FINRA SIE — Securities Industry Essentials — All Questions

Which statement best describes a key difference between common stock and preferred stock?

• a.Common stockholders normally have voting rights, while most preferred stockholders do not✓
• b.Common stock pays a dividend fixed in its charter, while preferred dividends vary
• c.Common stock has a stated maturity date, while preferred stock is perpetual
• d.Preferred stock gives holders the right to vote for the board, while common stock does not

Common shareholders typically vote on corporate matters such as electing directors, while preferred shares generally carry no vote in exchange for a fixed, priority dividend. Preferred dividends are fixed, not common ones, so the first choice is reversed. Neither security has a maturity date, so the last choice is wrong.

In a corporate liquidation, which of the following has the highest priority of claim on remaining assets?

• a.Holders of warrants
• b.Common stockholders
• c.Preferred stockholders
• d.Secured bondholders✓

Debtholders are paid before equity, and secured (collateralized) bondholders rank ahead of unsecured creditors, preferred, and common. Preferred stock ranks above common but below all debt. Warrants are equity-linked and rank with or below common.

A cumulative preferred stock missed its dividend for two years. Before common shareholders can receive any dividend, the company must:

• a.Convert the preferred shares into common shares at the stated conversion ratio
• b.Pay only the current year's preferred dividend, because arrears expire after twelve months
• c.Pay all missed (in arrears) preferred dividends plus the current preferred dividend✓
• d.Pay the preferred holders a penalty rate of interest on the two years of arrears

Cumulative preferred accumulates unpaid dividends in arrears, and all arrears plus the current preferred dividend must be paid before common shareholders get anything. Paying only the current year would apply to non-cumulative preferred. There is no automatic conversion or penalty interest requirement.

Which feature most directly benefits the ISSUER rather than the holder of a preferred stock?

• a.Callable feature✓
• b.Participating feature
• c.Cumulative feature
• d.Convertible feature

A callable (redeemable) feature lets the issuer buy back the shares, usually when rates fall, which benefits the issuer at the holder's expense. Convertible, cumulative, and participating features all add value for the holder.

An American Depositary Receipt (ADR) is best described as a security that:

• a.Represents shares of a U.S. company that trade on foreign exchanges
• b.Represents shares of a foreign company and trades in U.S. markets in U.S. dollars✓
• c.Represents a bond a foreign company sells to U.S. investors in U.S. dollars
• d.Gives U.S. investors a contract to buy foreign currency at a fixed rate

An ADR is issued by a U.S. depositary bank and represents a specified number of a foreign company's shares, trading and paying dividends in U.S. dollars. It is the foreign company's equity brought to U.S. markets, not a U.S. company's shares listed abroad. A bond a foreign company sells to U.S. investors in dollars is a Yankee bond, which is debt rather than equity, and an ADR is not a foreign-exchange contract.Securities Act of 1933

A company issues stock rights to existing shareholders. The rights primarily allow those shareholders to:

• a.Receive an extra cash dividend each quarter for a full year after the rights offering
• b.Vote twice on major corporate decisions such as mergers and board elections
• c.Buy new shares at a subscription price, usually below market, to avoid dilution✓
• d.Sell their existing shares back to the company at a guaranteed premium price

A rights offering gives current shareholders the preemptive right to buy new shares, usually at a subscription price below the current market price, so they can maintain their proportional ownership and avoid dilution. Rights do not repurchase shares, add dividends, or grant extra votes.

How do warrants typically differ from stock rights when first issued?

• a.Warrants are issued only to a company's own employees as pay
• b.Warrants must be exercised the same day they are issued or they lapse
• c.Warrants pay a guaranteed quarterly dividend to holders, while rights do not
• d.Warrants have a long-term (often years) life, while rights are short-term✓

Warrants are long-term instruments, often lasting several years, and their exercise (strike) price is usually set above the market price at issuance. Rights are short-term and priced below market. Warrants are not same-day, employee-only, or dividend-paying.

An investor who buys common stock is exposed to which of the following characteristics?

• a.A dividend guaranteed each quarter regardless of company earnings
• b.Priority over bondholders and preferred holders in a liquidation
• c.A fixed maturity value repaid to the holder on a stated date
• d.Residual claim on earnings and assets and potential voting rights✓

Common stock represents a residual (last-in-line) ownership claim on earnings and assets, and it typically carries voting rights. It has no maturity, no guaranteed dividend, and ranks behind bondholders in bankruptcy.

A convertible preferred stock is most valuable to a holder when:

• a.The issuer suspends its common dividend, which raises conversion value
• b.The issuer's common stock price rises well above the conversion price✓
• c.The issuer's common stock price falls sharply below the conversion price
• d.Market interest rates rise significantly, lifting the conversion ratio

A convertible lets the holder exchange the preferred for a set number of common shares, so it gains the most value when the common stock rises well above the conversion price. Falling common prices, rising rates, or dividend cuts reduce the security's value.

Treasury stock refers to shares that:

• a.Are authorized but unissued shares the board may still sell
• b.Are held solely by the corporation's board of directors
• c.Are debt securities issued by the U.S. Treasury Department
• d.Were issued and later repurchased by the issuing corporation✓

Treasury stock is shares the corporation issued and then bought back; it has no voting rights and receives no dividends while held by the company. It is unrelated to the U.S. Treasury, is not unissued, and is not restricted to directors.Securities Exchange Act of 1934

A shareholder wants to maintain the same percentage ownership after a company issues new shares. Which right supports this goal?

• a.Cumulative dividend right
• b.Conversion right
• c.Preemptive right✓
• d.Right of redemption

A preemptive right lets existing shareholders buy a proportional amount of newly issued shares before others, preserving their percentage ownership and preventing dilution. Cumulative dividends, conversion, and redemption relate to income or exchange features, not ownership percentage.

Which of the following statements about an ADR holder is TRUE?

• a.The holder still faces currency risk because the underlying shares are foreign✓
• b.The holder generally receives dividend payments in the issuer's foreign currency
• c.The holder has full voting rights identical to a domestic common shareholder
• d.The holder is guaranteed against currency risk by the depositary bank

Even though an ADR trades in U.S. dollars, its value reflects a foreign company's shares, so the holder is exposed to currency (exchange-rate) risk. Dividends are converted to dollars, voting rights are often limited, and the bank does not guarantee against currency risk.

A debenture is best described as a corporate bond that is:

• a.Guaranteed by the federal government against default
• b.Secured by a portfolio of other companies' securities held in trust
• c.Backed only by the general credit and good faith of the issuer✓
• d.Backed by specific real estate the issuer owns and pledges

A debenture is an unsecured bond backed solely by the issuer's general credit and promise to pay, not by specific collateral. Mortgage bonds use real estate, collateral trust bonds use other securities, and no corporate bond is federally guaranteed.

A corporate bond has a 5% coupon and a $1,000 par value. How much annual interest does the bondholder receive?

• a.$5
• b.$50✓
• c.It depends on the current market price
• d.$500

The coupon is a fixed percentage of par, so 5% of $1,000 equals $50 per year, regardless of the bond's current market price. The interest amount does not change with market price; only yield does.

Which corporate bond feature allows the issuer to redeem the bonds before maturity, typically when interest rates have fallen?

• a.Call feature✓
• b.Sinking fund deposit requirement
• c.Put feature
• d.Convertible feature

A call feature gives the issuer the right to redeem bonds early, which it tends to do after rates fall so it can refinance more cheaply. A put favors the investor, a convertible allows conversion to stock, and a sinking fund is a repayment reserve, not an early-redemption right for the issuer's benefit in a rate decline.

A high-yield ('junk') bond generally offers a higher coupon than an investment-grade bond because it:

• a.Carries greater credit (default) risk✓
• b.Is exempt from federal and state income tax
• c.Is secured by a mortgage on the issuer's plant
• d.Requires a 30-year minimum maturity

High-yield bonds are rated below investment grade, so issuers must pay a higher coupon to compensate investors for greater credit or default risk. The higher yield is not due to maturity length, collateral, or tax exemption.

A bond's indenture is best described as:

• a.The written contract stating the issuer's obligations and the bondholders' rights✓
• b.The credit rating assigned to the issue by a nationally recognized statistical rating agency
• c.The market price at which the bond currently trades in the secondary market
• d.The commission a broker-dealer charges when the bond is bought or sold

The indenture (deed of trust) is the legal contract that spells out the coupon, maturity, covenants, and the rights of bondholders and duties of the issuer. It is not a price, a rating, or a commission.

An investor holds a convertible corporate bond. This feature primarily allows the investor to:

• a.Exchange the bond for a set number of the issuer's common shares✓
• b.Force the issuer to redeem the bond at par before maturity
• c.Avoid all credit risk because conversion guarantees repayment
• d.Receive a higher coupon automatically when interest rates rise

A convertible bond can be exchanged for a predetermined number of the issuer's common shares, letting the investor participate in stock appreciation. It does not force early repayment, adjust the coupon with rates, or eliminate credit risk.

Which U.S. Treasury security is issued at a discount, pays no periodic interest, and has a maturity of one year or less?

• a.Treasury Inflation-Protected Security (TIPS)
• b.Treasury bill✓
• c.Treasury note
• d.Treasury bond

Treasury bills mature in one year or less and are sold at a discount to face value, with the investor's return being the difference at maturity rather than periodic coupons. Notes and bonds pay semiannual interest, and TIPS pay interest and adjust principal for inflation.

How does a Treasury Inflation-Protected Security (TIPS) protect an investor from inflation?

• a.Its principal is adjusted upward with the Consumer Price Index (CPI)✓
• b.Its coupon rate is raised each year as measured inflation accelerates
• c.It converts into the issuer's common stock whenever inflation rises above 3%
• d.It pays a variable rate that is reset weekly to the 13-week T-bill rate

TIPS adjust their principal value based on changes in the CPI, so as inflation rises the principal (and the dollar amount of each fixed-rate coupon payment) increases. The coupon rate itself is fixed, it is not a floating T-bill rate, and it does not convert to stock.

U.S. Treasury securities are generally considered to have the LOWEST of which risk?

• a.Inflation (purchasing-power) risk
• b.Interest-rate risk
• c.Credit (default) risk✓
• d.Reinvestment risk

Because they are backed by the full faith and credit of the U.S. government, Treasuries carry essentially the lowest credit or default risk of any security. They still face interest-rate, inflation, and reinvestment risk like other bonds.

An investor wants Treasury interest that is subject to federal income tax but EXEMPT from state and local income tax. This tax treatment applies to:

• a.Municipal bond interest in the investor's home state
• b.U.S. Treasury note interest✓
• c.Corporate bond interest
• d.Bank certificate of deposit interest

Interest on U.S. Treasury securities is taxable at the federal level but exempt from state and local income tax. Corporate and CD interest are taxable at all levels, while municipal interest is generally federally tax-exempt, the opposite pattern.

Which of the following orders Treasury securities correctly from SHORTEST to LONGEST original maturity?

• a.T-bill, T-bond, T-note
• b.T-bill, T-note, T-bond✓
• c.T-note, T-bill, T-bond
• d.T-bond, T-note, T-bill

Treasury bills mature in one year or less, notes in 2 to 10 years, and bonds in more than 10 years (up to 30). Only the ordering T-bill, T-note, T-bond reflects shortest to longest maturity.

A Treasury STRIPS is best described as:

• a.A floating-rate Treasury security whose coupon resets against the 13-week bill auction
• b.A Treasury bond whose coupon rate is raised each year by the reported inflation rate
• c.A zero-coupon security created by separating a Treasury bond's principal and interest payments✓
• d.A short-term Treasury instrument issued only to banks and primary dealers

STRIPS are zero-coupon instruments created when a Treasury bond's principal and each interest payment are separated and sold individually at a discount. They are not inflation-linked, floating-rate, or bank-only instruments.

An investor holding a 30-year zero-coupon Treasury (STRIPS) is MOST exposed to which risk?

• a.Currency risk, because it is a foreign bond
• b.Default risk, because zero-coupons often default
• c.Interest-rate risk, because of its long duration✓
• d.Reinvestment risk on its semiannual coupons

A long-maturity zero-coupon bond has a very long duration, making its price highly sensitive to interest-rate changes. It has essentially no default risk (U.S. government) and no reinvestment risk because it pays no coupons, and it is not a foreign security.

Interest earned on U.S. Treasury notes and bonds is paid to investors:

• a.Semiannually (twice per year)✓
• b.Quarterly (four payments a year)
• c.Only at maturity, in a single sum
• d.Monthly (twelve payments a year)

Treasury notes and bonds pay a fixed coupon semiannually, meaning twice per year, until maturity. They do not pay monthly or quarterly, and only T-bills (zero-coupon) pay their return solely at maturity.

Ginnie Mae (GNMA) mortgage-backed securities differ from most other agency securities because they are:

• a.Backed only by the credit of the private issuing corporation
• b.Backed by the full faith and credit of the U.S. government✓
• c.Exempt from federal, state, and local income taxes
• d.Short-term discount instruments that pay no periodic interest

GNMA is a government-owned corporation, and its mortgage-backed securities carry the full faith and credit of the U.S. government, unlike Fannie Mae and Freddie Mac, which are government-sponsored but not directly guaranteed. GNMA interest is federally taxable, and the securities pay monthly interest and principal, not zero-coupon.

Fannie Mae and Freddie Mac are best described as:

• a.Agencies of the U.S. Treasury Department whose debt carries the full faith and credit of the federal government
• b.Government-sponsored enterprises (GSEs) whose securities are not directly guaranteed by the U.S. government✓
• c.Municipal financing authorities that issue tax-exempt revenue bonds for state and local affordable housing projects
• d.Foreign development banks that finance infrastructure projects in emerging market economies

Fannie Mae and Freddie Mac are government-sponsored enterprises that support the mortgage market; their securities carry slightly more credit risk than Treasuries because they are not directly backed by the U.S. government's full faith and credit. They are not Treasury agencies, foreign banks, or municipal authorities.

A holder of a mortgage-backed pass-through security faces prepayment risk, which means:

• a.The issuer defers scheduled principal payments to the final maturity date by contract
• b.Pass-through certificates have no secondary market, so the holder must wait for maturity
• c.The coupon rate automatically rises each year as the underlying mortgage pool seasons
• d.Homeowners may repay their mortgages early, often when rates fall, returning principal sooner than expected✓

Prepayment risk arises because homeowners can refinance and pay off mortgages early, usually when interest rates drop, so investors receive principal back sooner and must reinvest at lower rates. It is not about delayed payments, illiquidity, or automatic coupon increases.

Which of the following is a characteristic of money-market instruments?

• a.Equity ownership and voting rights in the issuer
• b.Short maturities of one year or less and high liquidity✓
• c.Guaranteed capital gains at maturity for the holder
• d.Maturities longer than 10 years and very limited liquidity

Money-market instruments are short-term debt with maturities of one year or less and are highly liquid, making them low-risk cash equivalents. They are not long-term, not equity, and do not guarantee capital gains.

Commercial paper is best described as:

• a.Short-term unsecured corporate debt issued to meet near-term funding needs✓
• b.A federally insured savings deposit that a bank issues at a fixed rate of interest
• c.A share of stock issued by a commercial bank and traded on a national exchange
• d.A long-term corporate bond secured by a specific pledge of company property

Commercial paper is short-term, unsecured promissory notes issued by corporations to fund short-term needs like payroll or inventory, typically maturing in 270 days or less. It is not a long-term secured bond, a stock, or an insured deposit.

A negotiable certificate of deposit (jumbo CD) issued by a bank differs from a traditional retail CD mainly because it:

• a.Can be traded in the secondary market before maturity✓
• b.Is insured in full by the FDIC no matter how large the deposit
• c.Pays the holder no interest at any point over its term
• d.Must be held to maturity and cannot be sold or transferred

A negotiable (jumbo) CD is issued in large denominations and can be bought and sold in the secondary market before maturity, giving it liquidity. Amounts above the insurance limit are not fully insured, it does pay interest, and its negotiability is the opposite of a non-transferable retail CD.

A repurchase agreement (repo) in the money market involves:

• a.Selling a security with an agreement to buy it back later at a slightly higher price✓
• b.Issuing newly created shares to the public to raise permanent equity capital for the issuer
• c.Permanently exchanging an existing bond position for newly issued common stock of the issuer
• d.Buying common stock on margin using credit extended by the customer's own brokerage firm

In a repo, one party sells securities (often Treasuries) and agrees to repurchase them shortly after at a higher price, effectively a short-term collateralized loan. It is not a permanent swap, a margin stock purchase, or a share issuance.

When market interest rates rise, the prices of existing fixed-rate bonds generally:

• a.Rise
• b.Rise then immediately fall to par
• c.Stay the same
• d.Fall✓

Bond prices and interest rates move inversely, so when market rates rise, existing bonds with lower fixed coupons become less attractive and their prices fall. They do not rise or stay unchanged with a rate increase.

A bond trading at a price below its par value is said to be trading at:

• a.A discount✓
• b.Par
• c.Its yield to maturity
• d.A premium

A bond priced below par ($1,000) is trading at a discount, which happens when its coupon is lower than current market yields. A price above par is a premium, and yield to maturity is a return measure, not a price description.

A bond has a 6% coupon and is currently priced at $1,200 (a premium). Its current yield is:

• a.Exactly 6%
• b.Cannot be determined
• c.Higher than 6%
• d.Lower than 6%✓

Current yield equals annual coupon divided by market price, so $60 / $1,200 = 5%, which is lower than the 6% coupon because the price is above par. When a bond trades at a premium, its current yield falls below the coupon rate.

For a bond purchased at a discount, which of the following relationships is correct?

• a.Coupon rate > current yield > yield to maturity
• b.Yield to maturity < coupon rate < current yield
• c.Coupon rate = current yield = yield to maturity
• d.Coupon rate < current yield < yield to maturity✓

For a discount bond, the yields rank from lowest coupon to highest yield to maturity: coupon < current yield < YTM, because the investor also gains the difference between the discounted purchase price and par at maturity. The premium bond shows the reverse order, and only a par bond has all three equal.

Yield to maturity (YTM) is best described as the total return an investor earns if the bond is:

• a.Called away by the issuer on the first call date at the stated call price
• b.Held until maturity, with coupons reinvested, accounting for any premium or discount✓
• c.Held for one year, earning only the annual coupon divided by today's market price
• d.Sold right away in the secondary market at today's quoted price

YTM measures the total annualized return assuming the bond is held to maturity and coupons are reinvested at the YTM, incorporating any gain or loss from buying at a discount or premium. It is not the yield if the bond is called on the first call date (that is yield to call). It is not the annual coupon divided by the current market price, which is current yield. It is also not the return from selling right away at the quoted price.

If a bond's current yield is 5% and its coupon rate is 5%, the bond is most likely trading at:

• a.An unknown price
• b.Par value✓
• c.A discount
• d.A premium

Current yield equals the coupon rate only when the market price equals par, because current yield is coupon divided by price. If current yield were higher it would be a discount, and if lower it would be a premium.

Two bonds are identical except for maturity. Which bond's price will generally change MORE for a given change in interest rates?

• a.The bond with the longer maturity✓
• b.The bond closest to maturity
• c.Both change equally
• d.The one with the higher credit rating

Longer-maturity bonds have greater interest-rate sensitivity (higher duration), so their prices move more for a given change in rates. Maturity, not credit rating, drives this effect, and the two do not move equally.

An investor buys a bond at par with a 4% coupon. If market rates later drop to 2%, the market value of the investor's bond will most likely:

• a.Increase, trading at a premium✓
• b.Decrease, trading at a discount
• c.Fall to zero
• d.Remain exactly at par

When market rates fall below a bond's fixed coupon, that bond becomes more attractive and its price rises above par to a premium. Prices move inversely to rates, so a rate drop raises the price rather than lowering it or leaving it unchanged.

Nominal yield on a bond refers to:

• a.The annual coupon divided by the current market price
• b.The yield if the bond is called early
• c.The total return if held to maturity
• d.The stated coupon rate as a percentage of par value✓

Nominal yield is simply the bond's stated coupon rate expressed as a percentage of par value, and it does not change with market price. Coupon over market price is current yield, held-to-maturity return is YTM, and early-call return is yield to call.

Duration is a measure that helps investors estimate:

• a.How sensitive a bond's price is to changes in interest rates✓
• b.The issuer's statistical likelihood of default before maturity
• c.The accrued interest a bond buyer owes the seller at settlement
• d.A bond's credit rating as assigned by Moody's or Standard & Poor's

Duration estimates the percentage change in a bond's price for a given change in interest rates, so higher duration means greater interest-rate sensitivity. It does not measure credit rating, default probability, or accrued interest.

Which of the following bond ratings represents the LOWEST credit risk?

• a.BB+
• b.AAA✓
• c.CCC+
• d.CCC-

AAA is the highest rating agencies assign, indicating the strongest capacity to pay and therefore the lowest credit risk. BB, B, and CCC are all below investment grade and carry progressively higher default risk.

The line between 'investment grade' and 'non-investment grade' (high-yield) bonds generally falls at:

• a.BBB (or Baa) and above is investment grade; BB (or Ba) and below is high-yield✓
• b.Any bond with a coupon above 5% is classified as high-yield debt
• c.Only unrated bonds are high-yield; all rated bonds are investment grade
• d.AAA (or Aaa) alone is investment grade; anything rated below it is high-yield

Bonds rated BBB/Baa and higher are considered investment grade, while those rated BB/Ba and lower are non-investment grade or high-yield. The cutoff is based on rating, not on coupon level or the mere absence of a rating.

If a rating agency downgrades a company's bonds, the most likely immediate effect on those existing bonds is that their:

• a.Coupon rates automatically increase
• b.Prices rise as demand increases
• c.Prices fall and their yields rise✓
• d.Maturity dates are shortened

A downgrade signals higher credit risk, so investors demand a higher yield, which pushes the existing bonds' prices down. Coupons are fixed and do not change, and a downgrade does not shorten maturity.

Credit (default) risk refers to the possibility that:

• a.The investor will have to reinvest coupon payments at a lower market rate
• b.Market interest rates will rise and push the bond's price down
• c.Inflation will erode the purchasing power of the coupon payments
• d.The issuer will fail to make timely interest or principal payments✓

Credit or default risk is the chance that the bond issuer cannot make its promised interest or principal payments on time. Rising rates describe interest-rate risk, lower reinvestment rates describe reinvestment risk, and eroding purchasing power describes inflation risk.

An investor holds long-term bonds and worries that rising market interest rates will reduce their price. This concern describes:

• a.Market liquidity risk
• b.Reinvestment risk
• c.Issuer credit risk
• d.Interest-rate risk✓

Interest-rate risk is the danger that rising market rates will lower the price of existing fixed-rate bonds, and it is greatest for long-term bonds. Credit risk relates to default, liquidity risk to selling quickly, and reinvestment risk to reinvesting cash flows at lower rates.

When interest rates fall, an investor who owns a callable bond faces the risk that the bond will be called and the proceeds must be reinvested at lower rates. This combined concern is BEST described as:

• a.Currency risk (exchange rate exposure)
• b.Purchasing-power risk (the risk of inflation)
• c.Credit risk (the risk the issuer defaults)
• d.Call risk (leading to reinvestment risk)✓

When rates fall, issuers often call bonds to refinance cheaper, forcing the investor to reinvest the returned principal at the now-lower market rates, so call risk gives rise to reinvestment risk. This is unrelated to inflation, default, or exchange rates.

An investor holding fixed-rate bonds during a period of rising inflation is MOST concerned about:

• a.Legislative risk from a new tax law
• b.Liquidity risk in a thin secondary market
• c.Purchasing-power (inflation) risk✓
• d.Business risk from weak company earnings

Purchasing-power or inflation risk is the danger that rising prices will erode the real value of a bond's fixed interest and principal payments. Liquidity, legislative, and business risks describe unrelated concerns about selling, law changes, and company operations.