Series 7 Practice Exam.
Free practice test — 200 quality-checked questions, instant feedback.

1. 1. An investor owns 500 shares of DEF stock and buys a put option to protect against downside loss. This strategy is known as:

   • A. A married put (or protective put)
   • B. A covered call
   • C. A collar
   • D. A spread
   Show answer & explanation

   Answer: A
   Buying a put to protect a long stock position is called a married put or protective put. The put sets a floor on losses. Choice B (collar) involves both a put and a call. Choice C (covered call) involves selling a call, not buying a put. Choice D (spread) involves positions in different months or strikes.

2. 2. An investor executes a bull call spread by buying a call with a $50 strike and selling a call with a $55 strike. Both expire in 60 days. What is the maximum profit potential on this position?

   • A. Unlimited, as long as the stock rises above $55
   • B. Limited to the net debit paid for the spread
   • C. Limited to the difference between the two strike prices minus the net debit
   • D. Equal to the strike price of the long call only
   Show answer & explanation

   Answer: C
   In a bull call spread, maximum profit occurs when the stock rises above the higher strike ($55). The profit equals the width of the strikes ($5 per share = $500 per contract) minus the net debit paid. This is limited profit. Choice A ignores the spread width. Choice C incorrectly assumes unlimited profit. Choice D ignores the short call's cap.

3. 3. A customer receives a dividend while holding a short stock position. How is the dividend treated in the account?

   • A. The customer must pay the dividend to the lender of the borrowed shares
   • B. The dividend is held in escrow until the short position closes
   • C. Dividends are not applicable to short positions
   • D. The customer receives the dividend as a credit to the account
   Show answer & explanation

   Answer: A
   When a customer holds a short position, they have borrowed shares and are obligated to pay dividends to the lender. This is a cost of borrowing. Choice B applies to long positions. Choice C is not standard practice. Choice D ignores the obligation.

4. 4. A company issues cumulative preferred stock with a $100 par value and 6% dividend. If the company skips dividend payments for two years and resumes payments in year three, which statement is TRUE regarding the preferred shareholders' rights?

   • A. Preferred shareholders may vote to force the company into bankruptcy if all accumulated dividends are not paid within 90 days.
   • B. Accumulated unpaid dividends are forgiven once the company's credit rating improves.
   • C. Preferred shareholders are entitled to receive interest on unpaid cumulative dividends at the prime rate.
   • D. The company must pay accumulated dividends before any common stock dividends can be distributed.
   Show answer & explanation

   Answer: D
   Cumulative preferred stock protects shareholders by requiring the company to pay all accumulated (missed) dividends before distributing any dividends to common shareholders. This is a contractual feature of the preferred shares. Non-cumulative preferred stock would allow the company to skip dividends without obligation to catch up. Preferred shareholders do not gain voting rights or bankruptcy enforcement rights from missed dividends, and accumulated dividends do not accrue interest beyond the stated rate.

5. 5. An investor purchases a corporate bond with a 5% coupon rate at a price of 95 (expressed as a percentage of par). Which of the following is correct?

   • A. The current yield is higher than the coupon rate.
   • B. The coupon payments will increase as the bond approaches maturity.
   • C. The yield to maturity equals the coupon rate of 5%.
   • D. The bond is trading at a premium to par value.
   Show answer & explanation

   Answer: A
   When a bond trades at a discount (95 is below par of 100), the current yield—calculated as annual coupon divided by market price—exceeds the coupon rate. Here, annual coupon is approximately $50 on a $1,000 par bond, divided by the market price of $950, yielding about 5.26%. The yield to maturity is even higher than the current yield because the investor also gains the discount appreciation to par at maturity. Coupon payments are fixed and do not change; the bond is at a discount, not premium.

6. 6. A municipal bond is issued with a 4% coupon. An investor in the 35% federal tax bracket purchases the bond. Assuming no state or local taxes, what is the approximate taxable-equivalent yield?

   • A. 6.2%
   • B. 3.2%
   • C. 5.4%
   • D. 2.6%
   Show answer & explanation

   Answer: A
   The taxable-equivalent yield shows what a taxable bond must yield to equal the after-tax return of a tax-free muni bond. The formula is: tax-free yield ÷ (1 − tax bracket). Here: 4% ÷ (1 − 0.35) = 4% ÷ 0.65 ≈ 6.15%, or approximately 6.2%. This tells the investor that a taxable bond would need to yield about 6.2% to match the 4% muni yield after federal taxes. Dividing by the tax rate (rather than 1 minus the rate) would incorrectly yield 11.4%.

7. 7. A convertible bond has a conversion price of $50 and a market price of 105. The common stock is currently trading at $48. Which statement best describes the bond's conversion feature?

   • A. The investor should convert if the stock price drops further.
   • B. The bond's market price is below parity and therefore cannot be converted.
   • C. The bond is in-the-money, and conversion should occur immediately.
   • D. The bond's conversion premium indicates the bond is trading above its conversion value.
   Show answer & explanation

   Answer: D
   Conversion value is the stock price multiplied by the number of shares the bond converts into. Here, conversion value is $48 × 20 shares (par $1,000 ÷ $50 conversion price) = $960. The bond trades at 105, or $1,050, which exceeds the $960 conversion value; this $90 difference is the conversion premium. A positive conversion premium suggests the bond's value as a bond (debt + interest) exceeds its conversion value, so immediate conversion is not optimal. The bond is out-of-the-money (stock price below conversion price), making conversion less likely as the stock price falls further.

8. 8. A closed-end fund has a net asset value of $18 per share and is trading at $16 per share. A broker recommends that a new investor purchase shares in the fund. Which statement is most accurate?

   • A. The fund is trading at a premium, and the investor should buy before the NAV rises further.
   • B. The discount guarantees the investor will earn a profit once the fund dissolves.
   • C. The fund is trading at a discount, which may offer better value, but the discount could narrow or widen.
   • D. The investor should wait until the NAV equals the market price before purchasing.
   Show answer & explanation

   Answer: C
   A closed-end fund trading below NAV is at a discount ($16 < $18 NAV = 11% discount). While a discount can represent value (you're buying assets for less than their calculated worth), it does not guarantee profit—the discount could widen, offsetting NAV appreciation. Conversely, a premium means the fund trades above NAV. The recommendation should acknowledge the discount as a potential advantage while warning that market sentiment drives closed-end fund discounts and premiums, not NAV alone.

9. 9. Which of the following statements about depository receipts (ADRs) is correct?

   • A. An ADR represents ownership of foreign shares held in custody by a U.S. depositary bank.
   • B. ADR dividend payments are exempt from U.S. federal income tax.
   • C. ADRs allow foreign companies to raise capital in the U.S. while bypassing SEC registration.
   • D. ADR prices are always equal to the price of the underlying foreign stock in its home market.
   Show answer & explanation

   Answer: A
   An ADR (American Depository Receipt) is a negotiable certificate evidencing ownership of foreign shares held by a U.S. depositary bank. This structure allows U.S. investors to buy foreign equity in dollars without dealing directly with foreign exchanges. ADRs are SEC-registered and subject to disclosure rules. ADR prices and the underlying foreign stock price are related by the exchange rate and the ADR ratio, but they may diverge due to supply/demand imbalances and currency fluctuations. Dividends on ADRs are taxable in the U.S.; tax treaties may apply but not automatic exemption.

10. 10. A customer wants to invest in a company with strong fundamentals but is concerned about downside risk. Which equity security would BEST address this concern?

    • A. Warrants to purchase common stock.
    • B. Growth stock with a low current yield.
    • C. Common stock with a high beta coefficient.
    • D. Cumulative participating preferred stock with a fixed dividend.
    Show answer & explanation

    Answer: D
    Preferred stock, particularly cumulative and participating, provides downside protection through: (1) senior claim on assets and earnings relative to common stock, (2) a fixed dividend that stabilizes cash returns, and (3) participation in extraordinary gains through the participating feature. Common stock has no such protection; high-beta stocks amplify volatility, growth stocks are unpredictable, and warrants are leveraged calls with no income, increasing risk. Preferred stock aligns with conservative investors seeking income with equity upside.

11. 11. A zero-coupon bond is purchased for $400 (per $1,000 par value) and matures in 10 years. The investor does not receive cash payments until maturity. Which issue must the investor address for tax purposes?

    • A. The investor must defer all tax liability until the bond is sold before maturity.
    • B. The investor owes taxes only on gains realized if the bond is sold above the purchase price.
    • C. The investor must report the annual accretion of discount as ordinary income each year, even though no cash is received.
    • D. The investor can choose to amortize the discount over 5 years instead of 10 years.
    Show answer & explanation

    Answer: C
    Zero-coupon bonds are issued at a deep discount and accrete (grow in value) to par at maturity. U.S. tax rules require investors to recognize the annual accretion as ordinary income (often called 'imputed interest'), even though no cash is received until maturity. This creates a 'phantom income' tax liability that must be paid out of pocket. The amortization schedule is fixed by the bond's terms, not investor choice. A taxpayer cannot defer the tax obligation until sale or maturity.

12. 12. A bond's duration is 7 years and its modified duration is 6.5 years. If interest rates rise by 100 basis points, which of the following best estimates the bond's price change?

    • A. The bond price will remain unchanged because duration is positive.
    • B. The bond price will fall by approximately 0.65%.
    • C. The bond price will rise by approximately 7%.
    • D. The bond price will fall by approximately 6.5%.
    Show answer & explanation

    Answer: D
    Modified duration measures a bond's price sensitivity to interest rate changes. The formula is: approximate percentage price change = −modified duration × change in yield (in decimal form). Here: −6.5 × 0.01 (100 basis points) = −0.065, or approximately a 6.5% price decline. Duration captures both the timing of cash flows and the reinvestment effect; it is always a positive number, and price changes inversely with yield changes. Confusing 100 basis points (1%) with 0.01% or adding (rather than subtracting) the change are common errors.

13. 13. A publicly traded company announces a 3-for-2 stock split. A shareholder holds 100 shares purchased at $60 per share. Immediately after the split, which statement is accurate?

    • A. The shareholder's total basis increases to $9,000.
    • B. The shareholder's cost basis per share remains $60.
    • C. The shareholder now holds 150 shares at an original cost of $40 per share.
    • D. The shareholder now holds 67 shares at an original cost of $90 per share.
    Show answer & explanation

    Answer: C
    In a 3-for-2 stock split, each existing share becomes 1.5 shares. The shareholder's 100 shares become 150 shares. The cost basis per share is adjusted proportionally: $60 ÷ 1.5 = $40 per share. Total basis remains $6,000 (150 shares × $40 = $6,000, same as 100 × $60), but is spread over more shares. The split adjusts the per-share basis to reflect the new share count while preserving total basis. Common error: confusing the split direction or forgetting to adjust the basis per share.

14. 14. An investor holds a bond with a maturity of 10 years and a coupon of 6%. The issuer calls the bond at 102 in 5 years, and market interest rates have fallen to 3%. Which scenario is most likely?

    • A. The issuer will allow the bond to mature because the call price is below par.
    • B. Rising yields have made the bond less attractive to the issuer for refinancing.
    • C. The issuer will call the bond because lower rates allow refinancing at a lower cost.
    • D. The investor should expect the bond to trade at 98, discounting for call risk.
    Show answer & explanation

    Answer: C
    Callable bonds are refinanced by the issuer when market rates fall below the coupon rate. Here, the 6% coupon is much higher than the 3% prevailing rate, so the issuer has a strong incentive to call the bond and refinance at the lower 3% rate, even though the call price (102) exceeds par. The investor would receive $1,020 per $1,000 par plus accrued interest, forfeiting the remaining 5 years of 6% coupons—hence the yield-to-call is lower than yield-to-maturity. The investor should factor this call risk into expected return calculations.

15. 15. An investor is considering a dividend-paying common stock and a corporate bond from the same company. The investor is in the 32% federal tax bracket and subject to the 3.8% net investment income tax (NIIT). Which statement compares the after-tax yields correctly?

    • A. The bond's coupon income is exempt from NIIT, while dividend income is fully subject to NIIT.
    • B. Qualified dividends are taxed at 32% plus 3.8%, whereas bond interest is taxed at 32% only.
    • C. The bond's after-tax yield is identical to the stock's after-tax yield because both are corporate securities.
    • D. The stock's qualified dividend yield receives more favorable tax treatment, resulting in a higher after-tax yield than the bond on equivalent pre-tax yields.
    Show answer & explanation

    Answer: D
    Qualified dividends on U.S. common stock receive preferential tax rates (15% or 20%, depending on income level) plus the 3.8% NIIT, totaling no more than 23.8% for high earners. Bond interest (coupon income) is taxed as ordinary income at 32% plus 3.8% NIIT, totaling 35.8%. On equal pre-tax yields, the stock's qualified dividend income is taxed at a lower rate, yielding a higher after-tax return. This tax advantage is a key reason dividend-paying stocks often outperform bonds on an after-tax basis. NIIT applies to both but at different top-line rates due to the preferential dividend rate.

16. 16. A customer purchases 100 shares of XYZ stock at $50 per share in a margin account. Under Regulation T, what is the minimum amount of equity the customer must deposit to open this position?

    • A. $5,000
    • B. $3,500
    • C. $2,500
    • D. $2,000
    Show answer & explanation

    Answer: C
    Under Regulation T, the initial margin requirement is 50% for equity purchases. On a $5,000 purchase (100 shares × $50), the customer must deposit 50% = $2,500 in equity. The firm can lend the remaining $2,500. Choice B ($2,000) represents an incorrect lower percentage. Choice C misapplies the math. Choice D is the full cost, not the required margin.

17. 17. A customer writes a covered call on 100 shares of ABC stock that she owns outright. What is the effect on the customer's margin requirement?

    • A. The margin requirement decreases because the position is hedged
    • B. The stock must be pledged to the firm as collateral for the short call
    • C. The margin requirement increases by 10-15%
    • D. The margin requirement remains unchanged
    Show answer & explanation

    Answer: D
    A covered call involves owning the underlying stock outright and selling a call. Since the customer already owns 100 shares, no additional margin is required for writing the call. The stock is already held in the account. Choice A incorrectly assumes margin requirements increase. Choice C misunderstands margin mechanics—hedging does not reduce requirements. Choice D confuses the role of collateral.

18. 18. A customer writes a short straddle (sells both a call and a put at the same strike). If the underlying stock remains near the strike price at expiration, what is the outcome?

    • A. A loss equal to the sum of both premiums collected
    • B. Maximum profit, as both options expire worthless
    • C. Breakeven, since one option offsets the other
    • D. Maximum loss, as both options are in-the-money
    Show answer & explanation

    Answer: B
    In a short straddle, the seller profits when the stock stays near the strike at expiration because both the call and put expire worthless. The seller keeps both premiums collected. Choice B reverses the outcome. Choice C misunderstands straddle mechanics. Choice D confuses premium collection with loss.

19. 19. A customer sells 100 shares of MNO stock short in a margin account. Under Reg T, what is the minimum equity the customer must deposit?

    • A. 25% of the sale proceeds
    • B. 100% of the sale proceeds
    • C. No deposit is required; the proceeds serve as collateral
    • D. 50% of the sale proceeds
    Show answer & explanation

    Answer: D
    Regulation T requires 50% initial margin for short sales, just as for long purchases. If the customer sells short at $50 per share, the proceeds are $5,000, and 50% = $2,500 must be deposited in equity. Choice B requires full deposit. Choice C applies to maintenance, not initial margin. Choice D incorrectly assumes proceeds alone satisfy the margin requirement.

20. 20. A customer owns 100 shares of GHI stock purchased on margin. The stock declines significantly, and the customer's equity falls below the maintenance requirement. What action does the firm typically take if the customer fails to meet the margin call?

    • A. The firm has no authority to take action; it is the customer's sole responsibility
    • B. The firm must wait 30 days and then close the account entirely
    • C. The firm may liquidate positions without customer consent to restore the account to maintenance level
    • D. The firm must suspend trading but cannot liquidate without written authorization
    Show answer & explanation

    Answer: C
    If a customer fails to meet a margin call, the firm may liquidate positions without customer consent to protect the creditor. This is a standard remedy outlined in margin account agreements. Choice B overstates the timeline. Choice C incorrectly restricts the firm's authority. Choice D ignores the firm's rights and responsibilities.

21. 21. An RR opens a new account for a customer who states she is a retired teacher with modest savings, stable income from a pension, and minimal investment experience. Which of the following pieces of information is NOT required for the RR to establish suitability?

    • A. The customer's risk tolerance and previous investment experience
    • B. The customer's tax bracket and expected tax filing status
    • C. The customer's investment objectives and time horizon
    • D. The customer's favorite color and media consumption habits
    Show answer & explanation

    Answer: D
    Suitability requires gathering facts about financial situation (income, assets, liabilities), investment objectives, time horizon, risk tolerance, and investment experience. Personal preferences unrelated to financial capacity or investing—such as favorite color or media habits—are irrelevant to suitability analysis. This distinction tests the candidate's understanding of what 'reasonable basis' for recommendations actually means under FINRA rules.

22. 22. A customer opens a margin account with a broker-dealer and receives the margin disclosure statement. The RR explains that the customer will be charged interest on any borrowed funds and that the broker-dealer's margin requirement is higher than the Regulation T minimum. The customer proceeds with the account opening. Which statement is most accurate regarding the broker-dealer's margin requirement?

    • A. The broker-dealer may set margin requirements higher than Regulation T minimums at its discretion as a risk management measure
    • B. The broker-dealer is prohibited from setting margin requirements above Regulation T minimums without Federal Reserve approval
    • C. The broker-dealer may set its margin requirement above Regulation T minimums, but the firm must justify this to FINRA on an annual basis
    • D. House margin requirements higher than Regulation T may only be imposed on customers with account balances exceeding $100,000
    Show answer & explanation

    Answer: A
    Regulation T sets the federal minimum initial margin requirement at 50%, but individual firms are permitted to set higher 'house' margin requirements as a prudent risk management practice. This discretion allows a broker-dealer to be more conservative than the federal floor. Choice A incorrectly suggests FINRA approval is required; choice B wrongly states the broker is prohibited; choice D imposes a false threshold. Understanding that firms have house rules above regulatory minimums is critical for Series 7 candidates.

23. 23. An RR recommends a speculative technology stock to a customer with a conservative investment objective and a 10-year time horizon. The RR documents that the customer has high risk tolerance and substantial investment experience. When questioned by the firm's compliance officer, the RR claims the recommendation is suitable based on the documented information. Which of the following is the most significant concern with this recommendation?

    • A. The recommendation is unsuitable because the customer's investment objective is conservative, regardless of risk tolerance or experience
    • B. The RR may recommend speculative securities as long as they are documented properly in the customer's file
    • C. The recommendation is suitable because the customer has a 10-year time horizon, which is sufficiently long for speculative holdings
    • D. The recommendation is unsuitable because speculative stocks should only be recommended to institutional investors
    Show answer & explanation

    Answer: A
    Suitability must align with the customer's stated investment OBJECTIVES, not just risk tolerance or experience. A conservative investor with conservative objectives should not receive speculative recommendations, even if they could technically handle volatility. Choice B confuses time horizon with risk tolerance; choice C incorrectly restricts speculative securities only to institutions; choice D wrongly implies documentation alone justifies any recommendation. This tests the integrated nature of suitability factors.

24. 24. A customer with a joint account (husband and wife) gives the RR permission to discretionary trading authority that is limited to 'purchases of blue-chip dividend-paying stocks.' Three weeks later, the RR exercises this discretion by purchasing a small-cap growth stock in the account without contacting either account owner. When the stock declines 15%, the customer objects. Which of the following is correct?

    • A. The RR must obtain written consent from both account owners before any exercise of discretionary authority
    • B. The RR has violated the terms of the discretionary authority because the purchase was outside the scope of the granted authorization
    • C. The RR's action is permissible because discretionary authority includes the right to make any equity purchases at the RR's judgment
    • D. The RR's action is permissible because a 15% decline is within acceptable market risk for any discretionary account
    Show answer & explanation

    Answer: B
    Discretionary authority is limited to the scope explicitly granted by the customer. The permission to purchase blue-chip dividend stocks does not authorize small-cap growth purchases. The RR exceeded the scope and violated the customer's instructions. While initial discretion requires written authorization (often already obtained when the account was opened), exercising it within the defined scope does not require repeated contact. Choice C overstates procedural requirements; choice D confuses market risk with scope violation. This tests boundary-setting in delegated authority.

25. 25. A customer calls her RR and asks him to 'do whatever you think is best' for her account without specifying any restrictions or parameters. The RR interprets this as a grant of full discretionary authority and begins trading in options and futures. The customer later claims she did not intend to give discretionary authority. Which statement best describes the RR's exposure?

    • A. The RR has likely violated FINRA rules requiring written discretionary authority even if the customer consented orally
    • B. The RR may trade in any securities the customer holds an account for, including options and futures, without prior authorization
    • C. Oral discretionary authority is enforceable as long as both parties agree it covers all securities including derivatives
    • D. The RR is protected from liability because the customer's oral statement grants apparent authority to trade
    Show answer & explanation

    Answer: A
    FINRA requires discretionary authority to be granted in writing. An oral statement, no matter how permissive in tone, does not constitute proper written authorization. The RR should have obtained a signed power of attorney or similar written document before exercising discretion. This protects both the firm and the customer. Choice A wrongly treats oral statements as sufficient; choice C denies discretion is needed; choice D contradicts the writing requirement. This tests the formal procedural safeguard around delegated trading authority.

26. 26. A firm receives notice that a customer has been declared legally incompetent and a guardian has been appointed. The account is now held in the guardian's name. The RR, who knows the customer personally, continues to execute trades based on the original customer's oral instructions. Which of the following is correct?

    • A. The RR may continue executing the customer's instructions because a long-standing relationship creates an exception to fiduciary duty
    • B. The RR must cease trading based on the original customer's instructions and obtain authorization from the legally appointed guardian
    • C. The firm may continue the same trading pattern without explicit new authorization as long as prior transactions were suitable
    • D. The RR may execute trades if the customer verbally asserts that he remains competent, regardless of the legal guardianship
    Show answer & explanation

    Answer: B
    Once a legal guardian is appointed, the guardian becomes the authorized representative for the account. The RR may no longer accept instructions directly from an incompetent person. All future trading authority must flow through the guardian. The RR's personal relationship does not override legal guardianship; the customer's own assertion of competence does not override a court determination; and past suitability does not authorize future trading without proper authority. This tests the RR's duty to respect legal capacity and authority boundaries.

27. 27. A customer requests a recommendation for a municipal bond suitable for her tax situation. The customer is in a high federal tax bracket but lives in State X and is subject to State X income tax. The RR recommends a municipal bond issued by State Y without reviewing the customer's state tax situation. The customer later learns that the bond interest is subject to State X income tax. Which of the following is most accurate?

    • A. The RR should recommend only federal municipal bonds or Treasury securities to ensure tax efficiency
    • B. The suitability review is complete once the customer confirms he is in a high federal tax bracket
    • C. The RR has met the suitability standard because municipal bonds are tax-advantaged at the federal level for all customers
    • D. The RR failed to gather information necessary to assess suitability because state-of-residence matters for tax-exempt bond selection
    Show answer & explanation

    Answer: D
    When a customer requests tax-efficient recommendations, the RR must gather information about state of residence and state income tax exposure. A municipal bond issued in one state may be subject to income tax in another state if the customer resides there. Federal muni bonds exist but are rare; the RR should match the customer's residence with appropriate state munis. Choice A ignores state tax consequences; choice C imposes an overly restrictive standard; choice D treats federal tax status as sufficient. This tests the integrative nature of tax-driven suitability analysis.

28. 28. A firm's supervisory procedures require annual suitability reviews for all customer accounts. An RR has documented that a customer's investment objective is 'growth,' but recent conversations suggest the customer now seeks 'income' to fund retirement in 2–3 years. The RR intends to wait until the next annual review to update the file. Which of the following is the most significant compliance risk?

    • A. The RR may continue recommending growth securities because the annual review has not yet occurred
    • B. A material change in investment objective requires prompt documentation; delaying the update creates a gap in suitability oversight
    • C. The annual review schedule is the only mechanism for updating customer information; no interim changes are necessary
    • D. The RR should recommend income securities regardless of timing because the customer's time horizon has become shorter
    Show answer & explanation

    Answer: B
    While annual reviews are a baseline, material changes in a customer's circumstances (job change, inheritance, retirement timeline, health status) must be documented when discovered, not deferred. A shift from growth to income within 2–3 years is material and affects suitability immediately. Delaying documentation creates regulatory exposure and leaves the account in a state of uncertain suitability. Choice A wrongly defers to the annual schedule; choice C treats annual reviews as the only update mechanism; choice D oversimplifies the response. This tests proactive suitability surveillance.

29. 29. A customer who is a widow, age 72, with limited investment experience, opens an account stating she wants to preserve capital for living expenses. An RR recommends a portfolio of low-correlation real-estate investment trusts, emerging-market bonds, and leveraged commodity ETFs. When questioned by the firm's compliance officer, the RR points to recent conversations in which the customer expressed interest in 'higher returns' and claims this justifies the recommendation. Which of the following is correct?

    • A. The RR's recommendation is unsuitable because it conflicts with the documented primary objective of capital preservation and the customer's age and experience level
    • B. The recommended portfolio diversifies across asset classes and therefore is suitable for any retiree
    • C. A customer's offhand comment about 'higher returns' overrides her documented objective of capital preservation
    • D. An RR may recommend complex, illiquid, or leveraged products to elderly customers if the customer has expressed a vague desire for returns
    Show answer & explanation

    Answer: A
    Suitability requires weighing all relevant factors: the documented objective (capital preservation), age (72), experience level (limited), liquidity needs (living expenses), and risk tolerance (implied conservative by her circumstances). A casual remark about wanting 'higher returns' does not override these foundational facts. The recommended portfolio—REITs, emerging-market bonds, leveraged commodities—introduces substantial volatility, complexity, and illiquidity, which are inappropriate for this profile. Choice B overstates the weight of an offhand comment; choice C confuses diversification with appropriateness; choice D wrongly permits complexity based on vague return talk. This is a comprehensive test of multi-factor suitability judgment.

30. 30. A customer places a buy order for corporate bonds. Settlement occurs T+1. On settlement date, the customer's broker fails to deliver the bonds. What is the customer's recourse against SIPC?

    • A. SIPC will reimburse the full value of the undelivered bonds immediately upon the broker's insolvency
    • B. SIPC protects only cash balances and securities positions held in the customer's account, not failed deliveries
    • C. SIPC will cover the loss only if the broker is deemed insolvent before T+2
    • D. The customer must wait 5 business days before SIPC can intervene in failed deliveries
    Show answer & explanation

    Answer: B
    SIPC protection covers cash and securities held in the customer's account up to the statutory limits—not fails-to-deliver or execution failures. A failed delivery is a settlement issue between the broker and clearinghouse, not a SIPC claim. The customer's remedy is against the broker for breach of settlement obligation, not a SIPC payout. SIPC steps in only when a broker becomes insolvent and there are missing customer assets.

31. 31. A registered representative learns that her firm's chief financial officer will announce major cost-cutting layoffs next week. The representative immediately recommends to several customers that they sell their positions in the firm's stock. Has the representative violated insider trading rules?

    • A. Yes, the representative traded on material non-public information obtained in a fiduciary capacity
    • B. No, if the customers agree to the trades and sign a disclaimer
    • C. No, because the news will eventually be public, so there is no unfair advantage
    • D. Yes, but only if the customers are institutional investors, not retail customers
    Show answer & explanation

    Answer: A
    Trading on material non-public information—information not yet disclosed to the public—violates insider trading rules under securities law. The representative obtained this information in her capacity as an employee of the firm and used it to benefit customers, which is a breach of her fiduciary duty. The fact that the news will eventually be public does not excuse the trading. Customer consent and disclaimers do not legalize insider trading. Insider trading restrictions apply equally to retail and institutional customers.

32. 32. A customer wants to sell covered call options against her long stock position. Her representative explains that the premium received reduces her cost basis and allows her to profit if the stock rises above the strike price. Is this explanation accurate?

    • A. The premium does reduce cost basis, but profit is capped at the strike price plus premium
    • B. Yes, and the customer has unlimited upside with no downside risk
    • C. Yes, the premium reduces cost basis and profit is unlimited if the stock exceeds the strike
    • D. No, covered calls never reduce cost basis; the premium is held as collateral
    Show answer & explanation

    Answer: A
    A covered call reduces the investor's cost basis by the premium received, which is correct. However, the rep's statement that 'profit is unlimited if the stock rises above the strike' is misleading. In a covered call strategy, the investor's upside is capped at the strike price plus the premium received; if the stock rises above the strike, it will be called away. The strategy does provide downside protection equal to the premium, but upside is limited. The representative must communicate this trade-off accurately.

33. 33. A firm discovers that one of its registered representatives has been recommending high-commission proprietary mutual funds to unsuitable customers for the past six months to boost his commissions. What must the firm do?

    • A. Issue a warning letter to the representative and allow him to continue trading
    • B. Report the conduct to FINRA and implement supervisory measures to prevent recurrence
    • C. Require the representative to return all commissions earned on unsuitable sales
    • D. Quietly terminate the representative's employment without reporting to regulators
    Show answer & explanation

    Answer: B
    Firms have a regulatory obligation to report misconduct involving unsuitable recommendations and potential fraud to FINRA and regulators. Simply terminating the employee without reporting does not satisfy the firm's duty. The firm must investigate, document the violations, report them, and implement corrective and preventive measures. While returning commissions may be part of customer remediation, reporting the conduct is the mandatory first step. A warning letter alone is insufficient when fraud and suitability violations are evident.

34. 34. A registered representative receives an email from a client asking for a recommendation on cryptocurrency mining company stock. The rep has no training in cryptocurrency valuation, no firm guidance on crypto securities, and the firm's compliance department has not approved any communications about crypto. What should the rep do?

    • A. Respond that she does not have adequate knowledge or firm approval to make a recommendation, and refer the customer to compliance
    • B. Recommend that the customer consult a financial advisor outside the firm instead
    • C. Recommend the stock based on recent positive news articles about the crypto market
    • D. Execute an unsolicited order without a recommendation to avoid liability
    Show answer & explanation

    Answer: A
    A representative must not recommend a security without adequate training, knowledge, and firm compliance support. Crypto-related securities pose novel valuation and regulatory questions; without internal guidance, the rep should not attempt a recommendation. The appropriate response is to acknowledge the customer's interest, explain the limitation, and involve compliance or management. Executing an unsolicited order might be permissible if documented, but responding that the firm does not support such recommendations is the more professional and compliant approach. Redirecting the customer outside the firm does not resolve the rep's responsibility.

35. 35. A customer enters a standing order to buy 100 shares of DEF stock whenever it drops below $40. The stock falls to $39, and the order triggers automatically. The customer calls two days later angry that the trade was executed without explicit permission. The representative explains that the standing order was the customer's own instruction. Is the representative's explanation sufficient?

    • A. Yes, but only if the customer signed a written agreement authorizing automatic orders
    • B. No, the rep should have called the customer before execution to re-confirm the order
    • C. No, standing orders are not legally binding and the rep violated the customer's consent requirements
    • D. Yes, a standing order is sufficient authorization; the customer approved the trade in advance
    Show answer & explanation

    Answer: D
    A standing order (also called a good-till-canceled or GTC order with conditions) constitutes advance authorization by the customer to execute a trade when specified conditions are met. Once the customer places the order, the firm may execute it when the condition triggers without obtaining explicit re-confirmation on each execution. This is especially true for limit orders and conditional buy/sell orders that the customer deliberately structures. The rep's explanation is sufficient because the customer authorized the trade through the standing order itself. Re-confirming every execution would undermine the purpose of standing orders.

36. 36. A corporation is liquidated in bankruptcy. Its capital structure contains secured mortgage bonds, straight debentures, subordinated debentures, preferred stock and common stock. After wages and taxes are satisfied, in what order are the remaining claims paid?

    • A. Straight debentures, mortgage bonds, subordinated debentures, preferred stock, common stock
    • B. Mortgage bonds, straight debentures, subordinated debentures, preferred stock, common stock
    • C. Preferred stock, mortgage bonds, straight debentures, subordinated debentures, common stock
    • D. Mortgage bonds, subordinated debentures, straight debentures, common stock, preferred stock
    Show answer & explanation

    Answer: B
    Secured creditors are satisfied first out of the pledged collateral, so mortgage bondholders rank ahead of every unsecured claim. General creditors come next, and straight debentures are general creditors. Subordinated debentures follow because the indenture contractually agrees to stand behind other debt. Equity is last, preferred ahead of common. The tempting error is choice B, which puts subordinated debentures ahead of straight debentures because both carry the word debenture; subordination is precisely an agreement to be paid after senior obligations, so it can only lower the claim, never raise it.

37. 37. A customer purchases an adjustment (income) bond in the secondary market. The trade confirmation shows no accrued interest added to the contract price, and the customer asks the representative why nothing was added.

    • A. Income bonds pay interest only if the board declares it out of sufficient earnings, so they trade flat
    • B. Corporate accruals use a 30/360 calendar, which produced a zero accrual for this calendar month
    • C. Accrued interest on corporate issues is billed separately by the trustee after settlement date
    • D. Accrued interest is waived whenever a bond trade is settled regular way rather than for cash
    Show answer & explanation

    Answer: A
    Adjustment or income bonds are typically issued in a reorganization and obligate the issuer to pay interest only when earnings are sufficient and the board declares it. Because interest is not contractually accruing, these bonds trade flat, meaning without accrued interest. Choice A is the trap for candidates who have memorized that corporates accrue 30/360: that convention standardizes every month at 30 days and a 360-day year, but it never produces a zero accrual merely because of where the calendar falls. Bonds in default trade flat for the same reason.

38. 38. A customer buys a 6% corporate bond at a price of 108 that the issuer may call at par in three years. The customer asks which of the four yields shown on the confirmation will be the lowest number.

    • A. Nominal yield
    • B. Yield to maturity
    • C. Yield to call
    • D. Current yield
    Show answer & explanation

    Answer: C
    For a bond bought at a premium the four yields rank in descending order: nominal, current, yield to maturity, yield to call. The premium is a loss the holder amortizes over the life of the bond, and a call at par three years out forces that entire loss into a much shorter period, which drives the yield to call to the bottom. Yield to maturity is the tempting answer because candidates correctly learn that premium bonds yield less to maturity than their coupon suggests, but maturity is the longer horizon here, so the annualized drag is smaller than it is to the call date.

39. 39. A customer living in a high income tax state wants interest income that is fully taxable at the federal level but exempt from state and local income tax. Which recommendation meets that requirement?

    • A. United States Treasury notes
    • B. Ginnie Mae pass-through certificates
    • C. Investment-grade corporate debentures
    • D. Bank-issued negotiable certificates of deposit
    Show answer & explanation

    Answer: A
    Interest on direct obligations of the United States Treasury is exempt from state and local income tax while remaining fully taxable federally, which is exactly the profile requested. Ginnie Mae is the trap: its pass-through certificates do carry a United States government guarantee, and candidates conflate that guarantee with the Treasury's tax treatment. But the payments represent pass-through mortgage interest from an agency, not direct Treasury interest, so they are taxable at the federal, state and local levels. Negotiable CDs and corporate debentures are likewise fully taxable at every level.

40. 40. A risk-averse customer is comparing mortgage-backed securities and asks the representative which of the agency issuers stands behind its pass-through certificates with the full faith and credit of the United States government.

    • A. None of the three carries a government guarantee; each is backed solely by its mortgage pool
    • B. Fannie Mae and Freddie Mac certificates carry the guarantee, while Ginnie Mae certificates do not
    • C. Ginnie Mae, Fannie Mae and Freddie Mac certificates all carry the full faith and credit guarantee
    • D. Only Ginnie Mae pass-through certificates carry the full faith and credit guarantee
    Show answer & explanation

    Answer: D
    Ginnie Mae is a wholly owned government corporation, and its pass-through certificates are backed by the full faith and credit of the United States. Fannie Mae and Freddie Mac are government-sponsored enterprises whose securities are agency obligations of the issuing corporation itself. Choice C is the trap, since all three trade as agency paper at similar spreads and candidates assume the guarantee is uniform. It is not, and the distinction matters in a credit event. Note that the guarantee covers timely payment of principal and interest; it does not remove prepayment risk from any of the three.

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