FINRA Series 7 — All Questions

Two revenue bonds on similar facilities carry the same rating. One has a gross revenue pledge and the other a net revenue pledge. Which statement is accurate?

• a.With a net pledge, debt service comes ahead of operating costs, so holders are stronger
• b.With a gross pledge, debt service comes ahead of operating costs, so holders are stronger✓
• c.The two differ only in the size of the reserve fund, not the order of payments
• d.With a gross pledge, operating costs are paid ahead of debt service, so holders rank second

A gross revenue pledge commits all revenue first to debt service, with operating expenses paid afterward, which gives bondholders the stronger position, though the facility can suffer if it cannot pay to operate. A net pledge pays operation and maintenance first, then debt service. The other two descriptions reverse that order. The reserve fund is a separate feature and does not define the pledge.Revenue bonds: gross versus net revenue pledge

A county development authority issues bonds to build a plant that it leases to a manufacturer. The lease payments are the only source of repayment. What is the principal credit risk?

• a.The county's ability to levy property taxes on its residents
• b.The state legislature's willingness to appropriate funds each year
• c.The manufacturer's ability to keep making the lease payments✓
• d.Traffic or usage on the plant, as with a toll facility

Industrial development bonds are repaid from payments by the corporate lessee, so the bondholders effectively hold that company's credit even though a government authority is the issuer. The county does not pledge its taxing power and is not obligated to make up shortfalls. No annual appropriation is involved. A plant leased to one manufacturer produces no user fees, so usage risk is not the primary concern.Industrial development revenue bonds: lessee credit

A city leases a new office building from a building authority and pays annual rent from its general fund. The lease is subject to annual appropriation, and certificates of participation fund the construction. What is the main risk to the holders?

• a.The building's tenants may leave and reduce rental income
• b.The council may decline to appropriate the rent in a future budget✓
• c.The state may revoke the city's power to issue general obligation bonds
• d.The city may be forced to raise property taxes above a legal cap

Under a lease with an annual-appropriation clause, the city's obligation to pay rent exists only if the council appropriates the funds each year, and non-appropriation is not a default on the city's GO debt. That makes the certificates riskier than GO bonds. A tax-rate cap relates to limited-tax GO bonds. Rent comes from the city, not from outside tenants. The authority to issue GO bonds is a separate matter unrelated to the lease.Lease rental bonds and certificates of participation

A state housing finance agency's bonds carry a moral obligation pledge. What does the pledge mean for investors?

• a.The legislature may restore the reserve but has no legal duty✓
• b.The state's insurance fund pays the bonds if the agency defaults
• c.The state's full faith and credit guarantee the principal and interest
• d.The state is legally required to appropriate funds for any shortfall

A moral obligation pledge states that if the debt service reserve is drawn, the state legislature may consider appropriating money to restore it, but it has no legal duty to do so. That is weaker than a legal obligation or a full faith and credit guarantee. It does not create a state-backed insurance fund. Investors rely mainly on the agency's own revenues, with the pledge as a secondary comfort.Moral obligation bonds

A county issues bonds payable first from the tolls of a new bridge, with a pledge of its taxing power if the tolls fall short. What type of bond is this?

• a.A double-barreled bond✓
• b.A moral obligation bond
• c.A limited-tax GO bond
• d.A special tax bond

A double-barreled bond has a primary source of repayment from a revenue-producing project, here the bridge tolls, and a second source in the issuer's general taxing power. A moral obligation pledge relies on a legislature that is not legally bound. A special tax bond is repaid only from a specific tax, such as a sales or fuel tax, and has no second source. A limited-tax GO bond is backed by property taxes within a rate cap rather than by project revenues.Double-barreled municipal bonds

A city issues bonds to build streets and sewer lines in a new subdivision. The bonds are repaid from assessments on the lots in that district. Which risk is greatest for the bondholders?

• a.Residents elsewhere in the city may vote down a general tax increase
• b.Owners of undeveloped lots may stop paying their assessments✓
• c.The sewer fees may be set below the level the state commission allows
• d.The city may be unable to raise the sales tax throughout the area

Special assessment bonds are secured only by assessments on the properties that benefit from the improvements, so delinquent owners, especially of unbuilt lots in a new development, threaten debt service. The city's general taxes are not pledged, so a sales tax or a general levy does not matter. Sewer fee regulation concerns revenue bonds backed by user charges rather than assessments.Special assessment bonds

An investor holds Build America Bonds issued by a city in 2010. Which statement is accurate?

• a.The interest is exempt from federal income tax but subject to AMT
• b.Interest is taxable, and direct-pay issuers got a federal subsidy✓
• c.The city may issue more Build America Bonds today under the program
• d.Every Build America Bond gave the investor a federal tax credit

Build America Bonds were taxable municipal bonds authorized for 2009 and 2010. For the direct-pay version, the issuer received a federal payment equal to 35% of its interest cost, later reduced by sequestration. The interest is not tax-exempt, so the AMT question does not arise. The authority to issue new bonds expired at the end of 2010. Only the tax-credit version gave investors a credit, and the direct-pay version paid the issuer.Build America Bonds (ARRA 2009)

A school district's bond anticipation notes mature in 60 days, but weak market conditions have delayed the long-term bond sale that was to repay them. What is the noteholders' main risk?

• a.The district may be unable to repay without a bond sale or a note rollover✓
• b.The notes lose their tax exemption whenever the bond sale is delayed
• c.The notes convert automatically into the delayed bonds at the same rate
• d.The notes must be repaid from property taxes, which cannot be collected in time

Bond anticipation notes are repaid from the proceeds of the bonds the issuer plans to sell. If the market for the bonds is poor, the issuer must either sell them on worse terms or issue new notes to pay off the old ones, and if neither is possible the noteholders face a delay in payment. The notes are not repaid from the property tax collection, which is the source for tax anticipation notes. Nothing converts the notes into bonds automatically, and a delay does not by itself remove their tax exemption.Municipal notes: bond anticipation notes and rollover risk

A client holds municipal VRDOs that reset their interest rate weekly and wants to know how liquid they are. Which statement is accurate?

• a.The client can tender only on the issuer's call date, with no notice required
• b.The client must hold to maturity, because the weekly reset takes the place of any put right
• c.The client can tender only at market price, with no backup if no buyer is found
• d.The client can tender at par on about seven days' notice, backed by a bank facility✓

VRDOs combine a floating rate that resets frequently, often weekly, with a put option. Holders can tender at par plus accrued interest on short notice, usually seven days, and a remarketing agent tries to resell the bonds. If it cannot, the liquidity facility, such as a letter of credit or standby purchase agreement from a bank, funds the purchase. The put is not tied to the call date, and the price is par, not market.Variable-rate demand obligations (VRDOs)

An investor holds municipal auction rate securities. At the scheduled auction, there are not enough buyers for all the securities offered. What happens?

• a.The auction is repeated at successively lower rates until every holder can sell
• b.The issuer must redeem the securities at par on the next business day
• c.The auction fails, holders cannot sell, and the rate resets to the maximum✓
• d.The securities convert automatically into fixed-rate bonds at par value

Auction rate securities depend on periodic auctions for liquidity. When sell orders exceed buy orders, the auction fails: holders keep the securities, and the interest rate is set at the maximum rate stated in the terms. Nothing obliges the issuer to redeem at par or repeat the auction, and the terms do not convert them into fixed-rate bonds. This risk surfaced widely in 2008, when many auctions failed at once.Auction rate securities: failed auctions

The indenture for a hospital revenue bond requires the issuer to redeem the bonds at par from insurance proceeds if the financed hospital building is destroyed and not rebuilt. Which call feature is this?

• a.Optional redemption, exercised when the issuer decides that rates are low enough
• b.Extraordinary redemption, caused by an event beyond the issuer's choice✓
• c.Mandatory sinking-fund redemption, retiring a set amount of bonds every year
• d.Make-whole call, priced at the present value of all the remaining payments

An extraordinary (special) redemption is triggered by a named event, such as destruction or condemnation of the project or an unspent-proceeds situation, and is usually at par. An optional redemption is at the issuer's discretion, usually after a call-protection period, and is not forced by an event. A mandatory sinking-fund redemption follows a fixed annual schedule whether or not anything happens to the project. A make-whole call is a corporate-bond feature priced at a Treasury-based premium, which is not how an insurance-funded par redemption works.Municipal bond call provisions: extraordinary (special) redemption

A county sells new bonds and uses the proceeds to buy Treasury securities held in an escrow account that will pay the county's older 5% bonds through their first call date. How are the older bonds described, and how are they usually priced?

• a.They are called now, with holders receiving par plus the full coupon today
• b.They are pre-refunded, with the county's credit unchanged and priced to maturity
• c.They are pre-refunded, with very high credit quality and a price based on the call date✓
• d.They are escrowed, with a lower rating and a price based on the call date

Once escrowed Treasuries are set aside to pay the old bonds, they are pre-refunded. Repayment no longer depends on the county, so the bonds typically trade at a very high credit quality (often AAA-equivalent). Because the escrow is sized to retire them at the first call date and price, they are priced to that call date rather than their final maturity. The old bonds are not redeemed at once, since the escrow carries them to the call date. The escrow improves the credit, so a lower rating or an unchanged county credit would be wrong.Pre-refunded municipal bonds: escrow of Treasury securities

A city has outstanding bonds that can first be called in six months. It wants to issue new tax-exempt bonds today, place the proceeds in escrow and use them to retire the old bonds on the call date. Under current federal tax law, what is the result?

• a.They can be tax-exempt, because the old bonds will be called within a year after the new bonds are sold
• b.They cannot be tax-exempt, because refunding over 90 days before the call is an advance refunding✓
• c.They cannot be tax-exempt, because only refundings that close after the call date qualify
• d.They can be tax-exempt, because each issue is allowed one advance refunding before its first call date

A current refunding closes within 90 days of the call or maturity date of the old bonds. This one is six months ahead, so it is an advance refunding. The 2017 tax act ended tax-exempt advance refundings, and an issuer that wants to refinance early must issue taxable bonds or wait until the 90-day window. The older rule that allowed one tax-exempt advance refunding per issue no longer applies. A one-year test does not exist. A current refunding does not have to wait until after the call date; it may close up to 90 days before it.IRC section 149(d), as amended by the Tax Cuts and Jobs Act of 2017 (advance refundings)

A 10-year, $24 million term bond has a mandatory sinking fund that retires $3 million of bonds in each of years 5, 6, 7, 8 and 9. How much principal is still outstanding to be repaid at final maturity in year 10?

• a.$15 million, the total retired by all the installments
• b.$9 million, the amount outstanding after five installments✓
• c.$6 million, after counting the installments from year 4
• d.$12 million, after counting only four of the five installments

Five installments of $3 million retire $15 million, leaving $24 million - $15 million = $9 million to be paid at maturity. This remaining amount is the balloon. Counting four installments would leave $12 million. Counting six installments, which would require a payment in year 4, would leave $6 million. The $15 million figure is what the sinking fund retires, not what remains.Municipal indenture: mandatory sinking fund

An issuer sells refunding bonds and places the proceeds in an escrow that pays interest on the new bonds until the crossover date. What happens to the old bonds in the meantime, and at the crossover date?

• a.The escrow pays them to their call date; at crossover new bond payments begin
• b.They are defeased on the sale date; at crossover the lien on them is released
• c.The escrow pays both issues; at crossover the old bonds are exchanged for new ones
• d.Revenues keep paying the old bonds; at crossover the escrow redeems them✓

In a crossover refunding the escrow first pays interest on the refunding bonds, while the old bonds are still serviced from the original pledged revenues. At the crossover date the escrow assets pay off (redeem) the old bonds, and the pledged revenues then begin paying debt service on the refunding bonds. In a typical (defeasance) structure the escrow pays the old bonds from the start. In a crossover, the escrow does not pay both issues and the bonds are not exchanged.Municipal refundings: crossover refunding structure

Three municipal bonds have the same 5% coupon, rating and maturity. One is non-callable, one is callable at 102 in ten years, and one is callable at par in two years. If market yields fall by 100 basis points, which bond's price rises the least?

• a.The non-callable bond, because it has the least protection against rate moves
• b.The bond callable at 102 in ten years, because a long call date caps its gain
• c.The bond callable at par in two years, whose price is held near the call price✓
• d.The three rise by the same amount, as their coupons and maturities match

Price compression limits the rise of a bond that is close to a call at a price near par. The bond callable in two years at par is likely to be redeemed once rates fall, so buyers price it toward the call date and it will not rise much above par. The non-callable bond has no such cap and rises the most. The bond callable in ten years at 102 sits between the two. Matching coupons and maturities do not make the prices move equally, because call terms change the likely life of the bond.Call risk: price compression and callable municipal bonds

What does an unqualified opinion from bond counsel normally say about a municipal issue?

• a.The bonds are secured by the full faith and credit of the state and carry no default risk
• b.The bonds are priced fairly and are suitable for investors seeking tax-exempt income
• c.The bonds are valid, binding obligations and interest is exempt from federal income tax✓
• d.The issuer's audited statements are accurate and it will be able to pay the debt service

Bond counsel's opinion addresses legal points: that the issue was legally authorized, that the bonds are valid and binding obligations of the issuer, and that interest is excluded from federal gross income (and usually from state tax in the issuing state). It is not a guarantee of payment or a state's backing, and it does not speak to credit quality, the fairness of the price, suitability or the accuracy of financial statements. Those are for the rating agencies, the official statement and the investor's own analysis.Municipal bond legal opinion: bond counsel opinion

A municipal official statement says that the legal opinion on a new issue is 'qualified.' What does the term mean?

• a.The bonds meet the test to be bank-qualified under the tax code
• b.Counsel stated a reservation or exception about a legal point✓
• c.The attorney is MSRB-certified to issue municipal legal opinions
• d.Counsel has confirmed the bonds are of investment-grade quality

A qualified legal opinion is one in which counsel states a reservation, condition or exception on a legal matter concerning the issue, so a buyer should read what has been carved out. It is not a certification of the attorney by the MSRB. Bank-qualified status is a separate designation under the tax code for small issuers. A legal opinion speaks to validity and tax treatment, not to credit quality or rating.MSRB glossary: qualified legal opinion

An underwriter's final agreement to purchase a new municipal issue is signed on Monday, March 2, 2026. Under the contract that Rule 15c2-12 requires the underwriter to obtain, by what date must the issuer deliver the final official statement? Assume no holidays fall in the period.

• a.Thursday, March 12, 2026, eight business days after signing
• b.Tuesday, March 10, 2026, counting the signing day as day one
• c.Monday, March 9, 2026, which is seven calendar days after the agreement
• d.Wednesday, March 11, 2026, seven business days after the agreement✓

The rule requires the underwriter to contract for the issuer to deliver the final official statement within seven business days after the final agreement to purchase. Counting business days from the next day: March 3, 4, 5, 6, 9, 10 and 11, which makes Wednesday, March 11. Seven calendar days gives March 9. Counting the agreement day itself as day one gives March 10. Eight business days gives March 12.SEC Rule 15c2-12: final official statement delivery timeline

A client is considering an insured municipal bond and asks what the insurance covers. What is the best answer?

• a.It pays the holder a premium if the issuer redeems the bonds before maturity
• b.It guarantees timely payment of interest and principal if the issuer defaults on them✓
• c.It protects the bond's tax exemption if the IRS later rules the interest taxable
• d.It protects against a fall in the bond's market price when interest rates rise

Municipal bond insurance is a financial guaranty: if the issuer fails to pay scheduled interest or principal, the insurer pays on time. It improves credit quality but does not remove interest-rate risk, so the market value still falls when rates rise. It does not insure the tax-exempt status of the interest, which depends on the legal opinion and compliance with the tax rules. It does not pay a premium when bonds are called, since redemption at the call price is not a default.Municipal bond insurance: what the policy guarantees

A customer wants to sell $15,000 par of municipal bonds from a small, unrated local issuer. The dealer's bid is well below the quotes seen for large AA-rated state bonds. What is the best explanation?

• a.Interest becomes taxable once a dealer buys the bonds back from the owner
• b.The MSRB requires odd-lot sales to be priced at a discount to par value
• c.Unrated municipal bonds cannot be resold by their holders before they mature
• d.Few buyers exist, so the market is thin and the spread is wide✓

Marketability depends on issue size, rating, name recognition and trading volume. A small unrated issue in an odd lot has few buyers, so the dealer must hold it longer and quotes a lower bid and a wider spread. Nothing bars resale of an unrated bond. The MSRB has no rule that odd lots must be priced below par; the discount reflects market conditions. Selling to a dealer has no effect on the tax-exempt status of the interest.Municipal secondary market: marketability of small and unrated issues

A customer buys 25 municipal bonds with a $5,000 par value each at a dollar price of 98.5. Ignoring accrued interest, what is the purchase price?

• a.$123,125, which is 98.5% of the $125,000 par✓
• b.$125,000, par value of the whole position
• c.$126,875, which adds the 1.5 points to par instead
• d.$24,625, which is 98.5% of 25 bonds at $1,000 each

Municipal bond prices are quoted as a percentage of par. Par is 25 x $5,000 = $125,000, and 98.5% of that is $123,125. Adding the 1.5 points to par instead of subtracting them gives $126,875, a premium price. Using par alone ignores the discount. Computing 98.5% of $25,000 applies the price to the number of bonds times $1,000 and understates the cost.Municipal bond pricing: dollar price on par value

An investor buys a tax-exempt municipal bond at 104 when it has 8 years to maturity and sells it at 102 after holding it for 3 years. For this problem, assume the premium is amortized straight-line. What is the tax result per $1,000 bond?

• a.A $20 capital loss, because the basis stays at $1,040
• b.A $35 capital loss, because amortization raises the basis
• c.A $5 capital loss, because the basis falls to $1,025✓
• d.A $20 loss, with $15 as deductible amortization and $5 capital

The $40 premium is amortized over 8 years, or $5 a year, so after 3 years the basis is reduced by $15 to $1,025. Selling at $1,020 is a $5 capital loss. Under Publication 550 the premium on a tax-exempt bond must be amortized, but the amortization is not deductible. A $20 loss ignores the required basis reduction. Adding amortization to basis moves it the wrong way. A deduction for the $15 would be allowed on a taxable bond, not on a tax-exempt one.Tax basis of tax-exempt bonds bought at a premium (IRS Publication 550)

On Thursday, May 14, 2026, a customer buys 25 municipal bonds of $5,000 par each with a 4% coupon that pay interest on March 1 and September 1. The trade settles on Friday, May 15, 2026. Using 30/360, what is the accrued interest due from the buyer?

• a.$1,041.67, from 75 days, including the settlement date itself
• b.$1,013.89, from 73 days, starting the count a day late
• c.$1,027.78, for 74 days of accrual from March 1 up to settlement✓
• d.$833.33, from two full months, ignoring the days in May

Annual interest on $125,000 of par is $5,000. On the 30/360 basis, accrual runs from March 1 up to, but not including, the May 15 settlement date: two months (60 days) plus 14 days is 74 days. Then $5,000 x 74/360 = $1,027.78. Counting 75 days includes the settlement date and gives $1,041.67. Counting 73 days gives $1,013.89, because it starts a day late. Using two months only gives $5,000 x 60/360 = $833.33, which ignores the days in May.MSRB Rule G-33 and FINRA Rule 11620: municipal accrued interest on 30/360

A taxable corporate bond yields 4.25% and a municipal bond of similar quality and maturity yields 3.40% tax-exempt. At what federal tax bracket would an investor be indifferent between them?

• a.80%, found by dividing 3.40% by 4.25% and stopping there
• b.0.85%, the gap between the yields, read as a tax rate
• c.20%, because 3.40% / 4.25% = 0.80 and 1 - 0.80 = 0.20✓
• d.25%, found by dividing the 0.85% gap by the 3.40% municipal yield

The investor is indifferent when the taxable yield times (1 - tax rate) equals the tax-exempt yield, so the break-even rate is 1 - (3.40% / 4.25%) = 1 - 0.80 = 20%. In a higher bracket, the municipal bond wins; in a lower bracket, the corporate bond does. Dividing the gap by the municipal yield measures the wrong base and gives 25%. The ratio 0.80 is the share of the corporate yield the investor keeps, not the tax rate. The yield gap is a number of percentage points, not a tax rate.Taxable-equivalent yield: break-even tax bracket for a municipal bond

A municipal bond with a 5% coupon is priced at 106 with 10 years to maturity and is callable in 3 years at 102. Using the approximate yield formulas, which yield is the yield to worst?

• a.About 4.3%, yield to the 10-year maturity
• b.About 3.5%, yield to the 3-year call✓
• c.5.0%, the coupon rate stated on the bond
• d.About 4.7%, current yield on the price paid

Yield to worst is the lowest of the yields to each possible redemption date. For a premium bond, the call usually gives the lowest yield because the premium is lost sooner. The yield to the call is about ($50 - $13.33 premium lost per year) / $1,040 average price, or about 3.5%. The yield to maturity is about $44 / $1,030, or 4.3%. The current yield is $50 / $1,060 = 4.7%, and the coupon is 5.0%. These all exceed the yield to the call.Yield to worst on a premium callable municipal bond (approximation)

A municipal bond with a 4% coupon paying interest semiannually has six months to maturity and is priced to yield 5.00%. Ignoring accrued interest on the pricing date, what is its approximate price per $1,000 bond?

• a.$971.43, from discounting $1,020 at the full 5%
• b.$995.12, from discounting $1,020 at 2.5% for one period✓
• c.$1,000.00, because a bond near maturity trades at par
• d.$990.48, from discounting $1,040 at the full 5%

With one period left the bond pays its final $20 coupon plus $1,000 of principal, or $1,020. At a 5% annual yield the semiannual rate is 2.5%, so the price is $1,020 / 1.025 = $995.12. Using the full 5% for a six-month period discounts too much and gives $971.43. Using a $1,040 payment treats the whole year's coupon as due and gives $990.48. Par only applies if the yield equals the 4% coupon, and here the yield is higher, so the price is below par.Municipal bond pricing: price of a bond one coupon from maturity

A municipal bond financing a privately used facility carries the notice 'interest subject to AMT.' How is the interest treated for a taxpayer who holds it?

• a.Exempt from regular tax and the AMT, like any other municipal bond
• b.Exempt from regular tax but subject to the 3.8% investment income surtax
• c.Exempt from regular federal tax but a preference item for AMT✓
• d.Fully taxable at regular rates because a private user benefits

Interest on specified private activity bonds is generally excluded from regular taxable income, but a portion may be a tax preference item that enters the alternative minimum tax calculation, which is why such bonds usually carry a higher yield than similar governmental-purpose bonds. The interest is not fully taxable, because the exclusion still applies to regular tax. It is not exempt from the AMT, which is the reason for the notice. The 3.8% surtax is a separate tax on net investment income and is not the consequence flagged by the notice.IRS Publication 550: specified private activity bonds and the alternative minimum tax

An investor buys a tax-exempt municipal bond in the secondary market at 96 with 5 years to maturity, and sells it two years later at 98.5. The bond had no original issue discount. Assume the market discount accrues ratably. What is the tax result per $1,000 bond?

• a.$25 is capital gain, because the sale was at a price below par
• b.$16 is ordinary income and the other $9 of the gain is capital gain✓
• c.$9 is ordinary income and the other $16 of the gain is capital gain
• d.$25 is tax-exempt, because the bond is a municipal security

The $40 discount exceeds the de minimis amount of 0.25% x $1,000 x 5 years = $12.50, so it is market discount. Accruing it ratably gives $8 a year, or $16 after two years. The total gain is $985 - $960 = $25. Publication 550 treats gain up to the accrued market discount as ordinary interest income, so $16 is ordinary and the remaining $9 is capital gain. Market discount on a tax-exempt bond is not itself tax-exempt. Treating the whole gain as capital ignores the accrued discount. Reversing the two amounts would put the larger share in the lower-taxed category.IRS Publication 550: market discount on a tax-exempt bond sold before maturity

An investor buys a new 10-year zero-coupon municipal bond at its $600 original issue price (par $1,000). After four years, she sells it for $800. For this problem, assume the discount accretes straight-line. What is the tax result?

• a.A $40 gain that is tax-exempt, since it comes from a municipal security
• b.A $200 gain, with $160 of it taxed as interest income while she held the bond
• c.A $200 capital gain, because her basis stays at the original $600 purchase cost
• d.A $40 capital gain, because $160 of exempt accretion raised basis to $760✓

The $400 discount accretes at $40 a year, so after four years $160 has accreted. Original issue discount on a tax-exempt bond is treated as tax-exempt interest, and the accreted amount increases the basis to $760. Selling for $800 gives a $40 capital gain. Leaving the basis at $600 would tax interest that is exempt. The accretion is not taxable as income in the years held. Price appreciation beyond the accreted value is a capital gain even on a municipal bond.IRS Publication 550: tax-exempt original issue discount and basis on a sale

Banks often pay more for 'bank-qualified' municipal bonds than for other municipals. What makes a bond bank-qualified?

• a.A small issuer, up to $10 million a year; banks deduct 80% of carrying costs✓
• b.Bond insurance, which allows a bank to hold the issue with no capital set aside
• c.An investment-grade rating, the only grade that bank regulators allow banks to hold
• d.Issuance by a state bank authority, so that all of a bank's interest cost is deductible

A qualified tax-exempt obligation is issued by a small issuer that reasonably expects to issue no more than $10 million of tax-exempt obligations in the calendar year, and that has designated the bonds for this purpose. A bank holding them may deduct 80% of the interest cost of carrying them, which is why banks accept lower yields. A rating or insurance does not create the designation, and the issuer need not be connected to a bank. Other bonds leave the bank with no deduction for the interest allocable to them.IRC section 265(b)(3): bank-qualified tax-exempt obligations

An investor is in the 24% federal bracket and pays 6% state income tax. Assume her state taxes interest on other states' municipal bonds. She compares an in-state bond yielding 3.50% with an out-of-state bond of similar credit and maturity yielding 3.70%. Which has the higher after-tax yield?

• a.The in-state bond, at 3.50% against about 3.48% for the out-of-state bond✓
• b.The out-of-state bond, since 3.70% is higher and both are exempt from federal tax
• c.Neither, as both are exempt from federal tax and the yields are equal
• d.The in-state bond, since the other bond nets only 2.59% after both taxes

Both bonds are exempt from federal income tax. The in-state bond is also exempt from her state's tax, so it keeps its full 3.50%. The out-of-state bond is taxed by her state: 3.70% x (1 - 0.06) = 3.478%. The in-state bond is slightly higher. Comparing the stated yields ignores the state tax. Applying the federal rate to exempt interest, as in 3.70% x 0.70 = 2.59%, taxes something that is not taxed. The yields are not equal, because only one of them is exposed to state tax.Tax-exempt yield comparison: in-state versus out-of-state municipal bond

A single retiree has $18,000 of adjusted gross income that excludes Social Security, $9,000 of municipal bond interest, and $20,000 of Social Security benefits. Provisional income is AGI plus tax-exempt interest plus half of the benefits. The 85% tier begins above $34,000. What is the result?

• a.Provisional income is $37,000, yet no benefits are taxable because interest is exempt
• b.Provisional income is $37,000, so up to 85% of the benefits may be taxable✓
• c.Provisional income is $47,000, since all of the benefits are included
• d.Provisional income is $28,000, so up to 50% of the benefits could be taxable

Provisional income is $18,000 + $9,000 + half of $20,000, or $10,000, which equals $37,000. Tax-exempt interest counts in this formula even though it is not taxed itself. That is above the $34,000 threshold for a single filer, so up to 85% of the benefits may be taxable. Leaving the municipal interest out gives $28,000 and the 50% tier. Adding all of the benefits instead of half gives $47,000. Counting the interest does not make the benefits tax-free; it increases the amount subject to tax.IRS Publication 915: tax-exempt interest and provisional income

An investor buys a new-issue municipal bond at par ($1,000). Eight months later, after interest rates fall, she sells it for $1,040. What is the federal tax treatment of the $40?

• a.Tax-exempt as part of the bond, since it is a municipal security
• b.A short-term capital gain, while the coupons stay tax-exempt✓
• c.A long-term capital gain, since municipal bonds are long-term
• d.Ordinary interest income, because the gain is part of the bond's yield

Municipal bond interest is excluded from federal income, but a gain on selling the bond is a capital gain like any other. Held for less than a year, it is a short-term gain taxed at ordinary rates. The type of bond does not exempt the gain from tax. The holding period is measured by how long the investor owned it, not by the bond's term. The gain came from a change in market price, not from market discount or accretion, so it is not interest income.Capital gains on municipal bonds: price appreciation is taxable

A county treasurer plans to place idle cash in a pooled fund run by the state that many local governments use. How are interests in such a local government investment pool (LGIP) classified?

• a.Bank deposits that are insured up to the FDIC limit for each government
• b.Short-term notes of the state, backed by its full faith and credit
• c.Municipal fund securities, so dealers that sell them are subject to MSRB rules✓
• d.Shares of a money market fund registered under the Investment Company Act

MSRB Rule D-12 defines municipal fund securities as municipal securities that would be investment company securities if they had not been issued by a governmental entity. Examples are 529 plans, ABLE programs and local government investment pools, and dealers selling them follow MSRB rules. An LGIP is not registered under the 1940 Act. It is not a note backed by the state's credit, because investors share in the pool's investments and its value can change. It is not a bank deposit, so FDIC insurance does not apply to it.MSRB Rule D-12: local government investment pools as municipal fund securities

In 2026, Maria is 49 and has a severe disability that began when she was 33. She meets the other ABLE eligibility requirements. Can she open an ABLE account?

• a.Yes, since the onset age limit rose to 46 on January 1, 2026✓
• b.No, because the owner must be under age 46 on the day of opening
• c.No, because the disability must have begun before she turned 26
• d.Yes, since ABLE accounts set no limit on when the disability began

ABLE eligibility turns on the age at which the disability began, not the owner's current age. The ABLE Age Adjustment Act raised that limit from 26 to 46 effective January 1, 2026, so onset at 33 qualifies even though Maria is 49 now. Before 2026 the onset limit of 26 would have excluded her. There is still an onset limit. The age cap does not apply to her current age.Achieving a Better Life Experience (ABLE) Act, as amended by the ABLE Age Adjustment Act

A grandmother contributes $80,000 to a 529 plan for her grandson in one year and elects to treat the gift as made over five years. She makes no other gifts to him, and the annual gift tax exclusion is $19,000. What is the result?

• a.$16,000 counts in each of the five years, all within the exclusion, so nothing is taxable✓
• b.$80,000 counts in the first year, and $61,000 of it exceeds the annual exclusion
• c.The election is unavailable below $95,000, so $61,000 of the gift is taxable
• d.$16,000 counts in each year, but no gift tax return is needed because every year stays under the exclusion

Electing the five-year spread treats the gift as made in equal parts, so $80,000 counts as $16,000 a year, which is below the $19,000 exclusion every year. Since $80,000 is under five times the exclusion ($95,000), nothing is left over and no part is a taxable gift. Counting the whole $80,000 in year one is the result without the election. The $95,000 figure is a ceiling on what may be spread, not a minimum needed to make the election. A gift tax return must still be filed to make the election, even though no tax is due.IRC section 529(c)(2)(B): five-year gift election for 529 contributions

A customer buys 1 CBRG Jan 55 call at 6.40 and sells 1 CBRG Jan 65 call at 2.15. At expiration CBRG closes at 68. Ignoring commissions, what is the customer's net result?

• a.A gain of $425
• b.A gain of $1,425
• c.A gain of $1,000
• d.A gain of $575✓

The spread costs a net debit of 4.25 (6.40 minus 2.15), or $425. With CBRG at 68 both calls are in the money and the spread is worth its full 10-point width, $1,000. The $1,000 less the $425 debit leaves a gain of $575. A $1,000 gain forgets the premium paid. A $425 gain treats the debit as the profit. A $1,425 gain adds the debit to the width instead of subtracting it.

A customer buys 1 HLXN Mar 80 put at 7.90 and sells 1 HLXN Mar 70 put at 3.40. At expiration HLXN closes at 62. Ignoring commissions, what is the customer's net result?

• a.A gain of $450
• b.A gain of $550✓
• c.A gain of $1,000
• d.A gain of $1,550

The net debit is 4.50 (7.90 minus 3.40). With HLXN at 62 the long 80 put is worth 18 and the short 70 put costs 8, so the spread is worth its full 10-point width, $1,000. Subtracting the $450 debit leaves $550. A $1,000 gain ignores the premium paid. A $450 gain mistakes the debit for the profit. A $1,550 gain adds the debit to the width.

A customer sells 1 VRTA Feb 45 put at 3.60 and buys 1 VRTA Feb 40 put at 1.25. VRTA closes at 36 at expiration. Ignoring commissions, what is the customer's net result?

• a.A loss of $235
• b.A loss of $540
• c.A loss of $265✓
• d.A loss of $500

The net credit is 2.35 (3.60 minus 1.25), or $235. At 36 the short 45 put costs 9 and the long 40 put recovers 4, so the spread loses 5, or $500. The $235 credit offsets part of that, leaving a $265 loss, which is also the maximum loss on this credit put spread (width less credit). A $500 loss ignores the credit received. A $235 loss treats the credit as the loss. A $540 loss ignores the protection of the long put and counts only the short put against the 3.60 premium.

A customer buys 1 QNTM Jun 120 call and sells 1 QNTM Jun 130 call, paying a net debit of 3.10. Which statement describes this position?

• a.A bull call spread that profits if QNTM rises, with no limit on the potential gain
• b.A bull call spread that profits if QNTM rises, with a maximum loss of $310✓
• c.A bull call spread that profits if QNTM rises, with a maximum loss of $690
• d.A bear call spread that profits if QNTM falls, with a maximum loss of $690

Buying the lower-strike call and selling the higher-strike call in the same month is a debit (bull) call spread. The most the customer can lose is the net debit, 3.10 x 100 = $310. The most the customer can make is the 10-point width less the debit, $690, so $690 is the maximum gain and not the maximum loss. Selling the 130 call caps the upside, so the gain is not unlimited. A bear call spread would sell the lower strike and buy the higher strike, and it would bring in a credit.

A customer sells 1 OPAL Apr 50 call at 4.80 and buys 1 OPAL Apr 55 call at 2.20. At expiration OPAL closes at 53.50. Ignoring commissions, what is the customer's net result?

• a.A loss of $240
• b.A loss of $90✓
• c.A gain of $260
• d.A loss of $350

The net credit is 2.60 (4.80 minus 2.20), or $260. At 53.50 the short 50 call costs 3.50 while the long 55 call expires worthless, so the credit less the $350 cost leaves a $90 loss. The breakeven on this credit call spread is 52.60. A $240 loss is the maximum loss, but it occurs only at 55 or higher. A $350 loss ignores the credit. A $260 gain would require OPAL to close at or below 50.

A customer buys 1 BRNX Sep 35 call at 5.10 and sells 1 BRNX Sep 45 call at 1.60. At what BRNX price at expiration does the customer break even?

• a.31.50
• b.38.50✓
• c.36.60
• d.48.50

The net debit is 3.50 (5.10 minus 1.60). A debit call spread breaks even at the lower strike plus the net debit: 35 + 3.50 = 38.50. Adding only the short call's premium to the lower strike gives 36.60. Adding the debit to the higher strike gives 48.50, which is above the price where the spread already reaches its maximum value. Subtracting the debit from the lower strike gives 31.50, the formula for a long put.

A customer holds a bull call spread on ZPHR: long 1 Dec 40 call and short 1 Dec 50 call. With ZPHR at 57 and three weeks to expiration, the short 50 call is assigned. Which statement is correct?

• a.The customer can decline to deliver because the assignment came before expiration
• b.The assignment is cancelled because the position was a spread when it was assigned
• c.The long 40 call is automatically exercised to offset the assigned short call
• d.The customer can exercise the long 40 call to obtain the shares needed for delivery✓

American-style equity options can be assigned at any time before expiration. The assigned writer must deliver 100 shares at 50, and the customer can obtain those shares by exercising the long 40 call. Nothing exercises the long call automatically, and spreads are not netted or cancelled by the clearing corporation, so the assigned writer cannot decline to deliver. Exercising early surrenders the long call's remaining time value, which is why the customer may prefer to buy the shares in the market and keep the call.FINRA Rule 2360

A customer buys 1 FRNT Aug 60 put at 5.30 and sells 1 FRNT Aug 50 put at 2.10. At expiration FRNT closes at 56. Ignoring commissions, what is the customer's net result?

• a.A gain of $400
• b.A gain of $680
• c.A gain of $80✓
• d.A loss of $320

The net debit is 3.20 (5.30 minus 2.10), or $320. At 56 the long 60 put is worth 4 and the short 50 put expires worthless, so the position returns $400 against a $320 cost, a gain of $80. A $320 loss assumes the long put expired worthless, but 56 is below the 60 strike. A $400 gain ignores the premium paid. A $680 gain is the maximum gain, which requires FRNT at 50 or lower.

A customer sells 1 TRVL Jul 55 call at 2.40 and sells 1 TRVL Jul 45 put at 1.90. Ignoring commissions, what are the two breakeven prices at expiration?

• a.42.60 and 56.90
• b.45.70 and 54.30
• c.40.70 and 59.30✓
• d.43.10 and 57.40

The total credit is 4.30 (2.40 plus 1.90). The writer of a strangle is protected by the whole credit on each side: the lower breakeven is the put strike less 4.30 (40.70) and the upper is the call strike plus 4.30 (59.30). Moving 4.30 from the midpoint of 50 gives 45.70 and 54.30, which ignores the gap between the strikes. Using each leg's own premium gives 43.10 and 57.40. Swapping the two premiums gives 42.60 and 56.90.

A customer sells 1 MRDN Oct 70 call at 3.20 and sells 1 MRDN Oct 60 put at 2.50. At expiration MRDN closes at 52. Ignoring commissions, what is the customer's net result?

• a.A loss of $800
• b.A loss of $1,370
• c.A gain of $570
• d.A loss of $230✓

The total credit is 5.70 (3.20 plus 2.50), or $570. At 52 the call expires worthless and the short 60 put costs 8, or $800. The $570 credit less the $800 cost leaves a $230 loss; the lower breakeven is 54.30, so 52 is below it. A $800 loss ignores the credit. A $570 gain would require MRDN to close between 60 and 70. A $1,370 loss adds the credit to the cost instead of subtracting it.

A customer buys 1 ORBT Nov 80 call at 4.50 and buys 1 ORBT Nov 80 put at 3.70. At expiration ORBT closes at 90. Ignoring commissions, what is the customer's net result?

• a.A loss of $820
• b.A gain of $1,820
• c.A gain of $1,000
• d.A gain of $180✓

The long straddle costs 8.20 (4.50 plus 3.70), or $820. At 90 the call is worth 10 and the put expires worthless, so the position returns $1,000 against an $820 cost, a gain of $180. The upper breakeven is 88.20. A $1,000 gain ignores the premium paid. A $820 loss is the maximum loss, which occurs only if ORBT closes exactly at 80. A $1,820 gain adds the cost to the intrinsic value.

A customer buys 1 PLVR Dec 90 call at 2.20 and buys 1 PLVR Dec 80 put at 1.60. What is the customer's maximum loss, and when does it occur?

• a.$380, if PLVR closes exactly at 85 at expiration
• b.$220, if PLVR closes between 80 and 90 at expiration
• c.$380, if PLVR closes at 76.20 or 93.80 at expiration
• d.$380, if PLVR closes between 80 and 90 at expiration✓

Buying a call and a put on the same stock with different strikes is a long combination, so it costs 3.80 (2.20 plus 1.60), or $380. That is the most the customer can lose, and the full loss occurs whenever both options expire worthless: any close from the put strike of 80 to the call strike of 90. The loss does not require a close at the midpoint. The $220 figure counts only the call's premium. The prices 76.20 and 93.80 are the breakevens, where the loss has fallen to zero.

A customer sells 1 GLDN May 50 call at 3.00 and sells 1 GLDN May 50 put at 2.50. GLDN then jumps to 61, and the customer buys both options back for a combined 12.50. Ignoring commissions, what is the customer's net result?

• a.A gain of $700
• b.A loss of $1,250
• c.A loss of $1,800
• d.A loss of $700✓

The short straddle brought in 5.50 (3.00 plus 2.50), or $550. Buying it back for 12.50 costs $1,250, so the closing transaction produces a loss of $700. A $1,250 loss ignores the premium originally received. A $1,800 loss adds the credit to the buyback cost. A $700 gain reverses the sign, as if the position had been bought at 12.50 and sold at 5.50 rather than the other way around.