.

29. All of the following communications are exempt from filing with FINRA except
    • Prospectuses and preliminary prospectuses
    • Retail communications that make a financial or investment recommendation
    • Communications that refer to an investment solely as part of a listing of products offered by the member
    • Retail communications previously filed with FINRA

    Correct answer: Retail communications that make a financial or investment recommendation

    Retail communications previously filed with FINRA, prospectuses and preliminary prospectuses, and communications that refer to an investment solely as part of a listing of products offered by the member are all exempt from filing with FINRA. Any retail communication that makes a financial or investment recommendation would require filing.

30. A registered representative may never
    • Act as a buyer's agent
    • Approve advertising
    • Act as a broker
    • Act as a sales agent

    Correct answer: Approve advertising

    Advertising or sales pieces are considered to be a form of communication with the public. All such pieces must be approved by a principal of the member firm.

31. Popular Investment Securities, a FINRA member firm, produces short videos describing the general characteristics of different types of securities. Periodically, an interstitial appears during the video. Under FINRA's rules on communications with the public,
    • The appearance of the interstitial defines the video as retail communication requiring filing
    • Video presentations of any kind must be filed with FINRA within 10 days after first use
    • As long as the presentation is strictly generic, filing with FINRA is not required
    • Interstitials may not be used in public communication without the consent of the viewer

    Correct answer: The appearance of the interstitial defines the video as retail communication requiring filing

    Probably the best example of an interstitial is the pop-up ad. Sometimes it is a full-page ad causing the viewer to see the advertisement before being able to see the rest of the content. Without the interstitial, a generic video describing general characteristics of a type of security would not require filing. But, once that advertisement pops up, it is now retail communication and must be filed.

32. Municipal securities advertisements must be approved by
    • The Municipal Securities Rulemaking Board
    • A municipal securities or general securities principal
    • The Securities and Exchange Commission
    • A financial and operations principal

    Correct answer: A municipal securities or general securities principal

    Advertising or sales pieces are considered to be a form of communication with the public. All such pieces must be approved by a principal of the member firm.

33. Which of the following is not a factor when a communication to be distributed to the public is either being reviewed or approved within the broker-dealer?
    • Whether the piece will be distributed in written form or via electronic media
    • The nature of the audience to which the communication is intended to be distributed
    • Whether achieving past performance results has been implied
    • Whether statements of benefits are balanced with statements of potential risks

    Correct answer: Whether the piece will be distributed in written form or via electronic media

    FINRA holds broker-dealers to certain general standards regarding all member firm communications. Consideration must be given to whether all statements in a communication are clear and not misleading, are balanced regarding the representation of risk and reward, do not omit material facts or make exaggerated claims, and do not imply that past performance can be projected to future outcomes. These standards would apply and be the same, whether the communication was distributed in written or electronic form.

34. Advertising relating to municipal securities must be approved by which of the following?
    • A designated supervisory analyst
    • The Securities and Exchange Commission (SEC)
    • The Municipal Securities Rulemaking Board (MSRB)
    • A general securities principal or municipal securities principal

    Correct answer: A general securities principal or municipal securities principal

    According to MSRB rules, advertising (communications with the public) must be approved by either a municipal securities principal or a general securities principal.

35. Which of the following statements could legally appear in mutual fund advertising or sales literature?
    • Our managers are dedicated to giving you the very best service.
    • Our growth fund net asset value will increase faster than the market in general.
    • The fund never yielded less than 8% and will continue at that rate in the future.
    • Our management is unequaled in the investment industry.

    Correct answer: Our managers are dedicated to giving you the very best service.

    A statement such as, "Our managers are dedicated to giving you the very best service," makes no promises and is therefore not in violation of the FINRA Conduct Rules. Exaggerated claims about the management's investment expertise are prohibited, as are predictions of future fund performance or unsubstantiated claims of superiority.

36. Which of the following observations may a registered representative make when giving a sales presentation based on performance statements and charts?
    • Yield over the past five years has fluctuated between 6% and 8%, indicating it will continue at 6% or better.
    • The portfolio's broad diversification will ensure the continuation of the 6% yield.
    • The fund has had a positive performance in the past few years.
    • The fund has consistently outperformed the market and should continue to do so.

    Correct answer: The fund has had a positive performance in the past few years.

    Predictions are strictly prohibited, and conjecture about future trends or occurrences must be labeled as such.

37. Démodé Classic Investments (DCI) is planning a direct mail campaign to several thousand potential investors. The topic of the campaign deals with owning real estate through direct participation program limited partnerships. Under FINRA Rule 2210 on communications with the public, this is considered
    • A retail communication and must be filed with FINRA at least 10 business days before first use or publication
    • A retail communication that needs approval, but not filing, by a designated DCI principal
    • Correspondence and needs review, not approval, by a designated DCI principal
    • A retail communication and must be filed with FINRA within 10 business days of first use or publication

    Correct answer: A retail communication and must be filed with FINRA within 10 business days of first use or publication

    A direct mail communication to more than 25 existing and/or potential clients within a 30-day period is a retail communication. Unless an exception applies, a designated principal of the firm must approve all retail communications. DPPs are part of a group of securities (other common examples are investment companies and CMOs) where filing with FINRA within 10 business days of first use or publication is the rule.

38. Under Options Clearing Corporation (OCC) rules regarding options communications with the public, if an educational piece making no projected performance figures or recommendations is distributed to customers, it
    • Need not be preceded by an options disclosure document (ODD)
    • Can only be distributed to retail customers
    • Need not be approved by a registered options principal (ROP)
    • Can only be distributed to institutional customers

    Correct answer: Need not be preceded by an options disclosure document (ODD)

    OCC communications rules do not distinguish between retail and institutional customers. Therefore, their communications rules apply to all customers. All communications pieces must be approved by an ROP. If the educational piece makes no recommendations or performance projections, it need not be preceded by an ODD, but it must be accompanied by a notice containing a name and address where the ODD can be obtained.

39. Pristine Brokerage Services, (PBS), accepted as a FINRA member firm seven months ago, is planning a direct mail campaign to several thousand potential investors. The topic of the campaign deals with owning real estate through direct participation programs. Under FINRA Rule 2210 on communications with the public, this is considered
    • A retail communication that needs approval, but not filing, by a designated PBS principal
    • Correspondence and needs review, not approval by a designated PBS principal
    • A retail communication and must be filed with FINRA at least 10 business days before first use or publication
    • A retail communication and must be filed with FINRA within 10 business days of first use or publication

    Correct answer: A retail communication and must be filed with FINRA at least 10 business days before first use or publication

    The key here is that PBS is within its first year of membership. As such, any retail communications (and a communication to more than 25 existing and/or potential clients within a 30-day period is retail communications) must be filed with FINRA at least 10 business days before first use. Retail communications must be approved by a designated principal before filing with FINRA. A more complete answer would have had both the approval and the filing, but sometimes a test question focuses on a single point such as this one does.

40. Which of the following statements is an accurate interpretation of FINRA Conduct Rules governing the use of communications with the public?
    • Institutional communications need not be preapproved by a principal.
    • Sales and product promotion materials distributed to registered representatives and other employees are retail communications and must be submitted for FINRA review, even though such materials are not intended for public distribution.
    • All retail communications must be filed with FINRA before first use.
    • All communications with individual clients are considered retail communications.

    Correct answer: Institutional communications need not be preapproved by a principal.

    FINRA does not require principal preapproval of institutional communications. The same is true for internal communications. Not all communications with individual clients are retail communications. Many times, they are correspondence. There could even be an individual client with assets of at least $50 million, and then it would be institutional communication. Prefiling with FINRA can depend on a number of factors such as the product. For example, prefiling of retail communications is required for certain pieces having to do with investment companies and variable annuities, but not for pieces having to do with direct participation programs or collateralized mortgage obligations.

41. Filing with FINRA within 10 business days of first use is required for all of the following except
    • Retail communications concerning public direct participation programs (DPPs),
    • Retail communications that promote or recommend a specific registered investment company or family of registered investment companies including exchange-traded funds (ETFs)
    • Retail communications concerning collateralized mortgage obligations (CMOs) registered under the Securities Act,
    • Retail communications that promote or recommend a specific real estate investment trust (REIT)

    Correct answer: Retail communications that promote or recommend a specific real estate investment trust (REIT)

    Real estate investment trusts (REITs) are not included in FINRA's list of retail communications requiring postfiling.

42. All the following retail communications must be prefiled with FINRA except
    • Retail communications concerning investment companies with custom ratings
    • Retail communications concerning public DPPs
    • Retail communications concerning the member firm's opening for business last month
    • Retail communications concerning options without previously providing an ODD

    Correct answer: Retail communications concerning public DPPs

    Retail communications concerning public DPPs do not need to be prefiled. Retail communications for all new member firms, concerning investment companies with custom ratings or options without previously providing an ODD must be prefiled with FINRA. New member firms, defined as being in their first year of business, must file retail communications with FINRA 10 business days in advance of use.

43. Under FINRA's Rule 2210 on communications with the public, which of the following is excluded from the filing requirements?
    • Correspondence with prospective clients that is delivered through electronic media
    • Retail communications concerning public direct participation programs
    • Retail communications that previously have been filed with FINRA and that are to be used with material change
    • Retail communications concerning collateralized mortgage obligations registered under the Securities Act of 1933

    Correct answer: Correspondence with prospective clients that is delivered through electronic media

    In most cases, retail communications must be filed with FINRA while correspondence, regardless of the method of delivery, is not. If the retail communication has previously been filed with FINRA and is being used without material change, it does not have to be refiled.

44. All of the following may be included in an advertisement for a collateralized mortgage obligation (CMO) issue except
    • A generic description of the CMO tranche
    • A disclosure of the CMO's coupon rate and final maturity date
    • A statement that the CMO is guaranteed by the U.S. government.
    • A disclosure that payment assumptions may or may not be met

    Correct answer: A statement that the CMO is guaranteed by the U.S. government.

    The U.S. government does not issue or back CMOs. It is also misleading to state or imply that a CMO's anticipated yield or average life is guaranteed. CMOs must include the coupon rate and the final maturity date, a generic description of the CMO tranche, and disclosure that payment assumptions may or may not be met.

45. Guarantees on insurance products
    • Are permissible for principal values in the separate account
    • Are only permissible for companies with an A+ rating from A.M. Best.
    • Must be specific to the insurance contract and not associated investments
    • Are not allowed

    Correct answer: Must be specific to the insurance contract and not associated investments

    Guarantees are only permissible for the specific guarantees within an insurance contract. Companies cannot guarantee returns or even principal values in investments, including separate accounts. While high ratings may indicate stability and quality in a company, they cannot be used to make a guarantee.

46. All of the following are excluded from the FINRA filing requirement for communications with the public except
    • Correspondence
    • Retail communications posted on an interactive forum online
    • Retail communications posted online that require a login to access
    • Retail communications that only identify the member firm

    Correct answer: Retail communications posted online that require a login to access

    Retail communications, unless specifically exempted, must be filed with FINRA. There is no exemption for requiring a login to access. Correspondence does not need to be filed with FINRA nor does retail communications only identifying the member firm or posted on an online interactive forum.

47. The ABC Insurance Company is advertising its variable annuity product as "ABC Lifetime Income—income generated from mutual fund returns." This advertisement is
    • Permitted
    • Prohibited because it doesn't reference an annuity
    • Prohibited because it implies returns from mutual funds
    • Permitted as long as there's no guarantee

    Correct answer: Prohibited because it implies returns from mutual funds

    Variable contracts or their underlying accounts cannot be advertised as mutual funds. Proprietary terms can be used instead of words such as "annuity."

48. In a competitive offering of municipal bonds, the issue is usually awarded to the syndicate that offers to sell the bonds
    • With the lowest net interest cost to the issuer
    • With the smallest spread
    • At the highest price
    • In the shortest possible time

    Correct answer: With the lowest net interest cost to the issuer

    In a competitive underwriting for municipal bonds, competing syndicates submit bids to the issuer. The issuer (or representative) examines the bids to determine which bid provides the issuer with the lowest net interest cost.

49. For the underwriting of a municipal bond issue, competitive bids are submitted by underwriters as
    • A firm commitment
    • A standby underwriting commitment
    • An all-or-none commitment
    • A best efforts underwriting commitment

    Correct answer: A firm commitment

    For new municipal bond issues, underwriters must submit bids for the entire bond offering—a firm commitment. Standby commitments are used only for corporate stock rights offerings. Best efforts commitments are used for corporate securities, and an all-or-none commitment is a type of best efforts commitment.

50. A syndicate member in a municipal underwriting wishes to place an order with the manager for its own portfolio. Under Municipal Securities Rulemaking Board rules, an order for a related portfolio must be
    • Entered as a designated order
    • Entered as a group order
    • Entered as a presale order
    • Disclosed to the manager

    Correct answer: Disclosed to the manager

    Disclosure is necessary to allocate orders. An order for a related portfolio will be accorded member status—the lowest priority.

51. A due diligence meeting occurs between
    • The underwriter and the SEC before the issuance of a final prospectus to insert the public offering price and make any last-minute changes at the SEC's request
    • The FINRA member firm and FINRA's Corporate Finance Department to discuss the fairness of the underwriting spread on a pending public offering
    • The issuing corporation and the underwriters to review and re-examine the full details of the pending underwriting and negotiate final terms to be included in the formal underwriting contract
    • All of these

    Correct answer: The issuing corporation and the underwriters to review and re-examine the full details of the pending underwriting and negotiate final terms to be included in the formal underwriting contract

    A due diligence meeting is held between the issuer and the underwriter before the effective date and is one of the final meetings held before the sale of the security so that each party may review all aspects of the issue.

52. In a new municipal bond offering, which of the following orders is placed after the bid is awarded and credits the entire syndicate with the takedown?
    • Designated
    • Presale
    • Member
    • Group

    Correct answer: Group

    A presale order is entered before the bid is awarded. If the syndicate wins the bid, the takedown is credited to all syndicate members. A group order is entered after the bid is awarded and the takedown is credited to all syndicate members. A designated order, entered after the bid is awarded, credits some, but not all, syndicate members with the takedown. A member order, entered after the bid is awarded, credits only the syndicate member entering the order with the takedown.

53. Within a firm commitment underwriting, which document details the responsibilities and liabilities of each firm?
    • Registration statement
    • Underwriting agreement
    • Letter of intent
    • Agreement among underwriters

    Correct answer: Agreement among underwriters

    The agreement among underwriters, also called the syndicate letter, is signed by representatives of all syndicate members and establishes a joint account to sell newly issued securities.

54. XYZ Corporation is preparing a registration statement for a new issue consisting of 300,000 new shares and 200,000 existing shares held by officers. The offering price is $30 per share, and the spread taken by the underwriters is $2 per share. After the offering is complete, XYZ will receive
    • $14,000,000.
    • $9,000,000.
    • $8,400,000.
    • $15,000,000.

    Correct answer: $8,400,000.

    XYZ Corporation will receive $28 per share for each of the 300,000 new shares being issued ($30 per share price less the $2 spread). The proceeds from the 200,000 shares sold by the officers will benefit the officers themselves, not XYZ Corporation.

55. Better Bond Sales (BBS) is the syndicate manager of new GO municipal bond issue. Should BBS sell some of the bonds, its earnings would be
    • The total takedown
    • The spread
    • The spread plus the manager's fee
    • Negotiated between the issuer and the manager

    Correct answer: The spread

    When the syndicate manager makes the sale of a new issue of bonds, the manager earns the entire spread (the difference between the amount paid to the issuer and the offering price). The manager's fee is included in that spread. The syndicate members earn the total takedown on bonds they sell.

56. New issue municipal bond orders are allocated according to priorities the syndicate sets in advance. The MSRB requires syndicates to establish priority allocation provisions for orders. Which of the following is the most common priority?
    • Presale, designated, group net, member
    • Presale, group net, designated, member
    • Member, designated, presale, group net
    • Group net, presale, designated, member

    Correct answer: Presale, group net, designated, member

    Remember our abbreviation: PGDM (Pro Golfers Don't Miss) and that will get you the correct answer to any of these order allocation questions.

57. Cutting Edge Securities is the managing underwriter for a new issue of 1 million shares of ABC common. While the underwriter has agreed to sell as much stock as possible in the market, ABC will cancel the offering if any portion of the stock remains unsold. This arrangement is known as what type of underwriting?
    • Mini-max
    • Standby
    • Best efforts
    • All or none

    Correct answer: All or none

    All-or-none underwritings require the underwriter to either sell the entire issue of stock or cancel the offering completely.

58. Stabilizing bids may be entered at
    • A price no higher than the public offering price
    • A price not exceeding 5% above the public offering price
    • Whatever stabilizing price is stated in the prospectus
    • Any reasonable price necessary to support the public offering price

    Correct answer: A price no higher than the public offering price

    Stabilizing bids cannot be used to raise the market price of an issue. Stabilization may only be used to support a new issue security at or below the public offering price.

59. If a customer purchases a new issue of stock from a syndicate member, the customer will pay the public offering price
    • With no markup or commission
    • Plus a markup
    • Plus a commission
    • Plus the spread

    Correct answer: With no markup or commission

    New issues are sold at the public offering price without a commission or markup. In the secondary market, securities are traded on an agency basis (commission) or on a principal basis (markup or markdown).

60. If municipal securities are offered on an inverted scale, this means
    • The coupon rates on short-term bonds are higher than coupon rates on long-term bonds
    • The yields on short-term maturities are higher than the yields on long-term maturities
    • The yields on long-term bonds are higher than yields on short- term bonds
    • The coupon rates are higher than the yields

    Correct answer: The yields on short-term maturities are higher than the yields on long-term maturities

    A normal scale of prices consists of lower yields on short-term maturities and higher yields on longer maturities. An inverted scale is the opposite.

61. What is the profit to a syndicate member if a syndicate is offering an 8.5% bond at 100, the syndicate manager is giving a 0.75 concession and a 1-point total takedown, and the syndicate member sells 1,000 bonds?
    • $17,500
    • $10,000
    • $7,500
    • $1,000

    Correct answer: $10,000

    When a member of the syndicate sells a bond, the member is entitled to the total takedown. In this case, one point ($10) per bond (1,000 bonds sold $\times$ $10 per bond = $10,000 profit). Remember that the concession would only go to those who are not members of the syndicate but are part of the selling group instead.

62. A syndicate won the bid for a general obligation bond of $1 million issued by a city. The syndicate has received the following orders: $500,000 net designated, $500,000 presale, and $1 million member at takedown. The orders would be filled as
    • $500,000 presale, $250,000 net designated, $250,000 to members.
    • $500,000 presale, $500,000 net designated, none to members.
    • None to presale, none to net designated, $1 million to members
    • $250,000 presale, $500,000 net designated, $250,000 to members.

    Correct answer: $500,000 presale, $500,000 net designated, none to members.

    Municipal syndicate customs dictate that presale orders have first priority, with group orders, net designated orders, and member orders following in that order.

63. Which of the following documents sets forth the priority of sale of securities?
    • A tombstone
    • The official notice of sale
    • An offering circular
    • The syndicate letter

    Correct answer: The syndicate letter

    The syndicate letter lists the terms under which members will conduct the sale of the bonds. It also describes each member's sharing of profits and expenses, the type of business entity (i.e., joint venture or partnership), and the good faith deposit required.

64. One member of a municipal syndicate is opposed to bidding on a particular issue because of some of the restrictions outlined in the official notice of sale. The other eight members of the syndicate have agreed on a price and vote to submit their bid. In this situation, the syndicate manager can do all of the following except
    • Allow members to drop from the syndicate and add new members
    • Require the dissenting member to accept its prorated share of the offering
    • Submit the bid after reaching a consensus
    • Withdraw from the bidding process

    Correct answer: Require the dissenting member to accept its prorated share of the offering

    The syndicate manager cannot force members to participate in the bid. The firm can ask members to reach a consensus, change the composition of the syndicate, or withdraw from the bidding process.

65. Which of the following best describes how a syndicate determines the amount to bid for a new municipal issue?
    • The average reoffering price minus the spread
    • The average reoffering price plus the takedown
    • The gross spread minus the takedown
    • The average sales price divided by the interest cost

    Correct answer: The average reoffering price minus the spread

    A spread is analogous to the gross profit margin in other businesses. A syndicate's bid is based on the average reoffering price (the price the public will pay) less the syndicate's spread (the amount the syndicate will charge for bringing the issue to market).

66. The underwriting agreement is signed by
    • The issuer and the managing underwriter
    • The issuer and the SEC
    • The selling group members and the syndicate members
    • The managing underwriter and the syndicate members

    Correct answer: The issuer and the managing underwriter

    The underwriting manager represents all underwriting members, and on behalf of the underwriting group, signs the underwriting agreement with the issuer. The agreement among underwriters is the document signed by the managing underwriter and all syndicate members. The selling group members have no formal agreement to be signed with the underwriters.

67. Shares of Marc Lighting Manufacturing Company trade on the NYSE with the ticker symbol MLM. The company wants to raise equity capital by issuing additional shares. An investment bank buys MLM's new shares and sells them to interested retail and institutional buyers. This transaction is most accurately described as
    • Underwriting an IPO
    • An additional primary offering
    • A private placement
    • A best-efforts offering

    Correct answer: An additional primary offering

    Because shares of the issuer are already trading, this cannot be an IPO. When a company sells new shares, it is always a primary offering. In this case, a follow on or additional primary offering. The question tells us that the investment bank bought the entire issue of shares. That means this is a firm commitment offering rather than a best-efforts offering. Nothing in the question indicates that the sale was private. Rather, with the shares currently trading on the NYSE, it is a reasonable assumption that these new shares will just increase the market float of MLM stock.

68. An underwriter in an Eastern syndicate has a 15% participation. The underwriting is for $20 million, and the underwriter has sold its $3 million allotment. The underwriting closes with $1 million remaining unsold. This underwriter's liability is
    • $1,000,000.
    • $15,000.
    • $150,000.
    • $0.00.

    Correct answer: $150,000.

    An Eastern syndicate is an undivided account. That means that each member is responsible for its share of any unsold portion. This underwriter's commitment is 15%, so that percentage of the $1 million remaining is $150,000. If this were a Western syndicate (divided), the underwriter would have had no liability.

69. The primary difference between an underwriting syndicate member and a selling group member in a firm commitment underwriting is that
    • The securities offered by each differs within the offering
    • The size of a syndicate member firm will always be larger than a selling group member firm
    • The syndicate assumes liability for unsold shares, while the selling group does not
    • The price per share paid by the public is more if purchasing new shares from a selling group member

    Correct answer: The syndicate assumes liability for unsold shares, while the selling group does not

    The underwriting syndicate makes a financial commitment in a firm underwriting to bring a new issue to market and take liability for unsold shares. A member of a selling group only agrees to provide a sales service for a certain number of shares in exchange for a commission on shares it sells. It has no responsibility for any unsold shares. The securities offered are identical, and the public offering price is the same. Both large and small firms can be either syndicate members or selling group members.

70. In the underwriting of a municipal bond, which of the following is determined by the issuer rather than the underwriter?
    • Underwriting spread
    • Yield to maturity
    • Net interest cost
    • Maturity

    Correct answer: Maturity

    The maturity is determined by the issuer and stated in the official notice of sale before bids are received.

71. An official notice of sale publicizes all of the following except
    • The bond counsel's name
    • The amount of good faith deposit required
    • The bond's rating
    • The issuer's name

    Correct answer: The bond's rating

    The notice of sale is the advertisement placed by a municipality soliciting bids from underwriters for an issue it wishes to sell. It does not include the bond's rating.

72. Nonmembers of a syndicate who are assisting in its sale of bonds buy the bonds at a discount called
    • A takedown
    • A concession
    • The basis price
    • A net designated price

    Correct answer: A concession

    Members of the syndicate buy the bonds at the offering price minus the takedown, and nonmembers buy at offering price minus a concession. The basis price is the yield to maturity.

73. In the context of municipal bond underwritings, the true interest cost (TIC) is different from the net interest cost (NIC) because it
    • Reflects the credit risk
    • Produces a lower cost of borrowing for the issuer
    • Is the method required by the IRS
    • Reflects the time value of money

    Correct answer: Reflects the time value of money

    The TIC method uses present value calculations that consider the time value of money (as opposed to NIC, which does not consider the timing of interest payments). It is a more complicated calculation than NIC. The IRS is not concerned with this issue.

74. When describing a new offering of municipal bonds, which statement is true regarding presale orders?
    • The takedown on presale orders is credited to the account of the syndicate member making the sale.
    • There is no takedown on a presale order; the buyers purchase at a discounted price.
    • The takedown on presale orders is split among the syndicate members based on their participation.
    • The takedown on presale orders is credited to the account of the syndicate manager.

    Correct answer: The takedown on presale orders is split among the syndicate members based on their participation.

    Unlike registered corporate issues, investors may place orders for a new municipal bond issue before the issue has even been awarded to the syndicate. These presale orders have the highest priority in terms of allocation, and all syndicate members share proportionately in the takedown (their underwriting compensation).

75. When an underwriting syndicate commits to distribute an entire offering, it may enlist other FINRA member firms to help in the offering. These member firms are known as
    • Co-managers
    • Selling group members
    • Affiliated members
    • Syndicate participants

    Correct answer: Selling group members

    Underwriting syndicates often enlist other FINRA member firms to help with the distribution of an offering. These members become part of the selling group. Unlike the syndicate members, selling group members have no capital commitment. They are acting as agents of the syndicate and earn a selling concession on their sales.

76. An issuer may engage in a primary offering
    • Once per year
    • Once every 90 days
    • Once
    • As often as it chooses

    Correct answer: As often as it chooses

    There is no limit to how often a company may issue shares in a primary offering. There will be regulatory requirements for each offering, depending on the offering and the type of issuer; however, they may be as common as daily (i.e., mutual funds).

77. Which of the following is least likely to impact an underwriter's considerations when establishing the offering price for a new issue?
    • Demand for the security by the investing public
    • Projected earnings for the company
    • Earnings multiples for other companies in the market in the same industry
    • Geographic location of the company headquarters

    Correct answer: Geographic location of the company headquarters

    Of the choices given, unless the geographic location of the company was critical to its financial success in some way it is the least likely factor to be considered by underwriters when pricing the new issue. Indications of interest (demand for the securities), projected earnings, and comparative financial data for similar companies in similar industries are much more likely to impact pricing of the new issue.

78. Which of the following is typically the largest component of a corporate underwriting spread and is received by members of the selling group?
    • Underwriting fee
    • Concession
    • Manager's fee
    • Reallowance

    Correct answer: Concession

    The concession tends to be the largest component of a corporate underwriting spread. That is paid to the members of the selling group. The manager's fee is generally the smallest component.

79. All the following statements are false about the process of awarding an underwriting to a syndicate except
    • A competitive bid underwriting is the standard for corporate offerings
    • A competitive bid underwriting is the standard for general obligation municipal underwritings
    • In a competitive bid situation, the contract is award to the syndicate bid that reflects the highest net interest cost to the issuer
    • A negotiated underwriting is the standard in a general obligation municipal underwriting

    Correct answer: A competitive bid underwriting is the standard for general obligation municipal underwritings

    The double negative in the question tells us we are looking for the true statement. A competitive bid underwriting is the standard for general obligation municipal bond underwritings. In many cases, state law requires competitive bidding. On the other hand, negotiated underwritings seem to dominate municipal revenue bonds. Negotiated is also the primary method for corporate issues. The award in a competitive bid is to the syndicate submitting a bid representing the lowest net interest cost (NIC). In some underwritings, it is the lowest true interest cost (TIC). TIC accounts for the time value of money.

80. The spread in a municipal competitive bid is
    • The difference between the stated yield and reoffering price
    • The excess of the dollar bid over par
    • The difference between the bid and production (the price at which the bonds are reoffered to the public)
    • The difference between the takedown price and reoffering price

    Correct answer: The difference between the bid and production (the price at which the bonds are reoffered to the public)

    Bid refers to the winning bid and is the price the syndicate pays to buy the bonds from the issuer. The term production is a sales term and refers to the price at which the bonds are reoffered to the public. The difference between the two is the spread.

81. In the underwriting of a new municipal GO bond issue, who would earn the selling concession?
    • A member of the syndicate
    • The syndicate manager
    • The registered representative who actually sold the bonds
    • A selling group member

    Correct answer: A selling group member

    When a selling group member is part of the underwriting, their compensation is the selling concession. The manager earns the management fee. The syndicate members earn the takedown.

82. Which of the following statements regarding a negotiated underwriting is not true?
    • The municipality appoints the underwriter.
    • Either municipal general obligation or revenue bonds can be underwritten on a negotiated basis.
    • All states require that general obligation bonds (GO) must be underwritten using a negotiated process.
    • The investment banker consults with the issuer to establish a price for the issue.

    Correct answer: All states require that general obligation bonds (GO) must be underwritten using a negotiated process.

    When a municipality appoints an underwriter, the bond issue is a negotiated underwriting. The price must be satisfactory to the issuer and still allow the underwriters to sell the bonds at a profit. There is no requirement that either municipal GO or revenue issues be underwritten as either negotiated or competitive bid. Each may be underwritten using either underwriting process.

83. If a corporation issues stock to the public at $10 per share, and the syndicate manager's fee is $0.10 per share, the underwriting fee is $0.25 per share, and the selling concession is $0.45 per share, what is the spread?
    • $0.60.
    • $0.90.
    • $0.80.
    • $0.70.

    Correct answer: $0.80.

    The spread is the sum of the manager's fee, the underwriting fee, and the selling concession.

84. The underwriting of most corporate issues is done on a negotiated basis. The investment banker who negotiates with the issuer on a firm commitment underwriting is known as
    • The chief negotiator
    • The principal underwriter
    • The syndicate manager
    • The prime investment banker

    Correct answer: The syndicate manager

    When a syndicate is formed, it is the responsibility of the syndicate manager to negotiate with the issuer and keep the syndicate records of the underwriting. You might also see this position referred to as the managing underwriter or the lead underwriter.

85. Which of the following competitive bids on a new municipal issue is most likely to be awarded the bid?
    • Six percent coupon with no premiums over par
    • Eight percent coupon with premiums over par
    • Six percent coupon with premiums over par
    • Seven percent coupon with no premiums over par

    Correct answer: Six percent coupon with premiums over par

    In a competitive bid bond sale, the winning bid is the one that provides the issuer with the lowest net interest cost. If the syndicate pays the issuer more than par for the bonds, the issuer is taking in more money than it must pay out at maturity. Therefore, its net interest cost is lower than the 6% coupon on the bonds.

86. Which of the following municipal securities could have been sold in a negotiated underwriting?
    • School bonds
    • All of these
    • Industrial development bonds
    • Limited tax bonds

    Correct answer: All of these

    Either municipal revenue or general obligation (GO) bonds can be underwritten using a negotiated underwriting process to set the terms of the new issue. Industrial development bonds are revenue bonds, while both limited tax bonds and school bonds are types of GO issues.

87. In its notice of sale in The Bond Buyer, an issuer states that it will take into consideration the timing of interest payments when evaluating bids. The issuer will be using which of the following methods in its bid selection?
    • Net interest cost
    • Real interest cost
    • Low interest cost
    • True interest cost

    Correct answer: True interest cost

    The true interest cost (TIC) method takes into consideration the time value of money. The issuer discounts future interest payments to arrive at a present value.

88. When an existing, long established publicly traded corporation issues a large block of new shares in order to expand or modernize, it is
    • A refunding
    • An IPO
    • A primary distribution
    • A secondary distribution

    Correct answer: A primary distribution

    New shares are always part of a primary distribution. When it is the first time, it is an initial public offering (IPO). That does not apply here because this company already has shares publicly trading.

89. In an undivided syndicate, liability for unsold securities rests with
    • The syndicate members that failed to sell their allotment
    • The syndicate manager
    • The syndicate members on a pro rata basis
    • The issuer

    Correct answer: The syndicate members on a pro rata basis

    In an undivided (Eastern) account, liability for unsold securities rests with each syndicate member based on its participation percentage. For example, if a syndicate member has a 10% participation, that member would be responsible for 10% of any unsold securities (even if that member sold all of its participation). Sales do not affect undivided accounts.

90. A firm underwriting of a municipal bond issue usually has a number of different broker-dealers involved. Those who earn a commission on each sale they make are performing in the role of
    • A selling syndicate member
    • A selling group member
    • A registered representative
    • The syndicate manager

    Correct answer: A selling group member

    Selling syndicate members use selling group members to expand their reach. These selling group members receive a selling concession (a commission) on each sale they make. They have no financial commitment and return any unsold bonds to the syndicate member. Although registered representatives will typically earn a commission on the bonds they sell, the question asks about the broker-dealers involved in the underwriting. Be sure to answer the specific question asked.

91. A municipal issuer publishes an official notice of sale to indicate that the offering will be made
    • Through a private placement
    • On a competitive basis
    • For none of these
    • On a negotiated basis

    Correct answer: On a competitive basis

    An official notice of sale is the issuer's method of inviting competitive bids on a new issue. It sets forth all of the information about the issue that a dealer would need to make a bid, including the size of the offering; the maturity dates; and the date, time, and place of the sale.

92. A firm underwriting of a municipal bond issue usually has a number of different broker-dealers involved. Those who earn the total takedown on each sale they make are performing in the role of
    • A selling syndicate member
    • The issuer
    • A selling group member
    • The syndicate manager

    Correct answer: A selling syndicate member

    Selling syndicate members have a commitment to sell the bonds allocated to them. On each bond the member sells, the total takedown (the takedown plus the additional takedown) is earned. Selling group members earn the concession. The syndicate manager earns the entire spread on any bonds it sells.

93. Your manager notifies you that a new municipal revenue bond issue you have been working on has been oversubscribed. How is the order acceptance priority for this issue determined?
    • As outlined in the agreement among underwriters
    • On a first-come, first-served basis
    • As outlined in the legal opinion
    • As outlined in the indenture

    Correct answer: As outlined in the agreement among underwriters

    The priority of filling municipal orders is established by the managing underwriter in the release terms letter sent to the syndicate once the bid is won. This letter is an amendment to the agreement among underwriters. The priority is also disclosed in the official statement.

94. The true interest cost (TIC) method of evaluating municipal bids
    • Can only be used for term bonds
    • Is required by the MSRB if a financial advisory relationship exists
    • Is required by the MSRB if a control relationship exists
    • Considers the time value of cash flows

    Correct answer: Considers the time value of cash flows

    The calculation of TIC (as opposed to net interest cost) takes the time value of money into account. The Municipal Securities Rulemaking Board has no requirement as to which method is used.

95. The manager will credit each syndicate member based on sales of that particular maturity allotted to the member, and such credits shall extinguish liability based only on such securities that are sold by the member. This statement describes an agreement among underwriters that is
    • An Eastern account
    • An undivided account
    • A divided account
    • A proportionate underwriting

    Correct answer: A divided account

    This is part of an agreement for a Western (divided) syndicate.

96. An underwriting spread is
    • The amount a selling group receives
    • The amount a managing underwriter receives
    • The difference between an offering price and the proceeds to an issuer
    • The amount a syndicate receives

    Correct answer: The difference between an offering price and the proceeds to an issuer

    A spread is the difference between the public offering price and the price an underwriter pays an issuer.

97. An initial public offering is conducted
    • Directly with principal shareholders
    • In the secondary market
    • With the issuer generally through an underwriter
    • On the New York Stock Exchange

    Correct answer: With the issuer generally through an underwriter

    Initial public offerings are a type of primary offering, meaning the issuer (generally through an underwriter) sells the new shares to the public. While shares may trade in the secondary market (between members of the public) on the New York Stock Exchange, such transactions would be after the IPO.

98. When syndicate members agree to share financial responsibility for any unsold securities on an undivided basis, this contractual arrangement comprises what type of account?
    • Eastern
    • Selling group
    • Western
    • Best efforts

    Correct answer: Eastern

    An undivided account, which is a shared underwriting liability for unsold securities, is an Eastern account.

99. ABC Corporation is offering 500,000 units to the public at $5 per unit. Each unit consists of two shares of ABC preferred stock and one perpetual warrant for half of a common share of ABC, exercisable at $5. How much capital was raised by the initial sale of the issue?
    • $2.5 million
    • $1.25 million
    • $5 million
    • $7.5 million

    Correct answer: $2.5 million

    Because the issuing corporation is offering 500,000 units to the public at $5 per unit, the total amount of capital to be raised by this sale will be $2.5 million (500,000 units $\times$ $5 per unit). Be sure to read the question carefully. It is only referring to the initial sale of the units. If those warrants are exercised in the future, the company will receive additional capital.

100. An order confirmed for the entire underwriting syndicate's benefit is called
     • A group net order
     • A market order
     • A net designated order
     • A member at the takedown order

     Correct answer: A group net order

     A municipal group net order is credited to syndicate members according to their percentage participation in the account. This order type is given priority over designated or member takedown orders (but not over presale orders). The normal order of priority is presale orders, group or syndicate orders, designated orders, and member orders.

101. One of your clients is an active investor using a tactical asset allocation strategy. As such, the client engages in numerous transactions every month. With each transaction, the client pays a separate transaction fee. Your firm has just begun offering an account to its clients whereby the client can pay one flat fee to cover all the trades in that account. You immediately bring this news to the client and suggest making the change. What type of account is this?
     • A pattern day trading account
     • A margin account
     • A fee-based account
     • A wrap-fee account

     Correct answer: A fee-based account

     With a fee-based account, the customer pays one fee that covers all transactions in an account. This account is most suitable for active, rather than passive investors. A wrap-fee account is one where a fee, usually based on assets under management, is charged to a customer to cover various services provided by a firm. Those services would include portfolio management and transaction fees. Firms that offer wrap-fee accounts are required to be registered as investment advisers as well as broker-dealers.

102. A margin account may not be used
     • To purchase corporate bonds
     • When opening a fee-based account
     • For retirement accounts
     • To purchase listed stocks

     Correct answer: For retirement accounts

     Investors cannot open a margin account for retirement plans. There are other restrictions on margin accounts, including accounts for minors. Listed and many OTC stocks and corporate bonds can be purchased on margin.

103. To be defined as a pattern day trader, the customer must execute at least
     • Four day trades on a single business day
     • Five day trades in five business days
     • Four day trades in five business days
     • Four day trades in the same week

     Correct answer: Four day trades in five business days

     FINRA defines a pattern day trader as one who executes 4 or more day trades in a 5-business-day period. That can stretch over two different weeks.

104. The term churning refers to
     • Repeatedly purchasing stock to keep the price up
     • Purchasing calls on a particular stock for your own account before entering a large customer order for the stock
     • Entering more transactions than necessary, solely for the purpose of generating commissions
     • Repeatedly selling a stock short to prevent a price rise

     Correct answer: Entering more transactions than necessary, solely for the purpose of generating commissions

     Unnecessary transactions entered into for the purpose of generating commissions constitute churning. A charge of churning can result from both an excessive number and the excessive size of transactions.

105. Which of the following accounts are billed a single fee annually for a group of services?
     • Margin account
     • Cash account
     • Wrap account
     • Option account

     Correct answer: Wrap account

     Wrap accounts are accounts for which firms registered as both broker-dealers and investment advisers provide a group of services, such as asset allocation, portfolio management, executions, and administration, for a single fee. Wrap accounts are generally investment advisory accounts.

106. A large institution dealing with several different broker-dealers would probably find it beneficial to open
     • A combined cash and margin account
     • A prime brokerage account
     • An institutional brokerage account
     • An accredited investor account

     Correct answer: A prime brokerage account

     A prime brokerage account is one in which a customer—generally an institution—selects one member firm (the prime broker) to provide custody, trading, and other services, while other firms, called executing brokers, typically execute most of the trades placed by the customer.

107. Which of the following accounts allow ownership of real estate?
     • An UTMA account
     • A cash account
     • A margin account
     • An UGMA account

     Correct answer: An UTMA account

     One of the primary differences between UTMA and UGMA is the investment flexibility. Real property can be transferred into an UTMA, while no such provision exists with UGMA. Brokerage accounts, cash or margin, are used to trade securities. Real estate is not a security (REITs and RELPs are, but that is not direct ownership of the real estate). There is nothing to stop an investor from depositing fully paid-for marginable securities into a margin account and using the margin loan to purchase real estate. However, that purchase is done outside of the margin account.

108. When a customer instructs a registered representative to transfer and ship, the representative instructs the margin department to transfer ownership into
     • The customer's name and deliver the securities to the customer's bank for safekeeping
     • The brokerage firm's name and deliver the securities to the customer
     • The customer's name and deliver the securities to the customer
     • The brokerage firm's name and deliver the securities to the brokerage firm's commercial bank for safekeeping

     Correct answer: The customer's name and deliver the securities to the customer

     The term transfer and ship means to transfer the securities into the name of the customer and ship (deliver) the securities to the customer. To hold in street name would require the securities to be transferred into the name of the broker-dealer and held for safekeeping.

109. Which of the following statements best describes the term churning?
     • Manipulation of market prices by a firm
     • Purchasing the same security in more than one customer account at a time
     • Trading in a customer's account considered excessive and for which no discernible investment purpose is detected
     • Making false or misleading statements to a customer for the purpose of inducing the customer to purchase or sell a security

     Correct answer: Trading in a customer's account considered excessive and for which no discernible investment purpose is detected

     Churning is excessive trading for a particular customer's circumstances or exceeding what would normally be considered suitable. This is equally true for both discretionary and nondiscretionary accounts.

110. In an account opened by two individuals as joint tenants with right of survivorship (JTWROS), all of the following statements are true except
     • Stock certificates may be delivered in the name of either party
     • In the event of death, the other party assumes full ownership of the account
     • Orders may be entered by either party
     • Mail may be directed to the joint owner agreed upon by both parties to the account

     Correct answer: Stock certificates may be delivered in the name of either party

     In a JTWROS account, each party has an equal, undivided interest in the account. Upon the death of one party in a two-party account, the other party assumes full ownership of the account. Orders may be entered by either party, and mail may be directed to either party. However, disbursements of cash or securities must be in the name of all parties to the account.

111. Which of the following individuals may not open a joint account?
     • Two spouses
     • Two business partners
     • Three sisters
     • A parent and a minor

     Correct answer: A parent and a minor

     A minor may not be a party in a joint account because a minor cannot legally exercise control over the account. A custodial account may be set up for the minor.

112. Many parents find that opening an UTMA account for their child is not only a good way to accumulate funds for the future but also a good way for the child to gain an appreciation for investing. The account custodian may use principal as well as income generated in the account to pay for all of the following for the child except
     • Private school
     • The latest model smartphone
     • New clothes
     • Summer camp

     Correct answer: New clothes

     The Uniform Transfer to Minors Act permits the custodian to use the funds for almost anything that is a benefit to the minor. The primary exceptions are those that most states consider to be the parental obligations of food, clothing, and shelter.

113. You have a client who is an active trader in his margin account. Wishing to take advantage of the tax benefits of the Roth IRA, he asks for the form to open the Roth. While attempting to complete the form, he calls to ask, "How do I indicate margin trading on this form." You would respond,
     • ""Let me check with our operations department for that information.""
     • ""Because our minimum for margin accounts is $20,000 is above the IRA maximum contribution, you will have to open it in a cash account.""
     • ""IRAs, traditional or Roth, can only be opened as cash accounts.""
     • ""Only traditional IRAs can be opened as margin accounts.""

     Correct answer: ""IRAs, traditional or Roth, can only be opened as cash accounts.""

     IRAs, and other retirement accounts, cannot be opened in margin accounts. They are limited to cash accounts only.

114. All of the following are the advantages of a margin account except
     • Less cash is needed
     • Money is borrowed
     • Leveraging is possible
     • Losses are minimized

     Correct answer: Losses are minimized

     Any losses on a margin trade are magnified because of the leverage.

115. A customer opens an account, and payment and delivery instructions are established. Beyond the opening of the account, these instructions may
     • Not be changed unless a new account is established
     • Be changed for individual transactions only
     • Be changed for individual transactions, or going forward, for all transactions
     • Be changed at any time for all transactions going forward

     Correct answer: Be changed for individual transactions, or going forward, for all transactions

     It is normal for new customers to establish payment and delivery instructions at the time the account is opened. An example would be "transfer and ship" where the investor's instructions are to have stock that is purchased transferred into their name and then sent to them. These instructions can be changed for any individual transaction or for all transactions going forward.

116. The Customer Identification Program requires that a tax identification number must be obtained when opening a new account. When the account is an UTMA, the Social Security number used is that of
     • The minor who is the beneficiary of the account
     • Either the custodian, a parent or guardian, or the minor
     • The appointed custodian
     • A parent or guardian of the minor

     Correct answer: The minor who is the beneficiary of the account

     The minor's Social Security number is required because the account is fully owned by and taxed to the minor, not to the custodian or the parent.

117. All of the following people could open a joint account except
     • A married couple
     • A mother and 22-year-old daughter
     • A father and 10-year-old son
     • Two business partners

     Correct answer: A father and 10-year-old son

     Joint accounts can only be opened between adults.

118. Which of the following persons must sign a stock or bond power to effect good delivery of securities sold from an account set up under the Uniform Transfer to Minors Act?
     • Parent
     • Custodian
     • Donor
     • Minor

     Correct answer: Custodian

     The custodian must sign securities in a custodial account to effect good delivery.

119. All of the following characteristics describe a joint tenants with right of survivorship (JTWROS) account except
     • In the event of the death of one of the tenants, the surviving party assumes control of the entire account
     • Orders may be given only by the party listed first on the account
     • Mail may be sent to either party with the permission of the other party
     • Checks must be made out in the name of the account

     Correct answer: Orders may be given only by the party listed first on the account

     In a JTWROS account, when the surviving party assumes control of the entire account in the event one of the tenants dies, any party named on the account may enter orders for the account. While distributions from the account must be sent in the names of all of the owners, mail could be sent to one party only, with permission from all other parties to the account.

120. If three individuals have a tenants in common account with your firm, and one individual dies, which of the following statements is true?
     • Trading is discontinued until the executor names a replacement for the deceased.
     • The account is converted to joint tenants with right of survivorship.
     • Two survivors continue as cotenants with the decedent's estate.
     • The account must be liquidated and the proceeds split evenly among the two survivors and the decedent's estate.

     Correct answer: Two survivors continue as cotenants with the decedent's estate.

     The decedent's estate becomes a tenant in common with the survivors.

121. Services offered by prime brokers include all of the following except
     • Complying with FINRA’s advertising rules
     • Supplying clearing services
     • Processing transactions
     • Providing back office support

     Correct answer: Complying with FINRA’s advertising rules

     Prime brokers provide services primarily to institutional investors. They have nothing to do with that institution's advertising. They do supply clearing services, lending services for marginable transactions, as well as back office support including cash management, account statements and transaction processing.

122. Which of the following is not a benefit gained by using a TOD account?
     • Estate taxes are reduced.
     • Percentage allocations can be changed at any time.
     • Beneficiaries can be changed at any time.
     • Probate is avoided.

     Correct answer: Estate taxes are reduced.

     The TOD (transfer on death) designation offers many benefits, but reducing estate taxes is not one of them. The assets in the account are included in the decedent's estate. However, the hassles of probate are avoided, and without any legal impediments, the owner of the account can make changes at will.

123. What type of account allows for the irrevocable transfer of almost any kind of asset, including works of art and real estate, for the benefit of a minor?
     • UGMA
     • Coverdell ESA
     • UTMA
     • Tenants in common

     Correct answer: UTMA

     UTMA expanded the types of property that are transferable into a custodial account. One of the main differences between an UTMA and UGMA is the types of assets they can hold. Assets within an UGMA are limited to cash (bank deposits), stocks, bonds, mutual funds, and other securities and insurance policies. UTMAs allow almost any kind of asset, including works of art and real estate. As with other assets, the title is registered in the name of a custodian for the benefit of the minor. Although there are a few states that allow the custodial property to remain in an UTMA account until the minor reaches age 25, more than half of the states set the age of majority for UTMA at 21 instead of 18.

124. Designating a beneficiary with a transfer on death (TOD) provision may be done in which of the following accounts?
     • Individual account only
     • Individual account, joint tenants with right of survivorship (JTWROS), and joint tenants in common (TIC)
     • Individual account and joint tenants with right of survivorship (JTWROS)
     • Individual account and joint tenants in common (TIC)

     Correct answer: Individual account and joint tenants with right of survivorship (JTWROS)

     The TOD designation is limited to the individual account and the JTWROS account.

125. A customer and her spouse own shares in the ABC Fund as joint tenants with right of survivorship (JTWROS). If the customer dies, what happens to the shares in the account?
     • The spouse would own all the shares.
     • Ownership of the shares must be determined by probate court.
     • The account would be frozen until the estate was settled.
     • Half of the shares would belong to the spouse, and the remaining half would be distributed to the customer's estate.

     Correct answer: The spouse would own all the shares.

     In a JTWROS account, securities pass to the surviving owner. The account does not have to be frozen but can continue to enter orders.

126. Two siblings have an account with your broker-dealer registered as joint tenants with right of survivorship (JTWROS). Both live in a state that recognizes community property as an ownership designation. If one of the siblings dies, which of the following will occur?
     • The entire account will be liquidated and divided in accordance with the community property laws of that state.
     • The deceased sibling's interest in the account will be divided in accordance with the community property laws of that state.
     • The deceased sibling's interest in the account will pass to the surviving sibling in accordance with the JTWROS account registration.
     • The deceased sibling's interest in the account will become the property of her estate.

     Correct answer: The deceased sibling's interest in the account will pass to the surviving sibling in accordance with the JTWROS account registration.

     This account, registered as JTWROS, will be handled in accordance with that account registration at the time of the death of either sibling. The deceased sibling's interest in the account will pass to the surviving sibling. Community property laws in jurisdictions presuming that type of ownership designation only applies to marital property (property acquired by the two individuals while married). Therefore, community property laws would not be applicable to siblings.

127. Three brothers open a joint account instructing you that if one of them dies, they want the cash and securities in the account to go to the remaining parties to the account. The account should be opened
     • As tenants in common
     • As community property
     • With right of survivorship
     • As tenants by the entireties

     Correct answer: With right of survivorship

     Using tenants with right of survivorship, each brother's interest in the account would go to the surviving brothers.

128. All of the following statements regarding a transfer on death (TOD) account are correct except
     • Estate taxes are reduced
     • The owner of the account may change beneficiaries at will
     • Only those assets held at the broker-dealer are transferred
     • Probate is avoided

     Correct answer: Estate taxes are reduced

     A TOD account avoids probate but not estate taxes. The owner of the account may change beneficiaries and their percentages as she wishes. The TOD account is an account at a specific broker-dealer and only relates to the assets in that account.

129. An agent is permitted to open all of the following customer accounts except
     • A minor's account opened by a custodian
     • An account in the name of Mrs. Jones opened by Mr. Jones.
     • A corporate account opened by the designated officer
     • A partnership account opened by the designated partner

     Correct answer: An account in the name of Mrs. Jones opened by Mr. Jones.

     An agent is not permitted to open an individual account in the name of a third person.

130. An agent taking which of the following actions would be committing a violation?
     • Buying securities in a cash account with the consent of the customer
     • Selling securities from a minor's custodial account without the custodian's consent but with the beneficial owner's consent
     • Selling securities from a corporate account by using limited power of attorney trading authority for the account
     • Buying securities in a joint account at the request of one party only

     Correct answer: Selling securities from a minor's custodial account without the custodian's consent but with the beneficial owner's consent

     The custodian—not the beneficial owner (minor)—is the person who has the authority to make investment decisions for an account. Any tenant in a joint account may give instructions for the account.

131. Which of the following businesses would have the simplest requirements for opening an account at a FINRA member firm?
     • A limited partnership.
     • An S corporation.
     • A general partnership
     • A sole proprietorship

     Correct answer: A sole proprietorship

     A sole proprietorship is opened up as an individual account because, legally, the business is the individual. The other entities require various forms authorizing named individuals to transact business in the account.

132. Which of the following is not true in jurisdictions that recognize the marital property designation known as community property?
     • Community property laws do not apply to gifts.
     • Community property laws do not apply to inheritances.
     • Community property applies to property that was owned individually before the marriage and is now joint property once the marriage has occurred.
     • There may be tax implications regarding the dissolution of community property at the time of a divorce, marriage annulment, or death.

     Correct answer: Community property applies to property that was owned individually before the marriage and is now joint property once the marriage has occurred.

     Community property applies to property obtained during a marriage but does not apply to property owned individually by one spouse before the marriage. In addition, it does not apply to inheritances or gifts. There can be federal tax implications for property designated as community property, and laws in states that recognize community property ownership differ from jurisdiction to jurisdiction.

133. Prime brokerage accounts are most often used by
     • Broker-dealers
     • Institutions
     • Investment advisers
     • Investment bankers

     Correct answer: Institutions

     Although any of these could use prime brokerage accounts, their primary users are institutional investors.

134. A broker-dealer has set up a prime brokerage account for one of its customers. This customer is most likely
     • An investment club
     • Two spouses, each having individual accounts and a joint account together
     • An individual retail customer
     • An institutional customer

     Correct answer: An institutional customer

     A prime brokerage account is one in which a customer—generally an institutional customer—selects one member firm (the prime broker) to provide custody and other services, while other firms—called executing brokers—handle all trades placed by the customer.

135. Under the Uniform Transfer to Minors Act (UTMA), how can stock subscription rights be handled in a custodial account?
     • The custodian can exercise, sell, or allow the rights to expire as he deems prudent.
     • The custodian cannot exercise rights; they can only be sold.
     • The custodian can exercise or sell the rights as he deems prudent.
     • The rights can be exercised or sold only if the custodian is also the donor.

     Correct answer: The custodian can exercise or sell the rights as he deems prudent.

     One thing that is never considered prudent is to let the rights expire. Even if the custodian does not believe adding more of the stock to the account is proper, there is a value to the rights, and the best interest of the minor is served by turning those rights into cash. Custodians in these accounts are able to sell or exercise the right, regardless of any relationship existing between them and the donor.

136. An incorporated business model that allows flow-through of business income and losses directly to shareholders in order to avoid double taxation is
     • A limited partnership
     • An S corporation
     • A C corporation
     • A general partnership

     Correct answer: An S corporation

     The S corporation, the general partnership, and the limited partnership are business models where all income or loss flows through to the owners. This avoids the double taxation on the business level and owner level, as is the case with the C corporation. With C corporations, corporate earnings taxed once at the business level and again when they are paid out to shareholders as dividends. Because the question is asking about the incorporated business model, the correct choice is the S corporation.

137. A registered representative of a FINRA member firm specializes in handling business accounts. In which of the following accounts are the business owners subject to double taxation?
     • Sole proprietorships
     • S corporations
     • LLCs
     • C corporations

     Correct answer: C corporations

     It is the C corporation whose owners are subject to double taxation. First, the corporation pays income tax on its earnings. Then, any dividends paid from the after-tax income are taxed again, this time to the shareholders.

138. Many businesses open brokerage accounts to invest surplus funds. For which of the following business forms would suitability information on the owners not be required?
     • An S corporation
     • A sole proprietorship
     • An LLC
     • A C corporation

     Correct answer: A C corporation

     A C corporation is the only business form where the tax and other consequences of the account do not accrue to the individual owners. Can you imagine a well-known publicly traded corporation with several million shareholders opening an account where the registered representative would have to obtain suitability information on all of them? Even when it is a small business, because the C corporation is its own taxable entity, the suitability requirements are not as critical as with the pass-through businesses (partnerships, LLCs, and S corporations). Of course, the sole proprietorship is the individual, so that is where the suitability is focused.

139. If a customer wants to open an account in the name of her adult son and wants the account to be approved for uncovered option writing, her request should be refused because
     • Opening an account for a third party is prohibited without the consent of that party
     • Discretionary authorization may not be granted with respect to writing uncovered options
     • Writing uncovered options is not suitable for minors
     • Uncovered options can only be written in margin accounts

     Correct answer: Opening an account for a third party is prohibited without the consent of that party

     An adult cannot open an account and name another adult as the beneficial owner unless approval is granted by that adult. The type of option trades and the third party's investment experience are not relevant. Furthermore, the child is an adult, not a minor, and we have no suitability information.

140. For which of the following business structures is the income taxed to the business?
     • A general partnership
     • A limited partnership
     • A C corporation.
     • An S corporation

     Correct answer: A C corporation.

     Partnerships, limited or general, and S corporations do not pay income tax. Any income earned by the business flows through to the owners. On the other hand, C corporations are taxable entities and must pay tax on their income before they can distribute dividends to shareholders.

141. On Monday, John bought and sold 1,000 shares each of MEDX and CETN stock. On Wednesday, he purchased an additional 500 shares of CETN and 1,600 shares of KRS, which he closed in two trades of 800 shares each, later that day. On Friday, John executed a trade to purchase 2,000 shares of BUV and sell 300 shares of the CETN he purchased on Wednesday. Under FINRA rules, John meets the definition of
     • A designated expert
     • A frequent trader
     • A pattern day trader
     • A day trader

     Correct answer: A pattern day trader

     A day trader buys and sells the same security on the same day. Pattern day trading is a regulatory designation for a day trader who executes four or more day trades in a five-business-day period. And, yes, the exam can be this specific.

142. The type of brokerage account that does not pass assets to other participants at the death of a participant is
     • Transfer on death
     • Joint tenants with rights of survivorship (JTWROS)
     • Tenants in common
     • Community property

     Correct answer: Tenants in common

     At the death of a participant in a tenants in common account, the decedent's assets do not pass to the other members. Rather, they pass to the estate of the deceased. With JTWROS, at the death of a participant, the assets are distributed equally to the surviving members. In those states where community property is the law, upon the death of a spouse, the assets in the account generally pass to the surviving spouse. Transfer on death is simply a designation that allows an account to avoid probate court. It is not available with tenancy in common.

143. A joint account could be opened for any of the following except
     • Two partners in a limited partnership
     • A parent and minor child
     • A corporation
     • Three business associates

     Correct answer: A parent and minor child

     Minor children cannot be a party to any account except an UGMA or UTMA.

144. If a new joint tenants with right of survivorship account is opened, all of the following statements are true except
     • Orders may be given by either party
     • In the event of death, the decedent's interest in the account goes to the other party
     • Checks may be drawn in the name of either party
     • Mail may be sent to either party (with the permission of each party)

     Correct answer: Checks may be drawn in the name of either party

     While either party may enter an order, any money or securities delivered out of the account must be in the names of both owners.

145. A hedge fund has contracted with your broker-dealer to handle all of its clearing functions and provide all back-office support functions while it is executing transactions through numerous other broker-dealers with whom your broker-dealer will have agreements. This type of account is known as
     • A prime brokerage account
     • A custodial account
     • A joint account
     • A numbered account

     Correct answer: A prime brokerage account

     In a prime brokerage account, a customer contracts with one broker—the prime broker—to provide a list of support services, such as clearing and settlement of transactions, while contracting with numerous other brokers for executions services.

146. Dale Wells, a British citizen temporarily working in the United States, wants to form a business venture with other investors. Wells is looking for favorable tax treatment of earnings and losses. Wells also wants to limit the number of investors but is willing to share control of the enterprise with others to attract them. What business form would you advise?
     • S corporation
     • C corporation
     • Limited partnership
     • General partnership

     Correct answer: General partnership

     Limited partnerships would not work because the other investors have limited say in how the enterprise is run. C corporations do not provide favorable tax treatment of gains or losses. Although an S corporation appears to be the right answer, only U.S. citizens or resident aliens can own one.

147. If a business owner's goal is to establish an entity that features ease in raising capital and limits personal liability, which of these entities is the most appropriate?
     • A general partnership
     • A sole proprietorship
     • An S form of corporation
     • A limited liability company (LLC)

     Correct answer: A limited liability company (LLC)

     If a business owner's goal is ease in raising capital, the limited liability company (LLC) is preferable because it has no restrictions on the number or nationality of investors. While the regular or C corporate form is also preferable, the S form of corporation is limited to a maximum of 100 potential shareholders, none of whom may be a nonresident alien. The sole proprietorship and general partnership carry unlimited personal liability.

148. Which of the following businesses must have more than one owner?
     • An S corporation
     • An LLC
     • A C corporation.
     • A partnership

     Correct answer: A partnership

     If you think about it, how could you have partners with less than one person? Although the other business forms usually have more than one owner, it is legally possible, for them to have a single owner.

149. Tenants in common (TIC) ownership provides that a deceased tenant's fractional interest in an account is retained by which of the following?
     • Will be decided during probate
     • The registered representative for the account
     • The surviving tenant
     • The deceased tenant's estate

     Correct answer: The deceased tenant's estate

150. One of your customers has a JTWROS account and an individual account. The individual account is the one approved for options trading. The customer wishes to make a large options trade and asks you to transfer a substantial sum from the cash balance in the joint account to the individual account. To do this,
     • You need the approval of a designated principal
     • The check would have to be made payable in the name of all the owners of the JTWROS account
     • You need the authorization of the customer
     • You need the authorization of both parties on the account and the approval of a designated principal

     Correct answer: The check would have to be made payable in the name of all the owners of the JTWROS account

151. Which of the following employer-sponsored plans is not required to meet the nondiscrimination provisions of ERISA?
     • 401(k) plans
     • Keogh plans
     • Defined benefit plans
     • Deferred compensation plans

     Correct answer: Deferred compensation plans

     Deferred compensation plans, by design, are nonqualified and not subject to ERISA. Therefore, they may discriminate as to who may participate. In any question on the exam, a qualified plan sponsored by a business will most likely have to comply with ERISA.

152. All of the following are true regarding nonqualified deferred compensation plans except
     • Employees may use accumulated funds as collateral for a bank loan
     • Income taxes on compensation are not due until constructive receipt
     • IRS approval is not needed for deferred compensation plans.
     • The plans need not be offered to all employees

     Correct answer: Employees may use accumulated funds as collateral for a bank loan

     Deferred compensation is a promise made by an employer to defer a certain amount of an employee's salary upon retirement. The employee has no right to the money until retirement, death, or disability, and thus cannot use it as collateral.

153. Which of the following types of business organizations does not protect owners' personal assets from losses incurred by the business?
     • Sole proprietorships
     • C corporation
     • LLCs
     • S corporation

     Correct answer: Sole proprietorships

     Corporations, whether organized as C or S corporations, and LLCs (limited liability companies), afford their owners limited liability. That means they have protection of their personal assets from losses incurred by the businesses. Sole proprietorships subject their owners to personal liability for losses of the business.

154. Which of the following business structures will generally have the fewest number of owners?
     • A general partnership
     • An LLC
     • An S corporation
     • A sole proprietorship

     Correct answer: A sole proprietorship

     A sole proprietorship has only one owner. That is what the "sole" means. Although S corporations and LLCs can be formed with a single shareholder or member, that would be the exception rather than the rule. A partnership needs at least two persons.

155. The concept of double taxation applies to shareholders of
     • General partnerships
     • Limited partnerships
     • S corporations.
     • C corporations.

     Correct answer: C corporations.

     It is the C corporation where the owners contend with double taxation. The first tax is on the corporation's earnings. After that, any dividends distributed to the shareholders are subject to tax.

156. Which of the following forms of business is preferred when the goal is raising a significant amount of capital?
     • C corporation
     • S corporation
     • LLCs
     • General partnership

     Correct answer: C corporation

     When there is a need for significant capital, it is the C corporation that is the form to use.

157. Which of the following occurs in a partnership account if one partner dies?
     • The surviving partners receive the deceased partner's share.
     • The account is frozen until a new or amended partnership agreement is received.
     • The surviving partners are considered joint tenants.
     • The surviving partners are considered joint tenants and receive the deceased partner's share.

     Correct answer: The account is frozen until a new or amended partnership agreement is received.

     Upon a partner's death, a partnership account is automatically frozen until a new or amended partnership agreement is received. The deceased partner's share usually goes to an estate, not to the other partners.

158. Under FINRA's rules governing the activities of member broker-dealers, prior notification to the employing firm and prior written consent from the employing firm would be required to open a brokerage account for all of the following except
     • An officer of another member firm opening a cash account
     • A registered representative of another member opening an options account
     • A clerical employee of another member opening a margin account
     • A registered representative of another member opening a 529 plan

     Correct answer: A registered representative of another member opening a 529 plan

     FINRA requires prior written notification be made and prior written consent be received before any employee can open a brokerage account with other members or financial institutions. Exceptions include accounts where the only activity will be in 529 plans, mutual funds, or variable annuities.

159. When opening a new retail account or updating account information for a specified adult, FINRA Rule 2165 urges member firms to obtain the name and contact information of a "trusted contact person." If the client supplies that information, the person
     • Has authority to submit buy and sell orders for the client's account
     • Has authority to request duplicate confirmations and account statements from the client's account
     • May help the member firm respond to possible financial exploitation or fraud in the client's account
     • Has authority to withdraw funds or securities from the client's account

     Correct answer: May help the member firm respond to possible financial exploitation or fraud in the client's account

     The primary reason behind Rule 2165 is to try to prevent senior exploitation. By obtaining the name and contact information of a trusted contact person (who must be at least 18 years of age), the firm has someone to reach out to when red flags appear. It is important to understand that the naming of this person does not convey any rights over the account. This is not a power of attorney.

160. Jack Mercure, age 72, has been a client of yours for many years. You have noticed he's a bit slower than before, but nothing troublesome. This morning, you get a call from Jack, and he wants you to wire a relatively substantial sum from his account to someone with a foreign address. Fearing this might be a case of senior exploitation, you discuss this with your manager. If the feeling is mutual, FINRA rules would permit your firm to
     • Contact Jack’s physician to inquire about any cognitive decline
     • Put a temporary hold on releasing the funds for not longer than 15 business days
     • Report this situation to the Office of Foreign Assets Control (OFAC)
     • Freeze the client’s account for not longer than 15 business days

     Correct answer: Put a temporary hold on releasing the funds for not longer than 15 business days

     FINRA Rule 2165 permits a member firm that has a reasonable belief that financial exploitation may be occurring to place a temporary hold on the disbursement of funds or securities from the account. Temporary means not longer than 15 business days.

161. All of the following pieces of information must be obtained from new individual customers except
     • Date of birth
     • Educational background
     • Residence address
     • Social Security number.

     Correct answer: Educational background

     A customer's educational background is not required to open a new account. In the case of an account opened in a business's name, the business address and tax identification number are required.

162. All of the following may be used to verify a customer's identity except
     • A certified birth certificate
     • A current drivers license
     • A valid passport
     • A valid military ID card

     Correct answer: A certified birth certificate

     Verifying a customer's identity requires presentation of at least one government-issued document with a photograph. Your birth certificate may have had a photo of you as a newborn, but that certainly will not suffice to identify you today.

163. If a person wishes to enter orders in his spouse's account, he
     • Could never be permitted to do so, as there is no provision that would allow for it to occur
     • Needs verbal permission from his spouse
     • Is free to do so
     • Needs written permission from his spouse through a power of attorney

     Correct answer: Needs written permission from his spouse through a power of attorney

     The only persons permitted to enter orders in an account are the account owners. For a person to enter orders in his spouse's account, the spouse whose name is on the account must sign a power of attorney.

164. If a member firm suspects exploitation in the account of a specified adult, proceeds from sales may be put on temporary hold for
     • 15 calendar days.
     • 15 business days.
     • Until the need for the hold ends
     • One month

     Correct answer: 15 business days.

     FINRA Rule 2165 permits a member that reasonably believes that financial exploitation has occurred, is occurring, has been attempted, or will be attempted, to place a temporary hold on the disbursement of funds or securities from the account of a "specified adult" customer. The maximum length of the hold is 15 business days. Do we expect the exam will ask you to choose between 15 business and 15 calendar days? No, that is not FINRA's style, but we do want you to know the correct count.

165. An employee of a FINRA member firm wishes to open an account at another member firm. The employee opening the account must
     • Notify FINRA, in writing, of the intent to open the account
     • Obtain prior written consent from FINRA before opening the account
     • Make written notification to the SEC before the account can be opened
     • Receive prior written consent from his employer

     Correct answer: Receive prior written consent from his employer

     Persons associated with one FINRA member firm may open securities accounts at other member firms, as long as prior written notice was made to, and prior written consent was received from, the employing broker-dealer before the account is opened. Neither notification nor consent is required from FINRA or the SEC.

166. One of your clients has appointed his daughter as the trusted contact person per FINRA Rule 2165. She contacts you to explain that her father's cognitive abilities are declining. Because of that, before it gets too late, she wants to know what can be done to give her control over the account. It is likely that the best suggestion would be to have her father sign
     • A durable power of attorney
     • The discretionary power authorization
     • A limited power of attorney
     • A full power of attorney

     Correct answer: A durable power of attorney

     A durable power of attorney is used when the account owner has diminished physical or mental capacity. It is durable because it survives the client becoming legally incompetent (but does not survive death).

167. A new customer is opening a cash account with your broker-dealer. The new account form must contain the signature(s) of
     • The principal and the registered representative working with the customer
     • The customer only
     • The customer and the registered representative working with the customer
     • The principal only

     Correct answer: The principal only

     To open a cash account, only the signature of the principal accepting the account is required. For margin accounts, the signature of the customer would be required on the margin agreement.

168. Broker-dealers are required to maintain customer identification programs and check the names of new clients against
     • The FBI's most wanted list
     • A list maintained by the Securities Exchange Commission
     • A list of sanctioned people and organizations maintained by the Department of Enforcement
     • A list compiled by the Office of Foreign Assets Control (OFAC)

     Correct answer: A list compiled by the Office of Foreign Assets Control (OFAC)

     All financial institutions are required by federal law to maintain a customer identification program and check the identifying information against a list maintained by the OFAC for suspected terrorists or terrorist organizations.

169. Dale Johnston has been a registered representative with Consolidated Investment Services (CIS) for over 20 years. Taylor Kahn has been Johnston's client for most of that time. Kahn recently reached full retirement age for Social Security and has begun using those funds for investment. Johnston's practice is to speak with clients on a quarterly basis, unless something merits a special call. It seems to Johnston that on the last call, Kahn seemed a bit confused over the strategy being used with the Social Security funds. A second call seemed to verify that Kahn was still a bit fuzzy. This morning, a phone call came in from Kahn's son asking Johnston to sell one of the holdings and forward the proceeds to his bank. Kahn's son does have a full power of attorney over the account but has never given instructions to have money sent to him before. What is the most appropriate action for Johnston to take?
     • Refuse to complete the trade
     • Place a temporary hold on the withdrawal
     • Freeze the account
     • Place the trade after receiving approval from your supervising principal

     Correct answer: Place a temporary hold on the withdrawal

     Member firms may place a temporary hold on the distribution of funds or securities from the account of a specified adult. The temporary hold is also allowed in certain circumstances where the member reasonably believes that financial exploitation of the specified adult has occurred, is occurring, has been attempted, or will be attempted. FINRA considers temporary to be up to 15 business days.

170. Jack has a margin account in his own name with BR Securities, Inc. He also has a joint tenancy account with his father, Roberto. Rosa, Jack's spouse, calls Joe, the registered representative who is assigned to both accounts, and instructs him to sell 100 shares of AOL from Jack's margin account. Which of the following should the registered representative do?
     • Not execute the order until he receives verbal authority from Jack, which authorizes his father to act with discretionary authority over his margin account
     • Transfer the AOL to the joint account and then execute the transaction in the joint account
     • Not execute the order until he receives written power of attorney from Jack, authorizing his spouse to act with trading authority over his margin account
     • Execute the transaction immediately

     Correct answer: Not execute the order until he receives written power of attorney from Jack, authorizing his spouse to act with trading authority over his margin account

     A registered representative may not execute a third-party order (one given by someone other than the account owner) without a signed written power of attorney from the account owner that has been accepted by the representative and a principal of the firm.

171. When an individual associated with another FINRA member firm wishes to open up an investment account at another member firm, the executing member must
     • Receive permission from the employer member before the initial transaction may take place
     • Provide duplicate statements and confirmations if requested by the employer member
     • Obtain a copy of the individual's Form U4 to verify registration status
     • Notify the employer member of the associated person's intent to open the account

     Correct answer: Provide duplicate statements and confirmations if requested by the employer member

     FINRA Rule 3210 requires that an executing member shall, upon written request by an employer member, transmit duplicate copies of confirmations and statements. The associated person is the one who must notify the employer member of the intent to open the account and receive written consent to do so. Furthermore, the associated person is required to give written notice to the executing member that the individual is associated with the employer member.

172. What can a broker-dealer do if it suspects tampering with the account of a senior investor?
     • Assess an investigation fee to the account
     • Place a temporary hold on disbursements of cash or securities from the account
     • Sell investments to cover any losses caused by the tampering
     • Close the account and send the funds and securities to the customer

     Correct answer: Place a temporary hold on disbursements of cash or securities from the account

     If a broker-dealer suspects exploitation occurring in the account of a senior investor, it may put a temporary hold on disbursements of cash or securities from the account. The hold cannot be longer than 15 days, and it can be put in place if the broker-dealer believes the tampering is about to occur. Suspected tampering is not a reason for the broker-dealer to close the account, assess any fees, or sell investments of the senior to cover losses caused by the tampering.

173. A new client turns in the new account form. While reviewing the information on the form, the registered representative handling the account notices that the space for listing the Social Security number is blank. Under the provisions of the USA PATRIOT Act of 2001,
     • The account can be opened without the number if at least two pieces of government ID are presented
     • The account cannot be opened until the number has been received
     • The account can be opened if the client assures you that an application will be filed
     • The account can be opened if the client has already applied for a number

     Correct answer: The account can be opened if the client has already applied for a number

     The customer identification program (CIP), a part of the USA PATRIOT Act of 2001, requires a Social Security or tax identification number included on the new account form. The firm can open the account if the number has been applied for. In this instance, the firm must obtain the number within a reasonable period and the account card must be marked applied for.

174. While interviewing a person to fill out the new account form, a registered representative asks the potential new client a number of questions. Information regarding which of the following would not be required on the form?
     • Social Security number or tax ID number
     • Educational background.
     • Name
     • Physical address

     Correct answer: Educational background.

     When opening a new account, the registered representative must obtain the name, date of birth, physical address, and Social Security number. Information such as educational background may be inquired about and useful to know, but is not required to open the account.

175. An employee of another broker-dealer would like to open an account with your firm. Under FINRA rules, all of the following statements regarding the employee and the account are true except
     • The employer must grant prior written approval to open the account
     • The employer must be notified, in writing, of the opening of the account
     • If the employer requests them, they must receive duplicate copies of all account transactions
     • The employer must approve each transaction before entry of the order

     Correct answer: The employer must approve each transaction before entry of the order

     FINRA rules do not require prior approval of individual transactions by either the broker-dealer at which the account has been opened or the employing broker-dealer. The rules do require that the employing broker-dealer be notified, in writing, and that they give prior written consent before the account can be opened. Duplicate copies of account statements and confirmations must be supplied only if the employing broker-dealer has requested them.

176. Which of the following individuals could most likely open an account at a FINRA member firm without notifying or receiving permission from her employer?
     • A bank employee selling fixed annuities only
     • An agent who sells variable annuities
     • A government security trader employed by a member
     • A purchases and sales clerk of a member

     Correct answer: A bank employee selling fixed annuities only

     Whenever an employee of a FINRA member wants to open a securities account with another FINRA member firm or financial institution, the employee must give prior written notice to her employer and receive prior written consent from her employer before the account can be opened. Someone selling fixed annuities only (not a security like variable annuities) is most likely not associated with a member.

177. Two friends would like to open a joint account but have the tax filed under the name of the nonemployed individual. That could be done in
     • A JTWROS account with the Social Security number of the designated person used
     • A tenants in common account with the percentage ownership in the name of the designated person
     • An account opened as a partnership
     • A joint account with a TOD designation

     Correct answer: A JTWROS account with the Social Security number of the designated person used

     In a JTWROS account, the assets are considered jointly owned. Only one tax identification number (Social Security number) is placed on the account. If it is the number of the nonemployed individual, the Form 1099 will go to that person and that is whom the IRS will expect to pay the taxes. That might be the correct answer to a test question. In the real world, it might not satisfy the IRS that the one in the lower tax bracket is being credited with all the income and gains. If the IRS audits the account and sees that the funds came from the working individual, there could be tax issues. However, the exam does not always deal with the real world and we won't either on this one.

178. An employee of a firm registers to open an account at another member firm. Under FINRA rules, all of the following statements are true except
     • The employing member firm must receive duplicate statements and confirmations if requested in writing
     • FINRA must receive duplicate statements and confirmations for each transaction.
     • The employing member firm must be notified, in writing, of the intent to open the account
     • The employee must receive prior written permission from the employing member firm

     Correct answer: FINRA must receive duplicate statements and confirmations for each transaction.

     Under FINRA rules, the employing member must be notified, in writing, of the prospective account and must give prior written approval before the account can be opened. It must be provided with duplicate statements and confirmations only if it makes a written request. There is no requirement that FINRA be either notified or provided with duplicate statements and confirmations.

179. Which of the following is required to sign a new account form for a cash account?
     • The customer
     • The principal
     • The spouse of the customer
     • The registered representative

     Correct answer: The principal

     To open a cash account, only the signature of the principal accepting the account is required. For margin accounts, the signature of the customer is required on the margin agreement. The signature of the spouse is required only for a joint account.

180. Obtaining all of the following complies with the regulations regarding customer identification programs except
     • Name
     • Taxpayer identification number
     • Date of birth
     • Post office box, instead of a physical address, if it is the primary mailing address

     Correct answer: Post office box, instead of a physical address, if it is the primary mailing address

     A post office box is never acceptable without a physical address.

181. If a customer who has granted a durable power of attorney to her son dies, which of the following statements regarding the power of attorney is true?
     • It remains in effect only if the son is the sole heir to the estate.
     • It remains in effect until the son cancels it.
     • It remains in effect until the executor of the estate cancels it.
     • It is canceled upon the death of either principal.

     Correct answer: It is canceled upon the death of either principal.

     When the customer or her son dies, the power of attorney also expires. However, a durable power of attorney will survive a declaration of mental incompetence and is useful in those cases where a parent suffers from dementia.

182. The federal legislation that requires broker-dealers to verify the identity of any person opening an account is
     • The Maloney Act
     • The USA PATRIOT Act of 2001
     • The Insider Trading Act
     • The Securities Exchange Act of 1934

     Correct answer: The USA PATRIOT Act of 2001

     The USA PATRIOT Act of 2001 requires firms to obtain identifying information on each new customer, verify the identity of each new customer, maintain records relating to identity verification, and determine if any new customer appears on a list of known or suspected terrorist groups compiled by the Office of Foreign Asset Control.

183. The child of one of your recently deceased clients comes to your office with several properly signed stock certificates inherited from a parent. The child does not have an account and wishes to sell the securities. An account is opened for the purpose of the liquidation. Regulation S-P would refer to this child as
     • A covered person
     • A consumer
     • A customer
     • A beneficiary

     Correct answer: A consumer

     Regulation S-P makes a distinction between consumers and customers. That is important because it makes a difference when it comes to annual reporting. A consumer is basically a "one-shot" client, as in this case. After the liquidation, this account will be closed and you probably won't ever hear from the child again. A customer has an ongoing relationship and requires annual privacy notices—the consumer does not.

184. If a customer wishes to open a cash account, who must sign the new account form?
     • Only the registered representative
     • The customer, the registered representative, and the principal
     • Only the principal
     • Only the customer

     Correct answer: Only the principal

     Neither the customer's signature nor the registered representative's signature is required to open a cash account. A principal must review and accept the new account by signing the form.

185. A new account is opened at your firm and you notice that there is a trusted contact person form attached to the documentation. You could safely surmise that this is an account for
     • A minor
     • A specified adult
     • A trust
     • A corporation

     Correct answer: A specified adult

     Per FINRA Rule 2165, a specified adult "is a natural person age 65 or older or a natural person age 18 or older who the member reasonably believes has a mental or physical impairment that makes the individual unable to protect his own interests." FINRA requires members to make reasonable efforts to obtain the name of and contact information for a trusted contact person. This person must be someone age 18 or older who may be contacted about the customer's account. The rules do not require a customer to provide trusted contact information, only that the firm make the effort.

186. Under the USA PATROIT Act of 2001, which of the following must be maintained by financial institutions, such as banks and broker-dealers, to prevent the financing of terrorist operations and money laundering?
     • Customer identification programs (CIPs)
     • Do-not-call lists
     • Specially Designated Nationals and Blocked Persons list
     • Privacy notices

     Correct answer: Customer identification programs (CIPs)

     The USA PATRIOT Act of 2001 requires financial institutions to maintain CIPs to protect against financing terrorist operations or activities and potential money laundering activities. The Office of Foreign Asset Control (OFAC) publishes and maintains the Specially Designated Nationals and Blocked Persons list, which financial institutions use to determine if any customers or potential customers have been identified by OFAC as posing a terroristic threat or are involved in money-laundering activities.

187. A 71-year-old client calls her registered representative and asks him to wire $10,000 to an offshore account. The rep asks the reason and she responds that she won money in a lottery and this is to pay the taxes. The registered representative is concerned that this might be a case of senior exploitation and should
     • Wire the money as instructed
     • Contact the client's trusted contact person on this account and inform them of the request
     • Refuse to wire the money
     • Get the wire instructions and escalate this to his supervisor

     Correct answer: Contact the client's trusted contact person on this account and inform them of the request

     Being 65 or older qualifies this client for the designation of specified adult. As such, the firm should attempt to obtain the name of a person who will act as the account's trusted contact person. Whenever the registered representative suspects something unusual, it is always prudent to reach out to that contact person.

188. An individual has given full power of attorney (POA) to a third party. This means that the designee is permitted to
     • Originate trades in the account and remove funds or securities
     • Remove funds or securities from the account but not originate trades
     • Originate trades in the account but not remove funds or securities
     • Close the account and reopen it in the designee's name

     Correct answer: Originate trades in the account and remove funds or securities

     Full POA gives the named third party—the designee—all of the power of the owner except the right to change the name on the account.

189. If a customer wishes to open a cash account in her name only and allow her spouse to make purchases and receive checks in his name only, she must instruct her broker-dealer to open
     • A margin account
     • A cash account with full power of attorney
     • A cash account with limited power of attorney
     • A cash account

     Correct answer: A cash account with full power of attorney

     For anyone other than the account owner, entering trades and withdrawing assets requires a full power of attorney. A limited power of attorney enables a nonaccount owner to enter trades but not to withdraw assets.

190. When opening a new account for an individual investor, FINRA asks its member to make a reasonable effort to obtain certain information about the account. Included information would be all of the following except
     • The occupation of the customer and name and address of the employer
     • The customer's tax identification or Social Security number
     • Whether the customer is an associated person of another member
     • The name(s) of the customer's dependents

     Correct answer: The name(s) of the customer's dependents

     Nowhere in the FINRA rules on account opening does it require or suggest obtaining personal information about family members. That information becomes important when we look at the suitability rules. Please note that the tax ID or Social Security number is required under the customer identification program (CIP), but not FINRA rules.

191. When an investor opens a new account at a member firm, FINRA rules require
     • The signature of the principal signifying that the account has been accepted
     • The applicant's signature
     • The applicant's date of birth
     • The applicant's Social Security number

     Correct answer: The signature of the principal signifying that the account has been accepted

     The only signature required on the new account form for an individual client is the signature of the partner, officer, or manager (a registered principal) denoting that the account has been accepted in accordance with the member's policies and procedures for acceptance of accounts. It is the customer identification program (CIP) that requires the date of birth and Social Security or tax ID number. All FINRA requires is a statement that the applicant is of legal age. FINRA states that each member shall also make reasonable efforts to obtain, prior to the settlement of the initial transaction in the account, the applicant's Social Security or tax ID number. Please notice that the question is differentiating between what is "need to know" and what is "nice to know."

192. A customer wants to open a new cash account and give her sibling trading authorization. The required documents to accommodate her request would be
     • A margin agreement and a limited power of attorney
     • A new account form and a loan consent agreement
     • A margin agreement and a loan consent form
     • A new account form and a limited power of attorney

     Correct answer: A new account form and a limited power of attorney

     When a customer wants to give trading authorization or discretionary privileges to a third party in a cash account, a member firm requires a new account form (as with all new accounts) and a limited power of attorney. A limited power of attorney gives the third party trading authority but prohibits that party from withdrawing assets (cash or securities) from the account.

193. All of the following must be verified or determined about a new customer except
     • Whether she appears on a list of known or suspected terrorists
     • Whether she has a brokerage account at another broker-dealer
     • Whether she is employed by another broker-dealer
     • Citizenship

     Correct answer: Whether she has a brokerage account at another broker-dealer

     Though individual firms may require it, there is no industry requirement to verify or determine that a customer has an account at another broker-dealer.

194. When a broker-dealer sends a communication to its customers that the sweep account used for customer credit balances will be changed from one money market fund to a different one, the communication must include
     • A detailed explanation of the reason for the change
     • A statement that the change will not take place until at least 45 days after the communication was sent
     • A description of the objectives of the new fund and its prospectus
     • A tabular comparison of the nature and amount of the fees charged by each fund

     Correct answer: A tabular comparison of the nature and amount of the fees charged by each fund

     The only one of these meeting FINRA's requirement when a negative response letter is sent is the tabular comparison. While a description of the new fund and its prospectus is required, the communication must also include a comparison of the objectives of the two funds. The minimum time is 30 days (not 45) and there is no requirement to include an explanation.

195. A FINRA member firm making a bulk transfer of customers' assets would most likely give notification through
     • FINRA's Central Registration Depository (CRD).
     • A broadly circulated publication such as the Wall Street Journal
     • A negative response letter
     • A positive response letter

     Correct answer: A negative response letter

     An example of a bulk transfer is the member firm deciding to switch money market funds used for sweeps of customer credit balances. A negative response letter is one where the customer's agreement is assumed unless responding negatively to the change.

196. You have two customers who are a couple. Each person has an individual account. They also have a JTWROS account in both names. One of the customers asks you to transfer funds from the other person's individual account in order to meet a margin call in the requesting customer's margin account. To do this,
     • You need the approval of a designated principal
     • You need the authorization of both customers
     • You need the authorization of both parties on the account and approval of a designated principal
     • Because they are both signatories on the joint account, you need the authorization of this customer only

     Correct answer: You need the authorization of both customers

     Because the customer asking for the transfer is not a signatory on the other customer's individual account, you need the authorization of both of them. As long as both consent, there is no need for authorization by a principal. However, in the real world, your firm may want to look at transfers of this type. Just remember, we are teaching the test world.

197. A married couple has several individual and joint accounts with your firm. One spouse calls you and requests that you make a transfer of funds between the accounts. This would not present a problem if
     • You verify the identity of the caller
     • The caller is a signatory on the account receiving the funds
     • The caller is a signatory on both accounts
     • You have the caller send the request in writing

     Correct answer: The caller is a signatory on both accounts

     It is only when the party initiating the transfer of funds between accounts is not a signatory on both accounts that this request presents a problem. In that case, a principal of the firm needs to get involved.

198. A married couple has had an account with your FINRA member firm for many years. The account is registered in both names, JTWROS. Upon the advice of their estate-planning attorney, they wish to move the assets in equal proportion to individual accounts. This would require all of the following except
     • Before obtaining approval of the account designation change, a designated principal must be personally informed of the essential facts relative to the change
     • Authorization of the change by a qualified registered principal designated by the member
     • A statement from the couple's attorney explaining the reason for the change
     • The essential facts relied upon by the person approving the change must be documented in writing and preserved with the customer account records

     Correct answer: A statement from the couple's attorney explaining the reason for the change

     There is no FINRA requirement to receive any information from the couple's lawyer. All the other statements are correct.

199. One of your customers with a JTWROS account contacts you to remove the other tenant and put the account into the customer's own name. This can be done only
     • Upon the death of the other tenant
     • If the change has been authorized by a qualified and registered principal designated by the member
     • If the customer has a full power of attorney over the account
     • If you contact the other tenant and get their approval

     Correct answer: If the change has been authorized by a qualified and registered principal designated by the member

     Under FINRA rules, no change in any account name(s) can be made unless the change has been authorized by a qualified and registered principal designated by the member. This principal must, before giving her approval of the account designation change, be personally informed of the essential facts relative thereto and indicate her approval of such change in writing. The essential facts relied upon by the person approving the change must be documented in writing and preserved with the customer account records. One of those facts is approval of the other tenant, but that approval goes to the principal, not to you, the registered representative. Even in the case of death of the other tenant, the principal needs to see the proper documentation, such as a death certificate.

200. A financial institution sends a communication to its clients indicating an action the institution plans to change. The communication states that this change will take place in 45 days and any client wishing to opt-out must notify the institution before the end of that period. This is known as
     • An informational communication
     • An unethical procedure
     • A negative response letter
     • A change letter

     Correct answer: A negative response letter

     A negative response letter is a communication where, unless the recipient responds negatively, the proposed action is accepted. The letter must contain certain disclosures such as different costs or features.

201. Sally Williams is a customer of your FINRA member firm. Sally was recently married and wishes to change the name on her individual account to her new last name. To do this,
     • The name change must be authorized by a court of competent jurisdiction
     • Sally must close the old account and open a new one in the new name.
     • The name change must be authorized by Sally's spouse
     • The name change must be authorized by a qualified registered principal designated by the member

     Correct answer: The name change must be authorized by a qualified registered principal designated by the member

     The name change requires approval of a designated principal of the member firm. The principal will want to see evidence of the change in status, such as a marriage certificate, before granting the approval.

202. Which of the following retirement plans must be ERISA compliant?
     • Traditional IRAs
     • Nonqualified plans
     • 401(k) plans
     • Roth IRAs

     Correct answer: 401(k) plans

     For exam purposes, if it is a private employer (nongovernmental) qualified retirement plan, it must be ERISA compliant. The most widely used of those today is the 401(k) plan. The "E" in ERISA stands for employee. IRAs are individual retirement accounts; there is no employer-employee relationship. Nonqualified plans are retirement plans that do not have to follow ERISA regulations. These non-qualified plans include deferred compensation plans, individual annuities, and some payroll deduction plans.

203. A similarity between common and preferred stock is
     • The dividend must be declared by the board of directors
     • Both are evidence of corporate indebtedness
     • The dividend is fixed
     • They have an equal vote

     Correct answer: The dividend must be declared by the board of directors

     All dividends, both common and preferred, must be declared by the board of directors. Preferred shares usually have a fixed dividend rate and usually have no (or very limited) voting powers. Both types of stock are equity, not debt, securities.

204. Which of the following statements regarding preferred stock is not true?
     • Unlike debt, preferred stock has no set maturity date.
     • Because there is no set maturity value or redemption date, the holder of preferred stock has to sell her shares in the open market to close out her position.
     • Voting rights of preferred shareholders take precedence over those of common shareholders.
     • The dividend is fixed except in the case of adjustable preferred.

     Correct answer: Voting rights of preferred shareholders take precedence over those of common shareholders.

     Preferred shareholders do not generally have voting rights. Voting rights are characteristic of common stock, not preferred. Preferred stock is unlike debt securities in that it has no set maturity date. It is true that the dividend on a preferred stock is fixed, except in the case of an adjustable preferred where the dividend can be tied to a market interest rate and readjusted. The holder of a preferred has to sell the shares in the open market to close out her position.

205. An investor purchasing an ADR for a company domiciled in South Korea should understand that
     • Any Korean taxes on dividends will be added to U.S. tax on those dividends.
     • The investor will be subject to currency risk
     • The investor will not be able to receive a stock certificate for that company
     • The ADR has greater market risk than the stock itself

     Correct answer: The investor will be subject to currency risk

     ADRs facilitate the purchase of foreign stock. This is because everything is in dollars and English. However, because the trading price and value of this security is based on the South Korean won, U.S. investors have currency (exchange) risk. Although not commonly done, investors can request the actual certificate to replace the ADR. There is a withholding tax in Korea, but as with any ADR on the exam, that tax paid may be taken as a credit against the U.S. tax due on the dividend. There is essentially no difference in market risk between the actual stock and the ADR.

206. The term plain vanilla describes which of the following preferred stock issues?
     • Straight
     • Convertible
     • Callable
     • Cumulative

     Correct answer: Straight

     Plain vanilla means there are no added features, just the fixed dividend.

207. When an issuer of a preferred stock exercises the call, it is usually at a price somewhat above the stock's par value. This excess over par is
     • The call privilege
     • The yield to call
     • The call premium
     • The call price

     Correct answer: The call premium

     Call premium is the term used to describe that excess over par that the issuer pays when calling in the preferred stock (or callable bond).

208. If a corporation attaches warrants to a new issue of debt securities, which of the following would be a resulting benefit to the corporation?
     • Reduction of the debt securities' interest rate
     • Increase in earnings per share
     • Reduction of the number of shares outstanding
     • Dilution of shareholders' equity

     Correct answer: Reduction of the debt securities' interest rate

     Usually, a warrant is issued along with a debt instrument, which is an enhancement that allows the issuer to offer a slightly lower interest rate.

209. Investors should always be aware of taxes applicable to investments they own. Which of the following taxes might be associated with income derived from American depositary receipts (ADRs) but not income from other investments?
     • Federal income tax
     • State income tax
     • Excise tax
     • Foreign income tax

     Correct answer: Foreign income tax

     In most countries, a withholding tax on dividends is taken at the source. To the holder of an ADR, this would be a foreign income tax. The foreign income tax paid may be taken as a credit against U.S. income taxes owed.

210. A customer owns cumulative preferred stock (par value of $100) that pays an 8% dividend. The dividend has not been paid this year or for the previous two years. How much must the company pay the customer per share before it may pay dividends to the common stockholders?
     • 0
     • 8
     • 24
     • 16

     Correct answer: 24

     If the company is going to pay a common stock dividend, it must pay the preferred dividends first. A cumulative preferred stockholder must also receive all dividends in arrears. There is $16 due in back dividends, in addition to $8 this year, for a total of $24.

211. The Securities Exchange Act of 1934 deals with all of the following except
     • Monitoring accounts for insider trading violations
     • Filing of financial statements by broker-dealers
     • Marking sales long or short on an order ticket
     • Filing an updated prospectus

     Correct answer: Filing an updated prospectus

     Prospectus filing is a requirement of the Securities Act of 1933.

212. In a proceeds transaction for a customer where the proceeds from the liquidation of one stock are used to purchase another stock, the 5% markup policy is computed on the basis of
     • Each side of the transaction separately
     • A combination of both the buy side and the sell side
     • The markup on the buy side only
     • The markdown on the sell side only

     Correct answer: A combination of both the buy side and the sell side

     In a proceeds transaction (sell one position; take the proceeds and buy another), the 5% markup is computed by adding the compensation made by the dealer on the sell side to that made by the dealer on the buy side and applying the total to the inside market on the buy side.

213. An investor who purchased 100 shares of REDP common stock on February 28, 2019, would receive long-term capital gain treatment if the stock is sold at a profit starting
     • March 1, 2020.
     • February 29, 2020.
     • March 2, 2020.
     • February 28, 2020.

     Correct answer: March 1, 2020.

     Investors must own a security for more than 12 months before it becomes long term for tax purposes. The first day after February 28, 2019, is March 1, 2019. Twelve months later is March 1, 2020. Always count 1 day and then add 12 month so that, in this case, you don't come up with February 29 because 2020 is a leap year.

214. An investor establishes a $5,000 position by purchasing 100 shares at $50 per share. She then sells all the shares six months later at $60 per share. Her taxable consequences are
     • A $1,000 short-term capital gain
     • A $1,000 short-term capital loss
     • A $1,000 long-term capital gain
     • A $6,000 short-term capital gain

     Correct answer: A $1,000 short-term capital gain

     The taxable consequence for this investor is a $1,000 short-term capital gain. She sold shares for $6,000 and purchased them for $5,000 resulting in a $1,000 gain. It is short-term gain because she did not hold the shares longer than one year. Short-term capital gains are taxed as ordinary income at the investor's marginal tax rate. Long-term capital gains are taxed at lower tax rates.

215. Aenical Corporation issued $100 million of $100 par value preferred stock a number of years ago. The stock pays quarterly dividends of $1.25. Recent issues of comparable preferred stock carry a dividend yield of 4%. One could expect the market price of the Aenical preferred stock to be closest to
     • $75.
     • $120.
     • $125.
     • $80.

     Correct answer: $125.

     As with other fixed-income securities, as market yields change, the price of previously issued securities increases or decreases to offer a comparable return. The logic is that investors will purchase fixed-income securities only if they can receive a return comparable to the current market rate. This stock is paying an annual dividend of $5 ($1.25 per quarter times four). Investors purchasing this stock expect their return to be approximately 4%, the current rate being paid in the market. The math here needs to first answer "$5 is 4% of what number?" Divide $5 by 4% and the answer is $125. At $125 per share, Aenical stock paying a $5 annual dividend is offering a 4% return on investment.

216. A key term in the SEC's lexicon is transparency. It is often said that "disclosure is the religion of the SEC." When investigating a security for a potential recommendation to a customer, it is likely that the least transparency exists when the stock trades in
     • The OTC market
     • The grey market
     • The secondary market
     • The listed market

     Correct answer: The grey market

     Securities trading on the "grey market" are not quoted on any U.S. quotation system. Broker-dealers are not willing or able to publicly quote these securities because of a lack of investor interest, company information availability, or regulatory compliance. Without quotes and reports to the SEC, there is little if any transparency. **This question deals with material not covered in your study materials, but it relates to recent rule changes and/or student feedback.

217. The over-the-counter (OTC) market could be characterized as what type of market?
     • Auction
     • Primary
     • Dealer
     • First

     Correct answer: Dealer

     The OTC market is a dealer market.

218. For individual public investors, dark pools of liquidity
     • Allow them to enter orders that are sent directly to the trading floors of stock exchanges
     • Lessen the transparency of the overall market as volume, quote and price information, and market participant identity is unknown
     • Prevent them from having their own orders entered on exchanges for execution
     • Allow them to give an order to their broker-dealer to buy or sell securities while only referencing an account known by a number and not their name

     Correct answer: Lessen the transparency of the overall market as volume, quote and price information, and market participant identity is unknown

     For individual public investors, dark pools of liquidity lessen the transparency of the overall marketplace. The pools refer to transactions that take place primarily among institutional traders or trading desks in large block transactions away from stock exchange floors, where volume, quote and price information, and participant identity are unknown. Though the existence of dark liquidity pools detracts from market transparency, it does not prevent individual public investors from having their own orders executed on listed exchanges.

219. The 5% markup policy applies to
     • New issues
     • Mutual funds
     • All of these
     • Principal over-the-counter (OTC) trades

     Correct answer: Principal over-the-counter (OTC) trades

     The 5% markup policy applies to agency and principal nonexempt securities and transactions, both exchange and OTC traded. It does not apply to prospectus offerings (mutual funds and new issues).

220. All of the following are subject to the 5% markup policy except
     • Commissions
     • Markups
     • Spreads in new stock offerings
     • Markdowns

     Correct answer: Spreads in new stock offerings

     The 5% markup policy applies to markups, markdowns, and commissions. New offerings sold by prospectus are exempt from this rule.

221. Without an exemption, member firms are required to provide purchasers of penny stocks each of the following except
     • Compensation to be earned by both the member firm and the associated person
     • Quarterly statements
     • Current inside bid and ask quotation
     • A risk disclosure document

     Correct answer: Quarterly statements

     If an exemption is not available, purchasers of penny stocks must receive the risk disclosure document, current inside bid and ask quotation, information on the compensation to be received by both the representative and the member in connection with the transaction, and monthly, not quarterly, statements.

222. An investor in the 28% tax bracket has a $5,000 loss after netting all capital gains and losses realized. How much may the investor deduct from income that year?
     • $5,000
     • $3,000
     • $0
     • $2,500

     Correct answer: $3,000

     The maximum deduction of net capital losses against other income in any one year is $3,000; any remaining loss can be carried forward into the next year.

223. A corporation pays a 10% stock dividend to common stockholders. All the following are true regarding this dividend except
     • The beauty of stock dividends is that they are nontaxable
     • The dividend is taxable in the year the sale of the shares takes place
     • The total value of the position is unchanged when the dividend is paid
     • The cost basis per share is adjusted based on the stock dividend

     Correct answer: The beauty of stock dividends is that they are nontaxable

     The stock dividend is taxable, but unlike cash dividends, which are taxed when received, stock dividends are taxable in the year the shares are sold. When the stockholder receives the additional shares, the cost basis is adjusted on a per-share basis with the total value of the position remaining unchanged. For example, if an investor owned 100 shares purchased at a price of $22 per share and the company paid a 10% stock dividend, the numbers would look like this. The number of shares owned is now 110 [100 + (10% of 100)] = 100 + 10. The adjusted cost basis per share (used when any of the shares are sold) is now $20 per share. The original cost is $2,200 (100 shares times $22 per share). After the stock dividend, the customer owns 110 shares, but there was no additional cost. Divide that original $2,200 by the new number of shares ($2,200 divided by 11) to arrive at an adjusted cost basis of $20 per share. The account value is still $2,200 (110 shares times $20 per share = $2,200).

224. An investor purchased 200 shares of Hightown National Bank (HNB) common stock at $120.06 per share. Thirteen months later, HNB pays a 15% stock dividend. Three months after that, the investor sells the shares received from the stock dividend at $112.57 per share. The tax consequence to the investor is
     • $245.10 short-term capital gain.
     • $245.10 long-term capital gain.
     • $122.55 short-term capital gain.
     • $$1,879.10 long-term capital gain.

     Correct answer: $245.10 long-term capital gain.

     The total value of the initial position is unchanged, remaining at $24,012 (200 times $120.06). After the stock dividend the investor owns 230 shares (200 times 15% = 30 + 200 = 230). Therefore, the adjusted cost basis is $100 per share ($24,012 divided by 230 = $104.40). The question tells us that the investor sells those 30 additional shares at $112.57 per share. That is a difference of $8.17 per share. Multiply that gain by 30 shares and the result is a profit of $245.10. It is a long-term gain because the holding period of shares received from a stock dividend or stock split begins with the initial purchase, not the receipt of the new shares. It is important to remember that anytime there is a distribution resulting in additional shares (stock split, stock dividend), the cost basis per share is reduced while the total account value remains the same. If you have to guess, or are running out of time, when you see two identical numbers with the only difference being short- or long-term gain, in almost all questions, one of those two is the correct answer. Now you have a 50% chance of guessing correctly and, if you remember that the holding period always begins with the initial purchase, then the odds are 100% in your favor.

225. An investor has received a cash dividend on a stock that they have owned for over 10 years. It is the first dividend the company has paid. The cash dividend would be taxable to the investor as
     • A short-term capital gain in the year in which it is received
     • A return of principal
     • A long-term capital gain in the year in which it is received
     • Income in the year in which it is received

     Correct answer: Income in the year in which it is received

     Cash dividends are always treated as income and are taxable to the investor in the tax year in which they are received by the investor. In those cases where the dividend is qualified, it will be taxed at a lower rate than the investor's ordinary income. That does not affect this question because the answer is the same if the dividend is qualified or not. A capital gain occurs when an investor sells an asset for more than its cost basis.

226. Which of the following is true with respect to excess capital losses realized by an individual taxpayer?
     • They may be carried back up to three years and carried forward indefinitely until exhausted.
     • They may be carried forward indefinitely until exhausted.
     • They may be carried forward with a time limit of five years.
     • No more than $3,000 per year may be used against capital gains

     Correct answer: They may be carried forward indefinitely until exhausted.

     Any taxpayer is permitted to reduce capital gains with realized capital losses. If the capital losses exceed the capital gains, up to $3,000 of the net capital loss may be deducted against taxable income. Anything in excess of that is carried forward and used against gains without limitation, or if there are no gains, taxable income, again with a $3,000 annual limit. Those losses can be carried forward with no time limit until they are all used against gains or income. Remember, the $3,000 limit applies only to the net losses that may be deducted against income; there is no limit to the amount of loss that can be netted against gains.

227. Before effecting a penny stock transaction with a customer, the member firm must
     • Provide the customer with a current bid and asked quote on the stock
     • Verify that the customer has sufficient funds in the account
     • Provide the customer with the price of the most recent trade in the stock
     • Receive the signed copy of the risk disclosure document

     Correct answer: Provide the customer with a current bid and asked quote on the stock

     To avoid price gouging, SEC Rule 15g-3 requires that no penny stock transaction may take place without the member firm providing the customer with the current inside market quotes. Those are the highest bid and the lowest ask price currently quoted. The current quotes are more important to the customer than the most recent trade because that trade may have been hours or even days ago. Trading may commence two business days after sending the risk disclosure document.

228. After a company splits its stock 2 for 1, an investor who owns 100 shares receives
     • Notice to send in the current certificate to be replaced by a new certificate for 200 shares
     • Notice that the investor's 100-share certificate now represents 200 shares
     • Another certificate for 200 shares
     • Another certificate for 100 shares

     Correct answer: Another certificate for 100 shares

     After a 2-for-1 split, the transfer agent will send the investor another certificate for 100 shares. The investor is not required to return the existing stock certificate.

229. When compared to statutory voting, cumulative voting gives an advantage to
     • Management rather than the board of directors
     • Minority stockholders
     • Majority stockholders
     • Participating preferred stockholders

     Correct answer: Minority stockholders

     Cumulative voting allows shareholders to aggregate their votes and cast them as they please. For example, they could cast all of their votes for a single candidate. Cumulative voting makes it easier for a minority group of shareholders to gain representation on the board.

230. A corporation is having a rights offering. The terms of the offering require eight rights plus $88 to purchase one share. With the stock's current market price at $112 per share, the theoretical value of one right on the ex-rights date is
     • $2.67.
     • $3.00.
     • $0.30.
     • $0.27.

     Correct answer: $3.00.

     Because the question is asking about the value on the ex-rights, it means we use the regular formula. That is, the (market price minus the subscription price) divided by the (number of rights it takes to buy one share). Plugging in the numbers gives us ($112 $-$ $88) $\div$ 8 = $24 $\div$ 8 = $3.00

231. Holders of common shares may generally vote on
     • Which member of the board of directors should be chairman
     • Whether a cash dividend is to be declared
     • Whether the company should issue additional preferred stock
     • Whether an administrative assistant should be promoted to management

     Correct answer: Whether the company should issue additional preferred stock

     Common shareholders must vote to approve the issuance of additional preferred stock because additional preferred shares dilute the common shares' residual assets under a liquidation. Common shareholders do not vote to declare dividends. Board members select the chairman of the board. Shareholders do not get involved in the daily operational activity of the corporation.

232. Which of the following would least likely occur when a corporation engaged in a rights offering?
     • After successful completion of the offering, the market price would rise slightly.
     • After successful completion of the offering, the market price would decline slightly.
     • The corporation would use a standby underwriter.
     • The number of outstanding shares would increase.

     Correct answer: After successful completion of the offering, the market price would rise slightly.

     Successful completion of a rights offering generally results in a slight decline in the market price of the stock. This is because the subscribers were able to purchase at a price below the current market. This would have a small dilutive effect, causing a slight reduction in the market price. The rights offering is of additional shares, so the number outstanding would increase. Most corporations use a standby underwriter who will buy any shares that were not exercised.

233. Stockholders' preemptive rights include the right to
     • Maintain proportionate ownership interest in the corporation
     • Sell stock back to the issuing corporation
     • Purchase Treasury stock
     • Serve as an officer on the board of directors

     Correct answer: Maintain proportionate ownership interest in the corporation

     Preemptive rights allow stockholders to maintain their proportionate ownership when the corporation wants to issue more stock. For example, if a stockholder owns 5% of the outstanding stock and the corporation wants to issue more stock, the stockholder has the right to purchase 5% of the new shares.

234. A corporation wishes to raise additional capital by making use of a rights offering. One of your clients owns 200 shares of the issuing corporation's common stock and 100 shares of its preferred stock. The terms of the offering state that four rights will be necessary to purchase one new share at the subscription price of $20. The current market price of the stock is $24 per share. How many rights will your client receive?
     • 50
     • 300
     • 200
     • 75

     Correct answer: 200

     No matter how many new shares are being offered and how many rights it takes to buy each new share, on your exam, shareholders will always receive one right for each share of common stock they own. With this client owning 200 shares, that is 200 rights. There are never rights with preferred stock.

235. Gargantuan Computers, Inc., (GCI) conducts a rights offering to its current shareholders at $50 per share, plus one right. If the current market price of GCI is $70, what is the value of one right before the stock trades ex-rights?
     • 300
     • 10
     • 5
     • 15

     Correct answer: 10

     The stock is trading cum rights (before the ex-date). The formula to calculate the value of one right before the ex-date is follows: CMV minus subscription price divided by the number of rights to purchase one share plus 1. Therefore, one right is valued at $10, computed as ($70 − $50) / 2 = $10.

236. One of your customers is looking for growth with some income. It would not be suitable for you to recommend
     • Common stock
     • ADRs.
     • Convertible preferred stock
     • Warrants with a five-year expiration

     Correct answer: Warrants with a five-year expiration

     Although warrants can provide growth if the underlying security's prices rises above the exercise price, they never produce any income. Each of the other three choices do. Preferred stock has limited growth possibilities, but this is a convertible preferred where the growth of the underlying common stock influences the price of the preferred. ADRs and common stock can provide income and growth.

237. Which of the following statements regarding warrants are true? I. They pay dividends. II. They represent ownership in the issuing corporation. III. They allow for the purchase of common stock at a fixed price. IV. They do not give holders voting rights.
     • I and II
     • II and III
     • III and IV
     • II and IV

     Correct answer: III and IV

     Holders of warrants have the right to buy stock from the issuer at a stated price for a specific time period. They do not pay dividends that are only paid to stockholders or give holders voting rights. The owner of the warrant does not own the stock until the warrant is exercised.

238. Five years ago, a corporation issued a portion of its authorized shares. Those shares currently trade on the New York Stock Exchange. In an effort to reduce the number of shares outstanding, the issuer purchases 30 million shares from existing shareholders. The shares purchased by the issuer in the secondary market are now known as
     • Treasury stock
     • Unissued stock
     • Authorized stock
     • Issued stock

     Correct answer: Treasury stock

     When an issuer acquires its own issued and outstanding stock, it becomes treasury stock. It can be an outright purchase, as described here, or stock received as a donation from a stockholder. Treasury stock has no voting or dividend rights. A corporation's charter specifies the number of shares that are authorized for issuance. When the corporation issues those authorized shares to raise capital, they represent the number of issued shares. When they begin trading in the secondary markets, they are issued and outstanding shares. Treasury stock is issued, but no longer outstanding. In Unit 13 when we compute some ratios, we use only the outstanding shares.

239. In order for an investor to be eligible to receive a previously declared cash dividend, the stock must be purchased
     • The day after the ex-dividend date
     • Before the ex-dividend date
     • On the ex-dividend date
     • The day before the record date

     Correct answer: Before the ex-dividend date

     The ex-date (it can be ex-dividend, ex-rights, or ex-split) is the first day on or after which a purchaser is not eligible to receive the dividend (or the rights or the split). With regular way delivery at T+2, one would have to buy the security at least 2 business days before the record date (the day the issuer makes a record of all eligible owners). Therefore, in most cases, the ex-date will be one business day prior to the record date. Buying then or afterwards is going to be too late to get the purchaser's name on the record books.

240. All of the following are advantages of investing in American depositary receipts (ADRs) except
     • Transactions are done in U.S. currency.
     • ADRs fall under the oversight of the SEC.
     • Dividends are received in U.S. currency.
     • Currency risk is virtually eliminated

     Correct answer: Currency risk is virtually eliminated

     ADRs carry currency risk because distributions on ADRs must be converted from foreign currency to U.S. dollars on the date of distribution. In addition, the trading price of the ADR is affected by foreign currency fluctuation.

241. Investors in all of the following securities could receive dividend payments that increase over time except
     • Adjustable-rate preferred stock
     • Participating preferred stock
     • Cumulative preferred stock
     • Common stock

     Correct answer: Cumulative preferred stock

     The dividend rate on cumulative preferred stock is fixed. It is never more than the stated rate. The cumulative feature simply means that if there are skipped dividend payments, those must be made up before dividends may be paid on common stock. That is not considered an increase in the dividend rate. Adjustable-rate preferred stock has a dividend that adjusts based on market interest rates. In a period of increasing interest rates, the dividends will increase. Participating preferred stock has a tie-in to the common stock dividend. As companies become more profitable or the need for retaining earnings decreases, the common stock dividend tends to increase, and that increases the payout to the participating preferred shareholders.

242. The issuer of an American depositary receipt (ADR) is
     • A foreign branch of a foreign bank
     • A domestic bank
     • A foreign branch of a domestic bank
     • A domestic branch of a foreign bank

     Correct answer: A domestic bank

     The ADR is issued by a domestic bank. Everything is in English and in U.S. dollars. The foreign certificates are usually held on deposit at a foreign branch of the domestic bank, and the ADRs are issued domestically.

243. Lambda Corporation has received a donation of 100,000 shares of its common stock from the spouse of the deceased founder of the company. This would appear on the company's books as
     • Treasury stock
     • Unissued stock
     • Authorized, but unissued stock
     • Reacquired stock

     Correct answer: Treasury stock

     When a corporation reacquires shares of outstanding stock, whether through open market purchase or, as in this case, donation, the stock is treasury stock.

244. Synapse Communication Corporation (SCC) is growing. To finance the expansion, the company has a $100 million debenture offering. Attached to the offering are five-year warrants to purchase SCC common shares. Each warrant allows for the purchase of one SCC share at a price of $53 per share. Three years after the issue date, SCC stock is trading at $63 per share. Each warrant has
     • No intrinsic value, only time value
     • An intrinsic value of $5 per warrant
     • An intrinsic value of $10 per warrant
     • An intrinsic value of $20 per warrant

     Correct answer: An intrinsic value of $10 per warrant

     A warrant has intrinsic value when the exercise price is lower than the stock's current market price. In this question, each warrant allows the holder to purchase one share of a $63 stock for $53 per share. That is a $10 per share difference. Therefore, intrinsically, the warrant is worth $10. With two years to go, it also has time value, but the question is not dealing with that. ** This question deals with material not covered in your study materials, but it relates to recent rule changes and/or student feedback.

245. In a 3-for-2 stock split, an investor will
     • Have two-thirds fewer shares at a 50% higher price
     • Have 50% more shares at two-thirds the price
     • Have 50% more shares at half the price
     • Have 50% fewer shares at twice the price

     Correct answer: Have 50% more shares at two-thirds the price

     If a stock splits 3 for 2, an investor will receive an additional 50 shares for every 100 shares owned. The price will decline by one-third, but the total value of the position will stay the same. For example, if a shareholder owns 100 shares priced at $60 per share ($6,000 total value) before the 3 for 2 split, the shareholder will have 150 shares after the split ($3/2 \times 100 = 150$). Because the total market value will remain the same, the new price per share will be $6,000 $\div$ 150 shares = $40 per share. There is a mathematical trick to determine the new price per share. Simply reverse the fraction and that is the new price per share. In this question, a 3:2 split results in a price that is 2/3rds the pre-split price. In a 2:1 split, the price becomes 1/2 ($30 in our example) and in a 5:4 split, the price becomes 4/5ths ($48 in our 100 shares at$60 example).

246. An investor owns 400 shares of ABC common stock. ABC's board of directors has declared a 5:4 stock split. As a result, the investor will receive how many additional shares?
     • 80 shares
     • 100 shares
     • 40 shares
     • 500 shares

     Correct answer: 100 shares

     In a 5:4 stock split, the shareholder will own five shares for each four shares currently held. This investor owns 400 shares so, after the split, the account will have 500 shares in it. The difference between 400 and 500 is 100 additional shares. If you chose 500, that is the total number of shares that will be owned, but the question does not ask for that—it asks for the number of additional shares.

247. Marcus owns 5,000 shares of KYZ stock. He recently received proxies in the mail. Marcus would be able to use the proxies for all of the following except
     • To vote on a proposed 2:1 stock split
     • To vote on the proposed issuance of 100,000 shares of convertible preferred stock
     • To vote for three members of the board of directors
     • To buy additional shares of KYZ common stock after the stock splits 2:1

     Correct answer: To buy additional shares of KYZ common stock after the stock splits 2:1

     A proxy is a form of absentee ballot used by stockholders to vote on company matters such as stock splits, members of the board of directors, and issuance of additional equity-related securities such as convertible securities. Stockholders do not vote on dividend-related matters, nor are proxies used to purchase shares of stock.

248. DJX Corporation's charter has authorized 10 million shares of common stock. It has issued 5 million shares and has 1 million shares in its treasury. How many shares of DJX common stock are authorized but unissued?
     • 6 million
     • 9 million
     • 4 million
     • 5 million

     Correct answer: 5 million

     This company has 10 million shares of common stock authorized. It has issued 5 million shares of which 1 million shares have been reacquired as treasury stock. That means there are 4 million shares still outstanding. The remaining 5 million are authorized but unissued. Remember that treasury stock is authorized and issued stock that is no longer outstanding.

249. If all other factors are equal, an investor would expect which type of preferred stock to pay the highest stated dividend rate?
     • Cumulative
     • Convertible
     • Callable
     • Straight

     Correct answer: Callable

     When the stock is called, dividend payments are no longer made. With callable preferred stock, to compensate for that possibility, the issuer pays a higher dividend than with straight preferred. Cumulative and convertible preferred have positive characteristics that would justify a lower fixed dividend than straight.

250. As interest rates fall, prices of straight preferred stock will
     • Become volatile
     • Remain unaffected
     • Rise
     • Fall

     Correct answer: Rise

     Preferred stock is interest rate sensitive. As rates fall, prices of preferred stocks tend to rise, and vice versa.

251. Corporations issue equity securities. One category of equity is preferred stock. A number of different adjectives can apply to preferred stock issues. All of the following are types of preferred stock except
     • Convertible preferred
     • Participating preferred
     • Cumulative preferred
     • Straight cumulative preferred

     Correct answer: Straight cumulative preferred

     Preferred stock can be noncumulative (straight) or it can be cumulative. It cannot be both. Cumulative preferred has the right to receive skipped dividends before any dividend can be paid to common shareholders. Those skipped dividends are known as dividends in arrears, or arrearage. Straight preferred does not have the right to receive skipped dividends; there is no arrearage. Once the dividend is not paid, the holder of straight preferred has no claim on it.

252. Preferred stock comes with many different options. What type of preferred stock would be most advantageous to the investor if the issuing company had strong revenue and earnings that exceeded industry estimates?
     • Callable preferred
     • Adjustable-rate
     • Participating
     • Cumulative

     Correct answer: Participating

     Participating preferred stock may receive an additional amount paid to shareholders based on superior performance of the issuer. Cumulative refers to unpaid dividends that accrue on a preferred issue. Those must be paid before common stockholders receive a dividend. That could be a benefit if the company had dividends in arrears and these higher earnings made it possible to pay them. However, unless something in the question indicated that these higher earnings followed several years of losses, there is no way to infer that the company is behind on its dividends. As you hear us say many times, do not read something into the question that is not there. Adjustable-rate preferred stocks adjust their dividends based on market interest rates, not on the company's earnings. Although it is possible that higher earnings could encourage the company to call in some of the outstanding callable preferred stock, doing so would be considered a benefit to the issuer rather than the investor.

253. A corporation has $25 million of 5% bonds outstanding. The bonds are callable at 102. Current market interest rates are 6%. If the company would like to retire $10 million of the debt, it might be smart to
     • Make a tender offer to purchase $10 million face amount of the bonds
     • Exercise the call provision for $10 million face amount of the bonds
     • Issue $10 million of new bonds at current rates and use the proceeds to call in outstanding ones
     • Issue $10 million of treasury stock and use the proceeds to retire the bonds

     Correct answer: Make a tender offer to purchase $10 million face amount of the bonds

     When current market interest rates are 6%, bonds with a 5% coupon are selling at a discount. That means the company could make a public offer to buy the bonds back at a price somewhat below par value. In simple terms, they could retire $10 million of debt for less than $10 million. It would make no sense to call the bonds at 102 ($1,020) when they can be purchased for less than $1,000 each in the open market. Issuing new bonds to retire old ones, a practice known as refunding, is done when interest rates have fallen. In this question, interest rates have gone up making that plan incorrect. A company cannot issue treasury stock. Issued and outstanding stock becomes treasury stock when it is reacquired by the issuer.

254. The CAST Corporation's first mortgage bond has a 5% coupon and a yield to maturity of 7%. The bond is callable in 10 years at 103. The bond is trading at
     • A discount
     • The call price
     • Par
     • A premium

     Correct answer: A discount

     The only way a bond with a nominal (coupon) rate of 5% can have a yield higher than 5% is by having a price below the par value. This is an example of the inverse relationship between bond prices and their yields. If the yield is above the coupon, the price is below par (a discount). If the yield is below the coupon, the price is above par (a premium). As we say in the study materials, "if you pay more, you get less" and "if you pay less, you get more."

255. When a bond is issued by a national government, it is referred to as
     • High-quality debt
     • Treasury debt
     • Sovereign debt
     • National debt

     Correct answer: Sovereign debt

     The term sovereign debt applies to securities issued by national governments. U.S. Treasuries are an example of sovereign debt issued here. Other countries have their versions, such as the Gilts of the United Kingdom. These are not considered alternative investments. Alternative investments are structured products that are complex and not easy to understand. Two of the most popular structured products are the ELNs and the ETNs.

256. A bond has a 7% coupon and an offering price of 108. The bond matures in ten years. An investor purchasing this bond at the offering price would have a yield to maturity closest to
     • 7.80%.
     • 7.50%.
     • 5.96%
     • 7.22%.

     Correct answer: 5.96%

     "When you pay more, you get less," Anytime a bond is purchased at a premium (a price above par), the yield to maturity (as well as the current yield and yield to call) must be lower than the nominal yield (the coupon rate). If you stop and think for a moment, there can be only one possibly correct answer. With a coupon rate of 7%, the answer must be something less than that. As will likely be the case on the exam, there is only one choice that is less than 7%. If you want to do the computation using our formula, it is: Annual interest $-$ (premium $\div$ years to maturity) $\div$ average price of the bond. Plugging in the numbers we have: $70 $-$ ($80 $\div$ 10) $\div$ [($1,080 $+$ $1,000) $\div$ 2]. This works out to: $62 $\div$ $1,040 = 5.96%. However, as stated above, with only one number below the coupon rate, that has to be it. A variation of this question has two choices below the coupon. If that were the case here, the other choice would be 6.48%. That is the current yield ($70 $\div$ $1,080). You need to remember that with a bond selling at a premium, the YTM will always be lower than the CY.

257. What is the amount of interest payable semiannually on a $1,000 par value, 5% corporate bond currently selling at 80 and redeemable at par in 20 years?
     • $40
     • $25
     • $50
     • $20

     Correct answer: $25

     The interest is based on the par value of $1,000. The current market price is irrelevant. With a coupon rate of 5%, this bond pays $50 per year. That would be $25 semiannually

258. Which of the following money market instruments is most often used by those in the import/export business?
     • Commercial paper.
     • Bankers’ acceptances
     • Negotiable CDs
     • Variable rate demand notes

     Correct answer: Bankers’ acceptances

     Bankers' acceptances are loans guaranteed by a commercial bank that are typically used to finance international transactions. Although all of the choices are money market instruments, it is the BAs that are primarily used by those engaged in international business.

259. The ELLA Distributing Company issued a bond with a nominal yield of 5%. The bond matures in 12 years and is currently trading at 94. The bond's yield to maturity is closest to
     • 4.64%.
     • 5.00%.
     • 5.67%.
     • 5.32%.

     Correct answer: 5.67%.

     The first point to notice is that the bond is trading at a discount. When bonds trade at a discount, our yield chart and example tells us that the yields, in ascending order, are nominal yield, current yield, yield to maturity, and yield to call. That last one is of no relevance to this question because a call feature is not mentioned anywhere. Therefore, we know that the yield to maturity must be greater than the nominal (coupon) yield of 5%. There are only two choices that are, so if you are running out of time or do not remember how to do this, at least you have a 50% chance. However, 50% doesn't pass the exam, so let's make that 100%. The yield to maturity computation is tricky, but current yield is not. It is simply the coupon divided by the current market price. In our question, that is 5% divided by 94 equals 5.32% (or $50 divided by $940). We know the yield to maturity for a bond selling at a discount is higher than its current yield. That means the correct answer must be greater than 5.32%. If you have a question like this on the actual exam, there will be only one choice higher than the current yield. As shown in the study materials, the YTM calculation goes like this: [annual interest + (discount divided by the number of years to maturity)] divided by the average price of the bond Plugging in the numbers, we get a numerator of $50 + ($60 divided by 12 years) = $50 + $5 = $55. The denominator is ($940 + $1,000) divided by 2 = $1,940 divided by 2 = $970. Solve by dividing $55 by $970 and the answer is 5.67%.

260. Which of the following bonds is most affected by interest rate risk?
     • 7.8s of '42
     • 7.6s of '45
     • 7.5s of '39
     • 7.3s of '37

     Correct answer: 7.6s of '45

     To begin with, let's be sure you understand the nomenclature used here. Each of the choices has two numbers. The first is the coupon rate of the bond and the second is the year the bond matures. For example, the 7.3s of '37 pay interest at a rate of 7.3% of the $1,000 par value per year and mature in 2037. The s is just to separate the two numbers. Interest rate risk is the loss in value due to a rise in interest rates. Because there is little difference in coupon rates, the bond with the longest maturity (highest duration) will experience the greatest fall in a rising interest rate market.

261. An investor anticipating a fall in interest rates would likely purchase
     • Noncallable bonds
     • Noncallable and callable bonds
     • None of these
     • Callable bonds

     Correct answer: Noncallable bonds

     If rates fall, bonds are likely to be called.

262. Which of the following debt instruments trades with accrued interest?
     • Negotiable CDs
     • Zero-coupon issues
     • Treasury bills
     • Bankers acceptances

     Correct answer: Negotiable CDs

     To trade with accrued interest, the security must pay interest. Of the choices, the only one that is interest bearing is the negotiable (jumbo) CD. All of the others are issued at a discount and return the face value at maturity.

263. Which of the following callable municipal bonds trading on a 7% basis is most likely to be called?
     • 7.5% coupon, callable at 100 in 2030
     • 6.5% coupon, callable at 100 in 2030
     • 6.5% coupon, callable at 105 in 2030
     • 7.5% coupon, callable at 105 in 2030

     Correct answer: 7.5% coupon, callable at 100 in 2030

     An issuer will call the higher coupon bonds before calling the lower coupon bonds. Of the two bonds with coupons of 7.5%, the one with the lower call price will likely be called first.

264. An economist is comparing the yields on 20-year U.S. Treasury bonds and AAA-rated corporate bonds with the same maturity. The economist is analyzing
     • The risk spread
     • The credit spread
     • The duration spread
     • The value spread

     Correct answer: The credit spread

     You should understand that the greater the risk, the higher the yield on the bond. Many analysts compare the difference between yields on bonds with the same maturity but different quality (rating) to get a sense of the market sentiment. One common measurement is the difference in yields between Treasuries and corporate bonds. This difference is called the yield or credit spread and tends to widen when economic conditions sour and narrow when they get better. ** This question deals with material not covered in your study materials, but it relates to recent rule changes and/or student feedback.

265. Market interest rates have been rising, which means the price of bonds traded in the secondary market has
     • Not changed because bond prices are not affected by interest rates
     • Not changed because only new bond prices are impacted by changes in interest rates, not the price of bonds already trading in the secondary market
     • Decreased
     • Increased

     Correct answer: Decreased

     When interest rates rise, bond prices fall.

266. If the dollar price of a municipal bond is 101 and, at that price, the basis is 6.10, the nominal yield is
     • Less than 6.10%
     • Exactly 6.10%
     • Greater than 6.10%
     • Less than the coupon rate

     Correct answer: Greater than 6.10%

     Basis is a common synonym for yield to maturity, especially for municipal bonds. For any bonds trading at a premium, the nominal yield (or coupon) is higher than the basis (YTM). For bonds at a premium, yields from lowest to highest are as follows: yield to call, yield to maturity, current yield, and nominal yield.

267. Which of the following statements regarding a bond quoted as QRS Zr 32 is true?
     • The bond pays $12 interest annually.
     • The bond pays $120 interest annually.
     • The bond pays no interest until maturity.
     • The interest payable is tax free.

     Correct answer: The bond pays no interest until maturity.

     QRS Zr 32 represents a zero coupon bond issued by the QRS Company maturing in 2032. Zero coupon bonds are bought at a discount and mature at face value. If a bond is held to maturity, the difference between the purchase price and the maturity price is considered interest, though it is taxed on a yearly basis.

268. Three 3% bonds are listed in the newspaper. One bond will mature in one year, another bond will mature in 10 years, and the third bond will mature in 20 years. If interest rates are going up, which bond will have the greatest decrease in value?
     • The bond with the 10-year maturity
     • None, as they will all have the same decrease in value
     • The bond with the 1-year maturity
     • The bond with the 20-year maturity

     Correct answer: The bond with the 20-year maturity

     Interest rate risk is based on a bond's duration. The longer the duration, the greater the effect of changes to interest rates. Duration consists of two components: coupon rate and length to maturity. When comparing bonds where the coupons are essentially equal (as in this question where they are all 3%), the bond with the most time remaining until maturity (such as the one with 20 years to go) will have the longest duration. Conversely, the bond maturing soonest (such as our one-year bond) will have the shortest duration and will be affected the least from changes to market interest rates. Although not relevant to this question, when the time remaining to maturity is essentially the same for all of the choices, the bond with the lowest coupon will have the longest duration. The closer a bond gets to its maturity date, the closer its price gets to par because there is so little time for changes in interest rates to have any effect.

269. A corporate bond with a nominal yield of 6% is currently trading at a yield to maturity (YTM) of 5.8%. It would be accurate to state that this bond is trading at
     • Par
     • Parity
     • A discount
     • A premium

     Correct answer: A premium

     If YTM is less than the nominal or coupon yield, the bond is trading at a premium.

270. An investor sells 10 5% bonds at a profit and buys another 10 bonds with a $5\tfrac{1}{4}\%$ coupon rate. The investor's yearly return will increase by
     • $2.50 per bond.
     • $2.00 per bond.
     • $1.00 per bond.
     • $1.50 per bond.

     Correct answer: $2.50 per bond.

     The first bonds are 5% and pay $50 per year per bond. The new bonds are $5\tfrac{1}{4}\%$ and pay $52.50 per year per bond, for a difference of $2.50 per bond.

271. Which of the following expressions describes the current yield of a bond?
     • Yield to maturity divided by par value
     • Annual interest payment divided by current market price
     • Annual interest payment divided by par value
     • Yield to maturity divided by current market price

     Correct answer: Annual interest payment divided by current market price

     The current yield on a bond is calculated by dividing the annual interest payment by the current market price of the bond.

272. The 5% markup policy applies to all of the following secondary market transactions except
     • Agency transactions on an exchange
     • Municipal bond transactions
     • Agency transactions in nonexempt unlisted securities
     • Principal transactions in the over-the-counter (OTC) market

     Correct answer: Municipal bond transactions

     The 5% policy applies to secondary market transactions. The secondary market is where trades are made in outstanding securities between buyers and sellers rather than a new issue. Excluded from the 5% policy are transactions in exempt securities such as municipal and government bonds. The policy applies to nonexempt securities and transactions on an exchange and in the OTC market, and it applies to both agency and principal trades. In the case of a primary offering (new issue) sold by prospectus, the 5% policy does not apply because the underwriting spread and commissions are already stated in the prospectus or other offering document.

273. You have a customer who is interested in reliable income. The customer recently added a bond maturing in 20 years to the portfolio. The bond has a duration of 12 years and four months, and the purchase price was $1,295.87. Which of the following statements is correct?
     • The yield to maturity is less than both the current yield and the coupon rate.
     • The coupon rate is higher than the yield to maturity, and the yield to maturity is higher than the current yield.
     • The coupon rate is lower than the yield to maturity, and the current yield should be higher than the coupon rate.
     • The current yield is higher than both the coupon rate and the yield to maturity.

     Correct answer: The yield to maturity is less than both the current yield and the coupon rate.

     Whenever a bond is purchased at a premium (a price above $1,000), the yield to maturity (YTM) is less than the current yield (CY) and the coupon rate (CR). Remember the relationship: Premium bonds: CR > CY > YTM Par bonds: CR = CY = YTM Discount bonds: CR < CY < YTM

274. Moody's Investment-Grade (MIG) rating would be applicable to
     • A New York state revenue bond
     • A New York state university bond
     • A New York state revenue anticipation note
     • A New York state general obligation bond

     Correct answer: A New York state revenue anticipation note

     A MIG rating is provided for short-term municipal debt commonly referred to as notes (revenue anticipation notes).

275. The term high-yield bond would apply to a bond with a Moody's rating of
     • Ba.
     • BBB.
     • BB.
     • Baa.

     Correct answer: Ba.

     High-yield bonds are those whose ratings fall below investment grade. Investment grade is the top four. Using Moody's descriptions, ratings run from Aaa to Aa to A to Baa to Ba to B and then below. The first rating below the top four is Ba. That is equivalent to a BB rating from Standard & Poor's (but the question asks specifically about Moody's).

276. It would be expected that your firm would employ heightened suitability standards when evaluating recommendations for
     • Structured products
     • Cumulative preferred stock
     • Sovereign debt
     • Nonvoting common stock

     Correct answer: Structured products

     The higher the risk of the investment, the greater the need for checking suitability. Structured products, such as equity-linked notes and exchange-traded notes, are considered complex products. In many cases, FINRA has discovered that registered representatives had inadequate understanding of the investment, leading to their making unsuitable recommendations.

277. In a discussion with one of your customers, the topic of alternative debt instruments is brought up. It seems that the customer was competing in a duplicate bridge tournament in town and one of the other competitors mentioned that they have been obtaining higher income returns from ELNs. When the customer asks you for the meaning of that abbreviation, you would reply
     • Exchange-linked notes
     • Equity-linked notes
     • Exchange-leveraged notes
     • Equity-leveraged notes

     Correct answer: Equity-linked notes

     An ELN is an equity-linked note. That is a strange name for a debt product. The equity refers to the specific stock, a basket of stocks, or an equity index upon which the return is based. Therefore, the return is not fixed and can be higher or lower than anticipated depending on the selected equity's performance. There are foreign exchange-linked notes where the performance is based on currency rates, but that is unlikely to ever be a topic covered on the exam. There are no such products as exchange or equity-leveraged notes.

278. Corporate bonds that are guaranteed are
     • Insured by Assured Guaranty Corporation
     • Guaranteed as to payment of principal and interest by another corporation
     • Guaranteed as to payment of principal and interest by the U.S. government.
     • Required to maintain a self-liquidating sinking or surplus fund

     Correct answer: Guaranteed as to payment of principal and interest by another corporation

     A guaranteed corporate bond is one guaranteed by another corporation that typically has a higher credit rating than the issuing corporation and is in a control relationship with it.

279. With the advent of the horseless carriage (a.k.a. the automobile), the Acme Buggy Whip Corporation's revenues fell to the point where it could no longer cover expenses. This led to an involuntary bankruptcy. The priority of payout was
     • Senior notes, preferred stock, common stock, general creditors
     • Senior notes, general creditors, preferred stock, common stock
     • Common stock, preferred stock, general creditors, senior notes
     • General creditors, senior notes, preferred stock, common stock

     Correct answer: Senior notes, general creditors, preferred stock, common stock

     Senior debt refers to obligations that have priority in the event of default. It parallels the use of senior when comparing preferred stock to common stock, the most junior of all securities.

280. An issuer of a bond will apply to the rating services for a rating for the purpose of
     • Reducing liquidity risk
     • Reducing interest rate risk
     • Reducing the bond's duration
     • Reducing credit risk

     Correct answer: Reducing credit risk

     What does the bond rating measure? It is a measurement of the credit risk. The higher the rating, the lower the credit risk and the reverse. With lower credit risk, the issuer will be able to borrow at a lower interest cost. Does the rating have an effect on the bond's liquidity? Possibly, but as is so often on the exam, you must select the answer that best fits the question.

281. If ABC Corporation reports a loss for the year, it is obligated to pay interest on all of the following except
     • Adjustment bonds
     • Variable-rate bonds
     • Nonconvertible bonds
     • Convertible bonds

     Correct answer: Adjustment bonds

     Even if a corporation reports a loss, the corporation is obligated to pay interest on all of its outstanding debt except for income (adjustment) bonds. Income—or adjustment bonds—require interest to be paid only if declared by the board of directors.

282. An investor viewing a stock market video is particularly interested in the discussion of convertible debt securities. Those are issued by
     • Municipalities
     • Foreign governments
     • Corporations
     • The U.S. Treasury.

     Correct answer: Corporations

     Convertible securities (debt or preferred stock) are always convertible into common stock. Therefore, they can be issued only by an entity that also issues common stock: a corporation.

283. Which of the following best describes a debenture?
     • A long-term corporate debt obligation with a claim against securities rather than against physical assets
     • Unsecured corporate debt
     • A corporate debt obligation that allows the holder to purchase shares of the company's common stock at specified dates before maturity
     • An investment in the debt of another corporate party

     Correct answer: Unsecured corporate debt

     A debenture is unsecured corporate debt.

284. Each of the following would be disclosed to potential municipal bond buyers in the official statement of a new municipal bond issue except
     • The issue's purpose
     • The creditworthiness of the issue
     • The source from which interest and principal will be paid
     • The disclosure that it was prepared by the underwriters

     Correct answer: The disclosure that it was prepared by the underwriters

     Although a broker-dealer acting in an advisory capacity may assist in preparing the official statement (OS), it is considered to be the responsibility of, and prepared by, the issuer. If qualifying for an exception (such as receiving no compensation other than the advisory fee), a BD acting in an advisory capacity may assist with preparing the OS and other similar duties normally associated with underwriting.The official statement identifies the issue's purpose, the source from which the interest and principal will be repaid, information regarding the issuer's financial and economic background, and information relating to the issue's creditworthiness.

285. Your new client lists income as the primary investment objective for an account with your broker-dealer. Which of the following investments would not be suitable?
     • Corporate preferred shares
     • Ginnie Mae government securities
     • Zero-coupon bonds
     • Corporate debt securities

     Correct answer: Zero-coupon bonds

     Zero-coupon bonds make no payments until maturity, and therefore, would not be suitable investments for those with an income objective. Typically, preferred shares (because of the fixed dividend they pay) and corporate or government securities, which make interest payments, would be suitable investments to meet an income objective.

286. A convertible bond callable at 101 is trading at 105. The bond is a 4% bond convertible at $25. The common stock is trading at $27. If an investor bought the bond and converted, her profit would be
     • $75.
     • $40.
     • $20.
     • $30.

     Correct answer: $30.

     First, calculate the number of shares each bond will convert to: $1,000 (par) divided by $25 per share equals 40 shares per bond. With market value at 105, each bond costs $1,050. What is the stock parity price? $1,050 divided by 40 shares equals $26.25 per share. Current market value of the stock minus stock parity price equals profit (or loss). $27.00 $-$ $26.25 = $0.75 per share $\times$ 40 shares = $30.

287. In active trading, a bond of standard size rises in price from $98\tfrac{5}{8}$ to $101\tfrac{3}{4}$. This represents a dollar change of
     • $0.3125.
     • $31.25.
     • $312.50.
     • $3.125.

     Correct answer: $31.25.

     Let's take this step by step remembering that every point in a bond quote equals $10 and every $\tfrac{1}{8}$ of a point equals $1.25 ($10/8 = $1.25). Method #1 1) The increase is $3\tfrac{1}{8}$ points ($101\tfrac{3}{4}$ minus $98\tfrac{5}{8}$ = $101\tfrac{6}{8}$ minus $98\tfrac{5}{8}$ = $3\tfrac{1}{8}$ 2) $3\tfrac{1}{8}$ = $30 (3 times $10 per point) + $1.25 which equals $31.25 Method #2 1) $101\tfrac{3}{4}$ = 101 x $10 = $1,010 + $\tfrac{3}{4}$ of $10 = $7.50, total price is $1,017.50. 2) $98\tfrac{5}{8}$ = 98 x $10 = $980 + $\tfrac{5}{8}$ of $10 = $6.25. total price is $986.25. 3) The difference between the two prices is $1,017.50 minus $986.25 which = $31.25.

288. KLM Company has 10 million convertible bonds outstanding that are convertible at $25. The bonds contain an antidilution feature. If KLM declares a 10% stock dividend, the new conversion price will be
     • $22.50.
     • $45.45.
     • $22.73.
     • $50.00.

     Correct answer: $22.73.

     Before the stock dividend, an investor would have received 40 shares of stock for each $1,000 bond ($1,000 / $25). A 10% stock dividend would now give an investor 44 shares on conversion (40 shares + 10% = 4 shares more). $1,000 / 44 shares = $22.73 per share for the new conversion price.

289. An institutional investor is seeking a quote on $2 million of term bonds issued by the City Water Authority. These are the 3s of 2050 and would be quoted
     • By yield to maturity
     • Using the dealer's bid price
     • By current yield
     • In dollars as a percentage of par

     Correct answer: In dollars as a percentage of par

     Term bonds are often called dollar bonds because they are quoted in a dollar price. That price is a percentage of par. Serial bonds are quoted on their basis (yield to maturity). A purchaser is going to be quoted based on the dealer's ask price (the bid price is when the customer is selling). The 3s of 2050 means that the coupon is 3% and the maturity date is 2050.

290. Who attests to the legality of a bond issue and issues a legal opinion on a proposed new municipal bond issue?
     • Syndicate manager
     • Case attorney
     • State administrator
     • Bond counsel

     Correct answer: Bond counsel

     The issuer hires a firm or an individual to act on its behalf as bond counsel.

291. An investor owns a convertible debenture with a conversion price of $10. If a 10% stock dividend is paid on the company's common stock, which of the following is true?
     • The investor will receive 10 shares of the common stock.
     • The investor will receive 1 share of the common stock.
     • The conversion price will be adjusted to $9.09.
     • The conversion price will be adjusted to $11.00.

     Correct answer: The conversion price will be adjusted to $9.09.

     You can assume that any convertible security on the exam will have an anti-dilutive provision. That means that a stock dividend or stock split will not cause the investor's conversion privilege to be diminished. With a conversion price of $10, the investor was able to convert into 100 shares ($1,000 divided by $10). After the 10% stock dividend, the investor must be able to convert into 10% more shares (110 shares). To get 110 shares from a $1,000 principal, the price must be reduced. The computation is $1,000 divided by 110. That equals $9.09 per share.

292. An investor purchased a new issue corporate zero-coupon bond for $600. The bond has a maturity of 20 years. Six years later, the investor sells the bond for $700. For tax purposes, this would result in
     • A capital loss of $280
     • A capital gain of $100
     • A capital loss of $20
     • A capital gain of $20

     Correct answer: A capital loss of $20

     The $400 discount is accreted over the 20 years to maturity. That is an annual accretion of $20. After 6 years, that is $120, making the tax basis of the bond $720. Because the sale at $700 is $20 less than the basis, the investor has a long-term capital loss.

293. An investor purchases a newly issued convertible bond at par. The bond is convertible at $40. Three years later, the underlying common stock is trading at $50 per share. If the investor sells the bond at a $50 premium over the parity price, there is
     • A long-term capital gain of $1,050
     • A long-term capital gain of $10 per share
     • A long-term capital gain of $200
     • A long-term capital gain of $300

     Correct answer: A long-term capital gain of $300

     This question involves several steps. The first is to determine the conversion ratio in shares. A bond convertible at $40 per share has a share conversion rate of 25 shares ($1,000 ÷ $40). The second step is to compute the parity price. That is, what are those 25 shares worth? Multiply 25 shares times $50 per share and that equals $1,250. When the bondholder sells the bonds at parity plus a $50 premium, $1,300 is received. The $300 profit over the $1,000 initial cost is a long-term capital gain. An alternative that might be easier for some is to look at the appreciation of the stock. It is $10 per share higher than the conversion price of $40. That represents an increase of 25% (10 ÷ 40). If the bond is at parity with the stock, its price must be 25% higher and that brings us again to the $1,250 parity price. Add the $50 premium to get to $1,300, $300 above the initial cost.

294. Municipal bonds—known as dollar bonds—are generally quoted
     • As a percentage of par
     • Yield to call
     • Yield to maturity
     • Net yield

     Correct answer: As a percentage of par

     Although municipal bonds are usually quoted on a yield basis, actively traded bonds known as dollar bonds are often quoted as a percentage of par (price). The term dollar bond comes from the quote being made in dollars. Remember that a percentage of par value ($1,000) equals a dollar price.

295. ABC Corporation has outstanding a 7.75% convertible debenture currently trading at 102. The bond is convertible into common stock at $40. ABC stock is trading $45 per share. Which of the following statements is true?
     • To profit in this situation, the investor should buy the bonds and short the stock.
     • An arbitrage opportunity does not exist in this situation.
     • To profit in this situation, the investor should buy the stock and short the bonds.
     • The bond is at parity with the stock.

     Correct answer: To profit in this situation, the investor should buy the bonds and short the stock.

     With a conversion price of $40, the bond is convertible into 25 shares of ABC common stock ($1,000 / $40 = 25 shares). As the common stock is currently trading at $45 per share, the value of the stock as converted would be $1,125 (25 shares $\times$ $45 = $1,125), which is greater than the current price of the bond ($1,020). Therefore, the bond and the stock are not at parity. An investor could profit in this situation by shorting the stock and buying an equivalent number of bonds. A bond could be purchased for $1,020 and immediately converted into stock worth $1,125—a risk-free profit opportunity.

296. DMF Company has $50 million of convertible bonds (convertible at $50) outstanding. The current market value of DMF's stock is $42. The bond indenture contains a nondilution feature. If DMF declares a 10% stock dividend, the new conversion price will be
     • The stock's current market price
     • Lower than $50
     • $50.
     • Higher than $50

     Correct answer: Lower than $50

     With an antidilution feature, the issuer will increase the number of shares available upon conversion if the company declares a stock split or stock dividend. This means the bondholder must be able to convert it to more shares, which requires a lower conversion price.

297. All of the following statements regarding convertible bonds are true except
     • The issuer pays a lower interest rate
     • Holders receive a fixed interest rate
     • Holders may share in the growth of the common stock
     • Holders receive a higher interest rate

     Correct answer: Holders receive a higher interest rate

     Because of the possibility of participating in the growth of the common stock through an increase in the market price of the common, the convertible can be issued with a lower interest rate. The interest rate on a convertible, just as with any other fixed-income security, does not change.

298. Expressed as a percentage of par, one basis point equals
     • One-one hundredth of 1%
     • One-one thousandth of 1%
     • 10%.
     • One-tenth of 1%

     Correct answer: One-one hundredth of 1%

     One basis point equals one-one hundredth of 1% of par. One percent of par ($1,000) equals $10; therefore, 1 basis point equals one-one hundredth of $10, or $0.10 (10 cents).

299. All of the following statements regarding a market not-held order are true except
     • The order ticket must be marked, not held
     • It is given to a specialist (designated market maker)
     • It gives the floor broker discretion over the price or time of execution
     • A small portion may be filled at a time

     Correct answer: It is given to a specialist (designated market maker)

     In a market not-held order, the client agrees not to hold the broker responsible if she cannot fill the complete order. Such an order allows the floor broker to use her judgment on the best execution strategy. Specialists (designated market makers) cannot accept market not-held orders.

300. If a customer wishes to change a day order to a good-til-canceled (GTC) order in the middle of the day, the registered representative should
     • Enter the new order as GTC and immediately cancel the day order
     • Enter the new GTC order immediately and do nothing about the day order
     • Enter a change notice immediately
     • Allow the day order to expire at the end of the day and put in the GTC order before the next day's opening

     Correct answer: Allow the day order to expire at the end of the day and put in the GTC order before the next day's opening

     The GTC is treated as a new order. The registered representative should wait until the close of trading so as not to lose the time priority of the original order that day.

301. An investor submits an immediate-or-cancel order to sell 800 shares of stock at 32.15. When the order reaches the trading floor, the quote is 32.18 – 32.26, $6 \times 8$. The investor
     • Sold 600 shares at 32.18
     • Sold 600 shares at 32.15
     • Did not sell any shares
     • Sold 600 shares at 32.26

     Correct answer: Sold 600 shares at 32.18

     An immediate-or-cancel order (IOC) is a limit order requiring immediate execution or cancellation. Unlike its cousin, the fill-or-kill (FOK) order, a partial fill is permitted with an immediate-or-cancel order. An IOC order to sell 800 shares at 32.15 means that the investor will accept the sale of anything up to and including 800 shares as long as the sale price is at least $32.15 per share. Sellers receive the highest bid price (the most an investor is willing to pay for the stock). At the time this order is presented, the highest bid was 32.18. Because the buyer was willing to take only 600 shares (the quote size was for 600), and the sale price exceed the limit, 600 shares are sold, and the balance of the order is canceled.

302. Which of the following would accelerate a decline in a bear market?
     • Sell stop
     • Sell limit
     • Buy limit
     • Buy stop

     Correct answer: Sell stop

     Sell stops, placed below the current market, become market orders to sell when the stock trades at or through (below) the stop price. Market sell orders can accelerate declines in the price of the stock.

303. Earlier in the day, you entered a customer order to buy 300 XYZ at 26.45 good til canceled (GTC). By late afternoon, you notice that XYZ is trading at your customer's limit price. At the close of trading, you contact the order desk and get a Nothing Done report because
     • The order was canceled at the close of trading
     • Of the small size of the order
     • Of the normal time delay between execution and execution reports
     • Of stock ahead

     Correct answer: Of stock ahead

     All limit orders stand in time priority.

304. Last week one of your customers placed a good-til-canceled order to sell 200 shares of ABC with an 18 stop when the stock was trading at $18.85. It is now the ex-date for a $0.55 dividend and the order has not yet been executed. What has happened to your customer's stop order?
     • It is increased to $18.55.
     • It is reduced to $17.45.
     • It is canceled.
     • It remains at $18.

     Correct answer: It is reduced to $17.45.

     Unless the customer has given DNR (do not reduce) instructions, open buy limit orders and open sell stop orders are reduced on the ex-dividend date by the amount of the dividend.

305. Your client has entered a limit order to buy 600 shares of DMF at $50 per share. DMF declares a 10% stock dividend. How would this order be adjusted on the ex-date?
     • 600 shares at $50
     • 660 shares at $46.50
     • 600 shares at $45.45
     • 660 shares at $46.37

     Correct answer: 600 shares at $45.45

     In this example, adjust only the share price: $50 $\div$ (1 + 0.10) = $45.45. The number of shares in the order is not adjusted unless the shares can be increased by a full round lot (100 shares).

306. An order to sell at 38.65 stop limit is entered before the opening. The subsequent trades are 38.85, 38.50, and 38.35. The order
     • Has not yet been executed
     • Was executed at 38.50
     • Was executed at 38.85
     • Was executed at 38.65

     Correct answer: Has not yet been executed

     A stop limit order is a stop order that becomes a limit order once the stop price has been triggered. On a sell stop order, the stop price is entered at a price below the current market. The order is not triggered until the market declines to or below the stop price. For this question, that means no trigger unless the stock trades at $38.65 or lower. When the limit price is the same as the stop price on a stop limit order, the order may be executed only at or better than the limit price. In this case, the order has not yet been executed because no transaction has occurred at or above the limit of 38.65 after the stop was triggered at 38.50.

307. The writer of an in-the-money put will receive the upcoming dividend from the underlying issuer if the contract is exercised
     • After the ex-date
     • On or after the ex-date
     • On the ex-date
     • Before the ex-date

     Correct answer: Before the ex-date

     When assigned, the put writer is obligated to purchase the stock. Provided the stock is purchased before the ex-date, its buyer becomes the owner of record on or before the record date and is therefore entitled to the dividend. This is no different from anyone else purchasing before the ex-date.

308. You receive a not-held order from a customer who wants you to buy 1,000 shares of ABC when the price is right. Under NYSE rules, this order is
     • A good-til-canceled order
     • A day order
     • A limit order
     • A fill-or-kill order

     Correct answer: A day order

     Unless the customer instructs you otherwise, not-held orders must be executed on the day received.

309. A customer enters an order to buy 1,000 ABC at 50, good for the week only. How will this order appear on the order book?
     • Buy 1,000 ABC 50 Day
     • Buy 1,000 ABC 50 GTC
     • Buy 1,000 ABC 50 GTW
     • Buy 1,000 ABC 50 GTM

     Correct answer: Buy 1,000 ABC 50 GTC

     Limit orders and stop orders are entered on the order book as either good til canceled (GTC) or day orders. Orders that are good for only a particular time frame (good for the week) will appear as GTC. It is the responsibility of the broker-dealer that entered the order to cancel it at the end of the week, if unexecuted.

310. Which of the following orders on the order book would be reduced for a cash dividend on the ex-date?
     • Buy 100 XYZ at 50 DNR
     • Sell 100 XYZ at 50 stop
     • Sell 100 XYZ at 60
     • Buy 100 XYZ at 60 stop

     Correct answer: Sell 100 XYZ at 50 stop

     Orders on the book adjusted on the ex-date for a cash dividend are those below the current market: buy limits and sell stops. The buy limit at 50 is marked DNR (do not reduce), so the only order reduced is the sell stop at 50.

311. A customer has sold short 100 GM at 70. GM is selling for 81. The customer had previously placed a good-til canceled buy stop order at 83. GM announces a stock split and an increase in the dividend. The stock starts to move up and the customer decides to cover the short sale at a loss and instructs his broker to buy 100 shares of GM at the market. The registered representative will
     • Buy 100 GM at the market
     • Sell 100 GM at the market
     • Sell 100 GM at 83
     • Buy 100 GM at the market and cancel the order to buy 100 GM at 83 stop good til canceled

     Correct answer: Buy 100 GM at the market and cancel the order to buy 100 GM at 83 stop good til canceled

     To cover a short sale, the customer must buy stock back, so the registered representative executes the customer's market order to buy 100 GM. In addition, it is incumbent upon the registered representative to cancel the old, now-redundant good-til-canceled buy stop order at 83. Both actions are required: buy at the market to cover the short, and cancel the stale GTC buy stop.

312. A customer tells a broker to buy 1,500 shares of ABC at 33.60 immediately for the full 1,500 shares. This is
     • A good-til-canceled order
     • An all-or-none (AON) order
     • A fill-or-kill (FOK) order
     • An immediate-or-cancel (IOC) order

     Correct answer: A fill-or-kill (FOK) order

     In an FOK order, the instruction is to fill the entire order immediately at the limit price or better. If this cannot be done, the order will be canceled (killed). An IOC order is similar, except that partial execution is acceptable. An AON order must be filled in its entirety. However, it can be filled over time; it does not require immediate execution.

313. At 2:00 pm ET, a customer enters an order to buy GGZ at the close on the NYSE. GGZ traded between 70 and 71 all day. Then, after a last-minute rally, it closed up 4 points at 74. The customer should expect to pay
     • The price as near to the close as possible, at the floor broker's discretion
     • The closing price
     • The average price calculated for the entire day
     • The opening price the next morning

     Correct answer: The closing price

     When an order is placed market at the close on an exchange, a customer should expect execution at the closing price.

314. An order designated fill-or-kill (FOK) means that the order must be executed
     • At the opening of trading
     • Immediately but not necessarily entirely
     • In its entirety but not immediately
     • Immediately and in its entirety

     Correct answer: Immediately and in its entirety

     FOK orders must be executed immediately in their entirety or they are canceled.

315. One of your clients has a profit in STV common stock. The purchase price was $40 per share and is now $60 per share. The client is looking to take the profit and feels the stock still has a bit more growth. The client's strategy is to enter a sell limit order at $62. It is critical that the client understand that
     • If the stock never reaches $62, the order will never be executed
     • Entering this order erases the holding period of the stock
     • The order becomes a market order when the price of $62 is reached
     • The sell limit order should be entered below the current market price

     Correct answer: If the stock never reaches $62, the order will never be executed

     One of the risks with a limit order, buy or sell, is that the stock may never reach the price limit. In that case, the order is never executed. For this client, if the stock climbs to $61.99 and then plunges, the client has lost out on much or maybe all of the profit. Because the order can never be executed below the price limit, it never becomes a market order. It is purchasing a put option on stock held less than 12 months and one day where the holding period is erased.

316. All open orders must be confirmed to the order book
     • Once a year on the anniversary of the order
     • The last business days of April and October
     • April 1 and October 1.
     • Every six months after the order has been entered

     Correct answer: The last business days of April and October

     All open orders must be confirmed the last business day of April and the last business day of October.

317. All of the following orders could be placed on the designated market maker's order display book except
     • Stop orders
     • Market orders
     • Limit orders
     • Stop limit orders

     Correct answer: Market orders

     Market orders are executed immediately. The order display book is for orders that are away from the current market, such as stop and limit orders.

318. A customer sold 100 shares of QRS short when the stock was trading at 19. If QRS is now trading at $14, and she wants to protect her gain, which of the following orders should she place?
     • Sell limit at 14
     • Buy limit at 14
     • Sell stop at 13.75
     • Buy stop at 14.25

     Correct answer: Buy stop at 14.25

     A buy limit order is used to buy at a lower price (when the market moves down). A buy stop order is used to buy in a short position at a higher price (when the market moves up). To protect the gain, a buy stop order would be placed just above where the stock is currently trading.

319. KLP common stock has been trading at or near $25 per share all day. Your client would like to buy 500 shares of KLP at 25, but he is willing to accept fewer shares at that price. Which of the following orders fulfills his intentions?
     • Market order to buy 500 shares of KLP
     • Limit order to buy 500 shares of KLP at 25 IOC (immediate-or-cancel)
     • Limit order to buy 500 shares of KLP at 25 FOK (fill-or-kill)
     • Limit order to buy 500 shares of KLP at 25 AON (all-or-none)

     Correct answer: Limit order to buy 500 shares of KLP at 25 IOC (immediate-or-cancel)

     Partial execution is permissible on an IOC order.

320. One of your clients has a profit in STV common stock. The purchase price was $40 per share and is now $60 per share. The client is concerned that the stock might backtrack and some of the profit might be lost. One way to protect that profit would be to
     • Enter a sell limit order at $55
     • Enter a sell limit order at $62
     • Enter a sell stop order at $62
     • Enter a sell stop order at $55

     Correct answer: Enter a sell stop order at $55

     Stop orders, frequently called stop-loss orders, are used to protect an existing profit or prevent a loss. In the case of a client owning stock, the fear is that the stock will decline in price. Sell stop orders are always placed below the current market, never above. In this question, should the stock's price fall to 55 (or lower), the stop order will be triggered and a market order entered. This will preserve at least some of the profit. Sell limit orders are placed above the market, but that will never be executed unless the stock rises to at least $62. A sell limit order placed below the current market is, in effect, a market order and is immediately executed.

321. Under NYSE rules, a not-held order
     • Requires discretionary authority from the customer
     • Is good for the day only
     • Is good til canceled
     • Is a limit order

     Correct answer: Is good for the day only

     Under NYSE rules, a not-held order where a customer gives you authority over the price or timing of the order is good for that day only.

322. If a customer gives his broker-dealer an order to sell his stock if it falls to or below 69 and will not accept a price below 69, the order is
     • A stop limit order
     • A sell limit order
     • A stop order
     • A buy limit order

     Correct answer: A stop limit order

     When an order is entered this way, the client has specified that it should not be triggered until the stock is at or below 69, a stop order. Because the client will not accept an execution below 69, it is a stop limit order.

323. For a client to get immediate execution on an order, it should be placed as which of the following?
     • All-or-none
     • Market
     • Good-til-canceled
     • Stop

     Correct answer: Market

     A market order is executed immediately at the best available market price.

324. A significant increase in which of the following types of orders may cause a bull market to accelerate?
     • Buy stops
     • Short sales
     • Sell stops
     • Buy limits

     Correct answer: Buy stops

     If the market is rising, only those orders on the order book above the current market will be executed. Buy stops and sell limits are both entered above the prevailing market price. Of these two, only buy orders (in this case buy stops) will accelerate a rise in the market.

325. Stop orders may be used for each of the following except
     • To establish positions
     • To protect profits on short positions
     • To lock in a specific price to close out a position
     • To protect profits on long positions

     Correct answer: To lock in a specific price to close out a position

     Stop orders are contingent orders that are triggered when the stock trades at or through a stated price. When triggered, they become market orders to buy or sell. They are used by technical traders to establish positions above or below resistance and support levels, respectively. Stop orders never guarantee a specific execution price.

326. One of your customers submits a market on close (MOC) order to sell 300 shares of IYH common stock, traded on the NYSE. The order is entered just before noon ET. At 3:00 pm, trading in IYH is halted for the remainder of the day. What does this do to the customer's order?
     • The order is cancelled.
     • The customer receives the price of the last trade before the halt.
     • The order is carried over to the following business day.
     • The order is carried over to the next day that IYH stock is traded.

     Correct answer: The order is cancelled.

     Market on close (MOC) orders are cancelled if there is a halt in trading of the stock before the market close. ** This question deals with material not covered in your study materials, but it relates to recent rule changes and/or student feedback.

327. A buy stop order is elected (triggered) when the underlying stock trades
     • Anywhere below the stop price
     • At or below the stop price
     • Through the stop price only
     • At or above the stop price

     Correct answer: At or above the stop price

     A buy stop order is placed above the prevailing market price and is elected (triggered), becoming a market order to buy when the stock trades at or through (above) the stop price.

328. On the morning of the ex-date for a cash dividend, which of the following orders on the order book will not be reduced?
     • Buy limit
     • Sell stop limit
     • Sell limit
     • Sell stop

     Correct answer: Sell limit

     It is sell limit and buy stop orders that are placed above the market and are not reduced. Orders entered below the prevailing market [unless marked DNR (do not reduce)] are reduced on the morning of the ex-date by the amount of the cash dividend. Those orders are buy limits and sell stops, including sell stop limits.

329. A client enters a buy stop order for 100 shares of XYZ at 40. Trades then oc­cur at 38, 39, 39.90, 40.05, 40.10, and 39.78. At what price is the order triggered?
     • $40.10
     • $39.00
     • $39.78
     • $40.05

     Correct answer: $40.05

     The order is triggered as soon as the price gets to 40 or higher. That would be the trade at 40.05. A typical use of a buy stop order is to protect a short stock position. Because the short stock position has unlimited potential loss, the short seller can gain protection by entering a buy stop order. That order is entered at a price above the current market (the short seller is hoping the price will fall), but if the price reaches or exceeds the stop price, the stop will be triggered. At that time, a market order is entered and the client pays the next price (which could be more or less than 40). In this case, the next price is 40.10, and although not the answer to our question, that is the likely price per share paid by the client.

330. A market order to purchase 100 shares of XYZ common stock is
     • Executed at the market close
     • Executed at the lowest price of the day
     • Good for that day only
     • Valid at the stipulated price only

     Correct answer: Good for that day only

     A market order is executed at the best price in the market at the time the order is entered. Because these orders have guaranteed execution (there is always a "best" price), there would be no practical reason for the order to be carried over to another day. There is a market on close order, but that would have to be specified in the order. A stipulated price is a limit order.

331. At 2:15 pm ET, a customer gives his registered representative a market order to buy 100 shares of ABC at the close. What should the registered representative do with the order?
     • Hold it at his desk until just before market close.
     • Send the order to the floor immediately.
     • Execute the order at the closing price first thing next morning.
     • Send in the order after the close to ensure he receives the closing price.

     Correct answer: Send the order to the floor immediately.

     The registered representative should mark the order ticket at close. His firm's floor broker will take on the responsibility for proper execution.

332. If a customer with an unrealized gain on a short stock position wishes to protect her profit, she should enter
     • A sell stop order
     • A buy limit order
     • A sell limit order
     • A buy stop order

     Correct answer: A buy stop order

     A buy stop order can be placed above the current market to protect the short stock position. If the stock trades at or above the stop price, the order is elected and becomes a market order to buy the stock, which will be used to cover the short position.

333. A customer entered an order to sell short 100 shares of ABC. The stock closed on Friday at $48. The stock will trade ex-dividend $0.50 on Monday. At what price can the order be executed at the opening?
     • $47.51
     • Any price
     • $47.49
     • $47.50

     Correct answer: Any price

     The stock's price is adjusted for the dividend at its opening the next morning. The adjustment in the stock does not limit where the short sale can be executed. The former requirement for short sales on an exchange floor (or Nasdaq) to be made on a plus or zero-plus tick was eliminated in 2008. Therefore, a customer short sale can be executed at any time in the trade sequence.

334. An investor sold 100 shares of MAS short when the stock was trading at 21. If MAS is now trading at 16, and the investor wants to protect her gain, which of the following orders should she place?
     • Sell limit at $16
     • Buy limit at $16
     • Sell stop at $16.25
     • Buy stop at $16.10

     Correct answer: Buy stop at $16.10

     A buy stop order is used to buy in a short position at a higher price (when the market moves up). To protect the gain, a buy stop order would be placed just above where the stock is currently trading. In this case with the stock trading at 16, a buy stop of 16.10 is the best choice.

335. An investor submits an immediate-or-cancel order to buy 500 shares of stock at 32.20. When the order reaches the trading floor, the quote is 32.18 – 32.26, $6 \times 6$. The investor
     • Bought 500 shares at 32.20
     • Bought 500 shares at 32.18
     • Did not buy any shares
     • Bought 500 shares at 32.26

     Correct answer: Did not buy any shares

     An immediate-or-cancel order (IOC) is a limit order requiring immediate execution or cancellation. Unlike its cousin, the fill-or-kill (FOK) order, a partial fill is permitted with an immediate-or-cancel order. An IOC order to buy 500 shares at 32.20 means that the investor will buy up to and including 500 shares as long as the purchase price is at no higher than $32.20 per share. Buyers pay the lowest ask price (the least a seller is willing to accept for the stock). At the time this order is presented, the lowest ask was 32.26. Even though the seller was willing to sell all 500 shares (the quote size was for 600), the price is not low enough, so the order is canceled.

336. A customer, concerned about a possible pull-back in XYZ stock, instructs her broker to "Sell my XYZ stock if it falls to 40, but I don't want less than 39.75 for my shares." The broker should enter
     • A sell limit order
     • A market order to sell
     • A sell stop order
     • A sell stop limit order

     Correct answer: A sell stop limit order

     A sell stop limit order would be appropriate (sell 100 XYZ 40 stop 39.75). Once the price of XYZ trades at or through (below) 40, the order is elected and becomes a limit order to sell at 39.75 or better (higher).

337. When a major decline occurs within a few minutes of the close, trading is halted on all markets for the remainder of the trading day. Under the market-wide circuit breaker (MWCB) rules, market-on-close (MOC) orders pending at the time trading is halted
     • Should be held for execution on the following trading day unless canceled by the customer
     • Are converted to market orders and executed at the opening on the following trading day
     • Should be held for execution on the following trading day
     • Must be canceled

     Correct answer: Must be canceled

     During shorter market-wide trading halts that will allow trading to resume on that same trading day, pending and new incoming orders should be forwarded to the appropriate market for execution upon the resumption of trading. If a halt closes the market for the remainder of the trading day, MOC orders pending at the time trading is halted should be canceled. MOC orders received after trading is halted should be declined.

338. Each of the following statements concerning fill-or-kill (FOK) orders and all-or-none (AON) orders are true except
     • An AON order must be canceled if the whole order cannot be executed immediately
     • An AON order must be filled in its entirety
     • An FOK order must be canceled if the whole order cannot be executed immediately
     • An FOK order must be filled in its entirety

     Correct answer: An AON order must be canceled if the whole order cannot be executed immediately

     An FOK order must be executed immediately in its entirety or else it is canceled. An AON order must be executed in its entirety but is not canceled if the whole order cannot be executed immediately.

339. An investor submits an immediate-or-cancel order to sell 500 shares of stock at 32.20. When the order reaches the trading floor, the quote is 32.18 – 32.26, $6 \times 6$. The investor
     • Sold 500 shares at 32.18
     • Sold 500 shares at 32.26
     • Sold 600 shares at 32.26
     • Did not sell any shares

     Correct answer: Did not sell any shares

     An immediate-or-cancel order (IOC) is a limit order requiring immediate execution or cancellation. Unlike its cousin, the fill-or-kill (FOK) order, a partial fill is permitted with an immediate or cancel order. An IOC order to sell 500 shares at 32.20 means that the investor will accept the sale of anything up to and including 500 shares as long as the sale price is at least $32.20 per share. Sellers receive the highest bid price (the most an investor is willing to pay for the stock). At the time this order is presented, the highest bid was 32.18. Even though the buyer was willing to take all 500 shares (the quote size was for 600), the price is not high enough, so the order is canceled.

340. Which of the following orders on the order book will not be filled if the stock rises?
     • Buy stops
     • Sell stop
     • Sell limit
     • Buy stop limit

     Correct answer: Sell stop

     Those orders on the book which are above the current market will be executed if the stock rises. Those open orders above the current market are buy stops (including buy stop limits) and sell limits.

341. A technical analyst has been charting XYZ stock and notes that it fluctuates between $36 and $41. The last trade was at $39. If the analyst expects a breakout through resistance, which of the following orders should be placed?
     • Buy XYZ 35 Stop GTC
     • Buy XYZ 35 GTC
     • Buy XYZ 42 Stop GTC
     • Buy XYZ 42 GTC

     Correct answer: Buy XYZ 42 Stop GTC

     A breakout through the resistance ($41) signifies, at least to a technical analyst, that the stock will continue to increase in price. This is a bullish sign. A buy stop order is placed above a resistance level. It is triggered if and when the stock trades at or above the stop price. This allows an investor to participate in a bullish breakout through the resistance. Why not enter "Buy XYZ 42 GTC"? That order calls for the stock to be purchased at a price of 42 or better (lower). With the current price at $39 per share, this is, in essence, a market order, and the stock is bought at the best price in the market. That defeats the purpose of not buying until the breakout is confirmed.

342. A buy stop order may be used for all of the following except
     • To protect a profit in a long position
     • To protect against loss in a short position
     • To acquire a long position as a stock breaks through resistance
     • To protect a profit in a short position

     Correct answer: To protect a profit in a long position

     Buying can only protect short positions, not long positions.

343. A technical analyst has been charting ABC stock and notes that the support/resistance levels are $20 and $30, respectively. If the analyst expects ABC to fall through support, which of the following orders should he enter?
     • Buy 100 ABC 20.50 stop
     • Sell 100 ABC 19.50 stop
     • Sell 100 ABC 29.75 stop
     • Buy 100 ABC 30.25 stop

     Correct answer: Sell 100 ABC 19.50 stop

     An analyst who expects a stock to fall through support is anticipating that the stock will decline. He can take advantage of this trend by establishing a short position at the top of the decline. He will enter a sell stop order just below the support price.

344. A client enters a buy stop order for 100 shares of XYZ at 40. Trades then oc­cur at 38, 39, 39.90, 40.05, 40.10, and 39.78. What is the likely price the client paid for the stock?
     • $40.05
     • $39.78
     • $40.10
     • $39.00

     Correct answer: $40.10

     The order is triggered as soon as the price gets to 40 or higher. That would be the trade at 40.05. A typical use of a buy stop order is protecting a short stock position. Because the short stock position has unlimited potential loss, the short seller can gain protection by entering a buy stop order. That order is entered at a price above the current market (the short seller is hoping the price will fall), but if the price rises, the stop will be triggered. At that time, a market order is entered and the client pays the next price (which could be more or less than 40). In this case, the next price is 40.10 and that is the likely price per share paid by the client.

345. Which of the following order types is permitted in Nasdaq and NYSE equity markets?
     • Stop orders.
     • Fill or kill (FOK)
     • Good til canceled (GTC)
     • Market

     Correct answer: Market

     Market orders are permitted on both of these major trading markets. Fill or kill, GTC, and stop orders may no longer be entered in the Nasdaq and NYSE equity markets. Most large broker-dealers provide the service of handling these orders.

346. Each of the following is true about stop orders except
     • They can accelerate the advance or decline of a stock's price if executed
     • They become market orders when there is a trade at, or the market passes through, a specific price
     • They are the same as limit orders
     • They can limit a loss in a declining stock

     Correct answer: They are the same as limit orders

     A stop order becomes a market order once the market price reaches or passes through the stop price. An investor in a long position can use the sell stop order for protection against a market decline. When a large number of stop orders are triggered at a particular price, the advance or decline of the market at that point can be magnified.

347. Which of the following orders is reduced on the order book on the ex-dividend date for a cash dividend?
     • Buy stop order
     • Sell limit order
     • Buy stop limit order
     • Limit order to buy

     Correct answer: Limit order to buy

     Only orders placed below the market price are reduced for cash dividends on the order book. Buy limits and sell stops are entered below the market price.

348. A customer has an order to buy 400 ABC at 60. ABC declares a 25% stock dividend. On the ex-date, the order on the order book will read
     • Buy 500 shares at 30
     • Buy 425 shares at 50
     • Buy 500 shares at 48
     • Buy 400 shares at 60

     Correct answer: Buy 500 shares at 48

     For stock dividends, all buy limit orders on the book are adjusted and the order value must be the same before and after the adjustment. Before the adjustment, 400 ABC at 60 stop = $24,000 total value. After the adjustment, total shares on the buy order will be 500 ($400 \times 25\% = 100$ new shares, $400 + 100 = 500$). To arrive at the new price, divide the total order value by the new number of shares ($24,000 $\div$ 500 shares = 48). After the adjustment the new order will read; buy 500 shares at 48.

349. All of the following kinds of orders may be turned over to the specialist (designated market maker) for execution except
     • Not-held orders
     • Limit orders
     • Stop orders
     • Market orders

     Correct answer: Not-held orders

     A not-held order is a market order in which the investor has given the authority to choose the price and time to the floor broker to achieve the best possible execution.

350. A representative enters a customer's immediate-or-cancel (IOC) order to sell 1,000 shares at $12. If only 500 shares can be sold at $12, which of the following will occur?
     • Because 500 shares can be sold, the balance of the order will remain as a sell limit order for 500 shares at $12.
     • None of these.
     • Because the entire order cannot be filled, the entire order will be canceled unexecuted.
     • The 500 shares will be sold at $12; the remainder of the order will be canceled unexecuted.

     Correct answer: The 500 shares will be sold at $12; the remainder of the order will be canceled unexecuted.

     An IOC order will take a partial fill. Time is the limiting factor in an IOC.

351. There are a number of different types of orders that a registered representative can enter for a client. Of the following, which one has the greatest assurance of being executed?
     • A limit order
     • A buy stop order
     • A market order
     • A sell stop order

     Correct answer: A market order

     Market orders are executed immediately at the best available price in the market. The other choices all have a specified price. There is no assurance that price will ever be reached.

352. Each of the following types of orders will remain open (working orders) until certain conditions are met, except
     • Market orders
     • Stop orders
     • Good-till-canceled orders
     • Stop limit orders

     Correct answer: Market orders

     A market order is executed immediately at the prevailing market price. A stop, or stop limit, order is not triggered until a set price is hit or passed through. A good-til-canceled order remains open until executed or canceled.

353. An order ticket is marked as follows: Buy 10 GGZ 9% debentures at 95 AON good til canceled (GTC). All of the following statements regarding this order are true except
     • The order will expire at the end of the day
     • This is a buy limit order
     • If executed, the customer will pay $9,500 or less for the bonds
     • The trade will be filled in its entirety or not at all

     Correct answer: The order will expire at the end of the day

     The customer has placed a limit order to buy 9% debentures issued by GGZ. The limit the customer is willing to pay is 95% of $10,000 worth of bonds, or $9,500 or lower. AON means all-or-none (either fill the order in its entirety or do not execute the order). GTC is a good-til-canceled order, not a day order.

354. AMZ Corporation has declared a cash dividend of $1.10. On the ex-dividend date, an open order to buy AMZ at 52 stop would
     • Remain at 52 stop
     • Be automatically adjusted to 53.10 stop
     • Be automatically adjusted to 51.90 stop
     • Be automatically adjusted to 52.10 stop

     Correct answer: Remain at 52 stop

     When a stock goes ex-dividend, the price of the stock falls by the amount of the dividend. This would require an adjustment in the amount of the dividend to orders placed below the market. This is a buy stop order and those are placed above the market so there is no adjustment to the price. Remember the SLoBS, where the Sell Limits and Buy Stops are above the market, and BLiSS, the Buy Limits and Sell Stops are below the market

355. A designated market maker is permitted to do all of the following except
     • Accept a not-held order
     • Represent a bid and offer simultaneously
     • Buy and sell for a proprietary account
     • Accept a limit order

     Correct answer: Accept a not-held order

     A specialist (designated market maker) on the floor does not deal directly with the public. Therefore, a designated market maker cannot accept any order that requires the exercise of discretion. A not-held order is one in which the floor broker can choose the price or time of execution.

356. A customer sells short 100 shares of XYZ Corporation at $78 per share. The support and resistance levels for XYZ are at $70 and $80, respectively. If he wishes to protect his position, which of the following is the best place to put in a buy stop order?
     • $80.10
     • $70.10
     • $78.10
     • $69.85

     Correct answer: $80.10

     The client will want to place a buy stop a little above the resistance level to protect himself against an upside breakout. Entering a buy stop order too close to the purchase price (78.10) would not afford the client an opportunity for gain.

357. An investor sold 100 shares of RAN common stock short at $50 per share. The RAN is now at $38. The investor is still bearish on the stock but would like to protect that gain. What would you recommend if this were your client?
     • Enter a buy stop order at $55
     • Enter a sell order at $40
     • Enter a buy stop order at $40
     • Enter a sell stop order at $40

     Correct answer: Enter a buy stop order at $40

     Buy stop orders are used as a protective tool for short sellers. In this case, if the stock should begin to rise from its current price of $38, once it reaches or exceeds $40, a buy order at the market is entered. The stock purchased is used to cover the short position, and the investor's profit is the $50 sale price minus the cost of the purchase. Buy stops are always placed above the current market. Because the investor is short, the only protective order would be a buy, not a sell (you buy protection)..

358. A broker-dealer informs a customer that her order was not executed because of stock ahead. The order was most likely
     • A margin purchase
     • A market order
     • A limit order
     • A short sale

     Correct answer: A limit order

     When there are a number of limit orders entered at the same price, they are filled in the order in which they have been received. It is possible that those orders received later could not be executed because the execution of the earlier orders has caused the market price to move away from the limit price. Market orders are always executed at the best price in the market (even though that might be far away from what the investor expected). If the investor wants immediate execution—turn in a market order. If the client wants a specific price—turn in a limit order but give the warning that it might never be executed.

359. A customer places an order to buy 300 DWQ at 140 stop, but not over 140.25. This is
     • A buy stop order
     • A buy limit order
     • A market not-held order
     • A buy stop limit order

     Correct answer: A buy stop limit order

     The customer has entered a stop limit order. If the stock rises to the stop price of $140, the order is elected and then becomes a buy limit order at 140.25, meaning an order to buy at 140.25 or lower.

360. What type of order provides that market activity can cause activation, but it is possible that the trade itself may or may not be executed?
     • A market order
     • An open buy order
     • A stop order.
     • A stop limit order

     Correct answer: A stop limit order

     With a stop limit order, if the stock price trades at or through the specified stop price, the order will be triggered or activated and become a limit order. But remember, a limit order may not be executed because the limit price may never be reached.

361. There are a number of different types of orders that a registered representative can enter for a client. Of the following, which one would be most appropriate for a client wishing to protect a profit on a short stock position?
     • A buy stop order.
     • A buy limit order.
     • A sell limit order.
     • A sell stop order

     Correct answer: A buy stop order.

     Protecting a profit on a short position means covering (buying back) the stock before its price increases above the original sale price. That means buying the stock. The investor would enter the buy stop order with a stop price above the current market, but below the original sale price. A buy limit order is placed below the market, and that is of no help if the price increases. A market order is executed at once, and selling the stock is not appropriate when the investor has already sold it.

362. A day order is entered to buy 500 LMN at 24.35. By the close of the trading day the firm has been able to purchase 100 shares at 24.25 and 200 shares at 24.35. If the remainder of the order is unfilled, what is the outcome?
     • The customer must accept the execution for 300 shares, and the remainder of the order is canceled after the close.
     • The customer may reject the incomplete order unless the remainder can be filled within three business days.
     • The customer may demand that the firm deliver the remaining shares at 24.35.
     • The customer may reject the incomplete order unless the broker-dealer can guarantee filling the remainder by the end of the day.

     Correct answer: The customer must accept the execution for 300 shares, and the remainder of the order is canceled after the close.

     The customer must accept the order for 300 shares. The representative cannot guarantee that the order will be filled by the end of day.

363. All of the following statements about trading index options on the Chicago Board Options Exchange are true except
     • Market orders entered by a market maker have priority over public orders
     • Market makers may trade for their own accounts
     • Floor brokers may execute orders for others on a commission basis
     • Limit orders are maintained in an order official's book

     Correct answer: Market orders entered by a market maker have priority over public orders

     Public orders must be filled before member orders. This is true if it is stock, bonds, and options of any kind.

364. There are a number of different types of orders that a registered representative can enter for a client. Of the following, which one would be most appropriate for a client wishing to protect a profit on a long stock position?
     • A sell limit order.
     • A sell stop order
     • A buy stop order
     • A market order

     Correct answer: A sell stop order

     Protecting a profit on a long position means getting out of the stock before its price declines below the original purchase price. That means selling the stock. The investor would enter the sell stop order with a stop price below the current market, but above the original cost. A sell limit order is placed above the market and that is of no help if the price drops. A market order is executed at once and buying the stock is not appropriate when the investor already owns it.

365. When referring to a stock, the term spread refers to
     • The range between the high and low price for a particular year
     • The dealer's markup
     • The difference between the bid and asked prices
     • The range between the high and low price for a particular trading day

     Correct answer: The difference between the bid and asked prices

     The term spread refers to the difference between the bid and asked prices.

366. XYZ Corporation has set Friday, January 23, as the record date for its next quarterly dividend distribution. To receive the dividend, a customer, long 1 XYZ Feb 40 call, must issue exercise instructions on or before
     • Monday, January 19.
     • Wednesday, January 21.
     • Tuesday, January 20.
     • Friday, January 23.

     Correct answer: Wednesday, January 21.

     Dividends are paid to investors who are owners of record as of the close of business on the record date. When a call option is exercised, money and stock are exchanged (settlement) on the first business day after notice is given to the Options Clearing Corporation (T+1). To be an owner of record by the record date (Friday, January 23), the stock must be acquired no later than the business day before the ex-date. With T+1 settlement, the ex-date is one business day before the record date (Thursday, January 22), so the customer must exercise the call no later than Wednesday, January 21. This is no different from anyone else purchasing stock before the ex-date.

367. A customer has his broker enter an order to buy GHI stock at the opening. Though transmitted promptly, the order does not reach GHI's trading post in time to be filled at the opening. How is the order handled?
     • The order is handled as a market order.
     • The order is executed in the day, at a price as close to the opening price as possible.
     • The order is canceled.
     • The order automatically becomes an at-the-open order in the following trading session.

     Correct answer: The order is canceled.

     An at-the-open order is to be filled at the opening price or not at all. An at-the-open order arriving later must be canceled.

368. Your client feels that GGZ, currently trading around 39, would be a good buy at 38. Therefore, she places an order to buy 200 GGZ at 38 GTC. On the ex-date, when the stock splits 2:1, the order is still on the order book. How is the order adjusted on the ex-date?
     • Buy 400 GGZ at 19 GTC
     • Buy 200 GGZ at 19 GTC
     • Buy 100 GGZ at 76 GTC
     • Buy 400 GGZ at 38 GTC

     Correct answer: Buy 400 GGZ at 19 GTC

     In a stock split, the number of shares is increased and the price is reduced proportionately on the ex-date ($200 \text{ shares} \times 2 = 400 \text{ shares}$; the new price is $38 \times 0.5$, or 19).

369. If a Nasdaq market maker is selling stock to a customer from inventory and the firm has held the shares to be sold for several months, what price should the dealer use as a basis for a markup?
     • Price at which it purchased the securities
     • Best offering price quoted in the interdealer market
     • Broker/dealer's own current offer price
     • Offer price shown in the electronic OTC Pink on the day of the current sale

     Correct answer: Best offering price quoted in the interdealer market

     FINRA rules require that a dealer's markup to a customer be based on the current market rather than the dealer's cost in an active, competitive market. The dealer's potential loss on inventory is considered to be a risk of making a market.

370. Last-sale information is always available for all of the following securities except
     • Nasdaq.
     • NYSE listed.
     • Over the counter (OTC), non-Nasdaq
     • CBOE listed option contracts.

     Correct answer: Over the counter (OTC), non-Nasdaq

     Last-sale information is available for listed (exchange-traded) securities and for all Nasdaq securities. While there are a number of sources for last-sale information in general, it may not always be available for a security that is OTC non-Nasdaq.

371. To fill a customer buy order for 800 WXYZ shares, your firm requests a quote from a market maker for 800 shares. The response is "bid 15, ask 15.25." If the order is placed, the market maker must sell
     • 100 shares at $15.25 per share.
     • 800 shares at $15 per share.
     • 800 shares at no more than $15 per share.
     • 800 shares at $15.25 per share.

     Correct answer: 800 shares at $15.25 per share.

     A market maker is responsible for honoring a firm quote. If no size is requested by the inquiring trader, a quote is firm for 100 shares. In this example, the trader requested an 800-share quote, so the market maker is responsible for selling eight round lots of 100 shares at the ask price of $15.25 per share.

372. An over-the-counter (OTC) quote that must be reconfirmed with the OTC trading room before a broker-dealer takes action is
     • Third party
     • Subject
     • Representative
     • Firm

     Correct answer: Subject

     Before a trade can take place, a subject quote always must be reconfirmed with the OTC trader or market maker that provided it. Subject quotes are typically used in conjunction with thinly traded securities or before filling large block orders.

373. A client of yours wishes to sell 400 shares of LMNO common stock. You contact your trading desk and receive the following quote: "We are currently quoting LMNO at 42-42.15, 6 by 4." You report this to the client who says, "Do it." The customer will receive
     • $4,200.
     • $16,800.
     • $16,860.
     • $4,215.

     Correct answer: $16,800.

     The statement from the trading desk indicates a firm quote. When the client is selling, the price received is the dealer's bid price. This quote indicates that the firm is willing to buy up to 600 shares at the bid price. Multiply 400 shares times the bid of $42 per share to arrive at $16,800. If the client was a buyer, the cost would be the ask price of $42.15 ($16,860). The other two choices are for students who didn't notice the client had 400 shares.

374. A financial intermediary that offers to buy an asset at a bid price and to sell the same asset at an ask price is best described as
     • An investment adviser
     • A market maker
     • A broker
     • An arbitrageur

     Correct answer: A market maker

     Market makers maintain an inventory of securities and profit from a bid-ask spread. They are acting in a principal (dealer) capacity as either the buyer or the seller. Brokers locate counterparties for buyers and sellers. They act in an agency capacity. Arbitrageurs seek to earn a riskless profit by buying an asset in one market and simultaneously selling the same asset for a higher price in another market. The function of investment advisers is rendering advice. They do not maintain quotes to buy and sell a security.

375. In performing their natural job functions, all of the following may act in a principal capacity in a transaction with customers except
     • Broker-dealers
     • OTC market makers.
     • Designated market makers (DMM) on the NYSE
     • Branch managers of FINRA member firms

     Correct answer: Branch managers of FINRA member firms

     When acting as a principal in a transaction, you are buying for or selling from inventory. Although branch managers of member firms are generally required to be registered as principals, that is different from acting in a principal capacity in a transaction. DMMs facilitate trading on the floor of the NYSE. Doing that sometimes requires them to buy or sell as principals. OTC market makers, by definition, act as principals. The term broker-dealer means that the firm can act either as a broker or a dealer. There are a number of words used in this exam than can have multiple meanings. Principal is one of those.

376. An over-the-counter (OTC) trader's quote of "60 to 63, work out," in response to a broker holding a customer order to sell a block of stock, indicates which of the following?
     • The quote is firm and the customer can sell an unlimited amount of stock at 60 or buy at 63.
     • The quote is tentative (nominal), merely suggesting a range in which the order is likely to be filled.
     • The quote is firm but the market maker must be given discretion over when the transaction will take place.
     • The market maker guarantees that a customer buy order can be filled no higher than 60.

     Correct answer: The quote is firm and the customer can sell an unlimited amount of stock at 60 or buy at 63.

     The term work out means that the quote is approximate, or nominal. As with a subject quote, the OTC trader that supplied the quote will most likely negotiate with a number of market makers to get the customer's securities sold or bought.

377. FINRA considers all of the following as prohibited conduct except
     • Honoring firm quotes
     • Backing away
     • Trade shredding
     • Interpositioning.

     Correct answer: Honoring firm quotes

     Member firms are obligated to honor their firm quotes. Doing so is what is expected of them and is certainly not prohibited conduct. Backing away is the prohibited practice of failing to honor firm quotes. Interpositioning is placing a third party between the broker-dealer and the best available quote. This invariably results in a less favorable execution for the customer. Trade shredding is mentioned nowhere in the course other than this question. It is here to improve your in test-taking skills. On the real exam, you will see answer choices you have never heard of. So what. You know that honoring a firm quote is exactly what your firm must do. If that is the correct answer, don't worry about trade shredding other than to make a note on your board at the test center that it is a prohibited practice just in case it shows up again.

378. Failure to honor a firm quote is called
     • Trading ahead
     • Backing away
     • Interpositioning
     • Front running

     Correct answer: Backing away

     Failure to honor a stated quote is a rules violation called backing away.

379. Sell order tickets must be
     • Marked only if they are short sales
     • Marked as either long or short
     • Executed in accordance with the appropriate rules, but not necessarily marked
     • Marked only if they are long sales

     Correct answer: Marked as either long or short

     Every sell order must be marked as either a long sale or a short sale.

380. Establishing short positions is typical for all of the following except
     • Preferred stock
     • Municipal bonds
     • Listed stock
     • Over-the-counter common stock

     Correct answer: Municipal bonds

     Even though there is no regulation that prohibits short sales of municipal bonds, this is rarely done. To short a security, it must be borrowed and later covered. The general illiquidity of the municipal market makes this difficult.

381. The locate requirement of Regulation SHO for short sales does not apply to
     • Over-the-counter equity securities
     • "B) American depositary receipts traded on the Nasdaq Stock Market.
     • Preferred stock traded on the NYSE
     • Nonconvertible bonds traded on the NYSE

     Correct answer: Nonconvertible bonds traded on the NYSE

     The locate requirement is applicable to all short sales of equity securities. It is unlikely to be tested, but, just in case, for purposes of this rule, convertible bonds are considered equity securities.

382. An investor places an order to sell short ABC at the open. The opening bid of $15.25 is the same as the prior day's close. At what price may the investor sell short at the open?
     • $15.26
     • $15.24
     • $15.25
     • The investor is prohibited from selling short at the open

     Correct answer: $15.25

     Short sales can occur any time during the trading day, including the opening and the close. In this case, the sale would take place at the best bid, which is $15.25.

383. An investor places a market order to sell short 200 shares of ABC stock. The order is filled at $23.45 per share. Assuming the investor can cover the short by purchasing the shares at $20 per share, calculate the gain or loss.
     • Gain of $690
     • Loss of $690
     • Loss of $345
     • Gain of $850

     Correct answer: Gain of $690

     A short seller makes a profit when the stock sold short can be purchased at a price below the sale price. The investor sold the shares for $23.45 and was able to cover the short at $20 per share. That is a profit of $3.45 per share. Because there are 200 shares, the total gain is $690 (200 times $3.45).

384. An investor believes that ICBS, a Nasdaq security, is overpriced at 40. She can sell ICBS short in the over-the-counter (OTC) market under which of the following circumstances?
     • Under no circumstances
     • With no restrictions
     • Only if she has an outstanding long position
     • Only at a price higher than the current inside bid

     Correct answer: With no restrictions

     As on exchanges, short sales on the Nasdaq Stock Market can occur at any time in the trade sequence.

385. One of your customers with an existing margin account turns in an order to sell short 500 shares of LMN common stock. Before entering the order, you must
     • Verify that the account has sufficient equity
     • Update the customer’s account profile
     • Determine if the trade is suitable for the customer
     • Be sure the firm can locate the stock

     Correct answer: Be sure the firm can locate the stock

     Regulation SHO mandates a locate requirement for short sales. Before entering a short sale order, members are required to locate the security to be ensured that delivery can be made on settlement date. The locate requirement applies to short sales in all equity securities. The margin call on a short sale should be met by settlement date (T+2) and must be met by the Regulation T deadline (S+2). Therefore, the money does not have to be in the account before the sale. Because this is an unsolicited order (the customer initiated the order), Regulation Best Interest on suitability does not apply (Regulation Best Interest only applies to your recommendations). Customer account profiles should be updated no less frequently than every 36 months, not with each order.

386. Municipal bonds are not normally sold short because
     • The municipal bond market is illiquid
     • The transaction is expensive to execute
     • Short sales are prohibited by municipal statute
     • Short sales are prohibited by Municipal Securities Rulemaking Board rules

     Correct answer: The municipal bond market is illiquid

     While there is no law or industry rule prohibiting short sale of municipal bonds, it is not a common practice. To short a security, it must be borrowed, and because most municipal securities are thinly traded, it is often difficult to locate the specific issue needed to cover the short position.

387. The practice of naked short selling is prohibited by
     • Regulation T.
     • The Options Clearing Corporation
     • Regulation SHO.
     • FINRA.

     Correct answer: Regulation SHO.

     Naked short selling is when the broker-dealer accepts an order to sell stock short but is not able to ascertain the location of stock to deliver.

388. Your customer asks you to borrow shares of stock from another investor's account and then sell the borrowed stock in the open market. Sometime later, the customer repurchases the stock in the open market and replaces, or covers, the borrowed stock. Identify the type of transaction that was used in this account.
     • Wash sale
     • Zero-cost collar
     • Protective put
     • Short sale

     Correct answer: Short sale

     This type of transaction is known as a short sale. A short sale allows an investor to take advantage of falling stock prices. The mechanics involve borrowing shares, selling them at a high price, and then returning those shares by buying them at a lower price. Collars and puts are options that can be used in the face of a potential decline in the price of the underlying stock. A wash sale occurs when an investor sells a security at a loss and then repurchases the same security (or one substantially identical) within 30 days before or after the sale at a loss.

389. Insiders (control persons or affiliates) of a company are prohibited from
     • Buying call options on the company's stock
     • Engaging in any short sales on stock of competing issuers
     • Selling short their own company's stock
     • Buying shares of affiliated issuers

     Correct answer: Selling short their own company's stock

     What a conflict of interest it would be for insiders to sell their own company's stock short! Wanting the shares to decline in price, then mismanaging the company into a loss to profit in their personal account at the expense of all the other stockholders? We don't think so and neither does the SEC. There are no restrictions on insiders buying call options on their company's stock nor buying shares of affiliated companies. The short sale restrictions apply only to the insider's company, not any others.

390. Regulation SHO prohibits
     • Short selling in cash accounts
     • Naked short selling
     • Short sales on an uptick
     • Unsuitable short selling

     Correct answer: Naked short selling

     Regulation SHO mandates a locate requirement with regard to short sales. Before entering a short sale order, members are required to locate the security to be ensured that delivery can be made on settlement date. The locate requirement applies to short sales in all equity securities. Failure to positively locate the stock before making the short sale is the prohibited practice of naked short selling. Although one can sell short only in a margin account, the prohibition against doing so in a cash account is part of Regulation T, not SHO. Short selling, just as with any activity in customer's accounts, must be suitable. That is part of the suitability requirements, not Regulation SHO. Short sales can be made on any tick: up, down, or the same.

391. Sell orders for equity securities
     • Do not need to be marked, only executed in accordance with the appropriate rules
     • Must be marked long or short
     • Must be marked only if they are short sales
     • Must be marked only if they are long sales

     Correct answer: Must be marked long or short

     Every sell order in an equity security must be marked as either a long sale or a short sale.

392. Typically, general obligation bonds are not sold short because
     • Thin markets may make it difficult to cover a short municipal position
     • They are backed by the full faith and credit of the issuing authority
     • Municipal Securities Rulemaking Board regulations prohibit short selling.
     • They trade over the counter

     Correct answer: Thin markets may make it difficult to cover a short municipal position

     Because the municipal trading market is thin, it is often difficult to cover (buy back) a municipal security that has been sold short. It is easy to short 100 shares of GM (borrow the stock), for example, because an equivalent 100 shares of GM can be purchased on the NYSE at any time.

393. The requirement for a broker-dealer to locate a security to be sold short before executing the order is found in
     • Regulation T.
     • TRACE.
     • Regulation SHO.
     • The FINRA Uniform Practice Code

     Correct answer: Regulation SHO.

     Regulation SHO mandates a locate requirement for short sales. Before entering a short sale order, members are required to locate the security to ensure that delivery can be made on settlement date. The locate requirement applies to short sales in all equity securities. Failure to positively locate the stock before making the short sale is the prohibited practice of naked short selling. Regulation T mandates that short sales be made in margin accounts. The Trade Reporting and Compliance Engine (TRACE) is the FINRA-approved trade reporting system for corporate and government agency bonds trading in the OTC secondary market. FINRA's Uniform Practice Code tangentially deals with this issue because the location requirements enable delivery of stock sold short to be made according to its rules on good delivery.

394. When an investor sells stock short on the ex-dividend date, the dividend belongs to
     • The short seller
     • The buyer of the stock
     • The issuer of the stock
     • The lender of the stock sold

     Correct answer: The lender of the stock sold

     The key here is that the sale is taking place on the ex-dividend date. That means that the buyer is not entitled to the dividend. Rather, it belongs to the seller. However, in this question, the seller does not own the stock because this is a short sale. Who is the owner of the stock? Whose name will be on the records? That would be the lender of the stock, and that is who will receive the dividend. This is one of those cases where a due bill is sometimes required to get the dividend to the proper party.

395. Under Regulation T, action by the broker-dealer is not required when
     • The total amount of the transaction does not exceed $1,000
     • The amount due does not exceed $100
     • The amount due does not exceed $200
     • The amount due does not exceed $1,000

     Correct answer: The amount due does not exceed $1,000

     Regulation T permits a broker-dealer to disregard any amounts due less than $1,000.

396. In a new margin account, a customer sells short 1,000 shares of XYZ at $30 per share and deposits the required margin. If the stock subsequently falls to $25 per share, the equity in the account is
     • $20,000.
     • $25,000.
     • $10,000.
     • $15,000.

     Correct answer: $20,000.

     When selling short, the initial credit balance is the sum of the proceeds of the sale ($30,000) plus the 50% Regulation T margin requirement ($15,000) or $45,000. The beginning equity is $15,000 (CR − SMV = EQ, or $45,000 − $30,000 = $15,000). If the market value falls to $25,000, equity is determined as $45,000 minus $25,000 equals $20,000.

397. Toby Jensen originally purchased 400 shares of CSC stock on margin at a price of $60 per share. The initial margin requirement is 50%, and the maintenance margin is 25%. CSC stock price has fallen dramatically in recent months, and it closed today with a sharp decline, bringing the closing price to $40 per share. Based on FINRA requirements, will Jensen receive a maintenance margin call?
     • Yes, because the account is below the house maintenance requirement.
     • Yes, the account does not meet the minimum maintenance margin requirement.
     • No, the account meets the minimum maintenance margin requirement.
     • No, the account meets the minimum initial margin requirement.

     Correct answer: No, the account meets the minimum maintenance margin requirement.

     Minimum maintenance requires equity equal to 25% of the current market value. If the price per share is $40, then the value of the 400 shares is $16,000. That would make the minimum equity requirement $4,000 ($16,000 times 25%). The initial purchase was $24,000 resulting in a debit balance of 50%, or $12,000. If the LMV is $16,000 and the debit balance is $12,000, the account is right at the minimum maintenance level of $4,000. Toby might be below the house maintenance, but because that is not given in the question, there is no way to tell.

398. In a customer's margin account, a broker-dealer must segregate
     • The excess securities above 140% of the accounts debit balance
     • 100% of the long market value.
     • 50% of the equity balance.
     • 140% of the debit balance.

     Correct answer: The excess securities above 140% of the accounts debit balance

     A broker-dealer may hypothecate (pledge) 140% of a customer's debit balance. Any customer securities in excess of 140% of the debit balance must be physically segregated.

399. Issued and outstanding stock is the authorized stock of a corporation that has been purchased by investors. The remaining authorized but unissued stock may be used for all of the following except
     • Sending to the IRS for payment of federal income taxes
     • Paying stock dividends to stockholders
     • Raising capital at a later date
     • Exchanging stock with stockholders in a conversion

     Correct answer: Sending to the IRS for payment of federal income taxes

     The IRS does not want a corporation's authorized but unissued stock to pay federal income taxes. The IRS treats a corporation as an entity like an individual taxpayer and wants money, not stock. This unissued stock can be issued to raise future capital, used to pay stock dividends, and to exchange for convertible preferred stock and convertible bonds upon conversion.

400. Which of the following is true regarding a 5-for-4 stock split?
     • Each shareholder's proportionate equity will be unchanged.
     • The par value will be unchanged.
     • Retained earnings will be increased.
     • The net worth of the company will be reduced.

     Correct answer: Each shareholder's proportionate equity will be unchanged.

     Because each shareholder will receive additional stock, the proportional equity will remain the same.

401. Due to a sudden drop in earnings, the board of directors of Amalgamated Metal Industries (AMI) has voted to suspend all dividend payments this year. This would have the least effect on holders of AMI's
     • Cumulative preferred stock
     • Common stock
     • Adjustable-rate preferred stock
     • Callable preferred stock

     Correct answer: Cumulative preferred stock

     The notable feature of cumulative preferred stock is that it carries any skipped dividends on its books. They appear as dividends in arrears. This arrearage must be paid before any dividend can ever be paid on the company's common shares. There is no guarantee that the company will ever be able to make up those dividends, but in none of the other choices is there any concept of arrearage.

402. An investment banker purchasing what is left unsold from a rights offering is engaging in
     • Firm commitment underwriting
     • Preemptive rights underwriting
     • Standby underwriting
     • All or none underwriting

     Correct answer: Standby underwriting

     In many cases, when a corporation is issuing new shares, existing shareholders receive preemptive or stock rights to buy these new shares to maintain their current proportionate ownership. In the event some of the rights are not used, the standby underwriter agrees to purchase those unsubscribed for shares.

403. The rate on an adjustable preferred stock may be indexed to
     • The Consumer Price Index
     • The Dow Jones Industrial Average
     • The Treasury bill rate
     • The Producer Price Index

     Correct answer: The Treasury bill rate

     The dividend on an adjustable rate preferred stock is tied to a particular interest rate, and the Treasury bill rate is a common benchmark.

404. Nickelplate Manufacturing Corporation (NMC) is capitalized with 1 million shares of a 6% $50 par callable, cumulative preferred stock and 10 million shares of $1 par common stock. NMC has not paid any dividends at all for the past five quarters. The current quarter's earnings are excellent and the company would like to pay a dividend to its common shareholders. Doing so would require
     • An affirmative vote of the common shareholders
     • Paying the preferred shareholders a dividend of $3.75 per share
     • Paying the preferred shareholders a dividend of $0.75 per share
     • Paying the preferred shareholders a dividend of $4.50 per share

     Correct answer: Paying the preferred shareholders a dividend of $4.50 per share

     A corporation cannot pay a dividend to its common shareholders without satisfying the dividend requirements of any outstanding preferred stock. NMC has a 6% $50 par preferred. The annual dividend requirement (if declared) is $3 per share. That is $0.75 per quarter. On the exam, all dividends are paid quarterly unless stated otherwise. Once that dividend is paid to the preferred, the declared dividend can be paid to the common. But, the question tells us that NMC has not paid preferred dividends for more than one year (five quarters). What about those skipped dividends? This preferred stock is cumulative. That means the five skipped quarters ($0.75 times 5 = $3.75) plus the current quarter ($0.75) must be paid. Be careful to read the question. Shareholders do not vote on cash dividend payments. That decision is made by the company's board of directors.

405. Which of the following are characteristics of both stock rights and warrants?
     • One must be a current stockholder to receive them.
     • They are frequently used as a sweetener to attract purchasers to another security.
     • They offer the holder an opportunity to purchase stock at a fixed price.
     • When initially offered, neither one has intrinsic value.

     Correct answer: They offer the holder an opportunity to purchase stock at a fixed price.

     Rights and warrants are equity securities granting the holders the ability to purchase shares of the issuer at a pre-determined price. In the case of a rights offering, the price is always below the current market price. In the case of warrants, the exercise price is always above the current market price. That means only the rights have intrinsic value when initially offered. It is the warrants that are frequently attached to a new issue to make the offering more attractive. It is only the rights where one must be a current stockholder to initially obtain them. After that, they trade in the secondary market.

406. Which of the following statements regarding warrants is true?
     • Warrants are safer than corporate bonds.
     • Warrants give the holder a perpetual interest in the issuer's stock.
     • Warrants' terms are generally shorter than rights' terms.
     • Warrants are often issued with other securities to make the offering more attractive.

     Correct answer: Warrants are often issued with other securities to make the offering more attractive.

     Warrants are generally issued with bond offerings to make the bonds more attractive. Warrants are long-term options to buy stock, and because they are equity securities, warrants, as investments, are considered less safe than bonds.

407. Cement Mixer Corporation has 1 million shares of convertible preferred stock and 2 million shares of common outstanding. Each share of preferred can be converted into half a share of common. The preferred stock is selling at $17.50, and the common stock is selling at $35.75. If all preferred shares were converted, how many shares of common stock would be outstanding after conversion?
     • 3,000,000
     • 2,000,000
     • 2,500,000
     • 500,000

     Correct answer: 2,500,000

     One million shares of preferred, each converted to half a share of common, is 500,000 common shares, and 500,000 shares after conversion, added to 2 million shares of common previously outstanding, equals 2.5 million common shares.

408. When comparing preemptive rights and warrants, one similarity is
     • The method by which the issuer distributes them to shareholders
     • Their exercise price relative to the market price of the underlying stock
     • The length of time before they expire
     • Their voting privilege

     Correct answer: Their voting privilege

     In an odd play on words, the only similarity here is that neither of them have voting rights. Warrants are long-term while rights are short-term. The exercise price of a right is below the current market while that of a warrant is above. Only rights are distributed to existing shareholders in proportion to the investor's current stock ownership. Warrants are not sent to shareholders; they are most often part of another issue.

409. Which of the following securities typically carries the highest dividend rate?
     • Straight preferred
     • Convertible preferred
     • Participating preferred
     • Callable preferred stock.

     Correct answer: Callable preferred stock.

     Straight preferred is the benchmark rate. As the name suggests, there are no conversion or participating features. Compared to straight preferred, both convertible and participating preferred tend to carry lower dividend rates, as the investor has been given something extra—the right to convert into common shares at a fixed price or the right to earn more than the stated rate if the issuer has a good year and the board of directors elects to make an additional dividend payment. Callable preferred allows the issuer to call the securities away from the investor. From an investor's point of view, this is not an incentive. Therefore, callable preferred tends to pay higher rates.

410. Many investors diversify by adding foreign securities to their portfolios. Those who do so with ADRs are least likely to be concerned with
     • Currency risk
     • Market risk
     • Political risk
     • Liquidity risk

     Correct answer: Liquidity risk

     Most ADRs actively trade on the exchanges or OTC market. As such, their liquidity is generally quite good. Because the investment is in a foreign corporation, there is foreign currency risk. Market risk is universal anytime you are investing in something traded in "the market." Political risk is always a concern when investing overseas. It is true that it is not very high in most developed markets, but it is still there and more prevalent than liquidity risk.

411. Your customer wishes to invest in a security that will pay a specific level of dividends, but may also receive additional dividend amounts, should the underlying company have outstanding performance. Which of the following securities would best match this customer's objectives?
     • Class A common stock
     • Cumulative preferred stock
     • Convertible preferred stock.
     • Participating preferred stockholders.

     Correct answer: Participating preferred stockholders.

     Participating preferred stock provides a stated dividend amount (as a percentage of par value) plus the opportunity to receive additional dividends, based on predetermined conditions, such as the profitability level of the underlying company. Although the convertible stock offers the possibility of capital appreciation due to its linkage to the common stock, that has no effect on the dividend.

412. Corporations issue equity securities. One category of equity is preferred stock. A number of different adjectives can apply to preferred stock issues. Which of the following preferred stock issues would likely offer the greatest protection against interest rate risk?
     • Participating
     • Cumulative
     • Callable
     • Convertible

     Correct answer: Convertible

     Owners of convertible preferred stock have the ability to convert the preferred into common stock. This offers growth potential not otherwise available to a preferred stockholder. This feature causes the stock's price to track that of the common. That results in convertible preferred stock having less interest rate risk than the others do.

413. It would be correct to describe a warrant in all of the following ways except
     • Warrants do not have voting rights
     • It has a longer life than a stock right
     • It may be used as a sweetener for a bond issue
     • The exercise price is generally slightly below the current market price

     Correct answer: The exercise price is generally slightly below the current market price

     Warrants always carry an exercise price that is above the current market price of the underlying security. The upside potential is viewed as a sweetener for other issues, particularly bonds. This results in the issuer borrowing at a lower interest cost. Unlike preemptive (stock) rights that have a short life, warrants do not expire for a long time, sometimes five years or longer.

414. One of the primary differences between rights and warrants is
     • Rights may be sold in the secondary market
     • Warrants have a life before expiration that is much longer than rights
     • Warrants provide the ability to purchase shares of common stock at a specified price
     • The exercise of rights will result in a decline in the issuer's earnings per share

     Correct answer: Warrants have a life before expiration that is much longer than rights

     Warrants have an expiration date that often runs as long as 5 years. In fact, there is no legal maximum, but it is rare to see one with an expiration date longer than 10 years from issuance. On the other hand, most rights expire within 30-45 days and it is rare to see one with a life exceeding 60 days. Both rights and warrants provide the holder with the ability to acquire shares of common stock at a specified price. The exercise of each will result in additional shares outstanding and will cause earnings per share to decline. Both instruments are marketable and may trade in the secondary market.

415. Which of the following is not an advantage of purchasing American depositary receipts (ADRs)?
     • They eliminate exchange rate risk.
     • They allow U.S. investors to buy foreign country stock denominated in dollars.
     • Foreign taxes withheld can be claimed as a credit to offset income taxes on dividends received.
     • Transactions are done on an organized exchange in the U.S.

     Correct answer: They eliminate exchange rate risk.

     ADRs are priced in U.S. dollars and therefore have exchange rate risk. That is, if the value of the currency in the home country of the company underlying the ADR should decline in relationship to the U.S. dollar, the investor could actually lose money even if the stock's price rises. For example, the foreign company's stock is selling for $50 per share Canadian. At the time of purchase, the Canadian dollar is worth $0.80 U.S. That would make the ADR value approximately $40 per share U.S. If the client decides to sell that ADR when the company stock is selling for $52 per share on its domestic exchange, but the Canadian dollar is now worth $0.70 U.S., the ADR's value will be approximately $36.40. Therefore, we've seen the price of the stock go up while the value of the ADR to the U.S. investor has declined.

416. A company that has issued cumulative preferred stock
     • Pays the current dividends on the preferred, but not the past dividends on the preferred, before paying a dividend on the common
     • Pays past and current preferred dividends before paying dividends on common stock
     • Pays the preferred dividend before paying the coupons due on its outstanding bonds
     • Forces conversion of the preferred that is trading at a discount to par, thereby eliminating the need to pay past-due dividends

     Correct answer: Pays past and current preferred dividends before paying dividends on common stock

     Current and unpaid past dividends on cumulative preferred stock must be paid before common stockholders can receive a dividend. Bond interest is always paid before dividends. Dividends in arrears on cumulative preferred have the highest priority of dividends to be paid.

417. American depositary receipts (ADRs) are used to facilitate
     • The foreign trading of domestic securities
     • The domestic trading of foreign securities
     • The domestic trading of U.S. government securities.
     • The foreign trading of U.S. government securities.

     Correct answer: The domestic trading of foreign securities

     An ADR is a negotiable security that represents an ownership interest in a non-U.S. company. Because they trade in the U.S. marketplace, ADRs allow investors convenient access to foreign securities.

418. A corporation is having a rights offering. The terms of the offering require four rights plus $40 to purchase one share. With the stock's current market price at $50 per share, the theoretical value of one right before the ex-rights date is
     • $2.50.
     • $0.25.
     • $2.00.
     • $0.20.

     Correct answer: $2.00.

     Because the question is asking about the value before ex-rights, it means we use the cum-rights (with rights) formula. That is, the (market price minus the subscription price) divided by the (number of rights it takes to buy one share plus one). Plugging in the numbers gives us ($50 $-$ $40) $\div$ (4+1) = $10 $\div$ 5 = $2.00

419. GIN Corporation is offering shareholders the right to subscribe to a new issue of stock at $30 per share. The current market price of the GIN stock is $44 per share, and it takes 20 rights plus the subscription price to purchase one share. The theoretical value of a single right, prior to the ex-rights date, is approximately
     • $0.73.
     • $0.70.
     • $0.67.
     • $1.50.

     Correct answer: $0.67.

     Because this is cum rights (before the ex-rights date), the formula is $\frac{M - S}{N + 1}$. Thus, ($44 $-$ $30) $\div$ (20 + 1) = 14 $\div$ 21 = $0.67

420. Aenical Corporation issued $100 million of $100 par value preferred stock a number of years ago. The stock pays quarterly dividends of $1.25. Recent issues of comparable preferred stock carry a dividend yield of 10%. One could expect the market price of the Aenical preferred stock to be closest to
     • $100.
     • $50.
     • $25.
     • $75.

     Correct answer: $50.

     As with other fixed-income securities, as market yields increase, the price of previously issued securities declines. The logic is that investors will purchase fixed income securities only if they can receive a return comparable to the current market rate. This stock is paying an annual dividend of $5 ($1.25 per quarter times four). Investors will be most interested in this stock if their return will be approximately 10%, the current rate being paid in the market. The math here needs to first answer "$5 is 10% of what number?" Divide $5 by 10% and the answer is $50. At $50 per share, Aenical stock paying a $5 annual dividend is offering a 10% return on investment.

421. Aenical Corporation issued $100 million of $100 par value preferred stock a number of years ago. The stock pays semiannual dividends of $1.25. Recent issues of comparable preferred stock carry a dividend yield of 10%. One could expect the market price of the Aenical preferred stock to be closest to
     • $25.
     • $50.
     • $75.
     • $100.

     Correct answer: $25.

     As with other fixed-income securities, as market yields change, the price of previously issued securities increase or decrease to offer a comparable return. The logic is that investors will purchase fixed-income securities only if they can receive a return comparable to the current market rate. This stock is paying an annual dividend of $2.50 ($1.25 every six months). If not stated, dividends are always paid quarterly. This question specifically states the dividends are semiannual; do not get tripped up with something like this on the exam. Investors will be most interested in this stock if their return will be approximately 10%, the current rate being paid in the market. The math here must first answer "$2.50 is 10% of what number?" Divide $2.50 by 10% and the answer is $25. At $25 per share, Aenical stock paying a $2.50 annual dividend is offering a 10% return on investment.

422. Corporate stocks trade in all of the following locations except
     • The over-the-counter (OTC) market
     • The commodities market
     • The third market
     • Stock exchanges

     Correct answer: The commodities market

     Corporate securities issues do not trade in the commodities market. That is where physical assets such as agricultural products, industrial metals, and precious metals trade. Listed stocks are the ones that have qualified for listing on exchanges. Unlisted stocks are traded OTC. The third market is the trading of listed stocks in the OTC market.

423. Stock prices in the over-the-counter (OTC) market are determined by
     • The 5% markup policy
     • Buyers and sellers bidding directly against each other in a double auction market
     • Open outcry for the securities at a central marketplace
     • Negotiation between buyers and sellers

     Correct answer: Negotiation between buyers and sellers

     The OTC market is a negotiated market (not an auction market as is the case with an exchange) in which dealers negotiate stock trades with each other.

424. A Nasdaq market maker buys 1,000 shares of stock from a customer at its bid to satisfy a customer order. This is an example of
     • A principal trade
     • A riskless principal trade
     • A block trade
     • An agency trade

     Correct answer: A principal trade

     The market maker is acting in a principal (dealer) capacity.

425. The KPL Corporation is considering having its stock listed on the New York Stock Exchange (NYSE). Who will make the final decision as to whether it will be listed?
     • The NYSE
     • FINRA
     • The SEC
     • The Board of Directors of KPL

     Correct answer: The NYSE

     The NYSE has certain requirements that a company must meet before its stock can be considered for listing. Because the NYSE sets the requirements, it must make the final decision.

426. The Nasdaq Stock Market permits listing for all of the following except
     • Common stock
     • Warrants
     • Convertible bonds
     • Nonconvertible debt securities

     Correct answer: Nonconvertible debt securities

     The Nasdaq Stock Market is an equity and equity equivalent market. Listed are common stock, preferred stock, warrants, limited partnerships, American depositary receipts, and convertible bonds. Straight debt securities are not part of Nasdaq.

427. A portion of the OTC market where companies that have been delisted for regulatory reasons are usually traded is
     • The fourth market
     • The grey market
     • The ""pink"" market
     • The third market

     Correct answer: The grey market

     The grey market is sometimes called the "dumping ground" for stocks that cannot trade on the organized markets for regulatory reasons or have such little investor interest that broker-dealers are unwilling to quote them. The third market is the trading of listed securities OTC, and the fourth market is institution-to-institution trading to avoid the use of broker-dealers. The "pink" market is part of the OTC Markets Group and does not handle issues with regulatory problems. **This question deals with material not covered in your study materials, but it relates to recent rule changes and/or student feedback.

428. The over-the-counter (OTC) market is
     • The first market
     • A negotiated market
     • All of these
     • An auction market

     Correct answer: A negotiated market

     The OTC market is a negotiated market. Registered market makers compete among themselves to post the best bid and ask prices.

429. A recommendation to purchase a security traded in which of the following venues would most likely result in the greatest scrutiny by your manager?
     • The Nasdaq Stock Market
     • The New York Stock Exchange
     • The OTC Bulletin Board
     • The grey market

     Correct answer: The grey market

     Securities trading on the "grey market" are not quoted on any U.S. quotation system. Broker-dealers are not willing or able to publicly quote these securities because of a lack of investor interest, company information availability, or regulatory compliance. **This question deals with material not covered in your study materials, but it relates to recent rule changes and/or student feedback.

430. The Securities Exchange Act of 1934 applies to all of the following except
     • Regulation of new issues
     • The extension of credit on purchase of securities
     • Registration of broker-dealers
     • Secondary market trading

     Correct answer: Regulation of new issues

     The Securities Act of 1933 deals with new issues. The Securities Exchange Act of 1934 created the SEC, required the registration of broker-dealers, empowered the Federal Reserve to control the extension of credit on securities transactions, and created rules dealing with secondary market trading.

431. A network of market makers that offers to trade securities not listed on an exchange is called
     • The over-the-counter (OTC) market
     • NYSE Arca.
     • National Daily Quotation Service.
     • National Association of Securities Dealers Automated Quotations.

     Correct answer: The over-the-counter (OTC) market

     This best describes the OTC market which is an interdealer market linked by computer terminals to FINRA member firms across the country.

432. Stocks that are listed on the NYSE can also traded in all of the following except
     • The third market
     • The fourth market
     • The CBOE (Chicago Board Options Exchange)
     • An electronic communications network (ECN)

     Correct answer: The CBOE (Chicago Board Options Exchange)

     NYSE-listed stocks would never be listed on an options exchange such as the CBOE; those are strictly for trading options, not stock. The third market is the trading of listed securities in the over--the-counter market. The fourth market is the use of ECNs for institutions to trade without the "middleman," a broker-dealer.

433. The Securities Exchange Act of 1934 regulates or mandates all of the following except
     • Creation of the SEC
     • Extension of credit to customers
     • Full and fair disclosure on new offerings
     • Manipulation of the secondary market

     Correct answer: Full and fair disclosure on new offerings

     The Securities Exchange Act of 1934 created the SEC and regulates the secondary market. The Securities Exchange Act of 1934 does not address full and fair disclosure issues; the Securities Act of 1933 addresses these issues.

434. When you hear your firm's traders talking about institutions trading with a lack of transparency, they are probably referring to
     • The over-the-counter market
     • The OTC Bulletin Board
     • The third market
     • Dark pools

     Correct answer: Dark pools

     Dark pools, sometimes referred to as dark pools of liquidity, is trading volume that occurs that is not openly available to the public. The bulk of this volume represents large trades engaged in by institutional traders and trading desks away from the exchange markets. Trading in the other choices is relatively transparent.

435. All of the following securities trade in the over-the-counter (OTC) market except
     • Government and agency securities
     • Open-end investment companies
     • Nasdaq securities.
     • American depositary receipts.

     Correct answer: Open-end investment companies

     Municipal bonds, government and agency securities, and corporate securities (listed and unlisted) all trade in the OTC market. Foreign securities trade in the United States if the companies comply with SEC registration and disclosure requirements. Mutual fund shares (open-end companies) do not trade.

436. All of the following statements regarding the over-the-counter (OTC) market are true except
     • It trades listed securities
     • More issues trade OTC than on the exchanges
     • It trades unlisted securities
     • It is an auction market

     Correct answer: It is an auction market

     The OTC market is a negotiated market. The exchanges are auction markets.

437. All of the following statements regarding over-the-counter (OTC) markets are true except
     • An offer is the lowest price a dealer will accept when selling
     • A bid is the highest price a dealer will pay when buying
     • The OTC market is an auction market
     • Securities traded OTC include American depositary receipts (ADRs) and municipal bonds

     Correct answer: The OTC market is an auction market

     The OTC market is a negotiated market in which market makers post their quotes to facilitate negotiating price. A bid is the highest price a buyer is willing to pay, and an offer is the lowest price a seller is willing to accept. Among the securities traded OTC, both ADRs and municipal securities would be included.

438. The RJN Corporation has issued warrants where each warrant offers the holder the right to purchase one share of RJN's common stock for $20 per share. The warrants are exercisable anytime within the next five years. Chelsea purchases 80 warrants for $2 each. If three years after the purchase, the market price of RJN common stock has risen to $25 per share and Chelsea sells the warrants for their intrinsic value, she has realized
     • A long-term capital gain of $400
     • A long-term capital gain of $240
     • A short-term capital gain of $240
     • A short-term capital gain of $400

     Correct answer: A long-term capital gain of $240

     The intrinsic value of a warrant is the difference between the exercise price and the current market price. Being able to purchase stock at $20 per share when the market price is $25 per share means the warrant is intrinsically worth $5. With 80 warrants, the sale proceeds are $400 (80 times $5 each). Don't forget that Chelsea paid $2 for each warrant, a cost of $160 (80 times $2). That makes her net gain $240 ($400 proceeds minus $160 cost). The gain is long-term because she held the warrants longer than 12 months.

439. The RJN Corporation has issued warrants where each warrant offers the holder the right to purchase one share of RJN's common stock for $20 per share. The warrants are exercisable anytime within the next five years. Chelsea purchases 80 warrants for $2 each. Three years after the purchase, the market price of RJN common stock has risen to $25 per share. Chelsea exercises the warrants and immediately sells the RJN stock at the market price. The result of these transactions is that Chelsea has realized
     • A net short-term capital gain of $400
     • A net long-term capital gain of $240
     • A net long-term capital gain of $400
     • A net short-term capital gain of $240

     Correct answer: A net short-term capital gain of $240

     Exercising the warrants means that Chelsea purchases 80 shares at $20 each. That is a cost of $1,600 (80 times $20). She then sells those 80 shares immediately at the current market price of $25 generating proceeds of $2,000 (80 times $25). The difference between the proceeds and the cost is $400 ($2,000 minus $1,600). Don't forget that Chelsea paid $2 for each warrant adding $160 to her cost (80 times $2). That makes the net realized gain $240 ($400 minus the $160 cost of the warrants). The net gain is short-term because she did not hold the stock for more than 12 months.

440. For tax-reporting purposes, qualified dividends are considered to be what type of income?
     • Earned
     • Phantom
     • Passive
     • Portfolio

     Correct answer: Portfolio

     Portfolio income includes dividends, interest, and net capital gains derived from the sale of securities.

441. The DCAV corporation has declared a 10% stock dividend. Which of the following is true regarding the shareholders receiving the stock dividend?
     • The stock dividend would not be taxable upon receipt by the shareholder.
     • The stock dividend would increase the cost basis per share.
     • The stock dividend would decrease their percentage of ownership within the corporation.
     • The stock dividend would increase their percentage of ownership within the corporation.

     Correct answer: The stock dividend would not be taxable upon receipt by the shareholder.

     When a stock dividend is paid, the shareholders receive a dividend of additional shares instead of cash. The effect of this is an increase in the number of share with a reduction in the cost basis of each share. Because there is no monetary impact, there is no current taxation. The stock dividend would decrease their original cost basis. Although the stock dividend is not taxable upon receipt, it would be taxable upon the sale of the shares if sold for more than the adjusted cost basis. Stock dividends have no effect on a shareholder's proportionate ownership of the corporation.

442. If a customer buys $28,000 of ABC stock in April 20XXand at year end, the stock is worth $23,000, how much may the customer deduct on his 20XX tax return?
     • $5,000
     • $2,000
     • $3,000
     • $0

     Correct answer: $0

     Until the customer realizes the loss by selling, there is no tax deduction.

443. A customer has $12,000 of capital gains, $15,000 of capital losses, and $50,000 adjusted gross income. How much unused loss is carried forward to the following tax year?
     • $0
     • $3,000
     • $12,000
     • $15,000

     Correct answer: $0

     After netting capital gain and losses, the customer has a net capital loss of $3,000. Because $3,000 of net losses can be deducted from income in any single tax year, there is no carryforward.

444. An investor who purchased 100 shares of PERD common stock on June 30, 2020, would receive long-term capital gain treatment if the stock is sold at a profit starting
     • July 1, 2021.
     • June 31, 2021.
     • December 31, 2021.
     • June 30, 2021.

     Correct answer: July 1, 2021.

     Investors must own a security for more than 12 months before it becomes long term for tax purposes. The first day after June 30, 2020, is July 1, 2020. Twelve months later is July 1, 2021. Remember, there is no June 31.

445. At year's end, your client reports $12,000 in capital gains and $20,000 in capital losses. The net effect of this on his taxes would be
     • A $4,000 deduction from ordinary income with a $4,000 loss carryforward
     • An $8,000 deduction from ordinary income
     • A $3,000 deduction from ordinary income with a $2,500 loss carryforward
     • A $3,000 deduction from ordinary income with a $5,000 loss carryforward

     Correct answer: A $3,000 deduction from ordinary income with a $5,000 loss carryforward

     The customer may offset all of the gains with the losses. This leaves a new loss of $8,000. Because the maximum net capital loss that may be deducted against ordinary income is $3,000 per year, we take off the $3,000 and have a carryforward of the balance ($5,000).

446. Your customer has experienced $7,500 in capital losses this year. He has realized $2,000 in capital gains and has $65,000 adjusted gross income. How much of his loss will he be able to carry forward to next year?
     • None of these.
     • $4,500
     • $2,500
     • $5,500

     Correct answer: $2,500

     He will first offset his $2,000 in capital gains, leaving $5,500 in losses. He next offsets $3,000 in adjusted gross income, leaving $2,500 in losses to carry forward to next year. Provided the loss is offset to the maximum each year, there is no limit to how long losses may be carried forward.

447. Four years ago, you declared a net capital loss of $23,000 on your tax return. You have had no further capital gains or losses since then. For that year and the next two, you took the maximum allowable income deduction. How much may you deduct from your income this year, and how much loss will you have to carry forward?
     • $2,000/$11,000.
     • $3,000/$12,000.
     • $2,000/$12,000.
     • $3,000/$11,000.

     Correct answer: $3,000/$11,000.

     The maximum allowable deduction against income is $3,000. You will have taken four such deductions against $23,000, which leaves you with $11,000 to carry forward ($23,000 – $12,000).

448. A married couple who files jointly has a $5,000 long-term capital loss with no offsetting capital gains. Regarding the tax treatment of this loss, all of the following statements are true except
     • The maximum they can deduct this year is $3,000
     • Capital losses can be deducted dollar for dollar against capital gains
     • They can carry forward $2,000 to future years
     • Capital losses can be used to offset capital gains only

     Correct answer: Capital losses can be used to offset capital gains only

     Capital losses are deducted from ordinary income, and therefore, reduce tax liability. The maximum that individuals or married couples can deduct is $3,000 annually. If the long-term capital loss exceeds the maximum, the excess is carried forward to future years until the loss is exhausted. Under current IRS regulations, $1 in losses results in $1 in deductions.

449. An investor had a $20,000 capital loss, a $15,000 capital gain, and $50,000 in income for the year. How much of the income is taxable?
     • $20,000
     • $47,000
     • $50,000
     • $30,000

     Correct answer: $47,000

     Capital losses may be used to reduce taxable income. The first step is to net the gains and the losses. This investor has a net loss of $5,000. Of that net loss, a maximum of $3,000 can be written off against the income for the year. That reduces the investor's taxable income to $47,000. The unused $2,000 of the net loss is carried forward to subsequent tax years until utilized.

450. All of the following corporate transactions are nontaxable to investors when received except
     • Cash dividends
     • Reverse stock splits
     • Stock dividends
     • Stock splits

     Correct answer: Cash dividends

     The receipt of a cash dividend is a taxable event. Stock splits are nontaxable because although the number of shares owned changes, the cost basis of the shares is adjusted to keep the total investment unchanged. Stock dividends are adjusted in the same way as stock splits, so they are also nontaxable events. It is not until shares received as part of a stock split or stock dividend are sold that there is a taxable event (gain or loss).

451. If your client has a $21,000 net capital loss this year, and he plans to apply the maximum deduction toward his ordinary income for the year, after this year, he may
     • Not carry the loss forward
     • Deduct a maximum of $3,000 per year and carry the remaining loss forward indefinitely
     • Carry the loss forward indefinitely and offset capital gains only
     • Carry $3,000 of the loss forward

     Correct answer: Deduct a maximum of $3,000 per year and carry the remaining loss forward indefinitely

     Capital losses may be used to offset capital gains. Once all capital gains have been offset, $3,000 of net capital losses may be used to offset ordinary income annually. Remaining losses may be carried forward in future years until the loss is exhausted.

452. The following dividends were received by a husband, his spouse, and both of them jointly: husband, $160; spouse, $160; joint, $100. What amount of dividends that would be subject to taxation if they filed a joint tax return?
     • $420
     • $220
     • $0
     • $200

     Correct answer: $420

     $160 + $160 + $100 = $420. This would all be taxable as ordinary income.

453. If a customer has $9,000 of capital losses and $2,000 of capital gains in a tax year, that year's consequences are
     • A $9,000 loss deduction
     • A $7,000 loss deduction with no carryforward
     • A $3,000 loss deduction with no carryforward
     • A $3,000 loss deduction with $4,000 carryforward

     Correct answer: A $3,000 loss deduction with $4,000 carryforward

     For tax purposes, the customer can net gains with losses. In this case, the customer's net losses are $7,000. However, there is an annual capital loss deduction limit of $3,000. Therefore, the investor can deduct $3,000 this year and carry forward $4,000 to the following tax year.

454. One of your customers owns 100 shares of GTS common stock. The purchase was made two years ago at a price of $51 per share. GTS has recently declared a 3:2 stock split. At the customer's request, as soon as the new shares are in the account, you sell them and $2,000 from the proceeds of the sale is credited to the customer's account. Based on this information, the tax impact of this transaction is
     • A long-term capital loss of $1,400
     • A short-term capital gain of $300
     • A long-term capital loss of $1,333 and a short-term capital loss of $667
     • A long-term capital gain of $300

     Correct answer: A long-term capital gain of $300

     Immediately after the stock split, the total investment of the initial position remains unchanged at $5,100 (100 shares at $51 per share). After the stock split, the customer owns 150 shares (3/2 times 100 = 150 shares). Therefore, the adjusted cost basis per share is $34 ($5,100 divided by 150 shares). Those 50 shares were sold for $2,000 and have a cost basis of $1,700 ($34 times 50). That is a profit of $300. Alternatively, you could say that 50 shares sold for $2,000 represents a selling price of $40 per share ($2,000 divided by 50 shares), which is a $6 per-share profit ($40 minus the $34 cost basis). Fifty shares times $6 equals a profit of $300. The gain is long-term because the holding period of securities received through a stock split (or stock dividend) is that of the original purchase. If you have to guess, or are running out of time, when you see two identical numbers with the only difference being short- or long-term gain, in almost all questions, one of those two is the correct answer. Now you have a 50% change of guessing correctly and, if you remember that the holding period always begins with the initial purchase, then the odds are 100% in your favor.

455. SEC rules require that customers be given a copy of the risk disclosure document before their first transaction in a penny stock. The member firm must receive a signed and dated acknowledgment from the customer that the document has been received. In addition to obtaining the client's signature, the SEC requires the firm to wait at least
     • Two business days after sending the statement before executing the first trade
     • Two business days after receiving the statement before executing the first trade
     • Five business days after receiving the statement before executing the first trade
     • Five business days after sending the statement before executing the first trade

     Correct answer: Two business days after sending the statement before executing the first trade

     It is SEC Rule 15g-2 that requires the firm wait at least two business days after sending the risk disclosure document before executing the first penny stock trade for a new customer.

456. The 5% markup policy would apply to all of the following equity transactions except
     • A proceeds transaction
     • A riskless principal transaction
     • An agency trade done on an exchange
     • A primary market transaction

     Correct answer: A primary market transaction

     The 5% markup policy applies to secondary market transactions in nonexempt securities.

457. A customer sells securities and uses the proceeds to buy more securities at the same cost. Under the 5% markup policy, the markup is calculated on
     • The sell side only
     • The buy side only
     • Each side separately
     • The total of both sides

     Correct answer: The total of both sides

     The firm must consider the entire transaction (a proceeds transaction) when calculating the markup.

458. All of the following considerations apply to the 5% markup policy except
     • The cost of executing the transaction
     • The availability of the security
     • The customer's ability to pay
     • The services rendered by the broker-dealer

     Correct answer: The customer's ability to pay

     The 5% policy is a guideline for markups and commissions for exchange and over-the-counter trades. A firm cannot charge a higher commission or markup to a customer on the basis of the customer's ability to pay. Factors relevant in determining the fairness of a commission or markup include the type of security, the services rendered by the firm, and the expenses and difficulty of executing a particular trade.

459. When an investor's account contains penny stocks,
     • The account must maintain minimum equity of $25,000
     • Account statements must be sent monthly
     • Account statements must be sent weekly
     • Orders must be approved before being submitted

     Correct answer: Account statements must be sent monthly

     One of the aspects in which accounts containing penny stocks differ from those that do not is the requirement to send monthly rather than quarterly account statements. As with all other orders, principal approval is done after the execution report is received. The $25,000 minimum equity is for pattern day trader accounts.

460. Which of the following transactions would not be subject to the 5% markup policy?
     • Your client enters trades to purchase two different mutual funds in the same fund family. The combined purchases do not qualify for any breakpoints. The client is charged a sales charge of 6.5%.
     • A client enters an order to purchase one share of a stock to be put in the name of her grandchild. You charge the client the minimum commission for your firm ($15) even though the stock is currently trading at $26 per share.
     • A client sells shares of an over-the-counter stock and uses the proceeds to purchase shares from your firm's inventory account.
     • Your firm agrees to do an agency cross-transaction between two of your clients. Each client has been charged a commission.

     Correct answer: Your client enters trades to purchase two different mutual funds in the same fund family. The combined purchases do not qualify for any breakpoints. The client is charged a sales charge of 6.5%.

     It is important to understand that the FINRA Markup Policy is a guide, not a rule. The policy describes the various factors that a member firm should consider when determining the markup, markdown, or commission to charge in any given transaction. Because securities sold by prospectus have a stated offering price per share, a guide is unnecessary; the price is the price. In the case of mutual funds, which are always sold by prospectus, the formula for computing the price (NAV plus the sales charge, if any) is clearly listed in that prospectus. Once again, member firms do not need a guide; the price is the price. The policy is frequently referred to as the five percent policy, but that number is simply a guideline, and the broker-dealer's charge can exceed that percentage, especially in the case of a small transaction, such as one share at $26.

461. For purposes of the SEC Rule 15g-9 dealing with penny stocks, the term established customer does not include a person who has
     • Both a cash and a margin account with the firm
     • Purchased the securities of three different penny stocks on three different days involving three different issuers
     • Effected a securities transaction in an account more than one year before the proposed penny stock transaction
     • Deposited funds or securities in an account more than one year before the proposed penny stock transaction

     Correct answer: Both a cash and a margin account with the firm

     Rule 15(g)9 deals with sales practices relating to penny stocks. If a member is soliciting new customers to buy penny stocks, the member must prepare a suitability statement showing why the proposed penny stock trade is suitable for that customer. A suitability statement is not required if the member is soliciting an established customer. The type of account or the number of accounts is not part of the definition. An established customer is one who has effected a securities transaction, made a deposit of funds or securities in an account at least 1 year before the proposed penny trade, or made 3 purchases of penny stocks on 3 separate days involving 3 different issuers.

462. All of the following statements regarding the 5% markup policy are true except
     • The markup policy does not apply to securities sold at a specific price and with a prospectus
     • The type of security is a factor to consider
     • A riskless transaction is not generally covered by the 5% markup policy
     • A transaction in common stock customarily has a higher percentage markup than a bond transaction of the same size

     Correct answer: A riskless transaction is not generally covered by the 5% markup policy

     Riskless transactions are covered by the 5% markup policy.

463. Which of the following customer accounts requires the sending of monthly customer statements?
     • A margin account
     • An account containing penny stocks
     • An options account
     • A discretionary account

     Correct answer: An account containing penny stocks

     It is the account containing penny stocks where the customer must receive a monthly statement. In all other cases, the required frequency is not less than quarterly.

464. One of your customers has asked you about trading penny stocks. After discussing the risks, the customer decides to go ahead. The firm sends the individual a copy of the special penny stock risk disclosure document. The firm needs the customer's signed and dated acknowledgment of receipt of the document. Trading in penny stocks may not begin in that account until
     • At least two business days after sending the statement
     • At least two business days after receiving the statement
     • The day the signed acknowledgment has been received
     • At least $25,000 in equity is in the account

     Correct answer: At least two business days after sending the statement

     It is SEC Rule 15g-2 that requires the firm to wait at least two business days after sending the risk disclosure document before executing the first penny stock trade for a new customer. The $25,000 is the minimum equity in a pattern day trading account.

465. One of your clients frequently enters unsolicited orders to purchase penny stocks. This means
     • The client must sign and return the penny stock suitability statement
     • As an unsolicited order, the client is exempt from the compensation disclosure requirements
     • The client must be given a copy of the risk disclosure document prior to each trade
     • The client receives monthly statements

     Correct answer: The client receives monthly statements

     Once a client's account contains penny stocks, monthly account statements are required. The penny stock suitability statement is not required when the order is unsolicited. That statement is required only when a penny stock purchase is due to a recommendation. The risk disclosure document is required before the first trade only. Even when the order is unsolicited, the compensation earned by the member firm and the registered representative must be disclosed.

466. ABC Corporation offers statutory voting. At the upcoming annual meeting, it is announced that six people are running for the four available open seats on the board. An investor with 100 shares would be able to cast
     • 600 votes on one of the individuals.
     • 400 votes on one of the individuals.
     • 100 votes for each of four individuals.
     • 100 votes for each of six individuals.

     Correct answer: 100 votes for each of four individuals.

     With statutory voting, the shareholder has one vote for each share and can use those votes for each open seat on the board. It is cumulative voting where the shareholder can lump votes to place on a single seat. Any of the other choices could be correct for cumulative voting.

467. One of your clients owns 300 shares of common stock in a publicly traded corporation. The acquisition cost of those shares was $60,000 and the last trade of the stock was $220 per share. There was a news report that the company was going to pay shareholders a 100% stock dividend. The client wants to know how this dividend will affect the holding. You would respond that the customer will
     • Now own 150 shares and the market price will be approximately $440 per share
     • Now own 600 shares and the market price will be approximately $220 per share
     • Now own 600 shares and the market price will be approximately $110 per share
     • Still own 300 shares and the market price will be approximately $440 per share

     Correct answer: Now own 600 shares and the market price will be approximately $110 per share

     The effect of a 100% stock dividend is the same as a 2:1 stock split. The customer will have twice as many shares worth half as much each. That would be 600 shares worth $110 per share for a total value of $66,000. Note that the total value is unchanged from the pre-split value of 300 shares at $220 per share.

468. ZYX Corporation has 100 million shares of common stock authorized in its charter, with 80 million shares outstanding. The board of directors of ZYX could vote to take which of the following actions?
     • Announce an additional public offering of 40 million shares of common stock
     • Declare a stock dividend of 10%
     • Issue 20 million shares of a 4%, $100 par preferred stock, convertible at $50
     • Declare a 2:1 stock split

     Correct answer: Declare a stock dividend of 10%

     A corporation cannot issue more shares than authorized. True, there could be a vote to amend the charter, but be careful not to read anything into the question that is not given. A 10% stock dividend will require issuing 8 million more shares. That will bring the total outstanding to 88 million. A 2:1 stock split would need an additional 80 million shares and ZYX has only 20 million left. With only 20 million authorized, but unissued shares remaining, where is ZYX going to get 40 million shares for the additional public offering? Likewise, the convertible preferred is convertible into two shares each ($100 par divided by the $50 conversion price). That would also require 40 million shares to be available if everyone elected to convert. As mentioned in the beginning, if Company ZYX wished to conduct a 2:1 stock split, or offer 40 million additional shares, either through a public offering or the issuance of convertible preferred stock, an amendment to the corporate charter, approved by the board of directors and the shareholders, would be necessary.

469. ABC, Inc., has 1 million shares of common stock outstanding ($10 par value), paid-in surplus of $10 million, and retained earnings of $20 million. If ABC stock is trading at $20 per share, what would be the effect of a 2-for-1 stock split?
     • The retained earnings would be decreased by $10 million
     • The number of shares outstanding would decrease by 50%.
     • The par value would decrease to $5 per share.
     • The market price of the stock would double.

     Correct answer: The par value would decrease to $5 per share.

     A stock split results in more outstanding shares at a lower par value per share. In the case of a 2-for-1 split, there are twice as many shares (2 million) and the par value is cut in half ($10 $\div$ 2 = $5) The total par value of stock outstanding is unchanged ($2 million $\times$ $5 = the same $10 million in total par value). Remember, a 2:1 split is the same as changing a $10 bill for two $5 bills. Retained earnings are not affected by a stock split. Although not part of this question, the market value of the stock would be approximately $10 per share (half of the $20 per share before the split).

470. Your client owns 100 shares of CCC at $25. CCC declares a 25% stock dividend. After the ex-date, what will she own?
     • 125 shares at $20
     • 100 shares at $31.25
     • 100 shares at $25
     • 125 shares at $18.75

     Correct answer: 125 shares at $20

     Stock dividends make the number of shares owned increase and the cost per share decrease. The overall value should remain unchanged before and after the adjustment: 125 shares $\times$ $20 = $2,500, and 100 shares $\times$ $25 = $2,500.

471. ABC has 1 million shares of common stock outstanding. Mr. Chen owns 100,000 shares of ABC common stock. If ABC issues an additional 500,000 shares, and assuming ABC's charter calls for preemptive rights, Chen will receive enough rights to purchase
     • 15,000 additional shares.
     • 20,000 additional shares.
     • 10,000 additional shares.
     • 50,000 additional shares.

     Correct answer: 50,000 additional shares.

     Mr. Chen has a 10% ownership position in ABC (100,000 divided by 1,000,000). Therefore, if an additional 500,000 shares are issued, Mr. Chen has a preemptive right to maintain his 10% position. Ten percent of 500,000 = 50,000 additional shares.

472. A corporation must have stockholder approval to
     • Declare a cash dividend
     • Issue convertible bonds
     • Declare a 15% stock dividend
     • Repurchase 100,000 shares of stock for its Treasury

     Correct answer: Issue convertible bonds

     Stockholders are entitled to vote on the issuance of additional securities that would dilute shareholders' equity (the shareholders' proportionate interest). Conversion of the bonds would cause more shares to be outstanding, thus reducing the proportionate interest of current stockholders. Decisions that are made by the board of directors and do not require a stockholder vote include the repurchase of stock for its Treasury, declaration of a stock dividend, and declaration of a cash dividend.

473. JDX Corporation's charter has authorized 10,000,000 shares of common stock. It has issued 5,000,000 shares and has 1,000,000 shares in its treasury. JDX decides to use all of the treasury stock to pay a dividend to shareholders. As a result, the number of outstanding shares is
     • 5,000,000.
     • 4,000,000.
     • 6,000,000.
     • 10,000,000.

     Correct answer: 5,000,000.

     Treasury stock is stock that has been issued and reacquired by the company. At that point, it is no longer outstanding in the hands of the public. Sending those shares out as a dividend puts them back in the hands of the investing public. Now, all of the five million issued shares are outstanding.

474. When reading a corporation's annual report, a registered representative notices that there are 100 million shares authorized, 70 million shares outstanding, and 10 million shares in the treasury. Based on this information, the representative would deduce the number of unissued shares is
     • 80 million.
     • 30 million.
     • 20 million.
     • 10 million.

     Correct answer: 20 million.

     Of the 100 million authorized shares, 80 million have been issued (the 70 million outstanding plus the 10 million in the treasury). That leaves 20 million shares still unissued.

475. A share of common stock in the hands of a stockholder carries with it certain rights. Among those rights is
     • Entitlement to receive profits through dividends when distributed but not the right to vote for who will serve on the board of directors
     • Entitlement to receive profits through dividends when distributed and the right to vote for the amount of that dividend
     • A claim on the assets of the corporation second only to that of the company's secured creditors
     • Entitlement to receive profits through dividends when distributed and the right to vote for who will serve on the board of directors

     Correct answer: Entitlement to receive profits through dividends when distributed and the right to vote for who will serve on the board of directors

     Each share of common stock entitles its owner to a portion of the company's earnings through dividends when distributed and a proportionate vote in major management decisions such as electing individuals to the board of directors (BOD). It is the board that determines the amount and frequency of dividend payments. The common stockholders' claim is behind everyone—they are last in line.

476. ADJ Corporation's charter has authorized 10,000,000 shares of common stock. It has issued 5,000,000 shares and has 1,000,000 shares in its treasury. How many shares of common stock are currently outstanding?
     • 5,000,000 shares
     • 4,000,000 shares
     • 6,000,000 shares
     • 9,000,000 shares

     Correct answer: 4,000,000 shares

     Shares outstanding are those that are in the hands of the public. To determine the number of outstanding shares, take the number issued minus the number in the treasury. In this question, that is 5 million minus 1 million = 4 million. If, at a later time, ADJ should decide to issue some of the authorized, but unissued shares, the number of outstanding shares will obviously increase. The same would happen if the company sold some of the treasury stock in the open market or used it to pay stock dividends to current shareholders.

477. JEG Corporation common stock is currently trading at $25 per share. The par value of JEG stock
     • Has nothing to do with the current market value of the stock
     • Is most likely $25 per share
     • Is most likely less than $25 per share
     • Is most likely more than $25 per share

     Correct answer: Has nothing to do with the current market value of the stock

     Common stock has a par or stated value on the corporation's books that has nothing to do with the market price of the stock. That price can be above, below, or the same as the par value. The market price is determined by supply and demand.

478. If a company splits its stock 3 for 2, how many additional shares will be issued to an investor who owns 200 shares?
     • 300
     • 400
     • 100
     • 500

     Correct answer: 100

     The investor will receive an additional 100 shares from a 3-for-2 stock split. To calculate the additional shares as a result of a split, multiply the existing number of shares by the split rates ($200 \text{ shares} \times 3/2 = 300 \text{ shares}$). Because the investor owned 200 shares, she will be issued 100 additional shares, bringing ownership to 300 shares.

479. A client has 100 shares of GHI when the stock undergoes a split. After the split, the client has
     • Greater exposure
     • A proportionately decreased interest in the company
     • A proportionately increased interest in the company
     • No effective change in the value of the position

     Correct answer: No effective change in the value of the position

     When a stock splits, the number of shares each stockholder has either increases or decreases (in the case of a reverse split). The customer experiences no effective change in position because the proportionate interest in the company remains the same.

480. An investor purchased 100 shares of ABC common stock valued at $6,000. What is the adjusted cost basis per share of this position after the company pays a 20% stock dividend?
     • $48.00
     • $60.00
     • $72.00
     • $50.00

     Correct answer: $50.00

     The total value of the initial position is unchanged, remaining at $6,000. After the stock dividend, the investor owns 120 shares ($100 \times 20\% = 20 + 100 = 120$). Therefore, the adjusted cost basis is $50 per share ($6,000 divided by 120 = $50). It is important to remember that anytime there is a distribution resulting in additional shares (stock split, stock dividend), the cost basis per share is reduced while the total account value remains the same.

481. By regular or statutory voting procedures, a shareholder with 100 shares would be able to vote to fill seats for six directors in which of the following ways?
     • 600 votes for any one director, no votes for the others
     • 100 votes for each of the six candidates
     • 300 votes for any two, none for the other four
     • 150 votes for any four candidates

     Correct answer: 100 votes for each of the six candidates

     With regulatory or statutory voting, the investor has one per share per vacant seat. In this case, this is 100 shares for each of the six open seats. Any of the choices would work for cumulative voting.

482. Reasons why a corporation might engage in a stock buy-back program would include all of these except
     • Having stock available for future acquisitions
     • Using the stock for employee stock options
     • Increasing earnings per share
     • Reducing annual interest expense

     Correct answer: Reducing annual interest expense

     There is no interest expense with stock. When a company buys back its stock, it becomes treasury stock. That stock is no longer outstanding. Buying back the stock should cause the earnings per share to increase (there are now fewer shares outstanding). Many times one company will acquire another one by paying for the purchase with its treasury stock rather than cash. Many companies offer employees ownership opportunities through employee stock options. This is a way to ensure that the company has enough stock to meet the needs.

483. A stockholder owns 200 shares of common stock in a corporation that features statutory voting. If an election is being held in which six candidates are running for three seats on the board, the stockholder could cast the votes in which of the following ways?
     • 600 votes for any one director, no votes for the others
     • 100 votes for each of six directors.
     • 200 votes for each of three directors
     • 300 votes for each of two directors.

     Correct answer: 200 votes for each of three directors

     A stockholder has one vote per seat for each share of stock he owns. Thus, in this case, the stockholder has a total of 600 votes. Under the statutory voting method, he must allocate an equal number to each seat, or 200 for each of three seats.

484. An investor owns 300 shares of XYZ common stock, currently selling for $50 per share. The investor also owns 100 shares of XYZ's 5% $100 par preferred stock currently trading at $90 per share. A 2:1 stock split is declared. After the payment date, the investor will own
     • 150 shares of common at $100 per share and 100 shares of the preferred at $90 per share.
     • 600 shares of common at $25 per share and 100 shares of the preferred at $90 per share.
     • 600 shares of common at $25 per share and 200 shares of the preferred at $45 per share.
     • 300 shares of common at $50 per share and 200 shares of the preferred at $45 per share.

     Correct answer: 600 shares of common at $25 per share and 100 shares of the preferred at $90 per share.

     A stock split is always of common stock. In a 2:1 split, the number of shares doubles, and the price is 50% of the presplit price, which means 600 shares at $25 per share. The stock split has no effect on the preferred stock.

485. Common stock that has no voting power, no rights to receive dividends, that has been authorized and issued but is not outstanding is known as
     • Subordinated shares
     • Class B common shares.
     • Unissued stock
     • Treasury stock

     Correct answer: Treasury stock

     This is the definition of treasury stock.

486. An investor holds 3,000 shares of a stock with a current market value of $12 per share. After a 1:6 stock split, the investor's position will be
     • 15,000 shares with a market value of $12 per share.
     • 500 shares with a market value of $2.40 per share.
     • 15,000 shares with a market value of $2.40 per share.
     • 500 shares with a market value of $72 per share.

     Correct answer: 500 shares with a market value of $72 per share.

     This is an example of a reverse split. For each share owned, the investor will now have 1/6 of a share. That turns 3,000 shares into 500. At the same time, the market price per share will increase approximately by a factor of six. The key to any stock split question is that the total value of the account remains the same. Presplit, it was 3,000 $\times$ $12 = $36,000 and postsplit it is 500 $\times$ $72 = $36,000.

487. A corporation has gone out of business and the assets are being liquidated. Investors of the corporation have claim to those assets, including common stockholders. All the following terms apply to the common stockholders' claim except
     • Last
     • Junior
     • Senior
     • Residual

     Correct answer: Senior

     Creditors, such as bondholders and general creditors, as well as preferred stockholders of the corporation, would have a prior or senior claim to corporate assets in liquidation. Common stockholders have the last claim to assets in liquidation. This also known as the most junior or residual claim.

488. Treasury stock is
     • Authorized but unissued stock owned by the company
     • Preferred stock
     • Issued by the U.S. Treasury Department.
     • Stock repurchased by the issuer

     Correct answer: Stock repurchased by the issuer

     A company may, from time to time, go into the market and buy some of its own outstanding stock, which is then placed in the Treasury and called Treasury stock. Treasury stock has no voting rights and does not receive dividends. Treasury stock is not included when calculating shareholders' equity or net worth.

489. A company's dividend on its common stock is
     • Mandatory if the company is profitable
     • Voted on by shareholders
     • Specified in the company charter
     • Determined by its board of directors

     Correct answer: Determined by its board of directors

     A common stock's dividend payment and amount are determined by the company's board of directors.

490. A company has reverse split its common stock. The effect on the earnings per share will be
     • None of these
     • An increase
     • No effect
     • A decrease

     Correct answer: An increase

     When a reverse split takes place, the number of outstanding shares is reduced. Because the split has no effect on earnings of the company, dividing those earnings by fewer shares will cause an increase to the earnings per share.

491. A corporation's corporate charter allows for cumulative voting. A shareholder with 300 shares would be able to vote in an election for three open seats in any of the following ways except
     • 900 votes for any one open seat.
     • 300 votes for each open seat.
     • 450 votes for any two open seats.
     • 900 votes for each open seat.

     Correct answer: 900 votes for each open seat.

     With cumulative voting, the shareholder multiplies the number of shares owned by the number of seats being contested. With 300 shares and three seats, the shareholder has 900 shares to be invested in any manner desired. But, that is a total of 900, not 900 times 3.

492. Which of the following securities is considered the most junior?
     • Common stock
     • Debenture
     • Prior lien preferred stock
     • Mortgage bond

     Correct answer: Common stock

     In the event of a company's bankruptcy, common stock owners have the lowest priority in claims against corporate earnings and assets. This identifies common stock as the most junior security.

493. Minority stockholders are more likely to be able to elect directors through which form of voting?
     • Statutory
     • Cumulative
     • Regular
     • Progressive

     Correct answer: Cumulative

     Minority stockholders are more likely to be able to elect representatives to the board of directors through cumulative voting. Small stockholders may cast all of their votes on one position rather than spread them out, and thus dilute them over two or three positions.

494. The board of directors of DMF, Inc., announces a 5, for-4 stock split. The market price of DMF after the split should decrease in value by
     • 10%.
     • 20%.
     • 25%.
     • 30%.

     Correct answer: 20%.

     The easy way to handle questions about stock splits is to turn the split into a fraction. You know that after a split, which increases the number of shares outstanding, the market price per share will be reduced. With a 5-for-4 stock split, the new price should be about four-fifths of the old price. A one-fifth change equals 20% (100% / 5 = 20%).

495. An investor purchased 200 shares of DCAST common stock at $200 per share. What is the adjusted cost basis per share of this position after the company pays a 100% stock dividend?
     • $100
     • $200
     • $400
     • $50

     Correct answer: $100

     The total value of the initial position is unchanged, remaining at $40,000 (200 times $200). After the stock dividend, the investor owns 400 shares (200 times 100% = 200 + 200 = 400). Therefore, the adjusted cost basis is $100.00 per share ($40,000 divided by 400 = $100). Perhaps you recognized that a 100% stock dividend has the same effect as a 2:1 split. That is, the stock's cost basis is cut in half. It is important to remember that anytime there is a distribution resulting in additional shares (stock split, stock dividend), the cost basis per share is reduced while the total account value remains the same.

496. Elisha purchased 100 shares of RMBN common stock on June 6, 2019, at $60 per share. On February 11, 2020, RMBN paid shareholders a 20% stock dividend. Elisha sells the shares received as the stock dividend on December 5, 2020, at $55 per share. What are the tax consequences of this trade?
     • $100 short-term capital loss
     • $100 long-term capital gain
     • $100 short-term capital gain
     • $100 long-term capital loss

     Correct answer: $100 long-term capital gain

     When a stock dividend is paid, the cost basis of the shares is adjusted. In this case, Elisha now owns 120 shares and the total cost is still the original $6,000. That makes the adjusted cost basis per share $50 ($6,000 $\div$ 120). With the new cost basis of $50 per share, when the sale of those 20 shares takes place at $55 per share, the result is a gain of $100 ($5 per share profit times 20 shares. Alternatively, $1,100 total proceeds [20 shares x $55 per shares] minus $1,000 cost basis [20 shares x $50 per share adjusted cost per share)). Even though these shares were acquired less than 12 months before the sale, their holding period is based on the original purchase date and that is clearly more than 12 months before the sale. That is why it is long term.

497. Common stockholders have certain voting rights. Those rights do not include voting on
     • Determining the annual dividend rate
     • Declaring stock splits
     • Issuing convertible products or additional common stock
     • Important corporate decisions such as mergers and acquisitions

     Correct answer: Determining the annual dividend rate

     Common stockholders cannot determine the annual dividend rate. Only the board of directors can declare dividends. Common stockholders do have the right to vote for or against conversions, substantial corporate decisions, and the declaration of stock splits.

498. Synapse Communication Corporation (SCC) is growing. To finance the expansion, the company has a $100 million debenture offering. Attached to the offering are five-year warrants to purchase SCC common shares. Each warrant allows for the purchase of two SCC shares at a price of $53 per share. Three years after the issue date, SCC stock is trading at $63 per share. Each warrant has
     • An intrinsic value of $10
     • An intrinsic value of $20
     • No intrinsic value, only time value
     • An intrinsic value of $5

     Correct answer: An intrinsic value of $20

     A warrant has intrinsic value when the exercise price is lower than the stock's current market price. In this question, each warrant allows the holder to purchase two shares of a $63 stock for $53 per share. That is a $10 per share value times two. Therefore, intrinsically, the warrant is worth $20. With two years to go, it also has time value, but the question is not dealing with that. ** This question deals with material not covered in your study materials, but it relates to recent rule changes and/or student feedback.

499. QED Corporation, whose common stock is currently selling for $90 per share, is having a rights offering. The terms of the offering require seven rights plus $83 to subscribe to one share of stock. Compute the theoretical value of a right on the ex-rights date.
     • $7.00
     • $1.125
     • $0.875
     • $1.00

     Correct answer: $1.00

     Because this is ex-rights (without the rights), the formula does not include the "+1." The formula is (M − S) N. Plugging the numbers in, we have ($90 − $83) 7 = $7.00 7 = $1.00.

500. Which of the following is an advantage of owning American depositary receipts (ADRs)?
     • The investor can buy, sell, and receive dividends in U.S. dollars rather than a foreign currency.
     • The investor receives preemptive rights should the issuer make an additional stock offering.
     • The investor avoids the currency risk that characterizes many foreign investments.
     • The investor has the right to vote at stockholders' meetings.

     Correct answer: The investor can buy, sell, and receive dividends in U.S. dollars rather than a foreign currency.

     ADRs permit an American investor to purchase a certificate of deposit for stock (not stock itself) in a foreign company. The advantage is that the transactions are done in dollars, but the ADR itself does not carry a vote or stock rights and subjects the owner to currency risk.

501. Investing in ADRs presents certain risks that do not apply to investing in domestic stocks. One specific risk that applies only to ADRs is
     • Business risk
     • Currency risk
     • Market risk
     • Financial risk

     Correct answer: Currency risk

     Because the ultimate value of the ADR is based on the underlying stock's value in its local currency, ADRs have currency risk. Both have market risk. You may not know business or financial risk, but you should know that currency risk is part of investing in ADRs.

502. Dividends may be paid to holders of
     • Treasury stock.
     • Warrants
     • American depositary receipts (ADRs).
     • Rights

     Correct answer: American depositary receipts (ADRs).

     ADR owners have most of the rights common stockholders normally hold. One of these includes the right to receive dividends when declared. Rights and warrants allow holders to purchase stock from a corporation, and Treasury stock is stock that has been issued by the corporation and then bought back. Rights, warrants, or Treasury stock holders do not have the right to receive dividends.

503. A tombstone ad for a new bond issue announces that warrants to purchase shares of the issuer's common stock at $75 per share are attached to the bonds. The common stock is currently traded at $45 per share and the warrants expire in five years. What is the most likely reason the issuer attached the warrants to the bonds?
     • To decrease the dilution of the current shareholders
     • To improve the marketability of the bond issue
     • To make the bonds convertible into the issuer's common stock
     • To increase the dilution of the current shareholders

     Correct answer: To improve the marketability of the bond issue

     Warrants are often issued as a bonus (or sweetener) to entice investors to purchase new bond issues. Dilution may occur at the time the warrants are exercised (if ever), but this would not be a reason for their issuance. A warrant has nothing to do with the bond's convertibility into the underlying common stock.

504. The DERP Corporation has a rights offering. The common stock is currently selling at $45.50. DERP is issuing one new share of stock at $40 per share for each 10 shares owned. What is the theoretical value of one right when the stock is traded ex-rights?
     • $0.40
     • $0.55
     • $0.45
     • $0.50

     Correct answer: $0.55

     The formula for the theoretical value of a right when it is ex-rights (the buyer doesn't get the rights) is $(M - S) \div N$ where M = market price of the stock, S = the subscription price, and N = number of rights needed. Plug in the numbers and you have ($45.50 ‒ $40) divided by 10. That is $5.50 divided by 10 or $0.55 each

505. A corporation has 1 million shares of common stock outstanding. There is also a $100 par 6% cumulative convertible preferred issue with 100,000 shares outstanding. If the corporation wishes to use a rights offering to raise additional capital by selling 500,000 new shares of common, which of the following statements is true?
     • It will require five rights granted to the preferred stockholders to buy one new share.
     • Each common share will receive half of a right.
     • It will require two rights to buy one new share.
     • Each preferred share would receive five rights.

     Correct answer: It will require two rights to buy one new share.

     The number of rights necessary to acquire one new share is computed by dividing the number of outstanding shares of common stock by the number of new shares being issued. In this question, that is $1{,}000{,}000 \div 500{,}000 = 2$.

506. A convertible preferred stock issue (par value $100) is selling at $125 and is convertible into five shares of common stock. The conversion price of the common stock is
     • $25.
     • $100.
     • $20.
     • $1,200.

     Correct answer: $20.

     Par value divided by conversion price equals the number of shares into which the security is convertible. If this security is convertible into five shares, we need to know what number goes into $100 five times. That number is $20. The current market value of the preferred stock is unnecessary information.

507. Nickelplate Manufacturing Corporation (NMC) is capitalized with 1 million shares of a 6% $50 par callable preferred stock and 10 million shares of $1 par common stock. NMC has not paid any dividends at all for the past five quarters. The current quarter's earnings are excellent and the company would like to pay a dividend to its common shareholders. Doing so would require
     • Paying the preferred shareholders a dividend of $3.75 per share
     • Paying the preferred shareholders a dividend of $0.75 per share
     • Paying the preferred shareholders a dividend of $4.50 per share
     • An affirmative vote of the common shareholders

     Correct answer: Paying the preferred shareholders a dividend of $0.75 per share

     A corporation cannot pay a dividend to its common shareholders without satisfying the dividend requirements of any outstanding preferred stock. NMC has a 6% $50 par preferred. The annual dividend requirement (if declared) is $3 per share. That is $0.75 per quarter. On the exam, all dividends are paid quarterly unless stated otherwise. Once that dividend is paid to the preferred, the declared dividend can be paid to the common. But, the question tells us that NMC has not paid preferred dividends for more than one year (five quarters). What about those skipped dividends? This preferred stock is callable, not cumulative. Be careful to read the question. Shareholders do not vote on cash dividend payments. That decision is made by the company's board of directors.

508. American depositary receipt (ADR) owners have all the following rights except
     • The right to sell the ADR in the foreign market
     • The right to receive dividends in U.S. dollars.
     • The right to sell in the secondary market
     • The right to receive the underlying foreign security

     Correct answer: The right to sell the ADR in the foreign market

     The purpose of the ADR is to facilitate trading in U.S. markets. The ADR can only be traded in the United States. If the owner exercises the right to obtain the actual foreign security, it may be sold overseas.

509. A registered representative has a customer looking to invest in stock for income. The customer is looking for the highest fixed rate of return available based on her risk profile. Which of the following would be least suitable?
     • Callable preferred
     • Convertible preferred
     • Cumulative preferred
     • Straight preferred

     Correct answer: Convertible preferred

     Convertible preferred stock is convertible into the issuer's common stock. This conversion feature has value if the market price of the underlying stock should increase. Because of that feature, issuers are able to attract investor interest with a lower dividend on this preferred stock compared with preferred stock that has no conversion feature. Therefore, it would be the least suitable investment for this client.

510. Sagacious Publishing Company (SPC) has issued a $25 par 4% preferred stock. If current market interest rates should rise, it is probable that
     • SPC will lower the par value of the stock.
     • SPC will increase the dividends to match market returns.
     • The market price of this stock will decline
     • Investors holding shares of this stock will vote to increase the dividends

     Correct answer: The market price of this stock will decline

     Because preferred stock is a fixed-income investment, its market price moves inversely to changes in interest rates. As interest rates in the market go up, the price of preferred stock goes down. The dividend rate and par value of a preferred stock is fixed at issuance and do not change. It is rare to find a preferred stock with voting powers. Even then, they would never be voting on changing the dividend rate on a preferred stock. That is one of the benefits of adjustable-rate preferred stock. Because the dividend rate adjusts in response to changes in the market interest rate, the price generally remains relatively stable. How do we know this is not adjustable-rate preferred? Because the question would have to state that fact.

511. New offering: 800,000 units at $6 per unit. Each unit has two shares of common stock and one warrant. Each warrant is to purchase half a share of common stock. Based on this information, how many shares of stock will be sold, and how many warrants will be sold?
     • 800,000 shares and 200,000 warrants
     • 1.6 million shares and 400,000 warrants
     • 1.6 million shares and 800,000 warrants
     • 800,000 shares and 400,000 warrants

     Correct answer: 1.6 million shares and 800,000 warrants

     Warrants may be distributed to stockholders in an underwriting as part of a unit. The warrant is a form of bonus to entice investors to purchase the unit. As each unit contains two shares, 1.6 million shares are being distributed. As each unit also includes one warrant, 800,000 warrants are being distributed.

512. A convertible preferred stock with a par value of $100 is currently trading at $125 per share. The conversion ratio is 5:1. If the common stock is trading at $30 per share, what must the preferred stock's price be to be at parity?
     • $70
     • $130
     • $150
     • $103

     Correct answer: $150

     The math is 5 $\times$ $30 = $150. The logic is, you can convert the preferred stock into five shares of the common. If the common is trading at $30 per share, to be equal, the preferred stock must be selling for five times that price.

513. One of your clients asks about a recent purchase of a preferred stock. When looking at online information about the stock, the client notices that no par value is assigned. How does the company determine the amount of dividend to be paid?
     • On a no-par preferred stock, the company has the flexibility to increase or decrease the dividend as earnings warrant.
     • The board of directors determines the amount each quarter based on current interest rates.
     • On a no-par preferred stock, the dividend is paid as a percentage of the common stock dividend.
     • On a no-par preferred stock, the dividend is a stated rate.

     Correct answer: On a no-par preferred stock, the dividend is a stated rate.

     When a preferred stock is issued without a stated or par value, the dividend rate is stated in dollars. For example, it could be a $2 preferred. That would mean quarterly dividends of $0.50; $2 per year. Although the company is under no obligation to pay a preferred dividend (unless it plans to pay a dividend on its common stock), and the board of directors can pay a partial dividend, that does not mean the dividend can be increased over the stated rate.

514. XYZ Corporation, whose common stock is currently selling for $40 per share, is having a rights offering. The terms of the offering require 10 rights plus $35 to subscribe to one share of stock. Compute the theoretical value of a right before the ex-rights date.
     • $3.50
     • $0.50
     • $0.55
     • $0.45

     Correct answer: $0.45

     Because the stock is trading with rights (before the ex-rights date), the formula is (M − S) ÷ (N + 1), where M is the market price, S is the subscription price, and N is the number of rights needed. Plugging the numbers in, we have ($40 − $35) ÷ (10 + 1) = $5.00 ÷ 11 = $0.45.

515. A company is offering investors the opportunity to purchase shares for the next five years at a fixed price slightly above today's market price. The company is issuing
     • Warrants
     • A letter of intent
     • Futures
     • Call options

     Correct answer: Warrants

     A warrant is a security that allows the holder to purchase shares of the underlying issue at a fixed price (above the current market price when issued) for an extended period (typically two years or longer). Call options are similar, except they are short-term securities (nine months at issue).

516. Dividends from American depositary receipts (ADRs) held by U.S. investors are declared in
     • U.S dollars but paid in the foreign currency.
     • U.S. dollars and paid in U.S. dollars.
     • The foreign currency and paid in the foreign currency
     • The foreign currency but paid in U.S. dollars.

     Correct answer: The foreign currency but paid in U.S. dollars.

     Although the dividends paid by ADRs held by U.S. investors are declared in the foreign currency, they are paid in U.S. dollars. This is one reason currency risk is a factor for ADR holders.

517. A sophisticated investor wants to purchase stock of a foreign company or an American depositary receipt (ADR) representing the shares of that company. The purchase would align with the investor's goal of growth and income, but he makes several statements about the potential purchase, and only one of them is accurate. You feel it is important to point out and discuss from a suitability perspective which statements were and were not accurate. Which of the following is the accurate statement?
     • The direct purchase of the foreign stock shares eliminates currency risk.
     • With the ADRs, I'll have voting rights just like I would if I purchased the shares directly.
     • I can trade the foreign shares right here on U.S. exchanges.
     • The purchase of ADRs representing the shares exposes me to currency risk.

     Correct answer: The purchase of ADRs representing the shares exposes me to currency risk.

     From a suitability perspective, correcting any inaccuracies about an investment that an investor might have is important. Currency risk cannot be avoided when investing in foreign companies, either directly or using ADRs. While ADRs trade on U.S. exchanges, foreign shares do not, and ADR issuers generally do not pass on voting rights to the ADR holders.

518. Certificates issued by U.S. domestic banks and trust companies against the deposit of shares of foreign securities are known as
     • American share receipts.
     • Certificates of deposit
     • Foreign depositary receipts
     • American depositary receipts.

     Correct answer: American depositary receipts.

     This is the definition of the ADR – the simplest way to trade foreign securities in the United States.

519. All of the following statements describe stock rights except
     • They are short-term instruments that become worthless after the expiration date
     • They are issued by a corporation
     • They are traded in the secondary market
     • They are most commonly offered with debentures to make the offering more attractive

     Correct answer: They are most commonly offered with debentures to make the offering more attractive

     A corporation issues rights to existing shareholders to allow them to purchase enough stock—within a short period and at less-than-current market price—to maintain their proportionate interest in the company. Rights need not be exercised but may be traded in the secondary market. Warrants, not rights, are often issued with debentures to sweeten the offering.

520. A participating preferred stock
     • Has a senior claim in liquidation over holders of debentures
     • Participates in voting along with the common shareholders
     • Receives both a fixed dividend plus a share of the common dividend
     • Must be paid any dividend arrearage before dividends may be paid on the common stock

     Correct answer: Receives both a fixed dividend plus a share of the common dividend

     In addition to the stated fixed dividend, participating preferred stock is eligible to receive a percentage of the common dividend. The participation has nothing to do with voting. Any preferred stock, although senior to common, has a junior claim to any debt security. It is the cumulative preferred where there is the obligation to clear up the arrearage before paying dividends on the common stock.

521. A corporate offering of 200,000 additional shares to existing stockholders may be made through
     • A warrant
     • A tender offer
     • A rights offering
     • A secondary offering

     Correct answer: A rights offering

     A rights offering is an offering of additional shares of stock to existing shareholders.

522. Which of the following securities cannot pay a dividend?
     • Class B common stock
     • Warrants.
     • Convertible preferred stock.
     • American depositary receipts.

     Correct answer: Warrants.

     Warrants represent long-term options to buy stock at a fixed price, and, like options, cannot pay dividends.

523. An investor has purchased 100 shares of common stock of the UOM Corporation. UOM Corporation is a Japanese company. Rather than receiving a UOM stock certificate, the investor receives an American depositary receipt (ADR). The investor calls his registered representative and wants to know why he did not receive the stock certificate. The registered representative tells the client that
     • The ADR is a substitute for the stock certificate and represents the investor's ownership in the foreign corporation's stock
     • UOM stock certificates were not available.
     • Receiving the stock certificates would cost the investor more money
     • Records of ownership in UOM stock is book-entry only

     Correct answer: The ADR is a substitute for the stock certificate and represents the investor's ownership in the foreign corporation's stock

     An ADR is a negotiable certificate that evidences an ownership interest the shares of a non-U.S. company that are on deposit with a foreign branch of a U.S. bank. It is similar to a stock certificate representing shares of stock. ADRs trade in U.S. dollars and clear through U.S. settlement systems, allowing ADR holders to avoid having to transact in a foreign currency.

524. An American depositary receipt (ADR) is used to
     • Facilitate trading foreign securities in U.S. markets by U.S. citizens living in the United States.
     • Sweeten a bond offering
     • Finance foreign trade in which U.S. citizens are engaged.
     • Facilitate trading U.S. securities in foreign markets by U.S. citizens living abroad.

     Correct answer: Facilitate trading foreign securities in U.S. markets by U.S. citizens living in the United States.

     ADRs make trading in foreign securities easier in U.S. markets for U.S. investors.

525. A new bond issue will include warrants to
     • Increase the price of the issue to the public
     • Increase the attractiveness of the issue to the public
     • Increase the capital raised by the issuer through the bond offering
     • Increase the spread to the underwriter

     Correct answer: Increase the attractiveness of the issue to the public

     By including warrants with debt issues, issuers increase the marketability of bonds. The warrants offer a long-term opportunity to buy the underlying stock at a fixed price. In addition to increasing the marketability of the issue, the issuer can offer the bonds with a lower coupon rate and, as a result, reduce fixed costs.

526. GC, Inc., is proposing an additional public offering of common stock. It conducts a rights offering to its current shareholders at $55 per share, plus five rights. If the market price of GCI is $70 after the ex-rights date passes, what is the value of one right?
     • 2.5
     • 5
     • 15
     • 3

     Correct answer: 3

     Because the stock is selling ex (after ex-rights), the formula is ($70 − $55) / 5. ($70 − $55 = $15) ($15 / 5 = $3).

527. Many investors diversify by adding foreign securities to their portfolios. Those who do so by purchasing foreign stock mutual funds are least likely to be concerned with
     • Liquidity risk
     • Market risk
     • Political risk
     • Currency risk

     Correct answer: Liquidity risk

     Because federal law requires mutual funds to offer redemption at net asset value within seven days of the request (in the real world, it is much quicker), liquidity risk is not a concern to this investor. Although the fund is trading in dollars and all distributions in the U.S. currency, the income to the fund comes through the foreign currency. That makes investors in the fund subject to the same currency risk as if they bought the stock directly. The foreign securities in the portfolio of the fund are subject to market risk and that directly affects the value of the fund shares. Political risk is always a concern when making foreign investments. Certainly, it is of less concern in the major developed countries, but we cannot compare that with the absence of liquidity risk.

528. Which of the following statements is true regarding dividend payments on common stock?
     • Dividends on common stock are paid at the discretion of the board of directors and may be paid ahead of preferred stock when necessary to allow the company to remain listed on the exchange.
     • Dividends on common stock are paid at the discretion of the board of directors and may be paid even where there are no earnings.
     • Dividends on common stock are paid at the discretion of the board of directors and are paid as a stated percentage of the corporation's net income.
     • Dividends on common stock are paid at the discretion of the board of directors and can be paid only when there are sufficient earnings.

     Correct answer: Dividends on common stock are paid at the discretion of the board of directors and may be paid even where there are no earnings.

     Dividends on common stock are paid at the discretion of the corporation's board of directors. Although each stockholder receives an amount proportionate to their holdings, the dividend can be any proportion of the company's earnings. In fact, a corporation can pay a dividend even when there are no earnings. However, no dividend on common stock can ever be paid before payment of the dividends due on preferred stock.

529. Which of the following features of preferred stock allows the holder to reduce the risk of inflation?
     • Noncumulative
     • Convertible
     • Callable
     • Cumulative

     Correct answer: Convertible

     Fixed-dollar investments, such as bonds and preferred stock, are subject to inflation risk, which is the risk that the fixed interest or dividend payments will be worth less over time in terms of purchasing power. The ability to convert to common stock, which tends to keep pace with inflation, offsets this risk.

530. Owners of a corporation's common stock who are unable to attend the corporation's annual meeting are
     • Sent proxies to cast their votes
     • Unable to change their vote if they should be able to attend the meeting
     • Forfeiting their right to vote
     • Required to give voting instructions to the broker-dealer handling the account

     Correct answer: Sent proxies to cast their votes

     A proxy is this industry's version of an absentee ballot. Most are handled electronically now. Should the situation change and the individual be able to make the meeting, the vote can be changed at that time if desired. The broker-dealer handling the account is frequently the one who solicits the proxy on behalf of the issuer. There is no action taken against a client who ignores the proxy, just as nothing happens to a citizen who decides not to vote in an election.

531. All of the following would be included in a penny stock risk disclosure statement except
     • The risks of investing in penny stock
     • The broker-dealer's statement of guarantee
     • The definition of penny stock
     • Investors' legal rights

     Correct answer: The broker-dealer's statement of guarantee

     Penny stock disclosure statements must be furnished to all buyers of unlisted, non-Nasdaq stocks of less than $5 per share. The disclosure must include the risks of penny stock investing, the rights of the investors, and the responsibilities of the broker-dealer to the investor. There would be no statements—either implied or expressly written—regarding guarantees.

532. Which of the following provisions of a new corporate debt issue would be least attractive to a potential investor?
     • A high nominal yield
     • A sinking fund
     • A low call price
     • Significant collateral

     Correct answer: A low call price

     Investors can be wary when it comes to callable bonds. When interest rates decline and the investors are smiling over the higher than market rates they are earning, along comes the issuer and calls that bond in. The lower the call price, the more attractive it is for the issuer, not the investor. A sinking fund is like the escrow account on a home mortgage. Money is being put aside to make sure that when it is due, it is there. Obviously the investor would prefer a higher coupon (nominal) yield than a lower one and collateral always adds to the security of the debt.

533. Which of the following is a money market instrument?
     • Long-term debt
     • Short-term debt
     • Preferred stock
     • Common stock.

     Correct answer: Short-term debt

     A money market instrument is short-term debt with one year or less to maturity.

534. DERF Corporation has a significant amount of cash on hand. The chief financial officer (CFO) has suggested to the chief executive officer (CEO) that it might be wise to pay off $10 million of the company's outstanding debt. There are four bond issues outstanding, and your broker-dealer is approached for advice on determining which issue to repay. Which of these four issues would the firm recommend?
     • $15 million @8% due in 10 years, callable at 101
     • $10 million @6% due in 20 years, callable at par
     • $25 million @5% due in 5 years, callable at 104
     • $30 million @12% due in 15 years, non-callable

     Correct answer: $15 million @8% due in 10 years, callable at 101

     Anytime we have extra cash, it can make sense to pay off debt. Corporations feel the same way. When it comes to deciding which debt to repay, the wisest move is to pay down the debt with the highest interest cost. In this case, that would be the 12% bond. However, that bond is non-callable. Based on the inverse relationship between interest rates and bond prices, the 12% bond is going to be selling at a higher price than any of the others. Any savings in interest payments would be more than offset by the price the company would have to pay to buy the bond in the open market. The next highest interest rate is 8% and that bond will cost us a slight premium of $10 per bond to call. Although the 6% bond is callable at par, the company would be far better off removing an 8% debt than one at 6%. In fact, the 1 point call premium is saved after the first semiannual interest payment. A partial call, calling in $10 million of the 8% bond, should be the recommendation.

535. An investor sells 10 5% bonds at a profit and buys another 10 bonds with a 5.25% coupon rate. The investor's yearly return will increase by
     • $2.50 per bond.
     • $2.00 per bond.
     • $1.00 per bond.
     • $1.50 per bond.

     Correct answer: $2.50 per bond.

     The first bonds are 5% and pay $50 per year per bond. The new bonds are 5.25% and pay $52.50 per year per bond, for a difference of $2.50 per bond.

536. A corporation plans to make a public tender for 50% of its outstanding bonds. The price of the tender will be set by
     • The trustee
     • The issuer
     • The transfer agent
     • The paying agent

     Correct answer: The issuer

     In a tender offer, the issuer is offering to buy back all or a portion of the issue at a stated price. The price of the tender is set by the issuer although the issuer may engage an underwriter to help it set the price. This could happen when interest rates have gone up, causing the price of the outstanding bonds to fall. From a practical standpoint, this would mean the corporation paying off debt at a price below face value.

537. When a corporation issues a debt security, the terms of the loan are expressed in a document known as the bond's indenture. The indenture is sometimes referred to as
     • The debenture
     • The bond resolution
     • The deed of trust
     • The loan agreement

     Correct answer: The deed of trust

     The indenture, sometimes also referred to as the deed of trust, states the issuer's obligation to pay back a specific amount of money on a specific date. A debenture is a debt security containing an indenture. The bond resolution is a term used for municipal bonds not corporate debt.

538. A bond you are recommending to a customer has call protection. What does that mean?
     • It is the number of years into the issue before the issuer may exercise the call privilege.
     • The issuer has set up a sinking fund to provide funds for the call.
     • The issuer records the phone number of investors and puts it on the do-not-call list.
     • It is the number of years into the issue before the investor may exercise the call privilege.

     Correct answer: It is the number of years into the issue before the issuer may exercise the call privilege.

     The definition of call protection is the length of time an investor is protected against the issuer exercising the right to call the bonds in. What is the maximum possible call protection? A noncallable bond. In many cases, the issuer sets up a sinking fund to use for the call, but that is not the definition of call protection.

539. An investor might expect to receive the greatest gain on an investment in a corporate bond by purchasing
     • Long-term bonds when interest rates are low
     • Short-term bonds when interest rates are high
     • Long-term bonds when interest rates are high
     • Short-term bonds when interest rates are low

     Correct answer: Long-term bonds when interest rates are high

     If an investor purchases bonds when market interest rates are high, a drop in interest rates will lead to a corresponding increase in bond value. Long-term debt instruments will fluctuate to a greater degree than those with short-term interest rates. Thus, long-term debt offers the greater chance of gain.

540. The legal contract stating the issuer's obligation to pay back a specific amount of money on a specific date to its bondholders is best described as
     • The prospectus
     • The official notice of sale
     • The official statement
     • The trust indenture

     Correct answer: The trust indenture

     A trust indenture delineates the covenants or promises made by an issuer to its bondholders. Those would include the amount of the debt, the maturity date, and the rate of interest. A trustee would also be identified in the indenture who would act on behalf of the bondholders in the event of default on any of the indenture's provisions.

541. What happens to outstanding fixed-income securities when market interest rates drop?
     • Short-term fixed-income securities are affected most.
     • The coupon rates increase.
     • The yields increase.
     • The prices increase.

     Correct answer: The prices increase.

     When interest rates drop, the price of outstanding bonds rises to adjust to the lower yields on bonds of comparable quality.

542. A corporation is likely to call eligible debt when interest rates are
     • Stable
     • Rising
     • Declining
     • Volatile

     Correct answer: Declining

     A corporation generally calls in its debt when interest rates are declining to replace old, higher interest rate debt with new, lower interest rate issues.

543. A convertible corporate bond with an 8% coupon yielding 7.1% is available but may be called sometime this year. Which feature of this bond would probably be least attractive to your client?
     • Coupon yield
     • Near-term call
     • Current yield
     • Convertibility

     Correct answer: Near-term call

     The near-term call would mean that no matter how attractive the bond's other features, the client may not have very long to enjoy them.

544. If a fund has a fixed portfolio of municipal bonds with long maturities, how will substantial changes in general interest rates affect the fund's portfolio?
     • The current value will not change, but the investment income will fluctuate significantly.
     • Both the income and the current value will fluctuate significantly.
     • Both the income and the current value will remain unchanged.
     • The current value will fluctuate significantly, but the investment income will remain relatively unchanged.

     Correct answer: The current value will fluctuate significantly, but the investment income will remain relatively unchanged.

     For a fund with a fixed portfolio of long-term municipal bonds, the market value of the portfolio will fluctuate with changing interest rates, but the income will remain unchanged.

545. Corporate bonds are considered safer than common stock issued by the same company because
     • If there is a shortage of cash, dividends are paid before interest
     • Bonds and similar fixed-rate securities are guaranteed by SIPC
     • The par value of bonds is generally higher than that of stock
     • Bonds place the issuer under an obligation but stock does not

     Correct answer: Bonds place the issuer under an obligation but stock does not

     A bond represents a legal obligation to repay principal and interest by the company. Common stock carries no such obligation.

546. The XYZ Corporation has issued some 4% callable bonds maturing in 20 years. The bonds are callable at 102 commencing in 10 years. Regarding these bonds, which of the following statements is not correct?
     • These bonds will appreciate faster in declining interest rate markets than comparable bonds without a call feature.
     • The call premium generally will not compensate the bondholder for the loss of interest if the bond is called.
     • The bonds will likely be called in a declining interest rate market, forcing the bondholders to reinvest at lower rates.
     • XYZ will most probably call these bonds when it can refund the issuer at a lower interest rate.

     Correct answer: These bonds will appreciate faster in declining interest rate markets than comparable bonds without a call feature.

     All things being equal, callable bonds will not show as much appreciation in a declining interest rate market as bonds without a call feature. Logically, as interest rates fall, those bonds will be called making them less attractive than bonds where the higher interest rate payments will continue until maturity. It is correct that the premium ($20 in this question) is generally not going to equal the amount of interest that the investor would have been able to earn on the bond. It is some compensation, but not full. The bonds will be called when interest rates have declined, and the investor will now have the cash but faces the reinvestment risk of having to put the money to work at those lower interest rates.

547. Your customer is interested in long-term corporate bonds. Which of the following interest rate environments makes a call protection feature most valuable to your customer?
     • Volatile interest rates
     • Rising interest rates
     • Stable interest rates
     • Declining interest rates

     Correct answer: Declining interest rates

     A call protection feature is an advantage to bondholders in periods of declining interest rates. When interest rates are falling, issuers are more likely to call in bonds previously issued at higher interest rates. For bondholders, calling bonds creates reinvestment risk, as they are unlikely to be able to reinvest at the rate they had been earning. Call protection gives the bond holder a specified length of time during which the bond cannot be called.

548. A corporate bond is quoted at 102⅝. A customer buying 10 bonds would pay
     • $10,262.50.
     • $10,025.80.
     • $10,258.00.
     • $10,285.00.

     Correct answer: $10,262.50.

     Par ($1,000) $\times$ 102% = $1,020. Five-eighths of one bond point ($10) equals 0.625 $\times$ $10 = $6.25. Therefore, the quote reading $102\tfrac{5}{8}$ equals $1,026.25 per bond ($1,020 + $6.25). Because we are told the customer is buying 10 bonds, we multiply $1,026.25 by 10 bonds, which equals the amount the customer will need to pay to make the entire purchase: $10,262.50.

549. A bond investor who is looking for capital gains should invest in bonds when interest rates are
     • High and expected to rise
     • High and expected to decline
     • Low and expected to rise
     • Low and expected to decline

     Correct answer: High and expected to decline

     This is about the inverse relationship between interest rates and bond prices. As interest rates rise, bond prices fall. Conversely, when interest rates decline, bond prices increase. If an investor buys bonds when the current interest rates are high, a future decline in those interest rates will cause the price of the bonds to increase.

550. An investor would most likely purchase money market instruments for their
     • Liquidity
     • Yields
     • Inflation protection
     • Appreciation potential

     Correct answer: Liquidity

     Money market instruments are frequently referred to as cash equivalents. That is largely due to their high liquidity. Yields on these instruments are very low, and as fixed-income instruments, they offer no appreciation potential or inflation protection.

551. A respected analyst reports that last week's T-bill rate at 1% is lower than the rate for the preceding week and lower than the average for the past month. Which of the following is true?
     • The general level of interest rates is increasing.
     • Investors are paying more for T-bills.
     • Prices are descending.
     • Investors are paying less for T-bills.

     Correct answer: Investors are paying more for T-bills.

     When the rate is lower, the price has gone up. This means investors are paying more as interest rates are going down.

552. All of the following are money market instruments except
     • Commercial paper
     • Bankers' acceptances
     • Options
     • Reverse repurchase agreements

     Correct answer: Options

     Money market instruments are short-term (one year or less to maturity) liquid debt instruments. Reverse repurchase agreements, repurchase agreements, commercial paper, CDs, and bankers' acceptances are examples. Options are not money market instruments.

553. The Union Fidelity Bank of Highville has issued jumbo CDs with a term of three years and a fixed interest rate of 3.5%. The minimum denomination of the CDs is $100,000, and the CDs are callable at 101% of face value beginning on the first anniversary of the issue date. Under which of the following circumstances is it most likely that the bank would exercise the call feature on that anniversary date?
     • Five-year jumbo CDs are currently being issued with a fixed interest rate of 2.7%.
     • One-year jumbo CDs are currently being issued with a fixed interest rate of 4%.
     • Three-year jumbo CDs are currently being issued with a fixed interest rate of 3.5%.
     • Three-year jumbo CDs are currently being issued with a fixed interest rate of 4%.

     Correct answer: Five-year jumbo CDs are currently being issued with a fixed interest rate of 2.7%.

     As is the case with other fixed payment callable issues, whenever interest rates decline, it is generally beneficial to call in the older issue. In this case, the bank would pay an extra 1% to redeem but could refinance at a rate that is at least .8% lower and extend the maturity. We say at least .8% lower because with the new five-year CDs paying 2.7%, if the bank wanted to keep to the same final maturity date (two more years), it is expected that the rate on two-year CDs would be lower than that of CDs with a five-year maturity.

554. Which of the following instruments is essentially a letter of credit?
     • Negotiable CDs
     • Bankers' acceptances.
     • Commercial paper
     • Margin loans

     Correct answer: Bankers' acceptances.

     A letter of credit (LOC) is a commitment, usually made by a commercial bank, to honor demands for payment of a debt upon compliance with conditions and/or the occurrence of certain events specified under the terms of the letter of credit. Those in the import/export business use these LOCs in the form of bankers' acceptances. **This question deals with material not covered in your study materials, but it relates to recent rule changes and/or student feedback.

555. All of the following statements regarding negotiable jumbo certificates of deposit are true except
     • They are fully insured in any denomination by the FDIC
     • They are usually issued in denominations of $100,000 to $1,000,000
     • They are readily marketable
     • They usually have maturities of less than one year

     Correct answer: They are fully insured in any denomination by the FDIC

     The FDIC insures only up to $250,000.

556. Which of the following does not issue commercial paper?
     • Corporations
     • Broker-dealers
     • Finance companies
     • U.S. Treasury

     Correct answer: U.S. Treasury

     The U.S. Treasury does not issue commercial paper. Its short-term borrowing is done with Treasury bills. Commercial paper is unsecured, short-term corporate debt most commonly issued by finance companies but also by industrial corporations and broker-dealers.

557. Which of the following is a short-term money market instrument with a bank guarantee that is used to provide capital for exporters to foreign countries?
     • Commercial paper.
     • Bankers' acceptances.
     • American depositary receipts (ADRs).
     • World Bank drawing rights

     Correct answer: Bankers' acceptances.

     Bankers' acceptances are money market instruments used to finance international trade. A banker's acceptance is a time draft drawn on a bank by an importer or exporter of goods, and it represents the bank's conditional promise to pay the face amount of the note at maturity (normally less than three months).

558. All of the following statements regarding commercial paper are correct except
     • Interest is received at maturity
     • It is quoted on a discount yield basis
     • It is quoted as a percentage of par
     • It is unsecured

     Correct answer: It is quoted as a percentage of par

     Commercial paper is short-term, unsecured corporate debt. It is issued and traded at a discount of face value and does not pay periodic interest. Like all zeroes, it is quoted on a discounted yield basis.

559. It is most accurate to state that commercial paper is
     • Sold at a discount
     • Secured
     • Interest bearing

     Correct answer: Sold at a discount

     Commercial paper (CP) is short-term unsecured paper issued by corporations (especially finance companies), primarily to raise working capital. These are always issued at a discount from the face value. The minimum denomination is usually $100,000, making them unsuitable for small investors.

560. Debt normally issued by big corporations with reliable credit ratings that seek to finance short-term needs best describes
     • Certificates of deposit
     • Commercial paper
     • Revenue anticipation notes
     • T-bills.

     Correct answer: Commercial paper

     This is the definition of commercial paper, as known as promissory notes. They are short-term corporate-issued instruments sold at a discount and maturing at par.

561. When a well-established corporation needs short-term borrowing for working capital needs, it will most likely issue
     • A letter of credit
     • A jumbo CD
     • Commercial paper
     • Preemptive rights

     Correct answer: Commercial paper

     Commercial paper is the most common tool for corporations to raise short-term funds. A letter of credit is issued by a bank. On the exam, this would usually take the form of bankers' acceptances for those in the import/export business. Banks issue CDs, and preemptive rights are used for the sale of common stock. Stock is long-term capital.

562. The minimum face amount of a negotiable CD is
     • $50,000.
     • $100,000.
     • $25,000.
     • $10,000.

     Correct answer: $100,000.

     Negotiable CDs are issued in the minimum face amount of $100,000. These are called jumbo CDs and are traded in blocks of $1 million.

563. Which of the following is not a characteristic of certificates of deposit (CDs)?
     • A CD is often issued by a bank.
     • A CD may be payable to the bearer or registered in the name of the investor.
     • A CD can be negotiable or nonnegotiable.
     • The Federal Deposit Insurance Corporation (FDIC) provides insurance for CDs to $500,000.

     Correct answer: The Federal Deposit Insurance Corporation (FDIC) provides insurance for CDs to $500,000.

     The FDIC provides insurance for CDs up to $250,000. All of the other characteristics are applicable to CDs.

564. Transactions in all of the following are affected in the money market, as opposed to the capital market, except
     • Jumbo CDs
     • Commercial paper
     • Municipal revenue bonds
     • U.S. Treasury bills.

     Correct answer: Municipal revenue bonds

     The money market is the marketplace for short-term (less than one year) debt obligations. The capital market is where long-term capital is raised. Municipal bonds, being long term, are a part of the capital market.

565. Interest and principal on a Eurodollar bond issued in Germany are paid
     • In U.S. dollars.
     • In German deutsche marks
     • In European Union euros
     • In German euros

     Correct answer: In U.S. dollars.

     It is always the final part of the word that describes the currency of a eurobond. A Eurodollar bond pays in U.S. dollars, while a Euroyen bond would pay in Japanese yen.

566. One of your individual customers would like to add some foreign debt securities to their portfolio. When told that the investment would be $2,500, the best suggestion would be to
     • Contact a broker-dealer in the foreign country of choice and open an account there
     • Invest in a mutual fund concentrating in foreign debt securities
     • Tell the customer that $2,500 is below the minimum purchase quantity of foreign bonds
     • Use one of the overseas branches of your firm to suggest the appropriate issues

     Correct answer: Invest in a mutual fund concentrating in foreign debt securities

     For small investments, a mutual fund or exchange-traded fund (ETF) is usually going to be the most suitable choice. Most countries do not allow nonresident noncitizens to open local brokerage accounts, and that is a pretty impractical idea anyway. If your firm has an overseas office, it could be a source of information, but when only $2,500 is involved, purchasing individual bonds issued by a foreign nation is usually not reasonable.

567. When a bond is issued by a national government, it is called
     • Sovereign debt
     • High-quality debt
     • National debt
     • Treasury debt

     Correct answer: Sovereign debt

     The term sovereign debt applies to securities issued by national governments. U.S. Treasuries are an example of sovereign debt issued here. Other countries have their versions. Not all are considered high quality, especially those issued by emerging economies.

568. In the United Kingdom, they are called gilts. In Germany, they are called Bunds. In France, they are called OATS. To investors, they are known as
     • Sovereign debt
     • Commodities
     • Stock exchanges
     • Eurobonds

     Correct answer: Sovereign debt

     Although it is highly unlikely that you would ever see any of these terms on the exam, you might need to know what sovereign debt is. For the United States, the sovereign debt (the debt issued by the sovereign nation) is Treasury securities. The safety of sovereign debt depends on the economy of the specific nation. You would probably not recommend the debt of a third-world country to a customer wishing to avoid risk.

569. A bond issued by a Swiss company, sold outside the United States and the issuer's country, but for which the principal and interest are stated and paid in U.S. dollars, is the definition of a
     • Francodollar bond.
     • Eurodollar bond.
     • Eurobond.
     • Matterhornbond.

     Correct answer: Eurodollar bond.

     The key to a Eurodollar bond is that everything is in U.S. dollars. The issuer is either a non-U.S. corporation or government, and the security is not issued in the United States.

570. Many investors, especially institutions, diversify their fixed-income portfolios by purchasing bonds issued outside of the United States. When a French corporation issues a bond denominated in Swiss francs, it is known as
     • A euroswiss bond
     • A eurobond
     • A eurodollar bond
     • Sovereign debt

     Correct answer: A eurobond

     The term eurobond is the generic name given to a long-term debt instrument issued and sold outside the country of the currency in which it is denominated. An example would be eurosterling bonds where a non-U.K. entity issues a debt denominated in British pounds. In our question, the French company is borrowing in Swiss francs instead of the domestic currency (the euro). Sovereign is issued by the sovereign government, e.g., U.S. Treasury bonds.

571. A customer buys a 5% bond at par. The bond is callable in five years at par and matures in 10 years. Which of the following statements is true?
     • Nominal yield is higher than either YTM or YTC.
     • YTC is higher than YTM.
     • YTC is lower than YTM.
     • YTC is the same as YTM.

     Correct answer: YTC is the same as YTM.

     If a bond is trading at par, the nominal yield (coupon rate) equals current yield equals yield to maturity (YTM) equals yield to call (YTC). YTC is higher than YTM if the bond is trading at a discount to par. YTC is lower than YTM if the bond is trading at a premium over par. Nominal yield is higher than either YTM or YTC if the bond is trading at a premium over par.

572. When a bond is selling at a premium
     • The nominal yield will always be lower than the yield to call
     • The yield maturity will always be higher than the nominal yield
     • The current yield will always be higher than the yield to maturity
     • The current yield will always be higher than the nominal yield

     Correct answer: The current yield will always be higher than the yield to maturity

     When a bond is selling at a premium, all of the yields are lower than the nominal (coupon) yield. The sequence in descending order of yield is NY, CY, YTM, YTC.

573. If interest rates increase, the interest payable on outstanding corporate bonds will
     • Increase
     • Decrease
     • Change according to the inverse payout theory
     • Remain unchanged

     Correct answer: Remain unchanged

     The interest payable is the nominal yield, which is stated on the face of the bond. It is the percentage of face value the bond will pay each year, regardless of the prevailing interest rates in the market. It is the market price of bonds—not the interest payable—that responds inversely to changes in interest rates.

574. The LLAW Manufacturing Company issued a 6.25% debenture 5 years ago. The bond is callable in seven years at 102 and matures in 15 years. The bond's current yield is 4.23%. If one of your customers decided to purchase this bond, they would have to understand they would be
     • Required to pay the call price
     • Receiving a yield to maturity in excess of 4.23%
     • Paying a premium for the bond
     • Buying the bond at a price below par

     Correct answer: Paying a premium for the bond

     The first thing to notice is that the current yield is below the nominal (coupon) rate. That automatically tell us the bond is selling at a premium. Whenever a bond is selling at a premium, in increasing order, the order of the yields is yield to call, yield to maturity, current yield, and nominal yield. Therefore, if the current yield is 4.23%, the yield to mature cannot be higher than that; it must be less. As we say in the study materials, "if you pay more, you get less" and "if you pay less, you get more." The issuer pays the call price when, and if, the bond is called.

575. A callable municipal bond maturing in 30 years is purchased at 102. The bond is callable at par in 15 years. If the bond is called at the first call date, the effective yield earned on the bond is
     • Not determinable
     • Higher than the yield to maturity
     • Lower than the yield to maturity
     • The same as the yield to maturity

     Correct answer: Lower than the yield to maturity

     When a bond is purchased at a premium ($1,020) and called for redemption, the investor's effective yield is the yield to that call date. That will be lower than the bond's yield to maturity because the premium is lost sooner.

576. An investor is looking to add some fixed-income securities to their portfolio. A registered representative suggests either the ABC 6s of 2050, or the XYZ 6s of 2043. Should there be an increase to market interest rates,
     • The XYZ bonds will enjoy a price increase greater than the ABC bonds
     • The ABC bonds will enjoy a price increase greater than the XYZ bonds
     • The ABC bonds will suffer a price decline greater than the XYZ bonds
     • The XYZ bonds will suffer a price decline greater than the ABC bonds

     Correct answer: The ABC bonds will suffer a price decline greater than the XYZ bonds

     This is a basic duration problem. When interest rates change, the bond with the longest duration will have the greatest price change. When there are two bonds with the same coupon rate (6%), the bond maturing latest has the longest duration. That tells us that the ABC bonds will fluctuate more than the XYZ bonds. Then, we need to remember that when interest rates increase, bond prices fall. That means that while both bonds will decline in price, the decline of the ABC bonds will be greater.

577. Two bonds currently quoted at a 5.50 basis mature in exactly 15 years. Their coupons are 6% and 7%, respectively. Which bond would experience the greatest appreciation in value if the yields dropped to a 5.20 basis?
     • Neither because both would decline in value
     • The 7% bond
     • The 6% bond
     • Both would appreciate the same amount

     Correct answer: The 7% bond

     These bonds are selling at a premium (their coupons are above their yield to maturity, or basis). If the YTM declines to 5.20, it means that the prices of the bonds went up. Without getting too deep into the mathematics, in order for both bonds to have the same basis (5.20), the one with the 7% coupon must have a higher price because the $10 per year additional interest has to be offset by a larger annual "loss." Here is a general rule that will apply to your exam questions. When interest rates are falling, bonds with higher coupon rates are going to appreciate in price at a greater rate than bonds with lower coupon rates. Conversely, when interest rates are rising, those bonds with higher coupons will decrease in price at a slower rate than bonds with lower coupons. In our specific question, the 7% bond will have a greater price increase than the 6% bond. If, however, our question showed the bond selling at a discount, e.g., the basis (YTM) is 8%, the 7% bond would be selling closer to par value than the 6% bond.

578. The current yield on a bond with a coupon rate of 7.5% currently selling at $105\tfrac{1}{2}$ is approximately
     • 7.5%.
     • 8%.
     • 6.5%.
     • 7.1%.

     Correct answer: 7.1%.

     A bond with a coupon rate of 7.5% pays $75 of interest annually. Current yield equals annual interest amount divided by bond market price, or $75 / $1,055 = 7.109% or approximately 7.1%.

579. A bond offered at par has a coupon rate
     • Greater than its yield to maturity
     • Less than its yield to maturity
     • Equal to its current yield
     • Less than its current yield

     Correct answer: Equal to its current yield

     When a bond is selling at par, its coupon or nominal rate, current yield, and yield to maturity are all the same.

580. In which of the following will a change in interest rates cause the greatest price fluctuation?
     • 7% 30-year U.S. Treasury bond
     • Series EE bond
     • 7% AA-rated one-year municipal note
     • 7% AAA-rated corporate bond with eight years until maturity

     Correct answer: 7% 30-year U.S. Treasury bond

     Price fluctuations are the greatest in bonds with the longest terms to maturity. The riskier the instrument, the more price volatility. Long-term bonds have greater risk than short-term bonds.

581. Which of the following statements regarding a $1,000 corporate 8.50% bond offered at 110 is true?
     • The bond is a discount bond.
     • To determine the bond's current yield, its stated rate must be compared against other fixed-rate investments in the client's portfolio.
     • The bond's current yield is calculated by dividing its annual interest by its market price.
     • The bond's current yield is lower than its yield to maturity.

     Correct answer: The bond's current yield is calculated by dividing its annual interest by its market price.

     A bond's current yield is calculated by dividing its annual interest by its current (market) price. The current yield will be higher than its yield to maturity, which will include the premium return. The determination of a bond's yield is unrelated to other bonds. In addition, this is a premium bond, not a discount bond.

582. Nickelplate Manufacturing Corporation (NMC) is capitalized with 1 million shares of a 6% $50 par callable preferred stock and 10 million shares of $1 par common stock. Your customer's required rate of return on fixed income investments is 8%. The NMC preferred stock would be an appropriate addition to this customer's portfolio only if the stock was not priced in excess of
     • $75.00.
     • $66.66.
     • $37.50.
     • $40.00.

     Correct answer: $37.50.

     How does a 6% preferred stock return 8%? Remember the inverse relationship between interest rates and fixed income security prices. As one goes up, the other goes down. An increased return results from a decreased price. The math is basic algebra. We know the annual dividend is $3 per share (6% of $50 = $3); that is fixed. What number results in a payment of $3 providing an 8% return? Divide 3.00 by $8 and the answer is $37.50. You could also do this question by working backwards. Multiply each of the choices by 8% and the one where the product is $3 is correct.

583. A 5% bond is trading at a premium. Which of the following would be the bond's highest yield?
     • Yield to maturity
     • Current yield
     • Dividend yield
     • Coupon yield

     Correct answer: Coupon yield

     If a bond is trading at a premium, its coupon rate will represent the highest of its yields. Bonds do not have a dividend yield.

584. Nickelplate Manufacturing Corporation (NMC) is capitalized with 1 million shares of a 6% $50 par callable preferred stock and 10 million shares of $1 par common stock. With the preferred stock currently selling at $75 per share and the common stock at $60 per share, the current yield of the preferred stock is closest to
     • 6%.
     • 8%.
     • 4%.
     • 5%.

     Correct answer: 4%.

     Current yield on any security, stock or bond, is the annual income (dividend on stock, interest on bond) divided by the current market price per share (or per bond). The math in this question is the dividend of $3 (a 6% $50 par preferred stock is paying an annual dividend of 6% of $50, or $3 per share) divided by the current market price of the preferred stock ($75). The quotient is .04 or 4%. What about the common stock? All of that information is just to distract you. We cannot compute the current yield of the common stock because we do not have any information about its dividend.

585. In a scenario of falling interest rates and a positive yield curve, assuming all to be of equal face value, which of the following bonds will appreciate the most?
     • 1-year bond selling at a premium
     • 20-year bond selling at a discount
     • 1-year bond selling at a discount
     • 20-year bond selling at a premium

     Correct answer: 20-year bond selling at a discount

     In general, prices of long-term bonds are more volatile than prices of short-term bonds. Therefore, the 20-year bonds will appreciate more than the 1-year bonds when interest rates fall. Also, prices of bonds with low coupon rates tend to be more volatile than prices of bonds with high coupon rates. A bond sells at a discount when its coupon is lower than prevailing interest rates. Because of its lower coupon, the 20-year discount bond tends to appreciate more than the 20-year premium bond.

586. When a bond is selling at a discount
     • The nominal yield will always be lower than the current yield
     • The current yield will always be higher than the yield to call
     • The yield to maturity will always be lower than the current yield
     • The yield to call will always be lower than the yield to maturity

     Correct answer: The nominal yield will always be lower than the current yield

     When a bond is selling at a discount, all of the yields are higher than the nominal (coupon) yield. The sequence in ascending order of yield is NY, CY, YTM, YTC.

587. The following is taken from the S&P Bond Guide: FLB Zr 37 87 $87\tfrac{1}{2}$. What is the coupon rate on this bond?
     • 8.70%
     • 0.37%
     • 8.75%
     • 0%

     Correct answer: 0%

     FLB is the issuer, Zr means zero coupon, 37 indicates the year of maturity (2037), 87 is the bid price ($870), and $87\tfrac{1}{2}$ is the asked price ($875).

588. The price of which of the following will fluctuate most with a change in interest rates?
     • Money market instruments
     • Common stock.
     • Short-term bonds
     • Long-term bonds

     Correct answer: Long-term bonds

     Long-term debt prices fluctuate more than short-term debt prices as interest rates rise and fall.

589. The price of which of the following will fluctuate most with fluctuating interest rates?
     • Short-term bonds
     • Long-term bonds
     • Money market instruments
     • Common stock

     Correct answer: Long-term bonds

     Long-term debt prices will fluctuate more than short-term debt prices as interest rates rise and fall. When buying a debt instrument, a person is really buying the interest payments and final principal payment. Money has a time value: the longer it takes to receive the money, the less it is worth today.

590. The coupon on a bond can be described as its
     • Basis
     • Yield to call
     • Current yield
     • Nominal yield

     Correct answer: Nominal yield

     The coupon on a bond is also known as the nominal yield, and it indicates the annual interest paid. For example, a 4% bond pays $40 of interest per year.

591. The basis of a bond with a 5% nominal yield maturing in twenty years and selling at 115 is approximately
     • 5.75%.
     • 4.35%.
     • 4.65%.
     • 3.95%.

     Correct answer: 3.95%.

     A bond's basis is its yield to maturity (YTM). It is not necessary to do the YTM calculation because it could only be one choice. We can easily compute the current yield by dividing the $50 annual interest by the $1,150 current market price. That is about 4.35%. The YTM must be lower than that because it includes the eventual loss realized when the bond matures at par. There is only one selection that is lower than 4.35%. The calculation would follow our formula of: Annual interest $-$ (premium $\div$ number of years to maturity), all $\div$ [(Current market price $+$ par) $\div$ 2] Plugging in the numbers, we have: ($50 - $7.50) divided by $1,075. That is 3.95%

592. The basis of a bond with a 5% nominal yield maturing in twenty years and selling at 85 is approximately
     • 4.59%.
     • 6.22%.
     • 5.75%.
     • 5.88%.

     Correct answer: 6.22%.

     A bond's basis is its yield to maturity (YTM). It is not necessary to do the YTM calculation because it could only be one choice. We can easily compute the current yield by dividing the $50 annual interest by the $850 current market price. That is about 5.88%. The YTM must be higher than that because it includes the eventual profit realized when the bond matures at par. There is only one selection that is higher than 5.88%. The calculation would follow our formula of: Annual interest $+$ (discount $\div$ number of years to maturity), all $\div$ [(Current market price $+$ par) $\div$ 2] Plugging in the numbers, we have: ($50 $+$ [$150 $\div$ 20 years]) = ($50 $+$ $7.50) divided by ([$850 $+$ $1,000] $\div$ 2) = $57.50 $\div$ ($1,850 $\div$ 2) = $57.50 $\div$ $925 = 6.22%

593. Six percent XYZ debentures are trading for $1,200. Other similarly rated bonds are offered at 4.5%. What is the current yield on the 6% XYZ debentures?
     • 1.5%
     • 5%
     • 6%
     • 7.5%

     Correct answer: 5%

     Current yield is defined as the annual income (or coupon rate) from a bond divided by the bond's current market price. Accordingly, $60 / $1,200 = $0.05 \times 100 = 5$%. The current yield will be lower than the coupon rate when the bond is trading at a premium.

594. The market price of fixed-income securities, especially bonds, are highly sensitive to changes in market interest rates. Based on that knowledge, which of the following bonds will have the greatest price change when market interest rates decrease?
     • 10-year maturity, 4% coupon
     • 10-year maturity, 6% coupon
     • 20-year maturity, 6% coupon
     • 20-year maturity, 4% coupon

     Correct answer: 20-year maturity, 4% coupon

     Without getting into complicated math, assume that market interest rates fell to 2%. Those investors holding a bond with a 4% coupon are going to be earning twice the going rate while those with the 6% coupon are earning three times the going rate of 2%. Presented with that information, what would be worth more to an investor: the 4% bond or the 6% bond? I think most would rather earn 6% and would pay a higher price for that bond. The next step is thinking about how long the investor will be receiving that higher-than-market rate. Would you rather receive three times the going rate for 10 years or for 20 years? Clearly, the longer you can get those higher interest payments, the more attractive the bond. That makes the 6% bond with a 20-year maturity the most attractive investment, and its price will increase more than the others. Remember, there is an inverse relationship between bond market prices and changes to market interest rates. As interest rates decrease, the value of older bonds (with their higher coupons) increases. The higher the coupon, the greater the increase. When their coupons are the same, the longer the time to maturity, the more valuable that higher coupon rate.

595. The market price of fixed-income securities, especially bonds, is highly sensitive to changes in market interest rates. Based on that knowledge, which of the following bonds will have the greatest price change when market interest rates increase?
     • 20-year maturity, 6% coupon
     • 20-year maturity, 4% coupon
     • 10-year maturity, 6% coupon
     • 10-year maturity, 4% coupon

     Correct answer: 20-year maturity, 4% coupon

     The longer the duration, the greater the decrease in price when interest rates go up. The bond with the longest duration will have the longest term to maturity and lowest coupon. Without getting into complicated math, assume that interest rates rose to 8%. Those investors holding a bond with a 4% coupon are going to be earning half of the going rate while those with the 6% coupon are earning 75% of the going rate of 8%. Presented with that information, you can ask what would be worth more to an investor: the 4% bond or the 6% bond? I think most would rather earn 6% and would pay a higher price for that bond. The next step is thinking about how long the investor will be stuck with that lower-than-market rate. Would you rather receive half the going rate for 10 years or for 20 years? Clearly, the sooner you can get your principal back and reinvest at the higher rates, the more attractive the bond. That makes the 4% bond with a 20-year maturity the least attractive investment, and its price will decline more than the others. That relates to our first two statements: the longer the duration, the more the price decline, and the longest term to maturity with the lowest coupon rate will have the longest duration.

596. An analyst is comparing the yields of U.S. Treasury bonds and AAA-rated corporate bonds with similar maturities. This measurement would indicate an improving economy when
     • The yield spread is remaining stable
     • The yield spread is narrowing
     • The yield spread is widening
     • The yields on the Treasury bonds are lower than those on the corporate bonds

     Correct answer: The yield spread is narrowing

     You should understand that the greater the risk, the higher the yield on the bond. Many analysts compare the difference between yields on bonds with the same maturity but different quality (rating) to get a sense of the market sentiment. One common measurement is the difference in yields between Treasuries and corporate bonds. This difference is called the yield or credit spread and tends to widen when economic conditions sour and narrow when they get better. You will never see (at least on the exam and probably in the real world as well) the yield on a corporate bond lower than a Treasury bond when the maturities are similar. It is the spread, the difference in yields, that is important. ** This question deals with material not covered in your study materials, but it relates to recent rule changes and/or student feedback.

597. A bond would be considered speculative below which of the following Standard & Poor's (S&P) ratings?
     • BBB
     • BB
     • B
     • A

     Correct answer: BBB

     A rating of BBB is the lowest investment-grade rating assigned by S&P. Any rating beneath this is considered speculative.

598. When part of an issue of speculative bonds with a 25-year maturity are called, the effect on the remaining bonds will be to
     • Improve their quality
     • Increase their coupon rate
     • Decrease their coupon rate
     • Decrease their quality

     Correct answer: Improve their quality

     Speculative bonds are those with lower ratings. They are considered to be of lower quality because the risk of timely payment and principal are higher than investment-grade bonds. When a company shows its determination to honor its debt by paying off some of it in advance, the rating associations take note of that and invariably increase the rating. Compare this to your personal credit score. Your score might be relatively low because you have a lot of outstanding debt. As you pay down that debt, your credit score is likely to increase. It is the same logic here.

599. Most rating services rate which of the following?
     • Reinvestment risk
     • Marketability
     • Quality
     • Durability

     Correct answer: Quality

     The rating services are concerned with quality, which is defined as the ability of the issuer or guarantor to pay (default risk).

600. The SEC recognizes all of the following under the Credit Rating Agency Reform Act as being registered with the commission to rate debt instruments. Which of them historically has specialized in ratings for the insurance sector?
     • Moody's
     • Fitch Ratings
     • A.M. Best
     • Standard & Poor's

     Correct answer: A.M. Best

     A.M. Best historically has specialized exclusively on the insurance marketplace. They issue financial strength ratings measuring insurance companies' ability to pay claims and rate financial instruments issued by insurance companies, such as bonds and notes. They can issue debt and financial strength ratings for other sectors as well under the Credit Rating Agency Reform Act.

601. A bond analyst plots the yields of AAA corporate bonds and compares them to the yields of U.S. Treasury bonds with similar maturities. This is known as
     • Inverse yield analysis
     • Yield comparison analysis
     • Yield curve analysis
     • Yield plot analysis

     Correct answer: Yield curve analysis

     The plotting of bond yields results in a curve, usually one where the longer the time to maturity, the higher the yield. The term yield curve analysis is the proper way to describe comparing the yields of highly-rated corporate bonds to those of Treasury bonds. When the spread between the yields is narrow, economic conditions in the United States are generally favorable. If the spread (sometimes called the credit spread) widens, it is generally a sign of a worsening economy. ** This question deals with material not covered in your study materials, but it relates to recent rule changes and/or student feedback.

602. One of your customers calls and asks you about a security with an S&P rating of SP-2. The customer is most likely asking about which of the following?
     • Your firm's privacy notice
     • A municipal note
     • Commercial paper
     • A municipal bond

     Correct answer: A municipal note

     The three major rating services each have their own rating system for short-term municipal debt (notes). In the case of Standard and Poor's, the ratings are SP-1, SP-2, and SP-3 in declining order of quality. Regulation S-P (with the hyphen between the S and P) deals with privacy notices. Although it is unlikely to be tested, commercial paper is rated A-1, A-2, A-3, and then into the "Bs."

603. The industry term "junk bond" applies to a bond with a Standard and Poor's rating no higher than
     • C.
     • BB.
     • B.
     • BBB.

     Correct answer: BB.

     Once a bond's rating has fallen below the top four grades (AAA, AA, A, and BBB), it is no longer considered investment grade. At that point, BB (or Moody's Ba) or lower, it is considered a high-yield or junk bond.

604. Which of the following choices is least similar to the others?
     • Fitch.
     • Standard & Poor's.
     • Moody's.
     • Financial Guaranty Insurance Corp.

     Correct answer: Financial Guaranty Insurance Corp.

     Standard & Poor's, Fitch, and Moody's are all agencies that rate debt securities, including municipals and equity securities. The Financial Guaranty Insurance Corp. is one of several entities that insure municipal bonds.

605. Which of the following debt instruments would likely be suitable for sophisticated investors only?
     • Debentures
     • Equity-linked notes
     • Jumbo CDs
     • First mortgage bonds

     Correct answer: Equity-linked notes

     Despite the misleading name, ELNs are debt instruments. When traded on an exchange, they are exchange-traded notes (ETNs). In either case, these are considered alternative products with unique risks, and therefore, not suitable for most investors. Although debentures are corporate debt without any pledged collateral, some of the financially strongest companies in the country issue them and receive high ratings. Even though Jumbo CDs require a minimum of $100,000, it does not require any sophistication to understand the product.

606. All of the following are characteristics associated with equity-linked notes (ELNs) except
     • They have final payments at maturity linked to the return of an underlying stock or basket of stocks
     • They are considered to be nonconventional structured investments
     • They can be exchange traded or traded over-the-counter (OTC)
     • They are equity securities

     Correct answer: They are equity securities

     Despite their name, ELNs are debt instruments, not equity instruments. They have a partial fixed return, as well as a final payment linked to the performance of a single stock or equity index. Some are exchange traded, while others trade OTC. FINRA, who considers ELNs to be nonconventional structured investments, has expressed concerns that investors might not fully understand ELNs or the risks associated with them.

607. A term used to define certain alternative forms of debt financing, such as equity-linked notes (ELNs) and exchange-traded notes (ETNs), is
     • Combination products
     • Principal protected products
     • Structured products
     • High-risk investments

     Correct answer: Structured products

     In Notice to Members 05-59, FINRA defined a structured product as "securities derived from or based on a single security, a basket of securities, an index, a commodity, a debt issuance and/or a foreign currency." The most important thing for you to know for the exam is that these generally carry higher risk than other debt securities. These should be recommended only when the registered representative has a thorough understanding of the product and believes it is suitable for the specific investor. Yes, these are high-risk investments, but that is not the term used to describe them.

608. Which of the following would be considered an equity security?
     • A collateralized mortgage obligation
     • A prior lien preferred stock
     • An exchange-traded note
     • An equity-linked note

     Correct answer: A prior lien preferred stock

     Stock means equity. Prior lien means that this preferred has priority over other preferred stock the company has issued. The other three are alternative forms of debt financing. Do not fall into the equity-linked note trap; it is a debt security.

609. In recent years, much publicity has surrounded the rapid growth of start-up businesses. In most cases, the early financing was done privately. When private debt is used at the intermediate stage of a company's development, it is called
     • Middle-risk debt
     • Mid-term debt
     • Intermediate debt
     • Mezzanine debt

     Correct answer: Mezzanine debt

     Just as the mezzanine in a theater is between the balcony and the orchestra levels, mezzanine debt represents financing supplied at the intermediate point in a new company's development. The funds are provided on a private basis and the investment carries a high degree of risk. As an alternative investment, it will be suitable for a very narrow range of customers. **This question deals with material not covered in your study materials, but it relates to recent rule changes and/or student feedback.

610. During a period of sustained low interest rates, many investors, particularly institutions, look to increase their return through alternative debt investments. Examples of those would include all of the following except
     • Exchange-traded notes
     • Leveraged ETFs
     • Equity-linked notes
     • Private placement debt

     Correct answer: Leveraged ETFs

     Although leveraged ETFs (exchange-traded funds) are certainly an alternative investment, they represent an equity investment rather than debt. Despite the misleading name, equity-linked notes are, in fact, debt instruments.

611. Which of the following would be most likely to issue an equipment trust certificate?
     • A social media company installing new servers
     • A company using specialized equipment on an oil drilling rig
     • A user of farming equipment
     • An airline company

     Correct answer: An airline company

     When you see "equipment trust certificate," think transportation companies such as airlines and railroads.

612. You have a client who is about to retire and wants to rearrange his portfolio to have predictable income. Which of the following would not be a good investment vehicle?
     • U.S. Treasury note
     • AA-rated debenture
     • AA-rated IDB
     • Income bonds

     Correct answer: Income bonds

     Income bonds, also known as adjustment bonds, are issued when a company is reorganizing and coming out of bankruptcy. Income bonds pay interest only if the company has enough income to meet the interest payment. As a result, these bonds normally trade flat without accrued interest. Therefore, they are not suitable for customers seeking income.

613. Which of the following corporate bonds is backed by other securities?
     • Debentures
     • Mortgage bond
     • Collateral trust bond
     • Equipment trust certificate

     Correct answer: Collateral trust bond

     Collateral trust bonds are backed by a portfolio of other securities, while mortgage bonds are backed by real estate. Equipment trust certificates are backed by equipment, while debentures are backed only by the company's promise to pay.

614. An investor seeking income combined with a conservative level of risk would purchase
     • AA-rated mortgage bonds.
     • Junk bonds
     • AAA-rated convertible debentures.
     • Unrated income bonds

     Correct answer: AA-rated mortgage bonds.

     The conservative level of risk eliminates the income bonds and the junk bonds. Income bonds pay interest only if the issuer has the funds to do so. Junk bonds are named such because of their high risk. Even though the convertible debentures have a higher rating than the mortgage bonds, the difference is relatively insignificant at that level and either would be suitable for the conservative investor. However, because of the convertible feature, it is always true on the exam that the income return is lower than non-convertible issues. Therefore, the most suitable for this investor would be the mortgage bonds.

615. Which of the following debt instruments is unsecured?
     • Collateral trust certificates
     • Equipment trust certificates
     • AAA/AAA-rated debentures
     • Junior lien mortgage bonds

     Correct answer: AAA/AAA-rated debentures

     Corporate debentures are unsecured bonds backed by the credit of the issuing corporation; they are not secured by underlying collateral. Mortgage bonds are secured with real estate serving as collateral. Collateral trust bonds are secured by securities that a corporation owns in other companies or bonds. Equipment trust certificates are secured by transportation equipment owned by the corporation.

616. If a mutual fund's objective is income, it would not hold which of the following securities in its portfolio?
     • Preferred stock
     • U.S. T-notes
     • Income bonds
     • Corporate bonds

     Correct answer: Income bonds

     A fund designed to generate current income for its shareholders would not hold an income bond, also known as an adjustment bond. Income bonds pay interest only if the issuer has enough earnings to do so. They are often issued by companies coming out of bankruptcy. As a result, these bonds tend to trade like zeroes.

617. Which of the following would be the most likely unsuitable recommendation for a client whose objective is steady income?
     • A U.S. Treasury bond
     • A bank CD
     • A subordinated debenture
     • An income bond

     Correct answer: An income bond

     Income (or adjustment) bonds carry the unique characteristic of requiring payment of interest only when the issuer's income is sufficient. They are used primarily for companies undergoing a financial restructuring, usually after a bankruptcy filing. Don't be fooled by the subordinated debenture. Although it stands last in line of the creditors in the event of a liquidation, that does not mean the investor is not going to get regular interest payments, especially when the debenture is investment grade. Bank CDs typically pay interest quarterly.

618. An investor wants to maximize income using debt securities. Which of the following lists rank securities from the least suitable to the most suitable recommendation if income is the investment objective?
     • Convertible bond, income bond, nonconvertible bond
     • Treasury bills, convertible bond, income bond
     • Income bond, convertible bond, nonconvertible bond
     • Nonconvertible bond, convertible bond, income bond

     Correct answer: Income bond, convertible bond, nonconvertible bond

     The income (or adjustment) bond is the least suitable because it is issued by companies coming out of bankruptcy with interest payable only if the money is available. Therefore, it is not suitable given the objective. A convertible bond has a lower coupon than a nonconvertible bond because of the convertibility feature. Therefore, if seeking to maximize income, the corporate bond would be the most suitable of the three choices (from least to most: income bond, convertible bond, and nonconvertible bond).

619. A corporation coming out of a bankruptcy proceeding would probably find it most attractive to issue
     • A subordinated debenture
     • A collateral trust certificate
     • A promissory note
     • An income bond

     Correct answer: An income bond

     Income (or adjustment) bonds carry the unique characteristic of requiring payment of interest only when the issuer's income is sufficient. They are used primarily for companies undergoing a financial restructuring, usually after a bankruptcy filing. Each of the other choices would require timely payment, and failure to do so could result in the company's failure.

620. Bondholders may not take action against the corporation if it fails to make interest payments for
     • Subordinated debentures
     • Income bonds
     • Convertible bonds
     • Debentures

     Correct answer: Income bonds

     Income bonds pay interest only if earnings are sufficient and declared by the board of directors. This is not true of any of the other fixed-income securities listed (debentures, subordinated debentures, or convertible bonds).

621. Equipment trust certificates are commonly issued by
     • The U.S. government.
     • Utilities
     • Political subdivisions
     • Transportation companies

     Correct answer: Transportation companies

     Equipment trust certificates are corporate bonds commonly issued by transportation companies such as railroads and airlines. These bonds are backed by equipment (e.g., aircraft) the issuer uses in their business.

622. Libby sees a tombstone advertisement for a new issue of Southwest Barge subordinated convertible debentures. The bonds will carry an $11\tfrac{1}{4}\%$ coupon, are convertible into common stock at $10.50, and are being issued to the public at 100. The proceeds of the issue will be used specifically for purchasing new Southwest barges. Libby's concerns about the issue could include which of the following?
     • The new barges might sink, and the collateral would be gone.
     • She should not be concerned, as the bonds will be first in liquidation.
     • The issue may have a junior claim to another security issue.
     • The company might demand that she accept common stock for her bond.

     Correct answer: The issue may have a junior claim to another security issue.

     The word subordinated is the key to the question. A subordinated bond has other debt holders ahead of it in the event of liquidation. The barges do not serve as collateral, as the bonds are identified as debentures, and having to convert to common stock is not a threat because she is the one that will, if she desires, exercise the conversion privilege.

623. One of your customers owns 10 HBH Creations 4.5% convertible callable debentures. The conversion price into HBH common stock is $40. With the current market price of the HBH Creations stock at $44, the company publishes a notice that all of the debentures will be called in thirty days at a price of 104. When the customer calls for your advice, you would probably recommend
     • Selling the debenture
     • Exercising the conversion privilege
     • Accepting the call
     • Selling the stock

     Correct answer: Exercising the conversion privilege

     Generally, a corporation exercises the call privilege when the call price is below the parity price. With a current market price of the stock at $44 per share, the parity price of the debenture is 110 ($1,100). The effect of this call is that it, in essence, forces the investors to convert, and the issuer never has to pay off the debt. Let's take a look at the math here. With a conversion price of $40, a debt security with a par value of $1,000 is convertible into 25 shares ($1,000 ÷ 40). If the stock is currently selling at $44 per share and the investor could convert into 25 shares, it makes the conversion worth $1,100 (25 shares × $44 = $1,100). In our question, the call price is 104 ($1,040) so the question becomes, "What is a better deal for your customer: exercising the conversion privilege that gives the customer stock with a value of $1,100 or accepting the call worth $1,040?" Why not just sell the debentures? Because once the call at 104 has been issued, the price of the debentures will decline to approximately that level. Why not sell the stock? The investor doesn't own any stock until conversion, so there is nothing yet to sell.

624. A customer purchases 600 shares of the $100 par ABC 6.5% convertible preferred stock at $80. The conversion price is $20. If the common stock is trading two points below parity, the price of ABC common is
     • $12.
     • $16.
     • $18.
     • $14.

     Correct answer: $14.

     The conversion ratio is computed by dividing par value by the conversion price ($100 par / $20 = 5). Parity price of the common stock is computed by dividing the market price of the convertible by the conversion ratio ($80 / 5 = $16). $16 − 2 = $14. Alternatively, with the preferred stock selling 20% below its par value, the parity price will be 20% less than the conversion price. That would make the parity price $16 (20% of $20 = $4 and $20 minus $4 = $16). The question states that the common stock is two points below parity which would, once again, be $16 minus $2 or $14.

625. ABC Corporation has issued a convertible preferred stock with a par value of $100. The stock is convertible at $40. The current market price of the stock is $80. It would be correct to state that the conversion ratio is
     • 2.5:1.
     • 4:10.
     • 4:5.
     • 2:1.

     Correct answer: 2.5:1.

     When a $100 par preferred has a conversion price of $40, the stockholder can convert into 2.5 shares. That is a 2.5:1 ratio. The current market price of the stock is only relevant if the question asks about the parity price (which is $32).

626. An investor owns ten ABC 6s of 2045. The debentures have a conversion price of $50 with an anti-dilution provision. After ABC distributes a 20% stock dividend, the investor's position will be
     • Ten ABC 6s of 2045 convertible into 16.67 shares
     • Twelve ABC 6s of 2045 with conversion price of $50
     • Ten ABC 6s of 2045 convertible into 20 shares plus forty additional shares
     • Ten ABC 6s of 2045 with a conversion price of $41.67

     Correct answer: Ten ABC 6s of 2045 with a conversion price of $41.67

     This question deals with the anti-dilution provisions of a convertible security. When there is a stock dividend or a stock split, the holder of the convertible maintains the same equity proportion as before. With a conversion price of $50, the debenture is convertible into 20 shares ($1,000 $\div$ $50). After a 20% stock dividend, the holder should be able to acquire 20% more shares. That makes the security convertible into 24 shares. Divide the $1,000 par value by 24 shares and the conversion price is now $41.67.

627. The market price of a convertible bond depends on all of the following except
     • The conversion prices of bonds from similar companies
     • The value of the underlying stock into which the bond can be converted
     • Current interest rates
     • The rating of the bond

     Correct answer: The conversion prices of bonds from similar companies

     A convertible bond's current market price will be impacted by the value of the underlying stock into which the bond can be converted, current interest rates, and the rating of the bond. Conversion prices are not set in competition; therefore, the conversion prices of similar bonds would be of no concern regarding price.

628. A 7% convertible debenture is selling at 101. It is convertible into the common stock of the same corporation at $25. The common stock is currently trading at $23. If the stock were trading at parity with the debenture, the price of the stock would be
     • $40.00.
     • $25.25.
     • $25.00.
     • $43.91.

     Correct answer: $25.25.

     To determine the parity price of the common, first find the number of shares the debenture is convertible into (conversion ratio) by dividing par value by the conversion price ($1,000 / $25 = 40 shares). Next, divide the current price of the bond by the conversion ratio. The result is the parity price of the common stock. (1,010 / 40 = $25.25).

629. An investor purchases a PQR convertible bond at 98 on June 18, 1994. The bond is convertible at $25, and on June 19, 1995, when the common stock is trading at $26 per share, the investor converts his bond into the stock. For tax purposes, these transactions will result in
     • A $40 capital gain
     • A $60 capital gain
     • Neither gain nor loss
     • A $40 capital loss

     Correct answer: Neither gain nor loss

     The process of converting a convertible bond into common stock is not a taxable event. When the stock is sold, the taxable event occurs.

630. An investor interested in acquiring a convertible bond as part of her investment portfolio would
     • Want the safety of a fixed-income investment along with potential capital appreciation
     • Want the assurance of a guaranteed dividend on the underlying common stock
     • Seek to minimize changes in the bond price during periods of steady interest rates
     • Be interested in tax advantages available to convertible debt securities

     Correct answer: Want the safety of a fixed-income investment along with potential capital appreciation

     An investor who wants the safety of a fixed-income investment with the potential for capital gains would be most interested in purchasing a convertible bond. However, because convertible bonds can be exchanged for common stock, their market price tends to be more volatile during times of steady interest rates than other fixed-income securities.

631. An investor owns 100 shares of the 4% $80 par convertible, callable, cumulative preferred stock issued by HBH Creations. With a conversion price of $20 and a current market price of $84, HBH issues a call of all of the outstanding preferred shares at $82. If the HBH Creations common stock is currently selling at $18 per share, what is likely the wisest choice for the investor?
     • Hold on to the preferred stock
     • Sell the preferred stock
     • Convert the preferred into the common at the stated conversion rate
     • Accept the call at $82

     Correct answer: Accept the call at $82

     Although issuers generally exercise the call privilege when the common stock's price is above the conversion price, there are cases when the call is exercised with the hope of eliminating some of the preferred shares with their preferred dividend payout. Let's go through the math of this question. With a par value of $80 and a conversion price of $20, each share of the preferred stock is convertible into 4 shares of the HBH Creations common stock. If the investor converts, those 4 shares are currently worth $18 each or a total of $72 for each share of preferred converted. That being the case, the investor's decision is, "Do I convert and have stock worth $7,200 (remember, there are 100 shares of the preferred, each convertible into 4 shares of the common), or do I accept the call at $82 per share of preferred totaling $8,200?" Why not sell the preferred stock at $84? Because the moment the call is announced, the price of the preferred will fall. Holding on to the preferred stock doesn't make sense because after the call date, the preferred will no longer receive dividends.

632. Under what circumstances will a dilution of equity occur?
     • The conversion of convertible bonds into common stocks
     • Stock dividend
     • Issue of mortgage bonds to replace debentures
     • Stock splits.

     Correct answer: The conversion of convertible bonds into common stocks

     Dilution of equity occurs when stockholders experience a reduction in their percentage ownership of the company. If bonds are converted, more common shares are issued, and the shareholder's equity is diluted. A stock dividend or stock split does not change a stockholder's percentage of ownership. Refunding debts has no effect on stockholders.

633. A 7% convertible debenture is selling at 101, and it is convertible into the common stock of the same corporation at $25. The common stock is currently trading at $23. What is the parity price of the debenture?
     • $910
     • $920
     • $929
     • $850

     Correct answer: $920

     To determine the parity price of the bond, first find the number of shares the debenture is convertible into (conversion ratio) by dividing par value by the conversion price ($1,000 / $25 = 40 shares). Next, multiply the current price of the common by the conversion ratio. The result is the parity price of the bond (40 shares $\times$ $23 = $920).

634. ABC Company issues a 10% bond due in 10 years. The bond is convertible into ABC common stock at a conversion price of $25 per share. The ABC bond is quoted at 90. Parity of the common stock is
     • $100.00.
     • $36.00.
     • $25.00.
     • $22.50.

     Correct answer: $22.50.

     The bond is quoted at 90, so it is selling for $900. The parity price of the common stock is $22.50, calculated as follows: the bondholder could convert the bond into 40 shares of stock ($1,000 face amount / $25 per share = 40 shares). Because the bond has a current price of $900, divide $900 by 40 to get the underlying parity price (90% $\times$ $25 = $22.50).

635. A DMF convertible bond (convertible into 25 shares) has increased 20% above par in market value. Which of the following would you expect the price of the DMF's common stock to be?
     • $32
     • $40.
     • $42
     • $48

     Correct answer: $48

     $1,000 (par) + 20% = $1,200 / 25 shares = $48. Alternatively, it is ordinarily the 20% increase in the value of the common stock that has caused the bond to increase 20% in value. $1,000 divided by 25 shares equals $40 plus 20% equals $48.

636. A customer owns a 7.5% ABC convertible bond currently trading at 115. The conversion price is $40. What is the parity price of the common?
     • $46.00
     • $28.75
     • $34.00
     • $44.00

     Correct answer: $46.00

     What does parity price mean? Here is what it says in the study materials: Calculating Conversion Parity Parity means that two securities are of equal dollar value (in this case, a convertible bond and the common stock into which it can be converted). The question is looking for the parity price of the common stock. That is the market price per share, where the total value of the stock received upon conversion equals the market price of the bond. There are two ways to do this. The first is generally the easiest to understand. We are told that the bond has a conversion price of $40. That means you can get 25 shares if you wish to convert. That is because the issuer is basically saying, "We owe you $1,000 and will let you spend it on our stock at $40 per share." Now that we know we can get 25 shares, what does each share have to be worth to equal $1,150? If you divide $1,150 by 25 shares, the result is $46. The other method to do this is as follows: The bond is selling at a 15% premium. To be equal to that, the stock must be selling at a 15% premium over the conversion price. $40 times 115% equals $46. If that makes sense to you, it is much faster than the first method.

637. A bond convertible at $50 is selling at 105% of parity, while the common stock has a current market value of $45. What is the market value of the bond?
     • $900
     • $1,045
     • $945
     • $1,000

     Correct answer: $945

     When a bond is convertible at $50, it means the holder can exchange each $1,000 par value bond for the company's common stock at a rate of $50 per share. Dividing $1,000 (always use the par value, not the market value) by $50 results in a conversion rate of 20 shares per bond. With the bond convertible into 20 shares and the market price of each share currently $45, the parity price, the price at which the value of the stock and the bond are the same, is $900, (20 x $45). The question tells us that the bond is selling for 105% of the parity price. That would be $900 x 105% = $945. An alternative method is to recognize that the stock is selling for 10% below its conversion price ($45 is $5 less than $50 and $5 $\div$ $50 = 10%). That means the parity price of the bond must be 10% below the par value, or $900 (which is 10% less than $1,000). Once you have the $900, multiply by 105% to arrive at the correct answer of $945.

638. A customer purchased 10 ABC 9s of 2045 convertible debentures at 99. The debentures are callable at 101. The conversion ratio is 40. Some time later, the debentures are called while the common is trading at $24 and the debenture is trading at 98. Which of the following options would be most beneficial to the customer?
     • Tender the bonds to the corporation
     • Convert the bonds and sell the common stock
     • Wait for a better offer from the corporation
     • Sell the bonds

     Correct answer: Tender the bonds to the corporation

     First of all, recognize that the investor purchased 10 of the debentures. They have a coupon of 9% and mature in 2045. None of that is relevant to answering the question, but we want to be sure you understand the terminology.The option most beneficial to the investor is tendering the debentures to the corporation for $10,100 (10 times $1,010). If the debentures were sold on the market, the investor would receive $9,800 (10 times $980). If the debentures were converted into common, the investor would receive 400 common shares (40 shares per debenture times 10) that could be sold for their current price of $24, for a total of $9,600.

639. One of your customers owns five JLO 5s of 2042. The debentures have a conversion price of $15. When the market price of the convertible is 80, the parity price of the stock is
     • $18.00.
     • $12.00.
     • $15.00.
     • $5.33.

     Correct answer: $12.00.

     A debenture with a conversion price of $15 is convertible into 66.66 shares ($1,000 $\div$ $15). It is always the par value that is used, not the market price. To determine the parity price of the stock, divide the current market price of $800 by 66.66 and the answer rounds off to $12. Some students find it easier to recognize that the bond is 20% below its par value. To be equal (and that is what parity means), the stock must be 20% below the $15 conversion price (or 80% of it). Reducing $15 by 20% is a $3 reduction to $12 or taking 80% of $15 equals $12.

640. What action could a corporation take that would result in the forced conversion of an outstanding convertible debt security?
     • Exercise the call feature when the debt security’s conversion value exceeds the call price
     • Reduce the dividends on the common stock to a rate lower than the interest on the debt security
     • Exercise the conversion feature when the debt security’s conversion value exceeds the call price
     • Reduce the coupon rate below the dividend rate on the common stock

     Correct answer: Exercise the call feature when the debt security’s conversion value exceeds the call price

     One of the investor benefits of a convertible security is that an increase in the market price of the underlying common stock will lead to a comparable increase in the price of the convertible. For example, when the market price of the common stock is $25 per share, a $1,000 convertible debenture with a conversion ratio of 50 shares per bond has a conversion value of $1,250 (50 shares time $25 per share). Because most convertibles are also callable, by calling the bonds at the stated call price (perhaps 102 or 103) the company can force the bond holders to convert the bonds. Using our example, why would investors hold onto the bonds knowing that, within about 30 days, they're going to get a check for $1,020 or so for each bond when they could convert and own shares worth $1,250 per bond. This is known as forced conversion. The coupon rate is fixed, and an investor would not want to convert to the stock just because the dividends on the stock are lower than the interest on the bond. ** This question deals with material not covered in your study materials, but it relates to recent rule changes and/or student feedback.

641. With a bearish outlook on the market, an investor would like to purchase something that will generate income now during current bearish conditions but would also be able to take advantage of capital appreciation should market sentiment turn bullish. Which of the following would be a suitable purchase recommendation that puts the investor in a position to do both?
     • Nonconvertible bonds
     • Cumulative preferred stocks
     • Convertible bonds.
     • Common stock

     Correct answer: Convertible bonds.

     A convertible bond would generate income from interest payments during the bear market, but if market sentiment becomes bullish, the bond can be converted into common stock, taking advantage of the change in market conditions. None of the remaining choices could fulfill both of these investment objectives.

642. Convertible debentures offer which of the following benefits to investors?
     • Highest priority in the event of dissolution
     • A higher coupon rate than comparable non-convertible debt
     • Forced conversion when the underlying stock price increases
     • The upside potential of a common stockholder with less downside risk

     Correct answer: The upside potential of a common stockholder with less downside risk

     If the price of the underlying stock increases, the holder of the debenture can exercise the conversion privilege and capture that growth. Unlike the stock, as a debt security, the regular periodic interest payments tend to provide a floor below which the price of the debenture will not fall. In exchange for this benefit, the coupon rate is lower than a comparable non-convertible security. Many of these convertibles have a call feature. If the price of the stock rises, the issuer may decide to call it in and the investor's best option is to convert. This is known as forced conversion and forces the investor in a debt security to own an equity security. Debentures have a lower priority in dissolution than secured bonds.

643. A corporation with an outstanding convertible debenture issue could force conversion by
     • Publishing an announcement that the debenture holders have thirty days to tender their bonds at the call price
     • Soliciting proxies from the common shareholders asking them to vote for mandatory conversion
     • Decreasing the coupon rate on the debenture to a level where the dividend on the common stock provides a higher return
     • Issuing new debentures with a higher coupon rate

     Correct answer: Publishing an announcement that the debenture holders have thirty days to tender their bonds at the call price

     Most convertible debt securities are callable, usually at a price slightly above the par value. When the price of the underlying common stock rises to a point where the converted value of the bond is worth more than the par value, issuers will frequently exercise their call privilege. Because the call price is usually significantly less than the converted value, it is only common sense that the debenture holders will exercise their conversion privilege. For example, when the market price of the common stock is $25 per share, a $1,000 convertible debenture with a conversion ratio of 50 shares per bond, has a conversion value of $1,250 (50 shares time $25 per share). By calling the bonds at the stated call price, perhaps 102 or 103, the company can force the bond holders to convert the bonds. Using our example, why would investors hold on to the bonds knowing that, within about 30 days, they're going to get a check for $1,020 or so for each bond when they could convert and own shares worth $1,250 per bond. This is known as forced conversion. Shareholders do note vote on a management decision to call in debt. The coupon rate on the debenture is fixed; the issuer doesn't have the ability to change it. ** This question deals with material not covered in your study materials, but it relates to recent rule changes and/or student feedback.

644. Reggie owns a convertible bond that converts into 20 shares of common stock. The current market value of the bond was $118\tfrac{1}{2}$ at the close on Friday, April 1. A 30-day call is announced before the opening on Monday, April 4, at a price of 102. The stock is trading at $57.75. What should Reggie do?
     • Sell the bond
     • Convert the bond into the stock
     • Redeem the bond at the call price
     • Hold the bond to maturity

     Correct answer: Convert the bond into the stock

     Reggie will not be allowed to hold the bond to maturity because it is being called. The real question is whether he should sell the bond, allow it to be called, or convert it to the underlying stock. Now that the call has been announced, the market value of the bond will fall to meet the call price. This occurs as a result of declining demand. (Who wants to buy a bond that is about to be called at a lower price?) Thus, redeeming the bond at the call price and selling the bond would both yield the same results: $1,000 times 102% equals $1,020. If he converts the bond, he will get the following results: 20 shares times $57.75 equals $1,155. Therefore, it makes the most sense to convert the bond.

645. Which of the following statements regarding convertible bonds is not true?
     • Coupon rates are usually lower than nonconvertible bond rates of the same issuer.
     • Convertible bondholders are creditors of the corporation.
     • If there is no advantage to converting the bonds into common stock, they would sell at a price based on their market value without the convertible feature.
     • Coupon rates are usually higher than nonconvertible bond rates of the same issuer.

     Correct answer: Coupon rates are usually higher than nonconvertible bond rates of the same issuer.

     Coupon rates are not higher; they are lower because of the value of the conversion feature. The bondholders are creditors. If the stock price falls, the conversion feature will not influence the bond's price.

646. XYZ Corporation has outstanding a 7% convertible bond currently trading at 102. The bond, which has a conversion price of $50, was issued with an antidilution covenant. If XYZ declares a 10% stock dividend, the new conversion price, as of the ex-date, will be
     • $55.55.
     • $45.45.
     • $45.00.
     • $55.00.

     Correct answer: $45.45.

     To compute a new conversion price, divide the current conversion price by 100% plus the percent increase in shares. $50 / 110% = $45.45.

647. PDQ Corporation has a 6.25% $100 par value convertible preferred stock (conversion ratio of 4) outstanding. The stock has an antidilution covenant. If PDQ declares a 10% stock dividend, the antidilution covenant will adjust
     • The par to $90
     • The conversion price to approximately $27.50
     • The conversion price to approximately $22.73
     • The par to $110

     Correct answer: The conversion price to approximately $22.73

     When a $100 par value preferred stock is convertible into four shares of common stock, the conversion price is $25 per share, ($100 $\div$ 4 = $25). The antidilution covenant means the investors will have the same conversion rights after a stock split or stock dividend as they had before. After a 10% stock dividend, each share of preferred stock will be convertible into 4.4 shares (4 shares x 110% = 4.4). The par value of the preferred stock does not change. Divide that $100 par value by the new number of shares to get the new conversion price. It looks like this: $100 $\div$ 4.4 = 22.73. Alternatively, you can divide the original conversion price of $25 by 110% arrive at the same answer.

648. A convertible corporate bond with a conversion price of $20 is trading at 115. The parity price of the common stock is
     • $20.
     • $17.
     • $26.
     • $23.

     Correct answer: $23.

     A conversion price of $20 means the conversion ratio is 50 (i.e., each bond can be converted into 50 shares of common stock). $1,150 / 50 = $23 parity price.

649. A corporation has an outstanding issue of 8% convertible debentures with a conversion price of $25. The bond indenture contains an antidilutive clause guaranteeing the debt holders the right to maintain proportionate equity conversion in the corporation. If the company pays a 10% stock dividend to its common shareholders, how will that affect the debenture holders?
     • Each debenture holder will receive a check for $100.
     • The interest rate on the debentures will increase to 8.8%.
     • The bonds will now be convertible at approximately 22.73.
     • They will receive four shares of the common stock.

     Correct answer: The bonds will now be convertible at approximately 22.73.

     The antidilutive provision means the debenture holders will be able to convert into an equivalent share value as before. With a conversion price of $25, the bond is convertible into 40 shares ($1,000 $\div$ $25). After the 10% stock dividend, they should be able to have 10% more shares, or 44 shares. That means the conversion price must be reduced. Divide $1,000 by 44 shares and the result is $22.73. Remember, anytime there is a stock dividend, prices go down.

650. ABC Corporation has an outstanding 8% convertible bond that is callable at 102. Currently, the bond is trading at 101. The conversion price is $40, and the common stock is currently trading at $39.50. ABC announces a call at 102. To realize the greatest profit, a bondholder should
     • Sell the bonds at the current market price
     • Convert the bonds into common and sell the converted shares
     • Continue to hold the bonds and receive interest payments
     • Tender the bonds

     Correct answer: Tender the bonds

     The investor would realize the greatest sales proceeds by tendering the bond to the corporation for 102. Selling the bond at its current market value of 101 is not an attractive option. Converting the bond to common stock would result in 25 shares ($1,000 par converted at $40 = 25 shares) sold at $39.50 per share ($39.50 $\times$ 25 = $987.50). Once the call date passes, the issuer ceases interest payments making it unattractive to continue to hold the bonds.

651. Phantom income is a characteristic of
     • Zero-coupon bonds
     • Convertible bonds
     • American depositary receipts.
     • Preferred stock

     Correct answer: Zero-coupon bonds

     Phantom income is the term describing income that is not received, but it is taxed. With zero-coupon bonds, the principal payoff at maturity represents receipt of the discount in lieu of periodic interest. However, each year, a portion of that discount is reported to the IRS on Form 1099 OID and is taxed as ordinary income unless the security is a municipal bond.

652. An investor purchased a new issue corporate zero-coupon bond for $600. The bond has a maturity of 20 years. Six years later, the investor sells the bond for $740. For tax purposes, this would result in
     • A capital gain of $100
     • A capital loss of $280
     • A capital gain of $20
     • A capital loss of $20

     Correct answer: A capital gain of $20

     The $400 discount is accreted over the 20 years to maturity. That is an annual accretion of $20. After 6 years, that is $120, making the tax basis of the bond $720. Because the sale at $740 is $20 more than the basis, the investor has a long-term capital gain.

653. An investor purchases a newly issued convertible bond at par. The bond is convertible at $25. Three years later, the underlying common stock is trading at $33 per share. If the investor sells the bond at the parity price,
     • There is a long-term capital gain of $8 per share
     • There is a long-term capital loss of $175
     • There is a long-term capital gain of $320
     • The investor has no gain and no loss

     Correct answer: There is a long-term capital gain of $320

     This question involves several steps. The first is to determine the conversion ratio in shares. A bond convertible at $25 per share has a share conversion rate of 40 shares ($1,000 $\div$ $25). The second step is to compute the parity price. That is, what are those 40 shares worth? Multiply 40 shares by $33 per share and that equals $1,320. When the bondholder sells the bonds at parity, that $1,320 is received. The $320 profit over the $1,000 initial cost is a long-term capital gain. An alternative that might be easier for some is to look at the appreciation of the stock. It is $8 per share higher than the conversion price of $25. That represents an increase of 32% ($8 \div 25$). If the bond is at parity with the stock, its price must be 32% higher and that brings us again to the $1,320 price.

654. An investor purchases a zero coupon bond at a price of 64. The bond matures in nine years. Five years later, the investor sells the bond at a price of 80. This would result in
     • No gain and no loss
     • A long-term capital gain of $160
     • A long-term capital loss of $200
     • A long-term capital loss of $40

     Correct answer: A long-term capital loss of $40

     This question deals with accretion of the discount. The discount here is $360 (the difference between the $640 paid and the $1,000 maturity value). With nine years until maturity, the annual accretion is $360 divided by nine, or $40 per year. After five years, the bond's basis has increased by $200 ($40 times 5 years) to $840. The sale at $800 represents a long-term loss of $40.

655. If a customer sells a zero coupon bond before maturity, gain or loss will be the difference between sales proceeds and
     • Accreted value
     • Original cost
     • Discounted value
     • Par value

     Correct answer: Accreted value

     Zero coupon bonds must be accreted for tax purposes. Each year, the annual accretion is taxable to the holder. In addition, the customer may adjust the cost basis of the zero upward by the amount of the annual accretion.

656. An issuer may be able to diversify a single municipal bond issue by maturity because
     • Every state issues municipal bonds
     • Many municipal securities are very marketable
     • Municipal securities are mostly long term
     • Many municipal bonds are serial issues

     Correct answer: Many municipal bonds are serial issues

     Serial maturity means that within a single issue, portions of the issue mature at intervals. Municipal bonds typically mature serially.

657. All of the following would be found in a bond resolution for a new municipal issue except
     • Covenants to which the issuer must adhere
     • The costs to be incurred by the issuer in connection with the offering
     • A description of the issue
     • The issuer's obligations to bondholders

     Correct answer: The costs to be incurred by the issuer in connection with the offering

     The bond resolution (or the bond contract) spells out the characteristics of the issue (maturities, call features, etc.), the issuer's responsibilities to bondholders, and any restrictive covenants to which the issuer must adhere. Costs to be incurred by the issuer have no impact on bondholders.

658. The unqualified legal opinion on a municipal bond states that
     • The issuer has the authority to issue bonds that are legal, valid, and enforceable obligations of the issuer
     • The bond has passed the additional bonds test (parity test)
     • The issuer is creditworthy
     • The bond is marketable

     Correct answer: The issuer has the authority to issue bonds that are legal, valid, and enforceable obligations of the issuer

     Bond counsel attests that, to the best of its knowledge, the issuer has the legal right to issue the securities in question. In the case of tax-exempt bonds, the interest the issuer will pay on the bonds is exempt from federal taxation, and the bonds are exempt from federal registration requirements. The legal opinion does not go to the issue's marketability—or safety—debt service requirements.

659. The bond resolution includes all covenants between
     • The issuer and the trustee acting for the bondholders
     • The issuer and the bond counsel
     • The bond counsel and the bondholders
     • The issuer and the Municipal Securities Rulemaking Board

     Correct answer: The issuer and the trustee acting for the bondholders

     The bond resolution describes not only the characteristics of the proposed offering, but also the obligations the issuer has to its bondholders.

660. Which of the following documents would include information about the issuer's financial condition?
     • Bond resolution
     • Official statement
     • Trust indenture
     • Notice of sale

     Correct answer: Official statement

     The official statement is used to disclose all material information about the issuer that an investor would need to know to make a decision regarding issue purchase.

661. A municipal bond dealer is making a bona fide quote. Which of the following statements regarding such a quote is true?
     • The quote cannot represent an offer to sell bonds that the dealer does not currently own.
     • The quote may not take into consideration any anticipated market movement.
     • The quote need not be one that the dealer is prepared to act upon (buy or sell).
     • The quote must have a reasonable relationship to fair market value.

     Correct answer: The quote must have a reasonable relationship to fair market value.

     A bona fide quote must have a reasonable relationship to fair market value and can be made in consideration of any anticipated market movement. A bona fide quote is one the dealer is prepared to buy or sell on, as opposed to a workable, nominal, or subject quote. On the offer side of a bona fide quote, a dealer may make an offer to sell bonds that it does not hold in its own inventory, but it must know where to obtain the bonds if they are needed to complete the transaction.

662. Investor information about the financial condition of a municipal issuer is most likely found in
     • The official notice of sale
     • The Bond Buyer.
     • The official statement
     • The legal opinion

     Correct answer: The official statement

     The official statement, which is the disclosure document used in new municipal offerings, will describe the issue's financial condition in detail.

663. A legal opinion that has restrictions placed on it by the municipality's bond counsel is called
     • A restricted opinion
     • An unqualified opinion
     • A qualified opinion
     • A contingent opinion

     Correct answer: A qualified opinion

     A qualified opinion is one where the bond counsel to the municipality places certain legal restrictions (qualifications) on the issue that must be disclosed to purchasers. An unqualified opinion has no restrictions.

664. In most cases, new municipal bond issues are accompanied by a legal opinion. That legal opinion is drafted by bond counsel hired by
     • The MSRB
     • The municipal issuer
     • The syndicate
     • The managing underwriter

     Correct answer: The municipal issuer

     The legal opinion is written by an independent law firm hired by the municipal issuer. The underwriter or syndicate can also hire counsel, but that is not the official legal opinion attached to the bond.

665. A municipal securities principal must approve all of the following except
     • Legal opinions
     • Each transaction in municipal securities
     • The handling of written customer complaints
     • The opening of new customer accounts

     Correct answer: Legal opinions

     Municipal securities principals are required to approve all new customer accounts, all municipal transactions, and the handling of customer complaints. Legal opinions are prepared by bond counsel to determine the authority of an issuer and tax treatment of new municipal issues.

666. Which of the following would be most likely to require a mandatory sinking or surplus fund?
     • A public housing authority.
     • A water and sewer revenue bond
     • A tax anticipation note
     • A general obligation

     Correct answer: A water and sewer revenue bond

     Sinking or surplus funds force revenue bond issuers to set aside a portion of their revenue for debt retirement.

667. All of the following statements regarding municipal bond official statements are true except
     • All retail purchasers of a new municipal bond issue must receive a final official statement
     • A retail customer must receive an official statement no later than the settlement date
     • An official statement must be delivered only upon request of a retail customer
     • A municipal securities broker-dealer may satisfy the delivery requirements by providing a notice advising the customer how to obtain the official statement from Electronic Municipal Market Access (EMMA)

     Correct answer: An official statement must be delivered only upon request of a retail customer

     A final official statement must be delivered to retail buyers of a new issue on or before the settlement date. With today's technology, most investors receive their official statement through EMMA.

668. Your broker-dealer has prepared an advertising piece for general distribution to all of its retail customers regarding numerous option strategies. Filing the piece with FINRA is
     • Required within 10 business days of the time it is first used or published
     • Required at least 10 business days before first use or publication
     • Required to occur no later than the end of the month during which it was used
     • Not required

     Correct answer: Required at least 10 business days before first use or publication

     Filing with FINRA is required at least 10 business days before first use or publication for retail communications having to do with options.

669. An unqualified legal opinion means that
     • The issue is legal, but certain contingencies may limit the flow of funds in the future
     • The underwriter has failed to disclose sufficient information to qualify the issue
     • The bond counsel has rendered an opinion without any qualifying limitations
     • The interest is not exempt from state or local taxes

     Correct answer: The bond counsel has rendered an opinion without any qualifying limitations

     An unqualified legal opinion means that the bond counsel found no problems with the issue. A qualified opinion means that the issue is legal, but certain contingencies exist. For example, the bond counsel might render a qualified opinion because authority to tax is in question or the issuer does not have clear title to the property.

670. A municipal bond dealer gives your firm's trading desk an estimate of a municipal security's market value. This is
     • A workable indication
     • Holding a quote
     • A nominal quote
     • A firm quote

     Correct answer: A nominal quote

     A nominal, or subject, quotation indicates a dealer's estimate of a security's market value. Nominal quotations are provided for informational purposes only and are permitted if the quotes are clearly labeled as such. A workable indication is usually a firm bid price from a dealer and holding a quote is one that is firm for a specified time.

671. A qualified legal opinion issued for a municipal bond underwriting means that
     • The bond counsel is considered competent
     • The legal opinion is qualified with restrictions and conditions
     • The bond attorney is qualified to express her opinion on the bond
     • The revenue bond issue has certain debt limitations

     Correct answer: The legal opinion is qualified with restrictions and conditions

     The word qualified describes the legal opinion, not the attorney (or bond counsel) who issued it. A qualified legal opinion is one in which the bond counsel expresses reservations about conditions that may affect the bond's status. An unqualified legal opinion is rendered without restriction or condition.

672. A municipal revenue issue's flow of funds statement is contained in
     • The notice of sale
     • The bond contract
     • The legal opinion
     • The agreement among underwriters

     Correct answer: The bond contract

     The bond contract describes the nature of the contract and the issuers' duties to bondholders. The bond contract is a more expansive document than a bond resolution. The contract is comprised of the bond resolution (or trust indenture) and other security agreements and laws in force at the time of bond issuance.

673. Your FINRA member firm takes 100 GO bonds from a municipal bond dealer out-firm for one hour. This means that
     • After one hour, your firm owns the bonds
     • Your firm controls the bonds for one hour
     • The municipal bond dealer has one hour to sell these bonds to another member at a greater price
     • The municipal bond dealer has one hour to change the quoted price

     Correct answer: Your firm controls the bonds for one hour

     A municipal securities dealer may quote a bond price that is firm for a certain time. This is called an out-firm with recall quote. Generally, these quotes are firm for an hour (or half hour) with a five-minute recall period. During this time, the municipal dealer cannot offer those bonds to anyone else—they are under the control of your firm.

674. A quotation on a municipal security between dealers is assumed to be
     • A workable quote
     • An indication of interest
     • A bona fide quote
     • A nominal quote

     Correct answer: A bona fide quote

     Municipal bond quotations between dealers are required to be bona fide, or firm, quotes. They are required to be fair and reasonably related to the current market.

675. One of the benefits of adding a sinking fund provision to a municipal bond issue is that the bond will generally
     • Receive a higher rating
     • Have a longer maturity
     • Receive more favorable tax treatment
     • Carry a higher coupon

     Correct answer: Receive a higher rating

     Adding a sinking fund provision to a bond issue invariably results in a higher rating for the security. The fact that money is put aside to repay the principal on a regular basis offers greater safety. A higher rating results in a lower coupon, not a higher one. After all, the higher the rating, the lower the risk, and that means the issuer is able to borrow at a lower cost. Although the sinking fund itself does not change the maturity date, having a sinking fund enables the issuer to use partial calls to redeem the bond ahead of the final maturity date. A sinking fund has nothing to do with tax treatment.

676. Which of the following quotes represents a municipal dollar bond quote?
     • 8.20 - 8.00
     • 0.085
     • $850 - $870
     • $85\tfrac{1}{2}$

     Correct answer: $85\tfrac{1}{2}$

     Dollar bond quotes are based on a percentage of face amount (Par $1,000). Therefore, a quote of $85\tfrac{1}{2}$ is 85.5% of $1,000, or $855.

677. All of the following municipal securities are quoted on a yield basis except
     • Serial bonds
     • Tax anticipation notes
     • Term bonds
     • Secured bonds

     Correct answer: Term bonds

     Term bonds, or dollar bonds, are quoted like corporate bonds as a percentage of par. All other municipals are quoted in basis.

678. All of the following are allowable municipal dealer quotes except
     • Requests for bids only
     • An unidentified nominal quote
     • Requests for offers only
     • Bona fide quotes

     Correct answer: An unidentified nominal quote

     Municipal Securities Rulemaking Board Rule G-13 requires municipal brokers and dealers to give bona fide bids and offers for municipal securities. (Bona fide quotes are those good for trading.) It also allows for requests for bids (BW = bids wanted) and requests for offers (OW = offers wanted). A nominal quote (those for informational purposes only) is permissible, but only if it is identified as such.

679. Which of the following securities is typically sold with the legal opinion attached?
     • Municipal bonds
     • Participating preferred stock
     • U.S. Treasury issues
     • Corporate bonds sold under the Trust Indenture Act of 1939

     Correct answer: Municipal bonds

     The legal opinion is supplied by bond counsel, an attorney specializing in securities law. The opinion states that the municipal bond is legal and binding on the issuer. If the bond's interest is tax-exempt, that opinion is stated as well. Legal opinions are exclusive to municipal securities.

680. A 4% municipal bond maturing in 2040 has a current yield of 4.4% with a yield to maturity of 4.7%. What is the basis of this bond?
     • 4.4%
     • 4.5%
     • 4.7%
     • 4.0%

     Correct answer: 4.7%

     The basis of a municipal bond is its yield to maturity (YTM). The terms are used interchangeably. Therefore, in this question, the basis is the 4.7% stated as the YTM. There will be some questions on the exam similar to this where no math is involved. Just be sure to know your definitions.

681. In a new municipal offering, who is responsible for hiring bond counsel?
     • The syndicate manager
     • The issuer
     • Syndicate members
     • The Municipal Securities Rulemaking Board

     Correct answer: The issuer

     The issuer hires a bond attorney to render an opinion on the prospective municipal offering.

682. The call provisions of a municipal issue would be detailed most completely in
     • The bond resolution
     • The Bond Buyer.
     • The legal opinion
     • The official notice of sale

     Correct answer: The bond resolution

     The bond resolution is the document that authorizes the issuance of a municipal bond. The resolution also describes the proposed issue's features and the issuer's responsibilities to its bondholders.

683. Whether funds should be allocated to support the debt service on a moral obligation bond in default is usually determined by
     • The state legislature
     • The courts
     • The state governor
     • The trustee

     Correct answer: The state legislature

     Legislation authorizing the issuance of moral obligation securities usually grants the state legislature the authority to apportion money to support debt service payments on such securities but does not legally require the legislature to do so. This is called legislative apportionment.

684. You have a high-income client who wishes to maximize his after-tax interest income. Which of the following investments might not meet your client's objective?
     • AA-rated municipal note
     • AA-rated revenue bond
     • AA-rated general obligation bond
     • AA-rated industrial development bond

     Correct answer: AA-rated industrial development bond

     Industrial development bonds are private-purpose bonds, and the interest income could subject the holder to the alternative minimum tax. Thus, the interest income may not be completely tax free.

685. All of the following municipal bonds would be defined as revenue bonds except
     • New housing authority bonds
     • General obligation bonds
     • Special tax bonds
     • Special assessment bonds

     Correct answer: General obligation bonds

     A general obligation bond (GO) is not a revenue bond because it is backed by something other than a revenue-producing project. In general, the backing for GO bonds is the taxing ability of the issuer. That ability to tax is why they are frequently referred to as "full faith and credit" bonds. Revenue bonds include industrial development revenue bonds, special tax bonds, special assessment bonds, new housing authority bonds, and moral obligation bonds.

686. A city's day-to-day operational expenses may be met by the issuance of
     • Grant anticipation notes (GANs)
     • Bond anticipation notes (BANs)
     • Credit-linked notes (CLNs)
     • Tax anticipation notes (TANs)

     Correct answer: Tax anticipation notes (TANs)

     When a city needs short-term cash flow to meet ordinary operating expenses (e.g., to meet the payroll for city employees), it issues TANs. These notes are paid off when the city collects the expected tax revenues.

687. Which of the following are funded by general tax receipts?
     • Bond anticipation notes (BANs)
     • Hospital revenue bonds
     • Tax anticipation notes (TANs)
     • Revenue anticipation notes (RANs)

     Correct answer: Tax anticipation notes (TANs)

     Municipalities issue TANs to raise funds immediately. The community expects general tax revenues to generate the necessary funds to pay off the notes. RANs are eventually funded by revenues other than tax receipts, and BANs are eventually funded through the sale of bonds.

688. All of the following characteristics regarding industrial development bonds (IDBs) are true except
     • Funds from the lease are used to pay the principal and interest on the bonds
     • The bonds are normally backed by the full faith and credit of the municipality
     • The funds are used to construct a facility for a private corporation
     • The bonds are issued by municipalities or other governmental units

     Correct answer: The bonds are normally backed by the full faith and credit of the municipality

     IDBs are issued by a municipality, and the proceeds are used to construct facilities or purchase equipment for a private corporation. The corporation leases the facilities or equipment, and funds from the lease are used to repay investors. In addition to a first mortgage on the property, IDBs are backed by the full faith and credit of the corporation (not the municipality).

689. It is not uncommon for municipal revenue bonds to have a catastrophe call provision. Another term that might be used for this provision is
     • Unplanned call
     • Unexpected call
     • Extraordinary call
     • Premium call

     Correct answer: Extraordinary call

     An extraordinary call can occur at an unknown point in time prior to maturity. The issuer has the right to call the bonds, generally at par, when a certain event occurs, typically a catastrophe. Although catastrophe calls are unplanned or unexpected, the term that will be used for this type of call is extraordinary.

690. All of the following would be considered when evaluating a municipal revenue bond's creditworthiness except
     • Competing facilities
     • Management expense
     • Collection ratio
     • Coverage ratio

     Correct answer: Collection ratio

     The collection ratio shows the percentage of property taxes that are collected. This would be relevant in evaluating general obligation bonds, which are backed by the taxing authority of the issuer. Revenue bonds, however, are backed by user fees, not taxes.

691. Which of the following governmental bodies receive the least amount of their revenues from property taxes?
     • County governments
     • School districts
     • State governments
     • Municipalities

     Correct answer: State governments

     State governments generally do not assess property (ad valorem) taxes. These are assessed by local governments. Generally, state governments receive most of their income from sales and income taxes.

692. A city has issued bonds to construct a new sewage treatment facility. If the bonds are not backed by the full taxing authority of the city, all of the following statements about the bond issue are true except
     • If earnings fall short of the amount needed to make principal and interest payments, the debt service reserve can be used
     • The disbursement of principal and interest payments must be approved semiannually by the state public service commission
     • There is no debt limitation on the issue
     • The interest on these bonds is not considered a preference item for the alternative minimum tax

     Correct answer: The disbursement of principal and interest payments must be approved semiannually by the state public service commission

     As an exclusion question, we are looking for the false statement. The public service commission would have no approval power over revenue bond interest and principal payments. Because the bond is not backed by the taxing authority of the city, it is a revenue bond rather than a general obligation bond. The funds for payment of interest and repayment of principal are generated through the fees paid by those using the city's water and sewage facilities. Being a public, rather than private, facility, these would not be alternative minimum tax bonds.

693. Which of the following investment vehicles has the highest credit risk?
     • General obligation bonds
     • Industrial revenue bonds
     • New Housing Authority bonds
     • Ginnie Mae pass-through certificates

     Correct answer: Industrial revenue bonds

     The industrial revenue bonds would have the highest risk because debt service is the responsibility of the corporation leasing the facility rather than the issuing municipality.

694. In safety of principal, general obligation municipal bonds are considered second only to
     • Common stock
     • AAA-rated corporate bonds.
     • U.S. government and agency bonds.
     • Preferred stock

     Correct answer: U.S. government and agency bonds.

     Municipal securities are considered second in safety of principal to only U.S. government and agency issues.

695. If industrial development bonds are called because of condemnation, this would be covered under which of the following clauses in the bond indenture?
     • Catastrophe
     • Refunding
     • Refinancing
     • Defeasance

     Correct answer: Catastrophe

     Condemnation is considered a catastrophe and only applies to revenue bonds.

696. Which of the following types of municipal bond issues is associated with a flow of funds?
     • Tax anticipation notes (TANs)
     • General obligation (GO) bonds
     • Revenue bonds
     • School district bond

     Correct answer: Revenue bonds

     The flow of funds only relates to municipal revenue bonds. It describes the priority of disbursing revenues from the project. TANs are backed by taxes to be collected, while GO bonds are backed by the issuer's taxing authority. School districts are funded by GO bonds.

697. Which of the following bonds may be secured by a leaseback arrangement?
     • Lease-rental bonds
     • Variable-rate demand obligations
     • Toll-bridge bonds
     • Housing authority bonds

     Correct answer: Lease-rental bonds

     Certain revenue bonds—called lease-rental bonds—are secured by a leaseback arrangement. For example, the state may set up an agency to construct a new office complex to house all state agencies. This authority issued the bonds. Once the facility is built, the state leases the complex from that authority. The bonds are backed by the lease payments.

698. Long-term securities issued by municipalities that use a Dutch auction method to reset short-term interest rates known as clearing rates are
     • Real estate investment trusts (REITs)
     • American depositary receipts (ADRs).
     • Auction rate securities (ARS)
     • Collateralized mortgage obligations (CMOs)

     Correct answer: Auction rate securities (ARS)

     ARS are long-term securities issued by municipalities that use a Dutch auction to reset interest rates at short-term intervals. The reset rate is known as the clearing rate and establishes the rate paid during the period following the auction.

699. An investor anticipating a rise in interest rates would likely purchase
     • Callable bonds
     • Bonds issued by the U.S. Treasury.
     • Corporate bonds
     • Variable-rate demand obligations or reset bonds

     Correct answer: Variable-rate demand obligations or reset bonds

     Variable-rate or reset bonds have coupons that are adjusted based on the movements of other specified interest rates. A callable bond works to the issuer's advantage when interest rates fall but offers no added benefit to an investor when interest rates rise. Generic corporate or government-issued bonds offer no advantage for an investor anticipating a rise in interest rates.

700. A calamity (catastrophe) call may be made by a municipal issuer if
     • The issuer has accumulated excess money in its surplus account
     • The issuer must call outstanding bonds on a predetermined schedule as outlined in the bond contract
     • A building constructed with revenue bond financing has been condemned
     • Interest rates have fallen

     Correct answer: A building constructed with revenue bond financing has been condemned

     A calamity call is also known as a catastrophe call. If a facility built with revenue bond financing is destroyed or condemned, the issuer must call the bonds with the bulk of the funds provided by insurance proceeds.

701. Which of the following would not be found in a municipal revenue bond resolution?
     • Reporting requirements regarding revenues collected
     • Conditions of the maintenance covenant
     • Underwriting agreement
     • Terms of the rate covenant

     Correct answer: Underwriting agreement

     The bond resolution, which is also referred to as the bond contract, contains the requirement for the municipality to properly keep the facilities books, reporting requirements regarding revenues collected, conditions of the maintenance covenant, and terms of the rate covenant. The underwriting agreement is between the municipality and underwriters, and it spells out the terms agreed to for the underwriting of a new issue.

702. All of the following are characteristics of Section 8 bonds except
     • They are also known as Public Housing Authority (PHA) and New Housing Authority (NHA) bonds
     • They are backed by the U.S. government.
     • They are a type of general obligation bond
     • They are used to finance subsidized housing

     Correct answer: They are a type of general obligation bond

     Section 8 bonds are municipal revenue bonds backed by the U.S. government to help finance low- and moderate-income public housing. They are also known as PHA or NHA bonds.

703. Municipal bonds that are backed by the income from specific projects are known as
     • Income bonds
     • Revenue bonds
     • General obligation bonds
     • Debenture bonds

     Correct answer: Revenue bonds

     Principal and interest on municipal revenue bonds are paid from revenues of a particular project, whereas general obligation bonds are backed by the full taxing authority of the municipality.

704. A municipal bond, issued with a covenant that states, "If revenue collections are not sufficient to meet debt service requirements, the issue will be backed by the full faith and credit of the municipality," is known as
     • A moral obligation bond
     • A Section 8 bond
     • A double-barreled bond
     • A contingent liability bond

     Correct answer: A double-barreled bond

     When a municipal bond is backed by both a source of revenue and the taxing ability of the issuer, this is referred to as a double-barreled bond.

705. An investor has purchased a municipal certificate of participation (COP). COPs can be characterized by all of the following except
     • They would require voter approval before a municipality could issue them
     • The holder of a COP could foreclose on the asset generating the revenue in the case of default
     • The holder of the COP participates in lease or loan payments from a specific piece of equipment or facility purchased or built by the municipality
     • They are a form of municipal revenue bond

     Correct answer: They would require voter approval before a municipality could issue them

     COPs are considered revenue issues and, therefore, do not require voter approval. They are a form of lease revenue bond that allow the holders of the certificates to participate in some revenue stream (lease or loan payments) associated with land, equipment, or facilities purchased or built by the municipality. They are unique in that in the case of default, the holders of the COPs could foreclose on the asset associated with the certificate.

706. A customer purchased a full faith and credit bond. This bond would be known as
     • A sinking or surplus fund bond
     • A general obligation bond
     • A revenue bond
     • A moral obligation bond

     Correct answer: A general obligation bond

     General obligation bonds are also known as full faith and credit bonds.

707. If a municipal bond rated BBB is prerefunded, all of the following statements are true except
     • The marketability of the issue will decrease
     • Funds required to meet debt servicing have been set aside in escrow
     • The rating of the issue will increase
     • The issue is now backed by U.S. government securities.

     Correct answer: The marketability of the issue will decrease

     When funds are escrowed to call in a bond at a predetermined call date, the bond is said to be prerefunded. The money set aside is invested in government securities, which makes the issue very safe and highly marketable. The rating of prerefunded bonds is AAA, as they are now backed by U.S. government securities.

708. All of the following statements regarding municipal revenue bonds are true except
     • No debt limitation is set by the issuing municipality
     • The maturity of the revenue bond will usually exceed the useful life of the facility being built
     • Revenue bonds can be issued by inter- or intrastate authorities
     • The interest and principal are paid from revenue received from the facility

     Correct answer: The maturity of the revenue bond will usually exceed the useful life of the facility being built

     Revenue bonds are usually structured so their maturity is shorter than that of the facility they were issued to build.

709. When a securities professional refers to a bond as a full faith and credit issue, it is
     • A moral obligation bond
     • A general obligation bond
     • A special tax bond
     • A revenue bond

     Correct answer: A general obligation bond

     General obligation bonds are payable from general funds, including taxes, and are often referred to as backed by the "full faith and credit" of the governmental entity.

710. All of the following may be used to service special tax bond issues except
     • Gasoline taxes
     • Business license taxes
     • Excise taxes
     • Real estate taxes

     Correct answer: Real estate taxes

     Special tax bonds are sometimes included in the larger and more general category of revenue bonds. Bonds supported from the proceeds of specified income generators, such as gasoline, cigarettes, liquor, and business licenses, are special tax bonds. Ad valorem (real estate) taxes never service special tax bonds.

711. If an investor purchases a bond anticipation note (BAN) that matures in one year, when will the investor collect the interest?
     • At maturity
     • Semiannually
     • Quarterly
     • Monthly

     Correct answer: At maturity

     BANs are short-term money market instruments. Interest is paid at maturity.

712. All of the following might affect the credit rating of a municipal revenue issue except
     • The quality of the facilities management
     • The rate covenants set forth in the indenture
     • The tax rates of nearby municipalities
     • The debt service coverage ratio

     Correct answer: The tax rates of nearby municipalities

     The credit rating of a revenue issue would not be affected by tax rates in surrounding municipalities.

713. Which of the following secures an industrial revenue bond (IDR)?
     • Trustee guarantees
     • Corporate net lease payments
     • Municipal taxes
     • State taxes

     Correct answer: Corporate net lease payments

     Corporate net leases back up IDRs, which means the credit of the bond is as good as the credit of the corporation that signs the net lease.

714. A moral obligation bond is one where
     • The governing legislature is empowered, but not obligated to appropriate funds to prevent the bond from going into default
     • The board of directors of the entity is empowered, but not obligated to appropriate funds to prevent the bond from going into default
     • The U.S. government is empowered, but not obligated to appropriate funds to prevent the bond from going into default.
     • The bondholders are empowered, but not obligated to appropriate funds to prevent the bond from going into default

     Correct answer: The governing legislature is empowered, but not obligated to appropriate funds to prevent the bond from going into default

     The MSRB defines a moral obligation bond as: "A bond that, in addition to its primary source of security, is also secured by non-binding covenant that any amount necessary to make up any deficiency in debt service will be included in the budget recommendation made to the governing body, which may appropriate funds to make up the shortfall. The governing body, however, is not legally obligated to make such an appropriation."

715. Which of the following may not lead to an industrial development bond being called?
     • The municipality is approaching a statutory debt limit.
     • Interest rates are falling.
     • Funds are available in the surplus account to call the bond.
     • The facility is destroyed by a storm.

     Correct answer: The municipality is approaching a statutory debt limit.

     An issuer of industrial development revenue bonds is likely to call bonds to reduce interest costs when interest rates are falling, discontinue interest payments if the facility is destroyed by a natural disaster, or reduce debt if funds are available in a surplus account. Industrial development revenue bonds are not affected by the issuer's statutory debt limits, as they affect the issuance of general obligation bonds only.

716. Another term for municipal overlapping debt is
     • Refunded debt
     • Double-barreled debt
     • Coterminous debt
     • Defeased debt

     Correct answer: Coterminous debt

     In the context of municipal securities, the term coterminous refers to two or more taxing agencies that share the same geographic boundaries and are able to issue debt separately. Overlapping debt occurs when two or more issuers are taxing the same property to service their respective debt.

717. A variable-rate municipal bond investment's main advantage is that
     • It is likely to increase in value
     • Its price should remain relatively stable
     • Its interest is exempt from all taxes
     • It is noncallable

     Correct answer: Its price should remain relatively stable

     A variable-rate bond has no fixed coupon rate. The coupon is tied to a market rate (e.g., T-bond yields) and subject to change at regular intervals. Because the interest paid reflects changes in overall interest rates, the bond price remains relatively close to its par value. Its coupon is always representative of the current market rate. As rates rise, the coupon is adjusted upward. As rates fall, the coupon is adjusted downward.

718. Which of the following would not be found within the protective covenants for a municipal revenue bond issue?
     • The issue's rating
     • Catastrophe clause
     • Additional bonds test
     • Flow of funds

     Correct answer: The issue's rating

     There are different sources for bond ratings, but they would not be found within the revenue issue's protective covenants. The municipality agrees to abide by the covenants, and a trustee appointed in the bond indenture supervises the issuer's compliance with them. Some common covenants include rate or fee (promise to maintain user fees high enough to pay expense and debt service) maintenance, insurance, additional bonds test, sinking fund, catastrophe, flow of funds, books and records, and call or put features.

719. All of the following sources of revenue could be used to service general obligation debt except
     • Ad valorem taxes
     • Fines
     • Sales taxes
     • User charges

     Correct answer: User charges

     Historically, municipalities get most of their revenues from property taxes (ad valorem taxes). Other sources of revenue include sales taxes, income taxes, gasoline taxes, license fees, fines, and assessments. User charges would be used to service revenue bonds.

720. All of the following are examples of short-term municipal obligations except
     • Bond anticipation notes (BAN)
     • State and local government securities (SLGS)
     • Tax and revenue anticipation note (TRAN)
     • Tax anticipation note (TAN)

     Correct answer: State and local government securities (SLGS)

     SLGS are issued not by a municipality, but by the U.S. Treasury Department to assist local governments in complying with arbitrage restrictions imposed by the IRS. The other choices are examples of short-term funding used by municipalities.

721. A project that was funded with a revenue issue has been condemned by the state under an eminent domain proceeding. The outstanding bonds would be subject to which of the following call provisions?
     • Catastrophe call
     • Prerefunding call
     • Defeasance call
     • Refunding call

     Correct answer: Catastrophe call

     If a revenue project was condemned under eminent domain, the bonds would be subject to a catastrophe call.

722. Which of the following details would not be found on the bond resolution for a revenue bond?
     • The insurance covenant
     • The maintenance covenant
     • The rate covenant
     • The tax covenant

     Correct answer: The tax covenant

     Unless something in the question refers to special taxes, revenue bonds do not have tax backing. The other items are included in the bond resolution (or trust indenture). The rate covenant is a promise to maintain rates sufficient to pay expenses and debt service. The maintenance covenant is a promise to maintain the equipment and facility/facilities. The insurance covenant is a promise to insure any facility.

723. New Housing Authority (NHA) bonds are a relatively safe investment because
     • Rental income provides a hedge against inflation
     • Banks buy these bonds
     • They are backed by the full faith and credit of the issuing municipalities
     • The U.S. government guarantees a contribution to secure the bonds.

     Correct answer: The U.S. government guarantees a contribution to secure the bonds.

     NHAs are considered safe because, in addition to the backing of rental income, they are secured by a subsidy from an agency of the U.S. government. Thus, they are rated AAA.

724. A municipal bond rating service would consider all of the following when evaluating a revenue bond except
     • Feasibility studies
     • Operating revenues
     • The debt service coverage ratio
     • The public's attitude toward debt

     Correct answer: The public's attitude toward debt

     Debt service coverage ratio, feasibility studies, and projected operating revenues are important to the analysis of a municipal revenue bond. The public's attitude toward debt is relevant in evaluating general obligation bonds, which are backed by the taxing authority of the issuer.

725. Each of the following choices are potential sources of funds associated with the backing of a revenue bond issue except
     • Lease payments
     • Ticket revenues
     • Concessions
     • Fines

     Correct answer: Fines

     Fines received by a municipality or a state may be used to service the debt of a general obligation bond. Often fines are levied for reasons that include parking tickets, traffic violations, and the late payments of taxes. Concessions and lease payments are sources of funds commonly associated with airport revenue bond issues. Ticket revenue is another term for user fees, as would be the case for the ridership revenue of a municipal bus service.

726. In rating a general obligation (GO) bond, all of the following factors would be considered by an analyst except
     • The tax collection ratio
     • The total outstanding debt
     • The flow of funds
     • The public's attitude toward debt

     Correct answer: The flow of funds

     GO bonds are backed by the full faith and credit of a municipal issuer, which is based on its ability to levy and collect taxes. Therefore, among the considerations for an analyst, total outstanding debt, the tax collection ratio, and the public's attitude toward more municipal debt are prominent. The flow of funds is one of the protective covenants associated with municipal revenue bonds.

727. A municipal revenue bond has a catastrophe call feature, but otherwise, is not callable. Which of the following statements regarding the features of this bond that must be described on a customer's confirmation is true?\
     • It must be designated as callable.
     • It must be designated as callable in the event of an act of God.
     • It need not be designated as callable.
     • It must be designated as subject to eminent domain.

     Correct answer: It need not be designated as callable.

     Catastrophe call provisions associated with municipal revenue bond issues are not included on customer confirmations. Only call provisions with specific dates are included on confirmations.

728. The trust indenture of a revenue bond will show all of the following except
     • The rate covenant
     • The reoffering yields
     • The revenue pledge
     • The application of flow of funds

     Correct answer: The reoffering yields

     Reoffering yields are unrelated to trust indentures. However, the trust indenture for a revenue bond issue does include covenants (or promises) between the issuer and the trustee for the bondholders' benefit. Among these covenants are the flow of funds and the rate covenant.

729. Revenue bond rate covenants require the user fees to be high enough to cover all of the following obligations of the issuing authority except
     • The operations and maintenance
     • The optional call provisions
     • The debt service reserve fund
     • The debt service

     Correct answer: The optional call provisions

     Optional call provisions are at the option of the issuer. Rate covenants of an issue will not require enough to be collected to cover a call on the bonds.

730. You are having a discussion with one of your clients regarding suitable investments. The client is in a high-income tax bracket and has a high net worth as well. During the conversation, your client mentions several investments that he is thinking about that might be beneficial to him now. Of those listed, which would be the best recommendation?
     • Noninvestment-grade corporate bonds
     • A real estate investment trust (REIT)
     • Municipal bonds
     • A corporate blue-chip balanced mutual fund

     Correct answer: Municipal bonds

     Of the choices listed, only municipal bonds offer a tax consequence suitable for high-income, high-net-worth investors in the form of tax-free interest payments. Corporate bond interest, mutual fund dividends, and income earned from REITs are all taxable.

731. Variable-rate municipal bonds are subject to all of the following risks except
     • Interest rate
     • Default
     • Market
     • Liquidity

     Correct answer: Interest rate

     A variable-rate bond is one whose coupon is adjusted periodically (semiannually or annually) to reflect current interest rates. Therefore, if rates rise and force prices down, the coupon on a variable-rate bond will be adjusted upward, thereby tending to keep the bond's price at or near par. Therefore, no interest rate risk is associated with these bonds. However, if rates fall, the coupon will be adjusted downward, keeping the bond's price at or around par. Normally, a fall in rates will force prices up, but not with variable-rate bonds.

732. Which of the following is considered a source of debt service for a city-issued general obligation (GO) bond?
     • Revenue generated by a hospital
     • Sales taxes
     • Real estate taxes
     • Tolls on roads

     Correct answer: Real estate taxes

     General revenues of a city municipality, such as real estate taxes or licensing fees, may be used to pay the debt service on a GO bond. State-issued GO bonds will also include sales taxes as a source of money. Usage revenue, such as that generated from toll roads or hospitals, would be associated with funding revenue bonds.

733. Which of the following is a double-barreled bond?
     • General obligation bond to construct a new grade school
     • Hospital bond backed by revenues and taxes
     • Anticipation note
     • New Housing Authority (NHA) bond

     Correct answer: Hospital bond backed by revenues and taxes

     A double-barreled bond is backed by a defined source of revenue other than property taxes, as well as the full faith and credit of an issuer with taxing authority. NHA bonds are not double-barreled. If rental income from the housing cannot meet servicing costs, the shortfall is covered by the federal government. To be double-barreled, the issue must be backed by more than one municipal source.

734. Which of the following is not a source of revenue for a municipal revenue bond issue?
     • Fees
     • Ad valorem taxes
     • Assessments
     • Tolls on roads

     Correct answer: Ad valorem taxes

     Fund generators, such as tolls, assessments, and fees, subsidize revenue bonds. Ad valorem taxes support general obligation bonds.

735. All of the following items of information must be included in a municipal securities confirmation except
     • The date of maturity that has been fixed by a call notice
     • Whether the securities are fully registered or book entry
     • An extraordinary call provision
     • The capacity in which the broker-dealer acted

     Correct answer: An extraordinary call provision

     Municipal Securities Rulemaking Board rules require that certain information be included on all municipal confirmations, including the capacity in which the firm acted in filling the order, whether the bonds are in registered or book entry form, and any relevant call provisions. Information on catastrophe or extraordinary call provisions is not included on a confirmation because catastrophes have no planned dates of occurrence.

736. It is not uncommon for municipal revenue bonds to have a catastrophe call provision. Another term that might be used to refer to this provision is
     • An unplanned call
     • A premium call
     • An extraordinary call
     • An unexpected call

     Correct answer: An extraordinary call

     An extraordinary call can occur at an unknown point in time prior to maturity. The issuer has the right to call the bonds, generally at par, when a certain event occurs, typically a catastrophe. Because catastrophe calls are unplanned or unexpected, the term that will often be used is extraordinary.

737. A double-barreled bond would be defined as
     • A bond that is exempt from both federal and state taxes
     • A bond of a foreign issuer that is backed by the U.S. government, with the interest payable either in dollars or in foreign currency.
     • A bond that has its principal and interest backed by revenues of a facility and the general taxing authority of a municipality
     • A corporate bond that pays interest from ordinary income and revenue received from operating a facility for a municipality

     Correct answer: A bond that has its principal and interest backed by revenues of a facility and the general taxing authority of a municipality

     Double-barreled bonds have two sources of revenue to support them. They are municipal bonds.

738. Which of the following bonds is issued to finance the construction of subsidized housing and is backed by rents and the taxing authority of the U.S. government?
     • Special tax
     • Section 8
     • Special assessment
     • Moral obligation

     Correct answer: Section 8

     Section 8 bonds, also known as Public Housing Authority bonds and New Housing Authority bonds, are used to finance subsidized housing. These bonds are backed by rental income. If this income is insufficient to service the debt, the U.S. government makes up the difference. Essentially, these are revenue bonds backed by the U.S. government, and are therefore AAA rated.

739. A municipality that has issued grant anticipation notes (GANs) (short-term municipal notes) does so in expectation that the debt service will be paid by the receipt of funds attained
     • Via grants from the federal government
     • From both tax and other anticipated revenue
     • Through the issue of long-term bonds
     • From future tax revenue

     Correct answer: Via grants from the federal government

     GANs are short-term municipal notes issued in anticipation of funds via grants that the municipality is expecting from the federal government.

740. With bonds subject to a gross revenue pledge, the first priority will be to pay
     • The sinking or surplus fund
     • Operation and maintenance
     • Bond interest and principal
     • The first lien on the property

     Correct answer: Bond interest and principal

     Bonds subject to a gross revenue pledge (gross lien revenue bonds) are backed by the gross revenues of the facility (meaning revenues before expenses). In this case, the first money disbursed is for payment of interest and principal. However, most revenue bonds only pledge net revenues to pay off revenue bonds. In the more common net revenue pledge, the first priority is operation and maintenance; the second priority is interest and principal.

741. A bond resolution would most likely be found in an offering of
     • Corporate bonds
     • U.S. Treasury bonds.
     • Unrated bonds
     • Municipal bonds

     Correct answer: Municipal bonds

     Bond resolutions are most commonly found as part of the offering documents of a municipal bond issue. The bond resolution represents an official action taken by a state or local issuer with regard to the bonds.

742. If a moral obligation bond goes into default, the only way bondholders can be repaid is
     • By waiting for the issuer to become solvent again
     • A court order
     • Through legislative apportionment
     • Through an asset liquidation

     Correct answer: Through legislative apportionment

     A moral obligation bondis a state- or local-issued, or state- or local-agency issued, bond. If revenues or tax collections backing the bond are not sufficient to pay the debt service, the state legislature has the authority to appropriate funds to make payments. That is the only way the bondholders can be repaid. The legislature rarely reneges on its moral obligation.

743. All of the following information is included in a municipal bond resolution except
     • Compensation paid to the underwriters
     • An authorization to sell the securities
     • Restrictive covenants that are binding on the issuer
     • Any call provisions that allow the issuer to redeem the bonds before their scheduled maturity

     Correct answer: Compensation paid to the underwriters

     The bond resolution is the document in which the issuer authorizes the issuance of municipal securities. Among other things, the resolution describes the characteristics of the proposed issue and the issuer's duties to the bondholders. Compensation paid to the underwriters would be found in the official statement.

744. In addition to their tax advantages, municipal bonds are often purchased for their safety. Your client wishing to purchase municipal bonds with the utmost in safety should buy
     • Moral obligation bonds
     • Double-barreled bonds
     • New Housing Authority bonds.
     • General obligation bonds

     Correct answer: New Housing Authority bonds.

     NHAs, sometimes called Public Housing Authority or PHA bonds, have the backing of the federal government. As such, they are the safest of all municipal securities.

745. Debt service on an industrial revenue bond is secured by
     • Special assessments
     • Ad valorem taxes
     • Lease payments paid by a corporation
     • Sales taxes

     Correct answer: Lease payments paid by a corporation

     Industrial revenue bonds are issued by a municipality or an authority established by a municipality. No municipal assets or general revenues are pledged to secure the issue. The net lease payments by the corporate user of the facility are the only source of revenue for debt service.

746. Revenue bonds may be called for all of the following reasons except
     • Interest rates have fallen
     • A provision in a sinking fund agreement is calling for a partial call
     • The facility has been destroyed
     • The issuer has reached a statutory debt limit

     Correct answer: The issuer has reached a statutory debt limit

     Statutory debt limits only apply to general obligation bonds.

747. All of the following statements regarding a municipality's collection ratio are true except
     • A high collection ratio is more favorable than a low collection ratio
     • The collection ratio measures the municipality's property tax collections
     • The collection ratio is calculated as follows: taxes collected divided by taxes assessed
     • A poor collection ratio might mean the municipality is likely to default on its revenue bonds

     Correct answer: A poor collection ratio might mean the municipality is likely to default on its revenue bonds

     The collection ratio measures taxes collected versus taxes assessed. It is a tool used in analyzing general obligation bonds, which are backed by the taxing authority of the issuer. Revenue bonds are backed by user fees, not taxes.

748. Which of the following is limited in the case of a limited tax municipal bond?
     • The number of bonds issued
     • The number of taxpayers
     • The type of tax that can be used to service the debt
     • The number of buyers

     Correct answer: The type of tax that can be used to service the debt

     A general obligation (GO) bond may be backed by a specific tax. For example, a limited tax GO may be serviced only from sales tax revenue, not income tax revenue. As the source of debt service is limited (it is not backed by the full taxing authority of the issuer), these bonds are sold with higher yields than conventional GOs.

749. If an indenture has a closed-end provision, this means
     • Additional issues have no lien on the revenue stream
     • A sinking or surplus fund must be established
     • Additional issues will have junior liens
     • The bonds must be called before maturity

     Correct answer: Additional issues will have junior liens

     These additional issues are also known as junior lien bonds. Under a closed-end indenture, additional bonds issued against the same stream of revenues have a junior (subordinate) claim to those already outstanding unless the funds are required to complete construction of the facility.

750. Special tax bonds are
     • Backed by property taxes
     • Self-supporting bonds
     • General obligation bonds
     • Backed by sales, excise taxes, or both

     Correct answer: Backed by sales, excise taxes, or both

     A special tax bond is backed by one or more designated taxes (sales, cigarette, fuel, alcohol, etc.) other than ad valorem taxes. The designated tax need not be directly related to the project purpose. These bonds are not considered self-supporting debt.

751. An example of a taxable bond issued by a municipal government is
     • A general obligation bond (GO)
     • Series EE bonds.
     • A Build America Bond (BAB)
     • "D) a tax anticipation note (TAN).

     Correct answer: A Build America Bond (BAB)

     BABs are municipal issues created under the Economic Recovery and Reinvestment Act of 2009 to assist in reducing the cost of issuing municipalities and to stimulate the economy. Bonds to fund municipal projects have traditionally been sold in the tax-exempt arena, but BABs are taxable obligations.

752. Each of the following are generally used to service state general obligation bond issues except
     • Motor vehicle license fees
     • Real estate taxes
     • Income taxes
     • Sales taxes

     Correct answer: Real estate taxes

     State-issued municipals are backed by state revenues, including sales and income taxes, as well as fees for state-issued licenses and permits. States do not normally levy property (real estate) taxes. Real estate taxes—known as ad valorem taxes—are typically levied by local municipalities such as cities and counties.