FINRA Series 7 — All Questions

An investor sells 1 XYZ 30 put for a premium of 2. What is the maximum gain and the breakeven point?

• a.Maximum gain unlimited; breakeven $32
• b.Maximum gain $200; breakeven $28✓
• c.Maximum gain $2,800; breakeven $28
• d.Maximum gain $200; breakeven $32

A short (written) put's maximum gain is the premium received, $200, kept if the stock stays at or above the 30 strike. Breakeven is the strike minus the premium, 30 - 2 = $28, and the maximum loss occurs if the stock falls toward zero.

Preferred stock is generally considered more sensitive to interest rate changes than common stock because preferred:

• a.Represents only a residual ownership claim on the issuer's assets after creditors are paid
• b.Pays a fixed dividend, causing it to behave like a fixed-income security✓
• c.Has voting rights
• d.Pays cash dividends that automatically grow along with the issuing company's earnings

Because most preferred stock pays a fixed dividend, its price moves inversely with interest rates much like a bond. When rates rise, the fixed dividend becomes less attractive and preferred prices fall. Common stock dividends can vary with earnings, so common is less directly tied to rate movements.

A collateralized mortgage obligation (CMO) is structured into tranches primarily to:

• a.Redistribute prepayment and maturity risk among classes with different priorities✓
• b.Guarantee that investors in every single tranche can never lose any principal under any scenario
• c.Convert debt into equity
• d.Eliminate all interest rate risk

A CMO divides the cash flows from a pool of mortgages into tranches that receive principal in a set order, redistributing prepayment and average-life risk. Earlier tranches receive principal first and have shorter, more predictable lives, while later tranches bear more extension or prepayment uncertainty.

An investor establishes a short straddle by selling 1 XYZ 50 call for 3 and selling 1 XYZ 50 put for 2. The maximum gain is:

• a.$300, the premium on the short call alone
• b.Unlimited, because the short call exposes the seller to a rising stock price
• c.$500, if the stock closes exactly at 50 at expiration✓
• d.$5,000, the 50 strike times 100 shares

A short straddle's maximum gain is the total premium received, 3 + 2 = 5 points, or $500, earned only if the stock closes exactly at the 50 strike so both options expire worthless. The $300 figure counts the call premium alone and ignores the put premium. Unlimited describes the short call's loss potential if the stock rises, not the gain. The $5,000 figure is the strike times 100 shares, a number tied to the put's downside rather than the premium kept.

An accredited or sophisticated investor is often required for a hedge fund because hedge funds:

• a.Must distribute all income annually by law
• b.Are typically sold as private placements with limited liquidity, leverage, and higher risk✓
• c.Are the same as money market funds
• d.Are guaranteed by the federal government

Hedge funds are generally offered as private placements to accredited or qualified investors, use strategies involving leverage, derivatives, and illiquid holdings, and impose lock-up and redemption restrictions. Their higher risk and limited regulation make suitability and investor qualification especially important.

Accrued interest on municipal and corporate bonds is calculated using which day-count convention?

• a.Actual days in the period over actual days in the year (actual/actual)
• b.A 30-day month and a 360-day year (30/360)✓
• c.Actual days over a 360-day year (actual/360)
• d.Actual days over a 365-day year (actual/365)

Municipal and corporate bonds accrue interest on a 30/360 basis: every month is treated as 30 days and the year as 360 days. U.S. Treasury notes and bonds use actual/actual, and money-market instruments use actual/360. Trap: actual/actual (choice a) is the government-bond method, not the corporate/muni method.MSRB Rule G-33

In analyzing a general obligation (GO) municipal bond, an analyst focuses primarily on:

• a.The revenues and debt-service coverage ratio of one single specific revenue-producing project
• b.The dividend payment history of the municipality
• c.The credit rating of the U.S. federal government
• d.The issuer's assessed property values, debt per capita, and tax collection record✓

GO bonds are backed by the issuer's full faith, credit, and taxing power, so analysts examine the tax base (assessed valuations), debt per capita, debt-to-assessed-value ratios, and tax collection rates. Revenue and debt-service-coverage analysis (choice a) applies to revenue bonds, which are backed by a project's income rather than taxes.

Under the more common 'net revenue pledge' on a municipal revenue bond, bondholders are paid:

• a.Before the facility's operating and maintenance expenses are paid
• b.Only from statewide ad valorem property taxes
• c.After operating and maintenance expenses, out of net revenues✓
• d.Only if the state legislature votes to appropriate funds

Under a net revenue pledge, the flow of funds pays operation and maintenance (O&M) expenses first, then services the debt from net revenues. A gross revenue pledge (rare) pays debt service before O&M. Choice d describes a moral obligation/appropriation bond, and choice a reverses the standard net-revenue flow of funds.

A 529 college savings plan is classified for regulatory purposes as:

• a.A registered open-end investment company (mutual fund)
• b.A municipal fund security regulated under MSRB rules✓
• c.A direct participation program
• d.A federal agency security

529 savings plans are municipal fund securities and are sold under MSRB rules using an official statement rather than a prospectus. Although the plan invests in mutual-fund-like portfolios, it is not itself a registered investment company. Earnings grow tax-deferred and qualified education withdrawals are federal-tax-free.MSRB

An investor buys a municipal bond in the secondary market and later sells it for more than the purchase price. The gain on the sale is:

• a.Exempt from tax, just like the bond's interest
• b.Taxed as a nondeductible gift
• c.Never taxable under any circumstances
• d.Taxable as a capital gain✓

Only the interest on municipal bonds is federally tax-exempt; a capital gain from selling a muni above cost is taxable like any other capital gain (and a market discount is generally taxed as ordinary income at sale or maturity). The trap is assuming the tax exemption covers trading gains as well as interest.

A taxable corporate bond yields 6%. For an investor in the 24% federal tax bracket, the approximate after-tax yield is:

• a.4.56%✓
• b.7.89%
• c.6.00%
• d.1.44%

After-tax yield = taxable yield x (1 - tax rate) = 6% x (1 - 0.24) = 6% x 0.76 = 4.56%. This is compared with a municipal yield to see which is better after taxes. Trap: 7.89% is the taxable-equivalent yield of a 6% muni (6% / 0.76), the reverse computation; 1.44% is just the tax portion.

An investor sells 1 XYZ 50 put for 4 and buys 1 XYZ 45 put for 1. What are the maximum gain and maximum loss?

• a.Maximum gain $200; maximum loss $300
• b.Maximum gain unlimited; maximum loss $300
• c.Maximum gain $500; maximum loss $500
• d.Maximum gain $300; maximum loss $200✓

This is a bull (credit) put spread. Net credit = 4 - 1 = 3 points = $300, the maximum gain, kept if both puts expire worthless (stock at or above 50). Maximum loss = difference in strikes minus net credit = (50 - 45) - 3 = 2 points = $200. Breakeven = higher strike minus net credit = 50 - 3 = 47. Trap: reversing the gain and loss (choice a).

An investor buys 1 XYZ 60 put and sells 1 XYZ 50 put. This position is best described as:

• a.A bullish position that profits as the stock rises
• b.A bearish debit put spread that profits as the stock falls✓
• c.A long straddle
• d.A covered call

Buying the higher-strike (60) put and selling the lower-strike (50) put is a debit put spread. Because the more valuable higher-strike put is owned, it costs a net debit and is bearish: it gains maximum value if the stock falls to or below 50. Trap: assuming any put spread is bullish; the direction depends on which strike is bought.

An investor buys 100 shares of XYZ at $48 and sells 1 XYZ 50 call for a premium of 2 (a covered call). What is the maximum gain?

• a.Unlimited
• b.$200
• c.$400✓
• d.$4,800

If the stock is called away at the 50 strike, the gain equals the stock appreciation plus the premium: (50 - 48) + 2 = 4 points = $400. Breakeven is 48 - 2 = 46. The written call caps upside at $400 no matter how high the stock climbs; 'unlimited' (choice a) would apply to owning stock alone, not to a covered call.

An investor who has sold stock short is best protected against a sharp rise in the stock's price by:

• a.Buying a put on the stock
• b.Selling a call on the stock
• c.Selling a put on the stock
• d.Buying a call on the stock✓

A short seller loses as the stock rises, with theoretically unlimited risk. Buying a call caps that risk by locking in a price to buy back (cover) the shares. A protective put hedges a long position, not a short one (the trap). Selling options brings in only limited premium and provides no protection against a large adverse move.

An XYZ 40 call trades at a premium of 6 while the stock is at 43. The option's intrinsic value and time value are:

• a.Intrinsic value $6, time value $0
• b.Intrinsic value $3, time value $3✓
• c.Intrinsic value $0, time value $6
• d.Intrinsic value $4, time value $2

A call's intrinsic value equals stock price minus strike when in the money: 43 - 40 = 3. Time value = premium minus intrinsic value = 6 - 3 = 3. The call is in the money by 3 points. Trap: treating the entire 6-point premium as intrinsic value (choice a) ignores the time value component.

A put option is 'in the money' when:

• a.The stock's market price is above the strike price
• b.The option's premium has fallen to zero
• c.The underlying stock pays no dividend
• d.The stock's market price is below the strike price✓

A put grants the right to sell at the strike, so it has intrinsic value (is in the money) when the stock trades below the strike, letting the holder sell higher than the market. A call is in the money when the stock is above the strike, which is what choice a describes: the classic buyer/seller reversal trap.

The writer (seller) of a put option is obligated to:

• a.Sell the underlying stock to the option holder at the strike price on demand
• b.Pay a periodic cash dividend directly to the holder of the put option
• c.Buy the underlying stock at the strike price if assigned✓
• d.Do nothing at all, because the writer of the put option holds only rights

A put writer sells someone the right to 'put' (sell) stock to them, so upon assignment the writer must buy the stock at the strike price. A call writer, by contrast, must sell/deliver stock. The writer receives premium but takes on an obligation, not a right; choice d reverses the buyer/seller roles.

An investor writes 1 XYZ 30 put for a premium of 2. What is the maximum possible loss?

• a.$200
• b.$2,800✓
• c.Unlimited
• d.$3,000

The worst case for a short put is the stock falling to zero: the writer must buy at 30 while the shares are worthless, losing 30 points offset by the 2-point premium = 28 points = $2,800. Trap: 'unlimited' loss applies to a naked short call, not a short put, because a stock's price cannot fall below zero.

Fundamental analysis of a common stock focuses primarily on:

• a.Chart patterns, trading volume trends, and various historical price momentum indicators
• b.The ratio of advancing to declining stocks
• c.Historical price support and resistance levels
• d.The company's financial statements, earnings, management, and economic outlook✓

Fundamental analysis estimates a security's intrinsic value from financial statements (earnings, balance sheet, cash flow), management quality, and industry and economic conditions. Chart patterns, volume, and advance/decline data (choices a, b, c) are tools of technical analysis, which studies price action rather than business fundamentals.

A technical analyst who says a stock has 'broken through resistance' means:

• a.The company reported sharply higher quarterly earnings per share and simultaneously raised its full-year guidance
• b.The price has risen above a prior ceiling where selling had capped advances, often read as bullish✓
• c.The company increased its dividend
• d.The bond's credit rating was upgraded

Resistance is a price level where selling has historically halted advances; a breakout above it is a bullish technical signal. Support is the mirror image, a floor where buying tends to emerge. Technical analysis studies price and volume, not fundamentals like earnings, dividends, or credit ratings (the distractors).

The four phases of the business cycle, in typical order, are:

• a.Trough, contraction, peak, expansion
• b.Inflation, deflation, stagflation, recovery
• c.Bull, bear, correction, rally
• d.Expansion, peak, contraction, trough✓

The business cycle moves through expansion (growth), a peak, contraction/recession (decline), and a trough (bottom), then repeats. A recession is commonly defined as two consecutive quarters of declining real GDP. Choices b and c mix in unrelated price-level or market-sentiment terms.

If the Federal Reserve sells securities through open market operations, the likely effect is to:

• a.Drain reserves from the banking system, tending to push interest rates up✓
• b.Add new reserves into the banking system, which tends to lower short-term interest rates
• c.Change federal income tax rates
• d.Directly set the level of stock prices

Open market operations are the Fed's primary tool. Selling securities removes cash (reserves) from the banking system, tightening money and tending to raise short-term rates; buying securities adds reserves and lowers rates. Taxation (choice c) is fiscal policy set by Congress, not a Fed function.

Fiscal policy, as distinguished from monetary policy, is carried out through:

• a.The Federal Reserve's open market operations
• b.Government taxing and spending decisions✓
• c.Changes to the Federal Reserve's discount rate
• d.Adjustments to bank reserve requirements

Fiscal policy is the government's use of taxation and spending to influence the economy, controlled by Congress and the President. The open market operations, discount rate, and reserve requirements in the other choices are all monetary policy tools of the Federal Reserve.

An inverted (negative) yield curve exists when:

• a.Long-term interest rates clearly exceed short-term rates all along the curve
• b.Every maturity along the yield curve happens to carry exactly the same yield
• c.Municipal bond yields broadly exceed the yields on comparable corporate bonds
• d.Short-term interest rates are higher than long-term rates✓

Normally the yield curve slopes upward, with longer maturities yielding more. An inverted curve, where short-term yields exceed long-term yields, often reflects tight monetary policy and can signal an expected slowdown. Choice a describes a normal curve and choice b a flat curve.

Losses generated by a direct participation program (limited partnership) are generally treated as:

• a.Ordinary losses deductible against salary and wages
• b.Passive losses deductible only against passive income✓
• c.Capital losses limited to $3,000 per year
• d.Portfolio losses usable only against dividend income

Under the passive activity rules, DPP losses are passive and may offset only passive income, not earned income (salary) or portfolio income (dividends and interest). Unused passive losses carry forward and can be used when passive income arises or the interest is disposed of. They cannot shelter a client's wages, they are not capital losses subject to the $3,000 annual limit, and they are not portfolio losses that can be applied against dividends or interest.26 U.S.C. 469

In a limited partnership, the general partner:

• a.Has personal liability limited to the amount invested, as the limited partners do
• b.Is a passive investor who must stay out of management to keep liability protection
• c.Has unlimited personal liability but is barred from running the business day to day
• d.Manages the business and has unlimited personal liability for partnership debts✓

The general partner runs the partnership and bears unlimited personal liability for its debts. Liability limited to the amount invested is the limited partner's position, not the general partner's. Staying passive to keep liability protection also describes a limited partner, who can lose that protection by taking an active management role. A general partner is not barred from management; managing the business is its role.

Class A shares of a mutual fund typically feature:

• a.A level annual load through a higher 12b-1 fee, plus a one-year back-end charge of about 1%
• b.A front-end sales load with lower ongoing 12b-1 fees, often best for large, long-term investments✓
• c.A back-end charge that declines each year, higher 12b-1 fees, and conversion to Class A after several years
• d.No sales charge of any kind, available only to institutions with a very large minimum investment

Class A shares charge a front-end load (reduced by breakpoints) but carry lower ongoing 12b-1 fees, making them cost-effective for large or long-horizon purchases. A level load paid through a higher annual 12b-1 fee with a short back-end charge describes Class C. A declining back-end charge with higher 12b-1 fees that later converts to Class A describes Class B. A no-load share sold to institutions with a large minimum describes an institutional class.Investment Company Act of 1940

A mutual fund has total assets of $100 million, total liabilities of $2 million, and 4 million shares outstanding. Its net asset value (NAV) per share is:

• a.$25.00
• b.$24.00
• c.$24.50✓
• d.$25.50

NAV per share = (total assets - total liabilities) / shares outstanding = ($100M - $2M) / 4M = $98M / 4M = $24.50. Trap: $25.00 (choice a) forgets to subtract the $2M in liabilities. NAV is calculated at least once daily and mutual fund orders are priced forward at the next computed NAV.Investment Company Act of 1940

For a bond purchased at a premium that is also callable, the lowest (most conservative) yield used to price it is generally the:

• a.Yield to maturity
• b.Yield to call✓
• c.Current yield
• d.Nominal (coupon) yield

On a premium bond, yield to call is lower than yield to maturity because the premium is lost more quickly if the bond is called early. Dealers price premium callable bonds to the lower yield (yield to worst) to protect the investor. For a discount bond, the higher yield to maturity is the worst case instead.

An investor buys 1 DEF 40 call for a premium of 4. What is the maximum loss on this long call position?

• a.$400✓
• b.Unlimited
• c.$3,600
• d.$4,000

A long call buyer can lose no more than the premium paid. The premium of 4 points times the 100-share contract multiplier equals $400 (OCC standard equity contract = 100 shares). If DEF stays at or below 40, the call expires worthless and the entire loss is the $400 premium.

An investor buys 1 DEF 40 call for a premium of 4. What is the breakeven point at expiration?

• a.$40
• b.$36
• c.$4.04
• d.$44✓

For a long call, breakeven = strike price + premium paid = 40 + 4 = $44. The stock must rise above $44 before the buyer recovers the premium and earns a net profit (standard listed-option call breakeven).

An investor writes (sells) 1 uncovered GHI 45 call for a premium of 3. What are the maximum gain and the breakeven point?

• a.Maximum gain $300; breakeven $42
• b.Maximum gain $4,200; breakeven $48
• c.Maximum gain unlimited; breakeven $48
• d.Maximum gain $300; breakeven $48✓

A short call's maximum gain is the premium received, $300, kept if the stock closes at or below the 45 strike. Breakeven = strike + premium = 45 + 3 = $48. The call writer's gain is capped at the premium while the risk above breakeven grows.

An investor writes (sells) 1 uncovered GHI 45 call for a premium of 3. What is the maximum potential loss?

• a.$4,200
• b.$300
• c.Unlimited✓
• d.$4,500

An uncovered (naked) call writer faces theoretically unlimited loss because a stock's price has no ceiling, yet the writer must deliver shares at the 45 strike no matter how high the market rises. The $300 premium only partially offsets this exposure.

An investor buys 1 JKL 25 put for a premium of 1.50. What is the maximum gain on this long put?

• a.Unlimited
• b.$150
• c.$2,350✓
• d.$2,500

A long put gains as the stock falls, but the stock can fall no lower than zero. Maximum gain = (strike - premium) x 100 = (25 - 1.50) x 100 = $2,350, realized if the stock goes to zero and the holder exercises to sell at 25.

An investor buys 1 JKL 25 put for a premium of 1.50. What is the breakeven point at expiration?

• a.$23.50✓
• b.$25.00
• c.$26.50
• d.$23.85

For a long put, breakeven = strike price - premium paid = 25 - 1.50 = $23.50. The stock must fall below $23.50 for the put buyer to profit after recovering the premium.

An investor writes (sells) 1 MNO 60 put for a premium of 5. What is the maximum possible loss?

• a.$500
• b.$5,500✓
• c.$6,000
• d.Unlimited

The worst case for a short put is the stock falling to zero: the writer must buy at 60 while the shares are worthless, losing 60 points offset by the 5-point premium = 55 points = $5,500. A short put's loss is large but finite (a stock cannot fall below zero), unlike a naked short call.

An investor writes (sells) 1 MNO 60 put for a premium of 5. What are the maximum gain and the breakeven point?

• a.Maximum gain unlimited; breakeven $55
• b.Maximum gain $500; breakeven $65
• c.Maximum gain $5,500; breakeven $55
• d.Maximum gain $500; breakeven $55✓

A short put's maximum gain is the premium received, $500, kept if the stock stays at or above the 60 strike. Breakeven = strike - premium = 60 - 5 = $55, below which the writer begins to lose.

An investor buys 1 PQR 40 call for 6 and sells 1 PQR 50 call for 2 (a debit call spread). What is the maximum gain?

• a.$400
• b.$600✓
• c.$1,000
• d.Unlimited

The net debit is 6 - 2 = 4 points. Maximum gain = difference in strikes - net debit = (50 - 40) - 4 = 6 points = $600, realized if the stock is at or above 50 at expiration. In any vertical spread, max gain + max loss = the strike difference.

Using the same debit call spread (buy 1 PQR 40 call for 6, sell 1 PQR 50 call for 2), what is the maximum loss?

• a.Unlimited
• b.$400✓
• c.$600
• d.$1,000

The maximum loss on a debit spread is the net premium paid: 6 - 2 = 4 points = $400, lost if both calls expire worthless with the stock at or below 40.

Using the same debit call spread (buy 1 PQR 40 call for 6, sell 1 PQR 50 call for 2), what is the breakeven point?

• a.$46
• b.$44✓
• c.$40
• d.$50

For a debit call spread, breakeven = lower strike + net debit = 40 + 4 = $44. Above $44 the spread turns a net profit, up to its maximum at the higher strike.

An investor sells 1 STU 20 call for 5 and buys 1 STU 25 call for 2 (a bear/credit call spread). What is the maximum gain?

• a.$500
• b.$200
• c.Unlimited
• d.$300✓

A credit call spread's maximum gain is the net credit received = 5 - 2 = 3 points = $300, kept if both calls expire worthless (stock at or below 20). This bearish spread profits when the stock stays low.

Using the same credit call spread (sell 1 STU 20 call for 5, buy 1 STU 25 call for 2), what is the maximum loss?

• a.Unlimited
• b.$500
• c.$300
• d.$200✓

Maximum loss = difference in strikes - net credit = (25 - 20) - 3 = 2 points = $200, incurred if the stock rises to or above 25. Buying the higher-strike call caps what would otherwise be unlimited naked-call risk.

Using the same credit call spread (sell 1 STU 20 call for 5, buy 1 STU 25 call for 2), what is the breakeven point?

• a.$23✓
• b.$17
• c.$25
• d.$22

For a credit call spread, breakeven = lower strike + net credit = 20 + 3 = $23. The spread is profitable as long as the stock stays below $23 at expiration.

An investor sells 1 VWX 50 put for 4 and buys 1 VWX 45 put for 1 (a bull/credit put spread). What are the maximum gain and maximum loss?

• a.Maximum gain $300; maximum loss $200✓
• b.Maximum gain $200; maximum loss $300
• c.Maximum gain $500; maximum loss $500
• d.Maximum gain $300; maximum loss unlimited

Net credit = 4 - 1 = 3 points = $300 maximum gain, kept if both puts expire worthless (stock at or above 50). Maximum loss = strike difference - net credit = (50 - 45) - 3 = 2 points = $200. This bullish spread profits when the stock stays up.

An investor buys 1 YZA 70 put for 5 and sells 1 YZA 60 put for 1 (a bear/debit put spread). What is the maximum gain?

• a.$1,000
• b.Unlimited
• c.$600✓
• d.$400

Net debit = 5 - 1 = 4 points. Maximum gain = strike difference - net debit = (70 - 60) - 4 = 6 points = $600, achieved if the stock is at or below 60. Owning the higher-strike put makes this spread bearish.

Using the same debit put spread (buy 1 YZA 70 put for 5, sell 1 YZA 60 put for 1), what is the breakeven point?

• a.$74
• b.$64
• c.$66✓
• d.$60

For a debit put spread, breakeven = higher strike - net debit = 70 - 4 = $66. Below $66 the spread profits, to a maximum at the lower strike of 60.

An investor buys 1 BCD 80 call for 3 and buys 1 BCD 80 put for 2 (a long straddle). What is the maximum loss?

• a.Unlimited
• b.$300
• c.$8,000
• d.$500✓

A long straddle's maximum loss is the total premium paid, 3 + 2 = 5 points = $500, occurring if the stock closes exactly at 80 so both options expire worthless. The straddle buyer profits from a large move in either direction (buying volatility).

Using the same long straddle (buy 1 BCD 80 call for 3 and 1 BCD 80 put for 2), what are the two breakeven points?

• a.$85 and $75✓
• b.$83 and $77
• c.$88 and $72
• d.$80 and $80

Total premium is 5 points. Upside breakeven = strike + total premium = 80 + 5 = $85; downside breakeven = strike - total premium = 80 - 5 = $75. The stock must move outside the $75-$85 range for a net profit.

An investor sells 1 EFG 100 call for 4 and sells 1 EFG 100 put for 3 (a short straddle). What is the maximum gain?

• a.$10,000
• b.Unlimited
• c.$700✓
• d.$300

A short straddle's maximum gain is the total premium received, 4 + 3 = 7 points = $700, realized if the stock closes exactly at the 100 strike. The seller profits from low volatility but faces large losses on a big move in either direction.