Free Series 7 Practice Exam

1. Question 1

   An investor buys $20,000 of marginable stock with $10,000 of their cash and borrows $10,000. The stock declines to $12,000. If the maintenance requirement is 25% of current market value, what is the maintenance deficiency?

   • A.$2,000
   • B.$0
   • C.$1,000
   • D.$3,000
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   Correct answer: C. $1,000

   Equity is $12,000 - $10,000 debit = $2,000. Required equity is 25% x $12,000 = $3,000, leaving a $1,000 deficiency.

   • AA. This is the current equity, not the shortfall.
   • BB. Equity of $2,000 is below the $3,000 requirement, so a deficiency exists.
   • CC. $3,000 required less $2,000 equity equals $1,000.
   • DD. This is the required equity, not the deficiency.

   • Source: FINRA Rule 4210
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2. Question 2

   An investor buys a corporate zero-coupon bond at a discount to par in a taxable account. Although no cash interest is paid until maturity, how is the bond taxed in the interim?

   • A.No tax is due until the bond matures or is sold, at which point the entire discount is taxed as interest income in that single year.
   • B.Taxation is deferred until maturity as long as the bond is held in a taxable account and the investor does not elect to accrue the discount currently.
   • C.The entire discount is taxed in the year of purchase as a long-term capital gain, because the investor locks in the full discount at the time of acquisition and reports it on Schedule D.
   • D.The annual accretion of the original issue discount (OID) is taxed each year as ordinary 'phantom' income, even though the investor receives no cash during the year.
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   Correct answer: D. The annual accretion of the original issue discount (OID) is taxed each year as ordinary 'phantom' income, even though the investor receives no cash during the year.

   Zero-coupon bonds accrete toward par over their life, and in a taxable account the IRS requires the annual accretion (OID) to be reported and taxed as ordinary income each year, even though the investor doesn't actually receive that cash until maturity or sale. Hence the term 'phantom income.'

   • AA. Tax isn't deferred until maturity or sale for a taxable zero-coupon bond; the OID accretion is taxed annually as it accrues.
   • BB. Taxation is not deferred in a taxable account, and there is no election needed; the annual OID accretion is currently taxable despite the lack of cash interest.
   • CC. The discount isn't taxed all at once as a capital gain in the purchase year or reported on Schedule D; it accretes and is taxed annually as ordinary income over the holding period.
   • DD. Even though no cash is received, the annual accretion of original issue discount on a taxable zero-coupon bond is taxed each year as ordinary phantom income.

   • Source: IRC Section 1272 (original issue discount)
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3. Question 3

   A client wants a DPP primarily for its purported tax deductions, but will need most invested capital within two years. Which objection is strongest?

   • A.The core problem is that DPP losses can offset only portfolio income such as dividends and interest, so the deductions are too small to matter, whatever the client's time horizon.
   • B.Private placement status bars this client from owning a DPP at all, so the two-year liquidity need never enters the suitability analysis.
   • C.The main objection is the sponsor's fee load, because the general partner guarantees return of principal and so the liquidity and tax limits are secondary.
   • D.Illiquidity, uncertain exit value and potential tax limitations may make the DPP incompatible with a two-year liquidity need, especially given limited secondary markets.
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   Correct answer: D. Illiquidity, uncertain exit value and potential tax limitations may make the DPP incompatible with a two-year liquidity need, especially given limited secondary markets.

   DPP interests usually have limited secondary markets, and tax benefits depend on basis, at-risk and passive-activity rules. A short liquidity need conflicts with those features.

   • AA. Wrong. Passive losses generally offset passive income, not portfolio income, so this misstates the tax rule. It also dismisses the liquidity mismatch, which is the client's most pressing constraint.
   • BB. Wrong. Eligible investors, such as accredited investors, can buy private placement DPP interests, so there is no blanket bar. The objection ignores the real issue, which is illiquidity against a two-year need.
   • CC. Wrong. General partners do not guarantee principal, and DPP investors can lose capital. Fees matter, but they are not the strongest objection when the client needs the money back within two years.
   • DD. Illiquidity, uncertain exit value and tax limits make a DPP a poor fit for a two-year need.

   • Source: 26 U.S.C. § 469
   • Source: 26 U.S.C. § 465
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