FINRA Series 6 — All Questions

A fund has a net asset value of $14.40 and a sales charge of 4% of the public offering price. A customer invests $9,000. How many shares does the customer buy?

• a.576 shares
• b.601 shares
• c.600 shares✓
• d.625 shares

The offering price is $14.40 divided by 0.96, or $15.00, and $9,000 divided by $15.00 is 600 shares. Dividing $9,000 by the NAV of $14.40 gives 625 shares, which ignores the sales charge. Taking 4% off the $9,000 and then dividing by $15.00 gives 576 shares, which charges the load twice. Adding 4% to NAV to reach $14.98 gives 601 shares, but the stated load is a percentage of the offering price, not of NAV.Mutual fund pricing

A mutual fund prices its shares at 4:00 p.m. Eastern. A customer's order is received by the firm at 4:20 p.m. Which price applies?

• a.The net asset value computed at the next pricing time after receipt✓
• b.The average of that day's and the next day's net asset values
• c.The 4:00 p.m. net asset value, because the customer decided before the close
• d.The public offering price in effect at the time the representative took the order

Forward pricing requires orders received after the pricing time to get the next computed price. Giving the earlier price to an order that arrived after the close is late trading, and it is illegal. Averaging two days' prices has no basis in the rule. The offering price is NAV plus any sales charge as computed at the pricing time, not as of whenever the order is taken.Investment Company Act of 1940 Section 22(c) and Rule 22c-1

Under the 2023 money market fund amendments, an institutional prime fund must impose a liquidity fee when its net redemptions for a day exceed what share of net assets?

• a.5%✓
• b.1%
• c.25%
• d.10%

The mandatory liquidity fee is triggered when daily net redemptions exceed 5% of the fund's net assets, unless the fee would be de minimis. Ten percent was the old daily liquid asset minimum. Twenty-five percent is the daily liquid asset minimum, a different test. One percent is not a trigger in the rule.17 CFR 270.2a-7(c)(2)

A unit investment trust prospectus lists a deferred sales charge and, separately, a creation and development fee. The creation and development fee compensates the sponsor for:

• a.Running a secondary market for units after the offering, charged each time units are resold
• b.Forming the trust and building its portfolio, collected when the offering period closes✓
• c.Selecting and replacing securities over the trust's life, deducted from annual income
• d.Holding the trust's securities and mailing distributions, charged to unitholders every year

The creation and development fee reimburses the sponsor for creating the trust and developing the product, and it is paid once, at the close of the initial offering period. A secondary market is maintained voluntarily by the sponsor and is not funded by this fee. A UIT is not actively managed, so no fee pays for ongoing security selection. Safekeeping and distribution costs belong to the trustee's separate fee.

A fixed-term UIT is terminating. In a taxable account, a holder rolls the proceeds into the sponsor's next series at a reduced sales charge. For federal income tax purposes, the rollover is generally:

• a.A tax-deferred rollover that is recognized only when the new units are eventually sold
• b.A nontaxable reinvestment, because the proceeds never reach the holder's bank account
• c.A tax-free exchange of like-kind investments under Section 1035, with the old basis carried over
• d.A taxable disposition of the old units, with gain or loss recognized for that tax year✓

Termination pays out the old units, so the holder has sold them and recognizes gain or loss even though the cash is immediately reinvested; the reduced sales charge affects cost, not taxation. Section 1035 covers insurance and annuity exchanges, not UIT units. Tax deferral exists only inside a retirement account, not in a taxable account. Where the cash goes does not change the recognition of the sale.Internal Revenue Code Section 1001

After the offering, one stock in an equity UIT falls 45% on an earnings warning, though the issuer has neither defaulted nor gone bankrupt. What generally happens to that position?

• a.The sponsor leaves it in place, since the portfolio is fixed and changes only in narrow disclosed cases✓
• b.The trust's portfolio manager sells it and buys a stronger stock in the same sector of the market
• c.Unitholders vote on its removal at the trust's next annual shareholder meeting
• d.The trustee sells it automatically once it loses 25% of its value after the deposit date

A UIT portfolio is not managed: securities are sold only in limited circumstances described in the prospectus, such as a default, and a price decline alone does not qualify. A UIT has no portfolio manager, since the sponsor selects the securities up front. The trustee has no automatic loss trigger. A UIT has no board and holds no regular shareholder meetings, so there is no vote to remove a holding.Investment Company Act of 1940 Section 4(2)

Who selects the securities for a new unit investment trust and deposits them with the trustee in exchange for units?

• a.The board of directors, which reviews each security before the trust is offered to the public
• b.The sponsor, also called the depositor, which typically maintains a secondary market✓
• c.The investment adviser, which chooses securities under a management contract with the trust
• d.The trustee, which picks the securities and also holds them for the unitholders' benefit

The sponsor (depositor) builds the portfolio, deposits it with the trustee for units, and typically repurchases units in a secondary market. The trustee is a bank that holds the securities and pays out income but does not choose investments. A UIT has no investment adviser managing it and, by definition, has no board of directors.Investment Company Act of 1940 Section 4(2)

A unit investment trust holds insured municipal bonds. What does the bond insurance cover?

• a.The market value of the units, so redemptions occur at no less than the purchase price
• b.The purchase price if the sponsor stops maintaining a secondary market for the units
• c.Only the principal due at maturity, with interest payments left uninsured during the trust's life
• d.Timely payment of the bonds' interest and principal, but not the market value of the units themselves✓

Municipal bond insurance guarantees that scheduled interest and principal will be paid if the issuer fails to pay; it does not protect against price declines caused by interest rate changes, so unit values still fluctuate. It is not a guarantee of the unit price or of a market for the units. Insured interest payments are covered along with principal, not principal alone.

A holder of a municipal bond UIT receives monthly distributions funded by the trust's interest income. How is that income generally treated for federal income tax purposes?

• a.It is exempt only for unitholders who live in the state where the bonds were issued
• b.It is taxed as a qualified dividend at long-term rates, as with a corporate stock fund
• c.It is taxed as ordinary income, because a trust rather than the municipal issuer pays it
• d.It keeps its tax-exempt character, so it is generally free of federal income tax✓

A UIT passes income through to unitholders, and interest from municipal bonds retains its federal tax-exempt character. The trust is a conduit, so the payer does not change the character. The federal exclusion does not depend on where the unitholder lives, although state tax treatment may differ. The income is interest, not a qualified dividend. Gains on sales of the units or of trust bonds remain taxable.Internal Revenue Code Section 103(a): interest on state and local bonds

An investor buys 5,000 UIT units at a $10.00 public offering price. The maximum sales fee is made up of a 1.00% initial charge, a deferred sales charge of $0.175 per unit collected later, and a creation and development fee of $0.05 per unit paid from trust assets at the close of the offering period. How much of the sales fee is collected after the purchase date?

• a.$500, the 1.00% initial charge, which is paid at the time of purchase
• b.$875, the deferred charge alone, without the creation and development fee
• c.$1,125, the deferred charge plus the creation and development fee✓
• d.$1,625, the initial charge added to the deferred charge and creation fee

The deferred charge is 5,000 x $0.175 = $875, and the creation and development fee is 5,000 x $0.05 = $250, so $1,125 comes out after purchase. The 1.00% initial charge is 5,000 x $0.10 = $500 and is paid at purchase, which is why $500 is not the later amount. The deferred charge alone, $875, omits the creation fee, and $1,625 adds the initial charge.

A customer asks whether a fixed-income UIT will return $10.00 per unit at its termination date. Which response is accurate?

• a.Yes, if the units were bought during the initial offering period at the public offering price
• b.Yes, because the trustee is required to hold every bond until it matures
• c.No, because the proceeds depend on the value of the remaining bonds, above or below $10.00✓
• d.No, because a UIT returns only its income and never any principal at termination

A UIT has a termination date, but nothing guarantees a return of the unit price. Bonds sold or maturing near termination are worth whatever the market or issuers pay, so proceeds can fall short of or exceed the original price. The trustee has no obligation to hold to maturity, and buying in the initial offering carries no guarantee. A UIT does distribute principal as bonds mature or are sold, so principal is returned in part.

A fund's total 12b-1 charge is 1.00% of average net assets. Which split between an asset-based sales charge and a service fee fits the limits of FINRA Rule 2341?

• a.1.00% asset-based sales charge and no service fee
• b.0.85% asset-based sales charge and a 0.15% service fee
• c.0.50% asset-based sales charge and a 0.50% service fee
• d.0.75% asset-based sales charge and 0.25% service fee✓

Rule 2341 caps the asset-based sales charge at 0.75% of average annual net assets and the service fee at 0.25%, so a full 1.00% charge must be split exactly that way. A 0.85% sales charge exceeds the 0.75% cap. A 0.50% service fee exceeds the 0.25% cap. A 1.00% asset-based sales charge also exceeds the 0.75% cap.FINRA Rule 2341(d)

A customer buys $20,000 of Class C shares. Eight months later the shares are worth $21,000 and the customer redeems all of them. The Class C contingent deferred sales charge is 1.00% in the first year, applied to the lower of original cost or current value. What is the charge?

• a.$133, which is 1.00% of cost prorated for eight of twelve months
• b.$200, which is 1.00% of the $20,000 original cost✓
• c.$210, which is 1.00% of the $21,000 current value
• d.$10, which is 1.00% of the $1,000 gain only

A CDSC is applied to the lower of the shares' original cost or their value at redemption. Cost ($20,000) is lower than value ($21,000), so the charge is 1.00% x $20,000 = $200. Using current value overstates it, and the charge is not prorated by month within the year. It is not limited to the gain either.FINRA Rule 2341(d)

A small employer will offer a fund in its 401(k) plan through a plan recordkeeper. Which share class is built for employer retirement plans and typically pays for distribution and servicing through a 12b-1 fee instead of a sales charge?

• a.Class B, a back-end load class that converts to Class A over time
• b.Class R, a class designed for employer-sponsored retirement plans✓
• c.Class T, a front-end load class sold through intermediaries
• d.Class I, an institutional class with a very high minimum

Class R shares are designed for employer-sponsored retirement plans and generally have no front-end load or CDSC, with an ongoing 12b-1 fee paying for distribution and plan servicing. Class I shares are institutional and normally carry no 12b-1 fee. Class T charges a front-end load. Class B imposes a declining back-end charge and is generally closed to new investors.

A foundation plans to invest $5 million in one fund family and wants the class that usually carries neither a sales charge nor a 12b-1 fee. Which class is it generally eligible for?

• a.Class C, because its 1.00% 12b-1 fee is waived on large accounts
• b.Class T, because it has a front-end load but no ongoing fee
• c.Class A, because large purchases get a load waiver and a 12b-1 waiver
• d.Class I, institutional shares with a high minimum investment✓

Institutional (Class I) shares usually have no sales charge and no 12b-1 fee, but require a high minimum that a $5 million foundation can meet. Class A at that size generally waives the front-end load yet still bears a 12b-1 fee, typically 0.25%. Class C keeps its 12b-1 fee regardless of account size. Class T carries a front-end load and a 0.25% 12b-1 fee.

A representative describes Class T shares to a client. Which description fits the class?

• a.A maximum 2.50% front-end load and a 0.25% annual 12b-1 fee, with no CDSC✓
• b.A maximum 5.75% front-end load and a 0.25% annual 12b-1 fee, with no CDSC
• c.No front-end load, a 1.00% annual 12b-1 fee and a CDSC that declines over six years
• d.No front-end load, a 1.00% annual 12b-1 fee and a 1% CDSC in the first year

Class T shares are sold through intermediaries with a maximum front-end load of 2.50%, a 12b-1 fee of up to 0.25% and no CDSC. A 5.75% maximum load describes a traditional Class A. A one-year 1% CDSC with a 1.00% 12b-1 fee describes Class C. A declining multi-year CDSC with a 1.00% 12b-1 fee describes Class B.

Two weeks after redeeming Class A shares, a customer puts the proceeds back into the same fund family and pays no new front-end sales charge. Which privilege applies?

• a.The combination privilege, which aggregates purchases of different funds to reach a breakpoint
• b.Rights of reinvestment, which let a redeemer buy back within a stated window at NAV✓
• c.A letter of intent, which sets a reduced sales charge for purchases over thirteen months
• d.The exchange privilege, which moves money between two funds in one family at NAV

A reinstatement (rights of reinvestment) privilege lets a shareholder who redeemed shares buy back into the fund within the period stated in the prospectus without paying a new load. An exchange moves money between funds without a redemption and repurchase decision and does not restore a sale. A letter of intent covers future purchases, and the combination privilege adds up purchases across funds; neither addresses reinvesting redemption proceeds.

A client sends a representative $1.5 million for a single fund. The representative places all of it in Class C shares, which pay the firm more over time, even though Class A would carry no front-end load at that size. The main problem is that the representative:

• a.Sold a share class the fund is barred from offering to individual investors
• b.Put the firm's compensation ahead of the client's interest in choosing a share class✓
• c.Exceeded the 8.5% maximum sales charge that FINRA Rule 2341 allows on a single purchase order
• d.Failed to obtain a signed letter of intent from the client before accepting the order

Choosing the costlier of two available share classes for the firm's benefit breaches the care and conflict obligations of Regulation Best Interest. Class C has no front-end charge, so the 8.5% cap is not at issue. A letter of intent is unnecessary for one purchase already above the breakpoint. Class C shares may be offered to individuals; the problem is the recommendation, not the class.Regulation Best Interest, 17 CFR 240.15l-1

A fund charges 5.0% on purchases under $100,000, 4.0% from $100,000 to $249,999, and 3.0% from $250,000 to $499,999, each as a percentage of the offering price. A customer signs a $250,000 letter of intent and makes a first deposit of $60,000 when the NAV is $20.00. Ignoring fractions, how many shares does that deposit buy?

• a.2,850 shares, using the 5.0% rate for a purchase under $100,000
• b.2,880 shares, using the 4.0% rate for a $100,000 purchase
• c.2,910 shares, using the 3.0% rate from the letter of intent✓
• d.3,000 shares, which assumes no sales charge

The letter of intent earns the 3.0% rate on every purchase, including the first deposit. Offering price = $20.00 / (1 - 0.03) = $20.6186, and $60,000 / $20.6186 = 2,910 shares (equivalently $60,000 x 0.97 / $20). The 5.0% and 4.0% rates apply to purchases made without the letter, and ignoring the charge would give 3,000 shares.

Ignoring investment growth, an investor compares $10,000 in Class A shares (3.75% front-end load, 0.25% annual 12b-1 fee) with $10,000 in Class C shares (no load, 1.00% annual 12b-1 fee). Applying each percentage to the $10,000, after how many years are the cumulative costs equal?

• a.4 years, from comparing the load only with Class C's full annual fee
• b.15 years, from dividing the load by Class A's annual fee
• c.5 years, when Class A's load and fees equal Class C's fees✓
• d.3 years, from adding the two annual fees together

Class A costs $375 up front plus $25 a year; Class C costs $100 a year. The cumulative costs match when $375 + $25t = $100t, so t = 5 years. Four years comes from comparing the load only with Class C's full $100 and forgetting Class A's own 12b-1 fee. Three years adds the two annual fees together, and 15 years divides the load by Class A's fee alone.

At the close, a fund holds securities worth $48,000,000, cash of $2,000,000 and $500,000 of dividends and interest receivable. It owes $300,000 in accrued expenses and $200,000 for securities it bought but has not paid for. With 2,500,000 shares outstanding, what is its NAV per share?

• a.$19.80, from leaving out the dividends and interest receivable
• b.$20.00, which is net assets of $50,000,000 over 2,500,000 shares✓
• c.$19.00, from counting only the securities less liabilities
• d.$20.20, from total assets before subtracting any liabilities

NAV = (total assets - liabilities) / shares. Assets are $48,000,000 + $2,000,000 + $500,000 = $50,500,000, and liabilities are $300,000 + $200,000 = $500,000, leaving $50,000,000; divided by 2,500,000 shares gives $20.00. Ignoring the liabilities gives $20.20. Dropping the receivable gives $19.80. Counting only securities gives $19.00.Investment Company Act of 1940 Rule 22c-1

During the year a fund earned $9,000,000 of dividends and $3,000,000 of interest, and paid $4,000,000 of operating expenses. It has 20,000,000 shares outstanding. What is its net investment income per share?

• a.$0.25, which leaves out the interest earned
• b.$0.40, which is $8,000,000 of net investment income over the shares✓
• c.$0.45, which counts the dividends earned, with no expenses subtracted
• d.$0.60, which is total income with no expenses subtracted

Net investment income is investment income minus expenses: ($9,000,000 + $3,000,000) - $4,000,000 = $8,000,000, or $0.40 on 20,000,000 shares. Gross income of $12,000,000 gives $0.60 before expenses. Dividends alone give $0.45, and dividends less expenses give $0.25, so each leaves out part of the correct calculation.

A mutual fund holds a thinly traded foreign security that has no reliable market quotation at the close. Under the SEC's fair value rule, who is responsible for determining its fair value in good faith?

• a.The fund's custodian bank, which values every security it holds on the board's behalf each day
• b.The principal underwriter, because it sets the public offering price at the close
• c.The fund's independent auditor, which assigns values when market quotes are not available
• d.The fund's board, which may designate the adviser as valuation designee under the board's oversight✓

Rule 2a-5 makes the board responsible for fair value when market quotations are not readily available; it may assign the task to the adviser as valuation designee and must oversee it. A custodian safeguards assets and does not set values. The principal underwriter sells shares at a price built from NAV. The auditor reviews valuation in the annual audit but does not price the portfolio.Investment Company Act of 1940 Rule 2a-5

Which of the following describes the late trading that Rule 22c-1 forward pricing is meant to prevent?

• a.Buying fund shares at that day's NAV after the 4:00 p.m. close, using news that came after the close✓
• b.Charging a customer the next business day's NAV for an order the customer entered at 4:30 p.m.
• c.Pricing an order entered on a Saturday at the closing NAV of the following Monday session
• d.Crediting dividends reinvested on the payable date at the NAV next computed that day

Forward pricing requires orders to receive the next NAV computed after the fund receives them. Late trading lets someone place or confirm an order after the cutoff and still get that day's already-known price, capturing post-close news. Pricing a 4:30 p.m. order at the next day's NAV and a Saturday order at Monday's NAV is correct forward pricing. Reinvesting dividends at the next computed NAV is normal.Investment Company Act of 1940 Rule 22c-1

A fund averages $400 million in net assets. It charges a 0.55% management fee and a 0.25% 12b-1 fee, and incurred $600,000 in other operating expenses. What is its expense ratio?

• a.1.40%, which treats the $600,000 as 0.60%
• b.0.95%, which is the sum of the management, 12b-1 and other expense ratios✓
• c.0.80%, which leaves out the other operating expenses
• d.0.70%, which leaves out the 12b-1 fee

Other expenses are $600,000 / $400,000,000 = 0.15%. The expense ratio adds the components: 0.55% + 0.25% + 0.15% = 0.95%. Omitting other expenses gives 0.80%, omitting the 12b-1 fee gives 0.70%, and misreading $600,000 as 0.60% gives 1.40%.

A fund share began the year at a $25.00 NAV. During the year it paid $0.50 per share of income and $1.00 of capital gains, and the year-end NAV was $26.50. Ignoring reinvestment and taxes, what was the total return?

• a.8.0%, which adds only the income dividend
• b.10.0%, which adds only the capital gain
• c.6.0%, which counts only the change in NAV
• d.12.0%, which counts the NAV change plus all distributions✓

Total return counts the change in NAV plus all distributions: ($26.50 - $25.00) + $0.50 + $1.00 = $3.00, and $3.00 / $25.00 = 12.0%. The NAV change alone gives 6.0%. Adding only the $0.50 dividend gives 8.0%, and adding only the $1.00 capital gain gives 10.0%.

Apart from money market funds, an open-end mutual fund may not acquire an illiquid investment if, right after the purchase, illiquid investments would exceed what share of its net assets?

• a.25%, the figure used for a money market fund's daily liquid assets
• b.15%, measured against net assets right after the purchase✓
• c.10%, the figure that caps a fund's share of an issuer's voting stock
• d.5%, the figure that caps any one issuer in the diversification test

Rule 22e-4 prohibits an open-end fund from buying an illiquid investment if illiquid holdings would then exceed 15% of net assets. Money market funds are excluded from the rule and operate under Rule 2a-7 with their own, stricter liquidity requirements. The 25% figure resembles a money market daily-liquid threshold, which is a minimum, not a cap on illiquid holdings.Investment Company Act of 1940 Rule 22e-4

A mutual fund realizes net capital losses for the year, and shareholders ask whether they can claim the loss on their own returns. How are the fund's losses treated?

• a.They are deducted on the fund's income dividends, reducing each shareholder's ordinary income
• b.They pass through to shareholders in proportion to shares held on the record date
• c.The fund carries them forward to offset its future capital gains, and shareholders cannot deduct them✓
• d.They expire at year-end if the fund does not sell enough winning securities to offset them

A regulated investment company cannot pass its net losses to shareholders; it carries them forward to offset gains it realizes in later years, which reduces future capital gain distributions. Shareholders can claim only losses on their own sales of fund shares. Losses do not reduce income dividends, and they do not expire at year-end.Internal Revenue Code Section 1212

A money market fund's policies and procedures limit every beneficial owner of its shares to natural persons. How does Rule 2a-7 classify the fund, and what pricing method may it use?

• a.A retail money market fund, which may use amortized cost or penny rounding to hold a stable NAV✓
• b.A government money market fund, which must invest 99.5% of assets in government securities and repos
• c.A retail money market fund, which must float its NAV because only government funds may use amortized cost
• d.A prime money market fund, which must float its NAV because it holds corporate debt

Rule 2a-7 defines a retail money market fund by its policies and procedures reasonably designed to limit all beneficial owners to natural persons, and retail and government funds may use amortized cost or penny rounding to maintain a stable NAV. Funds that are neither retail nor government must price to at least the fourth decimal place, which is the floating NAV. The government fund label depends on what the fund holds (99.5% or more in cash, government securities and fully collateralized repurchase agreements), not on who owns it. Retail funds are not required to float, and a fund holding corporate debt is not automatically a floating-NAV fund if it is limited to natural persons.17 CFR 270.2a-7(a)(21), (c)(1)

A money market fund reports a dollar-weighted average maturity of 45 days, a dollar-weighted average life of 130 days, daily liquid assets of 30% and weekly liquid assets of 55%. Which Rule 2a-7 limit does it breach?

• a.The 50% minimum for weekly liquid assets as a share of total assets
• b.The 120-day limit on dollar-weighted average life of the portfolio✓
• c.The 25% minimum for daily liquid assets as a share of total assets
• d.The 60-day limit on dollar-weighted average maturity of the portfolio

Rule 2a-7 caps dollar-weighted average maturity at 60 days, dollar-weighted average life at 120 days, and requires at least 25% daily liquid and 50% weekly liquid assets. At 130 days the fund exceeds the average-life limit. Its 45-day maturity is under 60, its 30% daily liquidity is above 25%, and its 55% weekly liquidity is above 50%, so none of those limits is breached.17 CFR 270.2a-7(d)

A 6% bond with eight years to maturity is quoted at 105. Which statement about its yields is correct?

• a.Yield to maturity and current yield both equal the 6% coupon because the coupon is fixed
• b.Yield to maturity is below current yield, which is below the 6% coupon✓
• c.Current yield is below yield to maturity, and both are above the 6% coupon rate
• d.Current yield is above the 6% coupon rate, and yield to maturity is below the current yield

For a premium bond, current yield = $60 / $1,050 = 5.71%, which is below the 6% coupon, and yield to maturity is lower still (about 5.2%) because the premium is amortized away by maturity. The ordering with yield to maturity above current yield describes a discount bond. A fixed coupon does not fix the yield, which moves with price. Current yield can exceed the coupon only when the bond sells at a discount.

An investor in the 24% federal bracket compares a 3.9% municipal bond fund with a taxable bond fund yielding 5.0%. Ignoring state taxes, which statement is correct?

• a.The taxable fund is better, because after 24% tax it still keeps about 4.2% against the 3.9% municipal yield
• b.The taxable fund is better, because its 5.0% yield is higher than the municipal fund's 3.9% yield
• c.They are equal, because 3.9% is the 5.0% taxable yield reduced by a 22% federal tax rate
• d.The municipal fund is better; its taxable equivalent is about 5.13%, above the 5.0% taxable yield✓

The taxable equivalent yield is 3.9% / (1 - 0.24) = 5.13%, which beats 5.0%; equivalently the taxable fund keeps 5.0% x 0.76 = 3.80%, below 3.9%. Comparing the stated yields ignores the tax difference. The two funds would tie only at a 22% rate, since 3.9 / 5.0 = 0.78, which is not this investor's bracket. The 4.2% figure is not what 24% tax leaves of 5.0%.

A TIPS has a $1,000 original par value and a 2.0% coupon. After CPI adjustments the principal is $1,050. What is the next semiannual interest payment?

• a.$10.50, which is 1% of the $1,050 adjusted principal✓
• b.$5.25, which is 0.5% of the adjusted principal each period
• c.$21.00, which is 2% of the adjusted principal paid at one time
• d.$10.00, which is 1% of the $1,000 original par value

TIPS pay a fixed rate on the adjusted principal every six months, so each payment is 2.0% / 2 = 1% of $1,050 = $10.50. Using original par ignores the inflation adjustment, which is the point of the security. $21.00 is a full year of interest, and TIPS pay twice a year. $5.25 would be a quarterly payment.

A TIPS was issued at $1,000 par. Deflation over its life leaves the adjusted principal at $960 on the maturity date. What principal does the holder receive at maturity?

• a.$960, because principal is always paid at its inflation-adjusted amount
• b.$1,040, which restores the amount lost through a deflation make-whole payment
• c.$1,000, because the greater of adjusted or original principal is paid✓
• d.$980, the average of the original principal and the adjusted principal

At maturity a TIPS pays the greater of its inflation-adjusted principal or its original principal, so the holder gets $1,000 even though the adjusted figure is $960. Paying the adjusted principal would remove the deflation floor. Averaging has no basis in the terms, and no make-whole payment exists above original par.

A client wants to buy 2040 Treasury STRIPS directly in a TreasuryDirect account to avoid a dealer markup. What is the accurate response?

• a.STRIPS are limited to institutional investors, so individuals must buy a STRIPS fund
• b.TreasuryDirect sells them, but only to investors who agree in writing to hold them until maturity
• c.STRIPS are sold only through a financial institution, broker or government securities dealer✓
• d.TreasuryDirect sells STRIPS directly at auction in $100 increments, with no intermediary or markup

Treasury STRIPS are held in the commercial book-entry system, and the Treasury states that they can be bought, held, sold and redeemed only through a financial institution, broker or dealer that handles government securities. TreasuryDirect does not sell them at auction or on a hold-to-maturity basis. Individuals may buy STRIPS directly through a broker, so no fund is required.

Market interest rates rise sharply after an investor buys a 30-year mortgage pass-through certificate. What happens to the certificate's expected average life?

• a.It stays the same, because the certificate follows a fixed 30-year schedule
• b.It lengthens, because fewer homeowners refinance or prepay, which is extension risk✓
• c.It lengthens, because the guarantor delays principal payments until market rates fall again
• d.It shortens, because homeowners prepay faster, which is contraction risk

When rates rise, refinancing and prepayments slow, so principal comes back later and the expected average life extends, while the price falls; this is extension risk. Faster prepayment and a shorter life occur when rates fall. Prepayments are not scheduled, so average life is not fixed. A guarantor stands behind timely payment and does not delay principal.

A private fund avoids registering as an investment company by relying on Section 3(c)(1) of the Investment Company Act of 1940. Which condition must it meet?

• a.Its securities have no more than 100 beneficial owners and are not publicly offered✓
• b.Its shares must be redeemable on demand at net asset value so investors can leave at any time
• c.Every investor must be a qualified purchaser, though there is no limit on the number of investors
• d.It must register under Section 8 but may skip the board and shareholder-vote requirements

Section 3(c)(1) excludes an issuer whose outstanding securities are beneficially owned by not more than 100 persons and which is not making a public offering. The qualified-purchaser approach with no investor cap is Section 3(c)(7). A fund relying on 3(c)(1) is excluded from the definition and does not register under Section 8. Daily redemption is a feature of registered open-end funds, not a condition of the exclusion.Investment Company Act of 1940 Section 3(c)(1)

A closed-end fund's board decides each period whether to make a repurchase offer under the tender offer rules, and no fundamental policy requires the fund to do so. Which type of fund is it?

• a.A tender offer fund, because it has no fundamental policy obliging periodic repurchases✓
• b.A unit investment trust, because the sponsor repurchases units only when it chooses to
• c.An open-end fund, because shareholders may redeem at net asset value on any business day
• d.An interval fund, because interval funds repurchase shares only when the board approves each offer

An interval fund under Rule 23c-3 must adopt a fundamental policy to repurchase a stated percentage of shares at fixed intervals, while a tender offer fund makes repurchase offers under Rule 13e-4 at the board's discretion with no obligation. An open-end fund must redeem on demand. A unit investment trust is not a closed-end fund and has no board.Investment Company Act of 1940 Rule 23c-3

A U.S. fund owns a Japanese stock whose yen price is unchanged, and the yen weakens 5% against the dollar. What happens to the holding's value in dollars?

• a.It stays flat, because a fund's holdings are valued in local currency
• b.It rises by about 5%, because a weaker yen boosts the exporter's earnings
• c.It stays flat, because the stock's own price in yen did not move at all
• d.It falls about 5%, a currency loss despite the unchanged yen price✓

A fund reports in dollars, so a foreign holding's value reflects both the local price and the exchange rate. With the yen price unchanged and the yen down 5%, the dollar value drops about 5%: currency risk. A flat local price does not mean a flat dollar value, and funds convert foreign holdings to dollars rather than reporting them in local currency. Any earnings boost would show up in the local price, which is stated to be unchanged.

A $1,000 convertible bond converts at $40 of par per common share. The stock trades at $46 and the bond trades at $1,180. What is the bond's conversion (parity) value?

• a.$1,000, the par value repaid at maturity
• b.$1,180, the bond's current market price
• c.$1,840, from 40 shares at $46 each
• d.$1,150, which is 25 shares at $46 each✓

The conversion ratio is $1,000 / $40 = 25 shares, and 25 x $46 = $1,150. The bond sells for $1,180, so it trades at a premium of $30 over parity. $1,840 uses the $40 conversion price as the share count. $1,000 is par, which is unrelated to what the shares are worth now.

A commodity ETF holds near-month futures and rolls each contract into a later month that costs more than the expiring one. With the spot price unchanged, what does the roll generally cause?

• a.A drag on return, because the fund sells the expiring contract low and buys the next one higher✓
• b.No effect, because futures prices always converge with the spot price at expiration
• c.A gain, because the fund collects the price difference between the two contract months
• d.A cash payment to shareholders, because the price difference is passed through as a dividend

When later contracts cost more than expiring ones (contango), each roll sells low and buys high, which erodes the fund's return even if the spot price does not move. The difference is a cost, not a gain. Convergence at expiry is why the roll costs matter and does not remove them. The difference is not a dividend and is not distributed.

A fund holds senior bank loans whose coupons reset to a short-term benchmark every 90 days. If short-term rates rise one percentage point, how does its price sensitivity compare with a fixed-rate bond fund of similar credit quality?

• a.Prices tend to rise, because the fund's income increases by the full one percentage point
• b.Prices tend to fall more, because floating coupons are linked to short-term benchmark rates
• c.Prices are unaffected, because senior loans are secured and carry no credit risk
• d.Prices tend to fall less, because coupons reset higher, although credit risk remains✓

Coupons that reset every 90 days keep the loans close to par when rates rise, so a loan fund typically falls much less than a fixed-rate bond fund, although it still bears credit risk and can lose value if borrowers default. Linkage to short rates is the reason for lower, not higher, price sensitivity. Being secured does not remove credit risk. Higher income does not automatically push prices above par.

A firm's designated office receives a complete deferred variable annuity application package on a Monday. A registered principal approves the application on the Thursday of the following week. Did the firm meet the timing requirement of FINRA Rule 2330?

• a.No; the review was due within seven business days of receiving the package✓
• b.Yes; Rule 2330 gives the principal ten business days from receipt of the complete package
• c.Yes; the review period runs from the date the insurer issues the contract
• d.No; Rule 2330 requires approval on the same business day the package arrives

Rule 2330(c) requires a registered principal to review and approve or reject a deferred variable annuity application before it goes to the insurer, and no later than seven business days after the member's office of supervisory jurisdiction receives a complete and correct application package. Approval on the Thursday of the following week falls on the eighth business day after receipt, past the deadline. Ten days is not the rule, the clock does not wait for contract issuance, and same-day approval is not required.FINRA Rule 2330(c)

A variable annuity is annuitized under a life with 10-year period certain option, and the annuitant dies after four years of payments. What happens to the payments?

• a.The beneficiary receives the remaining payments through the end of the tenth year✓
• b.The insurer pays the beneficiary the remaining account value in one lump sum
• c.Payments stop at death, because the payout was based on the annuitant's life
• d.Payments continue for the beneficiary's lifetime at the same number of annuity units

A period certain option guarantees payments for at least the stated period even if the annuitant dies early, so the beneficiary collects the remaining six years of payments. Ending payments at death describes a life-only option. After annuitization the owner no longer has an account value to refund. The guarantee covers the stated period, not the beneficiary's lifetime.

In a non-qualified variable annuity, an owner moves $50,000 from an equity subaccount, which has a gain, to a bond subaccount in the same contract. What is the immediate federal tax result?

• a.No current tax; the gain stays deferred until withdrawn or annuitized✓
• b.The gain is ordinary income that year, plus 10% if the owner is under 59 1/2
• c.The gain is taxable only if the transfer exceeds 10% of the contract value in the year
• d.The gain is taxed as a long-term capital gain in the year of the transfer

Transfers among subaccounts inside one annuity contract are not distributions, so earnings stay tax deferred until withdrawal or annuitization, and then they are taxed as ordinary income. Annuity gains never receive capital gain treatment. The 10% additional tax applies to taxable distributions, and no transfer limit of 10% triggers tax.Internal Revenue Code Section 72(e)

The investment in the contract of a non-qualified annuity is $60,000, and the expected return under the contract is $90,000. Each monthly payment is $1,200. How much of each payment is taxable as ordinary income?

• a.$800, which is the portion of each payment that is excluded
• b.$1,200, because every annuity payment is fully taxable ordinary income
• c.$400, because two-thirds of each payment is excluded from tax✓
• d.$600, because half of each payment returns the owner's cost

The exclusion ratio is the investment in the contract divided by the expected return: $60,000 / $90,000 = 66.67%. Of each $1,200 payment, $800 is excluded and $400 is taxable. The $800 figure is the tax-free part. Payments are not fully taxable because part returns the owner's after-tax cost, and the exclusion ratio is not fixed at one half.Internal Revenue Code Section 72(b)

A variable annuity pays the greater of the account value or the highest contract anniversary value as its death benefit. The owner paid $100,000, anniversary values were $112,000, $104,000 and $108,000, and there were no withdrawals. The owner dies when the account value is $95,000. What is the death benefit?

• a.$100,000, the premium the owner paid at issue
• b.$112,000, the highest anniversary value✓
• c.$108,000, the value on the most recent anniversary
• d.$95,000, the account value on the date of death

The contract pays the greater of account value or the highest anniversary value, and the highest of the three anniversary values is $112,000, which exceeds the $95,000 account value. The latest anniversary is not the highest. A return-of-premium benefit would be $100,000, but this contract is not written that way. The account value alone would ignore the step-up feature.

A variable annuity charges a 1.15% M&E charge, a 0.15% administrative fee, 0.70% in subaccount fund expenses and a 0.80% rider fee, all as a percentage of a $150,000 account value. What is the total annual cost in dollars?

• a.$3,150, leaving out the fund expenses
• b.$4,200, the sum of all four charges✓
• c.$3,975, leaving out the administrative fee
• d.$3,000, leaving out the rider fee

The four charges add to 1.15% + 0.15% + 0.70% + 0.80% = 2.80%, and 2.80% of $150,000 is $4,200. Dropping the rider fee gives 2.00% = $3,000. Dropping fund expenses gives 2.10% = $3,150. Dropping the administrative fee gives 2.65% = $3,975. Each omitted layer understates the real cost.

A 76-year-old owns a Traditional IRA and a non-qualified deferred variable annuity bought with after-tax money. During the owner's lifetime, which of these carries required minimum distributions?

• a.Both, because any tax-deferred account must start distributions after the required age
• b.The annuity only, because insurers must start payouts at the owner's required beginning date
• c.The Traditional IRA only, because the non-qualified annuity has no lifetime required distribution✓
• d.Neither, because required distributions apply only to employer plans such as a 401(k)

Traditional IRAs follow the required minimum distribution rules during the owner's life, and at 76 this owner is already past the starting age of 73 or 75 under SECURE 2.0. A non-qualified annuity has no lifetime RMD; its own rules require distribution only after the holder's death. Tax deferral alone does not trigger RMDs, and IRAs are covered along with employer plans. Insurers are not required to begin payouts for the owner at a set age.Internal Revenue Code Section 408(a)(6)

A 50-year-old owns a non-qualified annuity worth $70,000 with a $50,000 after-tax investment. She withdraws $30,000 before annuitizing. What is the 10% additional tax?

• a.$0, because the withdrawal is less than her $50,000 investment
• b.$1,000, which is 10% of the $10,000 withdrawn above the earnings
• c.$3,000, which is 10% of the entire $30,000 withdrawal
• d.$2,000, which is 10% of the $20,000 of earnings withdrawn first✓

Withdrawals from a non-qualified annuity are taxed earnings first, so the first $20,000 is taxable and subject to the 10% additional tax for an owner under 59 1/2, which gives $2,000; the remaining $10,000 is a return of investment. The tax does not apply to the whole withdrawal. Treating basis as coming out first would erase the tax, which is the opposite of the earnings-first rule.Internal Revenue Code Section 72(q)