FINRA SIE — Securities Industry Essentials — All Questions

Credit (default) risk is best measured for a corporate bond by looking at its:

• a.Time to maturity, since bonds maturing past ten years carry a speculative rating
• b.Average daily trading volume, which directly measures issuer creditworthiness
• c.Rating from a nationally recognized statistical rating organization✓
• d.Coupon payment frequency, such as semiannual versus quarterly interest

Credit or default risk is the chance the issuer will fail to make interest or principal payments. Rating agencies such as Moody's, S&P, and Fitch assign ratings (for example, AAA down to below investment grade) that summarize an issuer's creditworthiness. Lower-rated (high-yield or 'junk') bonds carry greater default risk and therefore pay higher yields.

An investor in the 32% federal tax bracket is comparing a municipal bond yielding 4% with a corporate bond. The taxable-equivalent yield of the muni is approximately:

• a.6.25%
• b.5.88%✓
• c.3.04%
• d.4.32%

Taxable-equivalent yield = tax-free yield / (1 - tax rate) = 4% / (1 - 0.32) = 4% / 0.68 = about 5.88%. This means a taxable corporate bond would need to yield roughly 5.88% to match the muni's after-tax return, so the muni is more attractive unless the corporate bond yields more than 5.88%.

A single manufacturer's stock drops after the company loses a major product-liability lawsuit. This loss is an example of:

• a.Purchasing-power (inflation) risk
• b.Unsystematic (company-specific) risk✓
• c.Interest rate (bond price) risk
• d.Systematic (market-wide) risk

A lawsuit affecting one specific company is a company-specific, or unsystematic, risk because it does not stem from broad market forces. This type of risk can be reduced through diversification, since holding many different companies dilutes the impact of any single firm's misfortune. Market-wide events, by contrast, would be systematic risk.

A client wants a government-backed security whose cash flow comes from homeowners' monthly mortgage payments and carries the full faith and credit of the U.S. government. The best fit is:

• a.A six-month U.S. Treasury bill sold at a discount
• b.An unsecured long-term corporate debenture
• c.A municipal revenue bond backed by tolls
• d.A Ginnie Mae (GNMA) pass-through security✓

Ginnie Mae pass-throughs pass monthly principal and interest from a pool of home mortgages through to investors and are backed by the full faith and credit of the U.S. government. T-bills are government-backed but not tied to mortgages, and Fannie/Freddie securities are mortgage-based but lack the direct full-faith-and-credit guarantee. GNMA uniquely satisfies both conditions.

Parents want a tax-advantaged account to save for their child's future college tuition, with tax-free withdrawals for qualified education costs. The most appropriate choice is:

• a.A negotiable jumbo bank CD
• b.An ABLE disability account
• c.A 529 college savings plan✓
• d.A rolling commercial paper program

A 529 plan is designed specifically for education savings, offering tax-deferred growth and tax-free withdrawals for qualified education expenses. An ABLE account is for disability-related expenses, not general college saving, and money-market instruments like CDs or commercial paper provide no education-specific tax benefit. The 529 best fits the stated goal.

A U.S. investor buys a bond denominated in euros. The euro then falls sharply against the dollar. The investor has been hurt primarily by:

• a.Legislative (tax law change) risk
• b.Coupon reinvestment rate risk
• c.Issuer credit (default) risk
• d.Currency (exchange rate) risk✓

When the investor converts euro-denominated interest and principal back into dollars, a weaker euro means fewer dollars, reducing the return even if the bond itself performed as expected. This is currency, or exchange rate, risk, which is inherent in holding foreign-currency assets. It is separate from the issuer's credit quality.

An investor in a GNMA pass-through security is most exposed to prepayment risk when:

• a.Interest rates rise and homeowners keep their mortgages much longer
• b.The security reaches its stated final maturity date and repays par
• c.The issuer defaults on all the underlying mortgage loans in the pool
• d.Interest rates fall and homeowners refinance their mortgages early✓

Prepayment risk is the danger that homeowners will pay off their mortgages early, returning principal to investors sooner than expected. This happens most when interest rates fall and borrowers refinance at lower rates. The investor then must reinvest the returned principal at the new, lower prevailing rates, reducing expected income.

An investor must sell a thinly traded, small-issue municipal bond quickly but can only find a buyer at a price well below fair value. This illustrates:

• a.Liquidity (marketability) risk✓
• b.Credit (issuer default) risk
• c.Coupon reinvestment rate risk
• d.Inflation (purchasing-power) risk

When a security trades infrequently, an investor who needs to sell fast may have to accept a much lower price to attract a buyer. That gap between a quick-sale price and fair value is the hallmark of liquidity, or marketability, risk. It is common in small municipal issues, limited partnerships, and other thinly traded assets.

An investor who wants a portfolio that is LESS volatile than the overall market should favor stocks with:

• a.A beta below 1.0✓
• b.A beta exactly equal to 1.0
• c.A negative dividend yield
• d.A beta above 1.0

Beta measures volatility relative to the market, which has a beta of 1.0. Stocks with a beta below 1.0 tend to move less than the market, so a portfolio built from low-beta stocks is generally less volatile and carries less systematic risk. High-beta stocks (above 1.0) amplify market swings.

Which of the following is a characteristic shared by money-market instruments such as T-bills, commercial paper, and banker's acceptances?

• a.They all pay tax-exempt interest
• b.They are all backed by the full faith and credit of the U.S. government
• c.They all mature in more than 10 years
• d.They are short-term, highly liquid debt instruments✓

Money-market instruments are short-term debt securities (generally maturing in one year or less) that are highly liquid and relatively low risk. T-bills, commercial paper, banker's acceptances, and negotiable CDs are all examples. They differ in issuer and backing, so not all are government-guaranteed or tax-exempt, but all share the short-term, liquid profile.

The ability of a city to repay a general obligation bond depends most directly on its:

• a.Corporate sponsorship and naming-rights fees
• b.Its annual federal transit grant allocation
• c.Net revenue collected from a single toll bridge
• d.Taxing power and overall financial health✓

Because a GO bond is backed by the issuer's full faith and credit, its repayment depends on the municipality's power to levy taxes and on its overall fiscal condition. Analysts review property values, tax collection rates, debt levels, and the local economy. Revenue from a single facility backs a revenue bond, not a GO bond.

A 'double-barreled' municipal bond is one that is backed by:

• a.Guarantees purchased from two separate municipal bond insurance companies
• b.Two different maturity dates within the same bond certificate
• c.Both a specific revenue source and the issuer's general taxing power✓
• d.A federal Treasury guarantee combined with a state guarantee

A double-barreled bond combines features of both a revenue bond and a general obligation bond: it is payable first from a defined revenue source, but is also backed by the issuer's full faith and credit and taxing power if that revenue falls short. This dual backing generally makes it safer than a pure revenue bond.

Municipal notes such as TANs, RANs, and BANs are used primarily to:

• a.Convert into common stock of the municipality after five years
• b.Provide short-term interim financing until longer-term revenue or funds arrive✓
• c.Provide a federally guaranteed retirement benefit to city employees
• d.Offer 30-year permanent financing for major infrastructure projects

Municipal anticipation notes are short-term instruments that bridge timing gaps in a municipality's cash flow. A TAN is repaid from anticipated taxes, a RAN from anticipated revenues, and a BAN from the proceeds of a future long-term bond issue. They mature in a relatively short time and are used for interim, not permanent, financing.

Interest from certain 'private activity' municipal bonds may be:

• a.Exempt from every federal, state, and local tax, including capital gains
• b.Subject to state and local income tax in every state including the issuer's
• c.Taxed at the federal level as ordinary interest income under Section 103
• d.Included as a preference item for the alternative minimum tax (AMT)✓

Some municipal bonds finance private activities and, while their interest is generally exempt from regular federal income tax, that interest can be a preference item that must be added back when computing the alternative minimum tax (AMT). Investors subject to the AMT may therefore owe tax on this otherwise tax-exempt interest, which lowers the bond's after-tax appeal for them.

Some municipal bonds, such as Build America Bonds, are TAXABLE at the federal level because:

• a.They are backed by the full faith and credit of the U.S. Treasury rather than the issuer
• b.They finance religious institutions, which Congress excluded from the exemption
• c.The issuer failed to register the bonds with the SEC before selling them to investors
• d.They were structured to be taxable, often in exchange for a federal interest subsidy to the issuer✓

Not all municipal bonds are tax-exempt. Certain issues, like Build America Bonds, were deliberately structured as taxable to the investor, with the federal government subsidizing part of the issuer's interest cost. Because their interest is taxable, they typically offer higher yields than comparable tax-exempt munis to remain competitive.

A prepaid tuition plan, a type of 529 plan, primarily allows a family to:

• a.Deduct the full contribution from federal income tax in the year it is made
• b.Withdraw funds tax-free for any purpose, including non-education costs
• c.Lock in future tuition at today's prices for eligible institutions✓
• d.Invest in individual stocks and bonds chosen by the account owner

A prepaid tuition plan lets families pay for future college tuition at current rates, hedging against rising tuition costs at participating schools. This differs from a 529 college savings plan, which invests contributions in market-based portfolios whose value fluctuates. Both are 529 plans, but the prepaid version locks in tuition rather than exposing savings to market returns.

An agency debenture issued by a GSE such as the Federal Home Loan Bank is:

• a.An unsecured debt obligation of the agency, backed by its general credit rather than a specific mortgage pool✓
• b.A federally insured bank deposit, protected by the FDIC for up to $250,000 per depositor at each bank
• c.A share of ownership in the agency, carrying voting rights and a claim on its residual profits
• d.A tax-exempt municipal security whose interest is exempt from federal income tax for the holder

Some agency securities are debentures, meaning unsecured bonds backed by the issuing agency's general creditworthiness rather than a pool of mortgages. They are considered high quality but, as GSE obligations, they are not directly guaranteed by the U.S. government, so they yield slightly more than Treasuries. They differ from mortgage-backed pass-throughs, whose cash flow comes from underlying loans.

A key risk unique to owning a CMO compared with a plain Treasury bond is:

• a.Currency risk, because the underlying mortgage payments arrive in foreign currency
• b.The complete absence of interest rate risk in every tranche of the CMO deal
• c.Exemption from all federal income tax on the interest that is received
• d.Prepayment (extension and contraction) risk from the underlying mortgages✓

Because a CMO's cash flows come from a pool of mortgages, its actual maturity depends on how fast homeowners prepay. When rates fall, prepayments speed up (contraction risk); when rates rise, prepayments slow and the CMO's life extends (extension risk). A plain Treasury bond has a fixed maturity and no such prepayment uncertainty.

An investor holding long-term fixed-rate bonds is most concerned about purchasing-power risk, which means:

• a.Inflation may erode the real value of the fixed interest payments over time✓
• b.The issuer may default on interest or principal before the bonds mature
• c.Exchange rates may move against the investor holding foreign-currency bonds
• d.The bond may be called away early at a set redemption price after rates fall

Purchasing-power (inflation) risk is the danger that rising prices will erode the real value of a bond's fixed coupon and principal. It is especially significant for long-term, fixed-rate bonds, where payments are locked in for many years. Investments like TIPS or equities are often used to help offset this risk.

A broad market decline during a recession causes almost every stock in a diversified portfolio to fall. This is an example of:

• a.Unsystematic business risk
• b.Systematic (market) risk✓
• c.Liquidity/marketability risk
• d.Reinvestment rate risk

A recession-driven, market-wide drop affects nearly all securities regardless of how well individual companies are run, which is the definition of systematic or market risk. Because it hits the whole market, diversification cannot eliminate it. Unsystematic risk, by contrast, would affect only a single company or sector.

Call risk is the danger that:

• a.An issuer will redeem a bond before maturity, usually when interest rates have fallen✓
• b.Rising inflation will erode the real value of the bond's fixed coupon payments
• c.The investor cannot find a buyer for the bond at a fair price in a thin market
• d.An issuer will default and fail to make the bond's scheduled interest and principal payments

Call risk arises when a bond is callable, letting the issuer redeem it early. Issuers most often call bonds after interest rates have dropped, so they can refinance at lower rates. The investor then loses the higher-coupon bond and must reinvest at lower prevailing rates, which links call risk closely to reinvestment risk.

An investor in a structured note linked to a stock index should understand that, even if the index rises, the investor can still lose money if:

• a.The note is simply held to its stated maturity date rather than sold early
• b.The issuing financial institution becomes insolvent and cannot pay✓
• c.The linked index rises on price alone and pays out no dividends
• d.Prevailing interest rates remain unchanged over the note's full term

A structured note is an obligation of the issuing financial institution, so its promised payoff depends on that issuer remaining solvent. If the issuer becomes insolvent, the investor is a general creditor and may lose principal regardless of how the linked index performed. This issuer credit risk is a key, sometimes overlooked, feature of structured products.

Even a well-diversified stock portfolio still carries which type of risk?

• a.No risk at all, since diversification removes every source of loss
• b.Company-specific risk from one firm's own operating problems
• c.Systematic (market) risk that affects the entire market✓
• d.Unsystematic risk only, since market risk is diversified away

Diversification reduces or removes unsystematic (company-specific) risk, but it cannot eliminate systematic risk, which stems from market-wide forces such as recessions or interest rate changes. Therefore, even a broadly diversified portfolio remains exposed to systematic risk. This is why diversification lowers, but never fully removes, total portfolio risk.

A conservative client wants to minimize credit risk and default risk in the fixed-income portion of her portfolio. Which security best fits that goal?

• a.Commercial paper from a lower-rated company
• b.A short-term U.S. Treasury bill✓
• c.A BBB-rated revenue bond
• d.A high-yield ('junk') corporate bond

A U.S. Treasury bill is backed by the full faith and credit of the U.S. government and is considered essentially free of credit and default risk, making it the best match for a client who wants to minimize those risks. High-yield bonds and lower-rated commercial paper carry substantial default risk, and even a BBB revenue bond has more credit risk than a Treasury. The trade-off is that the safest security typically offers the lowest yield.

Which statement best distinguishes common stock from preferred stock?

• a.Common stock has the lowest claim in liquidation, while preferred has none
• b.Common stock pays a fixed dividend, while preferred pays a variable payout
• c.Common stockholders usually have voting rights, while most preferred stockholders do not✓
• d.Preferred stock carries the vote on director elections, while common stock does not

Common stockholders usually vote; most preferred stockholders do not. Common has the lowest liquidation claim (not "none"), common dividends are variable while preferred are fixed, and preferred generally lacks a vote — so the other choices are reversed.

In a corporate liquidation, which class is paid last?

• a.Common stockholders✓
• b.Secured bondholders
• c.General (unsecured) creditors
• d.Preferred stockholders

Common stockholders are paid last in a liquidation, after secured creditors, general creditors, and preferred stockholders. Owners always stand behind creditors.

A debenture is best described as:

• a.A bond secured by a first lien on the issuer's real property
• b.A bond backed by a pledge of specific rolling-stock equipment
• c.An unsecured bond backed by the issuer's general credit✓
• d.A residual ownership share in the issuing corporation

A debenture is an unsecured bond backed only by the issuer's general credit and promise to pay. Mortgage and equipment bonds are secured; a share of ownership describes stock, not a bond.

Market interest rates rise after an investor buys a bond. The price of the existing bond will most likely:

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

By the price–yield seesaw, when rates rise, existing bond prices fall. The bond's fixed coupon is now below market, so its price drops to make its yield competitive.

For a bond purchased at a discount, which yield is the highest?

• a.Yield to maturity✓
• b.Nominal yield
• c.Current yield
• d.All the yields are equal

For a discount bond the yields rank nominal < current < YTM, so yield to maturity is the highest because the investor also gains the price appreciation to par. (For a premium bond the order reverses.)

Which security is considered to carry essentially no credit (default) risk because it is backed by the full faith and credit of the U.S. government?

• a.A U.S. Treasury bond✓
• b.A corporate debenture
• c.A municipal revenue bond
• d.Commercial paper

A U.S. Treasury bond is backed by the full faith and credit of the government and is treated as essentially free of default risk. A debenture, a revenue bond, and commercial paper all carry credit risk.

Which of the following carries the full faith and credit of the U.S. government?

• a.FNMA (Fannie Mae) mortgage-backed securities
• b.FHLMC (Freddie Mac) mortgage-backed securities
• c.Corporate commercial paper
• d.GNMA (Ginnie Mae) mortgage-backed securities✓

GNMA (Ginnie Mae) securities carry the government's full faith and credit. FNMA and FHLMC are government-sponsored enterprises whose securities are not directly government-guaranteed; commercial paper is corporate.

The interest paid on most municipal bonds is:

• a.Taxed federally above the corporate bond rate
• b.Taxable in the issuer's own home state
• c.Generally exempt from federal income tax✓
• d.Guaranteed by the federal government

Municipal bond interest is generally exempt from federal income tax, which is its defining advantage. It is not federally guaranteed, and it is often (not always) state-tax-exempt for residents.

Shares of an open-end mutual fund are:

• a.Traded on an exchange throughout the day at a premium or discount to NAV
• b.Fixed in number after the initial offering
• c.Priced once per day at net asset value using forward pricing✓
• d.Priced continuously throughout the trading day

Open-end mutual fund shares are priced once daily at NAV using forward pricing (the next computed NAV). Exchange trading at a premium/discount and continuous intraday pricing describe closed-end funds and ETFs; open-end share counts are not fixed.

Unlike an open-end fund, a closed-end fund:

• a.Trades on an exchange and can sell above or below its NAV✓
• b.Continuously issues new shares and redeems existing shares at NAV
• c.Prices its shares at net asset value at the daily close
• d.Has no fixed share count, so the total grows and shrinks

A closed-end fund trades on an exchange and its market price can be above or below NAV. Continuous issuance/redemption at NAV and an unfixed share count describe open-end funds.

A mutual fund share class that charges a front-end sales load at the time of purchase is:

• a.Class C
• b.A no-load fund
• c.Class A✓
• d.Class B

Class A shares carry a front-end sales load paid at purchase (usually with lower ongoing expenses). Class C is a level load, Class B is back-end (CDSC), and a no-load fund has no sales charge.

Which product holds a basket of securities but trades throughout the day on an exchange like a stock?

• a.A traditional open-end mutual fund
• b.A unit investment trust (UIT)
• c.A fixed annuity
• d.An exchange-traded fund (ETF)✓

An ETF holds a basket of securities but trades intraday on an exchange like a stock. A mutual fund and a UIT do not trade continuously; a fixed annuity is an insurance product.

A unit investment trust (UIT) is characterized by:

• a.An actively managed portfolio that trades securities frequently
• b.A fixed portfolio held for a set term with no active manager✓
• c.Continuous issuance of new shares to investors at the daily NAV
• d.Daily exchange trading at a premium or discount to the fund's NAV

A UIT holds a fixed portfolio for a set term with no active manager. It does not actively trade, continuously issue shares, or trade at a premium/discount like a closed-end fund.

A variable annuity is considered a security because:

• a.The insurer guarantees a fixed minimum annual rate of return
• b.The owner bears the investment risk of the subaccounts✓
• c.It is insured by the FDIC for up to $250,000 per depositor
• d.Its account value is floored at the sum of the premiums paid

A variable annuity is a security because the owner bears the investment risk of the subaccounts. A fixed annuity (insurer bears the risk) is not a security; annuities are not FDIC-insured and can lose value.

A call option gives its holder the right to:

• a.Sell the underlying security if its price falls below the strike price
• b.Buy the underlying security at the exercise price✓
• c.Buy the underlying security at the market price on the expiration date
• d.Collect the stock's dividends

A call gives its holder the right, but not the obligation, to buy the underlying security at the strike price. Selling the underlying security is the right a put gives, and a call has no price-drop trigger. On exercise the holder pays the strike price, not the market price on the expiration date. An option holder collects no dividends and has no vote until the shares are actually bought through exercise.

The writer (seller) of an option:

• a.Pays a premium in exchange for the right to buy or sell the underlying security
• b.Has risk limited to the premium paid at the time of purchase
• c.Can refuse an assignment by returning the premium to the holder
• d.Receives a premium and takes on an obligation if the option is exercised✓

The writer receives the premium and takes on the obligation to perform if exercised. The buyer pays the premium and has limited risk; a writer can indeed be assigned.

Which type of risk affects the entire market and cannot be eliminated through diversification?

• a.Business risk
• b.Credit risk
• c.Liquidity (marketability) risk
• d.Systematic (market) risk✓

Systematic (market) risk affects the whole market and cannot be diversified away. Business, credit, and liquidity risks are unsystematic and can be reduced by diversifying.

Diversifying a portfolio across many companies and industries is most effective at reducing:

• a.Interest-rate risk
• b.Unsystematic (company-specific) risk✓
• c.Inflation risk
• d.Systematic risk affecting the broad market

Diversification reduces unsystematic (company-specific) risk by spreading exposure across many holdings. Interest-rate, inflation, and broad market risks are systematic and remain.

Purchasing-power (inflation) risk is generally greatest for:

• a.Common stocks of growing companies
• b.Directly owned real estate
• c.Physical commodities
• d.Long-term fixed-income securities✓

Inflation (purchasing-power) risk is greatest for long-term fixed-income securities, whose fixed payments lose real value as prices rise. Stocks, real estate, and commodities can rise with inflation.

Compared with a right, a warrant typically:

• a.Has a very short life and is priced below the market price
• b.Is issued only to the company's existing shareholders at a discount price
• c.Has a longer life and an exercise price initially above the market✓
• d.Settles only in cash rather than being exercised for shares

A warrant has a longer life and an exercise price initially above the market, often issued as a sweetener. Short life, below-market pricing, and existing-shareholder distribution describe rights.

An American Depositary Receipt (ADR) allows a U.S. investor to:

• a.Buy municipal bonds whose interest is exempt from federal, state, and local income tax
• b.Avoid all market risk
• c.Receive a dividend that is guaranteed by the federal government
• d.Hold shares of a foreign company that trade in U.S. dollars, subject to currency risk✓

An ADR lets a U.S. investor hold a foreign company's shares priced in U.S. dollars, carrying currency risk. It is not tax-free, risk-free, or federally guaranteed.

If an issuer skips a dividend on its cumulative preferred stock, the missed dividend:

• a.Is permanently forfeited by the preferred shareholder
• b.Accumulates and must be paid before any common dividend✓
• c.Automatically converts into common shares of the issuer
• d.Must be redirected to the issuer's bondholders instead

On cumulative preferred, a skipped dividend accumulates and must be paid before any common dividend. It is not lost (that is straight/noncumulative preferred), does not auto-convert, and is not redirected to bondholders.

Because a convertible bond can be exchanged for common shares, it usually:

• a.Pays a higher coupon than a comparable nonconvertible bond
• b.Has no stated maturity date, unlike a straight bond
• c.Must be secured by a first lien on the issuer's assets
• d.Pays a lower coupon than a comparable nonconvertible bond✓

The conversion feature is valuable, so a convertible bond usually pays a lower coupon than a comparable nonconvertible bond. It still has a maturity and need not be secured.

Municipal bonds are generally most attractive to investors who are in:

• a.The lowest tax brackets
• b.The highest tax brackets✓
• c.A tax-exempt retirement account
• d.A foreign tax jurisdiction

Because muni interest is tax-free, munis benefit high-tax-bracket investors most. Low brackets gain little, and holding a tax-free bond inside a tax-exempt retirement account wastes the advantage.

Which of the following is a money market instrument?

• a.Commercial paper✓
• b.A 30-year Treasury bond
• c.Common stock
• d.A convertible debenture

Commercial paper is short-term (one year or less) corporate debt — a money market instrument. A 30-year bond and a convertible debenture are long-term debt; common stock is equity.

A real estate investment trust (REIT):

• a.Passes both its income and its operating losses through directly to its investors
• b.Pools capital to invest in income-producing real estate and trades like a stock✓
• c.Is an insurance contract that pays lifetime income
• d.Guarantees investors a fixed rate of return

A REIT pools capital to invest in income-producing real estate and trades like a stock. It does not pass through losses (unlike a DPP), is not an insurance contract, and does not guarantee a return.