FINRA Series 6 — All Questions

An owner gives a non-qualified annuity worth $90,000, with a $60,000 investment in the contract, to an adult child. What is the owner's immediate income tax result?

• a.None until the child surrenders the contract, when the child pays tax on the gain
• b.None, because a gift is not taxable income to the person who gives it
• c.The $30,000 gain is treated as received by the owner at the time of the gift✓
• d.The full $90,000 value is taxable to the owner as ordinary income

Transferring an annuity without full consideration triggers the deferred gain: the owner is treated as receiving the excess of the contract's value over the investment in the contract, here $30,000, and the transfer is not a tax-free gift for the gain. Transfers between spouses or incident to divorce are excepted. Only the gain is taxed, not the $60,000 of the owner's own after-tax money.Internal Revenue Code Section 72(e)(4)(C)

An insurer accepts a customer's variable annuity application, and four business days later the customer tenders the contract for redemption. What must the sales agreement between the member and the insurer provide about the selling commission?

• a.The member must return the commission to the issuing insurance company✓
• b.The commission is paid to the customer on top of the contract value redeemed
• c.The insurer and the member split the commission equally between them
• d.The member keeps it, since the sale was complete once the application was accepted

Rule 2320 requires the sales agreement to provide that the sales commission be returned to the issuing insurer if the contract is tendered for redemption within seven business days after the application is accepted. Keeping it contradicts that term. The commission is a cost the insurer recovers, not an amount owed to the customer, and the rule has no equal split.FINRA Rule 2320(e)

A customer sends payment on Tuesday for a variable life contract, and the representative promises the contract will be priced at Monday's closing unit value. What is wrong with that promise?

• a.The price must be set at the unit value on the day the representative first quotes the contract to the customer
• b.Nothing is wrong, provided the insurer agrees in writing to honor the earlier value
• c.Nothing is wrong, because the prior close is the latest value the insurer has published
• d.A variable contract must be sold at a value determined after the insurer receives the payment✓

Rule 2320(c) bars a member from selling a variable contract on any basis other than a value to be determined following receipt of payment, in accordance with the contract's terms, so Monday's value cannot be promised for a Tuesday payment. Using the latest published value is backward pricing. Pricing as of the quote or signing date looks back before the payment, and an insurer's side agreement to honor an earlier value cannot override what the rule requires.FINRA Rule 2320(c)

A variable life policy is a modified endowment contract with a $80,000 cash value and $50,000 of premiums paid. The 45-year-old owner takes a $20,000 policy loan. What are the federal tax results?

• a.$20,000 is taxable income, but the 10% additional tax does not apply to loans
• b.$20,000 is taxable income and a $2,000 additional 10% tax applies✓
• c.$30,000 is taxable income, because the loan triggers tax on the entire gain
• d.Nothing is taxed, because a loan against cash value is never a taxable event

Loans from a modified endowment contract are treated as distributions taxed earnings first. The gain is $30,000, so the $20,000 loan is all taxable, and an owner under 59 1/2 also owes the 10% additional tax of $2,000. Loans from a policy that is not a MEC are generally not taxed, which is why the first choice fails. The additional tax is not waived for loans, and only the amount borrowed is taxed, not the whole gain.Internal Revenue Code Sections 72(e)(10) and 72(v)

A variable universal life policy with an increasing death benefit option has a $300,000 face amount and a $60,000 cash value. What death benefit is paid if the insured dies?

• a.$240,000, face amount reduced by the cash value
• b.$60,000, which is the cash value in the policy
• c.$360,000, the face amount plus the cash value✓
• d.$300,000, the face amount stated in the policy

With an increasing (face plus cash value) option, the death benefit equals the face amount plus the cash value: $300,000 + $60,000 = $360,000. Paying only the face amount describes the level option. Subtracting the cash value gives the net amount at risk, which is not what is paid. The cash value is part of the benefit, not all of it.

A life insurer sells a funding agreement to an institutional investor. How is the product best described?

• a.A deposit contract paying interest and principal, backed by the insurer's general account and credit✓
• b.A separate account contract whose payments rise and fall with its subaccount portfolio
• c.A policy that pays a death benefit to a named beneficiary when the insured dies
• d.A unit investment trust that holds the insurer's bonds and issues redeemable units to investors

A funding agreement is an insurance product in which the purchaser, usually an institution, deposits money and receives scheduled interest and principal; the deposit goes to the insurer's general account, so the insurer's general credit backs the payments. Separate account payments vary with the portfolio, which is a variable contract. A death benefit describes life insurance. A UIT is a registered trust of securities and not an insurer's obligation.

A variable life insurance owner becomes totally disabled and the policy includes a waiver of premium rider. What is the effect of the rider?

• a.The owner's premiums are reduced by half but must continue until the policy matures
• b.The full death benefit is paid to the owner immediately as a disability benefit
• c.The insurer cancels the policy and refunds the premiums already paid
• d.The insurer waives premiums during the disability and the policy stays in force✓

A waiver of premium rider has the insurer cover the premiums while the owner is totally disabled, so coverage continues without payment. It does not cancel the policy or refund premiums. A death benefit is not an accelerated payout under this rider, and the rider does not simply halve the premium.

A 529 account owner changed the investment option for existing contributions in March and again in July. In November the owner asks for a third change, with no change of beneficiary. What does the federal rule on qualified tuition programs provide?

• a.It is allowed if the owner pays the plan's fee for an additional change
• b.It is allowed, because the limit applies only to new contributions, not to existing balances
• c.A plan may not allow it, because investment direction is limited to two changes a year✓
• d.It is allowed once the owner has held the current option for 90 days

Section 529 conditions qualified status on the plan limiting a contributor's or beneficiary's direction of investment of contributions, and earnings on them, to no more than two times in a calendar year. The limit covers existing balances as well as new money, and it cannot be bought back with a fee or waived after a holding period. The owner could reallocate again in the next calendar year.Internal Revenue Code Section 529(b)(4)

A 529 account holds $60,000, of which $45,000 is contributions. The owner changes the beneficiary from her son to an unrelated family friend. What are the federal tax results?

• a.No tax results, because an owner may name any person as beneficiary at any time
• b.The $15,000 of earnings is taxable, but no additional tax applies to a change of beneficiary
• c.A nonqualified distribution: $15,000 of earnings is taxable, plus a $1,500 additional tax✓
• d.The full $60,000 is taxable, because the account must be closed when the beneficiary is replaced

A change of beneficiary avoids tax only when the new beneficiary is a member of the family of the old one. A friend is not, so the change is treated as a distribution not used for education. Only the earnings, $60,000 - $45,000 = $15,000, are included in income, and the 10% additional tax on earnings is $1,500. The owner cannot name anyone without tax effect. The additional tax is not waived for beneficiary changes, and the owner's contributions are not taxed again.Internal Revenue Code Section 529(c)(3)(C)

A married couple will use five-year averaging and gift splitting to fund one grandchild's 529 plan in 2026, when the annual gift tax exclusion is $19,000. What is the most they can contribute at once without using any lifetime exemption?

• a.$95,000, which is one donor's five years of annual exclusions
• b.$19,000, which is one annual exclusion for one year
• c.$38,000, which is two donors' annual exclusions for a single year
• d.$190,000, which is $19,000 x 2 donors x 5 years✓

A donor may elect to treat a contribution above the annual exclusion as made ratably over five years, so one donor can contribute 5 x $19,000 = $95,000. A married couple that elects gift splitting doubles that to $190,000 (the election is made on a gift tax return). $38,000 ignores the five-year election, and $19,000 is one donor with no averaging.Internal Revenue Code Section 529(c)(2)

A 529 account is worth $50,000, with $35,000 of contributions and $15,000 of earnings. The owner withdraws $10,000 for a vacation, and each dollar withdrawn is treated as drawn proportionally from contributions and earnings. What is the 10% additional tax?

• a.$300, which is 10% of the $3,000 earnings portion✓
• b.$1,000, which is 10% of the entire $10,000 withdrawal
• c.$1,500, which is 10% of all the earnings in the account
• d.$0, because the owner's contributions exceed the amount withdrawn

Earnings are 30% of the account ($15,000 / $50,000), so $3,000 of the $10,000 withdrawal is earnings. That $3,000 is taxable income and carries the 10% additional tax, $300. The tax does not apply to the contributions returned, and it does not reach earnings left in the account. The contribution total does not shelter the withdrawal, because each dollar comes out proportionally.Internal Revenue Code Section 529(c)(3)(A)

A public school teacher's 403(b) plan holds its assets in a custodial account instead of an annuity contract. What may the custodial account invest in under the Internal Revenue Code?

• a.Shares of regulated investment companies, which are mutual funds✓
• b.Individual stocks and bonds chosen by the teacher, but never mutual funds
• c.Only fixed annuity contracts issued by an insurance company
• d.Any investment the custodian approves, including real estate and collectibles

A 403(b)(7) custodial account must be invested in stock of regulated investment companies (mutual funds), or in a group trust under current law. That is why mutual fund companies sell 403(b) custodial accounts to school employees. The account is not limited to individual securities, annuities or any investment a custodian chooses.Internal Revenue Code Section 403(b)(7)

A 30-year-old beneficiary's 529 plan has been maintained for 16 years. She has put $2,000 into her own IRAs this year, the 2026 IRA limit is $7,500, she has ample earned income, and $20,000 has already been rolled from 529 plans to her Roth IRA in earlier years. What is the most that can be rolled to her Roth IRA in 2026?

• a.$13,000, which is the lifetime balance less this year's IRA contribution
• b.$5,500, which is the $7,500 limit less the $2,000 already contributed✓
• c.$7,500, which is the full IRA limit for 2026
• d.$15,000, which is the remaining lifetime amount

The rollover is capped by the Roth contribution limit for the year, reduced by the beneficiary's other IRA contributions: $7,500 - $2,000 = $5,500. The lifetime cap of $35,000 less the $20,000 already rolled leaves $15,000, which is higher and so does not bind. The full $7,500 ignores the IRA contributions already made, and $13,000 mixes the two limits.Internal Revenue Code Section 529(c)(3)(E)

A 529 plan has been maintained for the beneficiary for 16 years and is worth $40,000. Of that, $9,000 is made up of contributions from the last five years together with the earnings on them. Ignoring the annual and lifetime caps, how much qualifies for rollover to the beneficiary's Roth IRA?

• a.$0, because any contribution within five years disqualifies the whole account
• b.$31,000, which excludes the recent contributions and their earnings✓
• c.$9,000, which is the amount contributed in the last five years
• d.$40,000, because the account has been open more than 15 years

The Roth rollover is limited to the amount contributed, and earnings on it, before the five-year period ending on the distribution date, and only once the program has been maintained for 15 years. Here $40,000 - $9,000 = $31,000 qualifies. The 15-year age of the account does not remove the five-year exclusion. The rule excludes the recent contributions only, not the whole account.Internal Revenue Code Section 529(c)(3)(E)

In 2026 a 41-year-old woman, whose disability began when she was 38, wants to open an ABLE account. Is she eligible based on the age of disability onset?

• a.No, because onset must have occurred before age 18
• b.Yes, but only if a parent opens the account for her
• c.No, because onset must have occurred before age 26
• d.Yes, because eligibility now requires onset of the disability before age 46✓

Beginning in 2026, an ABLE account is available to a person whose disability began before age 46; the earlier cutoff was age 26. Her onset at 38 meets the current test. The age-18 limit is not an ABLE rule, and an eligible adult can open her own account without a parent.Internal Revenue Code Section 529A(e)(1)

A mother contributes $9,000, a father $8,000 and an uncle $4,000 in one calendar year to an ABLE account for a beneficiary with no earned income. Assume the account's annual contribution limit that year is $20,000. What is the result?

• a.The $1,000 above the limit is allowed, because the limit applies only to the beneficiary's own deposits
• b.The $4,000 from the uncle is the excess, because only parents count toward the limit
• c.There is no excess, because each contributor may give up to $20,000
• d.$1,000 is an excess contribution, because the limit applies to all contributors combined✓

The annual limit is a single ceiling on total contributions to the account from all sources in the calendar year. The three gifts total $21,000, which is $1,000 over $20,000. The limit is not per contributor, it does not count only parents, and it is not limited to deposits by the beneficiary.Internal Revenue Code Section 529A(b)(2)

An ABLE account beneficiary dies with $60,000 in the account. Medicaid paid $45,000 for the beneficiary during life, and the state has filed a claim. Ignoring other expenses, how much may the state recover from the account?

• a.Up to $45,000, the total medical assistance paid✓
• b.Nothing, because ABLE account assets are exempt from claims
• c.The whole $60,000, whatever Medicaid actually paid
• d.$30,000, which is half of the account balance

At the beneficiary's death, a qualified ABLE program must pay the state, from the remaining balance, up to the total medical assistance paid for the beneficiary after the account was opened. The state's claim is capped by what Medicaid paid, not by the whole balance. The exemption during life does not extend to the payback, and there is no half-of-balance rule.Internal Revenue Code Section 529A(f)

Which of the following is a municipal fund security under MSRB Rule D-12?

• a.An interest in a local government investment pool✓
• b.A general obligation bond issued by a county
• c.Shares of a registered open-end fund that holds municipal bonds
• d.A revenue bond secured by bridge tolls

Municipal fund securities are municipal securities issued by an issuer that, but for Section 2(b) of the Investment Company Act of 1940, would be an investment company; 529 plans, ABLE programs and local government investment pools are examples. Bonds are municipal securities but not municipal fund securities. A registered municipal bond fund is an investment company security sold by prospectus.MSRB Rule D-12

An employee earning $120,000 defers $10,000 into a 401(k) plan. The employer matches 50% of the employee's deferrals up to 6% of salary. How much does the employer contribute?

• a.$5,000, which is 50% of the full $10,000 deferral
• b.$7,200, which is 6% of salary matched dollar for dollar
• c.$3,600, which is 50% of the 6% of salary that is matched✓
• d.$600, which is 6% of the employee's deferral

The match applies only to deferrals up to 6% of salary, which is $7,200. The employer pays 50% of that amount, or $3,600. Matching half of the whole $10,000 ignores the 6% cap on matched pay. Matching the $7,200 dollar for dollar ignores the 50% rate, and taking 6% of the deferral confuses the cap with the base.Treas. Reg. 1.401(m)-1: employer matching contributions under the plan formula

A diversified open-end fund has $400 million in total assets. For the 75% portion of the diversification test, what is the most it can hold in any one issuer's securities, other than government securities, and still count that holding?

• a.$20 million, which is 5% of the fund's total assets✓
• b.$40 million, which is 10% of the fund's total assets
• c.$15 million, which is 5% of the 75% portion alone
• d.$300 million, which is the 75% portion itself

To be diversified, at least 75% of total assets must be in cash, government securities, other investment company shares and other securities, with no issuer counted for more than 5% of the fund's total assets, and the fund must hold no more than 10% of an issuer's voting stock. The 5% is measured against total assets, so it is $20 million here. Applying 5% to the 75% portion understates it, the 10% figure is the voting-stock cap, and $300 million is the size of the basket.Investment Company Act Section 5(b)(1)

A large asset manager buys the investment adviser of a mutual fund family by acquiring a controlling block of the adviser's voting stock. What happens to the funds' existing advisory contracts?

• a.They terminate automatically, because the transfer of control is an assignment✓
• b.They continue if the adviser gives shareholders 60 days' written notice of the sale
• c.They continue unchanged until the board's next annual review of the contracts
• d.They continue, because only a change of portfolio manager can end an advisory contract

An advisory contract must provide that it terminates automatically upon assignment, and a transfer of a controlling block of the adviser's stock is treated as an assignment. The fund then needs a new contract approved by its board and shareholders. The 60-day notice is the fund's right to cancel a contract without penalty, not a way to keep a contract alive, and a change of portfolio manager does not end the contract.Investment Company Act Section 15(a)(4)

A fund has 100 million shares outstanding, and holders of 70 million shares attend a special meeting to change a fundamental policy. Under the Act's definition of a majority of the outstanding voting securities, how many shares must vote in favor?

• a.More than 35 million, which is a majority of those present
• b.At least 66.7 million, which is two-thirds of all shares outstanding
• c.At least 46.9 million, which is 67% of the shares present✓
• d.More than 50 million, which is over half of the shares outstanding

The Act defines the vote as the lesser of 67% or more of the shares present, if more than 50% of the outstanding shares are present, or more than 50% of the outstanding shares. Here 70 million is more than half of the 100 million outstanding, so the first test applies: 67% x 70 million = 46.9 million, which is less than 50 million. Neither a simple majority of shares present nor two-thirds of all outstanding shares is the standard.Investment Company Act Section 2(a)(42)

A 45-year-old holds a target-date fund described as a through fund. How does its asset allocation behave after the target date arrives?

• a.It becomes a money market fund and redeems its equity holdings
• b.It keeps shifting toward more conservative holdings✓
• c.It holds its most conservative allocation without any further changes
• d.It guarantees the investor's principal as of the target date itself

A through target-date fund continues to lower its equity exposure for some years after the target date, while a to fund stops shifting at the target date. Neither design converts to a money market fund, and a target-date fund guarantees neither principal nor a level of income, even at the target date. The description of the first option fits a to fund.

A fund named the Pacific Health Sciences Fund has net assets of $500 million and no borrowings. Under the SEC names rule, what is the least it must invest in health sciences investments?

• a.$450 million, which is 90% of the fund's total net assets
• b.$375 million, the 75% figure used in the diversification test
• c.$400 million, which is 80% of the fund's $500 million in net assets✓
• d.$250 million, which is a simple majority of its net assets

Rule 35d-1 requires a fund whose name suggests a type of investment or an industry to adopt a policy of investing at least 80% of its assets in that area, and 80% of $500 million is $400 million. The 75% figure comes from the diversification test, a simple majority is not the standard, and no 90% standard applies to sector names.Investment Company Act Rule 35d-1

A fund markets itself as a small-cap value fund. Over three years its holdings drift to mostly large-cap growth stocks, and its prospectus never changes. What is this called, and why does it matter to an investor?

• a.Style drift, which can leave an investor's allocation different from the one intended✓
• b.Rebalancing, which returns the holdings to the targets set in the prospectus
• c.Churning, which means excessive trading by a registered representative to earn commissions
• d.Window dressing, which means buying recent winners before the fund reports its holdings

Style drift is a departure from the stated investment style, and it matters because the investor may have chosen the fund to fill a particular slot in an allocation. Window dressing is pre-report buying of winners, churning is a sales practice abuse by a representative, and rebalancing is a return to the targets rather than a move away from them.

An S&P 500 index fund returns 9.70% for the year while the index returns 10.00%. What is the most likely main source of the 0.30% shortfall?

• a.A front-end sales charge, deducted from the fund's reported total return
• b.Capital gains distributions, which are excluded from the fund's reported total return
• c.The manager's decision to overweight sectors that lagged the market during the year
• d.The fund's operating expenses and trading costs, which the index does not bear✓

An index is a calculation with no costs, while the fund pays operating expenses and the trading costs of tracking it, so it usually trails by about the size of its expense ratio. An index fund does not make sector bets, a sales charge is not deducted from the fund's own return, and total return counts distributions that are reinvested.

In a year when the largest companies in the S&P 500 sharply outperform the smaller ones, how would a cap-weighted S&P 500 index fund likely compare with an equal-weight S&P 500 fund?

• a.The two funds would match, since both hold the same 500 stocks
• b.The equal-weight fund would likely do better, as it holds more dollars in the biggest companies
• c.The cap-weighted fund, since it holds larger positions in the biggest companies✓
• d.The cap-weighted fund would likely do worse, as it holds fewer shares of the smallest companies

A cap-weighted index puts the most money in the largest companies, so a rally led by them lifts it more than an equal-weight fund that gives each company the same weight. Holding the same stocks does not mean the same return, because the weights differ. The equal-weight fund holds fewer dollars, not more, in the biggest names.

A stock fund has an average annual return of 8% and a standard deviation of 12%. Assuming returns are normally distributed, between which two figures would about two-thirds of annual returns fall?

• a.0% to 16%, which is the mean plus and minus eight points
• b.-4% to 20%, which is the mean plus and minus one standard deviation✓
• c.-12% to 12%, which is centered on zero rather than the mean
• d.-16% to 32%, which is the mean plus and minus two standard deviations

One standard deviation either side of the mean covers about 68% of outcomes: 8% - 12% = -4% and 8% + 12% = 20%. The range of -16% to 32% is two standard deviations, which covers about 95%, the range of -12% to 12% is centered on zero instead of the mean, and 0% to 16% uses the mean, 8%, as the spread.

A portfolio has a beta of 1.4. If the market is expected to fall 5%, by about how much is the portfolio expected to fall?

• a.7.0%, which is the beta of 1.4 times the 5% market decline✓
• b.3.6%, which divides the market decline by the beta
• c.5.0%, which treats the portfolio as having a beta of 1.0
• d.1.4%, which treats the beta as a percentage of return

Beta measures sensitivity to the market, so the expected move is 1.4 x 5% = 7.0%. Dividing 5% by 1.4 gives 3.6%, which inverts the relationship; 5.0% would be a beta of 1.0; 1.4% confuses beta with a return.

Fund A returned 11% with a standard deviation of 15%. Fund B returned 9% with a standard deviation of 8%. The risk-free rate is 3%. Which fund has the better risk-adjusted return by the Sharpe ratio?

• a.Fund A, at 0.73, because its return is two points higher than Fund B's
• b.Neither, because the funds' ratios are equal once the risk-free rate is included
• c.Fund A, at 1.00, because its excess return of 8 points is the larger
• d.Fund B, at 0.75 against 0.53, as it earned more excess return per unit of risk taken✓

The Sharpe ratio is excess return over the risk-free rate divided by standard deviation. Fund A: (11 - 3) / 15 = 0.53. Fund B: (9 - 3) / 8 = 0.75. Fund B earned more excess return per unit of risk. A higher raw return does not rank higher unless risk is the same, and the ratios here are not equal.

A bond fund earned a nominal return of 7.5% in a year when inflation was 3%. About what was its real return?

• a.About 2.5%, which divides the nominal return by inflation
• b.About 7.5%, which ignores the effect of inflation
• c.About 4.5%, which is the nominal return less inflation✓
• d.About 10.5%, which adds inflation to the nominal return

The real return is approximately the nominal return less inflation: 7.5% - 3% = 4.5%. Adding the two gives 10.5%, which counts inflation as a gain, 2.5% divides the nominal return by the inflation rate, and 7.5% ignores the loss of purchasing power.

An investor holds a portfolio of large-cap US stock funds and wants to lower its overall volatility. Which addition is most likely to do that?

• a.A fund of stocks that has produced the highest return of any fund in the past year
• b.A second large-cap fund holding almost the same companies as the existing funds
• c.A leveraged fund that moves two times as much as the existing holdings
• d.A Treasury bond fund whose returns have a low correlation with those of the stock holdings✓

Volatility is reduced most by assets that do not move together with the portfolio, so a low correlation matters more than a high return. Adding a near copy of the holdings adds no diversification, the best recent performer says nothing about correlation, and a leveraged fund raises volatility.

A portfolio is 60% in a stock fund with an expected return of 9% and 40% in a bond fund with an expected return of 4%. What is the portfolio's expected return?

• a.6.5%, which is the simple average of the two returns
• b.6.0%, which swaps the weights of the two funds
• c.7.0%, the weighted average of the two expected returns✓
• d.13.0%, which adds the two expected returns

The expected return is the weighted average: 0.60 x 9% + 0.40 x 4% = 5.4% + 1.6% = 7.0%. Using 6.0% swaps the weights, 6.5% is the simple average of the two returns, and 13.0% adds them.

An investor invests $300 a month for three months in a fund, buying at $10, $12 and $15 per share. What is the investor's average cost per share?

• a.$12.00, which is $900 divided by the 75 shares bought✓
• b.$15.00, which is the price of the most recent purchase
• c.$12.33, which is the simple average of the three prices
• d.$12.50, which is the midpoint of the highest and lowest prices

The investor buys 30 shares, 25 shares and 20 shares, which is 75 shares for $900 in total, or $12.00 each. The simple average of the three prices is $12.33, which ignores that more shares were bought at the lower prices. $12.50 is the midpoint of the highest and lowest prices, and $15.00 is only the last price paid.

A bond fund has a duration of 6 years. If interest rates rise by 0.5 percentage points, by about how much is the fund's price expected to change?

• a.A decrease of about 3%, which is 6 times 0.5%✓
• b.An increase of about 3%, which gets the direction wrong
• c.A decrease of about 12%, which divides 6 by 0.5
• d.A decrease of about 0.5%, which ignores the duration

Duration estimates the percentage price change for a one point change in yield, so 6 x 0.5% = 3%, and the price moves in the opposite direction of rates. A rise of 3% gets the direction wrong, 12% divides rather than multiplies, and 0.5% ignores duration.

An ETF's shares trade at $50.60 while its net asset value is $50.00 per share. What typically happens to bring the price back toward NAV?

• a.The fund manager buys back shares from the market until the price falls to $50.00
• b.The fund's board lowers the NAV to match the market price at the end of the day
• c.Authorized participants deliver a basket for new ETF shares and sell them✓
• d.The ETF redeems shares from any investor who asks at the $50.60 market price

When an ETF trades at a premium, an authorized participant can deliver the underlying basket to the ETF in exchange for new shares, then sell those shares at the higher price, which adds supply and pushes the price down toward NAV. NAV is set by the value of the holdings, not by the board. ETF shares are redeemed in large blocks by authorized participants, not at market price for individual investors.

A closed-end fund has a net asset value of $24.00 per share and trades at $22.20 in the market. What is the discount?

• a.92.5%, which is the market price as a share of the NAV
• b.8.1%, which measures the dollar gap against the market price
• c.1.8%, which is the dollar gap shown as a percentage
• d.7.5%, which is the dollar gap measured against NAV✓

The discount is measured against NAV: ($24.00 - $22.20) / $24.00 = 7.5%. Dividing by the market price gives 8.1%, 1.8% reports the dollar difference as a percentage, and 92.5% is the price as a percentage of NAV.

To qualify as a REIT, an entity must distribute at least what percentage of its REIT taxable income to shareholders each year?

• a.90%, computed without the dividends-paid deduction and excluding net capital gain✓
• b.95%, computed without the dividends-paid deduction and excluding net capital gain
• c.80%, computed without the dividends-paid deduction and excluding net capital gain
• d.75%, computed without the dividends-paid deduction and excluding net capital gain

Section 857 requires a REIT to distribute at least 90% of its REIT taxable income. The 75% figure is the asset and income test for real estate holdings and 95% was the pre-2001 distribution requirement, so both are common mix-ups.Internal Revenue Code Section 857(a)

What day-count convention is used to compute accrued interest on a municipal bond?

• a.Actual days in the month and a 365-day year
• b.Thirty-day months and a 360-day year✓
• c.Actual days in the month and the actual days in the year
• d.Thirty-day months and a 365-day year

MSRB Rule G-33 calculates municipal accrued interest on a 30/360 basis. Actual-day counts are used for U.S. Treasury notes and bonds, and that is the usual source of confusion.MSRB Rule G-33

Which description fits a unit investment trust?

• a.It has a board of directors and issues redeemable securities representing shares in a portfolio that is managed daily
• b.It has no board of directors and issues non-redeemable shares that trade only in the secondary market
• c.It has a board of directors and sells a fixed number of shares that are not redeemable
• d.It has no board of directors and issues only redeemable securities, each an undivided interest in a unit of specified securities✓

The statute defines a UIT as organized under a trust indenture or similar instrument, with no board of directors, issuing only redeemable securities that each represent an undivided interest in a unit of specified securities. That is why the portfolio is fixed rather than managed.Investment Company Act of 1940 Section 4(2)

What must a government money market fund invest in?

• a.At least 95% of its total assets in U.S. Treasury securities, with no repurchase agreements allowed
• b.At least 80% of its total assets in Treasury bills, with the rest allowed in commercial paper
• c.At least 99.5% of its total assets in municipal securities that are exempt from federal tax
• d.At least 99.5% of its total assets in cash, government securities and fully collateralized repurchase agreements✓

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 repos. Commercial paper and municipal holdings are not part of that definition.17 CFR 270.2a-7

A fund describes itself as a retail money market fund under Rule 2a-7. What limits who may invest in it?

• a.It has a minimum investment of $25,000 so that institutions are discouraged
• b.It limits investors to accredited investors who hold no other money market fund
• c.It has policies and procedures reasonably designed to limit all beneficial owners to natural persons✓
• d.It limits sales to investors who live in the state where the fund is organized

A retail money market fund is one with policies and procedures designed to limit all beneficial owners to natural persons. A minimum investment may discourage institutions but is not the test.17 CFR 270.2a-7

A bond is trading at a premium and is callable at par. How does its yield to call compare with its yield to maturity?

• a.Yield to call cannot be compared, because the bond may never be called
• b.Yield to call is lower, because the premium is lost over a shorter period✓
• c.Yield to call is higher, because the principal is returned sooner
• d.The two yields are equal, because the coupon rate is the same in either case

A premium paid above par is written off over the time to the call date, so a bond that is called sooner loses that premium sooner and earns a lower yield. That is why investors use the lower yield as the conservative measure on premium callable bonds.

A discount bond with a 4% coupon is trading at 92. Compared with the coupon rate, what is true of its current yield and its yield to maturity?

• a.Current yield equals the coupon rate, and yield to maturity is below the coupon rate
• b.Current yield is above the coupon rate, and yield to maturity is below the current yield
• c.Current yield is below the coupon rate, and yield to maturity is below the current yield
• d.Current yield is above the coupon rate, and yield to maturity is above the current yield✓

Current yield is $40 divided by $920, about 4.35%, which is above the 4% coupon. Yield to maturity is higher still because the bond also earns the gain from 92 up to par at maturity.

In the creation and redemption process for an ETF, who may deal directly with the fund in creation units?

• a.Authorized participants, which exchange a basket of securities or assets for creation units✓
• b.Any retail investor, who exchanges cash for creation units through a broker-dealer
• c.The fund's investment adviser, which sets the number of creation units each day
• d.The exchange where the ETF is listed, which issues the creation units on request

Only authorized participants place orders for creation units with the ETF, usually delivering a basket of securities. Retail investors buy and sell shares on an exchange from other investors.17 CFR 270.6c-11

For which kind of bond is the interest not excluded from federal gross income, even though the issuer is a state or local government?

• a.A bond issued at a discount by a school district
• b.A general obligation bond of a county
• c.An arbitrage bond✓
• d.A revenue bond that finances a municipal water system

Section 103(a) excludes interest on state and local bonds, but Section 103(b) denies the exclusion for arbitrage bonds, among others. Governmental general obligation bonds, essential-service revenue bonds and original issue discount bonds can all qualify for the exclusion.Internal Revenue Code Section 103(b)(2)

A convertible bond is convertible at $50 a share, and the bond is trading at 110 ($1,100). What stock price makes the stock equal in value to the bond (the parity price)?

• a.$55, found by dividing the $1,100 bond price by the 20 shares the bond converts into✓
• b.$50, which is the conversion price stated in the indenture
• c.$110, which is the bond's price quoted as a percentage of par
• d.$22, found by dividing the $1,100 bond price by the $50 conversion price

The conversion ratio is $1,000 divided by $50, or 20 shares. Parity is the bond price divided by the ratio: $1,100 divided by 20 is $55. If the stock trades below $55, the bond is priced at a premium to its conversion value.

What is the key feature that distinguishes an open-end management company from a closed-end management company?

• a.An open-end company invests only in bonds and a closed-end company invests only in stock
• b.An open-end company sells shares on an exchange and a closed-end company sells directly to investors
• c.An open-end company offers, or has outstanding, redeemable securities and a closed-end company does not✓
• d.An open-end company has a board of directors and a closed-end company has a trustee

The Act defines an open-end company as a management company that offers for sale or has outstanding redeemable securities, and a closed-end company as any other management company. Open-end funds redeem at NAV and closed-end funds typically trade in the secondary market.Investment Company Act of 1940 Section 5(a)

Which expense may a fund pay out of assets under a Rule 12b-1 plan?

• a.The investment adviser's management fee
• b.Brokerage commissions on the fund's portfolio trades, which are paid out of the fund's assets whenever it buys or sells securities
• c.The custodian's fee for safekeeping the fund's assets
• d.Advertising, compensation of dealers and sales personnel, and printing and mailing of sales literature✓

Rule 12b-1 covers financing of any activity primarily intended to result in the sale of fund shares, including advertising, compensation of dealers and sales personnel, and printing and mailing of prospectuses to new investors and sales literature. Portfolio brokerage, custody and advisory fees are operating costs.17 CFR 270.12b-1

A fund has a net asset value of $20.00 a share and pays a $1.00 per-share distribution that is not reinvested. Ignoring market movement, what is the NAV on the ex-dividend date?

• a.$20.50
• b.$20.00
• c.$21.00
• d.$19.00✓

The distribution leaves the fund, so assets per share fall by the amount paid, from $20.00 to $19.00. The shareholder holds the same total value in a lower NAV plus the cash distribution, which is taxable even though the NAV dropped.