Multiple Choice Questions
1. When is the latest time that an investor may exercise a listed option?
a. 5:30 p.m. EST on the third Friday of the expiration month
b. 4:00 p.m. EST on the third Friday of the expiration month
c. 8:30 p.m. EST on the Saturday after the third Friday of the expiration month
d. 11:59 p.m. EST on the Saturday after the third Friday of the expiration month
2. Barry Bonds purchases an ABC 8 % corporate bond at 80. How much does Barry have to claim on his taxes each year, if the bond matures in ten years and he holds it to maturity?
3. If a technical analyst identifies a “head and shoulders topping formation,” this indicates which type of condition?
c. Reversal of a bullish trend
d. Reversal of a bearish trend
4. When applying the NASD 5% rule, each of the following is FALSE EXCEPT:
a. The 5% rule is a guideline for the sales of open-ended investment companies
b. Securities sold through a prospectus are exempt from the rule
c. The security type or class is not a consideration
d. Riskless arbitrage transactions are exempt from the rule
5. If an investor buys an ABC corporate bond with an 8% coupon and 10 years until maturity for 80, and then sells it 5 years later for 89, what gain or loss is realized by the investor?
a. A gain of $70
b. A loss of $70
c. A gain of $10
d. A loss of $10
6. Which of the following MUST be a closed-end fund?
a. POP – $15, NAV – $13.90
b. POP – $21, NAV – $19.10
c. POP – $8, NAV – $7.35
d. POP – $11, NAV – $10.25
7. Each of the following is a FALSE statement about an ADR, EXCEPT:
a. The actual shares are not held in a custodian bank
b. The investor cannot receive dividends in cash
c. ADRs represent shares of U.S. securities trading in foreign markets
d. The investor does not receive the actual certificate
8. Determine the purchase price of a 6% corporate bond that carries a 6.5% yield-to-call after five years and a 6% basis.
a. Above $1000
c. Below $1000
d. Not enough information provided
9. Unless specifically stated to the contrary , a CMO has an S&P rating of
10. Dewey, Cheetum & Howe Brokerage acquires a large block of ABC Corp for $39 per share. Two weeks later, shares of ABC are quoted in the market at 34 – 34.15. Which of the following prices must the firm use as its basis when selling shares to its customers?
Multiple Choice Answers
1. A: The last time that an investor can trade a listed option is at 4:00 p.m. on the third Friday of the expiration month (answer B). Options may be exercised until 5:30 p.m. on the third Friday of the expiration month (answer A). Options officially expire at 11:59 p.m. on the Saturday after the third Friday of the expiration month (answer D). It is important to remember that some test questions may use CST instead of EST because many options are traded primarily in Chicago at the CBOE.
2. B: Barry’s tax liability is determined by calculating the annual interest he receives plus the annual accretion. The interest is calculated by multiplying the annual coupon by the par value of the bond (8% * $1000 = $80). Accretion is determined by dividing the discount received in the purchase price (par value minus market price) by the number of years to maturity ($1000 – $800 / 10 = $20). Therefore, Barry’s annual tax liability is $80 of interest added to the $20 of accretion, or $100.
3. C: This is another question is which you must determine which is the “best answer.” A head and shoulders topping formation is a bearish indicator, but more accurately it signals that a bullish trend is reversing. Therefore, while answer B is technically also correct, the “best” answer is C because it is more complete and accurate. The type of formation can apply to an individual stock or the market as a whole, and it gets its name from the “picture” of a head and two shoulders “appearing” on the chart of the security being investigated.
4. B: The NASD 5% rule is somewhat of a misnomer – it is more of a guideline than a regulatory rule. It states that a brokerage firm should not charge more than 5% for commissions, markups, or markdowns when collecting fees from customers. It was enacted to help ensure that customers were not charged excessively in the over-the-counter (OTC) market. It covers OTC trades with public customers in dealing with outstanding, non-exempt securities. The policy is not intended to cover new securities – like those offered through a prospectus. Each of the other statements is false.
5. D: The first step to solving this problem is to properly accrete the bond. Accretion is determined by dividing the discount received in the purchase price (par value minus market price) by the number of years to maturity ($1000 – $800 / 10 = $20). This amount must be added to the purchase price to determine the investor’s ultimate cost basis ($800 + $100 = $900). If the investor sells the bond for 89, he or she receives $890 (89% * $1000 par value = $890). The difference realized by the investor is, therefore, a loss of $10 ($890 – $900 = -$10). Remembering to add the accretion is the critical step in this problem.
6. B: When evaluating any question on the exam, pay careful attention to words that are emphasized (MUST in this case). Any of the combinations of public offering price (POP) and net asset value (NAV) could indicate a closed-end fund but, under the maximum 8.5% sales charge rule, answer B must be a closed-end fund because its sales charge exceeds 8.5%. The sales charge implied in the combinations given can be calculated as: sales charge = (POP – NAV) / POP. Each of the answer choices results in a sales charge below 8.5%, except for B, which must, therefore, be a closed-end fund.
7. D: An American Depository Receipt (ADR) represents the shares of a foreign security trading in the U.S. The very definition eliminates answer C. An investor IS able to receive dividends in cash and the certificates are held in a custodial bank, NOT delivered to the investor. Answers A and B can also be eliminated, leaving only answer D as the one TRUE statement of the four answer choices given in the question. ADR questions tend to be very straightforward and should be an easy place to gain points if you are familiar with the basics.
8. B: The key to this question is to recognize that the test writers often like to provide you with an excess of information in an effort to confuse you or trick you into believing that the question is more complicated than it actually needs to be. The fact that the bond carries a call premium after 5 years is completely irrelevant to determining the correct answer. If the basis and the coupon are equal, the investor paid par for the bond. This means that the investor paid $1000 for the bond – what has happened since is not relevant to determining the purchase price.
9. A: A Collateralized Mortgage Obligation (CMO) normally has a Standard & Poor’s credit rating of AAA because they are comprised of GNMAs (directly backed by the U.S. Government), FNMAs and FHLMCs (these are agencies implicitly backed by the U.S. Government as we saw during the recent housing crisis). All of these securities are considered exceptionally safe and receive S&P’s highest rating unless they are accompanied by a statement to the contrary. Whether this will remain the case remains to be seen, but for the time being, and for the current test, it is accurate.
10. C: Despite the brokerage firm’s wish to sell shares using its own cost basis (the price at which the firm acquired the shares and took them into their inventory), the current market price is the only price at which the shares may be sold (plus the commission charged by the firm). Since the question asks what price the brokerage sells the shares for, the current ask or offer price ($34.15) should be used – the customer is buying at the offer. The brokerage could buy the shares from a customer at the bid, less any commission.