Congratulations! You’ve just completed Practice Exam 2 (unless you’re just randomly flipping through the book). After grading both Practice Exam 1 and 2, you should have a good idea of where you stand regarding the Series 7 exam. Kudos if you did really well on both exams.

In this practice test, I decided to step it up a notch and add a few questions with exhibits. Exhibit questions aren’t really any harder, but they’re just different, and you need to make sure that seeing one doesn’t throw you off your game.

As with the first practice exam, review all the questions that you got wrong and the ones you struggled with. Test yourself again by answering all the questions you highlighted and the questions you answered incorrectly, and make sure you get them right this time! Please give yourself a week or two before taking the same test again. Memorizing answers can give you a false sense of security, and you won’t get an accurate forecast of how well you’ll do on the Series 7 exam (you certainly don’t want your score to be as unpredictable as the weather). I encourage you to take as many Series 7 practice exams as possible.

If you’re short on time but just can’t wait to see how well you did, you can check out the abbreviated answer key (without the explanations) at the end of this chapter. I explain how the Series 7 is scored in the section “Knowing the Score,” just before the answer key. But I strongly suggest you come back later and do a more thorough review.

1. A. (Chapter 5) Another primary issue of shares would dilute Mark’s ownership because new shares would be coming to the market. Don’t forget that when a corporation issues stock dividends, splits its stock, or makes a secondary offering, the percent of equity does not change.
2. D. (Chapter 9) The answer to this question is Choice (D). To calculate the long market value that would trigger a maintenance call, use the following formula (DR = debit balance):
   
3. D. (Chapter 13) Fundamental analysts decide what to buy and technical analysts decide when to buy. A fundamental analyst would compare the earnings per share (EPS) of different companies as well as balance sheets and income statements. However, trendlines are something that would be examined by a technical analyst.
4. A. (Chapter 14) The Series 7 exam tests you on your knowledge of TRACE. The trade reporting system known as TRACE is approved by FINRA for corporate bonds trading in the OTC secondary market. Therefore, Choice (A) is the correct answer. Choices (B), (C), and (D) are incorrect because warrants are not applicable to corporate bond trading, and municipal securities and asset-backed securities are specifically excluded from the TRACE reporting requirements.
5. A. (Chapter 16) You can accept the trade and mark it as unsolicited. Even if a customer wants to purchase a security that doesn’t fit his investment profile, you can still accept it in most cases by marking it as unsolicited. I call this the CYD (cover your derriere) rule. As long as you mark the ticket as unsolicited, you save yourself some aggravation (and maybe arbitration) if Mike loses money on the deal.
6. D. (Chapter 14) When a securities firm buys securities for or sells securities from its own inventory, it is acting as a dealer (principal or market maker). When a dealer sells securities from its own inventory, it charges a price that includes a markup.
7. A. (Chapter 12) To determine the break-even point for a put option, you have to subtract the premium from the strike price of 60. To find the premium for the Dec 60 put, look under the last column. The last column is for December puts. Next, find the 60 strike price from the second column — it’s in the bottom row. If you intersect the bottom row with the last column (the lower right-hand corner), you see that the premium is 12. By subtracting 12 from 60, you get a break-even point of 48.
8. C. (Chapter 16) To determine good delivery, always look at the shares. The certificates must be in multiples of 100 shares (for example, 100, 200, 300, and so on), divisors of 100 shares (1, 2, 4, 5, 10, 20, 25, and 50), or shares that add up to 100 (for example, 80 + 20, 75 + 15, 60 + 30 + 10, and so on). Choice (A) is okay because 900 is a multiple of 100 and the odd lot portion (30 shares) is exempt. Choice (B) is fine because 400 is a multiple of 100, 50 is a divisor of 100, and the odd lot portion (30 shares) is exempt. Choice (D) works because 200 is a multiple of 100 and 10 is a divisor of 100. Choice (C) is the bad one (in this case, the one you’re looking for) because even though 200 is a multiple of 100, 13 doesn’t divide into 100 evenly.
9. C. (Chapter 7) T-strips or Treasury receipts are long-term zero-coupon bonds backed by the full faith and credit of the U.S. government. Zero-coupon bonds are ideal investments to plan for future events because investors don’t face reinvestment risk. In addition, the purchase price for long-term zero-coupon bonds is comparatively low.
10. A. (Chapter 8) The Series 7 examiners want to see that you can distinguish revenue bonds from general obligation bonds. In this question, Choice (A) is the correct answer. Revenue bonds are backed by a project’s earning capacity. Choices (B), (C), and (D) are incorrect because revenue bonds are not secured by a specific pledge of property, are not a type of general obligation bond, and are not subject to debt limitations the way that many general obligation bonds are.
11. A. (Chapter 13) When you look at a corporation’s balance sheet, the left-hand side lists all the assets and the right-hand side lists all the liabilities plus the shareholders’ equity. The left side and the right side balance out (equal the same amount of money).
12. C. (Chapter 15) Dividends are profits shared by corporations. Dividends can be taxed as either qualified (up to a maximum rate of 20 percent) or nonqualified (according to the investor’s tax bracket). In order for the dividends to be qualified, the investor must have held onto the stock for at least 61 days. The 61-day holding period starts 60 days prior to the ex-dividend date.
13. B. (Chapter 12) This question is looking at how an option contract is adjusted for corporate actions. Cash dividends don’t affect listed options because they don’t change the amount of shares a company has outstanding. However, if a company splits its stock or gives a stock dividend, the terms of an option contract change (in other words, the more option contracts, the lower the strike price and/or the more shares per contract).
14. D. (Chapter 6) Cain has a total of 4,000 votes (1,000 shares × 4 vacancies). Since HIT allows cumulative voting, Cain can vote the shares in any way that he sees fit, even if he votes them all for one candidate. Statutory or regular voting would only have allowed Cain to vote up to 1,000 shares for each candidate.
15. B. (Chapter 8) An official statement includes all relevant information about a new municipal bond. Municipal bonds don’t have a prospectus, but an official statement is along the same lines. An official statement gives information about the municipal issue, such as the reason the bonds are being issued, what revenues are going to be used to pay the bonds, the issuer’s payment history, and so forth. A tombstone ad is a brief advertisement that does not go into detail about the security being issued, and a registration statement is used by corporations when they are filing with the SEC.
16. C. (Chapter 16) Brokerage firms must keep records of written customer complaints as well as whatever action was taken for a minimum of 4 years and kept easily accessible for at least 2 years.
17. A. (Chapter 15) The main difference between traditional IRAs and Roth IRAs is the tax implications. Contributions to traditional IRAs are made from pretax dollars (you can write them off on your taxes), whereas contributions to Roth IRAs are made from after-tax dollars (you can’t write them off on your taxes). However, distributions (withdrawals) from traditional IRAs are taxed on the amount above contribution, whereas withdrawals from Roth IRAs are tax-free. When withdrawing from a Roth IRA, neither the amount invested, which was already taxed, nor the amount the account has gone up in value (appreciation) is taxed, which is a great benefit to Roth IRA holders.
18. B. (Chapter 16) Broker-dealers cannot validate mutilated certificates. Mutilated certificates must be validated by entities directly associated with the issuer.
19. C. (Chapter 10) Certainly all the choices listed are important, but the most important one is the investment objectives of the mutual fund. In other words, you need to know whether the investor is looking for a growth fund, an income fund, a municipal bond fund, an international fund, and so on. When comparing funds with the same investment objectives, all the other things, such as comparing management fees, whether the fund is load or no-load, and so on, come into play.
20. A. (Chapter 6) Common stockholders may cast votes for candidates to be members of the board of directors; therefore, Choice (A) is the correct answer. Choice (B) is incorrect because while common stockholders may vote on important issues that affect the welfare of the corporation, they do not have voting rights on the day-to-day operations of the corporation, like buying office supplies. Choice (C) is incorrect because a stockholder doesn’t receive interest payments, bondholders do. Finally, Choice (D) is incorrect because a common stockholder’s initial investment can be lost if a corporation fails; therefore, par value is not guaranteed.
21. A. (Chapter 10) The clues in this question are that the investor is 21 years old, has limited resources, and would like to start investing on a regular basis. This investor is screaming out to be put in a mutual fund. Typically, investors of mutual funds are in it for the long haul; they’re not in and out like they may be with other investments. Ideally, this investor should probably be set up on a dollar cost averaging plan whereby he invests x amount of dollars every so often (for instance, once a month). Because this investor is young, he or she can take a little more risk, so a growth fund would be ideal. CDOs, buying call options, and hedge funds are too risky, require too much money, and/or require a certain degree of sophistication.
22. A. (Chapter 16) Penny stock rules require that brokers must describe or mail out a penny stock disclosure document prior to the customer's first transaction in penny stocks. However, the customer must receive a written disclosure document by the time the customer receives a confirmation of the transaction.
23. B. (Chapter 8) The answer is Choice (B). Choices (A), (C), and (D) are incorrect. Revenue bonds are generally considered low-risk because they’re issued by municipalities. The riskiest municipal bonds are IDRs (Industrial Development Revenue bonds), which are backed by a corporation, not the municipality.
24. D. (Chapter 16) When a client receives a trade confirmation (receipt of trade), the confirmation must show the trade date, settlement date, the name of the security, how many shares were traded, whether the broker-dealer acted as an agent or principal, and the amount of commission if traded on an agency basis.
25. B. (Chapter 16) The correct answer is Choice (B) because when Jessica grants her registered representative a limited power of attorney, she is the one who must sign the document. Although a principal must approve before the registered representative exercises his or her discretionary authority, the registered representative does not have to sign the document, and Jessica’s approval of each order is not required.
26. B. (Chapter 10) Real Estate Investment Trusts pass through income earned by the real-estate investments, but not losses. Real-estate limited partnerships pass through income and losses to investors because DPPs aren’t responsible for paying business taxes.
27. D. (Chapter 16) I hope this was an easy one for you. Principals must approve all new accounts and must sign all new account forms.
28. D. (Chapter 16) Broker-dealers must keep records of customer accounts at least 6 years after the customer closes his account.
29. B. (Chapter 13) When a corporation declares a cash dividend, its liabilities increase. Liabilities are something that is owed. Once a corporation declares a dividend, it must pay it. The assets will remain the same until it pays the dividend, and then the assets will decrease. The working capital and stockholder's equity decrease when a corporation declares a cash dividend.
30. B. (Chapter 9) Because George is borrowing money through a margin account to purchase securities, he must leave the stock in the broker-dealer’s safekeeping, pay interest on the loan, register the stock in street name, and agree to allow the broker-dealer to pledge the securities because he signed a loan consent agreement.
31. D. (Chapter 6) The Series 7 examiners want to make sure that you know the difference between the different types of securities. Both convertible preferred and participating preferred stocks tend to carry lower dividend rates because they give Terri an extra benefit, which is the right to convert to common shares at a fixed price or the right to earn more than the stated rate if the issuer has a good year and makes an extra dividend payment. Straight preferred stock has no conversion or participating features and probably carries a better rate than convertible and participating stocks. Choice (D) is the correct answer, however, because callable preferred stock allows the issuer to “call” the securities away from Terri; therefore, callable preferred stock tends to pay higher rates than any of the other answer choices to offset this call risk.
32. A. (Chapter 5) A Regulation D offering is a provision in the Series Act of 1933 that exempts offerings sold to no more than 35 unaccredited (small) investors each year. Even though Regulation D offerings are limited to the number of small investors, the amount of money they can raise is not limited.
33. B. (Chapter 15) Variable life insurance policies often have a rider or statement of condition that allows individuals to keep their policy in force if they become disabled. This waiver of premium forgives policyholders of paying additional premiums if they become totally disabled.
34. D. (Chapter 16) Certainly just about anything you can think of could change a client’s investment objectives. As people get older, they usually can’t take as much risk. Conversely, investors who get higher-paying jobs are likely to want to take additional risk. Someone who is getting (or has gotten) divorced is likely to have less money (due to alimony payments, one person paying for the house instead of two, child support payments, and so on). Obviously, having triplets puts a financial burden on an investor (unless she gets a reality show).
35. A. (Chapter 6) Remember, the ex-dividend date (the first day the stock trades without the dividend) is one business day before the record date. In this case, the record date is Thursday, September 14, which makes the ex-dividend date Wednesday, September 13. The opening price on the ex-dividend date is reduced by the amount of the dividend ($0.40 in this case).
36. D. (Chapter 8) When you purchase a municipal bond issued within your home state, the interest you receive is triple tax-free (exempt from federal, state, and local taxes). In addition, if you purchase a bond issued by a U.S. territory (such as Puerto Rico, U.S. Virgin Islands, Guam, Samoa, and Washington, D.C.), the interest is triple-tax free. However, if you purchase a bond issued by another state, the interest is exempt from federal taxes only.
37. D. (Chapter 16) According to FINRA, charges for services provided by broker-dealers (transfers, collection of monies, safe-keeping of securities, and so on) shall be “reasonable and not unfairly discriminatory among customers.”
38. A. (Chapter 11) Of the choices listed, a real-estate partnership that invests in raw land is the riskiest. Partnerships that invest in raw land are considered speculative, as are oil and gas wildcatting programs. The risk of investing in raw land is that even though the property is purchased at a low price, developers may not be interested in that area and the partnership may be stuck with relatively worthless property.
39. D. (Chapter 16) In order to answer “ownership transfer” questions correctly on the Series 7 exam, you must be able to distinguish a registrar’s functions from a transfer agent’s functions. If that isn’t stressful enough, you have an “except” question, which means you’re looking for a false answer. As for functions, a registrar accounts for the number of shares on the corporation’s books to ensure that the outstanding shares don’t exceed the total number of shares on the books. The registrar also audits the transfer agent. The correct answer is Choice (D) because the transfer agent — not the registrar — records the names of stockholders, cancels old shares, and transfers shares to new owners’ names.
40. A. (Chapter 5) The final offering price would not be found on the preliminary prospectus (red herring) because the price hasn’t been finalized at this point. After the issuer and the syndicate manager come up with a final offering price, they place it on the final prospectus.
41. D. (Chapter 16) Day-trading accounts are obviously very risky. So customers who want to open a day-trading account must receive a risk disclosure statement and the member firm shall make a reasonable effort to make sure that it is an appropriate strategy for the customer. To help determine that, the firm should determine the customer's investment objectives, investment experience, investment knowledge, financial situation, tax status, employment status, marital status, number of dependents, and age.
42. C. (Chapter 10) To determine the sales charge percentage of a fund, use the following equation:
    

    The POP is the public offering price, which is the price that investors pay, including the sales charge. The NAV is the net asset value and is where the fund should be trading, excluding the sales charge.

43. D. (Chapter 13) Regulatory risk is the risk that the price of a security will decline due to new regulations placed on specific corporations.
44. C. (Chapter 5) On a competitive bid for a new municipal underwriting, the difference between the bid to the issuer and the dollar price at which the underwriter reoffers the bonds to the public is the spread, which, importantly, is also the underwriter’s compensation.
45. B. (Chapter 16) Remember, when a customer opens a cash account, the only signatures that are required are that of the registered rep and a principal of the firm. However, if a customer were to open up a margin account, she’d have to sign a margin agreement.
46. C. (Chapter 14) An immediate-or-cancel (IOC) order must be attempted to be filled immediately by the firm handling the order but may be filled partially. It is a one-time order and does not allow the order to be executed in several attempts.
47. D. (Chapter 14) Although municipal bonds may be sold short, they typically aren’t. The reason is that the security must be borrowed and later found to cover the short position. Because municipal bonds are usually thin issues, they are not very liquid and therefore not good candidates for selling short.
48. C. (Chapter 9) Because this investor is opening a margin account (initial transaction), additional rules other than the 50 percent Regulation T requirement are in play. When purchasing securities for the first time, investors must pay in full, pay Regulation T (50 percent) of the transaction, or pay $2,000. If the cost is less than $2,000, the investor pays in full. If the cost is more than $2,000 but Regulation T is less than $2,000 (as it is in this case), the investor pays $2,000. If the cost of the securities is more than $2,000 and Regulation T is greater than $2,000, the investor pays the Regulation T amount.
49. A. (Chapter 7) The indenture (trust indenture or deed of trust) of a bond is a legal contract between the issuer and the trustee representing the investors. The bond indenture includes the coupon rate (nominal yield), the maturity date, the name of the trustee, collateral that may be backing the bond, and so on. However, the credit rating isn’t found on the indenture because that’s something that would change if the financial condition of the issuer changes.
50. C. (Chapter 11) The certificate of limited partnership is the legal agreement between the limited and general partners and has to be filed with the secretary of state. The certificate of limited partnership includes the name of the partnership, the partnership’s primary place of business, the names and addresses of the limited and general partners, the goals of the partnership and how long it’s expected to last, the amount contributed by each partner, how the profits are to be distributed, the roles of the participants, how the partnership can be dissolved, and whether a limited partner can sell or assign his or her interest in the partnership. The authority that allows the general partner to charge a fee for making management decisions is found in the partnership agreement.
51. A. (Chapter 6) The correct answer is Choice (A). Because warrants are basically long-term options to buy stock at a fixed price from the issuer, they can’t pay dividends.
52. C. (Chapter 12) To create a short combination, Marty has to sell a call and sell a put on the same stock with different expiration months and/or strike prices. Because you need to have two sells to create a short combination, you can cross off Choices (A) and (B). The difference between a straddle and a combination is in the expiration months and the strike prices. If the expiration months are the same and the strike prices are the same, you have a straddle. If the expiration months and/or the strike prices are different, you’re looking at a combination.
53. B. (Chapter 10) Choice (B) is the correct answer because three components are true about a REIT. As indicated by its acronym, a REIT is a Real Estate Investment Trust. REITs engage in real-estate activities and are organized as trusts. In order to qualify for favorable tax treatment, a REIT must pass through at least 90 percent of its net investment income to its shareholders. Statement IV is false because, although a REIT can pass through income to investors, it can’t pass through losses.
54. D. (Chapter 12) The easiest way to calculate the break-even point for stock/option problems is to take a look at what’s happening. This investor purchased the stock for $45 per share and then purchased the options for $6 per share. The investor paid $51 ($45 + $6) per share out of pocket, so the investor needs the stock to be at $51 per share in order to break even.
55. D. (Chapter 5) All the securities listed are exempt from the registration and disclosure provisions under the Securities Act of 1933.
56. B. (Chapter 11) Investors of limited partnerships bear additional risks, such as the possibility of money being tied up for a long period of time, little or no liquidity, the making of additional loans to the partnership, and so on. As a registered rep, you need to prescreen your customers to see whether they’re a good match for the partnership. You should also look at the partnership and management itself to see whether they have a good track record and whether the partnership makes sense. You need to explain the risks to your customer and have your customer fill out a subscription agreement, not a partnership agreement. The subscription agreement needs to include a check, a signature giving the general partner power of attorney, financial statements, and so on.
57. C. (Chapter 10) Life-cycle funds are ideal for investors of any age. The idea behind them is that investors buy into life-cycle funds that are targeted for their age. The percentage of equities held by the fund decreases over time, whereas the percentage of fixed-income securities increases, because investors should hold a higher percentage of fixed-income securities as they age. For example, say a 45-year-old investor buys into a life-cycle fund that’s targeted for investors who are currently between the ages of 44 and 47. At this particular point, the fund may have a nearly 50-50 split between equity securities and fixed-income securities. The fund rebalances every so often so that 10 years into the future, the fund may have 40 percent invested in equity securities and 60 percent invested in fixed-income securities. Ten years after that, the fund may have a 30-70 split between equity and fixed-income securities. This fund is designed to take the guesswork out of the equation for investors.
58. A. (Chapter 7) Planned amortization class (PAC) tranches are considered the safest of all tranches because a large portion of the prepayment and extension risk is absorbed by a companion tranche. Targeted amortization class (TAC) tranches are considered second in terms of safety because they’re subject to additional prepayment and extension risk. Companion tranches are considered risky because the average life of a companion tranche varies greatly as interest rates change. Z tranches are basically zero-coupon tranches and are the most volatile of all tranches because they receive no payments until all the CMO tranches are retired.
59. A. (Chapter 14) An IPO (initial public offering) is the first time a corporation ever sells securities to the public. A first-market trade is a trade of exchange-listed securities trading on an exchange. A rights offering is when a company offers new shares to existing shareholders at a discount.
60. D. (Chapter 13) A saucer formation is similar to an inverted head and shoulders pattern in that it is a reversal of a bearish trend. However, a saucer formation is a more gradual change in direction. A saucer formation is a bullish sign, and an inverted saucer formation is a bearish sign.
61. D. (Chapter 14) Broker-dealers act as both brokers (middlemen) and dealers (selling securities out of their own inventory). When broker-dealers act as brokers, they’re purchasing or selling securities for an investor through a market maker. When acting as brokers, they charge a commission. When acting as dealers, they either buy securities from investors to add to their own inventory or sell securities to investors from their own inventory. In this case, the broker-dealer charges a markup (if the customer is buying) or a markdown (if the customer is selling). So, all answer choices given are correct depending on the capacity of the trade.
62. D. (Chapter 12) The best way to determine the maximum gain is to set up an options chart. The first thing you need to do is find the premiums for the two options. Looking at the exhibit, you can see that the premium for the TUV Nov 60 put is 4 and the premium for the TUV Nov 50 put is 1.25. Because the investor purchased the 60 put, you have to put 400 (4 premium × 100 shares per option) on the “Money Out” side of the chart. Next, you have to put 125 (1.25 premium × 100 shares per option) on the “Money In” side of the chart because the investor sold that option. After doing that, you can see that you have $275 more in money out than money in, so that’s the investor’s maximum loss. To get the maximum gain, you have to exercise both options. Because “puts switch,” you have to put the exercised strike price of $6,000 on the opposite side of its premium and the exercised strike price of $5,000 on the opposite side of its premium.

    

    After totaling up the two sides, you can see that the maximum gain is $725, because there’s $725 more money in than out.

63. A. (Chapter 13) Fundamental analysts compare companies to help determine what to buy. Technical analysts examine the market to try to determine when to buy. Knowing that, fundamental analysts are definitely interested in earnings trends. Technical analysts would be interested in such things as support and resistance and the breadth of the market.
64. A. (Chapter 16) The broker-dealer must send out account statements at least once every three months (quarterly) for an inactive account. If there has been any activity during a particular month, the brokerage firm must send out an account statement that month. Mutual funds must send out account statements once every six months (semiannually).
65. B. (Chapter 6) If you look at Choices B and C, you will see that the answers oppose each other, so one of them has to be the answer to the question. Treasury stock is stock that was issued and subsequently repurchased by the company. Treasury stock has no voting rights and does not receive dividends.
66. D. (Chapter 8) Because this is an “except” question, you must find the false answer. The correct answer is Choice (D). The dated date of a bond issue is the date on which the issue begins to earn interest, which has less impact on marketing than the other answer choices.
67. B. (Chapter 15) IRAs may be set up as single life, joint and last survivor, or uniform lifetime. Life with period certain is a way to set up payout for an annuity, not an IRA. Single life is when the owner is the beneficiary of the account. Joint and last survivor is when the sole beneficiary of the account is a spouse who is more than ten years younger than the owner. Uniform lifetime is when the spouse is not the sole beneficiary or the spouse is not more than ten years younger than the owner.
68. C. (Chapter 15) Similar to variable annuities, variable life insurance policies have a separate account of securities. All variable life insurance (VLI) policies have a set premium and a minimum death benefit. However, if the securities held in the separate account perform well, the policy will build up cash value, which will increase the death benefit.
69. B. (Chapter 13) Certainly, all the choices listed are important when determining a client’s investment profile. However, this is an “except” question, which means that you’re looking for an investment influence that is financial. The amount of marketable securities an investor owns is part of her financial profile as well as other things like net worth, money available for investing, current income, expenses, home ownership, and so on.
70. B. (Chapter 16) A durable power of attorney gives power of attorney to someone else to handle financial affairs in the event that the grantor becomes incapacitated. A durable power of attorney is unlike a regular power of attorney, which terminates once the grantor becomes incapacitated.
71. B. (Chapter 7) There is a lot of information in this question that was not required to come up with an answer. All you needed to know was that it is a 4 percent bond and that your client held it until maturity. The fact that it was yielding 5 percent and that it is a convertible bond is not relevant to the question. When investors hold a bond until maturity, they receive par value (usually $1,000). However, if the bond is paying interest, holders will also receive their last coupon payment at maturity. It is a 4 percent bond, so investors will receive $40 per year interest ($4 percent of $1,000 par) broken down into two $20 semiannual payments. So in this case, your client will receive $1,020 at maturity.
    
72. A. (Chapter 9) Normally, if Barbara were purchasing $10,000 worth of stock on margin, she’d have to deposit $5,000 to meet the margin call (you can assume Regulation T is 50 percent of the purchase). First, you have to find out whether she has any excess equity in her margin account to help offset the $5,000 payment. Use the following equation:

    LMV – DR = EQ

    After setting up the equation, enter the market value of the securities ($30,000) under the long market value (LMV). Next, enter the $12,000 under the debit record (DR), also known as the debit balance. When you subtract the DR from the LMV, you come up with an equity (EQ) of $18,000. Multiply Regulation T (50 percent) by the LMV to get the amount of equity the customer needs to have in the account to be at 50 percent. This investor needs only $15,000 in equity to reach 50 percent, and this investor has $18,000, $3,000 more than necessary:

    

    The $3,000 is excess equity (SMA, or special memorandum account), which she can use to help offset the margin call for the $10,000 worth of stock she wants to buy:

    $5,000 margin call – $3,000 excess equity = $2,000 to deposit

73. C. (Chapter 8) The interest received on municipal bonds is federally tax-free. Because Ginny is in the highest income tax bracket, she can save more tax money by investing in municipal bonds. This strategy will put her on equal footing with other investors because neither high-income nor low-income investors have to pay taxes on the interest received from municipal bonds. Therefore, municipal bonds are more advantageous to investors in high income tax brackets.
74. B. (Chapter 15) Capital gains on securities held one year or less are considered short-term and taxed at the investor's tax bracket.
75. A. (Chapter 8) The largest backing for municipal GO (general obligation) bonds is property taxes. The credit rating of GO bonds is highly dependent on the municipality's tax collection record, the number of people living in the municipality, property values, whether it's a limited tax GO bond or unlimited tax GO bond, and so on. Unlike revenue bonds, GO bonds typically require voter approval prior to being issued.
76. D. (Chapter 16) Upon learning about the death of a customer, a registered representative should mark the account as deceased, freeze the account (not do any trading), cancel all open orders (good-till-canceled orders), cancel all written powers of attorney, and await the proper legal papers for guidance about what to do with the account.
77. B. (Chapter 14) Believe it or not, concealing the trading volume for some orders from the public is not a violation. Sometimes large institutional investors like to keep the trading volume of some of their orders hidden from other institutional investors. This practice is called “dark pools of liquidity.” They usually do this so as not to provide too much information to some of their competitors.
78. B. (Chapter 14) Designated Market Makers (DMMs) should keep trading as active as possible but cannot compete with public orders. To keep trading as active as possible, a DMM may place an order in-between the current bid and ask prices to narrow the spread but cannot place an order for his own inventory at the same price as a customer's order.
79. C. (Chapter 7) Mortgage bonds, collateral trusts, and equipment trusts are all forms of secured bonds. Because these bonds are secured with collateral, the collateral securing the bonds is sold to satisfy the bondholders if the issuer defaults. However, debentures are not backed with collateral and are therefore riskier. Because more risk equals more reward, debenture holders can expect a coupon rate that’s higher than that of the secured bonds.
80. D. (Chapter 7) Of the answer choices given, Choice (D) is the least preferable and, therefore, the correct answer. AA rated bonds, U.S. Treasury notes and AA rated debentures can yield predictable income. By contrast, income bonds are issued when a corporation is coming out of bankruptcy and trying to reorganize. Therefore, income bonds only pay interest if the corporation can meet the interest payment and normally trade without accrued interest. Income bonds are not suitable for Dana because she’s seeking predictable income.
81. A. (Chapter 12) You’ll find that this question is actually much easier than you may have originally thought. To get the maximum loss on a debit (long) spread, all you have to do is put the premiums in the option chart to see that you have more money out than in. The difference between those two numbers is the maximum loss.
82. C. (Chapter 10) Although international funds may be okay to help diversify a portfolio, they’re certainly the riskiest of all the choices given. International funds invest in securities outside of the investor’s home country. International funds have additional risks that many other securities don’t have, such as currency risk (the risk that the currency exchange rate will be bad). Also, the investor faces political risk (the risk that political changes in a country may adversely affect the price of securities). You should definitely steer this investor away from international funds.
83. A. (Chapter 12) The OCC (Options Clearing Corporation) is the issuer and guarantor of all listed options. The OCC determines which options will be traded and guarantees that option holders can always exercise their options.
84. C. (Chapter 10) Dividends that are distributed by municipal bond funds are federally tax-free, but any capital gain distribution is taxable. Choice (C) is the right answer.
85. C. (Chapter 9) This investor is opening a combined (long and short) margin account. The best way to deal with this is to treat each transaction separately. The investor is purchasing $15,000 ($15 × 1,000 shares) worth of ABC and shorting $12,000 ($12 × 1,000 shares of DEF). Assuming Regulation T at 50 percent, this investor would have to come up with 50 percent of each transaction.
    
    
    

    This investor would have to deposit $13,500 as a result of the two transactions.

86. C. (Chapter 8) Hopefully, the “G” in “GANs” was enough to help you get the correct answer. GANs are grant anticipation notes, which a municipality issues to provide temporary financing while waiting for a grant from the U.S. government.
87. D. (Chapter 12) “Long” means to buy, so to have a long straddle, you can’t have any sells (shorts). Thus, you can cross off Choices (A) and (B). To create a long straddle, the investor needs to buy a call and buy a put with the same stock, same strike price, and same expiration date. The only answer that works is Choice (D).
88. D. (Chapter 9) Luke owns the calls that he’s exercising. Luke exercises the options at a profit of $10 per share (less the premium) and is selling the stock immediately, so no deposit’s required. It certainly wouldn’t make much sense to have Luke pay $30 per share when exercising the options and then have the firm send Luke a check for $40 per share. The key here is that Luke exercised the option and sold the stock on the same day.
89. B. (Chapter 9) The margin requirement for both long and short margin accounts is set at 50 percent. However, the minimum maintenance for a long account is 25 percent and the minimum maintenance for a short account is 30 percent.
90. C. (Chapter 13) To determine the net worth of a company, use the following equation:

    net worth = assets – liabilities

    net worth = $11,500,000 – $3,350,000 = $8,150,000

91. D. (Chapter 12) Standard options expire on the 3rd Friday of the expiration month 9 months after issuance.
92. D. (Chapter 9) Portfolio margin looks at the risk of an investor’s portfolio as a whole when determining margin requirements. Portfolio margin allows investors greater leverage but is only available to more sophisticated investors, and those investors must keep a minimum equity in their account of around $150,000.
93. A. (Chapter 7) The correct answer is Choice (A) because issuers call bonds when interest rates are falling. Choice (B) is incorrect because after the notes are called, new bonds at the lower rate are issued to raise funds in order to call the outstanding bonds with the higher rate. Choice (D) is incorrect because municipal bond call provisions are advantageous to issuers; the call provisions reduce fixed costs by providing issuers with the ability to redeem bonds before maturity.
94. C. (Chapter 13) You can quickly cross off Choice (D), because this answer can be determined. To determine the price/earnings (PE) ratio, use the following formula:
    

    The answer is 5.50, Choice (C).

95. C. (Chapter 14) The Order Audit Trail System (OATS) is an automated computer system that tracks the life of an over-the-counter (OTC) order from entry to execution or cancellation. OATS tracks all OTC securities, including OTCBB (over-the-counter bulletin board) stocks and OTC Pink Market stocks.
96. B. (Chapter 16) All written complaints need to be handled by a principal and kept on file. Even though the complaint was sent via email, it’s still considered a written complaint. The complaint does not need to be forwarded or sent to FINRA.
97. B. (Chapter 11) A partnership flows through passive gains, losses, and income to investors each year.
98. A. (Chapter 11) This question is actually somewhat of a logic question, and I actually put the statements in order for you. Secured creditors (loans secured with collateral) are paid first, followed by general creditors (loans not secured with collateral), then limited partners (the main investors), and lastly, the general partners.
99. A. (Chapter 5) All securities sold in a state must be registered in that state (also known as blue-sky registration). Coordination, qualification, and notification (filing) are all types of state registration; registration by cooperation is not. If an agent wants to sell in a state, the security, the registered rep, and the broker-dealer must be registered in that state.
100. B. (Chapter 12) The easiest way to figure out the answer to this question is to use the equation P = I + T, where
     • P = the Premium of the option
     • I = the Intrinsic value of the option (how much it is in the money)
     • T = the Time value of the option (how much the investor is paying for the time to use the option)

     P = I + T
     9 = 5 + T
     T = 4

     First, put the premium of 9 into the equation. Next, because the option is 5 points in the money (call options go in the money when the price of the stock goes above the strike price), insert the intrinsic value of 5 in the equation. Because the premium is 9 and the option is 5 points in the money, the time value is 4.

101. B. (Chapter 16) Principals of a firm must approve all new accounts, advertising used by the firm, handling of complaints, trades in all accounts, and so on. However, as far as the Series 7 exam goes, principals don’t need to approve recommendations made by registered reps. In real life, I would get approval before making recommendations if I were you. You have to remember that principals must sign all order tickets, and if you don’t clear a recommendation with them first, they may be reluctant to do so.
102. B. (Chapter 7) If you want to pass the Series 7 exam, you have to know your quotes. The correct answer is Choice (B) because it’s the only discounted instrument, and discounted instruments (such as T-bills) are quoted on a discount yield basis.
103. C. (Chapter 8) LRBs (lease revenue bonds) are similar to IDRs (industrial development revenue bonds), but instead of the bonds being backed by corporations, they’re backed by lease payments made by office buildings, universities, prisons, and so forth. LTGOs (limited tax general obligation bonds) are a type of GO (general obligation) bond that’s backed by taxes that aren’t used to back other bonds. BABs (build America bonds) are taxable municipal bonds in which the U.S. Treasury either reimburses the issuer or gives a tax credit to investors for up to 35 percent of the interest cost.
104. D. (Chapter 13) You can use logic to answer this question. When the company pays a cash dividend, it pays off some of its liabilities because the dividend was declared previously. The net worth does not change because assets (cash) and liabilities decrease by the same amount.
105. D. (Chapter 8) Remember that an “except” question is looking for a false answer. The correct answer is Choice (D). Taxable equivalent yields cannot be shown because every investor has a unique tax issue and bracket.
106. B. (Chapter 12) If the investor is looking for potential premium income, she must have sold something, so you can rule out Choice (C). Because the maximum loss potential for a short straddle or short combination is unlimited and the investor wants to limit her loss, you can cross out Choice (D). Actually, the only answer that works is a credit spread. To create a credit (short) spread, the investor sells an option that will be in the money first and purchases the option that will go in the money later. If the option never goes in the money, the investor gets to keep the premium of the option sold. To limit the loss, the investor purchases an option that will go in the money later. This position provides potential premium income and limits the maximum potential loss.
107. A. (Chapter 16) Under FINRA rules, the representative should execute the trade in accordance with the customer’s request and note on the trade ticket that the order was unsolicited.
108. C. (Chapter 13) You can calculate the working capital, net worth, and quick assets by looking at a corporation’s balance sheet, but you need information on the income statement to calculate the current yield.
109. A. (Chapter 7) Money market securities are a popular topic on the Series 7 exam. Remember that commercial paper, as well as negotiable certificates of deposit, are money market securities.
110. B. (Chapter 15) Any income derived from an investment in a limited partnership is termed passive. Passive gains can only be written off against passive losses. Earned income includes money made from salary, bonuses, tips, and so on. Portfolio income includes money made from interest, dividends, and capital gains made from investing in securities.
111. B. (Chapter 13) The “P” in PE ratio stands for “market Price,” the “E” stands for “Earnings per share,” and the word “ratio” lets you know that you need to divide. So let's set up the equation:.
     

     The market price is $40 and the earnings per share is $8, so that means that the PE ratio is 5.

112. C. (Chapter 12) Listed options expire at 11:59 p.m. EST (10:59 p.m. CST) on the Saturday following the third Friday of the expiration month. The last time to trade an option is 4:00 p.m. EST (3:00 p.m. CST) on the third Friday of the expiration month. The last time to exercise an option is 5:30 p.m. EST (4:30 p.m. CST) on the third Friday of the expiration month.
113. B. (Chapter 11) Limited partners have access to all the financial information regarding the partnership, they may vote to terminate the partnership, and they may invest in competing partnerships. However, limited partners may not make management decisions; that right is limited to the general partner(s).
114. C. (Chapter 11) The primary reason for investing in undeveloped land is appreciation potential. People who invest in undeveloped land either privately or by way of a real-estate DPP are hoping that their land will be of more value sometime in the near future.
115. A. (Chapter 10) Closed-end funds are typically listed on an exchange and have a fixed number of shares outstanding. Closed-end funds must be sold to another investor and are not redeemable. In addition, closed-end funds may issue common stock, preferred stock, and bonds.
116. C. (Chapter 10) ETFs (exchange traded funds) and inverse ETFs are easily tradable and money market funds are easily redeemable, so they all have a high degree of liquidity. Hedge funds are the least liquid because they are unregulated and require a minimum holding period (lock-up provision) before investors can make withdrawals. Hedge funds are speculative and employ strategies unavailable to regulated investment companies. Hedge funds may purchase securities on margin, sell securities short, purchase or sell options, and so on.
117. D. (Chapter 12) I figured I’d give you an easy one toward the end of the test. When buying a call option, the maximum potential gain is unlimited, so an investor who’s selling a call option faces an unlimited maximum potential loss.
118. A. (Chapter 6) After the split, stockholders are going to have 5 shares for every 4 that they had before. If the number of shares is going to increase, the price of the stock is going to decrease to make up for the additional shares. After the split, the investor should have the same overall market value of securities. Use the following equation to determine the number of shares and the stock price after a split:
     
     
119. D. (Chapter 13) Actually, all the choices listed would likely change the investor's investment objectives. Typically, as investors grows older, they will likely want to take less risk. By the same token, investing for one person or two people, as in someone getting married or divorced, would change the investment objectives. Also, as people gain investment experience, they will likely be more open to more speculative investments. Plus you can assume that if an investor has more family responsibilities, he or she will want to take less risk.
120. D. (Chapter 13) Debt to equity ratio is the ratio of long term debt to stockholders’ equity (net worth). Therefore, the debt to equity ratio of a company measures the leverage (long term debt) of a company. The other ratios mentioned are short-term ratios measuring the liquidity of a company.
121. C. (Chapter 7) Commercial paper is generally issued for the purpose of raising capital for a corporation. Choice (A) is incorrect because commercial instruments are not quoted as a percent of par. Choice (B) is incorrect because a commercial instrument is proof of a debt, not ownership. Choice (D) is incorrect because commercial instruments are a debt security; therefore, if a claim is filed against the issuing corporation, the commercial instrument holds a senior position to preferred stock.
122. B. (Chapter 16) Municipal fund securities include 529 college savings plans. All securities advertising must be approved by a principal of the firm and cannot be fraudulent (antifraud rules apply to everything). The MSRB and the states do not have to approve advertising.
123. D. (Chapter 15) In most instances, individuals may invest up to $5,500 per year in an IRA ($6,500 if they’re age 50 or older). The maximum investment occasionally changes due to inflation, so please check the IRS website for the latest info.
124. D. (Chapter 10) A specialized or sector fund invests within a single industry or geographical area.
125. D. (Chapter 15) Withdrawals from a Roth IRA may begin any time after the investor reaches age 59½. However, there’s no required beginning date (RBD) or required minimum distribution (RMD) for Roth IRAs like there is for other retirement plans. You need to remember that the money withdrawn from a Roth IRA is tax-free, so the IRS doesn’t care when these investors take their money because it isn’t getting any of it.

Knowing the Score

Here’s how the Series 7 exam is scored:

• You get one point for each correct answer.
• You get zero points for each incorrect answer.

A passing grade is 72 percent. In other words, you need at least 90 correct answers on the whole test to get one step closer to your Nobel Prize in stockbrokerage (okay, economics). To calculate your score for this test, multiply the number of correct answers by 0.8 or divide it by 125. Whatever grade you get, make sure you round down, not up. For example, a grade of 71.2 is a 71 percent, not a 72.

Answer Key for Practice Exam 2

1. A
2. D
3. D
4. A
5. A
6. D
7. A
8. C
9. C
10. A
11. A
12. C
13. B
14. D
15. B
16. C
17. A
18. B
19. C
20. A
21. A
22. A
23. B
24. D
25. B
26. B
27. D
28. D
29. B
30. B
31. D
32. A
33. B
34. D
35. A
36. D
37. D
38. A
39. D
40. A
41. D
42. C
43. D
44. C
45. B
46. C
47. D
48. C
49. A
50. C
51. A
52. C
53. B
54. D
55. D
56. B
57. C
58. A
59. A
60. D
61. D
62. D
63. A
64. A
65. B
66. D
67. B
68. C
69. B
70. B
71. B
72. A
73. C
74. B
75. A
76. D
77. B
78. B
79. C
80. D
81. A
82. C
83. A
84. C
85. C
86. C
87. D
88. D
89. B
90. C
91. D
92. D
93. A
94. C
95. C
96. B
97. B
98. A
99. A
100. B
101. B
102. B
103. C
104. D
105. D
106. B
107. A
108. C
109. A
110. B
111. B
112. C
113. B
114. C
115. A
116. C
117. D
118. A
119. D
120. D
121. C
122. B
123. D
124. D
125. D