SIE Part 1: Understanding Products and Their Risks Flashcards
(103 cards)
1
Q
For preferred shares, the annual dividend payment is
A)
fixed and stated as a percentage of its current market value (CMV).
B)
subject to variation and stated as a percentage of its par value.
C)
fixed and stated as a percentage of its par value.
D)
subject to variation and stated as a percentage of its current market value (CMV).
A
fixed and stated as a percentage of its par value.
A preferred stock’s annual dividend payment is its fixed rate of return, unlike that of common shares where the dividend is subject to variation.
2
Q
When investing in overseas markets in foreign securities, investors should be aware of and understand
A) business risk. B) market risk. C) currency risk. D) reinvestment risk.
A
currency risk.
Whenever investing in securities issued in non-U.S. markets, investors need to be sensitive to the different risks that might apply to foreign investments. Of those listed here, currency risk should be of concern. Currency risk is the possibility that an investment denominated in a foreign currency could decline for U.S. investors if the value of that currency declines in its exchange rate with the U.S. dollar.
LO 6.d
3
Q
Which of the following sell transactions is not subject to the holding period restriction specified in SEC Rule 144?
A)
Unregistered stock acquired by a corporate affiliate in a stock option program
B)
Stock acquired in the OTC market by a corporate affiliate
C)
Stock acquired by a corporate affiliate in a private placement
D)
Unregistered stock acquired by a nonaffiliate under an investment letter
A
Stock acquired in the OTC market by a corporate affiliate
The holding period rule applies only to unregistered stock, which may or may not be control stock. Unregistered stock results from either private placements or the exercise of a corporate stock option. Because this question asked which securities were not subject to the Rule 144 holding period, only stock acquired in the OTC market by a corporate affiliate is the correct answer. However, the affiliated person is subject to volume restrictions.
LO 1.g
4
Q
A bond having an 8% coupon is selling with an 8.25% yield to maturity. Which of the following statements are true?
- Nominal yield is higher than yield to maturity (YTM).
- Current yield is higher than nominal yield.
- Nominal yield is lower than yield to maturity (YTM).
- Current yield is lower than nominal yield.
A) II and III B) I and III C) II and IV D) I and IV
A
2 & 3
The bond is offered with a YTM of 8.25%. Because the YTM is higher than the 8% coupon, the bond is trading at discount to par. For discount bonds, the nominal yield is lower than both the current yield and the YTM.
LO 2.b
5
Q
All of the following are types of maturities for debt instruments except
A) balloon. B) serial. C) series. D) term.
A
Series
The three types of maturities for debt instruments are term, serial, and balloon.
LO 2.a
6
Q
T-bonds and T-notes
A) have interest paid on an annual basis. B) are both priced as a percentage of par. C) are both priced at a discount to par. D) have interest that accrues until paid at maturity.
A
Are both priced as a percentage of par
Both Treasury notes and bonds are priced as a percentage of par. Interest on these is paid semiannually. Comparatively, T-bills are priced at a discount to par with the interest not paid until maturity (the difference between the discount paid and par value received).
LO 2.j
7
Q
A change to tax rates on dividends would be an example of
A) purchasing power risk. B) liquidity risk. C) legislative risk. D) currency risk
A
Legislative Risk
When legislation is passed that affects the income received on an investment, the investor is exposed to legislative risk. Only a legislature can change tax rates.
LO 6.d
8
Q
All of the following are examples of legislative risk except
A)
a luxury tax imposed on high-priced amenities such as automobiles or yachts.
B)
a law that would either allow or eliminate a tax deduction.
C)
an environmental regulation enacted to require certain precautions be taken.
D)
changes made to the tax code regarding income tax.
A
an environmental regulation enacted to require certain precautions be taken.
Legislative risk results from a change in the law. Changes to the tax code are the most common legislative risks. Regulatory risk comes from a change to regulations that might impact certain individuals or businesses. The imposition of environmental regulations is one such example.
LO 6.d
9
Q
When selling a bond, the issuer is taking
A) a loaners position. B) a borrower's position. C) an equity position. D) a creditors position.
A
a borrower’s position.
Issuers of bonds are borrowing money from the purchaser of the bond.
LO 2.a
10
Q
When speaking to a customer about exchange-traded funds (ETFs), a registered representative could make which of the following correct statements?
A)
ETFs have different potential tax consequences than mutual funds.
B)
ETFs can be purchased only by paying a sales charge added to the NAV.
C)
ETFs cannot be purchased using traditional limit or stop orders.
D)
ETFs cannot be bought on margin.
A
ETFs have different potential tax consequences than mutual funds.
The potential tax consequences of owning an ETF can be different than those experienced when owning mutual funds. While an ETF can make a capital gains distribution, they generally do not—unlike a mutual fund, which generally would make such distributions on an annual basis. ETFs can be traded like other exchange products using traditional stock-trading techniques and order types and are priced by supply and demand. Customers pay commissions, not sales charges.
LO 5.k
11
Q
All investors and investments are different. Recognizing this, it is true that
A)
all investments can be deemed suitable for every investor.
B)
most investments are not deemed suitable for any investor.
C)
no investment should be deemed suitable for every investor.
D)
some investments can be suitable for all investors.
A
no investment should be deemed suitable for every investor.
Because all investments are different, carrying different levels of risk and reward, no investment can ever be assumed as being suitable for all investors. Each investment type and/or strategy will be suitable for some investors but not all.
LO 6.a
12
Q
Municipal bonds are issued by all of the following government entities except
A) agencies. B) territories. C) states. D) districts.
A
agencies.
Municipal bonds can be issued by any government entity except the federal government.
LO 2.h
13
Q
What is the tax status of a dividend paid to a U.S.-based American depositary receipts (ADR) investor?
A) These dividends may be taxed by both the foreign country and the United States. B) These dividends are tax free. C) These dividends are tax deferred. D) These dividends are only taxable to foreign buyers.
A
These dividends may be taxed by both the foreign country and the United States.
Dividends paid to a U.S. investor may be subject to a withholding tax by the home country of the underlying foreign stock issuer. In many cases, the amount of tax withheld by the foreign government is applied as a credit against the investor’s U.S. tax liability. Note: Any trading profits (capital gains) from the ADR would only be taxable here in the United States.
LO 1.h
14
Q
A corporation has issued debt securities backed by the shares of another corporation that it owns. These debt securities are known as
A) mortgage bonds. B) collateral trust bonds. C) equipment trust certificates. D) debentures.
A
collateral trust bonds.
A corporation can deposit securities it owns into a trust to be used as collateral to back its debt issues. When this is done, the securities issued are known as collateral trust bonds.
LO 2.f
15
Q
An investor purchases 1 KLP October 95 put at 6.50. What is the investor’s maximum potential gain with this position?
A) $9,500 B) $9,650 C) $8,850 D) $10,150
A
C)
$8,850
The maximum gain on a long put is calculated by subtracting the premium from the strike price (95 − 6.50 = 88.50 per share). Because one contract represents 100 shares, the owner’s maximum gain is $8,850 and would occur if the stock falls to zero. Remember, put buyers are bearish; therefore, they will make money if the stock falls below the breakeven point—in this case, below 88.50.
LO 3.g
16
Q
The coupon rate on a debt security represents
A)
the principal amount due to the investor at maturity.
B)
the interest rate the investor has agreed to pay the issuer.
C)
the principal amount loaned to the issuer.
D)
the interest rate the issuer has agreed to pay the investor.
A
the interest rate the issuer has agreed to pay the investor.
The coupon rate on a debt security represents the interest rate the issuer has agreed to pay the investor for use of the funds loaned to the issuer.
LO 2.a
17
Q
For Treasury bills, which of the following are true?
- T-bills are issued at a discount to par.
- T-bills have maturities of 1–10 years
- Most T-bill issues are callable and convertible.
- T-bills are a direct obligation of the U.S. government.
A) II and III B) I and III C) I and IV D) II and IV
A
I and IV
T-bills are issued at a discount to par, are six months or less to maturity, and are a direct obligation of the U.S. government. Callable and convertible features are those that should be associated with corporate issues not government issues.
LO 2.j
18
Q
XYZ Corporation is guaranteeing a debt issue for the IHG Company. Regarding these bonds, which of the following is true?
A)
These bonds are secured, with the value of the guarantee being as good as the strength of XYZ.
B)
These bonds are unsecured, with the value of the guarantee being as good as the strength of IHG the issuer.
C)
These bonds are unsecured, with the value of the guarantee being as good as the strength of XYZ.
D)
These bonds are secured, with the value of the guarantee being as good as the strength of IHG issuer.
A
These are guaranteed bonds where the value of the guarantee is only as good as the financial strength (good faith and credit) of the company making the guarantee—in this case, XYZ Corporation. Because these bonds are backed by the good faith and credit of XYZ and not by any tangible asset, they are unsecured debt instruments. Always remember that even though the word “guaranteed” is used to describe such issues, the bonds are unsecured debt.
LO 2.f
19
Q
A put will have intrinsic value if, just before expiration, the price of the underlying stock is
A) less than the exercise price. B) greater than the exercise price. C) anywhere near the exercise price, above or below. D) equal to the exercise price.
A
less than the exercise price.
Put buyers are bearish. Puts have intrinsic value if the price of the underlying stock falls below the exercise price of the option, The client will be profitable if the price decline (below the strike) exceeds the amount of the premium paid. If the price of the stock rises above the exercise price or is the same as the exercise price, the put will expire worthless.
LO 3.d
20
Q
For those owning preferred classes of stocks, priority of asset dissolution refers to
A)
the order in which preferred shareholders receive dividend payments and the order in which preferred shareholders are paid in the event of a bankruptcy liquidation.
B)
the order in which preferred shareholders are paid in the event of a bankruptcy liquidation.
C)
the order in which the board of directors (BOD) declares dividend payments.
D)
the order in which preferred shareholders receive dividend payments when declared.
A
the order in which preferred shareholders are paid in the event of a bankruptcy liquidation.
Priority at dissolution refers to the priority that preferred stockholders have over the claims of common stockholders on any assets remaining after creditors have been paid when assets are being liquidated.
LO 1.i
21
Q
Systematic risk would include all of the following except
A) market risk. B) inflation risk. C) business risk. D) interest rate risk.
A
business risk.
Nonsystematic risks are those associated with the issuer (like a bad business strategy). Systematic risks impact large portions of the market and are difficult to reduce by diversification.
LO 6.c
22
Q
Treasury bonds mature in
A) 1 year or more. B) 2 years or more. C) 10 years or more. D) less than 2 years.
A
10 years or more.
Treasury bonds (T-bonds) are the U.S. government’s long-term debt instrument having maturities of 10 years and up to 30 years.
LO 2.j
23
Q
Treasury bills pay
A) annual interest payments. B) all interest at maturity. C) semiannual interest payments. D) monthly interest payments.
A
all interest at maturity.
Treasury bills (T-bills) are the only Treasury security issued at a discount to par value. At maturity, par value is received. The difference between what was paid and the par value received would be considered the interest income.
LO 2.j
24
Q
A bank issues and guarantees certificates of deposit, and those that are negotiable are considered money market instruments. What makes a CD negotiable?
A) A fixed interest rate B) Backing by the banks good faith and credit C) Short-term maturity D) Secondary market trading
A
Secondary market trading
While all of these are characteristics of negotiable certificates of deposit issued by banks, it is the ability to trade the CDs in the secondary market that makes them negotiable.
LO 2.m
25
If a preferred shareholder received a $3.50 annual dividend each year, it could be assumed that
```
A)
this is a 3.5% preferred class.
B)
these shares are trading at $35.00.
C)
the shares had increased by 3.5% each year.
D)
the common shareholders receive the same $3.50 annual dividend.
```
this is a 3.5% preferred class.
An annual dividend of $3.50 simply tells you that this is a 3.5% preferred class of stock (3.5% × par ($100) = $3.50) or ($3.50 ÷ par ($100) = 0.035). The current market value is not used to calculate the fixed dividend, nor does this dividend amount tell us what common shareholders received.
LO 1.i
26
Regarding bankruptcy proceedings,
A)
the procedure is only available to individuals seeking protection from creditors and not business entities.
B)
courts protect both corporate and individual filers from creditors.
C)
a plan for reorganization must be submitted first before the courts can offer protection from creditors.
D)
liquidation of assets must occur first before the courts can offer protection from creditors.
courts protect both corporate and individual filers from creditors.
Bankruptcy is a general term for court procedures available to both individuals and businesses. During the proceedings, filers are protected by the court from creditors. Protection is granted independent of any actions to liquidate or file a plan for reorganization.
LO 2.f
27
How often may funds be rolled over from one state's Section 529 plan to another's?
```
A)
No more than twice per calendar year
B)
Once per semester
C)
As often as necessary
D)
Once every 12 months
```
Once every 12 months
A rollover involves actually withdrawing funds from one account for reinvestment in another. The investor thus has constructive receipt of the money and could be liable for taxes on any growth or earnings withdrawn if the rollover is not completed. The rollover procedure, when completed, protects from tax liability but may only be done once every 12 months.
LO 5.a
28
Which of the following positions will mitigate the risk of a short call position?
```
A)
Long calls
B)
Short stock
C)
Long puts
D)
Short puts
```
Long Calls
A short call has unlimited risk unless the investor owns the stock (long position) or has another way to purchase the shares at a set price (warrants, stock rights, or long calls, for example).
LO 3.h
29
Different categories of preferred shares offered by an issuer
```
A)
must all be convertible shares.
B)
all have preference over the issuer's common shares.
C)
must all be callable shares.
D)
all must have the same fixed dividend rate.
```
all have preference over the issuer's common shares.
Separate categories of preferred shares may differ in several ways, including dividend rate and profit participation privileges. However, all maintain preference over common stock shares issued.
LO 1.i
30
A bond having a call feature
A)
can be redeemed before maturity at the issuer's option.
B)
can be redeemed before maturity at the bond holder's option.
C)
is guaranteed not to be redeemed before maturity.
D)
must be redeemed before the bond matures.
can be redeemed before maturity at the issuer's option.
A bond with a call feature may be redeemed before maturity at the issuer's option. There is no guarantee that it will or will not be called, nor is there a requirement that it must be called.
LO 2.b
31
T-notes pay interest
```
A)
monthly.
B)
quarterly.
C)
semiannually.
D)
annually.
```
semiannually.
Treasury notes (T-notes) and bonds (T-bonds) pay interest on a semiannual basis.
LO 2.j
32
An investor lending money to an entity receives back the principal amount of the loan on
```
A)
the maturity date.
B)
the payable date.
C)
the interest payment date.
D)
the record date.
```
the maturity date.
The date that the principal amount of a loan is due to be paid back to an investor is known as the maturity date.
LO 2.a
33
All of the following are corporate secured bonds except
```
A)
mortgage bonds.
B)
equipment trust certificates.
C)
collateral trust certificates.
D)
debentures.
```
debentures.
Debentures are unsecured. Mortgage bonds are backed by property. Equipment trust certificates are backed by equipment. Collateral trust certificates are backed by securities.
LO 2.b
34
T-bonds are delivered in
```
A)
book entry.
B)
registered form to principal only.
C)
bearer form.
D)
physical certificates.
```
book entry.
All U.S. government issues are delivered in book entry.
LO 2.f
35
A customer purchased 1 MNO Jan 50 call at 2. What is the breakeven point for both the purchaser and the seller?
```
A)
50 and 48
B)
50
C)
52
D)
52 and 48
```
52
Whether long or short the call, the breakeven for a call is found by adding the premium to the strike price. For the call buyer, the contract is profitable above the breakeven. For a call seller, the contract stands to lose money if the price of MNO rises above breakeven.
LO 3.g
36
Regarding the decision to dissolve a LP before its scheduled predetermined dissolution date, it would need to be
A)
ratified by the IRS because of the tax implications to dissolve earlier than planned.
B)
made by the general partner with the largest capital contribution with no vote required.
C)
voted on by the limited partners holding a majority interest.
D)
voted on by the general partner(s) only.
voted on by the limited partners holding a majority interest.
In instances where a decision to dissolve a limited partnership before its predetermined date is made, an affirmative vote to do so must be taken by the limited partners.
LO 5.e
37
All of the following are issuer transactions where the proceeds of the offering go to the issuing company except
```
A)
an initial public offering (IPO).
B)
a repurchase agreement (REPO).
C)
an additional public offering (APO).
D)
a subsequent public offering (SPO).
```
a repurchase agreement (REPO).
APOs, IPOs, and SPOs all result in funds going to the issuer and are, therefore, issuer transactions. A REPO is a money market instrument where money changes hands between the buyer and the seller.
LO 2.m
38
A company has issued bonds (debt securities) to investors. For these investors, these securities represent
```
A)
a loan to the issuing company.
B)
liability for the issuing company's debt.
C)
ownership in the existing company.
D)
equity in the issuing company.
```
a loan to the issuing company.
Purchasers of bonds have essentially given the issuer a loan for which they will receive repayment plus interest.
LO 2.g
39
A general partner would be considered to have a conflict of interest with the limited partnership if the GP
```
A)
manages the day-to-day business.
B)
is compensated for managing the partnership.
C)
borrows money from the business.
D)
acts as agent making decisions for the business.
```
borrows money from the business.
The general partner manages the business and acts as agent for the business for which they may receive compensation. They may not borrow from the partnership because this would be considered a conflict of interest.
LO 5.e
40
The United States Congress has authorized all of the following enterprises to issue securities except
A)
Government National Mortgage Association (GNMA).
B)
Federal Deposit Insurance Corporation (FDIC).
C)
Federal National Mortgage Association (FNMA).
D)
Federal Home Loan Mortgage Corporation (FHLMC).
Federal Deposit Insurance Corporation (FDIC).
In addition to U.S. Treasury securities, the U.S. Congress authorizes certain agencies of the federal government to issue debt securities. These would include GNMA, FNMA, and FHLM. The Federal Deposit Insurance Corporation (FDIC) does not issues securities but is set up to insure bank deposits in the event of bank failure.
LO 2.j
41
For a real estate DPP, which of the following is true?
A)
Neither income nor capital growth would come from rents received.
B)
Income can be derived from rents received for the properties.
C)
Capital growth can be derived from rents received.
D)
Income will come from appreciation of the portfolio properties.
Income can be derived from rents received for the properties.
For real estate DPPs, both income and capital growth are possible. Income comes from the property rents received, and capital growth would come from the appreciation of the properties.
LO 5.e
42
A call feature attached to a bond allows
A)
an issuer to call in a bond before maturity at times that will benefit the bondholder.
B)
an issuer to call in a bond before maturity at times that will benefit the issuer.
C)
a bondholder to call the issuer for a redemption before the maturity date.
D)
a bondholder to hold a bond beyond the maturity date benefitting the bondholder.
an issuer to call in a bond before maturity at times that will benefit the issuer.
A call feature attached to a bond allows an issuer to call in a bond before maturity. Issuers will do this when interest rates have fallen. For example, if an issuer has an outstanding bond paying 6% and interest rates have fallen to 4%, why pay out 6% when prevailing market rates are only 4%? Better to call in the 6% bond and reissue a new bond at the current rate of 4%. Obviously, the ability to call in the bond benefits the issuer.
LO 2.d
43
The two classifications of chapters for corporate bankruptcies are
1. liquidations.
2. reorganizations.
3. bankruptcy.
4. failures.
```
A)
III and IV
B)
I and II
C)
I and IV
D)
II and III
```
I and II
Corporate bankruptcies can be either liquidations, where assets are sold off and proceeds are distributed based on the priority of the claim, or reorganizations, where the company continues to operate under a plan to repay creditors.
LO 2.f
44
An investor is long 1 July 40 call at 2. This investor
A)
can exercise the contract to purchase stock at $2 per share.
B)
can exercise the contract to sell stock at $40 per share.
C)
has the right to buy 200 shares of stock.
D)
has paid $200 for the call contract.
has paid $200 for the call contract.
An investor who is long 1 July 40 call at 2 has paid $200 premium to purchase the call. Owning the call, the investor has the right to exercise the contract to purchase 100 shares of stock at the strike price ($40).
LO 3.b
45
An investor short a January 30 call at 4 has a maximum gain potential of
```
A)
30 points or $3,000.
B)
34 points or $3,400.
C)
26 points or $2,600.
D)
4 points or $400.
```
4 points or $400.
Maximum gain for any short option position (call or put) is the premium initially received when the contract was written. In this case, it is 4 points or $400. This would occur if, at expiration, the contract was at or out of the money and, therefore, left unexercised.
LO 3.g
46
Treasury bills
A)
are always issued at a slight premium to par value.
B)
are issued at a discount without a stated interest rate.
C)
have the highest interest-rate risk of all Treasury securities.
D)
can be issued with initial maturities of 3, 12, 24, and 50 weeks.
are issued at a discount without a stated interest rate.
Treasury bills are always issued at a discount, without a stated interest rate. Because of their short-term maturities, they have the lowest interest-rate risk for Treasury securities, not the highest. They are issued with maturities of 4, 13, 26, and 52 weeks.
LO 2.j
47
In a limited partnership, which of the following best describes who is responsible for tax consequences of the business?
```
A)
The general partners
B)
The business
C)
The limited partners
D)
The investors
```
The investors
All tax consequences of the business flow through proportionality to the investors. All partners will have some tax impact, not just the general or just the limited partners.
LO 5.f
48
While preferred shares tend to be less volatile than common shares, one type of preferred is noted as being even more stable in price than the others. This would be
```
A)
participating.
B)
convertible.
C)
callable.
D)
adjustable rate.
```
adjustable rate.
Because the dividend payment adjusts to current interest rates, the price of the stock remains relatively stable. In other words, it is the return that fluctuates rather than the price.
LO 1.i
49
While preferred shares tend to be less volatile than common shares, one type of preferred is noted as being even more stable in price than the others. This would be
```
A)
participating.
B)
convertible.
C)
callable.
D)
adjustable rate.
```
adjustable rate.
Because the dividend payment adjusts to current interest rates, the price of the stock remains relatively stable. In other words, it is the return that fluctuates rather than the price.
LO 1.i
50
A guaranteed bond is usually guaranteed by which of the following entities?
```
A)
The U.S. Guarantee Association
B)
The broker-dealer who sold it
C)
A parent company
D)
The U.S. government
```
A parent company
A guaranteed bond is back by a third party, normally a parent company backing the debt of a subsidiary company.
LO 2.g
51
Risks that are unique to a specific industry, business type, or investment type are known as
```
A)
nonsystematic risks.
B)
systematic risks.
C)
stock market risk.
D)
security risks.
```
Nonsystematic risks are those that are unique to a specific industry, business enterprise, or investment type.
LO 6.c
52
The breakeven point on a long call is
```
A)
the premium.
B)
the strike price.
C)
strike + premium.
D)
strike – premium.
```
strike + premium.
In order for an investor to breakeven on a long call, she must be able to sell the stock for her cost (the strike price), plus enough to cover the cost of the option (premium). The formula for breakeven on a long call is BE= XP + Pr.
LO 3.d
53
Securities and Exchange Commission Rule 144 regulates
A)
the sale of new issue securities in the primary market.
B)
communications with public retail investors.
C)
the sale of control and restricted securities.
D)
state-level (blue-sky) registration of securities.
the sale of control and restricted securities.
Securities and Exchange Commission Rule 144 regulates the sale of control and restricted securities in the secondary market. The rule stipulates the holding period, quantity limitations, manner of sale, and filing procedures when divesting of control or restricted shares.
LO 1.g
54
All of the following would generally be associated with a limited partnership (LP) except
```
A)
partners responsible for reporting to the IRS.
B)
tax credits for specific programs.
C)
the pass through of gains and losses.
D)
freely transferrable interests.
```
freely transferrable interests.
With no secondary market trading, one of the greatest disadvantages of a limited partnership is that an investor's partnership interest in one is generally not considered to be freely transferrable. The pass through of gains and losses, all tax consequences, and the individual partners being responsible for reporting to the IRS are all characteristics of LPs.
LO 5.d
55
For revenue bonds issued by a state or municipality, which of the following is true?
A)
The bonds carry an unqualified promise to pay interest and principal backed by the power of the issuer to levy taxes.
B)
Interest and principal payment is backed by the full faith and credit of the issuer.
C)
Interest will be paid only if the enterprise owned and operated by the state or municipality has sufficient earnings to cover the interest payments or the debt service reserve.
D)
Interest and principal payment is guaranteed.
Interest will be paid only if the enterprise owned and operated by the state or municipality has sufficient earnings to cover the interest payments or the debt service reserve.
Revenue bonds are not backed by the full faith and credit of the municipality that issues them. Instead, they are backed by the revenue produced by the project or facility that they support. In that light, the revenue must be large enough to cover the interest and principal payments if those obligations are to be met.
LO 2.h
56
On a long put, when the premium equals the intrinsic value, the put is
```
A)
out of the money.
B)
at parity.
C)
at its breakeven point.
D)
past expiration.
```
at parity.
All puts are in the money when the market price is below the strike price. They are out of the money when the market price is above the strike price. They are at the money when the market price equals the strike price. They are at parity when the premium equals the intrinsic value.
LO 3.d
57
Hedge funds attempt to
A)
mitigate all risks making them suitable for most investors.
B)
achieve high returns and are, therefore, associated with high-risk investments.
C)
achieve modest returns and are, therefore, associated with being low-risk investments.
D)
mitigate all risk using hedging as an investment strategy.
achieve high returns and are, therefore, associated with high-risk investments.
While hedging is the practice of attempting to limit or mitigate risk, most hedge funds specify generating high returns as their primary investment objective. In attempting to achieve these returns, they tend to entail a substantial amount of risk for those who own shares.
LO 5.j
58
Callable preferred stock is advantageous to the issuing company because it allows the company to
A)
call in the stock at less than par value and capture the difference as income.
B)
issue fixed-rate securities at a yield lower than usual.
C)
replace a higher, fixed-rate issue with a lower issue after the call date.
D)
take advantage of higher interest rates.
C)
replace a higher, fixed-rate issue with a lower issue after the call date.
By issuing a callable preferred stock, a corporation can call in a high dividend payment issue and replace it with a lower one when interest rates have fallen. This feature allows the company to take advantage of reduced interest rates by calling in high-rate preferred issues and replacing them with lower ones.
LO 1.i
59
Regarding CDs and negotiable CDs issued by banks,
A)
only CDs are considered money market instruments.
B)
only negotiable CDs are considered money market instruments.
C)
neither CDs nor negotiable CDs are considered money market instruments.
D)
both CDs and negotiable CDs are considered money market instruments.
only negotiable CDs are considered money market instruments.
Banks issue and guarantee CDs with fixed interest rates. Some that can be traded in the secondary market are known as negotiable CDs. Only these negotiable CDs are considered money market instruments.
LO 2.m
60
Preferred shares have
A)
characteristics of both equity and debt securities.
B)
only the characteristics matching those of equity securities.
C)
characteristics of neither equity nor debt securities.
D)
only the characteristics matching those of debt securities.
characteristics of both equity and debt securities.
Preferred shares are equity securities, but not only do they have the characteristics of equity securities, they share some of the characteristics of debt securities as well. The most notable characteristic is that a preferred stock's annual dividend represents its fixed rate of return, like the fixed rate of return for a bond (debt security).
LO 1.i
61
Interest is best described as
A)
a specific rate of return the lender pays the borrower over the life of the loan.
B)
a specific rate of return the borrower pays the investor for use of the funds.
C)
the amount the borrower receives from a lender.
D)
the amount that an investor lends to a borrower.
a specific rate of return the borrower pays the investor for use of the funds.
Interest is the rate of return above the principal sum received by a lender (investor) from a borrower. Interest is rate of return the investor receives for use of the funds over the life of the loan.
LO 2.a
62
A bond that is structured so that the principal of the whole issue matures at once is
```
A)
a series bond.
B)
a balloon bond.
C)
a serial bond.
D)
a term bond.
```
A term bond
With a term bond, the entire offer matures at the same time. A serial bond has portions maturing over a period of years. A balloon is a hybrid of a term and a serial maturity. Series is not a type of bond maturity.
LO 2.a
63
As interest rates rise, prices of preferred stock will
```
A)
remain unaffected.
B)
become volatile.
C)
rise.
D)
fall.
```
fall
Because it pays a fixed dividend, preferred stock is interest-rate sensitive. As rates rise, prices of preferred stocks tend to fall and vice versa.
LO 1.i
64
In an LP, which of the following is true?
A)
Any gains realized from a limited partnership are tax exempt.
B)
The partners are not responsible for paying taxes on gains.
C)
Only losses but not gains flow through to the individual partners.
D)
The partnership entity is not responsible for paying taxes on gains.
The partnership entity is not responsible for paying taxes on gains.
Both gains and losses from an LP flow through to the individual partners. Gains are taxable, and any taxes due are the responsibility of the individual partners, not the partnership entity.
LO 5.d
65
Common shareholders wanting to vote on issues at a shareholder meeting can do so in all of the following ways except
```
A)
in person.
B)
by proxy delivered by mail.
C)
by proxy delivered online.
D)
by telephone or text message.
```
by telephone or text message.
Common shareholders wanting to vote at a shareholder meeting can do so in person or in absentia, using a proxy delivered by mail or online. Voting by text or telephone would not be permitted.
LO 1.e
66
Your customer is long 1 October 55 put at 4. The customer's breakeven point is
```
A)
40.
B)
59.
C)
51.
D)
55.
```
51
For puts, the breakeven is found by subtracting the premium (4) from the strike price (55). Because put buyers are bearish, the long put contract is profitable below the breakeven at expiration.
LO 3.g
67
Under penny stock rules, what is required for a broker-dealer to consider an investor an established customer?
```
A)
Open cash account for six months or more
B)
Signed risk disclosure statement
C)
At least three separate penny stock purchases
D)
Signed transaction agreement
```
At least three separate penny stock purchases
Under penny stock rules, investors are established customers if they have deposited funds or securities in an account for at least one year before the penny stock transaction, or have purchased at least three different penny stocks from the same broker-dealer.
LO 1.c
68
An investor owns a bond carrying a 4% coupon. Interest rates in the marketplace have been moving downward and are currently at 2.5%. Given the current interest rates in the marketplace, this investor should see
```
A)
the price of the bond be unchanged.
B)
the coupon of the bond adjusted downward.
C)
the price of the bond move lower.
D)
the price of the bond move higher.
```
the price of the bond move higher.
Prices of bonds trading in the secondary market have an inverse relationship to interest rates. As interest rates rise in the marketplace, the prices of bonds trading in the secondary market will fall, and as interest rates fall in the marketplace, the prices of bonds trading in the secondary market will rise. Once the coupon rate is established by the issuer, it remains unchanged throughout the life of the bond.
LO 2.b
69
A balloon maturity for an issuer's debt securities is most accurately described as
A)
a later final maturity within a serial issue of bonds that contains a disproportionately large percentage of the principal amount of the original issue.
B)
bonds comprising all of a particular issue that come due in a single maturity.
C)
a serial issue of bonds on which the interest rate periodically changes over the life of the issue for all bonds remaining outstanding.
D)
an obligation granting the bondholder the right to require the issuer to purchase the bonds at par at a certain time before maturity.
a later final maturity within a serial issue of bonds that contains a disproportionately large percentage of the principal amount of the original issue.
A balloon maturity is generally distinguished from term bonds by the presence of serial maturities in the years immediately preceding the final maturity date. While some of the principal is paid back on the serial dates, the major portion of the principal is paid back on the final maturity date.
LO 2.a
70
Treasury bills (T-bills) are
A)
issued at face value, with a stated rate of return received as interest annually.
B)
issued at a discount to par, paying interest at maturity.
C)
issued at face value, with all interest paid in monthly checks.
D)
issued at a discount, with a stated interest rate paid annually.
issued at a discount to par, paying interest at maturity.
T-bills, the shortest-term government-issued securities, are not issued with a stated rate of return. Instead they are issued at a discount to par rather than face value, and they mature at par. The difference between the discounted price paid and the par value received at maturity is considered the interest.
LO 2.j
71
Listed options can be exercised by
```
A)
the holder after the expiration date.
B)
the holder from the time of purchase until they expire.
C)
the writer from the time of purchase until they expire.
D)
the writer after the expiration date.
```
the holder from the time of purchase until they expire.
Listed options can be exercised by the holder (owner, buyer, party who is long) from the time of purchase until they expire. Writers (sellers, party who is short) cannot exercise contracts. Instead, writers are assigned when the owners of the contracts exercise them.
LO 3.k
72
Distinguishing by the issue's term to maturity for those securities issued by the U.S. federal government, which of the following is correct?
```
A)
Notes represent long-term issues.
B)
Bills represent short-term issues.
C)
Bonds represent intermediate-term issues.
D)
Bonds and notes are both intermediate-term issues.
```
Bills represent short-term issues.
Securities issued by the U.S. federal government, the shortest term to the longest term are bills, notes, and bonds.
LO 2.j
73
An investor who buys and sells options on stock is
```
A)
a stockholder.
B)
an owner of the company.
C)
a lender to the company.
D)
neither an owner of nor a debtor of the company.
```
neither an owner of nor a debtor of the company.
Derivative securities of corporate equity securities represent neither equity (ownership) in a company nor debt (a loan). They represent the right to either buy or sell the stock at a later time at a fixed price.
LO 3.a
74
Which of the following is the best description of a limited partnership?
A)
An investment that allows only for income to flow through to the investors
B)
An investment that exempts individual investors from reporting gains or losses
C)
An investment that allows for losses only to pass through as write-offs to the investors
D)
An investment that permits both gains and losses to pass through to the investors
An investment that permits both gains and losses to pass through to the investors
Limited partnerships (LPs) are investment opportunities that permit the economic consequences of a business to flow or pass through to investors (limited partners). These would include the consequences of both income received and losses incurred.
LO 5.d
75
An example of a fixed-income security would include all of the following except
A)
common stock that has historically paid dividends.
B)
preferred stock that has historically paid dividends.
C)
a municipal bond that has historically made late interest payments.
D)
a money market instrument that has historically made timely interest payments.
common stock that has historically paid dividends.
Securities that have an agreed rate of return, such as bonds, notes, money market instruments, and other debt instruments, are deemed fixed-income securities. Preferred stock acts in many ways like a bond in that it has a fixed dividend rate, making it a fixed-income security. Common stock may or may not pay a dividend depending on the board of directors. Common stock is not deemed a fixed-income security.
LO 1.c
76
A corporation has issued a single bond having successive maturity dates set from 2020 through 2030. This is known as what type of bond?
```
A)
Term
B)
Serial
C)
Series
D)
Balloon
```
Serial maturity bonds are all issued at one time and mature in successive years. Note that there is no series maturity type.
LO 2.a
77
In safety of principal, municipal bonds are considered second only to
```
A)
corporate common stock issues.
B)
U.S. government and agency bonds.
C)
AAA-rated corporate debt issues.
D)
corporate preferred stock issues.
```
U.S. government and agency bonds.
Municipal securities are considered second in safety of principal only to U.S. government and agency issues.
LO 2.h
78
T-bills are the U.S. government's
```
A)
only callable debt.
B)
intermediate-term debt of 2–10 years.
C)
long-term debt of over 10 years.
D)
short-term debt of 1 year or less.
```
short-term debt of 1 year or less.
T-bills have a maximum maturity of 52 weeks (one year) by law.
LO 2.j
79
Your customer establishes the following position: Long 1 XYZ January 50 put at 2. You can correctly inform the customer that the maximum potential gain on the position is
```
A)
unlimited.
B)
$4,800.
C)
$200.
D)
$5,200.
```
$4,800.
Maximum gain for a long put is calculated by subtracting the premium from the strike price (50 − 2 = 48 per share). One contract represents 100 shares, so the buyer's maximum gain is $4,800 (this occurs if the stock becomes worthless).
LO 3.g
80
There are several types of investment risks that will generally fall into two categories. These categories are known as
```
A)
investment and investor.
B)
high return and low return.
C)
averse and nonaverse.
D)
systematic and nonsystematic.
```
systematic and nonsystematic.
The two categories of investment risks are systematic (the risk that change in overall economy will impact individual securities) and nonsystematic (those risks that are unique to a particular industry, business, or investment type).
LO 6.a
81
Regarding corporate bond issues, which of the following statements best describes secured debt and unsecured debt?
A)
Secured debt is asset backed, while unsecured debt is not.
B)
Only unsecured debt can be issued by corporations, while secured debt cannot be.
C)
Only secured debt can be issued by a corporation, while unsecured debt cannot be.
D)
Unsecured debt is asset backed, while secured debt is backed by the issuer's full faith and credit.
Secured debt is asset backed, while unsecured debt is not.
Corporations can issue both secured and unsecured debt securities. Secured debt issues are backed by real assets, while those that are unsecured are simply backed by the issuer's full faith and credit.
LO 2.f
82
Your customer has a portfolio consisting entirely of municipal-issued securities. Therefore, the entire portfolio would have to consist of
```
A)
Treasury STRIPS and bills.
B)
Treasury notes and general obligation bonds.
C)
Treasury receipts and government agency bonds.
D)
general obligation and revenue bonds.
```
general obligation and revenue bonds.
Two categories of municipal securities are general obligation (GO) bonds and revenue bonds.
LO 2.h
83
An investor holds a debt security backed by ad valorem taxes. This security is issued by
```
A)
the federal government.
B)
a state.
C)
a city or local municipality.
D)
either a state or city government.
```
a city or local municipality.
Ad valorem taxes are real estate taxes. Real estate taxes can only back debt securities issued by towns, cities, or counties (never states). These are collectively known as local municipalities.
LO 2.h
84
A common stock shareholder's residual right to corporate assets refers to which of the following?
A)
During the dissolution of corporate assets, common shareholders will be paid first— before debtholders and preferred shareholders are paid.
B)
During the dissolution of corporate assets, common shareholders will be paid if any funds are left after preferred shareholders are paid but before debtholders are paid.
C)
During the dissolution of corporate assets, common shareholders will be paid if any funds are left after debtholders are paid but before preferred shareholders are paid.
D)
During the dissolution of corporate assets, common shareholders will be paid if there are any funds left after debtholders and preferred shareholders are paid.
During the dissolution of corporate assets, common shareholders will be paid if there are any funds left after debtholders and preferred shareholders are paid.
For common shareholders, having a residual right to corporate assets means that they will only be paid in the event of a corporate dissolution if there are any funds left after debtholders and preferred shareholders are paid.
LO 1.e
85
An investor chooses to have a portfolio made up of domestically listed U.S. securities only. In so doing, this investor is primarily avoiding which of the following two risks?
```
A)
Call and reinvestment
B)
Political and currency
C)
Market and purchasing power
D)
Inflation and interest rate
```
Political and currency
By having a portfolio made up of only domestically listed U.S. securities, the investor is primarily avoiding political risk and currency risk. Political risk is attributable to political instability, rarely associated with U.S. domestic markets. Currency risk is most prevalent when buying or selling involves a foreign currency that can fluctuate in value against the U.S. dollar. While these two are avoided, the investor could still be exposed to each of the other risks listed here.
LO 6.d
86
Unique tax advantages associated with oil and gas direct participation programs are
```
A)
tax credits and depreciation allowances.
B)
intangible costs and cash flow allowances.
C)
tax credits and cash flow allowances.
D)
intangible costs and depletion allowances.
```
intangible costs and depletion allowances.
Explanation
Intangible drilling costs (IDCs) and depletion allowances are both unique tax advantages associated with oil and gas DPPs. IDCs can all be written off completely in the first year of the program instead of over the entire life of the program, and depletion allowances are allowable deductions that compensate for the depletion of the natural resource taken after it is sold.
LO 5.e
87
Which of the following projects would be funded by general obligation (GO) bonds?
```
A)
Sports stadiums
B)
Airports
C)
Public schools
D)
Public housin
```
Public schools
Schools are funded by state and local taxes which is what backs GO bonds.
LO 2.h
88
Which of the following are municipal securities?
```
A)
529 Savings Plans
B)
Coverdale Saving Plans
C)
UTMA Saving Accounts
D)
UGMA Saving Accounts
```
529 Savings Plans
529 plans are established by each individual state—therefore they are municipal issues.
LO 5.a
89
If a callable bond is priced at par, which of the following is true?
A)
Yield to maturity (YTM) is less than yield to call (YTC).
B)
Current yield (CY) equals yield to call (YTC).
C)
Current yield (CY) is greater than yield to maturity (YTM).
D)
Current yield (CY) is less than yield to maturity (YTM).
Current yield (CY) equals yield to call (YTC).
For any bond priced at par, all of the yields are equal; nominal = CY = YTM = YTC if callable.
LO 2.b
90
All of the following terms and phrases are associated with the sell side of the contract except
```
A)
has an obligation.
B)
receives the premium.
C)
writes the contract.
D)
owns the contract.
```
owns the contract.
The buyer of the contract pays the premium and loses it if the contract expires. The seller receives the premium and keeps it if the contract expires. The buyer has a right to exercise the contract. The seller has an obligation if the buyer decides to exercise. Buyer, holder, owner, and long all mean the same thing. Seller, short, and writer all mean the same thing.
LO 3.c
91
An investor is long 6 MAS February 60 calls at 2.25 each. If at the time of the February expiration, the calls expire unexercised, how much money will the investor lose?
```
A)
$6,225
B)
$1,350
C)
$225
D)
$810
```
$1,350
Buyers of options (calls or puts) lose the premium paid if the options expire unexercised. The most this investor can lose is the number of contracts (six) multiplied by the amount of the premium received, $225. Therefore, this investor's maximum loss is $1,350.
LO 3.d
92
The maximum loss on a long call is
```
A)
unlimited.
B)
strike price + premium.
C)
the premium.
D)
strike price – premium.
```
the premium.
The maximum loss on any long option position is the premium paid. If the price of the underlying security moves against the option, the owner simply does not exercise the option, allowing it to expire worthless.
LO 3.d
93
An investor holds a 4% bond, callable in 8 years, and maturing in 12 years. The bond's current yield (CY) measures its annual coupon payment relative to
```
A)
its value when callable.
B)
its value at maturity.
C)
par value.
D)
its market price.
```
its market price.
The CY measures a bond's annual coupon payment (interest) relative to its market price, as shown in the following equation: annual coupon payment ÷ market price = current yield.
LO 2.b
94
Which of these investment companies trade in the secondary market?
```
A)
Closed end funds
B)
Unit investment trusts
C)
Face amount certificates
D)
Open end funds
```
Closed end funds
Another name for closed end funds is publicly traded funds because they trade in the market like stock of other companies. The other three investment companies listed here are purchased and redeemed through the issuer (a primary market transaction).
LO 4.a
95
Which of the following require voter approval?
```
A)
Municipal revenue bonds
B)
Government agency bonds
C)
Treasury bills
D)
Municipal general obligation (GO) bonds
```
Municipal general obligation (GO) bonds
Municipal general obligation (GO) bonds require voter approval because the debt service for these bonds (principal and interest payments) is funded by the taxes collected by the municipal issuer. Voters pay these taxes.
LO 2.h
96
All of the following actions must be completed before a customer enters the first option order except
A)
completion of the new account form.
B)
completion of (signing of) the options agreement.
C)
approval by a branch office manager (BOM) or registered options principal (ROP).
D)
delivery of an Options Clearing Corporation (OCC) disclosure booklet.
completion of (signing of) the options agreement.
Customers do not have to complete (sign) the options agreement before entering an order, although under the rules, the agreement must be signed and returned by the customer within 15 calendar days of account approval.
LO 3.j
97
Which of the following would be unlawful regarding use of a mutual fund prospectus?
A)
Calling an investor's attention to a section that may be interesting
B)
Sending a prospectus to someone who has shown no interest in the fund
C)
Leaving a typographical error in the text unmarked
D)
Failing to highlight a small section the customer has specifically asked about
Calling an investor's attention to a section that may be interesting
A prospectus for any security, not just one for a mutual fund, may not be marked, highlighted, or otherwise altered in any way, nor may steps be taken to call an investor's attention to some passage or section that might be of special interest, even if the potential customer asked that it be done.
LO 4.i
98
A member firm is assigned an exercise notice by the Options Clearing Corporation (OCC). The member firm may assign the exercise notice to one of its short customers by any of the following methods except
```
A)
in any way that is fair and reasonable.
B)
to the customer having the largest short position.
C)
on a random-selection basis.
D)
to the customer having the oldest short position.
```
to the customer having the largest short position.
While the OCC can assign exercise notices using only the random-selection basis, a member firm may use any method that is fair and reasonable. The two most common methods are first in, first out (FIFO) and random selection.
LO 3.k
99
Purchasers of common stock may generally look to all of the following risks associated with that investment except
A)
low priority.
B)
reduction in dividend payout.
C)
interest rate risk.
D)
market risk.
interest rate risk
Investors in common stock face market risk, in that the market value of the security may fall, and business difficulties may lead to possible reduction or elimination of the dividend—and even bankruptcy leading to loss of principal. If the firm is bankrupted, a company's debt and preferred shares are considered senior securities and will have residual rights to corporate assets upon dissolution prior to common shareholders. Interest rate risk applies to preferred shares, bonds, and other fixed-income securities, but common stock generally bears little risk due to fluctuations in interest rates.
LO 1.e
100
If a bond is trading at a discount, which of the following rates is correctly ranked from low to high?
A)
Yield to call, yield to maturity, current yield, nominal yield
B)
Nominal yield, yield to maturity, current yield, coupon rate
C)
Yield to call, current yield, nominal yield, coupon rate
D)
Coupon rate, current yield, yield to maturity, yield to call
Coupon rate, current yield, yield to maturity, yield to call
The order from low to high is coupon rate, current yield, yield to maturity, yield to call.
LO 2.e
101
A bond that is structured so that a portion of the principal is scheduled to mature at intervals over several years is
```
A)
a term bond.
B)
a serial bond.
C)
a series bond.
D)
a balloon bond.
```
a serial bond.
With a serial bond, portions of the issue mature over a period of years until the entire issue is paid.
LO 2.f
102
Which of the following bonds trade flat (without interest) unless interest payments are declared by the board of directors (BOD)?
```
A)
Callable bonds
B)
Income bonds
C)
Mortgage bonds
D)
Debentures
```
Income bonds
Bonds that trade flat (without interest), unless the payments are declared by the BOD, are income bonds (also known as adjustment bonds).
LO 2.f
103
With CCD stock at 40, a September 45 call trading at 3 is out of the money by
```
A)
5 points and has negative intrinsic value.
B)
2 points and has no intrinsic value.
C)
2 points and has negative intrinsic value.
D)
5 points and has no intrinsic value.
```
5 points and has no intrinsic value.
When a calls strike price is higher than the underlying stocks value, the call contract is out of the money. In this case, it is out of the money by 5 points (45 – 40). When a contract is out of the money, we say that it has no intrinsic value. We do not use the term negative when referring to contracts with no intrinsic value.
LO 3.d
