Chapter 15 - Ethics, Reco's, Taxation

Question 1

What are Conduct Rules?

Answer 1

They deal with ethical treatment of customers.

Question 2

Who at the branch is responsible for enforcing rules of the B/D?

Answer 2

The principal

Question 3

T or F, B/D may have house rules that are less stringent than those of the self regulatory organization.

Answer 3

False, the B/D can have rules that are more stringent than the SRO but never less.

Question 4

T or F, B/D are required to maintain written supervisory procedures.

Answer 4

True

Question 5

For an employee, is passive investments prohibited?

Answer 5

No, it is not considered outside business activity

Question 6

What is churning?

Answer 6

Excessive trading in a customers account to generate commissions rather than help the customer.

Question 7

If a registered person borrows or lends to a customer, what is required?

Answer 7

The representative must notify the firm in writing and receive written permission.

Question 8

What is Painting the Tape?

Answer 8

When one party sells to another party knowing that stock will be repurchased later in the day at virtually the same price. Gives the appearance that more activity is in security than actually is.

Question 9

What is marking the close?

Answer 9

Effecting/Falsely reporting trades to influence a closing price.

Question 10

In Front Running, what is the size of the order? Why would someone do it?

Answer 10

The size of the order is 10,000 shares. A person with non-public knowledge knows that someone is going to place a large block order. They will place an order in a personal account before the block order is placed to benefit from the rise in stock.

Question 11

What are some recommendations for someone that wants preservation of capital or safety?

Answer 11

Government securities or Ginnie Maes

Question 12

What are some recommendations for someone that wants growth

Answer 12

Common stocks and mutual funds

Question 13

What are the recommendations for someone that wants balanced or moderate growth? aggressive growth? income?

Answer 13

1) Blue Chips
2) Tech stocks or sector funds
3) Bonds, no zero’s though

Question 14

What are some recommendations for someone that wants high yield income? income from stock portfolio? liquidity? keep pace with inflation?

Answer 14

1) Corp. bonds and corp. bond funds
2) Preferred stock and utility stocks
3) money market
4) stock portfolio

Question 15

What is systematic risk and non systematic risk?

Answer 15

Systematic risk is the risk of general market decline and can’t be diversified away. Non-systematic risk is selection risk and is a risk that a single investment will not perform. Diversifying minimizes non-systematic risk.

Question 16

What is risk?

Answer 16

The uncertainty that an investment will earn its expected rate of return.

Question 17

What is Beta? If the beta is 1.5 what does that mean?

Answer 17

Measure of a stock’s volatility in relation to the overall market. The stock will rise or fall by 15% if the S&P were to rise or fall 10%..

Question 18

What is Duration?

Answer 18

The time, in years, it takes for a bond to pay for itself. The lower the coupon rate the greater the bonds duration, vice versa. And the higher the duration the more its value will change given a 1% change in interest rates, vice versa.

Question 19

A customer bought 100 shares at $90 plus commission of $100. Six months later the customer sold the shares at $96 less $100 commission. What is the original payment for the shares? The cost basis? Capital gain or loss?

Answer 19

Original payment = 90 * 100 + 100 = $9100
Cost Basis = $9100
Sales = 96 * 100 - 100 = $9500
Capital gain = $9500 - $9100 = $400

Question 20

What is a wash sale?

Answer 20

If an investor sells a security at a loss to offset gains, and then within 30 buys the same or substantially identical security back, it is a wash.

Question 21

For municipal tax swaps a strategy, to avoid the wash sale rule, tax advisers will recommend changing 2 of the three characteristics. What are they?

Answer 21

Issuer, Coupon, Maturity date

Question 22

An investor has a US government bond, AAA municipal bond, and an AA corporate bond. Place the bonds in order of their pretax yields, highest to lowest.

Answer 22

AA corp. bond, US government bond, AAA muni bond.
US gov would have higher rate than the AAA muni. Remember the muni is exempt from taxes federally which already is calculated into the coupon.

Question 23

If an investor buys a muni bond at a premium what are the advantages to amortize the bond?

Answer 23

Reduces cost basis, and reduces reported interest income.

Question 24

An investor buys five year muni bond at 105. Two years later the bond is sold at 104. What is the adjusted cost basis?

Answer 24

Premium of five points is amortized over 5 years, 1 point, or $10. After two years the adjusted cost basis is 103. The sale at 104 creates a capital gain of 1 point or $10.

Question 25

Accretion does what for a municipal bond?

Answer 25

Used with discount municipal bonds which will increase cost basis and increase reported interest income.

Question 26

A customer buys a 5% municipal bond with a 10-year maturity at 90 in the secondary market. Five years later the customer sells the bond at 97. What are the tax consequences?

Answer 26

Annual accretion is $10 per bond ( 10 point discount/10 years). Cost basis at the time of sale is 95, 5 years at 1 point per year. Sold at 97 - 95 = 2 points, $20 capital gain.

Question 27

An investor buys a 5% muni bond with 10 years to maturity at 110. The basis, (YTM) is 3.95%. After taking taxes into consideration, the customers effective after tax yield is what?

Answer 27

3.95%, Most cases the stated YTM on a muni is the effective after tax yield. The only exception is when bonds are purchased at discount in the secondary market, they will be somewhere between the YTM and the coupon of the bond.

Question 28

For corporate bond holders, adjusting cost basis, they have the option to amortize on premium bonds, T or F?

Answer 28

True, they may amortize and report lower interest income through the years, but at maturity, they won’t be able to claim a loss.

Question 29

For discount corporate bonds bought in the secondary market it is not taxed as interest income, T or F?

Answer 29

False, it is taxed as interest income