FINRA SIE — Securities Industry Essentials — All Questions

An investor wants to sell a thinly traded municipal bond quickly but can only do so by accepting a much lower price. This difficulty illustrates:

• a.Bond issuer credit (default) risk
• b.Coupon reinvestment (rate) risk
• c.Liquidity (marketability) risk✓
• d.Interest-rate risk on long bonds

Liquidity or marketability risk is the danger that an investor cannot sell a security quickly at a fair price, which is common with thinly traded bonds. It is distinct from interest-rate, credit, and reinvestment risk, which concern price sensitivity, default, and reinvesting cash flows.

Which type of risk can an investor most effectively reduce through diversification across many different securities?

• a.Inflation (purchasing-power) risk
• b.Interest-rate (price) risk on bonds
• c.Unsystematic (business/specific) risk✓
• d.Market (systematic, economy-wide) risk

Unsystematic risk is specific to a single company or industry and can be greatly reduced by holding a diversified portfolio. Market, interest-rate, and inflation risks are systematic and affect the whole market, so diversification cannot eliminate them.

Market (systematic) risk is best described as the risk that:

• a.A particular stock will be hard to sell quickly at a fair price in a thin market
• b.A single company's management will run its operations poorly and lose market share
• c.Broad market declines will affect nearly all securities regardless of the individual issuer✓
• d.A specific bond issuer will default and miss both its scheduled interest and principal payments

Market or systematic risk affects the entire market from broad factors like recessions or rate shifts, so it cannot be diversified away. Company mismanagement is business risk, issuer default is credit risk, and difficulty selling is liquidity risk.

An investor buys a short-term bond and, when it matures, can only reinvest the proceeds at a lower interest rate than before. This describes:

• a.Default (credit) risk
• b.Call redemption risk
• c.Exchange rate risk
• d.Reinvestment risk✓

Reinvestment risk is the danger that maturing principal or coupon payments must be reinvested at lower prevailing rates, reducing future income. It differs from call risk (early redemption), credit risk (default), and currency risk (exchange rates).

Compared with a long-term bond, a short-term bond of the same issuer generally has:

• a.Higher interest-rate risk and higher purchasing-power risk
• b.Identical interest-rate risk and reinvestment risk
• c.Lower interest-rate risk but higher reinvestment risk✓
• d.Higher interest-rate risk but lower reinvestment risk

Short-term bonds have less price sensitivity to rate changes (lower interest-rate risk) but must be reinvested sooner, exposing the investor to more reinvestment risk. Longer bonds show the opposite trade-off, so the risks are not identical.

An investor buys an ADR of a European company. Even if the company performs well, the investor's dollar return can be reduced by:

• a.Bond call (early redemption) risk
• b.Mortgage pool prepayment risk
• c.Currency (exchange-rate) risk✓
• d.Bond reinvestment rate risk

Because the ADR's value is tied to a foreign stock, a decline in the foreign currency relative to the dollar can lower the investor's dollar-denominated return even if the company does well. Reinvestment, call, and prepayment risks apply to bonds, not this equity currency exposure.

Which statement about the risk-return relationship of common stock versus corporate bonds of the same company is generally TRUE?

• a.Common stock offers a guaranteed rate of return, unlike the company's bonds, which may default
• b.Bonds rank behind common stock in a bankruptcy liquidation, so bondholders are paid last
• c.Common stock typically carries higher risk and higher potential return than the company's bonds✓
• d.Bonds outperform the company's stock in any year in which reported earnings decline

Common stock is a residual claim with no fixed payment and last priority in bankruptcy, so it carries higher risk and higher potential return than the same company's bonds. Bonds do not always outperform, stock returns are not guaranteed, and bonds rank ahead of stock in bankruptcy.

A stock's par value on the balance sheet primarily represents:

• a.An arbitrary accounting value assigned to each share, unrelated to market price✓
• b.The current market price at which the stock most recently traded today
• c.The guaranteed price at which the company promises to repurchase the shares on demand
• d.The minimum annual dividend the company is required to pay on each share

For common stock, par value is an arbitrary bookkeeping figure with little relation to the share's actual market price. It is not the market price, a repurchase guarantee, or a required dividend.

Banker's acceptances are money-market instruments most commonly used to finance:

• a.Long-term corporate plant expansion financed over twenty years
• b.International trade transactions such as imports and exports✓
• c.The federal government's budget deficit through Treasury auctions
• d.Municipal water and sewer infrastructure construction projects

A banker's acceptance is a short-term, bank-guaranteed instrument that facilitates international trade by financing goods in transit for importers and exporters. It is not used for long-term expansion, municipal projects, or federal deficits.

An investor seeking regular income with more safety than common stock, but a higher fixed payment priority, would MOST likely choose:

• a.Stock rights of the same company
• b.Additional common shares
• c.Warrants of the same company
• 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. Warrants and rights are speculative equity instruments, and more common stock would not add income priority.

Which feature is characteristic of an open-end investment company (mutual fund)?

• a.It continuously issues new shares and redeems them at net asset value✓
• b.It issues a fixed number of shares in a single one-time offering
• c.It trades on an exchange at prices set purely by supply and demand
• d.It holds a fixed, unmanaged portfolio of bonds until a termination date

An open-end fund continuously offers new shares to the public and stands ready to redeem outstanding shares at their net asset value. Because purchases and redemptions occur at NAV rather than on an exchange, the number of shares outstanding constantly changes. This structure is defined under the Investment Company Act of 1940.Investment Company Act of 1940

A mutual fund has total assets of $50 million, total liabilities of $2 million, and 4 million shares outstanding. What is the net asset value (NAV) per share?

• a.$13.00
• b.$12.00✓
• c.$12.50
• d.$10.00

NAV per share equals (total assets minus total liabilities) divided by shares outstanding: ($50,000,000 - $2,000,000) / 4,000,000 = $12.00. NAV is the price at which shares are redeemed and, for a no-load fund, purchased.Investment Company Act of 1940

An investor plans to make a large lump-sum investment and hold it for 20 years. Which mutual fund share class is generally most cost-effective for this investor?

• a.Any class, because the total cost of every share class is identical over 20 years
• b.Class C shares, because the level 12b-1 fee is cheapest for long holding periods
• c.Class A shares, because of front-end breakpoint discounts and lower ongoing fees✓
• d.Class B shares, because the contingent deferred sales charge is waived immediately

Class A shares charge a front-end sales load but offer breakpoint discounts on large purchases and typically carry the lowest ongoing 12b-1 fees. For a large, long-term investment, the reduced annual expenses usually outweigh the up-front charge, making Class A the most economical choice.FINRA Rule 2341

Class B mutual fund shares are best described as shares that:

• a.Are no-load shares whose distribution costs the adviser pays from its own management fee
• b.Carry a contingent deferred sales charge that declines over time and often convert to Class A✓
• c.Charge a front-end sales load deducted from each payment at the time of purchase
• d.Are sold only to institutional investors at net asset value with no sales charge or annual 12b-1 fee

Class B shares impose a contingent deferred sales charge (CDSC), or back-end load, that is paid if shares are redeemed within a certain number of years and declines the longer they are held. They usually carry higher 12b-1 fees than Class A and often convert to Class A shares after the CDSC period ends.FINRA Rule 2341

An investor wants to invest a modest amount for only about two to three years. Which share class is often most appropriate?

• a.Class A shares, because the front-end breakpoint discount is largest on small buys
• b.Class C shares, because of no front-end load and a short-lived, small back-end charge✓
• c.Class B shares, to benefit from the long declining CDSC schedule over six years
• d.No-load shares, which FINRA prohibits for holding periods under five years

Class C shares typically carry no front-end load and only a small contingent deferred sales charge that lapses after about one year, but they have a higher ongoing 12b-1 fee. For a small, short-term investment, avoiding the front-end load makes Class C often more suitable than Class A or B.FINRA Rule 2341

A Letter of Intent in a mutual fund purchase allows an investor to:

• a.Convert Class C shares into Class A shares automatically after the first 13 months
• b.Count purchases of unrelated clients of one representative toward a breakpoint
• c.Qualify now for a breakpoint discount by pledging to invest a set amount within 13 months✓
• d.Receive the breakpoint discount only after the full pledged amount is invested

A Letter of Intent (LOI) lets an investor obtain the reduced sales charge of a breakpoint immediately by committing to invest the required amount over a stated period, usually 13 months. If the investor fails to reach the target, the fund adjusts the sales charge on the shares already purchased. The discount is available on each purchase from the start, not only after the full amount is invested. An LOI covers the investor's own commitment, so it cannot pool unrelated clients, and it does not convert share classes automatically or waive deferred sales charges. It carries no guaranteed return.FINRA Rule 2341(d) and FINRA breakpoint guidance

Breakpoints on Class A shares reduce the sales charge based on the size of the investment. Which of the following would typically qualify a purchase for a breakpoint discount?

• a.A registered representative splitting one large order into several smaller tickets across days
• b.Buying just below the breakpoint amount so the client avoids the extra paperwork and delay
• c.Combining the accounts of several unrelated clients of the same representative to reach the threshold
• d.A single investor's purchase, together with holdings by their spouse and dependent children, reaching the threshold✓

Breakpoint discounts apply based on the total investment made by a single account, including purchases combined across an individual, their spouse, and dependent children. Combining unrelated investors is not permitted, and deliberately selling just below a breakpoint (breakpoint selling) is a violation.FINRA Rule 2342 and FINRA breakpoint guidance

A registered representative recommends that a client invest $24,000, an amount just under a $25,000 breakpoint, so the transaction avoids reduced sales charges. This practice is known as:

• a.Breakpoint selling✓
• b.A combination privilege
• c.Dollar-cost averaging
• d.Rights of accumulation

Breakpoint selling is the unethical practice of recommending a purchase just below a breakpoint threshold to earn a higher sales charge, depriving the client of a discount. It is a violation of FINRA rules. Rights of accumulation and combination privileges, by contrast, are legitimate ways to reach breakpoints.FINRA Rule 2342

Shares of a closed-end investment company:

• a.Trade on an exchange and may sell at a premium or discount to net asset value✓
• b.Are redeemed directly by the fund at net asset value on demand
• c.Are bought and sold at net asset value plus a maximum 8.5% sales load
• d.Represent a fixed, unmanaged portfolio that self-liquidates at maturity

A closed-end fund issues a fixed number of shares in an IPO, after which the shares trade on an exchange or over the counter. Their market price is set by supply and demand and can be above (a premium) or below (a discount) the fund's net asset value, unlike open-end fund shares that transact at NAV.Investment Company Act of 1940

Which statement correctly distinguishes a closed-end fund from an open-end fund?

• a.An open-end fund's shares trade on an exchange at a premium or discount to NAV, while closed-end shares are redeemed by the issuer
• b.A closed-end fund has a fixed number of shares that trade in the secondary market, while an open-end fund issues and redeems shares at NAV✓
• c.Only a closed-end fund may borrow or issue senior securities, since the Investment Company Act bars open-end funds from any leverage
• d.Both types continuously issue new shares and redeem them at net asset value, differing only in the sales charge each may impose

The key structural difference is capitalization: a closed-end fund raises capital once through a fixed share offering, and those shares then trade in the secondary market at market prices. An open-end fund has a variable number of shares that it continuously issues and redeems at net asset value.Investment Company Act of 1940

Which of the following is generally TRUE of an exchange-traded fund (ETF)?

• a.It may not be sold short or purchased on margin in a brokerage account
• b.It trades throughout the day on an exchange at market-determined prices✓
• c.It can only be bought or sold once per day at the closing NAV
• d.It must be actively managed by a portfolio manager to beat an index

ETFs trade intraday on an exchange like a stock, so investors can buy or sell at market prices at any time during the trading session, and shares may be bought on margin or sold short. Many ETFs track an index passively, though some are actively managed. This intraday tradability distinguishes ETFs from open-end mutual funds.Investment Company Act of 1940

An investor wants to place a limit order and trade intraday, and to be able to use stop orders. Compared with a traditional open-end mutual fund, which product better meets these needs?

• a.Neither, because SEC rules bar limit and stop orders on any pooled investment product
• b.A unit investment trust, because units trade like stocks and are repriced each minute by its sponsor
• c.A traditional open-end mutual fund, because its shares are priced continuously during the session
• d.An ETF, because it trades on an exchange throughout the day and supports limit and stop orders✓

Because ETFs trade on exchanges throughout the day, investors can use limit orders, stop orders, and trade at intraday prices. Traditional open-end mutual fund shares are priced only once per day at the next calculated NAV (forward pricing), so intraday order types do not apply to them.Investment Company Act of 1940

A distinguishing feature of a unit investment trust (UIT) is that it:

• a.Holds a fixed portfolio of securities that is not actively managed and has a set termination date✓
• b.Charges a contingent deferred sales load that rises the longer an investor continues to hold the units
• c.Employs an investment adviser who continuously trades the portfolio in an effort to beat a benchmark
• d.Continuously issues and redeems new shares at net asset value each business day like an open-end fund

A UIT is an investment company that buys a fixed portfolio of securities and holds it, without active management, until a predetermined termination date. It issues redeemable units representing an undivided interest in the portfolio and has no board of directors or investment adviser making ongoing trading decisions.Investment Company Act of 1940

When a unit investment trust reaches its predetermined termination date, what typically happens?

• a.The sponsor appoints a new portfolio manager and the trust continues indefinitely
• b.The trust automatically converts into an open-end mutual fund and holders receive fund shares
• c.Unit holders must roll their units into the sponsor's next trust series and may not elect cash
• d.The underlying securities are sold or distributed and proceeds are returned to unit holders✓

A UIT has a fixed life. When it reaches its stated termination date, the trust dissolves: the underlying portfolio is liquidated or distributed and the proceeds are paid to unit holders. This contrasts with a managed fund, which has no set termination date.Investment Company Act of 1940

To qualify for favorable tax treatment as a real estate investment trust (REIT), the entity must distribute to shareholders at least:

• a.100% of its gross rental revenue
• b.50% of its net investment income
• c.90% of its taxable income✓
• d.75% of its capital gains

A REIT that distributes at least 90% of its taxable income to shareholders generally avoids federal income tax at the corporate level on the distributed amount, passing income through to investors. REITs let investors participate in income-producing real estate, and equity REITs own property while mortgage REITs finance it.Internal Revenue Code Section 857(a)(1)

An investor wants exposure to real estate that generates income from mortgage interest rather than from owning and renting property. Which product best fits?

• a.A direct participation program in raw land
• b.A mortgage REIT✓
• c.An equity REIT
• d.A UIT of municipal bonds

A mortgage REIT invests in real estate loans and mortgage-backed securities, earning income primarily from the interest on those mortgages. An equity REIT, by contrast, owns and operates income-producing properties, deriving income mainly from rents.Internal Revenue Code Section 856

In a fixed annuity, who bears the investment risk?

• a.A separate account run by the insurer's portfolio manager
• b.The annuitant, whose payments vary with market performance
• c.The broker-dealer that sold and services the contract
• d.The insurance company, which guarantees a stated rate of return✓

A fixed annuity guarantees a minimum rate of return and a fixed payout, so the insurance company assumes the investment risk and funds the contract from its general account. Because there is no securities investment risk to the buyer, a fixed annuity is an insurance product and generally not a security.Securities Act of 1933 Section 3(a)(8)

A variable annuity differs from a fixed annuity primarily because the variable annuity:

• a.Is not considered a security under the Securities Act of 1933, so no prospectus is required
• b.Guarantees both the principal and a fixed monthly payment for life from the insurer's general account
• c.Invests premiums in a separate account, so payouts vary with investment performance and the investor bears the risk✓
• d.May be sold by insurance agents holding only a state life license, with no securities registration

A variable annuity invests contributions in a separate account holding subaccounts of securities, so the value and payouts fluctuate with investment performance and the contract owner bears the investment risk. Because of this securities exposure, a variable annuity is both an insurance product and a security, requiring a prospectus and a securities registration to sell.Investment Company Act of 1940

An equity-indexed annuity typically credits interest based on:

• a.A rate that floats each day with short-term Treasury bill yields
• b.The performance of a securities index, subject to a cap and a guaranteed minimum✓
• c.A dividend rate declared each quarter by the insurer's board of directors
• d.The performance of a single variable subaccount the contract owner selects

An equity-indexed (or fixed-indexed) annuity credits interest linked to the return of a market index, such as the S&P 500, but limits the upside with a participation rate or cap and provides a guaranteed minimum return. It sits between a fixed and a variable annuity in risk and reward.Securities Act of 1933 Section 3(a)(8)

A 68-year-old retiree wants guaranteed lifetime income and cannot tolerate any loss of principal. Which product is most suitable?

• a.A leveraged sector ETF
• b.A direct participation program in oil and gas exploration
• c.A variable annuity invested aggressively in equity subaccounts
• d.A fixed annuity providing a guaranteed income stream for life✓

A fixed annuity offers a guaranteed rate and a guaranteed lifetime income stream with no market risk to principal, matching the retiree's need for safety and predictable income. A variable annuity or leveraged ETF exposes principal to market loss, and a DPP is illiquid and speculative, making them unsuitable here.Securities Act of 1933 Section 3(a)(8)

During the pay-in (accumulation) phase of a variable annuity, an investor's contributions purchase:

• a.Accumulation units, whose number is fixed at annuitization to compute annuity units✓
• b.Guaranteed interest certificates that the insurer redeems at par on demand
• c.Shares of the insurer's own common stock held in its general account
• d.Annuity units, whose fluctuating value sets the size of each monthly payout

In the accumulation phase, contributions buy accumulation units whose value fluctuates with the separate account's performance. At annuitization, the accumulated value is converted into a fixed number of annuity units, and the value of each annuity unit then determines the varying monthly payment during the payout phase.Investment Company Act of 1940

Which statement about the two phases of an annuity is correct?

• a.Once annuitized, the contract may be surrendered for a lump sum at any time with no charge or restriction
• b.The annuitization phase comes first and ends at age 59 1/2, when the accumulation phase pays income
• c.Earnings during the accumulation phase are taxed each year as ordinary income at the owner's top rate
• d.The accumulation phase is when money is paid in and grows tax-deferred; the annuitization (payout) phase is when income is paid out✓

An annuity has an accumulation phase, during which contributions are invested and grow tax-deferred, and an annuitization or payout phase, when the accumulated value is converted into an income stream. Taxes on earnings are deferred until withdrawal, and once a contract is annuitized the income election generally cannot be undone.Investment Company Act of 1940

A variable life insurance policy is considered a security because:

• a.It is issued only by federally chartered banks rather than by licensed insurance companies
• b.Its death benefit is fixed at issue by the insurer's general account, apart from subaccount results
• c.It guarantees a fixed minimum cash value and a set rate of return regardless of market results
• d.Its cash value is invested in separate account subaccounts, so it fluctuates with investment performance✓

Variable life insurance places policy cash values in separate account subaccounts of securities, so the cash value and potentially the death benefit vary with investment performance and the policyholder bears investment risk. Because of this securities exposure, variable life is regulated as both insurance and a security, requiring a prospectus and securities registration to sell.Investment Company Act of 1940

The buyer (holder) of a call option has the right to:

• a.Sell the underlying stock at the exercise price, the way a put holder does
• b.Buy the underlying stock at the market price when the option expires
• c.Compel the issuer to issue new shares to the holder on demand
• d.Buy the underlying stock at the strike price✓

A call option gives its buyer the right, but not the obligation, to buy the underlying security at the strike (exercise) price before expiration. Selling at the strike price is the right a put gives. The holder pays the strike price on exercise, not the market price on the expiration date. The other side of an exercised listed option is the writer, not the issuer, so no new shares are created. Call buyers are generally bullish, profiting if the underlying price rises above the strike plus the premium paid.

An investor who buys a put option is generally:

• a.Neutral, expecting no price movement
• b.Bearish, expecting the underlying price to fall✓
• c.Bullish, expecting the underlying price to rise
• d.Obligated to buy the underlying stock at the strike

The buyer of a put has the right to sell the underlying security at the strike price and profits when the underlying price falls below the strike minus the premium paid. Put buyers are therefore bearish, and they may also buy puts to hedge (protect) a long stock position.

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

• a.Pay the option holder each quarter's dividend until expiration
• b.Do nothing; a writer's duty ends once the call goes out of the money
• c.Deliver (sell) the underlying stock at the strike if the holder exercises✓
• d.Buy the underlying stock at the strike price if the holder exercises

A call writer receives the premium and, in exchange, is obligated to sell (deliver) the underlying security at the strike price if the holder exercises the call. The writer is bearish to neutral and faces potentially unlimited loss on an uncovered (naked) call as the stock price rises.

An investor writes (sells) a put option. This investor:

• a.Is obligated to buy the stock at the strike price if exercised, and is generally bullish to neutral✓
• b.Profits most when the stock falls sharply below the strike, since the premium grows with the decline
• c.Holds the right, but not the obligation, to sell the stock at the strike price until expiration
• d.Has unlimited profit potential, since the gain keeps growing as the stock price falls toward zero

A put writer receives a premium and takes on the obligation to buy the underlying stock at the strike price if the holder exercises. The writer profits if the stock stays above the strike (the put expires worthless) and is therefore bullish to neutral; the maximum loss occurs if the stock falls toward zero.

A call option with a strike price of $50 is held while the underlying stock trades at $57. This call is:

• a.At-the-money
• b.In-the-money by $7✓
• c.Out-of-the-money by $7
• d.Worthless because it is past expiration

A call is in-the-money when the stock price is above the strike price. Here the stock at $57 exceeds the $50 strike by $7, so the call has $7 of intrinsic value. A call is out-of-the-money when the stock is below the strike and at-the-money when the two are equal.

A put option with a strike price of $40 is held while the underlying stock trades at $45. This put is:

• a.In-the-money by $85
• b.In-the-money by $5
• c.At-the-money at $40
• d.Out-of-the-money by $5✓

A put is in-the-money when the stock is below the strike and out-of-the-money when the stock is above the strike. Here the $45 stock is above the $40 strike, so the put is out-of-the-money by $5 and has no intrinsic value; exercising it would make no economic sense.

When the market price of the underlying stock exactly equals the strike price, both a call and a put on that stock are said to be:

• a.Automatically exercised at the strike price
• b.In-the-money, with positive intrinsic value
• c.Worthless and immediately delisted by the exchange
• d.At-the-money, with zero intrinsic value✓

An option is at-the-money when the underlying market price equals the strike price. In that case the option has no intrinsic value; any premium is entirely time value. Both calls and puts on the same underlying are at-the-money simultaneously when price equals strike.

An option premium is composed of:

• a.Intrinsic value plus time value✓
• b.Strike price plus expected dividends
• c.Time value and volatility only
• d.Intrinsic value at expiration only

An option's premium equals its intrinsic value (the amount by which it is in-the-money) plus its time value (the extra amount reflecting the time remaining until expiration and volatility). An out-of-the-money option has zero intrinsic value, so its entire premium is time value, which erodes as expiration approaches.

An investor owns 100 shares of a stock and sells one call option against those shares. This strategy is:

• a.A covered call, used to generate income and modestly hedge✓
• b.A protective put, used to insure the shares against a decline
• c.A naked call, written without owning any of the underlying shares
• d.A long straddle, a call and a put bought at one strike

Writing a call against stock already owned is a covered call. The investor collects the premium as income and gains slight downside cushion, but caps upside gains at the strike price because the shares may be called away. It is a common income strategy in a neutral to mildly bullish outlook.

An investor holds a long stock position and buys a put on that stock to limit downside risk. This is known as:

• a.A protective put (a hedge)✓
• b.A bullish call spread
• c.Writing an uncovered put
• d.Writing a covered call

Buying a put while owning the underlying stock is a protective put, functioning like insurance: if the stock falls, the put gains value and limits the loss, while the upside on the stock remains open (less the premium paid). It is a hedging strategy for a bullish investor worried about a near-term decline.

What is the maximum loss for the buyer of a call option?

• a.The premium paid✓
• b.The strike price times 100
• c.The difference between strike and market price
• d.Unlimited

The most a call buyer can lose is the premium paid, which occurs if the option expires out-of-the-money and worthless. This limited, defined risk is a key attraction of buying options, while the potential gain on a long call is theoretically unlimited as the stock rises.

What is the maximum gain for the writer of a put option?

• a.The difference between strike and zero
• b.The premium received✓
• c.The strike price times 100
• d.Unlimited

A put writer's maximum gain is the premium received, realized when the put expires out-of-the-money (the stock stays at or above the strike). The writer's risk, however, is substantial: if the stock falls to zero, the loss equals the strike price minus the premium, times the contract size.

An investor buys one XYZ call with a $30 strike for a $2 premium. At expiration XYZ trades at $35 and the investor exercises. Ignoring commissions, what is the investor's net profit per share?

• a.$0
• b.$3✓
• c.$5
• d.$2

Intrinsic value at expiration is $35 - $30 = $5 per share. Subtracting the $2 premium paid gives a net profit of $3 per share (or $300 on the 100-share contract). The breakeven point on a long call is the strike plus the premium, here $32.

A general obligation (GO) municipal bond is backed primarily by:

• a.The full faith, credit, and taxing power of the issuing municipality✓
• b.An unconditional repayment guarantee from the federal government
• c.The corporate profits of the private company operating the project
• d.Net revenue collected from a specific facility such as a toll road or an airport

A GO bond is secured by the issuer's full faith and credit, meaning its ability to levy taxes (such as property taxes) to repay the debt. Because repayment depends on taxing power rather than a single project's income, GO bonds are often viewed as relatively safe and may require voter approval.MSRB Rules

A revenue bond is distinguished from a general obligation bond because a revenue bond is repaid from:

• a.A federal interest subsidy, as with Build America Bonds
• b.The income generated by the specific project or facility it finances✓
• c.Annual appropriations from the state's general fund, subject to a vote
• d.Ad valorem property taxes the city levies on assessed valuations

A revenue bond is serviced solely by the revenue produced by the facility it finances, such as a toll road, airport, or utility. A general obligation bond is repaid from the issuer's property taxes. Annual state appropriations back a different, appropriation-type bond, and a federal subsidy, as on Build America Bonds, reimburses the issuer for part of its interest cost without repaying the bonds. Because repayment depends on that project's income rather than the issuer's taxing power, revenue bonds are generally considered somewhat riskier than GO bonds and do not usually require voter approval.MSRB Rules

A primary tax advantage of most municipal bonds is that their interest is:

• a.Fully deductible from the investor's gross income
• b.Taxed at a reduced capital gains rate
• c.Exempt from all state and local taxes for every investor
• d.Generally exempt from federal income tax✓

Interest on most municipal bonds is generally exempt from federal income tax, which is their principal tax benefit. Interest may also be exempt from state and local taxes for residents of the issuing state (potentially triple tax-exempt). This federal exemption makes munis especially attractive to investors in high tax brackets.IRC §103(a) (26 U.S.C. 103)

For which investor is a tax-exempt municipal bond generally MOST suitable?

• a.A low-income investor who holds the bond inside a tax-deferred traditional IRA rollover account
• b.A young investor who is seeking maximum long-term capital growth from a diversified equity portfolio
• c.A high-income investor in a high federal tax bracket holding the bond in a taxable account✓
• d.A tax-exempt pension fund that already owes no federal income tax on its investment earnings

Municipal bonds are most beneficial to investors in high tax brackets who hold them in taxable accounts, because the federal tax exemption raises their after-tax yield relative to taxable bonds. Placing munis in a tax-deferred account (like an IRA) or a tax-exempt entity wastes the tax benefit, and growth-seekers are better served by equities.MSRB Rules