FINRA Series 7 Exam Practice Questions (P. 4)
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Question #31
Bubba buys a $4 convertible preferred with a $50 par value that is exchangeable for common stock at 47.50. If the preferred stock is trading at 52 and the common stock at 51, Bubba determines that the preferred stock is:
- Aoverpriced and will quickly decline
- Bselling at a 4% premium over conversion value
- Cunderpriced and should rise quickly
- Dgoing to be called when the common stock price is $52
Correct Answer:
C
underpriced and should rise quickly. The parity price for the common stock is about $49.38 - determined as:50 / 47.50 = 1.053 52 / 1.053 = 49.38
Since the common stock is trading at 51, the preferred is underpriced.
C
underpriced and should rise quickly. The parity price for the common stock is about $49.38 - determined as:50 / 47.50 = 1.053 52 / 1.053 = 49.38
Since the common stock is trading at 51, the preferred is underpriced.
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Question #32
A case of leverage is:
- Aselling common stock short and buying warrants for the equivalent number of shares followed by subscribing to the shares and covering the short
- Bborrowing at 6% and investing the funds at 10%
- Cbuying stock on the NYSE and later selling it the same day on the CBOE
- Dredeeming a convertible bond before maturity
Correct Answer:
B
borrowing at 6% and investing the funds at 10%. Leverage is all about using money obtained at a lower cost than what can be earned deploying the funds elsewhere. It is unrelated to arbitrage.
B
borrowing at 6% and investing the funds at 10%. Leverage is all about using money obtained at a lower cost than what can be earned deploying the funds elsewhere. It is unrelated to arbitrage.
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Question #33
Bubba holds 200 shares of common stock in a utility company and receives rights to subscribe to an additional 100 shares at $20. The utility company is raising
$40 million of new capital.
How many rights does Bubba receive?
$40 million of new capital.
How many rights does Bubba receive?
- A20
- B50
- C100
- D200
Correct Answer:
D
200. In an issue of rights, there is always one right per share. Bubba owns 200 shares and thus receives the same number of rights.
D
200. In an issue of rights, there is always one right per share. Bubba owns 200 shares and thus receives the same number of rights.
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Question #34
Bubba holds 200 shares of common stock in a utility company and receives rights to subscribe to an additional 100 shares at $20. The utility company is raising
$40 million of new capital.
How many shares of common stock for the utility company were outstanding prior to the rights offering?
$40 million of new capital.
How many shares of common stock for the utility company were outstanding prior to the rights offering?
- A2,000,000
- B4,000,000
- C1,000,000
- D40,000,000
Correct Answer:
B
4,000,000. Bubba owns 200 shares and receives rights for 100 more. The basis for the rights offering is therefore one new share for each two shares outstanding. The utility company is raising $40 million by selling shares at $20. Therefore, the company is selling 2,000,000 new shares. Since the ratio of existing shares to new shares is 2 to 1, there must be 4,000,000 presently outstanding shares.
B
4,000,000. Bubba owns 200 shares and receives rights for 100 more. The basis for the rights offering is therefore one new share for each two shares outstanding. The utility company is raising $40 million by selling shares at $20. Therefore, the company is selling 2,000,000 new shares. Since the ratio of existing shares to new shares is 2 to 1, there must be 4,000,000 presently outstanding shares.
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Question #35
Bubba owns a perpetual warrant to buy one share of Internet Corporation common stock at $30. Internet Corporation stock is trading at 41.50 and is ex-dividend today at $0.75.
What is the market value of Bubbas warrant?
What is the market value of Bubbas warrant?
- A5.75
- B5.62
- C5.38
- Dcannot be determined from this information
Correct Answer:
D
cannot be determined. Bubba can put away the calculator. The warrant is "perpetual" so the value is not determinable from today’s price of the common stock.
D
cannot be determined. Bubba can put away the calculator. The warrant is "perpetual" so the value is not determinable from today’s price of the common stock.
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Question #36
The preferred stock of Greatest Technology Corporation has a $100 par and is convertible into four shares of common stock. The preferred is trading at 104.50.
The preferred is callable at 101. If the common stock price is presently 27.89, which of the following actions would be a successful arbitrage:
The preferred is callable at 101. If the common stock price is presently 27.89, which of the following actions would be a successful arbitrage:
- Apurchase 400 shares of common stock and sell 100 shares of preferred stock as "short exempt" (that is, the sale is exempt from the uptick rule)
- Bpurchase the preferred stock and sell an appropriate amount of the common stock "short exempt"
- Cpurchase both the common and the preferred stocks as a hedge against further market risk
- Dpurchase the preferred stock and let it be called, which is inevitable at these market prices
Correct Answer:
B
purchase the preferred stock and sell an appropriate amount of the common stock "short exempt". Arbitrage is the nearly simultaneous purchase and sale of equal securities in different markets for a profit. Selling four shares of common stock for every one share of preferred stock purchased provides a profit.
The transactions involve the same number of common shares because the preferred is convertible to common at a four to one ratio.
B
purchase the preferred stock and sell an appropriate amount of the common stock "short exempt". Arbitrage is the nearly simultaneous purchase and sale of equal securities in different markets for a profit. Selling four shares of common stock for every one share of preferred stock purchased provides a profit.
The transactions involve the same number of common shares because the preferred is convertible to common at a four to one ratio.
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Question #37
Commercial paper is typically issued with a maturity date not exceeding:
- A90 days
- B6 months
- C270 days
- D1 year
Correct Answer:
C
270 days. A characteristic of commercial paper is relatively short duration, normally not exceeding 270 days.
C
270 days. A characteristic of commercial paper is relatively short duration, normally not exceeding 270 days.
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Question #38
The minimum denomination for a US treasury bond is:
- A$100
- B$1,000
- C$10,000
- D$100,000
Correct Answer:
B
$1,000. This is the minimum denomination. Normally, US treasury bonds are in much larger denominations.
B
$1,000. This is the minimum denomination. Normally, US treasury bonds are in much larger denominations.
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Question #39
Which of the following has the least active secondary market?
- Atreasury bills
- Bbanker’s acceptances
- Ccertificates of deposit
- Dcommercial paper
Correct Answer:
D
commercial paper. The sizes of secondary markets for these securities are listed in order with treasuries first, then bankers acceptances, followed by certificates of deposit. There is only a very small secondary market for commercial paper.
D
commercial paper. The sizes of secondary markets for these securities are listed in order with treasuries first, then bankers acceptances, followed by certificates of deposit. There is only a very small secondary market for commercial paper.
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Question #40
Which of the following is not classified as a money market instrument?
- Abanker’s acceptances
- Bcommercial paper
- CAmerican Depository Receipts
- Dtreasury bills
Correct Answer:
C
American Depository Receipts. American Depository Receipts are used to facilitate transfer of ownership in foreign securities. They are not money market instruments.
C
American Depository Receipts. American Depository Receipts are used to facilitate transfer of ownership in foreign securities. They are not money market instruments.
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