Knopman General Exam # 2

Front 1

A registered representative with ABC Securities has recently become aware of a new variable annuity. As tax time is approaching, the representative decides to recommend the variable annuity to all of his customers as an attractive addition to their portfolios. The representative should:

1. recommend the variable annuity to all of his clients because the tax advantage almost always results in a greater return.
2. recommend the variable annuity to those clients whose needs and objectives match the investment.
3. recommend the variable annuity to all of his clients because of the performance potential of the subaccounts.
4. not recommend the investment to all of his clients in spite of the tax advantages and additional features.

A) II and III.
B) I and III.
C) II and IV.
D) I and IV.

Back 1

The correct answer was: II and IV.
Recommendations may be made only when it is suitable for the customer's needs. Therefore, he would not recommend the variable annuity to all of his clients despite the tax advantages.

Reference: 15.2.1 in the License Exam Manual.

Front 2

A similarity between common and preferred stock is:

A) the dividend must be declared by the board of directors.
B) the dividend is fixed.
C) they have an equal vote.
D) both are evidence of corporate indebtedness.

Back 2

The correct answer was: the dividend must be declared by the board of directors.
All dividends, both common and preferred, must be declared by the board of directors. Preferred shares usually have a fixed dividend rate and usually have no (or very limited) voting powers. Both types of stock are equity, not debt, securities.

Reference: 1.3.1.1 in the License Exam Manual.

Front 3

On February 16, 2004, an investor purchases 100 shares of QRS common stock at $60 per share. On July 19, 2004, the investor writes one QRS Mar 70 call at 2. On expiration date, the price of QRS is $75 per share, and the investor receives a notice of assignment. Disregarding commission, what is the tax consequence of these transactions?

A) $1,200 long-term capital gain.
B) $1,200 short-term capital gain.
C) $1,500 long-term capital gain, $200 short-term capital gain.
D) $1,700 long-term capital gain.

Back 3

The correct answer was: $1,200 long-term capital gain.
When a call option is exercised, the writer adds the premium ($200) to the strike price ($7,000) to determine the sales proceeds. Sales proceeds are then compared to the purchase price of $6,000 to establish a $1,200 gain. The gain is long term since the holding period of the stock was from February of 2004 through March of 2005.

Reference: 4.7.3.3 in the License Exam Manual.

Front 4

Which of the following statements regarding the economics of fixed-income securities are TRUE?

1. Short-term interest rates are more volatile than long-term rates.
2. Long-term interest rates are more volatile than short-term rates.
3. Short-term bond prices react more than long-term bond prices given a change in interest rates.
4. Long-term bond prices react more than short-term bond prices given a change in interest rates.

A) II and III.
B) II and IV.
C) I and III.
D) I and IV.

Back 4

The correct answer was: I and IV.
There are two separate issues in this question: the volatility of rates and volatility of bond prices. Short-term rates are more volatile than long-term rates and move more quickly than long-term rates. Often the most volatile interest rate is the federal funds rate, which is an overnight rate of interest. Given a change in rates, long-term bond prices move more than short-term bond prices because of the compounding effect over a much longer period.

Reference: 2.2.7.6 in the License Exam Manual.

Front 5

Which of the following choices does NOT influence the level of interest rates?

A) Amount of loanable funds in the financial markets.
B) Federal Reserve's monetary policy.
C) New housing starts.
D) Inflation expectations.

Back 5

The correct answer was: New housing starts.
New housing starts are affected by the level of interest rates, but they are not a factor in the determination of interest rates. Interest rates are determined by the supply and demand for loanable funds. The more money that is available for lending, the lower the rates.

Reference: 14.1.1.3.1 in the License Exam Manual.

Front 6

You have a high-income client who wishes to maximize his after-tax interest income. Which of the following investments might NOT meet your client's objective?

A) AA rated IDB.
B) AA rated revenue bond.
C) AA rated municipal note.
D) AA rated GO bond.

Back 6

The correct answer was: AA rated IDB.
Industrial development bonds are private purpose bonds, and the interest income could subject the holder to the alternative minimum tax. Thus, the interest income may not be completely tax free.

Reference: 3.1.1.2.5 in the License Exam Manual.

Front 7

Which of the following affects the holding period of XYZ stock, a position that has been held for 6 months?

1. Buying an in-the-money put
2. Buy an out-of-the-money put
3. Writing an in-the-money call
4. Writing an out-of-the-money call.

A) I and II.
B) III and IV.
C) II and III.
D) I, II, III and IV.

Back 7

The correct answer was: I and II.
Buying a put (in or out-of-the-money) on a stock held short term (one year or less) stops the holding period until the put is disposed of.

Reference: 4.7.1 in the License Exam Manual.

Front 8

Limited partnership programs are categorized as direct participation programs. The term "direct participation" refers to:

A) most general partners directly participate in the management of the partnership.
B) the ability, through partnership democracy, for each partner to have his vote flow through to the general partner.
C) the flow-through of profits and losses of the partnership to the individual limited partners.
D) the ability of any partner, limited or general, to participate in the running of the partnership.

Back 8

The correct answer was: the flow-through of profits and losses of the partnership to the individual limited partners.
Understanding the flow-through concept is critical with DPPs. Only DPPs allow flow-through of losses.

Reference: 13.1 in the License Exam Manual.

Front 9

Interest income from all of the following are exempt from state and local taxation EXCEPT:

A) Series EE savings bonds.
B) Treasury bonds.
C) Treasury bills.
D) FNMA mortgage-backed issues.

Back 9

The correct answer was: FNMA mortgage-backed issues.
As a general rule, the interest income from U.S. government and agency securities is subject to federal taxation only; it is generally exempt from state and local taxation. However, the interest income from mortgage-backed securities is fully taxable.

Reference: 15.5.4.1.1 in the License Exam Manual.

Front 10

If a customer wants to place an order for a specific municipal bond and provides the bond's issuer, coupon, maturity date, and CU.S.IP number, but has not disclosed his financial objectives or tax status, the representative must:

A) recommend a different bond of the same issuer with a higher rating.
B) determine whether the transaction is suitable.
C) refuse the order.
D) execute the order and mark it "unsolicited".

Back 10

The correct answer was: execute the order and mark it "unsolicited".
When a customer wants to buy a specific municipal bond and possesses all of the bond's material information, MSRB Rule G-19 allows the representative to execute the order and mark it "unsolicited." The representative may not recommend any municipal bond without first knowing the customer's financial objectives and tax status.

Reference: 3.5.1.1 in the License Exam Manual.

Front 11

The income level of a donor:

1. may affect contributions into a Coverdell ESA.
2. will NOT affect contributions into a Coverdell ESA.
3. may affect contributions into a Section 529 plan.
4. will NOT affect contributions into a Section 529 plan.

A) I and IV.
B) I and III.
C) II and IV.
D) II and III.

Back 11

The correct answer was: I and IV.
Contributions into a Coverdell ESA are phased out at high income levels, whereas the income level of a donor has no impact on contributions made into a Section 529 plan.

Reference: 11.2.5.1 in the License Exam Manual.

Front 12

All of the following events will affect the NAV per share of a mutual fund EXCEPT:

A) Wholesale redemption of fund shares .
B) Changes in the market value of the fund's portfolio of securities .
C) The fund pays dividends to its shareholders.
D) The fund receives cash dividends on the securities in its portfolio .

Back 12

The correct answer was: Wholesale redemption of fund shares .
Dividends paid and received by the fund directly affect NAV. Changes in the portfolio value affect NAV because the securities are marked to market daily. While share redemption will reduce total net asset value, the number of shares outstanding decreases in proportion, so the NAV per share stays the same.

Reference: 10.7.6 in the License Exam Manual.

Front 13

If the Swiss franc closes at 56, 1 SF 59 put is:

A) 3 points in-the-money.
B) without intrinsic value.
C) 3 points out-of-the-money.
D) at the money.

Back 13

The correct answer was: 3 points in-the-money.
The put is in-the-money when the underlying instrument's market price is below the put's strike price.

Reference: 4.1.5.1 in the License Exam Manual.

Front 14

An order to sell at 38.65 stop limit is entered before the opening. The subsequent trades are 38.85, 38.50, and 38.35. The order:

A) was executed at 38.65.
B) was executed at 38.50.
C) was executed at 38.85.
D) has not yet been executed.

Back 14

The correct answer was: has not yet been executed.
A stop limit order is a stop order that becomes a limit order once the stop price has been triggered. When the limit price is the same as the stop price on a stop limit order, the order may be executed only at, or better than, the limit price. In this case, the order has not yet been executed because no transaction has occurred at, or above, 38.65 since the stop was triggered at 38.50.

Reference: 8.4.2.4.3 in the License Exam Manual.

Front 15

Which of the following are discretionary orders?

1. A customer sends a check for $25,000 to an agent and instructs the agent to purchase bank and insurance company stocks when the price appears favorable.
2. A customer instructs an agent to buy 1,000 shares of ABC Corporation at a time and price determined by the agent.
3. A customer instructs an agent to purchase as many shares of XYZ as the agent considers appropriate.
4. A customer instructs an agent to sell 300 shares of LMN, Inc., when the agent deems the time and price appropriate.

A) II and IV.
B) I and IV.
C) II and III.
D) I and III.

Back 15

The correct answer was: I and III.
Discretion authorizes a representative to choose the security, the amount of shares, or whether to buy or sell. Time and/or price alone are not discretionary decisions.

Reference: 5.2.2 in the License Exam Manual.

Front 16

Which of the following is a lagging indicator?

A) The GNP.
B) Durable goods orders.
C) Housing starts.
D) Corporate profits.

Back 16

The correct answer was: Corporate profits.
Corporate profits are a lagging indicator, as the economic direction has been established before it is reflected in corporate profits.

Reference: 14.1.1.3.3 in the License Exam Manual.

Front 17

Three 3% bonds are listed in the newspaper. One bond will mature in one year, another bond will mature in ten years, and the third bond will mature in 20 years. If interest rates are going up, which bond will have the greatest decrease in value?

A) The bond with the 1-year maturity.
B) The bond with the 20-year maturity.
C) The bond with the 10-year maturity.
D) They will all have the same decrease in value.

Back 17

The correct answer was: The bond with the 20-year maturity.
Long-term bonds have the greatest interest rate risk. A bond with only 1 year to maturity will trade very close to par.

Reference: 2.2.7.6 in the License Exam Manual.

Front 18

Each of the following are permitted to open an IRA EXCEPT:

A) an individual whose sole income consists of dividends and capital gains.
B) a self-employed attorney who has a Keogh plan.
C) a divorced mother whose sole income is alimony and child support.
D) a corporate officer covered by a 401(k) plan.

Back 18

The correct answer was: an individual whose sole income consists of dividends and capital gains.
An IRA contribution can be made only from earned income. Dividends and interest are investment income, but alimony is considered earned income. Individuals can contribute to an IRA even if they are already covered by a corporate pension plan or Keogh plan. However, although a contribution can be made, it may or may not be deductible depending on the individual's income.

Reference: 11.2 in the License Exam Manual.

Front 19

The following chart shows the capital transactions of ABC Corporation.
Date Event Amount
10-19-96 Initial Offerings 6 million shares
4-1-2000 Treasury Purchase 500,000 shares


ABC wants to raise additional capital by selling 2 million shares through a rights offering and engages an underwriter on a standby basis. By the expiration date, ABC was only able to sell 1 million shares to existing shareholders. After expiration, how many shares does ABC have outstanding?

A) 7.5 million.
B) 7 million.
C) 8 million.
D) 6.5 million.

Back 19

The correct answer was: 7.5 million.
Before the rights offering, the company had 5.5 million shares outstanding (6 million issued minus 500,000 Treasury shares). In connection with the offering, ABC engages a standby underwriter that commits to purchase any unsold shares. Therefore, regardless of the number of shares initially subscribed to, all 2 million shares will be sold.

Reference: 1.7.1.1 in the License Exam Manual.

Front 20

If a high-income customer is subject to AMT, which of the following preference items must be added to adjusted gross income to calculate his tax liability?

A) Income from a municipal security issued to finance parking garages.
B) Interest on a private purpose municipal bond issued after September 1987.
C) Distributions from a corporate bond mutual fund.
D) Interest on a municipal bond issued to finance highway construction.

Back 20

The correct answer was: Interest on a private purpose municipal bond issued after September 1987.
If more than 10% of a bond's proceeds go to private entities, the interest on the bond is a tax preference item for alternative minimum tax purposes.

Reference: 15.5.10 in the License Exam Manual.

Front 21

Which of the following is NOT a risk to a U.S. resident owning a eurodollar bond?

A) Interest rate risk.
B) Default risk.
C) Currency risk.
D) Inflation risk.

Back 21

The correct answer was: Currency risk.
Eurodollar bonds are denominated in dollars; therefore, no currency risk exists for a U.S. resident.

Reference: 2.10.4.2 in the License Exam Manual.

Front 22

Which of the following is an automated system of delivering information relating to the market for municipal securities?

A) INSTINET.
B) "Munifacts".
C) "The Bond Buyer".
D) "The Blue List".

Back 22

The correct answer was: "Munifacts".
Munifacts supplies up-to-the-minute information to its subscribers via computer. "The Bond Buyer" offers the Munifacts service.

Reference: 3.2.3.2 in the License Exam Manual.

Front 23

If LMN, Inc. has filed for bankruptcy, in what order would interested parties be paid?

1. Holders of secured debt.
2. Holders of subordinated debentures.
3. General creditors.
4. Preferred stockholders.

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

Back 23

The correct answer was: I, III, II, IV.
The liquidation order is as follows: the IRS (and other government agencies), secured debt holders, unsecured debt holders, holders of subordinated debt, preferred stockholders, and common stockholders.

Reference: 2.3.2.3 in the License Exam Manual.

Front 24

Any branch office employee who refers customers to municipal securities registered representatives and is compensated for any transactions that result must be a:

A) financial and operations principal.
B) general securities principal.
C) registered representative.
D) municipal securities dealer employee.

Back 24

The correct answer was: registered representative.
An employee who receives compensation based on sales must be registered as a sales representative.

Reference: 3.4.4.2 in the License Exam Manual.

Front 25

The result of declining inflation on outstanding bonds would be:

A) higher prices and higher yields.
B) higher prices and lower yields.
C) lower prices and lower yields.
D) lower prices and higher yields.

Back 25

The correct answer was: higher prices and lower yields.
Declining inflation means declining interest rates. If interest rates decline, bond prices rise.

Reference: 2.2.7.6 in the License Exam Manual.

Front 26

An affiliate of a corporation wants to sell 80 calls covered by 8,000 shares of Rule 144 stock she owns. This transaction is:

A) not allowed because Rule 144 stock may not be sold unrestricted by an affiliate.
B) allowed because the calls will be considered covered by the stock.
C) allowed because the 8,000 shares of stock may be sold unrestricted.
D) not allowed because an affiliate of a corporation may not trade options in the company's stock.

Back 26

The correct answer was: not allowed because Rule 144 stock may not be sold unrestricted by an affiliate.
Rule 144 stock is considered to be illiquid. It cannot be sold unrestricted by an affiliate and could, therefore, not be used to cover the calls in the event the calls were exercised.

Reference: 7.6.2.4 in the License Exam Manual.

Front 27

An example of overlapping debt would be a school district and:

A) county general debt.
B) corporate debt of the county's largest employer.
C) a water pollution control facility.
D) a local power plant.

Back 27

The correct answer was: county general debt.
Do not combine revenue bonds with GOs to determine overlapping debt. Overlapping debt occurs in real estate taxing situations. Only GOs are backed by real estate taxes.

Reference: 3.1.1.1.2 in the License Exam Manual.

Front 28

In April, a customer sold short 100 shares of QRS stock at $50 and simultaneously wrote 1 QRS Jan 50 put for a premium of $7. If the January put is exercised when the market value of QRS is 43 and the stock acquired is used to cover the short stock position, what is the customer's profit or loss per share?

A) $7 loss.
B) $7 gain.
C) 0.
D) $14 loss.

Back 28

The correct answer was: $7 gain.
Because the stock is purchased on exercise of the short put for $50 and is used to cover the $50 short sale, the investor incurs no gain or loss on the stock. The customer keeps the $700 collected in premiums for a profit of $7 per share.

Reference: 4.3.4 in the License Exam Manual.

Front 29

The Securities Act of 1933 requires securities issued by all of the following to register and be subject to prospectus provisions EXCEPT:

A) investment companies.
B) corporations involved in interstate commerce.
C) the U.S. government.
D) foreign governments with which the United States maintains diplomatic relations.

Back 29

The correct answer was: the U.S. government.
The Securities Act of 1933 does not require U.S. government securities to be issued by prospectus. The act covers the issuance of securities by companies engaged in interstate commerce. Investment company shares must be sold by prospectus. The exemption for securities issued by foreign governments is found in the Uniform Securities Act, not the federal law.

Reference: 7.6.1 in the License Exam Manual.

Front 30

If a customer has a restricted margin account with SMA of $2,500, how much must he deposit to purchase $10,000 worth of stock?

A) 10000.
B) 5000.
C) 2500.
D) 0.

Back 30

The correct answer was: 2500.
The purchase of $10,000 requires a $5,000 deposit, which can be reduced dollar for dollar by the existing SMA.

Reference: 6.2.1.6 in the License Exam Manual.

Front 31

If a customer buys 1 OEX Feb 350 call at 5 and sells 1 OEX Feb 335 call at 16 when the underlying index is at 344, he will profit if the

1. spread narrows.
2. spread widens.
3. underlying index does not change.
4. underlying index rises in value.

A) III and IV.
B) I and IV.
C) II and IV.
D) I and III.

Back 31

The correct answer was: I and III.
This is a credit spread because the investor received more premium than was paid. Sellers profit if both contracts expire or the spread narrows. The breakeven point is 346 (335 + 11, the net premium) and because the spread is bearish, the customer profits if the index is below 346.

Reference: 4.4.1.3 in the License Exam Manual.

Front 32

Mr. Jones calls his registered representative and places an order to write an XYZ Oct 90 call and at the same time to write an XYZ Oct 80 put. The orders are executed at a premium of 5 for the call and 9 for the put. Which of the following best describes the customer's investment strategy?

A) Neutral strategy.
B) Bullish strategy.
C) Mixed strategy.
D) Bearish strategy.

Back 32

The correct answer was: Neutral strategy.
A customer who writes both a call and a put on the same underlying security wishes for little or no market movement. This is referred to as a neutral strategy. Technically, the customer has created a short combination (an investment position very similar to a short straddle, with the same investment characteristics), and, in this case, a little less risk than a pure straddle because of the spread in the strike prices.

Reference: 4.4.2.3 in the License Exam Manual.

Front 33

If QRS, Inc., makes a new offering not registered with the SEC to accredited investors, this arrangement is called a(n):

A) Rule 144 offering.
B) intrastate offering.
C) private placement.
D) secondary offering.

Back 33

Your answer, private placement., was correct!.
A private placement, which is exempt from registration with the SEC, is an offering of a new issue to an unlimited number of accredited investors and, for larger offerings, a maximum of 35 nonaccredited investors.

Reference: 7.6.2.2 in the License Exam Manual.

Front 34

Mutual fund Class B shares assess:

A) a level load.
B) a front-end load.
C) no load.
D) a deferred sales load.

Back 34

The correct answer was: a deferred sales load.
Class B shares carry a deferred sales load. This is sometimes referred to as a back-end load. Class A shares carry a front-end load. Class C shares carry a level load.

Reference: 10.7.5.5 in the License Exam Manual.

Front 35

Which of the following statements regarding a shelf offering are TRUE?

1. It can be used to distribute an initial public offering only.
2. It can be used to distribute an additional offering only.
3. Its maximum duration is 90 days.
4. Its maximum duration is 3 years.

A) I and IV.
B) I and III.
C) II and III.
D) II and IV.

Back 35

The correct answer was: II and IV.
Shelf offerings are used by publicly traded companies to issue additional equity or debt securities. The issuer must sell the securities within 3 years after the registration is declared effective.

Reference: 7.3.3.6 in the License Exam Manual.

Front 36

In a discretionary account, due diligence requires a member to receive prior written consent before purchasing nonconventional investments (NCIs). All of the following are considered NCIs EXCEPT:

A) Distressed corporate debt.
B) Equity linked notes.
C) Hedge funds.
D) Corporate bond funds.

Back 36

The correct answer was: Corporate bond funds.
Equity linked notes, debt issued by corporations that have filed for bankruptcy or are considering filing for bankruptcy, and hedge funds are all examples of investments that carry unique risks that an investor needs to be aware of. Therefore, before purchasing these types of investments in a discretionary account, proper due diligence by the broker/dealer requires that the customer provide prior written consent.

Reference: 5.2.2.3 in the License Exam Manual.

Front 37

Under NYSE rules, a not-held order:

A) is a limit order.
B) is good until canceled.
C) requires discretionary authority from the customer.
D) is good for the day only.

Back 37

The correct answer was: is good for the day only.
Under NYSE rules, a not-held order where a customer gives you authority over the price or timing of the order is good for that day only.

Reference: 8.4.3.4 in the License Exam Manual.