FINRA Series 6 — All Questions

How is the net asset value (NAV) per share of an open-end investment company calculated?

• a.Total assets minus total liabilities, divided by the number of shares outstanding✓
• b.The market price of the fund's shares at the close of trading on the exchange
• c.Total assets divided by the number of shares outstanding
• d.Total assets minus total liabilities, divided by the number of shareholders of record

NAV per share is the fund's net worth (assets less liabilities) spread over the shares outstanding, computed at least once each business day. Ignoring liabilities overstates value, so the first choice is wrong. Open-end fund shares do not trade on an exchange at a market price, and dividing by shareholders rather than shares produces a meaningless figure.Investment Company Act of 1940

A customer calls at 11:00 a.m. and places an order to buy shares of a mutual fund that prices its portfolio once daily at the close of the market. Which price will the customer receive?

• a.The next NAV computed after the order was received✓
• b.The NAV computed at the close of the previous business day
• c.The NAV in effect at the moment the order was accepted
• d.The average of the previous day's and the current day's NAV

Forward pricing requires that purchase and redemption orders be executed at the next price calculated after the order is received, which here is that day's closing NAV plus any sales charge. Using the prior day's price or an intraday value would let investors trade on stale information. Averaging two days' prices is not a pricing method any fund uses.Investment Company Act of 1940

A mutual fund has a net asset value of $9.30 per share and a sales charge of 7% of the public offering price. What is the public offering price?

• a.$10.00✓
• b.$10.65
• c.$9.95
• d.$10.35

POP equals NAV divided by (100% minus the sales charge percentage), so $9.30 / 0.93 = $10.00. Adding 7% to the NAV gives $9.95, a common error because the sales charge is a percentage of the offering price, not of NAV. The other figures reflect sales charges well above the 7% stated.

A fund's public offering price is $12.50 and its net asset value is $11.50. What is the sales charge percentage?

• a.9.3%
• b.8.7%
• c.7.5%
• d.8.0%✓

The sales charge equals the dollar spread divided by the public offering price: $1.00 / $12.50 = 8%. Dividing the $1.00 by the NAV instead produces 8.7%, which is the classic trap because the sales charge is always stated as a percentage of POP. The remaining figures do not correspond to either calculation.

Under FINRA rules, an open-end fund may impose the maximum permitted sales charge of 8.5% only if it offers which combination of features?

• a.A no-load share class, quarterly dividends, and daily liquidity
• b.Breakpoints, rights of accumulation, and reinvestment of dividends at net asset value✓
• c.A guaranteed minimum return, breakpoints, and monthly statements mailed to shareholders each and every month
• d.Rights of accumulation, a letter of intent, and a contingent deferred sales charge feature at the time of purchase

FINRA conditions the 8.5% maximum on the fund giving investors quantity discounts (breakpoints), rights of accumulation, and the ability to reinvest distributions at NAV; a fund lacking any of these must charge less. No fund may guarantee a return, and offering a no-load class is not a condition of charging a load. A letter of intent and a CDSC are optional features, not the required trio.FINRA Rule 2341 (Investment Company Securities)

A customer wants to invest $24,000 in a fund whose next breakpoint occurs at $25,000. The representative processes the $24,000 order without mentioning the breakpoint. This conduct is best described as:

• a.Breakpoint selling, which is prohibited✓
• b.Switching, which requires principal approval
• c.Acceptable, because breakpoints apply only to purchases above $50,000
• d.Acceptable, because the customer named the dollar amount

Selling shares in an amount just below a breakpoint without disclosing that a slightly larger purchase would reduce the sales charge is breakpoint selling, a prohibited practice that benefits the representative at the customer's expense. The customer naming the amount does not relieve the representative of the duty to disclose. Breakpoint schedules commonly start well below $50,000, and switching refers to moving assets between funds, not to a single new purchase.FINRA Rule 2341 (Investment Company Securities)

Which statement about a letter of intent (LOI) for mutual fund breakpoints is correct?

• a.It is a binding contract requiring the investor to complete the purchases on penalty of forfeiting the discount
• b.It covers 13 months and may be backdated up to 90 days to include a prior purchase✓
• c.It permits the investor to count purchases made in any other fund family toward reaching the breakpoint discount
• d.It covers a period of 24 months and cannot be backdated

An LOI lets an investor obtain a reduced sales charge by pledging to invest a stated amount within 13 months, and it may be backdated as much as 90 days so a recent purchase counts toward the goal. The letter is not binding: if the investor does not complete it, the fund simply liquidates escrowed shares to collect the higher sales charge. Purchases in unrelated fund families do not count toward the LOI.FINRA Rule 2341 (Investment Company Securities)

Rights of accumulation differ from a letter of intent in that rights of accumulation:

• a.Eliminate the sales charge entirely on all future purchases once the first breakpoint has been reached
• b.Apply only to shares purchased with reinvested dividends
• c.Require the investor to commit to future purchases within a stated period to keep the reduced sales charge
• d.Have no time limit and let existing holdings count toward the next breakpoint✓

Rights of accumulation allow the current value or total cost of shares already owned to be added to a new purchase so the combined amount reaches a breakpoint, and there is no deadline for using them. A letter of intent, by contrast, looks forward over 13 months. Rights of accumulation reduce, but do not eliminate, the sales charge and are not limited to reinvested shares.

A 12b-1 fee charged by a mutual fund is used primarily to pay for:

• a.Brokerage commissions incurred when the fund trades securities inside the fund's investment portfolio each year
• b.Distribution and shareholder servicing costs, such as marketing and compensation to selling firms✓
• c.The portfolio manager's advisory fee
• d.Custodial and transfer agent recordkeeping only

Rule 12b-1 under the Investment Company Act of 1940 permits a fund to use fund assets to pay for distribution and shareholder servicing, and the fee is deducted from assets annually rather than charged at the point of sale. The advisory fee, portfolio transaction costs, and custodial fees are separate expense line items disclosed in the prospectus.Investment Company Act of 1940

A fund may describe itself as "no-load" only if its annual 12b-1 charges do not exceed:

• a.There is no limit, because no-load refers only to the absence of a front-end charge
• b.0.75% of average net assets
• c.0.25% of average net assets✓
• d.1.00% of average net assets

FINRA permits the no-load label only when combined asset-based sales and service charges stay at or below 0.25% per year. The 0.75% figure is the cap on the distribution portion alone, and 1.00% is the total ceiling on 12b-1 charges for a fund that does not claim to be no-load. A fund with meaningful ongoing distribution fees is not truly no-load even without a front-end charge.FINRA Rule 2341 (Investment Company Securities)

A 45-year-old investor has $250,000 to invest for retirement in about 20 years and expects to add money over time. Which share class is generally most appropriate?

• a.Class B shares, because the contingent deferred sales charge disappears over time
• b.Class C shares, because the level load spreads the cost evenly across the holding period, keeping the annual cost constant over the entire holding period
• c.Class A shares, because the large purchase qualifies for breakpoints and the ongoing expenses are lowest✓
• d.Any class, because total costs are identical over a 20-year period

A large, long-horizon investment favors Class A shares: the front-end charge is heavily discounted by breakpoints and the low ongoing 12b-1 fee compounds into a smaller drag over two decades. Class B shares typically are not even offered at this size and carry higher ongoing fees during the CDSC period. Class C shares charge a higher level fee every year, which over 20 years costs far more than a discounted front-end load.

An investor plans to place $15,000 in a fund but expects to need the money in about two to three years. Which share class is generally most suitable?

• a.Class B shares, because the deferred charge is waived after one year
• b.Class A shares, because the front-end load is smallest over short periods of investment of only a year or two before the money is needed
• c.Class C shares, because there is little or no front-end charge and only a short contingent deferred charge✓
• d.No mutual fund is suitable for any holding period shorter than five years

Class C shares impose a level annual asset-based fee with at most a small CDSC that usually lapses after 12 months, which keeps costs low over a short holding period. A front-end load on Class A shares is paid up front and cannot be recovered in two or three years at this dollar amount. Class B deferred charges typically run several years, and it is not accurate to say no fund fits a short horizon.

Which statement most accurately describes Class B mutual fund shares?

• a.They pay no 12b-1 fee because the sales charge is deferred
• b.They may be redeemed at any time with no sales charge of any kind
• c.They carry a front-end sales charge and the lowest annual expenses of any class
• d.They carry a contingent deferred sales charge that declines each year and typically convert to Class A shares after a set period✓

Class B shares are sold without a front-end load but impose a back-end charge that steps down annually and eventually disappears, after which the shares usually convert to the lower-expense Class A shares. During the deferred-charge period Class B shares carry higher 12b-1 fees, not none. Redeeming early does trigger the CDSC.

A fund's expense ratio represents:

• a.The percentage of the portfolio turned over during the year through the manager's ongoing buying and selling
• b.The difference between the bid and the ask price of the shares as quoted for the shares in the secondary market
• c.Annual operating costs, including management and 12b-1 fees, as a percentage of average net assets✓
• d.The sales charge stated as a percentage of the public offering price charged at the time of each purchase

The expense ratio measures ongoing annual costs of running the fund, chiefly the advisory fee, 12b-1 fee, and other operating expenses, divided by average net assets. Sales charges are one-time transaction costs and are shown separately in the fee table. Portfolio turnover and the bid-ask spread are different measures entirely.

When a shareholder redeems open-end fund shares, the fund must transmit payment within:

• a.Seven calendar days✓
• b.Thirty calendar days
• c.One business day
• d.Three business days

The Investment Company Act of 1940 requires redemption proceeds to be paid within seven calendar days of a proper request, absent an SEC-permitted suspension. One and three days reflect general securities settlement conventions, not the statutory redemption deadline, and thirty days is far outside the requirement.Investment Company Act of 1940

To be classified as a diversified investment company, a fund must satisfy the 75-5-10 test, which requires that:

• a.At least 75% of assets be in equities, 5% in cash, and 10% in bonds
• b.At least 75% of assets be invested with no more than 5% in any one issuer and no more than 10% of any issuer's voting securities held✓
• c.No more than 75% of assets be in one industry, 5% in derivatives, and 10% in foreign issuers
• d.At least 75 different issuers be held, with 5% minimum and 10% maximum positions

The diversification test applies to 75% of total assets: within that portion, no single issuer may exceed 5% of assets and the fund may not own more than 10% of any issuer's voting stock. The remaining 25% is unrestricted. The other choices invent asset-allocation or issuer-count requirements that do not appear in the Act.Investment Company Act of 1940

Which statement correctly distinguishes accumulation units from annuity units in a variable annuity?

• a.Both the number of units and their value are fixed once the contract is issued
• b.Accumulation units have a fluctuating value but annuity units have a fixed value
• c.Accumulation units vary in number as the contract owner invests, while at annuitization a fixed number of annuity units is established whose value fluctuates✓
• d.Annuity units are purchased during the pay-in phase and accumulation units during the payout phase

During the accumulation phase, each purchase payment buys a varying number of accumulation units, so the unit count grows. At annuitization the accumulated value is converted into a fixed number of annuity units, and the payment changes only because the unit value moves with separate account performance. The other choices reverse the phases or freeze the wrong variable.

A variable annuity contract has an assumed interest rate (AIR) of 4%. In a month when the separate account earns 6%, the annuitant's next payment will:

• a.Be suspended until performance returns to the AIR
• b.Decrease compared with the prior payment
• c.Remain the same, because the AIR guarantees a level payment
• d.Increase compared with the prior payment✓

The AIR is the benchmark used to price annuity payments, so performance above it raises the annuity unit value and the payment goes up. Performance below the AIR would lower the payment, and performance exactly equal to it would hold the payment level. The AIR is a calculation assumption, not a guarantee, and payments are never suspended for poor performance.

Which annuity payout option generally produces the largest monthly payment for a given account value?

• a.Joint and last survivor
• b.Life with 20-year period certain
• c.Unit refund life annuity
• d.Straight life (life only)✓

A life-only payout ends at the annuitant's death with no residual benefit to anyone, so the insurer can pay the most each month. Every other option adds a guarantee to a second person or a minimum number of payments, and that added obligation reduces the monthly amount. Joint and last survivor typically produces the smallest payment because two lives must be covered.

A married couple, both age 66, want annuity income that continues for as long as either of them is alive. Which settlement option fits?

• a.Unit refund life annuity
• b.Straight life on the older spouse
• c.Joint and last survivor✓
• d.Life with 10-year period certain

A joint and last survivor option pays until the death of the second annuitant, which is exactly what the couple described. Straight life stops at the first death, leaving the survivor with nothing. A period certain or unit refund option guarantees only a limited number of payments or a return of principal, not lifetime income for the survivor.

A surrender charge on a deferred variable annuity is best described as:

• a.A contractual charge on early withdrawals that typically declines each year and eventually disappears✓
• b.A fee charged annually for as long as the contract is held
• c.A penalty imposed by the IRS on withdrawals before age 59 1/2
• d.A charge deducted from every purchase payment before it is invested in the contract's separate account subaccounts

The surrender charge is the insurance company's way of recovering distribution costs if the owner withdraws money during the early contract years, and the schedule steps down annually until it reaches zero. It is not an annual fee on all assets and it is not the IRS penalty, which is a separate 10% tax on premature distributions. Variable annuities generally have no front-end sales load deducted from deposits.

A customer wants to move the full value of an existing non-qualified variable annuity into a different insurer's non-qualified annuity. Handled correctly, this transaction:

• a.Triggers tax only on the amount that exceeds the original cost basis of the surrendered original contract
• b.Triggers ordinary income tax on the entire account value
• c.Is prohibited because annuity contracts cannot be transferred between insurers under the terms of state insurance law
• d.Is a 1035 exchange and is not a taxable event, though surrender charges may still apply✓

Section 1035 of the Internal Revenue Code allows an annuity-to-annuity exchange without current taxation as long as the funds move directly between carriers and the annuitant does not take possession. Cost basis carries over to the new contract. The exchange does not waive the old contract's surrender charges or the new contract's new surrender schedule, which is why suitability review is required.Internal Revenue Code Section 1035

Which of the following exchanges does NOT qualify for tax-free treatment under Section 1035?

• a.An annuity contract exchanged for a life insurance policy✓
• b.A life insurance policy exchanged for another life insurance policy
• c.A life insurance policy exchanged for an annuity contract
• d.An annuity contract exchanged for another annuity contract

Section 1035 permits life-to-life, life-to-annuity, and annuity-to-annuity exchanges, but not annuity-to-life, because that would move funds from a contract whose gains are always taxable into one whose death benefit can pass income tax free. The other three combinations are expressly allowed. Representatives must confirm the direction of the exchange before recommending it.Internal Revenue Code Section 1035

A 52-year-old owner of a non-qualified deferred annuity withdraws $20,000 from a contract with $60,000 of earnings and $40,000 of after-tax contributions. What is the tax result?

• a.The entire $20,000 is taxed as ordinary income and is subject to a 10% early withdrawal penalty✓
• b.The entire $20,000 is taxed as a long-term capital gain
• c.Half is ordinary income and half is a return of principal because the contract is treated as only partly annuitized
• d.The entire $20,000 is a tax-free return of principal

Non-qualified annuity withdrawals are taxed last-in, first-out, so earnings come out first and are taxed as ordinary income; because the owner is under 59 1/2, an additional 10% penalty applies to the taxable amount. Principal is not returned until all earnings have been withdrawn, so no part of this withdrawal is tax free. Annuity earnings never receive capital gains treatment.Internal Revenue Code

When a non-qualified annuity is annuitized, the exclusion ratio is used to:

• a.Calculate the surrender charge remaining on the contract during each remaining year of the payout phase
• b.Set the assumed interest rate for the payout phase
• c.Determine what portion of each payment is a tax-free return of the owner's after-tax cost basis✓
• d.Allocate the death benefit between beneficiaries

Once payments begin, each one is split between a tax-free recovery of the after-tax investment and a taxable portion representing earnings, and the exclusion ratio sets that split. Surrender charges, the AIR, and beneficiary allocations are governed by the contract, not by this tax formula. Once basis is fully recovered, later payments are fully taxable.Internal Revenue Code

In a scheduled premium variable life insurance policy:

• a.Both the death benefit and the cash value are guaranteed by the insurer for the entire life of the policy contract
• b.Neither the death benefit nor the cash value can change after issue
• c.A minimum death benefit is guaranteed, while the cash value is not guaranteed and may fall to zero✓
• d.The cash value is guaranteed but the death benefit varies with separate account performance in every policy year without exception

Variable life provides a guaranteed minimum face amount as long as scheduled premiums are paid, but the cash value rides entirely on separate account results and carries no floor. Guaranteeing the cash value would defeat the variable structure. The death benefit above the minimum can also rise with strong investment performance, so nothing about the policy is fully fixed.

A representative who wants to sell variable life insurance must hold:

• a.Only a state insurance license, because the product is an insurance contract
• b.Both a state insurance license and the appropriate securities registration✓
• c.Neither, if the policy is sold through an insurance agency
• d.Only a securities registration, because the separate account is registered with the SEC

Variable products are dual-regulated: the insurance element requires a state license, while the separate account interest is a security requiring FINRA registration through a broker-dealer. Holding just one credential is insufficient regardless of where the sale takes place. This is a central reason the Series 6 exists as a limited representative registration.Securities Act of 1933

Assets supporting a variable annuity's investment performance are held in:

• a.The broker-dealer's proprietary trading account
• b.A custodial bank account owned directly by the contract holder and held in the contract holder's own individual name
• c.The insurer's general account, where they are backed by the insurer's claims-paying ability and the insurer's own general reserves
• d.A separate account, which is registered as an investment company and holds the underlying subaccounts✓

Variable annuity assets sit in a separate account that is legally insulated from the insurer's creditors and registered under the Investment Company Act of 1940, usually as a unit investment trust. The general account backs fixed products, where the insurer bears the investment risk. Contract holders own an interest in the separate account, not the securities themselves, and no broker-dealer account is involved.Investment Company Act of 1940

Which feature distinguishes a unit investment trust from a management company?

• a.A UIT has a board of directors that hires an investment adviser
• b.A UIT actively trades its portfolio to outperform a benchmark
• c.A UIT holds a fixed portfolio, has no board of directors or investment adviser, and has a stated termination date✓
• d.A UIT issues shares that trade on an exchange at a premium or discount

A unit investment trust is organized under a trust indenture with a fixed, unmanaged portfolio and a preset termination date, so it needs neither a board nor an adviser. Active trading and adviser oversight are hallmarks of management companies. Exchange trading at a premium or discount describes closed-end funds, and UIT units are redeemable.Investment Company Act of 1940

Shares of a closed-end investment company differ from open-end fund shares because closed-end shares:

• a.Are always sold with a maximum 8.5% sales charge under FINRA's cap on total fund sales charges
• b.Are redeemable with the fund at net asset value on any business day at the shareholder's own request
• c.Trade in the secondary market at a price that may be above or below net asset value✓
• d.Cannot be purchased in the secondary market by retail investors through an ordinary retail broker-dealer

A closed-end fund issues a fixed number of shares in an offering and those shares then trade among investors, so supply and demand determine whether they sell at a premium or a discount to NAV. Redeemability at NAV is the defining feature of open-end funds. Closed-end trades involve brokerage commissions rather than the 8.5% sales charge ceiling, and any investor may buy them in the market.

An open-end investment company may issue:

• a.Only one class of voting common stock, with different sales charge arrangements permitted✓
• b.Common stock and long-term bonds, but no preferred stock
• c.Any capital structure approved by a majority of the board
• d.Both common shares and multiple classes of preferred shares that carry equal voting and liquidation rights

An open-end fund is limited to a single class of voting stock, though it may offer that stock through different sales charge structures such as Class A, B, and C shares. Senior securities such as preferred stock and bonds may be issued by closed-end funds, not open-end funds. The board cannot vote to override this statutory capital structure limit.Investment Company Act of 1940

A 529 college savings plan interest is classified for regulatory purposes as:

• a.An exempt security not subject to any securities regulation
• b.An open-end investment company registered under the Investment Company Act of 1940
• c.A variable annuity separate account interest
• d.A municipal fund security, subject to MSRB rules✓

Because 529 plans are established by states, their interests are municipal fund securities and sales practices are governed by MSRB rules rather than by the Investment Company Act. Investors receive an official statement or program disclosure document rather than a statutory prospectus. Calling them completely unregulated is wrong, as suitability, disclosure, and advertising rules all apply.Internal Revenue Code Section 529

A grandparent withdraws $8,000 from a 529 plan and uses all of it for the beneficiary's college tuition. The federal tax treatment of the earnings portion is:

• a.Taxable as ordinary income with a 10% penalty on the entire amount that was distributed
• b.Taxable as a long-term capital gain on the earnings that had accumulated in the plan
• c.Taxable to the beneficiary at the beneficiary's rate because 529 withdrawals shift the tax to the enrolled student
• d.Not taxable, because the distribution was used for qualified education expenses✓

Earnings in a 529 plan grow tax deferred and come out entirely free of federal income tax when the distribution pays qualified education expenses such as tuition. Tax and a 10% penalty on earnings apply only to non-qualified withdrawals. Contributions are made with after-tax dollars, so no federal deduction was taken going in.Internal Revenue Code Section 529

Which statement about control of a 529 plan account is accurate?

• a.Control passes to the beneficiary's parents once the beneficiary enrolls in college
• b.The state sponsoring the plan controls how the assets are invested
• c.The beneficiary gains full control of the account at the age of majority
• d.The account owner retains control, may change the beneficiary to another qualified family member, and may take a non-qualified withdrawal✓

Unlike a custodial account, a 529 plan leaves ownership and control with the person who opened it, including the right to redirect the funds to a different eligible family member. The beneficiary has no ownership right and never takes control by reaching a certain age. The state establishes the plan and its investment menu, but the owner chooses among the offered options.Internal Revenue Code Section 529

The Investment Company Act of 1940 classifies investment companies into which three types?

• a.Open-end funds, closed-end funds, and hedge funds as the categories defined by the statute
• b.Growth funds, income funds, and balanced funds, grouped by their stated investment objective
• c.Face-amount certificate companies, unit investment trusts, and management companies✓
• d.Mutual funds, exchange-traded funds, and separate accounts, the three statutory categories named in the Investment Company Act of 1940

The Act defines exactly three classifications, with management companies then subdivided into open-end and closed-end. Hedge funds are typically structured to rely on exclusions from the Act rather than being a statutory class. ETFs and separate accounts are organized within the existing classifications, and growth, income, and balanced describe investment objectives rather than legal form.Investment Company Act of 1940

To be treated as a regulated investment company and avoid paying tax at the fund level on distributed income, a fund must distribute at least:

• a.90% of its net investment income to shareholders✓
• b.75% of its realized capital gains to shareholders
• c.50% of its net investment income to shareholders
• d.100% of its gross income to shareholders

Under Subchapter M of the Internal Revenue Code, a fund that distributes at least 90% of its net investment income acts as a conduit and is taxed only on what it retains. Falling below that threshold subjects the fund's entire income to corporate taxation, creating a second layer of tax for shareholders. Distributing all gross income is neither required nor possible after expenses.Internal Revenue Code

When must a prospectus be delivered to a purchaser of open-end fund shares?

• a.Only if the customer requests it in writing, since delivery is otherwise left to the selling representative's discretion
• b.Within 30 days after the trade settles, the deadline the rules set for post-sale prospectus delivery
• c.At or before the confirmation of the sale, and always before or during any solicitation of the sale✓
• d.Only for purchases exceeding $10,000, the dollar threshold above which the disclosure requirement is triggered

Because open-end funds are in continuous primary distribution, every purchase is a new issue and the buyer must receive the current prospectus no later than the confirmation. Delivery is mandatory regardless of dollar amount and does not depend on a customer request. A delivery 30 days after settlement would deprive the investor of disclosure before the investment decision.Securities Act of 1933

A customer asks for more detail about a fund's officers, its brokerage allocation practices, and its full financial statements. This information is found in the:

• a.Form filed only with the state insurance commissioner and not made available to retail customers
• b.Statement of Additional Information, which must be provided free upon request✓
• c.Annual report only, which is sent every three years mailed only to the fund's shareholders of record
• d.Official statement filed with the MSRB

The Statement of Additional Information supplements the prospectus with detailed operational, governance, and financial disclosure and must be sent at no charge to any shareholder or prospective investor who asks. Shareholder reports are sent at least semiannually and contain less operational detail. Official statements relate to municipal securities and insurance filings to insurance products.Investment Company Act of 1940

For purposes of combining purchases to reach a breakpoint, which of the following does NOT qualify as a single "person"?

• a.An investment club whose members pool their money✓
• b.A husband and wife purchasing in a joint account
• c.A parent purchasing in a UTMA account for a minor child
• d.An individual investor

Breakpoint aggregation is available to an individual, a married couple, and their minor children's custodial accounts because those represent one family unit. Investment clubs, partnerships, and other groups formed mainly to obtain a reduced sales charge are expressly excluded. Allowing clubs to aggregate would let unrelated investors buy their way into discounts intended for a single household.FINRA Rule 2341 (Investment Company Securities)

A shareholder elects to have all fund dividends and capital gains distributions automatically reinvested. Those reinvested amounts purchase additional shares at:

• a.A 50% discount to the public offering price
• b.The public offering price, including the full sales charge
• c.Net asset value, with no sales charge✓
• d.The prior month's average share price

Automatic reinvestment at NAV is one of the features a fund must offer to charge the maximum sales load, and it lets distributions compound without a new sales charge. Charging the full load on reinvested distributions would penalize long-term holders. Neither a fixed 50% discount nor a monthly average price is used, because forward pricing governs the transaction.

The combination privilege offered by many fund families allows an investor to:

• a.Exchange one fund for another in the family without recognizing a taxable gain event at the fund's net asset value
• b.Add together simultaneous purchases of two or more funds in the same family to reach a breakpoint✓
• c.Combine purchases made in unrelated fund families to reach a breakpoint threshold across separate and unrelated fund sponsors
• d.Redeem shares at net asset value without any deferred sales charge

The combination privilege lets an investor aggregate concurrent investments across different funds in the same family so the total qualifies for a quantity discount. The trap is confusing it with the exchange (conversion) privilege, which moves money between funds at NAV but is a taxable event. Purchases in unrelated families never combine, and redemption charges are a separate matter.FINRA Rule 2341 (Investment Company Securities)

An investor uses a fund family's exchange (conversion) privilege to move from a growth fund into a bond fund at net asset value. The correct statement is:

• a.No new sales charge applies, but the exchange is a taxable sale of the growth fund and purchase of the bond fund✓
• b.The exchange is completely tax free because it stays within the family of funds offered under a single sponsor's umbrella arrangement
• c.A full front-end sales charge must be paid on the bond fund
• d.The exchange is tax free only if completed within 30 days

The exchange privilege waives an additional sales charge but does not change the tax law: the investor has disposed of one security and acquired another, so gain or loss is recognized. The common misconception is that staying inside the family makes it tax free. Representatives should warn customers of the tax consequence before an exchange.Internal Revenue Code

Dollar cost averaging involves investing a fixed dollar amount at regular intervals. Its principal effect is that:

• a.It guarantees the investor a profit over time
• b.More shares are bought when prices are low and fewer when prices are high, producing an average cost per share below the average price paid✓
• c.It eliminates market risk entirely
• d.The investor buys the same number of shares each period

Because a fixed dollar amount buys more shares at low prices and fewer at high prices, the mathematical result is an average cost per share lower than the simple average of the prices paid. Dollar cost averaging does not guarantee a profit or remove market risk; a sustained decline still produces a loss. A fixed dollar amount, not a fixed share count, is the defining feature.

A fund's sales charge schedule is: under $25,000 = 5.0%; $25,000 to $49,999 = 4.25%; $50,000 to $99,999 = 3.5%. A customer invests $40,000. What sales charge applies?

• a.5.0%, or $2,000
• b.4.25%, or $1,700✓
• c.3.5%, or $1,400
• d.No sales charge, because $40,000 exceeds the first breakpoint

A $40,000 purchase falls in the $25,000 to $49,999 tier, so the rate is 4.25%: $40,000 x 0.0425 = $1,700. Applying the first-tier 5% ($2,000) ignores that the breakpoint at $25,000 already reduced the rate, and using 3.5% would require reaching $50,000. Crossing a breakpoint lowers the charge but never eliminates it.FINRA Rule 2341 (Investment Company Securities)

A customer already owns fund shares now worth $46,000 and invests an additional $9,000. The fund's first breakpoint is at $50,000. Under rights of accumulation, the new purchase:

• a.Receives no breakpoint because the $9,000 purchase alone is below $50,000 in total new contribution value
• b.Qualifies only if the customer signs a letter of intent
• c.Qualifies for the reduced sales charge, because current holdings plus the new purchase exceed $50,000✓
• d.Reduces the sales charge only on the amount above the breakpoint

Rights of accumulation add the current value of existing holdings ($46,000) to the new purchase ($9,000) for a combined $55,000, which clears the $50,000 breakpoint, so the reduced charge applies to the new money. It is a mistake to look only at the new purchase in isolation. A letter of intent is a separate, forward-looking way to reach a breakpoint and is not required here.FINRA Rule 2341 (Investment Company Securities)

A customer invests $12,000 in a fund whose public offering price is $30.00 per share. Ignoring fractional-share rounding, how many shares are purchased?

• a.360 shares
• b.400 shares✓
• c.40 shares
• d.1,200 shares

Shares acquired equal the dollars invested divided by the public offering price, because the investor pays the POP (NAV plus sales charge): $12,000 / $30.00 = 400 shares. Dividing by ten or multiplying instead of dividing produces the other figures. The sales charge is already embedded in the POP, so no separate adjustment is needed.

Which statement best describes an exchange-traded fund (ETF)?

• a.It is a registered fund whose shares trade throughout the day on an exchange at market-determined prices, usually near NAV✓
• b.It is redeemed directly with the fund at NAV by any retail investor, like an open-end fund
• c.It guarantees investors the exact return of the underlying index
• d.It is prohibited from being purchased by retail investors

An ETF trades intraday on an exchange like a stock, and an arbitrage mechanism keeps its price close to net asset value. Unlike an open-end fund, a retail investor buys and sells ETF shares in the secondary market rather than redeeming with the fund; only authorized participants redeem in large creation units. ETFs track but do not guarantee an index and are freely available to retail investors.Investment Company Act of 1940

Which statement about a money market mutual fund is generally correct?

• a.It guarantees a return of principal backed by FDIC insurance
• b.Its shares trade on an exchange at a premium or discount to NAV
• c.It seeks to maintain a stable net asset value, typically $1.00 per share, and is usually sold with no sales charge✓
• d.It invests primarily in long-term corporate bonds to maximize yield

A money market fund invests in short-term, high-quality instruments and aims to hold a stable $1.00 NAV, and most are no-load. The classic trap is thinking money funds are FDIC insured; they are securities and can, in rare cases, lose value. They are open-end funds redeemed at NAV, not exchange-traded, and they hold short-term, not long-term, paper.

An investor whose primary objective is current income with relative stability of principal would be best matched with:

• a.An aggressive growth fund
• b.A bond (fixed-income) fund✓
• c.A sector fund concentrated in a single industry
• d.A fund that reinvests all earnings and pays no distributions

A bond fund is built to generate a steady stream of interest income with lower principal volatility than equities, matching an income objective. Growth and sector funds pursue capital appreciation and carry more price risk, and a fund that pays no distributions provides no current income at all. Objective must drive the fund selection.

A key characteristic of an index fund is that it:

• a.Attempts to outperform its benchmark through active stock selection through the portfolio manager's continual active stock selection and market timing
• b.Charges the highest management fees among fund types
• c.Is always structured as a closed-end fund
• d.Seeks to replicate the performance of a market index and typically has low expenses and low portfolio turnover✓

An index fund passively mirrors a benchmark, which keeps trading, research, and management costs low. Active outperformance and high fees describe actively managed funds, the opposite approach. Index funds are commonly open-end funds or ETFs, not necessarily closed-end funds.

The mortality and expense risk (M&E) charge in a variable annuity compensates the insurer for:

• a.Guaranteeing the death benefit and the annuity payout rate, and bearing the risk that expenses exceed the contract's guaranteed maximum✓
• b.The commission paid to the selling representative only
• c.The securities transaction costs inside the subaccounts
• d.The state premium tax on the contract

The M&E charge covers the insurer's mortality guarantees, such as the death benefit and the promise to pay for life at the guaranteed rate, plus the risk that its expenses run higher than the contract's ceiling. It is not simply the sales commission, nor the subaccounts' internal trading costs, nor state premium tax, which are separate items. M&E is a recurring asset-based charge disclosed in the prospectus.

During the accumulation phase of a typical variable annuity, the standard death benefit pays the beneficiary:

• a.The total of all future annuity payments the owner would have received under the contract's settlement option
• b.The greater of the current account value or total purchase payments made, less any withdrawals✓
• c.A fixed amount set by the state insurance department
• d.Nothing, because death benefits apply only after annuitization

The common variable annuity death benefit guarantees the beneficiary at least the money paid in (net of withdrawals) even if the separate account has fallen, or the account value if it is higher. It is not a projection of future payments, nor a state-set figure, and the benefit applies during the accumulation phase. Enhanced death benefit riders can raise this floor for an added fee.

A guaranteed minimum withdrawal benefit (GMWB) rider on a variable annuity:

• a.Guarantees that the separate account itself will never lose value
• b.Allows the owner to withdraw a specified minimum amount each year regardless of separate account performance, usually for an additional fee✓
• c.Eliminates all surrender charges on the contract
• d.Automatically converts the variable annuity into a fixed annuity

A GMWB guarantees a stream of withdrawals up to a stated amount even if poor performance would otherwise deplete the account, and the insurer charges an extra fee for the guarantee. It protects the withdrawal stream, not the account value itself, so the subaccounts can still decline. It neither waives surrender charges nor changes the contract into a fixed annuity.

A representative recommends that a customer surrender an existing variable annuity to buy a new 'bonus' annuity that credits an extra 4% to the initial premium. The primary suitability concern is that:

• a.Bonus annuities are illegal
• b.The bonus is immediately taxable as ordinary income
• c.The new contract may carry higher ongoing fees and a fresh, longer surrender period that outweigh the bonus, while the surrender may trigger charges on the old contract✓
• d.A 1035 exchange cannot be used for the transaction

Bonus annuities typically recover the credited bonus through higher M&E fees and a new multi-year surrender schedule, so the headline bonus can cost the customer more than it delivers, and surrendering the old contract may impose its own charges. Bonus annuities are legal, the transaction can qualify as a 1035 exchange, and the bonus is not immediately taxed. This is a classic unsuitable-switch red flag.FINRA Rules

The value of one accumulation unit in a variable annuity separate account is determined by:

• a.Dividing the net asset value of the separate account by the number of accumulation units outstanding✓
• b.The assumed interest rate stated in the contract
• c.The performance of the insurer's general account
• d.A fixed schedule printed in the prospectus at issue and left completely unchanged for the entire life of the contract

An accumulation unit works like a mutual fund share: its value is the separate account's net assets divided by the units outstanding, so it moves with subaccount performance. The AIR is used only in the payout phase to price annuity units, not accumulation units. The general account backs fixed guarantees, and the unit value is not fixed.Investment Company Act of 1940

An owner of a non-qualified variable annuity dies and leaves the contract to a beneficiary. Compared with inheriting appreciated mutual fund shares, the annuity:

• a.Also receives a full step-up in basis to date-of-death value, precisely as inherited appreciated mutual fund shares receive
• b.Passes entirely income-tax free to the beneficiary
• c.Is taxed to the beneficiary at long-term capital gains rates on the appreciation above the owner's original cost basis
• d.Does not receive a stepped-up basis; the gain above cost basis is taxed to the beneficiary as ordinary income✓

Annuity gains are tax-deferred ordinary income and do not qualify for a step-up at death, so the beneficiary pays ordinary income tax on the amount exceeding the owner's cost basis. Inherited appreciated stock or fund shares, by contrast, generally get a basis step-up that erases the gain. The annuity wrapper never converts that gain into capital gains treatment.Internal Revenue Code

A distinctive feature of variable life insurance compared with a variable annuity is that variable life:

• a.Provides no death benefit, paying only the accumulated cash value to the estate at death
• b.Allows the policyowner to borrow against the policy's cash value through a policy loan✓
• c.Is not considered a security and therefore requires no prospectus or securities registration
• d.Guarantees that the cash value will grow each year regardless of the separate account's investment performance

Variable life builds a cash value the owner can access through policy loans, a feature annuities do not offer in the same way. Variable life provides a guaranteed minimum death benefit and, like variable annuities, is a security requiring securities registration to sell. Its cash value rides on separate account performance and is not guaranteed to grow.

Compared with a scheduled (fixed) premium variable life policy, a variable universal life (VUL) policy generally offers:

• a.Flexible premium payments and an adjustable death benefit within policy limits✓
• b.A fully guaranteed cash value
• c.No exposure to separate account investment risk because premiums are swept into the insurer's general account
• d.Premiums that can never be changed once set, unlike a scheduled-premium variable life policy

VUL combines the investment flexibility of variable life with the premium and death-benefit flexibility of universal life, letting the owner vary payments and adjust coverage within limits. Its cash value is still tied to the separate account and is not guaranteed. A scheduled premium policy, by contrast, requires fixed, level premiums.

An open-end investment company share is called a redeemable security because:

• a.It can be resold to other investors on a stock exchange
• b.The issuing fund stands ready to buy the share back from the investor at its next computed net asset value✓
• c.It may be redeemed only at a fixed price stated in the prospectus
• d.The investor may return it for a full refund of the sales charge at any time at any time following the original date of purchase

A redeemable security is one the issuer will repurchase; an open-end fund continuously redeems its shares at the next-computed NAV under forward pricing. Selling to other investors on an exchange describes closed-end funds and ETFs. The redemption price is NAV, which floats, not a fixed figure, and the sales charge is not refunded on redemption.Investment Company Act of 1940

A balanced fund is best described as a fund that:

• a.Invests only in money market instruments to hold its net asset value stable at exactly one dollar per share
• b.Holds a mix of both equity and fixed-income securities to provide a combination of growth and income✓
• c.Invests exclusively in a single industry sector chosen for its long-term growth potential over the market cycle
• d.Guarantees an equal return to every shareholder each year regardless of prevailing market conditions or portfolio holdings

A balanced fund blends stocks and bonds in one portfolio, aiming to deliver growth from equities and income and stability from fixed income. A money market fund and a sector fund pursue very different, narrower objectives. No fund guarantees a return, so the promise of an equal annual return is false.

A variable annuity separate account has net assets of $9,000,000 and 600,000 accumulation units outstanding. The value of one accumulation unit is:

• a.$15.00✓
• b.$6.67
• c.$150.00
• d.$1.50

Accumulation unit value equals the separate account's net assets divided by the units outstanding: $9,000,000 / 600,000 = $15.00. Inverting the division gives $0.067 and misplacing the decimal gives $1.50 or $150.00. The calculation mirrors how a mutual fund computes NAV per share.

An open-end fund has a net asset value of $18.60 per share and a maximum sales charge of 7% of the public offering price. What is the public offering price?

• a.$21.30
• b.$18.60
• c.$19.90
• d.$20.00✓

POP equals NAV divided by (100% minus the sales charge percent): $18.60 / 0.93 = $20.00. Adding 7% to the NAV gives $19.90, the classic error, because the sales charge is a percentage of the offering price, not of NAV (FINRA Rule 2341).

A fund's public offering price is $50.00 and its net asset value is $46.50. What is the sales charge percentage?

• a.6.5%
• b.7.5%
• c.7.0%✓
• d.8.0%

Sales charge % = (POP - NAV) / POP = ($50.00 - $46.50) / $50.00 = $3.50 / $50.00 = 7%. Dividing the $3.50 spread by NAV instead yields about 7.5%, the trap, since the charge is always stated as a percent of the POP (FINRA Rule 2341).

A customer invests $9,000 in a fund whose public offering price is $18.00 per share. Ignoring fractional shares, how many shares are purchased?

• a.450
• b.500✓
• c.540
• d.1,800

Shares = dollars invested / POP, because the investor pays the offering price (NAV plus load): $9,000 / $18.00 = 500 shares. The sales charge is already embedded in the POP, so no separate deduction is made.

A variable annuity separate account has net assets of $24,000,000 and 1,500,000 accumulation units outstanding. What is the value of one accumulation unit?

• a.$62.50
• b.$1.60
• c.$160.00
• d.$16.00✓

Accumulation unit value = separate account net assets / units outstanding = $24,000,000 / 1,500,000 = $16.00, the same conduit math a mutual fund uses for NAV per share (Investment Company Act of 1940).

A fund's public offering price is $25.00 per share and it charges a 5% sales load. What is its net asset value per share?

• a.$20.00
• b.$26.25
• c.$23.81
• d.$23.75✓

NAV = POP x (1 - sales charge %) = $25.00 x 0.95 = $23.75. Dividing $25.00 by 1.05 gives $23.81, a trap, because the 5% load is a percentage of the POP, not of NAV.

A fund's schedule is: under $50,000 = 4.5%; $50,000-$99,999 = 3.5%; $100,000-$249,999 = 2.5%. A customer invests $75,000. What sales charge, in dollars, applies?

• a.$3,375
• b.$1,875
• c.$2,625✓
• d.$1,500

A $75,000 purchase falls in the $50,000-$99,999 tier at 3.5%: $75,000 x 0.035 = $2,625. Applying the first-tier 4.5% ($3,375) ignores that the breakpoint already lowered the rate; reaching 2.5% would require $100,000 (FINRA Rule 2341).

An investor signs a $50,000 letter of intent and deposits $30,000, then adds nothing more before the letter expires. The fund will:

• a.Automatically renew the letter for another 13 months
• b.Liquidate shares held in escrow to collect the higher sales charge due on the $30,000 actually invested✓
• c.Charge a cash penalty equal to the unmet $20,000 commitment, since a signed letter of intent is a binding purchase obligation
• d.Refund all sales charges the investor paid

A letter of intent is not binding; if the investor fails to reach the stated amount within 13 months, the fund redeems escrowed shares to recover the difference between the reduced and full sales charge on the amount actually invested (FINRA Rule 2341).

FINRA rules cap a fund's total annual 12b-1 charge (asset-based sales charge plus service fee) at what percentage of average net assets?

• a.0.25%
• b.1.00%✓
• c.0.75%
• d.0.50%

Under FINRA Rule 2341 the service (shareholder-servicing) fee is capped at 0.25% and the asset-based sales charge at 0.75%, for a combined ceiling of 1.00% of average net assets per year.

Which description best fits Class C mutual fund shares?

• a.A high front-end load and no ongoing 12b-1 fee
• b.A level ongoing asset-based fee and usually a small 1% contingent deferred sales charge that lapses after about one year✓
• c.The lowest total cost of any class for a 20-year holding period
• d.A back-end charge that steps down over six years and then converts to Class A, giving it the lowest long-run cost of any share class

Class C shares carry a level annual asset-based (12b-1) fee and typically a 1% CDSC that expires after roughly 12 months, which suits short horizons but is costly over long periods because the level fee never goes away.

An investor buys $600 of a fund each quarter. In a fluctuating market, the mathematical result over time is that the investor's average cost per share is:

• a.Guaranteed to produce a profit
• b.Equal to the average of the prices paid
• c.Higher than the average of the prices paid, because a fixed schedule concentrates buying when prices are high over the full holding period
• d.Lower than the average of the prices paid, because the fixed dollar amount buys more shares when prices are low✓

Dollar cost averaging buys more shares at low prices and fewer at high prices, so average cost per share is mathematically below the simple average of the prices paid. It does not guarantee a profit or eliminate market risk.

Shares of a closed-end investment company in the secondary market are priced at:

• a.A fixed price stated in the prospectus
• b.A market price set by supply and demand, which may be above or below net asset value✓
• c.Net asset value plus a maximum 8.5% sales charge, the same ceiling that applies to open-end mutual fund shares
• d.Net asset value only, set once daily

A closed-end fund issues a fixed number of shares that then trade among investors, so the market price can be at a premium or discount to NAV. Redeemability at NAV is instead the hallmark of open-end funds.

A unit investment trust is characterized by:

• a.A fixed, unmanaged portfolio, no board of directors or investment adviser, and a stated termination date✓
• b.Shares that trade on an exchange at a premium or discount, with the trust adjusting the portfolio to track a benchmark
• c.An actively managed portfolio and a board of directors
• d.A perpetual existence with no termination date

A UIT holds a fixed portfolio under a trust indenture with a preset end date and needs neither a board nor an adviser (Investment Company Act of 1940). Its redeemable units are not exchange-traded like closed-end shares.

Which statement about a money market mutual fund is correct?

• a.It guarantees investors a fixed rate of return
• b.It trades on an exchange at a premium or discount to NAV
• c.Its shares are insured by the FDIC up to applicable limits because the fund holds only bank-issued instruments
• d.It invests in short-term, high-quality instruments and generally is sold with no sales charge✓

Money market funds hold short-term, high-quality paper, are typically no-load, and seek a stable $1.00 NAV. They are securities, not FDIC-insured deposits, and can in rare cases lose value.

How does a retail investor typically buy and sell shares of an exchange-traded fund (ETF)?

• a.In the secondary market at intraday market prices, with only authorized participants dealing in creation units✓
• b.By redeeming directly with the fund at NAV, like an open-end fund, with the trade priced once daily after the market close
• c.At NAV computed once at the market close
• d.Only in large creation units of 50,000 shares

Retail investors trade ETF shares intraday on an exchange at market prices; only authorized participants create or redeem large creation units directly with the fund, and arbitrage keeps the price near NAV (Investment Company Act of 1940).

Compared with a broadly diversified equity fund, a sector fund concentrated in one industry primarily exposes an investor to greater:

• a.Purchasing power risk, because a single industry cannot keep pace with long-run inflation
• b.Interest rate risk
• c.Reinvestment risk
• d.Non-systematic (industry concentration) risk✓

Concentrating in a single industry increases non-systematic (unsystematic) risk that broad diversification would otherwise reduce. Interest rate and reinvestment risks chiefly affect bonds, and all equities share systematic risk.

A fund that holds a continuous mix of common stocks and bonds to provide both growth and income is called a:

• a.Sector fund
• b.Balanced fund✓
• c.Specialized fund
• d.Money market fund

A balanced fund blends equities for growth with fixed income for income and relative stability in one portfolio. Sector, money market, and specialized funds pursue narrower objectives.

An index fund is best described as a fund that:

• a.Actively trades to beat its benchmark and charges high fees to cover its research and frequent portfolio turnover
• b.Guarantees the exact return of the index it tracks
• c.Is always organized as a closed-end fund
• d.Seeks to replicate a market index, with low expenses and low portfolio turnover✓

An index fund passively mirrors a benchmark, keeping management, research, and trading costs low. It tracks but cannot guarantee the index return, and it is commonly an open-end fund or ETF.

A fund whose primary objective is maximum capital appreciation, with little or no current income, is a:

• a.Growth fund✓
• b.Money market fund
• c.Government bond fund
• d.Balanced fund

A growth fund invests in companies expected to appreciate, reinvesting rather than paying large dividends, so it fits a long-horizon appreciation objective. The other choices emphasize income or stability.

A fund has annual operating expenses of $8,000,000 and average net assets of $640,000,000. Its expense ratio is:

• a.1.25%✓
• b.0.125%
• c.0.80%
• d.8.00%

Expense ratio = annual operating expenses / average net assets = $8,000,000 / $640,000,000 = 1.25%. It captures ongoing costs such as the advisory and 12b-1 fees, not one-time sales charges.

A shareholder submits a redemption order for a mutual fund at 2:00 p.m.; the fund prices once daily at the 4:00 p.m. close. The shareholder receives:

• a.The average of today's and yesterday's NAV
• b.The prior day's closing NAV
• c.That day's NAV computed at the 4:00 p.m. close✓
• d.The NAV at the moment the order was received, locking in the intraday price quoted when the customer phoned in

Forward pricing requires purchase and redemption orders to be executed at the next NAV computed after the order is received, which here is the 4:00 p.m. close (Investment Company Act of 1940). Proceeds must be paid within seven days.

Under the Investment Company Act of 1940, once a mutual fund receives a proper redemption request, it must pay the proceeds within:

• a.Seven calendar days✓
• b.Fifteen calendar days
• c.Thirty calendar days
• d.Two business days

The Act requires redemption proceeds to be sent within seven calendar days of a proper request, absent an SEC-approved suspension. Ordinary trade-settlement conventions do not govern the statutory redemption deadline.

When a customer buys open-end fund shares, the public offering price the customer pays consists of:

• a.The net asset value per share plus the applicable sales charge✓
• b.A price negotiated between the customer and the representative
• c.The net asset value per share minus a redemption fee
• d.The prior day's closing price plus a commission

For a load fund the POP equals NAV plus the sales charge, with the charge figured as a percentage of the POP (FINRA Rule 2341). Fund shares are not priced by negotiation or by the prior day's close.

A 40-year-old will invest a $300,000 lump sum for retirement 25 years away and add more over time. Which share class is generally most appropriate?

• a.Any class, since long-run costs are identical
• b.Class A, because the large purchase earns steep breakpoint discounts and ongoing expenses are lowest✓
• c.Class C, so the level fee stays constant
• d.Class B, so the deferred charge disappears over time and the large purchase avoids any front-end sales charge entirely

A large, long-horizon investment favors Class A: breakpoints sharply cut the front-end load and the low 12b-1 fee compounds into a small drag over decades. Class C's level fee costs far more over 25 years, and Class B is usually unavailable at this size.

A key tax feature of a non-qualified variable annuity's accumulation phase, compared with a taxable mutual fund account, is that:

• a.Earnings grow tax-deferred until withdrawal, when they are taxed as ordinary income✓
• b.Gains are taxed as long-term capital gains
• c.Contributions are federally tax-deductible, much like pre-tax contributions to a traditional retirement account
• d.Distributions are always tax-free

A non-qualified annuity's earnings compound tax-deferred, but withdrawals are taxed as ordinary income on a LIFO basis, never at capital-gains rates (Internal Revenue Code). Contributions to a non-qualified annuity are not deductible.

A variable annuity has an assumed interest rate (AIR) of 5%. In a month when the separate account earns 3%, the next annuity payment will:

• a.Be suspended until performance recovers
• b.Stay the same
• c.Increase from the prior payment
• d.Decrease from the prior payment✓

When actual separate-account performance is below the AIR, the annuity unit value falls and the payment decreases versus the prior one. Performance above the AIR raises the payment; performance exactly at the AIR keeps it level. The AIR is a pricing benchmark, not a guarantee.

After a variable annuity is annuitized, the number of annuity units credited to the contract each month is:

• a.Fixed, while the value of each unit fluctuates with separate account performance✓
• b.Reduced each year by the surrender charge
• c.Fixed, and each unit's value is also fixed for life
• d.Increased whenever the separate account rises, so a strong market adds more annuity units to the contract each month

At annuitization the accumulated value converts into a fixed number of annuity units; monthly income then varies only because the unit value moves with separate-account performance relative to the AIR.

For a given account value, which annuity settlement option generally produces the smallest monthly payment?

• a.Life with 10-year period certain
• b.Unit refund life annuity
• c.Joint and last survivor✓
• d.Straight life (life only)

Joint and last survivor must cover two lives, the longest expected payout, so each payment is smallest. Straight life pays the most because it ends at the single annuitant's death with no residual guarantee.

A surrender charge on a deferred variable annuity is:

• a.A fee deducted from every purchase payment before investment, similar to a front-end sales load charged on a mutual fund
• b.A contract charge on early withdrawals that typically declines each year and eventually reaches zero✓
• c.A recurring annual charge on all contract assets for life
• d.An IRS penalty on withdrawals before age 59 1/2

The surrender charge lets the insurer recover distribution costs if the owner withdraws in the early contract years; the schedule steps down to zero over time. The 10% early-distribution penalty is a separate IRS tax.

The mortality and expense (M&E) risk charge in a variable annuity compensates the insurer for:

• a.The subaccounts' internal securities trading costs and the brokerage commissions the separate account pays each time it trades securities
• b.Guaranteeing the death benefit and lifetime payout rate and bearing the risk that expenses exceed the contract's ceiling✓
• c.State premium taxes on the contract
• d.The representative's sales commission only

The recurring asset-based M&E charge covers the insurer's mortality guarantees (death benefit and the promise to pay for life at the guaranteed rate) plus the risk that expenses exceed the contract maximum. Trading costs, premium tax, and commissions are separate items.

During a variable annuity's accumulation phase, if the owner dies, the standard (base) death benefit pays the beneficiary:

• a.A fixed amount set by the state
• b.Nothing, because death benefits apply only after annuitization once the contract has been annuitized and payments begin
• c.The projected total of all future annuity payments
• d.The greater of the current account value or total purchase payments made, less withdrawals✓

The common death benefit guarantees the beneficiary at least the money paid in (net of withdrawals) or the account value if higher. Enhanced riders can raise this floor for an added fee.

In a scheduled-premium variable life insurance policy, if the scheduled premiums are paid:

• a.The cash value is guaranteed but the death benefit is not
• b.A minimum death benefit is guaranteed, while the cash value rides on separate-account performance and can fall to zero✓
• c.Neither the cash value nor the death benefit can change
• d.Both the cash value and the death benefit are fully guaranteed by the insurer for as long as the scheduled premiums are paid

Variable life guarantees a minimum face amount as long as scheduled premiums are paid, but the cash value follows the separate account with no floor. Strong performance can raise the death benefit above the minimum.

Compared with scheduled-premium variable life, variable universal life (VUL) generally adds:

• a.Investment only in the insurer's general account
• b.Fixed, unchangeable premiums
• c.A fully guaranteed cash value that the insurer credits regardless of separate-account performance
• d.Flexible premium payments and an adjustable death benefit within limits✓

VUL combines variable-life investment risk with universal-life flexibility, letting the owner vary premiums and adjust coverage within limits. Its cash value still depends on the separate account and is not guaranteed.

To sell a variable annuity, a representative must hold:

• a.Both a state insurance license and the appropriate FINRA securities registration✓
• b.Only a state insurance license, because the annuity is regulated solely as an insurance contract
• c.Neither, if the sale is made through a bank
• d.Only a FINRA securities registration

Variable products are dual-regulated: the insurance element requires a state license and the security element (the separate account interest) requires FINRA registration through a broker-dealer. Holding just one credential is insufficient.

The separate account that funds a variable annuity is:

• a.The broker-dealer's proprietary trading account
• b.Part of the insurer's general account, backed by its reserves and its overall claims-paying ability as a company, where the insurer bears all investment risk
• c.Registered as an investment company under the Investment Company Act of 1940 and insulated from the insurer's creditors✓
• d.A bank custodial account titled in the contract owner's name

Variable annuity assets sit in a separate account registered under the 1940 Act (often as a unit investment trust) and shielded from the insurer's general creditors. The general account backs fixed products, where the insurer bears investment risk.

A customer moves the full value of one non-qualified annuity directly into another insurer's non-qualified annuity. Handled correctly, this is:

• a.Taxable only on the gain above cost basis
• b.Fully taxable as ordinary income on the entire value in the year the funds move between the two carriers, with tax due even though no cash was received
• c.Prohibited under state insurance law
• d.A Section 1035 exchange, not a taxable event, though surrender charges may still apply and cost basis carries over✓

Section 1035 of the Internal Revenue Code lets funds move annuity-to-annuity between carriers without current tax; cost basis carries over. Old surrender charges and a new surrender schedule may still apply, which is why suitability review is required.

Which exchange does NOT qualify for tax-free treatment under Section 1035?

• a.Life insurance for life insurance
• b.Annuity for an annuity
• c.An annuity for a life insurance policy✓
• d.Life insurance for an annuity

Section 1035 permits life-to-life, life-to-annuity, and annuity-to-annuity, but not annuity-to-life, which would move always-taxable annuity gains into a contract whose death benefit can pass income-tax-free.

How does a guaranteed minimum withdrawal benefit (GMWB) rider on a variable annuity work?

• a.Eliminates all surrender charges
• b.Lets the owner withdraw a stated minimum amount each year regardless of separate-account performance, usually for an extra fee✓
• c.Guarantees the separate account will never lose value, protecting the full account balance from any market decline, so the owner can never lose principal
• d.Converts the contract into a fixed annuity automatically

A GMWB protects a withdrawal stream up to a stated amount even if performance would otherwise deplete the account; the insurer charges an added fee. It does not protect the account value itself or waive surrender charges.

A representative recommends surrendering an in-force variable annuity to buy a new bonus annuity crediting an extra 5% to the deposit. The chief suitability concern is that:

• a.A 1035 exchange cannot be used
• b.Higher ongoing fees and a fresh, longer surrender period may outweigh the bonus, and surrendering the old contract may trigger charges✓
• c.The 5% bonus is immediately taxable
• d.Bonus annuities are illegal

Bonus annuities typically recoup the credit through higher M&E fees and a new multi-year surrender schedule, so the bonus can cost more than it delivers; surrendering the old contract may impose its own charges (FINRA Rules). This is a classic unsuitable-switch red flag.

How is the value of a single accumulation unit in a variable annuity separate account computed?

• a.The performance of the insurer's general account
• b.The assumed interest rate stated in the contract, which is set at issue and fixes the unit value for the life of the contract
• c.A fixed schedule set at issue and never changed
• d.Dividing the separate account's net assets by the number of accumulation units outstanding✓

An accumulation unit works like a mutual fund share: value = separate-account net assets / units outstanding, so it moves with subaccount performance. The AIR prices annuity units only in the payout phase (Investment Company Act of 1940).

For regulatory purposes, an interest in a 529 college savings plan is classified as:

• a.A variable annuity separate account interest
• b.An exempt security subject to no regulation
• c.A municipal fund security, subject to MSRB rules✓
• d.An open-end investment company under the 1940 Act

Because states establish 529 plans, their interests are municipal fund securities governed by MSRB rules; investors receive an official statement rather than a statutory prospectus (Internal Revenue Code Section 529).

Earnings withdrawn from a 529 plan and used entirely for the beneficiary's qualified college tuition are:

• a.Taxed as ordinary income with a 10% penalty
• b.Taxed to the beneficiary at the student's rate
• c.Taxed as a long-term capital gain
• d.Free of federal income tax✓

A 529 plan's earnings grow tax-deferred and come out federally tax-free when used for qualified education expenses (Internal Revenue Code Section 529). Tax plus a 10% penalty on earnings apply only to non-qualified withdrawals.

In a 529 plan, control of the account:

• a.Belongs to the state sponsor
• b.Passes to the beneficiary at the age of majority
• c.Passes to the beneficiary's parents at college enrollment
• d.Stays with the account owner, who may change the beneficiary to another qualified family member✓

Unlike a custodial account, a 529 leaves ownership and control with the person who opened it, including the right to redirect funds to another eligible family member (Section 529). The beneficiary has no ownership right.

What capital structure is an open-end investment company permitted to issue?

• a.Any capital structure the board approves
• b.Common stock and long-term bonds, but no preferred stock, giving the fund a leveraged senior capital structure
• c.Only one class of voting common stock, though it may be offered under different sales-charge arrangements✓
• d.Multiple classes of preferred stock with equal voting rights

The Investment Company Act of 1940 limits an open-end fund to a single class of voting stock, offered through structures such as Class A, B, and C shares. Senior securities such as preferred stock and bonds are permitted only for closed-end funds.

The Investment Company Act of 1940 classifies investment companies as:

• a.Growth, income, and balanced funds
• b.Face-amount certificate companies, unit investment trusts, and management companies✓
• c.Mutual funds, ETFs, and separate accounts
• d.Open-end funds, closed-end funds, and hedge funds, the three legal forms the statute expressly defines

The Act names exactly three classes, with management companies further split into open-end and closed-end. Hedge funds rely on exclusions from the Act, and growth, income, and balanced describe objectives, not legal form.

To qualify as a regulated investment company under Subchapter M and avoid fund-level tax on distributed income, a fund must distribute at least:

• a.50% of its realized capital gains to shareholders
• b.75% of its net investment income to shareholders
• c.90% of its net investment income to shareholders✓
• d.100% of its gross income to shareholders

Under Subchapter M of the Internal Revenue Code, a fund distributing at least 90% of its net investment income is taxed only on amounts it retains, acting as a conduit to shareholders. Falling short subjects all income to corporate tax.

A fund family's combination privilege allows an investor to:

• a.Exchange funds within the family with no tax consequence
• b.Add together simultaneous purchases of two or more funds in the same family to reach a breakpoint✓
• c.Redeem shares with no charge
• d.Combine purchases across unrelated fund families to reach a breakpoint offered by any participating fund sponsor

The combination privilege aggregates concurrent purchases across different funds in the same family so the total qualifies for a quantity discount (FINRA Rule 2341). It should not be confused with the tax-triggering exchange privilege.

An investor uses a fund family's exchange privilege to move from a growth fund to a bond fund at net asset value. For tax purposes:

• a.It is tax-free only if completed within 30 days
• b.No new sales charge applies, but the exchange is a taxable sale of the growth fund and purchase of the bond fund✓
• c.A full front-end load must be paid on the bond fund
• d.It is tax-free because it stays within the same family, so that no gain or loss is ever recognized on the transaction

The exchange privilege waives an additional sales charge but does not change the tax result: the investor has disposed of one security and acquired another, so gain or loss is recognized (Internal Revenue Code). Representatives should disclose this before the exchange.

An open-end fund share is called a redeemable security because:

• a.It can be resold to other investors on an exchange at a market-determined premium or discount to net asset value
• b.The issuing fund stands ready to buy the share back at its next-computed net asset value✓
• c.The sales charge is refunded on redemption
• d.It may be redeemed only at a fixed price stated in the prospectus

A redeemable security is one the issuer repurchases; an open-end fund continuously redeems shares at the next-computed NAV under forward pricing (Investment Company Act of 1940). Exchange resale describes closed-end funds and ETFs.

A prospectus must be delivered to a purchaser of open-end fund shares:

• a.Only if the customer requests it in writing, since delivery is otherwise left to the selling representative
• b.Only for purchases over $10,000
• c.No later than the confirmation of the sale, regardless of dollar amount✓
• d.Within 30 days after settlement

Open-end funds are in continuous primary distribution, so each purchase is a new issue and the buyer must receive the current prospectus by the confirmation (Securities Act of 1933). Delivery does not depend on a request or a dollar threshold.

Detailed disclosure of a fund's officers, brokerage allocation practices, and full financial statements is found in the:

• a.Official statement
• b.Statement of Additional Information, provided free on request✓
• c.Summary prospectus
• d.Annual report only, which the fund mails to shareholders once every three years

The Statement of Additional Information supplements the prospectus with detailed governance, operational, and financial disclosure and must be sent at no charge to anyone who asks (Investment Company Act of 1940).

Which of the following qualifies as a single person eligible to aggregate purchases for a breakpoint?

• a.A parent buying in a UTMA account for one minor child, combined with the parent's own account✓
• b.A group of coworkers pooling funds
• c.Several unrelated partners in a partnership formed to get the discount
• d.An investment club pooling members' money to buy a single fund position together as a group for a shared discount

Breakpoint aggregation covers an individual, a married couple, and their minor children's custodial accounts as one household. Clubs, partnerships, and groups formed mainly to obtain a discount are excluded (FINRA Rule 2341).

When a shareholder elects automatic reinvestment of fund dividends and capital gains, the distributions buy additional shares at:

• a.The public offering price, including the full load
• b.The prior month's average price
• c.Net asset value, with no sales charge✓
• d.A 50% discount to the public offering price

Reinvestment at NAV is one of the features a fund must offer to charge the maximum sales load, letting distributions compound without a new sales charge (FINRA Rule 2341). Charging a load on reinvested distributions would penalize long-term holders.

On the ex-date of a mutual fund's capital gains distribution, the fund's net asset value per share, all else equal:

• a.Doubles
• b.Falls by the amount of the distribution✓
• c.Is unchanged
• d.Rises by the amount of the distribution

A distribution transfers value from the fund to shareholders, so NAV drops by the per-share distribution on the ex-date. This is why selling dividends, urging a purchase just before a distribution, offers no real economic gain.

A fund has total assets of $525,000,000, total liabilities of $25,000,000, and 40,000,000 shares outstanding. Its NAV per share is:

• a.$12.50✓
• b.$20.00
• c.$13.75
• d.$13.13

NAV per share = (total assets - total liabilities) / shares outstanding = ($525,000,000 - $25,000,000) / 40,000,000 = $500,000,000 / 40,000,000 = $12.50 (Investment Company Act of 1940). Ignoring liabilities overstates it at about $13.13.

A customer invests $10,000 at a public offering price of $25.00 per share (the sales charge is already reflected in that price). Ignoring fractions, how many shares are purchased?

• a.400✓
• b.250
• c.375
• d.500

Shares = amount / POP = $10,000 / $25.00 = 400 shares. Because the load is embedded in the $25.00 POP, no separate sales-charge deduction is made.

A fund may impose the maximum 8.5% sales charge only if it offers investors:

• a.A letter of intent, a CDSC, and rights of accumulation
• b.A no-load class and daily liquidity
• c.Breakpoints, rights of accumulation, and reinvestment of distributions at NAV✓
• d.A guaranteed return, breakpoints, and monthly statements that are sent to every shareholder each and every month

FINRA Rule 2341 conditions the 8.5% ceiling on the fund providing breakpoints, rights of accumulation, and reinvestment of distributions at NAV; a fund lacking any of these must charge less. No fund may guarantee a return.

A customer wants to invest $49,000 in a fund whose next breakpoint is at $50,000. The representative processes it without mentioning the breakpoint. This is:

• a.Switching, requiring principal approval
• b.Acceptable, because breakpoints start above $100,000
• c.Acceptable, because the customer named the amount
• d.Breakpoint selling, a prohibited practice✓

Selling just below a breakpoint without disclosing that a slightly larger purchase would cut the sales charge is breakpoint selling, prohibited under FINRA Rule 2341. The customer naming the amount does not excuse the representative's duty to disclose.

Rights of accumulation allow an investor to:

• a.Commit to future purchases within 13 months to keep a discount
• b.Add the current value of existing holdings to a new purchase to reach a breakpoint, with no deadline✓
• c.Count purchases in unrelated fund families toward a breakpoint
• d.Eliminate the sales charge on all future purchases once the first breakpoint is reached, and apply to every later purchase made in the fund family

Rights of accumulation let existing holdings count toward a new purchase's breakpoint, and there is no time limit (FINRA Rule 2341). Committing to future purchases within 13 months describes a letter of intent instead.

A letter of intent for mutual fund breakpoints:

• a.Lets purchases in any fund family count toward the goal
• b.Is a binding contract the investor must complete or forfeit the discount
• c.Covers 24 months and cannot be backdated
• d.Covers 13 months and may be backdated up to 90 days to include a recent purchase✓

An LOI pledges a stated investment within 13 months for a reduced sales charge and may be backdated as much as 90 days to include a recent purchase (FINRA Rule 2341). It is not binding; unmet, the fund liquidates escrowed shares to collect the higher charge.

Which statement about Class B mutual fund shares is accurate?

• a.They pay no 12b-1 fee because the load is deferred
• b.They carry a front-end load and the lowest annual expenses of any class
• c.They may always be redeemed with no charge of any kind
• d.They carry a contingent deferred sales charge that declines each year and typically convert to Class A after a set period✓

Class B shares are sold without a front-end load but impose a CDSC that steps down annually and eventually disappears, after which they usually convert to lower-expense Class A shares. During the CDSC period they carry higher 12b-1 fees, not none.

A fund may call itself no-load only if:

• a.It waives only the front-end charge, with no limit on 12b-1 fees
• b.It has no 12b-1 plan of any kind
• c.Its combined annual asset-based sales and service charges do not exceed 0.25% of average net assets✓
• d.It charges no more than a 3% front-end load

FINRA Rule 2341 permits the no-load label only when combined 12b-1 sales and service charges stay at or below 0.25% per year. A fund with meaningful ongoing distribution fees is not truly no-load even without a front-end charge.