Series 6 Review

Bonds Retirement Plans
Term = Dollar = % of par IRA – max. contribution is $5,500;

Serial = Yield = Basis $6,500 for age 50 or over
Corps  quoted as a % of par in 1/8ths Roth IRA – non-deductible
 Interest is fully taxable Keogh – lesser of 20% or $52,000
401k - $17,500
Gov'ts  quoted as a % of par in
1/32nds 403b – nonprofit plans
Series EE & HH 457 – for gov't employees of states,
T-Bills cities, etc…and tax-exempt org.
T-Notes
T-Bonds Coverdell Education Savings Plan -
$2,000 max. contribution
 Interest is Subject to Fed. tax; Exempt
from State Section 529 – Qualified Tuition Plans
Money Rates – Rates Highest to Lowest
Agency bonds (Fannie, Ginnie, Freddie) Prime Broker Discount Fed Funds Tax
 Interest is fully taxable Tax Equivalent Yield = Muni Yld. %
Options 100% - T.B %
Munis  quoted in Basis  Buying a Call is Bullish; Buying a
General Obligation Put is Bearish
Revenue Regulations
 Selling a Call is Bearish; Selling a Securities Act of '33 – regulates non-
 Interest Tax Status Depends: Put is Bullish
 1) Exempt from Fed. tax; Subject to exempt new issue market
State Securities Act of '34 – regulates trading
Trading Markets markets for ALL securities
 2) Triple Tax Free Secondary Market  M anipulation - Fraud
 3) Fully Taxable  First – on the floor of exchange  I nsiders
 Second – OTC unlisted  S EC created
Current Yield / Dividend Yield  Third – OTC exchange listed  P roxies
Annual Income  Fourth - institutional
=  E xchange & member firm
Market Price registration with SEC
Tools of the Fed - DORM
 D iscount rate (Fed to member bank  R eports – 10K, 10Q
Conversion Ratio = Par
rate)  M argin – Reg. T
Conversion Price
 O pen market operations  MSRB – creates the rules for munis
Bond's Price Repurchase Agreement  Stabilization – of new issues
Conversion Ratio =
Stock' s Parity Price Fed buys, injecting $ into $ supply,
loosening credit, rates go down Exempt from Registration:
 R eserve requirements •Reg. A – Small Dollar offering $5MM
Discount  YTC > YTM > CY > NY  M argin on non-exempt securities •Reg. D – private placement; 35 non-
 discounts must be priced YTM accredited investors
Premium  YTC < YTM < CY < NY Mutual Funds •Rule 147 – intrastate offering
 premiums must be priced YTC A B
Sales Charge = SIPC – covers $500K equity, inclusive
A of $250K in cash
NAV
Adjusted POP =
(100%  SC %)
Securities
Insurance
Variable Life
Level Premiums
Universal
Variable Life Whole Life
Flexible Premiums Universal Insurance

Life
Term Life
No Cash Value
Increasing Premiums
Series #6 Cheat Sheet Peter A. Gibowicz peter@bullbeartraining.com

Suitability Recommendations Decision Tree
Step 1: FINANCIAL STATUS
Does the customer have net worth
or discretionary income to invest?
NO: YES: Step 2: INVESTMENT TIME HORIZON

Recommend customer Is the customer investing for long-term (3 – 5 years)?
wait to invest
NO: YES: Step 3: DETERMINE INVESTMENT OBJECTIVE
Recommend
Money
Market Funds
PRESERVATION OF CURRENT LIFETIME CAPITAL AGGRESSIVE

CAPITAL/SAFETY INCOME INCOME APPRECIATION GROWTH
Recommend: Recommend: Recommend: Recommend: Recommend:
For Safety For Income For Fixed For Capital For Higher
x Treasury Securities with Safety Income Appreciation Capital Appreciation
Funds x Treasury Securities x Fixed Annuity with Low Risk with Higher Risk
x GNMA Funds Funds x Balanced Funds x Micro-Cap
x GNMA Funds For Income with x Asset Allocation Growth Funds
For Safety with Inflation Protection Funds x Small-Cap
For Higher Income
Tax-Exempt Income x Variable Annuity Growth Funds
x Municipal Bond
with Higher Risk For Capital x Sector Funds
Funds x High-Yield Corp. Appreciation x Emerging
Bond Funds with Moderate Risk Markets Funds
For Safety with x International Bond x Growth Funds
Liquidity Funds x Large-Cap Funds
x Money Market x Value Funds
For Tax-Exempt
Funds Income x S & P 500 Index
Funds
x Municipal Bond Funds
For Capital
For Income with Appreciation
Growth and Low/ with Higher Risk
Moderate Risk
x International
x Growth and Income Growth Funds
Funds
x Mid-Cap Growth
x Blue Chip Stock Funds Funds
x Balanced Funds
x Convertible Securities
Funds
x Equity Income Funds
x Asset Allocation Funds
For Income with
Growth and
Higher Risk
x REIT Funds
Customer Accounts Suitability Factors Chapter 7-47

What Type of Debt is This?
Types of Debt
Type of Tax Status of Reg. Way

Debt the Interest Settlement
Rec’d
Fed Tax
Fed. State Tax
U.S. Gov’t
Series #6 Types of Debt 2
Bull & Bear Training Co., Inc. - Peter A. Gibowicz 1
3

Rec’d
Fed. Tax State Tax
Gov’t Agency

Rec’d
Fed. Tax State Tax
Privatized
Gov’t Agency
4

Rec’d
Fed. Tax State Tax
Corporate
5
Series #6 Types of Debt

Rec’d
Fed. Tax State Tax
Municipal
5
Investment Securities
CORPORATIONS
• NEED FINANCING
INVESTMENT • CAN ISSUE:
– EQUITY
SECURITIES • common stock
• preferred stock
– DEBT
Series #6 Investment Securities 1 Series #6 Investment Securities 2
Equity — Common Equity — Preferred

• stockholders are the "owners" of a • preferred stock has preference over
corporation common as to the payment of dividends and
• each common share represents proportional as to assets upon liquidation
ownership in the corporation • before common shareholders are paid
– 10% of the outstanding shares are held, then the preferred shareholders are paid IF declared
holder owns 10% of the corporation by the Board of Directors
• pays dividends (in most cases) quarterly, if
declared by the Board of Directors
Which of the following would be considered

Debt owners of a corporation?
• bondholders are creditors of the corporation I Common Shareholders

• the corporation has a legal responsibility to II Preferred Shareholders
III Convertible Bondholders
pay its bondholders — interest and principal
IV Warrant Holders
• before the corporation pays taxes, it MUST
pay its bondholders -- BTP A. I only
• if payments cannot be met, then the B. I and II only
C. I, II, III, IV
corporation is in default
D. None of the above
Bull & Bear Training Co., Inc. - Peter A. Gibowicz

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Which of the following would be considered Which of the following do NOT have an equity
creditors of a corporation? position?
I Common Shareholders I convertible preferred shareholders

II Preferred Shareholders II preferred shareholders
III Convertible Bondholders III convertible debenture holders
IV Warrant Holders IV subordinated debenture holders
A. III only A. I, II
B. III and IV only B. I, III, IV
C. I and II only C. III, IV
D. I, II, and IV D. I, II, III, IV
CAPITALIZATION COMMON STOCK

• to evaluate a company's capital structure • AUTHORIZED STOCK
• TOTAL LONG TERM CAPITAL = – the fixed number of shares that may be issued
– Long Term Debt + Preferred Stock + Common • ISSUED STOCK
Equity* – a corporation doesn't "issue" all of authorized
• * where Common Equity = Capital at Par + Capital stock so that the corporate charter doesn't have
in Excess of Par + Retained Earnings to be amended
• OUTSTANDING STOCK
– stock that is in the public's hands
– shares that trade in the market
COMMON STOCK (cont.) COMMON STOCK (cont.)

• TREASURY STOCK
– these shares have been authorized to be issued,
they have been issued, but they are no longer
outstanding
• repurchased shares – corporation buys back its own
stock in the market
• with fewer shares outstanding, earnings per share
will rise
– does not vote nor receive dividends
– formula: issued — outstanding

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Which of the following statements best describes

The definition of Treasury Stock is: what will happen if a company repurchases its
own common shares?
A. issued shares which are outstanding
B. issued shares which are no longer outstanding A. the number of outstanding shares will
C. unissued shares which are outstanding decrease
D. unissued shares which are no longer B. the number of outstanding shares will increase
outstanding C. the number of issued shares will decrease
D. the number of unissued shares will increase
COMMON STOCK (cont.)

The definition of Treasury Stock is:
• PAR VALUE
– has no bearing on market price
A. issued stock minus authorized stock – arbitrary value, usu. set low
B. issued stock minus outstanding stock • BOOK VALUE
– essentially the dollar amount that shareholders would
C. authorized stock minus outstanding stock get if the corporation liquidated
• MARKET VALUE
D. outstanding stock minus authorized stock
– based on investor expectations about the company's
future
SHAREHOLDER SHAREHOLDER
RECORDKEEPING RECORDKEEPING (cont.)
• REGISTRAR • TRANSFER AGENT
– maintains record of stockholders' names and – as trades of stock settle, report is made to the
addresses transfer agent
– makes sure company doesn't issue more shares – the transfer agent:
• cancels old shares which have been sold, and issues
than authorized new shares in the name of the new buyer
– watchdog over transfer agent • keeps an accurate record of shareholders which is
updated daily
• usu. handles mailings to shareholders (dividends,
voting materials, corporate records,...)

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SHAREHOLDER
RECORDKEEPING (cont.) All of the following are functions of the
• TRANSFER AGENT (cont.) transfer agent EXCEPT:
– BOOKENTRY CERTIFICATE
• instead of physically issuing and canceling A. Mails dividend payments to shareholders
certificates, the transfer agent keeps the ownership B. Prepares and mails proxies
record along with the clearing corporation settling
trade
C. Sets the Declaration Date
D. Cancels old shares and issues new
shares
The transfer agent will typically perform which of

the following functions?
I Canceling old stock certificates All of the following are the responsibilities of the
II Issuing new stock certificates registrar EXCEPT:
III Acting as disbursement agent for the
corporation A. Distributing dividends, corporate reports, and
IV Maintaining a record of all shareholder voting materials
names and addresses B. Acting as a watchdog over the transfer agent
C. Accounting for the number of shares issued
A. II, III, IV D. Maintaining a record of all shareholder names
B. I, II, III
C. I, III, IV
D. I, II, III, IV
Which function would be performed by the

registrar?
A. verifying the record of all shareholder

names and addresses RIGHTS OF THE COMMON
B. acting as disbursement agent for the SHAREHOLDERS
corporation
C. issuing new stock certificates
D. canceling old stock certificates

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RIGHTS OF THE COMMON RIGHTS OF THE COMMON

SHAREHOLDERS (CONT.) SHAREHOLDERS (CONT.)
• To Vote: • Voting for the Board of Directors
– must be at the annual meeting to vote OR – Two Voting Methods
proxies can be completed by shareholders who
don't attend • 1) statutory voting
– If The Corporation Wishes To: • 2) cumulative
• declare a stock or reverse stock split
• issue convertible bonds or preferred stock
• issue stock options to officers on a preferential basis
– For The Board Of Directors

• Voting Methods • Voting Methods
– 1) statutory voting – 2) cumulative voting
• # of shares X # of Board of Directors to be
• 1 vote per 1 share chosen
• i.e. 100 shrs, 3 B.O.D. to choose • i.e. 100 shrs, 3 B.O.D. to choose
– 100 votes can be made for 1 Director – 300 votes can be placed for 1 Director
– 100 votes can be made for another Director – no more votes are allowed
– 100 votes can be made for another Director • considered advantageous for the smaller
investor
When comparing the statutory voting method to the RIGHTS OF THE COMMON
cumulative voting method, which statement is true?
SHAREHOLDERS (CONT.)
A. Minority shareholders have the same voting
effectiveness with both methods
• do NOT vote on:
B Minority shareholders have greater voting
– management
effectiveness with cumulative voting – cash or stock dividends
C. Minority shareholders have greater voting • stock dividends are distributions of 25% or
effectiveness with statutory voting less
D. Minority shareholders have limited voting powers – rights distribution
under the statutory and full voting powers under the – repurchase of shares for Treasury
cumulative method

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A corporation declares a 2:1 stock split. A corporation declares a 5:4 stock split.
For a customer who owns 100 shares at For a customer who owns 100 shares at
$60, how many shares will he now have $60, how many shares will he now have
and at what dollar price? and at what dollar price?
A. 100 shares at $30 A. 120 shares at $50

B. 200 shares at $30 B. 125 shares at $48
C. 200 shares at $50 C. 120 shares at $40
D. 200 shares at $60 D. 125 shares at $50
A corporation declares a 5:4 stock split. A corporation declares a 5:4 stock split.
For a customer who owns 100 shares at For a customer who owns 100 shares at
$60, how many additional shares will he $60, how many shares will he now own?
now own?
A. 25
A. 25 B. 100
B. 100 C. 120
C. 120 D. 125
D. 125

• to inspect books and records • to maintain proportionate ownership if the
– NOT the minutes of the last B.O.D.'s corporation wishes to issue new shares
meeting – a.k.a. pre-emptive right
• to transfer ownership (negotiable – if a corporation wishes to issue more shares,
existing shareholders have the right to buy
tradable) these new shares before anyone else does (so
– however, mutual funds and savings bonds that the shareholder can maintain her
are NOT negotiable, but redeemable proportional ownership)

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A corporation is having a rights offering

PREEMPTIVE RIGHTS (CONT.) where 10 rights are needed to subscribe to
• RIGHTS OFFERING one additional share. A shareholder has
– offer of these shares to existing shareholders 100 shares. How many rights does he
• RIGHTS AGENT have?
– to handle mechanics of offering
– usu. the existing transfer agent
A. 1 right
• STANDBY UNDERWRITER
– used if all these shares are not picked up B. 10 rights
– ensures issuer sells entire issue and gets needed funding
• every 1 share = 1 right C. 100 rights
• rights typically expire in 30-60 days D. 110 rights

• to receive dividends if declared by the • DECLARATION DATE
b.o.d. – date dividend is declared
A) declaration date • RECORD DATE
B) record date – date on which corporation takes shareholder
name from transfer agent to mail dividend
C) payable date – last day to buy and get the dividend is 3
D) ex-date business days prior to record date
RIGHTS OF THE COMMON June

SHAREHOLDERS (CONT.) S M T W H F S
• PAYABLE DATE 1 2 3 4 5 6 7
– date dividend checks will be mailed by corporation's
transfer agent 8 9 10 11 12 13 14
• CUM DIVIDEND DATE 15 16 17 18 19 20 21
– with dividend
22 23 24 25 26 27 28
• EX-DIVIDEND DATE
– first day that the stock trades without the dividend 29 30
– because the trade will settle after record date If record date is set at Thursday June 12, when is
– the stock price is reduced by the amount of the dividend the last day to buy the stock and receive the
distribution dividend: reg. way settlement? cash settlement?
– ex-date is set at: 2 business days prior to record date when is ex-date?

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June July
S M T W H F S S M T W H F S
1 2 3 4 5 6 7 1 2 3 4 5 6 7
8 9 10 11 12 13 14 8 9 10 11 12 13 14
15 16 17 18 19 20 21 15 16 17 18 19 20 21
22 23 24 25 26 27 28 22 23 24 25 26 27 28
29 30 29 30 31
If record date is set at Monday, July 9, when is the
If record date is set at Wednesday, June 11, when is
last day to buy the stock and receive the dividend:
the last day to buy the stock and receive the
reg. way settlement? cash settlement? when is ex-
dividend: reg. way settlement? cash settlement?
date?
when is ex-date?
To receive a previously declared dividend, A trade date is Wednesday, July 2. What is

an investor must own the security on what the cash settlement date? (July 4 is a legal
date? holiday)
A. Payable date A. July 2nd

B. Ex-dividend date B. July 3rd
C. Record date C. July 4th
D. Declaration date D. July 5th
RIGHTS OF THE COMMON If a corporation liquidates, rank the priority to its

SHAREHOLDERS (CONT.) assets upon dissolution
• TO ASSETS UPON DISSOLUTION
I secured bonds
– if corporation is dissolved, the common
stockholder is paid last II debentures
1) Secured bondholders (BTP) III common stock
2) Wages, taxes, general creditors IV preferred stock
3) Debentures
A. I, II, III, IV
4) Subordinated debentures
B. IV, III, II, I
5) Preferred stockholders
6) Common stockholders C. I, II, IV, III
D. II, I, IV, III

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If a corporation liquidates, rank the priority to its

assets upon dissolution:
Common stockholders have all of the
I subordinated debentures following "rights" EXCEPT:
II taxes
III common stock
A. Right to vote for the Board of Directors
IV preferred stock
B. Right to vote for the annual dividend rate
A. I, II, III, IV C. Pre-emptive right
B. IV, III, II, I D. Rights to corporate assets upon
C. I, II, IV, III dissolution
D. II, I, IV, III
A vote of the common stockholders is required

Which of the following are rights of a common
for a corporation to do which of the following?
shareholder?
I Issue convertible securities
I right to manage
II Accept a tender offer for the company's
II right to transfer shares
shares
III right to receive a dividend
III Declare a stock split
IV right to vote
IV Declare a stock dividend
A. I and IV
A. III and IV only
B. II, III, IV
B. I, II, III
C. I, II, III
C. I, II, IV
D. I, II, III, IV
D. I, II, III, IV
Common stockholders have which of the following

rights? The common stockholder has which of the
following rights?
I Inspecting minutes of executive meetings
II Maintaining proportionate ownership in the I management rights
company II dividend rights
III Voting for the Board of Directors III pre-emptive rights
IV Transferring share ownership without IV voting rights
restriction by the issuer
A. III and IV only
A. II and IV
B. I, II, IV
B. III and IV
C. I, II, III C. II, III, IV
D. II, III, IV D. I, II, III, IV

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In a corporate liquidation, common

stockholders are paid:
A. first
B. after creditors but before preferred
stockholders
PREFERRED STOCK
C. after bondholders but before preferred
stockholders
D. last
PREFERRED STOCK PREFERRED STOCK (cont.)

• has priority over common stock in all situations
– i.e. dividends, if company liquidates, etc...
• issued at $25, $50, or $100 par with a stated fixed dividend
rate — paid semiannually or quarterly
• if Board of Directors votes to omit dividend to holders,
then there is no recourse
• bought by corporations with excess funds
– 70% of dividends received are not taxable to the corporate investor
• price is influenced by interest rates
– interest rates up, the price of the preferred goes down
All of the following are true about

preferred stock EXCEPT:
A corporate investor would benefit from all
of the following investments EXCEPT: A. Dividends are paid before common
B. In most cases dividends are paid semi-
A. Common stocks annually
B. Preferred stocks C. Corporations must pay preferred
C. Preferred stock mutual funds dividends
D. Bonds D. Preferred shareholders are paid before
common shareholders upon liquidation of
a corporation

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Common Stock /Preferred Stock

PREFERRED STOCK Features Comparison to Bonds
FEATURES
Common Preferred Bonds
• no voting or preemptive rights Stock Stock
Par Value Arbitrary value, $100 or $50 or $1,000
• DIFFERENCES BETWEEN BONDS: set low $25
– bonds have priority in liquidation Dividend •Pays a dividend •Pays a fixed Pays a fixed
– bonds mature on a set date set by the Board dividend rate interest rate based
Rate of Directors based on par on par value
• preferred has an indefinite life value Taxed at a
•Dividend Rate
– bonds have legal rights to interest payments varies •Taxed at a maximum rate of
•Taxed at a maximum rate of 39.6% (taxed as
• preferred dividends are only paid if declared by 15%-20% "ordinary
maximum rate of
Board of Directors income")
15%-20%
Common Stock /Preferred Stock Common Stock /Preferred Stock

Features Comparison to Bonds Features Comparison to Bonds
Preferred Bonds Common Preferred Bonds
Common
Stock Stock Stock
Stock N/A Can be convertible into common
Convertible
Pays semi- Pays semi-
Dividend / •Pays usually annually (like annually Directly Interest Yes, price has a direct inverse
Interest quarterly bonds) or Paid before Rate Sensitive No relationship to interest rate movements
quarterly preferred
Occurrence •Paid after Paid before Bond interest Pre-emptive Rights Yes No, only common has pre-emptive rights
common stock, but expense is
preferred after bonds mandatory (bonds Senior Yes, senior to Yes, Senior to
Preferred stock have a legal right Securities
No common
common and
preferred
dividends are paid to interest
only if declared by payments) Voting Rights No, only common has
the B.O.D. Yes voting rights
Paid before Bonds have priority in a
Priority in a Last in line in a Bonds Mature on a
common, but after liquidation to preferred Maturity Perpetual Life set date
Liquidation liquidation bonds
stock and common stock
Which of the following describes both preferred

stock and bonds?
PREFERRED STOCK TYPES
I fixed rate • CUMULATIVE PREFERRED
II can be callable – if issuer omits dividend payment, it
III fixed maturity date accumulates
IV semi-annual payments – shareholder receives all back unpaid dividends
and this year's dividend before a common
A. III only dividend is paid
B. I, II, IV
C. II, III, IV
D. I, II, III, IV

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ABC Company has outstanding 10% non- ABC Company has outstanding 10% cumulative
cumulative preferred stock. Two years ago, ABC preferred stock. Two years ago, ABC paid a 6%
paid a 6% preferred dividend. Last year, ABC paid preferred dividend. Last year, ABC paid a 7%
a 7% preferred stock dividend. This year, ABC preferred stock dividend. This year, ABC wishes to
wishes to pay a common dividend. The preferred pay a common dividend. The preferred
shareholders must receive: shareholders must receive:
A. 0% A. 0%
B. 7% B. 7%
C. 10% C. 10%
D. 17% D. 17%
If interest rates fall, issuers most likely will:

PREFERRED STOCK TYPES (CONT.)
I call low interest paying preferred issues
II call high interest paying preferred issues
• CALLABLE PREFERRED
III replace the old issue with a new one at
– issuer has right to "call in" shares after a set lower rates
date, usu. at par IV replace the old issue with a new one at
– issuer will call in shares if interest rates have higher rates
fallen
• after retiring old higher rates, new shares can be A. I and III
issued at current lower rates (it’s like refinancing the B. I and IV
mortgage on your home) C. II and III
D. II and IV
ABC has a convertible Preferred issue with an "anti-

PREFERRED STOCK TYPES (CONT.) dilutive" covenant. ABC declares a stock dividend.
After the stock dividend, what happens to the
common shares?
• CONVERTIBLE PREFERRED
I There are more common shares outstanding
– shareholders can convert their shares into
II There are fewer common shares outstanding
common shares based on a predetermined price III Each common share is worth proportionally
more
IV Each common share is worth proportionally less
A. I and III
B. I and IV
C. II and III
D. II and IV

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Which statements are true regarding participating preferred

PREFERRED STOCK TYPES (CONT.) stock?
I shareholders participate in any bond interest payments

• PARTICIPATING PREFERRED II shareholders participate in "extra" common dividends
(A.K.A. PERFORMANCE declared by the Board of Directors
III the rate received is fixed as to a minimum but not as to
PREFERRED) a maximum
– in addition to the fixed dividend rate, holders IV the rate received is fixed as to a maximum but not as
"participate" in any "extra" dividends declared to a minimum
by Board of Directors A. I and III
– the dividend rate is set as to a minimum but not B. I and IV
as to a maximum C. II and III
D. II and IV
PREFERRED STOCK TYPES (CONT.) Which security of the same issuer is

likely to give the highest current yield?
• ADJUSTABLE RATE PREFERRED (A.K.A.
RESET PREFERRED)
– instead of a "fixed" dividend rate, the dividend rate is A. warrant
"reset" periodically to an index of market rates
– if interest rates rise, the rate will increase at the reset
date; if interest rates fall, the rate will decrease at the
B. common stock
reset date
– because interest rate "resets”, as market rates move, C. convertible preferred stock
price will remain stable (i.e. stays at par)
D. non-convertible preferred stock
BOND
• debt security which obligates issuer to pay interest
- usu. semi-annually- and repay principal amount
when debt matures
• TRUST INDENTURE
Corporate Bonds – protects the interest of the bondholders
• PAR VALUE
– set usu. at $1,000 minimum and with a stated rate of
interest (the coupon)
• REDEMPTION
– at maturity, the bond is redeemed by issuer at par

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A customer buys 10 Allied Corporation 8% A customer buys 10 Allied Corporation 10%

$1,000 par debentures, M‘19, at 90 on Monday, $1,000 par debentures, M‘19, at 90 on Monday,
Oct 8. The interest payment dates are Feb 1 and Oct 8. The interest payment dates are Feb 1 and
Aug 1. The trade settled on Thurs., October 11. Aug 1. The trade settled on Thurs., October 11.
The annual interest payments amount to: The amount of the next interest payment will be:
A. $74.50 A. $25
B. $80 B. $250
C. $754 C. $500
D. $800 D. $1,000
A customer buys 10 Allied Corporation 8% Registration of Bonds

$1,000 par debentures, M‘19, at 90 on
Wednesday, April 19. The interest payment
dates are Mar 1 and Sept 1. The trade settled • Fully Registered form
on Monday, April 24. The customer will – physical certificate is issued
receive how many months of interest in the
next payment? • Book Entry form
– transfer agent keeps a record of who
A. 1 1/2 should receive principal and interest
B. 2 1/2
C. 3
D. 6
Bond Redemption Bond Redemption (cont.)

• RETIRING DEBT • REFUNDING DEBT
– corporate bonds may be redeemed at maturity – instead of retiring debt, corporation may simply
or if a call provision is included in Trust roll it over in part or in full
Indenture, it may be called under terms of this • PRE-REFUNDING DEBT
– sinking fund – issued when interest rates have dropped
• money is deposited into a fund periodically (usu.
• done to retire expensive debt and replace it with
annually) and the funds are used to retire bonds at
lower interest rate debt
maturity or retire a portion of them each year after a
specified date

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A corporation publishes a Notice of Redemption for

the purpose of pre-refunding an entire debt issue at Which of the following municipal bonds
par. The corporation plans to reissue new bonds at
lower interest rates. Which of the following activities
would most likely be refunded by the issuer?
may be taken by bondholders of the outstanding
issue?
A. 5% G.O., M'35, callable in 2015 at par
A. Retain the old bonds and continue to receive the
higher interest rate B. 6% G.O., M'35, callable in 2015 at 102
B. Retain the old bonds and receive the lower
interest rate of the new refunding bonds C. 7% G.O., M'35, callable in 2015 at 102
C. Sell the bonds at the current market price
D. Exchange the old bonds for the new refunding D. 8% G.O., M'35, callable in 2015 at par
bonds
BOND ISSUE STRUCTURE BOND ISSUE STRUCTURE

– Term Bonds (cont.)
• TERM BONDS • most corporate, government, and any municipal
issues which are term bonds are quoted on a
– all the bonds are issued on the same date and percentage of par basis
they mature on the same date • $1,000 par Corporate bonds are quoted as a
• every bond has same interest rate and maturity percentage of par value with minimum 1/8 point
– i.e. 101 3/8 = $ ; i.e. 98 1/4 = $
– quoted on a percentage of par basis, meaning • $1,000 par U.S. Gov't bonds are quoted as a
on a dollar price basis percentage of par value with minimum 1/32 point
– a.k.a. dollar bonds – i.e. 99.24 = $ ; i.e. 101.16 = $
– these are much more actively traded than corporate bonds
BOND ISSUE STRUCTURE (cont.) BOND ISSUE STRUCTURE (cont.)
• SERIAL BONDS • SERIES BOND

– all of the bonds are issued on the same date, but they – all the bonds have the same maturity, but
mature on differing dates
different dates of issuance
• differing maturities will require different interest rates
• this is done because, perhaps, all of the money is not
– most municipal bonds and corporate equipment trust
needed immediately
certificates
– thus, instead of floating a $10MM bond at once, the issuer
– Balloon Maturity can maybe sell $4MM one year, $3MM the next year, and
• most of the bond matures in the later years $3MM the following year
• each maturity has a different interest rate • by phasing in the bonds, the issuer’s total interest cost
– the longer the maturity, the higher the interest rate is reduced
– are rarely issued
Series #7 Debt 89 Series #6 Investment Securities 90

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A bond issue with the same day of

issuance but with differing maturities A bond issue where every bond has the
is a: same interest rate and maturity is a:
A. term bond offering

A. term bond offering B. series bond offering
B. series bond offering C. serial bond offering
C. serial bond offering D. combined serial and term bond
D. combined serial and term bond offering
offering
SECURED
A bond issue where the bonds have the CORPORATE DEBT
same maturity but different dates of • specific collateral is pledged to back the
issuance is a: issue
• because of extra protection, it can be sold at
A. term bond offering lower interest rates than unsecured bonds
B. series bond offering
• if Trust Indenture is open end, corporation
C. serial bond offering
can sell additional bonds having equal
D. combined serial and term bond offering
status
SECURED TYPES OF SECURED

CORPORATE DEBT (cont.) CORPORATE DEBT
• Additional Bonds Test • MORTGAGE BONDS
– usu. has an "additional bonds test" which tests – most common form of corporate debt
to make sure earnings before interest expense
for the preceding period exceed both current – backed by real estate/property
interest expense plus projected expense on – bondholder has a lien on real estate
additional bonds sold -- this test must be met
before new bonds are sold – usu. issued by utilities which get a high rating
– if closed end, new bonds can be issued only if because of the collateral
they are issued as junior to (have a lower status
than) existing bonds

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TYPES OF SECURED Which of the following corporate bonds are

CORPORATE DEBT (cont.) secured?
• EQUIPMENT TRUST CERTIFICATE I collateral trust certificate

– backed by equipment or machinery II subordinated debenture
– commonly issued by transportation companies III second mortgage bond
(common carriers) IV equipment trust certificate
– serial issues, requiring issuer to repay a portion
A. II and III only
of principal each year until bonds are retired
B. II and IV only
• COLLATERAL TRUST CERTIFICATE C. I, III, IV
– backed by a portfolio of marketable securities D. I, II, III, IV
UNSECURED CORPORATE DEBT UNSECURED CORPORATE DEBT (cont.)

• simply backed by issuer's promise to pay
• COMMERCIAL PAPER
– very short maturities; usu. 14 to 90 days; 30 days most
• DEBENTURE
common – intermediate and long term corporate debt
– will never exceed 270 days because then it'd be SEC backed solely by full faith and credit
registered (which is expensive and time consuming)
– sold at a discount maturing at par
– issued by "Blue Chip" organizations with high
– sold in units $100,000 up to $1,000,000 credit ratings or lower credit rated companies in
– sold in book entry form the form of high yield or "junk" bonds
– purchasers are large institutions with excess cash to
invest
– limited trading as investors hold them to maturity
UNSECURED CORPORATE DEBT (cont.) UNSECURED CORPORATE DEBT (cont.)
• SUBORDINATED DEBENTURE • INCOME BONDS (ADJUSTMENT BONDS)

– issued when corporation is about to go bankrupt —
– holders agree to lower status than debentures in done to replace existing bonds
a corporate liquidation – only obligates issuer to pay if it has sufficient earnings
– interest rate is increased to induce customers to – bondholders are likely to accept this new instrument
buy because they're receiving nothing anyway
– interest is only paid if corporation returns to
– get paid AFTER the debentures if the profitability
corporation liquidates – trade flat - without accrued interest (because bonds are
not currently paying interest)

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Which of the following best describes a

bond which is trading "flat"? A corporate bond which obligates the
issuer to pay interest only if the company
A. the bond is purchased at par meets specified earnings tests is a(n):
B. the bond is purchased without accrued
interest A. guaranteed bond
C. the bond is purchased to receive B. subordinated bond
interest payments annually C. income bond
D. the bond is purchased at a discount and D. collateral trust certificate
matures at par
A corporate bond which is backed solely A short term corporate bond which is
by the full faith and credit of the issuer is backed solely by the full faith and credit
known as a: of the issuer is known as:
A. debenture A. commercial paper

B. income bond B. income bond
C. mortgage bond C. mortgage bond
D. general obligation bond D. general obligation bond
ZERO-COUPON BOND 1 zero coupon, $1,000 par, purchased at $200 with 10 years to
maturity
•how much will the bond's accreted value be after the first
• stated par value (usu. $1,000 minimum) but year?
without a stated rate of interest
•what is the amount of interest that would be taxed?
• no interest payments are made - these are
1 zero coupon, $1,000 par, purchased at $800 with 5 years to
purchased at a discount and mature at par
maturity
• tax status?
•how much will the bond's accreted value be after the first
– though no income is received until maturity, the year?
bondholder must pay tax on the accreted value
•what is the amount of interest that would be taxed?
– good for what type of account?

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Which of the following statements are true regarding CONVERTIBLE

corporate zero coupon bonds?
CORPORATE DEBT
I the rate of return for zero coupon bonds is subject to
reinvestment risk
• can be converted, at the option of the
II the rate of return for zero coupon bonds is not holder, into common stock
subject to reinvestment risk • at time of issuance, conversion price is set
III zero coupons offer investors a current return
IV zero coupons do not offer investors a current return per share
• bond can be converted into a fixed number
A. I and III
B. I and IV of common shares based on par value
C. II and III
D. II and IV
CONVERTIBLE BOND ADVANTAGES

ARBITRAGE AND DISADVANTAGES
• trader buys the lower priced security and • ADVANTAGE TO ISSUER

simultaneously sells equivalent higher – benefit to issuer is that investor will accept
priced security to lock in profit lower interest rate since there's potential price
appreciation based on converting bond if stock
price rises
CONVERTIBLE BOND ADVANTAGES CONVERTIBLE BOND ADVANTAGES

AND DISADVANTAGES (cont.) AND DISADVANTAGES (cont.)
• Forced Conversion • ADVANTAGE TO BONDHOLDER

– when bonds are called, the issuer can replace – benefit to bondholder is the possibility of
bonds with equity securities and this relieves capital gains
issuer of interest payment burden
• DISADVANTAGE TO ISSUER
– tax deductible interest payments for corporation
are replaced by nondeductible dividends

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CONVERTIBLE BOND ADVANTAGES CONVERTIBLE

AND DISADVANTAGES (cont.) CORPORATE DEBT (cont.)
• DISADVANTAGE TO BONDHOLDER A) Conversion Ratio = Par Value of Bond
– Dilution Of Earnings Conversion Price
• when conversion occurs, existing stockholders' equity is
diluted
• bondholders receive lower interest rates and possible dilutive B) Conversion Ratio = Bond Market Value
effect of a large conversion Parity Price of Stock
• in order to issue convertible bonds, shareholder approval is
necessary
• once convertible securities are issued, bondholder is protected 1) Find C.R. if not given, using formula A
by an antidilutive covenant 2) Put in the appropriate numbers
• conversion price is adjusted for stock dividends and splits
CONVERTIBLE CONVERTIBLE
CORPORATE DEBT (cont.) CORPORATE DEBT (cont.)
• EXAMPLE: A 10%, $1,000 Par • EXAMPLE: A 10%, $1,000 Par Convertible Bond
Convertible Bond Is Issued When The Is Issued When The Market Price Of The
Market Price Of The Common Stock Is $40 Common Stock Is $40 Per Share. The Conversion
Price Per Share Is Set At $50 Per Share. Currently
Per Share. The Conversion Price Per Share The Market Price Of The Stock Is $60 Per Share.
Is Set At $50 Per Share. The Conversion The Parity Price Of The Bond Is:
Ratio Is:
CONVERTIBLE A customer bought a $1,000 par

CORPORATE DEBT (cont.) convertible subordinated debenture at
par, convertible into common at $25 per
• EXAMPLE: A 10%, $1,000 Par Convertible Bond
share. If the bond's market price
Is Issued When The Market Price Of The
Common Stock Is $40 Per Share. The Conversion increases by 20%, the parity price of
Price Per Share Is Set At $50 Per Share. Currently the stock will be:
The Market Price Of The Bond Is $1,400. The
Parity Price Of The Stock Is: A. 25
B. 30
C. 40
D. 48

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A convertible debenture is convertible into

common at $40 per share. If the market price of
the bond rises to a 10 point premium over par, A corporation has issued 10%, $1000 par
which statements are true? convertible debentures, convertible at $40. The
common stock is currently trading at $45. If the
I The conversion ratio is 20:1 bond and the common are trading at parity, a
II The conversion ratio is 25:1 customer purchasing 5M of the bonds will pay:
III The parity price of the stock is $44
IV The parity price of the stock is $50 A. $4,950
B. $5,000
A. I and III C. $5,625
B. I and IV D. $6,550
C. II and III
D. II and IV
Ford Motor Company has issued 8% convertible

debentures, convertible at a 12.5:1 ratio. Currently
A corporation has issued 10%, $1000 par the debenture is trading at 90. The stock is trading
convertible debentures, convertible at $100. The at 75. Which statements are true?
common stock is currently trading at $90. If the
bond and the common are trading at parity, a I the conversion ratio is 1 to 12.5
customer purchasing 5M of the bonds will pay: II the conversion ratio is 12.5 to 1
III the parity price of the common stock is 72
A. $4,500 IV the parity price of the common stock is 90
B. $5,000
C. $5,225 A. I and III
D. $5,500 B. I and IV
C. II and III
D. II and IV
ABC has 10%, $1,000 par convertible bonds

Corporate bonds are issued with an "anti-dilutive"
outstanding convertible at a 40:1 ratio. The
covenant. If the corporation declares a 5% stock
common stock is currently trading at $24.75. If dividend, which statements are true?
the bond is currently trading at 101, at what
market price of the common stock would an I The conversion price is reduced
arbitrage possibility exist between the II The conversion price is increased
convertible bond and the stock into which it is III The number of common shares is reduced
convertible? IV The number of common shares is increased
A. 24 A. I and II
B. 25 B. I and IV
C. 25.25 C. II and III
D. 26 D. II and IV

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A customer purchases a convertible bond at 90,

convertible into the common stock at $40. The common
A convertible bond is convertible into stock is currently trading at $42. Which statements are
common stock at a 32:1 ratio. The true?
common stock is currently trading at $30.
I There is a bona fide arbitrage opportunity
The bond is currently trading at $980. II The conversion ratio is 25:1
What is the bond's parity price? III The bond and the stock are trading at parity
IV If the bond is purchased and the equivalent number
of common shares are sold short, there is an immediate
A. $940 profit
B. $960
C. $980 A. II and III only
B. I and III only
D. $1,000 C. I, II, IV
D. I, II, III, IV
S&P Moody's
Bond Ratings AAA Aaa

AA Aa Investment
• Bond Ratings Services
Grade
– Standard and Poor's A A
– Moody's BBB Baa
– Fitch's
BB Ba
B B Speculative
CCC Caa Grade
CC Ca
C C
What is the highest investment grade? A bond is rated Aaa by Moodys. The
bond is:
A. AAA+ A. Highest Quality Investment

B. AAA Grade
C. AA
B. High Quality Investment Grade
C. Low Quality Investment Grade
D. A D. Highest Level Speculative Grade

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A bond is rated BBB by Standard and The lowest investment grade rating
Poors. The bond is: is:
A. Highest Quality Investment Grade A. Baa

B. High Quality Investment Grade B. Ba
C. Lowest Quality Investment Grade C. CCC
D. Highest Level Speculative Grade D. C
At which rating is a bond first Below which rating is a bond first

considered to be speculative? considered to be speculative?
A. Baa A. Baa
B. Ba B. Ba
C. CCC C. CCC
D. C D. C
EFFECTS OF INTEREST RATE

MOVEMENTS ON BOND PRICES
Yld to Call Yld to
Current
BOND YIELDS
Maturity Nominal
Yld • NOMINAL YIELD = stated
Yld Market
• DISCOUNT BOND Price rate of interest (the coupon)
• CURRENT YIELD
Interest Rates • YIELD TO MATURITY =
Yld to Current Nominal Market takes into account both
• PAR BOND Yld to Call Maturity Yld Yld Price market price and gains/losses
Interest Rates if held to maturity
• YIELD TO CALL/PUT =
Interest Rates
Nominal
Market takes into account both
• PREMIUM BOND Price market price and the price at
Yld to Current Yld
Yld to Call Maturity Yld which the bond is called (or
put)

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Discount $800 Discount $800
Current Yield = 12.5%
$1,000 Par, 10 %, w/ 10 $1,000 Par, 10 %, w/ 10

years to maturity years to maturity
Interest rates going up Interest rates going up
Discount $800
Yield to Maturity = 13.3%

$1,000 Par, 10 %, w/ 10
years to maturity
Interest rates going up
Discount $800
Yield to Call

$1,000 Par, 10 %, w/ 10
years to maturity

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Discount $800
Interest rates going down
Yield to Call
Current Yield = 12.5% $1,000 Par, 10 %, w/ 10

years to maturity
$1,000 Par, 10 %, w/ 10
years to maturity
YTC > YTM > CY > Coupon for a discount bond

Premium $1,200
Interest rates going down Interest rates going down
$1,000 Par, 10 %, w/ 10 $1,000 Par, 10 %, w/ 10

years to maturity years to maturity
Current Yield = 8.3% Current Yield = 8.3%
Premium $1,200 Premium $1,200

$1,000 Par, 10 %, w/ 10
years to maturity
Yield to Call <- Bond must be priced here
Premium $1,200

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YTC < YTM < CY < Coupon for a premium bond
$1,000 Par, 10 %, w/ 10
years to maturity
Yield to Call <- Bond must be priced here
Premium $1,200
Discount $800
Yield to Call A corporation has issued 10% AA rated sinking fund
debentures at par. Three years later, similar issues are
being offered in the primary market at 12%. Which are true
Yield to Maturity = 13.3% statements about the outstanding 10% issue?
I The current yield will be higher than the nominal yield
$1,000 Par, 10 %, w/ 10 II The current yield will be lower than the nominal yield
years to maturity III The dollar price of the bond will be at a premium to par
IV The dollar price of the bond will be at a discount to par
A. I and III
Yield to Maturity = 7.27% B. I and IV
C. II and III
Yield to Call <- Bond must be priced here D. II and IV
Premium $1,200
interest rates
For bonds trading at a discount, rank the yield For bonds trading at a premium, rank the yield
measures from lowest to highest? measures from lowest to highest?
I Nominal I Nominal
II Current II Current
III Basis III Basis
IV Yield to Call Basis IV Yield to Call Basis
A. I, II, III, IV A. I, II, III, IV

B. IV, III, II, I B. IV, III, II, I
C. II, I, III, IV C. II, I, III, IV
D. I, III, II, IV D. I, III, II, IV

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When the price of a bond increases, which of the In 2015, a customer buys 5 GMAC 10%
following statements regarding yields are true? debentures, M‘35. The interest payment dates
are Feb 1 and Aug 1. The bonds are callable
I Current yield increases as of 2025 at 103. The current yield on the
II Current yield decreases bonds is 11.76%. The bond is trading:
III Yield to maturity increases
IV Yield to maturity decreases
A. at a premium
A. I and III B. at a discount
B. I and IV C. at par
C. II and III D. in the money
D. II and IV
In 2015, a customer buys 5 GMAC 10%

debentures, M‘35 at 150. The interest All of the following callable bonds are trading at
payment dates are Feb 1 and Aug 1. The an 8% basis. Which is most likely to be called?
bonds are callable as of 2025 at 103. The
current yield on the bonds is:
A. 6 3/4% coupon rate callable at 103 in 2015
B. 7 1/2% coupon rate callable at 103 in 2015
A. 6.7%
C. 8 3/4% coupon rate callable at 100 in 2015
B. 8.7%
D. 8 3/4% coupon rate callable at 105 in 2015
C. 10%
D. 11.4%
Regarding bond price volatility and interest rate movements,

Bond Price Volatility which of the following are true?
I the shorter the maturity, the greater the bond's price

Low Coupon High Coupon volatility
II the longer the maturity, the greater the bond's price
Short Maturity Long Maturity volatility
III the lower the coupon rate, the greater the bond's price
volatility
Discount Premium IV the higher the coupon rate, the greater the bond's price
volatility
Small Discount Large Discount
A. I and III
B. I and IV
Small Premium Large Premium C. II and III
D. II and IV

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Which statements are true regarding bond price volatility?
I High coupon bonds have the lowest price volatility

II Low coupon bonds have the lowest price volatility
III Long maturity bonds have the lowest price volatility
IV Short maturity bonds have the lowest price volatility
U.S. GOV'T DEBT
A. I and III
B. I and IV
C. II and III
D. II and IV
MARKETABLE U.S. U.S. GOV'T DEBT IS SOLD

GOVERNMENTS AT AUCTION
• T-Bills • short term Treasury Bills, Treasury Notes, and
• T-Notes Treasury Bonds are issued in book entry form
(since 1983)
• T-Bonds
• Treasury Bills are sold at the weekly auction
• TIPS
• Treasury Notes - depends
• T-STRIPS – 2-Year T-Notes are sold monthly
– 5- and 10-Year Notes are sold quarterly
• Treasury Bonds are sold quarterly
TREASURY BILLS Treasury Notes

• maturities range from 2 to 10 years
• issued with 4-week, 13-week, 26-week,
• issued in multiples of $100 par value
and 52-week maturities
• trades settle next business day
• issued at a discount from par - $100
• pay interest semi-annually
minimum - and mature at par
• quoted in 32nds
• quoted on a discount yield basis • are non-callable
• trades settle next business day

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GOVERNMENT SPONSORED
Treasury Bonds ENTITIES (GSEs)
• created by Congress to fund loans to groups of
• maturities ranging from 10 to 30 years borrowers such as homeowners, farmers, and students
• multiples of $100 par at affordable rates
• trades settle next business day • these entities are set up as:
• pay interest semi-annually – Government Agencies: Government National Mortgage
Association (Ginnie MAE) which is a division of the
• quoted in 32nds government whose securities are backed by the full faith and
• long-term Treasury Bonds are usu. callable 5 years credit of the United States government
prior to maturity – Regional Bank Systems:
• Federal Home Loan Banks and Federal Farm Credit Banks; and
– i.e. if interest rates have dropped – privately owned corporations: Student Loan Marketing
Association (Sallie MAE); Federal National Mortgage
Association (Fannie MAE); and Federal Home Loan
Mortgage Corporation (Freddie MAC)
Farmer Loans
• FED. FARM CREDIT
CONSOLIDATED SYSTEM
Agency Debt – Banks for Cooperatives

– Federal-Intermediate Credit Banks
– Federal Land Banks
U.S. GOV'T PROMOTES HOME

All of the following are obligors of Federal OWNERSHIP THROUGH
Farm Credit Consolidated System bonds
EXCEPT:
ACTIVITIES OF:
• Federal National Mortgage Association -
Fannie Mae
A. Federal Intermediate Credit Banks • Government National Mortgage Association -
B. Banks for Cooperatives Ginnie Mae
• Federal Home Loan Mortgage Corporation -
C. Agricultural Credit Corporations Freddie Mac
D. Federal Land Banks

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Which of the following agencies is Mortgage-Backed Securities

directly backed by the U.S.
• Ginnie Mae, Fannie Mae, and Freddie Mac
Government? buy "conforming mortgages" from
originating lenders
A. FNMA • they will only buy mortgages with either 15
year or 30 year maturities
B. FHLMC
• the mortgages that are purchased are pooled
C. FLB and $25,000 certificates are sold that
D. GNMA represent an undivided interest in the pool
Mortgage-Backed Securities Mortgage-Backed Securities

• the purchaser of a $25,000 certificate in a 30 year • Problems With Pass Through Certificates
mortgage pool will receive monthly payments – A) Prepayment Risk
• two reasons why mortgages are paid off early:
from the underlying mortgages – 1) interest rates have fallen and the mortgage is being refinanced
• even though these are 30 year mortgages, that – 2) the home has been sold
does not mean the certificate holder will get 30 – B) Extension Risk
• the risk that the mortgage will be paid off LATER than
years of payments because homeowners tend to anticipated (happens when interest rates rise)
move and prepay their mortgages after, say 15 • CMOs were developed by brokerage firms to
years (for illustration purposes - actual experience minimize these risks
is about 12 years) – CMOs have $1,000 denominations
MUNICIPAL ISSUES
• General Obligation Bonds
– backed by full faith, credit, and taxing power of
issuer (ad valorem - property taxes)
MUNICIPAL DEBT – muni have Statutory & Constitutional Debt
limits imposed (they can’t keep raising tax rates
to pay off debt!)
• to exceed the limit, a public referendum (vote) is
required
– overlapping debt
• regional school

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MUNICIPAL ISSUES Municipal bonds that are backed by the

full faith, credit, and unlimited taxing
• Revenue Bonds power of the issuer, are known as:
– self-supporting debt (no Constitutional Debit
Limit)
– backed by tolls, user fees, rents, and leases A. general obligation bonds
– though muni debt is exempt, these bonds will
B. moral obligation bonds
most likely have a Trust Indenture because it is
difficult to sell the bonds without one C. special tax bonds
D. debentures
The type of municipal bond issue that would

be used to finance the construction of public Types of funds used to back revenue bond
schools would be a: issues include all of the following EXCEPT:
A. excise taxes
A. revenue bond
B. lease rentals
B. special tax bond
C. ad valorem taxes
C. moral obligation bond
D. enterprise activity income
D. general obligation bond
MUNICIPAL ISSUES Industrial development bonds are issued

by municipalities to build facilities that are
• Industrial Revenue Bonds (industrial leased to:
development bonds)
– a revenue bond used to finance a project which A. corporations
is leased to an outside company
B. government agencies
C. municipalities
D. sovereign governments

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The final responsibility for the debt TAX STATUS OF MUNICIPAL

service on industrial revenue bonds DEBT INTEREST
rests with the: • 1) exempt from Federal tax; subject to state and
local tax -- * the most important for the exam
• 2) triple tax free -- * the most important for the
A. issuing municipality investor
– i.e. a resident purchasing his own municipality's bonds OR
B. corporate lessee of the facility – a U.S. resident purchasing a bond issued by a territory or
possession of the U.S. (Guam, Puerto Rico, Virgin Islands,…)
C. bond trustee • 3) fully taxable

– for a non-essential use, private purpose facility
– i.e. sports stadium/complex, convention center
D. bond underwriter
A customer purchases a NY state G.O. A resident of NY purchases a NY state

bond. How will the bond interest be taxed? G.O. bond. How will the bond interest be
taxed?
A. exempt from Federal; subject to state A. exempt from Federal; subject to state
and local and local
B. exempt from state and local; subject to B. exempt from state and local; subject to
Federal Federal
C. triple tax free C. triple tax free
D. fully taxable D. fully taxable
Which of the following municipal issues Issuers of Federal tax exempt commercial
would NOT be exempt from taxation of paper include:
interest by the Federal Government?
I Corporations
A. San Francisco, CA – Convention Center II Federal Government
Revenue Bond III Municipal Government
B. Miami, FL – Sewer and Water Revenue
Bond A. I only
C. Nassau County, NY – Pollution Control B. II only
Bond C. III only
D. Des Monies, IA – School District Bond D. I, II, III

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TAX STATUS OF MUNICIPAL

DEBT INTEREST (cont.) An investor in the 31% tax bracket
buys a 7% municipal bond quoted on
• when we talk about muni bond interest, we look at the interest
as being exempt from Fed. tax a 6.25 basis. To calculate the
• if you're in the 20% tax bracket and you purchase an 10% equivalent taxable yield:
corporate, what is the equivalent tax-free (municipal) yield?
A. divide 6.25% by 69%
B. multiply 6.25% by 69%
C. divide 7% by 69%
D. multiply 7% by 69%
A municipal investor is considering the A municipal investor is considering the

purchase of a 10 year, 6% G.O. bond with purchase of a 10 year, 6% G.O. bond with a
a 5 3/4% yield to maturity. The investor is 6 1/4% yield to maturity. The investor is in
in the 31% tax bracket. The equivalent the 28% tax bracket. The equivalent taxable
taxable yield is: yield is:
A. 8.3% A. 6.3%
B. 8.69% B. 8.3%
C. 16.9% C. 8.7%
D. 19.35% D. 9.6%
A customer residing in California is in the 30% Federal Tax

bracket and 10% State Tax bracket. She wises to make a
bond investment with the following bonds available:
Yield
AAA Corporate Bond 6.50%
U.S. Treasury Bond 4.50%
AAA Federal Home Loan Bank Bond
AAA California Bond
5.00%
4.00%
MONEY MARKET
The best recommendation for the customer is: INSTRUMENTS
A. AAA Corporate Bond
B. U.S. Treasury Bond
C. AAA Federal Home Loan Bank Bond
D. AAA California Bond

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MONEY MARKET DEBT TYPES OF MONEY

(VS. CAPITAL MARKET DEBT) MARKET INSTRUMENTS
• MONEY MARKET DEBT • TREASURY BILLS
– maturity is 1 year or less – actually, ANY Gov't which matures in 1 year or less
– low risk • COMMERCIAL PAPER

• BANKER'S ACCEPTANCE
– more liquid than longer term
– used to facilitate trading of imports and exports
• CAPITAL MARKET
– PRIME B.A.
– maturity of over 1 year • a B.A. eligible for Federal trading
– higher risk • NEGOTIABLE CDs
– less liquid than shorter term
OPEN MARKET OPEN MARKET

OPERATIONS OPERATIONS (cont.)
• Fed buys money market instruments • Fed sells money market instruments
– REPURCHASE AGREEMENT – REVERSE REPURCHASE AGREEMENT
• used to take money out of the money supply
• used to inject cash in money supply
• to tighten money supply
• Fed buys securities injecting money into the • interest rates go up as there is less money available
money supply, loosening credit to be borrowed
• interest rates go down as there is more • only the “safest” securities are eligible for Fed
money available to be borrowed trading
MONEY RATES MONEY RATES (cont.)

• Prime Rate • Discount Rate
– the rate banks charge their best corporate – the rate the Federal Reserve charges banks for
clients for loans overnight loans (for those banks to meet reserve
• Broker (Call) Loan Rate requirements)
– the rate banks charge brokerages for margin • Federal Funds Rate
accounts – the rate banks charge other banks for overnight
loans (for those other banks to meet reserve
requirements)

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MONEY RATES (cont.)

Which of the following rates is the
• highest to lowest: highest?
– Prime Rate
– Broker Rate A. Prime Rate
– Discount Rate
B. Broker Rate
– Federal Funds Rate
C. Federal Funds Rate
D. Discount Rate
Which of the following rates is set by the Federal

Reserve?
Which of the following rates is the
lowest? I Prime Rate
II Broker Rate
III Federal Funds Rate
A. Prime Rate
IV Discount Rate
B. Broker Rate
A. IV only
C. Federal Funds Rate B. I, II, III
D. Discount Rate C. I, II, IV
D. I, II, III, IV
Which of the following statements are true regarding

reverse repurchase agreements?
All of the following rates are set
by banks EXCEPT: I The Federal Reserve is tightening credit
II The Federal Reserve is loosening credit
III Banks have less money to loan out for individuals
A. Prime Rate who need loans
IV Banks have more money to loan out for individuals
B. Broker Rate who need loans
C. Federal Funds Rate A. I and III

B. I and IV
D. Discount Rate C. II and III
D. II and IV

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Which of the following are eligible for Fed trading?

The highest quality issue of this debt
I Treasury Bonds instrument which is used to finance
II Prime Banker's Acceptances imports and exports and is eligible for
III Treasury Bills Fed trading is:
IV Commercial Paper
A. II and IV only
A. Overnight repurchase agreement
B. I, II, III
B. Federal Funds
C. I, III, IV
C. Eurodollars
D. I, II, III, IV
D. Prime banker's acceptance
Banker's Acceptances are:

Which of the following money market I overnight loans available to member
institutions of the Federal Reserve System
instruments is eligible for Fed trading? II drafts on banks used to finance imports
and exports
A. A 30-year T-Bond which matures III negotiable securities
within a year IV non-negotiable securities
B. Negotiable CD A. I and III
C. Commercial Paper B. I and IV
D. Banker's Acceptances C. II and III
D. II and IV

Federal Funds?
I these are overnight loans available to member

institutions of the Federal Reserve System
II these are Eurodollar loans made between major
international banks
III the interest rate charged on Fed Funds is the
Federal Funds Rate SPECIAL SECURITIES
IV the interest rate charged on Fed Funds is the
LIBOR
A. I and III
B. I and IV
C. II and III
D. II and IV

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RIGHTS A corporation wishes to raise funds to build a new

manufacturing facility. Which method is suitable for the
• short term options to buy stock at a fixed issuer to obtain financing?
price
A. Force conversion of outstanding convertible
• typically issued for 30-60 days and then preferred
expire
B. Split the outstanding shares of common stock 2 for 1
• are issued under offering of new common
C. Issue rights to outstanding shares of common stock
shares to existing shareholders
D. Call outstanding convertible preferred
• trade separately on exchange
WARRANTS A corporation is offering a new issue consisting of

100,000 units at $200 each. Each unit consists of 2
shares of preferred stock and a warrant to buy one
• long term option to buy stock at a fixed price additional common share. A full warrant allows the
• usu. attached to sale of a new stock/bond issue as purchase of an additional common share at $5. If all the
a "sweetener" to make issue more attractive warrants are exercised, the corporation will have:
• usu. has a "wait" period before it can be exercised
until expiration A. 100,000 preferred shares and 100,000 common
shares
• indeterminate value at issuance B. 200,000 preferred shares and 100,000 common
• exercise price is set at a premium to the market shares
price at issuance — holders gain only when C. 200,000 preferred shares and 50,000 common shares
common stock rises D. 50,000 preferred shares and 100,000 common shares
All statements are true regarding warrants

EXCEPT:
All of the following pay dividends
A. Warrants generally have a life of 9 months
EXCEPT:
B. At issuance, the exercise price of the
warrant is set higher than the current market
price of the underlying common stock A. Preferred Stock
C. The price of the warrant will vary with the B. ADR's
price movements of the underlying stock C. Warrants
D. The price of the warrant will vary D. Real Estate Investment Trusts
depending upon the time to expiration of the
warrant

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Options
A customer who is long call contracts would have
• Calls
what kind of market sentiment?
– options to BUY stock for buyer
– must SELL stock if the seller A. bullish
• Puts B. bearish
– options to SELL stock for buyer C. neutral
– must BUY stock if the buyer D. bullish and bearish
• Writing options
– for income
Options
A customer who is long put contracts would have
what kind of market sentiment? • a legal and binding contract entered into
between two parties
A. bullish • buyer = holder = long position
B. bearish – pays the premium
C. neutral • seller = writer = short position
D. bullish and bearish – receives the premium
1 ABC Jan 50 Call Options

• 1 -> # of options contracts, covering 100 shares • Equity / Stock Option
• ABC -> stock – if the underlying security is a common or
preferred stock
• Jan -> expires Sat. following the 3rd Friday of the
month at 11:59 PM EST • Foreign Currency Option
• 50 -> Strike Price – buy that foreign currency CALL option if the
• Call -> two types: Calls & Puts
currency is expected to go up compared to the
U.S. dollar
• maximum expiration is 9 months
– buy that foreign currency PUT option if the
• premiums are quoted in increments of $.05 (a nickel) currency is expected to go down compared to
the U.S. dollar

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The market sentiment of an investor who buys a

An investor who sells a call would make money if the
call is: market price of the underlying stock relative to the strike
price of the option would:
I Bullish
I go up
II Bearish
II go down
III Neutral III remain the same as the strike price
A. I only A. I only
B. II only B. II only
C. III only C. III only

D. II and III
D. I and III
When reading the morning newspaper, you see that AMERICAN DEPOSITARY
Japan is suffering from economic turmoil while
Canada is experiencing record economic growth. An RECEIPTS
appropriate strategy is to:
• vehicle for trading foreign securities in U.S.
I Buy Canadian Calls – the bank holds foreign securities in country of
II Buy Yen Calls origin and then issues receipts in the U.S. backed
III Buy Canadian Puts by the foreign security
IV Buy Yen Puts • foreign companies don't want their shares
issued in U.S. because of registration with SEC
A. I and II
B. I and IV • no voting rights and no preemptive rights
C. II and III
D. II and IV
ADRS (CONT.)
American Depositary Receipts would • ADR's are registered with SEC
– all exchange listed ADR's are sponsored
trade on all of the following EXCEPT: • meaning the foreign company "sponsors" the issue
– nonsponsored ADR's trade OTC
A. London Stock Exchange • these are assembled by banks and broker's without
issuer's participation
B. New York Stock Exchange
• dividends are declared in foreign currency,
C. NASDAQ System though are converted and paid in U.S.
D. American Stock Exchange dollars
• influenced by foreign currency exchange
fluctuations

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An ADR is:
American Depositary Receipts only
pay dividends in: A. a U. S. security held in U. S. branches of
foreign banks
B. a foreign security held in foreign
A. Eurodollars
branches of U. S. banks
B. European currency Units C. a negotiable certificate denominated in a
C. Foreign Currency foreign currency
D. U.S. Dollars D. a negotiable certificate denominated in
U. S. currency
Restricted Securities
• aka "letter stock" / "private placement"
• not offered to the general public
Series #6 Investment Securities 237

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Securities Markets & Market Terms
TRADING MARKETS
PRIMARY MARKET
– new issues being sold for the first time
Securities Markets & SECONDARY MARKET
Market Terms – trading of issued securities
– First
– Second
– Third
– Fourth
Series #6 Securities Markets & Market Terms 1 Series #6 Securities Markets & Market Terms 2
SECONDARY MARKET SECONDARY MARKET (cont.)
FIRST MARKET FIRST MARKET (cont.)

– trading of exchange listed securities on floor of
stock exchange
– options trade on exchanges
• this is an auction market • largest trading is done on CBOE
– NYSE, AMEX, and regional stock exchanges – bonds usu. trade OTC, because of
– about 3,000 companies traded on NYSE with the efficiency of the market
average volume of 1+ billion shares
THE TICKER TAPE SECONDARY MARKET (cont.)

"s" = SECOND MARKET
– Round lots of 100s – over the counter trading of unlisted securities
• i.e. 2s 114
– 2 round lots of 100 shares sold at 114
– a negotiated market
Block = – dealer to dealer market done over the phone
regulated by FINRA
– 10,000 shares; full amount of block is printed
on tape – greater number of companies are traded OTC
• i.e. 10,000s 114 • well over 10K companies trade OTC with about
– 10,000 shares sold at 114 4,000 companies quoted on NASDAQ

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SECONDARY MARKET (cont.) SECONDARY MARKET (cont.)

SECOND MARKET (cont.)
SECOND MARKET (cont.) – What else trades OTC?
– average volume on the NASDAQ is about 1.5+ • most corporate bonds
Billion shares • all corporate commercial paper
– most start up companies begin trading OTC as • U.S. Gov't bonds
listing requirements are less stringent • municipals
– Sold OTC, but NOT traded:
• New issues
• Mutual funds
NASDAQ LEVELS NASDAQ LEVELS (cont.)

– Level 1 – Level 2
• summary of market intended for use by • lists all market makers and their quotes
registered reps. • firm's trading desk uses Level 2 of
NASDAQ
• Inside Market
– defined by highest bid and lowest ask
– Level 3
– the prices at which the next trades would take • same as Level 2, EXCEPT market makers
place can enter and change quotes
SECONDARY MARKET (cont.) Bid Ask

MM I 9.50 10.13
The inside market is NASDAQ: MM II 9.75 10.13
MM III 9.50 10
A. Level I
B. Level II MM IV 9.63 10.25
C. Level III
D. Level IV What’s the inside market?

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THIRD MARKET FOURTH MARKET

– OTC trading of exchange listed securities – direct trading between institutions OTC
– stays open 24 hours companies bypassing brokers and large
commissions
– ECNs (Electronic Communications Networks);
Instinet
The first market is the:

The trading of listed securities over-
the-counter occurs in the:
A. trading of NASDAQ stocks
B. issuance of listed stocks
A. Primary Market
C. trading of listed stocks on the floor
B. First Market
of an exchange
C. Second Market
D. issuance of listed and unlisted
D. Third Market
stocks
The Fourth market is direct trading of

The First Market would represent
securities between:
trading in:
A. brokers buying for their own
A. unlisted issues
accounts
B. new issues
B. NYSE customers
C. NYSE issues
C. NASDAQ customers
D. OTC issues
D. institutions

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On which of the following markets do

Instinet is the: the greater number of companies
trade?
A. first market
A. first
B. second market
B. second
C. third market
C. third
D. fourth market
D. fourth
Bull / Bear Market

BEAR MARKET
– indices have fallen 20% in a 2-month period
Market Terms and
BULL MARKET Quotations
– indices have risen 20% in a 2-month period
Broker-Dealers Bid VS Ask

• every firm is a broker-dealer • Bid
• the firm cannot act as both a broker AND a – redemption price
dealer in the same trade – selling price
– NAV
– i.e. you can earn either a commission or a
mark-up, not both • Ask
– offer price
– buy price
– abc = Agent = Broker = Commission
– POP
– p-diddy-music = Principal = Dealer = Mark-up
Series #7 Cheat Sheet Peter A Gibowicz for Pass Perfect 23 Series #6 Securities Markets & Market Terms 24

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GOOD DELIVERY OF
Trade Date VS Settlement Date
SECURITIES
• Trade Date • on settlement, securities are delivered and
• Settlement Date paid for; if securities are not in good form,
– regular way they can be rejected and settlement will not
– cash take place
• securities can be endorsed on the back (or a
"stock power" or "bond power" is signed
which transfers the ownership of the stock
without signing the security)
GOOD DELIVERY OF GOOD DELIVERY OF

SECURITIES (cont.) SECURITIES (cont.)
• stock delivered in round lots of 100 shares • the “good delivery of securities” is for those in
or multiples thereof physical form
– most securities are held in book entry form
– i.e. 400 share trades acceptable: 1 certificate of
400 shares; 4 certificates of 100 shares; 8 • Direct Registration System (DRS)
certificates of 50 shares – run by DTC which maintains custody of most physical
certificates
• NOT acceptable: 10 certificates of 40 shares
– allows investors to be registered on the books of the
• securities cannot be mutilated unless transfer agent without a physical certificate being
accompanied by a validation letter issued
– completely paperless
Series #6 Securities Markets & Market Terms 27 Series #99 Customer Disclosure & Settlement Rules 28
All of the following are considered

to be a good delivery for a 400 All of the following are considered to be a
good delivery for a 600 share trade of
share purchase of stock EXCEPT: stock EXCEPT:
A. One 400 share certificate A. One 600 share certificate

B. Eight 50 share certificates B. Six 100 share certificates
C. Ten 60 share certificates
C. Ten 40 share certificates D. Twelve 50 share certificates
D. Sixteen 25 share certificates

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All of the following are considered to be a FEDERAL RESERVE MARGIN

good delivery for a 475 share trade RULES SET UNDER REG. T
EXCEPT:
• Reg. T only applies to nonexempt securities
A. One 400 share certificate and one 75- (not U.S. Gov't, Agency, or Municipal)
share certificate • Reg. T controls credit from broker to
B. Four 100-share certificates and three customer
25-share certificates • Industry Minimum Maintenance Margins
C. Five 80-share certificates and one 75- also apply (these are set by exchanges and
share certificate FINRA and NOT by FRB)
D. Nineteen 25 share certificates
REGULATION T REGULATION T (cont.)

cash account
• controls credit from broker to customer
– payment is made promptly, but no later than 5
• sets initial margins for securities and basic business days after trade date
account procedures for collection of moneys – "S + 2" (Settlement + 2 business days)
• applies to non-exempt securities only • if payment isn't collected, firm may ask for "Reg. T
Extension" (3 business days)
• only actively traded securities are • if not paid, firm is obligated to sell out position but
marginable NOT whole account and freeze account for 90 days
– when account is frozen, all trades require cash payment in
advance
Formulas A company's common stock is selling in

the market at a "multiple of 20". If the
Dividend or Current Yield = Annual Income market price of the common stock is
Market Price currently $10, what is the earnings per
Price Earnings Ratio = Market Price of Security share?
Earnings Per Share
Earnings Per Share = Market Price A. $.02
B. $.20
"Multiple"
C. $.50
D. $2.50

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INVESTMENT BANKING
A company's common stock is selling in
the market at a "multiple of 15". If the RELATIONSHIP
market price of the common stock is • INVESTMENT BANKER
currently $10, what is the earnings per STRUCTURES ISSUE
share? – investment banker examines:
• existing financial structure of company
A. $.15 • industry outlook
B. $.16 • intended use of funds
C. $.67 • current status of financial markets in order to
recommend proper financing vehicle (should the
D. $1.50 company issue equity or debt)
LETTER OF INTENT
A Company wants to issue a new series of
bonds. It would prefer to issue them at 5%.
Who would analyze the market to determine • LETTER OF INTENT
if this rate will probably be attractive enough – agreement between issuer and underwriter (not binding)
to sell the issue? – INCLUDES:
• type of security to be sold
A. The company’s Chief Financial Officer • size of issue
• total par value
B. An investment banker
• estimated Public Offer Price
C. A commercial bank • estimated interest rate
D. The company’s Board of Directors • underwriter's spread
• underwriting commitment
UNDERWRITING UNDERWRITING
COMMITMENTS COMMITMENTS (cont.)
• FIRM COMMITMENT • BEST EFFORTS (cont.)
– investment banker acts as principal, buying – all or none
issue from company and then resells issue to • deal is contingent on entire issue being sold; deal is
public, earning the spread canceled otherwise
– underwriter assumes full financial liability – mini-maxi
• BEST EFFORTS • minimum amount must be sold
– investment banker acts as "agent", taking no • underwriter continues to sell issue up to a maximum
financial liability portion of deal
– if part of issue is unsold, it remains with issuer – this "maxi" is on a best efforts basis

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UNDERWRITING
COMMITMENTS (cont.)
When an underwriter agrees to buy any unsold
• STANDBY UNDERWRITING portion of a new issue of securities, bearing all
– used when company attempts to sell additional shares the risk, what is this type of underwriting?
through a rights offering
– underwriter stands by on a firm commitment basis to A. Best efforts underwriting
"pick up" unsubscribed shares at subscription price B. Syndicate agreement
• negotiated underwriting C. All–or–none commitment
– typical for corporate underwritings; terms are D. Firm commitment
negotiated between issuer and underwriter
ABC Corporation issues rights to current

shareowners for a new issue of ABC common An investment banker agrees to act as agent in
stock. The underwriter agrees to purchase any an underwriting of a new issue, selling whatever
remaining shares after current shareowners portion of the issue that it can and assuming no
exercise their rights to purchase the issue. This risk for unsold shares. This is a(n);
type of underwriting is a:
A. best efforts underwriting
A. mini-maxi underwriting B. stand–by underwriting
B. best efforts underwriting C. firm commitment underwriting
C. all-or-none underwriting D. all or none underwriting
D. stand-by underwriting
FORMATION OF THE
When a corporation considering the sale of a new SYNDICATE
issue of securities stipulates that it will issue no • AGREEMENT AMONG
securities unless the entire issue sells, the
UNDERWRITERS
arrangement is a(n):
– investment banker will invite other firms into
syndicate, offering them a piece of issue
A. best efforts underwriting
B. stand–by underwriting – formal agreement is called the Syndicate
C. all–or–none commitment Agreement
D. firm commitment

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FORMATION OF THE FORMATION OF THE

SYNDICATE (cont.) SYNDICATE (cont.)
• MANAGING UNDERWRITER
– the Agreement Among Underwriters gives manager • MANAGING UNDERWRITER (cont.)
of syndicate full control over syndicate decisions – manager determines each member's share of
– DUE DILIGENCE profit or loss after underwriting is completed
• manager is responsible for researching issuer – for handling underwriting, the manager gets a
and for insuring full disclosure to investors management fee which is a portion of spread
• corporates come under the requirement of the
Securities Act of 1933 which regulates the sale
of nonexempt new issues
Components of the Spread

The Agreement Among Underwriters is
also known as the: Spread
– difference between what the public pays for the
issue and what the issuer receives
A. Due Diligence Agreement
– underwriter’s concession
B. Syndicate Agreement
C. Selling Group Agreement – selling concession
D. Partnership Agreement – reallowance
– management fee
UNDERWRITER'S
SELLING CONCESSION
CONCESSION
• the profit that the managing underwriter • the profit the selling group earns for helping
"concedes" to the syndicate members if they sell the syndicate sell the new issue; comes out
directly to the public
– AKA Total Takedown of the underwriter's concession
• the syndicate member earns everything except for – Selling Group
the management fee if the issue is sold directly to • used to help sell issue if underwriting is very large
the public
• always acts as agent taking on no liability
– Additional Takedown
• what the syndicate member earns if the issue is sold
to a selling group member

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REALLOWANCE Components of $1 Spread

What
Syndicate
.05 Reallowance
• this is a small discount given to firms not in Members
Additional
syndicate or selling group S Earn if
Takedown
P Issue is
– i.e. what Non-Members of the Syndicate or Selling .30 .35
sold
Group earn for their participation in selling the new R directly to
issue E public -
A .55 Selling Total
D Concession Takedown
.90
.10 Management Fee
Which statements are true regarding a firm

commitment underwriting?
I Syndicate members assume potential liability

II Syndicate members have no potential liability
Members of a selling group:
III Selling group members assume potential
liability A. are members of the syndicate
IV Selling group members have no potential B. help syndicate members sell a new issue
liability C. assume responsibility to buy unsold shares
D. earn the spread when they sell shares to the
A. I and III public
B. I and IV
C. II and III
D. II and IV
In a corporate new issue offering, the underwriter's

ISSUER'S FUNCTIONS responsibilities include which of the following?
I Managing the syndicate account

• company prepares the issue for the sale
II Determining each syndicate member's participation
• process is regulated under Security Act of 1933 which
controls issuance of nonexempt securities in the U.S. III Printing the certificates
• registration statement must be filed with SEC by IV Registering the certificates
issuer
– most of registration statement is copy of Prospectus which A. I and II
gives complete disclosure about issue
B. III and IV
– when registration statement is filed, issue enters 20 day
cooling off period C. I and III
D. II and IV

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Investment Analysis
INVESTMENT
ECONOMIC FACTORS
ANALYSIS
Series #6 Investment Analysis 1 Series #6 Investment Analysis 2
ECONOMIC FACTORS ECONOMIC ANALYSIS (cont.)

• GROSS DOMESTIC PRODUCT (GDP) EXAMPLE: 1990s 2010s
Yld On 30-Yr T-Bond 10% 4%
– sum of all goods and services produced in Inflation Rate 7% 1%
country Real Interest Rate 3% 3%
– consists of consumer spending plus Gov't
spending plus business investment
– Real GDP • Note That The Real Interest Rate Is Unchanged Over The
Past 20 Years
• any effects of inflation on prices are eliminated to • The Real Interest Rate = Nominal Rate - Inflation Rate
achieve a valid measure
Gross Domestic Product (GDP) is:

Business Cycle
A. the sum of all goods and services produced in
the U.S. computed in real dollars • business activity tends to expand in a cyclical
B. a representative sampling of selected goods and fashion
services produced in the U.S. computed in real
dollars
C. the broadest measure of the money supply,
consisting of M-1, M-2, and M-3
D. the value of all net exports from the U.S.
computed in real dollars

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Investment Analysis
Business Cycle (cont.) Business Cycle (cont.)

• Recession
• Expansion – business contraction
– beginning at a low point, activity expands and – when GNP drops 2 consecutive quarters
Real GNP output increases • Depression
• Prosperity – if drop continues for at least 18 months
– as expansion ages, it tends to reach a peak • Recovery
– business decline bottoms out before starting
next expansion phase
During which phase of the economic cycle

The usual order of the economic cycle is: would one most likely find monetary
"inflation" starting to occur?
A. expansion, recession, recovery, peak
A. Expansion
B. recession, recovery, peak, expansion
B. Prosperity
C. expansion, peak, recession, recovery
C. Recession
D. peak, recession, expansion, recovery
D. Recovery
ECONOMIC THEORIES TO
A six month mild decline in economic activity is EXPLAIN BUSINESS CYCLE
a(n):
• 1) Keynesian Theory
– theory developed in midst of Great Depression
A. recession – John Maynard Keynes developed this and other theories
on economy that advocated "Fiscal Policy" as a means
B. depression of achieving a "full employment" economy
– determined by forces of income and spending
C. correction – consumption is driving force behind growth
– to stimulate consumption, Keynes advocated increased
D. expansion Gov't spending and transfer payments to individuals

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Investment Analysis
ECONOMIC THEORIES TO ECONOMIC THEORIES TO

EXPLAIN BUSINESS CYCLE (cont.) EXPLAIN BUSINESS CYCLE (cont.)
• 2) Monetarist Theory
– fiscal policy is NOT main determinant of 3) Supply Side Theory
economic activity, rather monetary policy is the – i.e. Reaganomics, Christie Todd Whitman
causal factor – the economy is stimulated (effected) by tax cuts
– actions of Fed. Reserve are driving force – tax cuts and reduced government spending are
behind economic cycles the driving force behind economic cycles
Monetarist Theory states that:

Keynesian Theory states that the economy
is stimulated by: A. increased government spending will stimulate the
economy
A. the actions of the Federal Reserve B. tax rate reductions and lower government
spending will stimulate the economy
B. increased Government spending
C. the actions of the Federal Reserve control the
C. decreased Government spending level of economic output
D. lowered tax rates D. tax rate increases and increased transfer
payments will stimulate the economy
ECONOMIC ACTIVITY AND

Supply Side Theory states that:
PRICES
A. increased government spending will stimulate • INFLATION
the economy – price increase for same output
B. tax rate reductions and lower government – economic output doesn't change, just price does
spending will stimulate the economy • DEFLATION
C. the actions of the Federal Reserve are the – if price drops for same unit of output
driving force behind the economy
D. tax rate increases will stimulate the economy

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Investment Analysis
GROWTH IS AFFECTED BY: GROWTH IS AFFECTED BY: (cont.)
• Fiscal Policy • Fiscal Policy (cont.)

– Gov't actions that influence economic activity – to stimulate the economy
– can be used to increase or decrease take home • tax rates can be cut
pay of American public by:
• transfer payments increased
• changing tax rates
• changing transfer payments (such as Social
• Gov't spending increased
Security)
• changing Gov't spending on goods and services
The Federal Reserve Board is

GROWTH IS AFFECTED BY: (cont.) charged with the responsibility for
establishing:
• Monetary Policy
– action taken by Fed. Reserve to
influence growth of money supply A. Fiscal policy
– by expanding money supply, credit is
loosened and interest rate lowered (this B. Monetary policy
stimulates economy) C. Foreign policy
D. Tax policy
Monetary policy is conducted through all of

Fiscal policy is set by: the following methods EXCEPT:
A. Supreme Court decisions

A. setting margin requirements
B. Congressional action
B. setting tax rates
C. Presidential edict
C. conducting open market operations
D. Federal Reserve action
D. setting reserve requirements

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Investment Analysis
ROLE OF THE
Measures of Inflation
FEDERAL RESERVE
• Consumer Price Index • Fed. Reserve controls money supply growth
– a "market basket" of selected goods and services across
the country • TOOLS OF FED. RESERVE:
– components of CPI include housing costs, food, – Discount Rate
clothing, medical, transportation,...
• Producer Price Index – Open Market Operations
– based on producer goods and does NOT include – Reserve Requirements
services
– increases in this are usually a precursor to increases in – Margin (Reg. T)
the CPI
ROLE OF THE ROLE OF THE

FEDERAL RESERVE (cont.) FEDERAL RESERVE (cont.)
• Setting Discount Rate • Conducts Open Market Operations
– discount rate is rate that Fed. Reserve charges – Fed. Reserve trading desk in NY adjusts credit
member banks to borrow reserves availability daily through repurchase and
reverse-repurchase agreements with Gov't
– to tighten credit, Fed. increases discount rate dealers
– to loosen credit, Fed. lowers discount rate – under a "repo", Fed. gives dealer funds in return
for temporary pledge of Gov't securities
– under a "reverse-repo", Fed. gives dealer a
temporary pledge of Gov't securities in return
for cash, tightening credit
ROLE OF THE ROLE OF THE

FEDERAL RESERVE (cont.) FEDERAL RESERVE (cont.)
– Setting Reserve Requirements • Setting Margins on NonExempt Securities
• Fed. sets level of reserves that member – Fed. sets initial margin rates for nonexempt
banks must maintain securities under Reg. T
• if reserve requirement is set at 10%, then
– to tighten credit, Fed. can increase margins
bank can lend 90%
• increasing reserve requirement would tighten – to loosen credit, Fed. can lower margins
credit
• reducing reserve requirement would loosen
credit

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Investment Analysis
If the Federal Reserve Board raises the

If the Federal Reserve Board lowers the discount
discount rate, all of the following should
rate, which of the following is true?
also occur EXCEPT:
I the Fed is loosening credit
A. Passbook Savings Rate should II the Fed is tightening credit
increase III lending levels at financial institutions should fall
IV lending levels at financial institutions should
B. Treasury Bill Discount Rate should rise
increase
C. Lending levels at financial institutions A. I and III
should fall B. I and IV
C. II and III
D. Federal Funds Rate should increase D. II and IV
If the FOMC directs the Federal Reserve trading desk to

tighten credit, which of the following will happen? MEASURES OF MONEY
I The trading desk will engage in repurchase agreements
with banks
SUPPLY
II The trading desk will engage in reverse repurchase • M1: Currency Plus Checkable Deposits
agreements with banks – "fast money"; funds that can be accessed and used
III Cash reserves will be injected into the banking system quickly
IV Cash reserves will be drained from the banking system – Fed Reserve actions to control credit availability are
gen. targeted at M1
A. I and III • M2: M1 Plus Time Deposits
B. I and IV – the broader money definition, including M1 PLUS
C. II and III Time Deposits of less than $100,000 (such as
nonnegotiable bank CDs)
D. II and IV
MEASURES OF MONEY
The narrowest measure of the money
SUPPLY (cont.)
supply is:
• M3
– a broader money definition, including M2
PLUS Time Deposits over $100,000
A. M-1
• L B. M-2
– the broadest money definition, including M3
PLUS Money Market Instruments and savings
C. M-3
bonds D. L

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Investment Analysis
The broadest measure of the money

The components of M-2 include all of the
supply is: following EXCEPT:
A. M-1 A. Jumbo CDs
B. M-3 B. Time Deposits
C. L C. Demand Deposits
D. Currency in Circulation
D. GDP
MARKET ANALYSIS
• THE EFFECT OF THE BUSINESS CYCLE ON
THE MARKETS
– stock market is leading economic indicator
MARKET ANALYSIS • investor expectations

• inflation expectations
• conditions in international markets
• interest rates
– if interest rates are higher in foreign markets than in U.S.,
then Gov't will have problem financing its perennial
deficit
FOREIGN CURRENCY FOREIGN CURRENCY

MARKETS MARKETS (cont.)
• foreign currency is traded in the "Interbank" • for each foreign currency trade, the buyer
market which is a global market, trading 24 and seller negotiate price and settlement
hours a day terms can be:
• trading is unregulated between foreign and – Spot: settlement and delivery in 1 or 2 business
domestic banks in very large units (usu. days (depending on international date line)
$5,000,000 minimum) – Forward: settlement later than "spot", usu.
months in the future

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Investment Analysis
Trades of foreign currencies settle: LONG TERM CURRENCY

I Cash VALUE
II Spot
• trends reflect changing economic fortunes
III Forward of each country
IV Future • factors that influence long term currency
values:
A. I only
– economic growth
B. II only • the stronger the economy as measured by GNP, the
C. II or III stronger the currency value
D. I, II, III, IV
LONG TERM CURRENCY

Which of the following actions listed would the
VALUE (cont.) Federal Reserve use to combat a weakening U.S.
• factors that influence long term currency dollar?
values (cont.)
– inflation rate I raise interest rates
• the lower the inflation rate in a country, the higher II lower interest rates
the currency value III buy foreign currencies
– interest rates IV buy U.S. Dollars
• the higher the interest rates, the higher the currency
value
– occurs because higher rates attract greater foreign
A. I and III
investments B. I and IV
• to make those investments, foreigners must buy C. II and III
securities denominated in that currency
D. II and IV
A foreign government wishes to stabilize its currency, which

Which of the following actions are likely to cause the has been falling against the U.S. Dollar. The government
value of the U.S. Dollar to rise? would:
I Buy U.S. Dollars
I The Federal Reserve lowers the discount rate II Sell U.S. Dollars
II The Federal Reserve raises the discount rate
III United States investors purchase foreign III Buy the foreign currency
securities IV Sell the foreign currency
IV Foreign investors purchase U.S. securities
A. I and III
A. I and III
B. I and IV
B. I and IV
C. II and III C. II and III
D. II and IV D. II and IV

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Investment Analysis
EVENT EFFECT ON U.S.

DOLLAR
If the dollar falls against foreign currencies,
all of the following are true EXCEPT: Inflation Increases
Inflation Decreases
A. U.S. goods are cheaper to foreign
Trade Deficit Widens
countries
Trade Deficit Narrows
B. U.S. exports are likely to rise
C. Foreign currencies buy fewer dollars Fed. Raises Interest Rates
D. Foreign imports are likely to fall Fed. Lowers Interest Rates
EVENT EFFECT ON
EVENT EFFECT ON U.S.
DOLLAR U.S. STOCK PRICES
Economic Output Rises
More Foreigners Buy U.S.
Securities
Economic Output Falls
More U.S. Citizens Buy Foreign
Securities Interest Rates Fall
More U.S. Citizens Visit
Foreign Countries Interest Rates Rise
More Foreigners Visit U.S. Inflation Falls
Inflation Rises
In a deflationary period, which of the following are true?

I Interest rates will rise
During extended periods of high inflation, it can be
expected that common stock price movements, as II Interest rates will fall
measured by the NYSE Composite Index, will show III As a defensive investment, an investor would purchase
a: equity securities
IV As a defensive investment, an investor would
A. positive correlation purchase fixed income securities
B. negative correlation A. I and III

C. lower volatility level B. I and IV
D. greater volatility level C. II and III

D. II and IV

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Investment Analysis
All of the following economic events would

have a positive long term impact on
common stock prices EXCEPT:
A. Falling interest rates

ANALYSIS OF
B. Falling capital gains tax rates INVESTMENT RISK
C. Rising employment rates
D. Rising inflation rates
Types of Investment Risk Types of Investment Risk (cont.)

• Business/Financial Risk • Capital Risk (Market Risk)
– risk that an issuer's business declines, often due to – risk that the amount invested may not fully be
technological change; bad business decision making; and recovered
law changes.
• In turn, the value of the issuer's securities declines. • Credit Risk
• Call Risk – risk that the issuer cannot make interest and principal
– if interest rates fall, it becomes attractive for issuers to call payments as due.
in outstanding bonds and refinance at lower current rates • Currency Exchange Risk
– the bonds most likely to be called are those with high – risk associated with the exchange of one foreign
interest rates and low call premiums currency to another.
– the bonds least likely to be called are those with low
interest rates and high call premiums
Types of Investment Risk (cont.) Types of Investment Risk (cont.)

• Inflationary Risk (see: Purchasing Power Risk) • Liquidity Risk
• Interest Rate Risk (Market Risk) – risk that selling a position will result in higher than
– as interest rates go up, bond prices fall - this is interest rate risk normal transaction costs (commissions)
– the bonds that are most susceptible to interest rate risk are: – typical for smaller, thinly traded issues
• Longer maturity issues; and
• Low coupon issues. • Market Risk (see: Capital Risk; Interest Rate
• Legislative Risk Risk; Systematic Risk)
– risk of new law changes which could impact the tax treatment of • Marketability Risk
certain investments.
• e.g. Legislative risk for holders of municipal issues is the risk that the – risk that a security will be difficult to sell; smaller,
Federal Government will tax the interest income on the bonds. thinly traded issues are most subject to marketability
risk

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Investment Analysis
Types of Investment Risk (cont.) Types of Investment Risk (cont.)

• Political/Social Risk • Systematic Risk (Market Risk)
– for holders of foreign securities and for issuers that have operations in
politically unstable foreign countries – undiversifiable risk is Systematic Risk, also known as Market Risk
– risk that the foreign government reneges on its obligations or seizes assets – this is the risk that general economic conditions (i.e. due to bad
held by foreigners economic conditions, war, rising interest rates, inflation, etc.) will
• Purchasing Power Risk (Inflationary Risk) affect a portfolio negatively.
– if inflation rates increase, interest rates increase as well.
• Non-Systematic Risk
– if interest rates increase, bond prices fall - this is purchasing power risk
• Reinvestment Risk – risk of a single investment going sour
– risk that interest rates drop after the issuance of a bond, and the semi- • by diversifying your portfolio, this risk is minimized
annual interest payments received from a bond are now reinvested at • Timing Risk
lower current market rates
• thus, the overall rate of return on the investment is reduced – The risk that buying and selling occur at disadvantageous price
– zero-coupon bonds do not make periodic interest payments, and hence, do levels due to poor market timing
not have reinvestment risk
Which of the diversification factors below will

When recommending domestic corporate
not reduce the non-systematic (credit) risk of
long-term debt instruments to a customer,
a bond portfolio?
which of the following risks is the LEAST
important consideration?
A. Maturity
A. Inflation (purchasing power) risk
B. Industry in which issuer operates B. Market risk
C. Coupon rate C. Credit risk
D. Currency exchange risk
D. Geographic location of issuer
When making a recommendation of

Customers who actively trade their
corporate commercial paper to a
listed stock portfolios should have a
customer, which risk is the MOST
strong understanding of:
important consideration?
A. Liquidity risk
A. Inflation (purchasing power) risk
B. Inflation risk
B. Call risk
C. Timing risk
C. Market risk
D. Call risk
D. Credit risk

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Investment Analysis
When making a recommendation of a A trader liquidates an exchange listed

10 year Treasury Note to a customer, stock position and invests the
the MOST important risk consideration proceeds in an exchange listed stock
is: index fund. The trader has reduced:
A. Liquidity risk A. Call risk

B. Credit risk B. Inflation risk
C. Market risk C. liquidity risk
D. Call risk D. Capital Risk
A trader maintains a position in a

small capitalization stock that has low Adding foreign stocks to a portfolio of
domestic securities:
trading volume. The trader has a high
level of:
A. increases risk
A. Market risk B. decreases risk
B. Liquidity risk C. has no effect on risk
C. Interest rate risk
D. is a prohibited practice
D. Business risk
An investor has a broadly diversified A customer holds a large portfolio of corporate

portfolio of blue chip stocks. The use of bonds. The customer is worried about business
index options to hedge the portfolio (capital) risk. Which diversification strategy would
be least effective to minimize capital risk for this
reduces: customer? Diversification among differing:
A. systematic risk
A. issuers in differing states
B. non-systematic risk
B. industries
C. interest rate risk C. maturities
D. timing risk D. coupon rates


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Investment Analysis
Which of the following is an example of purchasing

power risk?
An investor who places the majority of assets
A. The balance of payments deficit increases, and the in a single stock exposes the portfolio to:
value of the U.S. dollar declines as a result
B. The market value of all equity securities listed on
an exchange declines due to worries about increasing A. business risk
interest rates
B. liquidity risk
C. The financial statements that a company has
issued are not reflective of the company's actual C. inflation risk
financial status
D. market risk
D. Inflation increases at a greater rate than expected,
causing bond yields to rise and stock prices to fall
Which security is most affected by interest Which of the following securities has the
rate risk? highest level of credit risk?
A. Common stock A. General Obligation Bond

B. Preferred stock B. Industrial Development Bond
C. Treasury bill C. Equipment Trust Certificate
D. Commercial paper D. Mortgage Bond
A customer holds a position in a computer

software company stock. The company has been Risk and Return
accused by the Department of Justice of being a
monopoly and is being sued in Federal court. The • Investment income
price of the stock dropped 25% on the day that the – dividends on stock
lawsuit was announced. This is an example of: – interest on bonds
• Capital growth
A. business risk – appreciation occurs when the market price of the
security rises
B. financial risk
C. market risk • TOTAL RETURN = Income (Dividends for
Equities; Interest for Debt) + Growth (or – Loss)
D. purchasing power risk

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Investment Analysis
YIELD CURVE YIELD CURVE (cont.)

• NORMAL
• shows market rates of interest for bonds of – yields increase as
different maturities with similar credit maturities lengthen
ratings – because investors demand
premium for the extra risk
associated with longer
term
– when monetary policy is
loosened
– occurs during economic
expansion
YIELD CURVE (cont.) YIELD CURVE (cont.)

• FLAT • INVERTED
– when monetary policy – when short term rates
is tightened rise above long term
– as short term rates rise rates
closer to long term – rarely occurs
levels – occurs when short term
– occurs when economy credit is severely
is peaking tightened by the
Federal Reserve
During periods when a normal yield curve exists, which of

Rank the yields from highest the following are true?
to lowest. I long term bond prices are less volatile than short
term bond prices
I AAA Corporates
II Governments II long term bond prices are more volatile than short
III AAA Municipal term bond prices
III yields on long term maturities are greater than yields
A. I, II, III on short term maturities
B. I, III, II
IV yields on short term maturities are greater than
C. II, I, III
D. III, II, I yields on long term maturities
A. I and III
B. I and IV
C. II and III
D. II and IV

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Investment Analysis
When the yield curve is inverted:

I short term interest rates are lower than long
term interest rates When short term interest rates are
II short term interest rates are higher than long
higher than long term interest rates, the
term interest rates
III the Federal Reserve is pursuing a "loose" yield curve is said to be:
money policy
IV the Federal Reserve is pursuing a "tight" A. flat
money policy B. normal
A. I and III C. inverted
B. I and IV D. bell shaped
C. II and III
D. II and IV
Diversification PORTFOLIO ANALYSIS

• SYSTEMATIC RISK • PORTFOLIO CONSTRUCTION
– risk of general market decline affecting – types of equity securities:
portfolio
• BLUE CHIP
– also called Market Risk and cannot be
diversified away – highest quality companies with proven
earnings and dividend records
• NONSYSTEMATIC RISK
– mainly NYSE listed issues
– risk of a single investment going sour
– by diversifying portfolio, this risk is minimized
PORTFOLIO ANALYSIS (cont.) PORTFOLIO ANALYSIS (cont.)

– types of equity securities (cont.)
• EMERGING GROWTH
• GROWTH – brand new ventures of high risk but also high
– companies in a period of above average growth potential reward
due to rapid market expansion or unique – have NO track record and can't afford to pay
products dividends
– usu. do not have a proven track record and have • INCOME
very low dividend payout ratios – mature companies with high dividend payout
– tend to sell at higher PE multiples than mature ratios
companies because of their exceptional potential – i.e. Utilities

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Investment Analysis
PORTFOLIO ANALYSIS (cont.) Which of the following stocks would be

considered cyclical?
• CYCLICAL
– companies whose fortunes track business cycle A. automobile manufacturer
closely
– an example of a cyclical stock is a "durable B. pharmaceutical manufacturer
goods" manufacturer
• when business cycle turns down, people feel C. gold mining company
poorer and can't afford to buy cars and
washing machines D. computer software developer
PORTFOLIO ANALYSIS (cont.) Which of the following stocks would be

considered counter-cyclical?
• COUNTER-CYCLICAL
A. automobile manufacturer
– companies whose fortunes operate in
reverse to business cycle B. pharmaceutical manufacturer
– an example is a basic food producer
• when people feel poorer, they don't eat C. gold mining company
out as much, so in-home cooking
increases D. computer software developer
PORTFOLIO ANALYSIS (cont.)

Which of the following industries is NOT
– types of equity securities (cont.) considered to be defensive?
• DEFENSIVE A. pharmaceuticals
– a company which remains unaffected
during business cycle downturns B. building materials
– i.e. drug companies, public utilities,... C. food products
D. electric power

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Investment Analysis
PORTFOLIO ANALYSIS (cont.) PORTFOLIO ANALYSIS (cont.)
– types of equity securities (cont.) – types of equity securities (cont.)

• SPECULATIVE • SPECIAL SITUATIONS
– companies that fly high during business – company going through a takeover,
cycle upturns restructuring, bankruptcy, or management
– i.e. toy companies and airplane change that will greatly change nature of
manufacturers go through "feast" and its operations and hence its earnings
"famine" periods that mirror business
potential
cycle
A customer buys pharmaceutical and Historically, which of the following

utility stocks in his portfolio. This investments has provided the highest return
portfolio would be best characterized over time?
as:
A. Treasury Bills
A. balanced B. Treasury Bonds
B. defensive
C. Listed common stocks
C. aggressive
D. cyclical D. Listed corporate bonds
Growth companies typically have: Mature companies typically have:

I Low dividend payout ratios I Low dividend payout ratios
II High dividend payout ratios II High dividend payout ratios
III Low Price / Earnings ratios III Low Price / Earnings ratios
IV High Price / Earnings ratios IV High Price / Earnings ratios
A. I and III A. I and III

B. I and IV B. I and IV

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Investment Analysis
Which of the following is NOT considered to All of the following are defensive stocks
be a cyclical stock? EXCEPT:
A. Home appliance manufacturer A. Beer Manufacturer

B. Automobile manufacturer B. Supermarket Chain
C. Natural gas producer C. Home Builder
D. Home builder D. Public Utility
Rank the following investments from highest to lowest, for

overall historical returns experienced by investors over long
periods of time:
Financial Status
I Treasury Bills
• Current Assets
II AAA Rated Corporate Bonds – checking / saving account
III Common Stocks • Fixed Asset

– house
• Current Liabilities
A. I, II, III – credit card balance
• Fixed Liability
B. III, II, I
– mortgage
C. II, III, I • Assets = Liabilities + Net Worth
D. III, I, II • Working Capital = CA - CL
INCOME INCOME (cont.)

1) Earned
2) PORTFOLIO (INVESTMENT) INCOME
2) Portfolio – capital gains, dividends, & interest income
3) Passive – maximum tax rate for:
• cash dividends is 20% (as long as stock is bought and held
more than 60 days during the 120-day window of time which
begins 60 days prior to ex-dividend date)
1) EARNED INCOME • bond mutual fund dividends is 39.6%
– salaries and wages; alimony • REIT dividends is 39.6%
• cash dividends received by owner of margin securities that
have been lent to a short seller is 39.6%

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Investment Analysis
INCOME (cont.)
Royalties received from an oil
3) PASSIVE INCOME and gas program are:
– investments in real estate or limited partnerships
A. partnership income
• net income from each 3 categories is added and
taxed at taxpayer's bracket B. passive income
C. earned income
D. portfolio income
All of the following would be A writer writes a book and receives

royalties from the publisher. These
defined as "earned income" under
royalties are:
IRS regulations EXCEPT:
A. earned income
A. Long term capital gains
B. portfolio income
B. Alimony payments
C. Royalty payments C. passive income
D. Bonus payments D. active income
CAPITAL LOSS A customer has $20,000 in passive losses

DEDUCTION from a limited partnership investment. If the
customer has no other passive income for
• one can only offset any losses generated that tax year, the customer may deduct:
from a category from the income generated
from that category EXCEPT:
A. 0
– $3,000 of Net Capital losses can be deducted
per year from one’s earned income B. $3,000
C. $17,000
D. $20,000

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Investment Analysis
A customer has $20,000 in passive losses

from a limited partnership investment. If the
customer has $20,000 of passive income for A customer buys $23,000 of ABC stock in March
that tax year, the customer may deduct: of 2014. On January 31, 2015, the stock is
valued at $10,000. The customer will be able to
deduct how much on this year's tax return?
A. 0
A. 0
B. $3,000 B. $3,000
C. $6,500
C. $10,000 D. $13,000
D. $20,000
A customer has $3,000 of capital losses and

A customer buys $23,000 of ABC stock in March
$7,000 of capital gains in a tax year. On that
of 2014. On January 31, 2015, the stock is
year's tax return, the investor has:
valued at $19,000 and the customer sells the
position. The customer will be able to deduct how
A. no loss to put on his tax return
much on this year's tax return?
B. a $3,000 capital loss deduction with no loss
carryforward
A. 0
C. a $3,000 capital loss deduction and a $4,000
B. $1,500
loss carryforward
C. $3,000
D. a $7,000 capital loss deduction with no loss
D. $4,000
carryforward
A customer has $7,000 of capital losses and CAPITAL GAINS TAXATION

$3,000 of capital gains in a tax year. On that
year's tax return, the investor has:
• capital gains tax rates depend on the
A. no gain or loss to put on his tax return holding period:
B. a $3,000 capital loss deduction with no loss
carryforward
Holding Tax Rate
C. a $3,000 capital loss deduction and a $1,000
loss carryforward 12 months or under individual's tax bracket
D. a $7,000 capital loss deduction with no loss (maximum of 39.6%)
carryforward 12 months + 1 day or over 20%

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Investment Analysis
A capital gain is considered to be long term

if an investment is held over:
A. 6 months
B. 12 months
C. 18 months
D. 24 months
Series #6 Investment Analysis 121

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Investment Companies
INVESTMENT COMPANY
• a portfolio or trust through which investors

INVESTMENT COMPANIES / pool their money in order to obtain the
BUYING AND SELLING following attributes:
– 1) diversification – reducing risk to the investor
MUTUAL FUND SHARES – 2) professional selection of investments
– 3) ongoing management
Series #6 Investment Companies 1 Series #6 Investment Companies 2
INVESTMENT COMPANY ACT OF

1940 DEFINES 3 TYPES OF
COMPANIES
1) Unit Investment Trust
a) Fixed UIT
b) Participating UIT (Plan Company)
2) Face Amount Certificate Company
3) Management Company
a) Open end (a.k.a mutual fund)
b) Closed end
2) FACE AMOUNT
1) UNIT INVESTMENT TRUST
CERTIFICATE COMPANY
• organized under a "trust indenture" rather • virtually obsolete; investors pay fixed monthly
than being set up by a corporation amount to investment company which invests
• a unit trust that holds only mutual fund funds in highest quality obligations (i.e. U.S. Gov't
shares is a Plan Company Debt & AAA municipal and corporate debt)
• corporation can issue shares while trusts • certificate promises investor a guaranteed rate of
issue "shares of beneficial interest" which return
represent the interest in the specified • total payments made by investor are less than face
securities held by the trustees amount received at maturity

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3) MANAGEMENT COMPANY 3) MANAGEMENT COMPANY (cont.)
• investment company organized as a a) open end management company

corporation, issuing shares of stock – a.k.a. mutual fund; most popular investment
• investment adviser company structure
– is used to decide what securities to place in – company issues only common shares the
portfolio number of shares issued is "open ended"
– this "manager" is free to buy and sell securities – as investors place new money in fund, they're
consistent with fund's investment objective issued additional shares
– shares are non-negotiable, BUT redeemable
3) MANAGEMENT COMPANY (cont.) 3) MANAGEMENT COMPANY (cont.)
a) open end management company (cont.) b) closed end management company

– Requirements: – fund has one time issuance of stock
• Net worth = $100,000 • capitalization is fixed
• 100 shareholders • may issue senior securities
• clearly defined investment objective – negotiable "publicly traded" funds
• issues only 1 class of securities = common stock • shares are listed on exchanges and trade like regular
• borrowing is limited to 1/3 of net asset value stocks and can be traded at prevailing market prices
• (NOT redeemable)
A customer buys 100 shares of an investment

company and pays a commission. This Which of the following is not defined as
customer purchased a(n) an "investment company" under the
Investment Company Act of 1940?
A. Open End Management Company A. Face Amount Certificate Company

B. Closed End Management Company B. Real Estate Investment Trust
C. Management Company
C. Face Amount Certificate Company D. Unit Investment Trust
D. Unit Investment Trust

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Which of the following are defined as investment

companies under the Investment Company Act of 1940? Open End VS Closed End
I Unit Investment Trust
II Face Amount Certificate Company
Open Closed
• continuous issuance of • one time stock
III Mineral Lease Holding Company new shares & redemption issuance – and then
IV Management Company of old ones
the books are closed
• pay a sales charge – max.
= 8 ½% on the dollar • pay a commission or
A. I and II amount invested mark-up
B. II and IV • NAV is calculated based • market price is
on the closing values of determined by market
C. I, II, III the securities in the supply & demand
D. I, II, IV portfolio
Open End VS Closed End (cont.) A customer places an order to buy a mutual fund
with:
Open End Prices Closed End Prices
1. NAV Price
NAV = $9.15 and POP = $10.
1. NAV POP
$9.15 $10
$9.15 $10 How much will the customer pay for 1 share?
2. NAV Price
2. NAV POP $9.15 $9.15
$9.15 $9.15 3. NAV Price A. $9.15
$9.15 $9.00
• buying the fund at the B. $9.15 + commission
• buying and selling at the
POP (which may include
"Price" C. $10
a sales charge) and
• the NAV is how much the
redeeming at NAV securities in the fund are D. $10 + commission
valued at NOW
A customer places an order to sell a mutual fund A customer places an order to buy a closed end
with: fund with:
NAV = $9.15 and POP = $10. NAV = $9.15 and Price = $10.
How much will the customer receive for 1 share? How much will the customer pay for 1 share?
A. $9.15 A. $9.15
B. $9.15 - commission B. $9.15 + commission
C. $10 C. $10
D. $10 - commission D. $10 + commission

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A customer places an order to sell a closed end

fund with: The major difference between an
open and closed end fund is:
NAV = $9.15 and Price = $10.
How much will the customer receive for 1 share?
A. capitalization
A. $9.15
B. management
B. $9.15 - commission
C. $10
C. portfolio of securities
D. $10 - commission D. diversification
Which of the following statements correctly distinguishes

between most open-end and most closed-end investment
companies?
Which of the following investment
A. An open-end company makes a one time offering of a company terms are synonymous?
specific number of shares; a closed-end company does not
B. A closed-end company offers redeemable shares; an A. Bid; Net Asset Value
open-end company does not
B. Bid; Public Offering Price
C. A closed-end company’s shares are publicly traded; an C. Ask; Net Asset Value
open-end company’s shares are not
D. Ask; Redemption Price
D. Shares of an open-end company may sell at a discount
from net asset value; shares of a closed-end company do
not
An order placed to buy or redeem mutual

fund shares is filled:
A. at yesterday's opening Net Asset Value Open-End Investment

B. at yesterday's closing Net Asset Value
Company
C. at that day's opening Net Asset Value
D. at that day's closing Net Asset Value

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CHARACTERISTICS OF CHARACTERISTICS OF
MANAGEMENT COMPANIES MANAGEMENT COMPANIES (cont.)
– i.e. fund targeted to investors who want
absolute safety
• U.S. Gov't & Agency securities
• formed when someone conceives an idea
– i.e. fund targeted to corporate treasurers with
for an investment company objective excess funds
needed by investors • high dividend rate preferred shares to take
advantage of corporate dividend exclusion
– i.e. fund targeted to speculators willing to buy
bankrupt companies in hopes of achieving large
capital gains if some companies emerge from
bankruptcy
Continuous Offering of Shares Diversified Investment Company
• mutual funds offer only 1 class of • FUND CAN BE SET UP AS A:

redeemable stock – DIVERSIFIED FUND
• 75 - 5 - 10 RULE
• each share is entitled to 1 vote • 75% or more assets invested in securities
– many funds have fractional shares (to 3 decimal • maximum of 5% of its assets invested in any one issuer
• maximum holding of 10% of voting securities in any one
points) issuer
– fractional shares are allowed a vote, too – NONDIVERSIFIED FUND
• i.e. if you had 34.52 shares, you would have 34.52 • one that doesn't meet the "diversified" definition
votes
Under the Investment Company Act of 1940, to Under the Investment Company Act of 1940, to
be “diversified”, an investment company can be “diversified”, an investment company can
hold no more than which percentage of issuer’s hold no more than which percentage of its
voting stock? assets in one issuer’s voting stock?
A. 5% A. 5%
B. 10% B. 10%
C. 15% C. 15%
D. 25% D. 25%

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Which of the following statements concerning requirements under the

Investment Company Act of 1940 for a diversified investment company STRUCTURE OF MANAGEMENT
are correct?
COMPANIES
I The company must invest at least 75% of its assets in securities of
other companies or cash • Board of Directors
II The company may invest no more than 5% of its total assets in – sets the investment policy and supervises the
one company
operations of the fund
III The company may invest no more than 10% of its assets in non-
voting stock – must have a:
• a minimum term of 1 year; and
A. I and II
• a maximum term of 5 years
B. I and III
C. II and III
D. I, II, III
STRUCTURE OF MANAGEMENT
COMPANIES (cont.) The Board of Directors of an open-
end management company that has
• Board of Directors (cont.) been segregated into classes, must
– 40% of the board cannot be interested persons
• interested persons include:
have minimum terms of:
– legal counsel, broker-dealer, investment adviser, underwriter
• affiliated persons include:
– officers, directors, employees, owners of 5% of the voting stock, A. 1 year
and controlling persons
B. 2 years
– a majority of the board must also be independent of the
fund's regular broker and principal underwriter C. 3 years
• there is an exception to No-Load funds – all except for 1
member of the board may be interested persons
D. 5 years
The Board of Directors of an open- COMPANIES (cont.)
end management company that has
been segregated into classes, must • Investment Adviser
– in the prospectus, it details which adviser is to
have maximum terms of: manage the fund within its objective
– earns a management fee based on a percentage
A. 1 year of all assets under management (which is
usually about ½% of the fund's average daily
B. 2 years NAV)
C. 3 years – adviser's contract is initially set for 2 years and
D. 5 years subject to shareholder vote every year after

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STRUCTURE OF MANAGEMENT STRUCTURE OF MANAGEMENT

COMPANIES (cont.) COMPANIES (cont.)
• Underwriters / Fund Sponsors / Distributors • Selling Group
– must register funds with SEC before security can be
sold – underwriter can hire a number of firms to form
– the prospectus would detail the fees involved, track a selling group
record of sponsor, etc... whether open or closed end – selling group member acts as agent, selling
– P.O.P. = Net Asset Value per share + Maximum Sales fund for sponsor
Charge
– sell the fund to securities dealers – OPEN-END FUND
– receives a concession which is part of the overall sales • continuously issued
charge • purchaser must receive latest Prospectus
– contract is reviewed/approved like the adviser's
The custodian bank performs all of the
COMPANIES (cont.) following functions EXCEPT:
• Custodian
– safeguards funds assets A. sending dividends and capital gains
– can act as transfer agent and paying agent distributions to shareholders
• making dividend distributions, sending out B. selecting the investment manager
proxies,… C. preparing and mailing proxies to
– receives custodial fee shareholders
D. holding the portfolio of investments in
safekeeping
The primary function of the investment

adviser is to:
The underwriter of a mutual fund is known as the:
A. Sponsor A. manage the fund

B. Manager B. set the investment objective for the fund
C. Custodian C. safekeep the assets of the fund
D. Selling Group
D. prepare the financial statements of the
fund

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STRUCTURE OF
MANAGEMENT COMPANIES Rights of Shareholders
(cont.)
• to vote:
– for the Board of Directors
– for changes in the investment objective or
policy
– annually on investment adviser
– on buying or selling real estate
– on becoming a 12b-1 mutual fund
• marketing expenses can be paid using fund
assets
• to receive annual and semiannual reports
Convenience of the Mutual Fund Mutual funds that have an automatic

Investment reinvestment provision will typically reinvest:
• professional management
• safekeeping of fund shares A. only dividends at Net Asset Value
• simplified purchases of shares
• diversification is preserved when selling shares B. only capital gains at Net Asset Value
• collateral for loans (after 30 days)
• automatic reinvestment of dividends and capital gains C. dividends at Net Asset Value and capital
• exchange privileges (a taxable event) gains at the Public Offering Price
• record keeping by the fund
• tax information D. dividends at Net Asset Value and capital
• portfolio diversification gains at the Net Asset Value
Special Services re: All of the following statements are true concerning
special services offered by money market mutual
Money Market Funds funds EXCEPT:
• Check Writing
– money market funds are managed to maintain an NAV A. many money market mutual funds permit investors
= $1.00 per share to draw on their accounts directly by writing checks
– investors may draw on their accounts directly
B. money market mutual funds compound interest on
• interest is usually compounded on a daily basis
a daily basis and pay dividends monthly
and pay dividends monthly
• wire transfers of funds from bank accounts and C. money market mutual funds allow telephone
exchanging of shares within a group of funds is transfers of money from bank accounts to the funds
allowed D. money market funds issues shares with a sales
• money market funds are no load funds charge

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Which of the following statements is true

regarding money market funds?
An customer invests $1,000 in a money
market fund. If the fund's assets appreciate
by 10%, the customer will have:
A. The Net Asset Value per share is constant at
$1
B. The Net Asset Value per share is constant at A. 100 shares @ $11.00 each
$10
C. Net Asset Value per share varies with the
B. 110 shares @ $10.00 each
performance of the portfolio C. 1000 shares @ $1.10 each
D. Net Asset Value per share cannot be
D. 1100 shares @ $1.00 each
determined in a money market fund
TYPES OF FUNDS TYPES OF FUNDS (cont.)

• GROWTH FUND
– invests primarily in equity securities of rapidly growing • GROWTH & INCOME FUND
companies to get capital gains – invests in equities and fixed income
• PERFORMANCE FUND
– aggressive growth funds seeking maximum capital
• BALANCED FUND
appreciation while taking on greater risks – provides income and capital gains
• CONSERVATIVE GROWTH FUND potential
– invests in more established and better known
companies
TYPES OF FUNDS (cont.) TYPES OF FUNDS (cont.)

• SPECIALIZED / SPECIALTY FUND
• INCOME FUND – invests in a particular industry or geographic
– invests in fixed income security such as area
preferred stocks & bonds • AKA sector fund like energy funds or gold funds
– U.S. Gov't Securities Fund • SPECIAL SITUATIONS FUND
– Municipal Bond Fund – invests in companies in bankruptcy or
"takeover" candidates
– Preferred Stock Fund
– larger capital gains if company emerges from
– Corporate Bond Fund bankruptcy or "takeover"
– Money Market Securities Fund

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TYPES OF FUNDS (cont.) TYPES OF FUNDS (cont.)
• TAX-EXEMPT FUNDS • VALUE FUND

– invests in municipal bonds – invests in equities that have a below average
price to earnings ratio, price to book ratio,
• ASSET ALLOCATION FUNDS etc…or through some other fundamental
– invests in a variety of assets such as analysis, the fund appears to be selling for less
international securities, real estate, gold, and than for what it is really worth
other precious metals • BLEND FUND
– a % of the funds are allocated to each type of – a fund with assets composed of many asset
investment classes, including money market securities
TYPES OF FUNDS (cont.) A mutual fund sponsor has three different

income funds, holding AAA rated debt securities
• PRINCIPAL PROTECTED FUND with similar maturities. Assuming that the
expense ratios for the funds are identical, which
– a fund that guarantees investors will not lose
money if they hold the investment for a fund would have the highest yield from
minimum number of years; or investment income:
– a fund that promises returns tied to a specific
market index (like the S&P 500) – and, if the A. Government Bond Fund
market goes down, they guarantee the investor B. Corporate Bond Fund
to at least get the principal back after so many C. Municipal Bond Fund
years, pays a modest amount of interest D. Cannot be determined
A mutual fund sponsor has three different income

A mutual fund which invests in common
funds, holding AAA rated debt securities with
similar maturities. Assuming that the expense stocks, preferred stocks, and bonds of
ratios for the funds are identical, which fund companies in various industries is known
would have the lowest yield from investment as a:
income:
A. balanced fund
A. Government Bond Fund B. dual purpose fund
B. Corporate Bond Fund
C. hedge fund
C. Municipal Bond Fund
D. Cannot be determined D. sector fund

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A mutual fund which invests in securities An investor is looking to invest in an

found in one industry or geographic area is income fund. All of the following are
known as a: suitable recommendations EXCEPT:
A. special situations fund A. Municipal bond fund

B. dual purpose fund B. Preferred stock fund
C. hedge fund C. Money market securities fund
D. sector fund D. Hedge fund
A retired investor seeks monthly income along

with preservation of capital and minimum risk. A growth fund would likely invest in which of
Which of the following funds would be a the following securities?
suitable recommendation?
A. Non-convertible corporate bonds
A. Capital shares in a dual purpose fund
B. Government bonds
B. Specialty fund
C. Convertible bonds
C. U.S. Government securities fund
D. Preferred stocks
D. Growth fund
An investor wishes to buy mutual fund shares

with the primary objective of aggressive A money market fund would invest in all of
growth. Based on this information, the the following EXCEPT:
appropriate recommendation is a:
A. Commercial Paper
A. balanced fund
B. Treasury Bills
B. money market fund
C. American Depositary Receipts
C. sector fund
D. Banker's Acceptances
D. preferred stock fund

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A retired investor seeks safety of principal

An investor in a "Ginnie Mae" mutual fund and current income. All of the following
assumes all of the risks EXCEPT: funds would be suitable recommendations
EXCEPT:
A. Fluctuation of Net Asset Value
B. Reinvestment Risk A. Government Bond Fund
C. Credit Risk B. Special Situations Fund
D. Prepayment Risk C. Money Market Fund

D. Insured Corporate Bond Fund
PUBLIC OFFERING PRICE

• investors buy funds from a dealer at the
public offering price which could include a
BUYING AND SELLING concession for the dealer and a smaller
concession for the underwriter
MUTUAL FUND SHARES – sales charge = load
• difference between what the investor pays for the
security versus the actual amount credited to the
investor's account
• each fund sets a minimum purchase amount
The front-end load on a mutual fund is best

12-b-1 Funds
described as:
• impose fees for the cost of soliciting new customers
• the letter "p" is used to designate those funds charging marketing and
distribution fee
A. the expense ratio • Investment co. can finance activities such as advertising, mailing
prospectuses,…
B. the cost of investing in a fund – which are all used to increase Net Assets
– adoption of the plan requires a majority vote of:
C. the taxation of dividend distributions from • outstanding shares, fund's B.O.D., and directors who are non-
interested
investing in the fund – terminating the plan requires a majority vote of:
• the non-interested members or outstanding shares
D. the taxation of capital gains from investing • the B.O.D. must review the amounts expended under the plan and the
purposes for which the expenditures were made at least quarterly
in the fund

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All of the following statements are true regarding mutual

funds that have adopted 12b-1 plans EXCEPT: For an open-end investment company to adopt a 12b-1
distribution plan, majority vote is required from which of the
following?
A. Plan adoption requires majority vote of the outstanding
shares; the Board of Directors; and its disinterested
members I Outstanding shares
B. Discontinuance of the plan requires majority vote of the II Board of Directors

outstanding shares or the disinterested members of the III Non-interested members of the Board of Directors
Board
C. Mailings to existing shareholders of the fund are an A. I only
acceptable 12b-1 charge B. I and II
D. Expense ratios for funds that have adopted 12-b-1 C. II and III
plans can be expected to be higher than for similar funds
without 12b-1 fees D. I, II, III
Which of the following statements is true regarding From which of the following sources may
12b-1 fees for advertising and marketing of mutual a mutual fund deduct 12b-1 fees?
fund shares?
A. The Board of Directors approves the plan and

reviews the expenditures quarterly
A. Public offering price when shares are
initially sold
B. The Board of Directors approves the plan and
reviews the expenditures semi-annually B. Difference between net asset value
C. The Board of Directors approves the plan annually and public offering price
and reviews the expenditures semi-annually
C. Value of the fund’s total net assets
D. The Board of Directors approves the plan annually
and reviews the expenditures quarterly D. Gross investment income of the fund
If a mutual fund wishes to adopt or reapprove a "12-b-1" If a mutual fund wishes to terminate a "12-b-1" plan, which
plan, which of the following are required? of the following are required?
I Majority vote of the outstanding shares of the fund I Majority vote of the outstanding shares of the fund
II Majority vote of directors of the fund II Majority vote of directors of the fund
III Majority vote of the "uninterested" directors of the fund III Majority vote of the "uninterested" directors of the fund
IV Majority vote of investment advisory board of the fund IV Majority vote of investment advisory board of the fund
A. I or III only A. I or III only

B. IV only B. IV only
C. I, II, III C. I, II, III
D. I, II, III, IV D. I, II, III, IV

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NET ASSET VALUE NET ASSET VALUE (cont.)
• price at which the fund will redeem shares • selling dividends is prohibited
– usually the redemption price is based on the – ex-dividend and ex-capital gains distribution
valuation of the underlying stocks as of 4 PM dates reduce the NAV by the amount of the
EST (the close of business of the NYSE) distribution
• NAV = Gross Asset Value – Liabilities
– NAV / # of outstanding Shares = NAV per
share
SALES CHARGES SALES CHARGES
• Sales Charges are a % of the POP (NOT • maximum sales charge = 8 ½%

NAV) • if the fund doesn’t offer:
– dividend reinvestment at NAV, rights of accumulation,
Sales Charge = A - B and breakpoints; OR
A • the fund has 12b-1 fees; THEN
POP = Needs A Vodka (on the table) = NAV – the maximum sales charge = 6 ¼%
100% - Served Chilled 100% - SC% – 12b-1 fees cannot exceed .75% of average annual net
assets
NAV = POP (100% - SC%) – service fees cannot exceed .25%
Under FINRA rules, the maximum sales Open End Prices

charge that may be imposed on a mutual
fund purchase is: • whenever they give the POP for mutual
funds, it is inclusive of a maximum sales
A. 5% of Net Asset Value charge -- if you purchase more of the fund,
you qualify for a reduced sales charge
B. 5% of the Public Offering Price
C. 8 1/2% of Net Asset Value
D. 8 1/2% of the Public Offering Price

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Open End Prices (cont.)

A mutual fund has a net asset value per
• The following is a breakpoint schedule
share of $10.45. The maximum offering
located in the mutual fund prospectus:
price per share is:
Purchase Sales NAV POP
Amount Charge % A. $10.60
0 - $10,000 8 ½% $9.15 ? B. $11.33
C. $11.42
$10,001 – $20,000 7 ¾% $9.15 ? D. $11.50
$20,001 – over 6 ½% $9.15 ?
A customer has $20,000 to invest in a mutual fund with a A customer wants to buy $30,000 of a mutual fund that has a N.A.V. of
$9.15 and P.O.P. of $10. The fund has the following breakpoint
Net Asset Value per share of $9.42 and a Public Offering schedule:
Price of $10.30. In the prospectus is the following
breakpoint schedule: Purchase Amount Sales Charge
0 - $10,000 8 ½%
Purchase Amount Sales Charge
$0 - $10,000 8 1/2% $10,001 - $25,000 7 ¾%
$10,001 - $25,000 7 3/4% $25,001 - Over 6 ½%
$25,001 - over 6 1/2%
The customer will be able to buy:
How many shares of the fund can the customer purchase?
A. 3000 shares
A. 1942
B. 3033 shares
B. 1959
C. 2123 C. 3066 shares
D. 2159 D. 3099 shares
MUTUAL FUNDS
Fund Net Asset Value Offering Price The sales charge on a fund with
Kapital $9.01 $9.59 NAV of $15.75 and POP of $15.75
is:
The sales charge percentage on Kapital
Fund is:
A. 0%
A. 6.05% B. 5%
B. 7.75% C. 5 1/2%
C. 8.5% D. 8 1/2%
D. 9.39%

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A non-12-b-1 fee mutual fund has a Net Asset

Under the FINRA Rules of Fair Practice
Value per share of $9.20. The fund charges a
regarding mutual fund breakpoints, the maximum
1/2% redemption fee. What is the maximum
sales charge on single purchases of non 12-b-1
permitted Public Offering Price under FINRA
mutual funds up to $10,000 is:
Rules?
A. 8 1/2% of the public offering price A. $9.20

B. 8 1/2% of the net asset value B. $9.25
C. 9% of the public offering price C. $10.00
D. 9% of the net asset value D. $10.05
Contingent Deferred
A non-12-b-1 fee mutual fund has a Net Asset
Value per share of $9.15 per share. If the Sales Charge
customer purchases $5,000 of the fund, the • the letter "r" is used to designate those funds
maximum offering price per share is: charging redemption fees
• a fund charging no sales charge to purchase
A. $9.15 shares, BUT, if investor redeems shares within an
allotted time period, a redemption charge is
B. $9.50 imposed
C. $9.92
• NOTE: if the letter "t" is used, it designates a fund
D. $10.00 which charges a 12b-1 fee AND a redemption fee
An investor buys 100 shares of an open-end BUYING AND SELLING MUTUAL

investment company with a 5% contingent FUND SHARES
deferred sales charge. The sales charge is
reduced by 1% for every full year that the fund is • Dividend Reinvestment At Net Asset Value
held. The investor redeems the 100 shares at an – any fund sold by a FINRA member must offer dividend
reinvestment AT N.A.V.
NAV of $15 per share after holding them for 5
months. The investor will receive: • Requirements To Charge The Maximum Sales
Charge Of 8 ½%
A. $1,350 – Breakpoints
B. $1,425 – Letter of Intent
C. $1,475 – Rights of Accumulation
D. $1,500

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Breakpoints Which of the following customers is allowed a

breakpoint on mutual fund purchases?
• reduced sales charge for a large dollar purchase
• Breakpoints Are Not Allowed For Unrelated Investors
A. A corporate treasurer buying for investment
– breakpoints are allowed for:
• individuals
B. An investment club account buying for the club
• individual, spouse, and minor child
• corporation, provided that it is not formed to obtain the lower sales participants
charge
• trustee or fiduciary purchasing for a trust or pension plan C. A partnership account where the partnership is
• employee benefit plan formed to buy mutual funds
• tax-exempt organization
– investment clubs cannot obtain breakpoints D. An investment adviser omnibus account
• breakpoint sales are prohibited
Letter of Intent (LOI) All of the following statements are true

regarding a mutual fund "Letter of Intent"
• if signed, customer says he'll buy more of a fund EXCEPT:
to get the breakpoint price NOW
• if he doesn't complete the LOI, purchases are A. The letter can cover a period of 13 months
recalculated B. The letter can be backdated 90 days
• can be backdated 90 days C. The extra shares purchased under the
• good for 13 months, inclusive of 90 day backdate breakpoint are held in escrow until the letter
period is completed
• note that appreciation in mutual fund share price D. During the period covered by the letter,
does NOT count towards completing an LOI! the customer cannot redeem his shares
Which statements are true about a mutual fund letter of

intent?
Rights of Accumulation
I Maximum time is 12 months
II Maximum time is 13 months
• as investor builds a position in the mutual
fund, his accumulated position counts
III Can be backdated 30 days
towards the breakpoint for subsequent
IV Can Be backdated 90 days
purchases
A. I and III
B. I and IV
C. II and III
D. II and IV

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A customer has purchased $25,000 of a mutual fund. Over the

past 5 years, the fund has appreciated to $46,000. At this point,
Other Matters Concerning
the customer wants to buy another $15,000 of the fund. In the
prospectus, the breakpoint schedule is:
Sales Charges
• Combination Privilege
0 - $10,000 8 1/2% – an investor may qualify for reduced sales
>$10,000 - $20,000 7 1/2% charges by combining purchases in more than
>$20,000 - $45,000 6 1/2% one fund within a family of funds
>$45,000 - $65,000 5 1/2%
>$65,000 5% • Reinstatement Privilege
– allows investors to replace money withdrawn
For the $15,000 purchase, the customer will pay a sales charge of: from the fund without any additional sales
A. 7 1/2%
B. 6 1/2%
charge (generally has to occur within 30 days
C. 5 1/2% of the withdrawal)
D. 5%
Dollar Cost Averaging Dollar Cost Averaging (cont.)

• Investor invests $50/month for 6 months
• the periodic purchase of a fixed dollar Price Per Share Shares Bought
amount over a period of time $50 $8 6.25
• as long as the market value is fluctuating, $50 $12 4.17
the average cost per share will be lower $50 $15 3.33
$50 $10 5
than the average price of the shares over the $50 $ 6 8.33
same period $50 $ 4 12.5
Avg. Price = 55 / 6 = $9.16 39.58
Avg. Cost per share = 300 / 39.58 = $7.58
A customer is dollar cost averaging by investing Determine the difference between the average cost and
$200 per month into a mutual fund. Over 4 the average price per share.
months, the customer has made purchases at Month Share Price Shares Bought
$13, $10, $8, and $9 per share respectively. By
1 $8 15
using this method, the customer has paid a
weighted average price per share that is how 2 $10 12
much lower than the straight average? 3 $6 20
4 $12 10
A. 0
A. $.58
B. $.25
B. $.65
C. $.32 C. $.82
D. $.50 D. $.90

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Regularly scheduled investments of the

same dollar amount in fund shares will most
likely result in a:
A. lower average price per share

COMPARING
B. higher average price per share MUTUAL FUNDS
C. lower average return on investment
D. higher average return on investment
BASIS OF COMPARISON
• compare funds:
– with:
SELLING
• similar objectives
• similar risk and investment policies
MUTUAL FUND
– over the same time period
– based on total return
SHARES
– and their expense ratio
REDEMPTION OF SHARES
According to the Investment Company Act of 1940,
• shares are sold back to the fund NOT traded! payment for shares of an open-end investment
• request for redemption must be in writing, though some company must be made within how many days of
funds also offer telephonic redemption a shareholder’s request for redemption?
• funds may charge a redemption fee but all fees combined
cannot be greater than 8 1/2 % A. 1 business day
• purchasing AND redeeming shares are "forward priced" B. 5 business days
– computation of the NAV as of the close of business C. 5 calendar days
• fund must make payment to the customer within 7 calendar D. 7 calendar days
days

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A customer redeems 1,000 shares of XYZ An investor purchases 1,000 mutual fund shares with a Net
Fund. The computed Net Asset Value per Asset Value of $10 each, where the fund imposes a 5%
contingent deferred sales charge if the shares are redeemed
share is $13 and the Public Offering Price is within the first year. The sales charge decreases by 1% for
$13. The fund has a 1/4% redemption fee. each year the investor remains invested in the fund. If the
The customer will receive? investor were to redeem his shares during the second year of
holding the fund, based upon the NAV of $10, he or she will
receive:
A. $12,967
A. $10,000
B. $12,979
B. $9,600
C. $13,000 C. $9,500
D. $13,003 D. $9,400
Systematic Withdrawal Plans An individual wishes to receive a fixed

amount monthly from her investment
• investor specifies periodic withdrawal: company. She should elect which type of
– Fixed Dollar withdrawal plan?
• receives specified dollar amount for an allotted period and fund
redeems enough shares to meet requirement
– Fixed Shares A. fixed shares
• specified number of shares to be redeemed periodically
– Fixed Percentage B. fixed period
• specified percentage of total net assets to be redeemed
– Fixed Period C. fixed percentage
• specified liquidation of account over period of time (for
college education) D. fixed dollar
An individual wishes to have a complete

An individual wishes to have a fixed number
liquidation of the account done over a 5 year
of shares liquidated each month. He should
time frame. He should elect which type of
elect which type of withdrawal plan?
withdrawal plan?
A. fixed shares
A. fixed shares
B. fixed period
B. fixed period
C. fixed percentage
C. fixed percentage
D. fixed dollar
D. fixed dollar

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An individual wishes to have a fixed portion of FUND EX-DATES

the portfolio liquidated each month. He should
elect which type of withdrawal plan? • closed-end fund ex-date set by exchange
• open-end fund ex-date set by fund’s BOD
A. fixed shares
B. fixed period
C. fixed percentage
D. fixed dollar
Which of the following statements are true regarding the

ex-date for a mutual fund? The ex-dividend date on open-end investment
company shares is:
I it is set by the Board of Directors of the Fund
II it is set by FINRA
III it is the date on which the fund's NAV per share is A. Two business days after the record date
reduced for any distributions
IV it is 2 business days prior to the record date and B. Four business days before the payment date
will reduce the fund's NAV per share by the amount of
the distribution C. The date designated by the issuer or the
principal underwriter
A. I and III
B. I and IV D. The day after the company receives payment
C. II and III of dividends from portfolio securities
D. II and IV
CLOSED-END FUND Which of the following NAV and POP prices could
be listings for mutual funds?
• one time stock issuance and stock then trades on I NAV = $10; POP = $9
an exchange II NAV = $10; POP = $10
• can trade at a premium or discount to Net Asset III NAV = $10; POP = $10.25
Value IV NAV = $10; POP = $10.50
– NOT redeemable
• customer receives execution price less a A. I only
commission upon liquidation B. I, II
C. II, III, IV
• customer buys and sells at the "ask"
D. I, II, III, IV
– the NAV is what the fund is worth if it liquidates

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Franciscan Fund has a net asset value of $12.35

and a public offering price of $13.50. Which of Which of the following statements are true
the following statements are true? regarding closed end investment companies?
I The fund can be open-end
II The fund can be closed-end I There is a one-time stock issuance
III If this is an open-end fund, the sales charge II Shares are continually issued
is 8 1/2% III Shares trade on an exchange or OTC
IV If this is an initial public offering of a closed- IV Shares are redeemed with the issuer
end fund, the spread is $1.15
A. I and III
A. I and III B. I and IV
B. II and IV C. II and III
C. I and II D. II and IV
D. I, II, III, IV
Which statements are true regarding closed-end

investment companies? CLOSED END BOND FUNDS
Fund Net Asset Value Stock Close NAV Change
I The initial offering of shares is made under a Acme $9.90 10 1/4 +.10
prospectus
II Shares are redeemable with the issuer at NAV A customer who places an order to buy 100
III Shares trade in the secondary market at shares of Acme Fund will pay approximately:
prevailing market prices
IV The portfolio of investments is not managed
A. $990
A. I and II B. $1,025
B. I and III C. $990 plus commission
C. III and IV D. $1,025 plus commission
D. I, III, IV
Fund Net Asset Value Stock Close NAV Change Joe places an order to buy shares of a closed-
Acco $8.32 8.13 -.08 end fund in a regular way trade. Under FINRA
rules, the securities will be delivered and Terry
A customer who places an order to sell 100 shares must make payment:
of Acco Fund will receive:
A. prior to the processing of the trade
A. $805 less a commission B. by the end of the business day on which the
B. $813 less a commission trade was executed
C. $821 less a commission C. on the 3rd business day following trade date
D. $832 less a commission
D. on the 5th business day following trade date

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Exchange Traded Funds (ETFs) Exchange Traded Funds (ETFs) (cont.)
• ETFs are investment companies legally • the investors, who are institutions, buy
classified as open-end companies or Unit Creation Units with a basket of securities
Investment Trusts but are different from that generally mirrors the ETF’s portfolio
traditional open-end companies and UITs in • after purchasing a Creation Unit, the
the following respects: institution splits it up and sells the
– ETFs don’t sell individual shares directly to individual shares in the secondary market,
investors, but rather only issue their shares in allowing other investors to purchase
large blocks (blocks of 50,000 shares, for
individual shares (instead of Creation Units)
example) that are known as "Creation Units"
Exchange Traded Funds (ETFs) (cont.) Exchange Traded Funds (ETFs) (cont.)
• investors who want to sell their ETF shares have • because of the limited redeemability of ETFs, they are not
two options: considered to be—and may not call themselves—mutual
funds
– (1) they can trade individual shares to other investors
• thus, ETFs are shares of ownership in portfolios of
on the secondary market; or common stock that track the performance of a specific
– (2) they can redeem the Creation Units back to the ETF. index
• ETFs generally redeem Creation Units by giving investors the – i.e. the S&P 500 Index Fund, traded on the AMEX, called
"SPIDER" (SPDR), which stands for "Standard and Poor's
securities that comprise the portfolio instead of cash Depository Receipt"
– i.e. an ETF invested in the stocks contained in the Dow Jones • though ETFs trade like stock, the purchaser is required to
Industrial Average (DJIA) would give a redeeming shareholder receive a prospectus or a product document summarizing
the actual securities that constitute the DJIA instead of cash
key information about the ETF and the details of where a
prospectus may be obtained
Exchange Traded Funds (ETFs) (cont.) Exchange Traded Funds (ETFs) (cont.)
• Advantages of an ETF VERSUS an Index • Most Actively Traded ETFs
Mutual Fund – SPDRs
– ETFs trade continuously throughout the day with the • Standard and Poor's 500 Depository Receipts
market price based on the instantaneous value of all the • a.k.a. Spiders
securities included within the underlying index – DIAs
– ETFs are purchased or sold any time during the day • Dow Jones Industrial Average – 30 Industrial Stocks
(incurring a commission) • a.k.a. Diamonds
– ETFs can be purchased on margin and sold short – QQQs
– ETFs have generally lower expense ratios • NASDAQ 100 Index
• a.k.a. Q's
• dividends and capital gains are distributed to
– the principal trading market for ETFs is the American
shareholders to BOTH ETFs and mutual funds Stock Exchange

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All of the following are Exchange SPDRs are based on the:

Traded Funds EXCEPT:
A. Standard and Poor's 100 Index

A. DIAMOND
B. Standard and Poor's 500 Index
B. SPDRs
C. Standard and Poor's 1000 Index
C. QQQs
D. Standard and Poor's 5000 Index
D. ADS
"DIAMONDS" trade on the: Exchange Traded Funds are NOT:
A. New York Stock Exchange A. marginable

B. American Stock Exchange B. negotiable
C. Chicago Mercantile Exchange C. redeemable
D. NASDAQ Stock Market D. diversifiable
Which statements are true?

Which statement is FALSE about Exchange Traded
I Mutual fund shares can be bought on 50% margin Funds (ETFs)?
II Mutual fund shares must be paid in full when
purchased, but become marginable after being held for A. ETFs are registered under the Investment
30 days
Company Act of 1940
III ETF shares can be bought on 50% margin
B. ETFs are typically structured as open-end
IV ETF shares must be paid in full when purchased,
but become marginable after being held for 30 days management companies
C. ETFs hold the underlying shares of companies
A. I and III included in a stock index
B. I and IV D. ETFs permit individual investors to buy creation
C. II and III units
D. II and IV

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Fund Income & Taxation
SOURCES OF PROFIT OR LOSS

• profits can arise from 3 sources:
– 1) distributions of dividends
FUND INCOME AND – 2) capital gains distributions
– 3) appreciation in the value of the mutual fund
TAXATION shares
Series #6 Fund Income & Taxation 1 Series #6 Fund Income & Taxation 2
NET DIVIDEND INCOME PER

SHARE
• GROSS INVESTMENT INCOME All of the following are included in a fund’s gross
– distributions received on the securities held investment income EXCEPT:
– dividends from stocks; interest from bonds
– distributions of short term capital gains on
securities held for 1 year or less A. interest received from bonds
B. dividends received from common stock
C. dividends received from preferred stock
• NOT INCLUDED AS GROSS INVESTMENT D. capital gains realized from sales of portfolio
INCOME securities
– capital gains (held for more than 1 year) and
unrealized appreciation in the value of securities
• INCOME STATEMENTS COMPUTE NET INVESTMENT INCOME

– EXAMPLE: Assume that a fund has collected $200,000,000 Of
Total Net Assets. Also, assume that the fund's income statement
shows the following: Gross Investment Income: = $20,000,000
• NET INVESTMENT INCOME Expenses: Management fee

Distribution fee
=
=
$ 1,000,000
$ 550,000
– deducting operating expenses from gross Custodial fee
Printing fee
=
=
$ 200,000
$ 50,000
investment income Legal & audit fee = $ 100,000
Administrative fee = $ 100,000
Net investment income = $18,000,000
Question 1: What Is The Fund's Question 4: What is The Fund’s

– Operating Expenses Gross Return On Assets? Expense Ratio?
• management fees, custodial fees, transfer agent
fees, printing and mailing costs, legal and audit Question 2: What Is The Fund's
fees, overhead, and 12b-1 fees (if applicable) Net Return On Assets?
• management fees are usually the largest portion of
these expenses Question 3: What Is The Expense
Portion Of The Fund's Return On
Assets?

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Snow White Fund received dividends totaling

$350,000 from its portfolio securities, and it received
ACCO, an open–end investment company interest payments totaling $200,000. Operating costs
which has not made a 12b–1 election, would were $20,000, and transfer fees and other fees were
include all of the following as operating $10,000. There are 1 million shares of Snow White
expenses EXCEPT: Fund outstanding. Snow White Fund's Net Investment
Income (NII) per share is:
A. audit fees
B. custodial fees A. $.18
C. marketing fees B. $.33
D. management fees C. $.52
D. $.55
DIVIDENDS
A mutual fund has received dividend and interest
• paid from net investment income income from its portfolio of investment securities.
• the amount of the dividend paid, as well as How often during the year can it make
distributions of these as dividends to its
the frequency, may vary shareholders?
• dividend yield does NOT include capital
gains A. One time
B. Two times
C. Four times
DIVIDEND YIELD = Dividend Paid
D. As often as the fund sees fit
Current Net Asset Value
UNREALIZED APPRECIATION OR
During the past year, the Snow White Mutual DEPRECIATION OF INVESTMENTS
Fund paid a dividend of $1.00 per share and
capital gains of $1.50 per share. At the end of • UNREALIZED APPRECIATION in fund shares is a
the year, the net asset value per share for the component of an investor's total return
fund was $25, up from $23 the previous year. – i.e. if a fund holds stock that appreciates in value, the
What is the dividend yield for the Snow White net asset value will increase
• investors are not taxed on this gain until the fund sells the
Fund? shares
• UNREALIZED DEPRECIATION in fund shares
A. 4%
reduces the net asset value per share
B. 6%
– a "loss" is realized when the depreciated securities
C. 10% are sold by the fund
D. 11%

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REALIZED CAPITAL GAINS AND LOSSES
• to realize a capital gain, a mutual fund must sell the securities for a profit
• CAPITAL GAINS are DISTRIBUTED ANNUALLY
When a management company shows an increase
• under IRS rules, if a fund doesn’t distribute at least 98% of capital gains, it is in net asset value due to a rising market, this is
subject to a 4% excise tax on undistributed income called:
– if the fund realizes it has not distributed enough capital gains, the fund may make
a supplemental long-term capital gains distribution, to avoid this excise tax
• a fund may not decided to distribute all of its capital gains to retain A. asset appreciation
cash
– shareholders must still report their allocated portion of the gains for income tax
B. net investment income
via Form 2439 – Notice to Shareholder of Undistributed Long-Term Capital C. a capital gain distribution
Gains
• any losses can offset gains and the fund only distributes the net capital gain D. increased asset coverage
(if applicable)
A mutual fund can distribute which of the following

to shareholders?
When a management company shows a decrease
in net asset value due to a falling market, this is A. Gains on appreciated securities that have been
called: sold by the fund
B. Gains on appreciated securities that have not yet
A. asset depreciation been sold by the fund
B. net operating loss C. Losses on depreciated securities that have not
C. a capital loss distribution yet been sold by the fund
D. decreased asset coverage D. Losses on depreciated securities that have been
sold by the fund
TOTAL RETURN = Dividend Distributions +

Capital Gains + Appreciation in Fund Shares
INCOME TAX CONSEQUENCES
• the dividends and capital gains are taxable • IDENTIFYING INCOME TAX CONSEQUENCES OF
DISTRIBUTIONS
each year – Qualified Dividend distributions are taxed at a
• share appreciation is NOT taxable until maximum of 15%-20% (the 20% is for individual
earning $400K; or couples earning $450K) – these
shares are sold are the dividends received from a corporation that are
then passed through to the mutual fund investor
– Other Dividends that are taxed at the investor's tax
bracket (i.e. they are looked at as "ordinary income"
distributions) include dividends from:
• investments in money market mutual funds, bonds (i.e. the
fund distribution consisting of interest income), and short-
term capital gains

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The tax rate applied to cash dividends received The tax rate applied to interest received from
from stock investments is the same rate as: bond investments is the same rate as for:
A. ordinary income A. ordinary income

B. short term capital gains B. long term capital gains
C. long term capital gains C. gifts
D. passive income D. estates
LONG TERM CAPITAL GAINS

Which of the following statements describes a
capital gain?
• are taxed at a maximum rate of 15%-20%
(the 20% is for individual earning $400K;
A. A mutual fund makes a dividend distribution
or couples earning $450K)
to shareholders
• note unrealized gains (the appreciation of B. A mutual fund makes a distribution of a return
securities held in the mutual fund) are not of capital to shareholders
distributed and, thus, are not taxed C. A mutual fund share is sold for more than its
• Form 1099-DIV details the tax cost
consequence of any distributions for the D. A mutual fund share is sold for less than its
investor cost
Which of the following statements concerning the tax rates

for short-term and long-term capital gains is correct? REINVESTED DISTRIBUTIONS
I Short term capital gains are taxed at "capital gains" tax
rates
• if an investor opts to reinvest any
II Short term capital gains are taxed at "ordinary income" distribution into additional fund shares, the
tax rates investor must still pay tax in the year the
III Long term capital gains are taxed at "capital gains" tax
rates
distribution was received
IV Long term capital gains are taxed at "ordinary income"
tax rates
A. I and III
B. I and IV
C. II and III
D. II and IV

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TAX-EXEMPT INTEREST
Two years ago, an individual had invested INCOME
$5,000 in a mutual fund. Over the two years, the
fund has distributed $100, consisting of $75 of • the dividends received from a mutual fund
dividends and $25 of capital gains. The investor that invests in tax-free municipal bonds
has reinvested these distributions in additional are not taxable, however, when a tax-free
shares of the fund. The investor's aggregate municipal bond fund distributes capital
current cost basis is:
gains, these gains would be subject to
A. $5,025 capital gains tax
B. $5,075 – only the interest income is tax exempt
C. $5,100
D. $5,225
TAX CONSEQUENCES TO TAX CONSEQUENCES TO INVESTORS

INVESTORS OF REDEMPTIONS OF REDEMPTIONS (cont.)
• if investor liquidates his mutual fund position, • NETTING SHORT TERM GAINS AGAINST LOSSES
the "cost basis" is the original purchase price – short term gains are offset by short term losses;
PLUS all reinvested distributions; the net amount is either taxed as a gain (at
– cost basis includes reinvested distributions ordinary income tax rates); or can be reported as
because investor has already paid taxes in the a loss
year of the distribution!
• if sale proceeds exceeds the cost basis, there
is taxable capital gain – the capital gain • NETTING LONG TERM GAINS AGAINST LOSSES
would be considered long term (i.e. taxed at – long term gains are offset by long term losses;
the lower tax rate) if the mutual fund was held the net amount is either taxed as a gain (at the
lower long term gains tax rates); or can be
for more than 1 year reported as a loss
TAX CONSEQUENCES TO INVESTORS

OF REDEMPTIONS (cont.) Donations
• Donations To Charity
• TAX CONSEQUENCES OF CAPITAL LOSSES – gives deduction equal to current market value
– note that any net losses can be used to – cost basis becomes current market value
• i.e. if customer buys a mutual fund at $40 and then it's worth
reduce ordinary income taxes $60 and then mutual fund is donated to a charity, tax deduction
is $60
– up to $3,000 of Net Capital losses can be
deducted per year from one’s earned income
• Donations To Family (i.e. anyone other than a
– any amount of the $3,000 can be carried over charity)
to the next year – NO deduction
– recipient's cost basis is same as for donor
• i.e. customer owns a mutual fund originally at $40 and now it's
worth $60 and the mutual fund is donated to the daughter, her
cost basis becomes $40

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INHERITED SECURITIES A customer bought stock many years ago for

$10,000. It is now worth $100,000 and the
• cost basis is fair market value at date of stock is donated to a charity. The allowed
death (known as a "stepped-up basis" – deduction is:
note that the decedent's estate may be
subject to estate taxes on the value of any
securities) A. 0
B. $10,000
C. $90,000
D. $100,000
A father bought stock five years ago at $45. He

dies when the stock is worth $52. He wills the
An individual buys 100 shares of ABC stock at stock position to his daughter who decides to
$40. Years later, this person gifts the stock to her sell the stock upon receipt when the market
daughter when the stock is trading at $52. The price is at $58. What is the daughter’s basis for
daughter sells the stock when it is trading at $55. the stock position?
The daughter's cost basis in the stock is:
A. $0 A. $38
B. $40 B. $45
C. $52
D. $55 C. $52
D. $58
LIQUIDATION USING IDENTIFIED SWITCHING WITHIN THE SAME

SHARES FAMILY OF FUNDS
• if an investor holds a large position which • in most cases there is no sales charge if
has been accumulated over a period of customer switches mutual funds in same
time at varying prices, specific "family", however, the IRS considers this a
identification of shares being sold can be taxable event
made
– if specific identification is not used, the IRS
mandates FIFO (first in first out) accounting

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A mutual fund family offers a variety of funds and WASH SALE RULE
has an "exchange feature" at NAV. If an investor
opts to switch out of one fund into another in this
family, which of the following statements are true? • applies to the purchase of security sold at a
loss (as remember, up to $3,000 of net
I a sales charge will be paid upon switching capital losses can be used to offset one's
II no sales charge will be incurred earned income)
III a tax event will take place upon switching • the loss is disallowed if the security bought
IV no taxable event occurs because of the back within 30 days
exchange feature • also, the loss is disallowed if equivalent
security is purchased (i.e. call option,
A. I and III warrant, convertible bond, convertible
B. I and IV preferred stock, or rights are purchased)
C. II and III
D. II and IV • to avoid the rule, wait 31 days
ALTERNATIVE MINIMUM TAX – AMT

To avoid the application of the "wash
sale rule", the earliest day to • added to the tax code to ensure that high-
repurchase shares that were sold at a income taxpayers with many deductions
loss is: pay at least a minimum amount of tax
• thus, if a taxpayer itemizes deductions,
A. 15 days he/she must compute the regular tax bill
B. 30 days AND the AMT – the taxpayer pays
whichever one is higher!
C. 31 days
D. 1 year plus 1 day
INVESTMENT ADVISORY EXPENSES

If the alternative minimum tax computation is
less than the regular income tax computation,
• for expenses in connection with mutual fund
which statement is true?
share investments, they can be deducted
A. The alternative amount is due against their earned income IF the investor
B. The regular amount is due itemizes deductions and the total
C. The alternative amount is added to the regular miscellaneous deductions are in excess of
amount, with the combined amount due 2% of the adjusted gross income
D. The taxpayer selects the computation he • note that sales charges are NOT deductible,
wishes to use for that year, but must continue as these charges are part of the investor's
using that method in future years cost basis in the shares

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TREATMENT OF MUTUAL FUNDS UNDER REGULATED INVESTMENT

IRS CODE SUBCHAPTER M COMPANY
• corporations are affected by "double • a Regulated Investment Company
taxation" – i.e. the corporation computes computes net income at the corporate
net income and must pay tax on it; if the level, but this is not taxed – the before-tax
corporation makes a dividend distribution net income is distributed to shareholders,
to its shareholders, the shareholder must who include this on their tax returns
pay tax on it – thus, the dividends, "flow through" to the
shareholder without being taxed at the
corporate level – there is only one tax paid
(and it's paid by the shareholder NOT the
investment company)
REGULATED INVESTMENT
COMPANY (cont.)
If Franciscan Growth Mutual Fund makes net
• if 90% of an investment company's Net Investment Income (NII) is investment income of $100,000, to be
distributed to shareholders, the fund is "Regulated" under
Subchapter M regulated under Subchapter M of the Internal
– fund only has to pay tax on retained income Revenue Code, Franciscan must distribute to
– if 90% isn't distributed, it's not "Regulated" shareholders at least:
– to be Regulated:
• 90% of a fund's NII, income derived from dividends, interest, and A. $85,000
gains must be distributed to shareholders; B. $90,000
• 50% of a fund's assets must be invested in diversified securities
• the fund must be registered under the Investment Company Act of
C. $95,000
1940 D. $100,000
• election to the regulated must be filed with the IRS
UNDISTRIBUTED CAPITAL
GAINS
• shareholders are taxed for undistributed
capital gains
• if a fund realized $1.00 capital gain and
only distributed $.80, the shareholder must
still report $1.00 for that year
– however, shareholders get a credit against
their tax liability for any tax paid by the fund
on that gain
Series #6 Fund Income & Taxation 47

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Variable Annuities
• Until the 1950s, insurance companies sold 2

products:
• fixed life insurance
• fixed annuities
– with these products, the insurance company collects a
premium from the policyholder and invests it in its
VARIABLE general account.
– no matter how good or bad the investments in the
ANNUITIES general account perform, this does not affect the

amount of insurance or the amount of annuity paid to
the holder
– product type  insurance
• these are insurance products, not securities, since the
insurance company bears the investment risk.
Series #6 Variable Annuities 1 Series #6 Variable Annuities 2
• In the 1950s, insurance companies started selling 2

A variable annuity is a(n)
new products:
• variable life insurance
• variable annuities
A. exempt security under the Securities Act of 1933
– with these products, the insurance company collects a B. non-exempt security under the Securities Act of
premium from the policyholder and invests it in a 1933 because the purchaser bears the investment
designated SEPARATE account that buys mutual fund
risk
shares (SEPARATE from the insurance co.'s gen. acct.)
– the amount of insurance or the amount of annuity paid C. non-exempt security under the Securities Act of
to the holder depends on the performance of the mutual 1933 because the issuer bears the investment risk
fund in the separate account
– product type  securities D. insurance product that is not defined as a
• these are securities since the policyholder bears the security, and thus is not subject to securities
investment risk regulations
Moneys that are deposited to a variable

Separate Accounts annuity contract go into the insurance
company's:
• must register under the Investment Co. Act
of 1940 and registered as a security under
the Securities Act of 1933 A. Cash Account
B. Special Memorandum Account
C. Separate Account
D. General Account

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Variable Annuities
Comparing Fixed VS Variable Comparing Fixed VS Variable

Annuities Annuities (cont.)
• Annuity • Fixed Annuity
– contract in which a life insurance company – insurance company bears the investment risk,
promises to make periodic payments to the promising to pay the annuitant a fixed amount
owner for the individual's (annuitant's) lifetime over a designated period of time
• Accumulation Period • Variable Annuity
– investor contributing to the plan – insurance company promises to pay benefits to
• Annuity Period the annuitant over a designated period of time,
but the promise is to pay a fixed # of annuity
– insurance co. distributing from the plan UNITS (NOT a fixed amount of money)
Comparing Fixed VS Variable Comparison


Fixed Annuity
insurer guarantees to pay a 
Variable Annuity
dollar amount of the benefit
Benefit
Annuities (cont.) 
fixed amount for each
period

paid in each period may vary
with investment results
Premium insurer invests premium in insurer invests premium in a
Investment its general account separate account
• Variable Annuity Advantages  investments are mostly  purchaser selects amount
Assets fixed-income assets not separate accounts w/ varying
– purchaser may benefit if the separate accounts selected by the purchaser objectives
 insurer guarantees  insurer does NOT guarantee
are able to produce a higher return than fixed- investment return during and the actual results will
Investment Return
income investments both the accumulation and depend on the separate
payout years account performance
• usu. a better hedge against inflation than a fixed  insurer assumes  purchaser assumes investment
Investment Risk
investment risk risk
annuity  voting rights are for the board
 owners have no voting of managers, investment
Votes
rights adviser, CPA firm, and for
changes to investment policies
 state insurance AND federal
Regulation  state insurance laws
securities laws
Contract-holder  safety of principal and  hedge against inflation
Objectives guaranteed fixed return
Series #6 Variable Annuities 9
Guarantees for All Annuities The purchaser of a variable annuity bears

all of the following risks EXCEPT:
• in any annuity, there is a mortality and
expense guarantee
– MORTALITY GUARANTEE A. investment risk
• insurance company pays annuity for one's life
• if person dies later than "projected mortality", B. mortality risk
payments are guaranteed to continue
C. legislative risk
– EXPENSE GUARANTEE
• if expenses exceed a given %, insurance company D. interest rate risk
absorbs excess

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Variable Annuities
Types of Variable Annuities

Variable annuity products could include all of
• Immediate Annuities the following EXCEPT:
– with a single lump sum payment, a person can
elect to have the payout period beginning
immediately A. Lump Sum Payment/Immediate Annuity
• i.e. monthly payment, first payment is made a month
after purchase B. Periodic Payment/Immediate Annuity
• Deferred Annuities C. Lump Sum Payment/Deferred Annuity
– annuitant elects to delay the beginning of
benefit payments D. Periodic Payment/Deferred Annuity
Features of Variable
Capital gains realized in a variable annuity
Annuity Contracts separate account during the accumulation
• tax deferred accumulation period are:
• voting rights
A. not subject to tax
B. subject to a maximum tax rate of 20%
C. subject to a maximum tax rate of 28%
D. subject to a maximum tax rate of 35%
In order to recommend a variable annuity to a customer, the

Recommending Variable representative must inform the customer, in general terms,
about any:
Annuities
• the rep. must have a reasonable basis to believe that: I potential surrender period and surrender charge
– the customer has been informed of the material features of the product; II potential tax penalty
– the customer will benefit from the features of the product; and
– the particular annuity, the separate accounts to which funds are allocated, III mortality and expense fees
and the riders to the policy are suitable
• the rep. signs a statement that these determinations were IV charges for and features of enhanced riders
performed
A. I and II only
• lastly, the rep. must make a reasonable effort to obtain
information regarding the customer's: B. III and IV only
– age, income, investment experience/objectives, risk tolerance, tax
status…and any other info that is needed to make a reasonable C. I, II, III
recommendation to the customer
D. I, II, III, IV

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Variable Annuities
Annuity Payout Options Annuity Payout Options (cont.)

• the payment option chosen influences the amount • Payout Options (for preservationists):
of each annuity payment – here investors take a lump sum payment and purchase a
fixed annuity contract
• Payout Options (for gamblers):
– Choices:
– Life Annuity - this option results in the highest periodic
• Installments for Designated Period
payment
– annuitant specifies the period of time over which he
– Life Annuity with Period Certain wishes to receive the annuity (after which the account
interest is depleted)
– Joint and Last Survivor Annuity
• Installments for Designated Amount
– Unit Refund Life Annuity - if annuitant dies before
– annuitant specifies the dollar amount that he wants to
receiving the full investment value, his estate gets a receive in each payment (he receives that amount until
“refund” the account is depleted)
A variable annuity contract holder wants an Which of the following annuity payment options
annuity payout option that will guarantee that will pay the estate of the annuitant if the full
payments continue only for his or her life. The
value of the account was not received?
appropriate payout option is:
A. Life annuity
A. Life annuity
B. Life annuity with period certain B. Life annuity with period certain
C. Joint and last survivor annuity C. Joint and last survivor annuity
D. Unit refund annuity D. Unit refund annuity
Which of the following annuity payment

Which annuity payout option usually options will continue payments for a
results in the largest periodic payment? specified time period if the annuitant dies
prematurely?
A. Life annuity A. Life Annuity
B. Life annuity with period certain B. Life Annuity with Period Certain
C. Joint and last survivor annuity C. Joint and Last Survivor Annuity
D. Unit refund annuity D. Unit Refund Annuity

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Variable Annuities
A customer buys a variable annuity and elects a payout

option of Life Income with a 20 year period certain. This
means that:
Death Benefit
A. Payments will continue for the annuitant's life, not to • if an investor buys a fixed deferred annuity
exceed 20 years and dies before the payout period, the
B. Payments will continue for the annuitant's life, but if he insurer pays a named beneficiary the
dies before 20 years elapse, payments continue to his annuity's cash value
heir(s)
• if an investor buys a variable deferred
C. Payments continue for the life of the annuitant and then
cease annuity and dies before the payout period,
D. Payments continue for 20 years to the annuitant or
the insurer pays a death benefit equal to the
beneficiary value of the account at the date of death
If a variable annuity is purchased and the plan Surrender Value

holder dies before annuitization, the insurance
company will pay what amount to a beneficiary?
• during the accumulation period, the annuity
owner can surrender the annuity for the
A. Nothing value of the account
B. The amount of any period certain selected – there are options allowing the owner to obtain
the account value or to receive annuity
C. The value of the separate account at date of
payments based on the account value
death
D. The unit refund amount as of date of death
PURCHASING VARIABLE
ANNUITIES
To sell a variable annuity, what license(s) is (are)
• to sell contracts to customers, either a Series #7 or #6 needed?
is required as well as a state insurance license
• customers invest by making a lump sum investment, A. Series #6 only
varied periodic payments, or by signing a "long-term B. Series #7 only
investment contract" (a.k.a. contractual plan) C. Insurance license only
– here, the customer decides to invest (let's say) D. Series #6 or Series #7 plus a state insurance
– $100 a month for the next 10 years license
• sales charges must be "fair and reasonable"
Series #6 Variable Annuities 29 Series #6 Variable Annuities / Insurance 30

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Variable Annuities
Valuing a Variable Annuity Valuing a Variable Annuity (cont.)
• ACCUMULATION UNITS • ANNUITY UNITS

– when payments are completed, accumulation units plus
– instead of buying "shares", holder purchases any interest/dividend payments are converted into
units annuity units
• these units represent the ownership interest in the – there is a fixed number of annuity units, depending on
separate account certain criteria
• i.e. age, habits (such as smoking),...
– MANDATORY REINVESTMENT
– once annuitization occurs, the periodic payment made is
• any dividend payments, interest payments,.. are the # of units X annuity unit value
automatically reinvested (increasing the account • annuity unit value fluctuates and tends to keep pace with
value) and grow tax deferred inflation since equity prices usu. rise with inflation
During the accumulation phase of a variable

The accounting measure that is used to show a annuity contractual plan, which of the following
person's ownership interest in a variable statements are true?
annuity contract is a(n):
I Payments are fixed
II Payments vary
A. Accumulation Unit III Number of units purchased is fixed
IV Number of units purchased varies
B. Share
A. I and III
C. Accumulation Account B. I and IV
D. Annuity Unit C. II and III
D. II and IV
When the annuitization of a variable annuity

occurs, which of the following statements are At the point where a variable annuity separate account
true? interest is "annuitized," the holder of the contract receives:
I Dollar value of the units is fixed A. a fixed number of annuity units based on the number of
II Dollar value of the units vary accumulation units.
III Number of units is fixed B. a fixed number of annuity units based on the value of the
IV Number of units varies accumulation units.
C. a fixed value for the annuity units as set forth in the
A. I and III original contract.
B. I and IV
C. II and III D. a lump sum payment equal to the value of the units.
D. II and IV

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Variable Annuities
All of the following are purchase and payout

An annuitized account in a variable annuity is
options for variable annuity contracts
most similar to:
EXCEPT:
A. a mutual fund
A. Lump sum payment; Deferred annuity
B. a whole life insurance unit
B. Periodic payments; Immediate annuity
C. pension payments
C. Periodic payments; Deferred annuity
D. an individual retirement account
D. Lump sum payment; Immediate annuity
Valuing a Variable Annuity (cont.)

The "AIR" stated in a variable annuity prospectus is a:
• Assumed Interest Rate (AIR)
– insurance company estimates a very A. guaranteed fixed interest rate for the annuity
conservative return estimating the future B. guaranteed minimum interest rate for the annuity
earnings
– this rate is for Annuity Units NOT C. conservative illustration of an interest rate for the
Accumulation Units annuity
D. guaranteed maximum interest rate for the annuity
Income Tax Treatment of Income Tax Treatment of

Variable Annuities Variable Annuities (cont.)
• primarily used as a retirement funding • DISTRIBUTIONS
vehicle – once age 59 1/2 is reached, distributions can
commence without penalty
• NON-TAX QUALIFIED PLAN
– portion representing original contribution is not
– investment was made with "after tax dollars" taxed
– TAX DEFERRED – amount above the initial contribution is taxed
• during accumulation period, dividends are – also, the IRS mandates LIFO accounting
reinvested and this "buildup" grows tax deferred • if any amount is withdrawn, the portion representing
the build-up comes out first and is taxed as ordinary
income

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Variable Annuities
Which of the following statements are true regarding the

taxation of payments from variable annuities? Income Tax Treatment of
I FIFO accounting is used to determine the taxation
Variable Annuities (cont.)
II LIFO accounting is used to determine the taxation
• amount above the initial contribution is
III The tax deferred amount above the basis come out
first, followed by the original contribution taxed
IV The original contribution comes out first, followed by – i.e. separate account:
the tax deferred build-up • from contributions = $10,000
A. I and III • from buildup = $5,000
– if investor takes out $5,000, this amount is taxed
B. I and IV – if investor takes out $7,000, $5,000 is taxed and
C. II and III $2,000 is a return of principal (which has
already been taxed)
D. II and IV
Income Tax Treatment of All of the following are true about variable
annuities EXCEPT:
Variable Annuities (cont.)
• i.e. separate account: A. Salesman must register with both the SEC
and the State Insurance Commission
– from contributions = $10,000
B. Annuity payments may not be reduced despite
– from buildup = $5,000 increased expenses absorbed by the insurance
• of the total $15,000: company
– 67% = already taxed; 33% taxable
C. Variable annuities are considered to be
• investor takes 200 monthly payments as the payout securities regulated by the Investment Company
option
Act of 1940
– each payment = $15,000 / 200 = $75
– $50 is not taxable while $25 is taxable
D. Investment risk is carried by the issuer of the
annuity
Jane, aged 63, bought a variable annuity contract

All of the following are true about variable
in 2006 for $10,000. Jane withdrew $5,000 in 2012
annuities EXCEPT:
when her account was valued at $17,000. Under
these circumstances, which of the following is true?
A. Variable annuity contracts contain a mortality
guarantee
A. Jane is subject to a premature withdrawal
B. If an investor dies later than his "projected
penalty
mortality", the insurance company will still pay
B. Jane avoids federal income taxes on the
C. The insurance company will guarantee
withdrawal because it is a return of capital
against any fluctuation of market value
C. Jane is in receipt of $5,000 of taxable income
D. Variable annuity contracts contain an
D. A $15,000 withdrawal would have meant receipt
expense guarantee
of $15,000 of taxable income

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Variable Annuities
Jane, aged 63, bought a variable annuity James Darrow elected the life income option for
contract in 2006 for $10,000. In 2012 Jane payout of the $250,000 account balance in his non-
elects to terminate her variable annuity contract qualified variable annuity. Darrow has a cost basis of
and accept a life income when her life $75,000. Darrow's life expectancy is 15 years. How
expectancy was 12.5 years and the account much of each annual payment will be excludible from
value was $27,000. How much of the first Darrow's taxable income each year?
annual payment of $3,000 would be taxable?
A. $300
A. $600 B. $1,667
B. $1,200
C. $3,000
C. $1,800
D. $2,200 D. $5,000
A customer has contributed $100,000 to a non-tax qualified variable

annuity over the past 10 years and now has a balance of $200,000 in
Richard Walker purchased a nonqualified variable
her accumulation account. The customer wishes to annuitize and
annuity with a lump sum payment of $45,000. The has a life expectancy of 10 years. Which statements are true?
investment earnings over two years were $5,000.
I The accumulation account has a cost basis for tax purposes of
Walker, who is now 50 years of age, withdrew $4,000 zero
from the annuity to pay for his child's tuition. What are
II The accumulation account has a cost basis for tax purposes of
the income tax consequences of this withdrawal?
$100,000
III Annual payments received will be 100% taxable
A. Income tax will be due on $400. IV Annual payments received in excess of $10,000 will be taxable
B. Income tax and 10% penalty will be due on $400. A. I and III
C. Income tax will be due on $4,000. B. I and IV
D. Income tax and 10% penalty will be due on $4,000. C. II and III
D. II and IV
The owner of a variable annuity contract surrenders Which two of the following terms are descriptive of
the contract for a lump sum during the accumulation annuity contracts?
period. Under these circumstances, all of the
following statements are correct EXCEPT: I Universal
II Variable
A. Only the dollar amount in excess of the contract III Fixed
owner’s cost basis is included in her gross income
B. If surrender occurs before age 59 1/2 while the IV Participating
contract owner is in good health, a 10% penalty is
imposed on any taxable income A. I and III
C. If surrender occurs after age 59 1/2, the B. I and IV
accumulated investment income escapes income
C. II and III
taxes
D. The 10% penalty is not imposed after age 59 1/2 D. II and IV

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Variable Annuities
Comparison Mutual Fund Variable

All of the following statements are true regarding
Annuity
BOTH mutual funds and variable annuities
Purchaser is
EXCEPT:
Buying:
Investments are A. The return to investors is dependent on the
Held in a: performance of the securities in the underlying
Dividends Rec'd portfolio
Are:
B. The Investment Company Act of 1940 is the
Dividend regulating legislation
Reinvestment Is:
C. Distributions are taxable to the holder in the
Withdrawal Prior year the distribution is made
To Age 59 ½:
D. The underlying portfolios are managed
To sell variable annuities, salesmen must be

All of the following statements are true regarding registered with the:
BOTH mutual funds and variable annuities EXCEPT:
I Securities and Exchange Commission
A. The return to investors is dependent on the II State Insurance Commission
performance of the securities in the underlying
portfolio. III State Banking Commission
B. The Investment Company Act of 1940 is the
regulating legislation. A. I only
C. Earnings are taxable to the holder in the year they B. II only
are earned.
C. I and II
D. The underlying portfolios are managed.
D. I, II, III
A variable annuity contract offers a GMIB. This is

GUARANTEED MINIMUM a(n):
INCOME BENEFIT (GMIB) I standard feature of variable annuity contracts
• an optional “rider” offered by many variable annuities II optional feature of variable annuity contracts
• this guarantees that, when the separate account is III floor on the minimum rate that the separate
annuitized, if the account has not grown at the account will earn
guaranteed minimum rate, the account will be IV cap on the maximum rate that the separate
annuitized as if it grew at that guaranteed minimum rate account will earn
– i.e. if the separate accounts grows by 1% and then GMIB is
A. I and III
4%, then the account will be valued at annuitization based on
the 4% minimum benefit B. I and IV
• note, while popular, this doesn’t come free! C. II and III
D. II and IV

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Variable Annuities
VARIABLE ANNUITY VARIABLE ANNUITY

ROLLOVER ROLLOVER (cont.)
• the exchange of one annuity contract for • TAX-FREE EXCHANGE – LIKE-FOR-LIKE
another to get a contract, perhaps, with – Section 1035 of the tax code allows certain
better performance or lower expenses exchanges without a tax consequence
• annuity exchanged for another annuity (either
• this can be done without a tax consequence
variable or fixed); or
• life insurance policy exchanged for another life
insurance policy; or
• life insurance policy exchanged for an annuity
(either variable or fixed)
VARIABLE ANNUITY
ROLLOVER (cont.) All of the following rollovers are tax free EXCEPT:
• TAXABLE EXCHANGE A. Exchange of one variable annuity contract for

– however, exchanging a variable contract for an another variable annuity contract
life insurance policy IS taxable B. Exchange of a life insurance contract for a
• the tax code does not allow a tax-free exchange in variable annuity contract
this case because the proceeds of a life insurance C. Exchange of a variable annuity contract for a life
policy are not taxable while the distributions from insurance contract
an annuity are taxable D. Exchange of a life insurance contract for another
– if an annuity owner could exchange tax-free for a life
insurance policy, the IRS would lose tax money
life insurance contract
In a variable life settlement, which of the following

VARIABLE LIFE statements are TRUE?
SETTLEMENT I The variable life settlement provider (buyer) pays

the premiums
• this is created when a life insurance policyholder II The seller (policyholder) of the life insurance policy
gets immediate cash in exchange for the sale of pays the premiums
their life insurance policy ownership rights III The variable life settlement provider (buyer)
• the buyer of the policy continues to pay the future receives the death benefit
premiums and collects the death benefit when the IV The seller (policyholder) of the life insurance policy
receives the death benefit
insured dies
– the return on investment depends upon how long the A. I and III
policyholder lives! B. I and IV
C. II and III
D. II and IV

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Variable Annuities
Equity Indexed Annuities Equity Indexed Annuities (cont.)

• defined as an insurance product because premiums are • Equity-Indexed Annuity Characteristics:
invested in the insurance company’s general account – minimum guarantee on rate of return;
– currently defined as insurance;
• while general account investments are typically weighted
– monthly annuity payment varies with performance of Standard and
towards safety, this annuity gives a rate of return tied to a Poor’s 500 Index, but is capped to a maximum annual amount;
broad-based index such as the Standard and Poor’s 500 – insurance company assumes mortality risk – the risk that you live
Index longer than expected and they must continue to make payments;
– however, it caps the maximum rate of return and promises a – insurance company assume expense risk – the risk that the
minimum guaranteed rate of return expenses of insurance company operations increase faster than
expected, which will not reduce your monthly payment;
– to do this, the insurance company invests in S & P 500 Index – inflation risk falls between that of a fixed annuity and a variable
stocks, either directly or through an index-fund and then collars the annuity because monthly payments are capped as to growth;
positions by buying index puts and selling index calls – high expenses to pay for the cost of collaring the index
Which of the following terms describe Equity-Indexed Which statements are TRUE when comparing Equity Indexed Annuities
to Variable Annuities?
Annuities?
I In a year of sharply rising stock prices, variable annuities will
I Investment product outperform equity indexed annuities
II Insurance product II In a year of sharply rising stock prices, equity indexed annuities will
outperform variable annuities
III Principal protected
III In a year of sharply falling stock prices, variable annuities will
IV Not principal protected outperform equity indexed annuities
IV In a year of sharply falling stock prices, equity indexed annuities will
outperform variable annuities
A. I and III
B. I and IV A. I and III
B. I and IV
C. II and III
C. II and III
Which of the following statements concerning term

Life Insurance life insurance is correct?
• Term Life Characteristics: A. The cash value is invested in the insurer’s

– pure insurance with no investment feature; general account
– no cash value; B. The representative must have a Series 6
– premium payment increases as customer ages; license to sell the policy
– not permanent – insurance is not renewed after C. The policy owner can skip premium payments
a specified age (typically age 75) in some years
D. The premium is much lower than for whole life
while the insured is young

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Variable Annuities
All of the following statements concerning a whole

Life Insurance (cont.) life insurance policy are correct EXCEPT:
• Whole Life Characteristics:
– both insurance and an investment; A. premium payments are level and fixed for the
– builds cash value; insured’s lifetime
– level premium which does not increase as customer ages;
– initial premiums start higher than term life, with the excess B. the cash value increases based on equity
“invested” by the insurance company in its general account; investments
– this is “permanent insurance” – as long as the level
premium is paid, insurance continues; C. the death benefit is fixed and guaranteed for the
– cash value can be borrowed in later years to pay the annual insured’s entire life
premium;
– the annual premium and coverage amount do not change
D. policy loans will reduce the amount paid at death
over time

whole life insurance policy? Life Insurance (cont.)
A. A policy owner has flexibility in skipping some • Universal Life Characteristics:
premium payments – both insurance and an investment;
– flexible premium payment – minimum payment just
B. The cash value increases based on equity pays for cost of insurance; and premium paid above this
investments amount is invested in the general account builds cash
value;
C. The death benefit is fixed and guaranteed for – if only minimum payment is made, policy operates as
the insured’s entire life term insurance;
– cash value can be used to buy more insurance or to
D. Premium payments are low for a young decrease or discontinue premiums
insured and increase with age • thus, the death benefit amount and premium amount can
change
Under which of the following circumstances would a Which of the following statements describes a
universal life insurance policy operate as term insurance? universal life insurance policy?
A. The policy's cash value is approximately one-half the

death benefit A. The policy owner can change the schedule of
premium payments
B. The policy owner pays a cash premium equal to the
required mortality and expense charges and has no cash B. The cash value is invested in equities in
value separate accounts
C. The policy owner requests the insurer to pay the
policy's $500 level premium by reducing the policy's $2,500
C. The death benefit is fixed and guaranteed for
cash value the insured’s entire life
D. The policy's cash value increased by less than the $500 D. Premium payments are low for a young insured
annual premium and increase with age

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Variable Annuities
All of the following statements concerning a

Life Insurance (cont.) variable life insurance policy are correct EXCEPT:
• Variable Life Characteristics:
– both insurance and an investment – essentially a variant of whole life; A. premium payments are level and fixed for the
– builds cash value;
– level premium which does not increase as customer ages;
insured’s lifetime
– initial premiums start higher than term life, with the excess “invested”
by the insurance company in a separate account; B. the cash value increases based on equity
– if the investments in the separate account perform well, policy builds investments
cash value at a faster rate than whole life;
– permanent – as long as the level premium is paid, insurance continues;
– cash value can be borrowed in later years to pay the annual premium;
C. the death benefit is fixed and guaranteed for
– the annual premium and coverage amount do not change over time; the insured’s entire life
– defined as a security that must be registered and sold with a prospectus
because investment is made in a separate account D. policy loans will reduce the amount paid at
death

variable life insurance policy?
Variable life insurance policies are a variety of
A. A policy owner has flexibility in skipping some which of the following?
premium payments
A. Fixed annuities
B. The cash value increases based on equity
investments B. Mutual funds
C. The death benefit is fixed and guaranteed for C. Term life insurance policies
the insured’s entire life
D. Whole life insurance policies
D. Premium payments are low for a young
insured individual and increase with age
An insurance policy that promises to pay a named Which type of life insurance has a fixed annual
beneficiary a specified amount of money only if premium, a fixed death benefit, a fixed time period
the insured dies within a certain limited time is a: for coverage and no cash value?
A. whole life policy A. Whole life

B. universal life policy B. Universal life
C. variable life policy C. Variable Life
D. term life policy D. Term Life

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Variable Annuities

whole life insurance policy?
Which type of insurance has a fixed annual
premium, a fixed death benefit, coverage for the
entire life of the insured, and cash value? A. A policy owner has flexibility in skipping some
premium payments
A. Whole life B. The cash value increases based on equity
investments
B. Universal life
C. The death benefit is fixed and guaranteed for
C. Variable Life
the insured’s entire life
D. Term Life
D. Premium payments are low for a young
insured and increase with age
Which type of insurance requires a fixed annual

Insurance companies may invest premiums into
premium, pays a variable death benefit, provides
their general accounts for all of the following types
protection for the entire life of the insured, and
of life insurance policies EXCEPT:
gains cash value?
A. Whole life A. Universal life
B. Universal life B. Variable universal life
C. Variable Life C. Whole life
D. Term Life D. Term life

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Retirement Plans / College Plans
RETIREMENT PLANS
• ERISA
– employer established plans are regulated under
ERISA (Employee's Retirement Income
RETIREMENT PLANS Security Act)
Series #6 Retirement Plans 1 Series #6 Retirement Plans 2
ERISA Plans that comply with ERISA

• plans that comply with ERISA: requirements include all of the
– deferred compensation plans following EXCEPT:
– profit sharing plans
– defined contribution plans A. Deferred compensation plans
– defined benefit plans
– tax deferred Annuity Plans (403b)
B. Federal Government plans
– payroll deduction savings plans C. Payroll deduction savings plans
– covers "private" plans only, NOT for U.S. Gov't or D. Profit sharing plans
State employees who are exempt
TAX QUALIFIED NON-TAX QUALIFIED

• deductible against contributor's taxable • NOT deductible against contributor's
income taxable income
• amount has NOT yet been taxed • contribution has been taxed
• earnings build up tax deferred • earnings build up tax deferred
• i.e. variable annuity purchase
• all ERISA plans are tax qualified
• distributions are partially taxable
• distributions 100% taxable ("buildup") & partially tax free (return of
original contribution)

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Which of the following statements are true Which of the following statements are true
regarding a tax qualified retirement plan? regarding a non-tax qualified retirement plan?
I contributions were never taxed I contributions were never taxed

II contributions are made with after-tax dollars II contributions are made with after-tax dollars
III upon withdrawal 100% will be taxed III upon withdrawal 100% will be taxed
IV upon withdrawal only the amount above the IV upon withdrawal only the amount above the
initial amount contributed will be taxed initial amount contributed will be taxed

IRA
The maximum contribution into an IRA
• any employed person qualifies and can for an individual, age 50 or older, is:
contribute lesser of 100% of income or:
Year Amount A. $500
2015 $5,500 B. $3,000
– if married and filing a joint return, the couple C. $4,500
can contribute 2 TIMES the amount
D. $6,500
– "IRA Catch-Up”
– for taxpayers aged 50 or over, the individual
can contribute an additional $1,000
IRA (cont.) An individual makes $1,000 a year. What

is the maximum permitted IRA
• income received from investments is NOT contribution?
counted (meaning earned income is used for
investments in an IRA only)
A. 0
• contributions for each tax year can be made
until April 15 of the following year B. $1,000
C. $3,000
D. $5,000

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An individual, who earns $200,000 a year, is not covered by

another qualified retirement plan. Which statements are
IRA (cont.) true?
• contribution is always tax deductible in full I The maximum permitted IRA contribution is $2,000
if not covered by another pension plan II The maximum permitted IRA contribution is $5,500
– however, if investor IS in another plan, tax III The contribution is tax deductible
deductible amount is phased out as income IV The contribution is not tax deductible
level increases
A. I and III
B. I and IV
C. II and III
D. II and IV
IRA (cont.) IRA (cont.)

• can contribute until 70 ½ • allowed investments
– if contribution is in excess of allowable amount, – stocks, bonds, unit trusts, mutual funds, U.S.
6% penalty tax is imposed on excess amount Gov't,...
• only allowable CONTRIBUTION is cash • NOT allowed investments
and then the cash can be used for – term insurance, art, collectibles, and insurance
investments policy "cash" values
Which of the following are allowed investments in IRA (cont.)

an Individual Retirement Account?
• no withdrawal without penalty until age 59 ½
I Preferred Stock
– if withdrawn before this age, normal income tax, PLUS
II U.S. Government Gold Coins penalty tax of 10%
III Antiques, Art, and Other Collectibles • EXCEPTIONS to the penalty tax:
IV U.S. Government Bonds – for the purchase of a first home;
– for education expenses; or
– if person dies or becomes disabled
A. IV only
B. I and IV • for the Standard IRA, distributions must
C. I, II, and IV commence by April 1st of year after turning 70
D. II, III, and IV 1/2

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Which statements are true about Roth IRAs?

ROTH IRA I Contributions are tax deductible
• allows a non-deductible contribution of the same amount
as the Standard IRA II Contributions are not tax deductible
• if the maximum is contributed to a standard IRA, then no III Distributions are taxable
contribution can be made to the Roth IRA
• if monies are kept in the account for 5 years (and the IV Distributions are not taxable
person is at retirement age), any distributions are not
taxable
• as long as the investor has earned income, contributions A. I and III
can still be made (meaning, after age 70 1/2)
• Note: there are phase out ranges prohibiting high-income B. I and IV
earners from contributing to a Roth IRA (these phase out
ranges are not tested) C. II and III
D. II and IV
Distributions from Roth IRAs:

IRA (cont.)
A. must commence by April 1st of the year prior to • IRA Rollover
reaching age 70 1/2 without being penalized – must be completed within 60 days; limited to 1 per year
B. must commence by April 1st of the year of – unless distributions from qualified retirement plans are
reaching age 70 1/2 without being penalized rolled over into an IRA, they are taxable
• to insure that the tax will be paid, the tax code requires that
C. must commence by April 1st of the year after 20% of the distribution amount be withheld as a credit against
taxes due
reaching age 70 1/2 without being penalized
• IRA Transfer
D. can commence at any time after reaching age – must be effected directly between trustees; unlimited
59 1/2 without being penalized transfers allowed
IRA (cont.) IRA (cont.)

• Required Minimum Distributions • Joint and Last Survivor Table
– used by a customer whose sole beneficiary is a spouse who is more
(RMDs) than 10 years younger than the account holder
– there are IRS life expectancy tables that are • as this gives the longest expected payout time frame and reduces the
RMD
used to determine how much money must be • Uniform Lifetime Table
taken out of the IRA once the customer turns 70 – used by a customer whose spouse is not the sole beneficiary and
½ who is less than 10 years younger than the customer
• there is a 50% penalty if the RMD is not taken by • Single Life Expectancy Table
Dec 31st of each year – used by a sole beneficiary of an account, giving the largest RMD,
because only 1 lifetime is covered!

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All of the following retirement plans require that The penalty tax applied for not taking required
minimum distribution amounts be taken once the minimum distribution from a qualified retirement plan
participant reaches the age of 70 1/2 EXCEPT: in a given year is:
A. 403(b) plans A. 6% of the shortfall

B. 401(k) plans B. 10% of the shortfall
C. Roth IRAs C. 15% of the shortfall
D. Traditional IRAs D. 50% of the shortfall
A 50 year old becomes disabled and wishes

to withdraw money from his IRA. With Individual Retirement Account
regards to the withdrawal, how will it be contributions can only be made
taxed?
with:
A. There will be no tax, as the individual is
disabled A. bonds
B. The withdrawal is subject to income tax
C. The withdrawal is subject to income tax
B. cash
and a penalty tax for early withdrawal C. mutual funds
D. The withdrawal is only subject to a penalty D. stocks
tax
To maintain the tax-deferred status of a

distribution from a qualified pension plan into
DEATH OF IRA OWNER
an Individual Retirement Account, a rollover • upon death, generally, the beneficiary must take
must be completed within how many days of the proceeds over the longer of 5 years or the
the distribution: beneficiary's life
• note that there is NO penalty tax on distributions
(just regular income tax)
A. 10 • 4 Options Available to the IRA Beneficiary
– 1) IRA Roll Over (available for spousal beneficiaries
B. 30 only)
– 2) Transfer IRA into a Beneficiary Distribution (a.k.a.
C. 60 inherited IRA)
D. 90 – 3) Cash Out the IRA
– 4) Disclaim the IRA

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DEATH OF IRA OWNER (cont.) DEATH OF IRA OWNER (cont.)

• 4 Options Available to the IRA Beneficiary (cont.) • 4 Options Available to the IRA Beneficiary
– 1) IRA Roll Over (available for spousal beneficiaries only)
• here, the spouse rolls over the IRA into an existing or new IRA (cont.)
– no tax is due until the spouse starts taking distributions
• if the surviving spouse is under age 70 ½, additional contributions can – 3) Cash Out the IRA
be made
• the beneficiary gets all of the money immediately
– 2) Transfer IRA into a Beneficiary Distribution (a.k.a.
inherited IRA) and pays tax on the entire distribution
• both the deceased and beneficiary's names remain on the account – 4) Disclaim the IRA
• distributions commence immediately and must occur to deplete the
account over 5 years – or stretched over the beneficiary's life • the IRA can be given to someone else
expectancy (if longer than 5 years)
– if the IRA is left to multiple beneficiaries, then the life expectancy of the • here, the recipient will be treated as having received
oldest is used the IRA directly and will be liable for any tax as
• distributions are taxable
distributions are taken
Your customer, age 68, that has an IRA account at your

firm valued at $500,000, passes away. The customer
leaves the account to his wife, age 58. She has no need Your customer, age 68, that has an IRA account at your
for current income as she is still working, and wishes to firm valued at $500,000, passes away. The customer
know her best option to minimize taxes. She expects to leaves the account to his wife, age 48, who does not
retire in 12 years, at which time, she will need the funds work. She needs current income and wishes to know
to pay for annual living expenses. You should advise the her best option to minimize taxes. You should advise the
spouse to: spouse to:
A. roll the funds over into a new IRA in the spouse's A. roll the funds over into a new IRA in the spouse's
name name
B. transfer the IRA funds to a beneficiary distribution B. transfer the IRA funds to a beneficiary distribution
account account
C. cash out the inherited IRA account C. cash out the inherited IRA account
D. disclaim the inherited IRA account D. disclaim the inherited IRA account
Your customer, age 68, that has an IRA account at your

firm valued at $500,000, passes away. The customer
Coverdell Education Savings
leaves the account to his son, age 38. He has no need Account (ESA)
for current income as he is still working, and wishes to • formerly known as an Education IRA
know his best option to minimize taxes. He expects to • established solely for paying qualified education
retire in 22 years, at which time, he will need the funds to (grammar, junior high, high school, or college) expenses
pay for annual living expenses. You should advise the for a child under age 18
son to: • maximum annual non-deductible contribution is $2,000 per
beneficiary
• anyone can open and contribute to Education Savings
A. roll the funds over into a spousal IRA Account for a child, HOWEVER, the maximum annual
B. transfer the IRA funds to a beneficiary distribution contribution in any and all accounts is $2,000
account • no further contributions can be made once the beneficiary
turns 18
C. cash out the inherited IRA account
• earnings build up tax-deferred
D. disclaim the inherited IRA account

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Coverdell Education Savings The maximum annual contribution to a

Account (ESA) (cont.) Coverdell Education Savings Account
• WITHDRAWALS used to pay qualified education is:
expenses are NOT taxed
• once the beneficiary reaches 30, any unexpended
funds cannot be used for the beneficiary A. $500
– HOWEVER, they can be transferred to a family
member of the beneficiary for THEIR qualified
education expenses B. $1,000
• note, there are phase-out rules, similar to those of
the Roth IRA, prohibiting high-income earners C. $2,000
from contributing to an Education Savings
Account
D. $4,000
Distributions from a Coverdell High earning individuals can make

Education Savings Account must contributions to:
cease when the beneficiary reaches
I UGMA Accounts
the age of:
II Roth IRAs
III UTMA Accounts
A. 16 IV Coverdell ESAs
B. 18
A. I and III
C. 21 B. I and IV
C. II and III
D. 30 D. II and IV
Section 529 (Qualified Section 529 (Qualified

Tuition) Plans Tuition) Plans (cont.)
• a tax-deferred higher (college only) education plan • unlike the Education Savings Accounts
established by each State
(ESA), there is no income "phase-out" that
• the State establishes the minimum and maximum
contributions to be made and the contributions on stops higher earning persons from
the Federal level are NOT tax deductible (certain establishing such a plan and there is no
States allow a deduction on the State level) mandatory distribution age
• earnings build up tax deferred and distributions to – any unused funds can be transferred to another
pay for higher education expenses are NOT eligible beneficiary (relatives)
taxable
– distributions are made directly by the plan to the • note, annual contributions can be made to
educational institution which can be in any State BOTH a Section 529 Plan and an ESA

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Section 529 (Qualified

Section 529 (Qualified
Tuition) Plans (cont.)
• while federal tax advantages are standard to all college savings
Tuition) Plans (cont.)
plans, state tax treatment of 529 plans varies from state to • states offering tax deductions or credits to in-state investors
state – Arizona, Louisiana, Ohio, Arkansas, Maine, Oklahoma, Colorado, Maryland,
Oregon, Connecticut, Michigan, Pennsylvania, District of Columbia,
– in over 30 states, contributions are either tax deductible if you're a resident Mississippi, Rhode Island, Georgia, Missouri, South Carolina, Idaho,
of the state sponsoring the 529 plan or you can receive a tax credit for Montana, Utah, Illinois, Nebraska, Vermont, Indiana, New Mexico, Virginia,
contributions Iowa, New York, West Virginia, Kansas, North Carolina, Wisconsin
• in five of those states—Arizona, Kansas, Maine, Missouri and Pennsylvania— • several states impose taxes on qualified withdrawals from out-of-state
you can claim a state tax deduction from any 529, regardless of its location! plans and a few tax earnings on out-of-state plans
– deductions and tax credits vary from state to state – in an effort to keep money in its own state plan, New York even "recaptures"
• i.e. Colorado currently allows residents to deduct the entire amount of their state income tax deductions that were given to state residents who move
contribution to their in-state plan for each beneficiary, up to the amount of their money from the New York college savings plan to a college savings plan in
annual gross income another state!
• Rhode Island, on the other hand, allows only a $1000 deduction in total for joint • the smart move is to check out a plan in your home state—especially if
filers and $500 for single filers your state allows you to deduct some or all of your 529 contributions, but
– many states also follow the federal tax lead of allowing earnings to grow always do the math to evaluate the value to you of any state tax benefit
tax-free and imposing no state tax on qualified withdrawals from in-state
and out-of-state plans
Section 529 plans are KEOGH (HR10) PLANS

established by the: • self-employed persons only
• maximum contribution is 20% of "before
Keogh deduction" (i.e. Gross) earnings or
A. state $53,000, whichever is less
B. donor • full-time employees who work 1,000 hours
C. recipient per year and who have worked for 1 year
must be included (their contribution is 25%)
D. custodian • same age and penalty rules as IRA
A customer earns $100,000 per year

as a self employed foot doctor. The A customer earns $200,000 per year as a
maximum annual contribution to a self employed foot doctor. The maximum
annual contribution to a Keogh plan is:
Keogh plan is:
A. $40,000
A. $5,000 B. $53,000
B. $20,000 C. $96,000
C. $49,000 D. $112,500
D. $53,000

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A doctor earns $260,000 per year and A self-employed individual earns $100,000 per year. He
works part time for a corporation and earns an additional
contributes the maximum for the year to a Keogh. $50,000. Which of the following statements are true?
The doctor employs a male nurse earning
I The maximum annual contribution to a Keogh Plan
$40,000 a year. The contribution to be made on
for this person is $20,000
behalf of the male nurse is: II The maximum annual contribution to a Keogh Plan
for this person is $53,000
III The individual may not contribute to an IRA
A. $4,000 IV The individual may contribute a maximum of $5,500
to an IRA
B. $6,000
A. I and III
C. $8,000 B. I and IV
C. II and III
D. $10,000 D. II and IV
TAX DEFERRED
To be included in a Keogh (HR10) Plan, ANNUITIES - TDAs (403b)
employees must work in excess of:
• normally, annuities are nontax qualified, however,
employees of nonprofit organizations (i.e. schools,
A. 500 hours per year hospitals,..) are allowed to contribute "tax
qualified" annuities
B. 1,000 hours per year – the investments in the plan must be managed by a
professional manager
C. 1,500 hours per year – contributions are tax deductible and earnings are tax
deferred
D. 2,000 hours per year – so all distributions are 100% taxable
A 403b plan could be sponsored

for all of the following institutions
403(b) Plans are permitted to invest in all of the
EXCEPT: following EXCEPT:
A. Common stocks
A. private corporations B. Mutual Funds
B. foundations C. Fixed Annuities
D. Variable Annuities
C. state universities
D. local schools

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Which statements are true regarding 457 plans?

457
I They are established by for-profit
• deferred compensation plans of state and local corporations
governments and tax-exempt organizations II They are established by government
entities
• a note is that these plans can cover "contract III They are qualified plans
employees" while 403b plans cannot IV They are non-qualified plans
• the eligible plans allow employees to defer income
tax on retirement savings into future years A. I and III
B. I and IV
C. II and III
D. II and IV
Which of the following statements concerning 457

plans are correct? Life Cycle Funds
I They can be restricted to highly paid
• these funds shift the customer's investments to
employees
mutual funds that are relative based on that
II They are for set up for government employees
person's time horizon
III The employer receives an immediate tax
– i.e. a younger person with many years to retirement
deduction would want to weight her investment portfolio towards
IV They are qualified retirement plans growth stocks
– i.e. an older person, closer to retirement, would want to
A. I and II only weight her investment portfolio towards "safety" stocks
B. I and IV only • the general rule for asset allocation is to take 100
C. II and III only and subtract that person's age
D. III and IV only – this is the % of assets that should be invested in equities
The manager of a pension plan ERISA

would invest in all of the following • companies are not obligated to fund entire
EXCEPT: pensions – there are minimum funding
requirements, though
•
A. Agency Bonds • other retirement plan types:

– Profit Sharing
B. Corporate Bonds • allows company to share profits with employees
C. Municipal Bonds • maximum contribution is 25% of employee compensation up
to $53,000
D. Government Bonds • all earnings are tax deferred

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ERISA ERISA
• Payroll Deduction Savings • Simplified Employee Pension (SEP) IRA
– employers match employee contributions – generally used by small businesses
– employer makes contribution on employee's behalf
– 401K plan
– virtually all employees included (full & part-time) as long as
– build up is tax deferred; when payments are taken, they're 21 years old and have worked at least 3 out of the last 5
100% is taxable upon distribution years
– maximum annual contribution is $18,000 in 2015 – contribution is made by "salary reduction"
– contribution is deducted from gross income employee received
– subject to ERISA
– cannot exceed 25% of income up to a maximum of $53,000
– used by smaller employers because it's less complicated

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Customer Accounts
SUITABILITY
• FOR ALL FINRA, MSRB, CBOE:
– these entities are known as SROs (Self‐Regulatory
Organizations)
CUSTOMER ACCOUNTS • non‐governmental organizations that have the power to create
and enforce industry regulations and standards
• the main objective is to protect investors through the
establishment of rules that promote ethics and equality
– the information required on a new account form would
depend upon the type of securities that will be traded
– know your customer rule; suitability determination is
required before making recommendations
Series #6 Customer Accounts 1 Series #6 Customer Accounts 2
When determining suitability, inquiry must be made into a

customer's:
I Investment Objective
The Self Regulatory Organizations (SROs) are: II Investment Experience

III Financial Situation
A. private companies IV Financial Needs
B. government sponsored enterprises
A. I and II
C. membership organizations
D. publicly traded companies B. I and IV
C. II and III
D. I, II, III, IV
NEW ACCOUNT FORM In order to open a new account for an individual

customer, which information is required on the new
• 4 Pieces of Information that are REQUIRED for an account form?
"Independent Verification" of the customer identity:
– 1) Name
– 2) Address I Date of birth
– 3) S.S.# or tax I.D. # II Date of reaching legal majority
– 4) Date of birth
– this can be accomplished by matching the information provided by the
III Social security number
customer to a copy of the customer's current driver's license or IV Telephone number
passport (ID cannot be expired!)
• OR, the firm can match the information to database providers to verify
the customer's identity
A. I and III
• this "independent verification" must be made within a
reasonable time before or after account opening B. I and IV
C. II and III
D. II and IV

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Customer Accounts
A customer wishes to open a new account, but refuses In order to open a new account for an
to give her social security number and date of birth, individual customer, which information is
claiming that the release of such information would required on the new account form?
allow the customer's identity to be stolen. Which
statement is true? I Customer name
II Residence address
A. As long as the customer signs a statement to the
III Date of birth
effect that she is the true account owner, then the
account can be opened IV Social security number
B. The account can be opened as long as the firm is
able to verify the customer's identity A. I and III
C. The account can be opened as long as the manager B. II and IV
approves C. I, II, III
D. The account cannot be opened D. I, II, III, IV
NEW ACCOUNT FORM (cont.)
Independent verification of a new
customer's identity can be satisfied by • the rep opening the account must obtain the customer's
occupation
obtaining a photocopy of all of the – if the customer is an employee of another FINRA member, the
following EXCEPT the customer's: executing firm must determine whether opening the account is a
conflict of interest
– before opening the account, the firm sends notices of the opening of
the account to the employing firm
A. passport • the executing firm must make available duplicate confirmations and
B. driver's license statements
• this rule does NOT apply to an employee of another firm wanting to open
C. military ID an account solely to buy investment company securities, as the employee
has NO idea which specific securities the fund manager will be purchasing
D. marriage certificate
Which of the following information must be obtained when

NEW ACCOUNT FORM (cont.) opening a new cash account for a customer?
I Customer’s employer
• no customer signature needed on New II Written verification from the customer that she is at
Account Form least 21 years of age
• though the signatures of the rep opening the account and III Customer’s Social Security or tax identification
the principal approving the account are required number
IV Written signature of the customer
A. I and III
B. II and IV
C. I, II, III
D. I, II, III, IV

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Customer Accounts
When opening a new account, the registered

Which of the following signature(s) would be found on a
representative must verify:
completed new account form?
I Customer
A. the income and net worth information provided by
II Registered representative the customer against a copy of the customer’s latest
III Registered principal tax return
B. that the customer understands the risks of any
A. I only recommendation
B. II only C. the customer’s name and address against a copy

of the customer’s birth certificate
C. II and III
D. the customer’s social security number against the
D. I, II, III
customer’s social security card
FEDERAL RESERVE MARGIN RULES SET
UNDER REG. T
• 100% must be deposited for a mutual fund
• closed end funds may be bought in the
secondary market on margin
Regulation T • Reg. T only applies to non‐exempt securities
(not U.S. Gov't, Agency, or Municipal)
– Reg. T controls credit from broker to customer
DISCRETIONARY ACCOUNT DISCRETIONARY ACCOUNT (cont.)
• customer gives brokerage firm trading
authorization • considered "discretionary" if size and/or
• customer must sign trading authorization BEFORE security are chosen by broker
any discretionary trades take place • principal must approve orders promptly
• 4 items chosen:
– size of trade
– security
– price of execution
– time of execution

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Customer Accounts
DISCRETIONARY ACCOUNT (cont.) A customer calls his broker and says, "I am going on

vacation for 2 weeks. Do what ever you think is
• PROHIBITED PRACTICES: necessary for my account". Which statement is true?
– unsuitable trades for the account
– too frequent trades in account
– trades of excessive size for account A. The broker can exercise discretion in the account
– if the principal finds unsuitable discretionary activity, he B. The broker cannot exercise discretion in the account
will discipline broker, remove trades from customer's C. The broker can exercise discretion in the account only
account, and they'll be reversed next trading day if each trade is approved in advance by the branch
• any loss on these trades would be charged to the representative
manager
D. The broker can exercise discretion in the account only
if each trade is approved by the NASD
Given the following orders, which one requires Which one of the following orders requires
specific customer authorization? specific customer authorization?
A. Customer's order is to buy 100 shares of A. Customer's order is to sell 100 shares of KO
IBM at the best price available at the market
B. Customer's order is to sell 100 shares of KO B. Customer's order is to buy as much of GE at
at the market $40 during this trading day
C. Customer's order is to buy 100 shares of C. Customer's order is to buy 100 shares of
any computer stock priced at under $40 IBM at $125
D. Customer's order is to sell 100 shares of D. Customer's order is to sell 100 shares of GE
GM when it gets to a certain level or lower when it gets to a certain level or lower
All of the following statements are true Under New York Stock Exchange rules, a
regarding discretionary accounts EXCEPT: written power of attorney is required for a
registered representative to choose which of the
A. The account must be approved by a principal following order related items?
or branch manager
B. An account can be opened once a customer I Security to be traded
II Size of the order
has guaranteed that a written power of attorney III Price of Execution
has been placed in the mail IV Time of Execution
C. Each order ticket must be marked
"discretionary" A. I and II
D. Every order ticket must be approved B. III and IV
promptly by a general principal or branch office C. I, II, III
manager D. I, II, III, IV

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Customer Accounts
In order to open a discretionary cash THIRD PARTY TRADING

account, all of the following procedures are
required EXCEPT: • customer allows someone other than himself or the
brokerage firm to trade
• LIMITED TRADING AUTHORIZATION
A. signature of the manager on new account – orders to buy and sell can be entered, but funds can't be
form withdrawn
• FULL TRADING AUTHORIZATION
B. signed trading authorization – orders can be entered AND funds can be withdrawn
BUT (of course), the customer's name is on check
C. signed customer's agreement – a Duplicate Confirmation, upon written request, may
be given to third party
D. completed customer new account form
THIRD PARTY TRADING (cont.)
• THIRD PARTY TRADING (cont.) All of the following are allowable joint

– DURABLE POWER OF ATTORNEY
accounts EXCEPT:
• a power of attorney which remains in effect even when
one becomes incompetent A. father and 12-year old son
– NON‐DURABLE POWER OF ATTORNEY
• a power of attorney that ends if the person becomes
B. father and 25-year old son
incompetent C. husband and wife
• note that ANY power of attorney becomes D. two partners in a business
void when the grantor dies
CORPORATE / PARTNERSHIP ACCOUNTS
All of the following paperwork is required to
open a corporate account EXCEPT:
CORPORATE ACCOUNT
– copy of corporate charter is required
A. corporate charter
– a "resolution" with corporate seal affixed to it
will state who has trading authorization B. corporate resolution
PARTNERSHIP ACCOUNT C. proof of domicile
– copy of partnership agreement must be
obtained D. corporate seal

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Customer Accounts
Which statement is true regarding corporate FIDUCIARY ACCOUNT

accounts?
• third party is acting for the owner of the
A. Only members of the Board of Directors are account
allowed to trade the account • Trust Account, Guardian Account,
B. Only officers of the company are allowed to Administrator of Estate, Executor of Estate,
trade the account Conservator for Income, Receiver in
Bankruptcy
C. Only employees of the company's treasurer's
department are allowed to trade the account • no third party trading (fiduciary is considered
"third party")
D. Anyone authorized in the resolution can trade
the account
ACCOUNTS FOR INVESTMENT
FIDUCIARY ACCOUNT (cont.)
ADVISERS
• cash account only, no margin unless specifically INVESTMENT ADVISER
authorized – person that a customer entrusts to manage his money
• fiduciaries are often limited to investing in securities – will open account with brokerage firm to perform trades for
customer
that are on a "legal list" (safe securities)
– can have hundreds of customers
– this list is provided by the State OR they must follow the
"Prudent Man Rule" – Wrap Account
• this rule states that only investments that would be made by a • where all brokerage services are paid by the customer through a flat
prudent individual are allowed annual fee
• thus, there are no separate commissions on trades or charges for
other services
• reps offering these accounts must be registered as an Investment
Adviser Rep and pass either the Series #65 or Series #66 state‐
licensing exam
ACCOUNTS FOR INVESTMENT ADVISERS Which of the following are ways in which an Investment Adviser

(cont.) account can be opened?
OMNIBUS ACCOUNT I An omnibus account holding the monies of all clients

without specific identification of each client
– investment adviser's clients are grouped under 1
II Separate client accounts with a power of attorney given
account by each client to the investment adviser
– usu. an annual management fee III Joint account with tenancy in common for all of the
– confirms of trades and statements sent to both investment adviser's clients
customer and investment adviser IV Joint account with rights of survivorship for all of the
investment adviser's clients
NUMBERED ACCOUNTS
– name confidential, but firm is obligated to A. I or II only
maintain record of true owner B. III or IV only
C. I, II, III
D. I, II, III, IV

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Customer Accounts
BOOKS AND RECORDS
Which of the following is a true statement about
managed wrap accounts? The customer is charged:
• purchase and sales records must be
A. a single annual fee based on total assets in the maintained for 6 years and readily accessible
account for account transactions and maintenance during the first 2 years of operations
B. a commission for each transaction performed • a separate file of customer complaints must
C. a commission for each recommendation that be kept and any action taken by the member
results in a transaction
D. both a commission on each transaction
in response
performed and an annual maintenance fee based
on total assets in the account
FORMS OF OWNERSHIP FOR FORMS OF OWNERSHIP FOR
INVESTMENTS INVESTMENTS (cont.)
INDIVIDUAL ACCOUNTS JOINT ACCOUNTS
• held in the name of a single person – Joint Tenancy with Rights of Survivorship
– only that person can enter orders (i.e. trade the account) • if one party dies, the other is the sole owner
– Transfer on Death ‐ TOD – Tenancy in Common
• has a named beneficiary receiving the assets of the account only
upon death of the owner • each party has a % and is passed to estate if he dies
– the assets pass directly to the beneficiary, avoiding probate
• this designation is used many times for elderly people who can
provide for automatic transfer of assets to heirs after death, but
still maintain control over the assets during their lifetime
For IRS reporting purposes, the opening of a joint

account for a husband and a wife requires that the social
security number be obtained from the: All of the following are allowable joint
accounts EXCEPT:
I Husband
II Wife
A. father and 12-year old son
III Beneficiary
B. father and 25-year old son
A. I C. husband and wife
B. II D. two partners in a business
C. I or II
D. I, II, III

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Customer Accounts
Two brothers wish to open an account with a Two brothers wish to open an account with a
registered representative. In sharing in the registered representative. In sharing in the
account's gains or losses, they wish that if one account's gains or losses, they wish that if one
dies, the deceased brother's interest be dies, the deceased brother's interest will go to
handled by his estate. What kind of account the other brother. What kind of account should
should be opened? be opened?
A. corporate account
A. corporate account
B. partnership account
B. partnership account
C. joint account with rights of survivorship
D. joint account with tenants in common C. joint account with rights of survivorship
D. joint account with tenants in common
Which of the following are types of joint accounts? TRUST ACCOUNTS

I Guardian for an incompetent • ownership of securities, given by a "grantor", is
II Custodian for a minor entrusted to a trustee who holds the asset for a
beneficiary
III Tenants in Common
• trusts can be set up as an "inter‐vivos" – during one's
IV Joint Tenants with Rights of Survivorship life; or be established in one’s will upon death (i.e.
“testamentary” trust ‐ as in, “last will and
A. I and II testament”).
B. III and IV – inter‐vivos trusts can be set up either as revocable or non‐
revocable trusts, whereas testamentary trusts are non‐
C. I, II, III revocable
D. II, III, IV
TRUST ACCOUNTS (cont.)
The person who donates the assets into
• Revocable Trust the trust is the:
– the grantor transfers assets into a trust, but has
the right to take them back
A. Custodian
• taxed at the rate of the grantor
• Irrevocable Trust B. Fiduciary
– the grantor cannot take the assets back
• taxed at the rate of the trust C. Grantor
D. Trustee

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Customer Accounts
The principal benefit of establishing a living trust is:

The person that administers a trust is
the: A. tax deferred build-up of earnings in the trust
B. elimination of estate taxes upon the death of the
A. grantor grantor of the trust
B. beneficiary C. removal of assets held in the trust from the

decedent's estate, avoiding probate
C. trustee D. increasing investment returns because asset
selection in the trust is exempt from the "Prudent
D. conservator Man" rule
Which of the following are attributes of a living trust?

I Taxable build-up of earnings in the trust Income in a non-revocable trust is taxed
II Tax-deferred build-up of earnings in the trust at the:
III Upon death, the decedent's estate avoids probate
IV Upon death, the decedent's estate is subject to
probate
A. corporate rate
B. individual rate
A. I and III
B. I and IV
C. trust rate
C. II and III D. AMT rate
D. II and IV
Which of the following statements are true regarding non- To open a new account for a non-revocable trust,
revocable trusts?
which statement is true?
I Income is taxed at the rate scheduled for the grantor
II Income is taxed at the rate scheduled for the trusts A. The tax identification number of the trust must be
III The grantor has control over the assets obtained
IV The trustee has control over the assets B. The tax identification number of the trustee must
be obtained
A. I and III C. The tax identification of the trust beneficiary must
be obtained
B. I and IV
C. II and III D. There is no required to obtain a tax identification
number when opening a trust account
D. II and IV

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Customer Accounts

revocable trusts?
Income in a revocable trust is taxed at I Income is taxed at the rate scheduled for the grantor
the: II Income is taxed at the rate scheduled for the trusts
III The grantor has control over the assets
A. corporate tax rate IV The trustee has control over the assets
B. trust tax rate

A. I and III
C. grantor's tax rate B. I and IV
C. II and III
D. gift tax rate
D. II and IV
Which of the following can be the beneficiary CUSTODIAN ACCOUNTS

of a trust?
• UGMA – UNIFORM GIFTS TO MINORS ACT
I Grantor – once the minor reaches "adulthood", the account
II Trustee reverts to his/her name
III Beneficiary
• UTMA – UNIFORM TRANSFERS TO MINORS ACT
A. III only – here, the custodian can specify a transfer age up to age
25 (the time when the account will be turned over to
B. I and III the "new" adult)
C. II and III
D. I, II, III
CUSTODIAN ACCOUNTS (cont.)
Which of the following best describes a
– any adult can open account for minor (doesn't have to be
custodian in a Uniform Gifts to Minors
related) Account?
– all securities must be registered in account name
– cash balances can't be held in account for extended period A. Adult
must be invested in a security or transferred to a
Custodian Account maintained at a bank B. Relative
– one custodian for one minor account
• canNOT have "John Jones as custodian for Jill and Jean Jones" C. Person living in minor’s state of residence
• need 2 separate accounts: for John & Jill and John & Jean
D. Person with parental obligation to the
minor

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CUSTODIAN ACCOUNTS (cont.) CUSTODIAN ACCOUNTS (cont.)
– cash accounts only NO margin accounts – no third party trading authorizations
– gifts are irrevocable – options usu. NOT considered appropriate for
custodian accounts (covered call writings not bad,
– S.S. # of minor is needed
though)
– if custodian is the parent and the minor is
under 18, the parent's S.S. # must also be – if rights offering, custodian sells rights or exercises
obtained because any substantial income custodian cannot let them expire worthless as this
generated is taxable at the adult's tax bracket isn't in account's best interest
Under the Uniform Gifts To Minor's Act, which of the

following statements are true?
A minor can open which of the
I only adults related to the minor may open a
custodian account following accounts?
II any adult can open a custodian account for a
minor
III only gifts that have a gain are irrevocable
A. custodial account
IV all gifts are irrevocable B. joint with rights of survivorship
C. UGMA account
A. I and III
B. I and IV D. a minor cannot open an account
C. II and III
D. II and IV
Which of the following transactions are

Which of the following statements is true
permitted in a custodian account? regarding custodian accounts?
I Short sale of common stock A. A custodian account can be established

II Sale of pre-emptive rights as a margin account
III Purchase of warrants B. Any adult can act as custodian for any
IV Purchase of mutual fund shares
minor
A. I, IV C. The account must use the tax
B. II, III identification number of the adult
C. II, III, IV D. Two custodians must be appointed for
D. I, II, III, IV each minor on an account

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Customer Accounts
MARGIN ACCOUNT RULES
Uniform Gifts to Minors Act accounts
require the social security number of • OPENING A MARGIN ACCOUNT
the: – when opened, it allows the customer to put up
50% to buy a security
• the customer borrows the other 50% from the
A. parent if child is below 18 years of brokerage firm
age
B. custodian
C. minor
D. donor
MARGIN ACCOUNT RULES (cont.) MARGIN ACCOUNT RULES (cont.)
– when the account is opened, the customer signs the
Margin (a.k.a. Hypothecation or Customer) Agreement, • the Federal Reserve sets the initial margin on non‐
pledging securities as collateral for the 50% borrowed exempt (corporate) securities under Regulation T
• the broker‐dealer holds these securities in "street name", meaning
in the name of the firm, thereby allowing the broker‐dealer to sell – marginable securities
the securities at any time without needing the customer's • stocks traded on exchanges and NASDAQ
signature • closed‐end funds
• hypothecation allows the firm to commingle customer margin • U.S. Government and Municipal securities
securities with other customer margin securities • Corporate bonds
– note that any fully paid securities must be segregated and placed in
safe‐keeping – non‐marginable securities
• new issues, including mutual funds and UITs
• non‐negotiable Series EE and HH bonds
MARGIN ACCOUNT RULES (cont.) MARGIN ACCOUNT RULES (cont.)
• note that if a security is not marginable, it • if the level falls lower than the minimum, a
must be paid for in full maintenance call is issued, requiring the
– also, after held for 30 days, mutual funds become customer to deposit more money so that the
marginable account goes back up to the minimum
• after the account is opened, the customer maintenance of 25%
must keep minimum maintenance margin
requirements set by FINRA
– i.e. where the initial margin is 50%, the minimum
is only 25%

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Customer Accounts
MARGIN ACCOUNT RULES (cont.)
• besides margin, Regulation T also requires investors to deliver
and make payment for securities "promptly", but no later
Under Regulation T, full payment in a
than 2 days after the settlement (i.e. T + 5 = trade date plus 5 cash account must be made:
business days = S + 2 = Settlement plus 2 business days)
– if payment isn’t received by 5 days, an extension may be requested
• if the position is still not paid, the firm is obligated to sell out the position
A. promptly
and freeze the account for 90 days B. within 5 business days of trade date
– when the account is frozen, all trades require cash payment in advance
C. within 35 calendar days of trade date
D. within 90 calendar days of trade date
MARGIN ACCOUNT RULES (cont.)
Payment for a securities transaction
must be received by how many days • lastly, if the amount of the margin call is for $1,000
in order for the account not to be or less, the broker‐dealer may elect to not liquidate
the position or freeze the account
frozen?
A. promptly
B. next business day
C. 3 business days
D. 5 business days
CONTINUING MAINTENANCE OF CONTINUING MAINTENANCE OF
ACCOUNT ACCOUNT (cont.)
• confirms are sent day after trade date Inherited Account
• statements sent quarterly unless trades occur then • if an account is "inherited" by another
sent for that month
representative, the account should be
• mail can't be held by brokerage firm, however, if updated prior to effecting transactions in the
customer requests that his mail be held:
account (note, there is no need for an
• IF TRAVELING:
additional new account form to be completed)
– DOMESTICALLY
• 2 months holding permitted
– INTERNATIONALLY
• 3 months holding permitted

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Customer Accounts
SHARING PROFITS IN AN
A customer is traveling to Alaska and ACCOUNT
directs your firm to hold his mail. • reps cannot share in the profits of an account unless
Under NYSE rules, the mail can be the firm approves of this in writing; and the rep
held for: shares in proportion to his/her financial contribution
– an exception to the proportionate test is allowed where
the joint account is opened with an immediate family
A. one month member
• i.e. for a rep opening an account with her spouse, sharing need not
B. two months be "proportionate
C. three months
D. the duration of the trip
BORROWING FROM OR LENDING TO
CUSTOMERS
A registered representative is permitted to share in • normally, reps cannot borrow from or lend money to customers
the gain and loss of a customer account: • however, loans are allowed for:
– immediate family members (also included here are non‐related persons under
the rep's financial control)
A. only with FINRA approval – financial institutions which normally provide credit in the course of its
B. if the sharing is in proportion to capital business
– customers who are reps of the same firm
contributed and the principal approves – customers and reps who have a personal relationship outside of the
C. if the customer is not related to the registered broker/customer relationship (such as live‐in boyfriend/girlfriend) OR a
business relationship outside of the broker/customer relationship
representative
• the rep must obtain firm approval of any of these arrangements with
D. if such sharing will benefit the customer customers EXCEPT in the case of immediate family and financial
institutions
Which statements are true about a representative that

A registered representative has a joint account with her wishes to borrow money from a customer?
sister, who is a doctor. The representative has asked
her sister for a $5,000 loan to pay her income tax bill. I Representatives are permitted to borrow money from
Which statement is true about this? customers
II Representatives are prohibited from borrowing money
from customers
A. The representative is prohibited from borrowing the
III Representatives are permitted to borrow money from
$5,000 from her sister
customers that are immediate family members
B. The representative can borrow the $5,000 from her IV Representatives are prohibited from borrowing
sister as long as this complies with the firm's policies money from customers that are immediate family members
and procedures
C. The representative can borrow the $5,000 from her
sister with prior written approval of FINRA A. I and III
D. The representative can borrow the $5,000 from her B. I and IV
sister without restriction C. II and III
D. II and IV

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Which statements are true about customer complaints

CUSTOMER COMPLAINTS under FINRA rules?
I A complaint is defined as one that is received in

• when a rep receives a written customer writing
complaint (this is a "bad one"), the rep must II A complaint is defined as one that is received
either verbally or in writing
forward the complaint to the manager for
III A copy of the complaint must be forwarded by the
resolution representative to a manager or principal for resolution
• copies of complaints must be kept on file for 3 IV A copy of the complaint must be forwarded to
FINRA within 10 business days of receipt
years
A. I and III
B. I and IV
C. II and III
D. II and IV
A registered representative receives a letter from a CUSTOMER PRIVACY RULES

customer complaining about the performance of her
investments over the last quarter. Which statement is • SEC Regulation SP
TRUE?
– broker‐dealers and other financial institutions
A. The representative must attempt to resolve the must provide to retail customers a notice of the
matter on his or her own firm's privacy policies and practices
B. The representative must forward the complaint to the • firms must deliver an initial privacy notice to new
manager or principal for resolution customers when the account is opened and an annual
C. The representative must forward the complaint to the privacy notice to all customers
FINRA District Hearing Panel for resolution • this privacy notice applies to customers that have funds
D. The representative should do nothing unless the or securities in custody of the firm
complaint is received from the customer in writing
CUSTOMER PRIVACY RULES CUSTOMER PRIVACY RULES
• SEC Regulation SP (cont.) • acceptable opt‐out notices:
– firms cannot divulge non‐public information about – including a reply form with an opt‐out notice;
customers to 3rd parties unless the firm has given – providing an electronic means to opt‐out, if the
notice to the customers of this intent and the customer agrees to electronic delivery of info
customer has not elected to opt out of the – providing a toll‐free #
disclosure (the customer is given 30 days to "opt
out") – including designated check‐off boxes on the
relevant forms

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Customer Accounts
• unacceptable opt‐out notices • Non‐Objecting Beneficial Owner ‐ NOBO
– having the customer write a letter exercising his – a customer who has chosen NOT to opt‐out, and thus the
customer’s name and address can be disclosed to any
opt‐out right; or
issuer in which the customer has invested
– having the consumer use check‐off boxes on a • thus, the issuer can send out proxies, 10Ks, 10Qs,…directly to the
form only included in the original notice, but not customer
within the subsequent annual notice • Objecting Beneficial Owner ‐ OBO
– a customer who HAS chosen to opt‐out, and thus the firm
canNOT disclose customer info
• an issuer distributions would be sent to the firm and the firm
would retransmit info to the customer
• note that if a person does not have an account and • this rule applies to individual transactions and
simply wants to sell some securities and then have a NOT to aggregated or averaged information
check remitted, this person is a "consumer" and NOT that is not linked to a specific customer
a customer
– the consumer only gets the privacy notice at the time of • lastly, if a regulator (i.e. FINRA or the SEC)
the transaction requests customer information, the privacy
• also, the broker‐dealer must: rules do not apply
– ensure the security and protect the confidentiality of
customer records; and
– protect customer records against unauthorized access
SEC Regulation SP covers: If a member firm sends an initial privacy

notice to a customer which contains an "opt
A. notification to customers of a member out" provision, under Regulation SP the firm
firm’s privacy policies and practices may not disclose non-public, personal
B. selective disclosure of material non-public information about that customer for:
information by issuers
C. standardization of disclosure of financial A. 10 days from mailing
and non-financial information by issuers B. 15 days from mailing
D. registration filings with the SEC by small C. 20 days from mailing
business issuers D. 30 days from mailing

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Customer Accounts
Which of the following are true statements about Regulation

SP?
All of the following is considered to be
I Customers must be provided with a privacy notice at
confidential customer information under
account opening
Regulation S-P EXCEPT:
II Consumers must be provided with a privacy notice at
account opening
A. a customer's name and address
III Customers must be offered a privacy notice annually B. a customer's cookie trail through the member
IV Consumers must be offered a privacy notice annually firm's website
C. the average account balance of all customers
A. I and III
at a member firm
B. II and IV D. the individual holdings that are maintained in
C. I, II, III a customer account
D. I, II, III, IV
BANK SECRECY ACT ANTI‐MONEY LAUNDERING RULES
• MONEY LAUNDERING • PATRIOT Act
– the principal scope of the act – Congress passed the Providing Appropriate Tools
– there are 3 main activities of money laundering: Required to Intercept and Obstruct Terrorism
• 1) depositing "ill‐begotten" money in a bank and then
transferring these funds as legitimate funds somewhere else (PATRIOT) Act after the 9/11 World Trade Center
• 2) structuring – concealing illegal money through a series of bombing requiring securities firms and financial
transactions rather than in a one‐lump sum institutions to:
• 3) integration – commingling suspect funds with legitimate
funds
• establish written money laundering programs;
• WIRE TRANSFERS • provide ongoing training to employees so that they can
detect and prevent money laundering; and
– detailed transactions of amounts of $3,000 or more must be made
available for regulators' review (though they need not be filed) • report suspicious transactions and activity
ANTI‐MONEY LAUNDERING RULES ANTI‐MONEY
(cont.) LAUNDERING RULES (cont.)
• thus, outside of the SROs' Suitability rules, a • when opening an account, the firm must
higher level of scrutiny must be given to independently verify the customer's
customers who: name and address; and for non‐resident
– are from a country which is NOT a member of the aliens, must obtain the customer's
Financial Action Task Force (FATF) – these are 29 passport number and the necessary U.S.
countries that combat money laundering tax forms
worldwide;
– reside in countries that have bank secrecy laws;
– operate cash‐intensive businesses

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ANTI‐MONEY
LAUNDERING RULES (cont.) The purpose of OFAC (Office of Foreign Assets
Control) is to:
• the Department of Treasury’s Office of Foreign
Assets Control maintains a list of named countries, A. set higher margin requirements for foreign
organizations, and individuals with whom anyone in nationals that wish to invest in the United States
the US is prohibited from doing business B. monitor the activities of foreign investors in the
– the list must be checked before opening an account for a U.S. markets
foreigner or foreign entity C. impose economic sanctions against hostile
– a financial institution having knowledge of a payment to foreign countries and groups
or from one of these countries/entities is required to D. monitor foreign currency inflows into the U.S.
block the transaction; and report to OFAC within 10 days markets
ANTI‐MONEY ANTI‐MONEY
LAUNDERING RULES (cont.) LAUNDERING RULES (cont.)
• also, the firm must match the customer's
name against a terrorist watch list • the broker‐dealer must file Suspicious Activity
maintained by the federal government Reports (SARs) with the Financial Crime
Enforcement Network (FinCEN – part of the
– if there is a match, the account cannot be Treasury Dept.) which acts as the central
opened; and the federal authorities must be
notified collection point for these reports and then
provides intelligence info to the appropriate law
enforcement groups
– note SARs must be filed with FinCEN within 30 days of
detection of the activity if the amount in question is $5K or
more and the firm believes that illegal activity is occurring in
the account
• Potential Money Laundering Acts at the Account • Potential Money Laundering Acts Related to Account
Opening stage Activity
– If the customer is: – If the customer:
• unusually concerned with the firm's compliance with government • attempts to make frequent or large deposits of currency or cash –
reporting requirements; known as “layering” – where the owners of illegal funds deposit
• reluctant to reveal personal info about his/her business activity; them in “layers” to different accounts to disguise true ownership;
• furnishing suspicious ID or business documents; • engages in cash transactions (or similar ones, like money orders)
• wishing to engage in transactions inconsistent with the customer's structured to be under the $10,000 IRS reporting limit;
investment strategy; – cash transactions of $10,000 or more are required to be reported to FinCEN
by an “approving official” as a currency transaction report – CTR – within 15
• acting as agent for another entity and is evasive about providing days
info about that entity • note integration occurs when the funds from structuring and
• having a difficult time describing his/her business layering appear to be legitimate!

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Customer Accounts
• Potential Money Laundering Acts Related to • Potential Money Laundering Acts Related to
Account Activity Account Activity (cont.)
– If the customer (cont.): – If the customer:
• engages in multiple or sudden or unexplained wire transfers to
countries that are considered non‐cooperative by the FATF and • has multiple accounts with a large number of inter‐
FinCEN; account transfers or excessive journal entries for no
• makes a funds deposit followed by an immediate request that the apparent business purpose
funds be transferred to another party for no apparent business
purpose; • deposits bearer bonds followed by a request for the
• makes a funds deposit for the purchase of a long‐term investment, disbursement of funds;
followed shortly by a request to liquidate the position and transfer
proceeds out of the account; • exhibits a lack of concern regarding risks, commissions,
and other transaction costs
Money laundering regulations are established by the:

I Financial Industry Regulatory Authority
Member firms are required to keep detailed II Securities and Exchange Commission
records of wire transfers where the amount
III Federal Reserve Board
involved is:
IV Department of Treasury
A. $3,000 or more
B. $5,000 or more A. I and II
C. $10,000 or more
B. III and IV
D. $15,000 or more
C. I and IV
D. II and III
Under the requirements of the USA PATRIOT Act, if a

member firm suspects that an account is engaging in money
laundering, the firm is obligated to file: What should a firm do if it believes that it is in
I a SAR possession of a check that has been altered
II a FOCUS
because the routing number of the financial
institution appears to be inaccurate?
III with the SEC
IV with FinCen A. Deposit the check
B. File a SAR
A. I and III C. Contact the client and ask him to reclaim the
B. I and IV check
D. File a CTR
C. II and III
D. II and IV

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SAR reports are required to be filed with FinCEN:

Which of the following best describes "structuring"?
I for any transaction amount
A. Depositing or withdrawing cash in amounts just II for transaction amounts of $5,000 or more
over $10,000 III if deposits or withdrawals of cash are made
B. Depositing or withdrawing cash in amounts just IV if the member firm believes that an illegal
under $10,000 activity may be taking place
C. Diversifying among asset classes in amounts
just over $10,000 A. I and III
D. Diversifying among asset classes in amounts B. I and IV
just under $10,000 C. II and III
D. II and IV
As it relates to money laundering, layering is

best described as a client's strategy to:
A Currency Transaction Report (CTR) requires
A. Deposit a small amount of illicit funds in an the signature of:
account
B. Deposit large sums of illicit funds directly in a A. An approving official of the financial institution
brokerage account receiving the funds
C. Make numerous deposits just below the B. The customer who deposited the funds
reporting threshold C. The customer's registered representative
D. Use numerous accounts with multiple owners D. The chief compliance officer
to avoid detection
Which one of the following customer actions could

be an indicator of money laundering? Which of the following is a
potential money laundering
A. Depositing $50,000 of registered stock into the
account and directing that it be transferred into street activity?
name
B. Buying a security in advance of the ex-date and
selling after the record date in order to receive a A. Laddering
cash dividend
C. Buying and selling the same security over a short B. Structuring
period of time, incurring significant commission costs C. Diversifying
D. Buying a security and selling short an equivalent
convertible security to lock in a price difference D. Amortizing

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When opening an account for a non-resident Deposits of which TWO of the following by a
alien, the registered representative must obtain customer could be indicators of potential
which of the following from the customer? money laundering?
I United States Passport Number I Cash
II Foreign Country Passport Number II Checks drawn on U.S. banks
III United States Tax Identification Number III Money orders
IV Foreign Country Tax Identification Number IV Wire transfers from U.S. banks
A registered representative (RR) wants to open a new

account for a client who is a resident of Mexico. Which of
Which of the following situations is NOT a the following statement is TRUE?
potential red flag? A customer deposits:
A. Customer verification of the client's personal information
A. cash from an illegal activity is not required if the customer was referred by an existing
client
B. cash in such a way as to evade filing a report
B. Customer verification of the client's personal information
required under the Bank Secrecy Act (BSA) is required if the name is on the Office of Foreign Assets
C. cash from a source that the firm cannot Control (OFAC) list
clearly identify C. The client can have a taxpayer identification number and
D. $12,000 cash a passport number and country of origin
D. The client must have a taxpayer identification number to
open the account
Which of the following customer actions would NOT Which of the following cash transactions must be
be an indicator of potential money laundering? reported to FinCEN under the firm's AML policies?
A. Deposits of bearer bonds to a margin account A. Deposits of cash from a single customer adding to
followed by immediate withdrawals of funds $7,500
B. Extensive wire activity with accounts in countries B. A money order drawn by a customer in the amount
with stringent bank secrecy laws of $7,500
C. Frequent deposits or withdrawals of cash in C. Deposits of cash from a single customer adding to
amounts just under $5,000 more than $10,000
D. Frequent trades of securities of issuers D. Deposits of cash from a single customer adding to
headquartered outside the United States more than $1,000

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FINRA ANTI‐MONEY LAUNDERING FINRA ANTI‐MONEY LAUNDERING
RULE RULE
• firms must: • the AML policy should include “KYC” – Know Your

– establish and implement procedures to detect and Customer – procedures that allow the firm to make
report suspicious transactions; a reasonable risk‐based determination as to its
– provide independent testing for compliance to be customers, its customers’ sources of income, and
conducted by member personnel or a qualified outside expected activity
party; • the policy should breakdown types of suspicious
– designate a principal responsible for monitoring day‐to‐ activity into three areas:
day operations of the program; – wire transfers;
– provide on‐going training regarding money‐laundering – deposits; and
issues – monetary instruments
The main purpose of the Financial Crimes

Annual testing of a member firm's AML program Enforcement Network (FinCEN) is to:
may be conducted by:
A. Block transactions by individuals and companies
A. the designated anti-money laundering not permitted to do business in the U.S.
compliance person B. Create and update lists of Specially Designated
B. a person who performs the functions being Nationals (SDNs)
tested C. Create and implement policies and procedures to
detect and prevent money laundering
C. a qualified outside party or member personnel D. Create and implement policies and procedures to
D. any of the above detect unregistered foreign securities from being sold
in the U.S.
PROHIBITED PRACTICES PROHIBITED PRACTICES
• guaranteeing the customer account against loss • charging excessive commissions
• churning • manipulating the market by “painting the tape”
• front running – if a rep receives a large institutional • wash trades
order that is likely to have an impact on the • trading in mutual fund shares
underlying security, he/she cannot place an order • selling mutual funds just below breakpoint levels
ahead of this order for his/her own benefit
• selling dividends
• reps sharing in the gains/losses in customer accounts
(discussed in detail later) • free riding – buying a security without the intent of
ever paying for it before you sell it

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A customer has $24,000 to invest in mutual fund

shares. The registered representative advises the
customer to invest $8,000 in ABCD fund; $8,000
All of the following are violations of the FINRA
in DEFF fund; and $8,000 in XYZZ fund; to give
Conduct Rules EXCEPT:
the customer complete diversification and to
reduce risk. These 3 funds all have different
A. selling dividends
sponsors. This action is:
B. selling away
C. breakpoint sales
A. appropriate for the customer
D. rehypothecating securities
B. a violation known as a breakpoint sale
C. a violation known as spinning
D. a violation known as interpositioning
A registered representative buying call options on Securities purchased by a customer in a cash

a stock with the advance knowledge of a large account are NOT paid for by the payment date. If
buy order being placed by an institution. This is a the securities are sold by the customer, this is an
prohibited practice known as: example of:
A. Free Riding A. Churning

B. Front Running B. Day trading
C. Interpositioning C. Free-riding
D. Backing Away D. Marking to market
A mutual fund has the following breakpoint A registered representative says the following to
schedule: her customer: "If we do not generate an
investment return of 10% within 1 year, we will
happily refund your money." This statement is:
$0 - $10,000 6%
$10,001-$25,000 5%
A. permitted since the customer benefits from the
$25,001-over 4%
guarantee
Which of the following single purchase amount B. prohibited because it is not known if the
would be considered a "breakpoint sale"? broker-dealer will be in business 1 year later
C. prohibited since this is a guarantee of
A. $1,000 performance
B. $11,000 D. permitted if the broker-dealer maintains
C. $24,000 adequate Net Capital to fund any customer refund
D. $26,000 claims made

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All of the following statements concerning ex-dates

are correct EXCEPT:
A registered representative can promise a
customer that he will resell a security at a
price equal to that paid by the customer: A. on the ex-date, share prices are reduced by the
amount of the dividend
B. on the ex-date, share prices remain unchanged
A. only if agreed to in writing
C. buying shares just before the ex-date is not
B. only if approved by a manager
advantageous for the purchaser
C. only if the customer is sophisticated
D. representatives may not recommend that
D. under no circumstances
customers buy shares just before the ex-date to get
the dividend
If a customer places a very large order to trade a stock that is

likely to have a market impact, the registered representative
may:
Which of the following actions is prohibited when
I buy the stock for his personal account prior to executing selling mutual fund shares?
the order
II not buy the stock for his personal account prior to A. The sponsor selling shares to a selling group
executing the order
III sell stock for his personal account prior to executing the
member at a discount from POP
order B. A selling group member selling shares to the
IV not sell the stock for his personal account prior to public at a discount from POP
executing the order C. The sponsor selling shares to a selling group
member at NAV
A. I and III
B. I and IV D. The sponsor selling shares of a “no–load” fund
C. II and III to the public at NAV
D. II and IV
Step 1: Financial Status
Does the customer have a
net worth or discretionary
income to invest?
Excessive trading in a client’s account for Yes. Step 2: Investment

No
generating commissions is: Recommend that the
Time Horizon
Is the customer investing
customer wait to invest
for long‐term (3‐5 years)?
A. Churning
B. Hypothecation
C. Free riding and withholding No
Yes. Step 3: Determine
D. Commingling Recommend money market Investment Objective
funds

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Customer Accounts
PR E S E R VA TI ON OF CAPI TA L / SAFE TY C URREN T IN C O ME

Recommend:
For Safety:
LIFETIME INCOME
Recommend:
R e co m m e n d :
For Income w/ Safety
Tr e a s u r y S e cu r i ti e s F u n d s
SUITABILITY FACTORS
Treasury Securities Funds GNMA Funds
GNMA Funds For Fixed Income For Higher Income w/ Higher Risk

H i g h ‐ Yi e l d C o r p B o n d F u n d s
For Safety w/ Tax‐Exempt Income
Muni Bond Funds
Fixed Annuity
For Income w/ Inflation Protection
International Bond Funds
F o r T a x ‐ Ex e mp t I n c o m e
• obviously before a rep makes an appropriate
For Safety w/ Liquidity
Money Market Funds
Variable Annuity
Muni Bond Funds
For Income w/ Growth and Low/Moderate

investment recommendation to a customer,
Risk
G r o w t h & I n co m e F u n d s
B l u e C h i p S to ck F u n d s
the rep should obtain the customer's:
CAPITAL APPRECIATION B a l a n ce d F u n d s
Recommend: C o n v e r t i b l e S e cu r i ti e s F u n d s
Eq u i t y I n co m e F u n d s
– 1) INVESTMENT OBJECTIVES;
For Capital Appreciation w/ Low Risk A s s e t A l l o ca t i o n F u n d s
Balanced Funds – 2) FINANCIAL AND TAX STATUS; AND

Asset Allocation Funds
AGGRESSIVE GROWTH
For Capital Appreciation w/ Moderate Risk
Recommend:
– 3) RISK TOLERANCE
Growth Funds
Large Cap Funds For Higher Capital Appreciation w/ Higher Risk
Value Funds Micro‐Cap Growth Funds
S&P 500 Index Funds
Small‐Cap Growth Funds
For Capital Appreciation w/ Higher Risk Sector Funds
International Growth Funds
Emerging Markets Fund
Mid‐Cap Growth Funds
1) CLIENT INVESTMENT OBJECTIVES
(cont.)
– generally, the client has one or more of these – Preservation of Capital
three main investment objectives: • keeping principal safe and avoiding investment loss
• Preservation Of Capital • these investors are conservative and will generally
• Capital Appreciation pursue defensive investment strategies of low risk
• Current Income – Capital Appreciation
• accepting some risk to achieve growth
• Aggressive Growth
– for investors willing to take on even greater risks for the
potential of greater returns
2) CLIENT FINANCIAL/TAX STATUS
(cont.)
– Current Income –to analyze a client's financial status,
• for investors who are more interested in receiving income from
their investments the rep should look at the client's:
• Tax‐Exempt Income
– for investors in high tax brackets who desire income free from • Balance Sheet; and
income tax (like by investing in municipal bonds)
» the return on the municipal investments should be higher than
• Income Statement
the after‐tax return on taxable investments
» note that "private purpose" municipal bonds are taxable
• like for a sports stadium
» "public purpose" municipal bonds are not taxable
• like for a school

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2) CLIENT FINANCIAL/TAX STATUS 2) CLIENT FINANCIAL/TAX STATUS
(cont.) (cont.)
– Balance Sheet
• gives the customer's financial situation
– Income Statement
• Assets = Liabilities + Net Worth • shows the client's income and expenses over
– Assets are what the client owns
» Current Assets are ones that can be transferred into cash quickly (like
the entire year
securities)
• Discretionary Income = Total Income – Total
» Fixed Assets are ones that cannot readily be turned into cash (like real
estate) Expenses
– Liabilities are what the client owes
» Current Liabilities are bills that must be repaid within 1 year (like a credit • Disposable Income = Total Income – Taxes (i.e.
card bill)
it does NOT consider expenses)
» Long‐Term/Fixed Liabilities are bills payable in more than 1 year (like a
mortgage)
– Net Worth is what is left from the Assets after paying the Liabilities
3) RISK TOLERANCE AND TIME 3) RISK TOLERANCE AND TIME
HORIZON HORIZON (cont.)
– Risk Tolerance • for those not as aggressive, but risk tolerant might invest in
growth funds, value funds, international funds, and similar
• probably the most important of all suitability common stock funds
considerations • more conservative investors who tolerate only a moderate level of
• risk takers are aggressive investors seeking higher risk might find a growth and income fund or a blue‐chip stock fund
more suitable
returns
• for risk averse investors seeking preservation of capital, a
– for those that want current income, a high‐yield bond fund
government securities fund might be suitable
might be suitable
• regarding senior citizens it should be noted that while many
retired individuals are risk averse, some might still tolerate a more
aggressive investment, like one in a common stock fund
3) RISK TOLERANCE AND TIME 3) RISK TOLERANCE AND TIME
HORIZON (cont.) HORIZON (cont.)
– Investment Time Horizon – Volatility
• the length of time a customer expects to hold an • the fluctuation of the value of invested capital as
investment market prices change
– customers should have liquid assets to meet short‐term • aggressive growth funds are likely to have greater
needs, including emergency needs changes in value than other funds (like a balanced
• stocks should normally be purchased for one who has a fund) during periods of stock market volatility
time horizon of at least 3‐5 years • interest rate changes affect long term bond funds more
• a customer who needs money within a short time than short‐term bond funds
should invest in a money market fund • high‐volatility investments are suitable to more risk‐
tolerant customers

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3) RISK TOLERANCE AND TIME FINRA RULES REGARDING
HORIZON (cont.) RECOMMENDATIONS
– the rep should review a customer's suitability • before making a recommendation, reps must
factors periodically to make sure of any changes in make a reasonable effort to obtain the
the customer's investment objectives/situations customer's (suitability):
– financial and tax status;
– investment objectives; and
– any other info considered reasonable when
making a recommendation
FINRA RULES REGARDING
RECOMMENDATIONS (cont.)
• if the customer refuses to provide sufficient
personal information, the rep cannot make The definition of net worth for a customer is:
recommendations, but can still open the
A. assets minus liabilities
account and accept unsolicited orders from
B. income minus expenses
the customer C. assets plus liabilities
D. capital plus income
Why should a registered representative

determine a customer’s net worth?
All of the following would be found on a client's
A. It reveals the liquid assets that should be personal balance sheet EXCEPT:
invested for the customer
B. It discloses whether the customer has the A. cash in savings accounts
ability to invest presently B. mortgage interest paid
C. It determines the minimum amount to be C. equity in a brokerage firm account
invested for the customer D. mortgage loan payable
D. It is a major determinant of the customer’s
investment time horizon

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Customer Accounts
A customer's balance sheet shows the following:

Cash: $130,000
Securities: 0
Automobile: $25,000
Home: $300,000
Which of the following are NOT short term Unsecured Credit Line Payable this Year: $5,000
Credit Cards Payable: $5,000
emergency sources of cash? Auto Loan Payable: $15,000
Mortgage Payable: $100,000
A. Credit card advances
Assuming this customer's income exceeds expenses and that the
B. Margin loans from a broker-dealer customer will need a $20,000 emergency cash reserve, the amount that
C. Cash value of term life insurance is available for investment in a portfolio is:
D. Home equity line of credit
A. $5,000
B. $50,000
C. $100,000
D. $125,000
A customer has the following balance sheet:

Cash: $ 20,000 Your customer, a recent college graduate, has $3,000 in
Marketable Securities - Money Fund: $ 50,000
Market Value Retirement Portfolio: $100,000 savings. Her only debt is a $20,000 school loan, payable
Market Value - Cars: $ 30,000 in $2,000 installments over the next 10 years. She is
Market Value - Home: $400,000 considering a mutual fund investment of the $3,000 in
Market Value - Personal Items and Furnishings: $ 60,000 savings to meet future loan payments. Which
Bills Payable: $ 50,000 recommendation is most suitable for this customer?
Car Loan: $ 15,000
Mortgage on Home: $250,000
A. She should invest the $3,000 in an aggressive growth
The amount that the customer has available for investment, assuming a fund
$20,000 cash reserve, is: B. She should invest the $3,000 in an income fund
C. She should invest the $3,000 in a balanced fund
A. $0
B. $50,000 D. She should defer investment of the $3,000 until she
C. $70,000 has enough savings to meet emergency needs
D. $100,000
Which of the following formulas correctly

Total income minus taxes and expenses is: describes discretionary income?
A. Disposable income A. Total income – Total expenses

B. Discretionary income B. Total income – Total liabilities
C. Fixed liabilities C. Net income – Total expenses
D. Current liabilities D. Total Income – Taxes

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Customer Accounts
A registered representative has just had a meeting

at a new customer’s home, and the customer has
Before making a recommendation to a customer, requested a recommendation of a mutual fund.
a registered representative must make a Before the representative can recommend a mutual
reasonable effort to obtain all of the following fund, what must the representative do?
customer information EXCEPT:
A. Obtain the customer’s signature on a new
A. Knowledge of investments account form
B. Risk tolerance B. Request a check to set up an account
C. Investment objectives C. Ask for customer information on financial status
D. Financial status D. Describe the risks of investing in the stock
market
When a registered representative is making an

A registered representative is asked to investment recommendation to a customer, which of
recommend some highly volatile investments the following considerations is the LEAST
that will be appropriate for a client. Under important?
FINRA rules, the registered representative
must inquire about all of the following EXCEPT A. The customer's future needs for money for a
the client's: child's education, retirement, etc.
B. The customer's risk tolerance, income, net worth,
A. investment objectives and investment objective
B. knowledge of investment strategies C. The customer's previous investment experience
C. net worth and sophistication
D. risk tolerance D. The customer's ability to commit money to
investment for long time periods
Which of the following considerations is LEAST

If a customer refuses to disclose personal important for determining a customer’s risk
financial information during a suitability tolerance?
determination, the registered representative:
A. The customer’s income fluctuates from period
to period
A. can make recommendations to that client B. The customer has an adequate fund for
B. cannot make recommendations to that client emergencies
C. cannot open an account for that client C. The customer has little discretionary income
D. must file an SAR report on that client D. The customer is interested in tax exempt
income

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When a registered representative investigates

Which of the following investment objectives
suitability factors for a client, the measure of the
is only appropriate for an investor with a high
period of time until a client needs to liquidate the
risk tolerance?
investment is called:
A. Capital appreciation
A. Risk tolerance
B. Current income
B. Time horizon
C. Aggressive growth
C. Market risk
D. Tax exempt income
D. Liquidity risk
Which statement is FALSE about making a determination

of a customer's time horizon?
Which of the following mutual funds is
A. A client should not make some investments unless the appropriate for an investor with a short
client can hold that investment for a minimum period of investment time horizon?
time
B. A client with a long time horizon will want to make
different investments from those made by clients with A. Money market fund
short time horizons B. Growth fund
C. A client with a short time horizon should select C. U.S. Treasury Securities fund
investments with high safety and liquidity D. Balanced fund
D. A client with a short time horizon will have more
choices from which to select a suitable investment
While meeting with a new client, you discover that she is 82

years old and is new to investing. The client is retired, lives Which customer would suffer the greatest
on Social Security and a small pension, and does not have a harm from a loss of income on an
mortgage on her home. She recently sold some property
investment?
that was her only major asset except for her home. She
does not have a will, and her health is poor. As her
registered representative, you should: A. A recent college graduate who has started
her first job
A. offer to help her draw up a will on some new software you B. A retiree whose main source of income is
bought social security
B. insist that both she and her accountant sign all
C. A middle-aged divorced woman who is
documents
C. require that another person accompany the new client to looking to re-enter the workplace
verify your conversations D. An older worker who is covered by a
D. take particular care in making suitable investments and defined benefit plan
thoroughly explain any potential investments

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Customer Accounts
In order to recommend a variable annuity to a

customer, the registered representative should
have a reasonable basis to believe that the
customer would benefit from All of the following investments can be
recommended to a customer whose
I tax-deferred growth of the separate account investment objective is preservation of capital
II the assurance of receiving income for life EXCEPT:
III any living or death benefit provided by the
contract A. GNMA pass-through certificates
B. U.S. Treasury notes
A. I only C. Money market fund
B. I and II D. Growth stock mutual fund
C. II and III
D. I, II, III
A registered representative calls on a retired 80–year–old

A customer believes the stock market will rise widow. She is a conservative investor and is not sure how to
invest $50,000 inherited from her sister. She is in the 15%
over the next few years. Which of the following income tax bracket and receives a small pension and Social
investments would give the greatest asset Security. She is in good health and needs additional
appreciation in a rising market? income. Which of the following would be a logical and
appropriate investment objective for this widow?
A. Income fund
B. Common stock fund A. Current income with growth
B. Growth of invested capital
C. Bond fund C. Current income with stable capital
D. Balanced fund D. Maximum inflation hedge
If a customer wants to receive income from an

All of the following investments will be appropriate
investment to pay current expenses, but also wants
to recommend for an investor whose objective is
some protection from inflation, what is the
aggressive growth EXCEPT:
customer’s investment objective?
A. Emerging market stocks
A. Current income
B. Large company stocks
B. Capital appreciation
C. Small company stocks
C. Growth and income
D. Technology stocks
D. Aggressive growth

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Customer Accounts
Amanda has a lunch meeting with a new client,

Samantha, who is age 23. During the meeting, Amanda
learns that Samantha is a recent engineering graduate
and has just started a new job with a local firm.
Which of the following investments should be Samantha feels that her new job will take so much of her
recommended to a customer whose time that she will not have any time to learn much about
investing. Amanda also learns that Samantha has $8,000
investment objective is tax exempt income? to invest. Samantha asks Amanda to recommend a
mutual fund for her investment. What recommendation
A. Corporate bond fund should Amanda make?
B. Municipal bond fund
C. Blue-chip stock fund A. Amanda does not have enough client information to
D. Convertible bond fund make a recommendation
B. A sector fund because Samantha is very young
C. A U.S. Treasury Bond Fund for safety because
Samantha knows little about investing
D. A balanced fund to provide wide diversification
A client, age 68, currently has an investment portfolio worth

$600,000, which consists of $200,000 invested in an Nicole is 23 years old and a recent college
emerging markets fund, $200,000 invested in a growth fund, graduate. She is single with no children and has
and $200,000 invested in a Treasury securities fund. The an annual income of $28,000. She is renting an
client informs you that he has just retired and wants to apartment and saving to buy a condominium
increase the income that he earns from his investments, and
within the next 3 years. She carries a $28,000
that he wants a high level of safety due to his advanced age.
The best recommendation would be for the customer to:
group life policy through her employer and has
saved $3,400. She is considering investing the
A. liquidate the Treasury securities fund and invest the $3,400. Which variable annuity product should
proceeds in a high yield bond fund her registered representative recommend?
B. liquidate the emerging markets fund and invest the
proceeds in an income fund A. Periodic premium, immediate annuity
C. liquidate the growth fund and invest the proceeds in an B. Periodic premium, deferred annuity
aggressive growth fund C. Fixed annuity
D. do nothing, since the portfolio is properly allocated to meet D. An annuity is inappropriate for this client .
the customer's objectives and needs
Ellie is a 28-year old nurse. She is single with an income of

$50,000 a year. She has saved $4,000 for a down payment on A married couple comes to your office seeking
a townhome and has an emergency fund. She hopes to buy the investment advice. They are currently holding
townhome within 3 years. She has adequate insurance and
$100,000 until a lawsuit is settled. If they lose the
fully funds her retirement plan at the hospital. She is interested
in purchasing a variable annuity to defer taxes until she buys case, they will need the money to pay the judgment.
the townhome. All of the following statements about Ellie's The case may take 2 or more years to settle, so they
planned purchase of an annuity are correct EXCEPT: are concerned about the safety of the investment.
A. a liquidation of the contract in 3 years will result in the
They do not feel that they can take any risk with this
imposition of surrender fees money. What is the most suitable recommendation for
B. her investment time horizon is too short for an annuity these clients?
because of the loss of up-front sales charges imposed on the
contract
C. a liquidation in 3 years will result in a 10% penalty tax A. ABC Money Market Fund
imposed on any investment gains B. ABC Corporate Bond Fund
D. the tax-deferral offered by the contract will more than offset C. ABC Value Fund
the costs involved with investing in an annuity contract for only
D. ABC Municipal Bond Fund
3 years

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Customer Accounts
Douglas and Melinda are 68 years of age and have

A young married couple plan on buying a been retired for three years. They receive Social
house within the next 9 months. They would Security and pension benefits and have paid off the
like to see their money grow as much as it can mortgage on their home. Douglas has received an
over that time frame, maximizing their return. inheritance of $50,000 from his brother who just died.
Douglas wants a safe investment so he can leave the
Which of the following terms does NOT apply
money as an inheritance for their daughter, but they
to this situation? would like to use the income during their lifetimes.
Which of the following recommendations is suitable for
A. Liquidity Douglas and Melinda?
B. Conservation
C. Growth A. Ginnie Mae fund
B. U.S. Treasury bond fund
D. Time Constraints That Limit Investment
C. Balanced fund
Options D. Asset Allocation fund
A wealthy customer in the highest federal and state

tax bracket wishes to minimize income tax liability,
A customer that is willing to assume risk in return
yet invest with a high level of safety. The best
for achieving a high level of current income would
recommendation is a(n):
invest in a(n):
A. municipal bond fund of his or her state of
A. emerging markets fund
residence
B. high yield bond fund
B. municipal bond fund of any state rated AA or
C. convertible bond fund
better
D. municipal bond fund
C. U.S. Treasury securities fund
D. investment grade corporate bond fund
All of the following recommendations are

Which recommendation is appropriate for a
appropriate for a customer seeking defensive
customer seeking a defensive investment?
investments EXCEPT:
A. Tool and die company
A. money market funds
B. Automobile distributor
B. utility stocks
C. Building materials company
C. defense company stocks
D. Pharmaceutical manufacturer
D. food company stocks

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Customer Accounts
Which of the following investment

recommendations are most suitable for a
customer seeking growth with lower than
All of the following mutual fund investments average risk?
would be appropriate for a customer who
seeks both income and growth EXCEPT a(n): I ABC Money Market Fund
II ABC Balanced Fund
A. REIT fund III ABC Small Cap Growth Fund
B. convertible bond fund IV ABC Asset Allocation Growth Fund
C. balanced fund
D. specialty fund A. I and III
B. I and IV
C. II and III
D. II and IV
You have just received updated information on the Zenith

Precious Metals Fund that looks very interesting. The
fund invests in mining interests throughout the world.
Although the fund is only three years old, the manager
All of the following investments offer an objective
has a great reputation, and the fund has performed very
of growth with a moderate level of risk EXCEPT: well. What characteristics would make a client a potential
investor in the fund?
A. Standard and Poor's Mid-Cap 400 Fund
B. Value fund A. Clients with low risk tolerance and a capital
C. Large Cap Global Equities Fund appreciation investment objective
B. Clients with high risk tolerance and a short investment
D. Russell 2000 Index Fund
time horizon
C. Clients with high risk tolerance and aggressive growth
investment objective
D. All clients deserve this investment opportunity
A working husband and wife, ages 26 and 28, have 2

young children that are now 2 and 4 years old. They earn
Which of the following mutual fund investments
a combined $48,000 per year and are in the 15% tax
bracket. They wish to start a college fund for the kids by would be appropriate for a customer that seeks
making an investment that is safe and that has the lowest safety and growth to fund a child's college
capital commitment. Which of the following investments education 15 years from now?
would be the best recommendation?
A. REIT fund
A. 15 - 20 year maturity Corporate income bonds
B. Zero-coupon Treasury fund
B. 15 - 20 year maturity Treasury STRIPs
C. 15 - 20 year maturity General Obligation bonds C. Balanced fund
D. 15 - 20 year maturity Mortgage Backed Pass-Through D. Specialty fund
Certificates

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Customer Accounts
Johnny is a 35-year old professional with an annual

Louise is a 63 year old widow who has just retired. Louise owns her home, income of $150,000. He has no debt except his mortgage
has no debt, and lives on Social Security payments, a pension, interest and has put away a substantial emergency fund “just in
from her Certificates of Deposit, and a passbook savings account at a local case” he needs it one day. Johnny makes the maximum
bank. Two of her CDs are due to mature, and interest rates have dropped.
Louise would like an investment that will provide more in monthly income contribution to his firm’s 401(k) plan. He recently received
than her CDs will at the new lower interest rate. She is concerned about a $50,000 bonus for his outstanding work on a project at
meeting her expenses if her income drops, and she is risk averse. Her his firm. He comes to you for investment advice for the
representative recommends ABC Equity Asset Allocation Fund to Louise. bonus. He tells you that he is looking for growth with a bit
The fund has had outstanding performance over the past 3 years and is of income, but is not willing to accept much risk and that
managed by a well known money manager. Is the representative’s
recommendation suitable for this client? he plans to keep the investment for at least 10 years.
Which is the LEAST suitable recommendation?
A. Yes, the past performance and manager make this a good
recommendation A. Zenith Balanced Fund
B. Yes, the fund will meet the client’s objective B. Zenith Emerging Markets Fund
C. No, the fund will not meet the client’s objective of monthly income
D. No, the fund’s risk level is too low for the client C. Zenith Blue Chip Equities Fund
D. Zenith Asset Allocation Fund
Recommendations of low-price speculative Which statement is TRUE about a representative that

securities to customers are: recommends that a customer trade mutual fund shares on a
short-term basis?
A. prohibited under FINRA rules A. These securities are not proper trading vehicles and such
B. permitted only if they are made in writing and an activity is, on its face, a rule violation
not over the telephone B. These securities are listed and trade like other stocks, so
C. permitted only if information is collected about this is a permitted practice
the customer's other financial holdings and C. These securities can only be traded if the fund has closed
itself to new investment and the shares cannot be
financial situation and needs
purchased in the normal manner
D. permitted if the customer signs an arbitration D. These securities must be on the "Legal List" in order for
agreement prior to the first trade trading to be authorized
A customer sells stock out of an account, receiving

net proceeds of $38,000. The customer wishes to use
the proceeds to buy ACME mutual fund shares. The
A breakpoint sale is defined under FINRA rules as
fund has a breakpoint at $40,000. The customer has
a purchase of mutual fund shares:
no additional funds available for investment. You
should recommend that the customer:
A. in an amount sufficient to afford the investor a
reduced sales charge
A. invest in a fund with lower breakpoints
B. just below the amount sufficient to afford the
B. sign a Letter of Intent to buy $40,000 of ACME
investor a reduced sales charge
fund
C. under a Letter of Intent
C. invest an additional $2,000 in ACME fund in
D. through automatic reinvestment of dividends
addition to the proceeds from the stock sale
D. refrain from investing in ACME fund until the
customer accumulates $40,000

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A representative makes the following recommendation to a

Which statement concerning a mutual fund’s customer: "You should buy 1000 shares of ABCD stock which is
breakpoints is TRUE? currently trading at $40 because it has the potential to appreciate
by 25% in the near term." The customer likes the
recommendation, but explains that he only has $4,000 available
A. A sale below the breakpoint means a lower for investment right now. The representative should tell the
dealer commission customer to:
B. A dealer may not recommend a larger sale to A. take a home equity line on his house to obtain the $40,000
reach a breakpoint necessary to make the investment
C. FINRA rules allow breakpoint sales because B. borrow from family members to obtain the $40,000 necessary
investors are buying dividends to make the investment
C. buy 100 shares of ABCD instead of the recommended amount
D. Recommending a Letter of Intent to reach a of 1000 shares
breakpoint is an acceptable business practice D. close his account since he cannot make minimum purchase
payments
Which statement concerning ex-dates is TRUE?

Excessive trading in a client account for the sole
purpose of increasing a representative's
A. On the ex-date, the share price rises
commission income is:
B. On the ex-date, the share price remains
unchanged
A. discretionary trading
C. Buying shares just before the ex-date is
B. front running
advantageous to receive the dividend
C. churning
D. Buying shares just before the ex-date to
D. shadowing
receive the dividend is not advantageous
An institutional client placed a large order to sell

shares and before the order was executed, the
registered representative executed the sale of the A member firm is permitted to sell a mutual
same stock in his own account. This is a prohibited fund at a discount from the Public Offering
practice known as: Price to:
A. institutional customers
A. Front running B. retail customers
B. Free riding C. any customer who requests
C. Selling away D. another member firm
D. Churning

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A customer places an order to buy mutual fund shares

directly from the fund wholesaler (fund underwriter)
and, therefore, does not use a broker–dealer included
in the fund’s selling group. Under FINRA rules, all of
the following statements concerning this transaction
are true EXCEPT:
A. the wholesaler must be a registered FINRA

member
B. the customer must pay the POP as the prospectus
describes it
C. the wholesaler can offer the customer a lower sales
charge since it will pay no concession to a selling
group member
D. pricing must be based on the next computed NAV
Series #6 Customer Accounts 217

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Regulations
‘33 VS ‘34 SECURITIES ACT OF 1933

• Securities Act of 1933 • new issues need detailed prospectus before
– primary market purchase
– new issues • SEC mandates that all nonexempt issues
register and file an S1 statement
• Securities and Exchange Act of 1934
• SEC mandates full and fair disclosure only
– secondary market – SEC does NOT approve or disapprove of the offering
– trading markets – SEC does NOT set nor recommend the public
offering price
• need a registration statement filed with SEC
before sales related activities can take place
Series #6 Regulations 1 Series #6 Regulations 2
ONCE THE REGISTRATION

SECURITIES ACT OF 1933 (cont.)
STATEMENT HAS BEEN FILED
• before filing a registration statement with the
SEC, NOTHING can happen, but after filing:
– 20 day cooling off period, during which: Prohibited Activities Allowed Activities
• full and fair disclosure is required sales of the issue distributing red herring
– DUE DILIGENCE soliciting accepting indications of interest
» making sure that disclosure is adequate and advertising publishing tombstones
truthful
• omission or misstatement of material fact is fraud
• if SEC is not pleased with the information provided, it
will submit to the corporation a deficiency letter,
requiring MORE disclosure
TOMBSTONES &
PRELIMINARY PROSPECTUS
ADVERTISING
• called "red herring" because it says "THIS IS • Tombstone Ad (really an "announcement")
NOT AN OFFER TO SELL...." in red ink need not be accompanied by a prospectus
• used by brokers to obtain an indication of as it says on it "this is not an offer to sell or
interest from potential buyers solicit…" and "…the offer can only be
• syndicate meets during 20 day cooling off period made with a prospectus…"
with "indications of interest" in hand
– if increasing interest in issue, price will likely be raised
(or interest rates lowered)

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Regulations
TOMBSTONES & TOMBSTONES &

ADVERTISING (cont.) ADVERTISING (cont.)
• MUTUAL FUND ADVERTISING is limited to: • GENERIC ADVERTISING
– the type of fund (i.e. common stock fund, bond fund, – does NOT make reference to a specific security, but
etc…) rather refers to the investment company in general
– identifying its investment adviser terms (i.e. how to contact the firm to obtain info
– if the fund wishes to include additional info on regarding investments)
investment objectives, services, aggregate NAV, – a prospectus is NOT required for generic advertising
etc…then the following legend is contained in the ad: – may only name the principal underwriter, while
• "For more complete info about the [name of the fund], send tombstones can name the specific fund, adviser, or
for a prospectus from [name/address]. Read it carefully investment company
before investing."
• note that neither Tombstones nor generic ads
provide performance information
Which of the following activities are allowed before

A preliminary prospectus may first be sent to registration is filed?
a customer:
I Sending a customer a "red herring" preliminary
prospectus
A. prior to the filing of a registration II Accepting an indication of interest from the
statement with the SEC customer
B. once the registration statement has been III Accepting a deposit from the customer
filed with the SEC IV Accepting a firm order from the customer
C. once a final price amendment has been A. I and II
filed with the SEC B. III and IV
D. once registration is effective C. II and IV
Which of the following activities are allowed once

registration is filed?
Which of the following can be found in an
I Sending a customer a "red herring" preliminary initial public offering preliminary prospectus?
prospectus
II Accepting an indication of interest from the
customer A. The public offering price of the issue
III Accepting a deposit from the customer
IV Accepting a firm order from the customer B. The current market price of the issue
A. I and II C. The financial statements of the issuer

B. III and IV
D. The SEC statement of approval of the issue
C. II and IV

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Distribution of a preliminary prospectus Once registration is effective for a non-exempt

during the 20-day cooling off period for a new issue, customers that previously received a
new issue that is in registration with the preliminary prospectus during the 20-day cooling
off period are:
SEC is:
A. automatically confirmed with a purchase of
A. prohibited under the Securities Act of the issue
1933 B. contacted by the underwriter to see if they
B. used to determine the level of investor wish to purchase the issue
interest in the issue C. obligated to buy an amount of the issue
C. used to solicit customers to buy the issue determined by the underwriter
D. used to recommend the purchase of the D. permitted to make a competitive bid for the
issue to customers issue
Which statements concerning mutual fund tombstone

An advertisement in a newspaper states that advertisements and generic advertisements are
Bean, Stalk & Co. sells growth funds. Which of correct?
the following statements about this
advertisement is correct? A. A tombstone advertisement is an offer to sell a
security while a generic advertisement is not
A. This advertisement is a generic ad B. A tombstone advertisement must include information
B. This advertisement must include a on where to obtain a prospectus but a generic
statement as to where to obtain a prospectus advertisement does not
C. Bean, Stalk, & Co. is an investment C. A generic advertisement must include price
company information but a tombstone advertisement does not
D. This advertisement must be filed with D. A generic advertisement may name the specific
security offered but a tombstone advertisement may
FINRA 30 days in advance of use
name only the underwriter
MUTUAL FUND PROSPECTUS

SECURITIES ACT OF 1933 (cont.)
INCLUDES:
• fund investment objective and policies – after 20 day period and there's issuer compliance,
• sales charges and breakpoints, if applicable registration is effective and issue can be sold
• fund expenses and expense ratio – prospectus delivered at or prior to confirmation of sale
• methods for buying and redeeming shares
• also, investors can find the fund's current holdings and other financial – 90 day prospectus delivery
statements in the prospectus OR in the Statement of Additional • primary offering of non-NASDAQ stocks
Information (SAI) which is available only upon customer request
– 40 day prospectus delivery
– financial statements include:
• secondary primary offering of non-NASDAQ stocks
• current schedule of investments
• assets & liabilities • if issuer has outstanding stock and wants to perform
• income & expenses
another offering
• statements of changes in net assets – 25 day prospectus delivery
• auditor's report • for exchange listed and NASDAQ issuers

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If the SEC sends a deficiency letter to the issuer

SECURITIES AND TRANSACTIONS
regarding an issue in registration, which of the following EXEMPT FROM THE ACT OF 1933
are true? • EXEMPT ISSUES
– U.S. Gov'ts, Agencies, Muni's, & Foreign
I disclosure in registration is complete Government Obligations
II disclosure in registration is not complete
– Issuers already regulated under other laws
III the SEC will allow registration to be effective after • Bank issues
20 days • Insurance company offerings (EXCEPT variable
IV the SEC will allow registration to be effective after annuities) covered under state insurance laws
adequate documentation has been provided • Common Carrier Issues (i.e. railroads, trucking
companies,…
• Public Utility issues
A. I and III
• NonProfit and Charitable Organizations Issues
B. I and IV
• Banker's Acceptances and Commercial Paper as long as
C. II and III the maturity is 270 days or less
D. II and IV • Small Business Investment Company issues (SBIC)
Which of the following are exempt securities under the

Securities Act of 1933?
All of the following are exempt securities I US Gov't bonds
under the Securities Act of 1933 EXCEPT:
II General Obligation bonds
III Mortgage bonds
A. Charitable organization issues
B. Commercial Paper maturing under 270 IV Convertible debentures
days A. I and II
C. Foreign Government obligations B. III and IV
D. Industrial machinery issues C. II, III, IV
D. I, II, III, IV
PERFORMANCE DATA
Commercial paper is an exempt security as
long as its maturity does not exceed: • if performance data is shown in an
investment company ad, it must state
something to the effect that "past
A. 30 days performance is not indicative of future
B. 60 days results" and that "investment return and
principal may fluctuate"
C. 90 days • note: money market funds do not need to
D. 270 days make a disclosure about fluctuation of
principal

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PERFORMANCE DATA (cont.) PERFORMANCE DATA (cont.)

• Fee Disclosure • furthermore, if the fund includes performance data, it is
limited to quoting the following types of performance info:
– if the fund has a load or other nonrecurring – 1) AVERAGE ANNUAL TOTAL RETURN
fees, the advertisement of performance data • total return is shown as if dividends and capital gains were
reinvested
must disclose the maximum amount of the
• must be for 1, 5, and 10 year periods – or for the life of the fund if
load/fee; OR shorter
– that the data does not reflect the deduction of – 2) CURRENT YIELD
• if a yield is shown in advertising, it must show a current yield
fees and that the performance data would be quotation and compute the yield over a 30-day period
reduced if fees were deducted • also, a quotation of total return must accompany the current yield
quotation
Which of the following statements concerning a

PERFORMANCE DATA (cont.) mutual fund advertisement that includes
performance data is TRUE?
– 3) TAX EQUIVALENT YIELD
• if quoted, the Total Return and Current Yield must A. The advertisement must state that the return on
also be included investment will fluctuate
– 4) HISTORICAL MEASURES OF PERFORMANCE, B. The performance data cannot deduct sales
reflecting all of the elements of return charges or other non-recurring fees
C. An advertisement for a money market fund must
• lastly, sales literature and oral
include a statement that NAV cannot fall below $1
communications can NOT (obviously) be per share
misleading D. The advertisement must state that the
performance data shown predicts future
performance
The Atlantis Bond fund has prepared a piece of

Sales literature for the Atlantis Growth and sales literature to send to prospective customers,
Income fund contains a performance chart showing the fund's yield. How is the fund
showing "Total Return." The chart must cover: required to calculate the yield for this purpose?
A. at least 6 months A. It must use the standard 7-day effective yield
B. at least 12 months B. It must use the standard 30-day current yield
C. at least 10 years or the life of the fund, C. It must use the lower of the 7-day effective
whichever is shorter yield or the 30-day current yield
D. a period that includes both a rising and falling D. It must use the annualized total return for 1-,
market 5-, and 10-years

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When making a sales presentation about investment SECURITIES AND EXCHANGE

company securities, which of the following is
permitted? ACT OF 1934
• M anipulation
A. Comparing the investment company's returns to • I nsiders
that of a relevant index
• S EC created
B. Discussing the benefits of the investment more
• S hort Sale Rule
prominently than the discussion of risks of the
investment • P roxy Rules
C. Discussing the methods of operation of the mutual • E xchanges must register with the SEC
fund while omitting the limitations associated with • R eports annual and quarterly financial reports
these methods • M argin control over credit on securities given to
D. Portraying past income generated by the fund in a Federal Reserve
manner that implies that the same income would • S tabilization
result in the future
A primary offering has been made to the

public by ABC Company. A new
shareholder decides to dispose of his or
The Securities Act of 1934 regulates all of
her stock immediately. The stock would be
the following markets EXCEPT:
sold in which of the following markets?
A. Primary
A. Primary market
B. Secondary
B. Secondary market C. Third
D. Fourth
C. New issue market
D. Initial public offering market
PROVISIONS OF SECURITIES
AND EXCHANGE ACT OF 1934 MANIPULATION
• act does not apply to exempt securities • manipulation is fraud whether the
– BUT, fraud provisions apply to both exempt securities are exempt or nonexempt
and nonexempt securities • SECTION 9
– unlawful practices
– i.e. sale of security using false statements,
effecting wash trades,...
• Wash Trades
– buying and selling to create "appearance" of trade (a.k.a.
“painting the tape”)

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MANIPULATION (cont.) MANIPULATION (cont.)

– Trading Pools • suit must be brought within 1 year of
• investors group together and "trade" stock discovery, but no later than 3 years after
to move up prices without actually changing violation occurred
ownership of stock
– Trading by Underwriters
• trading a new issue before its effective date
MANIPULATION (cont.) Fraud, in the trading of which of the following securities, is a

violation of the Securities and Exchange Act of 1934?
• Rule 10b5 I U.S. Government bonds
– "catchall" fraud rule
– states that it is illegal to commit undefined actions II Municipal bonds
that would operate as a fraud III Corporate bonds
– anything Act doesn't specify can be fraud
IV Corporate stock
– see, if the SEC defined EXACTLY what amounted
to fraud, then scheming individuals (schlockers)
would try to circumvent the "definition" of fraud A. I and II
and do things just up to the point of FRAUD and
B. III and IV
get away with it
• SECTION 15 C. II, III, IV
– requires broker-dealers to be registered D. I, II, III, IV
INSIDER RULES INSIDER RULES (cont.)

• insiders are prohibited from trading based on
non-published info. • brokers/dealers must have
• technical insider definition under 1934 Act procedures to prevent misuse of
– officer, director, or 10% shareholder material nonpublic info.
• court's definition of insider – Chinese Walls
– person receiving nonpublic info. that can influence • set to fully segregate info. flow;
price of stock and trading on info. • a company's true identity may be known by
– liability for tipper AND tippee only top management
– once info. is public, person can trade

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INSIDER RULES (cont.) INSIDER RULES (cont.)

• Violation For Insider • Informer Bounty
– minimum penalty is the greater of 3 times profit
achieved or loss avoided (treble damages) – to be paid up to 10% to informants of
– criminal penalties include $5MM fine and up to 20 infractions
years in jail! – insiders can be sued by any person who
– note that if a "controlling person" knew of insider traded that security during time period inside
trading activity and recklessly disregarded the fact
that a violation occurred, then that person could also trades occurred
be subject to a $25MM fine
• fines are payable to the Department of
Treasury
INSIDER RULES (cont.) Which of the following can be considered an insider?

I President of a company
• Short Swing Profits II Secretary of a company
– profits derived from "insider" trades within a 6
III Accountant for a company
month period
– must be paid back to corporation IV Lawyer for a company
A. I and II only
B. II and III
C. III and IV
D. I, II, III, IV
The president of a company is out playing golf with a

Under the Securities and Exchange Act of 1934, a registered representative and tells her, in confidence,
short swing profit is defined as a profit derived on a that this will be the best quarter ever. Based on this
information, the registered representative buys this
security by an insider within:
stock. Who, if anyone, has violated the insider trading
rules?
A. 3 months
A. the registered representative only
B. 6 months
B. the president only
C. 9 months
C. both the registered representative and the president
D. 1 year D. neither the registered representative nor the
president

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MISSPERMS (cont.) MISSPERMS (cont.)

• SEC CREATED • EXCHANGE
– regulates securities only, NOT insurance products, – and member firm registration with the SEC
commodities, or future contracts – members must comply with:
• SHORT SALE RULE • Net Capital Rule requirements
– short sales must be effected on an uptick or a • segregation of fully paid customer securities
zerouptick • segregation of excess margin securities
• notification of free credit balances and that
• PROXY SOLICITATION these funds are available upon request
– shareholders are given a fair opportunity to vote • notification of broker / dealer financial condition
through the use of proxies (semiannual balance sheet reports are sent
out)
MISSPERMS (cont.) Which of the following are included in the 10K?

I Income statement
• REPORTS II Balance sheet
– 10K Report – audited annual report
III Retained earnings statement
– 10Q Report – unaudited quarterly
IV Cash flow statement
report
– 8K Report A. I and II only
• corporate reports of "big" changes at the B. III and IV only
company such as: C. I, II, III
– a change in Board of Directors
– filing bankruptcy, a merger, etc... D. I, II, III, IV
MISSPERMS (cont.)
Which of the following is true about credit on
new issues?
• MARGIN REGULATION
– Reg. T A. new issues are marginable as long as the
• controlling credit from broker to customer offer is made with a prospectus
– Reg. U B. new issues are not marginable until the
• controlling credit from bank to broker effective date
– credit is not allowed on nonexempt new C. new issues are not marginable until 30 days
issues, only on nonexempt "listed" from the completion of the offering
securities (ones trading) D. new issues are not marginable until 60 days
• new issues cannot be margined until 30 days from the completion of the offering
after the completion of the offering

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MISSPERMS (cont.)
The federal regulation that controls credit
from bank to broker is: • STABILIZATION OF NEW ISSUES IN THE
TRADING MARKET
– rules:
A. Reg. T • only one stabilizing bid is allowed; placed by
manager
B. Reg. U • bid placed at or below P.O.P., never above
• "notice of stabilization" on prospectus
C. Reg. Q • bid is withdrawn when syndicate is disbanded
D. Reg. G
The provisions of the Securities and Exchange

Which of the following are covered under the
Act of 1934 apply to which of the following
Securities and Exchange Act of 1934?
activities?
I registration of broker/dealers
I trading of municipal bonds
II registration of exchanges
II issuance of municipal bonds
III registration of new issues
III issuance of corporate financial statements
IV stabilization of new issues
IV trading of corporate bonds
A. I only
A. I and II only
B. I, II, IV
B. III and IV only
C. II, III, IV
C. I, III, IV
D. I, II, III, IV
D. I, II, III, IV
The general provisions of the Securities and The Securities Exchange Commission was
Exchange Act of 1934 apply to all of the created under the:
following EXCEPT:
A. Individuals trading non-exempt securities A. Securities Act of 1933

B. Individuals trading exempt securities
C. Broker/dealer firms trading non-exempt B. Securities and Exchange Act of 1934
securities C. Trust Indenture Act of 1939
D. Broker/dealer firms issuing non-exempt
securities D. Investment Company Act of 1940

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Rule 17-f-2 Under Rule 17-f-2, which of the following employees of

Fingerprinting a broker-dealer must be fingerprinted?
I Registered representatives
• persons who do NOT have to be
fingerprinted: II Registered principals
– those not engaged in the sale of securities III Unregistered employees that process securities
– those not in access to the keeping or IV Unregistered employees that process monies
handling of securities and/or monies
– those that have direct responsibility for the A. I and II only
above-mentioned B. III and IV only
C. I and IV only
D. I, II, III, IV
Under SEC Rule 17-f-2 all of the following

individuals would need to be fingerprinted
Registration of Personnel
EXCEPT:
• every person engaged in managing or training of
persons associated with the member must be
A. employee of a transfer agent with access to registered as a general principal - Series #24
securities and securities records • general principals (must have 2 principals unless
B. registered representative who sells only firm is a sole proprietorship) are:
investment company shares – sole proprietors
– officers
C. clerical employee of a broker-dealer who – partners
handles customer records – managers of OSJ
– directors of corporations
D. employee of a broker-dealer with access to
securities and securities records
Registration of Personnel (cont.) Registration of Personnel (cont.)
• Limited Principals (cont.) • RR definition

– Investment Companies and Variable – #7
Annuities Principal – anyone who solicits or conducts business
• for a firm that solely engages in the sale of in securities for a member firm
redeemable securities and has no other securities
business • who is NOT a RR
• these firms are allowed to participate in the original – persons whose duties are totally clerical or
distribution of closed-end funds, BUT no who solely handle exempt securities
secondary market activity is allowed in these
shares – foreign dealers who deal exclusively
• #26 -- prerequisite is the #6 or #7 outside the U.S.

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• Investment Companies/Variable Annuities (Series #6) – Limited • Sales Assistant
Rep.
– can qualify new customers
– for a rep selling only mutual funds and variable products
– accepts unsolicited orders only
– note that variable products are non-exempt securities AND
ALSO insurance products – works on an hourly or salaried basis
• therefore, to sell these products, the rep must also pass a state – Series #11
insurance exam
– allows the rep to sell prospectus offerings ONLY
• Exempt from #11
• i.e. mutual funds, IPOs of closed end funds, unit investments trusts, – if individuals only
and variable life and annuity contracts • relay last sale price information for customers
– thus, these reps cannot handle any TRADING of securities • write memoranda of unsolicited customer orders
– to sell 529 College Savings Plans, individuals need to have the – then the person does not need #11
Series #6 or #7 license, as these are securities
Sales Assistants (Series #11 licensed individuals) are An assistant sales representative accepts an
permitted to: unsolicited customer order. Which statement is
true?
I Provide securities price quotes to customers
II Accept unsolicited customer orders A. this action is prohibited unless that individual
passes the General Securities exam
III Sign up new customers
IV Solicit new customers B. The order must be approved by a principal prior
to entry
A. I and II only
C. The order must be approved by a supervising
B. I and IV only
registered representative prior to entry
C. II, III, IV
D. The order must be reviewed by a principal at
D. I, II, III, IV the end of the day (promptly)
Registration of Personnel (cont.)

All of the following licenses allow an individual to
accept unsolicited orders for the shares of closed- • U-4 Form
end management companies that are trading in – to register as a representative or principal, this
the secondary market EXCEPT: form must be completed and filed with FINRA
– the U-4 has a questionnaire in it that inquires
about arrests, convictions, etc. and includes
whether the applicant was convicted of
A. Series #6 possession of drugs, DUIs, assault, etc…
• the SRO is permitted by the SEC to approve these
B. Series #7 individuals convicted of a non-securities felony on a "case-
by-case" basis
C. Series #11 • this application essentially asks, "Is this person a risk to
investors?"
D. Series #62

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• U-4 Form (cont.) • U-4 Form (cont.)
– application includes:
• applicant's name and address
– registration is only effective after the
• broker-dealer's name and address appropriate exam(s) are taken and passed
• old broker-dealer's address if transferring from another firm • if an exam is failed, 30 days must elapse before
• 5 year consecutive residence history another attempt
• 10 year consecutive employment history
• any other businesses in which registrant is engaged
• if the individual fails 3 successive times, a re-
• any aliases attempt is only allowed after 180 days elapse – if
• disclosure of any arrests, convictions, involving investments, failed again, another 180 must elapse before
fraud,… another attempt is allowed

• U-4 Form (cont.) • Continuing Education
– if anything changes, the U-4 filing must be – Regulatory Element
amended promptly • computerized regulatory training session must be
– signed by the applicant completed on the registrant's 2nd anniversary of
– principal verifies prior 3 years’ employment registration and every 3 years thereafter
– if not completed within 120 days of notice, the person's
history registration is suspended and the person cannot function
as a registered rep. until the element is completed
• dual registration is permitted if
disclosed on U-4 (and approval of the – Firm Element
• annual training plan must be prepared by member
employer is given) firms to cover relevant compliance issues
All of the following topics are appropriate Military Duty

for a member firm's annual compliance
review held with each registered person • if a registered rep. is called for active
EXCEPT: military duty, that person becomes
"inactive" and both the CE Regulatory and
Firm Elements are suspended
A. e-communications content
– the employing broker-dealer sends a letter to
B. trading ahead prohibitions CRD along with the rep.'s name, CRD #, and
the date the firm received notification of the
C. registration requirements "call to duty"
D. sales effectiveness measures

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Military Duty (cont.) Military Duty (cont.)

– once the rep. is discharged from military service, a – lastly, the individual must reassociate with
copy of the discharge is sent to CRD so that the the member firm within 90 days of returning
person's registration can be reinstated (basically from
to civilian life, or the registration is terminated
the point where he/she left off)
• note that the rep. can reassociate with the same firm or with
another broker-dealer at this point
• also note that the firm can still pay the individual while on
military duty and the rep. can arrange for another rep. at the
same firm to service his/her customers and can share
commissions with that other rep.
A registered representative has been called to

If a registered person fails to complete the active military duty and his registration has been
Regulatory Element of the Continuing Education placed in "inactive status" by the member firm.
requirement within the allotted time, that person: Once the registered individual returns to civilian
life, special inactive status ceases if the individual
A. may request an extension from FINRA does not return to work at the member firm within:
B. will have their license suspended, but can still
be compensated by the member firm A. 30 days
C. will have their license suspended and cannot B. 60 days

be compensated by the member firm C. 90 days
D. must be terminated within 30 days D. 120 days
An employee of a FINRA member firm wishes to sell

A registered representative that has been called to
mutual funds, part time, for another member firm.
active duty in Afghanistan can share commissions Which statement is true?
during the period of military service:
A. It is acceptable for the employee to be dual
A. under no circumstances registered if there is a prior written agreement between
members
B. with another representative at the same firm that
will handle that representative's customers B. The SEC must be given prior notification of the dual
registration via Form U-4
C. with another representative at any registered
C. FINRA must be given prior notification of the dual
broker-dealer that will handle that representative's registration via Form U-4
customers
D. Dual registration with 2 different broker-dealers is
D. with the prior approval of the principal prohibited

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Registration of Personnel (cont.) A registered person resigns from a broker-dealer

and does not become associated with another
• hanging licenses is prohibited firm. If that person re-enters the industry at a
• FINRA retains jurisdiction over the later date, how many years can elapse before
terminated person for 2 years that person must be requalified with new exams?
A. 1 year
B. 2 years
C. 3 years
D. 5 years
CENTRAL REGISTRATION
FINRA BROKER-CHECK
DEPOSITORY (CRD)
• each registered person's record is on file • for the general public to inquire as to a
at CRD registered person's disciplinary history, they can
go to www.finra.org
• any disciplinary action is part of the U-4
• the information found includes the broker’s:
information and is recorded in that
– 10-year consecutive employment history;
person's file – securities licenses and registrations; and
– disciplinary record, which includes both complaints;
allegations that have not yet been resolved; and a
record of any disciplinary or settlement actions taken
FINRA BROKER-CHECK (cont.)

All of the following information is included in a
• specifically EXCLUDED (due to privacy Broker-Check report EXCEPT a record of:
issues):
A. broker qualifications, including current
– residence history; s.s. #; physical
registrations and licenses
characteristics (i.e. eye color, height, etc…),…
B. pending customer complaints or allegations that
• information is also available to customers have not been resolved or proven
via a toll-free # for people who don’t have C. disciplinary actions taken against the broker by
internet access FINRA and other regulators
D. residence history, for the preceding 5 years

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BrokerCheck information is available for:
I currently registered representatives that are

active in the securities industry
II previously registered representatives no
longer active in the securities industry
III currently registered broker- dealer firms that
are active in the securities industry FINRA CONDUCT RULES
IV previously registered broker-dealer firms that
are no longer active in the securities industry
A. I and II only
B. III and IV only
C. I and III only
D. I, II, III, IV
Conduct of Customer
A broker-dealer is recommending the purchase of shares of
Accounts a corporation that is affiliated with the broker-dealer. The firm
can buy these shares for its discretionary customer
• suitability accounts:
• cannot guarantee customer A. under no circumstances

against loss B. if the firm has on file discretionary power of attorney
signed by the customer
C. if the control relationship is disclosed to the customer
prior to entering into the contract to buy the security
D. if each discretionary order ticket is approved by a
principal in writing prior to the execution of the trade
A FINRA member sells a new issue of non-exempt A “bona-fide” customer is defined as a person
securities to a customer with an agreement to buy who:
the securities back at the end of 3 months at the
Public Offering Price. This action is:
A. has cash and/or securities in the possession of
A. permitted as long as the activity is disclosed in the member
the Prospectus
B. has traded through the member within the past
B. permitted if evidenced in writing and approved by 3 months
a principal
C. permitted without restriction C. is not a member of FINRA
D. prohibited since customer accounts cannot be D. has engaged in any business transaction with
guaranteed against loss by a member the member within the past 12 months

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Conduct of Customer Accounts Conduct of Customer Accounts

(cont.) (cont.)
• Cannot Share In Customer • Cannot Borrow From / Lend To Customers
Account Unless In Direct – HOWEVER, the rule does not apply to immediate
Proportion To The Capital family or to (obviously) lending institutions
Contributed and Principal – also, the rule allows with prior approval of the firm
Approves lending or borrowing between:
• 2 reps at the same firm;
– EXCEPTIONS: • a rep and a customer with whom the rep has a personal
• sharing with immediate family members / relationship (i.e. boyfriend/girlfriend); and
significant others / or lending institutions • a rep and a customer with whom the rep has a business
relationship
A representative in your branch office manages the

A registered representative is permitted to share in customer account of his long-term girlfriend, with
the gain and loss of a customer account: whom he lives. The representative wishes to borrow
money from the girlfriend. Which statement is true?
A. under no circumstances A. This is prohibited under FINRA rules

B. only if the broker-dealer is the subsidiary of a B. This is permitted only if the terms of the loan are
parent bank where the customer has an account documented in writing and filed with FINRA
C. only if the sharing is in proportion to the financial C. This is permitted only if the loan conforms to the
contribution made by the representative firm's written policies and procedures
D. only if the customer is related the registered D. This is permitted without restriction due to the
representative existence of the personal relationship between the
customer and the representative
Prior approval of a member firm's compliance department is Conduct of Customer Accounts

required if a registered employee wishes to borrow money (cont.)
from or lend money to a customer:
• Gift Limit is $100
I where there is a pre-existing personal relationship – business entertainment is not subject to the limitation as long as
it is not too frequent or too excessive
II that is an immediate family member
– FINRA requires member firms to:
III where there is a pre-existing business relationship • create written policies and procedures covering business
entertainment; and
IV where the customer is a lending institution • audit, record, and retain info regarding these expenses for
compliance
– paying for work is allowed as long as:
A. I and III
• there is a written agreement spelling out the work and the
B. I and IV agreement is approved by a principal before it takes into
effect
C. II and III • a separate record is required and is maintained for 3 years
D. II and IV

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Conduct of Customer Accounts An Operations Professional (OP) wishes to work in

(cont.) her family’s bar at nights and on weekends. She will
not be paid a salary, but will earn tips. Which
• Outside Work statement is TRUE?
– registered persons cannot be employed
by anyone other than the member firm, A. This is prohibited because registered persons
UNLESS the person provides prompt cannot hold outside jobs
written notice to the member and follows B. This is prohibited because registered persons are
prohibited from dispensing alcohol
any instructions of the employer
C. This is prohibited unless the OP notifies the
member firm in writing and follows the firm’s
instructions
D. This is prohibited unless the OP notifies FINRA in
Series #6 Regulations 103
writing
Series #6
and follows FINRA’s instructions
Regulations 104
Conduct of Customer Accounts

A representative at a member firm is approached by a
(cont.) person outside that firm to sell promissory notes through
that member firm's branch office. Which statement is
• Prohibited Acts true?
– “selling away”
• handling securities transactions for a customer A. The rep. is prohibited from selling the promissory
through another firm notes
– no private securities trades B. The rep. may sell the promissory notes only after
• except if firm is given prior written notice of receiving verbal permission of the member firm
transaction and compensation to be received
C. The rep. may sell the promissory notes only after
• firm must approve in writing receiving written permission of the member firm
D. The rep. may sell the promissory notes without
restriction
Which statement is true regarding private securities

A customer requests his agent to perform a securities trade
transactions of an associated person?
privately, without it being recorded on the books and records
of the broker-dealer. Which statement is true?
A. Member firms are not permitted to allow their associated
persons to engage in private securities transactions
B. Member firms can allow their associated persons to engage A. This is an exempt transaction and the customer's request
in private securities transactions if prior approval is obtained can be honored
from FINRA
B. This is a prohibited practice because all transactions
C. Member firms can allow their associated persons to engage
effected by agents must be recorded on the books and
in private securities transactions if the firm approves in writing,
records the transaction, and supervises it as a proprietary records of the broker-dealer
transaction C. The representative must always follow the customer's
D. Member firms can allow their associated persons to engage instructions as given and perform the transaction privately
in private securities transactions if the firm approves in writing,
records the transaction, and supervises it as a customer D. The representative can only execute the transaction for the
transaction customer if the securities involved are exempt

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Conduct of Customer Accounts FINRA DEFINED

(cont.) COMMUNICATIONS
• disputes handled through Binding • FINRA defines 3 major categories of
Arbitration if signed by the customer (and communication (and then 4 other
most firms will not allow the account
opened unless signed) categories):
• 1) CORRESPONDENCE
– any written or electronic communication
distributed or made available to 25 or fewer
retail investors, existing OR prospective,
within any 30 calendar time frame
FINRA DEFINED FINRA DEFINED

COMMUNICATIONS COMMUNICATIONS
• 2) RETAIL COMMUNICATION • the basic rule is that CORRESPONDENCE
– any written or electronic communication distributed or made
available to more than 25 retail (i.e. non-institutional) investors AND INSTITUTIONAL COMMUNICATION DO
within a 30 calendar time frame (specifically an investor with less NOT REQUIRE PRIOR PRINCIPAL APPROVAL
than $50MM of assets)
• 3) INSTITUTIONAL COMMUNICATION
prior to distribution, while RETAIL
– any written or electronic communication distributed or made COMMUNICATION DOES
available only to institutional investors
• these include banks, savings and loans, investment companies,
government entities, FINRA members, or any person with assets of
$50MM or more
OTHER COMMUNICATION OTHER COMMUNICATION

CATEGORIES CATEGORIES
• 4) ADVERTISING • 5) SALES LITERATURE
– material intended for a mass market – material sent to more than 25 investors
– i.e. newspapers, magazines, TV, tape – more specific in nature (i.e. directed to a
recordings, websites, billboards,… specific audience, like a firm’s customers)
– also included would be static, "non- – i.e. market letters, circulars, seminars,
interactive" information on Internet Bulletin research reports, form letters,…
Boards, social networking sites,… – note password protected websites would be
included (though websites accessible to the
general public are considered advertising)

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Regulations
OTHER COMMUNICATION OTHER COMMUNICATION

CATEGORIES CATEGORIES
• 6) INDEPENDENTLY PREPARED REPRINT • 7) PUBLIC APPEARANCE / PUBLIC FORUM
– participation in a seminar, forum (including electronic venues,
– a reprint or excerpt of any article issued by a such as internet chat rooms), radio, TV, or other public
publisher not affiliated with the FINRA appearance
member and not commissioned by the FINRA – these are spontaneous, unrehearsed "appearances"
– note, "interactive", real-time content on blogs, social networking
member sites, and chat rooms are deemed "public appearances" (versus
• if distributed to more than 25 investors, it is retail static content is advertising)
communication • note a public appearance attended by more than 25 investors would follow
rules for retail communications; 25 or fewer would follow that of
• if distributed to 25 or less, it is correspondence correspondence
APPROVAL OF APPROVAL OF
COMMUNICATIONS COMMUNICATIONS
• CORRESPONDENCE • RETAIL COMMUNICATION
– if the firm doesn’t have a communication compliance – must be approved in writing by a principal
program in place that trains reps with regards to what
prior to use or filing with FINRA (if required)
can and cannot be said; and that audits this for
compliance, then all correspondence must be pre-
approved
– however, if the firm DOES have a communications
compliance program in place, FINRA only requires a
“post-use review and approval” by a principal
Which of the following is defined as an Under FINRA rules, which of the following is
advertisement under FINRA rules? defined as "sales literature"?
A. A securities research report A. Television commercials

B. A market letter B. Newspaper articles
C. A billboard C. Research reports
D. A prospectus D. Billboards

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Regulations
A registered principal must approve all of the

The definition of the term “sales literature”
following before a firm may use them or send
includes all of the following, EXCEPT:
them to a customer EXCEPT:
A. Market letters
A. advertising
B. Research reports
B. research reports
C. Reprints of promotional speeches
C. prospectuses
D. A radio speech
D. form letters
Regarding the use of instant messaging by employees of

member firms, FINRA:
A. prohibits the use of instant messaging at member firms

Which of the following is defined as because these are spontaneous communications that cannot be
properly monitored
advertising?
B. requires the member to monitor, capture, and retrieve instant
messages consistent with the firm's electronic correspondence
A. Market letter
compliance procedures
B. Web site
C. Form letter C. requires that the member firm to specifically review and
approve each electronic instant message that is sent to a
D. Research report customer, but this is not required for internal instant messages
D. permits the use of instant messaging without restriction by
member firm employees since these are protected
communications of the "freedom of speech" statutes
CUSTOMER COMPLAINTS CUSTOMER COMPLAINTS

• any complaint received in writing! • if the manager cannot resolve the issue, it
– if a rep receives such a complaint, he/she is escalated again to the firm’s compliance
canNOT attempt to resolve it on his/her own dept.
– all written complaints must be resolved by the – records of all escalation procedures must be
manager/principal and the OSJ must keep a part of the complaint record
copy of all complaints and their resolution
• the firm’s Written Supervisory Procedures
• complaints received must be “escalated” (WSPs) detail the provisions of these
to the next level for resolution by a escalation procedures
manager

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Regulations
CUSTOMER COMPLAINTS
A member firm receives a written customer
• if a written complaint is directed at the firm
complaint alleging that an associated person
(rather than a “person”), the problem is to forged the customer's signature on a discretionary
be escalated to compliance account power of attorney. This complaint:
A. is not required to be reported

B. must be reported to FINRA promptly
C. must be reported to SIC promptly
D. must be reported to the SEC promptly
OTHER MISCELLANEOUS OTHER MISCELLANEOUS

ITEMS (cont.) ITEMS (cont.)
• FINRA • FINRA (cont.)
– Code of Procedure – Code of Procedure (cont.)
• the District Hearing Panel holds a hearing with both parties in
• if a customer has a written customer complaint that attendance, and reaches a decision
has been filed with a NASD/FINRA district office, – if either party is not satisfied with the district hearing panel's
the district sends a copy of the complaint to the decision, either can appeal to the NASD/FINRA National
firm with a directive to respond in writing Adjudicatory Council
» (formerly known as the National Business Conduct
• if the customer is not satisfied with the response to Committee - NBCC) which is located in Washington
the complaint, the complaint is then given to the – if either party is not satisfied with the National Adjudicatory
District Hearing Panel (formerly known as the Council's decision, an appeal may be made to the SEC
District Business Conduct Committee - DBCC) – finally, if either party is not satisfied with the SEC decision, a
last appeal can be filed in the Federal Courts
OTHER MISCELLANEOUS
A decision has been reached by the District Hearing ITEMS (cont.)
Panel under the Code of Procedure. Which
• FINRA (cont.)
statement is true?
– Code of Arbitration
• firms will generally not be involved with the Code of
Procedure for resolving customer disputes because most
firms require, as policy, that the customer sign an arbitration
A. The decision is binding and cannot be appealed agreement
• The Code of Arbitration Is Mandatory to Settle Customer
B. An appeal may be filed with the National Disputes Only If the Customer Previously Signed an
Adjudicatory Council Arbitration Agreement
• Arbitration Is Mandatory for Settling Intra-industry
Disputes
C. An appeal may be filed with the SEC
• Industry Arbitration Is Binding and not appealable
D. An appeal may be filed with the Federal Courts • the statute of limitation for filing an arbitration claim is 6 years

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Regulations
Why is arbitration preferred over litigation over settling A decision has been reached under the Code of
disputes between customers and brokerage firms? Arbitration. Which statement is true?
A. The decision is binding and cannot be appealed

A. There is a possibility of bigger damage awards
B. An appeal may be filed with the National
B. It is cheaper and faster Adjudicatory Council
C. It is easier for the claimant to prove the case C. An appeal may be filed with the SEC
D. It is easier for the defendant to prove the case D. An appeal may be filed with the Federal Courts
MINOR RULE VIOLATION BRANCH OFFICE

• for minor complaints, the Department of • any branch office (which must be
Enforcement may offer the respondent a registered with FINRA and properly
"Minor Rule Violation" letter where the supervised) is defined as a location:
respondent admits guilt to the minor – advertised as a branch or where the member
conducts investment banking or securities
offense and is then subject to a maximum related business; or
of $2,500 fine – where the member directly or indirectly
contributes to a substantial portion of the
location’s operating expenses
All of the following are defined as “branch” offices of BRANCH OFFICE (cont.)
your firm by FINRA EXCEPT:
• Offices EXCLUDED from the
A. A home office of a registered representative
where your firm pays a substantial portion of the Branch Definition
operating expenses – back offices, residences of RRs,
B. An office sublet by your firm to another FINRA "offices of convenience", and satellite
member offices are NOT defined as branches
C. An office location of your firm listed in a
telephone directory
D. An office shared with another company that is not
in the securities business

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Regulations
OFFICES OF CONVENIENCE SATELLITE OFFICE

• i.e. a diner where a RR meets a client • a location used to engage in non-securities
activities (i.e. an office that sells life insurance)
– are NOT considered "branches" as long as and that effects no more than 25 securities
they are only used occasionally trades in a year is NOT defined as a branch –
• if a RR sets up regular working hours each day at this is a "satellite" office
the same table at a diner, this would fall under the • ANY orders taken in a home office or "office of
"branch" definition
convenience" must be processed through the
registered branch location; and must be under
the supervision of the branch
BRANCH OFFICE LOCATED IN A An advertisement recommending investments is prepared by a

broker-dealer subsidiary of a financial institution and will be
BANK placed in each physical banking location of that financial
institution. Which statements are true about the advertisement?
• physical location of the member's services
I It must state that securities products are not deposits
should be conducted in a distinct area from
where the bank takes in deposits II It must disclose that the investment can lose value
• member's name must be clearly displayed III It must disclose that the investment is not FDIC insured
• at, or prior to, opening an account, the member IV It must disclose that the broker-dealer is a member of SIPC
must disclose:
A. I and II
– the account is NOT FDIC insured;
– securities are NOT guaranteed by the bank B. III and IV
– securities are subject to investment risk and may lose C. I, II, and IV
value D. I, II, III, IV
A registered representative in your office wishes to open a A registered representative that works in your
satellite office that is closer to his customers, and wants to branch has just had a child and will be splitting her
take another representative with him. In order to do so, which time working 3 days a week from home and 3 days
statement is true under FINRA rules?
in the branch office. The address to be used on any
correspondence with customers is the:
A. One of the two representatives in the office must pass the
a principal examination
A. firm's main office address
B. Both of the representatives in the office must pass a B. branch office address
principal examination
C. the home office address
C. The location must be registered with FINRA as a small D. the home office address for communications
branch sent from the home locations and the branch office
D. The location is defined as an office of convenience that is address for communications sent from the branch
not required to be registered location

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Regulations
A #24 principal supervises both a main office with 30 A location held out to the public as a place
representatives and a satellite office that has 2 where the member firm conducts investment
representatives. The satellite office primarily sells
banking or securities business is defined as
insurance products and does fewer than 25 securities
trades per year. Under FINRA rules, the satellite office a(n):
is considered to be a(n):
A. branch office
A. branch office
B. satellite office
B. non-branch office
C. office of convenience C. office of supervisory jurisdiction
D. small office D. main office
A registered representative holds investment seminars

on a regular basis at the local public library branch. A registered representative meets his client for
This location would be defined as a branch of the drinks at a local bar. The client hands the
representative's broker-dealer: representative a check payable to the
representative’s firm. The rep may:
A. if 25 or more clients attend the seminar
B. if the seminar is held at least 25 times at that A. accept the check on behalf of his brokerage firm
location B. only accept the check if his firm is an introducing
broker-dealer
C. if customer accounts are opened or trades are C. only accept the check if his firm is a clearing
accepted at the seminar broker-dealer
D. under no circumstances since the location is a D. only accept the check if payment would be
public forum received later than required under Regulation T
BUSINESS CONTINUITY PLAN

BUSINESS CONTINUITY PLAN (cont.)
(BCP)
• member firms must create a business continuity • the plan must cover:
plan that identifies procedures that must be – data back-up and recovery; mission critical systems; financial
and operations assessments; alternate communications between
followed in an emergency or business disruption member and customers – and member and employees; alternate
– there is NO requirement to file the plan with FINRA, physical location of employees; critical business, bank, and
but it must be available upon FINRA request; and a counter-party impact; regulatory reporting and communications
with regulators; and assurance that customers have prompt
copy of the plan must be maintained at a secure, off- access to their funds in the event that the member ceases
site facility business
– if there is a material change in a firm's operations, the • for introducing members (that introduce their accounts into a
clearing firm), the clearing firm normally performs these functions,
plan must be updated HOWEVER, a plan must still be created by the firm (the plan
– the plan is approved by a Series #24 Principal; and COULD use information found within the clearing firm's continuity
plan for this purpose)
there is an annual #24 principal review of the plan

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Regulations
BUSINESS CONTINUITY PLAN (cont.)

Member firm business continuity plans
• at account opening, customers must be must be reviewed, at a minimum:
given disclosure, in writing, about how
the firm's continuity plans address the
A. monthly
possibility of business disruption and the
proposed response B. quarterly
– the disclosure is also on the firm's website C. annually
and must be mailed to customers upon
request D. bi-annually
All of the following must be included in a

A member firm's business continuity plan must be: member firm's business continuity plan
EXCEPT:
A. disclosed to customers in writing at the time of
account opening
A. communications with clients
B. posted on the member firm's web site
B. regulatory reporting
C. mailed to customers on request
C. ongoing operations
D. All of the above
D. payroll data distribution
Which statements are true about the FINRA rule covering TRUST INDENTURE
business continuity plans?
ACT OF 1939
I The rule's requirements are flexible and allow the plan to be
tailored to the needs of each member • enforced because it was felt that the Act of 1933
didn't adequately protect bondholders after
II The rule's requirements are inflexible and the plan must offering was completed
adhere to each point set forth in the rule
• requires all interstate offerings of "non-exempt"
III The plan must be reviewed annually and updated if needed bonds of $5,000,000 or more be made with a
IV The plan must be reviewed every 3 years and updated if
Trust Indenture
needed – does NOT apply to U.S. Gov't, Agency, or municipal
debt (exempt securities)
A. I and III • requires the appointment of a "substantial"
B. I and IV Trustee to protect interest of bondholders and
insure that the requirements set forth are
C. II and III adhered to by issuer
D. II and IV

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Regulations
Which of the following bond issues is required to have a

The Trust Indenture Act of 1939 applies to: trust indenture?
I U.S. Government Agency Bonds I Treasury bond

II Municipal Bonds II General Obligation bond
III Corporate Bonds III Mortgage bond
IV Regulation A - Corporate Small Dollar Offering
IV Debenture
A. III only A. I and II only

B. IV only B. III and IV only
C. II and IV
C. II, III, IV
D. I, III, IV
D. I, II, III, IV
INVESTMENT COMPANY ACT INVESTMENT ADVISERS ACT

OF 1940 OF 1940
• investment companies must register with • investment adviser is one who gives investment advice
for a fee
SEC • these persons must register with the SEC if they give
• also defines types of investment advice interstate to 15 or more persons
• persons who give advice that is incidental to their
organizations that are allowed business and that do not charge separately for this
– i.e. face amount certificate company, advice do NOT have to register
– brokers/dealers, banks, and general circulation newspapers are
management company, and unit investment NOT considered to be Investment Advisers
trust – however, market newsletter services ARE subject to registration
A lawyer who gives advice about investing in Which of the following must be registered
securities as part of an overall estate tax plan: with the SEC as an investment adviser
under the Investment Advisers Act of 1940?
A. must register as a registered investment
adviser
A. Broker-dealer
B. must register as a broker-dealer
B. Bank
C. must register as both a broker-dealer and an
investment adviser C. Senior Editor of an investment magazine
D. does not have to register as either a broker- D. Accountant who gives investment advice
dealer or an investment adviser to clients for a fee

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Regulations
SECURITIES INVESTORS SECURITIES INVESTORS

PROTECTION ACT OF 1970 PROTECTION ACT OF 1970 (cont.)
• protects customers from broker/dealer failure • partners are NOT covered
• SIPC • each B/D is required to use the SIPC logo in its
– neither a gov't agency nor a regulatory authority, it is a non- advertising
profit member corporation funded by its member securities
broker-dealers • NOTE: SIPC does NOT apply to investment companies
– covers $500,000 equity per customer, inclusive of $250,000 registered under the 1940 Act
cash coverage – thus, mutual funds and variable annuities are NOT covered
– if a brokerage firm fails, trustee is appointed to oversee under SIPC
liquidation • finally, for SIPC purposes, the valuation date, for
– the trustee distributes the assets as follows: customer securities held in an account at a failed broker-
• securities registered in customer name returned without dollar dealer, is the date of the filing of the protective court
limitation (i.e. fully paid securities)
• customer "street name" (margin) securities distributed on a pro rata decree
basis up to $500,000 of equity – i.e. the date that SIPC asks a court to place the troubled broker-
– cash and margin account considered to be one account dealer in liquidation – called the "filing date"
A customer has an account with $350,000 in

In a SIPC liquidation, if a customer still has
securities and $350,000 of cash. What is the
claims above the covered amount, the
coverage amount in a SIPC liquidation?
customer becomes a:
A. $500,000 A. secured creditor
B. $450,000 B. general creditor
C. $350,000 C. limited partner
D. $150,000 D. general partner

Mike Jones has two accounts at a failed brokerage firm; a

cash account with $350,000 of cash and a margin account
with $600,000 in securities. Which of the following A brokerage firm holds $550,000 of securities that
statements is true regarding SIPC coverage limits? are registered in the name of a customer. If the firm
was undergoing an SIPC liquidation, the customer
A. The customer is covered for the total amount of $950,000 would:
B. The customer is covered for $250,000 for the cash
account and $500,000 of the securities A. Be insured for $50,000 of securities
B. Be insured for $500,000 of securities
C. The customer is covered for a total of $500,000 in
C. Lose the entire $550,000
securities only
D. Receive the entire $550,000 of securities
D. The customer becomes a general creditor for $100,000 of
cash and $350,000 in securities

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FEDERAL TELEPHONE CONSUMER

Which of the following is a term that PROTECTION ACT OF 1991
is NOT associated with mutual • Cold Calling Rules
funds? – unsolicited calls cannot be made before 8:00
AM, nor after 9:00 PM, in the time zone where
received
A. LOI – caller must identify himself by:
• name, firm, where he is calling from (address or
B. ROA telephone #)
– the rule does not apply to charitable organizations
C. CDSC – Do Not Call List
• if a person called states that he doesn't wish to receive
D. SIPC calls, he must be placed on the firm's "don't call" list
FEDERAL TELEPHONE CONSUMER FEDERAL TELEPHONE CONSUMER

PROTECTION ACT OF 1991 PROTECTION ACT OF 1991
• National Do Not Call Registry • individuals CAN be contacted regardless of the 8
– overseen by the FTC, any person can register AM – 9 PM "restricted time" if the member has
with this and telemarketers have 31 days to an established business relationship with the
remove that person's phone number from customer
their call lists – Established Business Relationships would be
• telemarketers must search the list every 31 days defined as those with individuals who:
and remove any names found • did business with the firm in the preceding 18 months; or
• violations can be enforced by consumers, • contacted the member to inquire about products/services in
the preceding 3 months
states, and the Federal Trade
Commission (FTC) – thus, these individuals can still be contacted
UNLESS the person is on the FIRM'S do not call
list
FEDERAL TELEPHONE CONSUMER FEDERAL TELEPHONE CONSUMER

PROTECTION ACT OF 1991 PROTECTION ACT OF 1991
• Persons on the National Do Not Call • In Summary Solicitations To:
List – individuals on the Firm's do not call list cannot be solicited
even if this person is a customer of the firm
– solicitations to these individuals are not
allowed unless: – individuals NOT on the Firm's do not call list but on the
Federal do not call list cannot be called unless there is an
• the member has an established business EBR, or that person asked to be called; or the rep has a personal
relationship with the person; or relationship with that person
• member received that person's written consent to – individuals NOT on the Firm's OR Federal do not call list
be contacted; or CAN be solicited between 8AM-9PM in the recipient's time zone
• the rep making the call has a personal relationship
with the person being contacted (i.e. the person is • telephone numbers on the registry are only removed
a friend or family member) when the consumer chooses to remove the number from
the registry (or the # gets disconnected and reassigned!)

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Regulations
Which of the following callers is EXEMPT

from the provisions of the Federal Primary responsibility for enforcement of
Telephone Consumer Protection Act of the Federal Telephone Consumer
1991? Protection Act rests with the:
A. SEC
A. Telemarketing firm
B. FTC
B. Real estate company
C. FCC
C. Non-profit organization
D. FINRA
D. Securities firm
A newly registered representative is making solicitation

calls to potential clients. The representative is told by his A satisfied customer gives his representative a client
father that his brother, the representative’s uncle, might be referral. Which statement is true?
interested in getting investment advice. When the
representative enters the telephone number of his uncle, it
comes up as blocked since this person is on the National A. The representative should check the Do Not Call
“Do Not Call” list. Which statement is true? list before acting on the referral
B. The representative is not required to check the Do
A. Because the referral was made by an immediate family
Not Call List prior to acting because the client was
member, the uncle can be solicited by the representative
B. Because a personal relationship exists between the referred
uncle and the representative, the solicitation may be made C. The referred client may only be contacted
C. Because the representative is newly registered and has between the hours of 8:00 AM and 9:00 PM
not “seasoned” for 18 months, the solicitation cannot be D. The representative is not permitted to contact the
made referred client unless the referred client initiates the
D. Because the uncle is on the National “Do Not Call” list,
contact
no solicitation by the representative
Series #6 Regulations
is permitted 177 Series #6 Regulations 178
GRAMM-LEACH-BLILEY
Which of the following maintain Do Not Call lists? PRIVACY PROTECTION
• firms cannot disclose customer information
I SEC
to third parties unless the firm notifies the
II Member firm
customers of its intent and provides an
III FTC
"opt-out notice"
IV FINRA
• there is an exception to the privacy
A. I and IV protection for an existing customer of the
B. II and III firm
C. II and IV • Regulation SP implements this rule for
D. I and III broker-dealers

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Regulations
Private Securities Trades A representative at a member firm is approached by a

person outside that firm to sell promissory notes through
• any securities transactions outside the regular scope of an associated that member firm's branch office. Which statement is
person's employment with a member are NOT allowed except if the member true?
firm is given prior written notice of the transaction and compensation to be
received
• the firm must approve the transaction in writing
– if the firm approves the transaction, it will be recorded on the books and records
A. The rep. is prohibited from selling the promissory
of the member and the member shall supervise the person's participation in the
transaction as if the transaction were executed on behalf of the member
notes
– if the member disapproves the transaction, the person shall not participate in the
transaction in any manner, directly or indirectly B. The rep. may sell the promissory notes only after
• regarding transactions not for compensation receiving verbal permission of the member firm
– if the associated person has not and will not receive any selling compensation, a
member which has received notice of the private securities transaction shall
provide the associated person prompt written acknowledgment of said notice and C. The rep. may sell the promissory notes only after
may, at its discretion, require the person to adhere to specified conditions in
connection with his participation in the transaction. receiving written permission of the member firm
• "selling compensation"
– any compensation paid directly or indirectly from whatever source in connection D. The rep. may sell the promissory notes without
with the purchase or sale of a security.
restriction

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Bonds Retirement Plans

Term = Dollar = % of par IRA – max. contribution is $5,500;

Flexible Premiums Universal Insurance

Series #6 Cheat Sheet Peter A. Gibowicz peter@bullbeartraining.com

NO: YES: Step 2: INVESTMENT TIME HORIZON

PRESERVATION OF CURRENT LIFETIME CAPITAL AGGRESSIVE

Customer Accounts Suitability Factors Chapter 7-47

Type of Tax Status of Reg. Way

Series #6 Types of Debt 2

Bull & Bear Training Co., Inc. - Peter A. Gibowicz 1

Type of Tax Status of Reg. Way

Series #6 Types of Debt 3

Type of Tax Status of Reg. Way

Series #6 Types of Debt 4

Bull & Bear Training Co., Inc. - Peter A. Gibowicz 2

Type of Tax Status of Reg. Way

Type of Tax Status of Reg. Way

Series #6 Types of Debt 6

Bull & Bear Training Co., Inc. - Peter A. Gibowicz 3

Series #6 Investment Securities 1 Series #6 Investment Securities 2

Equity — Common Equity — Preferred

Which of the following would be considered

• bondholders are creditors of the corporation I Common Shareholders

Bull & Bear Training Co., Inc. - Peter A. Gibowicz

I Common Shareholders I convertible preferred shareholders

CAPITALIZATION COMMON STOCK

COMMON STOCK (cont.) COMMON STOCK (cont.)

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Bull & Bear Training Co., Inc. - Peter A. Gibowicz

Which of the following statements best describes

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COMMON STOCK (cont.)

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Bull & Bear Training Co., Inc. - Peter A. Gibowicz

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The transfer agent will typically perform which of

Which function would be performed by the

A. verifying the record of all shareholder

Bull & Bear Training Co., Inc. - Peter A. Gibowicz

RIGHTS OF THE COMMON RIGHTS OF THE COMMON

RIGHTS OF THE COMMON RIGHTS OF THE COMMON

Bull & Bear Training Co., Inc. - Peter A. Gibowicz

A. 100 shares at $30 A. 120 shares at $50

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RIGHTS OF THE COMMON RIGHTS OF THE COMMON

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Bull & Bear Training Co., Inc. - Peter A. Gibowicz

A corporation is having a rights offering

RIGHTS OF THE COMMON RIGHTS OF THE COMMON

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RIGHTS OF THE COMMON June

Bull & Bear Training Co., Inc. - Peter A. Gibowicz

To receive a previously declared dividend, A trade date is Wednesday, July 2. What is

A. Payable date A. July 2nd

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RIGHTS OF THE COMMON If a corporation liquidates, rank the priority to its

Bull & Bear Training Co., Inc. - Peter A. Gibowicz

If a corporation liquidates, rank the priority to its

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A vote of the common stockholders is required

Common stockholders have which of the following