Textbook

Question 1

If one spouse opens an individual account, can the other spouse execute trades in the account?

Answer 1

Only if they are granted third-party trading authorization.

Question 2

JTWROS Accounts

Answer 2

Joint Tenancy with Right of Survivorship
- Accounts owned by at least two people, where all tenants have an equal right to the account’s assets and are afforded survivorship rights in the event of the death of another account holder.

Question 3

TEN COM

Answer 3

Tenancy in Common

- Each owner has a % of ownership and, at the time of death, the deceased person’s interest passes to his estate.

Question 4

Community Property Accounts

Answer 4

Essentially the same as accounts that are established as JTWROS, but are only permitted between legally married couples

Question 5

Corporate Resolution

Answer 5

A document created by the board of directors which appoints one or more persons to operate the account. (Note: the customer is the corporation, not the person opening the account.)

If a corporation intends to open a margin or options account, a copy of the corporate charter must also be obtained. The charter is the document that certifies whether the corporation is authorized to have such an account.

Question 6

Limited versus Full POA

Answer 6

A limited trading authorization permits the authorized person only to place orders for the account, but not to make withdrawals. With full trading authorization, in addition to placing buy and sell orders, the authorized person is able to withdrawal money and securities from the account. In either case, the b/D must receive written trading authorization that’s signed by the account owner prior to permitting the authorized person to trade the account. The firm should also obtain the signature of each authorized person and the date that the trading authority was granted.

Question 7

Member firm selling its own stock to the public and it wishes to place some of the stock in the account of a customer for whom the member first holds discretionary authorization.

Answer 7

It must obtain prior written consent from the customer to execute the trade.

Question 8

Pattern Day Trader

Answer 8

Any customer who executes four or more day-trades over a five-business-day period.

Question 9

Primer Brokerage agreement

Answer 9

A client selects one firm as its prime broker to essentially consolidate the bookkeeping process. The client still uses several broker-dealers for reasons such as their execution capabilities, research services, and access to IPOs, but all trades are ultimately handled through an account that’s maintained with its primer broker.

Question 10

DVP/RVP Accounts

Answer 10

Delivery versus payment
Receive versus payment

The bank will either pay the B/D for client purchases or send securities to the B/D for client sales.

Question 11

Regulation SP divides clients into two categories - what are they?

Answer 11

Customer:
- A person who has an ongoing relationship with the firm.
Consumer:
- A person who is in the process of providing information to the firm in connection with a potential transaction.

Firms must initially provide every customer with a privacy notice at the time the relationship is first established. Thereafter, they must follow up with an updated version of this notice annually.
For consumers, a firm must provide a privacy notice before it discloses non-public, personal information to any unaffiliated third party. However, if the firm doesn’t intend to disclose any consumer information to an unaffiliated third party, then a notice is not required to be provided.

Question 12

Securities Exchange Act of 34: Definition of an insider

Answer 12

Any director, officer, or owner of more than 10% of the voting stock of a corporation and his immediate family members.
Within 10 days of becoming an insider, a person is required to report to the SEC on Form 3. An insider is required to file Form 4 to report any changes in his stock position by the second business day following the change.

Question 13

Short-swing profit

Answer 13

The result of an insider selling her stock at a profit within six months of its acquisition. For violations of the rule, the corporation may sue for recovery of the profit (a process that’s referred to as disgorgement). This restriction also applies if an insider sells stock that was held longer than six months and then, within six months of the sale, repurchases it at a lower price than the previous sale price.

Question 14

Before being sent to customers, FINRA rules require approval by a principal all of the following EXCEPT:
A.) An article from a newspaper about a mutual fund the B/D sells.
B.) The script for a seminar on mutual fund investing to be presented by an RR
C.) A form letter that includes the names of all mutual funds sold by the B/D
D.) A prospectus for a mutual fund for which the RR’s firm acts as a dealer

Answer 14

D.) Under FINRA rules regarding communications with the public, advertising and/or sales literature must be approved by a principal before being sent to the public. A prospectus is not covered by these rules.

Question 15

Method for calculating current yield on common or preferred stock

Answer 15

Is found by dividing the yearly dividend by the current market price of the stock.

The number of shares the client owns and the original cost of the stock are not relevant in calculating the current yield.

Question 16

When analyzing the benefits of a non-qualified deferred compensation plan, an individual would consider that the plan would have all of the following characteristics EXCEPT:

A.) The plan may be offered to a select group of employees.
B.) Income taxes are due only when compensation has been paid to the employee
C.) The accumulated funds can be used as collateral when purchasing a new home
D.) The IRS need not approve the creation of the plan

Answer 16

C.) Non-qualified deferred compensation plans are often unfunded, meaning the employer does not actually set aside money to fund the promised plan benefits. The employer promises to pay the plan benefits when they are due to the employee, usually at retirement. This creates the risk that if the employer is in financial difficulty when the payments should be made, the employee might not receive them.

Question 17

Which of the following statements is TRUE regarding a prime broker?

A.) It is only permitted to execute transactions for a hedge fund
B.) It is only permitted to clear transactions for a hedge fund
C.) It may execute and clear transactions, but may not provide securities lending services to a hedge fund
D.) It may execute and clear transactions, and may also provide securities lending services to a hedge fund

Answer 17

D.) A prime-brokerage arrangement involves a variety of services offered by a broker-dealer to an active trading firm, such as a hedge fund. Most prime brokers offer both execution and clearing services to these customers. There are no rules preventing a broker-dealer from acting in both capacities. There is no restriction for providing securities lending services to a hedge fund.

Question 18

Which of the following statements is NOT TRUE of treasury stock?

A.) It is listed on the company’s balance sheet
B.) Treasury stock has no voting rights and does not receive dividends
C.) It is outstanding stock that has been repurchased by the corporation
D.) Treasury stock has been issued by the U.S. Treasury and was purchased by a corporation

Answer 18

D.) Treasury stock is stock that has been issued and was outstanding but has been repurchased by the company. Treasury stock does not have voting rights nor the right to receive dividends.

Question 19

For a corporation that’s in the 21% tax bracket, which of the following choices will provide the best return if the corporation wants to invest some of its surplus cash?
A.) preferred stock paying a 7.50% dividend
B.) corporate bond yielding 8%
C.) common stock yielding 6%
D.) municipal bond yielding 6%

Answer 19

A.) Corporations receive a tax advantage on dividends that they received from investments in preferred stock and common stock of other corporations. If a corporation owns at least 20% of the distributing corporation, it’s only required to declare only 35% of the dividends received as income (i.e., the remaining 65% is excluded). If a corporation owns less than 20% of the distributing corporation, it’s only required to declare 50% of the dividends received as income (i.e., the remaining 50% is excluded). In order to answer this question, the after-tax return on each investment must be found. To calculate each answer, let’s assume that the corporation is simply investing $100 (please note, the amount chosen will not impact the correct answer). A $100 investment in the 7.50% preferred stock will generate $7.50 of total income. However, only $3.75 is taxable income ($7.50 x 50%). Therefore, after paying $0.79 in taxes ($3.75 x 21% tax rate), the after-tax return is $6.71 ($7.50 - $0.79).

Since the corporate bond is fully taxable, the $100 investment will generate $8.00 of total income. However, after paying $1.68 in taxes ($8.00 x 21% tax rate), the after-tax return is $6.32 ($8.00 - $1.68 tax).

The common stock dividends have the same tax treatment as the preferred stock. Since the preferred stock is paying 7.50%, it’s a better investment than the common stock which is only yielding 6%. Lastly, since the municipal bond provides tax-free income, a $100 investment will yield $6.00 after-tax ($100 x 6%). Ultimately, the $6.71 after-tax return from the preferred stock dividend is the best choice available.

Question 20

What’s the tax treatment of dividends if a corporation invests in the preferred or common shares of another corporation?

A.) 20% of the dividends are excluded if ownership doesn’t exceed 50%.
B.) 20% of the dividends are excluded if ownership doesn’t exceed 65%.
C.) 50% of the dividends are excluded if ownership exceeds 20%.
D.) 65% of the dividends are excluded if ownership exceeds 20%.

Answer 20

D.) According to the corporate dividend exclusion rule, corporations are able to exclude from taxation a portion of the dividends they receive from the common and/or preferred stocks that they own of other corporations. If a corporation owns less than 20% of the distributing company, it’s able to exclude 50% of eligible dividends from taxation. However, if a corporation owns 20% or more of the distributing company, it’s able to exclude 65% of eligible dividends from taxation.

Question 21

Regarding warrants issued by a corporation, which TWO of the following statements are TRUE?

I.) They are issued with a discount subscription price
II.) They are issued with a premium subscription price
III.) They are relatively long term
IV.) They are relatively short term

Answer 21

III.) Warrants are relatively long-term securities (sometimes perpetual) giving the holder the right to buy stock from the corporation at a fixed price. When issued, the subscription price is at a premium to the stock’s market price.

Question 22

A broker-dealer is NOT required to maintain a record of which of the following items?

A.) Institutional communication
B.) Final prospectuses
C.) Customer complaints
D.) Research reports

Answer 22

B.) According to FINRA rules, all retail communications, institutional communications, research reports, and correspondence (including e-mail and instant messages) that are used by a member firm must be kept on file for a minimum of three years. SEC registration statements (i.e., Form S-1 or S-3), prospectuses, and other documents that are written by an issuer are not required to be kept on file by member firms.

Question 23

Which of the following statements is NOT TRUE regarding discretionary accounts?

A.) All discretionary orders must be marked discretionary
B.) A written power of attorney must be updated every three years
C.) Orders need not be verbally approved by the customer prior to execution
D.) Orders must not be excessive in terms of size or frequency

Answer 23

B.) When transacting business for a discretionary account, the registered representative must have written power of attorney (POA) authorizing him to act for the customer. It does not need to be updated. A POA may only be revoked by either the death of the customer or in writing by the customer. Each order in which the registered representative exercises discretion must be marked discretionary. The registered representative should not enter orders that are excessive in size or frequency in order to churn the account to generate commissions. The registered representative makes the investment decisions and does not need to receive the customer’s approval for each order being executed.

Question 24

When describing accounts for customers, all of the following are TRUE, EXCEPT:

A.) Social Security numbers are not required for non-United States residents
B.) The Uniform Gifts to Minors Act does not provide for joint accounts
C.) Joint account information will be reported for both Social Security numbers on Form 1099
D.) A notarized copy of a death certificate is acceptable documentation of a customer’s passing

Answer 24

C.) Joint account information is reported on one Social Security number

Question 25

A broker-dealer is NOT required to maintain a record of which of the following items?
A.) The first research report issued after the firm managed an issuer’s IPO
B.) Instant messages
C.) Red herrings
D.) Order tickets

Answer 25

C.) According to FINRA rules, all retail communications, institutional communications, research reports, and correspondence (including e-mail and instant messages) that are used by a member firm must be kept on file for a minimum of three years. SEC registration statements (i.e., Form S-1 or S-3), prospectuses (which includes red herrings or preliminary prospectuses), and other documents that are written by an issuer are not required to be kept on file by member firms.

Question 26

A Form 4 must be filed:

A.) Within two business days of becoming a director
B.) Within two business days of the date on which a director buys or sells securities
C.) Within 10 days of becoming a director
D.) Within 10 days of the date on which a director buys or sells securities

Answer 26

B.) A person must file Form 4 with the SEC within two business days of the date on which an insider changes her ownership position (i.e., buys or sells). An insider is defined as any director or officer of a corporation or any person with beneficial ownership of more than 10% of issuer’s equity securities. Form 3 must be filed with the SEC within 10 days of the date on which a person becomes an insider.

Question 27

Series K preferred stock has the following characteristics:

Answer 27

• It is issued by a financial service company
• It has no maturity date
• It pays a fixed rate for a period and switches to a
  floating rate (usually based on LIBOR)
• It’s dividend is non-cumulative and it may not carry
  voting rights
• It is callable at the option of the issuer

Question 28

Of the choices listed, which one is Moody's lowest rating for a municipal note?
A.) MIG 1
B.) MIG 3
C.) Aaa
D.) D

Answer 28

B.) MIG 3

MIG stands for Moody’s Investment Grade and refers to ratings given municipal notes. There are three MIG ratings, with the best rating being MIG 1 and the lowest rating being MIG 3. Aaa is Moody’s best rating for bonds, and C is its lowest rating for bonds.

Question 29

A corporation announced in an ad in The Wall Street Journal that it intends to call for the redemption of all its outstanding 7.25% callable bonds at 103 1/4 plus accrued interest. The market price of the bonds was 102 3/4 at the time of the announcement. Which of the following alternatives is MOST advantageous to an existing bondholder?

A.) Redeem the bonds
B.) Sell the bonds at the current market price
C.) Do nothing and hope for a takeover bid from another company
D.) Hold the bonds to maturity and continue to earn interest

Answer 29

A.) Redeem the bonds

When bonds are called for redemption, the bondholder can only redeem the bonds at the callable price or otherwise sell them in the market. The bondholder cannot continue to hold the bonds in anticipation of a better offer or until maturity.

Question 30

An increase in which of the following factors does NOT indicate credit conditions are deteriorating for a municipality?

A.) Bankruptcies
B.) Consumer debt
C.) Bond defaults
D.) Assessed valuations

Answer 30

D.) Assessed Valuations

All of the items mentioned would indicate credit conditions are deteriorating for a municipality except an increase in assessed valuations. This is the value placed on property by the municipality for purposes of taxation. An increase in assessed valuations would indicate that homes within the municipality are increasing in value, which will improve the municipality’s credit.

Question 31

Which of the following statements is TRUE concerning bonds issued by FNMA (Fannie Mae)?

A.) They have yields that are lower than comparable Treasury securities
B.) They are a direct obligation of the U.S. government
C.) The value of these securities is highly dependent on current interest rates
D.) They are generally not considered suitable for investors seeking income

Answer 31

C.) The value of these securities is highly dependent on current interest rates

Government-Sponsored Enterprise (GSE) bonds, such as those issued by FNMA (Fannie Mae) or FHLMC (Freddie Mac) are not direct obligations of the U.S. government. They are able to borrow funds from the government, which makes their yield slightly higher than Treasury securities with the same maturities. As with most fixed-income securities, their value is highly dependent on current interest rates, and they are suitable for investors seeking income.

Question 32

An individual purchasing a U.S. Treasury bond would be most concerned with which TWO of the following risks?

I.) Liquidity risk
II.) Interest-rate risk
III.) Timing risk
IV.) Credit risk

A.) I and II
B.) I and III
C.) II and III
D.) II and IV

Answer 32

C.) II and III

Treasury bonds are back by the U.S. government and as such essentially lack credit risk, providing a risk-free rate of return. Treasury bonds are also very liquid, since the market for them is very large and active. Bonds are subject to interest-rate risk since they are long-term. All securities, including bonds are subject to timing risk since you may be forced to sell at an inappropriate period of time.

Question 33

A quote of 5.90 - 5.75 is a quote for which of the following securities?

A.) Treasury bills
B.) Treasury notes
C.) Treasury bonds
D.) A mortgage-backed security

Answer 33

A.) Treasury Bills

Treasury bills are quoted on a discount yield basis while the other choices are quoted at a price. Since yield is inversely related (moves opposite) to price, the higher yield (5.90) represents the lower price and is the bid. The lower yield (5.75) represents the higher price and is the ask (offer). The other securities are all quoted as a percentage of par in 32nds.

Question 34

The official statement for a revenue bond issue states that the bonds are backed by a pledge of the project’s net revenues. This means that the:

A.) Debt service is the first item paid after operating and maintenance expenses
B.) Debt service is paid after the replacement and renewal fund
C.) Operating and maintenance expenses are paid after debt service
D.) Debt service is the last item paid in the flow of funds

Answer 34

A.)

Most municipal revenue bonds are net revenue pledge bonds. This means that bond (debt) service is paid from net revenue (revenue after operating and maintenance expenses).

Question 35

An XYZ Corporation convertible bond is selling in the market at $1,248.75. It is convertible at $30. XYZ common stock’s market price is 37.50. The bond has been called at 103. Which of the following activities is the LEAST attractive alternative for a holder of the bond?
A.) Sell the bond
B.) Convert to common and sell the common
C.) Allow the bond to be called
D.) Convert common stock to a bond

Answer 35

C.) Allow the bond to be called

The holder could sell the bond and receive $1,248.75. If he converted, he would receive 33 1/3 shares ($1,000 par divided by $30 per share conversion feature) with a total value of $1,249.88 (33 1/3 x $37.50). The least attractive alternative is to allow the bond to be called and receive $1,030.

Question 36

Bonds back by investments of other issuers are referred to as

Answer 36

Collateral trust bonds

Question 37

A ________ is another name for an unsecured bond

Answer 37

Debenture

An unsecured short term obligation is referred to as commercial paper

Question 38

Bonds issued with low coupons that increase over time are referred to as

Answer 38

Stepped coupon bonds

Question 39

What is a type of bond that is issued by foreign government

Answer 39

Sovereign debt

Question 40

An announcement in The Wall Street Journal states that New York State plans an advance refunding of its 7 1/2% Dormitory Bonds through the issuance of a special $50,000,000 bond issue. This means that:

A.) Existing bondholders will receive a new bond with a lower rate of interest
B.) Existing bondholders will receive a new bond with a higher rate of interest
C.) Proceeds from the sale of a new bond issue will be put in an escrow account to retire the existing bond issue
D.) The Dormitory bonds will be convertible into Treasury bonds

Answer 40

C.) Proceeds from the sale of a new bond issue will be put in an escrow account to retire the existing bond issue

Advance refunding means that proceeds from the sale of the new bond issue will be put in an escrow account to retire the existing bond issue. If a municipality wants to engage in advance refunding, as is the case in this example, the municipality will sell the new issue with the proceeds of the sale going into an escrow account containing U.S. government securities. The U.S. government securities would be purchased with a maturity date that coincides with the issue’s call date. This allows the refunded issue to be retired using the proceeds from the matured government securities.

Question 41

Which of the following bonds has a provision that may result in the debt becoming the responsibility of the state legislature?

A.) Special tax bonds
B.) Moral obligation bonds
C.) Special assessment bonds
D.) Housing revenue bonds

Answer 41

B.) Moral obligation bonds

Moral obligation bonds are first supported by revenues of a project, but if the revenues are insufficient, the state legislature is morally (but not legally) obligated to assume the debt.

Question 42

A customer purchases a municipal bond at $960 in the secondary market that will mature in four years. Which of the following statements regarding the purchase is NOT TRUE?

A.) The interest is exempt from federal income tax
B.) The customer will have taxable income if the bond is held to maturity
C.) The customer will need to pay a tax on the prorated amount of the discount each year
D.) If the bond was a new issue when purchased, and held to maturity, the customer will not have to pay any federal tax

Answer 42

C.) The customer will need to pay a tax on the prorated amount of the discount each year

If a municipal bond is purchased at a discount in the secondary market and held to maturity, there will be reportable taxable income. The investor may pay the tax each year or elect to report the entire gain at maturity. If a municipal bond is purchased at an original issue discount and held to maturity, there will be no federal tax liability. The IRS requires that the discount be accreted each year and be used to increase the cost basis of the bond. However, the amount of the accretion is considered interest and is, therefore, exempt from federal tax.

Question 43

Which of the following is the highest S&P speculative grade bond rating?
I.) BBB
II.) Baa
III.) BB
IV.) Ba

Answer 43

III.) BB

Standard and Poor’s speculative grade bond ratings begin with BB. Ba is Moody’s highest speculative grade rating. Use the following memory aide to distinguish Moody’s ratings from S&P ratings. The name Moody’s is a capital letter followed by small letters, just like their ratings (e.g., Baa). S&P consists of all capital letters, just like their ratings (e.g., BBB).

Question 44

Dealer A offers bonds on a firm basis to Dealer B with a recall. What does this mean?

I.) Dealer B has the right to buy the bonds before anyone else
II.) The price of the bonds has been set
III.) A time to sell the bonds has been set
IV.) A recall time has been established

A.) I and III only
B.) II and III only
C.) II, III, and IV only
D.) I, II, III, and IV

Answer 44

D.) I, II, III, and IV

When a dealer wants to buy bonds, such as Dealer B, he asks Dealer A to make a firm offer which will hold good for a specified time. The bonds are said to be out firm. Dealer B has the option or right to buy the bonds from Dealer A and sell the bonds before anyone else within the set time. A recall privilege can be set, which gives Dealer A the right to notify Dealer B that he has only a set time (for example, five minutes) to buy the bonds, after which time the firm pricing is cancelled.

Question 45

An auction rate security (ARS) is a type of investment that has its interest rate or dividend rate reset periodically. The reset rate is referred to as the:

A.) The limit rate
B.) The hold rate
C.) The clearing rate
D.) The bid rate

Answer 45

C.) The clearing rate

Based on the bids that are submitted by holders and prospective buyers, the net clearing rate is set by the auction agent. The net clearing rate is the lowest rate that matches supply and demand and is sufficient to cover all of the securities that are exposed for sale. After the deadline for submission of orders, the auction agent assembles all of the orders from the lowest to the highest bid and determines the net clearing rate. This rate is paid on the entire issue for the upcoming period.

Question 46

Which of the following have a fixed rate of interest on their face?

I.) Treasury bonds
II.) Treasury notes
III.) Treasury bills

A.) I and II only
B.) I and III only
C.) II and III only
D.) I, II, and III

Answer 46

A.) I and II only

Treasury bills are purchased at a discount and mature at a face value. They do not pay semiannual interest, unlike Treasury notes and Treasury bonds, which do. The earnings on Treasury bills is calculated by subtracting the discounted purchase price from the face amount of the bill.

Question 47

A customer is most interested in safety of principal and wishes to avoid risk. List the securities you would recommend to the customer from those with the LEAST risk to those with the MOST risk.

I.) General obligation bonds
II.) Treasury notes
III.) Treasury bills
IV.) Revenue bonds

A.) III, I, II, and IV
B.) II, III, I, and IV
C.) III, II, I, and IV
D.) I, IV, III, and II

Answer 47

C.) III, II, I, and IV

Question 48

A customer purchased a municipal bond with a 6.50% coupon rate that was priced at a 6.95 basis. If the bond is currently trading at $945, the current yield is:

A.) 6.95%
B.) 6.73%
C.) 6.88%
D.) 6.50%

Answer 48

C.) 6.88%

The current yield is found by dividing the yearly interest payment of $65 by the market price of $945. This equals 6.88%. The fact that the bond was purchased at a 6.95 basis is not relevant.

Question 49

Which of the following municipal securities are MOST likely to be backed by ad valorem taxes?

A.) Special assessment bonds
B.) State general obligation bonds
C.) Certificates of participation
D.) School district bonds

Answer 49

D.) School district bonds

Ad valorem tax is a tax whose amount is based on the value of property (i.e., property tax is a form of ad valorem tax). Local governments, such as school districts, secure their general obligation bonds by ad valorem taxes. On the other hand, state G.O. bonds are secured by forms of taxes other than property taxes (e.g., income and sales tax). Special assessment bonds are revenue bonds that are backed by assessments that are made on those who directly benefit from the facilities, such as developing or improving water and sewer systems, sidewalks, and streets. Certificates of participation (COPs) are lease financing agreements which are typically issued in the form of tax-exempt or municipal revenue bonds.