FINRA SIE — Securities Industry Essentials — All Questions

Before a representative may exercise discretion over which security to buy in a customer's account, the firm must have:

• a.Verbal authorization from the customer
• b.Written approval from the branch manager alone
• c.Prior written discretionary authorization from the customer✓
• d.Customer authorization signed after the first trade

FINRA Rule 3260(b) says no member or registered representative may exercise discretionary power in a customer's account unless the customer has given prior written authorization to a stated individual and the member has accepted the account in writing. A verbal instruction is not enough, a manager's approval cannot replace the customer's own authorization, and authorization signed after the first trade comes too late.FINRA Rule 3260(b)

Under the Federal Reserve's Regulation T, the initial margin requirement for a purchase of marginable securities is currently:

• a.50% of the purchase price✓
• b.25% of the purchase price
• c.30% of the purchase price
• d.100% of the purchase price

Regulation T sets the initial margin requirement at 50% of the purchase price. The 25% figure resembles a maintenance minimum; 100% would be a cash purchase.

Excessive trading in a customer's account primarily to generate commissions is called:

• a.Front running
• b.Churning✓
• c.Selling away
• d.Backing away

Excessive trading to generate commissions is churning, a suitability/fair-dealing violation. Front running, selling away, and backing away are different violations.

A representative who arranges a private securities transaction outside the firm without giving the firm prior written notice has engaged in:

• a.Churning
• b.Front running
• c.Unauthorized trading
• d.Selling away✓

Participating in a private securities transaction without first giving the firm written notice is selling away (FINRA Rule 3280 requires prior written notice). Churning is excessive trading to generate commissions, front running is trading ahead of a customer's order, and unauthorized trading is trading in a customer's account without the customer's authority.FINRA Rule 3280

Which of the following violates the prohibition on insider trading?

• a.Buying a stock the day after reading its published annual report
• b.Tipping material nonpublic information to a friend who then trades on it✓
• c.Selling a stock based on a widely published wire-service news article
• d.Placing a limit order below the current market price to average in

Tipping material nonpublic information to someone who then trades violates the insider-trading prohibition — you need not trade yourself. Trading on public information or placing a routine limit order is lawful.

A Currency Transaction Report (CTR) is generally required for cash transactions:

• a.Of $10,000 or more in a single day
• b.Exceeding $5,000 in a single day
• c.Exceeding $10,000 in a single day✓
• d.Exceeding $3,000 in a single day

A CTR is required when currency transactions by or for one person total more than $10,000 in a single business day (31 CFR 1010.311 and the aggregation rule in 1010.313). Exactly $10,000 does not trigger it, because the rule says 'more than $10,000'. The $5,000 and $3,000 figures belong to other rules (suspicious activity reporting and certain funds-transfer and monetary-instrument recordkeeping). Splitting cash to stay under the threshold is structuring, which is itself a federal offense.31 CFR 1010.311

When a firm files a Suspicious Activity Report (SAR):

• a.It may not disclose the filing to the customer involved✓
• b.It must notify the customer in writing within 30 days of the filing
• c.It may tell the customer once the account involved has been closed
• d.It may tell the customer if the customer asks whether a report was filed

A SAR, and any information that would reveal its existence, is confidential, so a firm and its personnel may not disclose the filing to the customer involved. The prohibition has no exception for a closed account or a direct question from the customer, and there is no customer-notification requirement at all.31 CFR 1023.320(e)

The Customer Identification Program (CIP) requires a firm at account opening to collect and verify a customer's:

• a.Annual salary and current employer only
• b.Name, date of birth, physical address, and taxpayer identification number✓
• c.Personal credit score
• d.A complete list of every brokerage firm where the customer previously held accounts

The CIP requires collecting and verifying a customer's name, date of birth, physical address, and taxpayer identification number at account opening. Salary, credit score, and prior-firm lists are not the CIP's four required elements.

An investor who sells stock short faces:

• a.Risk capped at the original investment
• b.No real risk if the stock is widely held
• c.Theoretically unlimited risk if the price rises✓
• d.A guaranteed profit in efficient markets

A short seller faces theoretically unlimited risk if the price rises, because there is no ceiling on how high a stock can go. The risk is not capped, is not eliminated by wide ownership, and is never a guaranteed profit.

A very narrow bid-ask spread on a security generally indicates that the security is:

• a.Highly liquid and heavily traded✓
• b.Thinly traded and hard to sell quickly
• c.About to be delisted by the exchange
• d.Exempt from SEC registration rules

A narrow bid-ask spread signals a highly liquid, heavily traded security. Wide spreads indicate thin markets; the spread does not by itself signal delisting or an exemption.

A stop order:

• a.Executes immediately at the best price then available in the market
• b.Remains dormant until the market reaches a trigger price, then activates✓
• c.Guarantees the customer execution at one specific price regardless of market conditions
• d.Can be entered only as a buy order under FINRA's order-entry rules

A stop order stays dormant until the market hits its trigger price, then activates (becoming a market order). It does not execute immediately, guarantee a price, or work only for buys.

A market maker in a security:

• a.Posts a bid only, leaving the offer side to the exchange floor
• b.Charges its customers a separate advisory fee on each trade
• c.Is prohibited by FINRA from trading securities for its own account
• d.Continuously quotes both a bid and an ask, providing liquidity✓

A market maker continuously quotes both a bid and an ask, supplying liquidity and profiting from the spread. It both buys and sells, charges no separate advisory fee, and does trade for its own account.

A firm's obligation to use reasonable diligence to know the essential facts about each customer is established by:

• a.Regulation T
• b.The Bank Secrecy Act and the USA PATRIOT Act
• c.The Investment Company Act of 1940
• d.FINRA Rule 2090 (Know Your Customer)✓

The know-your-customer duty is set by FINRA Rule 2090. Regulation T governs margin, the BSA governs anti-money-laundering, and the 1940 Act governs investment companies.

The federal agency that oversees the entire securities industry and approves the rules adopted by self-regulatory organizations is the:

• a.FINRA
• b.MSRB
• c.SEC✓
• d.Federal Reserve Board

The SEC is the top federal regulator and approves the rules SROs adopt. FINRA and the MSRB are SROs/rule-writers under SEC oversight; the Federal Reserve handles monetary policy and credit.

An individual seeking to register as a representative applies, through the sponsoring firm, by filing:

• a.Form U4✓
• b.Form U5
• c.Form BD
• d.Form 10-K

An individual registers by filing Form U4 through the sponsoring firm. Form U5 reports a departure, Form BD registers the firm, and Form 10-K is an issuer's annual report.

Which statement about the SIE exam is correct?

• a.It requires employer sponsorship in order to take it
• b.Passing it alone fully qualifies a person to transact securities business
• c.It replaces all top-off representative-level exams
• d.Anyone may take it, even without association with a firm✓

Anyone may take the SIE, even without firm association or sponsorship. Passing it alone does not fully qualify a person, and it does not replace the top-off exams.

The Regulatory Element of continuing education is:

• a.Training that each individual member firm designs and delivers from its own needs analysis
• b.Completed on the second, fifth, and tenth anniversaries of initial registration
• c.A portion of the SIE exam that is completed once, when a person first registers
• d.Standardized, industrywide training on compliance and ethics completed on a set schedule✓

The Regulatory Element is standardized, industrywide training that a registered person completes on a set schedule: FINRA Rule 1240 requires it annually by December 31 for the person's registration category. Firm-designed training based on the firm's own needs analysis is the Firm Element. It is not tied to multi-year registration anniversaries, and it is not part of the SIE, which is a one-time qualification exam.FINRA Rule 1240

Under FINRA Rule 3220, a gift given in connection with the business to a person at another firm may not exceed:

• a.$100 per recipient per year
• b.$300 per recipient per year✓
• c.$500 per recipient per year
• d.Any amount; there is no limit

FINRA Rule 3220 caps business gifts at $300 per recipient per year — raised from $100 by Regulatory Notice 26-05 (SR-FINRA-2025-003), effective March 30, 2026. The $100 figure is the old limit and is a trap for anyone studying from pre-2026 materials; $500 and “no limit” have never been the rule.

When a registered representative leaves a firm, the firm reports the termination by filing:

• a.Form U5✓
• b.Form U4
• c.Form BD
• d.A new registration statement

A firm reports a representative's departure by filing Form U5. Form U4 registers the person, Form BD registers the firm, and a registration statement is for a securities offering.

To become fully qualified as a general securities representative, a candidate who has passed the SIE must also:

• a.Wait a mandatory five years
• b.Personally file Form BD
• c.Pass a top-off (representative-level) exam, which requires firm sponsorship✓
• d.Do nothing further; passing the SIE alone is sufficient to transact business

After the SIE, a candidate must pass a top-off (representative-level) exam, which requires firm sponsorship, to be fully qualified. There is no five-year wait, the individual does not file Form BD, and the SIE alone is not sufficient.

An investor seeking regular income, with priority over common stockholders for dividends and in liquidation, would MOST likely choose:

• a.Subscription rights to buy more of the company's common stock
• b.More common shares
• c.Warrants to buy the company's common stock at a set price
• d.The company's preferred stock✓

Preferred stock pays a fixed dividend and ranks ahead of common stock for dividends and in liquidation, offering steadier income with more priority than common. Rights and warrants are short-term or speculative ways to buy common stock and pay no income, and more common shares would not add any income priority.

Under FINRA Rule 2341, a mutual fund that has no asset-based sales charge and pays no service fee, and that offers rights of accumulation and quantity discounts, may impose front-end and deferred sales charges totaling no more than:

• a.6.25% of the amount invested, the cap for a fund with both an asset-based sales charge and a service fee
• b.7.25% of the offering price, the cap when the fund pays a service fee
• c.8.0% of the offering price, the cap when rights of accumulation are not offered
• d.8.5% of the offering price✓

FINRA Rule 2341(d)(1) caps the aggregate front-end and deferred sales charges of a fund with no asset-based sales charge at 8.5% of the offering price, provided the fund offers rights of accumulation and quantity discounts on the required schedules. The cap falls to 8.0% if rights of accumulation are not offered on the required terms, and to 7.25% if the fund pays a service fee. A fund with an asset-based sales charge that also pays a service fee is held to 6.25% under a different formula, so none of those lower caps apply to the fund described.FINRA Rule 2341(d)(1)

A trade is executed for 'cash' settlement on a Monday morning. Under FINRA Rule 11320, when is delivery of the securities due?

• a.Wednesday, two business days later, the cycle in effect before May 28, 2024
• b.Tuesday, the next business day, the same as a regular way trade
• c.The same Monday (trade date)✓
• d.The day the seller chooses, as in a seller's option trade

Under FINRA Rule 11320(a), delivery on a 'cash' trade is due at the purchaser's office on the day of the transaction, so a Monday cash trade is due Monday. Regular way delivery under Rule 11320(b) is the first business day after the trade date, which has been T+1 since May 28, 2024, so a regular way trade done Monday would be due Tuesday. Wednesday was the regular way date under the former T+2 cycle. A seller's option lets the seller pick a later delivery date, which is a different settlement type from cash.FINRA Rule 11320(a)

Under FINRA Rule 4512, whose signature must appear on a new customer account record to show the account was accepted under the firm's policies?

• a.The customer opening the account, who must sign every new account form
• b.A partner, officer or manager of the member firm✓
• c.The registered representative who introduced the account to the firm
• d.The trusted contact person the customer names on the account

FINRA Rule 4512(a)(1)(D) requires the signature of a partner, officer or manager showing that the account was accepted in accordance with the firm's account-acceptance policies and procedures. The rule does not make the customer's signature a requirement of every new account record, although other account types such as margin or options accounts carry their own signed-agreement requirements under other rules. The representative responsible for the account must be identified by name, but the rule does not call for that person's signature as acceptance. The trusted contact person is someone the firm may reach about the customer's account and does not sign anything.FINRA Rule 4512(a)(1)(D)

Under FINRA Rule 3280, a representative's duty to give the firm written notice before taking part in an outside securities transaction ('selling away') exists primarily to ensure that:

• a.Representatives must register each outside offering with the SEC before selling it
• b.Firms can share in the commissions representatives earn on outside products
• c.A firm can supervise its representatives' securities transactions to protect customers✓
• d.Only institutional investors are allowed to buy private placement securities

The notice requirement exists so the firm can supervise its representatives' securities transactions to protect customers. Private securities transactions conducted outside the firm's knowledge escape its supervision and can expose customers to unvetted or fraudulent offerings. Rule 3280 is a notice-and-approval rule for the firm, not an SEC registration step for the representative, and it does not set up a way for the firm to share in outside commissions. Private placements are not limited to institutions. The SEC approved new FINRA Rule 3290 on September 15, 2026; it will replace Rules 3270 and 3280 once FINRA announces an effective date, so Rule 3280 still applies until then.FINRA Rule 3280

Which self-regulatory organization writes the rules governing the municipal securities market, including the conduct of municipal securities dealers?

• a.The North American Securities Administrators Association (NASAA)
• b.The SEC's Office of Municipal Securities
• c.The Municipal Securities Rulemaking Board (MSRB)✓
• d.FINRA (the Financial Industry Regulatory Authority)

Congress created the Municipal Securities Rulemaking Board under Section 15B of the Securities Exchange Act of 1934 to write the rules for municipal securities dealers, municipal advisors and the municipal market. The MSRB does not examine or enforce its own rules; FINRA examines and enforces them for broker-dealers, and the SEC and bank regulators oversee the rest. NASAA is an association of state regulators and is not a rulemaking self-regulatory organization, and the SEC oversees the MSRB rather than writing the dealer conduct rules itself.Securities Exchange Act of 1934 Section 15B(b)

MSRB Rule G-37 addresses political contributions by municipal securities dealers. What is the primary consequence if a dealer's municipal finance professional makes a contribution to an issuer official that is not covered by the de minimis exception?

• a.The dealer is banned from municipal securities business with that issuer for two years✓
• b.The dealer is banned from municipal securities business with that issuer for one year
• c.The dealer may continue the business but must disclose the contribution on Form G-37
• d.The dealer is banned for two years from municipal securities business with every issuer in the state

MSRB Rule G-37(b) bars a dealer from engaging in municipal securities business with a municipal entity (issuer) for two years after a contribution to an official of that issuer by the dealer, a municipal finance professional of the dealer, or a political action committee controlled by either. The ban is tied to the issuer whose official received the contribution, not to every issuer, and it lasts two years, not one. Quarterly disclosure on Form G-37 is also required, but disclosure does not replace the ban. A de minimis exception lets a municipal finance professional contribute up to $250 per candidate, per election, to an official he or she is entitled to vote for.MSRB Rule G-37(b)

A registered representative gives the head trader at an institutional client four concert tickets, with a face value and cost of $60 each, as a thank-you for the client's business. The representative will not attend. Under FINRA Rule 3220, this gift is:

• a.Permitted, because the $240 total is under the $300 per-person annual limit✓
• b.A violation, because the limit is $100 per person per year
• c.Permitted without limit, because gifts tied to the client's business are exempt from the rule
• d.A violation, because the rule bans any gift of tickets unless the representative attends the event too

Rule 3220 bars a member from giving anything of value over $300 per individual per year to an employee or agent of another party in relation to the business of that person's employer. The limit was $100 until FINRA raised it to $300 effective March 30, 2026 (Regulatory Notice 26-05). Tickets are valued at the higher of cost or face value, here $240 in total, and all gifts to the same person in a year count together. The rule applies precisely because the gift relates to the recipient's employer's business, so being a thank-you for business does not exempt it. Tickets the representative does not use with the recipient are treated as a gift subject to that limit, not banned outright. Gifts to individual retail customers fall outside Rule 3220.FINRA Rule 3220

A firm discovers that one of its representatives opened a brokerage account at another member firm without notifying either firm. Under FINRA Rule 3210 on accounts at other broker-dealers, the representative was generally required to:

• a.Obtain the executing firm's prior written consent, then notify the employer of the account within 30 days
• b.Notify the employer within 30 days after opening the account, with no notice to the executing firm
• c.Obtain the employer's prior written consent and notify the executing firm in writing of the association✓
• d.Obtain the employer's prior written consent, and tell the executing firm only if it asks

Under FINRA Rule 3210, an associated person must not open an account at another member (the executing member) or at any other financial institution without the employer member's prior written consent, and must notify the executing member in writing of the association. On request the executing member sends the employer duplicate confirmations and statements. Consent comes from the employer, not the executing firm, it must come before the account is opened rather than afterward, and the executing firm must also be told of the association. The 30-day period applies only to an account that already existed when the person became associated with the employer.FINRA Rule 3210

As a widely used rule of thumb, a recession is defined as:

• a.Two consecutive quarters of rising unemployment
• b.A stock-market decline of 20% or more from a recent high
• c.Two consecutive quarters of declining GDP✓
• d.A sustained rise in consumer prices

The common rule of thumb for a recession is two consecutive quarters of declining GDP. A stock-market decline of 20% or more from a recent high is a bear market, a sustained rise in consumer prices is inflation, and rising unemployment is a related labor-market signal; none of them is the definition.

For a U.S. individual, the Customer Identification Program (CIP) requires a firm at account opening to collect and verify, at a minimum, the customer's:

• a.Name, date of birth, employer, annual income, net worth, and investment objectives
• b.Name, date of birth, physical address, and taxpayer identification number✓
• c.Name, residential address, occupation, employer, net worth, and risk tolerance
• d.Name, date of birth, physical address, and a reference letter from a prior broker-dealer

The CIP rule (31 CFR 1023.220(a)(2)) requires a broker-dealer to obtain at least the customer's name, date of birth (for an individual), address and identification number before opening an account; for a U.S. person the identification number is a taxpayer identification number, while a non-U.S. person may supply a passport or similar government-issued number. Investment profile items such as income, net worth, employer and objectives are collected for suitability and account-record purposes, not as CIP minimums, and a reference letter from a prior firm is not required.31 CFR 1023.220(a)(2)

A firm's obligation to use reasonable diligence, in opening and maintaining every account, to know the essential facts about each customer is established by:

• a.FINRA Rule 2111 (Suitability)
• b.SEC Rule 17a-3 (broker-dealer recordkeeping)
• c.FINRA Rule 4512 (Customer Account Information)
• d.FINRA Rule 2090 (Know Your Customer)✓

FINRA Rule 2090 requires every member to use reasonable diligence, in regard to the opening and maintenance of every account, to know (and retain) the essential facts concerning every customer and the authority of each person acting on the customer's behalf. Rule 2111 covers the suitability of recommendations, and Rule 4512 and SEC Rule 17a-3 prescribe what account information must be recorded and kept; none of them is the general know-your-customer duty.FINRA Rule 2090

When a company sells newly issued shares to the public in the primary market, the money investors pay goes to:

• a.The issuer, minus the underwriters' spread✓
• b.The underwriting syndicate, which keeps it all
• c.The shareholders selling in the aftermarket
• d.The exchange that lists the new shares

In a primary offering the issuer sells newly created shares and receives the proceeds, less the underwriting spread. The syndicate earns only that spread, not the full amount raised. Existing shareholders who sell to other investors are trading in the secondary market, where the issuer receives nothing. An exchange earns listing fees but never receives the offering proceeds.Securities Act of 1933

An investment bank agrees to buy a new issue outright from the issuer at a set price and keeps any shares it cannot resell. This arrangement is called:

• a.An all-or-none underwriting
• b.A standby underwriting
• c.A firm commitment underwriting✓
• d.A best-efforts underwriting

In a firm commitment, the underwriter buys the whole issue and bears the risk of any unsold shares. In a best-efforts deal the bank only tries to sell the shares and returns what it cannot place. A standby underwriting backs a rights offering by buying only the shares existing holders decline. An all-or-none deal is cancelled unless every share is sold, so the bank never keeps unsold stock.Securities Act of 1933

After an issuer files its registration statement but before the SEC declares it effective, which action is permitted?

• a.Accepting binding orders and payment from customers
• b.Confirming sales of the shares at the final offering price
• c.Delivering the final prospectus, which is required to open accounts
• d.Giving interested investors a preliminary prospectus✓

During the cooling-off period an underwriter may distribute a preliminary (red herring) prospectus and collect non-binding indications of interest. Sales cannot be made, orders cannot be accepted, and money cannot be taken until the SEC declares the registration effective. The final prospectus, with the final price, does not exist yet, so nothing can be confirmed at a final price.Securities Act of 1933 Section 5

A company sells shares in a Regulation D private placement to accredited investors only, with no advertising. Compared with a registered public offering, which statement is correct?

• a.No SEC registration is needed, but buyers get restricted shares✓
• b.Buyers may resell the shares freely after a 30-day holding period
• c.The issuer must file a full Form S-1 registration statement
• d.The offering is capped at 35 purchasers in total

A Regulation D offering is exempt from registration, but buyers receive restricted securities that cannot be resold freely. There is no 30-day rule; resale depends on Rule 144 holding periods or another exemption. The issuer files a short Form D notice, not a Form S-1. The 35-purchaser limit applies only to non-accredited investors in a Rule 506(b) offering; the number of accredited investors is unlimited.Securities Act of 1933 Regulation D

A manufacturer wants to raise $40 million from the general public with scaled-down disclosure and without a full registration. Which exemption fits?

• a.Regulation A Tier 2, which allows up to $75 million in 12 months✓
• b.Rule 144A, which is limited to qualified institutional buyers
• c.Regulation A Tier 1, which is capped at $20 million
• d.Rule 506(b) of Regulation D, which bars general solicitation

Regulation A Tier 2 permits offerings of up to $75 million in a 12-month period to the public with reduced disclosure, so $40 million fits. Tier 1 stops at $20 million. Rule 506(b) allows no general solicitation, so it cannot be used to sell to the general public. Rule 144A covers resales to qualified institutional buyers, not a public capital raise.Regulation A, 17 CFR 230.251(a)

Which organization, overseen by the SEC, writes and enforces conduct rules for broker-dealers and registered representatives who deal with the public?

• a.SIPC, the insurer of customer accounts
• b.NASAA, the state securities administrators
• c.The MSRB, for municipal securities dealers
• d.FINRA, a self-regulatory organization✓

FINRA is the self-regulatory organization that writes and enforces rules for broker-dealers and their registered representatives, under SEC oversight. The MSRB writes rules for municipal securities activities. NASAA coordinates state regulators but does not write or enforce FINRA-style rules. SIPC protects customers when a member firm fails and does not regulate conduct.

SIPC protection is designed to help a brokerage customer in which situation?

• a.Securities are missing because the member firm failed✓
• b.The value of the securities fell because the market declined
• c.A representative recommended an unsuitable investment that lost money
• d.A commodity futures contract held at the firm lost value

SIPC restores missing cash and securities, up to $500,000 per customer including $250,000 for cash, when a member brokerage fails. It does not protect against market declines or against losses from bad advice or unsuitable recommendations. It also does not cover commodity futures contracts.

When the Federal Reserve wants to increase the money supply and lower interest rates, it would most likely:

• a.Raise the discount rate charged to banks
• b.Buy government securities in the open market✓
• c.Sell Treasury securities to government dealers
• d.Raise the reserve requirement for banks

Buying securities in the open market puts cash into the banking system, which expands the money supply and pushes rates down. Raising the discount rate, selling Treasury securities, and raising reserve requirements all drain or restrict credit and tighten policy.

A shareholder owns 1,000 shares of common stock and 500 shares of non-voting preferred stock. At the annual meeting, how many shares carry a vote?

• a.None; the directors alone vote
• b.1,000 shares, the common stock only✓
• c.500 shares, since preferred ranks first
• d.All 1,500 shares, one vote per share

Common stock carries the vote, one vote per share, so only the 1,000 common shares count. Non-voting preferred gives up the vote in exchange for a fixed dividend and priority over common in dividends and liquidation, not in voting. Shareholders, not just the directors, elect the board and vote on major proposals.

A preferred stock pays a 6% dividend on $100 par, is callable after 5 years, and trades at $105. Which statement is correct?

• a.The holder may require the issuer to buy it back at its $100 par value
• b.The holder may exchange it for common stock at any time
• c.The issuer may redeem it at the call price after the call date✓
• d.The $6 annual dividend rises if market interest rates fall

A call provision belongs to the issuer, which can redeem the preferred at the call price after the call date. The holder has no right to put the stock back at par. A straight preferred pays a fixed dividend, here 6% of $100 or $6 a year, regardless of market rates. Exchanging into common requires a separate conversion feature, which the stem does not mention.

A corporate bond is issued at par ($1,000) with a 4% coupon. If market interest rates then rise to 5%, which statement is correct?

• a.The annual interest payment increases from $40 to $50
• b.The price rises above $1,000 because market yields are higher
• c.The bond's price falls below $1,000 as new bonds pay more✓
• d.The coupon resets to 5%, so the price stays at $1,000 par

Bond prices move opposite to yields. The bond pays a fixed $40 a year, while new bonds pay $50, so buyers will only take the old bond at a discount to par. The coupon of a fixed-rate bond never resets, so the interest payment stays at $40 and the price cannot stay at par.

An investor in the 25% federal tax bracket is comparing a 3% tax-exempt municipal bond with taxable bonds. What taxable yield gives the same after-tax return?

• a.3.00%, because no adjustment is needed
• b.4.00%, found by dividing 3% by 0.75✓
• c.2.25%, found by multiplying 3% by 0.75
• d.3.75%, found by multiplying 3% by 1.25

The taxable-equivalent yield is the tax-free yield divided by (1 minus the tax rate): 3% / 0.75 = 4.00%. Multiplying by 1.25 understates the answer, and multiplying by 0.75 gives an after-tax yield, which moves in the wrong direction. Leaving the yield at 3% ignores that the taxable bond's interest is reduced by tax.

A bond with a 5% coupon and $1,000 par trades at 90 ($900). How do its current yield and yield to maturity compare?

• a.Both equal the 5% coupon rate, since the coupon is fixed
• b.Current yield is about 5.56%, and the YTM is higher✓
• c.Current yield is about 5.56%, and the YTM is lower than that
• d.Current yield is 5.00%, equal to the coupon, and the YTM is lower

Current yield is annual interest divided by price: $50 / $900 = 5.56%. A discount bond also gains about $100 as it moves back to par at maturity, so its YTM is higher than the current yield. Current yield is not simply the coupon rate unless the bond trades at par. YTM falls below current yield only for a premium bond.

ABC stock trades at $55. A call option on ABC has a $50 strike and a $7 premium. Which statement is correct?

• a.It is out of the money, since the stock is above the strike
• b.It is at the money, so the whole $7 premium is time value
• c.It is in the money by $5, and the whole $7 premium is intrinsic value
• d.It is in the money by $5, and $2 of the premium is time value✓

A call is in the money when the stock is above the strike. Intrinsic value is $55 - $50 = $5, and the remaining $7 - $5 = $2 of the premium is time value. Intrinsic value cannot be the whole premium unless no time value remains. Out of the money means the stock is below the strike for a call, and at the money means the stock equals the strike.

The holder of a put option has the right to do what?

• a.Buy the underlying stock at the strike price
• b.Require the issuing company to repurchase the shares
• c.Sell the underlying stock at the market price on expiration
• d.Sell the underlying stock at the strike price✓

A put gives its holder the right to sell the underlying stock at the strike price until expiration, which pays off when the market price is lower than the strike. Buying at the strike is the right a call holder has. The put is exercised against the option writer, not the issuer. Selling at the market price does not need an option, so it gives no protection or profit.

An investor writes (sells) a call option on DEF stock. Which statement describes the writer's position?

• a.Holds the right to sell the stock at the strike price
• b.Keeps the premium and owes nothing if exercised
• c.Must buy the stock at the strike price if assigned
• d.Must sell the stock at the strike price if assigned✓

The writer of a call collects the premium but must deliver the stock at the strike price if the holder exercises and the writer is assigned. A writer who must buy the stock at the strike is describing a put writer. Having a right rather than an obligation describes the option buyer. The premium never releases the writer from the obligation to deliver.

Which risk is caused by broad economic or market conditions and cannot be removed by diversification?

• a.Credit risk, which depends on one issuer's ability to pay
• b.Liquidity risk, which depends on how easily the asset trades
• c.Systematic risk, which affects the market as a whole✓
• d.Business risk, which depends on one company's management

Systematic (market) risk comes from factors such as interest rates, recessions, and inflation that hit nearly all securities, so owning more securities does not remove it. Credit, liquidity, and business risks are tied to a specific issuer, security, or company and can be reduced by diversifying among issuers.

Interest rate risk is the risk that:

• a.An issuer misses a scheduled interest payment
• b.Coupons must be reinvested at a lower rate
• c.A bond cannot be sold without a large loss
• d.A bond's price falls when market interest rates rise✓

Interest rate risk is the price risk of fixed-income securities: when market rates rise, existing bonds lose value. A missed payment is credit (default) risk. Having to reinvest coupons at lower rates is reinvestment risk. Difficulty selling without a large loss is liquidity or marketability risk.