FINRA Series 7 — All Questions

A representative recommends 30 trades in a retail customer's account in two months. Each trade may be reasonable alone, but total commissions are very high compared with the account's value. Which Reg BI obligation is most directly implicated?

• a.The Compliance Obligation, because the firm must register each trade with the SEC
• b.The Disclosure Obligation, because the firm must disclose the commissions before every individual trade
• c.The Conflict of Interest Obligation, because commissions on any recommended trade are always prohibited
• d.The Care Obligation, because a series of recommended trades must not be excessive for the customer✓

The Care Obligation requires a reasonable basis to believe a series of recommended transactions, even if each is in the customer's best interest alone, is not excessive in light of the customer's investment profile. Disclosure is a separate duty, firms do not register individual trades with the SEC, and Reg BI permits commissions but requires managing the conflict.Regulation Best Interest, Care Obligation

Which compensation practice must a broker-dealer eliminate under Reg BI's Conflict of Interest Obligation?

• a.A bonus paid to representatives only for selling one fund family in a three-month window✓
• b.A flat salary paid to all representatives regardless of the products they recommend
• c.A year-end bonus based on total assets gathered across all product types and accounts
• d.A commission schedule that pays the same rate on all equity products sold by the firm

Reg BI requires firms to eliminate sales contests, quotas, bonuses and non-cash compensation based on sales of specific securities or specific types of securities within a limited period. A salary, a uniform commission schedule and a bonus tied to general asset gathering do not give that incentive to favor a particular product.Regulation Best Interest, Conflict of Interest Obligation

Before or at the time of a recommendation to a retail customer, the broker-dealer must disclose in writing:

• a.Only the representative's commissions on the specific security that is being recommended
• b.All material facts about the relationship, such as capacity, fees, costs and conflicts✓
• c.A complete history of the representative's customer complaints for each of the last ten years
• d.The firm's net capital and balance sheet for its most recently completed fiscal year

The Disclosure Obligation requires full and fair written disclosure of material facts about the scope and terms of the relationship, such as the capacity in which the firm acts, fees and costs, and conflicts of interest. Limiting disclosure to commissions on one security is too narrow, and complaint history and net capital are not part of this obligation.Regulation Best Interest, Disclosure Obligation

After the initial 15 business day hold and the first 10 business day extension on a disbursement from a senior customer's account, the firm has reported its belief of exploitation to a state securities regulator. What further extension does Rule 2165 allow?

• a.A further 30 business days, if the matter was reported to a state regulator, agency or court✓
• b.No further extension, because a temporary hold cannot exceed 15 business days in total
• c.A further 90 business days, if the customer's trusted contact agrees to the extension
• d.A further 30 business days, even if the firm has not reported the matter to any authority

Rule 2165 allows an initial hold of 15 business days, 10 more if the firm's internal review supports a reasonable belief of exploitation, and a further 30 business days if the firm has reported or notified that belief to a state regulator, agency or court. Without such a report the 30-day extension is unavailable, a trusted contact cannot authorize an extension, and the 15-day period can be extended.FINRA Rule 2165

A customer asks his representative whether the firm has filed a Suspicious Activity Report about his account. What should the representative do?

• a.Deny the filing, to avoid alerting the customer to the firm's compliance concerns
• b.Confirm the filing, because the customer is the person that the report concerns
• c.Confirm the filing only if the customer agrees not to move the account elsewhere
• d.Decline to confirm or deny it and refer the question to the AML compliance officer✓

The existence of a SAR is confidential and may not be disclosed to the subject, including by confirming it. The representative should refuse to answer and escalate to compliance. Confirming it breaks the confidentiality rule even with conditions attached, and a false denial would be dishonest as well as unnecessary.31 U.S.C. 5318(g)(2)

An investor buys a 10-year, 6% corporate bond at 92. Which statement correctly ranks the bond's yields?

• a.Nominal 6.00%, current yield 5.52%, and a yield to maturity above 6.00%
• b.Nominal 6.00%, current yield 6.52%, and a yield to maturity above 6.52%✓
• c.Nominal 6.00%, current yield 6.52%, and a yield to maturity below 6.00%
• d.Nominal 6.52%, current yield 6.00%, and a yield to maturity above 6.52%

The coupon is $60 on $1,000 par, and the price is $920, so the current yield is 60/920 = 6.52%. A discount bond also pays back par at maturity, so yield to maturity is higher than the current yield, which in turn is above the nominal 6.00%. A yield to maturity under 6.00% describes a premium bond. Calling 6.52% the nominal yield swaps the coupon rate and the current yield. A current yield of 5.52% subtracts the discount instead of dividing the coupon by the price.Bond yield measures (nominal, current, yield to maturity)

A 6% corporate bond bought at par later trades at 105. How have its nominal yield and its current yield changed?

• a.Nominal stays 6.00% and current yield rises to 6.30%
• b.Nominal falls to 5.71% and current yield stays 6.00%
• c.Nominal rises to 6.30% and current yield stays at 6.00%
• d.Nominal stays 6.00% and current yield falls to 5.71%✓

The nominal yield is the coupon divided by par, so it stays 60/1,000 = 6.00% no matter what the bond trades at. The current yield is the annual interest divided by the market price: 60/1,050 = 5.71%, lower because the investor pays more for the same $60. A rising nominal yield with an unchanged current yield swaps the two measures. A nominal yield that falls to 5.71% also swaps them, because the coupon rate is fixed by the indenture. A current yield of 6.30% multiplies the coupon by the price ratio instead of dividing by it.Bond yield measures (nominal yield versus current yield)

A customer buys a bond at 94 that is callable at par in three years and matures in 12 years. Which yield should the representative quote as the yield to worst?

• a.Nominal yield, because the coupon is the lowest return on the bond
• b.Yield to maturity, because a call at par would only add to the return✓
• c.Yield to call, because the issuer will call as soon as it can
• d.Current yield, because it ignores the call and maturity dates

Bought at 94, the investor gains 6 points if the bond is called at par in three years, which gives a higher return than waiting for maturity, so yield to maturity is the lower number and the worst case. Yield to call is the lowest figure only for bonds bought at a premium. Current yield and nominal yield ignore the repayment of principal, so neither is the yield-to-worst test.Yield to worst (callable bond bought at a discount)

A 10-year corporate bond yields 5.85% and the 10-year Treasury yields 4.60%. What is the yield spread, and what does a wider spread signal?

• a.125 basis points; wider spreads mean less credit risk
• b.1,250 basis points; wider spreads mean more risk
• c.12.5 basis points; wider spreads mean less risk
• d.125 basis points; wider spreads mean more risk✓

The spread is 5.85% - 4.60% = 1.25 percentage points, and one basis point is 0.01%, so the spread is 125 basis points. Investors demand a wider spread when they see more credit or liquidity risk in the corporate bond compared with the Treasury, so a widening spread signals more risk, not less. Stating 1,250 basis points treats a basis point as 0.001%. Stating 12.5 basis points treats it as 0.1%, and it also reads the widening the wrong way.Yield spread over Treasuries (basis points)

A bond's price changes by about $0.72 per $1,000 par for each basis point of yield change. If its yield rises 35 basis points, what is the approximate price change per bond?

• a.A gain of about $25.20
• b.A decline of about $2.52
• c.A decline of about $25.20✓
• d.A decline of about $20.16

35 basis points times $0.72 is $25.20 per bond, and the price falls because bond prices and yields move in opposite directions. A decline of $2.52 slips a decimal place. A gain of $25.20 gets the direction wrong. A decline of $20.16 uses 28 basis points rather than the 35 in the question.Price value of a basis point

A $1,000 par bond with a 5% coupon and 10 years to maturity is bought at 95. Using the approximate-yield formula (annual interest plus annual discount accretion, divided by the average of price and par), what is the approximate yield to maturity?

• a.5.00%
• b.5.13%
• c.5.26%
• d.5.64%✓

Annual interest is $50 and the $50 discount accretes at $5 a year, so the numerator is $55; the average of $950 and $1,000 is $975, giving 55/975 = 5.64%. A result of 5.26% is the current yield, 50/950, which leaves out the discount. A result of 5.00% is the coupon rate. A result of 5.13% accretes the discount over the year but still divides by par.Approximate yield to maturity

A bond with a 4.5% coupon has a current yield of 5.0%. At what price is it trading?

• a.$1,100
• b.$900✓
• c.$950
• d.$1,000

The annual interest is $45, and price = interest / current yield = 45 / 0.05 = $900. A price of $950 splits the difference between par and the true price. A price of $1,100 mistakenly reads a higher current yield as a premium. A price of $1,000 would give a current yield equal to the 4.5% coupon, not 5.0%.Bond yield measures (current yield and price)

A bond's quoted yield to maturity assumes which of the following?

• a.The bond is held to maturity and each coupon is reinvested at the coupon rate
• b.The bond is held to maturity and each coupon is reinvested at the yield to maturity✓
• c.The bond is sold in one year at the same yield and coupons are spent
• d.The bond is redeemed at its first call date and each coupon is spent

Yield to maturity is a return measure that assumes the investor holds to maturity and reinvests every interest payment at that same yield. An early redemption at the first call date is the assumption behind yield to call. A sale after one year at an unchanged yield is not part of the calculation. Reinvestment at the coupon rate would give a different return unless the bond happened to trade at par.Yield to maturity (reinvestment assumption)

A customer buys an 8% bond at 110 that matures in 10 years and is not callable. Which statement about the bond's yields is correct?

• a.Current yield is 8.00%, and the yield to maturity is higher than that
• b.Current yield is 7.27%, and the yield to maturity is lower than that✓
• c.Current yield is 7.27%, and the yield to maturity is higher than that
• d.Current yield is 8.80%, and the yield to maturity is lower than that

The current yield is $80 divided by $1,100, which is 7.27%. The $100 premium is lost when the bond is redeemed at par, so the yield to maturity falls below the current yield and the nominal yield of 8%. A higher yield to maturity describes a discount bond. A current yield of 8.80% multiplies the coupon by the price ratio. A current yield of 8.00% is just the coupon rate.Bond yield measures (premium bond)

A railroad finances new locomotives by issuing debt that is secured by the locomotives themselves, with a trustee holding title until the last certificate is paid. Which security is this?

• a.Collateral trust bond
• b.First mortgage bond
• c.Subordinated debenture
• d.Equipment trust certificate✓

An equipment trust certificate is secured by specific rolling stock, aircraft or similar equipment, and the trustee keeps title until the debt is retired. A collateral trust bond is secured by securities the issuer deposits, not by physical equipment. A first mortgage bond is secured by real property such as track and buildings. A subordinated debenture is unsecured and ranks behind other debt.Corporate bond types (equipment trust certificates)

A holding company deposits shares of its operating subsidiaries with a trustee as security for a new bond issue. This bond is best described as a:

• a.parent-guaranteed bond
• b.first mortgage bond
• c.equipment trust certificate
• d.collateral trust bond✓

Bonds secured by securities that the issuer owns and pledges with a trustee are collateral trust bonds. A first mortgage bond is secured by a lien on real property. An equipment trust certificate is secured by specific equipment, not by securities. A parent-guaranteed bond relies on another company's promise to pay, which says nothing about pledged securities.Corporate bond types (collateral trust bonds)

Which list ranks claims on a liquidating corporation's assets from highest priority to lowest?

• a.Secured bondholders, subordinated debenture holders, debenture holders, preferred stockholders, common stockholders
• b.Secured bondholders, debenture holders, subordinated debenture holders, preferred stockholders, common stockholders✓
• c.Debenture holders, secured bondholders, subordinated debenture holders, preferred stockholders, common stockholders
• d.Secured bondholders, debenture holders, preferred stockholders, subordinated debenture holders, common stockholders

Secured creditors look first to their collateral, general unsecured creditors such as debenture holders come next, and subordinated debt is contractually junior to them. Equity ranks after all debt, with preferred ahead of common. Putting subordinated debentures ahead of ordinary debentures reverses their contractual ranking. Placing preferred stock ahead of subordinated debt treats equity as senior to debt. Ranking unsecured debentures above secured bonds ignores the claim on collateral.11 U.S.C. Section 726 and Section 507 (priority of claims in liquidation)

After secured creditors and all other senior claims are paid, a liquidating company has $5 million left. Its debentures are owed $4 million, its subordinated debentures $3 million, and there is preferred and common stock outstanding. What happens to the subordinated debenture holders?

• a.They receive $1 million, about one-third of their claim, and equity holders receive nothing✓
• b.They receive $3 million in full, and the debenture holders absorb the shortfall
• c.They receive nothing, because only senior debt and preferred stock are paid before common
• d.They receive $1.5 million, sharing the $5 million evenly with the debenture holders

Debenture holders are paid first, taking $4 million in full and leaving $1 million, which goes to the subordinated holders against their $3 million claim, about one-third. Nothing remains for preferred or common stockholders. Subordinated holders cannot jump ahead of senior debentures. Creditors of different rank do not share pro rata. Subordinated debt still ranks above all equity, including preferred stock.11 U.S.C. Section 726 (distribution in liquidation); subordination agreements

A company issues income bonds. In a weak year, its earnings fall short of the interest due and it pays no interest. Which statement is correct?

• a.The missed payment is generally not a default, because interest is owed only to the extent earned✓
• b.The missed interest is added to the principal, because the bonds are payment-in-kind
• c.The trustee may accelerate the principal, because any missed coupon is a default
• d.The company must redeem the bonds at par, because earnings tests act as a put feature

Under an income bond indenture, interest is payable only if the issuer has earned it, so a skipped payment in a low-earnings year is ordinarily not an event of default. Acceleration by the trustee follows a default on an ordinary bond, not on an income bond. Payment-in-kind bonds are a different structure that pays in additional securities. An earnings shortfall gives holders no right to put the bonds back to the issuer.Corporate bond types (income bonds)

Compared with a fixed-rate note of the same maturity and credit quality, how does a floating-rate note's price usually react when market interest rates rise?

• a.It falls by the same amount, because duration depends only on maturity
• b.It stays closer to par, because the coupon resets to follow the benchmark rate✓
• c.It rises, because the higher benchmark makes the note more valuable than par
• d.It falls further, because the coupon cannot rise until the maturity date

A floating-rate note resets its coupon to a benchmark plus a spread, so its price tends to stay near par when rates move. A fixed coupon cannot adjust, which is why a fixed-rate note falls further. The claim that the coupon cannot rise before maturity describes the fixed-rate note. A price above par would require the coupon to exceed what the market now demands. Resets shorten the effective duration, so price sensitivity is not the same as for a fixed-rate note.Corporate bond types (floating-rate notes)

A corporate indenture contains a sinking fund provision. What is the primary effect for the bondholders?

• a.The issuer retires part of the issue before maturity, which reduces the amount due in one lump sum at the end✓
• b.The bonds convert into common stock on a schedule, which reduces the interest paid in each period
• c.The holder may require the issuer to buy the bond back at par on set dates before maturity
• d.A third-party insurer guarantees the principal, which raises the rating to the insurer's level

A sinking fund requires the issuer to set aside money or retire bonds on a schedule, so less principal is left as a balloon at maturity and default risk at the end is lower. A right to sell the bond back to the issuer is a put feature. Scheduled conversion into stock is not a sinking fund; conversion is a separate option. A third-party guarantee of principal is bond insurance or credit enhancement.Corporate bond indenture features (sinking fund)

A 10-year corporate bond has a make-whole call provision. How is the price the issuer must pay on an early call generally determined?

• a.Par value alone, payable only when the call-protection period has fully ended
• b.Par plus a fixed premium that falls by half a point for each year the bond is outstanding
• c.Par plus the next coupon, plus a premium fixed at issuance and unchanged through maturity
• d.Present value of remaining coupons and principal, discounted at a Treasury yield plus a spread✓

A make-whole call prices the bond at the present value of the payments the holder gives up, discounted at a benchmark Treasury yield plus a small spread, which makes calling expensive when rates have fallen. A premium that declines by a set schedule is a conventional call schedule. Par plus a fixed premium is a negotiated penalty, not a make-whole formula. A call at par after protection ends is an ordinary call price.Corporate bond call features (make-whole call)

Which of the following debt offerings is exempt from the qualification requirements of the Trust Indenture Act of 1939?

• a.A registered $300 million convertible debenture of a manufacturer
• b.A registered $75 million first mortgage bond of an electric utility
• c.A registered $200 million subordinated debenture of a bank
• d.A general obligation bond issued by a county or city government✓

Securities issued or guaranteed by a state or a political subdivision are exempt from the Trust Indenture Act, so a city's general obligation bond needs no qualified indenture. Large registered corporate offerings of notes, bonds or debentures must be issued under a qualified indenture with an independent trustee, whether they are subordinated, secured or convertible, and the small-offering exemption covers only $10 million or less.Trust Indenture Act of 1939, Section 304 (exempted securities)

A $1,000 convertible debenture is convertible at $40 per share. The common stock trades at $44 and the bond trades at $1,150. How does the bond's price compare with its conversion value?

• a.The bond is at parity with a $1,150 conversion value
• b.The bond is $150 above its $1,000 conversion value
• c.The bond is $50 above its $1,100 conversion value✓
• d.The bond is $50 below its $1,200 conversion value

The conversion ratio is $1,000 / $40 = 25 shares, so conversion would deliver 25 x $44 = $1,100 of stock. The bond sells $50 above that parity value, a conversion premium of about 4.5%. Treating the $1,000 par as the conversion value ignores the stock price altogether. A $1,200 conversion value would require the stock to be at $48. A $1,150 conversion value would require a stock price of $46, and at $44 the bond would be at parity only if it traded at $1,100.Convertible bonds: conversion ratio, parity and conversion premium

An investor owns a $1,000 convertible bond with a conversion price of $50. The issuer declares a 2-for-1 forward split of its common stock, and the indenture's anti-dilution clause adjusts the conversion terms. What are the adjusted terms?

• a.Conversion price $50 and conversion ratio of 40 shares
• b.Conversion price $100 and conversion ratio 10 shares per bond
• c.Conversion price $25 and conversion ratio 20 shares per bond
• d.Conversion price $25 and conversion ratio 40 shares per bond✓

Before the split the ratio is $1,000 / $50 = 20 shares. A 2-for-1 split doubles the shares, so the ratio rises to 40 and the price halves to $25, which keeps ratio x price at the $1,000 par. The price of $100 with 10 shares is the adjustment for a 1-for-2 reverse split. Keeping the price at $50 while moving to 40 shares would be worth $2,000 of par value. Moving the price to $25 while leaving 20 shares would reduce the claim to $500.Convertible bond indenture: anti-dilution adjustment for stock splits

A company has 10 million shares outstanding and net income of $20 million. It also has $50 million of 4% convertible bonds that convert into 1 million shares, and its tax rate is 30%. Under the if-converted method, what is fully diluted EPS?

• a.$2.14, adding the interest to the old shares
• b.$1.95, adding back the after-tax interest✓
• c.$2.00, adding back interest before tax
• d.$1.82, adding the shares with no interest back

Interest on the bonds is $50 million x 4% = $2 million, or $1.4 million after a 30% tax rate. If the bonds were converted, that interest would not be paid, so net income becomes $21.4 million on 11 million shares, which is $1.945 or $1.95. Adding the shares without the interest add-back gives $20 / 11 = $1.82. Adding back the full pre-tax $2 million gives $22 / 11 = $2.00, which overstates income because interest is tax-deductible. Adding the interest back but leaving out the new shares gives $21.4 / 10 = $2.14.FASB ASC Topic 260 (Earnings Per Share), if-converted method

A convertible bond is callable at 103. The issuer announces a call while the shares into which the bond converts are worth $1,200 per bond. What should a rational holder do?

• a.Keep the bond, because a call cannot be enforced on a convertible
• b.Tender the bond at $1,030, because the issuer set that price
• c.Convert, because the shares are worth $1,200 versus the $1,030✓
• d.Wait for the call date, since conversion ends once a call is announced

Conversion is worth $1,200 per bond and redemption pays only $1,030, so converting captures $170 more. A call on a bond that is in the money is how issuers force conversion. Redemption at $1,030 gives up that value. A convertible cannot be kept after a valid call, since the issuer may redeem it. Conversion rights normally continue until shortly before the redemption date, so a call notice does not end them, but a holder who waits risks missing the deadline and gains nothing by delaying.Convertible bond indenture: issuer call and conversion value

A corporate bond rated BBB- by S&P is downgraded by one notch. How is the bond classified afterward?

• a.Investment grade, since BB+ is still the lowest investment-grade rating
• b.Below investment grade, at BB+ (Ba1 at Moody's), a fallen angel✓
• c.Below investment grade, at BB+ (Ba1 at Moody's), a rising star
• d.Below investment grade, at B+ (B1 at Moody's), a fallen angel

BBB- (Baa3 at Moody's) is the lowest investment-grade rating, so one notch lower is BB+ (Ba1), which is speculative or high-yield. A bond that falls from investment grade to high-yield is a fallen angel. BB+ is the top speculative notch, not the bottom of investment grade. One notch below BBB- does not reach B+, which is four notches lower. A rising star is a high-yield bond upgraded into investment grade, the opposite direction.S&P / Moody's rating scales (BBB-/Baa3 investment-grade cutoff)

A manufacturer reports EBIT of $90 million, depreciation of $15 million, interest expense of $15 million, taxes of $30 million and net income of $45 million. What is its times-interest-earned ratio?

• a.3.0 times, from net income over interest
• b.4.0 times, from taxed EBIT over interest
• c.6.0 times, from EBIT over interest✓
• d.7.0 times, from EBITDA over interest

Times interest earned is EBIT divided by interest expense, or $90 million / $15 million = 6.0. Interest is paid before taxes, so the pre-tax operating figure is used. Net income of $45 million is already after interest and taxes and gives 3.0. Reducing EBIT by taxes to $60 million gives 4.0. EBITDA of $105 million gives 7.0, but depreciation is a non-cash expense that the standard ratio does not add back.Credit analysis: times interest earned (EBIT / interest)

A client asks what a AAA rating on a corporate bond tells her. Which answer is accurate?

• a.It measures how little the bond's market price will move
• b.It estimates the chance the issuer will call the bond before maturity
• c.It is a recommendation that the bond is good value at today's price
• d.The agency's opinion of whether the issuer can pay on schedule✓

A credit rating is an opinion about the issuer's ability and willingness to meet interest and principal obligations when due. Price stability depends on duration and interest rates, so even a AAA long-term bond can fall sharply when rates rise. A rating says nothing about whether the price is attractive. Call risk depends on the call provisions and interest-rate levels, not on the rating.Credit ratings: what an agency rating measures

A customer buys 10 corporate bonds of $1,000 par each, with a 6% coupon paid January 1 and July 1, on Tuesday, September 16, 2025, for regular-way settlement. What accrued interest does the buyer pay?

• a.$128.22, for 78 actual days on a 365-day year
• b.$128.33, for 77 days counted through settlement
• c.$126.67, for 76 days from July 1 to settlement✓
• d.$125.00, for 75 days counted to the trade date

Corporate bonds settle the next business day, so this trade settles Wednesday, September 17. Accrued interest runs from the last coupon date up to, but not including, the settlement date, on a 30-day month and 360-day year: 2 months x 30 + 16 days = 76 days. Annual interest on 10 bonds is $600, and $600 x 76 / 360 = $126.67. Counting to the trade date gives 75 days and $125.00. Counting through the settlement date gives 77 days and $128.33. Actual days over 365 is the convention for Treasury notes and bonds, not corporates, and gives $128.22.FINRA Rule 11620 (accrued interest, 30/360 day count)

Which of these purchases would not show a separate accrued-interest charge on the customer's confirmation?

• a.A convertible debenture bought three months after its last coupon
• b.A first mortgage bond bought two months before its next coupon
• c.A corporate zero-coupon bond bought in the secondary market✓
• d.A floating-rate note bought midway between interest reset dates

A zero-coupon bond pays no periodic interest. Its return is the difference between the discounted price and par, which is already built into the price, so no accrued interest is added to the confirmation. A convertible debenture, a first mortgage bond and a floating-rate note all pay periodic coupons, so a buyer between payment dates compensates the seller for the interest earned since the last payment.Accrued interest: bonds that do not accrue

On Monday, December 8, 2025, a customer sells 10 of the 8% corporate bonds of $1,000 par each, with interest paid April 1 and October 1, at 101 for regular-way settlement. What are the seller's total proceeds before commissions?

• a.$10,100.00, the price with no accrued interest
• b.$10,500.00, the price plus a full semiannual coupon
• c.$10,251.11, the price plus 68 days of interest✓
• d.$9,948.89, the price less 68 days of interest

The trade settles Tuesday, December 9. Accrued interest runs from October 1 to December 9 on a 30/360 basis: 2 x 30 + 8 = 68 days. Annual interest on 10 bonds is $800, so $800 x 68 / 360 = $151.11. Ten bonds at 101 is $10,100, and the buyer pays the seller the accrued interest on top, for $10,251.11. Subtracting it treats the seller as the one paying. Leaving it out ignores interest the seller earned. A full coupon of $400 would only be added if the seller had held the bond through the coupon date.FINRA Rule 11620 (accrued interest, 30/360 day count)

An investor buys a corporate zero-coupon bond at original issue for $600 and reports $30 of original issue discount in the first year. In the second year, the investor sells the bond for $650. What is the tax result of the sale?

• a.A $50 capital gain, because basis stays at the $600 purchase price
• b.A $20 ordinary gain, because discount bonds are taxed as ordinary income
• c.No taxable gain, because the whole $50 gain was OID already taxed
• d.A $20 capital gain, because the reported OID raised the basis to $630✓

Each year's OID is taxed as interest and added to the bond's basis, so after year one the basis is $600 + $30 = $630. Selling at $650 produces a $20 gain over that adjusted basis, which is a capital gain. Keeping the basis at $600 would tax the $30 of OID a second time. Only $30 of the $50 rise was accreted OID, and the remaining $20 comes from the price move. Ordinary treatment applies to the OID accrual itself, while the gain above adjusted basis is capital.IRC 1272 (OID accrual) and basis adjustment

An investor buys a taxable corporate bond with 10 years to maturity at 90 in the secondary market and holds it until it is redeemed at par. How is the $100 of discount taxed?

• a.As ordinary income taxed every year, with no election required
• b.Not at all, because par redemption returns the principal
• c.As ordinary income at redemption, as accrued market discount✓
• d.As a long-term capital gain, since the bond was held to maturity

Discount on a bond bought below par in the secondary market is market discount, and when the bond is redeemed or sold the gain is ordinary income up to the accrued discount. The de minimis exception would apply only if the discount were under 0.25% of par for each full year to maturity, which is $25 here, so $100 is too large to be capital gain. Annual inclusion happens only if the investor elects it. Principal is returned at par, but the investor paid only $900, so $100 is a gain.IRC 1276 and 1278 (market discount on bonds)

A taxable corporate bond was bought at 104 and has 5 years remaining. The investor elects to amortize the premium under IRC 171 and amortizes $8 in the first year. What are the effects?

• a.Taxable interest falls by $8 but the basis stays at $1,040
• b.Taxable interest falls by $8 and basis falls by $8✓
• c.The $8 is a capital loss deduction and basis falls by $8
• d.Taxable interest is unchanged and the basis rises by $8

For taxable bonds, an investor who elects to amortize the premium offsets each year's amortization against the bond's interest income, and basis is reduced by the same amount so that it reaches par at maturity. Leaving basis at $1,040 would produce a capital loss at maturity on money already deducted. The amortization is an offset to interest, not a capital loss. Raising the basis would move it away from par instead of toward it.IRC 171 (amortizable bond premium) and 1016(a)(5)

An investor bought a corporate bond at 95 ($950) and sells it 15 months later for 99 ($990) plus $20 of accrued interest. How is the sale taxed?

• a.A $40 short-term capital gain and $20 of ordinary interest income
• b.A $60 long-term capital gain, because the buyer paid one price
• c.A $40 long-term capital gain and $20 of ordinary interest income✓
• d.A $60 ordinary gain, because the proceeds include interest

Part of the amount received at a sale between coupon dates is interest earned by the seller, and it is reported as interest income. The remaining $40 is the gain over the $950 cost, and a holding period of 15 months makes it long-term. Treating all $60 as capital gain converts interest into a lower-taxed gain. Treating all $60 as ordinary income taxes the true price gain at the wrong rate. A short-term label would require a holding period of one year or less.Pub. 550: bonds sold between interest dates

A single investor sells corporate bond A at a $7,000 loss and bond B at a $2,000 gain, with no other capital transactions this year. What happens to the net loss?

• a.Nothing is deducted now; $5,000 offsets future gains only
• b.$3,000 offsets ordinary income and $2,000 carries forward✓
• c.$5,000 offsets ordinary income in the year of the sales
• d.$2,000 offsets ordinary income and $3,000 carries forward

The $2,000 gain absorbs part of the loss, leaving a $5,000 net capital loss. Up to $3,000 of net capital loss can be deducted against ordinary income in a year for a single filer, and the $2,000 balance carries forward indefinitely. The full $5,000 cannot be deducted in one year. Reversing the split gives up part of the allowable deduction. Carried-forward losses can offset ordinary income too, so a net loss is not limited to future gains.IRC 1211(b) (limit on capital loss deduction)

A representative is comparing Yankee bonds and Eurodollar bonds for a client. Which statement distinguishes them correctly?

• a.A Yankee bond is issued in the foreign issuer's home currency in the U.S.; a Eurodollar bond is issued in euros outside the U.S.
• b.Both are sold only to foreign investors, but Yankee bonds pay in dollars and Eurodollar bonds pay in the foreign currency
• c.A Yankee bond is sold outside the U.S. in dollars; a Eurodollar bond is a foreign issuer's dollar bond registered with the SEC
• d.A Yankee bond is a foreign issuer's dollar bond registered and sold in the U.S.; a Eurodollar bond is sold outside the U.S.✓

Yankee bonds are issued by foreign borrowers in the U.S. market, denominated in dollars and registered with the SEC. Eurodollar bonds are also denominated in dollars but are issued and traded outside the U.S., generally without SEC registration. The first reversed description swaps the two markets. A Yankee bond is not issued in a foreign currency, and a Eurodollar bond is not a euro bond, since the name refers to dollars held outside the U.S. Yankee bonds are aimed at U.S. investors, and Eurodollar bonds pay in dollars.Foreign-issuer and Eurodollar bonds

A customer buys $300,000 of brokered CDs issued by one FDIC-insured bank. They are held in one individual name, with no other deposits at that bank, and $4,000 of interest has accrued. How much is covered by FDIC insurance?

• a.$254,000, which is $250,000 of principal plus the accrued interest
• b.$500,000, because the FDIC and SIPC limits stack on a brokered CD
• c.$250,000, with principal and accrued interest counted together✓
• d.$300,000, because each CD bought through a broker is insured on its own

FDIC coverage is $250,000 per depositor, per insured bank, per ownership category, and the limit includes accrued interest as well as principal. At least $50,000 of this position is uninsured. Interest is not covered on top of the limit. Buying through a broker does not create separate coverage for each CD at the same bank. SIPC protects against a brokerage failure, not a bank loss, and does not add to the FDIC limit.12 CFR Part 330 (FDIC standard maximum deposit insurance amount)

A town of 50,000 people has net direct debt of $40 million and its share of overlapping debt is $10 million. What is its overall net debt per capita?

• a.$1,200, from overlapping debt counted twice
• b.$200, from overlapping debt without the direct debt
• c.$1,000, from direct plus overlapping debt✓
• d.$800, from direct debt without the overlapping debt

Overall net debt combines the issuer's own net direct debt with its share of the overlapping debt of other governments that tax the same residents: $40 million + $10 million = $50 million. Divided by 50,000 residents, that is $1,000 per person. Direct debt alone gives $800, while overlapping debt alone gives $200. Counting the overlapping share twice gives $60 million and $1,200, which overstates the burden.Municipal GO analysis: overall net debt per capita

A county has assessed valuation of $600 million, which is 60% of a market value of $1 billion. It has gross direct debt of $36 million, of which $6 million is self-supporting revenue debt. What is its ratio of net direct debt to assessed valuation?

• a.5.0%, from net direct debt over assessed valuation✓
• b.3.0%, from net direct debt over market value
• c.6.0%, from gross direct debt over assessed valuation
• d.3.6%, from gross direct debt over market value

Net direct debt excludes self-supporting debt, so it is $36 million - $6 million = $30 million. Analysts measure it against assessed valuation, the tax base on which the levy is applied: $30 million / $600 million = 5.0%. Using gross debt gives 6.0%. Using market value for the base gives 3.0% for net debt and 3.6% for gross debt, but market value is not the base on which taxes are levied.Municipal GO analysis: net debt to assessed valuation

A county's general obligation bonds are secured by property taxes, but state law caps the rate that may be levied for debt service. How are these bonds best described?

• a.Revenue bonds, since a capped levy makes the pledge a dedicated source
• b.Double-barreled bonds, since the capped levy backs a second source of payment
• c.Unlimited-tax GO bonds, since the county pledges its full faith and credit
• d.Limited-tax GO bonds, whose holders face a cap on the revenue available✓

When the tax rate available for debt service is capped, the bonds are limited-tax GO bonds. If costs or a shrinking tax base push the needed rate above the cap, the county cannot raise the levy to make up the difference, which is the added risk. Unlimited-tax GO bonds carry no cap on the rate. A capped property tax is still a general tax pledge, not a dedicated revenue stream from a facility. Double-barreled bonds pair a revenue source with a tax pledge, which is not described here.Municipal GO bonds: limited-tax versus unlimited-tax pledge

A city plans to finance a new library with bonds and a water plant with bonds repaid from user fees. Which statement about approvals is typically accurate?

• a.Voters usually must approve both issues, since each adds to the city's debt
• b.Voters usually must approve the water plant's revenue bonds, but not the library GO bonds
• c.Neither issue needs voter approval, since a city council can pledge taxes on its own
• d.Voters usually must approve the library GO bonds, not the water plant revenue bonds✓

General obligation bonds commit the taxing power of the community, so most states and local charters require voter approval, often by referendum, and subject them to constitutional or statutory debt limits. Revenue bonds are repaid only from the facility's income, do not pledge taxes and usually do not need a vote. Reversing the two ignores how the taxpayers are affected. A requirement of voter approval for both overlooks that no tax is pledged for revenue bonds. Councils generally cannot pledge taxes for GO debt on their own.Municipal bond approvals: voter approval and revenue bonds

A school district has assessed valuation of $500 million and levies 20 mills for debt service. Historically it collects 96% of the taxes levied. How much does it expect to collect?

• a.$10.4 million, the levy grossed up for delinquent taxes
• b.$9.6 million, the levy less the 4% not collected✓
• c.$0.96 million, from a mill rate off by a factor of ten
• d.$10.0 million, the levy with no delinquency allowance

One mill is $1 of tax per $1,000 of assessed value, so 20 mills is 2% of assessed value: $500 million x 0.02 = $10 million. At a 96% collection rate, the district expects $10 million x 0.96 = $9.6 million. The full $10 million is the levy before delinquencies. Grossing up for delinquent taxes adds money that is not collected. Treating 20 mills as 0.2% gives $1 million, then $0.96 million after collection.Municipal GO analysis: property tax levy and collection rate

A water authority's indenture pledges net revenues. In what order are the funds applied from the revenue fund?

• a.Operation and maintenance, debt service reserve, debt service, renewal and replacement, then surplus
• b.Operation and maintenance, debt service, renewal and replacement, debt service reserve, then surplus
• c.Operation and maintenance, debt service, debt service reserve, renewal and replacement, then surplus✓
• d.Debt service, operation and maintenance, debt service reserve, renewal and replacement, then surplus

Under a net revenue pledge, the facility must first be kept running, so operation and maintenance is paid first. Debt service follows, then the debt service reserve is topped up, then renewal and replacement, with anything left going to surplus. Paying debt service first describes a gross revenue pledge. Funding renewal and replacement before the debt service reserve, or funding the reserve before debt service itself, changes the priority of the claims on revenue.Revenue bond flow of funds under a net revenue pledge

A toll bridge reports gross revenues of $24 million, operation and maintenance expenses of $14 million and annual debt service of $8 million. What is its debt service coverage ratio on net revenues?

• a.0.80 times, from debt service over net revenues
• b.1.25 times, from net revenues over debt service✓
• c.3.00 times, from gross revenues over debt service
• d.1.75 times, from operating expenses over debt service

Net revenues are gross revenues less operation and maintenance: $24 million - $14 million = $10 million. Coverage is $10 million / $8 million = 1.25 times. Using gross revenues ignores the operating costs that are paid before debt service on a net pledge. Dividing the other way around gives 0.80, which is a ratio of claims to resources instead of the reverse. Operating expenses over debt service has no meaning as a coverage measure.Revenue bonds: debt service coverage ratio

A revenue bond rate covenant requires net revenues of at least 1.25 times annual debt service of $10 million. Gross revenues are $30 million and operating expenses are $18 million. Has the covenant been met?

• a.Yes; net revenues of $12 million exceed debt service of $10 million
• b.No; coverage is 1.20 times against 1.25 required, so rates must rise✓
• c.No; coverage is 0.83 times because debt service exceeds net revenues
• d.Yes; coverage is 3.0 times, using gross revenues over debt service

Net revenues are $30 million - $18 million = $12 million, and $12 million / $10 million = 1.20 times, short of the 1.25 times required ($12.5 million). The covenant obliges the authority to raise rates or cut costs. Exceeding debt service by $2 million would satisfy only a 1.0 times test. Gross revenues are not the measure under a net pledge. A 0.83 ratio inverts the calculation, and debt service of $10 million is covered by net revenues of $12 million.Revenue bonds: rate covenant test

An airport authority's open-end indenture allows additional parity bonds only if historical net revenues are at least 1.5 times the maximum annual debt service on all bonds, old and new. Existing maximum annual debt service is $16 million and the new bonds would add $6 million. What historical net revenue must the authority show?

• a.$24 million, which is 1.5 times the existing $16 million
• b.$30 million, which is $24 million of coverage plus the new $6 million
• c.$22 million, which is the combined debt service at 1.0 times
• d.$33 million, which is 1.5 times the combined $22 million✓

The test applies to all bonds that would be outstanding, so maximum annual debt service becomes $16 million + $6 million = $22 million, and 1.5 times that is $33 million. Using only existing debt service gives $24 million and ignores the new bonds. Using the combined amount at 1.0 times ignores the coverage margin. Adding the new debt service without applying the 1.5 times coverage gives $30 million, which leaves the new bonds uncovered.Revenue bonds: additional bonds test (open-end indenture)

A hospital authority's revenue bonds require a debt service reserve fund. One year, patient revenues fall short of a scheduled debt service payment. What is the reserve fund's role?

• a.It funds equipment replacement to keep the hospital competitive
• b.It pays operating costs first so that revenues can go to bondholders
• c.It redeems bonds early when revenues exceed what the covenant needs
• d.It covers the missing payment and is restored from later revenues✓

A debt service reserve fund is a cushion held for bondholders, typically sized to a year of debt service. If revenues are insufficient, the trustee draws on it to make the payment on time, and the issuer must restore it from later revenues. Operating costs are covered through the operation and maintenance account. Equipment replacement is the job of the renewal and replacement fund. Early redemption comes from surplus or a sinking fund rather than the reserve.Revenue bonds: debt service reserve fund