Practice Test 1

Multiple Choice Questions

1. When performing strategic asset allocation for a 60 year-old customer, each of the following is TRUE EXCEPT:

a. The customers retirement plans should be considered.
b. A general rule of thumb is to invest 100 minus the customers age in stocks (40% here) and the rest in bonds and cash.
c. A large percentage of the customers portfolio should be in cash if the equity markets have been particularly weak during the previous 12 months.
d. Portfolio rebalancing should be performed regularly when needed.

2. A stocks support level is which of the following?

a. The average trading price of the security.
b. The lower price of the security’s recent trading range.
c. The upper price of the security’s trading range.
d. The price at which fairly priced call options will be profitable.

3. You determine with your customer Renee Retired, a 65 year-old retiree, that she should have a “defensive” investment strategy. Each of the following would be suitable investments for Renee’s account, EXCEPT:

a. High-yield bonds
b. Treasury bonds
c. Blue chip stocks
d. Money market funds

4. Which of the following would be of least interest to a fundamental analyst?

a. The P/E ratio
b. Working capital
c. Statement of cash flows
d. Historical prices

5. ABC broker-dealer is a member of a syndicate that is offering new shares of XYZ Corp common stock to the public. The size of the total offering is 10,000,000 shares, with ABCs allocation being 1,000,000. After selling its entire allotment, 1,000,000 shares remain unsold by other members of the syndicate. How many of the remaining shares is ABC responsible for?

I. 0 shares if the offering was on an Eastern account basis.
II. 0 shares if the offering was on a Western account basis.
III. 100,000 shares if the offering was on an Eastern account basis.
IV. 100,000 shares if the offering was on a Western account basis.

a. II and III only.
b. I and III only.
c. II and IV only.
d. I and IV only.

6. UGMA stands for _______.

a. Uniform Grant to Minors Act
b. Uniform Grant to Minorities Act
c. Uniform Gift to Minors Act
d. Uniform Gift to Minorities Act

7. An investor has the following investment results for the current year:

Capital gains: $20,000
Capital losses: $45,000

What is the tax status for this investor?

a. $3,000 loss for the current year, $22,000 carried over to the following year
b. $25,000 loss for the current year
c. $5,000 loss for the current year, $20,000 carried over to the following year
d. $3,000 loss for the current year, $3,000 carried over to the following year

8. All of the following statements are FALSE regarding callable municipal revenue bonds, EXCEPT:

a. Callable bonds increase in price faster than non-callable bonds in a rising interest rate environment.
b. Callable bonds usually have lower yields than non-callable bonds.
c. The issuer will typically call their bonds in a decreasing interest rate environment.
d. When bonds are called, the call premium is set to offset the missed interest payments the investor would have received had the bond not been called.

9. A customer is interested in purchasing equity securities with the objective of receiving dividends. Which of the following is LEAST likely to be a suitable investment recommendation?

a. ABC common stock
b. DEF warrants
c. QRS preferred stock
d. XYZ convertible preferred stock

10. Each of the following is a type of municipal note EXCEPT:

a. AONs
b. BANs
c. PNs
d. RANs

Multiple Choice Answers

1. C: The general rule of thumb is that customers should have 100 minus their age invested in stocks. However, years to retirement, retirement plans, and specific investment objectives should also be taken into account. Furthermore, as the customer ages, appropriate portfolio rebalancing should be conducted as a matter of routine procedure. Answer C is correct for two reasons: first, the question refers to strategic asset allocation, while answer C refers to a decision that would fall into the category of tactical asset allocation. Second, the performance of stocks in the most-recent 12 months is insufficient to guide an advisor with regard to the investment objectives of his or her customers.

2. B: In technical analysis (or charting), a stocks support level refers to the bottom patterning of a stocks recent trading range. Around this price, the stock seems to reverse direction and trade higher, and is said to have “price support.” If the stock falls below this bottoming level pattern, and particularly if the stock closes below this level, it is referred to (by technical analysts) as a “breakdown.” As a result, the stock price is expected to continue to fall until a new, but lower, trading range is established. The support level is determined by the price action of the stock and has nothing to do with the options.

3. A: As a retiree, Renee selects a defensive strategy because she is likely to prefer to take less risk- preferring capital preservation and current income. Of the listed choices, treasury bonds and money market funds will provide her with current income at a relatively low risk level. Blue chip stocks also present a lower risk profile and may offer additional income through the payment of dividends. High-yield bonds are considered a riskier investment, and thus inappropriate for Renee’s account and her goal of defensive investing.

4. D: Fundamental analysis examines the quality of a company’s earnings, its growth prospects, and its position within the industry in which it competes; it also tries to identify securities that are mispriced based on the analysts view of what the company’s stock should be worth. Unlike the technical analyst, who examines the price action of the stock, its volume, and its historical behavior, the fundamental analyst is only trying to determine what the “true value” of the stock is so that appropriate trading decisions can be made. D is the correct answer because the fundamental analyst doesn’t track the stocks price action in order to assign value to it. The value is set according to “fundamentals.”

5. A: There are two types of syndicates that may be set up to offer new shares for sale to the public – those that operate on a Western (or divided) account basis and those that operate on an Eastern (or undivided) account basis. Under the Western basis, each firm is responsible only for those shares which they originally were allotted. Under the Eastern basis, each firm is responsible for any unsold shares on the same percentage basis as in the original allotment. In this case, ABC was originally responsible for 10% of the total shares offered (1,000,000 / 10,000,000). ABC is, therefore, responsible for an additional 100,000 of the unsold shares if the syndicate is operating on an Eastern basis; otherwise, ABC has fulfilled its obligation and is not responsible for any additional shares.

6. C: The Uniform Gifts to Minors Act, commonly known as UGMA, is an act in some states of the United States that allows assets such as securities, where the donor has given up all possession and control, to be held in the custodian’s name for the benefit of the minor without an attorney needing to set up a special trust fund.
7. A: An investor may use any capital losses in a given tax year to offset capital gains, and then carry forward any unused losses to use in future years. However, only $3000 of losses per year may be written off against income gains. In this case, the investor has a net capital loss of $25,000 ($45,000 losses – $20,000 gains). The investor may, therefore, write off the maximum allowable $3000 in the current tax year and carry forward the remaining $22,000 into the following year. Next year, any capital gains may be offset against the $22,000, but if additional losses accrue, only another $3000 may be written off.

8. C: The key to the question is in the fact that the bonds are callable; there is no significance to the fact that they are municipal revenue bonds. Callable bonds, like any bonds, decrease in price when interest rates rise, so answer A is false. Callable bonds usually have a higher yield to compensate the bond holder for the risk that the bonds may be called early. Answer D is also false because the call premium (the penalty the issuer is required to pay when the bonds are called) is not tied to the lost coupon payments. If it were, bonds would never be called. Answer C is true, and thus the correct answer, because when rates are falling, issuers will often call outstanding bonds and reissue them at lower rates.

9. B: Common stock, preferred stock, and convertible preferred stock all MAY provide the holder with regular dividends payments – the specific features of each will vary from issue to issue and be dependent on the specific company issuing the security. A warrant gives the holder the right to purchase stock at a specified price for a specified period of time, but is not equivalent to stock. Holders do not receive dividends, so warrants would not be an appropriate investment recommendation for a customer whose goal is to receive dividends.

10. A: All or none (AON) is a type of underwriting or an order qualifier on certain types of securities orders. Bond anticipation notes (BANs), project notes (PNs), and revenue anticipation notes (RANs) are all short-term municipal notes. The trick in this question is somewhat obvious, and is designed to make sure the test-taker is paying attention. AONs are three letters, making PNs the stand-out. This is roughly the depth of understanding that is required about the specific municipal securities that are commonly encountered on the test.