FINRA Series 7 — All Questions

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

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

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

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

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

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

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

• a.$52
• b.$50✓
• c.$54
• d.$57

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

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

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

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

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

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

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

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

• a.$35
• b.$39
• c.$41✓
• d.$40

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The nominal yield of a bond refers to:

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

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

Duration is best described as a measure of:

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

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

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

• a.U.S. Treasury notes and bonds, quoted in 32nds of par
• b.Corporate bonds, traded at a stated percentage of par plus accrued interest computed on a 30/360 basis
• c.Zero-coupon corporate bonds, quoted as a percentage of par
• d.Municipal bonds, which are commonly quoted by yield✓

Municipal bonds, especially serial maturities, are typically quoted on a yield (basis) basis. Corporate bonds, including zero-coupon corporates, are quoted as a percentage of par (a dollar price), and Treasury notes and bonds are quoted in 32nds of par. Quoting by yield reflects the way municipal bonds trade and are compared.

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

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

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

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

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

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

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

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

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

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

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

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

BANs, TANs, and RANs are examples of:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

• a.4.5%
• b.8.7%
• c.0.8%
• d.8.0%✓

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

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

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

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

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

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

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

Class B mutual fund shares are typically characterized by:

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

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

A closed-end investment company is best characterized by:

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

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

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

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

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

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

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

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

How do equity REITs differ from mortgage REITs?

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

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

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

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

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

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

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

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

The discount rate set by the Federal Reserve is:

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

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

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

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

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

The federal funds rate is:

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

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

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

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

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