FINRA SIE — Securities Industry Essentials — All Questions

A direct participation program (limited partnership) is distinctive because it:

• a.Trades continuously on a national exchange and is highly liquid
• b.Gives the limited partners unlimited personal liability for its debts
• c.Passes both income and losses through to the limited partners✓
• d.Is guaranteed against loss by the general partner's own capital

A DPP (limited partnership) passes both income and losses through to the limited partners. It is illiquid, limited partners have limited (not unlimited) liability, and there is no loss guarantee.

The par value of a typical corporate bond, repaid at maturity, is conventionally:

• a.$100
• b.$1,000✓
• c.$500
• d.$10,000

A corporate bond's conventional par value is $1,000, the amount repaid at maturity. The other figures are not the standard par.

A fixed annuity differs from a variable annuity in that a fixed annuity:

• a.Exposes the owner to the market risk of the underlying investment subaccounts
• b.Guarantees a fixed rate, with the insurer bearing the investment risk✓
• c.Must be registered with the SEC and sold only with a prospectus
• d.Contains no insurance component, only investment subaccounts

A fixed annuity guarantees a fixed rate, with the insurer bearing the investment risk — an insurance product. Market exposure, securities registration, and "no insurance component" describe a variable annuity.

An investor who buys a put option is most likely expecting the underlying stock to:

• a.Fall in price✓
• b.Rise sharply
• c.Begin paying a higher dividend
• d.Stay exactly flat

A put buyer profits when the underlying falls — a bearish position (the right to sell at the strike). A call buyer is bullish; dividends and a flat market are not the point of a put.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Interest rate risk is the risk that:

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

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

Which event is an example of unsystematic (company-specific) risk?

• a.The dollar strengthens against major currencies
• b.A drug maker's only approved product is recalled by the FDA✓
• c.The Federal Reserve raises short-term interest rates
• d.A recession reduces consumer spending nationwide

A product recall affects one company and can be reduced by diversifying across issuers, so it is unsystematic risk. Recessions, Fed rate changes, and currency moves touch most securities at once, which makes them systematic risks that diversification cannot remove.

An investor holds mutual fund shares for ten years. Which cost does the fund charge every year during that time?

• a.A redemption fee, charged on each year's gain
• b.A brokerage commission on every dividend reinvested
• c.A front-end sales load, charged again on each anniversary
• d.The expense ratio, deducted from fund assets✓

The expense ratio covers management and operating costs and is deducted from fund assets every year the investor holds shares. A front-end sales load is paid once, at purchase. A redemption fee, where one exists, applies only when shares are sold. Reinvested dividends are normally purchased without a commission.

Which statement about ETFs (exchange-traded funds) is correct?

• a.Investors buy ETF shares directly from the fund at the NAV
• b.ETF shares trade on an exchange throughout the day at changing prices✓
• c.ETF shares are priced once a day at the NAV set after the market close
• d.Only institutions may trade ETF shares, in creation units

ETFs trade on exchanges all day at market prices that can differ from NAV, just like stocks. Pricing once a day at the closing NAV, and buying directly from the fund, describe traditional mutual funds. Creation units are used by authorized participants, but retail investors buy and sell ordinary ETF shares through a broker.

During the accumulation phase of a variable annuity, the owner's contributions purchase:

• a.Annuity units that pay a fixed monthly benefit
• b.Mutual fund shares the owner holds directly
• c.Fixed-rate contracts in the insurer's general account
• d.Accumulation units of separate-account subaccounts✓

A variable annuity owner's payments buy accumulation units in separate-account subaccounts, whose value rises and falls with the investments. Annuity units are used in the payout phase. The insurer's general account backs fixed annuities. The subaccounts are insurance company accounts and the owner does not hold fund shares directly.

A put option has a $75 strike while the underlying stock trades at $68. This put is:

• a.Out of the money, as the stock is below $75
• b.At the money, with no intrinsic value
• c.In the money, with $68 of intrinsic value
• d.In the money, with $7 of intrinsic value✓

A put is in the money when the stock trades below the strike. Intrinsic value is strike minus stock: $75 - $68 = $7. A put is out of the money when the stock is above the strike, and at the money only when the two are equal. The stock price itself is not the intrinsic value.

XYZ declares a $2 per-share cash dividend with a record date of Friday. An investor buys 100 shares on Thursday. Is the investor entitled to the dividend under current T+1 settlement?

• a.Yes, but only if the investor holds the shares through the payable date
• b.No; the stock went ex-dividend two business days before the record date
• c.No; the buyer must have owned the shares on the declaration date
• d.Yes; the trade settles on the Friday record date, so the investor receives $200✓

With T+1 settlement a Thursday purchase settles on Friday, so the buyer is the holder of record on the record date. For a regular cash dividend the ex-dividend date is now the same as the record date, not two days earlier, so a purchase before that date earns the dividend: 100 x $2 = $200. Ownership on the declaration date or the payable date is not required.FINRA Rule 11140

Reinvestment risk is the risk that:

• a.A bond's price falls as market interest rates increase
• b.New income must be reinvested at a lower rate✓
• c.The issuer defaults before the principal is repaid
• d.A company cuts its common stock dividend in a downturn

Reinvestment risk affects investors who must put coupon payments or principal back to work when market rates have fallen, so the new income is lower. A price decline from rising rates is interest rate risk. An issuer default is credit risk. A dividend cut is a business risk of owning the stock.

Which of the following describes inflation?

• a.A sustained rise in the general level of prices✓
• b.A sustained fall in the general level of prices
• c.A rise in the value of the dollar against other currencies
• d.A decline in output and employment across the economy

Inflation is a sustained increase in the general price level, which reduces purchasing power. A sustained fall in prices is deflation. A decline in output and employment describes a recession. A rising dollar describes currency appreciation.

To fight inflation, the Federal Reserve would most likely:

• a.Cut income taxes to leave consumers with more money
• b.Ease policy by buying securities and lowering rates
• c.Cut the federal funds rate to encourage borrowing
• d.Tighten policy by selling securities and raising rates✓

To slow inflation the Fed tightens credit, for example by selling securities and raising rates, which reduces the money supply and borrowing. Buying securities and cutting rates both stimulate demand and would add to inflation. Tax policy is fiscal policy set by Congress, not a Federal Reserve tool.

A warrant gives its holder the right to:

• a.Receive a fixed dividend ahead of common stockholders
• b.Vote alongside common stockholders at the annual meeting
• c.Sell shares back to the issuer at a set price
• d.Buy a stated number of shares at a fixed price✓

A warrant is a long-dated right to buy the issuer's stock at a set price. A right to sell back to the issuer describes a put, not a warrant. A fixed dividend ahead of common is a feature of preferred stock, and a vote comes with owning common stock rather than a warrant.

A call option has a $60 strike with six months to expiration, the stock trades at $55, and the premium is $3. Which statement is correct?

• a.$3 is intrinsic value, since the premium is paid up front
• b.$5 is intrinsic value, since the stock is $5 below the strike
• c.No time value exists, since the call is out of the money
• d.All $3 is time value, and the intrinsic value is $0✓

A call with the stock below the strike has no intrinsic value, so its entire $3 premium is time value, the price of the chance that the stock rises above $60 before expiration. Intrinsic value is never negative, and an out-of-the-money option still has time value. Paying the premium up front does not create intrinsic value.

An investor buys stock at $40 a share and later sells at $45. Ignoring dividends and costs, what is the percentage return?

• a.112.5%, dividing the $45 sale price by the $40 cost
• b.5.0%, using the $5 gain as the percentage
• c.11.1%, dividing the $5 gain by the $45 sale price
• d.12.5%, dividing the $5 gain by the $40 cost✓

Return is measured against the amount invested: $5 / $40 = 12.5%. Dividing by the sale price gives 11.1%, which is the wrong base. Using the $5 dollar gain as a percentage ignores the cost. Dividing $45 by $40 gives 112.5%, which is total value relative to cost and includes the original investment, not the return.

A bond fund holds BBB-rated corporate bonds, and one of them is downgraded to BB. This most directly illustrates which risk?

• a.Liquidity risk, the chance that a bond is hard to sell at a fair price
• b.Reinvestment risk, the chance that interest is reinvested at lower rates
• c.Interest rate risk, the chance that bond prices fall when rates rise
• d.Credit risk, the chance an issuer's ability to pay deteriorates✓

A downgrade from BBB to BB reflects a weaker issuer, which is credit risk and a step from investment grade into speculative grade. Interest rate risk arises from changes in market rates. Liquidity risk is about the ability to sell. Reinvestment risk is about the rate earned on coupons.

An investor places an order to buy mutual fund shares at 11:00 a.m. on a business day. At what price is the order filled?

• a.The price quoted at the opening bell that morning
• b.The next NAV the fund computes after receiving the order✓
• c.The NAV the fund set at the previous day's close
• d.The NAV at the moment the order is received

Mutual funds use forward pricing under Rule 22c-1: an order is filled at the next NAV the fund computes after it is received, usually as of 4:00 p.m. Eastern. The prior day's NAV is stale, and the fund does not compute an NAV at each moment of the day. A fund has no opening price like a stock does.Investment Company Act Rule 22c-1

Macaulay duration of a bond measures:

• a.The yield an investor earns if the bond is called
• b.The weighted-average time to receive the bond's cash flows✓
• c.The number of years until the bond reaches maturity
• d.The total interest the bond pays over its life

Macaulay duration is the weighted-average time, in years, until the bond's coupon and principal payments are received. For a coupon-paying bond it is shorter than the time to maturity. Total interest paid is a dollar amount, not a time measure, and the yield if called is yield to call.

A stock trades at $80 and has a P/E ratio of 20. What are its earnings per share?

• a.$4.00, found by dividing the $80 price by 20✓
• b.$0.25, found by dividing 20 by the $80 price
• c.$60, found by subtracting 20 from the $80 price
• d.$1,600, found by multiplying the $80 price by 20

P/E equals price divided by earnings per share, so EPS = price / P/E = $80 / 20 = $4.00. Dividing the P/E by the price inverts the formula, multiplying turns EPS into a price, and subtracting has no basis in the ratio.

An investor owns 300 shares trading at $90. The company completes a 3-for-2 forward stock split. After the split the investor holds:

• a.450 shares still trading near $90
• b.450 shares trading near $60✓
• c.600 shares trading near $45
• d.200 shares trading near $135

A 3-for-2 split gives three new shares for every two held, so 300 shares become 450, and the price adjusts to about $60 (300 x $90 = 450 x $60 = $27,000). Two-thirds of the shares at a higher price is a reverse split. The price must adjust after a forward split, and 600 shares at $45 is a 2-for-1 split.

When a variable annuity owner annuitizes the contract, the accumulated value is converted into:

• a.A single payment treated as a return of principal
• b.A guaranteed return that matches the Treasury rate
• c.Payments for life or for a stated period✓
• d.A tax deduction for the whole accumulated value

Annuitization turns the accumulated value into a stream of periodic payments for life or for a fixed period, with taxable earnings recognized as the payments are received. A lump sum is a withdrawal, not annuitization, and earnings in it are taxable. A variable annuity has no guaranteed return, and no deduction is created at payout.

What does it mean for a bond to be callable?

• a.The issuer may redeem it early at a stated call price✓
• b.The coupon resets whenever market rates change
• c.The holder may swap it for the issuer's common stock
• d.The holder may demand early repayment at par

A call provision lets the issuer retire the bond before maturity at a set price, usually when rates have fallen. A holder's right to demand repayment describes a put feature. A swap into common stock describes a convertible bond, and a reset coupon describes a floating-rate bond.

Which policy can only be sold by a person holding a securities registration, because its cash value is invested in subaccounts?

• a.Whole life insurance, with a guaranteed cash value schedule
• b.Term life insurance, which builds no cash value at all
• c.Universal life insurance, with cash value earning a declared rate
• d.Variable life insurance, with cash value in separate accounts✓

Variable life insurance is a security because its cash value depends on the performance of separate-account subaccounts, so the seller needs a securities registration as well as an insurance license. Whole life guarantees cash value, universal life credits a declared rate, and term life builds no cash value.

Under FINRA Rule 2341, an open-end fund may be described as 'no-load' only if it charges:

• a.No front-end or deferred load, but a 0.75% annual 12b-1 fee
• b.No front-end load, no deferred charge, and a 0.25% annual 12b-1 fee✓
• c.No front-end or deferred load, but a 0.50% annual 12b-1 fee
• d.No front-end load, a 1% first-year deferred charge, no 12b-1 fee

Rule 2341 bars calling a fund no-load if it has a front-end or deferred sales charge or if its charges against net assets exceed 0.25% of average net assets per year, so a 0.25% 12b-1 fee still qualifies. A 0.50% or 0.75% 12b-1 fee is over that line (0.75% is the cap on asset-based sales charges, not the no-load line), and a deferred charge disqualifies a fund even when it has no 12b-1 fee.FINRA Rule 2341

A mutual fund's net asset value is $24.70 per share, and its prospectus sales charge is 5.75% of the offering price. What is the public offering price per share, rounded to the nearest cent?

• a.$26.12, found by multiplying NAV by 1.0575
• b.$23.36, found by dividing NAV by 1.0575
• c.$26.21, found by dividing NAV by 0.9425✓
• d.$23.28, found by multiplying NAV by 0.9425

The sales charge is a percentage of the offering price, so POP = NAV / (1 - 0.0575) = $24.70 / 0.9425 = $26.21. Multiplying NAV by 1.0575 gives $26.12, which wrongly treats the load as a percentage of NAV. Dividing NAV by 1.0575 gives $23.36 and multiplying NAV by 0.9425 gives $23.28; both land below NAV, but a buyer who pays a load pays more than NAV.

An investor owns shares of a growth fund that have risen in value. Using the fund family's exchange privilege, she moves them into a bond fund of the same family and receives no cash. For federal income tax purposes, the exchange is treated:

• a.As a nontaxable event, because she received no cash and stayed in one fund family
• b.As taxable only if she exchanged the shares within 30 days of buying them
• c.As a tax-deferred exchange, like an annuity contract exchange under Section 1035
• d.As a sale of the growth fund shares, with any gain or loss reported that year✓

IRS Publication 550 treats any exchange of one fund's shares for another's as a sale, even inside one fund family, so the gain or loss is reported for the year of the exchange. Section 1035 covers exchanges of annuity and insurance contracts, not fund shares. Receiving no cash or staying in one family does not make the exchange tax-free, and there is no 30-day condition (the 30-day window belongs to the wash-sale rule for losses).IRS Publication 550

On Monday a client invests $20,000 in a mutual fund at a NAV of $25.00 per share. On Wednesday the fund pays a $1.00 per share capital gain distribution, its NAV drops to $24.00, and the client takes the payment in cash. For federal income tax purposes, the $1.00 per share distribution:

• a.Is not taxable, because the NAV fell by the same amount and her total value is unchanged
• b.Is taxable as a short-term gain, because she held the shares for only two days
• c.Is taxable to her as a long-term capital gain, even though she held the shares only two days✓
• d.Is a return of capital that lowers her cost basis and is untaxed until she sells

A capital gain distribution is always treated as a long-term capital gain by the shareholder, whatever the holding period, and a cash distribution is taxable when received. The matching drop in NAV does not remove the tax, and a capital gain distribution is not a nontaxable return of capital; buying just before a distribution simply brings forward a tax bill on gains the client did not earn.IRC Section 852(b)(3)

A mutual fund's operating expenses for the year were $3.6 million. Its net assets were $500 million at the start of the year, $400 million at the end, and averaged $450 million over the year. What is the fund's expense ratio?

• a.0.08%, with the decimal point misplaced
• b.0.80%, dividing by average net assets✓
• c.0.72%, dividing by starting net assets
• d.0.90%, dividing by year-end net assets

The expense ratio is annual operating expenses divided by average net assets: $3.6 million / $450 million = 0.80%. Using year-end assets gives 0.90%, using starting assets gives 0.72%, and 0.08% results from misplacing the decimal point.

In the ETF structure, which party can deal directly with the fund by creating or redeeming large blocks of shares called creation units?

• a.Only the exchange's specialist, who issues new shares whenever demand exceeds supply
• b.The fund's custodian bank, which buys and sells units for cash at a price posted by the sponsor
• c.An authorized participant, usually a large broker-dealer, using a basket of securities✓
• d.Any retail investor, by placing a market order that the ETF fills at the end-of-day NAV

Authorized participants, usually large broker-dealers, create and redeem creation units with the fund, typically in exchange for a basket of securities, and their arbitrage helps keep the market price near NAV. Retail investors trade ETF shares in the secondary market at market prices, not at NAV with the fund; an exchange specialist does not issue ETF shares; and a custodian only safeguards fund assets.Investment Company Act Rule 6c-11

A customer wants to hold a 2x daily leveraged index ETF for six months, expecting twice the index's six-month return. What should the representative explain?

• a.Because the fund resets daily, compounding can make its six-month return differ widely from 2x the index✓
• b.The swap counterparties that supply the leverage guarantee the 2x result over any period
• c.The fund's six-month return will equal twice the index return, because the fund targets a 2x multiple
• d.The six-month result will differ from 2x only if the ETF trades at a premium or discount to NAV

Leveraged and inverse ETFs generally reset daily, so their stated objective applies to a single day; over longer periods compounding can produce results that differ significantly from the stated multiple, and FINRA Regulatory Notice 09-31 says such products are typically unsuitable for retail investors who hold them beyond one trading session. The 2x multiple is not delivered over six months, a premium or discount to NAV is not the cause of the gap, and swap counterparties do not guarantee a multi-period outcome.FINRA Regulatory Notice 09-31

A closed-end fund has a NAV of $16.00 per share, and its shares trade on an exchange at $14.40. The shares are trading:

• a.At a 10.0% premium to NAV
• b.At an 11.1% premium to NAV
• c.At a 10.0% discount to NAV✓
• d.At an 11.1% discount to NAV

A market price below NAV is a discount, measured against NAV: ($16.00 - $14.40) / $16.00 = 10.0%. Dividing the $1.60 gap by the $14.40 market price gives 11.1%, which uses the wrong base, and a premium would require a market price above NAV.

An ETN tracks a commodity index. The index is unchanged over a month, yet the ETN's market price falls 12% right after its issuing bank's credit rating is cut. This illustrates that:

• a.ETNs are unsecured debt of the issuer, so holders bear its credit risk and own no underlying assets✓
• b.ETN prices are reset daily against the index, so a flat month still produces losses through compounding
• c.Authorized participants redeemed creation units, which forced the ETN to sell commodities at a discount
• d.ETNs hold the issuer's bonds as collateral, so a downgrade lowers the ETN's net asset value directly

An exchange-traded note is an unsecured debt obligation of the issuing bank, so its price depends on the issuer's creditworthiness as well as on the index, and holders own none of the underlying assets. An ETN does not hold collateral bonds or a basket of commodities, the daily-reset compounding problem belongs to leveraged and inverse products rather than explaining a drop with a flat index, and an ETN has no creation-unit redemption by authorized participants forcing asset sales.

Which statement about a non-traded REIT is accurate?

• a.Its shares can be sold any time on an exchange, but at deeper discounts than listed REITs
• b.Part of its distributions may come from offering proceeds or borrowed money✓
• c.It must redeem shares on demand each business day at NAV, as an open-end fund does
• d.It is exempt from SEC registration because its shares do not trade on an exchange

SEC investor guidance warns that non-traded REITs may pay distributions from offering proceeds or borrowings, not only from operating cash flow, which reduces the money available to buy properties. Non-traded REITs are illiquid and any redemption program is limited and can be suspended, so they are not open-end funds redeemable on demand; many are SEC-registered offerings, so no registration exemption applies; and they have no exchange market at all, which is the source of the liquidity problem.

A retiree annuitized a variable annuity with a 4% assumed interest rate (AIR). Over the next year the separate account's net return is 7%. What happens to the monthly payment?

• a.It stays the same, because the payment was fixed at annuitization
• b.It increases, because the separate account's 7% net return beat the 4% AIR✓
• c.It decreases, because a 7% return reduces the retiree's annuity units
• d.It increases only if the insurer's general account also earns above 7%

A variable annuity payment equals a fixed number of annuity units times the current unit value, and the unit value rises when the separate account's net return exceeds the AIR and falls when it is lower. A payment fixed at annuitization describes a fixed annuity, performance does not change the number of annuity units, and the general account backs fixed annuities and plays no role in a variable payout.

A 50-year-old owner of a nonqualified variable annuity bought in 2015 has a contract value of $120,000 and a cost basis of $90,000. He withdraws $20,000 as a lump sum before annuitizing. What is the federal tax result?

• a.The full $20,000 is long-term capital gain, plus a 10% additional tax of $2,000
• b.Nothing is taxed, because the $20,000 is less than his $90,000 cost basis
• c.The full $20,000 is ordinary income, plus a 10% additional tax of $2,000✓
• d.$5,000 is ordinary income, plus a 10% additional tax of $500

A withdrawal from a nonqualified annuity before the annuity starting date is taxed earnings first, so all $20,000 comes out of the $30,000 of gain and is ordinary income, and because he is under 59 1/2 the 10% additional tax applies to that taxable amount ($2,000). The pro rata $5,000 share ignores earnings-first ordering, annuity earnings are taxed as ordinary income rather than capital gain, and basis comes out only after earnings are exhausted.IRC Sections 72(e) and 72(q)

A retiree annuitizes an annuity under a life-with-10-year-period-certain option and dies in the fourth year of payments. What happens?

• a.The insurer pays the named beneficiary for the remaining six years of the guaranteed period✓
• b.Payments stop at death, because the insurer's obligation is limited to the annuitant's life
• c.The beneficiary receives payments for the beneficiary's own lifetime, as under a joint and survivor option
• d.The beneficiary receives ten more years of payments, counted from the date of death

A life annuity with a 10-year period certain pays for the annuitant's life but for at least ten years, so a death in year four leaves six guaranteed years that go to the beneficiary. Stopping at death describes the life-only option, lifetime payments to a survivor describe a joint and survivor option, and the ten years are counted from the start of payments rather than from the date of death.

An investor with a $150,000 salary owns an equipment-leasing limited partnership interest that produced a $30,000 loss this year. She also has $10,000 of passive income from another limited partnership. How much of the loss can she deduct this year?

• a.$10,000, against her other passive income, with the remaining $20,000 carried forward✓
• b.$0 this year, because passive losses stay suspended until the partnership interest is sold
• c.$3,000, against her ordinary income, with the remainder carried forward indefinitely
• d.$30,000, against her salary, because partnership losses pass through to her return

Losses from a limited partnership interest are passive, and passive losses are deductible only against passive income (IRC Section 469), so $10,000 offsets her other partnership income and the excess $20,000 is carried forward. Pass-through reporting does not let passive losses offset salary, the $3,000 figure is the net capital loss limit rather than a passive-loss rule, and suspension until sale applies only to the excess, not to the part that offsets passive income.IRC Section 469