Part 2 Flashcards

Question

Which statements are TRUE regarding a "step-down" certificate of deposit? I The interest payment is fixed II The interest payment may be reduced III The principal payment is fixed IV The principal payment may be reduced l and III I and IV **II and IlI** II and IV

Answer 1

A "step-down" CD is one that starts with a high introductory "teaser" interest rate. Then the rate "steps down" to the market rate of interest at specified intervals. Regardless, at maturity, the CD is redeemed at par.

Answer 2

This question boils down to the fact that you don't get something for nothing. With a step-down CD, you start with a higher-than-market "teaser" rate. This is used as an incentive to the client to buy the CD. Then, at a predetermined date, the rate steps down to a lower rate, and this rate is usually a bit lower than the market rate at that time, so that, on average, the investor will still earn the market rate over the life of the CD.

Answer 3

Market Index Linked CDs are a type of "structured product" that consists of a "zero-coupon" synthetic bond component that grows based on the returns of an equity index; and that has a maturity established by an embedded option, typically 3 years from issuance. Market Index Linked Certificates of Deposit tie their investment return to an equity index, usually the Standard and Poor's 500 Index. This can give a potentially better rate of return than that of a traditional CD. If held to maturity, there is no penalty imposed on any CD. For an early withdrawal, traditional CDs may reduce the interest earned, but there is no loss of principal. In contrast, market index linked CDs typically impose a 3-5% principal penalty for early withdrawal. This "early withdrawal" penalty is imposed because the embedded option that established the maturity of the instrument was paid for and now is not being used. Both regular and market index linked CDs qualify for FDIC insurance. Finally, the minimum life for market index linked CDs is typically 3 years; whereas traditional bank CDs can have lives as short as 3 months.

Answer 4

An ET is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. Thus, if the bank's credit rating is lowered, the value of the ET will fall as well - so it has credit risk. ENs are listed on an exchange and trade, so they have minimal liquidity risk. Their return can be based on "exotic" indexes, such as a Brazil or India index, so they can give investors access to the returns of foreign markets. Finally, ETs make no interest or dividend payments. Their value grows as they are held based on the growth of the benchmark index, with any gain at sale or redemption currently taxed at capital gains rates. Thus, they are tax-advantaged as compared to conventional debt instruments.

Answer 5

An ET is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. They are not an equity security - they are a debt instrument. ETs are listed on an exchange and trade, so they have minimal liquidity risk. Finally, ETs make no interest or dividend payments. Their value grows as they are held based on the growth of the benchmark index, with any gain at sale or redemption currently taxed at capital gains rates. Thus, they are tax-advantaged as compared to conventional debt instruments.

Answer 6

An ET is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. ETs make no interest or dividend payments, so they are not suitable for an investor seeking income. Their value grows as they are held based on the growth of the benchmark index, with any gain at sale or redemption currently taxed at capital gains rates. Thus, they are tax-advantaged as compared to conventional debt instruments.

Answer 7

ETs are "Exchange Traded Notes." They are an equity index linked structured product, that is listed and trades on an exchange. Because they trade, the liquidity risk aspect of structured products is eliminated. What is not eliminated, however, is credit risk. These products are only as good as the guarantee of the issuing bank. These products typically have a 7 year maturity and a lot can go wrong in 7 years. If the issuing bank is downgraded, then it would be expected that investor interest in the ET would fall. This should make the issue less marketable and also should cause the price to fall. In this question, the price rises, which can only be attributable to market interest rates falling. However, the ETN will still become less marketable after the downgrade.

Answer 8

ETs are "Exchange Traded Notes." They are an equity index linked structured product, that is listed and trades on an exchange. Because they trade, the liquidity risk aspect of structured products is eliminated. What is not eliminated, however, is credit risk. These products are only as good as the guarantee of the issuing bank. They typically have a 7 year life - and a lot can go wrong in 7 years (just ask anyone who purchased Lehman Brothers structured products or ETs).

Answer 9

An ET is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. Thus, if the bank's credit rating is lowered, the value of the ET will fall as well - so it has credit risk. ETs are listed on an exchange and trade, so they have minimal marketability risk. INs have market risk - if market prices fall, their value will fall in the market.

Answer 10

An ET is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. They are not an equity security - they a debt instrument. ETs are listed on an exchange and trade, so they have minimal liquidity risk. In comparison, a regular structured product is n negotiable and, if redeemed prior to maturity, imposes an early-redemption penalty. ETs make no interest or dividend payments. Their value gro as they are held based on the growth of the benchmark index, with any gain at sale or redemption currently taxed at capital gains rates. Thus, the are tax-advantaged as compared to other structured debt products.

Answer 11

Reverse convertible notes were created for customers looking for enhanced yield in a low interest rate environment. Of course, any enhanced yield comes with higher risk. The note is linked to the price movements of an underlying stock (or very rarely, an underlying index). At maturity, the holder will receive par value, as long as the price of the reference stock is above the "knock-in" price (typically 70-80% of the initial reference price). On the other hand, if at maturity, the reference stock falls below the "knock-in" price, then the holder will receive the shares of stock. In this example, the share price has fallen from $50 to $25, which is below the "$40 knock-in" price. Thus, at maturity, the holder of the note will get the stock - not par value. The original conversion ratio was based on the reference price of $50. $1,000 par / $50 conversion reference price = 20 shares per note. Thus, at maturity, the customer gets 20 shares, currently worth $25 each = $500 worth of stock. This customer has lost $500, partially offset by any interest income received.

Answer 12

Reverse convertible notes were created for customers looking for enhanced yield in a low interest rate environment. Of course, any enhanced yield comes with higher risk. The note is linked to the price movements of an underlying stock (or very rarely, an underlying index). At maturity, the holder will receive par value, as long as the price of the reference stock is above the "knock-in" price (typically 70-80% of the initial reference price). On the other hand, if at maturity, the reference stock falls below the "knock-in" price, then the holder will receive the shares of stock. Thus, if the market price of the reference stock declines below the "knock-in" price, the customer receives the stock at maturity and not par value. A reverse convertible note is a structured product that is an obligation of the issuing bank - not the corporation or the corporate securities on which the product is based. As such, the note only as good as the credit of the issuing bank. Furthermore, if the market price of the stock declines to, or through, the "knock-in" price, the customer receives stock at maturity and that stock could potentially be worthless. The customer should be made aware of all of these points.

Answer 13

Municipalities issue BANs (Bond Anticipation Notes) to "pull forward" funds that will be collected from a later permanent bond sale. For example, a municipality expects to float a 20 year bond issue in 6 months. It can get the funds today by issuing 6 month BANs now. When the bond issue is floated, the proceeds are used to pay off the BANs.

Answer 14

A bond trades flat (without accrued interest) when the issuer has defaulted on the interest payments, or if the issue is an income bond or a zero coupon bond. Therefore, a current bondholder receives no interest on bonds that trade flat. When such a bond is traded, no accrued interest is paid from buyer to seller - so the trade is being done at a "flat" amount without any accrued interest added to the price.

Answer 15

The proceeds of general obligation bonds are used by municipalities to provide services to the general population - including the building and improvement of schools, police and fire department structures, and general municipal buildings. These bonds are serviced from general tax collections. Revenue bonds are used where there is a specific revenue source that can be pledged to bondholders to service the debt. Toll roads; toll bridges and tunnels; industrial parks where rents paid are the revenue source; water and sewer systems where separate water and sewer charges are imposed; are all typically built with revenue bond issues.

Answer 16

When bonds are trading at a premium, the yield to call will be the lowest measure since the annual return is reduced by the annual amortized portion of the premium that will be "lost" over the life of the bond to the call date. The next highest yield will be the yield to maturity, since the premium will be lost over a longer "life" than if the bond is called early. Current yield will be higher than yield to maturity, since it does not include the annual premium loss. Stated yield will be the highest since it is the return based on par value.

Answer 17

CMBs are Cash Management Bills. They are sold at auction by the Treasury on an "as needed" basis to meet unexpected cash shortfalls, so they are not part of the regular auction cycle. They are the shortest-term U.S. government security, often with maturities as short as 5 days. They are sold in $100 minimums at a discount to par value, just like Treasury Bills.

Answer 18

The physical securities which are held in trust against the issuance of Treasury Receipts are either Treasury Notes or Treasury Bonds. Series EE bonds cannot be used because they are non-marketable. T-Bills cannot be used because their maturity is too short.

Answer 19

The interest income derived from "non-essential use" private purpose revenue bonds is included in the alternative minimum tax computation. Industrial Revenue Bonds fall into this category. Public purpose bonds, such as G.O's, and public facility revenue issues are not subject to the alternative minimum tax (AMT).

Answer 20

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. In periods of deflation, the principal amount is adjusted downwards. Even though the interest rate is fixed, the holder receives a lower interest payment. due to the decreased principal amount. In this case, when the bond matures, the holder receives par - not the decreased principal amount.

Answer 21

The formula for the equivalent taxable yield is: Tax Free Yield / (100% - Tax Bracket) = Equivalent Taxable Yield 6.25% / (100% - 31%) = 6.25% / .69 = 9.06%

Answer 22

When a municipality "defeases* its debt, it terminates the lien that the bondholders have on pledged revenues, and substitutes another acceptable form of collateral in the form of escrowed U.S. Government or Agency securities. The interest received from the escrowed government securities is the new revenue source for the issue. When the governments mature, the proceeds are used to pay off the bondholders. Thus, the outstanding debt is not retired until maturity, or a call date. (Also note that the tax law changes that took effect at the beginning of 2018 banned municipalities from doing any more advance refundings or pre-refundings. However, all the bonds that have been advance refunded remain outstanding until they reach their maturity date, while those that have been pre-refunded remain outstanding until their first call date.)

Answer 23

In a period of falling interest rates, bond prices will be rising. Therefore, a dealer would raise his quoted prices in Bloomberg. If the dealer has appreciated bonds that he wishes to sell, he can place "Requests for Bids" for those bonds in Bloomberg. The dealer may bid (buy) bonds that he has previously sold short to limit losses due to rising prices. To hedge existing short positions against rising prices, the dealer would buy call options, not put options. Put options are used to hedge existing long positions from falling prices.

Answer 24

As municipalities reached their debt limits with G.O bond issuance, they found it harder and harder to get voter approval to raise limits to sell additional G.O. bonds (think of Proposition 13 in California that capped property taxes to almost no increase unless the property was sold). To get around this, the COP - Certificate of Participation - was invented and COP issuance is now greater than G.O. bond issuance in many states.

Answer 25

Eurodollar bonds are issued by both domestic and foreign corporations outside of the U.S. markets to take advantage of lower interest rates. These bonds are denominated only in dollars and are payable only in dollars. Since trading does not take place in the U.S., these securities are not registered with the SEC.

Answer 26

If the bonds are tendered at the call price, the owner receives $1,000 per bond If the bonds are sold at the current market price, the owner receives $1,020 per bond. Since each bond is convertible into 14 common shares, the short sale of 14 common shares will yield 14 x $75.50 = $1,057. The bonds can then be converted to common to cover the short position. Thus, selling short the common is the best choice. Continuing to hold the bonds does not make sense since interest payments will cease.

Answer 27

Mortgage bondholders do not have claim to all property of the failed company (such as cash in bank accounts; accounts receivable; inventory; etc.); they only have claim to the real property pledged. If the bondholders' claims are not satisfied from the sale of the real property, then they become general creditors for the balance due.

Answer 28

Level debt service means that the issuer pays the same amount each year, with the funds being used to pay both interest and a portion of principal on the issue (similar to a mortgage amortization schedule). Since bonds are retired annually, the amount of the payment representing interest declines annually. The balance of the level payment is used to pay of bonds for that year. Thus, each year, the principal repayment amount increases

Answer 29

Liquidity risk is the risk that a security can only be sold by incurring large transaction costs. The easiest securities to sell (meaning the most readily marketable) are those with high credit ratings and short term maturities.

Answer 30

The regular way ex date is set at 1 business day prior to record date. The ex date is the very first date the stock trades without the value of the dividend. If the stock is bought on Wednesday, June 13th in a regular way trade, the trade settles in 2 business days on Friday, June 15th, so the holder is on record to receive the dividend (to receive the dividend, the trade must settle no later than the record date). If the stock is bought on Thursday, June 14th, the trade settles on Monday, June 18th. The stockholder would not have been on the record book as of the evening of June 15th (the record date) to receive the dividend. Thus, the first day that the stock trades without the purchaser receiving the dividend is Thursday, June 14th. This is the ex date.

Answer 31

To hedge a stock position, a put must be purchased. The leverage of the ETF has no impact on the number of contracts that must be purchased to hedge. Because of the leverage, the ETF will be more volatile, and the option premium will be higher to reflect this.

Answer 32

If the stock falls, the customer gains on the short stock position. The customer sold the stock for $40. If it falls to "O," the customer can buy the shares for "nothing" to replace the borrowed shares sold and make 40 points. The customer lets the call expire "out the money" losing 5 points, so the maximum potential gain is 35 points = $3,500.

Answer 33

The customer sold the stock for $36 and bought a call, paying a premium of $3 per share, for net proceeds of $33. The customer closes the positions by purchasing the stock at $30 and selling the call contract for $1, for a net payment of $29 per share. The net profit $33 - $29 = $4 or $400 on 100 shares.

Answer 34

The customer paid $4 for the ABC put and $39 for ABC stock, for a total of $43. This is the breakeven on ABC stock. The customer sold XYZ stock short for $51, but paid $5 for the XYZ call, for a net receipt of $46.

Answer 35

When XYZ rises, the customer exercises the long call to buy XYZ at $35. This stock is used to cover the short sale of XYZ stock at $35. There is no gain or loss on the stock but the premium paid of $600 for the call is lost. When ABC falls, the customer exercises the long put to sell ABC at $25. Since the customer bought the stock at $25, there is no gain or loss on the stock. However, the customer does lose the $400 paid in premiums for the put. The total loss is $1,000.

Answer 36

When XYZ rises, the customer exercises the long call to buy XYZ at $35. This stock is used to cover the short sale of XYZ stock at $35. There is no gain or loss on the stock but the premium paid of $600 for the call is lost. When ABC falls, the customer exercises the long put to sell ABC at $25. Since the customer bought the stock at $25, there is no gain or loss on the stock. However, the customer does lose the $400 paid in premiums for the put. The total loss is $1,000.

Answer 37

A rights agent is hired to handle the mechanics of a rights offering. To subscribe, the existing shareholders submit their rights with the subscription dollar amount to the rights agent.

Answer 38

Under an "anti-dilutive" covenant, if there is a stock split or stock dividend resulting in the issuance of additional common shares, the conversion price and hence the conversion ratio are adjusted to reflect the fact that the market price of each common share will drop on the ex date. Prior to the stock dividend, the conversion price was $8 per share. If there is a 2 for 1 stock split, the new conversion price will be adjusted to $8/2 = $4 per share. Since each preferred share is $100 par, the new conversion ratio will be $100/4 = 25:1.

Answer 39

Whether the yield curve is ascending (normal), flat or descending, the true statement always is that short term rates are more volatile than long term rates. Short term rates are susceptible to Federal Reserve influence, and move much faster than do long term rates. Long term rates respond more slowly; and reflect longer term expectations for inflation and economic growth, among other factors.

Answer 40

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.

Answer 41

The rules on taxation of interest income received, generally, are: Treasury/Agency Issues: Interest is subject to Federal Income tax, but is exempt from State and Local tax Municipal Issues: Interest is exempt from Federal Income tax, and exempt from State and Local tax when purchased by a resident of that state Corporate Issues: Interest is subject to Federal Income tax, and to State and Local tax

Answer 42

Interest income derived from municipal bonds is currently exempt from federal income tax; however it is subject to state and local tax unless the state exempts the issue from taxation. Most states allow this only for issues that are purchased by residents of that state.

Answer 43

When evaluating debt securities, all of the risks listed must be considered - credit risk; purchasing power risk; legislative risk; and interest rate risk.

Answer 44

FINA states that a complex product is one where investment returns vary under differing scenarios. Examples include: Asset-Backed Securities such as CMOs, where changing market interest rates affect the rate at which principal is repaid (prepayment and extension risk); Reverse Convertible Notes, which give a higher yield, but convert to equity if the stock falls below a pre-set level; Structured Notes, which offer a return tied to an equity index, subject to a floor and a cap;

Answer 45

Eurodollar bonds are issued by U.S. corporations, U.S. State and local municipalities, foreign corporations, and foreign governments. The bonds are issued in foreign countries but are payable in dollars. The U.S. Government does not issue Eurodollar Bonds.

Answer 46

A publicly traded fund has a 1 time stock issuance; closes its books to new investment and then lists its stock on an exchange or NASDAQ. The stock then trades like any other common stock, except the company is in the business of making investments; instead of say, making cars, beer, or computers. Thus, this type of fund is a "closed-end" fund - that is, closed to new investment.

Answer 47

The customer is purchasing enough ($30,000) to qualify for a 6 ½% sales charge. To compute the new lowered offering price, the formula is: Ask Price = Bid (NAV). / (100% - Sales Charge %)

Answer 48

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. Fund dividends are taxable, whether or not they are automatically reinvested in additional fund shares. Money market funds usually do not impose sales charges but all funds impose management fees.

Answer 49

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 are a tax sheltered investment that allow both gain and loss to flow through to the partnership investors.

Answer 50

REITs do not invest in limited partnerships, which are tax shelter vehicles. This makes sense because REITs cannot pass losses to their shareholders. They invest primarily in real estate and mortgages (under the tax code, at least 75% of the REIT's assets must be invested in real estate or mortgages). Any excess funds can be invested in securities, such as U.S. Governments, and can also be invested in the shares of other REITs.

Answer 51

If a Real Estate Investment Trust distributes at least 90% of its net investment income to shareholders, then it is regulated under Subchapter M of the Internal Revenue Code. The REIT pays no tax on the distributed income - the shareholder who receives the net income pays tax once. In addition, REITs must derive at least 75% of their income from real estate related activities to be "regulated" - however Choice A is not the best answer because these activities include investments in mortgages, as well as investments in real estate.

Answer 52

A stock breaks a "support" level as the market falls. If the stock breaks this level ($40), the investor feels that the price will plummet. To profit, he wants to sell short if the market breaks $40 on the downside, so the order is to sell (short) @ $39 Stop. The order must be a sell stop because it is placed lower than the current market. If the market falls to $39, the order is triggered and becomes a market order to sell short. The order can then be executed on the next trade. Once the short stock position is established, the customer believes that the price will plummet, and that the stock can be purchased later to cover the short sale at a much lower price for a profit.

Answer 53

The "after hours" trading sessions have much lower investor participation, so trading volumes are very small. Because of the lack of order flow, the market is less liquid; and as a result, few dealers participate in the market. Thus, one may not be able to get an execution; and each trade that is executed can result in a much greater than normal market price movement.

Answer 54

The NYSE does not set commission rates - these are set by brokers and dealers themselves. Odd lots are transactions for less than the normal trading unit of 100 shares. Odd lot orders are handled by the Specialist (now renamed the DMM - Designated Market Maker), by buying the odd lot into the Specialist's (DMM's) inventory account; or selling the odd lot out of the Specialist's (DMM's) inventory account. Orders for odd lots have no priority on the NYSE trading floor - trading is in round lot units only.

Answer 55

Specialists (now renamed DMMs - Designated Market Makers) cannot deal with the public, so they cannot act as underwriters. They are wholesale members of the NYSE who deal only with other member firms. DMMs act as market makers and broker's brokers. DMMs also act as the odd lot dealers for trades of NYSE listed stocks that are less than a round lot.

Answer 56

If a trade comes across the tape without the designation "s" (100 share units) or "s/s" (10 share units), then a round lot of 100 shares was traded.

Answer 57

A "When, As and If Issued" trade occurs without knowing the settlement date. When the securities are finally issued, a settlement date is set. If the settlement date is unknown, the amount of accrued interest due is unknown (interest accrues up to, but not including settlement). If the amount of accrued interest is unknown, the total transaction cost is unknown. The confirmation would state whether the trade was performed by the firm as agent or dealer.

Answer 58

The customer bought the stock at $55 and sells it at $58 for a $3 gain. However, he also sold the call at $3. The aggregate gain on both transactions is +$3 + $3 = $600 gain.

Answer 59

If the stock moves to $41, the call goes "in the money" and will be exercised and the put expires "out the money." When the call is exercised, the customer buys the stock at the strike price of $35, and sells it at the current market price of $41, for a 6 point gain. However, since 6 points was paid in combined premiums, the net result is no gain or loss. Thus, $41 is a breakeven point.

Answer 60

The customer has created a short put spread resulting in a $700 credit.

Answer 61

This is a hedging strategy. The customer paid $67 per share plus she paid $6 in premiums per share for the put contracts, for a total outlay of $73 per share. If the puts are exercised, the stock is sold for $70 per share, resulting in a 3 point loss per share. Since there are 200 shares involved, the total loss is $600.

Answer 62

A long stock position is not considered a "cover" for a short put since as the market goes down, the short put is exercised and the customer must buy another 100 shares of stock in addition to the shares already owned - so there is double downside risk. A short put is covered if the individual is short 100 shares of the security. As the market goes down, the short put is exercised and the customer is forced to buy back shares that have previously been sold "short." The credit from the short sale is used to buy the shares, so there is no loss to the put writer.

Answer 63

A contract trades "at parity" when the premium equals intrinsic value. The BP Jul 160 Call has intrinsic value of 4 (since the market is 164). Since the premium is 4, the contract is at parity.

Answer 64

Under the "cheap stock rule," if a customer wishes to short a stock under $5 a share, he or she must put up the greater of 100% or $2.50 per share. 100% of $2 per share × 1,000 shares = $2,000. $2.50 x 1,000 shares = $2,500. The greater amount is $2,500.

Answer 65

As the market drops, SMA locks. The amount available to borrow stays intact. A rising market (above 50% margin in the account) increases SMA. A purchase of securities uses SMA if the margin is not deposited. A sale of securities reduces the debit, increasing SMA.

Answer 66

Prior to making the new purchase, the margin account held 100 shares of ABC at $10, fully paid, for equity of $1,000 in the account. There is $500 of SMA from this position that cannot be used currently, since minimum margin to open an account is $2,000 of equity or the account being "fully paid," whichever is less. Now the customer wishes to buy another $5,000 of stock, which would generate a Regulation T call of $2,500. Since there is $500 of SMA in the account, the customer need only deposit $2,000. After all this, the account will show: Long Market Value - Debit Balance = Equity

Answer 67

The initial margin to buy stock is 50%. 50% of $12,000 = $6,000. The initial margin to short stock is 50%. 50% of $10,000 = $5,000. The total initial margin requirement is $11,000.

Answer 68

The margin requirement to buy LEAP options with over 9 months to expiration is 75%. 75% of $600 premium per contract = $450 margin requirement per contract × 10 contracts = $4,500 deposit.

Answer 69

The "death benefit" of a variable annuity contract is not really much of one. If the contract holder dies prior to annuitization, the insurance company pays the greater of current NAV or the amount invested to a beneficiary. If the contract holder dies after annuitization, there is no more "death benefit."

Answer 70

Contributions to tax qualified retirement plans are tax deductible. They are made with "before-tax" dollars, hence those funds were never taxed. When distributions commence, since no tax was paid on the entire amount, the distribution is 100% taxable.

Answer 71

Distributions from qualified retirement plans, unless they are rolled over into an IRA, are taxable. To ensure that the tax will be paid, the tax code requires that 20% of the distribution amount be withheld as a credit against taxes due. No withholding tax is imposed if a trustee to trustee transfer is made - with the assets being transferred directly into another IRA or qualified retirement plan.

Answer 72

Health Savings Accounts (HSAs) were first authorized by Congress starting in the beginning of 2004. They are a tax advantaged medical savings account that is owned by the individual.

Answer 73

Syndicate members in the underwriting group share in both the selling responsibility for the issue and in liability for any unsold shares (or bonds).

Answer 74

Most general obligation issues are sold through competitive bid while revenue bond issues are typically sold through negotiated offerings. Political subdivision issues are general obligation bonds of cities, counties, and townships. Enterprise activity issues are revenue bond issues where revenues from an enterprise pay for the debt service on the issue.

Answer 75

Whereas government securities are sold at auction conducted by the Federal Reserve, agency securities are sold to the public through a selling group of broker-dealers assembled by the agency. This is done on a negotiated basis, with the group consisting mainly of primary government dealers.

Answer 76

Primary offerings of agency securities to the public are made at par. The selling concession is paid to the selling group members by the agency issuing the security. The concession is paid out of the proceeds of the offering.

Answer 77

SEC Rule 10b-18 sets ground rules for issuers or affiliated persons who wish to buy their shares in the open market. If an issuer aggressively buys its stock in the market, or bids for its stock, it can manipulate the market price upwards. Bids and purchases that are made in compliance with Rule 10b-18 will not be considered manipulative activities under Rule 10b-5 ("catch-all" fraud rule). Rule 10b-18 purchases, as they are known: Must be effected through 1 broker/dealer on any given day; Cannot be the opening transaction; Cannot be executed within 10 minutes of market close if the security is "actively traded," otherwise it cannot be executed within 30 minutes of market close; Must be effected at prices no higher than the current market; Cannot exceed 25% of the trading volume in the security that day (except for block purchases handled outside the normal flow of orders).

Answer 78

There is no prohibition on "insiders" holding or exercising call options on the related company's stock - as long as the transactions are not effected using inside information.

Answer 79

The Securities and Exchange Commission was created by the Securities Exchange Act of 1934 (which was passed in the very beginning of 1934, while the 1933 Act was passed at the very end of 1933 - so these 2 Acts were really enacted "back-to-back"').

Answer 80

FINRA sets minimum disclosure requirements when advertising a CMO tranche. It requires disclosure of the: Coupon Anticipated Yield and Average Life Specific Tranche ID - Number and Class Final Maturity Date Underlying Collateral In addition, FINRA requires the following statement: "The yield and average life shown above consider prepayment assumptions that may or may not be met. Changes in payments may significantly affect yield and average life. Please contact your representative for information on CMOs and how they react to different market conditions." Then FINA states that the following disclosures are optional: Minimum Denomination Rating Agency / Government Backing Income Payment Structure Generic Description of Tranche (e.g., PAC, Companion) Yield to maturity of CMOs Offered at Par

Answer 81

Options communications that are distributed to more than 25 existing or prospective clients must be approved in writing prior to use by the designated Registered Options Principal (main office compliance ROP). Retail communications include advertising, sales literature and independently prepared reprints distributed to more than 25 existing or prospective clients. Options institutional sales literature and public appearances are the 2 public communications that do not require designated ROP approval. However, they are subject to the firm's policies and procedures. Options correspondence is a communication to up to 25 existing or prospective clients. It is subject to "post use review and approval" by a branch manager or ROP.

Answer 82

The discount on all original issue discount bonds (corporate, government and municipal) must be accreted over the life of the bond. If the bond is held to maturity, the entire discount has been accreted and the adjusted cost basis is par. Since the bonds are redeemed at par, there is no capital gain or loss at maturity.

Answer 83

Since these discount bonds are purchased in the secondary market, the market discount that is earned over the life of the bonds is treated as taxable interest income. This is nothing more than a "tax grab" by the Federal government - the idea being that wealthy people buy municipal bonds, so if there is a way that they can be taxed without jeopardizing their basic Federal income tax-free status, why not? The holder has the option of either accreting the discount annually, and paying tax on the portion of the market discount earned; or of waiting until the bonds are sold or redeemed to pay the tax (the better option). Since the bonds are valued at cost, there was no annual accretion of the discount. Thus, when the 10 year bonds are sold after 4 years, 4/10ths of the 10 point market discount has been "earned" and will be taxable as interest income at that point. The bonds were bought at 90; and sold for 95. Of the 5 point gain, 4 points (4% of $100,000 = $4,000) are taxed as interest income, with the remaining 1 point (1% of $100,000 = $1,000) taxed as capital gain.

Answer 84

The final determination of the amount of discount that must be accreted on any (municipal, corporate, and Government) original issue discount bond is made by the Internal Revenue Service.

Answer 85

When a call option is exercised by the holder, the Options Clearing Corporation "assigns" the contract to any one of the individuals or firms that sold that option on a random basis. Once assignment occurs, the writer must deliver the stock to the holder for $50, 2 business days after exercise (the same as a regular way trade). For tax purposes, the seller received $50 from selling the stock and also received $4 in premiums, so the "sales proceeds" are $54 per share. Any gain or loss depends on the price at which the shares were purchased ("the cost basis").

Answer 86

When a put is purchased on a stock on the same day that the stock is bought, the put is said to be "married" to the stock position. The only reason the option was purchased was to protect the customer against loss if the market for the stock fell. It was not purchased to speculate in the market. The IRS treats a "married" put as part of the cost basis of the stock. Notice that, therefore, the put premium cannot be deducted as a capital loss if the put expires worthless; instead, it has increased the stock's cost basis and will reduce any potential capital gain, when, and if, the stock is sold. As one would expect, this is the tax treatment that is most beneficial to the IRS and least beneficial to the investor. The cost of the stock is $51 + $4 premium = $55 per share. When the stock is sold at $59, the customer reports a 4 point capital gain.

Answer 87

Municipal bonds are not suitable for tax deferred accounts such as pension plans and IRAs. These accounts are already tax deferred, so putting taxable investments in them that generate a higher rate of return than municipals is appropriate. Furthermore, these higher returns will compound tax deferred as long as they are held in the pension account. Municipals give a lower rate of return than governments or corporates because of the federal tax exemption on their interest income. They are a bad choice for retirement accounts. TIPS (Treasury Inflation Protection Securities) are great for retirement accounts. Their return is adjusted each year by that year's inflation rate, and this builds tax deferred in a retirement account. Finally, good quality equities have historically given a higher total return than bond investments, so they are good for long term investment in a retirement plan.

Answer 88

The market price averages are rising, but the strength of the market is weakening because the number of advancing issues is declining relative to falling issues. The market is reaching an "overbought" condition, and is approaching a peak.

Answer 89

In a reverse stock split, the number of common shares outstanding is decreased and the market price per share is increased proportionately on the "ex" date. Because the corporations' earnings will be spread over fewer shares, earnings per share will increase. However, the company's Price / Earnings ratio will remain constant because both the stock market price and the earnings per share will increase in the same proportion keeping the Price / Earnings ratio unchanged.

Answer 90

CMO planned amortization classes give a good yield that is 50 or so basis points higher than equivalent maturity Treasuries and are extremely safe. These meet the customer's objective of additional income with low risk. Since this customer is only earning $35,000 per year, she is in a low tax bracket - making tax-deferred variable annuities unattractive. SPDRs - Standard and Poor's 500 Depository Receipts are an exchange traded fund that consists of equities - which don't provide much income. Income bonds only pay interest if the corporation has enough "income" - so these are not appropriate either.

Answer 91

A SEP IRA is a Simplified Employee Pension IRA, which is easier to set up and administrate than most other pension plans. It allows the employer to make a deductible contribution of a maximum of 25% of an employee's income (20% effective rate), capped at $66,000 in2023. It also allows the employer to vary the contribution percentage each year - a key advantage of a SEP IRA.

Answer 92

Active portfolio management practitioners believe that they can outperform a benchmark portfolio (say an index fund) by finding undervalued securities in the marketplace. Passive portfolio managers, in contrast, believe that the market is "efficient" in pricing securities so that one cannot find "undervalued" securities. Passive portfolio managers simply buy index funds (which are managed to match the composition and performance of the chosen index).

Answer 93

A bond that is escrowed to maturity (ETM) is backed by escrowed U.S. Government securities - so it becomes the "safest" municipal bond because it becomes government backed. AAA rated general obligation bonds are extremely safe - they are backed by unlimited tax collections and have a top credit rating. But they are not as safe as bonds backed by escrowed U.S. Government securities.

Answer 94

Rule 101 of Regulation M covers syndicate members who are not market makers in that stock that are in an underwriting group for an "add on" stock offering. The intent is to make sure that they do not try and manipulate the price of the security upwards prior to the effective date, so that a higher POP could be set. They are subject to a restricted period for secondary offerings, of either 1 business day or 5 business days prior to the effective date, where they are prohibited from purchasing, making a bid for, or inducing the purchase of, the underwritten security. If the security is very actively traded, there is no restricted period. Note that they can accept unsolicited orders to buy the security. The rule states that: Tier 1 Issue - if the security is actively traded (average daily trading volume of $1,000,000 or more and public float of at least $150,000,000), there are no restrictions placed on market makers trading the issue prior to the distribution. The idea here is that this issue is too big for the price to be manipulated. This is called a "Tier 1" issue. Tier 2 Issue - if the security has an average daily trading volume of $100,000 and a public float of at least $25,000,000 the restricted period is the business day prior to the effective date. This is called a "Tier 2" issue. Tier 3 Issue - any other security not meeting these minimums is a "Tier 3" issue and is subject to a restricted period of 5 business days prior to the effective date.

Answer 95

Insurance company offerings are exempt from the 1933 Act with the exception of variable annuity and variable life contracts. Thus, a fixed annuity offered by an insurance company is exempt from the 1933 Act. Listed stocks, and stock options are non-exempt issues that must be registered with the SEC.

Answer 96

Issues that are exempt from registration under Federal laws are also exempt under state laws, so U.S. Governments do not have to be registered with the state. However, sales representatives, broker-dealers, and non-exempt issues (such as REITs) must be registered.

Answer 97

In competitive bid municipal underwritings, the offering price of each maturity must be disclosed, but there is not requirement to disclose the spread, which is typically very thin. There is no requirement to disclose the participation amounts of the underwriters (since this in no way affects the customer). However, the order priority provisions must be disclosed (the usual priority is Pre-Sale; Group Net; Designated; Member Takedown).

Answer 98

When performing a municipal bond tax swap, the investor is selling existing bonds at a loss and using the proceeds to buy similar, but not identical bonds so that the loss deduction is allowed under the "wash sale rule".

Part 2 Flashcards

(122 cards)