FINRA SIE — Securities Industry Essentials — All Questions

An investor buys a 20-year zero-coupon corporate bond at $400 per $1,000 face in a taxable account and reports $60 of OID over the next 3 years. The investor then sells it for $520. What is the capital gain?

• a.$120
• b.$520
• c.$60✓
• d.$180

The OID reported each year increases the cost basis: $400 + $60 = $460. The capital gain on a $520 sale is $520 - $460 = $60. $120 ignores the basis adjustment, $180 adds the OID again, and $520 is the whole sale price.IRC §1272

An investor buys a tax-exempt municipal bond with exactly 4 years and 6 months left at 98.75 ($987.50 per $1,000 bond). Under the de minimis rule, how is the discount treated at maturity?

• a.As ordinary income, because the $12.50 market discount exceeds the $10 de minimis amount✓
• b.As tax-exempt interest, because the bond is a municipal bond
• c.As a capital gain, because the bond was bought on the secondary market
• d.As a capital gain, because the $12.50 discount exceeds the $10 de minimis amount

The de minimis amount = 0.25% x redemption value x full years to maturity = 0.0025 x $1,000 x 4 = $10. The market discount is $1,000 - $987.50 = $12.50, which exceeds $10, so it is not de minimis and the accrued market discount is taxed as ordinary income. A discount below the threshold would be treated as capital gain. Market discount is not tax-exempt interest.IRC §1278(a)(2)

An investor buys a tax-exempt municipal bond at a premium. How is the premium treated?

• a.It is added to the cost basis and recovered when the bond matures
• b.It must be amortized, with no deduction, and reduces cost basis✓
• c.It is ignored, and the investor reports a capital loss at maturity
• d.It may be amortized and deducted each year against ordinary income

For tax-exempt bonds, the premium is amortized over the life of the bond and reduces cost basis each year, but the amortization is not deductible because the interest is tax-exempt. As a result, the basis equals par at maturity and there is no capital loss. The other statements get either the deduction or the basis effect wrong.IRC §171

An investor buys a corporate bond for $970, receives $60 of coupon interest while holding it, then sells it for $1,010. How are the proceeds taxed?

• a.$60 as a capital gain and $40 as ordinary income
• b.$40 as ordinary income and $60 as capital gain
• c.$100 as ordinary interest income
• d.$60 as ordinary interest income and $40 as a capital gain✓

Coupon interest is ordinary income: $60. The sale price less the cost is a capital gain: $1,010 - $970 = $40. The other choices swap the types of income or treat everything as ordinary income.

An investor holds one XYZ 80 call covering 100 shares. XYZ then declares a 2-for-1 stock split. After the standard adjustment for the split, what does the investor hold?

• a.Two XYZ 80 calls, each covering 100 shares
• b.One XYZ 80 call covering 100 shares, left unchanged
• c.One XYZ 160 call covering 100 shares
• d.Two XYZ 40 calls, each covering 100 shares✓

In a 2-for-1 split the stock price falls to about half while holders end up with twice as many shares, so the option is adjusted to keep its economics the same: the number of contracts doubles and the strike is halved, which gives two 40 calls. Leaving the call at one 80 contract would turn a near-the-money call into a deep out-of-the-money one overnight. A 160 strike moves the wrong way and would gut the call's value just as the stock price halves. Doubling the contracts but keeping the 80 strike would give the holder the right to buy twice as many shares at a price now far above the market.OCC By-Laws, Article VI, Section 11

A customer holds one index call with a 5,000 strike and a $100 multiplier. The option is exercised when the index settles at 5,040. What happens at settlement?

• a.The writer pays $4,000 in cash, and no stock is delivered✓
• b.The writer delivers the index's component stocks to the holder at the strike
• c.The writer delivers the index's component stocks, worth $504,000
• d.The writer pays the holder $40 in cash, and no stock is delivered

Index options are cash settled. The amount owed is (index level minus strike) times the multiplier: (5,040 - 5,000) x $100 = $4,000. Paying only $40 forgets the multiplier. An index is not a deliverable asset, so nobody receives the component stocks, whether at the strike or at their full value. The $504,000 figure is the index value times the multiplier, which describes the size of the exposure, not what the writer pays on exercise.Characteristics and Risks of Standardized Options (ODD)

On Monday, a regular business day, a customer exercises an equity call on XYZ and the exercise is assigned to a short customer. Under the standard settlement cycle for exercises of equity options, when do the shares and payment change hands?

• a.On Wednesday, two business days after exercise
• b.On Tuesday, the next business day✓
• c.On Monday, the same day as the exercise
• d.On Thursday, three business days after exercise

Exercises of equity options settle on the next business day (T+1), the same cycle that applies to stock trades, so a Monday exercise settles on Tuesday. Wednesday reflects the former T+2 cycle and Thursday the older T+3 cycle, both of which have been replaced. Same-day settlement is not the standard: the shares have to be delivered and paid for through the clearing process, which takes a business day.OCC By-Laws, Article VI

A firm approves a customer's account for standardized options trading on March 3. Which statement correctly describes the firm's timing obligations under FINRA Rule 2360?

• a.The ODD may be sent with the first trade confirmation, and the signed account agreement is due by March 18
• b.The ODD must be delivered at or before approval on March 3, and the signed agreement is due by March 18✓
• c.The ODD must be delivered at or before approval on March 3, and the signed account agreement is due by April 2
• d.The ODD must be delivered by March 18, and the signed account agreement must be on file at or before approval on March 3

Rule 2360 has two separate clocks. The options disclosure document (ODD) must be furnished at or before the time the account is approved for trading, so March 3 at the latest. The customer's written account agreement, in which the customer agrees to be bound by the applicable rules, must be obtained within 15 days after approval, which is March 18. Reversing the two deadlines is wrong because the ODD comes first and the agreement can follow. A 30-day agreement window, ending April 2, is longer than the rule allows. Delaying the ODD until the first confirmation is too late, since the customer must see the risks before the account can trade.FINRA Rule 2360(b)(11) and (b)(16)(D)

An investor wants an exchange-listed put on ABC that expires about 20 months from now. Which statement is correct?

• a.It would be a LEAPS contract, which can only be exercised at expiration
• b.It cannot exist, because listed options may not expire more than nine months from listing
• c.It must be an over-the-counter contract, because listed options expire within one year
• d.It would be a LEAPS contract, which lists with more than nine months until expiration✓

LEAPS (Long-term Equity AnticiPation Securities) are exchange-listed calls and puts with expirations of more than nine months when listed, so a 20-month put is exactly what LEAPS are for. Listed options are not capped at nine months; that figure is the point above which an option is called a LEAPS contract. Nor must a long-dated option be over the counter, because LEAPS are standardized and cleared by OCC like other listed options. LEAPS on stocks are American style and can be exercised any time before expiration, so the claim that they exercise only at expiration is wrong.Characteristics and Risks of Standardized Options (ODD)

A customer is short five ABC 50 calls, and the holder of an ABC 50 call at another firm exercises. How is the assignment handled?

• a.OCC randomly picks a clearing member with shorts, which then assigns a customer at random or first-in, first-out✓
• b.Only uncovered writers can be assigned, and covered writers are passed over until expiration
• c.OCC assigns the writer who sold the contract earliest, ranked by trade date across all firms
• d.The exerciser chooses which writer to assign after reviewing the short positions held at each firm

When a holder exercises, OCC randomly assigns the exercise notice to a clearing member that carries short positions in the same series. The clearing member then assigns it to one of its short customers using a random or first-in, first-out method that it has disclosed. OCC does not rank writers by trade date across the market, and the exerciser has no say in who is assigned. Covered writers are not exempt, since a short call is subject to assignment whether or not the writer owns the stock.OCC By-Laws, Article VI

Open interest in an option series is 400 contracts. Trader A sells 50 contracts to open to Trader B, who is buying to open. Then Trader C sells 30 contracts to close to Trader D, who is buying to open. What is the open interest afterward?

• a.500 contracts
• b.480 contracts
• c.450 contracts✓
• d.420 contracts

Open interest counts contracts outstanding that have not been closed out or exercised. The first trade creates 50 new contracts because both sides are opening, so open interest rises to 450. In the second trade, C is closing an existing long position and D is opening a new one, so a contract merely changes hands and open interest does not move. A total of 500 would count both the long and the short side of the new contracts. A total of 480 treats the transfer as new contracts, and 420 treats C's closing sale as reducing the total even though D takes over the position.Characteristics and Risks of Standardized Options (ODD)

An investor buys one XYZ 50 put for a premium of $3.50. Ignoring commissions, what is the maximum possible gain on this position?

• a.$4,650✓
• b.$5,350
• c.$5,000
• d.$350

The put buyer profits most if the stock falls to zero, at which point the put is worth the full strike price of $50 per share. The gain is the strike minus the premium paid: ($50 - $3.50) x 100 = $4,650. The $5,000 figure ignores the premium that was paid to get the position. The $5,350 figure adds the premium instead of subtracting it. The $350 figure is the most the buyer can lose, not the most the buyer can gain.

An investor writes one uncovered ABC 40 call and collects a premium of $2.25. At expiration ABC is trading at $46. Ignoring commissions, what is the result of the position?

• a.A loss of $375✓
• b.A loss of $600
• c.A loss of $825
• d.A profit of $225

The call is in the money by $6 at expiration (46 - 40), so the writer must deliver at 40 stock worth 46, a loss of $6 per share before the premium. The premium collected offsets $2.25 of that, so the net loss is ($6.00 - $2.25) x 100 = $375. A $600 loss ignores the premium. A $825 loss adds the premium instead of subtracting it. A $225 profit would be the result only if the call expired worthless, which it does not because ABC finished above the strike.

An investor buys 100 shares of a stock at $52 and sells one 55 call for $2.50 against the position. The call is assigned at expiration. What is the investor's total profit on the position, ignoring commissions?

• a.$800
• b.$550✓
• c.$250
• d.$300

When the call is assigned, the shares are delivered at the 55 strike. The stock gain is ($55 - $52) x 100 = $300, and the investor also keeps the $2.50 x 100 = $250 premium, so the total profit is $550. This is also the most the position can earn, because the call caps the sale price at 55. The $300 figure leaves out the premium. The $250 figure leaves out the gain on the stock. The $800 figure counts the premium twice.

An investor buys 100 shares of a stock at $38 and, to limit risk, buys one 35 put for $1.60. Ignoring commissions, what is the maximum loss on the combined position?

• a.$300
• b.$160
• c.$460✓
• d.$3,800

With the put in place, the investor can always sell at 35, so the stock loss is capped at ($38 - $35) x 100 = $300. The put cost another $1.60 x 100 = $160, which is lost whatever happens. The maximum loss is therefore $300 + $160 = $460. A $300 answer forgets the cost of the put. A $160 answer counts only the premium. A $3,800 answer is the loss from the stock going to zero with no protection at all.

An investor buys one DEF 60 call at a premium of $3.20. Before expiration DEF rallies and the premium rises to $5.70, so the investor sells the call to close. Ignoring commissions, what is the result?

• a.A profit of $890
• b.A profit of $570
• c.A profit of $130
• d.A profit of $250✓

Selling the option to close realizes the change in premium: ($5.70 - $3.20) x 100 = $250. The investor never exercises, so strike prices do not enter the calculation. The $570 figure is the sale proceeds without subtracting the $320 cost. The $890 figure adds the buying and selling premiums together. The $130 figure does not come from any correct step and understates the gain.

An investor writes one JKL 45 put for a premium of $2.60. JKL falls and the put is assigned. What is the investor's effective cost per share for the 100 shares purchased, ignoring commissions?

• a.$45.00
• b.$47.60
• c.$42.40✓
• d.$2.60

When a put writer is assigned, the writer must buy the stock at the strike price of 45. The premium already collected reduces the net cost: $45.00 - $2.60 = $42.40 per share. Adding the premium ($47.60) is the wrong direction, because the premium was received, not paid. Paying exactly $45.00 ignores the premium. The $2.60 figure is just the premium and has nothing to do with the cost of the shares.

An investor writes one uncovered MNO 65 call for a premium of $3.10. At what stock price at expiration does the writer break even, ignoring commissions?

• a.$61.90
• b.$68.10✓
• c.$71.20
• d.$65.00

A call writer starts to lose money once the stock rises enough to wipe out the premium collected, so break-even is the strike plus the premium: $65.00 + $3.10 = $68.10. Strike minus premium ($61.90) is the break-even for a put buyer or writer, not a call. At the strike ($65.00) the call is only at the money, and the writer is still ahead by the $3.10 premium. The $71.20 figure double-counts the premium.

An investor buys 100 shares of a stock at $40 and, at the same time, buys one 40 put for $2.00 as a married put. What is the break-even stock price at expiration, ignoring commissions?

• a.$42.00✓
• b.$38.00
• c.$40.00
• d.$44.00

The put premium is an added cost of the stock position, so the shares must rise by the premium before the investor is even: $40.00 + $2.00 = $42.00. Strike minus premium ($38.00) is the break-even for a long put alone, not a married put. A price of $40.00 would be break-even only if the put were free. A price of $44.00 doubles the premium.

Ahead of an earnings release, an investor expects a large price move in XYZ but has no view on direction. Using options that all share one expiration, which position best fits this outlook?

• a.Buy one XYZ 50 call and sell one XYZ 55 call
• b.Buy one XYZ 50 call and one XYZ 50 put✓
• c.Write one XYZ 50 call and one XYZ 50 put
• d.Buy one XYZ 50 call and write one XYZ 50 put

Buying a call and a put with the same strike and expiration is a long straddle. It gains if the stock moves far enough in either direction, which is exactly a big-move, no-direction view. Buying one call and selling a higher-strike call is a bull spread that needs the stock to rise. Writing both a call and a put is a short straddle, which profits when the stock stays put and loses on a large move. Buying a call and writing a put at the same strike is a bullish position that loses if the stock drops.

An investor buys one XYZ 50 call for $3.00 and one XYZ 50 put for $2.50, both with the same expiration. What is the maximum possible loss on this position, and when does it occur?

• a.$250, if XYZ finishes above 50
• b.$5,000, if XYZ falls to zero
• c.$550, if XYZ finishes exactly at 50✓
• d.$300, if XYZ finishes below 50

This is a long straddle. The most the investor can lose is the total premium paid, ($3.00 + $2.50) x 100 = $550, and that loss occurs when XYZ closes exactly at the 50 strike so that both options expire worthless. Any move away from 50 makes one option worth something, and the position breaks even at 44.50 or 55.50. A $300 or $250 loss would be the premium on one leg only, but the investor paid for both. A fall to zero is the best outcome for the put, not the worst.

An investor buys one ABC 60 call for $5 and sells one ABC 65 call for $2, both with the same expiration. Which statement describes the position?

• a.A neutral position with a net cost of $300 and a maximum gain of $200
• b.A bullish credit spread with a net credit of $300 and a maximum loss of $200
• c.A bullish debit spread costing $300 net, with a $200 maximum gain✓
• d.A bearish debit spread with a net cost of $300 and a maximum gain of $200

Buying the lower-strike call and selling the higher-strike call is a bull call spread. The investor pays $5 and receives $2, a net debit of $3, or $300. The most the spread can be worth is the $5 difference between strikes, so the maximum gain is $500 - $300 = $200 and the maximum loss is the $300 paid. It is not a credit spread because money goes out on net. It is not bearish because the investor needs the stock to rise, and it is not neutral because the maximum gain requires the stock to finish at or above 65.

An investor owns 1,000 shares of XYZ, currently at $60, with a large unrealized gain. She does not want to sell yet and wants downside protection at little net cost. She sells 10 XYZ 70 calls and buys 10 XYZ 55 puts. What is this position called, and what does it do?

• a.A married put, which keeps all of the upside above the stock price
• b.A collar, which limits losses below 55 and caps gains above 70✓
• c.A covered straddle, which profits from large moves in either direction
• d.A bull spread, which profits only if XYZ rises above 70

A collar combines owning the stock with buying an out-of-the-money put for protection and selling an out-of-the-money call to help pay for it. The put sets a floor near 55, and the call caps the upside at 70, so the gains and losses are both bounded. A straddle pairs a call with a put at the same strike and is not designed around protecting stock. A married put has no short call, so the upside is not capped. A bull spread uses two calls and does not involve a put.

Which pair of positions on the same stock reflects the same market outlook?

• a.A long put and a short put
• b.A long call and a long put
• c.A long call and a short put✓
• d.A short call and a short put

A long call profits when the stock rises, and a short put also profits when the stock rises or stays above the strike, so both are bullish. A long call and a long put together make a straddle, which has no fixed direction. A short call is bearish and a short put is bullish, so that pair points in opposite directions. A long put profits when the stock falls and a short put profits when it rises or holds, so those two are opposites as well.

Section 4 of the Investment Company Act of 1940 divides registered investment companies into three classes. Which of the following is one of those classes?

• a.Real estate investment trust
• b.Face-amount certificate company✓
• c.Direct participation program
• d.Exchange-traded note issuer

Section 4 names face-amount certificate companies, unit investment trusts and management companies. A face-amount certificate company issues certificates that promise to pay a stated amount at a fixed future date, so it is one of the three. A REIT is a tax-status entity that invests in real estate and is not one of the Act's classes. A direct participation program is a pass-through business venture, usually a limited partnership, and falls outside the Act's classes. An exchange-traded note is a debt obligation of the issuing bank, not an investment company.Investment Company Act of 1940, Section 4

A diversified management company has total assets of $300 million. To meet the 75-5-10 test, what is the most it may hold in the securities of any one issuer within the 75% portion of its assets?

• a.$11.25 million
• b.$30 million
• c.$225 million
• d.$15 million✓

To be classed as diversified, a management company must hold at least 75% of its total assets in cash, government securities, other investment company shares and other securities, with no more than 5% of total assets in any one issuer and no more than 10% of that issuer's voting securities. Five percent of $300 million is $15 million. The $30 million figure applies the 10% voting-securities limit to the fund's own assets, which is a different test. The $11.25 million figure takes 5% of only the 75% portion, but the 5% limit is measured against total assets. The $225 million figure is the 75% bucket itself, not a limit on one issuer.Investment Company Act of 1940, Section 5(b)(1)

A private fund sells interests to 150 investors, all of whom are qualified purchasers, and does not make a public offering. Which statement is correct?

• a.It must register as an investment company, because it has more than 100 owners
• b.It may rely on Section 3(c)(1), because qualified purchasers are not counted toward the 100-owner limit
• c.It may rely on Section 3(c)(7), which has no 100-owner limit when all owners are qualified purchasers✓
• d.It may rely on Section 3(c)(1), because a private fund may have up to 150 owners

Section 3(c)(7) excludes a privately offered issuer whose securities are owned exclusively by qualified purchasers, and it contains no cap on the number of owners, so 150 qualified purchasers is permitted. Section 3(c)(1) does cap beneficial owners at 100 (with a separate higher cap only for qualifying venture capital funds), so 150 owners cannot rely on it. Registration is not required, because the 100-owner limit belongs only to Section 3(c)(1). Qualified purchasers are counted under Section 3(c)(1), so excluding them from the count is not an option.Investment Company Act of 1940, Section 3(c)(1) and 3(c)(7)

A fund's public offering price is $20.00 per share, and its sales charge is 4.75% of the public offering price. What is the net asset value per share?

• a.$19.09
• b.$20.95
• c.$19.05✓
• d.$15.25

Because the sales charge is a percentage of the public offering price, the NAV is the POP less that charge: $20.00 x (1 - 0.0475) = $20.00 x 0.9525 = $19.05. Dividing the POP by 1.0475 gives $19.09, which treats the charge as a percentage of NAV. Adding the charge to the POP gives $20.95, which moves in the wrong direction. Subtracting 4.75 dollars gives $15.25, which treats the percentage as a dollar amount.

A fund's public offering price is $24.00 and its net asset value is $22.56. What is the sales charge as a percentage of the public offering price?

• a.6.4%
• b.6.0%✓
• c.94.0%
• d.1.44%

The sales charge is the difference between POP and NAV: $24.00 - $22.56 = $1.44. Stated as a percentage of the public offering price, that is $1.44 / $24.00 = 6.0%. Dividing by NAV instead gives 6.4%, which uses the wrong base. The 94.0% figure is NAV as a percentage of POP, the amount that actually goes to work in the fund. The 1.44% figure is the dollar amount of the charge read as a percentage.

A client plans to hold a fund for 15 years. Class A shares carry a 5.50% front-end load and a 0.25% annual 12b-1 fee. Class C shares carry no front-end load and a 1.00% annual 12b-1 fee, with no deferred charge after the first year. Ignoring compounding and investment growth, which statement about the cost of the two classes over the full 15 years is correct?

• a.Class C costs less, because it has no front-end load
• b.Class A costs less, about 9.25% in total charges versus 15% for Class C✓
• c.The classes cost the same, because neither charges a deferred sales charge after year one
• d.Class A costs more, about 20.5% in total charges versus 15% for Class C

Class A: 5.50% once, plus 0.25% x 15 years = 3.75%, for a total of 9.25%. Class C: 1.00% x 15 years = 15%. For a long holding period the level annual charge of Class C adds up to more than the one-time load of Class A. Choosing Class C because it has no load looks only at the first day and ignores the recurring fee. The 20.5% figure charges Class A the 1.00% annual rate that belongs to Class C. The classes are not equal, because both a front-end load and annual 12b-1 fees are part of the cost.FINRA Rule 2341(d)

A fund has a net asset value of $19.00 and a 5.00% sales charge, stated as a percentage of the public offering price. An investor sends $10,000 to buy shares. How many shares does the investor receive, ignoring any breakpoint?

• a.525 shares
• b.500 shares✓
• c.475 shares
• d.526.32 shares

POP = $19.00 / 0.95 = $20.00. The investor's $10,000 buys at the public offering price: $10,000 / $20.00 = 500 shares. As a check, the sales charge is $1.00 a share (5% of $20.00), or $500 in all, and the remaining $9,500 buys 500 shares at $19.00 of NAV. Dividing by NAV gives 526.32 shares, which ignores the sales charge. The 475 figure takes the charge out of the money twice. The 525 figure adds 5% to 500 shares, which has the charge going the wrong way.

A client buys $20,000 of Class B shares. The deferred sales charge is 5%, 4%, 3%, 2% and 1% in years one through five, charged on the original $20,000 purchase amount. The client redeems everything during the third year, when the shares are worth $24,000. What is the deferred sales charge?

• a.$600✓
• b.$800
• c.$1,000
• d.$720

Redeeming during the third year puts the client in the 3% bracket. The charge is applied to the original purchase amount of $20,000, so 3% x $20,000 = $600. Using 4% ($800) treats the third year as the second. Applying 3% to the current value of $24,000 ($720) uses the wrong base, which the schedule in this question does not allow. Using 5% ($1,000) applies the first-year rate, which only applies to a redemption in the first year.

A customer with $55,000 to invest buys $49,000 of a fund just below a $50,000 breakpoint. When FINRA reviews whether this was a breakpoint sale, which record would best support the member's position that it was not?

• a.Records showing the trade followed a bona fide asset allocation program the member offers, with disclosure that breakpoint reductions might not be available✓
• b.A note that the customer verbally agreed to pay the higher sales charge on the $49,000
• c.A statement that the customer had never owned shares of that fund family before
• d.A copy of the prospectus page that lists the fund's breakpoint schedule

Rule 2342(b) says FINRA will look at the facts and circumstances, including whether the member retained records showing the trade was executed under a bona fide asset allocation program that is designed to meet customers' diversification needs and investment goals, and under which the member discloses that customers may not qualify for breakpoint reductions. A verbal agreement to pay the higher charge is not the kind of record the rule describes, and a customer cannot easily waive the protection. The prospectus schedule shows the breakpoint exists, which is exactly what makes a purchase just below it suspect. A first-time purchase says nothing about why the amount was chosen.FINRA Rule 2342(b)

A fund family offers a reduced sales charge at $50,000, and its prospectus says that rights of accumulation count the current value of existing holdings. A client's existing shares cost $32,000 and are now worth $40,000. The client wants to add $15,000 in the same family. Does the new purchase qualify for the reduced charge?

• a.No, because cost of $32,000 plus $15,000 is $47,000, below the breakpoint
• b.No, because only the new $15,000 purchase counts toward the breakpoint
• c.Yes, because the current value of $40,000 plus $15,000 is $55,000, above the breakpoint✓
• d.Yes, but only if the client first signs a letter of intent

Under the fund's stated rule, rights of accumulation count the current value of what the client already owns, so the test is $40,000 + $15,000 = $55,000, which clears the $50,000 breakpoint. Using the original cost of $32,000 reaches only $47,000, but the prospectus in this question measures by current value. Counting only the new purchase ignores the whole point of rights of accumulation. A letter of intent is for future purchases the client commits to make; it is not required to count shares already held.

A mutual fund calculates its NAV once a day at 4:00 p.m. ET. A customer places an order to buy shares at 4:45 p.m. ET on Tuesday. At what price will the order be executed?

• a.The NAV calculated on Tuesday at 4:00 p.m., plus any applicable sales charge
• b.The price when Wednesday's market opens
• c.The NAV next calculated on Wednesday, plus any applicable sales charge✓
• d.The average of Tuesday's and Wednesday's NAV

Mutual fund shares are forward priced. Under Rule 22c-1, a purchase or redemption is made at the current NAV that is next computed after the fund or its agent receives the order. An order that arrives at 4:45 p.m. is after Tuesday's calculation, so it gets the next one, which is Wednesday's. Tuesday's NAV is already history by the time the order comes in. A fund does not average two NAVs. Fund shares do not trade at market prices, so there is no opening price to use.SEC Rule 22c-1

A fund charges a sales charge of 5.5% on purchases under $50,000 and 4.5% on purchases from $50,000 to $99,999, applied to the entire purchase. A customer makes a single $60,000 purchase. What sales charge does the customer pay, and how much does the breakpoint save compared with the 5.5% rate?

• a.$2,250, which saves $1,050
• b.$3,300, which saves nothing
• c.$3,200, which saves $100
• d.$2,700, which saves $600✓

At $60,000 the customer is in the 4.5% bracket, and the stem says that rate applies to the whole purchase: 4.5% x $60,000 = $2,700. At 5.5% the charge would have been $3,300, so the breakpoint saves $600. A $3,200 charge treats the lower rate as applying only to the dollars above $50,000. A $2,250 charge applies 4.5% to the first $50,000 only. A $3,300 charge simply ignores that the customer has reached the breakpoint.

A client expects to invest $20,000 now and about $40,000 more over the next year, all in one fund family whose breakpoint is $50,000. The client wants the reduced sales charge from the first purchase. Which feature fits?

• a.Rights of accumulation, which count only holdings already owned
• b.A contingent deferred sales charge, which lowers the charge on later purchases
• c.Dollar-cost averaging, which sets the sales charge by the number of purchases
• d.A letter of intent, stating the total the client plans to invest✓

The SEC describes letters of intent and rights of accumulation as the two principal ways to reach breakpoints through purchases aggregated over time. A letter of intent is a statement that the client intends to invest a stated amount, and it is the tool for purchases that have not happened yet, so it fits a plan to buy $60,000 in total. Rights of accumulation look back at what the client already holds and would not help with the first $20,000. A CDSC is a charge on redemption, not a way to reduce a front-end charge. Dollar-cost averaging is an investing method and has no effect on the sales charge schedule.FINRA Rule 2341 (sales charges); SEC/FINRA investor bulletin on mutual fund breakpoints

A mutual fund has average net assets of $400 million for the year. Its management fee was $2.4 million, 12b-1 fees were $1.0 million and other administrative costs were $0.6 million. What is the fund's expense ratio?

• a.0.40%
• b.0.85%
• c.1.00%✓
• d.0.60%

The expense ratio is total annual operating expenses divided by average net assets. Total expenses are $2.4 million + $1.0 million + $0.6 million = $4.0 million, and $4.0 million / $400 million = 1.00%. The 0.60% figure counts only the management fee. The 0.85% figure leaves out the administrative costs. The 0.40% figure leaves out the management fee, which is normally the largest piece.

Fund A has an annual expense ratio of 1.40% and Fund B has 0.40%. An investor puts $20,000 in each and the funds earn identical gross returns. Ignoring compounding, how much more does Fund A charge in expenses over 10 years?

• a.$200
• b.$2,800
• c.$2,000✓
• d.$800

The gap in expense ratios is 1.40% - 0.40% = 1.00%. On $20,000, that is $200 a year, and over 10 years it comes to $2,000. The $200 figure is a single year only. The $2,800 figure is Fund A's total 10-year expenses (1.40% x $20,000 x 10), not the difference between the funds. The $800 figure is Fund B's 10-year expenses.

A fund's advisory fee schedule is 0.80% on the first $100 million of net assets, 0.60% on the next $100 million and 0.50% on assets above $200 million. What annual advisory fee does a fund with $260 million of average net assets pay?

• a.$2.08 million
• b.$1.6 million
• c.$1.3 million
• d.$1.7 million✓

A tiered schedule charges each rate only on its own slice of assets: $100 million x 0.80% = $0.8 million, $100 million x 0.60% = $0.6 million and $60 million x 0.50% = $0.3 million. The total is $1.7 million. Charging 0.80% on all $260 million gives $2.08 million, and charging 0.50% on everything gives $1.3 million, which ignore the tiers. The $1.6 million figure applies 0.50% to all $160 million above the first $100 million, skipping the middle tier's 0.60%.

A fund imposes a 2% redemption fee on shares sold within 60 days of purchase. An investor redeems $20,000 of shares after 45 days. What is the fee, and who keeps it?

• a.$400, retained by the fund for the benefit of remaining shareholders✓
• b.$40, retained by the fund for the benefit of remaining shareholders
• c.$400, paid to the investment adviser as an added management fee
• d.$400, paid to the principal underwriter as an added sales charge

The sale falls inside the 60-day window, so the fee is 2% x $20,000 = $400. Rule 22c-2 caps a redemption fee at 2% and requires that the fee be retained by the fund, so it protects the remaining shareholders from the trading costs of short-term traders. It is not a sales charge that goes to the underwriter, and it is not additional compensation for the adviser. The $40 figure misplaces the decimal and charges 0.2%.SEC Rule 22c-2

An investor bought mutual fund shares four months ago. The fund pays a capital gain distribution and the investor reinvests it in more shares. How is the distribution taxed for the year it is paid?

• a.As ordinary dividend income, because it was paid by a fund instead of a stock sale
• b.As a short-term capital gain, because the shares were held less than one year
• c.As a long-term capital gain despite only four months of ownership✓
• d.It is not taxed until the new shares are sold, because it was reinvested

A capital gain distribution reported by the fund is treated by the shareholder as gain on an asset held more than one year, no matter how long the shareholder has owned the fund shares. The four-month holding period matters only when the investor later sells shares. A fund's distribution of short-term gains is reported as an ordinary dividend, not as a capital gain distribution, so the character of this payment does not change because it came from a fund. Reinvestment does not defer anything: a reinvested distribution is taxed in the year paid exactly as if it had been taken in cash.IRC Section 852(b)(3)(B); IRS Topic 404

An investor buys 500 mutual fund shares at $20.00. The fund later pays a $1.00 per share distribution, which the investor reinvests at a NAV of $20.00 and reports as taxable income. The investor then sells all shares at $22.00. What is the taxable gain on the sale?

• a.$550
• b.$1,000
• c.$1,550
• d.$1,050✓

The reinvested distribution is $500 (500 shares x $1.00), which buys 25 more shares at $20.00, so the investor now owns 525 shares. Proceeds are 525 x $22.00 = $11,550. Because the distribution was taxed when paid, the $500 reinvested is added to the original $10,000 cost, giving a basis of $10,500, and the gain is $1,050. A gain of $1,550 ignores the added basis and taxes the distribution twice. A gain of $1,000 leaves out the 25 reinvested shares. A gain of $550 subtracts the reinvested amount from the basis a second time.IRS Publication 550 (Dividends Used to Buy More Stock)

A regulated investment company has $10 million of investment company taxable income for the year. What is the minimum it must distribute to shareholders to qualify for pass-through treatment under Subchapter M?

• a.$7.5 million
• b.$9.0 million✓
• c.$10.0 million
• d.$8.0 million

A regulated investment company keeps its conduit treatment only if it pays out at least 90% of its investment company taxable income, and 90% of $10 million is $9.0 million. Distributing the entire $10.0 million is allowed but is not the minimum. The $8.0 million and $7.5 million figures apply 80% and 75%, which are thresholds from other fund rules (the 80% names rule and the 75% test for diversification) and not the distribution requirement. Income retained above the minimum is taxed at the fund level.IRC Section 852(a)(1)

An investor in a national municipal bond fund receives $400 of exempt-interest dividends and a $100 capital gain distribution for the year. Ignoring state taxes and the alternative minimum tax, how much is subject to federal income tax?

• a.$0, because the fund holds only municipal bonds
• b.$400, the dividends paid from bond interest
• c.$500, because all fund distributions are taxable
• d.$100, the capital gain distribution only✓

An exempt-interest dividend, which a fund may pay when at least half its assets are in tax-exempt obligations, passes the exclusion from federal income tax through to shareholders. The statute defines an exempt-interest dividend as a dividend other than a capital gain dividend, so the $100 capital gain distribution does not share that exclusion and is taxed as a long-term capital gain. Taxing all $500 treats the exempt interest as ordinary income. Taxing $400 reverses the two pieces. Taxing nothing assumes a municipal fund's gains are exempt, but only the interest is.IRC Section 852(b)(5)

A money market fund has $3 billion in total assets. What is the minimum it must hold in cash, government securities and fully collateralized repurchase agreements to be a government money market fund?

• a.$2.400 billion
• b.$2.985 billion✓
• c.$2.970 billion
• d.$2.850 billion

Rule 2a-7 defines a government money market fund as one that invests 99.5% or more of its total assets in cash, government securities and fully collateralized repurchase agreements, and 99.5% of $3 billion is $2.985 billion. The $2.850 billion figure applies 95%, and $2.400 billion applies the 80% used in the names rule. The $2.970 billion figure applies 99%, which falls just short of the threshold and would leave the fund unable to use the government label.17 CFR 270.2a-7(a)(14)

An institutional prime money market fund has $10 billion in net assets. On one business day, shareholders redeem a net $600 million. What does Rule 2a-7 require of the fund?

• a.Nothing, because the mandatory fee threshold is 10% of net assets
• b.Apply a liquidity fee to all shares redeemed at that day's price✓
• c.Charge the fee only on redemptions above 5% of net assets
• d.Suspend redemptions until the next business day

Net redemptions of $600 million are 6% of $10 billion, which exceeds the 5% daily trigger. A money market fund that is neither a government fund nor a retail fund must then apply a liquidity fee, based on a good-faith estimate of its liquidity costs, to every share redeemed at the price computed that day. Rule 2a-7 no longer includes a redemption suspension for these funds. The fee is not limited to the portion above the trigger, and the trigger is 5%, not 10%, so doing nothing would violate the rule.17 CFR 270.2a-7(c)(2)(ii)

An interval fund with 40 million shares outstanding on the repurchase request deadline sets its quarterly repurchase offer at the smallest amount Rule 23c-3 allows. How many shares must it offer to repurchase?

• a.10 million shares
• b.4 million shares
• c.2 million shares✓
• d.8 million shares

Rule 23c-3 requires a repurchase offer amount of not less than 5% nor more than 25% of the shares outstanding on the repurchase request deadline, and 5% of 40 million shares is 2 million shares. The 4 million figure is 10%, the 8 million figure is 20% and the 10 million figure is 25%, the maximum. Each of those is inside the permitted range but none is the smallest amount the rule allows.17 CFR 270.23c-3(a)(3)

The Heartland Small-Cap Value Fund has $500 million in assets. Under the SEC names rule, how much must it normally invest in small-cap value investments?

• a.At least $450 million
• b.At least $350 million
• c.At least $250 million
• d.At least $400 million✓

Rule 35d-1 applies to a fund whose name suggests a particular investment focus, including terms such as value or growth. The fund must adopt a policy to invest, under normal circumstances, at least 80% of the value of its assets in investments matching that focus, and 80% of $500 million is $400 million. The $250 million figure is 50%, the $350 million figure is 70% and the $450 million figure is 90%. None of those is the percentage the rule sets.17 CFR 270.35d-1(a)(2)

A client wants a money market fund that holds a stable $1.00 share price using amortized cost. Which fund can do that?

• a.An institutional prime money market fund
• b.An institutional tax-exempt money market fund
• c.Any money market fund registered under the Investment Company Act
• d.A government money market fund✓

Only government and retail money market funds may use amortized cost or penny rounding to keep a stable price per share. Every other money market fund must price its shares by rounding NAV to at least the fourth decimal place, so an institutional prime fund or an institutional tax-exempt fund has a floating NAV. Being registered under the Investment Company Act is not enough, because the stable price depends on the type of fund and not on registration.17 CFR 270.2a-7(c)(1)