FINRA Series 7 — All Questions

A customer sells 1 XYZ Jan 40 put at 2.50 and is assigned, buying 100 shares at 40. What is the customer's basis in the shares, and when is the premium taxed?

• a.$4,250 basis; the premium is added to the cost of the stock bought
• b.$3,750 basis; the premium is ordinary income in the year it is received
• c.$3,750 basis; the premium is not taxed until the shares are sold✓
• d.$4,000 basis; the premium is a short-term gain taxed on assignment

When a written put is exercised and the writer buys the stock, the premium received reduces the basis: $4,000 minus $250 = $3,750. The premium is then reflected in the gain or loss when the shares are sold. It is not taxed on assignment. Adding the premium to the cost reverses the adjustment. Premium on an assigned put is never reported as ordinary income when received.IRS Pub. 550, Puts and Calls

A customer realizes a $10,000 gain on broad-based, cash-settled index options traded on a national exchange, all held for three weeks. How is the gain taxed?

• a.60% as long-term and 40% as short-term, whatever the holding period✓
• b.All as short-term, because the options were held under one year
• c.All as ordinary income, because index options are not capital assets
• d.40% as long-term and 60% as short-term, regardless of holding period

Cash-settled options on a broad-based index are nonequity options and are section 1256 contracts. Gains and losses on them are treated as 60% long-term and 40% short-term regardless of how long they were held. Reversing the split gives the wrong answer. The holding-period test used for equity options does not apply. These contracts are reported as capital gains, not ordinary income.IRS Pub. 550, Section 1256 Contracts

A customer owns 500 shares of RLNT bought at 18 and now trading at 61. The customer fears a decline over the next three months but does not want to sell because of the large taxable gain. Which strategy sets a floor on the selling price and keeps the upside?

• a.Sell 5 RLNT puts, collecting a premium for agreeing to buy more
• b.Buy 5 RLNT puts, paying a premium to set a minimum selling price✓
• c.Sell 5 RLNT calls, collecting premium that cushions a small drop
• d.Buy 5 RLNT calls, which adds exposure to a further price rise

A long put gives the right to sell at the strike price, so it sets a floor while leaving all upside open and requires no sale of the shares. Selling calls cushions only by the premium and caps the upside. Buying calls adds to the position and does nothing if the stock falls. Selling puts adds to the loss if the stock falls, because the customer would have to buy more shares.

A customer owns 800 shares of a stable stock trading at 42, expects it to move little over the next two months, and would be content to sell the shares at 46. Which strategy generates added income?

• a.Buy 8 puts with a strike of 40
• b.Sell 8 puts with a strike of 46
• c.Buy 8 calls with a strike of 46
• d.Sell 8 calls with a strike of 46✓

Writing calls against shares already owned brings in premium, and assignment at 46 would be an acceptable exit. Selling puts at 46 creates a new obligation to buy shares at a price above the market. Buying calls costs money and benefits only if the stock rises. Buying puts costs money and protects against a decline the customer does not expect.

A customer is moderately bullish on a stock at 48, expects it to approach 55 within three months, and wants to reduce the cost of the position while limiting the maximum loss to the net debit. Which strategy fits?

• a.Buy the 50 call and sell the 50 put
• b.Buy the 50 call and sell the 55 call✓
• c.Buy the 50 call and buy the 45 put
• d.Sell the 50 call and buy the 55 call

A bull call spread buys the lower strike and sells the higher strike. The sale reduces the cost, the debit is the most that can be lost, and the gain is capped at the width less the debit. Selling the lower strike and buying the higher is a bear call spread. Buying a call and selling a put at the same strike is cheap but exposes the customer to a large loss if the stock falls. Buying a call and a put adds cost and profits mainly from a large move in either direction.

A customer expects a large move in a stock now at 70 after an earnings announcement but cannot predict the direction. The customer wants a position that costs less than buying a straddle at 70. Which strategy fits?

• a.Buy the 65 call and buy the 75 put
• b.Buy the 75 call and buy the 65 put✓
• c.Buy the 70 call and buy the 70 put
• d.Sell the 75 call and sell the 65 put

A long strangle buys an out-of-the-money call and an out-of-the-money put, so it costs less than the at-the-money straddle but needs a larger move to profit. The straddle costs more by definition. Selling the same two options profits if the stock stays quiet, the opposite of the customer's view. Buying the 65 call and 75 put buys two in-the-money options, which costs more than the straddle.

A customer wants to buy 300 shares of a stock at 40 and would like to be paid while waiting. The stock now trades at 44, and the customer holds cash for the purchase. Which strategy fits?

• a.Sell 3 calls with a strike of 44
• b.Sell 3 puts with a strike of 40✓
• c.Buy 3 puts with a strike of 40
• d.Buy 3 calls with a strike of 44

Selling puts at 40 collects premium now, and if the stock falls to 40 and the puts are assigned the customer buys at the desired price, with the cash already on hand. Buying puts pays a premium for protection the customer does not need. Selling calls without owning the stock creates a large risk. Buying calls pays a premium to speculate on a rise instead of buying at 40.

A customer owns 1,000 shares bought at 30 and now at 45. The customer wants to protect the gain over six months with little or no out-of-pocket premium and will accept a cap on further gains. Which strategy fits?

• a.Sell ten 42 puts and sell ten 50 calls
• b.Sell ten 42 puts and buy ten 50 calls
• c.Buy ten 42 puts and buy ten 50 calls
• d.Buy ten 42 puts and sell ten 50 calls✓

A collar combines a long put, which sets a floor, with a short call, which caps the gain; the call premium offsets the put premium. Buying both options costs two premiums and leaves the upside open, so it is not a cap. Selling both options adds obligations on top of a long stock position and removes protection. Selling the put and buying the call speculates on a rise and gives no downside protection.

Corpyx Industries' charter authorizes 5,000,000 shares. The company has issued 3,200,000 shares to date and has since repurchased 450,000 of them, which it holds as treasury stock. How many shares are outstanding?

• a.2,750,000 shares, the issued total less the treasury shares✓
• b.4,550,000 shares, the authorized total less the treasury shares
• c.3,200,000 shares, since treasury shares still count as outstanding
• d.3,650,000 shares, the issued total plus the treasury shares

Outstanding shares are those issued and still held by the public: 3,200,000 issued minus 450,000 in the treasury leaves 2,750,000. Treasury shares are issued but not outstanding, so counting all 3,200,000 is wrong. Subtracting the treasury shares from the 5,000,000 authorized mixes up authorized and issued stock. Adding the treasury shares to the issued total moves them in the wrong direction.

Dunmore Logistics reports net income of $18.6 million for the year. It paid $2.4 million in dividends on its preferred stock and had 6,000,000 common shares outstanding throughout the year. What are its earnings per common share?

• a.$2.70, found after deducting the preferred dividends✓
• b.$3.50, found by adding the preferred dividends to net income
• c.$3.10, found by dividing the full net income by the shares
• d.$2.30, found by deducting the preferred dividends twice

Earnings per common share are net income less preferred dividends, divided by common shares: ($18.6 million - $2.4 million) / 6,000,000 = $2.70. Dividing the full $18.6 million gives $3.10, which leaves the preferred holders' claim in the common holders' earnings. Adding the preferred dividends to net income gives $3.50, which moves them the wrong way. Taking the $2.4 million out twice gives $2.30.

Pelham Tools has 8,000,000 common shares outstanding and net income of $20,000,000, expected to stay the same next year. If the company repurchases 1,000,000 of its shares in the open market, what will its earnings per share be afterward?

• a.About $2.86, because fewer shares divide the same earnings✓
• b.$2.50, because the buyback leaves earnings per share unchanged
• c.About $3.33, because the repurchased shares are subtracted twice
• d.About $2.22, because the repurchased shares are added to the count

After the repurchase 7,000,000 shares are outstanding, so earnings per share are $20,000,000 / 7,000,000 = about $2.86, up from $2.50. A buyback shrinks the share count while earnings are unchanged, so earnings per share rise. Leaving it at $2.50 ignores the smaller share count. Dividing by 9,000,000 adds the repurchased shares instead of removing them. Dividing by 6,000,000 removes them twice.

A customer owns 300 shares of Alvera Corp. at $90 per share. The company declares a 3-for-2 stock split. Disregarding other market moves, what does the customer hold afterward?

• a.450 shares at about $135, worth $60,750 in total
• b.450 shares at about $60, worth $27,000 in total✓
• c.200 shares at about $60, worth $12,000 in total
• d.200 shares at about $135, worth $27,000 in total

A 3-for-2 split gives three new shares for every two held: 300 x 3/2 = 450 shares. The price adjusts by the inverse, $90 x 2/3 = $60, so the position stays worth $27,000. Multiplying the price by 3/2 as well would inflate the value, and that is not what a split does. A holding of 200 shares at $135 describes a 2-for-3 reverse split. Cutting the shares to 200 while the price falls would destroy value.

A customer owns 2,000 shares of Wexton Energy trading at $40, a position worth $80,000. The company pays a 5% stock dividend, which leaves the company's total value unchanged. What does the customer own afterward?

• a.2,100 shares worth about $80,000 in total✓
• b.2,100 shares worth about $76,000 after the payout
• c.2,000 shares worth about $80,000 plus $4,000 cash
• d.2,100 shares worth about $84,000 at the old price

A 5% stock dividend adds 5% more shares: 2,000 x 1.05 = 2,100. Because the company's value is unchanged, the price drops to about $38.10 and the position is still worth about $80,000. Valuing 2,100 shares at the old $40 price treats the dividend as new wealth. A stock dividend pays no cash, so the $4,000 cash answer confuses it with a cash dividend. A value of $76,000 treats the dividend as a loss, but the holder's total stake is unchanged.

Brannock Corp. elects four directors at its annual meeting, and its charter provides for cumulative voting. A shareholder owns 300 shares. What is the largest number of votes that shareholder can cast for a single candidate?

• a.1,200 votes, by putting every vote on one candidate✓
• b.900 votes, because one seat must be left empty
• c.75 votes, with the 300 shares split among four seats
• d.300 votes, the same as under statutory voting

Cumulative voting gives each share one vote per open seat: 300 x 4 = 1,200 votes, and the holder may put all of them on one candidate. Under statutory voting a holder can cast at most 300 votes for any one candidate. Nothing requires a seat to be left empty, so 900 is wrong. Dividing the shares among the seats gives 75, which is not how votes are counted.

Halsey Corp.'s charter grants shareholders preemptive rights. It has 2,500,000 shares outstanding and plans to sell 500,000 new shares. How many of the new shares may a holder of 50,000 shares buy to keep the same percentage ownership?

• a.10,000 shares, which holds the stake at 2%✓
• b.5,000 shares, from a mistaken 1% stake
• c.50,000 shares, the number already held
• d.8,333 shares, from the post-offering count

The holder owns 50,000 / 2,500,000 = 2% of the company. A 2% share of the 500,000 new shares is 10,000, and 60,000 of 3,000,000 shares is still 2%. Using the post-offering count of 3,000,000 gives 1.67% and 8,333 shares, which would leave the holder diluted. Buying 50,000 shares would raise the stake to 3.3%. A 1% stake is not the holder's percentage.

Which statement about a corporation's treasury stock is accurate?

• a.It is outstanding and has a vote, but it receives no dividends
• b.It is authorized but unissued, and it is counted in earnings per share
• c.It is issued but not outstanding, with no vote and no dividends✓
• d.It is outstanding and receives dividends, but it has no right to vote

Treasury stock was issued and later reacquired by the company. Because it is no longer held by outside investors, it is not outstanding: it has no vote, receives no dividends and is left out of earnings per share. Describing it as outstanding with only one of those rights misreads its status. Authorized but unissued shares are a different category, and they are not counted in earnings per share either.

A corporation liquidates. After creditors and bondholders are paid in full, $4,000,000 remains. The company has 100,000 shares of preferred stock with a $25 liquidation value and 1,000,000 shares of common stock. How much does each common share receive?

• a.$1.50 per share, after the preferred stock is paid✓
• b.$4.00 per share, as if the preferred did not exist
• c.$3.64 per share, treating preferred like common shares
• d.$2.50 per share, with the preferred paid last

Preferred stockholders rank ahead of common holders: 100,000 x $25 = $2,500,000 goes to them first, leaving $1,500,000 for 1,000,000 common shares, or $1.50 each. Spreading $4,000,000 over the common alone gives $4.00 and ignores the preferred claim. Dividing it over 1,100,000 shares gives $3.64 and treats the preferred as common. Paying the common first reverses the priority, since common holders are last in line.

Torrance Utilities has 6% cumulative preferred stock with a $50 par value. The board skipped the preferred dividend for the last two years and now wants to pay a common dividend for the current year. How much per preferred share must be paid first?

• a.About $9.55, because unpaid dividends earn interest
• b.$3, covering this year's dividend but no arrears
• c.$6, covering the two missed years but not this year
• d.$9, covering the two missed years and this year✓

The annual dividend is 6% x $50 = $3. Cumulative preferred holders must receive all dividends in arrears plus the current one before any common dividend: 3 x $3 = $9. Paying $3 skips the arrears, and $6 skips the current year. Arrears do not earn interest, so $9.55 is wrong.

How does participating preferred stock differ from straight preferred stock?

• a.It gives the holder the same vote as common holders on every director
• b.It lets the holder exchange the shares for common stock at a set ratio
• c.It can receive an extra dividend above its stated rate if the terms allow✓
• d.It lets the issuer retire the shares at a stated price after a set date

Participating preferred stock pays its stated dividend and may share in additional distributions, as its terms provide, when earnings or common dividends reach a stated level. The right to exchange for common stock belongs to convertible preferred. The issuer's right to retire shares at a set price belongs to callable preferred. Preferred stock generally does not carry the same voting rights as common stock.

A $100 par convertible preferred stock can be converted into 4 shares of common stock. The common stock is trading at $27. At what price is the preferred stock at parity with the common?

• a.About $3.70, par over the common price
• b.$27, the price of a single common share
• c.$108, the value of 4 shares at $27 each✓
• d.$100, the par value of the preferred

Parity is the number of common shares received multiplied by the common price: 4 x $27 = $108. Par value of $100 does not set the conversion value. Using one common share's price ignores the ratio of four shares. Dividing par by the common price gives about 3.7, which is not a price at all.

An investor bought a 6.5% callable preferred stock at par. Market interest rates then fall sharply and the stock trades above its call price. What is the main risk to this investor?

• a.The dividend will be reset lower at the next scheduled rate reset date
• b.The market price will fall even further as interest rates keep falling
• c.The issuer may convert the shares into common stock at its own option
• d.The issuer may call the stock, forcing reinvestment at lower rates✓

When rates fall, issuers can retire high-dividend preferred stock and refinance at lower cost, so the holder gets the call price back and must reinvest at lower yields. Prices of fixed-rate preferred stock rise, not fall, when rates fall. A reset applies to adjustable-rate preferred stock, not a fixed 6.5% issue. The issuer has no right to force conversion of straight callable preferred stock into common.

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