Part 1 Flashcards

Question

A customer has asked his registered representative to sell 100 XYZ if the market falls to 50, but he does not want to sell for less than 45. This type of order is a: stop order limit order **stop limit order** split order

Answer 1

The order is a stop limit order - the customer wishes to sell if the market falls to $50 per share (this is the stop price). If the market falls to $50 or lower, the order is elected and becomes a limit order to sell at $45, meaning that the customer wants at least $45 per share to sell.

Answer 2

The orders that are executed if the market drops are “OBLOSS” - Open Buy Limits and Open Sell Stops. The orders that are executed in a rising market are “OSLOBS” - Open Sell Limits and Open Buy Stops.

Answer 3

The Primary Market is the sale of new issues for the first time; no trading takes place in the Primary Market. The First Market is trading of exchange listed securities on that exchange floor. The Second Market is trading of securities that are not exchange listed in the over-the-counter market. The Third Market is trading of exchange listed securities in the over the counter market.

Answer 4

The Secondary Market is divided into 4 subcategories: the First Market; the Second Market; Third Market; and the Fourth Market.

Answer 5

The First Market is trading of listed stocks on an organized stock exchange - like the NYSE, AMEX (now renamed the “NYSE American”), or NASDAQ. Exchanges have listing standards for the companies that trade there and accessible order books, where orders can be posted and traded against.

Answer 6

The NYSE trades stocks. The AMEX and PHLX trade stocks and stock options. (The AMEX is a wholly owned subsidiary of the NYSE, and it has renamed its equities market “NYSE American,” while its options market is still called the AMEX.) The CBOT - Chicago Board of Trade - is not a securities exchange. Rather, it is a futures market.

Answer 7

The Second Market is OTC (over-the-counter) trading of securities that are not listed on an exchange. For equities, the Second Market is the OTCBB (Over-The-Counter Bulletin Board) and the Pink OTC Markets. Also, virtually the entire debt market is “OTC” - including the Treasury market, municipal bond market, and the corporate bond market (only a tiny amount of corporate bonds are traded on exchanges).

Answer 8

The Second Market is over-the-counter trading of securities that are not listed on a stock exchange. For equities, the Second Market is the OTCBB (Over-The-Counter Bulletin Board) and the Pink OTC Markets.

Answer 9

The trading markets are: First Market: Trading of exchange listed securities on stock exchanges Second Market: Trading of unlisted securities over-the-counter Third Market: Trading of exchange listed securities over-the-counter The Primary Market is where new issues are sold (not traded).

Answer 10

The trading markets are: First Market: Trading of exchange listed securities on stock exchanges Second Market: Trading of unlisted securities over-the-counter Third Market: Trading of exchange listed securities over-the-counter

Answer 11

The Fourth Market is direct trading of securities between institutions on ECNs (Electronic Communications Networks) such as Instinet or Archipelago. The systems bypass brokerage firms, and therefore brokerage commissions. Instead, the ECN charges a small matching fee.

Answer 12

ECNs - Electronic Communications Networks - only accept orders for actively traded securities - that is, NYSE listed and NASDAQ stocks. Essentially they are electronic matching services, matching customer buy and sell orders for a very low fee (often as low as $1 per trade). ECNs do a lot of their volume when the major exchanges are closed - since these venues stay open 24 hours a day.

Answer 13

Equities - common stock, preferred stock, and American Depositary Receipts trade on exchanges and are traded “over-the-counter.” Municipal and U.S. Government bonds are traded “over-the-counter.” There is no trading of mutual fund shares - these are redeemable securities that are redeemable with the sponsor.

Answer 14

The amount of accrued interest is calculated after a bond trade is executed - it is not on the order ticket that is used to enter the order. The ticket must include the size of the trade, desired execution price, and customer identification.

Answer 15

Market orders are first in line to be filled at the current market price. The order will be executed, but the execution price is unknown (through it should be close to the price of the last reported trade).

Answer 16

The orders that are placed higher than the current market are “OSLOBS” - Open Sell Limits and Open Buy Stops. Thus, to sell at a price higher than the current market, an open sell limit order would be placed.

Answer 17

Since a price is specified with no other qualifications, this is a limit order to sell $5,000 face amount (“5M”) of 9% bonds maturing in 2035. Since a price is specified with no other qualifications, this is a limit order to sell. The customer wants to sell for 90% of par or more. Open sell limit orders are executed if the market rises.

Answer 18

Sell limit orders are placed above the current market value and are executed if the market rises to a price equal to or higher than the limit. Limit orders may be placed as either GTC or Day orders.

Answer 19

Sell limit specify a minimum sale price. They are used to sell securities at prices that are higher than the current market. They may only be filled at the limit price or higher - so they do guarantee a specific execution price or better. That said, if the price never reaches the limit, there is no guarantee of an execution.

Answer 20

Buy stop orders are placed above the market and are triggered as the market rises. If there is a large pool of buy stop orders at a certain price, when the market hits that level, they are triggered and become market orders to buy - fueling the rise in the market. Sell stop orders are placed below the market and are triggered as the market falls. If there is a large pool of sell stop orders at a certain price, when the market hits that level, they are triggered and become market orders to sell - fueling the drop in the market. Buy stop orders can be used to buy in short stock positions as the market rises, cutting losses. Conversely, sell stop orders can be used to sell out long stock positions in falling markets, cutting losses.

Answer 21

To limit loss on a long stock position, the investor wants to sell if the market drops. To sell in a falling market, the appropriate order is a sell stop order. A sell limit order is used to sell in a rising market, and thus is not appropriate.

Answer 22

Commissions must be disclosed for agency trades; also the name of the contra broker and time of the trade must be made available to the customer upon written request. In a principal transaction, the mark-up is included in a net price and is disclosed for NASDAQ securities transactions (but it is NOT disclosed for non-NASDAQ OTC securities transactions). The mark-up, or commission, must be fair and reasonable

Answer 23

The confirmation does not disclose the inventory position of the dealer - this has no bearing on the customer.

Answer 24

There is no requirement to disclose the source of income backing a general obligation issue because it must be taxing power. The MSRB does require that the type of revenue backing a revenue bond issue be disclosed, as well as the name of the corporate guarantor for industrial revenue bonds. “In Whole” call dates must also be disclosed on customer confirmations, since they can affect the pricing of the issue under MSRB rules (the MSRB requires that if a bond quoted on a yield basis is trading at a premium, and if it is callable “in whole” at preset dates and prices, then the dollar price must be computed to the call date rather than to the maturity date, since it will most likely be called).

Answer 25

There is no requirement that the tax equivalent yield be disclosed on a municipal confirmation. The commission in an agency trade, the yield basis upon which the trade was effected, and the redemption date used to compute the dollar price must all be disclosed

Answer 26

Paying agent name does not appear on a bond confirmation. The name of the broker-dealer, the accrued interest, and the capacity in which the transaction was executed, all appear

Answer 27

“In Whole” call dates, where the entire issue is callable at preset dates and prices, must be disclosed on customer confirmations under MSRB rules. The MSRB requires the corporate guarantor for industrial revenue bonds and that the type of revenue backing a revenue bond issue be disclosed. There is no requirement to disclose the source of income backing a general obligation issue because it must be taxing power

Answer 28

Much information must be included on a municipal bond trade confirmation - name, address, and telephone number of the municipal dealer; whether the trade was effected on an agency or principal basis; whether the bond was a General Obligation or a Revenue bond; and of course, the Trade date and Settlement date.

Answer 29

When pricing a municipal bond traded in the secondary market on a yield basis, the MSRB requires that the dollar price be computed on a “worst case” basis. For premium bonds, having the bond called early (losing the premium faster) is worst; so premium bonds must be priced to the nearest “in whole” call date. For discount bonds, having the bond last until the maturity date is worst, earning the discount slower. Thus, these dates are employed when pricing municipal bonds quoted on a yield basis. Of course, the purchase price of the issues would always be required. The dated date has no meaning for pricing a bond trading in the secondary market. It is simply the legal date of issuance of the bond, and is the date from which interest started accruing on the issue.

Answer 30

When a municipal dealer gives a basis quote, he is promising the purchaser a certain yield on the bond. MSRB rules require that when the actual dollar price is determined, that the dollar price be computed to the lowest dollar amount of yield to call or yield to maturity. The only calls that are considered are optional calls, meaning the issuer has the option of calling in the entire issue at preset dates and prices, as set forth in the bond contract. This is an “in whole” call. Settlement date is needed to compute the amount of accrued interest.

Answer 31

When municipal serial bonds are quoted on a yield basis, the dealer must compute the dollar price shown on the customer confirmation. This dollar price must assure, that at a minimum, the customer will receive the promised yield. This is known as pricing to the “worst case” scenario. For a premium bond, the “worst case” scenario is having the bond called early (which is the likely case). Bonds trade at a premium because market interest rates have dropped, so the issuer can refund the issue at lower current market rates by calling in the bonds. In this case, the bond is priced based on giving the customer the promised yield using the near-term in whole call date as the redemption date. If the bond were not called, the customer’s actual yield would improve, because the annual loss of premium incorporated into the yield would be spread over a longer time frame.

Answer 32

For a discount bond, the “worst case” scenario is having the bond held to maturity (which is the likely case). Bonds trade at a discount because market interest rates have risen, so the issuer would not call these bonds. In this case, the bond is priced based on giving the customer the promised yield using the maturity date. If the bond were called early, the customer’s actual yield would improve, because the annual earning of the discount incorporated into the yield would be spread over a shorter time frame.

Answer 33

When municipal serial bonds are quoted on a yield basis, the dealer must compute the dollar price shown on the customer confirmation. This dollar price must assure, that at a minimum, the customer will receive the promised yield. This is known as pricing to the “worst case” scenario. For a premium bond, the “worst case” scenario is having the bond called early (which is the likely case). Bonds trade at a premium because market interest rates have dropped, so the issuer can refund the issue at lower current market rates by calling in the bonds. In this case, the bond is priced based on giving the customer the promised yield using the near-term in whole call date as the redemption date. If the bond were not called, the customer’s actual yield would improve, because the annual loss of premium incorporated into the yield would be spread over a longer time frame.

Answer 34

When a municipal dealer gives a basis quote, he or she is promising the purchaser a certain yield on the bond. MSRB rules require that when the actual dollar price is determined, that the dollar price be computed to the lowest dollar amount of yield to call or yield to maturity. The only calls that are considered are optional calls, meaning the issuer has the option of calling in the entire issue at preset dates and prices, as set forth in the bond contract. Mandatory calls are not considered - an example of a mandatory call is a “sinking fund” call. In such a call, the issuer is obligated to deposit monies annually to a sinking fund, and then use the funds to call in bonds on a random pick method at specified dates. It is the luck of the draw as to whether a given bond is called or not. Since there is no reasonable certainty of a specific bond being called, this type of call is not considered when pricing municipal bonds. Extraordinary calls (such as catastrophe calls, or calls of bonds backed by mortgages due to mortgage prepayments) are not considered, again because of the lack of any certainty as to their actually happening.

Answer 35

This is a very difficult question. Since the bond has a stated rate of interest of 8%, but is priced to yield 7.50%, the bond is being sold at a premium. The amount of the premium that this equates to is about $100 (you do not need to know how to do this, but you should understand the concept that follows). The dollar price of the bond would be $1,100 to yield 7.50% to maturity. Under MSRB rules, bonds are priced on a worst case basis, meaning in this case where the premium ($100 in this case) is lost in the shortest time period. This premium will be lost in the shortest period of time if the bonds are called early. Thus, under MSRB rules, premium bonds must be priced to the near term call date. Then, the customer will get, at a minimum, the yield promised. If the bonds aren’t called, the yield actually improves on the bonds. Put options are not considered when pricing municipal bonds, since it is up to the holder to decide whether he or she wishes to “put” the bond.

Answer 36

The MSRB requires that dollar prices of bonds quoted on a yield basis be computed to the lowest dollar amount of Yield to Maturity or Yield to Call.

Answer 37

If a bond is purchased at a premium, its yield to call will be the lowest effective yield. Under MSRB rules, bonds are priced on a worst case basis, meaning, in this case where the premium is lost in the shortest time period. This premium will be lost in the shortest period of time if the bonds are called early. Thus, under MSRB rules, premium bonds must be priced to the near term call date. Then, the customer gets, at a minimum, the yield promised. If the bonds aren’t called, the yield actually improves on the bonds.

Answer 38

Municipal bonds trading in the secondary market at a premium must be priced to give the customer the promised yield based upon yield to call - this is the worst case basis. Using the call date assumes that the premium will be lost over the shortest time period - if the bond is not called, then the customer’s yield improves. If a par bond is called early, the customer’s yield stays the same (or improves, if there is a call premium paid). If a discount bond (or zero-coupon bond) is called early, then the customer’s yield improves. For both of these, the “worst case” is for the bonds to be held to maturity - earning the discount over the slowest period of time.

Answer 39

This is a very difficult question. Since the bond has a stated rate of interest of 7%, but is priced to yield 7.50%, the bond is being sold at a discount. The amount of the discount to which this equates is about $140 (you do not need to know how to do this, but you do need to understand the concept that follows). The dollar price of the bond would be $860 to yield 7.50% to maturity. Under MSRB rules, bonds are priced on a worst case basis, meaning in this case where the discount ($140 in this case) is earned over the longest period of time. This occurs if the bonds are held to maturity. If the bonds are called earlier, the yield actually improves on the bonds, since the customer earns the discount faster.

Answer 40

Regarding a bond purchased at a discount: the yield to call will be the highest effective yield. Under MSRB rules, bonds are priced on a worst case basis, meaning in this case where the discount is earned over the longest period of time. This occurs if the bonds are held to maturity. If the bonds are called, the yield actually improves on the bonds, since the customer earns the discount faster.

Answer 41

For transactions in callable issues effected on a yield basis, discount bonds are priced to maturity while premium bonds are priced to the near term call date. Thus, the customer is always given a dollar price that ensures he will, at a minimum, get the promised yield. In essence all bonds are priced at their “yield to worst.”

Answer 42

Trades effected for cash settle the same day. If the trade is effected in a margin account, payment is required either in part (the margin requirement) or in full on settlement. Cash settlement is same day settlement, before 2:30 PM ET.

Answer 43

Cash settlement is same day settlement, before 2:30 PM.

Answer 44

Government debt and listed options trades settle regular way the next business day. Listed corporate stock/debt and municipal bond trades settle regular way (2 business days after trade date).

Answer 45

Regular way trades settle in 2 business days. In a cash account, full payment is required.

Answer 46

Regular way settlement is 2 business days following trade date. If a regular way trade takes place on a Thursday, 2 days later is Saturday. However, 2 business days later is Monday, and that is the date the trade would settle.

Answer 47

The regular way ex date for cash dividends is set at 1 business day prior to record date. Since the record date is Friday, December 19th, the ex date is 1 business day prior and is Thursday, December 18th.

Answer 48

Buying a put allows the owner of stock to sell it a fixed price (Stilke price) if the market falls. This limits downside risk on the long stock position

Answer 49

When a client shorts stock and writes a put against the core bearish stock position it is know as “covered put writing” This strategy is used by short sellers who seek to generate income against an excising short position. If the stock falls sharply, the put will be exercise, and the writer will be force to bury back the shares at the strike price.

Answer 50

If the market rises, the put contract expertise, but the customer is responsible for covering the short rock position. The potential loss on the remains short stock position is unlimited, since the market can rise an unlimited amount

Answer 51

The maximum gain for the holder of a put occurs if the market goes to “0.” If it does, the customer can sell the stock at $40 and purchase it for nothing. Since the customer paid $900 in premiums for this right, the maximum potential gain is: **$4000 - $900 = $3100**

Answer 52

When a client has a short stock position, borrowed shares have been sold with the agreement that the customer will buy back the position at a later date. If the market rises, the loss potential is unlimited. The purchase of a call (long call) allows teh stock to be bought in at a fixed price, limiting upside risk

Answer 53

When a customer shorts stock and writes a put, he or she is engaged in covered put writing. This is an income-producing strategy for a client with a core short position. The core short stock position determine the client’s bearish bias.

Answer 54

If the market rises, the put contract expires, but the customer is responsible for covering the short stock position. The potential loss on the remaining short stock position is unlimited, since the market can rise an unlimited amount

Answer 55

When one has a short stock position, borrowed shares have been sold with the agreement that the customer will but back the posting at a later date. If the customer thinks that the market will remain flat, he or she can sell a covered put against his stock position to earn extra income during that time period. If the stock fails, the short put is exercised, obligating the customer to buy the stock at the same price at which it was sold.

Answer 56

If the stock drops, the call expires “out the money.” As the stock keeps dropping, the customer loses more and mor on the stock position. Because the customer effectively paid $3,700 ($39 price minus $2 premium collected) for the stock, this is the maximum potential loss. Writhing a **call** does not provide the same level of protection as buying a put

Answer 57

If the market drops, the short put is exercised, and the customer must buy the stock at $60. Since the stock was sold at $62, the customer gains 2 points, in addition to collecting 6 points of premiums. Thus, the maximum gain is $800. Conversely, if the market rises, the short put expires, leaving a short stock position that has potentially unlimited loss.

Answer 58

The purchase of a put has limited loss in a rising market - the maximum that can be lost is the premium paid. In a rising market, the loss potential on a short sale of stock is unlimited, since the stock must be purchased at the higher market price and replaced

Answer 59

A long stock position coupled with a call write is referred to as a covered call writer. This is a bullish position with a capped profit potential since the call will be exercised if the stock rises sharply.

Answer 60

The client has a core bearish stock bet. If the stock falls, the customer gains on the short stock position. The customer sold the stock for $41. If it falls to “0,” the customer can buy the shares for “nothing” to replace the borrowed shares sold and make 41 points.

Answer 61

The client’s core short stock position makes him or her bearish. The call was purchased as a hedge, which makes the clients cautiously bearish.

Answer 62

If the calls are exercised, the stock (which cost $68 per share) must be sold at the $70 strike price for a $2 gain times 200 shares which equals $400. The customer also received $200 per contract for selling the calls, for a total of $600 in premiums received.

Answer 63

Exchange traded option contracts have standardized contract sizes (e.g., 100 shares of stock), expiration dates, and strike prices. The premium or “price” of the option is determined minute by minute in the trading market

Answer 64

To breakeven, the customer must recover the $5 spent on the insurance. His or her core long position is stock which was purchased at $30 must rise by 5 points. (30 + 5 = 35). Any price movement higher is profitable

Answer 65

If an option is exercised, a regular way stock trade results (2 business day settlement). To be an owner of record, the call must be exercised 2 business days prior to July 17th, which is July 15th

Answer 66

Regular way trades of listed options securities settle next business day (as do regular way trades of US government)

Answer 67

A long call position give the holder the right to buy the stock at a fixed price. If the market price keeps rising, the holder keeps gaining, so the gain potential is unlimited. On the other hand, if the market price falls below the strike price, the call expires worthless.

Answer 68

The customer buys the put for $3 and buys the stock at $80 for a total outlay of $83 per share. The put has been purchased as protection if the stock price should fall. This means the client’s loss potential is limited by the hedge

Answer 69

If the market rises to $70, the put expires “out the money” (since the strike price is $65). The customer loses the $700 premium paid

Answer 70

The "prudent man rule" is part of Uniform State Law, and it requires fiduciaries to make investments for accounts under their control as would a "prudent man." This makes sense, since fiduciaries are investing for the benefit of others, and the investments are supposed to provide a long term future benefit to these persons.

Answer 71

Yields are based on annual return. The formula for current yield is: Annual Income/Market Price = Current Yield $.80/$40 = 2.00%

Answer 72

A bond issue where the bonds have the same maturity but different dates of issuance is a series bond issue. These are rarely issued and are used to finance long-term construction projects where all of the money is not needed at once.

Answer 73

If the BB bond has a sinking fund covenant, then the issuer must deposit money to the sinking fund annually, building up the funds needed to redeem the issue at maturity. Because the issuer is, in essence, prepaying the debt in installments, there is less net debt outstanding each year, improving the credit quality of the issue. In contrast, a term bond pays interest only during the "term" of the bond, and all principal is paid at maturity.

Answer 74

Cumulative voting allows a disproportionate voting weight to be placed on selected directors who are up for election. This is considered to be advantageous for the smaller investor, who wishes to have a specific director (or directors) elected.

Answer 75

Both common and preferred shareholders have the right to receive dividends, if declared by the Board of Directors. Common shareholders have both voting rights and preemptive/subscription rights (the right to maintain proportionate ownership if the issuer issues additional common shares). Preferred stockholders do not have voting rights and do not have preemptive/subscription rights.

Answer 76

Equipment trust certificates are issued by common carriers such as airlines, railroads, and trucking companies. The rolling (or flying) stock is the collateral for the debt. Securing the debt in this manner allows the issuer to lower its financing cost.

Answer 77

Trading of government and agency securities takes place in the over-the-counter market. The participants include large commercial banks, foreign banks, U.S. Government securities dealers, full service brokerage firms, and the Federal Reserve. Ginnie Mae is an Agency - it does not trade U.S. Government debt.

Answer 78

A revenue bond is backed by a "revenue pledge" - these are specific revenues from an enterprise activity (such as the revenue from operating an airport financed with an airport revenue bond issue). Other revenues (such as the revenue from a nearby toll bridge) would be used to pay for a revenue bond issue used to finance the building of that bridge - not of the airport, making Choice A incorrect. Tax collections by states and municipal entities are used to back General Obligation bonds, not revenue bonds.

Answer 79

Industrial development bonds are issued by municipalities to build facilities that are leased to corporations. These are a type of revenue bond where the lease payments made by the corporate lessee are the source of funds to pay debt service on the issue.

Answer 80

Treasury Notes are issued in 1 to 10 year maturities, hence they are not a money market instrument. A money market instrument is issued with a maturity under 1 year. Tax Anticipation Notes, Certificates of Deposit, and Commercial Paper are all money market instruments.

Answer 81

Overnight repurchase agreements are common for transactions between banks and the Federal Reserve. In such an agreement, the Fed buys U.S. Government securities from the dealer for 1 day; agreeing to sell them back to the dealer the next day. The difference in buying and selling price represents one day's worth of interest.

Answer 82

Overnight repurchase agreements are common for transactions between banks and the Federal Reserve. In such an agreement, the Fed buys U.S. Government securities from the dealer for 1 day; agreeing to sell them back to the dealer the next day. The difference in buying and selling price represents one day's worth of interest.

Answer 83

Management companies are either open-end or closed-end. Either has an investment manager, managing the fund based on a stated investment objective. An open-end management company is a mutual fund. Mutual funds (open-end funds) are "open" to new investment. Shares are issued and redeemed at the end of the day and do not "trade."

Answer 84

Mutual funds - common stock and bond funds - are redeemable securities which do not trade. Savings bonds (Series EE and HH) sold by the U.S. Government are redeemable securities. There is no trading in these issues. To "cash out," they are redeemed with an agent for the Government - a bank or savings and loan. Corporate debentures are negotiable (tradeable) - they cannot be redeemed with the issuer. They trade OTC and on exchanges.

Answer 85

The "SPDR" is the Standard and Poor's Depositary Receipt, one of the first index-ETFs. It is based on the composition of the Standard and Poor's 500 Index.

Answer 86

Index funds attempt to "shadow" the performance of a designated index, such as the Standard and Poor's 500 index; or the Value Line Index. Because no research is done to select stocks for the fund, the management fees are lower than for actively managed funds. It is false that the portfolio manager can invest in any stock in the Standard and Poor's 500 index, since the fund must match the composition of the index as a whole.

Answer 87

A wildcat well (or exploratory oil and gas limited partnership) has low mineral rights costs (since the likelihood of finding oil in unproven areas is slim) and high intangible drilling costs (much drilling is going to have to be done before any oil is found, if it is found). These programs initially have no income since in their early stages, oil has not yet been found. (And potentially; may never be found!)

Answer 88

Raw land is not depreciable; only the building on the land is depreciable. Existing housing is immediately depreciable. New construction is only depreciable after the building is completed - during the building phase, no depreciation deductions are permitted.

Answer 89

This one is pretty simple. The "spread" is the gross compensation to the underwriters. It is the difference between the POP (Public Offering Price) and the amount per share that was received by the issuer. In this case, the POP is $30, and the issuer received $29 per share, so the spread is $1.

Answer 90

U.S. Government securities are sold at auction conducted by the Federal Reserve. In contrast, agency securities are sold to the public through a selling group of broker-dealers assembled by the agency.

Answer 91

Rule 144 allows the sale of 1% of the issuer's outstanding shares or the weekly average of the preceding 4 weeks' trading volume (whichever is greater). This amount can be sold every 90 days (every 3 months), so a sale can occur 4 times per year.

Answer 92

Rule 147 exempts "intrastate" issues from registration with the SEC. However, the issue is still subject to state (blue-sky) registration. To obtain the 147 exemption, both the issuer and the purchaser must be state residents. Resale is restricted to state residents for 6 months following the offering; thereafter, the issue can be sold interstate. Note, however, that because these securities were never registered with the SEC, they cannot be publicly traded. The only way to resell them is in a "private transaction”

Answer 93

Rule 144A issues are private placement securities sold in minimum $500,000 blocks only to QIBs - Qualified Institutional Buyers (institutions with at least $100MM of assets available for investment). Whereas normal private placements cannot be traded, these can be traded from QIB to QIB. The market for this is PORTAL, but trading activity is thin in this market, especially as compared to the market for publicly traded securities.

Answer 94

Suitability statements are not required under the "penny stock rule" for so-called "established customers." These are customers who have either had cash or securities in custody of that broker-dealer for at least 1 year; or customers who have bought 3 or more "penny stock" issues previously from that broker-dealer.

Answer 95

The "prudent man rule" is part of Uniform State Law, and it requires fiduciaries to make investments for accounts under their control as would a "prudent man." This makes sense, since fiduciaries are investing for the benefit of others, and the investments are supposed to provide a long term future benefit to these persons.

Answer 96

FINRA requires that a readily apparent reference to BrokerCheck and a hyperlink to the BrokerCheck website be shown on a member firm's initial webpage that is intended to be viewed by retail investors and also on any member firm web page that includes a professional profile of a registered person (or a number of registered persons) who conducts business with retail investors.

Answer 97

Under MSRB rules, any advertisement that shows an interest rate or yield must state whether the rate of return shown is the coupon rate or the yield to maturity; and if the yield is being shown, it must be stated if it is yield to maturity, or yield to call date.

Answer 98

A stock split or dividend will have no effect on the Price / Earnings ratio of an issuer. The market price is adjusted on "ex date" for the split; and the earnings per share are restated downward to reflect the increased number of shares that will be issued. Since both decrease proportionately, the ratio stays the same.

Answer 99

The Federal Funds Rate is set by member banks, and is the rate on overnight loans of reserves from member to member.

Answer 100

In a deflationary period, prices fall. Therefore, money buys "more" in real terms.

Answer 101

Rising interest rates are bad for stock prices. More investors will switch from investments in stocks to bond investments. A falling capital gains tax rate makes stocks more attractive to investors since any potential profits would be taxed at a lesser rate. Rising unemployment indicates that the economy is contracting. This is bearish for corporate profits and hence, stock prices.

Answer 102

The tax law allows capital gains and losses to be netted each year. Net capital gains are fully taxable at the tax bracket. However, only $3,000 of net capital losses can be deducted in any year. Any losses above this amount can be carried forward to the next tax year. Here, the customer has a net capital loss of $8,000, of which $3,000 can be deducted this year; with a $5,000 loss carryforward to the next tax year.

Answer 103

Under the Securities Exchange Act of 1934, insiders are prohibited from selling their own company's stock short; must disgorge any profits obtained from short swing trading of that company's stock (defined as gains earned over a 6 month period); and are prohibited from trading based upon material, non-public ("inside") information. There is no prohibition on an insider exercising preemptive rights or call options held on that company's stock. However, these transactions would be reported to the SEC within 2 business days of the trade.

Answer 104

The customer is bullish due to the core long stock position and buys the put as a hedge. This makes the customer cautiously bullish. The loss is limited by the put hedge. If the stock falls, the client could sell the shares at the $50 strike price.

Answer 105

Commercial paper, which is issued by corporations, is not eligible for Fed trading. The eligible securities are U.S. Government debt, Government Agency debt, and prime Banker's Acceptances. These are the securities that the Fed trades with the primary U.S. Government dealers (the major commercial banks and brokerage firms) to control credit availability in the economy.

Answer 106

The customer has created an income strategy. In this case, the customer buys the stock and thinks that the market price of ABC will remain at or about the price for which the customer bought the stock. Thus, the customer sells a call against his or her long stock position. However, if the market goes up, he or she will not enjoy the market rise because the call goes "'in the money'" and is exercised. The customer will still make money - just not as much. The customer originally bought the stock at $44 and must deliver the stock at the strike price of the call, or $45, for a $1 point gain. The customer also gets $5 in premiums for selling the call. The total gain is $600.

Answer 107

It would be nice if the purchase of put options were mentioned, but that is not the case. The purchase of S&P 100 (SPX) or S&P 500 (SPX) index options is the most efficient way to hedge a broadly diversified stock portfolio. If the market drops, the gain on the index puts offsets the loss on the physical stock portfolio.

Answer 108

If an officer of a company makes an accidental disclosure of material non-public information at a presentation to analysts, Regulation FD considers the officer to be a tipper and the analysts to be tippees. To avoid insider trading liability, the company can either make an immediate public disclosure of the information or can file an 8K Report (a special report of significant events with the SEC, which makes the information public). A 10K is the corporation's annual audited financial statements and has nothing to do with Regulation FD.

Answer 109

Stop orders do not allow a specific execution price. Once the "stop" price is reached, the order is elected and becomes a market order to be filled at the next price - which could be higher, lower, or the same as the stop price. Stop orders can be used to protect a profit on a long stock position (place a sell stop order just below the current market price of the stock). They can be used to limit a loss on a long stock position (place a sell stop order for execution if the market falls to a certain price). Stop orders are placed "away" from the current market - sell stop orders are placed below the current market price while buy stop orders are placed above the current market price.

Answer 110

REITs do not allow for flow through of loss - only net income flows through to shareholders under conduit tax treatment. On the other hand, Real Estate Limited Partnerships (RELPs) are a tax sheltered investment that allow both gain and loss to flow through to the partnership investors.

Answer 111

The orders that are reduced on ex date are "OBLOSS" - Open Buy Limits and Open Sell Stops. These are the orders below the current market. The intent is to make sure that the order does not become executable due to the fact that the stock's opening price is reduced by the dividend amount. Therefore, Choice A would be reduced. If the order is DR, this means Do Not Reduce and on ex date the order would NOT be adjusted.

Answer 112

Purchasing power risk is the risk of inflation - that the prices of goods and services rises faster than real economic growth. When there is significant inflation, interest rates rise. And this causes bond prices to fall. Treasury "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher interest payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. Thus, there is no purchasing power risk with these securities.

Answer 113

Once a variable annuity contract is annuitized, accumulation units are converted to annuity units. These determine the annuity payments to be made.

Answer 114

An insurance policy remains "in force" as long as the premiums are paid. If the premiums are not paid, the policy will lapse and there is no more insurance! Because variable life is permanent insurance that build cash value, if the premium payment is not made, the insurance company will use the cash value (if any) to make the premium payment. "Nonforfeiture in an insurance policy means the actions that an insured individual can take not to forfeit the policy if the premium cannot be paid. These typically include taking the full cash value and forfeiting future coverage or accepting a "reduced paid up option" where the policy death benefit amount is reduced.

Answer 115

Hedge fund investors typically use a "prime broker" to consolidate all of their positions with one brokerage firm. In a prime brokerage agreement, the institutional investor can use different executing brokers for its trades, but all of these trades are settled by the "prime broker" who maintains custody of the positions, and most importantly, provides margin financing on these positions and arranges for stock loans on short stock positions. By using a single prime broker, trade reports and position reports come from a single source, making account recordkeeping easier. The hedge fund, in return for sending trades to different executing brokers at full commission rates, gets valuable research and recommendations in return. By using a prime broker to consolidate all positions the hedge fund gets lower financing costs on borrowed funds and "front of the line" status when it wishes to borrow securities to effect short sales.

Answer 116

Money market funds usually do not impose sales charges but all funds impose management fees. Fund dividends are taxable, whether or not they are automatically reinvested in additional fund shares. The reason why these funds are called "money" funds is that the securities held in the portfolios have very short maturities (less than 30 days) and turn over into cash quickly.

Answer 117

A "fund of hedge funds" is an investment fund that makes investments in underlying unregistered hedge funds. Hedge funds are only available to wealthy accredited investors in private placement offerings. They use aggressive leverage investment strategies to boost returns, but this comes with much higher levels of risk.

Answer 118

4 week, 8 week, 13 week and 26 week Treasury Bills are auctioned weekly; 1 year T-Bills are auctioned monthly. Bedause the amount of securities represented by non-competitive bids are withheld from auction and are always filled at the average winning yield, these bids have priority. Competitive bids will not be filled if the yield specified is too high. The bids are always awarded on the basis of lowest discount yield.

Answer 119

Even though minimum equity to open a long margin account is $2,000, this does not apply if the securities in the account are fully paid. A customer cannot be asked to deposit more than 100% when buying since this is the maximum potential loss. The customer wants to buy $1,000 of stock, so 100% or $1,000 must be deposited.

Answer 120

Corporations do not issue revenue bonds - rather, these are a type of municipal bond, backed by revenues from public projects such as toll roads, bridges, tunnels and airports. Corporations can issue mortgage bonds (backed by real property), collateral trust certificates (backed by a portfolio of marketable securities), and income or adjustment bonds (that obligate the issuer to pay only if there are sufficient earnings).

Answer 121

The advantages of buying a put over selling that security short are a lower capital requirement (paying 100% of the premium is lower than putting up 50% initial margin on the full value of the stock position); no requirement to make up dividend payments on borrowed shares; and no requirement to pay interest on a stock loan of borrowed shares. A disadvantage of holding an option is that every day its time value decreases, to zero at expiration. This does not occur with stock positions, since there is no finite life on the position.

Answer 122

Under a defined contribution plan, a fixed percentage or dollar amount is contributed annually for each year that the employee is included in the plan. If the corporation has an unprofitable year, it must still make the contributions.

Answer 123

Shorting stock and writing a put against the position is referred to as a covered put writer. The client is bearish due to the core short stock position and writes the put to collect the premium. This income-producing strategy limits profits since if the stock moves down sharply, the put will be assigned, and the writer will be forced to buy back stock at the strike price.

Answer 124

Adjustment bonds, also known as income bonds, pay interest only if the corporation hits a predetermined level of earnings. If the income level is not sufficient, there is no obligation to make the interest payment. Reset bonds are obligated to pay interest, however the rate is reset annually. Conversion and call features have no effect on the obligation to pay.

Answer 125

Ad valorem taxes back general obligation bonds. Revenue bonds can be backed by any source of revenue other than ad valorem taxes. These sources include revenue from facility operations, grants, excise taxes, or other non-ad valorem taxes, like sales and income taxes.

Answer 126

Variable annuities differ from other products sold by insurance companies in that the purchaser bears the investment risk; as opposed to the insurance company bearing the investment risk. For example, if an insurance company achieves poor investment results, this does not affect the amount of death benefit that one gets from a traditional insurance policy; if the separate investment account funding a variable annuity achieves poor investment results, the annuity payment will drop.

Answer 127

Money market funds invest in short term maturity money market instruments. These include Treasury Bills issued by the U.S. Government, commercial paper issued by corporations and banker's acceptances issued by banks. American Depositary Receipts are not a money market instrument - they are an equity security that is the vehicle for foreign stocks to trade in the United States.

Answer 128

A "red herring" preliminary prospectus may be sent to any prospective purchaser of that new issue once the issue has entered into the "20-day cooling off" period that commences upon filing of the registration statement with the SEC. It would not contain the POP since at this early juncture, the issue would not yet be priced.

Answer 129

Preferred stock has a fixed rate of return (the dividend rate), has priority claim to assets upon dissolution, and has priority claim to dividends if declared by the Board of Directors. Preferred stock does not have a fixed maturity date - it has an indefinite life.

Answer 130

The maximum gain for the holder of a call is unlimited, since the holder can exercise and buy the stock at a fixed price - no matter how high the market price of the stock rises. If the market price falls below the strike price, then the call expires "out the money" and the maximum loss is the premium. To breakeven, the premium paid must be recovered in a rising market. This occurs if the market price rises to the strike price plus the premium paid. To summarize, the formula for breakeven on a long call is:

Answer 131

The maximum tax rate on short term capital gains is 37% (the same as for ear (ordinary) income). For assets held over 12 months, the maximum tax rate drops to 15%. (Note that rate is raised to 20% for individuals in the highest tax bracket.)

Answer 132

The Official Statement provides disclosure about a new municipal issue to investors. It is requested by underwriters in order to perform due diligence on the issue, and to help sell the issue by having a disclosure document available for potential customers. It is not required under the Securities Act of 1933 since municipals are exempt.

Part 1 Flashcards

(159 cards)