FINRA SIE — Securities Industry Essentials — All Questions

An investor buys a working interest in an oil and gas drilling program as a general partner, holding it through an entity that does not limit the investor's liability. The investor spends little time on the program. How are the program's losses treated for passive loss purposes?

• a.As passive, because every partnership interest is a passive activity
• b.As nonpassive, so they can offset the investor's active income✓
• c.As passive, because the investor does not materially participate
• d.As nonpassive only if the investor works at least 500 hours during the year

The tax code excludes from the definition of passive activity any working interest in an oil or gas property that the taxpayer holds directly or through an entity that does not limit the taxpayer's liability. Material participation is therefore not the test, so the investor's few hours do not turn the loss passive. Not every partnership interest is passive, because the working interest rule is a stated exception. The 500-hour test is a material participation test and does not apply here.IRC Section 469(c)(3)

In year 1, an investor has $25,000 of passive losses from a direct participation program and no passive income, so the losses are disallowed and carried forward. In year 2, the investor has $40,000 of passive income from another investment and a new $10,000 passive loss. What is the investor's net passive income in year 2 after using the carried-forward losses?

• a.$40,000, because the carried-forward losses expire after one year
• b.$15,000, because the new $10,000 loss is ignored
• c.$30,000, because carried-forward losses are not used until the program is sold
• d.$5,000✓

Passive losses that are not allowed in one year carry forward and offset passive income in later years. Year 2 passive income is $40,000, reduced by the new $10,000 loss and by the $25,000 carryforward: 40,000 - 10,000 - 25,000 = $5,000. Waiting for a sale gives $30,000, which skips the carryforward. Leaving out the new loss gives $15,000. A one-year expiration gives $40,000, but disallowed passive losses carry forward indefinitely.IRC Section 469(a) and (b)

A corporation owns income-producing real estate and has 85 shareholders. It meets every other REIT requirement and plans to distribute the required income. Can it qualify as a real estate investment trust?

• a.No, because beneficial ownership must be held by at least 100 persons✓
• b.Yes, because it distributes at least 90% of its taxable income
• c.Yes, because a REIT needs only 35 shareholders
• d.No, because only exchange-listed companies can qualify as REITs

To qualify as a REIT the beneficial ownership must be held by 100 or more persons for at least 335 days of a 12-month tax year. With 85 shareholders the company fails that test even if every other condition is met. The figure of 35 comes from private offering rules and has no role here. Distributing at least 90% is a separate requirement that does not replace the 100-owner test. Listing is not required, and non-traded REITs exist.IRC Section 856(a)(5)

A REIT has $400 million in total assets at the end of a quarter. At least 75% of the value of its total assets must be in real estate assets, cash and cash items, and government securities. What is the minimum value of those assets?

• a.$200 million
• b.$380 million
• c.$300 million✓
• d.$360 million

At the close of each quarter, at least 75% of the value of a REIT's total assets must be represented by real estate assets, cash and cash items, and government securities. 75% of $400 million is $300 million. The $380 million figure applies 95%, which is the gross income test. The $200 million figure applies 50%, and the $360 million figure applies 90%, which is the distribution requirement. Neither of those is the asset test.IRC Section 856(c)(4)(A)

A REIT has $50 million of gross income for the year. At least 95% of gross income must come from sources such as dividends, interest and rents from real property. What is the minimum amount that must come from those sources?

• a.$37.5 million
• b.$50 million
• c.$45 million
• d.$47.5 million✓

The REIT income test requires at least 95% of gross income to be derived from specified sources including dividends, interest, rents from real property, and gain from sales of real property and securities. 95% of $50 million is $47.5 million. The $37.5 million figure applies 75%, which is a separate test for real property related income. The $45 million figure applies 90%. Requiring all $50 million overstates the test, since up to 5% may come from other sources.IRC Section 856(c)(2)

A private fund that is not a venture capital fund wants to sell interests to 140 investors, every one of them a qualified purchaser, with no public offering and without registering as an investment company. Which exclusion permits this?

• a.Section 3(c)(1), because accredited investors do not count toward its owner limit
• b.Section 3(c)(1), which allows up to 250 investors
• c.Section 3(c)(7), which allows ownership by qualified purchasers only and sets no fixed cap on the number of owners✓
• d.None; a fund with more than 100 investors must register as a mutual fund

Section 3(c)(7) excludes an issuer whose securities are owned only by qualified purchasers and that makes no public offering, and the Act sets no fixed number of owners for it. Section 3(c)(1) is limited to 100 beneficial owners, and the 250 figure applies only to a qualifying venture capital fund, which this fund is not. Accredited investors are counted under 3(c)(1), so being accredited does not exempt anyone from the count. A fund over 100 investors is not forced to register, since 3(c)(7) is a second route.Investment Company Act Sections 3(c)(1) and 3(c)(7)

Which of the following individuals is a qualified purchaser under the Investment Company Act?

• a.A person with income above $200,000 in each of the last two years
• b.A person with a $1 million net worth, not counting a primary residence
• c.A person with $5 million of net worth, most of it the value of a primary residence
• d.A person who owns at least $5 million in investments✓

An individual qualified purchaser is a natural person who owns at least $5 million in investments. The test counts investments, not total net worth, so a large home does not help. The $1 million net worth test (excluding the home) and the $200,000 income test are ways to be an accredited investor, which is a lower standard under the Securities Act and does not make someone a qualified purchaser.Investment Company Act Section 2(a)(51)

A hedge fund charges a 2% management fee on its $50 million of year-end net assets and a 20% incentive fee on the gain remaining after the management fee. The fund earned a gross gain of $8 million before any fees. No hurdle rate or high-water mark applies. What are the total fees?

• a.$1.6 million
• b.$1.4 million
• c.$2.4 million✓
• d.$2.6 million

The management fee is 2% of $50 million, or $1.0 million. The incentive fee is 20% of the gain left after that fee: 20% x ($8.0 million - $1.0 million) = $1.4 million. Total fees are $1.0 million + $1.4 million = $2.4 million. Charging the incentive fee on the full $8 million gives $1.6 million and a total of $2.6 million. The $1.4 million answer leaves out the management fee, and $1.6 million is the incentive fee on the gross gain alone.

An ETF share trades at $50.00 on the exchange while the net asset value per share is $48.00. To the nearest hundredth of a percent, what is the premium to NAV?

• a.2.00%
• b.4.00%
• c.104.17%
• d.4.17%✓

The premium is measured against NAV: ($50.00 - $48.00) / $48.00 = 4.17%. Dividing the $2.00 difference by the $50.00 market price gives 4.00%, which uses the wrong base. Stating the $2.00 dollar difference as a percent gives 2.00% and ignores the base entirely. The figure of 104.17% is the price as a percentage of NAV, not the premium.

An ETF's shares trade well above the value of its underlying holdings. Which action by an authorized participant tends to push the ETF's price back toward its NAV?

• a.Sell ETF shares directly back to the fund for cash at the market price
• b.Deliver the underlying basket of securities to the fund for new ETF shares, then sell those shares in the market✓
• c.Redeem ETF shares with the fund for the underlying basket, then sell the securities in the market
• d.Buy ETF shares in the market and hold them to support the price

When an ETF trades at a premium, an authorized participant can profit by assembling the underlying securities, delivering them to the fund for newly created ETF shares, and selling those shares at the higher market price. The added supply pushes the ETF price down toward NAV. Redeeming shares for the basket is the opposite trade and is used when shares trade at a discount. Buying more shares adds demand and widens the premium. Redemptions are priced at NAV through the creation and redemption process, not at the market price.

A fund holds $100 in a 2x daily leveraged ETF that seeks twice the daily return of an index. The index falls 10% on day 1 and rises 10% on day 2. Ignoring fees, what is the position worth after day 2?

• a.$99.00
• b.$100.00
• c.$98.00
• d.$96.00✓

A leveraged ETF resets daily. On day 1 it falls 20% to $80. On day 2 it rises 20%, which is $16, so it ends at $96. The index itself went from 100 to 90 to 99, a loss of 1%, so doubling that two-day return would suggest $98, but the fund does not track the two-day return. The $99 figure is the index result, and $100 assumes the gains and losses offset. Compounding of daily resets makes the result path-dependent.

An investor holds $10,000 in an inverse 2x daily ETF that seeks twice the opposite of an index's daily return. The index rises 3% in one day. Ignoring fees, what is the position worth at the close?

• a.$9,700
• b.$10,300
• c.$10,600
• d.$9,400✓

An inverse 2x ETF seeks -2 times the index return, so a 3% index gain means a 6% loss: $10,000 x 0.94 = $9,400. A $9,700 result would come from a 1x inverse fund. The $10,300 and $10,600 results have the direction wrong, as they treat the fund as if it gained when the index rose.

A U.S. investor owns a bond worth 10,000 euros. The bond's price in euros does not change, but the euro falls from $1.10 to $1.02. What is the investor's loss in dollars?

• a.$800✓
• b.$880
• c.$80
• d.$10,200

At $1.10 per euro the holding was worth $11,000. At $1.02 it is worth $10,200. The loss is $11,000 - $10,200 = $800, which is currency (exchange rate) risk even though the bond's price in euros was unchanged. The $880 figure takes 8 cents as 8% of the starting value, the $80 figure applies 8 cents once instead of to 10,000 euros, and $10,200 is the ending value, not the loss.

A certificate of deposit pays 4.5% a year while inflation runs at 3.1%. Using the simple approximation of nominal rate minus inflation, what is the investor's real return?

• a.4.5%
• b.-1.4%
• c.1.4%✓
• d.7.6%

The real return is the nominal return less inflation: 4.5% - 3.1% = 1.4%, the approximate gain in purchasing power. Adding the two figures gives 7.6%, which is not a purchasing power measure. The 4.5% figure is the nominal return, which ignores inflation. A result of -1.4% reverses the subtraction. This is purchasing power (inflation) risk: the nominal rate says nothing about what the money can buy.

An investor owns a mortgage pass-through security. Interest rates rise sharply and homeowners stop refinancing, so principal comes back more slowly than expected while the security's coupon is now below market rates. Which risk is the investor mainly experiencing?

• a.Reinvestment risk, because large cash flows must be put to work at lower rates
• b.Call risk, because the issuer is redeeming the security before maturity
• c.Extension risk, because the security's average life lengthens as prepayments slow✓
• d.Contraction risk, because principal is being returned early

Extension risk is the lengthening of a mortgage-backed security's average life when higher rates slow prepayments, leaving the investor holding a below-market coupon for longer. Contraction risk is the opposite, when falling rates speed prepayments and principal returns early. Principal is returning more slowly here, so there is no early redemption and no call. Reinvestment risk arises when cash comes back faster than expected and must be reinvested at lower rates, which is the opposite of this case.

An investor in a direct participation program needs cash after two years. There is no secondary market, and the only offer to buy her interest is at a deep discount to its value. Which risk has the investor run into?

• a.Purchasing power risk, because inflation has reduced the value of the proceeds
• b.Liquidity risk, because the interest cannot be sold quickly without a large price concession✓
• c.Interest rate risk, because rising rates have lowered the interest's price
• d.Credit risk, because the sponsor has failed to make a payment

Liquidity risk is the risk that an investment cannot be converted to cash quickly at a fair price. Direct participation program interests have no active market, so a seller who needs cash early may have to accept a steep discount. Nothing in the facts suggests the sponsor has defaulted, so credit risk is not the issue. The problem is not a rate move or inflation, which would affect the value of the interest rather than the ability to sell it.

Two competing manufacturers see sales fall by the same 15%. One is financed largely with debt, cannot cover its interest payments, and has its bonds downgraded. The other has no debt and stays profitable. Which risk explains the difference?

• a.Business risk, because the two firms operate in the same industry
• b.Market risk, because the sales decline reflects a market-wide fall in prices
• c.Financial risk, from the fixed interest obligations that come with borrowing✓
• d.Liquidity risk, because the bonds could not be sold at a fair price

Financial risk is the added risk of failing to meet fixed obligations that comes from financing with debt. Both firms faced the same business conditions, but the leveraged firm's fixed interest costs turned the same sales decline into a crisis. Business risk, which comes from the industry and operations, was identical for both and cannot explain the difference. Market risk is a broad price-level movement that would affect both alike. The difference arises from how each firm is financed, not from how easily the bonds trade.

Prices of tax-exempt municipal bonds fall while Congress debates eliminating the federal income tax exemption on their interest. Which risk is affecting bondholders?

• a.Credit risk, because the municipalities may be unable to pay interest
• b.Call risk, because the issuers may redeem the bonds early
• c.Interest rate risk, because market yields on all bonds have risen
• d.Legislative risk, because a change in law could reduce the value of the investment✓

Legislative risk is the chance that a change in law or regulation, here a change in tax treatment, will hurt the value of an investment. The bonds' tax exemption is a large part of their appeal, so the proposal alone can lower prices. Nothing indicates that the issuers' ability to pay has changed, so credit risk does not fit. Nothing suggests early redemptions. The price move comes from the policy debate, not from a general rise in market yields.

An investor puts $500 a month into a mutual fund for three months, when the price per share is $10, $8 and $5. What is the investor's average cost per share, to the nearest cent?

• a.$7.67
• b.$5.00
• c.$7.06✓
• d.$7.50

The investor buys 50 shares at $10, 62.5 shares at $8 and 100 shares at $5, for 212.5 shares and $1,500 invested. Average cost is $1,500 / 212.5 = $7.06. The $7.67 figure is the simple average of the three prices, which ignores that more shares are bought when the price is low. $7.50 is the midpoint of the high and low, and $5.00 is only the last price paid.

A $200,000 portfolio has a 60% stock and 40% bond target. After a rally, the stocks are worth $140,000 and the bonds $60,000. How much stock must be sold, with the proceeds going to bonds, to restore the target allocation?

• a.$80,000
• b.$10,000
• c.$20,000✓
• d.$28,000

At a 60% target, stocks should be worth 0.60 x $200,000 = $120,000. They are worth $140,000, so $20,000 of stock is sold and the proceeds buy bonds, bringing the bonds to $80,000, or 40%. Selling $10,000 only moves halfway. The $28,000 figure takes 20% of the stock value instead of the dollar gap to the target. Selling $80,000 would leave stocks at $60,000, matching the bonds, which is a 30% stock allocation.

An investor buys equal amounts of bonds maturing in 2, 4, 6, 8 and 10 years, and reinvests each maturing bond in a new 10-year bond. What is the main benefit of this laddered strategy?

• a.The investor earns the highest long-term yield on every dollar from the start
• b.The investor can time the market by selling the rungs that have risen in price
• c.Holdings are spread across several issuers, which lowers default risk
• d.Maturities are staggered, so only part of the portfolio is reinvested at any one set of interest rates✓

A ladder spreads maturities evenly, so cash returns at regular intervals and only a portion is reinvested at the then-current rates. That reduces the impact of rate changes on the whole portfolio. A ladder describes maturity dates, not issuers, so it does not diversify credit risk. Holding short maturities means that not every dollar earns the longest-term yield. A ladder is a steady approach, not an active strategy of selling bonds on price swings.

A client must pay a $50,000 tuition bill in 14 months and cannot accept a loss of principal. Which investment best matches the time horizon and the need to preserve principal?

• a.A high-yield bond fund, to earn more income before the bill is due
• b.A 30-year Treasury bond, to lock in a high yield
• c.A short-term U.S. Treasury security or a government money market fund✓
• d.A diversified stock index fund, to give the money time to grow

The goal is to have a known amount in 14 months, so the investment should be short-term and very low in credit risk and price volatility. Short-term Treasury securities and government money market funds fit both. A stock index fund can fall sharply within 14 months. A 30-year bond has a long maturity, so its price could drop if rates rise before the bill is due. A high-yield bond fund takes credit risk and price swings that the client has said cannot be tolerated.

A retiree wants a Treasury holding whose principal rises when the Consumer Price Index rises, so that the investment keeps pace with inflation. Which security matches that need?

• a.A Treasury STRIP, which pays a fixed amount at maturity
• b.A Treasury Inflation-Protected Security (TIPS), whose principal adjusts with changes in the CPI✓
• c.A 30-year Treasury bond, which pays a fixed coupon
• d.A Treasury bill, which is sold at a discount and matures within a year

TIPS principal is adjusted for changes in the Consumer Price Index, and the fixed interest rate is paid on the adjusted principal, so both the principal and the interest payments follow inflation. A STRIP is a zero-coupon security with a fixed face amount at maturity. A Treasury bond pays the same coupon on the same principal throughout its life. A Treasury bill is a short-term discount instrument with a fixed face value.

An investor's portfolio is concentrated in one stock. Which candidate offers the greatest diversification benefit, judged by its correlation with the stock already held?

• a.A correlation of -0.8✓
• b.A correlation of 0.0
• c.A correlation of +1.0
• d.A correlation of +0.5

The lower the correlation between assets, the more their price movements offset one another and the more risk is reduced. A correlation of -0.8 means the asset tends to move opposite to the existing stock, which gives the largest reduction in portfolio volatility. A correlation of +1.0 means the two move in lockstep, so there is no benefit. A correlation of +0.5 gives some benefit and 0.0 gives more, but neither is as strong as a negative correlation.

A customer bought XYZ at $80 and it now trades at $100. She enters a sell trailing stop order with a 10% trail. XYZ rises to $120 and then reverses. At what price does the order become a market order?

• a.$110.00, which is $10 below the $120 high
• b.$72.00, 10% below the original $80 cost
• c.$90.00, 10% below the price at order entry
• d.$108.00, which is 10% below the $120 high✓

A sell trailing stop ratchets upward as the stock makes new highs and never moves back down. With a 10% trail, the stop follows the $120 high to $108.00 (120 x 0.90), so the order becomes a market order when XYZ trades down to $108. The $90 level was only the starting stop and was raised along the way; $110 subtracts a fixed 10 points rather than 10 percent; $72 measures the trail from the purchase price, which a trailing stop does not do.

A customer holds a stock at $60 and enters a sell trailing stop with a $4 trail. The stock rises to $66, falls back to $63, climbs to $69, slips to $66.50 and then drops to $65. What happens when it trades at $65?

• a.The stop, now at $63, is reached and the order becomes a market order
• b.The stop, now at $65, is reached and becomes a market order✓
• c.The stop, still at $56, has not been reached and the order stays active
• d.The stop, now at $62, is reached and the order becomes a market order

The stop only moves up, following each new high by $4. The $69 high placed the stop at $65, so a trade at $65 converts the order to a market order. The $62 level was in force after the $66 high but was replaced when $69 printed; $56 is the starting stop ($60 - $4) that was raised as the stock climbed; $63 was merely the low of the first pullback and has no role in the stop price.

A customer owns 200 shares of ABC at $48 and enters a sell stop-limit order with a $45.00 stop and a $44.50 limit. After bad news, ABC opens at $43.00 and trades between $42.50 and $43.50 all day. What is the result?

• a.Canceled at the open, because the stock gapped through the stop price
• b.Triggered but not filled, because ABC never trades at $44.50 or higher✓
• c.Filled at exactly $44.50, because the limit price is guaranteed to the customer
• d.Filled near $43.00, because a stop becomes a market order when triggered

A stop-limit order becomes a limit order, not a market order, once the stop price trades. Here the limit is $44.50 and the stock never trades that high, so the order stays open unfilled; the price is protected but execution is not. A plain stop order would convert to a market order and fill near $43. A limit price guarantees a floor, not a fill. Gapping through the stop does not cancel the order.

A customer enters a limit order to buy 5,000 shares of DEF at $20.00, marked fill-or-kill (FOK). Only 3,000 shares are offered at $20.00 when the order reaches the market. What is the outcome?

• a.3,000 shares are bought, and the other 2,000 rest on the book until the close
• b.No shares are bought, and the entire 5,000-share order is canceled immediately✓
• c.3,000 shares are bought, and the unfilled 2,000 shares are canceled immediately
• d.No shares are bought, and the order stays on the book until all 5,000 can be filled

A fill-or-kill order must be executed immediately and in its entirety, or it is canceled in full. Buying 3,000 and canceling the rest describes an immediate-or-cancel order. Buying 3,000 and leaving 2,000 on the book describes an ordinary day limit order. Waiting for the full 5,000 describes an all-or-none order, which, unlike FOK, remains working.

A customer places a day order to sell 10,000 shares of GHI with an all-or-none (AON) instruction. At 10:15 a.m., buyers are available for only 6,000 shares at the limit price. What happens?

• a.6,000 shares are sold, and the remaining 4,000 shares keep working until the close
• b.Nothing executes, and the order keeps working until 10,000 shares can be sold or the day ends✓
• c.Nothing executes, and the entire order is canceled immediately because it cannot be completed
• d.6,000 shares are sold, and the remaining 4,000 shares are canceled immediately

An all-or-none order may execute only in its entirety, but it does not have to execute immediately; it stays active until it can be completed or it expires. Selling 6,000 and canceling the rest is an immediate-or-cancel result, canceling everything at once is fill-or-kill, and a partial fill with the balance still working is how an ordinary day limit order behaves.

At 2:00 p.m. a customer enters a market-on-close (MOC) order to sell 500 shares of JKL, which last traded at $30.10. JKL's official closing price is $29.40. At what price does the order execute?

• a.$29.95, the day's volume-weighted average
• b.$30.10, the last price before order entry
• c.$29.40, the official closing price for JKL✓
• d.$30.25, the opening price on that day

A market-on-close order is designed to execute at the closing price, so it fills at $29.40 regardless of where the stock traded when the order was entered. The price at entry, the volume-weighted average price and the opening price are different reference points, and none of them is what a MOC order is tied to.

Under SEC Rule 17a-3(a)(6), which item must a firm's memorandum of a customer's brokerage order show?

• a.The customer's investment objective and risk tolerance
• b.The customer's annual income and total net worth
• c.Whether the order was entered under discretionary authority✓
• d.The customer's taxpayer identification number on file

The order memorandum records the order itself: its terms and any changes, the account, the time of receipt and entry, the price, the responsible associated person, and whether the order was entered under discretionary authority. Income and net worth, investment objectives and risk tolerance, and the taxpayer identification number are customer-account information kept on the account record, not on the individual order ticket.SEC Rule 17a-3(a)(6)

A customer phones her representative and asks to buy 500 shares of a speculative biotech stock that the representative has never mentioned to her. The representative thinks the stock is too risky for her. How should the order be handled?

• a.Execute it as recommended, since voicing concerns is a recommendation
• b.Execute it and mark it unsolicited, as no advice was given✓
• c.Execute it only after a principal reviews and approves the order
• d.Refuse it, because Regulation Best Interest bars risky trades

Regulation Best Interest applies to recommendations. A customer-initiated order the representative never suggested is unsolicited, so it can be executed and should be marked unsolicited; voicing concerns about it does not change that. Refusing, or relabeling the trade as recommended, misreads the rule, and principal pre-approval is not what the rule requires for an unsolicited order.Regulation Best Interest (17 CFR 240.15l-1)

Three buy limit orders at $25.00 sit on an exchange's book in this sequence: 500 shares entered at 9:35, 1,000 shares at 9:40 and 200 shares at 9:42. A seller then sells 1,200 shares at $25.00 into the book. Applying price-time priority, how is the sale filled?

• a.The second order fills 1,000, the first fills 200, and the third gets none
• b.The third order fills 200, then the first and second fill 500 each
• c.The first fills 500, the second fills 700, the third gets none✓
• d.All three orders share the 1,200 shares in proportion to their sizes

At the same price, the order that arrived first has priority, so the 9:35 order fills in full (500) and the 9:40 order receives the remaining 700; the 9:42 order is not reached. Pro-rata sharing and size-based priority are allocation methods used in some other markets but not price-time priority, and nothing about the smallest order going first applies at all.

A member firm reviews the quality of its customer-order executions once a year and believes that satisfies the FINRA Rule 5310 best-execution requirement. Is the firm in compliance?

• a.Yes, if a principal signs off on the annual review each year
• b.Yes, an annual review satisfies best execution for customer orders
• c.No, the rule requires a monthly review of each execution venue
• d.No, regular and rigorous reviews are required at least quarterly✓

Supplementary Material .09 to Rule 5310 requires regular and rigorous reviews of execution quality at a minimum on a quarterly basis, more often if the firm's business warrants. An annual cycle is too infrequent, and principal sign-off does not cure that. The rule sets no monthly, venue-by-venue minimum, so that option overstates the requirement.FINRA Rule 5310

A dealer sells a customer 300 shares of PQR at $41.60. The dealer bought the shares for its own inventory two hours earlier at $40.00, and the prevailing market price has not changed. What is the percentage markup?

• a.3.85%, measured on the $41.60 sale price
• b.4.0%, based on the $40.00 market price✓
• c.5.0%, the figure from the FINRA 5% policy
• d.1.6%, the dollar markup stated as a percent

Markup is measured from the prevailing market price, and the dealer's own contemporaneous cost is the best evidence of that price. The markup is $41.60 - $40.00 = $1.60 per share, and $1.60 / $40.00 = 4.0%. Dividing by the sale price gives 3.85%, which uses the wrong base. Writing $1.60 as 1.6% confuses dollars with a percentage. The 5% policy is a guide to fairness, not a calculation result.FINRA Rule 2121

A customer sells 500 shares of STU to a dealer, and the dealer pays $12.00 per share. The prevailing market price at that time is $12.50. What is the dealer's total markdown?

• a.$0.50, the per-share difference only
• b.$6,250, the value of the shares at the market price
• c.$6,000, the total amount paid to the customer
• d.$250, which is $0.50 per share on 500 shares✓

A markdown is the amount by which the price paid to the customer falls below the prevailing market price. Here it is $12.50 - $12.00 = $0.50 per share, and $0.50 x 500 shares = $250. Stopping at $0.50 skips the multiplication by the share count. $6,000 (500 x $12.00) is what the customer received and $6,250 (500 x $12.50) is the market value; neither is the markdown.FINRA Rule 2121

A firm wants to execute a net transaction with a retail (non-institutional) customer, charging no separate commission. What must the firm obtain before it executes the order?

• a.A negative-consent letter sent when the account was opened
• b.Oral consent given once when the account was opened
• c.Written customer consent for that specific order✓
• d.The customer's signature on the confirmation after execution

For a customer who is not an institutional customer, Rule 2124 requires written consent obtained order by order before the net transaction is executed. A one-time oral consent or a negative-consent letter at account opening does not meet that standard, and a signature on the confirmation comes after execution, too late. Some of those methods are open only for institutional customers.FINRA Rule 2124

The best protected offer for VWX is $20.00 on Exchange A. A broker-dealer executes a customer's market order to buy 100 shares on Exchange B at $20.03 and none of the Rule 611 exceptions applies. What is the issue?

• a.It is a trade-through, because a better-priced protected quote was bypassed✓
• b.It is a locked market, because two exchanges show different offers
• c.It is a free-riding violation by the customer on Exchange B
• d.There is no issue, because a market order accepts any available price

Rule 611 (the Order Protection Rule) requires policies to prevent executions at prices inferior to protected quotations displayed by other trading centers. Buying at $20.03 when $20.00 was protected and accessible is a trade-through unless an exception, such as an intermarket sweep order, applies. A market order does not waive the rule. A locked market is a bid equal to an offer, and free-riding concerns payment for securities, not routing.Regulation NMS Rule 611

A dark pool that matches institutional orders without displaying them to the public operates as an alternative trading system (ATS). Which statement about it is correct?

• a.It must register with the SEC as a national securities exchange
• b.Its executions are exempt from trade reporting
• c.It may not trade securities that are listed on an exchange
• d.It must register as a broker-dealer and comply with Regulation ATS✓

An ATS matches buyers and sellers but is not an exchange. Regulation ATS requires it to register as a broker-dealer, and it then operates under Regulation ATS in place of exchange registration. Dark pools can and do trade exchange-listed stocks, and their trades are reported to a FINRA facility, so exemption from reporting is incorrect.Regulation ATS, 17 CFR 242.301(b)(1)

A Level 2 screen for MNO shows offers of 800 shares at $25.00 and 400 shares at $25.06, with larger sizes at higher prices. A customer enters a market order to buy 1,200 shares, and these are the only offers reached. What is the average execution price?

• a.$25.06
• b.$25.03
• c.$25.02✓
• d.$25.00

A market buy order takes the lowest offers first. The first 800 shares cost 800 x $25.00 = $20,000 and the next 400 cost 400 x $25.06 = $10,024. The total is $30,024, and $30,024 / 1,200 = $25.02. Using only the best offer gives $25.00. Averaging the two prices without weighting gives $25.03, and $25.06 is simply the last price reached.

A customer places an order to buy 400 shares of YZA. After receiving it, the firm buys 400 shares in the market at $48.00 and confirms them to the customer at $49.80 as principal. What is the firm's total markup?

• a.$1.80
• b.$19,920
• c.$19,200
• d.$720✓

When a firm fills a customer order by buying in the market, its contemporaneous cost is the best evidence of the prevailing market price. The markup is $49.80 - $48.00 = $1.80 per share, and $1.80 x 400 = $720. The per-share figure alone is incomplete, $19,200 is the firm's cost (400 x $48.00), and $19,920 is the customer's total price (400 x $49.80).FINRA Rule 2121

A dealer sells a stock from inventory at 4.2% above the prevailing market price. Under FINRA Rule 2121, which statement is correct?

• a.The 5% policy is a hard ceiling, so only markups above it can be unfair
• b.Markups of 5% or less are automatically within the rule
• c.A markup below 5% can still be unfair, because the 5% policy is only a guide✓
• d.The 5% figure is measured from the customer's price, not the market price

The 5% policy is a guide, not a rule. Whether a markup is fair depends on all relevant factors, including the price of the security, the size of the order and the services provided, so even a markup under 5% can be unfair. The policy is not a safe harbor or a hard ceiling, and markups are measured from the prevailing market price.FINRA Rule 2121

A customer sells short 200 shares of BCD at $60.00 and later buys them back at $71.25 to close the position. Ignoring commissions and interest, what is the result?

• a.A gain of $2,250
• b.A loss of $12,000
• c.A loss of $2,250✓
• d.A loss of $14,250

A short seller profits when the price falls and loses when it rises. The loss per share is $71.25 - $60.00 = $11.25, and $11.25 x 200 = $2,250. Calling it a gain reverses the direction. $14,250 (200 x $71.25) is the cost to cover, and $12,000 (200 x $60.00) is the original proceeds; neither is the difference.

A customer sells short 500 shares of EFG at $30.00 in a new margin account. Under Regulation T, what initial deposit is required?

• a.$22,500
• b.$3,750
• c.$7,500✓
• d.$15,000

Regulation T requires a short sale account to hold 150% of the current market value: the proceeds plus 50% equity. The short sale is worth 500 x $30.00 = $15,000, and the customer's own deposit is 50% of that, or $7,500; the $15,000 sale proceeds are credited to the account to make the 150%. $3,750 is 25% of the value, a long-position maintenance level and not the Regulation T deposit. $15,000 is a 100% deposit, and $22,500 is the total 150% held in the account, not the customer's deposit.Regulation T, 12 CFR 220.12

A customer is short 400 shares of HIJ when the company pays a $0.75 per share cash dividend and the stock goes ex-dividend. What happens in the customer's margin account?

• a.Nothing is posted, as a short seller owns no shares earning a dividend
• b.$300 is debited, because the short seller owes the lender the dividend✓
• c.$300 is credited, because a dividend adds to the short sale proceeds
• d.The $300 comes from the escrowed proceeds, with no balance change

A short seller borrowed the shares, and the lender is entitled to the dividend it would have received. The short seller must make a payment in lieu of the dividend of 400 x $0.75 = $300, which is debited from the margin account. It is not a credit. Having no shares does not remove the obligation, and the debit is a real charge to the customer rather than an internal transfer of proceeds.

A broker-dealer's customer sells short on Monday, October 5, 2026, and the broker-dealer fails to deliver on the T+1 settlement date. By when must the position be closed out under Rule 204, assuming no holidays?

• a.Before the open on Tuesday, October 6
• b.Before the open on Wednesday, October 7✓
• c.Before the open on Friday, October 9
• d.Before the open on Monday, October 12

T+1 settlement puts the settlement date on Tuesday, October 6. Rule 204 requires a short-sale fail to be closed out by the beginning of regular trading hours on the settlement day after the settlement date, which is Wednesday, October 7. Friday, October 9 is the third consecutive settlement day, the deadline for a long-sale fail. Tuesday is the settlement date itself, too early, and Monday, October 12 is beyond any applicable deadline.Regulation SHO Rule 204

A customer sells short 100 shares of KLM at $42.50 and pays a $20 commission on the sale and a $20 commission on the purchase to cover. Ignoring interest, at what cover price does the customer break even?

• a.$42.50
• b.$42.90
• c.$42.30
• d.$42.10✓

Net proceeds are 100 x $42.50 - $20 = $4,230. Covering costs 100 x P + $20, so breakeven requires 100P + $20 = $4,230, which gives P = $42.10. Commissions on both sides push the breakeven below the sale price, not above it. $42.50 ignores commissions, $42.30 deducts only one commission, and $42.90 adds the commissions as if they helped the seller.

An investor bought a stock at $40.00. A year later it trades at $43.00 after paying $1.60 per share in dividends during the year. What is the total return?

• a.10.7%
• b.4.0%
• c.7.5%
• d.11.5%✓

Total return combines price change and income: ($43.00 - $40.00 + $1.60) / $40.00 = $4.60 / $40.00 = 11.5%. The 7.5% figure counts only the $3.00 price gain, and 4.0% counts only the $1.60 dividend. Dividing $4.60 by the ending price of $43.00 gives 10.7%, which uses the wrong base; return is measured on the amount invested.

A stock trades at $60.00 and pays a regular dividend of $0.60 each quarter. What is its current yield?

• a.4.0%✓
• b.1.0%
• c.2.4%
• d.25.0%

Current yield is the annual dividend divided by the current market price. The annual dividend is 4 x $0.60 = $2.40, and $2.40 / $60.00 = 4.0%. Using one quarterly payment gives 1.0%. The figure 2.4% is the annual dividend in dollars written as a percent, and 25.0% inverts the ratio ($60.00 / $2.40).

A fund charges an annual management fee of 85 basis points. What is the yearly fee on a $24,000 investment?

• a.$2,040
• b.$850
• c.$20.40
• d.$204✓

One basis point is 0.01%, so 85 basis points is 0.85%, or 0.0085. The fee is $24,000 x 0.0085 = $204 per year. $20.40 moves the decimal one place too far, treating 85 bp as 0.085%. $2,040 treats it as 8.5%, and $850 multiplies 85 by ten and attaches a dollar sign.