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SEC Rule 10b-18 provides an opportunity for publicly traded issuers to reacquire their shares in the secondary market. To comply with this regulation:
the issuer must give the SEC advance notice at least 2 business days prior to its acquisition of its own outstanding shares.
the issuer must give the NYSE or NASDAQ at least 1 business day prior notices of its intended reacquisition of shares.
the issuer may purchase shares through only one broker-dealer but with no volume limitation on any given trading day.
the issue must limit its purchases of shares on any given trading day to maximums set in the regulation.
Question 1 Explanation:
There are volume reacquisition limits set forth in 10b-18 as well as time-of-day and bid price restrictions.
You take note of the dividend payout ratios and earnings growth of a number of listed companies whose stock may be suitable for several of your customers. The data you’ve gleaned from the Continental Consolidated Corporation (CCC) shows latest reported EPS of $5.00/share with a dividend distribution of $2.50, while the data from the Bergen Fairfield Company (BFC) has EPS of $1.15 and no dividend distribution.
Which of the following conclusions might be drawn from these data, in the absence of any other information?
CCC is defensive; BFC is cyclical
CCC is cyclical; BFC is defensive
CCC and BFC are growth
CCC is defensive; BFC is growth
Question 2 Explanation:
Analysts may debate this issue, but as a general rule, defensive industries tend to pay large dividends as a percentage of their earnings. CCC is paying out 50% of earnings in the form of dividends. That’s a large dividend payout ratio. CCC would appear to be defensive. On the other hand, in the growth-oriented industries, paying dividends is often deferred for years, even decades, until some level of stability is reached. They tend to plow back whatever earnings they have into research and development, and expansion/growth. BFC pays no dividends, and is most likely a growth company.
The Green Shoe option found in many stock prospectuses:
enables the company to engage in a shelf offering
enables the company to sell a limited number of additional shares beyond the amount initially registered with SEC, without filing a new registration statement
may only be activated when the managing underwriter is engaged in stabilizing the new issue
is also referred to as the underallotment provision
Question 3 Explanation:
A company is permitted to sell up to 15% more shares than initially registered without having to file a whole new registration statement. This is the ‘overallotment’ provision of SEC rules, also called the ‘Green Shoe’ option.
Non-recourse loans used to finance direct participation programs:
do not increase investor basis under any circumstances
increase investor basis only if the Subscription Agreement calls for non-recourse loans to be utilized
increase investor basis in real estate DPPs only
increase investor basis in all DPPs
Question 4 Explanation:
In DPP/limited partnership securities offerings, reference is made to the types of borrowing in which the General Partner may engage on behalf of the partnership. Non-recourse debt does not put the limited partners at risk, as the lender has no recourse to the limited liability investors (your client) in the event the partnership defaults on the loan. Since the investor is not at risk, this type of lending does not increase your client’s tax basis in the program. However, for real estate programs, IRS rules provide a special exception to the ‘at risk’ rules, resulting in a situation in which investor basis may be increased by the use of non-recourse financing in the program. Non-recourse loans do not increase investor basis in DPPs, except real estate DPPs.
Mr. Palmer, a high risk tolerant high net worth client of yours, has the following position in his margin account:
Short 1000 shares XYZ at $50/sh.
Cr. Bal. $ 75,000
Two weeks later, XYZ is trading at $40/sh. Assuming Palmer has not yet closed out his short position, his Cr. Bal. will now be:
Question 5 Explanation:
When CMV changes, either up or down, equity changes, but Credit Balance does not change – it remains constant.
In presenting an array of debt investments for your customer’s consideration, various investment risks are a major part of your presentation. When reinvestment risk is being discussed, which of the below instruments is least exposed to it?
15 year zero coupon bond
5 year T-note
20 year T-bond
25 year municipal GO callable in 5 years
Question 6 Explanation:
Bonds that have no coupon, no interest payments each year, by definition have no reinvestment risk. Reinvestment risk exists in those debt instruments that have coupon payments. With zeroes, there is nothing to reinvest each year.
At option expiration with CMV at the strike price, which account with no other positions beyond the following option positions will always experience profit?
Question 7 Explanation:
Option writers receive premium income. If the option expires, their profit is the premium. The option will expire if the CMV is equal to the Strike Price at expiration. The problem with the other choices is that with a long straddle, both options will expire and there will be total loss of straddle premium; and in the horizontal spread, there is no way to know if CMV at the Strike price will result in a profit or a loss – it could be either. In the case of the vertical spread, which strike price is the CMV equal to – the lower one or the higher one? The question doesn’t say, so you can’t know if it’s profitable. Short put will always be profitable when the option expires.
In financial planning discussions with Mr. Nicklaus, a customer of yours who has experience in real estate investing, he inquires about finding a securities investment through your firm which will provide upside potential from improvement in the real estate market while also providing liquidity in the event a quick exit is necessary. The most suitable investment meeting his criteria is:
real estate limited partnerships investing in fully-leased office buildings
real estate investment trusts
a raw land deal
Question 8 Explanation:
REITs are traded at bid and ask prices every day on exchanges, providing liquidity to the investor who may wish to purchase more or to sell out at any point in time. Non-traded REITs don’t have that sort of liquidity, and the other investments likewise lack liquidity. Raw land of course provides no cash flow/income and is unsuitable on its face. DPPs provide tax advantages but this client hasn’t requested tax sheltered investing.
Select from the below metrics the best test of corporate liquidity.
Question 9 Explanation:
Answers A, B and C are all very similar, but the quick test, also called the acid test, is the toughest test of liquidity from among these three choices. Book value says nothing about liquidity.
Variable annuities are subject to which of the following?
I. State blue sky regulations
II. SEC regulations
III. FINRA rules
IV. State insurance regulations
II and III
II, III and IV
I and IV
I, II, III and IV
Question 10 Explanation:
Variable annuities are an insurance product, and are subject to insurance regulations. Variable annuities are also a securities product, regulated by the SEC, the state securities regulators (blue sky rules) and FINRA.
The FINRA 5% policy applies to which of the following?
registered secondary distribution
3rd market transaction
municipal bond trades
Question 11 Explanation:
The 5% policy applies to retail trades in the secondary market where there is no prospectus in use (new issues). Since the MSRB has its own policy, FINRA’s 5% policy does not apply to municipal securities. That leaves 3rd market transaction as the only possible choice. Recall that a 3rd market trade is the purchase or sale of a stock exchange listed security in a marketplace other than the exchange on which the security is listed. Example: purchasing an NYSE listed stock out of the inventory of a broker-dealer rather than on the floor of the NYSE.
Your B/D is not a market maker in the stock of LANG Enterprises (ticker symbol: LANG), a NASDAQ listed stock. You receive, and accept, a customer buy order for 500 shares of LANG at the market. To fill this order, your order room purchases the shares from a market maker to fill the customer order. Which term below best describes this situation:
a simultaneous riskless trade
a principal transaction
a 3rd market transaction
an agency cross
Question 12 Explanation:
When a broker-dealer purchases a security from a market maker to fill an already-received customer buy order, this is defined as a simultaneous riskless transaction. Your firm has no risk because you’ve got the stock already sold.
Mr. Haas goes long 5.5% ABC debentures at 94 with 10 years until maturity. Five years later, due to a change in interest rates, credit quality and approaching maturity, the market value of his bonds has risen to 96. If he were to liquidate his bond position at this price, the most likely tax consequence in the year of sale would be:
$10 per bond capital loss
$20 per bond capital gain
$20 taxable accretion per bond and no capital gain
No gain, no loss
Question 13 Explanation:
You must first compute the accretion. He bought the bonds at $940, they mature at $1,000 par value in 10 years, the $60 discount is spread out over 10 years at the rate of $6 per year, called accretion. After 5 years, the accretion is 5 years x $6 = $30. The cost basis of the bonds is now $940 plus $30 = $970. Since he sold the bonds at a market price of only $960, tax law says he has a loss of $10 per bond. Had he sold them for greater than his cost basis of $970, he would have had a taxable capital gain.
One of the most notable risks which must be disclosed to your customer when recommending CMOs is that as interest rates in the US economy fall:
the liquidation market value of CMO interests will fall.
refinancing by homeowners may result in pre-payments to CMO holders due to mortgage pay-offs.
new money investments will slow down.
default risk will increase.
Question 14 Explanation:
Accelerated payment risk, pre-payment risk, or early repayment risk, are the various terms used to describe the risk that an owner of mortgage-backed securities is exposed to if the portfolio experiences an unplanned increase in mortgage pay-offs, primarily due to homeowners refinancing when rates drop. The risk to the investor is that his or her money isn’t earning the same high interest rate as it was when he or she first bought the CMO investment.
equity tradable instruments
equity traded notes
exchange traded notes
government sponsored notes designed to provide liquidity to businesses
Question 15 Explanation:
ETNs are unsecured debt instruments (notes) traded on an exchange, thus the name ‘exchange-traded notes.’
You have been approached by a long–time friend who has begun to package Reg. D offerings of real estate developments. His mission is to locate accredited investors and has asked you to provide him leads from your client list. He will pay you a finder’s fee for each lead which turns into a sale. If you wish to participate in this arrangement:
you must get your firm’s approval of this arrangement or you will be held in violation of the private securities transactions rules of the FINRA Code of Conduct.
you do not require your firm’s approval, but you do need to notify your firm of your intent to participate.
you may not participate under any circumstances since this is not a product approved by your firm.
you would have to resign your license using Form U-5 before participating in your friend’s deal.
Question 16 Explanation:
A private securities transaction, also called ‘selling away,’ is the violation that occurs if a registered rep engages in securities transactions ‘outside the scope of his or her firm’s business.’ If your firm reviews these real estate deals and finds them compliant with FINRA and SEC rules and regulations, your firm might add the product to your firm’s approved list. In that case, and only in that case, your participation in the deals would NOT be a violation.
A 40 year-old customer invested $10,000 in a nonqualified variable annuity. Ten years later she has a financial emergency and wishes to withdraw some of the current account value, which has grown to $18,000. She is concerned about the tax consequences of such a withdrawal. You explain to her that:
she may withdraw up to $10,000 tax free and without penalty.
all withdrawn monies will be subject to ordinary income tax plus a 10% penalty.
the first $8,000 of withdrawal will be taxed as ordinary income plus a 10% tax penalty.
the first $8,000 of withdrawal will be taxed partly as ordinary income and partly as capital gains, plus a 10% tax penalty for premature withdrawal.
Question 17 Explanation:
The key language in this question is the term ‘non-qualified.’ This VA product is funded by the client with after-tax (already-taxed income) dollars. Withdrawals prior to age 59½ will be on a LIFO basis, meaning the last-in money (the $8,000 of account earnings) is the first money to come out. Because she is 40 and her reason for the withdrawal does not qualify for a waiver of the 10% penalty, the earnings will be penalized 10% under the premature withdrawal rules. After the full $8,000 is withdrawn, she would then be withdrawing her original principal (her cost basis) on which there would be no tax or penalty.
Your client’s investment portfolio has a beta of 1.4 and yielded 7% over the previous 12 months. The S&P 500 Index has yielded 4.0% over the same 12 month period. Compute the Alpha of your client’s portfolio based upon these data.
Question 18 Explanation:
Alpha will be the excess yield over the ‘expected’ yield. Your client’s ‘expected’ yield is found by taking the S&P yield (4.0%) and multiplying it by the beta (volatility) of the portfolio which is 1.4. This gives us 5.6% as the expected return of your client’s portfolio. Then we can calculate that 7% minus 5.6% is the excess return above expectations, which is 1.4.
Compute the number of days of accrued interest payable by the purchaser of the J-J1 State of Virginia 4.75s42 bought on Wednesday, February 25th.
Question 19 Explanation:
These are municipal bonds. The 30/360 rule applies. The issuer pays semi-annual interest each January and July 1st (J-J1 is how you know that). Muni’s settle regular way 3 business days after the trade date (T+3). A trade on Wed. 2/25 will settle the following Monday, March 2nd. Accrued interest is computed up to but not including the settlement date. Accrued interest is due for the months of January and February, plus 1 day in March. Therefore, 2 months of interest is 60 days, plus 1 = 61 days of accrued interest.
Dealer to dealer good delivery of 580 shares of listed common stock, in accordance with the Uniform Practice Code of FINRA, would include each of the following deliveries except:
a stock certificate for 500 shares and a certificate for 80 shares
a stock certificate for 580 shares
580 certificates – 1 share each
5 certificates for 75 shares each; 9 certificates for 20 shares each; 5 certificates for 5 shares each
Question 20 Explanation:
A single certificate for 580 shares is unacceptable under the good delivery rules because it is a round lot odd lot combination in one certificate. As unusual as answer D appears, here is why it meets the good delivery rule. There are 19 certificates in this delivery. As long as you can combine them into SINGLE 100-share ‘piles,’ it’s good. You take each cert. for 75, you add a cert. for 20, you then add a cert. for 5 and you have a total of 100 shares represented by these 3 certificates. That is considered good delivery. You can make five such ‘piles’ to make good delivery of 500 of the shares in this order. What you’re left with are 4 certificates for 20 shares each…and they represent the odd lot of 80 additional shares, which is good delivery of those 80 shares.
The most significant distinction between a selling syndicate member and a selling group member is:
Question 21 Explanation:
Selling group members have a ‘best efforts commitment’ in the underwriting. Syndicate members have a ‘firm commitment.’
A FINRA member firm has become insolvent. A SIPC Trustee has just been appointed by the Court. Liquidation proceedings are imminent. Which of the following statements is inaccurate with regard to SIPC coverage?
All cash and securities that can be located, identified and attributed to specific customers will be returned to those customers without limit.
Up to $500,000 in cash and securities insurance coverage is provided to each ‘separate customer’ of the bankrupt broker/dealer.
Cash claims in excess of $250,000 are uninsured by SIPC, creating a general creditor status for claimants with claims for cash above that figure.
Up to $250,000 in cash in separate commodities accounts at the bankrupt B/D is covered by SIPC insurance.
Question 22 Explanation:
Commodities are not covered by the Securities Investor Protection Corporation. Commodities are not securities.
Christina Fauntleroy, a 78 year old widow and long time client of yours, wishes to open a joint account with her grand-niece Alison, who is about to enter high school. The purpose of the account is to teach Alison how to invest in the markets while also saving for college which will begin in 4 years.
you recommend the account be opened as JTWROS
you recommend the account be opened as TIC
you recommend the account be opened as joint tenants in their entireties
you cannot open this joint account
Question 23 Explanation:
The grand-niece is a minor. A minor cannot be a joint account holder. There are alternatives, such as UGMA or UTMA in which there is a Custodianship for the benefit of the minor.
In the business of underwriting new issues, the term Western Account is most often associated with:
joint & several liability
offerings of technology stocks
Question 24 Explanation:
Several liability is the legal term used when the members of the syndicate are solely responsible for selling their individual allocations, and have no continuing responsibility for the failed sales efforts of other syndicate members. Joint & several would refer to an Eastern syndicate, in which members have a continuing responsibility for the unsold shares of other members.
The State of Wyoming has outstanding $250,000,000 in 5.5% GOs which are callable at par one year out. The financial officials of the state are concerned that today’s 4% rates won’t be available to the state a year from now when the state will be permitted to call the 5.5% issue. To avail itself of today’s 4% rates, the state issues 4% GO bonds today in sufficient quantity to afford the call a year from now, escrowing the proceeds of this new issue in short term government securities for one year, at which time it will use those funds to call in the 5.5% issue.
this is not permitted – the state must wait until the call date to issue the new bonds
this is most often referred to as advance refunding
this is not permitted – it is considered Treasury arbitrage, a violation of the law
this is permitted only so long as the holders of the 5.5% issue are given a right of first refusal on the new 4% GOs
Question 25 Explanation:
Selling new bonds in order to raise capital to call in older high interest bonds is called refunding. When the issuer sells the new bonds months or years in advance of the call date, such as in this question, it is called advance refunding.
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