Module 3: Providing Investment Information, Making Recommendations and Maintaining Records

• Topic 01

  Equity Securities

  100 questions
• Topic 02

  Corporate Debt Securities

  199 questions
• Topic 03

  Municipal Securities

  106 questions
• Topic 04

  U.S. Government and Agency Securities

  115 questions
• Topic 05

  Mutual Funds and Exchange-Traded Products

  168 questions
• Topic 06

  Variable Contracts (Annuities and Life Insurance)

  114 questions
• Topic 07

  Options

  100 questions
• Topic 08

  Direct Participation Programs (DPPs)

  130 questions
• Topic 09

  Portfolio Analysis and Recommendations

  100 questions
• Topic 10

  Record-Keeping, Asset Transfers and Compliance

  106 questions

A few questions from this unit, with the answer and a full explanation. The complete bank is available when you start practising.

1. How does a protective put compare to a covered call in terms of cost and risk profile?

   • A
     Both strategies cost money and provide identical downside protection.
   • B
     A protective put generates income; a covered call costs money.
   • C
     A protective put caps upside potential; a covered call provides unlimited upside exposure.
   • D
     A protective put costs money (debit) and provides downside protection while preserving unlimited upside potential; a covered call generates income (credit) but caps upside potential while providing only limited downside protection equal to the premium received.
     Correct answer
   Explanation

   These are two fundamentally different strategies often confused on the Series 7 exam. Protective put: bullish on the stock + concerned about downside → buy insurance (pay a debit) → unlimited upside, capped downside loss. Covered call: own stock + want income + willing to sell at strike → collect premium (receive a credit) → capped upside (at strike), partial downside protection (only by the premium received).

2. What is the Investment Company Act of 1940 and what does it govern?

   • A
     The Investment Company Act of 1940 applies only to closed-end funds; ETFs and mutual funds are governed by the 1933 Act
   • B
     The Investment Company Act of 1940 governs investment advisers who manage portfolios for clients
   • C
     The Investment Company Act of 1940 is the primary federal law requiring registration and regulating mutual funds, closed-end funds, ETFs, and UITs — it mandates disclosure, governance, and operational standards
     Correct answer
   • D
     The Investment Company Act of 1940 created the FINRA self-regulatory organization for broker-dealers
   Explanation

   The 1940 Act requires investment companies (mutual funds, closed-end funds, ETFs, UITs) to register with the SEC before offering shares to the public. Key requirements: (1) governance — at least 40% independent board of directors (most funds have 75%+); (2) disclosure — annual report, shareholder proxy, prospectus; (3) operational limits — diversification requirements, leverage limits, restrictions on affiliated transactions; (4) capital preservation — each fund must maintain proper accounting records. The 1940 Act's goal is investor protection in managed investment vehicles.

3. What does SEC Rule 144 govern and what are the key restrictions on insider share sales?

   • A
     Rule 144 governs resale of restricted and control securities; key restrictions include a 6-month or 1-year holding period, volume limits, manner-of-sale requirements, and Form 144 filing
     Correct answer
   • B
     Rule 144 only applies to restricted securities (unregistered shares) and not to control securities held by insiders
   • C
     Rule 144 applies only to corporate officers and directors, not to significant shareholders
   • D
     Rule 144 requires insiders to report all trades within 2 business days on Form 4
   Explanation

   SEC Rule 144 provides a safe harbor for reselling restricted securities (acquired in unregistered transactions) and control securities (held by insiders). Requirements: (1) Holding period — 6 months for reporting companies, 1 year for non-reporting; (2) Current public information available; (3) Volume limits — limited to 1% of outstanding shares or average weekly trading volume over prior 4 weeks; (4) Manner of sale — through broker transactions or directly to market makers; (5) Form 144 filing for sales over $50,000.