Series 7 - General Securities Representative Exam Core Concepts Flashcards

Question 1

Long Put Option Payoff

Accepted Answer

Max Gain: Strike Price - Premium (if stock falls to zero). Max Loss: Premium paid. Breakeven: Strike Price - Premium. A long put is profitable if the underlying stock price falls below the breakeven point.

Question 2

Short Put Option Payoff

Accepted Answer

Max Gain: Premium received. Max Loss: Strike Price - Premium (if stock falls to zero). Breakeven: Strike Price - Premium. A short put is profitable if the underlying stock price stays above the breakeven point.

Question 3

Common Stock vs. Preferred Stock: Key Differences

Accepted Answer

Common Stock: Represents ownership, voting rights, variable dividends, last in liquidation. Preferred Stock: Fixed dividend, no voting rights, higher claim on assets/earnings than common stock in liquidation.

Question 4

Rights vs. Warrants

Accepted Answer

Rights: Short-term (30-45 days), issued to existing shareholders to buy new shares below market price, maintain proportionate ownership. Warrants: Long-term (years), allow purchase of shares at a set price above current market, often attached to bonds/preferred stock as a 'sweetener'.

Question 5

American Depositary Receipts (ADRs)

Accepted Answer

Certificates representing ownership of shares in a foreign company, traded in U.S. markets. Facilitate U.S. investment in foreign companies and are subject to currency risk.

Question 6

Bond Pricing and Yield Relationship

Accepted Answer

Bond prices and interest rates (yields) move in opposite directions. When interest rates rise, bond prices fall, and vice versa. This inverse relationship is fundamental to bond valuation.

Question 7

Current Yield Formula for Bonds

Accepted Answer

Current Yield measures the annual income (interest) an investor receives relative to the bond's current market price. The formula is: Current Yield = $\frac{	ext{Annual Interest}}{	ext{Market Price}}$

Question 8

Yield-to-Maturity (YTM) vs. Yield-to-Call (YTC)

Accepted Answer

YTM: The total return an investor can expect if they hold the bond until maturity, considering coupon payments and capital gains/losses. YTC: The total return if the bond is called prior to maturity, typically quoted for callable bonds trading at a premium.

Question 9

Municipal Bond Tax Treatment

Accepted Answer

Interest income from municipal bonds is generally exempt from federal income tax. If the bond is issued by a municipality within the investor's state of residence, the interest may also be exempt from state and local taxes (triple tax-exempt).

Question 10

General Obligation (GO) vs. Revenue Bonds

Accepted Answer

GO Bonds: Backed by the full faith and credit (taxing power) of the issuing municipality. Revenue Bonds: Backed by the revenues generated by the specific project they finance (e.g., tolls from a bridge, utility fees).

Question 11

Long Call Option Payoff

Accepted Answer

Max Gain: Unlimited (as stock price rises). Max Loss: Premium paid. Breakeven: Strike Price + Premium. A long call is profitable if the underlying stock price rises above the breakeven point.

Question 12

Short Call Option Payoff

Accepted Answer

Max Gain: Premium received. Max Loss: Unlimited (as stock price rises). Breakeven: Strike Price + Premium. A short call is profitable if the underlying stock price stays below the breakeven point.

Question 13

Long Straddle Option Strategy

Accepted Answer

Involves buying both a call and a put with the same strike price and expiration date. Profitable if the underlying stock moves significantly in either direction (up or down). Breakeven points: Strike Price + Total Premiums (upside) and Strike Price - Total Premiums (downside).

Question 14

Debit Spread vs. Credit Spread

Accepted Answer

Debit Spread: An options strategy where the premium paid for the long option is greater than the premium received for the short option, resulting in a net debit. Profitable if the spread widens (for calls) or narrows (for puts). Credit Spread: An options strategy where the premium received for the short option is greater than the premium paid for the long option, resulting in a net credit. Profitable if both options expire worthless or the spread narrows.

Question 15

Opening a New Customer Account: Required Information

Accepted Answer

Essential information includes: customer's name, address, date of birth, Social Security Number (or Tax ID), employment status, investment objectives, risk tolerance, and financial status. CIP (Customer Identification Program) requires verification of identity.

Question 16

Regulation T (Reg T) Initial Margin Requirement

Accepted Answer

Under Reg T, investors must deposit 50% of the purchase price when buying eligible securities on margin. The remaining 50% can be borrowed from the broker-dealer. This applies to both equity and options transactions.

Question 17

FINRA Maintenance Margin Requirement

Accepted Answer

FINRA Rule 4210 requires that customers maintain a minimum equity of 25% of the current market value of securities in a long margin account, and 30% for a short margin account. If equity falls below this, a maintenance call is issued.

Question 18

Restricted Margin Account

Accepted Answer

A margin account is restricted when the equity in the account is less than the Reg T initial margin requirement (50%) but still above the FINRA maintenance margin requirement (25%). No new purchases can be made on margin, but sales are permitted, with 50% of the proceeds reducing the debit balance.

Question 19

Special Memorandum Account (SMA)

Accepted Answer

A line of credit created when the market value of securities in a margin account increases, or when cash is deposited that is not needed to meet a margin call. SMA can be used to withdraw cash or buy additional securities on margin, but it does not increase the equity in the account.

Question 20

FINRA Suitability Rule (Rule 2111)

Accepted Answer

Requires broker-dealers and registered representatives to have a reasonable basis to believe that a recommended transaction or investment strategy is suitable for the customer. It has three main obligations: Reasonable-Basis, Customer-Specific, and Quantitative suitability.

Question 21

Municipal Securities Rulemaking Board (MSRB) Rules Enforcement

Accepted Answer

The MSRB creates rules for municipal securities firms and professionals, but it does not enforce them. Enforcement is handled by FINRA for broker-dealers, the SEC for municipal advisors, and the Comptroller of the Currency, Federal Reserve, and FDIC for banks.

Question 22

Insider Trading

Accepted Answer

The illegal practice of trading on the stock exchange to one's own advantage through having access to confidential information about a company before it is made public. Penalties can include disgorgement of profits, fines, and imprisonment.

Question 23

FINRA Rule 2210 (Communications with the Public)

Accepted Answer

Governs how firms communicate with the public. Classifies communications into three categories: Correspondence (to 25 or fewer retail investors within 30 days), Retail Communications (to more than 25 retail investors within 30 days, requires principal approval), and Institutional Communications (to institutional investors only, no principal approval required if supervised).

Question 24

Role of the Securities and Exchange Commission (SEC)

Accepted Answer

The primary federal regulator of the securities industry. Its mission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. It enforces federal securities laws and oversees SROs like FINRA.

Series 7 - General Securities Representative Exam Core Concepts

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