FINRA Series 7 — All Questions

A common stockholder in a corporation is generally entitled to which of the following rights?

• a.The right to vote on major corporate matters such as the election of the board of directors✓
• b.A fixed dividend paid before any distribution to bondholders
• c.A guaranteed return of principal at a stated maturity date
• d.A senior claim on assets ahead of secured creditors in a liquidation

Common stock carries voting rights, typically including election of directors and approval of major corporate actions. Dividends on common stock are never guaranteed, and common holders stand last in the liquidation priority, behind creditors and preferred holders.Securities Exchange Act of 1934

An investor owns 100 shares of a company that declares a 2-for-1 forward stock split. After the split, the investor will own:

• a.200 shares at half the pre-split price✓
• b.200 shares at the same pre-split price
• c.100 shares at the same price
• d.50 shares at twice the pre-split price

A 2-for-1 forward split doubles the number of shares while halving the per-share price, leaving total market value unchanged. The investor now holds 200 shares, each worth half of the prior price.

Cumulative preferred stock differs from straight (noncumulative) preferred stock in that cumulative preferred:

• a.Requires that any skipped dividends accumulate and be paid before common dividends resume✓
• b.Can be converted into common stock at the holder's option
• c.Pays a dividend that increases automatically each year
• d.Carries full voting rights equal to common shares

With cumulative preferred, dividends that are missed accumulate as arrears and must be paid in full before the corporation may pay any dividend to common shareholders. Straight preferred loses skipped dividends permanently.

An American Depositary Receipt (ADR) is best described as:

• a.A U.S. government-guaranteed foreign bond
• b.A negotiable receipt representing ownership of shares in a foreign company, trading in U.S. markets✓
• c.A derivative contract on a foreign currency
• d.A mutual fund limited to emerging market equities

An ADR is a negotiable certificate issued by a U.S. depositary bank representing a specified number of shares in a foreign corporation, allowing the shares to trade in U.S. dollars on U.S. markets. ADR holders face currency risk and generally lack full voting rights.

A corporate bond with a 6% coupon is currently trading at a price of 95 (a discount). Compared with the coupon rate, the bond's current yield and yield to maturity will be:

• a.Both equal to the coupon
• b.Both lower than the coupon
• c.Both higher than the coupon✓
• d.Current yield lower, yield to maturity higher

When a bond trades at a discount, its current yield and yield to maturity both exceed the coupon rate, and the yield to maturity is the highest of the three measures because it also captures the gain from par redemption. The ordering at a discount is coupon < current yield < YTM.

An investor buys a $1,000 par bond with a 5% coupon at a price of 80. What is the current yield?

• a.4.00%
• b.8.00%
• c.5.00%
• d.6.25%✓

Current yield equals annual coupon income divided by market price. The annual coupon is $50, and the market price is $800 (80% of par), so $50 / $800 = 6.25%.

Which statement about the relationship between bond prices and interest rates is correct?

• a.Bond prices are unaffected by changes in interest rates
• b.Bond prices and interest rates move in the same direction
• c.Only long-term bonds are affected by rate changes; short-term bonds are not
• d.When market interest rates rise, existing bond prices fall✓

Bond prices and market interest rates move inversely. When prevailing rates rise, the fixed coupons of existing bonds become less attractive, so their prices fall; when rates fall, existing bond prices rise. Longer maturities are more sensitive, but all fixed-rate bonds are affected.

Interest paid on general obligation municipal bonds to a resident investor is generally:

• a.Fully taxable at the federal, state, and local levels
• b.Taxed as a long-term capital gain
• c.Exempt from federal income tax and often exempt from state tax for in-state residents✓
• d.Subject only to federal tax but exempt from all state tax nationwide

Interest on municipal bonds is generally exempt from federal income tax, and is typically also exempt from state and local tax for residents of the issuing state (the 'triple tax-exempt' feature for in-state holders). This tax treatment is why municipal yields are compared on a taxable-equivalent basis.

An investor in the 32% federal tax bracket is comparing a 4% municipal bond with a taxable corporate bond. What taxable-equivalent yield must the corporate bond offer to match the municipal?

• a.4.00%
• b.2.72%
• c.5.28%
• d.5.88%✓

Taxable-equivalent yield equals the municipal yield divided by (1 minus the tax rate): 4% / (1 - 0.32) = 4% / 0.68 = 5.88%. A taxable bond must yield about 5.88% to give the same after-tax return as the 4% municipal.

A general obligation (GO) municipal bond is backed primarily by:

• a.Insurance from the FDIC
• b.An explicit full-faith-and-credit guarantee provided by the federal government
• c.The full faith, credit, and taxing power of the issuing municipality✓
• d.The net revenue generated by a specific project such as a toll road or toll bridge

A GO bond is secured by the issuer's full faith and credit, including its ability to levy taxes to service the debt. This contrasts with a revenue bond, which is backed only by revenues from a specific facility or project.

A revenue bond issued to finance a municipal water and sewer system is repaid from:

• a.Ad valorem property taxes levied on all real estate within the municipality
• b.Federal grants only
• c.User charges and fees collected from the facility's operations✓
• d.General sales tax revenue collected on retail transactions across the state

Revenue bonds are serviced from the income generated by the specific facility or enterprise they finance, such as user fees from a water and sewer system. Because they lack the issuer's general taxing power backing, analysts examine the project's projected revenues and any debt service coverage requirements.

U.S. Treasury bills are best characterized as:

• a.Securities that pay semiannual interest and mature in 30 years
• b.Short-term securities issued at a discount and maturing at par, with no periodic coupon✓
• c.Long-term coupon-bearing bonds
• d.Bonds backed by specific federal project revenues

Treasury bills are short-term obligations (one year or less) issued at a discount to face value and redeemed at par at maturity; the investor's return is the difference between purchase price and par. They pay no periodic coupon, unlike Treasury notes and bonds.

Interest income from U.S. Treasury securities is:

• a.Completely exempt from federal income tax but fully taxable at the state and local level
• b.Taxable only in the event that the securities are sold before their stated maturity date
• c.Taxable at the federal level but exempt from state and local income tax✓
• d.Fully exempt from all income taxes

Interest on U.S. Treasury securities is subject to federal income tax but is exempt from state and local income taxes. This is the reverse of municipal bonds, whose interest is generally federal-tax-exempt.

A convertible bond gives the holder the right to:

• a.Exchange the bond for a fixed number of common shares of the issuer✓
• b.Demand early repayment of the full principal at any time at par value on request
• c.Receive a variable coupon rate that is directly tied to a broad common stock index
• d.Vote in the issuer's shareholder meetings

A convertible bond can be exchanged, at the holder's option, for a predetermined number of the issuer's common shares based on the conversion ratio. This gives upside participation in the stock while providing bond income, though convertibles typically carry lower coupons in exchange for that feature.

A convertible bond has a par value of $1,000 and a conversion price of $40. How many shares of common stock will the holder receive upon conversion?

• a.25 shares✓
• b.40 shares
• c.4 shares
• d.250 shares

The conversion ratio equals par value divided by the conversion price: $1,000 / $40 = 25 shares. Each bond can be exchanged for 25 shares of the issuer's common stock.

Using a conversion ratio of 25 shares per bond, at what common stock price is a convertible bond trading at parity with a bond market price of $1,050?

• a.$25.00
• b.$42.00✓
• c.$40.00
• d.$26.25

Parity price of the stock equals the bond's market price divided by the conversion ratio: $1,050 / 25 = $42.00. If the stock trades above $42, converting and selling shares would be worth more than the bond's current market price.

A call feature on a corporate bond primarily benefits:

• a.The underwriter, who earns extra commission
• b.The issuer, who can redeem the bonds early, typically when interest rates fall✓
• c.The bondholder, who is thereby guaranteed a permanently higher yield to maturity for life
• d.The rating agency

A call provision lets the issuer redeem bonds before maturity, usually at a small premium. Issuers exercise calls when rates have fallen so they can refinance at lower cost, which exposes bondholders to reinvestment risk. To compensate, callable bonds generally offer higher yields.

Under the Investment Company Act of 1940, an open-end investment company (mutual fund):

• a.Issues a fixed number of shares that trade on an exchange at supply-and-demand-driven prices
• b.Is prohibited from charging any fees
• c.Continuously offers new shares and redeems outstanding shares at net asset value✓
• d.Cannot invest in equity securities

An open-end fund continuously issues new redeemable shares and redeems existing shares at net asset value (NAV), calculated at least daily. This contrasts with a closed-end fund, which issues a fixed number of shares that then trade in the secondary market at prices set by supply and demand.Investment Company Act of 1940

The public offering price (POP) of a mutual fund share with a front-end sales load is calculated as:

• a.Net asset value minus the sales charge
• b.A fixed price set by FINRA
• c.Net asset value plus the sales charge✓
• d.The market price set by exchange trading

For a front-end load fund, the public offering price equals the net asset value per share plus the sales charge. Investors buy at the POP and, absent a load, redeem at NAV. Closed-end funds, by contrast, trade at market prices that may be above or below NAV.Investment Company Act of 1940

A mutual fund share has a net asset value (NAV) of $19.05 and a maximum sales charge of 5%. What is the public offering price?

• a.$20.00
• b.$19.05
• c.$20.05✓
• d.$18.10

When the sales charge is a percentage of the POP, POP = NAV / (1 - sales charge rate) = $19.05 / (1 - 0.05) = $19.05 / 0.95 = $20.05. The sales charge is $1.00, which is 5% of the $20.05 offering price.Investment Company Act of 1940

A breakpoint in a front-end load mutual fund refers to:

• a.The maximum possible loss the fund could ever experience in a market downturn
• b.A reduced sales charge available for larger investment amounts✓
• c.The date the fund pays its annual dividend
• d.A point at which the fund permanently stops accepting any new investors at all

Breakpoints are investment thresholds at which the sales charge percentage decreases; larger purchases qualify for lower loads. A letter of intent or rights of accumulation may let an investor reach a breakpoint over time. Recommending purchases just below a breakpoint to earn a higher commission is a prohibited practice.

An exchange-traded fund (ETF) differs from a traditional open-end mutual fund primarily because an ETF:

• a.Can only be bought once per day at the closing NAV
• b.Is guaranteed against loss by the sponsor
• c.Cannot hold a diversified portfolio
• d.Trades intraday on an exchange at market-determined prices✓

ETF shares trade throughout the day on an exchange like a stock, so investors transact at intraday market prices that may differ slightly from NAV, and can use limit or stop orders. Traditional mutual fund shares are priced once daily at NAV after the market close (forward pricing).

A unit investment trust (UIT) is characterized by:

• a.An actively managed investment portfolio overseen by a formal board of directors
• b.A firm guarantee of the full return of principal at the trust's stated maturity date
• c.A fixed, generally unmanaged portfolio held until a set termination date✓
• d.A perpetual life with continuous trading by managers

A UIT holds a fixed portfolio of securities that is not actively traded and has a predetermined termination date. It has no board of directors or investment adviser making ongoing decisions, distinguishing it from managed open-end and closed-end companies under the Investment Company Act of 1940.Investment Company Act of 1940

A variable annuity's separate account value during the accumulation phase depends on:

• a.The investment performance of the subaccounts selected by the contract owner✓
• b.The consumer price index only
• c.The prime interest rate
• d.A fixed minimum rate of return that is fully guaranteed for life by the issuing insurer

In a variable annuity, premiums are allocated to separate account subaccounts (similar to mutual funds), and the account value fluctuates with the investment performance of those subaccounts. The investor bears the investment risk, unlike a fixed annuity where the insurer guarantees a set rate.

A fixed annuity exposes the contract holder primarily to which risk?

• a.Market risk arising from equity subaccounts whose value tracks the stock market's performance
• b.Currency exchange risk
• c.Liquidity risk equivalent to owning common stock
• d.Purchasing power (inflation) risk, because payments are fixed in dollar terms✓

A fixed annuity guarantees a set payment, so its main drawback is purchasing power risk: over time inflation erodes the real value of level payments. Variable annuities aim to counter inflation risk by investing in securities, but they introduce market risk instead.

A real estate investment trust (REIT) that qualifies for favorable tax treatment must generally:

• a.Be organized as a limited partnership
• b.Guarantee a fixed dividend to investors
• c.Invest only in residential mortgages
• d.Distribute at least 90% of its taxable income to shareholders✓

To qualify as a REIT and avoid corporate-level taxation on distributed income, the trust must distribute at least 90% of its taxable income to shareholders and meet asset and income tests concentrated in real estate. REIT dividends are then generally taxed to shareholders, and REITs are not flow-through vehicles for passing losses.

A key characteristic of a direct participation program (DPP), such as a limited partnership, is that:

• a.It is taxed as a corporation at the entity level
• b.Units are highly liquid and trade actively on exchanges
• c.Investors have no liability beyond guarantees they sign
• d.Income, gains, losses, and deductions flow through directly to the individual investors✓

A DPP is a flow-through (pass-through) entity: tax items pass directly to the limited partners' individual returns rather than being taxed at the entity level. Limited partners have limited liability but DPP interests are generally illiquid, and losses are typically passive.

An investor buys 1 XYZ call option with a strike price of 50 for a premium of 3. What is the maximum loss on this long call position?

• a.$4,700
• b.Unlimited
• c.$300✓
• d.$5,000

The buyer of a call can lose no more than the premium paid. Here the premium is 3 points times the 100-share multiplier, or $300. If the stock stays at or below 50, the option expires worthless and the $300 premium is the entire loss.

An investor buys 1 XYZ call with a 50 strike for a premium of 3. What is the breakeven point at expiration?

• a.$50
• b.$56
• c.$53✓
• d.$47

For a long call, breakeven equals the strike price plus the premium paid: 50 + 3 = $53. The stock must rise above $53 for the position to be profitable, because the buyer must recover the premium before earning a net gain.

An investor writes (sells) 1 uncovered XYZ call with a 50 strike for a premium of 3. The maximum potential loss is:

• a.Limited to $4,700
• b.Limited to $300
• c.Unlimited✓
• d.Limited to $5,000

An uncovered (naked) call writer faces theoretically unlimited loss because there is no ceiling on how high the underlying stock can rise, and the writer must deliver shares at the strike no matter the market price. The premium received only partially offsets this exposure.

An investor buys 1 XYZ put with a 40 strike for a premium of 2. What is the maximum gain on this long put?

• a.$3,800✓
• b.Unlimited
• c.$4,000
• d.$200

A long put profits as the stock falls, but the stock can fall no lower than zero. Maximum gain equals the strike minus the premium, times 100: (40 - 2) x 100 = $3,800, achieved if the stock goes to zero and the holder buys at market and exercises the put to sell at 40.

An investor buys 1 XYZ put with a 40 strike for a premium of 2. What is the breakeven point at expiration?

• a.$42
• b.$40
• c.$44
• d.$38✓

For a long put, breakeven equals the strike price minus the premium paid: 40 - 2 = $38. The stock must fall below $38 for the put buyer to earn a net profit after recovering the premium.

An investor who is bullish on a stock but wants to limit the cost of the position could establish a:

• a.Debit call spread (buy a lower-strike call, sell a higher-strike call)✓
• b.Long straddle
• c.A bearish credit call spread that is established for a net premium credit received
• d.An uncovered short put position that is established with no other offsetting trade

A debit call spread (bull call spread) involves buying a call and selling a higher-strike call, producing a net debit. It profits from a moderate rise in the underlying while capping both cost and maximum gain, making it a lower-cost bullish strategy than buying a call outright.

An investor buys 1 XYZ 50 call for 5 and sells 1 XYZ 60 call for 2. What is the maximum gain on this spread?

• a.$700✓
• b.$300
• c.Unlimited
• d.$1,000

This is a debit call spread with a net debit of 3 points ($5 paid minus $2 received). Maximum gain equals the difference in strikes minus the net debit: (60 - 50) - 3 = 7 points, or $700, realized if the stock is at or above 60 at expiration.

Using the same spread (buy 1 XYZ 50 call for 5, sell 1 XYZ 60 call for 2), what is the maximum loss?

• a.$1,000
• b.$300✓
• c.Unlimited
• d.$700

The maximum loss on a debit spread is the net premium paid. Here the net debit is 3 points (5 - 2), or $300, which is lost if both calls expire worthless with the stock at or below 50.

A long straddle consists of:

• a.Buying a call and buying a put with the same strike and expiration✓
• b.Buying a call option and selling a put option with the same identical strike price
• c.Selling both a call and a put that share the same strike and expiration month
• d.Buying two calls at different strikes

A long straddle is the purchase of both a call and a put on the same underlying with identical strike and expiration. The buyer profits from a large price move in either direction and is said to be buying volatility; the maximum loss is the total premium paid.

An investor buys 1 XYZ 50 call for 4 and 1 XYZ 50 put for 3 (a long straddle). What are the two breakeven points?

• a.$57 and $43✓
• b.$54 and $46
• c.$50 and $50
• d.$61 and $39

For a long straddle, the total premium is 7 points (4 + 3). The upside breakeven is the strike plus total premium (50 + 7 = 57) and the downside breakeven is the strike minus total premium (50 - 7 = 43). The stock must move outside 43 to 57 for a net profit.

An investor owns 100 shares of XYZ and sells 1 XYZ call against the position. This strategy is known as:

• a.A covered call✓
• b.A protective put
• c.A long straddle
• d.A naked call

Selling a call against stock already owned is a covered call. It generates premium income and provides limited downside cushion, but it caps the upside because the shares may be called away if the stock rises above the strike. Because the writer owns the underlying shares, the call is 'covered' rather than naked.

An investor who owns 100 shares of a stock and is worried about a near-term decline could best protect the position by:

• a.Selling a covered call
• b.Buying a protective put✓
• c.Writing a naked put
• d.Selling the stock short

Buying a put while holding the stock (a protective put) creates a floor: no matter how far the stock falls, the holder can sell at the put's strike. The cost is the premium paid, which acts like insurance and reduces the position's net return if the stock rises.

An investor buys 100 shares of XYZ at $48 and buys 1 XYZ 45 put for 2 (a protective put). What is the maximum loss?

• a.$500✓
• b.$300
• c.$4,800
• d.$200

With a protective put, the maximum loss is the stock purchase price minus the put strike, plus the premium paid, times 100: (48 - 45 + 2) x 100 = $500. Below the 45 strike, the put lets the investor sell at 45, capping the loss.

The Options Clearing Corporation (OCC) functions as:

• a.A rating agency for options
• b.A broker-dealer that recommends option strategies
• c.A federal agency that taxes option gains
• d.The issuer and guarantor of listed options contracts✓

The OCC issues all listed options and acts as the central counterparty, guaranteeing performance so that buyers and sellers do not rely on each other's creditworthiness. It also standardizes contract terms and processes assignments, which supports a liquid secondary options market.

Systematic risk refers to:

• a.The risk that is unique to one single company or industry and can be reduced or diversified away entirely
• b.The specific risk that an individual corporate or municipal bond issuer will default on its obligations
• c.Market-wide risk that affects nearly all securities and cannot be eliminated through diversification✓
• d.The risk of buying at the wrong time of day

Systematic (market) risk affects the entire market or broad asset classes and cannot be diversified away; examples include recessions and broad interest rate moves. Unsystematic (nonsystematic) risk is company- or industry-specific and can be reduced through diversification.

Reinvestment risk is most significant for an investor who:

• a.Holds all of their money in a non-interest-bearing bank checking account for many years
• b.Owns high-coupon bonds and must reinvest the periodic interest at prevailing rates✓
• c.Owns common stock paying no dividend
• d.Holds a zero-coupon bond to maturity

Reinvestment risk is the danger that periodic cash flows (coupons or called principal) must be reinvested at lower prevailing rates, reducing overall return. High-coupon and callable bonds are especially exposed. A zero-coupon bond held to maturity has no interim cash flows to reinvest, so it avoids this risk.

Credit (default) risk on a corporate bond is best assessed by reviewing:

• a.The issuer's common stock dividend payout ratio and its recent dividend history
• b.The total number of common shares the issuing corporation has outstanding
• c.The frequency with which the corporate bond pays out its stated periodic coupon
• d.The issuer's credit rating from a recognized rating agency✓

Credit risk is the possibility that the issuer fails to pay interest or principal. Independent credit ratings from recognized agencies summarize an issuer's ability to meet obligations, with investment-grade ratings indicating lower default risk than high-yield (speculative) ratings, which pay higher coupons to compensate.

A zero-coupon bond is purchased at a deep discount and:

• a.Pays a fixed amount of cash interest every month until its stated maturity date
• b.Can only ever be issued by state and local government municipalities themselves
• c.Pays no periodic interest, returning full par value at maturity✓
• d.Pays a floating coupon tied to inflation

A zero-coupon bond makes no periodic interest payments; the investor's return is the difference between the discounted purchase price and the par value received at maturity. Because there are no coupons to reinvest, zeros avoid reinvestment risk but are highly sensitive to interest rate changes.

Which of the following bonds is generally most sensitive to a given change in interest rates?

• a.A high-coupon bond maturing in two years
• b.A long-term, low-coupon (or zero-coupon) bond✓
• c.A short-term, high-coupon bond
• d.A bond maturing in 90 days

Interest rate (price) sensitivity, measured by duration, increases with longer maturities and lower coupons. A long-term, low- or zero-coupon bond has the highest duration and therefore experiences the largest price swing for a given change in market rates.

A mortgage-backed pass-through security, such as a GNMA (Ginnie Mae) certificate, passes through to investors:

• a.A guaranteed fixed redemption price regardless of prevailing market interest conditions
• b.Only monthly interest payments, with the principal returned solely at final maturity
• c.Corporate dividends
• d.Monthly payments of both principal and interest from a pool of mortgages✓

A mortgage pass-through security distributes to investors the monthly principal and interest payments collected from an underlying pool of mortgages. Because homeowners can prepay their loans, these securities carry prepayment risk, which accelerates return of principal when rates fall.

Prepayment risk in mortgage-backed securities means that:

• a.Interest rates will always rise
• b.The bonds cannot be sold before maturity
• c.The issuer will default on interest payments
• d.When interest rates fall, homeowners refinance and return principal sooner than expected✓

Prepayment risk arises because falling interest rates prompt homeowners to refinance, returning principal to investors earlier than expected. Investors then must reinvest that principal at the new, lower rates, which is a form of reinvestment risk specific to mortgage-backed securities.

A warrant differs from a right in that a warrant:

• a.Is always issued and priced at a level below the current market price of the underlying stock
• b.Must be exercised within days of issuance
• c.Pays a fixed dividend
• d.Typically has a long life and an exercise price initially above the market price✓

A warrant is a long-term instrument (often years) to buy stock at a set price, usually issued with an exercise price above the current market. A right (preemptive right) is short-term, usually lasting weeks, and lets existing shareholders buy new shares at a subscription price below market.

A money market instrument such as commercial paper is best described as:

• a.A municipal general obligation bond
• b.A short-term, unsecured corporate debt obligation, typically maturing in 270 days or less✓
• c.A federally insured deposit
• d.A long-term equity security

Commercial paper is short-term, unsecured corporate debt issued at a discount, usually with maturities of 270 days or less so that it is exempt from full registration under the Securities Act of 1933. It is a money market instrument used by corporations for short-term financing.

An investor sells 1 XYZ 30 put for a premium of 2. What is the maximum gain and the breakeven point?

• a.Maximum gain unlimited; breakeven $32
• b.Maximum gain $200; breakeven $28✓
• c.Maximum gain $2,800; breakeven $28
• d.Maximum gain $200; breakeven $32

A short (written) put's maximum gain is the premium received, $200, kept if the stock stays at or above the 30 strike. Breakeven is the strike minus the premium, 30 - 2 = $28, and the maximum loss occurs if the stock falls toward zero.

Preferred stock is generally considered more sensitive to interest rate changes than common stock because preferred:

• a.Represents only a residual ownership claim on the issuer's assets after creditors are paid
• b.Pays a fixed dividend, causing it to behave like a fixed-income security✓
• c.Has voting rights
• d.Pays cash dividends that automatically grow along with the issuing company's earnings

Because most preferred stock pays a fixed dividend, its price moves inversely with interest rates much like a bond. When rates rise, the fixed dividend becomes less attractive and preferred prices fall. Common stock dividends can vary with earnings, so common is less directly tied to rate movements.

A collateralized mortgage obligation (CMO) is structured into tranches primarily to:

• a.Redistribute prepayment and maturity risk among classes with different priorities✓
• b.Guarantee that investors in every single tranche can never lose any principal under any scenario
• c.Convert debt into equity
• d.Eliminate all interest rate risk

A CMO divides the cash flows from a pool of mortgages into tranches that receive principal in a set order, redistributing prepayment and average-life risk. Earlier tranches receive principal first and have shorter, more predictable lives, while later tranches bear more extension or prepayment uncertainty.

An investor establishes a short straddle by selling 1 XYZ 50 call for 3 and selling 1 XYZ 50 put for 2. The maximum gain is:

• a.$300
• b.Unlimited
• c.$500, if the stock closes exactly at 50 at expiration✓
• d.$5,000

A short straddle's maximum gain is the total premium received, 3 + 2 = 5 points, or $500, achieved if the stock closes exactly at the 50 strike so that both options expire worthless. The seller profits from low volatility but faces large losses on a big move in either direction.

An accredited or sophisticated investor is often required for a hedge fund because hedge funds:

• a.Must distribute all income annually by law
• b.Are typically sold as private placements with limited liquidity, leverage, and higher risk✓
• c.Are the same as money market funds
• d.Are guaranteed by the federal government

Hedge funds are generally offered as private placements to accredited or qualified investors, use strategies involving leverage, derivatives, and illiquid holdings, and impose lock-up and redemption restrictions. Their higher risk and limited regulation make suitability and investor qualification especially important.

Accrued interest on municipal and corporate bonds is calculated using which day-count convention?

• a.Actual days in the period over actual days in the year (actual/actual)
• b.A 30-day month and a 360-day year (30/360)✓
• c.Actual days over a 360-day year (actual/360)
• d.Actual days over a 365-day year (actual/365)

Municipal and corporate bonds accrue interest on a 30/360 basis: every month is treated as 30 days and the year as 360 days. U.S. Treasury notes and bonds use actual/actual, and money-market instruments use actual/360. Trap: actual/actual (choice a) is the government-bond method, not the corporate/muni method.MSRB Rule G-33

In analyzing a general obligation (GO) municipal bond, an analyst focuses primarily on:

• a.The revenues and debt-service coverage ratio of one single specific revenue-producing project
• b.The dividend payment history of the municipality
• c.The credit rating of the U.S. federal government
• d.The issuer's assessed property values, debt per capita, and tax collection record✓

GO bonds are backed by the issuer's full faith, credit, and taxing power, so analysts examine the tax base (assessed valuations), debt per capita, debt-to-assessed-value ratios, and tax collection rates. Revenue and debt-service-coverage analysis (choice a) applies to revenue bonds, which are backed by a project's income rather than taxes.

Under the more common 'net revenue pledge' on a municipal revenue bond, bondholders are paid:

• a.Before the facility's operating and maintenance expenses are paid
• b.Only from statewide ad valorem property taxes
• c.After operating and maintenance expenses, out of net revenues✓
• d.Only if the state legislature votes to appropriate funds

Under a net revenue pledge, the flow of funds pays operation and maintenance (O&M) expenses first, then services the debt from net revenues. A gross revenue pledge (rare) pays debt service before O&M. Choice d describes a moral obligation/appropriation bond, and choice a reverses the standard net-revenue flow of funds.

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

• a.A registered open-end investment company (mutual fund)
• b.A municipal fund security regulated under MSRB rules✓
• c.A direct participation program
• d.A federal agency security

529 savings plans are municipal fund securities and are sold under MSRB rules using an official statement rather than a prospectus. Although the plan invests in mutual-fund-like portfolios, it is not itself a registered investment company. Earnings grow tax-deferred and qualified education withdrawals are federal-tax-free.MSRB

An investor buys a municipal bond in the secondary market and later sells it for more than the purchase price. The gain on the sale is:

• a.Exempt from tax, just like the bond's interest
• b.Taxed as a nondeductible gift
• c.Never taxable under any circumstances
• d.Taxable as a capital gain✓

Only the interest on municipal bonds is federally tax-exempt; a capital gain from selling a muni above cost is taxable like any other capital gain (and a market discount is generally taxed as ordinary income at sale or maturity). The trap is assuming the tax exemption covers trading gains as well as interest.

A taxable corporate bond yields 6%. For an investor in the 24% federal tax bracket, the approximate after-tax yield is:

• a.4.56%✓
• b.7.89%
• c.6.00%
• d.1.44%

After-tax yield = taxable yield x (1 - tax rate) = 6% x (1 - 0.24) = 6% x 0.76 = 4.56%. This is compared with a municipal yield to see which is better after taxes. Trap: 7.89% is the taxable-equivalent yield of a 6% muni (6% / 0.76), the reverse computation; 1.44% is just the tax portion.

An investor sells 1 XYZ 50 put for 4 and buys 1 XYZ 45 put for 1. What are the maximum gain and maximum loss?

• a.Maximum gain $200; maximum loss $300
• b.Maximum gain unlimited; maximum loss $300
• c.Maximum gain $500; maximum loss $500
• d.Maximum gain $300; maximum loss $200✓

This is a bull (credit) put spread. Net credit = 4 - 1 = 3 points = $300, the maximum gain, kept if both puts expire worthless (stock at or above 50). Maximum loss = difference in strikes minus net credit = (50 - 45) - 3 = 2 points = $200. Breakeven = higher strike minus net credit = 50 - 3 = 47. Trap: reversing the gain and loss (choice a).

An investor buys 1 XYZ 60 put and sells 1 XYZ 50 put. This position is best described as:

• a.A bullish position that profits as the stock rises
• b.A bearish debit put spread that profits as the stock falls✓
• c.A long straddle
• d.A covered call

Buying the higher-strike (60) put and selling the lower-strike (50) put is a debit put spread. Because the more valuable higher-strike put is owned, it costs a net debit and is bearish: it gains maximum value if the stock falls to or below 50. Trap: assuming any put spread is bullish; the direction depends on which strike is bought.

An investor buys 100 shares of XYZ at $48 and sells 1 XYZ 50 call for a premium of 2 (a covered call). What is the maximum gain?

• a.Unlimited
• b.$200
• c.$400✓
• d.$4,800

If the stock is called away at the 50 strike, the gain equals the stock appreciation plus the premium: (50 - 48) + 2 = 4 points = $400. Breakeven is 48 - 2 = 46. The written call caps upside at $400 no matter how high the stock climbs; 'unlimited' (choice a) would apply to owning stock alone, not to a covered call.

An investor who has sold stock short is best protected against a sharp rise in the stock's price by:

• a.Buying a put on the stock
• b.Selling a call on the stock
• c.Selling a put on the stock
• d.Buying a call on the stock✓

A short seller loses as the stock rises, with theoretically unlimited risk. Buying a call caps that risk by locking in a price to buy back (cover) the shares. A protective put hedges a long position, not a short one (the trap). Selling options brings in only limited premium and provides no protection against a large adverse move.

An XYZ 40 call trades at a premium of 6 while the stock is at 43. The option's intrinsic value and time value are:

• a.Intrinsic value $6, time value $0
• b.Intrinsic value $3, time value $3✓
• c.Intrinsic value $0, time value $6
• d.Intrinsic value $4, time value $2

A call's intrinsic value equals stock price minus strike when in the money: 43 - 40 = 3. Time value = premium minus intrinsic value = 6 - 3 = 3. The call is in the money by 3 points. Trap: treating the entire 6-point premium as intrinsic value (choice a) ignores the time value component.

A put option is 'in the money' when:

• a.The stock's market price is above the strike price
• b.The option's premium has fallen to zero
• c.The underlying stock pays no dividend
• d.The stock's market price is below the strike price✓

A put grants the right to sell at the strike, so it has intrinsic value (is in the money) when the stock trades below the strike, letting the holder sell higher than the market. A call is in the money when the stock is above the strike, which is what choice a describes: the classic buyer/seller reversal trap.

The writer (seller) of a put option is obligated to:

• a.Sell the underlying stock to the option holder at the strike price on demand
• b.Pay a periodic cash dividend directly to the holder of the put option
• c.Buy the underlying stock at the strike price if assigned✓
• d.Do nothing at all, because the writer of the put option holds only rights

A put writer sells someone the right to 'put' (sell) stock to them, so upon assignment the writer must buy the stock at the strike price. A call writer, by contrast, must sell/deliver stock. The writer receives premium but takes on an obligation, not a right; choice d reverses the buyer/seller roles.

An investor writes 1 XYZ 30 put for a premium of 2. What is the maximum possible loss?

• a.$200
• b.$2,800✓
• c.Unlimited
• d.$3,000

The worst case for a short put is the stock falling to zero: the writer must buy at 30 while the shares are worthless, losing 30 points offset by the 2-point premium = 28 points = $2,800. Trap: 'unlimited' loss applies to a naked short call, not a short put, because a stock's price cannot fall below zero.

Fundamental analysis of a common stock focuses primarily on:

• a.Chart patterns, trading volume trends, and various historical price momentum indicators
• b.The ratio of advancing to declining stocks
• c.Historical price support and resistance levels
• d.The company's financial statements, earnings, management, and economic outlook✓

Fundamental analysis estimates a security's intrinsic value from financial statements (earnings, balance sheet, cash flow), management quality, and industry and economic conditions. Chart patterns, volume, and advance/decline data (choices a, b, c) are tools of technical analysis, which studies price action rather than business fundamentals.

A technical analyst who says a stock has 'broken through resistance' means:

• a.The company reported sharply higher quarterly earnings per share and simultaneously raised its full-year guidance
• b.The price has risen above a prior ceiling where selling had capped advances, often read as bullish✓
• c.The company increased its dividend
• d.The bond's credit rating was upgraded

Resistance is a price level where selling has historically halted advances; a breakout above it is a bullish technical signal. Support is the mirror image, a floor where buying tends to emerge. Technical analysis studies price and volume, not fundamentals like earnings, dividends, or credit ratings (the distractors).

The four phases of the business cycle, in typical order, are:

• a.Trough, contraction, peak, expansion
• b.Inflation, deflation, stagflation, recovery
• c.Bull, bear, correction, rally
• d.Expansion, peak, contraction, trough✓

The business cycle moves through expansion (growth), a peak, contraction/recession (decline), and a trough (bottom), then repeats. A recession is commonly defined as two consecutive quarters of declining real GDP. Choices b and c mix in unrelated price-level or market-sentiment terms.

If the Federal Reserve sells securities through open market operations, the likely effect is to:

• a.Drain reserves from the banking system, tending to push interest rates up✓
• b.Add new reserves into the banking system, which tends to lower short-term interest rates
• c.Change federal income tax rates
• d.Directly set the level of stock prices

Open market operations are the Fed's primary tool. Selling securities removes cash (reserves) from the banking system, tightening money and tending to raise short-term rates; buying securities adds reserves and lowers rates. Taxation (choice c) is fiscal policy set by Congress, not a Fed function.

Fiscal policy, as distinguished from monetary policy, is carried out through:

• a.The Federal Reserve's open market operations
• b.Government taxing and spending decisions✓
• c.Changes to the Federal Reserve's discount rate
• d.Adjustments to bank reserve requirements

Fiscal policy is the government's use of taxation and spending to influence the economy, controlled by Congress and the President. The open market operations, discount rate, and reserve requirements in the other choices are all monetary policy tools of the Federal Reserve.

An inverted (negative) yield curve exists when:

• a.Long-term interest rates clearly exceed short-term rates all along the curve
• b.Every maturity along the yield curve happens to carry exactly the same yield
• c.Municipal bond yields broadly exceed the yields on comparable corporate bonds
• d.Short-term interest rates are higher than long-term rates✓

Normally the yield curve slopes upward, with longer maturities yielding more. An inverted curve, where short-term yields exceed long-term yields, often reflects tight monetary policy and can signal an expected slowdown. Choice a describes a normal curve and choice b a flat curve.

Losses generated by a direct participation program (limited partnership) are generally treated as:

• a.Ordinary losses deductible against salary and wages
• b.Passive losses deductible only against passive income✓
• c.Capital losses limited to $3,000 per year
• d.Nondeductible under all circumstances

Under the passive activity rules, DPP losses are passive and may offset only passive income, not earned income (salary) or portfolio income (dividends/interest). Unused passive losses carry forward and can be used when passive income arises or the interest is disposed of. Trap: they cannot shelter a client's wages (choice a).

In a limited partnership, the general partner:

• a.Has personal liability that is strictly limited to the total amount originally invested
• b.Takes no part in day-to-day management
• c.Is prohibited from making management decisions
• d.Manages the business and has unlimited personal liability for partnership debts✓

The general partner runs the partnership and bears unlimited personal liability for its debts, while limited partners are passive investors whose liability is limited to their investment (plus any recourse debt assumed). A limited partner who takes an active management role can lose that limited-liability protection.

Class A shares of a mutual fund typically feature:

• a.No sales charge and no ongoing expenses
• b.A front-end sales load with lower ongoing 12b-1 fees, often best for large, long-term investments✓
• c.A high 12b-1 fee and a contingent deferred sales charge that never declines
• d.A guaranteed minimum return

Class A shares charge a front-end load (reduced by breakpoints) but carry lower ongoing 12b-1 fees, making them cost-effective for large or long-horizon purchases. Class B shares use a declining contingent deferred sales charge, and Class C shares carry level loads with higher 12b-1 fees better suited to shorter horizons. No mutual fund guarantees a return (choice d).Investment Company Act of 1940

A mutual fund has total assets of $100 million, total liabilities of $2 million, and 4 million shares outstanding. Its net asset value (NAV) per share is:

• a.$25.00
• b.$24.00
• c.$24.50✓
• d.$25.50

NAV per share = (total assets - total liabilities) / shares outstanding = ($100M - $2M) / 4M = $98M / 4M = $24.50. Trap: $25.00 (choice a) forgets to subtract the $2M in liabilities. NAV is calculated at least once daily and mutual fund orders are priced forward at the next computed NAV.Investment Company Act of 1940

For a bond purchased at a premium that is also callable, the lowest (most conservative) yield used to price it is generally the:

• a.Yield to maturity
• b.Yield to call✓
• c.Current yield
• d.Nominal (coupon) yield

On a premium bond, yield to call is lower than yield to maturity because the premium is lost more quickly if the bond is called early. Dealers price premium callable bonds to the lower yield (yield to worst) to protect the investor. For a discount bond, the higher yield to maturity is the worst case instead.

An investor buys 1 DEF 40 call for a premium of 4. What is the maximum loss on this long call position?

• a.$400✓
• b.Unlimited
• c.$3,600
• d.$4,000

A long call buyer can lose no more than the premium paid. The premium of 4 points times the 100-share contract multiplier equals $400 (OCC standard equity contract = 100 shares). If DEF stays at or below 40, the call expires worthless and the entire loss is the $400 premium.

An investor buys 1 DEF 40 call for a premium of 4. What is the breakeven point at expiration?

• a.$40
• b.$36
• c.$4.04
• d.$44✓

For a long call, breakeven = strike price + premium paid = 40 + 4 = $44. The stock must rise above $44 before the buyer recovers the premium and earns a net profit (standard listed-option call breakeven).

An investor writes (sells) 1 uncovered GHI 45 call for a premium of 3. What are the maximum gain and the breakeven point?

• a.Maximum gain $300; breakeven $42
• b.Maximum gain $4,200; breakeven $48
• c.Maximum gain unlimited; breakeven $48
• d.Maximum gain $300; breakeven $48✓

A short call's maximum gain is the premium received, $300, kept if the stock closes at or below the 45 strike. Breakeven = strike + premium = 45 + 3 = $48. The call writer's gain is capped at the premium while the risk above breakeven grows.

An investor writes (sells) 1 uncovered GHI 45 call for a premium of 3. What is the maximum potential loss?

• a.$4,200
• b.$300
• c.Unlimited✓
• d.$4,500

An uncovered (naked) call writer faces theoretically unlimited loss because a stock's price has no ceiling, yet the writer must deliver shares at the 45 strike no matter how high the market rises. The $300 premium only partially offsets this exposure.

An investor buys 1 JKL 25 put for a premium of 1.50. What is the maximum gain on this long put?

• a.Unlimited
• b.$150
• c.$2,350✓
• d.$2,500

A long put gains as the stock falls, but the stock can fall no lower than zero. Maximum gain = (strike - premium) x 100 = (25 - 1.50) x 100 = $2,350, realized if the stock goes to zero and the holder exercises to sell at 25.

An investor buys 1 JKL 25 put for a premium of 1.50. What is the breakeven point at expiration?

• a.$23.50✓
• b.$25.00
• c.$26.50
• d.$23.85

For a long put, breakeven = strike price - premium paid = 25 - 1.50 = $23.50. The stock must fall below $23.50 for the put buyer to profit after recovering the premium.

An investor writes (sells) 1 MNO 60 put for a premium of 5. What is the maximum possible loss?

• a.$500
• b.$5,500✓
• c.$6,000
• d.Unlimited

The worst case for a short put is the stock falling to zero: the writer must buy at 60 while the shares are worthless, losing 60 points offset by the 5-point premium = 55 points = $5,500. A short put's loss is large but finite (a stock cannot fall below zero), unlike a naked short call.

An investor writes (sells) 1 MNO 60 put for a premium of 5. What are the maximum gain and the breakeven point?

• a.Maximum gain unlimited; breakeven $55
• b.Maximum gain $500; breakeven $65
• c.Maximum gain $5,500; breakeven $55
• d.Maximum gain $500; breakeven $55✓

A short put's maximum gain is the premium received, $500, kept if the stock stays at or above the 60 strike. Breakeven = strike - premium = 60 - 5 = $55, below which the writer begins to lose.

An investor buys 1 PQR 40 call for 6 and sells 1 PQR 50 call for 2 (a debit call spread). What is the maximum gain?

• a.$400
• b.$600✓
• c.$1,000
• d.Unlimited

The net debit is 6 - 2 = 4 points. Maximum gain = difference in strikes - net debit = (50 - 40) - 4 = 6 points = $600, realized if the stock is at or above 50 at expiration. In any vertical spread, max gain + max loss = the strike difference.

Using the same debit call spread (buy 1 PQR 40 call for 6, sell 1 PQR 50 call for 2), what is the maximum loss?

• a.Unlimited
• b.$400✓
• c.$600
• d.$1,000

The maximum loss on a debit spread is the net premium paid: 6 - 2 = 4 points = $400, lost if both calls expire worthless with the stock at or below 40.

Using the same debit call spread (buy 1 PQR 40 call for 6, sell 1 PQR 50 call for 2), what is the breakeven point?

• a.$46
• b.$44✓
• c.$40
• d.$50

For a debit call spread, breakeven = lower strike + net debit = 40 + 4 = $44. Above $44 the spread turns a net profit, up to its maximum at the higher strike.

An investor sells 1 STU 20 call for 5 and buys 1 STU 25 call for 2 (a bear/credit call spread). What is the maximum gain?

• a.$500
• b.$200
• c.Unlimited
• d.$300✓

A credit call spread's maximum gain is the net credit received = 5 - 2 = 3 points = $300, kept if both calls expire worthless (stock at or below 20). This bearish spread profits when the stock stays low.

Using the same credit call spread (sell 1 STU 20 call for 5, buy 1 STU 25 call for 2), what is the maximum loss?

• a.Unlimited
• b.$500
• c.$300
• d.$200✓

Maximum loss = difference in strikes - net credit = (25 - 20) - 3 = 2 points = $200, incurred if the stock rises to or above 25. Buying the higher-strike call caps what would otherwise be unlimited naked-call risk.

Using the same credit call spread (sell 1 STU 20 call for 5, buy 1 STU 25 call for 2), what is the breakeven point?

• a.$23✓
• b.$17
• c.$25
• d.$22

For a credit call spread, breakeven = lower strike + net credit = 20 + 3 = $23. The spread is profitable as long as the stock stays below $23 at expiration.

An investor sells 1 VWX 50 put for 4 and buys 1 VWX 45 put for 1 (a bull/credit put spread). What are the maximum gain and maximum loss?

• a.Maximum gain $300; maximum loss $200✓
• b.Maximum gain $200; maximum loss $300
• c.Maximum gain $500; maximum loss $500
• d.Maximum gain $300; maximum loss unlimited

Net credit = 4 - 1 = 3 points = $300 maximum gain, kept if both puts expire worthless (stock at or above 50). Maximum loss = strike difference - net credit = (50 - 45) - 3 = 2 points = $200. This bullish spread profits when the stock stays up.

An investor buys 1 YZA 70 put for 5 and sells 1 YZA 60 put for 1 (a bear/debit put spread). What is the maximum gain?

• a.$1,000
• b.Unlimited
• c.$600✓
• d.$400

Net debit = 5 - 1 = 4 points. Maximum gain = strike difference - net debit = (70 - 60) - 4 = 6 points = $600, achieved if the stock is at or below 60. Owning the higher-strike put makes this spread bearish.

Using the same debit put spread (buy 1 YZA 70 put for 5, sell 1 YZA 60 put for 1), what is the breakeven point?

• a.$74
• b.$64
• c.$66✓
• d.$60

For a debit put spread, breakeven = higher strike - net debit = 70 - 4 = $66. Below $66 the spread profits, to a maximum at the lower strike of 60.

An investor buys 1 BCD 80 call for 3 and buys 1 BCD 80 put for 2 (a long straddle). What is the maximum loss?

• a.Unlimited
• b.$300
• c.$8,000
• d.$500✓

A long straddle's maximum loss is the total premium paid, 3 + 2 = 5 points = $500, occurring if the stock closes exactly at 80 so both options expire worthless. The straddle buyer profits from a large move in either direction (buying volatility).

Using the same long straddle (buy 1 BCD 80 call for 3 and 1 BCD 80 put for 2), what are the two breakeven points?

• a.$85 and $75✓
• b.$83 and $77
• c.$88 and $72
• d.$80 and $80

Total premium is 5 points. Upside breakeven = strike + total premium = 80 + 5 = $85; downside breakeven = strike - total premium = 80 - 5 = $75. The stock must move outside the $75-$85 range for a net profit.

An investor sells 1 EFG 100 call for 4 and sells 1 EFG 100 put for 3 (a short straddle). What is the maximum gain?

• a.$10,000
• b.Unlimited
• c.$700✓
• d.$300

A short straddle's maximum gain is the total premium received, 4 + 3 = 7 points = $700, realized if the stock closes exactly at the 100 strike. The seller profits from low volatility but faces large losses on a big move in either direction.

Using the same short straddle (sell 1 EFG 100 call for 4 and 1 EFG 100 put for 3), what are the two breakeven points?

• a.$110 and $90
• b.$100 and $100
• c.$107 and $93✓
• d.$104 and $96

Total premium collected is 7 points, so breakevens are strike +/- total premium: 100 + 7 = $107 and 100 - 7 = $93. The short straddle keeps a profit only while the stock stays between $93 and $107.

An investor buys 100 shares of HIJ at $52 and sells 1 HIJ 55 call for a premium of 2 (a covered call). What is the maximum gain?

• a.Unlimited
• b.$500✓
• c.$300
• d.$200

If the stock is called away at 55, the gain equals stock appreciation plus premium: (55 - 52) + 2 = 5 points = $500. The written call caps upside at $500 no matter how high the stock climbs, in exchange for the premium income.

Using the same covered call (buy 100 HIJ at $52, sell 1 HIJ 55 call for 2), what is the breakeven point?

• a.$52
• b.$50✓
• c.$54
• d.$57

For a covered call, breakeven = stock cost - premium received = 52 - 2 = $50. The premium lowers the effective cost basis and provides a small downside cushion.

Using the same covered call (buy 100 HIJ at $52, sell 1 HIJ 55 call for 2), what is the maximum loss?

• a.$5,000✓
• b.$200
• c.$5,200
• d.$500

The worst case is the stock falling to zero: the investor loses the $52 cost but keeps the $2 premium, for a net loss of 50 points = $5,000. A covered call reduces, but does not eliminate, downside risk on the stock.

An investor buys 100 shares of KLM at $40 and buys 1 KLM 35 put for a premium of 1 (a protective put). What is the maximum loss?

• a.$600✓
• b.$4,100
• c.$100
• d.$500

Maximum loss = (stock cost - put strike + premium) x 100 = (40 - 35 + 1) x 100 = $600. Below the 35 strike the put lets the investor sell at 35, so losses are capped like insurance.

Using the same protective put (buy 100 KLM at $40, buy 1 KLM 35 put for 1), what is the breakeven point?

• a.$35
• b.$39
• c.$41✓
• d.$40

For a protective put, breakeven = stock cost + premium paid = 40 + 1 = $41. The put premium raises the price the stock must reach before the hedged position is profitable, while upside remains open.

An NOP 25 put trades at a premium of 4 while the stock is at 22. The option's intrinsic value and time value are:

• a.Intrinsic value $0, time value $4
• b.Intrinsic value $1, time value $3
• c.Intrinsic value $4, time value $0
• d.Intrinsic value $3, time value $1✓

A put's intrinsic value = strike - stock price when in the money = 25 - 22 = 3. Time value = premium - intrinsic value = 4 - 3 = 1. The put is in the money by 3 points, with $1 of remaining time value.

A put option has intrinsic value (is 'in the money') when:

• a.The premium has fallen to zero
• b.The underlying stock pays no dividend
• c.The stock's market price is above the strike price
• d.The stock's market price is below the strike price✓

A put gives the right to sell at the strike, so it has intrinsic value (is in the money) when the stock trades below the strike. A call is in the money when the stock is above the strike, which is the classic buyer/seller reversal trap in choice a.

A listed equity option is quoted at a premium of 2.75. What is the total dollar cost to buy one contract (before commissions)?

• a.$275✓
• b.$27.50
• c.$2,750
• d.$2.75

Each standard equity option contract covers 100 shares, so the dollar cost = premium x 100 = 2.75 x 100 = $275. The 100-share multiplier converts the quoted point premium into dollars.

When a broad-based stock index option is exercised, settlement is made by:

• a.A cash payment equal to the in-the-money amount times the index multiplier✓
• b.No settlement, because index options cannot be exercised
• c.Physical delivery of an ETF share
• d.Physical delivery of every stock in the underlying index, in the exact share weightings, transferred from the writer to the holder

Index options are cash-settled: the writer pays the holder the difference between the index level and the strike, multiplied by the contract multiplier. There is no delivery of the underlying stocks, unlike physically settled equity options.

An investor buys 1 QRS 55 call for 2 and buys 1 QRS 45 put for 1 (a long combination). What is the maximum loss?

• a.$300✓
• b.Unlimited
• c.$1,000
• d.$200

Like a straddle, a long combination's maximum loss is the total premium paid: 2 + 1 = 3 points = $300. The position uses different strikes but still profits only on a large move up (above the call strike) or down (below the put strike).

An investor who is bearish on a stock but wants to limit risk to a known amount would most appropriately:

• a.Write an uncovered call, which carries unlimited risk
• b.Buy the stock on margin
• c.Buy a put option on the stock✓
• d.Sell a cash-secured put

Buying a put profits when the stock falls, with risk limited to the premium paid. Writing a naked call is also bearish but exposes the investor to unlimited loss, and buying stock or selling a put are bullish, so they do not fit a risk-limited bearish view.

A $1,000 par bond with a 7% coupon is trading at a price of 140. What is the current yield?

• a.7.00%
• b.5.00%✓
• c.6.40%
• d.9.80%

Current yield = annual coupon / market price = $70 / $1,400 = 5.00%. Because the bond trades at a premium (above par), the current yield is below the 7% coupon rate.

A $1,000 par bond with a 6% coupon is trading at a price of 75. What is the current yield?

• a.4.50%
• b.8.00%✓
• c.6.00%
• d.7.50%

Current yield = annual coupon / market price = $60 / $750 = 8.00%. At a discount (below par), the current yield exceeds the 6% coupon, and yield to maturity would be higher still.

An investor in the 25% federal tax bracket owns a 3% municipal bond. What is its taxable-equivalent yield?

• a.2.25%
• b.3.75%
• c.4.00%✓
• d.3.00%

Taxable-equivalent yield = municipal yield / (1 - tax rate) = 3% / (1 - 0.25) = 3% / 0.75 = 4.00%. A taxable bond must yield 4% to match the after-tax return of this 3% municipal.

An investor in the 35% federal tax bracket owns a 5% municipal bond. What is its taxable-equivalent yield?

• a.7.69%✓
• b.6.75%
• c.5.00%
• d.3.25%

Taxable-equivalent yield = municipal yield / (1 - tax rate) = 5% / (1 - 0.35) = 5% / 0.65 = 7.69%. The higher the investor's bracket, the greater the value of the municipal's tax exemption.

A taxable corporate bond yields 8%. For an investor in the 30% federal tax bracket, the approximate after-tax yield is:

• a.5.60%✓
• b.2.40%
• c.11.43%
• d.8.00%

After-tax yield = taxable yield x (1 - tax rate) = 8% x (1 - 0.30) = 8% x 0.70 = 5.60%. This is compared with a municipal's yield to decide which is better after taxes. The 11.43% figure is the reverse taxable-equivalent computation (8% / 0.70).

A convertible bond has a $1,000 par value and a conversion price of $25. What is the conversion ratio?

• a.25 shares
• b.250 shares
• c.40 shares✓
• d.4 shares

Conversion ratio = par value / conversion price = $1,000 / $25 = 40 shares. Each bond can be exchanged for 40 shares of the issuer's common stock.

A convertible bond with a conversion ratio of 40 shares is trading at a market price of $1,200. What common stock price represents parity?

• a.$30.00✓
• b.$40.00
• c.$48.00
• d.$25.00

Parity stock price = bond market price / conversion ratio = $1,200 / 40 = $30.00. If the stock trades above $30, converting and selling the shares would be worth more than the bond's current price.

A convertible bond has a conversion ratio of 40 shares, and the common stock trades at $32. What is the parity price of the bond?

• a.$800
• b.$1,200
• c.$1,280✓
• d.$1,320

Parity price of the bond = stock price x conversion ratio = $32 x 40 = $1,280. This is the bond value implied by the stock; if the bond trades below $1,280 an arbitrage opportunity may exist.

For a bond purchased at a premium that is also callable, the most conservative (lowest) yield used to price the bond is the:

• a.Nominal yield
• b.Yield to maturity
• c.Current yield
• d.Yield to call✓

On a premium bond, yield to call is the lowest measure because the premium is lost more quickly if the bond is called early. Dealers price premium callable bonds to this yield to worst to protect the investor. On a premium bond the order is YTC < YTM < current yield < coupon.

For a bond purchased at a discount, which yield measure is the highest?

• a.Current yield
• b.Yield to maturity
• c.Yield to call✓
• d.Nominal yield

For a bond bought at a discount the yield ranking from lowest to highest is nominal (coupon) < current yield < yield to maturity < yield to call. Yield to call is highest because a call returns par (above the discounted purchase price) sooner, so the gain is earned over a shorter period, raising the annualized yield. (YTM is the yield to worst on a discount bond; the ranking flips for a premium bond, where YTC is lowest.)

The nominal yield of a bond refers to:

• a.The total return earned if the bond is held all the way to maturity
• b.The yield calculated using the current secondary-market trading price of the bond
• c.The single lowest of all the standard bond yield measures for the security
• d.The fixed coupon rate stated on the bond✓

Nominal yield is simply the stated coupon rate, fixed as a percentage of par when the bond is issued. Current yield uses market price, and yield to maturity reflects total return to maturity, so those measures change as the bond's price moves.

Duration is best described as a measure of:

• a.A bond's price sensitivity to changes in interest rates✓
• b.The likelihood the issuer will call the bond
• c.The bond's coupon payment frequency
• d.A bond's credit quality and the probability that the issuer will default on its scheduled interest or principal payments

Duration measures how much a bond's price will change for a given change in interest rates; longer maturities and lower coupons produce higher duration and greater price volatility. It is an interest-rate (market) risk gauge, not a credit or call measure.

A bond quoted 'on a yield basis' (a basis price) rather than as a dollar price is most characteristic of:

• a.U.S. Treasury bills only
• b.Corporate bonds, which trade at a stated percentage of par plus accrued interest computed on a 30/360 basis
• c.A bond that has defaulted
• d.Municipal bonds, which are commonly quoted by yield✓

Municipal bonds are typically quoted on a yield (basis) basis, whereas corporate bonds are quoted as a percentage of par (dollar price) and Treasury notes/bonds in 32nds. Quoting by yield reflects the way munis are traded and compared.

A special tax bond, backed by a specific excise tax such as one on gasoline or tobacco, is best classified as a:

• a.Revenue bond, since it is backed by a specific tax rather than the issuer's general taxing power✓
• b.Corporate debenture
• c.Moral obligation bond of the federal government
• d.A general obligation bond, since any dedicated tax pledge automatically brings the issuer's full faith, credit, and ad valorem taxing power behind the bond

A special tax bond is a type of revenue bond: it is serviced by a dedicated excise or special tax, not by the issuer's full faith, credit, and ad valorem taxing power. That distinguishes it from a general obligation bond backed by property taxes.

The debt service coverage ratio on a municipal revenue bond is:

• a.Net revenue available divided by annual debt service; a higher ratio indicates greater safety✓
• b.The issuer's assigned letter credit rating from a nationally recognized statistical rating organization, expressed as a single numeric score
• c.The bond's coupon divided by its market price
• d.The ratio of a municipality's property taxes to its population

Debt service coverage = net revenue available for debt service / annual debt service (principal + interest). A higher ratio means more cushion to pay bondholders, which is central to analyzing revenue bonds backed by a project's income.

An 'additional bonds test' in a municipal revenue bond indenture is:

• a.A federal limit on total municipal issuance
• b.A protective covenant restricting new bonds of equal lien unless earnings coverage tests are met✓
• c.A rule requiring that bonds be sold only at par
• d.A requirement that the issuer double its property tax rate before it may sell any additional revenue or general obligation bonds

The additional bonds test is a covenant protecting existing revenue bondholders by permitting new parity (equal-lien) debt only if projected or historical revenues meet a specified coverage level. It guards against dilution of the existing bondholders' claim on revenues.

An investor buys an original issue discount (OID) municipal bond. The accretion of the discount each year is generally:

• a.Taxed as a long-term capital gain at maturity on the full difference between the discounted purchase price and par value
• b.Always fully taxable at the federal level
• c.Treated as tax-exempt interest, with the cost basis accreted upward each year toward par✓
• d.Taxed as ordinary income each year

On an OID municipal bond, the discount is treated as tax-exempt municipal interest and is accreted (added to cost basis) each year, so at maturity there is no taxable gain if held to par. This differs from a market discount on a muni, which is generally taxed as ordinary income.

BANs, TANs, and RANs are examples of:

• a.Federal agency securities
• b.Long-term revenue bonds that finance permanent capital projects and are repaid over twenty to thirty years from facility income
• c.Short-term municipal notes issued in anticipation of future bond proceeds or revenues✓
• d.Corporate commercial paper

Bond, tax, and revenue anticipation notes (BANs/TANs/RANs) are short-term municipal notes that provide interim financing, repaid from anticipated bond proceeds, tax collections, or other revenues. Their interest is generally federally tax-exempt like other munis.

An investor in the 32% federal tax bracket is choosing between a 4% municipal bond and a 5.5% taxable corporate bond of similar quality. Which is better after tax?

• a.Cannot be determined without the maturity date
• b.The corporate bond, because its stated 5.5% coupon is higher than the municipal's 4% and coupon rate alone determines after-tax return
• c.The municipal bond, because its taxable-equivalent yield of about 5.88% exceeds 5.5%✓
• d.They are exactly equal after tax

The muni's taxable-equivalent yield = 4% / (1 - 0.32) = 4% / 0.68 = 5.88%, which exceeds the 5.5% corporate yield, so the municipal gives the better after-tax return. Comparing pre-tax coupons alone (choice a) ignores the muni's tax exemption.

A resident of the issuing state who buys that state's general obligation bond generally receives interest that is:

• a.Exempt from federal tax but taxable by the resident's own state
• b.Exempt only from local tax
• c.Taxable at all three levels
• d.Generally exempt from federal, state, and local income tax ('triple tax-exempt')✓

Municipal interest is federally tax-exempt and, for a resident of the issuing state, usually exempt from that state's and locality's income tax as well, the 'triple tax-exempt' feature. Out-of-state residents typically owe their home state's tax on the interest.

A feasibility study prepared for a proposed municipal revenue bond is:

• a.A detailed study of the issuer's assessed property tax base, debt per capita, and historical tax collection rates used to size the levy
• b.A federal audit of the municipality
• c.An engineering and economic study projecting whether the facility's revenues will cover debt service✓
• d.A rating agency's periodic credit report

A feasibility study, prepared by independent consultants, projects the demand, revenues, and expenses of a proposed project to gauge whether it can generate enough net revenue to service the debt. It is central to evaluating a revenue bond, which lacks general taxing-power backing.

Which of the following is a municipal fund security sold under an official statement and MSRB rules?

• a.A 529 college savings plan✓
• b.A Treasury bond
• c.A corporate bond
• d.A bank certificate of deposit

529 college savings plans (and local government investment pools) are municipal fund securities regulated by the MSRB and offered via an official statement, not a prospectus. Although they invest in mutual-fund-like portfolios, they are not registered investment companies.

A mutual fund has total assets of $250 million, total liabilities of $10 million, and 12 million shares outstanding. Its net asset value (NAV) per share is:

• a.$20.00✓
• b.$19.17
• c.$21.67
• d.$20.83

NAV per share = (total assets - total liabilities) / shares outstanding = ($250M - $10M) / 12M = $240M / 12M = $20.00. Forgetting to subtract the $10M liability (choice a) is the common error.

A mutual fund share has an NAV of $9.50 and a maximum sales charge of 4.5% (as a percentage of the public offering price). What is the public offering price?

• a.$9.93
• b.$9.95✓
• c.$9.05
• d.$9.50

POP = NAV / (1 - sales charge rate) = $9.50 / (1 - 0.045) = $9.50 / 0.955 = $9.95. The sales charge of about $0.45 equals 4.5% of the $9.95 offering price (Investment Company Act of 1940 pricing).

A mutual fund share has a public offering price of $10.00 and an NAV of $9.20. What is the sales charge percentage?

• a.4.5%
• b.8.7%
• c.0.8%
• d.8.0%✓

Sales charge % = (POP - NAV) / POP = ($10.00 - $9.20) / $10.00 = $0.80 / $10.00 = 8.0%. The sales charge is always measured as a percentage of the public offering price, not of NAV.

A letter of intent (LOI) on a front-end load mutual fund is:

• a.A statement letting an investor obtain a breakpoint discount by committing to invest a set amount within 13 months, and it may be backdated up to 90 days✓
• b.A promise never to redeem shares
• c.A binding legal guarantee from the fund's sponsor that the shares will achieve a stated minimum annual rate of return over the coming thirteen-month holding period
• d.A required minimum distribution schedule

An LOI lets an investor qualify for a reduced sales charge (breakpoint) by pledging to invest a stated amount over 13 months; it can be backdated up to 90 days. If the amount is not met, the fund retains additional shares to cover the higher load owed.

Rights of accumulation on a mutual fund allow an investor to:

• a.Receive a guaranteed dividend reinvestment
• b.The right to vote the fund's portfolio shares in the underlying companies' corporate elections and proxy contests
• c.Reach breakpoints by counting the current value of existing holdings toward new purchases✓
• d.Take a federal tax deduction for contributions

Rights of accumulation let existing holdings (at current value) count toward reaching a breakpoint on new purchases, reducing the sales charge. Unlike a letter of intent, they apply as the account grows over time rather than requiring a prospective commitment.

Class B mutual fund shares are typically characterized by:

• a.A front-end sales load paid at the time of purchase that is deducted from the investor's initial contribution before any shares are bought
• b.No sales charge of any kind
• c.A level annual load that never ends
• d.A back-end contingent deferred sales charge that declines the longer shares are held, often converting to Class A✓

Class B shares carry a contingent deferred sales charge (CDSC) that decreases each year and eventually reaches zero, at which point the shares often convert to lower-cost Class A. They also generally carry higher 12b-1 fees than Class A during the CDSC period.

A closed-end investment company is best characterized by:

• a.Shares that are continuously issued and redeemed at net asset value calculated once per day after the market close under forward pricing
• b.A guaranteed return of principal
• c.A fixed number of shares that trade on an exchange at a market price which may be above (premium) or below (discount) NAV✓
• d.An unmanaged, fixed portfolio held to a termination date

A closed-end fund issues a fixed number of shares in an IPO that then trade in the secondary market at supply-and-demand prices, which can be at a premium or discount to NAV. Open-end funds, by contrast, continuously issue and redeem shares at NAV.

The assumed interest rate (AIR) in a variable annuity is:

• a.The sales load on the contract
• b.A guaranteed minimum interest rate that the insurer credits to the separate account during the accumulation phase regardless of subaccount performance
• c.The mortality and expense charge
• d.A benchmark used to set the initial annuity payout, against which actual separate-account performance is measured to raise or lower future payments✓

During the payout (annuitization) phase, the AIR is a conservative benchmark used to compute the first payment. If the separate account earns more than the AIR, the next payment rises; if it earns less, the payment falls. The AIR itself is not a guaranteed return.

Which annuity payout option generally provides the largest periodic payment to the annuitant?

• a.A straight life (life-only) annuity, because payments stop at death with no beneficiary guarantee✓
• b.A joint-and-last-survivor annuity, because covering two lives lets the insurer pay a larger amount than covering only a single life
• c.A lump-sum withdrawal
• d.Life with 20-year period certain

A straight life annuity pays the most per period because the insurer's obligation ends at the annuitant's death, with nothing to a beneficiary. Options that add survivor or period-certain guarantees spread the payout over a longer expected period, lowering each payment.

How do equity REITs differ from mortgage REITs?

• a.Equity REITs own and operate income-producing real estate, while mortgage REITs invest in real-estate loans and mortgage-backed securities✓
• b.Both are limited partnerships
• c.Both types invest only in residential and commercial mortgages and mortgage-backed securities, differing solely in their chosen geographic focus
• d.Equity REITs lend money while mortgage REITs own buildings

Equity REITs generate income mainly from rents on properties they own, while mortgage REITs earn interest by investing in real-estate debt and mortgage-backed securities. Both must distribute at least 90% of taxable income to keep their favorable tax status.

A 12b-1 fee charged by a mutual fund is:

• a.A guaranteed return paid to shareholders
• b.A one-time front-end sales load
• c.A federal excise tax on fund dividends and capital gain distributions that the fund collects from shareholders and remits to the IRS each year
• d.An annual fee deducted from fund assets to cover distribution and marketing (and sometimes servicing) costs✓

A 12b-1 fee is an ongoing annual charge against fund assets for distribution, marketing, and shareholder-servicing expenses. A fund charging more than 0.25% generally may not call itself 'no-load'; the fee reduces the investor's net return each year.

A 'no-load' mutual fund is one that:

• a.Is sold without a front- or back-end sales charge, though it may still deduct a 12b-1 fee of up to 0.25%✓
• b.Charges the maximum 8.5% sales load
• c.Is guaranteed by an agency of the federal government against any loss of the investor's original principal contribution
• d.Is a closed-end fund trading on an exchange

A no-load fund has no front-end or contingent deferred sales charge and may charge a 12b-1 fee no greater than 0.25% of average net assets while still being called no-load. FINRA caps total sales charges on funds at 8.5% under the Investment Company Act framework.

The discount rate set by the Federal Reserve is:

• a.The rate banks charge one another for overnight loans
• b.The rate on 3-month Treasury bills
• c.The prime rate banks charge their best customers
• d.The interest rate the Fed charges member banks that borrow directly from it✓

The discount rate is the rate the Federal Reserve charges depository institutions that borrow directly from the Fed's discount window. It is distinct from the federal funds rate (bank-to-bank overnight) and the prime rate (set by banks for customers).

If the Federal Reserve raises bank reserve requirements, the likely effect is to:

• a.Reduce the funds banks can lend, tightening money and tending to raise interest rates✓
• b.Have no effect on bank lending
• c.Directly set the level of stock prices
• d.Increase the money supply available for lending and push short-term market interest rates lower over time

Raising reserve requirements forces banks to hold more reserves and lend less, contracting the money supply and putting upward pressure on interest rates. Lowering the requirement does the opposite. It is one of the Fed's monetary-policy tools.

The federal funds rate is:

• a.The yield on long-term Treasury bonds
• b.The rate banks charge one another for overnight loans of reserves✓
• c.A rate set directly by Congress
• d.The rate the Fed charges banks at the discount window

The federal funds rate is the interest banks charge each other for overnight loans of reserve balances. It is a key indicator of monetary conditions and is influenced by the Fed's open market operations, but it is a market-determined bank-to-bank rate.

An accommodative ('easy money') monetary policy is typically carried out when the Federal Reserve:

• a.Sells securities in the open market to drain reserves from the banking system, tightening the availability of money and credit
• b.Raises the discount rate sharply
• c.Raises reserve requirements
• d.Buys securities in the open market, adding reserves and tending to lower short-term rates to stimulate the economy✓

To ease money, the Fed buys securities through open market operations, injecting reserves into the banking system, which tends to lower short-term interest rates and stimulate borrowing and spending. Selling securities or raising the discount rate/reserve requirements tightens instead.

A normal (positive) yield curve exists when:

• a.Short-term interest rates are higher than long-term rates all along the maturity spectrum of the curve
• b.Municipal yields exceed corporate yields
• c.All maturities yield the same amount
• d.Longer maturities carry higher yields than shorter maturities✓

A normal yield curve slopes upward because investors demand higher yields to lend for longer periods, compensating for greater interest-rate and inflation risk. An inverted curve (short rates above long) is the opposite and can signal an expected slowdown.

Which of the following are considered leading economic indicators?

• a.Building permits, new manufacturing orders, and stock prices, which tend to change before the broad economy✓
• b.The prime rate and the average duration of unemployment, both lagging
• c.Corporate profits and GDP, which are coincident measures
• d.The unemployment rate, a lagging figure

Leading indicators, such as building permits, new orders, stock prices, and initial jobless claims, tend to move ahead of the overall economy. GDP and corporate profits are coincident, while unemployment duration and the prime rate are lagging indicators.

M2 is best described as:

• a.A broad measure of the money supply including currency, checking and savings deposits, and retail money-market funds✓
• b.The national debt
• c.The federal government's annual budget deficit combined with the total accumulated national debt outstanding at each year end
• d.The total value of all listed stocks

M2 is a monetary aggregate that includes M1 (currency and checking deposits) plus savings deposits, small time deposits, and retail money-market fund balances. Money-supply measures like M2 help gauge liquidity and monetary conditions.

Demand-pull inflation occurs when:

• a.Aggregate demand outpaces the economy's productive capacity, pushing prices up✓
• b.Prices broadly fall because the supply of goods persistently exceeds total consumer demand in the economy
• c.A one-time tax increase reduces spending
• d.Unemployment rises while prices fall

Demand-pull inflation results from total demand for goods and services exceeding the economy's ability to produce them, bidding prices upward. It contrasts with cost-push inflation, which stems from rising input costs such as wages or raw materials.

Purchasing power (inflation) risk most seriously affects:

• a.A basket of physical commodities
• b.Long-term fixed-income securities with level payments, whose real value erodes as prices rise✓
• c.A broadly diversified portfolio of common stocks whose earnings and dividends tend to rise along with the general price level
• d.Directly owned real estate

Inflation risk is the danger that rising prices erode the real value of fixed cash flows. Long-term bonds and fixed annuities are most exposed because their payments do not increase with inflation, while equities, real estate, and commodities may adjust with price levels.