FINRA Series 7 — All Questions

Which statement describes adjustable-rate preferred stock?

• a.Its dividend rises with the issuer's earnings, so its price tracks the common stock
• b.Its dividend is fixed in dollars, so its price is highly sensitive to a rise in rates
• c.Its holder may exchange the shares for common stock at each dividend reset date
• d.Its dividend resets with a benchmark rate, so its price is steadier when rates move✓

An adjustable-rate preferred stock has a dividend that resets periodically with a benchmark rate, so its price is generally less sensitive to interest-rate changes than a fixed-rate issue. A fixed dollar dividend would be a straight preferred. A dividend that moves with earnings belongs to a participating feature. Converting a dividend into common shares is not a feature of the adjustable rate.

A customer owns 5% straight preferred stock with a $100 par value. Market yields on comparable preferred stocks rise to 6.5%. At approximately what price does the stock's current yield match the market?

• a.$130.00, the 6.5% rate divided by 5% times par
• b.$93.50, par less the 6.5-point rise in yield
• c.$100.00, because par value does not change
• d.About $76.92, the $5 dividend divided by 6.5%✓

The annual dividend is 5% x $100 = $5. For the current yield to equal 6.5%, the price must be $5 / 0.065 = about $76.92, so the stock trades at a discount when yields rise. Par value is the stated value, not the market price. Multiplying par by the ratio of the rates moves the price in the wrong direction. Subtracting the yield from par mixes a percentage with a dollar price.

Yarrow Corp. common is trading rights-on at $48. Existing holders may buy one new share at $40 for every 4 rights held. What is the theoretical value of one right?

• a.$8.00, the price gap, not divided
• b.$1.60, found as $8 divided by 5✓
• c.$3.00, found as $8 / 4, plus $1
• d.$2.00, found as $8 divided by 4

While the stock trades rights-on, one right is worth (market price - subscription price) / (rights needed + 1) = ($48 - $40) / (4 + 1) = $1.60. Dividing by 4 is the ex-rights formula and gives $2.00. Adding $1 after dividing by 4 misplaces the extra 1 and gives $3.00. The full $8 gap is spread over the rights needed, not given to one right.

Bexley Inc. common trades rights-on at $53. Holders need 4 rights plus $45 to buy one new share. All else equal, about what will the stock trade at on the ex-rights date?

• a.$45.00, the price rights holders pay
• b.$53.00, because the price does not change
• c.$51.00, the rights-on price less $2.00
• d.$51.40, the rights-on price less $1.60✓

A right is worth ($53 - $45) / (4 + 1) = $1.60 while the stock is rights-on. On the ex-rights date the buyer no longer receives the right, so the price falls by that value to about $51.40. Subtracting $2.00 uses the wrong divisor. Leaving the price at $53 ignores the lost right. The subscription price is what rights holders pay, not the market price of the stock.

A warrant entitles its holder to buy 2 shares of Kestrel common at $24 per share. Kestrel common is trading at $31. What is the warrant's intrinsic value?

• a.$38, found as (2 x $31) - $24
• b.$62, the value of two shares
• c.$7, the gain on one share only
• d.$14, found as 2 x ($31 - $24)✓

Intrinsic value is the amount by which the shares exceed the exercise cost: each share is $7 in the money, and the warrant covers two shares, so 2 x $7 = $14. Using one share gives $7. Applying the $24 exercise price only once gives $38, but the holder pays $24 for each share. The value of the two shares alone, $62, ignores the cost of exercising.

Which statement correctly contrasts stock rights with stock warrants?

• a.Rights have no expiration date, while warrants must be exercised within a few weeks of being issued
• b.Rights are exercisable at a premium to market, while warrants carry an exercise price at a discount
• c.Rights are distributed along with bond offerings, while warrants go only to existing common stockholders
• d.Rights are short-lived and priced below market, while warrants run for years and are priced above market✓

Rights go to existing stockholders, expire within a short period and let them buy new shares below market. Warrants usually accompany a bond or preferred issue, last for years and carry an exercise price set above the market price when issued. The other answers reverse those features, so each describes warrants as rights or the reverse.

Norwick Labs common stock is quoted over the counter at $3.80 and is not listed on a national securities exchange. The issuer has operated continuously for five years, has net tangible assets of $1.4 million and has averaged $2.1 million in revenue over the last three years, per audited statements dated within 15 months. Is the stock a penny stock?

• a.No, because the definition applies only to stocks quoted under $1.00
• b.Yes, because it is under $5 and fails both the asset and revenue tests✓
• c.No, because an issuer operating for over three years is exempt regardless
• d.Yes, but only if the issuer also reported a net loss in its latest year

A penny stock is an equity security priced under $5 that is not otherwise excluded. This one is unlisted and fails both issuer exemptions: net tangible assets must exceed $2 million for an issuer operating at least three years, and average revenue for the last three years must be at least $6 million. Operating history alone does not exempt a stock. The price test is $5, not $1. A net loss is not part of the definition.17 CFR 240.3a51-1

A firm recommends a penny stock to a customer whose account has been open for three years. The customer last effected a securities transaction in that account 14 months ago. Which statement is correct?

• a.Both requirements still apply, because the customer has not traded within the last 12 months
• b.Neither requirement applies, since established customers are exempt from every penny stock rule
• c.The risk disclosure document is waived, but account approval and a written agreement are still required
• d.Rule 15g-9 account approval is not required, but the risk disclosure document must still be delivered✓

An established customer is one who effected a transaction or deposited funds or securities in the account more than a year earlier, so the customer here qualifies. That exempts the trade from the account approval and written agreement requirements of Rule 15g-9. It is not an exemption from the risk disclosure document under Rule 15g-2, which the firm must still furnish and obtain a signed acknowledgment for. The established-customer test looks for activity older than one year, not for recent trading.17 CFR 240.15g-9

A firm that has no exemption sends a customer the Schedule 15G penny stock risk disclosure document on Monday, October 5, 2026. The customer signs and returns the acknowledgment the same day. Considering only this requirement, what is the earliest day the firm may effect a recommended penny stock transaction?

• a.Wednesday, October 7, two business days after sending✓
• b.Tuesday, October 6, one business day after sending it
• c.Thursday, October 8, two business days after signing it
• d.Monday, October 5, because the customer signed that day

The firm must obtain a signed and dated acknowledgment, and it may not effect the transaction less than two business days after it sends the document. Two business days after Monday is Wednesday. A same-day signature does not shorten the wait, so Monday and Tuesday are too early. The clock runs from the day the document is sent, not from the day the customer signs, so Thursday is later than required.17 CFR 240.15g-2

A customer buys 100 shares of Tessen Corp on Tuesday, March 3, 2026, in a taxable account, and the shares later rise. What is the earliest sale date that produces a long-term capital gain?

• a.Wednesday, March 3, 2027, on the one-year anniversary
• b.Friday, March 5, 2027, one year after the settlement date
• c.Thursday, March 4, 2027, the day after the anniversary✓
• d.Tuesday, March 2, 2027, the day before the anniversary

The holding period starts the day after the shares are acquired, and a gain is long-term only if the shares are held more than one year. Counting from Wednesday, March 4, 2026, one full year ends on Wednesday, March 3, 2027, so a sale on that day is still exactly one year and is short-term; Thursday, March 4, 2027, is the first day over one year. Settlement of the purchase is not what starts the clock, which makes Friday later than necessary. Tuesday, March 2, 2027, falls a day short of a year.IRS Pub. 550, Holding period

A customer buys 500 shares of common stock of Vantora Inc. on Thursday, August 13, 2026. The stock goes ex-dividend on Monday, August 17, 2026. The customer wants the dividend to be a qualified dividend and plans to sell as soon as the minimum holding period is met. What is the earliest sale date that meets it?

• a.Monday, August 16, 2027, more than one year of holding
• b.Thursday, November 12, 2026, the 91st day of holding
• c.Tuesday, October 13, 2026, the 61st day of holding✓
• d.Monday, October 12, 2026, the 60th day of holding

For common stock the holder must have held the shares more than 60 days during the 121-day period that begins 60 days before the ex-dividend date, counting the sale date but not the purchase date. A sale on Monday, October 12, 2026, is only 60 days and falls short, while Tuesday, October 13, is day 61. The more-than-90-day test applies to preferred stock, not to common stock, so November 12 asks for more than is required. A full year is the test for long-term capital gain, not for a qualified dividend.IRS Pub. 550, Qualified dividends

A customer buys 200 shares of Halcyon Marine at $36, sells them at $30 for a loss, and buys 200 shares of the same stock 12 days later at $31. What is the cost basis of the new 200 shares?

• a.$6,200, the price paid for the new shares only
• b.$7,400, the new purchase cost plus the disallowed loss✓
• c.$5,000, the new cost reduced by the realized loss
• d.$7,200, the cost of the old shares carried over

The sale produced a $1,200 loss ($7,200 cost less $6,000 proceeds), and because the identical stock was bought within 30 days, the loss is disallowed and added to the cost of the new shares: $6,200 plus $1,200 equals $7,400. Using only the $6,200 purchase price discards the postponed loss. Subtracting the loss lowers the basis when the rule raises it. Carrying over the $7,200 original cost ignores what was actually paid for the new shares.IRS Pub. 550, Wash sales

An investor buys 300 shares of Brightwell Energy at $20 and sells all 300 at $14. Within 30 days after the sale she buys 120 shares of the same stock. How much of the loss may she deduct for the year of the sale, assuming no other transactions?

• a.$1,800, since only part of the stock was replaced
• b.$1,080, the loss on the 180 shares left unreplaced✓
• c.$0, since a repurchase disallows the whole loss
• d.$720, the loss tied to the 120 shares bought back

The total loss is $1,800 (300 shares times $6). When fewer shares are bought back than were sold, the wash sale rule applies only to the matching number of shares: 120 of 300 shares disallows $720, leaving $1,080 on the other 180 shares as a deductible loss. Deducting the whole $1,800 ignores the repurchase altogether. The $720 figure is the disallowed part, not the deductible part. The rule does not wipe out the entire loss when only some of the shares are replaced.IRS Pub. 550, Wash sales

A customer owns 200 shares of Norcrest Holdings with an adjusted basis of $6,000. The company distributes one nontaxable right per share. Each share is worth $40 and each right is worth $8 at the time of distribution. The customer sells all the rights. What basis is allocated to the rights?

• a.$1,600, the market value of all the rights received
• b.$1,000, found by dividing the basis by relative market value✓
• c.$0, because sold rights carry no basis of their own
• d.$1,200, found by taking 20% of the old stock's basis

Rights worth 15% or more of the old stock's value must be allocated a share of its basis when they are sold or exercised. Here the stock is worth $8,000 and the rights $1,600, so the rights get $6,000 x $1,600 / $9,600 = $1,000, and the stock keeps $5,000. A zero basis applies only when the rights are worth less than 15%, and then only unless the holder elects to divide. Taking 20% of the basis ignores that the percentage is measured against the combined value. The market value of the rights is not the same as their share of cost.IRS Pub. 550, Nontaxable stock rights

A customer owns two lots of Ellsworth Foods: 100 shares bought at $20 and 100 shares bought at $30. The company pays a nontaxable stock dividend of one new identical share for each share held. What is the basis of each new share received on the lot bought at $30?

• a.$25.00, the average of the two lots' cost per share
• b.$15.00, the lot's cost spread over its old and new shares✓
• c.$12.50, the cost of both lots pooled over all 400 shares
• d.$30.00, the lot's original cost carried onto each new share

A nontaxable dividend in identical stock is handled lot by lot: each lot's basis is divided by the old and new shares that belong to it. The $3,000 lot now covers 200 shares, so each is $15.00, and the $20 lot works out to $10.00. Leaving $30.00 on each new share would double-count the cost of the lot. Pooling both lots gives $5,000 over 400 shares, or $12.50, which mixes the lots together and misstates the basis of each. The $25.00 figure averages the two purchase prices and ignores that the new shares dilute the cost.IRS Pub. 550, Stock bought at various times

A donor with a basis of $60 per share gives a customer 100 shares of Pellam Corp when the market value is $48 per share. The customer later sells all 100 shares at $52. What is the tax result?

• a.A loss of $1,200, the drop from the donor's basis to $48
• b.No gain or loss, because the two bases give opposite results✓
• c.A gain of $400, measured from the market value of $48
• d.A loss of $800, measured from the donor's basis of $60

When the market value at the time of the gift is below the donor's basis, the donee uses the donor's basis to figure a gain and the market value to figure a loss. Using $60 gives a loss, and using $48 then gives a gain, so a sale between the two prices produces neither. A loss of $800 uses the donor's basis even though the sale was above the gift-date value. A gain of $400 uses the lower value even though the donor's basis would give a loss. The $1,200 figure compares the two bases rather than the sale price.IRS Pub. 550, Property received as a gift

A customer buys 100 shares of Corvane Ltd. at $20, then 100 at $30, then 100 at $26. She later sells 150 shares at $34 and cannot identify which shares were sold. What is her gain?

• a.$800, with the highest-cost lots treated as sold first
• b.$1,300, with the average cost of all lots held per share
• c.$1,600, with the earliest shares bought treated as sold first✓
• d.$1,000, with the most recently bought lots sold first

When the shares sold cannot be identified, the shares acquired first are treated as sold first. The basis is 100 x $20 plus 50 x $30, or $3,500, against proceeds of $5,100, a gain of $1,600. Selling the highest-cost shares first would give a basis of $4,300 and a gain of $800. Selling the latest shares first would give a basis of $4,100 and a gain of $1,000. An average cost of about $25.33 would give $1,300, but average cost is not available for ordinary stock, only for certain mutual fund shares.IRS Pub. 550, Identification not possible

A customer owns 200 shares of Darrow Mills with an adjusted basis of $6,000 and receives nontaxable rights worth 20% as much as the stock. She lets the rights expire unsold and unexercised, then sells the 200 shares at $44. What is her gain or loss on the shares?

• a.A $3,800 gain, since $1,000 of basis moved to the rights
• b.A $2,800 gain, since the expired rights carry no basis✓
• c.A $1,800 gain, after a $1,000 loss on the expired rights
• d.A $4,000 gain, since the basis was cut 20% for the rights

Rights that are allowed to expire have no basis, so none of the stock's basis moves to them and the shares keep their full $6,000: $8,800 of proceeds less $6,000 is a $2,800 gain. A $3,800 gain assumes $1,000 of basis was moved to the rights, which is required only when rights are sold or exercised. A $1,800 gain deducts a $1,000 loss on the rights while keeping the full basis on the stock, which counts the same cost twice. A $4,000 gain cuts the basis by 20%, treating the rights' value as a share of the stock's value instead of a share of the combined value.IRS Pub. 550, Nontaxable stock rights

In one year a single filer has a short-term capital gain of $2,500 and a long-term capital loss of $8,500, with no other capital transactions. How much of the net loss may she deduct against ordinary income, and what happens to the rest?

• a.Deduct all $6,000 this year with nothing carried over
• b.Deduct $8,500 this year with nothing carried over
• c.Deduct $3,000 this year and carry over the other $3,000✓
• d.Deduct $3,000 this year and carry over the full $6,000

The gain and loss net to a $6,000 loss. The deduction against ordinary income is limited to $3,000 a year ($1,500 if married filing separately), and the unused $3,000 carries over to the next year. Deducting the full net loss ignores the annual limit. Carrying over $6,000 forgets that the allowed $3,000 is used this year. Deducting the $8,500 ignores both the netting against the gain and the limit.IRS Pub. 550, Capital losses

A U.S. depositary bank issues ADRs, each representing 2 ordinary shares of a European company. The ordinary shares trade at 30 euros in the home market, and the exchange rate is $1.10 per euro. Ignoring fees, what should one ADR be worth in dollars?

• a.$66.00, two shares at 30 euros converted at $1.10✓
• b.$60.00, two shares at 30 with no currency conversion
• c.$33.00, one share at 30 euros converted at $1.10
• d.$54.55, two shares at 30 euros divided by the $1.10 rate

The ADR price corresponds to the home-market price adjusted for the ratio of ADRs to shares, and here converted to dollars: 2 x 30 euros x $1.10 = $66.00. Converting a single share gives $33.00 and ignores the two-share ratio. Dividing by the exchange rate treats the dollar as the foreign currency and gives $54.55. Using 60 as dollars ignores the currency conversion, which is part of what an ADR holder bears.

A customer owns ADRs of a foreign company and asks what the receipts give her. Which statement is correct?

• a.The right to obtain the foreign stock that each ADR represents, whatever the ratio✓
• b.The right to the foreign stock only with the home exchange's approval
• c.The right to the foreign stock only if each ADR represents one whole share
• d.No right to the underlying shares, only a claim on the depositary bank

An ADR is issued by a U.S. depositary bank and represents one or more shares of foreign stock, or a fraction of a share, and the holder has the right to obtain the stock it represents; most U.S. investors simply find the ADR more convenient to own. The receipt is therefore not just a claim on the bank. The ratio of ADRs to shares affects the price, not the right, so a fractional or multiple-share ADR carries the same right. Nothing in the description makes that right depend on a home-exchange approval.

An alternative trading system is registered as a broker-dealer and limits its securities activities to U.S. government securities and commercial paper. How does Regulation ATS treat it?

• a.It must comply fully, since the rule makes no exclusion based on the instruments traded
• b.It is excluded from the Regulation ATS requirements because of the limited instruments it trades✓
• c.It must register as a national securities exchange, since it trades government securities
• d.It is excluded only if the SEC grants an exemption based on its limited trading volume

The rule excludes an alternative trading system that is registered as a broker-dealer, or is a bank, and limits its securities activities to government securities, certain repurchase agreements, certain options on government securities, and commercial paper. This system fits that description, so the requirements do not apply to it. Saying it must comply fully ignores that exclusion. A separate exclusion exists for systems the SEC exempts for limited volume, but the instrument exclusion does not depend on volume. The rule does not turn a government-securities venue into an exchange.17 CFR 242.301(a)(4)

An alternative trading system that is not registered as an exchange and not otherwise excluded wants to begin operating. What must it do under Regulation ATS?

• a.Register as a clearing agency so that it can settle the trades it matches
• b.Register as a national securities association, as FINRA is registered
• c.Register as an investment adviser to the subscribers who use the system
• d.Register as a broker-dealer under section 15 of the Securities Exchange Act✓

Under Regulation ATS an alternative trading system that is subject to the rule must register as a broker-dealer under section 15 of the Exchange Act, and it must also give the SEC notice of its operation. A national securities association is a self-regulatory body such as FINRA, not a registration category for a trading venue. A clearing agency settles trades rather than matching buyers and sellers. An investment adviser gives advice for pay, which is a different business.17 CFR 242.301(b)(1)

A customer owns a convertible bond of Halvern Corp. bought for $9,800. She converts it into Halvern common stock now worth $12,400, exactly as the bond's terms permit. What is the tax result at the time of conversion?

• a.Ordinary income of $12,400 is taxed at conversion
• b.A $2,600 capital gain is taxed in the year of conversion
• c.Generally no gain or loss is recognized at conversion✓
• d.A loss is recognized if the stock is below par value

Converting a bond into stock of the same corporation under a conversion privilege in the bond's terms generally does not produce a recognized gain or loss, even though the stock is worth $2,600 more than the bond cost. Tax is deferred until the stock is sold. Treating the $2,600 as capital gain taxes the conversion itself. Treating all $12,400 as income misreads a conversion as a sale for the stock's full value. Recognizing a loss measured against par fails for the same reason: nothing is recognized at conversion.IRS Pub. 550, Convertible stocks and bonds

A front-end load fund has a net asset value of $11.50 per share and a sales charge of 8% of the public offering price. What is the public offering price?

• a.$12.57
• b.$12.78
• c.$12.50✓
• d.$12.42

Because the charge is a percentage of the offering price, POP = NAV / (1 - 0.08) = $11.50 / 0.92 = $12.50. Multiplying NAV by 1.08 gives $12.42 and puts the charge on NAV instead of on the offering price. $12.57 comes from using the 8.5% FINRA maximum, and $12.78 from dividing by 0.90, a 10% charge the stem does not state.FINRA Rule 2341; Investment Company Act Section 22(d)

A customer invests $10,000 in a fund with an NAV of $18.75 and a sales charge of 6% of the offering price. Ignoring any breakpoint, how many shares does the customer receive, to two decimals?

• a.533.33
• b.501.33✓
• c.567.38
• d.503.14

The charge is a percentage of POP, so POP = $18.75 / 0.94 = $19.947, and $10,000 / $19.947 = 501.33 shares (equivalently $9,400 net / $18.75). Pricing the share at NAV plus 6% of NAV ($19.875) gives 503.14. Ignoring the load gives 533.33, and multiplying NAV by 0.94 gives 567.38.FINRA Rule 2341; Investment Company Act Rule 22c-1

A customer has $60,000 to invest in Class A shares of a fund family whose sales charge drops at $50,000. The representative proposes investing $48,000 in one fund and keeping the rest in cash, saying the customer can add the balance later. The representative earns more on the $48,000 purchase than on a $60,000 one. Which statement fits?

• a.It breaches the 8.5% sales charge cap in Rule 2341, which applies to any purchase under $50,000
• b.It is a switching violation, because Rule 2342 covers moving money between funds of one family
• c.It is a prohibited breakpoint sale, since the amount sits just below the discount threshold on purpose✓
• d.It is acceptable when the customer approves the amount, because disclosure of the charge cures a breakpoint problem

Rule 2342 bars selling investment company shares in amounts just below the point where the charge falls, so as to share in the higher charge. Customer consent does not excuse it, and the facts here show the amount was set by the commission. The 8.5% cap in Rule 2341 is not exceeded by an ordinary load, and switching refers to a different practice, not to an amount set just under a breakpoint.FINRA Rule 2342

A fund's Class A schedule is 5.75% under $50,000, 4.50% from $50,000 to $99,999 and 3.50% from $100,000. The fund values existing holdings at current NAV for rights of accumulation. A customer's existing Class A shares are worth $42,000, and she adds $10,000. What charge applies to the $10,000?

• a.None, because shares already held are exempt from new loads
• b.3.50%, because the purchase brings the total near $100,000
• c.5.75%, because $10,000 alone is under the first breakpoint
• d.4.50%, because the combined $52,000 reaches the second tier✓

Rights of accumulation let existing holdings count toward the breakpoint, so $42,000 + $10,000 = $52,000 falls in the $50,000-$99,999 tier and the new money is charged 4.50% ($450). Judging the $10,000 by itself ignores the accumulation right. $52,000 is nowhere near the $100,000 tier, and rights of accumulation reduce the rate but do not waive the load.FINRA Rule 2341; fund prospectus breakpoint schedule

A fund charges 5.50% under $50,000, 4.50% from $50,000 to $99,999 and 3.75% from $100,000 to $249,999. A customer signs a 13-month letter of intent for $100,000, then invests only $60,000 in total before the period ends. What additional sales charge is owed at the end?

• a.$450✓
• b.$2,700
• c.$0
• d.$1,050

The letter of intent is not a binding purchase commitment, but if the goal is missed the charge is recalculated at the rate for the amount actually invested: $60,000 belongs in the 4.50% tier, so the extra is (4.50% - 3.75%) x $60,000 = $450. $1,050 uses the 5.50% top rate, as if the discount never applied. $2,700 is the entire 4.50% charge rather than the difference. Owing nothing treats the lack of a binding commitment as keeping the discount.FINRA Rule 2341; fund prospectus letter of intent

A customer buys $20,000 of Class B shares with a CDSC of 5% in year one, 4% in year two, 3% in year three, 2% in year four and 1% in year five, applied to the lesser of original cost or redemption value. The shares are worth $24,000 when sold during the third year. What is the CDSC?

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

During the third year the rate is 3%, applied to the lower of cost ($20,000) and value ($24,000): 3% x $20,000 = $600. Using the $24,000 value gives $720. $800 is the 4% year-two rate, and $1,000 is the 5% year-one rate.Fund prospectus (contingent deferred sales charge)

Class A shares of a fund carry a 5.75% front-end load and a 0.25% annual 12b-1 fee. Class C shares carry no load, no deferred charge and a 1.00% annual 12b-1 fee. Ignoring growth and compounding, after how many full years does Class C's cumulative cost first exceed Class A's?

• a.After 6 years
• b.After 23 years
• c.After 8 years✓
• d.After 7 years

Class A costs 5.75% + 0.25% per year and Class C costs 1.00% per year, so C overtakes A once 0.75% x n exceeds 5.75%, which is n > 7.67. At 7 years C costs 7.00% against 7.50%, and at 8 years it costs 8.00% against 7.75%. Six years divides by the full 1.00% and ignores Class A's own fee; 23 years divides by 0.25% instead of the 0.75% difference; seven years is a rounding down of 7.67.FINRA Rule 2341(d); fund prospectus share classes

A customer holds shares of Fund X in a taxable account with a cost of $8,000 and a value of $9,500. She exchanges them for shares of Fund Y in the same fund family, with no sales charge. What are the tax consequences?

• a.The full $9,500 is taxed as income because it moved between funds
• b.Only the dividends are taxed, and the gain is deferred until Fund Y is sold
• c.The exchange is tax-free because both funds belong to the same family
• d.A taxable sale occurs and she recognizes a $1,500 gain✓

An exchange between funds, even within one family, is a redemption of one fund and a purchase of another, so the $1,500 gain is recognized in a taxable account. Only exchanges inside a tax-deferred account or a qualifying insurance product escape current tax. The gain is not deferred, and only the $1,500 gain, not the whole $9,500, is taxable.IRC Section 1001; IRS Publication 550

Under FINRA's sales charge rule, what are the maximum annual asset-based sales charge and the maximum annual service fee a fund may charge, each as a percentage of average net assets?

• a.0.75% asset-based sales charge and 0.50% service fee
• b.0.75% asset-based sales charge and 0.25% service fee✓
• c.0.50% asset-based sales charge and 0.50% service fee
• d.1.00% asset-based sales charge and 0.25% service fee

Rule 2341 caps the asset-based sales charge at 0.75% of average annual net assets and the service fee at 0.25%, so total 12b-1 fees top out at 1.00%. Allowing 1.00% for the sales charge confuses the combined ceiling with the sales charge cap. A 50/50 split and a 0.50% service fee both overstate the service-fee cap.FINRA Rule 2341(d)

A fund imposes no front-end or deferred sales charge but deducts a 0.40% annual 12b-1 fee. May it describe itself as 'no-load'?

• a.Yes, because the fund has neither a front-end nor a deferred sales charge to the investor
• b.Yes, because 12b-1 fees below 0.75% of assets are permitted for no-load funds
• c.No, because its annual 12b-1 and service fees together exceed 0.25% of its net assets✓
• d.No, because a fund that has any 12b-1 plan at all cannot use the word no-load

A fund may not be called no-load if it has a front-end or deferred sales charge or if its annual charges against net assets for sales, promotion and shareholder services exceed 0.25%. At 0.40% this fund is over the line. Lacking a load is not enough on its own. The 0.75% figure is the cap for asset-based sales charges, not the no-load test, and a 12b-1 plan of 0.25% or less would still be allowed.FINRA Rule 2341(d)

An investor bought shares of a stock fund four months ago. The fund distributes $1.80 per share of capital gains it realized on securities held for several years. How is the distribution taxed to the investor?

• a.As a short-term capital gain, because the fund shares were held under 12 months
• b.As a long-term gain, whatever the investor's holding period✓
• c.As a nontaxable return of capital, because it lowers the share price
• d.As ordinary dividend income, because the payment came from a fund

A capital gain distribution is always reported as long-term, because its character comes from the fund's holding period of its securities, not the investor's holding period of the fund shares. Four months of ownership therefore does not make it short-term. It is not an ordinary dividend, and it is not a return of capital, which would be a payout in excess of the fund's earnings.IRC Section 852(b)(3); IRS Topic 404

A fund sells stocks it owned for seven months at a gain and distributes the net gain. An investor who has held the fund for five years receives it. How is the distribution reported?

• a.As a long-term capital gain, because the investor held the fund over a year
• b.As an ordinary dividend, because the fund's gains were short-term✓
• c.As a return of capital that reduces the investor's basis
• d.As a long-term capital gain, because gains paid by a fund count as long-term

Only net long-term gains are passed through as capital gain distributions. Net short-term gains realized by a fund are paid out as ordinary dividends, whatever the investor's own holding period. The investor's five years of ownership does not change the character, and a payout of earnings is not a return of capital.IRC Section 852(b); IRS Publication 550

An investor buys 1,000 fund shares at an NAV of $24.00 one day before the ex-dividend date. The fund pays $1.20 per share, which is reinvested, and the NAV drops to $22.80. What is the investor's total cost basis after the reinvestment?

• a.$26,400
• b.$22,800
• c.$25,200✓
• d.$24,000

The investor paid $24,000 and owes tax on the $1,200 distribution; reinvesting it adds $1,200 of basis, giving $25,200 (about 1,052.63 shares). Leaving basis at $24,000 ignores the reinvestment. $22,800 values the shares at the post-distribution NAV, which is not what the investor paid, and $26,400 counts the distribution twice.IRS Publication 550 (reinvested distributions and basis)

An investor paid $10,000 for fund shares. The fund classifies $600 of a distribution as return of capital. What is the tax result?

• a.The $600 is ordinary income, and the basis stays at $10,000
• b.The $600 is a long-term gain, and the basis stays at $10,000
• c.The $600 is taxed now, and the basis also falls to $9,400
• d.No current tax on the $600, and the basis falls to $9,400✓

A return of capital is not taxed when received; it lowers the basis, so $10,000 becomes $9,400, and the amount is recovered later through a bigger gain or smaller loss on sale. It is not ordinary income or a gain at receipt, and the investor does not both pay tax and reduce basis, which would tax the same dollars twice.IRC Section 301(c); IRS Topic 404

An investor bought 100 fund shares at $10, another 100 at $14 and another 100 at $12, in that order. She sells 150 shares at $15 and elects average cost. What is her gain?

• a.$750
• b.$450✓
• c.$350
• d.$550

Average cost is $3,600 / 300 = $12 per share, so the sale produces $2,250 - $1,800 = $450. $550 is the first-in, first-out result (basis of $1,700), and $350 is the last-in, first-out result (basis of $1,900). $750 pairs the sale with the cheapest 150 shares at $10, which is not an average.Treas. Reg. 1.1012-1(e); IRS Publication 550

An investor sells all 200 shares of a fund at a $1,000 loss. Twelve days later, an automatic dividend reinvestment buys 8 shares of the same fund. What is the tax treatment of the loss?

• a.$960 is allowed, and $40 is disallowed and added to the basis of the 8 replacement shares✓
• b.The full $1,000 is allowed, because reinvested dividends are not purchases
• c.$40 is allowed, and $960 is disallowed because of the reinvestment
• d.The full $1,000 is disallowed, because any repurchase within 30 days voids the loss

The wash sale rule applies to replacement shares bought within 30 days, including through dividend reinvestment, but only to the extent of the shares replaced: 8 of 200 is 4%, so $40 is disallowed and carried into the new shares' basis. Treating reinvestments as exempt allows too much. Disallowing everything overstates the replacement, and allowing $40 reverses the proportions.IRC Section 1091; IRS Publication 550

A national municipal bond fund distributes $0.30 per share of exempt-interest dividends and $0.10 per share of long-term capital gains. For federal income tax purposes (ignoring AMT), what is taxable?

• a.Only the $0.10 capital gain distribution✓
• b.Only the $0.30, because interest from a fund is always taxable
• c.Both distributions, because the fund passes through taxable income
• d.Neither, because all payments from a municipal fund are exempt

Exempt-interest dividends keep their federal exemption when passed through, but a capital gain distribution from a municipal fund is taxable as a long-term gain. The fund structure does not remove the exemption on the interest, and the exemption does not extend to the gain.IRC Section 852(b)(5); IRS Publication 550

A retired customer sets up a fixed-dollar withdrawal plan of $2,000 a month from a bond fund yielding about 3%. Which statement is accurate?

• a.Withdrawals above the dividend are treated as a tax-free return of capital to the investor
• b.Each withdrawal redeems shares, so it may create gains or losses and erode principal✓
• c.A new sales charge applies to each withdrawal because shares are redeemed by the plan
• d.Withdrawals are limited to the dividends and gains the fund earns, so principal is protected

A fixed-dollar plan pays the stated amount by redeeming shares as needed, so the sale of shares can trigger gains or losses and shrink the account when withdrawals exceed income. A plan that pays only income is a different design. Proceeds above the dividend are share sales, not a tax-free return of capital, and a redemption carries no new front-end charge.Fund prospectus (systematic withdrawal plan)

An interval fund has 12 million shares outstanding. Which repurchase offer size is permitted under Rule 23c-3?

• a.1,200,000 shares✓
• b.360,000 shares
• c.3,600,000 shares
• d.480,000 shares

Rule 23c-3 requires each repurchase offer to be at least 5% and no more than 25% of outstanding shares, which is 600,000 to 3,000,000 here, so 1,200,000 shares (10%) qualifies. 360,000 is 3% and 480,000 is 4%, both under the floor. 3,600,000 is 30%, above the ceiling.Investment Company Act Rule 23c-3

How does a registered tender-offer fund differ from an interval fund?

• a.It lists its shares on an exchange, so liquidity comes only from market trades
• b.It must make a repurchase offer at set intervals for 5% to 25% of outstanding shares under a fundamental policy
• c.It redeems shares at NAV on any business day an investor asks, as an open-end fund must
• d.Its board decides whether and when to make repurchase offers; no policy requires them to be made✓

A tender-offer fund repurchases at the board's discretion and is not obliged to offer liquidity on a schedule, while an interval fund commits by fundamental policy to periodic repurchase offers of 5% to 25% of outstanding shares under Rule 23c-3. Neither redeems on demand every business day, which is an open-end feature, and a tender-offer fund is not listed, so its liquidity does not come from exchange trading.Investment Company Act Section 23(c); Rule 23c-3

The index tracked by an exchange-traded note is unchanged, yet the note falls after its issuing bank's credit rating is cut. Which risk does this show?

• a.Issuer credit risk, because an ETN is an unsecured debt obligation of the issuing bank✓
• b.Active management risk, because the manager changed the note's holdings
• c.Tracking error, because the ETN holds a basket of securities that missed the index
• d.Authorized participant risk, because creation units were redeemed in kind

An ETN is an unsecured debt obligation of its issuer, so its value depends on the issuer's creditworthiness as well as on the index. It holds no basket of securities, so tracking error against holdings and creation-unit mechanics do not apply as the explanation, and the index did not move, which also rules out manager choices.Exchange-traded notes (issuer credit risk)

A closed-end fund sells shares in its IPO at $20.00 with a 4.50% underwriting charge taken from the proceeds. Ignoring other costs, what is the NAV per share right after the offering?

• a.$19.14
• b.$19.00
• c.$19.10✓
• d.$19.55

The charge comes out of the money raised, so the fund keeps $20.00 x 0.955 = $19.10 per share. $19.14 divides by 1.045 as if the charge were added on top. $19.55 takes 4.5 cents rather than 4.5% off, and $19.00 uses a 5% charge. This shortfall is one reason new closed-end shares often fall below NAV.FINRA Rule 2111; closed-end fund offering

A 2x daily leveraged ETF is worth $100. Over two days its underlying index falls 10% and then rises 10%. What is the ETF worth at the end, assuming the fund resets daily?

• a.$98.00
• b.$96.00✓
• c.$99.00
• d.$100.00

Day one: -20% leaves $80. Day two: +20% on $80 adds $16, giving $96. The index itself ends at $99 (0.90 x 1.10), so $99 describes the unlevered index. Doubling the index's two-day -1% gives $98, which ignores daily compounding, and $100 assumes the gains and losses cancel.SEC Regulatory guidance on leveraged ETFs

A customer is offered a principal-protected structured note issued by a broker-dealer's parent. What should the representative explain about the protection?

• a.The Treasury backs the protection if the note is held to maturity
• b.FDIC insurance covers the principal up to $250,000 if the note is held to maturity
• c.SIPC coverage replaces the principal if the issuer of the note defaults
• d.It depends on the issuer's ability to pay, since the note is unsecured✓

Principal protection on a structured note is only a promise by the issuer, so the investor carries the issuer's credit risk. A note issued by a bank or broker-dealer parent is not a deposit, so FDIC insurance does not apply, SIPC protects against a failed broker-dealer holding customer assets rather than an issuer default, and the Treasury does not stand behind it.FINRA Regulatory Notice 12-03 (structured products)

Why do ETFs typically distribute fewer capital gains than comparable open-end mutual funds?

• a.ETFs are exempt from the pass-through rules that apply to other funds
• b.ETF portfolio managers must hold each security for more than a year
• c.ETF shares do not change in price between trades, so no gains arise in the portfolio
• d.Redemptions are usually in kind, so low-basis securities leave the fund without being sold✓

Authorized participants redeem creation units for baskets of securities, so the fund can deliver low-basis lots without a taxable sale. ETFs do have price changes and gains. ETFs must still follow the regulated investment company pass-through rules to avoid fund-level tax, and no rule forces a one-year holding period.SEC guidance on ETF structure (Rule 6c-11)

A unit holder in a fixed-portfolio bond UIT wants cash before the trust terminates. What is the usual way to exit?

• a.Redeem with the trustee at NAV, or sell the units to the sponsor's secondary market✓
• b.Sell the units on an exchange at a price set by the market, like an ETF share
• c.Ask the portfolio manager to remove the holder's pro rata bonds
• d.Wait until termination, since units cannot be redeemed before then

UIT units are redeemable securities, and the sponsor customarily maintains a secondary market, so an investor can redeem at NAV or sell back. UITs are not generally listed on exchanges. Units can be redeemed before the termination date, and there is no portfolio manager to carve out specific bonds.Investment Company Act Section 4(2); Section 26