FINRA SIE — Securities Industry Essentials — All Questions

Which statement best describes a key difference between common stock and preferred stock?

• a.Common stockholders normally have voting rights, while most preferred stockholders do not✓
• b.Common stock pays a dividend fixed in its charter, while preferred dividends vary
• c.Common stock has a stated maturity date, while preferred stock is perpetual
• d.Preferred stock gives holders the right to vote for the board, while common stock does not

Common shareholders typically vote on corporate matters such as electing directors, while preferred shares generally carry no vote in exchange for a fixed, priority dividend. Preferred dividends are fixed, not common ones, so the first choice is reversed. Neither security has a maturity date, so the last choice is wrong.

In a corporate liquidation, which of the following has the highest priority of claim on remaining assets?

• a.Holders of warrants
• b.Common stockholders
• c.Preferred stockholders
• d.Secured bondholders✓

Debtholders are paid before equity, and secured (collateralized) bondholders rank ahead of unsecured creditors, preferred, and common. Preferred stock ranks above common but below all debt. Warrants are equity-linked and rank with or below common.

A cumulative preferred stock missed its dividend for two years. Before common shareholders can receive any dividend, the company must:

• a.Convert the preferred shares into common shares at the stated conversion ratio
• b.Pay only the current year's preferred dividend, because arrears expire after twelve months
• c.Pay all missed (in arrears) preferred dividends plus the current preferred dividend✓
• d.Pay the preferred holders a penalty rate of interest on the two years of arrears

Cumulative preferred accumulates unpaid dividends in arrears, and all arrears plus the current preferred dividend must be paid before common shareholders get anything. Paying only the current year would apply to non-cumulative preferred. There is no automatic conversion or penalty interest requirement.

Which feature most directly benefits the ISSUER rather than the holder of a preferred stock?

• a.Callable feature✓
• b.Participating feature
• c.Cumulative feature
• d.Convertible feature

A callable (redeemable) feature lets the issuer buy back the shares, usually when rates fall, which benefits the issuer at the holder's expense. Convertible, cumulative, and participating features all add value for the holder.

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

• a.Is a U.S. Treasury instrument issued and denominated in a foreign currency
• b.Represents shares of a foreign company and trades in U.S. markets in U.S. dollars✓
• c.Represents a bond issued by a foreign government and payable in U.S. dollars
• d.Gives U.S. investors the contractual right to buy foreign currency at a fixed rate

An ADR is issued by a U.S. depositary bank and represents a specified number of a foreign company's shares, trading and paying dividends in U.S. dollars. It is equity-based, not a bond or Treasury, and it is not a foreign-exchange contract.Securities Act of 1933

A company issues stock rights to existing shareholders. The rights primarily allow those shareholders to:

• a.Receive an extra cash dividend each quarter for a full year after the rights offering
• b.Vote twice on major corporate decisions such as mergers and board elections
• c.Buy new shares at a subscription price, usually below market, to avoid dilution✓
• d.Sell their existing shares back to the company at a guaranteed premium price

A rights offering gives current shareholders the preemptive right to buy new shares, usually at a subscription price below the current market price, so they can maintain their proportional ownership and avoid dilution. Rights do not repurchase shares, add dividends, or grant extra votes.

How do warrants typically differ from stock rights when first issued?

• a.Warrants are issued only to a company's own employees as pay
• b.Warrants must be exercised the same day they are issued or they lapse
• c.Warrants pay a guaranteed quarterly dividend to holders, while rights do not
• d.Warrants have a long-term (often years) life, while rights are short-term✓

Warrants are long-term instruments, often lasting several years, and their exercise (strike) price is usually set above the market price at issuance. Rights are short-term and priced below market. Warrants are not same-day, employee-only, or dividend-paying.

An investor who buys common stock is exposed to which of the following characteristics?

• a.A dividend guaranteed each quarter regardless of company earnings
• b.Priority over bondholders and preferred holders in a liquidation
• c.A fixed maturity value repaid to the holder on a stated date
• d.Residual claim on earnings and assets and potential voting rights✓

Common stock represents a residual (last-in-line) ownership claim on earnings and assets, and it typically carries voting rights. It has no maturity, no guaranteed dividend, and ranks behind bondholders in bankruptcy.

A convertible preferred stock is most valuable to a holder when:

• a.The issuer suspends its common dividend, which raises conversion value
• b.The issuer's common stock price rises well above the conversion price✓
• c.The issuer's common stock price falls sharply below the conversion price
• d.Market interest rates rise significantly, lifting the conversion ratio

A convertible lets the holder exchange the preferred for a set number of common shares, so it gains the most value when the common stock rises well above the conversion price. Falling common prices, rising rates, or dividend cuts reduce the security's value.

Treasury stock refers to shares that:

• a.Are authorized but unissued shares the board may still sell
• b.Are held solely by the corporation's board of directors
• c.Are debt securities issued by the U.S. Treasury Department
• d.Were issued and later repurchased by the issuing corporation✓

Treasury stock is shares the corporation issued and then bought back; it has no voting rights and receives no dividends while held by the company. It is unrelated to the U.S. Treasury, is not unissued, and is not restricted to directors.Securities Exchange Act of 1934

A shareholder wants to maintain the same percentage ownership after a company issues new shares. Which right supports this goal?

• a.Cumulative dividend right
• b.Conversion right
• c.Preemptive right✓
• d.Right of redemption

A preemptive right lets existing shareholders buy a proportional amount of newly issued shares before others, preserving their percentage ownership and preventing dilution. Cumulative dividends, conversion, and redemption relate to income or exchange features, not ownership percentage.

Which of the following statements about an ADR holder is TRUE?

• a.The holder still faces currency risk because the underlying shares are foreign✓
• b.The holder generally receives dividend payments in the issuer's foreign currency
• c.The holder has full voting rights identical to a domestic common shareholder
• d.The holder is guaranteed against currency risk by the depositary bank

Even though an ADR trades in U.S. dollars, its value reflects a foreign company's shares, so the holder is exposed to currency (exchange-rate) risk. Dividends are converted to dollars, voting rights are often limited, and the bank does not guarantee against currency risk.

A debenture is best described as a corporate bond that is:

• a.Guaranteed by the federal government against default
• b.Secured by a portfolio of other companies' securities held in trust
• c.Backed only by the general credit and good faith of the issuer✓
• d.Backed by specific real estate the issuer owns and pledges

A debenture is an unsecured bond backed solely by the issuer's general credit and promise to pay, not by specific collateral. Mortgage bonds use real estate, collateral trust bonds use other securities, and no corporate bond is federally guaranteed.

A corporate bond has a 5% coupon and a $1,000 par value. How much annual interest does the bondholder receive?

• a.$5
• b.$50✓
• c.It depends on the current market price
• d.$500

The coupon is a fixed percentage of par, so 5% of $1,000 equals $50 per year, regardless of the bond's current market price. The interest amount does not change with market price; only yield does.

Which corporate bond feature allows the issuer to redeem the bonds before maturity, typically when interest rates have fallen?

• a.Call feature✓
• b.Sinking fund deposit requirement
• c.Put feature
• d.Convertible feature

A call feature gives the issuer the right to redeem bonds early, which it tends to do after rates fall so it can refinance more cheaply. A put favors the investor, a convertible allows conversion to stock, and a sinking fund is a repayment reserve, not an early-redemption right for the issuer's benefit in a rate decline.

A high-yield ('junk') bond generally offers a higher coupon than an investment-grade bond because it:

• a.Carries greater credit (default) risk✓
• b.Is exempt from federal and state income tax
• c.Is secured by a mortgage on the issuer's plant
• d.Requires a 30-year minimum maturity

High-yield bonds are rated below investment grade, so issuers must pay a higher coupon to compensate investors for greater credit or default risk. The higher yield is not due to maturity length, collateral, or tax exemption.

A bond's indenture is best described as:

• a.The written contract stating the issuer's obligations and the bondholders' rights✓
• b.The credit rating assigned to the issue by a nationally recognized statistical rating agency
• c.The market price at which the bond currently trades in the secondary market
• d.The commission a broker-dealer charges when the bond is bought or sold

The indenture (deed of trust) is the legal contract that spells out the coupon, maturity, covenants, and the rights of bondholders and duties of the issuer. It is not a price, a rating, or a commission.

An investor holds a convertible corporate bond. This feature primarily allows the investor to:

• a.Exchange the bond for a set number of the issuer's common shares✓
• b.Force the issuer to redeem the bond at par before maturity
• c.Avoid all credit risk because conversion guarantees repayment
• d.Receive a higher coupon automatically when interest rates rise

A convertible bond can be exchanged for a predetermined number of the issuer's common shares, letting the investor participate in stock appreciation. It does not force early repayment, adjust the coupon with rates, or eliminate credit risk.

Which U.S. Treasury security is issued at a discount, pays no periodic interest, and has a maturity of one year or less?

• a.Treasury Inflation-Protected Security (TIPS)
• b.Treasury bill✓
• c.Treasury note
• d.Treasury bond

Treasury bills mature in one year or less and are sold at a discount to face value, with the investor's return being the difference at maturity rather than periodic coupons. Notes and bonds pay semiannual interest, and TIPS pay interest and adjust principal for inflation.

How does a Treasury Inflation-Protected Security (TIPS) protect an investor from inflation?

• a.Its principal is adjusted upward with the Consumer Price Index (CPI)✓
• b.Its coupon rate is raised each year as measured inflation accelerates
• c.It converts into the issuer's common stock whenever inflation rises above 3%
• d.It pays a variable rate that is reset weekly to the 13-week T-bill rate

TIPS adjust their principal value based on changes in the CPI, so as inflation rises the principal (and the dollar amount of each fixed-rate coupon payment) increases. The coupon rate itself is fixed, it is not a floating T-bill rate, and it does not convert to stock.

U.S. Treasury securities are generally considered to have the LOWEST of which risk?

• a.Inflation (purchasing-power) risk
• b.Interest-rate risk
• c.Credit (default) risk✓
• d.Reinvestment risk

Because they are backed by the full faith and credit of the U.S. government, Treasuries carry essentially the lowest credit or default risk of any security. They still face interest-rate, inflation, and reinvestment risk like other bonds.

An investor wants Treasury interest that is subject to federal income tax but EXEMPT from state and local income tax. This tax treatment applies to:

• a.Municipal bond interest in the investor's home state
• b.U.S. Treasury note interest✓
• c.Corporate bond interest
• d.Bank certificate of deposit interest

Interest on U.S. Treasury securities is taxable at the federal level but exempt from state and local income tax. Corporate and CD interest are taxable at all levels, while municipal interest is generally federally tax-exempt, the opposite pattern.

Which of the following orders Treasury securities correctly from SHORTEST to LONGEST original maturity?

• a.T-bill, T-bond, T-note
• b.T-bill, T-note, T-bond✓
• c.T-note, T-bill, T-bond
• d.T-bond, T-note, T-bill

Treasury bills mature in one year or less, notes in 2 to 10 years, and bonds in more than 10 years (up to 30). Only the ordering T-bill, T-note, T-bond reflects shortest to longest maturity.

A Treasury STRIPS is best described as:

• a.A floating-rate Treasury security whose coupon resets against the 13-week bill auction
• b.A Treasury bond whose coupon rate is raised each year by the reported inflation rate
• c.A zero-coupon security created by separating a Treasury bond's principal and interest payments✓
• d.A short-term Treasury instrument issued only to banks and primary dealers

STRIPS are zero-coupon instruments created when a Treasury bond's principal and each interest payment are separated and sold individually at a discount. They are not inflation-linked, floating-rate, or bank-only instruments.

An investor holding a 30-year zero-coupon Treasury (STRIPS) is MOST exposed to which risk?

• a.Currency risk, because it is a foreign bond
• b.Default risk, because zero-coupons often default
• c.Interest-rate risk, because of its long duration✓
• d.Reinvestment risk on its semiannual coupons

A long-maturity zero-coupon bond has a very long duration, making its price highly sensitive to interest-rate changes. It has essentially no default risk (U.S. government) and no reinvestment risk because it pays no coupons, and it is not a foreign security.

Interest earned on U.S. Treasury notes and bonds is paid to investors:

• a.Semiannually (twice per year)✓
• b.Quarterly (four payments a year)
• c.Only at maturity, in a single sum
• d.Monthly (twelve payments a year)

Treasury notes and bonds pay a fixed coupon semiannually, meaning twice per year, until maturity. They do not pay monthly or quarterly, and only T-bills (zero-coupon) pay their return solely at maturity.

Ginnie Mae (GNMA) mortgage-backed securities differ from most other agency securities because they are:

• a.Backed only by the credit of the private issuing corporation
• b.Backed by the full faith and credit of the U.S. government✓
• c.Exempt from federal, state, and local income taxes
• d.Short-term discount instruments that pay no periodic interest

GNMA is a government-owned corporation, and its mortgage-backed securities carry the full faith and credit of the U.S. government, unlike Fannie Mae and Freddie Mac, which are government-sponsored but not directly guaranteed. GNMA interest is federally taxable, and the securities pay monthly interest and principal, not zero-coupon.

Fannie Mae and Freddie Mac are best described as:

• a.Agencies of the U.S. Treasury Department whose debt carries the full faith and credit of the federal government
• b.Government-sponsored enterprises (GSEs) whose securities are not directly guaranteed by the U.S. government✓
• c.Municipal financing authorities that issue tax-exempt revenue bonds for state and local affordable housing projects
• d.Foreign development banks that finance infrastructure projects in emerging market economies

Fannie Mae and Freddie Mac are government-sponsored enterprises that support the mortgage market; their securities carry slightly more credit risk than Treasuries because they are not directly backed by the U.S. government's full faith and credit. They are not Treasury agencies, foreign banks, or municipal authorities.

A holder of a mortgage-backed pass-through security faces prepayment risk, which means:

• a.The issuer defers scheduled principal payments to the final maturity date by contract
• b.Pass-through certificates have no secondary market, so the holder must wait for maturity
• c.The coupon rate automatically rises each year as the underlying mortgage pool seasons
• d.Homeowners may repay their mortgages early, often when rates fall, returning principal sooner than expected✓

Prepayment risk arises because homeowners can refinance and pay off mortgages early, usually when interest rates drop, so investors receive principal back sooner and must reinvest at lower rates. It is not about delayed payments, illiquidity, or automatic coupon increases.

Which of the following is a characteristic of money-market instruments?

• a.Equity ownership and voting rights in the issuer
• b.Short maturities of one year or less and high liquidity✓
• c.Guaranteed capital gains at maturity for the holder
• d.Maturities longer than 10 years and very limited liquidity

Money-market instruments are short-term debt with maturities of one year or less and are highly liquid, making them low-risk cash equivalents. They are not long-term, not equity, and do not guarantee capital gains.

Commercial paper is best described as:

• a.Short-term unsecured corporate debt issued to meet near-term funding needs✓
• b.A federally insured savings deposit that a bank issues at a fixed rate of interest
• c.A share of stock issued by a commercial bank and traded on a national exchange
• d.A long-term corporate bond secured by a specific pledge of company property

Commercial paper is short-term, unsecured promissory notes issued by corporations to fund short-term needs like payroll or inventory, typically maturing in 270 days or less. It is not a long-term secured bond, a stock, or an insured deposit.

A negotiable certificate of deposit (jumbo CD) issued by a bank differs from a traditional retail CD mainly because it:

• a.Can be traded in the secondary market before maturity✓
• b.Is insured in full by the FDIC no matter how large the deposit
• c.Pays the holder no interest at any point over its term
• d.Must be held to maturity and cannot be sold or transferred

A negotiable (jumbo) CD is issued in large denominations and can be bought and sold in the secondary market before maturity, giving it liquidity. Amounts above the insurance limit are not fully insured, it does pay interest, and its negotiability is the opposite of a non-transferable retail CD.

A repurchase agreement (repo) in the money market involves:

• a.Selling a security with an agreement to buy it back later at a slightly higher price✓
• b.Issuing newly created shares to the public to raise permanent equity capital for the issuer
• c.Permanently exchanging an existing bond position for newly issued common stock of the issuer
• d.Buying common stock on margin using credit extended by the customer's own brokerage firm

In a repo, one party sells securities (often Treasuries) and agrees to repurchase them shortly after at a higher price, effectively a short-term collateralized loan. It is not a permanent swap, a margin stock purchase, or a share issuance.

When market interest rates rise, the prices of existing fixed-rate bonds generally:

• a.Rise
• b.Rise then immediately fall to par
• c.Stay the same
• d.Fall✓

Bond prices and interest rates move inversely, so when market rates rise, existing bonds with lower fixed coupons become less attractive and their prices fall. They do not rise or stay unchanged with a rate increase.

A bond trading at a price below its par value is said to be trading at:

• a.A discount✓
• b.Par
• c.Its yield to maturity
• d.A premium

A bond priced below par ($1,000) is trading at a discount, which happens when its coupon is lower than current market yields. A price above par is a premium, and yield to maturity is a return measure, not a price description.

A bond has a 6% coupon and is currently priced at $1,200 (a premium). Its current yield is:

• a.Exactly 6%
• b.Cannot be determined
• c.Higher than 6%
• d.Lower than 6%✓

Current yield equals annual coupon divided by market price, so $60 / $1,200 = 5%, which is lower than the 6% coupon because the price is above par. When a bond trades at a premium, its current yield falls below the coupon rate.

For a bond purchased at a discount, which of the following relationships is correct?

• a.Coupon rate > current yield > yield to maturity
• b.Yield to maturity < coupon rate < current yield
• c.Coupon rate = current yield = yield to maturity
• d.Coupon rate < current yield < yield to maturity✓

For a discount bond, the yields rank from lowest coupon to highest yield to maturity: coupon < current yield < YTM, because the investor also gains the difference between the discounted purchase price and par at maturity. The premium bond shows the reverse order, and only a par bond has all three equal.

Yield to maturity (YTM) is best described as the total return an investor earns if the bond is:

• a.Called away by the issuer on the first call date at the stated call price
• b.Held until maturity, with coupons reinvested, accounting for any premium or discount✓
• c.Converted into common stock at the indenture's stated conversion ratio
• d.Sold right away in the secondary market at today's quoted price plus any accrued interest

YTM measures the total annualized return assuming the bond is held to maturity and coupons are reinvested at the YTM, incorporating any gain or loss from a discount or premium price. It is not the return from an immediate sale, an early call (that is yield to call), or conversion.

If a bond's current yield is 5% and its coupon rate is 5%, the bond is most likely trading at:

• a.An unknown price
• b.Par value✓
• c.A discount
• d.A premium

Current yield equals the coupon rate only when the market price equals par, because current yield is coupon divided by price. If current yield were higher it would be a discount, and if lower it would be a premium.

Two bonds are identical except for maturity. Which bond's price will generally change MORE for a given change in interest rates?

• a.The bond with the longer maturity✓
• b.The bond closest to maturity
• c.Both change equally
• d.The one with the higher credit rating

Longer-maturity bonds have greater interest-rate sensitivity (higher duration), so their prices move more for a given change in rates. Maturity, not credit rating, drives this effect, and the two do not move equally.

An investor buys a bond at par with a 4% coupon. If market rates later drop to 2%, the market value of the investor's bond will most likely:

• a.Increase, trading at a premium✓
• b.Decrease, trading at a discount
• c.Fall to zero
• d.Remain exactly at par

When market rates fall below a bond's fixed coupon, that bond becomes more attractive and its price rises above par to a premium. Prices move inversely to rates, so a rate drop raises the price rather than lowering it or leaving it unchanged.

Nominal yield on a bond refers to:

• a.The annual coupon divided by the current market price
• b.The yield if the bond is called early
• c.The total return if held to maturity
• d.The stated coupon rate as a percentage of par value✓

Nominal yield is simply the bond's stated coupon rate expressed as a percentage of par value, and it does not change with market price. Coupon over market price is current yield, held-to-maturity return is YTM, and early-call return is yield to call.

Duration is a measure that helps investors estimate:

• a.How sensitive a bond's price is to changes in interest rates✓
• b.The issuer's statistical likelihood of default before maturity
• c.The accrued interest a bond buyer owes the seller at settlement
• d.A bond's credit rating as assigned by Moody's or Standard & Poor's

Duration estimates the percentage change in a bond's price for a given change in interest rates, so higher duration means greater interest-rate sensitivity. It does not measure credit rating, default probability, or accrued interest.

Which of the following bond ratings represents the LOWEST credit risk?

• a.BB+
• b.AAA✓
• c.CCC+
• d.CCC-

AAA is the highest rating agencies assign, indicating the strongest capacity to pay and therefore the lowest credit risk. BB, B, and CCC are all below investment grade and carry progressively higher default risk.

The line between 'investment grade' and 'non-investment grade' (high-yield) bonds generally falls at:

• a.BBB (or Baa) and above is investment grade; BB (or Ba) and below is high-yield✓
• b.Any bond with a coupon above 5% is classified as high-yield debt
• c.Only unrated bonds are high-yield; all rated bonds are investment grade
• d.AAA (or Aaa) alone is investment grade; anything rated below it is high-yield

Bonds rated BBB/Baa and higher are considered investment grade, while those rated BB/Ba and lower are non-investment grade or high-yield. The cutoff is based on rating, not on coupon level or the mere absence of a rating.

If a rating agency downgrades a company's bonds, the most likely immediate effect on those existing bonds is that their:

• a.Coupon rates automatically increase
• b.Prices rise as demand increases
• c.Prices fall and their yields rise✓
• d.Maturity dates are shortened

A downgrade signals higher credit risk, so investors demand a higher yield, which pushes the existing bonds' prices down. Coupons are fixed and do not change, and a downgrade does not shorten maturity.

Credit (default) risk refers to the possibility that:

• a.The investor will have to reinvest coupon payments at a lower market rate
• b.Market interest rates will rise and push the bond's price down
• c.Inflation will erode the purchasing power of the coupon payments
• d.The issuer will fail to make timely interest or principal payments✓

Credit or default risk is the chance that the bond issuer cannot make its promised interest or principal payments on time. Rising rates describe interest-rate risk, lower reinvestment rates describe reinvestment risk, and eroding purchasing power describes inflation risk.

An investor holds long-term bonds and worries that rising market interest rates will reduce their price. This concern describes:

• a.Market liquidity risk
• b.Reinvestment risk
• c.Issuer credit risk
• d.Interest-rate risk✓

Interest-rate risk is the danger that rising market rates will lower the price of existing fixed-rate bonds, and it is greatest for long-term bonds. Credit risk relates to default, liquidity risk to selling quickly, and reinvestment risk to reinvesting cash flows at lower rates.

When interest rates fall, an investor who owns a callable bond faces the risk that the bond will be called and the proceeds must be reinvested at lower rates. This combined concern is BEST described as:

• a.Currency risk (exchange rate exposure)
• b.Purchasing-power risk (the risk of inflation)
• c.Credit risk (the risk the issuer defaults)
• d.Call risk (leading to reinvestment risk)✓

When rates fall, issuers often call bonds to refinance cheaper, forcing the investor to reinvest the returned principal at the now-lower market rates, so call risk gives rise to reinvestment risk. This is unrelated to inflation, default, or exchange rates.

An investor holding fixed-rate bonds during a period of rising inflation is MOST concerned about:

• a.Legislative risk from a new tax law
• b.Liquidity risk in a thin secondary market
• c.Purchasing-power (inflation) risk✓
• d.Business risk from weak company earnings

Purchasing-power or inflation risk is the danger that rising prices will erode the real value of a bond's fixed interest and principal payments. Liquidity, legislative, and business risks describe unrelated concerns about selling, law changes, and company operations.

An investor wants to sell a thinly traded municipal bond quickly but can only do so by accepting a much lower price. This difficulty illustrates:

• a.Bond issuer credit (default) risk
• b.Coupon reinvestment (rate) risk
• c.Liquidity (marketability) risk✓
• d.Interest-rate risk on long bonds

Liquidity or marketability risk is the danger that an investor cannot sell a security quickly at a fair price, which is common with thinly traded bonds. It is distinct from interest-rate, credit, and reinvestment risk, which concern price sensitivity, default, and reinvesting cash flows.

Which type of risk can an investor most effectively reduce through diversification across many different securities?

• a.Inflation (purchasing-power) risk
• b.Interest-rate (price) risk on bonds
• c.Unsystematic (business/specific) risk✓
• d.Market (systematic, economy-wide) risk

Unsystematic risk is specific to a single company or industry and can be greatly reduced by holding a diversified portfolio. Market, interest-rate, and inflation risks are systematic and affect the whole market, so diversification cannot eliminate them.

Market (systematic) risk is best described as the risk that:

• a.A particular stock will be hard to sell quickly at a fair price in a thin market
• b.A single company's management will run its operations poorly and lose market share
• c.Broad market declines will affect nearly all securities regardless of the individual issuer✓
• d.A specific bond issuer will default and miss both its scheduled interest and principal payments

Market or systematic risk affects the entire market from broad factors like recessions or rate shifts, so it cannot be diversified away. Company mismanagement is business risk, issuer default is credit risk, and difficulty selling is liquidity risk.

An investor buys a short-term bond and, when it matures, can only reinvest the proceeds at a lower interest rate than before. This describes:

• a.Default (credit) risk
• b.Call redemption risk
• c.Exchange rate risk
• d.Reinvestment risk✓

Reinvestment risk is the danger that maturing principal or coupon payments must be reinvested at lower prevailing rates, reducing future income. It differs from call risk (early redemption), credit risk (default), and currency risk (exchange rates).

Compared with a long-term bond, a short-term bond of the same issuer generally has:

• a.Higher interest-rate risk and higher purchasing-power risk
• b.Identical interest-rate risk and reinvestment risk
• c.Lower interest-rate risk but higher reinvestment risk✓
• d.Higher interest-rate risk but lower reinvestment risk

Short-term bonds have less price sensitivity to rate changes (lower interest-rate risk) but must be reinvested sooner, exposing the investor to more reinvestment risk. Longer bonds show the opposite trade-off, so the risks are not identical.

An investor buys an ADR of a European company. Even if the company performs well, the investor's dollar return can be reduced by:

• a.Bond call (early redemption) risk
• b.Mortgage pool prepayment risk
• c.Currency (exchange-rate) risk✓
• d.Bond reinvestment rate risk

Because the ADR's value is tied to a foreign stock, a decline in the foreign currency relative to the dollar can lower the investor's dollar-denominated return even if the company does well. Reinvestment, call, and prepayment risks apply to bonds, not this equity currency exposure.

Which statement about the risk-return relationship of common stock versus corporate bonds of the same company is generally TRUE?

• a.Common stock offers a guaranteed rate of return, unlike the company's bonds, which may default
• b.Bonds rank behind common stock in a bankruptcy liquidation, so bondholders are paid last
• c.Common stock typically carries higher risk and higher potential return than the company's bonds✓
• d.Bonds outperform the company's stock in any year in which reported earnings decline

Common stock is a residual claim with no fixed payment and last priority in bankruptcy, so it carries higher risk and higher potential return than the same company's bonds. Bonds do not always outperform, stock returns are not guaranteed, and bonds rank ahead of stock in bankruptcy.

A stock's par value on the balance sheet primarily represents:

• a.An arbitrary accounting value assigned to each share, unrelated to market price✓
• b.The current market price at which the stock most recently traded today
• c.The guaranteed price at which the company promises to repurchase the shares on demand
• d.The minimum annual dividend the company is required to pay on each share

For common stock, par value is an arbitrary bookkeeping figure with little relation to the share's actual market price. It is not the market price, a repurchase guarantee, or a required dividend.

Banker's acceptances are money-market instruments most commonly used to finance:

• a.Long-term corporate plant expansion financed over twenty years
• b.International trade transactions such as imports and exports✓
• c.The federal government's budget deficit through Treasury auctions
• d.Municipal water and sewer infrastructure construction projects

A banker's acceptance is a short-term, bank-guaranteed instrument that facilitates international trade by financing goods in transit for importers and exporters. It is not used for long-term expansion, municipal projects, or federal deficits.

An investor seeking regular income with more safety than common stock, but a higher fixed payment priority, would MOST likely choose:

• a.Stock rights of the same company
• b.Additional common shares
• c.Warrants of the same company
• d.The company's preferred stock✓

Preferred stock pays a fixed dividend and ranks ahead of common stock for dividends and in liquidation, offering steadier income with more priority than common. Warrants and rights are speculative equity instruments, and more common stock would not add income priority.

Which feature is characteristic of an open-end investment company (mutual fund)?

• a.It continuously issues new shares and redeems them at net asset value✓
• b.It issues a fixed number of shares in a single one-time offering
• c.It trades on an exchange at prices set purely by supply and demand
• d.It holds a fixed, unmanaged portfolio of bonds until a termination date

An open-end fund continuously offers new shares to the public and stands ready to redeem outstanding shares at their net asset value. Because purchases and redemptions occur at NAV rather than on an exchange, the number of shares outstanding constantly changes. This structure is defined under the Investment Company Act of 1940.Investment Company Act of 1940

A mutual fund has total assets of $50 million, total liabilities of $2 million, and 4 million shares outstanding. What is the net asset value (NAV) per share?

• a.$13.00
• b.$12.00✓
• c.$12.50
• d.$10.00

NAV per share equals (total assets minus total liabilities) divided by shares outstanding: ($50,000,000 - $2,000,000) / 4,000,000 = $12.00. NAV is the price at which shares are redeemed and, for a no-load fund, purchased.Investment Company Act of 1940

An investor plans to make a large lump-sum investment and hold it for 20 years. Which mutual fund share class is generally most cost-effective for this investor?

• a.Any class, because the total cost of every share class is identical over 20 years
• b.Class C shares, because the level 12b-1 fee is cheapest for long holding periods
• c.Class A shares, because of front-end breakpoint discounts and lower ongoing fees✓
• d.Class B shares, because the contingent deferred sales charge is waived immediately

Class A shares charge a front-end sales load but offer breakpoint discounts on large purchases and typically carry the lowest ongoing 12b-1 fees. For a large, long-term investment, the reduced annual expenses usually outweigh the up-front charge, making Class A the most economical choice.FINRA Rule 2341

Class B mutual fund shares are best described as shares that:

• a.Are no-load shares whose distribution costs the adviser pays from its own management fee
• b.Carry a contingent deferred sales charge that declines over time and often convert to Class A✓
• c.Charge a front-end sales load deducted from each payment at the time of purchase
• d.Are sold only to institutional investors at net asset value with no sales charge or annual 12b-1 fee

Class B shares impose a contingent deferred sales charge (CDSC), or back-end load, that is paid if shares are redeemed within a certain number of years and declines the longer they are held. They usually carry higher 12b-1 fees than Class A and often convert to Class A shares after the CDSC period ends.FINRA Rule 2341

An investor wants to invest a modest amount for only about two to three years. Which share class is often most appropriate?

• a.Class A shares, because the front-end breakpoint discount is largest on small buys
• b.Class C shares, because of no front-end load and a short-lived, small back-end charge✓
• c.Class B shares, to benefit from the long declining CDSC schedule over six years
• d.No-load shares, which FINRA prohibits for holding periods under five years

Class C shares typically carry no front-end load and only a small contingent deferred sales charge that lapses after about one year, but they have a higher ongoing 12b-1 fee. For a small, short-term investment, avoiding the front-end load makes Class C often more suitable than Class A or B.FINRA Rule 2341

A Letter of Intent in a mutual fund purchase allows an investor to:

• a.Convert Class C shares into Class A shares automatically after the first 13 months
• b.Redeem Class B shares at any point without ever paying a contingent deferred sales charge
• c.Qualify now for a breakpoint discount by pledging to invest a set amount within 13 months✓
• d.Receive a guaranteed minimum rate of return from the fund over the 13-month period

A Letter of Intent (LOI) lets an investor obtain the reduced sales charge of a breakpoint immediately by agreeing to invest the required amount within 13 months. If the investor fails to reach the target, the fund adjusts the sales charge on the shares already purchased. An LOI may be backdated up to 90 days.Investment Company Act of 1940

Breakpoints on Class A shares reduce the sales charge based on the size of the investment. Which of the following would typically qualify a purchase for a breakpoint discount?

• a.A registered representative splitting one large order into several smaller tickets across days
• b.Buying just below the breakpoint amount so the client avoids the extra paperwork and delay
• c.Combining the accounts of several unrelated clients of the same representative to reach the threshold
• d.A single investor's purchase, together with holdings by their spouse and dependent children, reaching the threshold✓

Breakpoint discounts apply based on the total investment made by a single account, including purchases combined across an individual, their spouse, and dependent children. Combining unrelated investors is not permitted, and deliberately selling just below a breakpoint (breakpoint selling) is a violation.Investment Company Act of 1940

A registered representative recommends that a client invest $24,000, an amount just under a $25,000 breakpoint, so the transaction avoids reduced sales charges. This practice is known as:

• a.Breakpoint selling✓
• b.A combination privilege
• c.Dollar-cost averaging
• d.Rights of accumulation

Breakpoint selling is the unethical practice of recommending a purchase just below a breakpoint threshold to earn a higher sales charge, depriving the client of a discount. It is a violation of FINRA rules. Rights of accumulation and combination privileges, by contrast, are legitimate ways to reach breakpoints.FINRA Rule 2341

Shares of a closed-end investment company:

• a.Trade on an exchange and may sell at a premium or discount to net asset value✓
• b.Are redeemed directly by the fund at net asset value on demand
• c.Are bought and sold at net asset value plus a maximum 8.5% sales load
• d.Represent a fixed, unmanaged portfolio that self-liquidates at maturity

A closed-end fund issues a fixed number of shares in an IPO, after which the shares trade on an exchange or over the counter. Their market price is set by supply and demand and can be above (a premium) or below (a discount) the fund's net asset value, unlike open-end fund shares that transact at NAV.Investment Company Act of 1940

Which statement correctly distinguishes a closed-end fund from an open-end fund?

• a.An open-end fund's shares trade on an exchange at a premium or discount to NAV, while closed-end shares are redeemed by the issuer
• b.A closed-end fund has a fixed number of shares that trade in the secondary market, while an open-end fund issues and redeems shares at NAV✓
• c.Only a closed-end fund may borrow or issue senior securities, since the Investment Company Act bars open-end funds from any leverage
• d.Both types continuously issue new shares and redeem them at net asset value, differing only in the sales charge each may impose

The key structural difference is capitalization: a closed-end fund raises capital once through a fixed share offering, and those shares then trade in the secondary market at market prices. An open-end fund has a variable number of shares that it continuously issues and redeems at net asset value.Investment Company Act of 1940

Which of the following is generally TRUE of an exchange-traded fund (ETF)?

• a.It may not be sold short or purchased on margin in a brokerage account
• b.It trades throughout the day on an exchange at market-determined prices✓
• c.It can only be bought or sold once per day at the closing NAV
• d.It must be actively managed by a portfolio manager to beat an index

ETFs trade intraday on an exchange like a stock, so investors can buy or sell at market prices at any time during the trading session, and shares may be bought on margin or sold short. Many ETFs track an index passively, though some are actively managed. This intraday tradability distinguishes ETFs from open-end mutual funds.Investment Company Act of 1940

An investor wants to place a limit order and trade intraday, and to be able to use stop orders. Compared with a traditional open-end mutual fund, which product better meets these needs?

• a.Neither, because SEC rules bar limit and stop orders on any pooled investment product
• b.A unit investment trust, because units trade like stocks and are repriced each minute by its sponsor
• c.A traditional open-end mutual fund, because its shares are priced continuously during the session
• d.An ETF, because it trades on an exchange throughout the day and supports limit and stop orders✓

Because ETFs trade on exchanges throughout the day, investors can use limit orders, stop orders, and trade at intraday prices. Traditional open-end mutual fund shares are priced only once per day at the next calculated NAV (forward pricing), so intraday order types do not apply to them.Investment Company Act of 1940

A distinguishing feature of a unit investment trust (UIT) is that it:

• a.Holds a fixed portfolio of securities that is not actively managed and has a set termination date✓
• b.Charges a contingent deferred sales load that rises the longer an investor continues to hold the units
• c.Employs an investment adviser who continuously trades the portfolio in an effort to beat a benchmark
• d.Continuously issues and redeems new shares at net asset value each business day like an open-end fund

A UIT is an investment company that buys a fixed portfolio of securities and holds it, without active management, until a predetermined termination date. It issues redeemable units representing an undivided interest in the portfolio and has no board of directors or investment adviser making ongoing trading decisions.Investment Company Act of 1940

When a unit investment trust reaches its predetermined termination date, what typically happens?

• a.The sponsor appoints a new portfolio manager and the trust continues indefinitely
• b.The trust automatically converts into an open-end mutual fund and holders receive fund shares
• c.Unit holders must roll their units into the sponsor's next trust series and may not elect cash
• d.The underlying securities are sold or distributed and proceeds are returned to unit holders✓

A UIT has a fixed life. When it reaches its stated termination date, the trust dissolves: the underlying portfolio is liquidated or distributed and the proceeds are paid to unit holders. This contrasts with a managed fund, which has no set termination date.Investment Company Act of 1940

To qualify for favorable tax treatment as a real estate investment trust (REIT), the entity must distribute to shareholders at least:

• a.100% of its gross rental revenue
• b.50% of its net investment income
• c.90% of its taxable income✓
• d.75% of its capital gains

A REIT that distributes at least 90% of its taxable income to shareholders generally avoids federal income tax at the corporate level on the distributed amount, passing income through to investors. REITs let investors participate in income-producing real estate, and equity REITs own property while mortgage REITs finance it.Securities Act of 1933

An investor wants exposure to real estate that generates income from mortgage interest rather than from owning and renting property. Which product best fits?

• a.A direct participation program in raw land
• b.A mortgage REIT✓
• c.An equity REIT
• d.A UIT of municipal bonds

A mortgage REIT invests in real estate loans and mortgage-backed securities, earning income primarily from the interest on those mortgages. An equity REIT, by contrast, owns and operates income-producing properties, deriving income mainly from rents.Securities Act of 1933

In a fixed annuity, who bears the investment risk?

• a.A separate account run by the insurer's portfolio manager
• b.The annuitant, whose payments vary with market performance
• c.The broker-dealer that sold and services the contract
• d.The insurance company, which guarantees a stated rate of return✓

A fixed annuity guarantees a minimum rate of return and a fixed payout, so the insurance company assumes the investment risk and funds the contract from its general account. Because there is no securities investment risk to the buyer, a fixed annuity is an insurance product and generally not a security.Investment Company Act of 1940

A variable annuity differs from a fixed annuity primarily because the variable annuity:

• a.Is not considered a security under the Securities Act of 1933, so no prospectus is required
• b.Guarantees both the principal and a fixed monthly payment for life from the insurer's general account
• c.Invests premiums in a separate account, so payouts vary with investment performance and the investor bears the risk✓
• d.May be sold by insurance agents holding only a state life license, with no securities registration

A variable annuity invests contributions in a separate account holding subaccounts of securities, so the value and payouts fluctuate with investment performance and the contract owner bears the investment risk. Because of this securities exposure, a variable annuity is both an insurance product and a security, requiring a prospectus and a securities registration to sell.Investment Company Act of 1940

An equity-indexed annuity typically credits interest based on:

• a.A rate that floats each day with short-term Treasury bill yields
• b.The performance of a securities index, subject to a cap and a guaranteed minimum✓
• c.A dividend rate declared each quarter by the insurer's board of directors
• d.The performance of a single variable subaccount the contract owner selects

An equity-indexed (or fixed-indexed) annuity credits interest linked to the return of a market index, such as the S&P 500, but limits the upside with a participation rate or cap and provides a guaranteed minimum return. It sits between a fixed and a variable annuity in risk and reward.Investment Company Act of 1940

A 68-year-old retiree wants guaranteed lifetime income and cannot tolerate any loss of principal. Which product is most suitable?

• a.A leveraged sector ETF
• b.A direct participation program in oil and gas exploration
• c.A variable annuity invested aggressively in equity subaccounts
• d.A fixed annuity providing a guaranteed income stream for life✓

A fixed annuity offers a guaranteed rate and a guaranteed lifetime income stream with no market risk to principal, matching the retiree's need for safety and predictable income. A variable annuity or leveraged ETF exposes principal to market loss, and a DPP is illiquid and speculative, making them unsuitable here.Investment Company Act of 1940

During the pay-in (accumulation) phase of a variable annuity, an investor's contributions purchase:

• a.Accumulation units, whose number is fixed at annuitization to compute annuity units✓
• b.Guaranteed interest certificates that the insurer redeems at par on demand
• c.Shares of the insurer's own common stock held in its general account
• d.Annuity units, whose fluctuating value sets the size of each monthly payout

In the accumulation phase, contributions buy accumulation units whose value fluctuates with the separate account's performance. At annuitization, the accumulated value is converted into a fixed number of annuity units, and the value of each annuity unit then determines the varying monthly payment during the payout phase.Investment Company Act of 1940

Which statement about the two phases of an annuity is correct?

• a.Once annuitized, the contract may be surrendered for a lump sum at any time with no charge or restriction
• b.The annuitization phase comes first and ends at age 59 1/2, when the accumulation phase pays income
• c.Earnings during the accumulation phase are taxed each year as ordinary income at the owner's top rate
• d.The accumulation phase is when money is paid in and grows tax-deferred; the annuitization (payout) phase is when income is paid out✓

An annuity has an accumulation phase, during which contributions are invested and grow tax-deferred, and an annuitization or payout phase, when the accumulated value is converted into an income stream. Taxes on earnings are deferred until withdrawal, and once a contract is annuitized the income election generally cannot be undone.Investment Company Act of 1940

A variable life insurance policy is considered a security because:

• a.It is issued only by federally chartered banks rather than by licensed insurance companies
• b.Its death benefit is fixed at issue by the insurer's general account, apart from subaccount results
• c.It guarantees a fixed minimum cash value and a set rate of return regardless of market results
• d.Its cash value is invested in separate account subaccounts, so it fluctuates with investment performance✓

Variable life insurance places policy cash values in separate account subaccounts of securities, so the cash value and potentially the death benefit vary with investment performance and the policyholder bears investment risk. Because of this securities exposure, variable life is regulated as both insurance and a security, requiring a prospectus and securities registration to sell.Investment Company Act of 1940

The buyer (holder) of a call option has the right to:

• a.Sell the underlying stock at the strike price
• b.Require the writer to buy stock from the holder
• c.Collect a fixed dividend from the underlying issuer
• d.Buy the underlying stock at the strike price✓

A call option gives its buyer the right, but not the obligation, to buy the underlying security at the strike (exercise) price before expiration. Call buyers are generally bullish, profiting if the underlying price rises above the strike plus the premium paid.

An investor who buys a put option is generally:

• a.Neutral, expecting no price movement
• b.Bearish, expecting the underlying price to fall✓
• c.Bullish, expecting the underlying price to rise
• d.Obligated to buy the underlying stock at the strike

The buyer of a put has the right to sell the underlying security at the strike price and profits when the underlying price falls below the strike minus the premium paid. Put buyers are therefore bearish, and they may also buy puts to hedge (protect) a long stock position.

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

• a.Pay the option holder each quarter's dividend until expiration
• b.Do nothing; a writer's duty ends once the call goes out of the money
• c.Deliver (sell) the underlying stock at the strike if the holder exercises✓
• d.Buy the underlying stock at the strike price if the holder exercises

A call writer receives the premium and, in exchange, is obligated to sell (deliver) the underlying security at the strike price if the holder exercises the call. The writer is bearish to neutral and faces potentially unlimited loss on an uncovered (naked) call as the stock price rises.

An investor writes (sells) a put option. This investor:

• a.Is obligated to buy the stock at the strike price if exercised, and is generally bullish to neutral✓
• b.Profits most when the stock falls sharply below the strike, since the premium grows with the decline
• c.Holds the right, but not the obligation, to sell the stock at the strike price until expiration
• d.Has unlimited profit potential, since the gain keeps growing as the stock price falls toward zero

A put writer receives a premium and takes on the obligation to buy the underlying stock at the strike price if the holder exercises. The writer profits if the stock stays above the strike (the put expires worthless) and is therefore bullish to neutral; the maximum loss occurs if the stock falls toward zero.

A call option with a strike price of $50 is held while the underlying stock trades at $57. This call is:

• a.At-the-money
• b.In-the-money by $7✓
• c.Out-of-the-money by $7
• d.Worthless because it is past expiration

A call is in-the-money when the stock price is above the strike price. Here the stock at $57 exceeds the $50 strike by $7, so the call has $7 of intrinsic value. A call is out-of-the-money when the stock is below the strike and at-the-money when the two are equal.

A put option with a strike price of $40 is held while the underlying stock trades at $45. This put is:

• a.In-the-money by $85
• b.In-the-money by $5
• c.At-the-money at $40
• d.Out-of-the-money by $5✓

A put is in-the-money when the stock is below the strike and out-of-the-money when the stock is above the strike. Here the $45 stock is above the $40 strike, so the put is out-of-the-money by $5 and has no intrinsic value; exercising it would make no economic sense.

When the market price of the underlying stock exactly equals the strike price, both a call and a put on that stock are said to be:

• a.Automatically exercised at the strike price
• b.In-the-money, with positive intrinsic value
• c.Worthless and immediately delisted by the exchange
• d.At-the-money, with zero intrinsic value✓

An option is at-the-money when the underlying market price equals the strike price. In that case the option has no intrinsic value; any premium is entirely time value. Both calls and puts on the same underlying are at-the-money simultaneously when price equals strike.

An option premium is composed of:

• a.Intrinsic value plus time value✓
• b.Strike price plus expected dividends
• c.Time value and volatility only
• d.Intrinsic value at expiration only

An option's premium equals its intrinsic value (the amount by which it is in-the-money) plus its time value (the extra amount reflecting the time remaining until expiration and volatility). An out-of-the-money option has zero intrinsic value, so its entire premium is time value, which erodes as expiration approaches.

An investor owns 100 shares of a stock and sells one call option against those shares. This strategy is:

• a.A covered call, used to generate income and modestly hedge✓
• b.A protective put, used to insure the shares against a decline
• c.A naked call, written without owning any of the underlying shares
• d.A long straddle, a call and a put bought at one strike

Writing a call against stock already owned is a covered call. The investor collects the premium as income and gains slight downside cushion, but caps upside gains at the strike price because the shares may be called away. It is a common income strategy in a neutral to mildly bullish outlook.

An investor holds a long stock position and buys a put on that stock to limit downside risk. This is known as:

• a.A protective put (a hedge)✓
• b.A bullish call spread
• c.Writing an uncovered put
• d.Writing a covered call

Buying a put while owning the underlying stock is a protective put, functioning like insurance: if the stock falls, the put gains value and limits the loss, while the upside on the stock remains open (less the premium paid). It is a hedging strategy for a bullish investor worried about a near-term decline.

What is the maximum loss for the buyer of a call option?

• a.The premium paid✓
• b.The strike price times 100
• c.The difference between strike and market price
• d.Unlimited

The most a call buyer can lose is the premium paid, which occurs if the option expires out-of-the-money and worthless. This limited, defined risk is a key attraction of buying options, while the potential gain on a long call is theoretically unlimited as the stock rises.

What is the maximum gain for the writer of a put option?

• a.The difference between strike and zero
• b.The premium received✓
• c.The strike price times 100
• d.Unlimited

A put writer's maximum gain is the premium received, realized when the put expires out-of-the-money (the stock stays at or above the strike). The writer's risk, however, is substantial: if the stock falls to zero, the loss equals the strike price minus the premium, times the contract size.

An investor buys one XYZ call with a $30 strike for a $2 premium. At expiration XYZ trades at $35 and the investor exercises. Ignoring commissions, what is the investor's net profit per share?

• a.$0
• b.$3✓
• c.$5
• d.$2

Intrinsic value at expiration is $35 - $30 = $5 per share. Subtracting the $2 premium paid gives a net profit of $3 per share (or $300 on the 100-share contract). The breakeven point on a long call is the strike plus the premium, here $32.

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

• a.The full faith, credit, and taxing power of the issuing municipality✓
• b.An unconditional repayment guarantee from the federal government
• c.The corporate profits of the private company operating the project
• d.Net revenue collected from a specific facility such as a toll road or an airport

A GO bond is secured by the issuer's full faith and credit, meaning its ability to levy taxes (such as property taxes) to repay the debt. Because repayment depends on taxing power rather than a single project's income, GO bonds are often viewed as relatively safe and may require voter approval.MSRB Rules

A revenue bond is distinguished from a general obligation bond because a revenue bond is repaid from:

• a.A federal subsidy indexed to inflation and paid out by the Treasury
• b.The income generated by the specific project or facility it finances✓
• c.Annual appropriations from the state's general fund, subject to a vote
• d.Ad valorem property taxes the city levies on assessed valuations

A revenue bond is serviced solely by the revenue produced by the facility it finances, such as a toll road, airport, or utility. Because repayment depends on that project's income rather than the issuer's taxing power, revenue bonds are generally considered somewhat riskier than GO bonds and do not usually require voter approval.MSRB Rules

A primary tax advantage of most municipal bonds is that their interest is:

• a.Fully deductible from the investor's gross income
• b.Taxed at a reduced capital gains rate
• c.Exempt from all state and local taxes for every investor
• d.Generally exempt from federal income tax✓

Interest on most municipal bonds is generally exempt from federal income tax, which is their principal tax benefit. Interest may also be exempt from state and local taxes for residents of the issuing state (potentially triple tax-exempt). This federal exemption makes munis especially attractive to investors in high tax brackets.MSRB Rules

For which investor is a tax-exempt municipal bond generally MOST suitable?

• a.A low-income investor who holds the bond inside a tax-deferred traditional IRA rollover account
• b.A young investor who is seeking maximum long-term capital growth from a diversified equity portfolio
• c.A high-income investor in a high federal tax bracket holding the bond in a taxable account✓
• d.A tax-exempt pension fund that already owes no federal income tax on its investment earnings

Municipal bonds are most beneficial to investors in high tax brackets who hold them in taxable accounts, because the federal tax exemption raises their after-tax yield relative to taxable bonds. Placing munis in a tax-deferred account (like an IRA) or a tax-exempt entity wastes the tax benefit, and growth-seekers are better served by equities.MSRB Rules

A municipal bond described as 'triple tax-exempt' provides interest that is free from:

• a.State and local income taxes but not from federal income tax
• b.Federal income tax and the alternative minimum tax, but not state or local tax
• c.Federal, state, and local income taxes for residents of the issuing state✓
• d.Federal income tax, capital gains tax, and federal estate tax

'Triple tax-exempt' means the bond's interest escapes federal income tax as well as state and local income taxes, which typically applies when an investor lives in the state (and sometimes locality) issuing the bond. Capital gains from selling a muni are still taxable, so the exemption applies to interest, not to gains.MSRB Rules

A city wants to finance a new municipal water and sewer system, and plans to repay bondholders only from the fees charged to users of that system. Which type of bond is this?

• a.A U.S. Treasury bond
• b.A revenue bond✓
• c.A general obligation bond
• d.A corporate debenture

Because repayment comes solely from the user fees generated by the water and sewer facility rather than from tax revenue, this is a revenue bond. A general obligation bond would instead be backed by the city's taxing power and typically require voter approval.MSRB Rules

A key tax feature of a direct participation program (DPP) is that it:

• a.Passes income, gains, losses, and deductions directly through to the investors✓
• b.Guarantees each investor a fixed quarterly dividend regardless of the program's results
• c.Provides interest income exempt from both federal and state income tax
• d.Is taxed as a C corporation, paying income tax at the entity level

A DPP, typically structured as a limited partnership, is a flow-through (pass-through) entity: it pays no tax at the entity level, and its income, gains, losses, and deductions flow directly to the investors' individual tax returns. This flow-through of tax items, along with potential deductions, is a defining feature of DPPs.

In a direct participation program organized as a limited partnership, the limited partners:

• a.Manage the day-to-day operations of the partnership's business
• b.Have liability limited to the amount of their investment✓
• c.Guarantee the general partner's obligations to lenders
• d.Are personally liable for all debts of the partnership

Limited partners are passive investors whose liability is limited to their invested capital, and they do not take part in day-to-day management. The general partner runs the business and bears unlimited liability. This limited liability, combined with pass-through taxation, defines the limited partnership structure of most DPPs.

Which of the following is a common type of direct participation program?

• a.A real estate limited partnership✓
• b.A U.S. Treasury note
• c.An open-end money market mutual fund
• d.A federally insured bank certificate of deposit

Common DPPs include real estate, oil and gas, and equipment-leasing limited partnerships, which let investors participate directly in the cash flow and tax consequences of the underlying venture. CDs, money market funds, and Treasuries are not DPPs because they lack the direct pass-through partnership structure.

Which is a primary risk that a registered representative should disclose about most direct participation programs?

• a.Their principal is federally guaranteed against loss by the SEC
• b.They are illiquid, with limited or no secondary market for the interests✓
• c.Their interests trade actively on a national securities exchange each day
• d.They provide a guaranteed monthly income to every limited partner

DPP interests are generally illiquid because there is little or no active secondary market, so investors may be unable to sell readily and should plan to hold for the long term. Combined with their speculative nature and reliance on the general partner, illiquidity makes DPPs suitable only for investors who can bear such risks.

Hedge funds are typically sold through private placements and are generally limited to:

• a.Accredited investors and other qualified, sophisticated investors✓
• b.Only tax-exempt charitable foundations and state public pension plans
• c.Investors under age 59 who hold the fund inside a traditional IRA
• d.Any retail investor who signs and returns the fund's prospectus

Hedge funds are usually offered privately under Regulation D of the Securities Act of 1933 and are restricted to accredited or otherwise qualified, sophisticated investors who meet income or net-worth standards. This exemption from full registration reflects the funds' complex, higher-risk strategies and limited disclosure.Securities Act of 1933

Compared with a registered open-end mutual fund, a hedge fund typically:

• a.Offers daily redemption at net asset value to any retail investor who requests it
• b.Is prohibited by the Investment Company Act from charging performance-based fees
• c.Is subject to the same strict leverage and diversification limits as a 1940 Act fund
• d.Uses aggressive strategies, may employ leverage and short selling, and often imposes lock-up periods✓

Hedge funds pursue aggressive, flexible strategies that can include leverage, derivatives, and short selling, and they frequently charge performance-based fees and restrict withdrawals through lock-up periods. Because they are lightly regulated and can be illiquid and high-risk, they suit only sophisticated investors, unlike heavily regulated mutual funds.Securities Act of 1933

Under the forward pricing rule, an order to buy or redeem open-end mutual fund shares is executed at:

• a.A price negotiated between the buyer and the selling dealer
• b.The next NAV calculated after the order is received✓
• c.The average NAV over the prior five business days
• d.The NAV calculated at the previous day's market close

Forward pricing requires that mutual fund purchase and redemption orders be filled at the next net asset value computed after the order is received, typically at the end of that business day. This prevents investors from trading on a stale, already-known price and is required under the Investment Company Act of 1940.Investment Company Act of 1940

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

• a.Federal and state income taxes owed by the fund on its earnings
• b.Ongoing distribution and marketing costs, deducted annually from fund assets✓
• c.A one-time front-end sales charge collected at the time of purchase
• d.The custodian's safekeeping of fund securities and cash balances

A 12b-1 fee is an annual charge, deducted from fund assets, that pays for distribution and marketing expenses such as advertising and compensation to selling brokers. Because it is an ongoing asset-based fee, it raises a fund's expense ratio and reduces investor returns over time; a 'no-load' fund's 12b-1 fee is limited to 0.25%.Investment Company Act of 1940

A mutual fund's expense ratio measures:

• a.Annual operating expenses as a percentage of the fund's average net assets✓
• b.The fund's annual dividend yield based on its net asset value
• c.The front-end sales load as a percentage of the public offering price
• d.The bid-ask spread quoted on the fund's shares in the market

The expense ratio expresses a fund's annual operating costs, including management fees, 12b-1 fees, and administrative expenses, as a percentage of its average net assets. A higher expense ratio directly reduces investor returns, so comparing expense ratios is important when selecting among similar funds.Investment Company Act of 1940

Under the 75-5-10 test, a mutual fund may call itself 'diversified' if, with 75% of its assets, it invests no more than:

• a.10% of assets in any one issuer and owns up to 5% of an issuer's outstanding voting stock
• b.5% of assets in any one issuer and owns no more than 10% of an issuer's voting stock✓
• c.50% of assets in U.S. government securities and no more than 25% in any one issuer
• d.25% of assets in any one issuer, with no limit at all on the voting stock owned

To be labeled diversified under the Investment Company Act of 1940, at least 75% of a fund's assets must be invested so that no more than 5% is in any single issuer and the fund owns no more than 10% of any issuer's voting securities. The remaining 25% is unrestricted, giving the fund some concentration flexibility.Investment Company Act of 1940

A retail money market mutual fund generally seeks to maintain a stable net asset value of:

• a.$1.00 per share✓
• b.$100.00 per share
• c.Whatever the market sets intraday
• d.$10.00 per share

A money market fund invests in short-term, high-quality debt instruments and typically strives to keep a stable $1.00 NAV per share, paying earnings out as dividends. Although generally low risk, money market funds are not federally insured, so a stable value is a goal rather than a guarantee.Investment Company Act of 1940

An investor is concerned that rising interest rates will reduce the value of a fund's holdings. This concern is most relevant to which fund?

• a.An equity growth fund
• b.A commodity fund
• c.A money market fund holding only overnight paper
• d.A long-term bond fund✓

Interest rate risk is the danger that rising rates reduce the market value of existing fixed-income securities, and it is greatest for funds holding long-maturity bonds. A long-term bond fund is therefore the most exposed, while money market funds with very short maturities have minimal interest rate risk.Investment Company Act of 1940

A sector fund that invests almost entirely in technology companies primarily exposes investors to:

• a.Interest rate risk alone, because technology firms borrow heavily
• b.Very low volatility and minimal risk, because technology earnings are stable
• c.Concentration risk, because performance depends heavily on one industry✓
• d.No market risk at all, because the fund is diversified across dozens of issuers

A sector (specialized) fund concentrates its holdings in a single industry, so investors face higher concentration risk: gains and losses hinge on the fortunes of that one sector rather than being spread across the broader market. This can boost returns when the sector thrives but magnifies losses when it declines.Investment Company Act of 1940

An index fund is designed to:

• a.Guarantee a fixed annual return to shareholders no matter how the broad market performs
• b.Outperform its benchmark by having a manager actively select undervalued stocks each year
• c.Match the performance of a specific market index by holding its component securities✓
• d.Invest only in short-term money market instruments that mature within thirteen months

An index fund follows a passive strategy, holding the securities that make up a target index (such as the S&P 500) in order to track that index's return rather than beat it. This passive approach typically results in lower turnover and lower expense ratios than actively managed funds.Investment Company Act of 1940

Under FINRA rules, the maximum sales charge on the purchase of open-end mutual fund shares generally may not exceed:

• a.6.25% of the offering price
• b.5.0% of NAV
• c.7.0% of NAV
• d.8.5% of the offering price✓

FINRA limits the maximum sales charge on mutual fund shares to 8.5% of the public offering price. To charge the full 8.5%, a fund must offer certain shareholder benefits such as breakpoints, rights of accumulation, and dividend reinvestment at NAV; otherwise the maximum is lower.FINRA Rule 2341

When an investor redeems open-end mutual fund shares, the fund must generally send payment within:

• a.Ninety days
• b.Seven days✓
• c.One day
• d.Thirty days

Under the Investment Company Act of 1940, an open-end fund must redeem shares at NAV and pay the proceeds within seven days of receiving the redemption request. This redeemability at NAV is a defining feature of open-end funds and provides investors with reliable liquidity.Investment Company Act of 1940

Rights of accumulation allow a mutual fund investor to:

• a.Redeem accumulated shares free of any capital gains tax once they have been held over one year
• b.Count the current value of existing holdings toward reaching a breakpoint on new purchases✓
• c.Buy Class B shares at the Class A price with no contingent deferred sales charge on redemption
• d.Receive fund dividends in cash at a reduced tax rate instead of reinvesting them in new shares

Rights of accumulation let an investor qualify for a breakpoint (reduced sales charge) by adding the current value of shares already owned to a new purchase. Unlike a Letter of Intent, there is no time limit and no obligation to invest a set future amount; the benefit accrues as holdings grow.Investment Company Act of 1940

When a customer purchases newly issued open-end mutual fund shares, the customer must be provided:

• a.A research report from an independent analyst
• b.Nothing, because mutual funds are exempt from disclosure
• c.A signed suitability guarantee from the fund manager
• d.A current prospectus, at or before the sale✓

Because open-end mutual fund shares are continuously issued as new securities, they must be sold with a current prospectus delivered at or before the completion of the sale, as required under the Securities Act of 1933. The prospectus discloses the fund's objectives, risks, fees, and expenses so the investor can make an informed decision.Securities Act of 1933

The taxable-equivalent yield of a municipal bond is used to:

• a.Compare a tax-exempt muni yield to the pre-tax yield a taxable bond must offer to be equally attractive✓
• b.Determine the bond's yield to maturity after subtracting the dealer's markup from the purchase price
• c.Calculate the state and local income tax a nonresident investor owes on out-of-state municipal interest
• d.Measure the bond's after-tax yield by subtracting the federal income tax owed on each coupon payment

Taxable-equivalent yield converts a tax-free municipal yield into the higher pre-tax yield a taxable bond would need in order to leave an investor with the same after-tax return. It lets an investor compare munis and taxable bonds on an apples-to-apples basis, and the higher the investor's tax bracket, the larger the advantage of the muni.

Interest paid on most general obligation municipal bonds is:

• a.Exempt from federal income tax✓
• b.Subject to federal capital gains tax as it is received
• c.Fully taxable at the federal level but exempt from state tax
• d.Taxed only if the bond is sold before maturity

The interest (coupon) on most municipal bonds is exempt from federal income tax, which is their primary appeal. It may also be exempt from state and local tax for residents of the issuing state. Capital gains on munis, however, remain taxable.

A 'bank-qualified' municipal bond is one that:

• a.Is guaranteed by a commercial bank rather than by a municipal bond insurer
• b.Automatically qualifies for the highest credit rating from the rating agencies
• c.May be purchased only by federally chartered commercial banks and thrifts
• d.Is issued by a small issuer and gives banks a partial tax advantage on the cost of carrying it✓

A bank-qualified municipal bond is issued by an issuer that reasonably expects to sell no more than a set annual amount of tax-exempt debt. This designation lets banks deduct a portion of the interest cost of carrying the bonds, making the bonds more attractive to banks and often lowering the issuer's borrowing cost.

A 529 college savings plan offers which key federal tax benefit?

• a.Earnings grow tax-deferred and qualified education withdrawals are federally tax-free✓
• b.Withdrawals are federally tax-free after five years, whatever the money buys
• c.Earnings are taxed annually at a reduced federal rate of 10% on gains
• d.Contributions are deductible on the federal income tax return up to $2,000

In a 529 plan, contributions are made with after-tax dollars, but earnings grow tax-deferred and withdrawals used for qualified education expenses are free from federal income tax. Nonqualified withdrawals of earnings are taxed and generally hit with a 10% penalty.

An ABLE account is designed primarily to:

• a.Fund private K-12 tuition and college costs for any family regardless of income, with the same deduction as a 529 plan
• b.Replace an employer 401(k) for self-employed persons by allowing unlimited pre-tax salary deferrals each year
• c.Let eligible individuals with disabilities save tax-advantaged funds for disability expenses without losing certain benefits✓
• d.Provide tax-free retirement income to any worker over age 50 who has already used up the annual IRA limits

An ABLE (Achieving a Better Life Experience) account lets eligible individuals whose disability began before a set age save and invest money that grows tax-deferred, with tax-free withdrawals for qualified disability expenses. Balances up to a threshold do not disqualify the beneficiary from means-tested benefits such as Medicaid or SSI.

The debt service on a municipal revenue bond is paid from:

• a.The income produced by the specific project or facility that the bond financed✓
• b.Ad valorem property taxes levied by the issuer on the assessed value of local real estate
• c.The general fund appropriated each year by the state legislature in its annual budget
• d.Federal grants earmarked for the issuing municipality by a specific act of Congress

A revenue bond is self-supporting: it is repaid solely from the revenue (user fees, tolls, or charges) generated by the facility it financed, such as an airport, toll bridge, or utility. Because repayment depends on that project's success rather than broad taxing power, revenue bonds typically carry somewhat more credit risk than GO bonds.

Which agency mortgage security is backed by the full faith and credit of the U.S. government?

• a.Freddie Mac (FHLMC) participation certificates
• b.Ginnie Mae (GNMA) pass-throughs✓
• c.Fannie Mae (FNMA) pass-throughs
• d.Private-label mortgage bonds

Ginnie Mae (GNMA) is a government-owned corporation, and its pass-through securities carry the explicit full faith and credit guarantee of the U.S. government. Fannie Mae and Freddie Mac are government-sponsored enterprises (GSEs) whose securities are NOT directly backed by the U.S. government's full faith and credit.

Fannie Mae (FNMA) is best described as a:

• a.Private hedge fund that trades Treasury bonds for wealthy accredited investors
• b.Government-sponsored enterprise that buys mortgages and issues mortgage-backed securities✓
• c.Federal agency wholly owned by the U.S. Treasury and directly backed by its full faith and credit
• d.Municipal issuer whose tax-exempt housing bonds fund state and local agencies

Fannie Mae is a publicly traded government-sponsored enterprise (GSE) that purchases mortgages from lenders and packages them into mortgage-backed securities. Its securities are not directly guaranteed by the U.S. government, so they typically yield slightly more than Treasuries or Ginnie Maes to compensate for the modestly higher perceived risk.

Freddie Mac (FHLMC) primarily:

• a.Issues short-term Treasury bills on behalf of the federal government to fund the deficit
• b.Purchases mortgages and issues mortgage-backed securities to support the secondary mortgage market✓
• c.Sets the federal funds target rate at the Federal Open Market Committee's meetings
• d.Insures bank deposits up to the $250,000 FDIC limit at each insured institution

Freddie Mac is a government-sponsored enterprise that buys mortgages, mainly from thrift institutions, and pools them into mortgage-backed securities. Like Fannie Mae, it adds liquidity to the secondary mortgage market, and its securities are not directly backed by the U.S. government's full faith and credit.

Compared with U.S. Treasury securities, GSE agency securities such as FNMA debentures generally offer:

• a.A slightly higher yield to compensate for the absence of a direct full-faith-and-credit guarantee✓
• b.A complete exemption from federal income tax on all of the interest paid to investors
• c.Exactly the same yield, because both are treated as direct obligations of the U.S. Treasury
• d.A lower yield because their principal and interest payments are federally insured to the FDIC limit

GSE securities are not directly guaranteed by the U.S. government, so investors demand a slightly higher yield than on comparable Treasuries to compensate for the marginally higher credit risk. Both are still considered very high quality, but the yield spread reflects the difference in backing.

A collateralized mortgage obligation (CMO) is:

• a.A share of common stock issued by a mortgage banking company that originates residential home loans
• b.A Treasury security that pays a fixed semiannual coupon and carries the full faith and credit of the U.S. government
• c.A single municipal revenue bond secured by the real estate taxes levied within the issuing district
• d.A security backed by a pool of mortgages and divided into tranches with different maturities and risk levels✓

A CMO takes a pool of mortgages (or mortgage-backed securities) and redistributes the principal and interest into separate classes called tranches. Each tranche has a different expected maturity and exposure to prepayment risk, letting investors choose the cash-flow profile that fits their needs. CMOs are backed by mortgages, not by the direct full faith and credit of the U.S. government.

In a CMO, the different tranches primarily allow investors to:

• a.Select a class with a prepayment and maturity profile matching their goals✓
• b.Receive monthly mortgage interest that is exempt from federal income tax
• c.Convert the tranche into shares of the issuing agency's common stock
• d.Avoid interest rate risk entirely, because the tranches are Treasury-guaranteed

CMO tranches channel mortgage prepayments to different classes in a set order, so each tranche has a distinct average life and prepayment exposure. An investor wanting more predictable, shorter cash flows can choose an earlier tranche, while one seeking higher yield can accept a later, more prepayment-sensitive tranche. This structure tailors risk, but does not remove interest rate risk.

Treasury STRIPS are best described as:

• a.Short-term Treasury bills sold at face value that pay a fixed coupon every six months
• b.Municipal bonds that have had their federal tax exemption stripped away by the state or city that issued them
• c.Zero-coupon securities created by separating the interest and principal payments of Treasury notes and bonds✓
• d.Floating-rate agency notes whose coupon resets periodically against a short-term rate

STRIPS (Separate Trading of Registered Interest and Principal of Securities) are created when a Treasury security's coupon and principal payments are separated and sold individually as zero-coupon instruments. Each STRIP is bought at a discount and pays face value at maturity, with no periodic interest. They are backed by the U.S. government but carry phantom (imputed) taxable income each year.

U.S. Treasury bills (T-bills) are:

• a.Perpetual securities that have no stated maturity date and keep paying interest to the holder forever
• b.Short-term securities issued at a discount and maturing at face value, paying no periodic coupon✓
• c.Long-term bonds that pay semiannual coupons for as long as thirty years to maturity
• d.Tax-exempt municipal securities issued by state and local governments to fund projects

T-bills are short-term U.S. government obligations with maturities of one year or less. They pay no periodic interest; instead they are sold at a discount to face value, and the investor's return is the difference between the discounted purchase price and the face value received at maturity. They are considered virtually free of credit risk.

The main difference between a Treasury note and a Treasury bond is:

• a.Notes are exempt from federal income tax while bond interest is fully taxable
• b.Their maturity length, with notes maturing in 2 to 10 years and bonds in more than 10 years✓
• c.Notes are backed by the full faith and credit of the government while bonds are not
• d.Notes pay no interest and mature at par while bonds pay a semiannual coupon

Treasury notes and bonds both pay semiannual coupons and are backed by the U.S. government; the key difference is maturity. Notes are issued with maturities of 2 to 10 years, while bonds are issued with maturities greater than 10 years (up to 30 years). Both are subject to interest rate risk that increases with maturity.

Treasury Inflation-Protected Securities (TIPS) protect investors by:

• a.Paying a coupon that is reset each month to the federal funds rate
• b.Adjusting the bond's principal value with changes in the Consumer Price Index✓
• c.Converting into common stock whenever inflation exceeds a 5% threshold
• d.Guaranteeing a real return of at least 3% a year above the coupon

With TIPS, the principal is adjusted up or down based on changes in the Consumer Price Index (CPI). The fixed coupon rate is applied to this adjusted principal, so both interest payments and the final principal repayment rise with inflation. This makes TIPS a direct hedge against purchasing-power (inflation) risk.

A negotiable (jumbo) certificate of deposit differs from an ordinary bank CD mainly because it:

• a.Is fully insured by the FDIC up to $1 million per depositor
• b.Pays the holder no interest until it is redeemed at par
• c.Can be traded in the secondary market before maturity✓
• d.Is a Treasury obligation sold through Fed auctions

A negotiable CD is a large-denomination time deposit (typically $100,000 or more) that can be bought and sold in the secondary market, giving the holder liquidity before maturity. Ordinary retail CDs are non-negotiable and usually charge a penalty for early withdrawal. Amounts above the FDIC limit are not insured, so a negotiable CD carries some credit risk of the issuing bank.

Commercial paper is:

• a.Short-term unsecured corporate debt sold at a discount, typically maturing in 270 days or less✓
• b.Common stock issued by large commercial banks and distributed to investors through their branches
• c.A long-term secured revenue bond issued by a municipality and backed by its full taxing power
• d.A federally guaranteed mortgage security backed by Ginnie Mae pass-through pools of home loans

Commercial paper is a short-term, unsecured promissory note issued by corporations to fund short-term needs such as payroll or inventory. It is usually sold at a discount and matures in 270 days or less, which exempts it from full SEC registration. Because it is unsecured, only financially strong issuers can sell it, and it carries the credit risk of the issuer.

A banker's acceptance (BA) is a money-market instrument most commonly used to finance:

• a.International trade transactions✓
• b.Long-term corporate expansion
• c.Municipal school construction
• d.Long-term federal budget deficits

A banker's acceptance is a time draft that a bank has agreed (accepted) to pay at a future date, effectively guaranteeing payment. Because it substitutes the bank's credit for the buyer's, it is widely used to finance imports and exports where the parties may not know each other's creditworthiness. It trades at a discount in the money market like other short-term instruments.

A structured product is generally:

• a.A share of common stock issued by a finance company that specializes in securitizing mortgage and consumer loan pools
• b.A tax-exempt municipal revenue bond secured solely by the revenues of the specific project that it finances, such as a toll road or an airport terminal
• c.A security whose return is linked to the performance of an underlying asset, index, or basket, often combining a debt instrument with a derivative✓
• d.A plain U.S. government bond that pays a fixed semiannual coupon and returns its par value at maturity, with no derivative

Structured products are pre-packaged investments that typically combine a bond (for principal) with a derivative (for the payoff linked to an index, stock, or commodity). Their return depends on the performance of the reference asset, and they may carry issuer credit risk, complexity, and limited liquidity. They are not simple bonds or equities.

Systematic risk is best described as the risk that:

• a.Is diversified away once a portfolio holds 30 or more issuers
• b.Arises solely from a single bond issuer defaulting on its debt
• c.Affects the entire market and cannot be eliminated through diversification✓
• d.Applies only to a single company because of its own poor management

Systematic risk (also called market risk) affects the whole market or a broad segment of it, driven by factors such as recessions, interest rate changes, or geopolitical events. Because it moves all securities to some degree, it cannot be diversified away. Investors are compensated for bearing systematic risk through expected returns above the risk-free rate.

Unsystematic risk refers to risk that is:

• a.Caused only by rising interest rates across the bond and money markets
• b.Impossible to reduce by diversification, hedging, or any other technique
• c.Common to all securities in the market and driven by recessions and rate shifts
• d.Specific to a single company or industry and can be reduced through diversification✓

Unsystematic risk (also called specific or diversifiable risk) is unique to a particular company or industry, such as a product recall, a lawsuit, or a labor strike. Because these events are not correlated across all firms, holding a diversified mix of securities reduces or nearly eliminates unsystematic risk. What remains after full diversification is systematic (market) risk.

The primary purpose of diversifying a portfolio is to:

• a.Increase the portfolio's beta well above 1.0 so that it outperforms the market in every period
• b.Guarantee a positive return in every calendar year regardless of market conditions
• c.Reduce unsystematic risk by spreading investments across different securities and sectors✓
• d.Eliminate systematic (market) risk along with recession and interest-rate exposure

Diversification spreads money across different companies, industries, and asset classes so that a bad outcome in one holding does not devastate the whole portfolio. This reduces unsystematic (company-specific) risk. It cannot remove systematic risk, which affects the entire market, nor can it guarantee positive returns.

A stock with a beta of 1.5 is expected to:

• a.Move 1.5% for every 1% move in the overall market, making it more volatile than the market✓
• b.Pay a dividend yield 1.5 times the average yield of the overall market each year
• c.Move only half as much as the overall market, because any beta above 1.0 dampens price swings
• d.Be completely uncorrelated with the overall market, moving only on company-specific news

Beta measures a security's volatility relative to the overall market, which has a beta of 1.0. A beta of 1.5 means the stock tends to move 1.5% for each 1% move in the market, so it is more volatile and carries more systematic risk. A beta below 1.0 indicates lower volatility than the market.

Political risk is most relevant to an investor who:

• a.Purchases FDIC-insured bank certificates of deposit at a local branch
• b.Invests in securities of companies operating in countries with unstable governments✓
• c.Holds a broadly diversified portfolio of large U.S. blue-chip common stocks and bonds
• d.Buys short-term U.S. Treasury bills and rolls them over every 13 weeks

Political risk is the danger that a government's actions, such as expropriation, war, or sudden regulatory change, will hurt the value of investments in that country. It is especially significant for investments in emerging or unstable markets. Stable-government instruments such as U.S. Treasuries carry very little political risk.

Legislative (regulatory) risk refers to the possibility that:

• a.A change in law or regulation, such as tax rules, reduces an investment's value✓
• b.Rising market interest rates drive down the prices of outstanding bonds
• c.A foreign currency weakens against the dollar and erodes overseas returns
• d.A company's chief executive resigns and poor management destroys value

Legislative risk is the chance that new laws or regulatory changes will adversely affect an investment. For example, a change to the tax treatment of municipal bond interest could reduce demand and prices. It is distinct from interest rate risk, management risk, and currency risk.

Currency (exchange rate) risk is the risk that:

• a.A bond issuer will miss its scheduled interest payments or fail to repay principal at maturity, placing the issue in default
• b.Changes in exchange rates will reduce the value of a foreign investment when converted back to the investor's home currency✓
• c.A domestic company's earnings will fall because its own management makes poor operating decisions in its home market year after year
• d.Interest rates will rise sharply and push down the market price of outstanding fixed-rate bonds and of preferred shares already issued

Currency risk arises when an investor holds assets denominated in a foreign currency. If that currency weakens against the investor's home currency, the value of the investment falls when converted back, even if the asset performed well locally. This risk is central to international investing and is not present in purely domestic, home-currency holdings.

Liquidity risk is the risk that an investor:

• a.Will have the bond called away by the issuer well before its stated maturity
• b.Will earn less real income because inflation rises faster than the coupon
• c.Cannot sell an investment quickly at or near its fair market value✓
• d.Will lose principal because the issuer defaults on its scheduled payments

Liquidity (marketability) risk is the chance that an investor cannot convert an asset to cash quickly without accepting a significant price concession. Thinly traded securities, such as certain municipal bonds, limited partnerships, or small-cap stocks, carry higher liquidity risk. Highly traded assets like Treasury bills or large-cap stocks have low liquidity risk.

Reinvestment risk is greatest for an investor who:

• a.Buys a growth stock that pays no dividend at any point to its shareholders
• b.Holds a zero-coupon Treasury STRIP, whose accreted interest must be reinvested yearly
• c.Holds idle cash in a checking account that pays no stated interest rate
• d.Receives regular coupon payments during a period of falling interest rates✓

Reinvestment risk is the danger that interest or principal received will have to be reinvested at a lower rate than the original investment. It is greatest for coupon-paying bonds when rates are falling, because each coupon must be reinvested at the new lower rate. Zero-coupon bonds like STRIPS have no interim payments to reinvest, so they avoid reinvestment risk if held to maturity.

An investor holding a 20-year municipal bond faces the greatest interest rate risk because:

• a.Municipal bonds are tax-exempt, so their prices do not react to market interest rates
• b.The bond's coupon rate is variable and resets with each change in rates
• c.Municipal issuers can raise taxes at will, so rate moves are the only risk
• d.The longer the maturity, the more the bond's price falls when interest rates rise✓

Interest rate risk is the tendency of bond prices to fall as market rates rise, and it increases with the length of maturity. A 20-year bond's price is far more sensitive to a rate change than a 2-year bond's. This is a form of systematic risk that affects all fixed-rate bonds, tax-exempt or not.

Credit (default) risk is best measured for a corporate bond by looking at its:

• a.Time to maturity, since bonds maturing past ten years carry a speculative rating
• b.Average daily trading volume, which directly measures issuer creditworthiness
• c.Rating from a nationally recognized statistical rating organization✓
• d.Coupon payment frequency, such as semiannual versus quarterly interest

Credit or default risk is the chance the issuer will fail to make interest or principal payments. Rating agencies such as Moody's, S&P, and Fitch assign ratings (for example, AAA down to below investment grade) that summarize an issuer's creditworthiness. Lower-rated (high-yield or 'junk') bonds carry greater default risk and therefore pay higher yields.

An investor in the 32% federal tax bracket is comparing a municipal bond yielding 4% with a corporate bond. The taxable-equivalent yield of the muni is approximately:

• a.6.25%
• b.5.88%✓
• c.3.04%
• d.4.32%

Taxable-equivalent yield = tax-free yield / (1 - tax rate) = 4% / (1 - 0.32) = 4% / 0.68 = about 5.88%. This means a taxable corporate bond would need to yield roughly 5.88% to match the muni's after-tax return, so the muni is more attractive unless the corporate bond yields more than 5.88%.

A single manufacturer's stock drops after the company loses a major product-liability lawsuit. This loss is an example of:

• a.Purchasing-power (inflation) risk
• b.Unsystematic (company-specific) risk✓
• c.Interest rate (bond price) risk
• d.Systematic (market-wide) risk

A lawsuit affecting one specific company is a company-specific, or unsystematic, risk because it does not stem from broad market forces. This type of risk can be reduced through diversification, since holding many different companies dilutes the impact of any single firm's misfortune. Market-wide events, by contrast, would be systematic risk.

A client wants a government-backed security whose cash flow comes from homeowners' monthly mortgage payments and carries the full faith and credit of the U.S. government. The best fit is:

• a.A six-month U.S. Treasury bill sold at a discount
• b.An unsecured long-term corporate debenture
• c.A municipal revenue bond backed by tolls
• d.A Ginnie Mae (GNMA) pass-through security✓

Ginnie Mae pass-throughs pass monthly principal and interest from a pool of home mortgages through to investors and are backed by the full faith and credit of the U.S. government. T-bills are government-backed but not tied to mortgages, and Fannie/Freddie securities are mortgage-based but lack the direct full-faith-and-credit guarantee. GNMA uniquely satisfies both conditions.

Parents want a tax-advantaged account to save for their child's future college tuition, with tax-free withdrawals for qualified education costs. The most appropriate choice is:

• a.A negotiable jumbo bank CD
• b.An ABLE disability account
• c.A 529 college savings plan✓
• d.A rolling commercial paper program

A 529 plan is designed specifically for education savings, offering tax-deferred growth and tax-free withdrawals for qualified education expenses. An ABLE account is for disability-related expenses, not general college saving, and money-market instruments like CDs or commercial paper provide no education-specific tax benefit. The 529 best fits the stated goal.

A U.S. investor buys a bond denominated in euros. The euro then falls sharply against the dollar. The investor has been hurt primarily by:

• a.Legislative (tax law change) risk
• b.Coupon reinvestment rate risk
• c.Issuer credit (default) risk
• d.Currency (exchange rate) risk✓

When the investor converts euro-denominated interest and principal back into dollars, a weaker euro means fewer dollars, reducing the return even if the bond itself performed as expected. This is currency, or exchange rate, risk, which is inherent in holding foreign-currency assets. It is separate from the issuer's credit quality.

An investor in a GNMA pass-through security is most exposed to prepayment risk when:

• a.Interest rates rise and homeowners keep their mortgages much longer
• b.The security reaches its stated final maturity date and repays par
• c.The issuer defaults on all the underlying mortgage loans in the pool
• d.Interest rates fall and homeowners refinance their mortgages early✓

Prepayment risk is the danger that homeowners will pay off their mortgages early, returning principal to investors sooner than expected. This happens most when interest rates fall and borrowers refinance at lower rates. The investor then must reinvest the returned principal at the new, lower prevailing rates, reducing expected income.

An investor must sell a thinly traded, small-issue municipal bond quickly but can only find a buyer at a price well below fair value. This illustrates:

• a.Liquidity (marketability) risk✓
• b.Credit (issuer default) risk
• c.Coupon reinvestment rate risk
• d.Inflation (purchasing-power) risk

When a security trades infrequently, an investor who needs to sell fast may have to accept a much lower price to attract a buyer. That gap between a quick-sale price and fair value is the hallmark of liquidity, or marketability, risk. It is common in small municipal issues, limited partnerships, and other thinly traded assets.

An investor who wants a portfolio that is LESS volatile than the overall market should favor stocks with:

• a.A beta below 1.0✓
• b.A beta exactly equal to 1.0
• c.A negative dividend yield
• d.A beta above 1.0

Beta measures volatility relative to the market, which has a beta of 1.0. Stocks with a beta below 1.0 tend to move less than the market, so a portfolio built from low-beta stocks is generally less volatile and carries less systematic risk. High-beta stocks (above 1.0) amplify market swings.

Which of the following is a characteristic shared by money-market instruments such as T-bills, commercial paper, and banker's acceptances?

• a.They all pay tax-exempt interest
• b.They are all backed by the full faith and credit of the U.S. government
• c.They all mature in more than 10 years
• d.They are short-term, highly liquid debt instruments✓

Money-market instruments are short-term debt securities (generally maturing in one year or less) that are highly liquid and relatively low risk. T-bills, commercial paper, banker's acceptances, and negotiable CDs are all examples. They differ in issuer and backing, so not all are government-guaranteed or tax-exempt, but all share the short-term, liquid profile.

The ability of a city to repay a general obligation bond depends most directly on its:

• a.Corporate sponsorship and naming-rights fees
• b.Its annual federal transit grant allocation
• c.Net revenue collected from a single toll bridge
• d.Taxing power and overall financial health✓

Because a GO bond is backed by the issuer's full faith and credit, its repayment depends on the municipality's power to levy taxes and on its overall fiscal condition. Analysts review property values, tax collection rates, debt levels, and the local economy. Revenue from a single facility backs a revenue bond, not a GO bond.

A 'double-barreled' municipal bond is one that is backed by:

• a.Guarantees purchased from two separate municipal bond insurance companies
• b.Two different maturity dates within the same bond certificate
• c.Both a specific revenue source and the issuer's general taxing power✓
• d.A federal Treasury guarantee combined with a state guarantee

A double-barreled bond combines features of both a revenue bond and a general obligation bond: it is payable first from a defined revenue source, but is also backed by the issuer's full faith and credit and taxing power if that revenue falls short. This dual backing generally makes it safer than a pure revenue bond.

Municipal notes such as TANs, RANs, and BANs are used primarily to:

• a.Convert into common stock of the municipality after five years
• b.Provide short-term interim financing until longer-term revenue or funds arrive✓
• c.Provide a federally guaranteed retirement benefit to city employees
• d.Offer 30-year permanent financing for major infrastructure projects

Municipal anticipation notes are short-term instruments that bridge timing gaps in a municipality's cash flow. A TAN is repaid from anticipated taxes, a RAN from anticipated revenues, and a BAN from the proceeds of a future long-term bond issue. They mature in a relatively short time and are used for interim, not permanent, financing.

Interest from certain 'private activity' municipal bonds may be:

• a.Exempt from every federal, state, and local tax, including capital gains
• b.Subject to state and local income tax in every state including the issuer's
• c.Taxed at the federal level as ordinary interest income under Section 103
• d.Included as a preference item for the alternative minimum tax (AMT)✓

Some municipal bonds finance private activities and, while their interest is generally exempt from regular federal income tax, that interest can be a preference item that must be added back when computing the alternative minimum tax (AMT). Investors subject to the AMT may therefore owe tax on this otherwise tax-exempt interest, which lowers the bond's after-tax appeal for them.

Some municipal bonds, such as Build America Bonds, are TAXABLE at the federal level because:

• a.They are backed by the full faith and credit of the U.S. Treasury rather than the issuer
• b.They finance religious institutions, which Congress excluded from the exemption
• c.The issuer failed to register the bonds with the SEC before selling them to investors
• d.They were structured to be taxable, often in exchange for a federal interest subsidy to the issuer✓

Not all municipal bonds are tax-exempt. Certain issues, like Build America Bonds, were deliberately structured as taxable to the investor, with the federal government subsidizing part of the issuer's interest cost. Because their interest is taxable, they typically offer higher yields than comparable tax-exempt munis to remain competitive.

A prepaid tuition plan, a type of 529 plan, primarily allows a family to:

• a.Deduct the full contribution from federal income tax in the year it is made
• b.Withdraw funds tax-free for any purpose, including non-education costs
• c.Lock in future tuition at today's prices for eligible institutions✓
• d.Invest in individual stocks and bonds chosen by the account owner

A prepaid tuition plan lets families pay for future college tuition at current rates, hedging against rising tuition costs at participating schools. This differs from a 529 college savings plan, which invests contributions in market-based portfolios whose value fluctuates. Both are 529 plans, but the prepaid version locks in tuition rather than exposing savings to market returns.

An agency debenture issued by a GSE such as the Federal Home Loan Bank is:

• a.An unsecured debt obligation of the agency, backed by its general credit rather than a specific mortgage pool✓
• b.A federally insured bank deposit, protected by the FDIC for up to $250,000 per depositor at each bank
• c.A share of ownership in the agency, carrying voting rights and a claim on its residual profits
• d.A tax-exempt municipal security whose interest is exempt from federal income tax for the holder

Some agency securities are debentures, meaning unsecured bonds backed by the issuing agency's general creditworthiness rather than a pool of mortgages. They are considered high quality but, as GSE obligations, they are not directly guaranteed by the U.S. government, so they yield slightly more than Treasuries. They differ from mortgage-backed pass-throughs, whose cash flow comes from underlying loans.

A key risk unique to owning a CMO compared with a plain Treasury bond is:

• a.Currency risk, because the underlying mortgage payments arrive in foreign currency
• b.The complete absence of interest rate risk in every tranche of the CMO deal
• c.Exemption from all federal income tax on the interest that is received
• d.Prepayment (extension and contraction) risk from the underlying mortgages✓

Because a CMO's cash flows come from a pool of mortgages, its actual maturity depends on how fast homeowners prepay. When rates fall, prepayments speed up (contraction risk); when rates rise, prepayments slow and the CMO's life extends (extension risk). A plain Treasury bond has a fixed maturity and no such prepayment uncertainty.

An investor holding long-term fixed-rate bonds is most concerned about purchasing-power risk, which means:

• a.Inflation may erode the real value of the fixed interest payments over time✓
• b.The issuer may default on interest or principal before the bonds mature
• c.Exchange rates may move against the investor holding foreign-currency bonds
• d.The bond may be called away early at a set redemption price after rates fall

Purchasing-power (inflation) risk is the danger that rising prices will erode the real value of a bond's fixed coupon and principal. It is especially significant for long-term, fixed-rate bonds, where payments are locked in for many years. Investments like TIPS or equities are often used to help offset this risk.

A broad market decline during a recession causes almost every stock in a diversified portfolio to fall. This is an example of:

• a.Unsystematic business risk
• b.Systematic (market) risk✓
• c.Liquidity/marketability risk
• d.Reinvestment rate risk

A recession-driven, market-wide drop affects nearly all securities regardless of how well individual companies are run, which is the definition of systematic or market risk. Because it hits the whole market, diversification cannot eliminate it. Unsystematic risk, by contrast, would affect only a single company or sector.

Call risk is the danger that:

• a.An issuer will redeem a bond before maturity, usually when interest rates have fallen✓
• b.Rising inflation will erode the real value of the bond's fixed coupon payments
• c.The investor cannot find a buyer for the bond at a fair price in a thin market
• d.An issuer will default and fail to make the bond's scheduled interest and principal payments

Call risk arises when a bond is callable, letting the issuer redeem it early. Issuers most often call bonds after interest rates have dropped, so they can refinance at lower rates. The investor then loses the higher-coupon bond and must reinvest at lower prevailing rates, which links call risk closely to reinvestment risk.

An investor in a structured note linked to a stock index should understand that, even if the index rises, the investor can still lose money if:

• a.The note is simply held to its stated maturity date rather than sold early
• b.The issuing financial institution becomes insolvent and cannot pay✓
• c.The linked index rises on price alone and pays out no dividends
• d.Prevailing interest rates remain unchanged over the note's full term

A structured note is an obligation of the issuing financial institution, so its promised payoff depends on that issuer remaining solvent. If the issuer becomes insolvent, the investor is a general creditor and may lose principal regardless of how the linked index performed. This issuer credit risk is a key, sometimes overlooked, feature of structured products.

Even a well-diversified stock portfolio still carries which type of risk?

• a.No risk at all, since diversification removes every source of loss
• b.Company-specific risk from one firm's own operating problems
• c.Systematic (market) risk that affects the entire market✓
• d.Unsystematic risk only, since market risk is diversified away

Diversification reduces or removes unsystematic (company-specific) risk, but it cannot eliminate systematic risk, which stems from market-wide forces such as recessions or interest rate changes. Therefore, even a broadly diversified portfolio remains exposed to systematic risk. This is why diversification lowers, but never fully removes, total portfolio risk.

A conservative client wants to minimize credit risk and default risk in the fixed-income portion of her portfolio. Which security best fits that goal?

• a.Commercial paper from a lower-rated company
• b.A short-term U.S. Treasury bill✓
• c.A BBB-rated revenue bond
• d.A high-yield ('junk') corporate bond

A U.S. Treasury bill is backed by the full faith and credit of the U.S. government and is considered essentially free of credit and default risk, making it the best match for a client who wants to minimize those risks. High-yield bonds and lower-rated commercial paper carry substantial default risk, and even a BBB revenue bond has more credit risk than a Treasury. The trade-off is that the safest security typically offers the lowest yield.

Which statement best distinguishes common stock from preferred stock?

• a.Common stock has the lowest claim in liquidation, while preferred has none
• b.Common stock pays a fixed dividend, while preferred pays a variable payout
• c.Common stockholders usually have voting rights, while most preferred stockholders do not✓
• d.Preferred stock carries the vote on director elections, while common stock does not

Common stockholders usually vote; most preferred stockholders do not. Common has the lowest liquidation claim (not "none"), common dividends are variable while preferred are fixed, and preferred generally lacks a vote — so the other choices are reversed.

In a corporate liquidation, which class is paid last?

• a.Common stockholders✓
• b.Secured bondholders
• c.General (unsecured) creditors
• d.Preferred stockholders

Common stockholders are paid last in a liquidation, after secured creditors, general creditors, and preferred stockholders. Owners always stand behind creditors.

A debenture is best described as:

• a.A bond secured by a first lien on the issuer's real property
• b.A bond backed by a pledge of specific rolling-stock equipment
• c.An unsecured bond backed by the issuer's general credit✓
• d.A residual ownership share in the issuing corporation

A debenture is an unsecured bond backed only by the issuer's general credit and promise to pay. Mortgage and equipment bonds are secured; a share of ownership describes stock, not a bond.

Market interest rates rise after an investor buys a bond. The price of the existing bond will most likely:

• a.Fall✓
• b.Rise
• c.Stay exactly the same
• d.Rise to par and then fall

By the price–yield seesaw, when rates rise, existing bond prices fall. The bond's fixed coupon is now below market, so its price drops to make its yield competitive.

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

• a.Yield to maturity✓
• b.Nominal yield
• c.Current yield
• d.All the yields are equal

For a discount bond the yields rank nominal < current < YTM, so yield to maturity is the highest because the investor also gains the price appreciation to par. (For a premium bond the order reverses.)

Which security is considered to carry essentially no credit (default) risk because it is backed by the full faith and credit of the U.S. government?

• a.A U.S. Treasury bond✓
• b.A corporate debenture
• c.A municipal revenue bond
• d.Commercial paper

A U.S. Treasury bond is backed by the full faith and credit of the government and is treated as essentially free of default risk. A debenture, a revenue bond, and commercial paper all carry credit risk.

Which of the following carries the full faith and credit of the U.S. government?

• a.FNMA (Fannie Mae) mortgage-backed securities
• b.FHLMC (Freddie Mac) mortgage-backed securities
• c.Corporate commercial paper
• d.GNMA (Ginnie Mae) mortgage-backed securities✓

GNMA (Ginnie Mae) securities carry the government's full faith and credit. FNMA and FHLMC are government-sponsored enterprises whose securities are not directly government-guaranteed; commercial paper is corporate.

The interest paid on most municipal bonds is:

• a.Taxed federally above the corporate bond rate
• b.Taxable in the issuer's own home state
• c.Generally exempt from federal income tax✓
• d.Guaranteed by the federal government

Municipal bond interest is generally exempt from federal income tax, which is its defining advantage. It is not federally guaranteed, and it is often (not always) state-tax-exempt for residents.

Shares of an open-end mutual fund are:

• a.Traded on an exchange throughout the day at a premium or discount to NAV
• b.Fixed in number after the initial offering
• c.Priced once per day at net asset value using forward pricing✓
• d.Priced continuously throughout the trading day

Open-end mutual fund shares are priced once daily at NAV using forward pricing (the next computed NAV). Exchange trading at a premium/discount and continuous intraday pricing describe closed-end funds and ETFs; open-end share counts are not fixed.

Unlike an open-end fund, a closed-end fund:

• a.Trades on an exchange and can sell above or below its NAV✓
• b.Continuously issues new shares and redeems existing shares at NAV
• c.Prices its shares at net asset value at the daily close
• d.Has no fixed share count, so the total grows and shrinks

A closed-end fund trades on an exchange and its market price can be above or below NAV. Continuous issuance/redemption at NAV and an unfixed share count describe open-end funds.

A mutual fund share class that charges a front-end sales load at the time of purchase is:

• a.Class C
• b.A no-load fund
• c.Class A✓
• d.Class B

Class A shares carry a front-end sales load paid at purchase (usually with lower ongoing expenses). Class C is a level load, Class B is back-end (CDSC), and a no-load fund has no sales charge.

Which product holds a basket of securities but trades throughout the day on an exchange like a stock?

• a.A traditional open-end mutual fund
• b.A unit investment trust (UIT)
• c.A fixed annuity
• d.An exchange-traded fund (ETF)✓

An ETF holds a basket of securities but trades intraday on an exchange like a stock. A mutual fund and a UIT do not trade continuously; a fixed annuity is an insurance product.

A unit investment trust (UIT) is characterized by:

• a.An actively managed portfolio that trades securities frequently
• b.A fixed portfolio held for a set term with no active manager✓
• c.Continuous issuance of new shares to investors at the daily NAV
• d.Daily exchange trading at a premium or discount to the fund's NAV

A UIT holds a fixed portfolio for a set term with no active manager. It does not actively trade, continuously issue shares, or trade at a premium/discount like a closed-end fund.

A variable annuity is considered a security because:

• a.The insurer guarantees a fixed minimum annual rate of return
• b.The owner bears the investment risk of the subaccounts✓
• c.It is insured by the FDIC for up to $250,000 per depositor
• d.Its account value is floored at the sum of the premiums paid

A variable annuity is a security because the owner bears the investment risk of the subaccounts. A fixed annuity (insurer bears the risk) is not a security; annuities are not FDIC-insured and can lose value.

A call option gives its holder the right to:

• a.Sell the underlying security at the strike price
• b.Buy the underlying security at the strike price✓
• c.Receive a fixed dividend from the issuer
• d.Vote the underlying shares

A call gives the right to buy the underlying at the strike price. Selling at the strike describes a put; options do not pay dividends or convey voting rights.

The writer (seller) of an option:

• a.Pays a premium in exchange for the right to buy or sell the underlying security
• b.Has risk limited to the premium paid at the time of purchase
• c.Can refuse an assignment by returning the premium to the holder
• d.Receives a premium and takes on an obligation if the option is exercised✓

The writer receives the premium and takes on the obligation to perform if exercised. The buyer pays the premium and has limited risk; a writer can indeed be assigned.

Which type of risk affects the entire market and cannot be eliminated through diversification?

• a.Business risk
• b.Credit risk
• c.Liquidity (marketability) risk
• d.Systematic (market) risk✓

Systematic (market) risk affects the whole market and cannot be diversified away. Business, credit, and liquidity risks are unsystematic and can be reduced by diversifying.

Diversifying a portfolio across many companies and industries is most effective at reducing:

• a.Interest-rate risk
• b.Unsystematic (company-specific) risk✓
• c.Inflation risk
• d.Systematic risk affecting the broad market

Diversification reduces unsystematic (company-specific) risk by spreading exposure across many holdings. Interest-rate, inflation, and broad market risks are systematic and remain.

Purchasing-power (inflation) risk is generally greatest for:

• a.Common stocks of growing companies
• b.Directly owned real estate
• c.Physical commodities
• d.Long-term fixed-income securities✓

Inflation (purchasing-power) risk is greatest for long-term fixed-income securities, whose fixed payments lose real value as prices rise. Stocks, real estate, and commodities can rise with inflation.

Compared with a right, a warrant typically:

• a.Has a very short life and is priced below the market price
• b.Is issued only to the company's existing shareholders at a discount price
• c.Has a longer life and an exercise price initially above the market✓
• d.Settles only in cash rather than being exercised for shares

A warrant has a longer life and an exercise price initially above the market, often issued as a sweetener. Short life, below-market pricing, and existing-shareholder distribution describe rights.

An American Depositary Receipt (ADR) allows a U.S. investor to:

• a.Buy municipal bonds whose interest is exempt from federal, state, and local income tax
• b.Avoid all market risk
• c.Receive a dividend that is guaranteed by the federal government
• d.Hold shares of a foreign company that trade in U.S. dollars, subject to currency risk✓

An ADR lets a U.S. investor hold a foreign company's shares priced in U.S. dollars, carrying currency risk. It is not tax-free, risk-free, or federally guaranteed.

If an issuer skips a dividend on its cumulative preferred stock, the missed dividend:

• a.Is permanently forfeited by the preferred shareholder
• b.Accumulates and must be paid before any common dividend✓
• c.Automatically converts into common shares of the issuer
• d.Must be redirected to the issuer's bondholders instead

On cumulative preferred, a skipped dividend accumulates and must be paid before any common dividend. It is not lost (that is straight/noncumulative preferred), does not auto-convert, and is not redirected to bondholders.

Because a convertible bond can be exchanged for common shares, it usually:

• a.Pays a higher coupon than a comparable nonconvertible bond
• b.Has no stated maturity date, unlike a straight bond
• c.Must be secured by a first lien on the issuer's assets
• d.Pays a lower coupon than a comparable nonconvertible bond✓

The conversion feature is valuable, so a convertible bond usually pays a lower coupon than a comparable nonconvertible bond. It still has a maturity and need not be secured.

Municipal bonds are generally most attractive to investors who are in:

• a.The lowest tax brackets
• b.The highest tax brackets✓
• c.A tax-exempt retirement account
• d.A foreign tax jurisdiction

Because muni interest is tax-free, munis benefit high-tax-bracket investors most. Low brackets gain little, and holding a tax-free bond inside a tax-exempt retirement account wastes the advantage.

Which of the following is a money market instrument?

• a.Commercial paper✓
• b.A 30-year Treasury bond
• c.Common stock
• d.A convertible debenture

Commercial paper is short-term (one year or less) corporate debt — a money market instrument. A 30-year bond and a convertible debenture are long-term debt; common stock is equity.

A real estate investment trust (REIT):

• a.Passes both its income and its operating losses through directly to its investors
• b.Pools capital to invest in income-producing real estate and trades like a stock✓
• c.Is an insurance contract that pays lifetime income
• d.Guarantees investors a fixed rate of return

A REIT pools capital to invest in income-producing real estate and trades like a stock. It does not pass through losses (unlike a DPP), is not an insurance contract, and does not guarantee a return.

A direct participation program (limited partnership) is distinctive because it:

• a.Trades continuously on a national exchange and is highly liquid
• b.Gives the limited partners unlimited personal liability for its debts
• c.Passes both income and losses through to the limited partners✓
• d.Is guaranteed against loss by the general partner's own capital

A DPP (limited partnership) passes both income and losses through to the limited partners. It is illiquid, limited partners have limited (not unlimited) liability, and there is no loss guarantee.

The par value of a typical corporate bond, repaid at maturity, is conventionally:

• a.$100
• b.$1,000✓
• c.$500
• d.$10,000

A corporate bond's conventional par value is $1,000, the amount repaid at maturity. The other figures are not the standard par.

A fixed annuity differs from a variable annuity in that a fixed annuity:

• a.Exposes the owner to the market risk of the underlying investment subaccounts
• b.Guarantees a fixed rate, with the insurer bearing the investment risk✓
• c.Must be registered with the SEC and sold only with a prospectus
• d.Contains no insurance component, only investment subaccounts

A fixed annuity guarantees a fixed rate, with the insurer bearing the investment risk — an insurance product. Market exposure, securities registration, and "no insurance component" describe a variable annuity.

An investor who buys a put option is most likely expecting the underlying stock to:

• a.Fall in price✓
• b.Rise sharply
• c.Begin paying a higher dividend
• d.Stay exactly flat

A put buyer profits when the underlying falls — a bearish position (the right to sell at the strike). A call buyer is bullish; dividends and a flat market are not the point of a put.