Series 7 sample questions, with worked answers

C: A general obligation bond issued in her home state. In-state municipal interest is usually exempt from both federal and state income tax, which matters most to a high-bracket investor in a high-tax state.

The trap: Choosing the out-of-state revenue bond because it is also municipal. Only in-state interest usually escapes the customer's own state tax.

A: Buy 5 XYZ puts. Long puts gain as the stock falls, offsetting losses on the shares. One contract covers 100 shares, so 5 contracts protect 500.

The trap: Selling calls for the premium. A covered call only cushions a fall by the premium received; long puts protect all the way down to the strike.

A: $43.50 and $56.50. A straddle has two breakevens: the strike plus and minus the total premium. 3.50 + 3 = 6.50, so 50 − 6.50 = $43.50 and 50 + 6.50 = $56.50.

D: is the chance that the issuer redeems a bond early after rates fall. Call risk is the chance that the issuer redeems a bond early after rates fall.

A: $450. A short straddle's best case is the stock closing at the strike, so both options expire worthless and the writer keeps both premiums: (3 + 1.50) × 100 = $450.

D: Nominal yield. Nominal yield is the highest when the bond was bought at a premium. On a discount bond the yields rise from nominal to current to maturity to call; on a premium bond they fall in that order.

A: 56. A put buyer profits when the stock falls, so the breakeven is the strike minus the premium: 60 − 4 = 56.

1. A put is the right to sell at the strike, 60.
2. The buyer paid 4, which must be recovered as the stock falls.
3. Breakeven: 60 − 4 = 56.

The trap: Adding the premium (64). That is the breakeven for a call; puts subtract.

B: $600. If the stock rises above 55 the shares are called away at 55. The gain is the rise to the strike plus the premium: (55 − 52 + 3) × 100 = $600.

1. Above 55 the call is exercised and the shares are sold at 55.
2. Stock gain: 55 − 52 = 3 points. Premium kept: 3 points.
3. 6 points × 100 shares = $600.

The trap: Answering "Unlimited" because the investor owns stock. Selling the call caps the upside at the strike.

B: 43. This is a bull call spread with a net debit of 5 − 2 = 3. A call spread breaks even at the lower strike plus the net debit: 40 + 3 = 43.

1. Net premium: paid 5, received 2, a net debit of 3.
2. It is a call spread, so add the net premium to the lower strike.
3. 40 + 3 = 43.

The trap: Using the higher strike (45 − 3 = 42, or 45 + 3 = 48). For calls, start from the lower strike.

A: 45 and 55. A straddle has two breakevens: the strike plus and minus the total premium. 3 + 2 = 5, so 50 − 5 = 45 and 50 + 5 = 55. Between them the seller profits.

1. Total premium: 3 + 2 = 5.
2. Upside breakeven: 50 + 5 = 55.
3. Downside breakeven: 50 − 5 = 45.

The trap: Applying each premium to its own side (53 and 48). A straddle uses the combined premium on both sides.

C: $700. The put lets the investor sell at 65 however far the stock falls. The loss is the drop to the strike plus the premium: (70 − 65 + 2) × 100 = $700.

1. Worst case: the stock falls and the shares are sold at 65 through the put.
2. Stock loss: 70 − 65 = 5 points. Premium paid: 2 points.
3. 7 points × 100 shares = $700.

The trap: Forgetting the premium ($500). What you pay for protection is part of the loss.

D: 6.00%. Tax-equivalent yield is the municipal yield divided by one minus the tax rate: 3.9% ÷ 0.65 = 6.00%.

1. One minus the tax rate: 1 − 0.35 = 0.65.
2. Divide the tax-free yield by it: 3.9 ÷ 0.65.
3. = 6.00%.

The trap: Multiplying by 1.35 (5.27%). Gross up by dividing by 0.65, not by adding 35%.

C: 6.25%. Current yield is the annual interest divided by the market price. The bond pays $60 a year and costs $960: 60 ÷ 960 = 6.25%.

1. Annual interest: 6% of $1,000 = $60.
2. Price: 96% of par = $960.
3. 60 ÷ 960 = 6.25%.

The trap: Multiplying the coupon by the price (5.76%). A discount bond's current yield is above its coupon, not below it.

D: The yield to call. For a discount bond the order is nominal, then current yield, then yield to maturity, then yield to call. The discount is earned back sooner if the bond is called, so the yield to call is highest.

1. Discount bond: the investor gets back more than was paid.
2. The sooner that gain arrives, the higher the yield.
3. A call comes before maturity, so the yield to call is highest.

The trap: Reversing the order. For a premium bond the yield to call is lowest; for a discount bond it is highest.

C: $1,100. The bond converts into 1,000 ÷ 40 = 25 shares, worth 25 × $44 = $1,100. That is the price at which the bond and the shares are worth the same.

1. Conversion ratio: 1,000 ÷ 40 = 25 shares.
2. Value of the shares: 25 × 44 = $1,100.
3. Parity price of the bond: $1,100.

The trap: Multiplying the stock price by 40 ($1,760). Divide par by the conversion price first to get the number of shares.

B: Act in the customer's best interest at the time of the recommendation, without putting its own interest first. Regulation Best Interest requires a broker-dealer to act in the retail customer's best interest when it makes the recommendation, through its disclosure, care, conflict of interest and compliance obligations. Cost matters, but the rule does not require the cheapest product.

1. Reg BI applies to recommendations to retail customers.
2. The standard is the customer's best interest at the time of the recommendation.
3. Cost is one factor in the care obligation, not the rule.

The trap: Choosing "lowest cost". Cost is a factor the firm must weigh, but a more expensive product can still be in the customer's best interest.

A: $52.10. A buy stop becomes a market order when a trade occurs at or above the stop price. The first trade at or above $52 is $52.10.

The trap: Triggering at $51.90 because it is "close". A buy stop needs a trade at or above the stop price.

A: $22,000. The debit is $33,000 ÷ 2 = $16,500. At the maintenance minimum, equity is 25% of market value, so the debit is 75% of it: market value = debit ÷ 0.75 = $16,500 ÷ 0.75 = $22,000.

C: is buying a security for the firm's account to fill a customer order the firm already holds. A riskless principal trade is buying a security for the firm's account to fill a customer order the firm already holds.

D: $35,000. The purchase is $50,000 and Regulation T requires 50%, so the customer deposits $25,000 and the debit is $25,000. At $60 the market value is $60,000, and equity is 60,000 − 25,000 = $35,000.

1. Purchase: 1,000 × 50 = $50,000; Reg T deposit 50% = $25,000; debit $25,000.
2. New market value: 1,000 × 60 = $60,000.
3. Equity = market value − debit = $35,000.

The trap: Answering the $10,000 price gain. The equity is the customer's deposit plus the gain.

B: $40,000. Equity must be at least 25% of the market value, so the debit can be at most 75% of it. The call point is the debit divided by 0.75: 30,000 ÷ 0.75 = $40,000.

1. At 25% maintenance, the debit is at most 75% of the market value.
2. Market value at the call: 30,000 ÷ 0.75.
3. = $40,000. Below that, equity is under 25%.

The trap: Adding 25% to the debit ($37,500). Divide by 0.75 instead.

B: Tuesday. Since 28 May 2024, regular-way settlement for most U.S. securities trades is one business day after the trade date (T+1), so Monday's trade settles on Tuesday.

1. Regular-way settlement for stock is T+1.
2. One business day after Monday is Tuesday.

The trap: Counting two days (Wednesday). T+2 ended in May 2024.

C: Written discretionary authority from the customer and principal approval of the account. Discretion over the security, the amount or the action requires the customer's prior written authorization and acceptance of the account by a principal, who also reviews the trades.

The trap: Treating the customer's spoken request as enough. Discretion needs written authority first, and a principal must accept the account.

B: The firm's do-not-call list. The firm's do-not-call list is the list of people who asked the firm not to call them, which must be honored for five years.

B: A trust account. A trust account is opened by a trustee, who must provide the trust document showing the authority to trade.

A: At least 10 business days before first use. For its first year of membership, a new member must file its retail communications with FINRA at least 10 business days before first use (FINRA Rule 2210).

1. The firm is in its first year of FINRA membership.
2. New members pre-file retail communications in that year.
3. The filing is due at least 10 business days before first use.

The trap: Choosing "within 10 business days after first use", which is the timing for some other filings, not for a new member's retail communications.

B: The hypothecation agreement. In the hypothecation agreement the customer pledges the securities to the firm, and allows the firm to rehypothecate them to a bank for the loan that funds the margin debit.

1. The credit agreement sets out the interest and terms of the loan.
2. The hypothecation agreement pledges the securities as collateral.
3. The loan consent, which is optional, lets the firm lend the securities to others.

The trap: Choosing the loan consent agreement. That lets the firm lend the securities to short sellers, not pledge them to a bank.

B: Open the account, having made a reasonable effort to get the name. FINRA Rule 4512 requires the firm to make a reasonable effort to obtain the name and contact details of a trusted contact person for a non-institutional account, but the customer may decline and the account can still be opened.

1. The firm must ask for a trusted contact.
2. The customer is not required to give one.
3. The account may be opened once the firm has made the effort.

The trap: Refusing the account. The rule requires a reasonable effort to get the name, not the name itself.