22 Products & Risks Practice Questions & Answers

Every Products & Risks practice question from the Series 7 Practice Test, with the correct answer and a short explanation.

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1. A corporation has outstanding 8% cumulative preferred stock with a par value of $100. The corporation paid no preferred dividend in either of the two preceding years. Before it may pay any dividend on its common stock this year, what amount must it pay on each preferred share?
- A.$32
- B.$16
- C.$8
- D.$24✓ Answer
Cumulative preferred stock accumulates unpaid dividends as arrearages, and all arrearages plus the current year's dividend must be paid before any dividend may be paid on common stock. The stated dividend is 8% of the $100 par value, or $8 per year, so two years of arrears plus the current year equals $24 per share.
Source: FINRA Series 7 General Securities Representative Exam Content Outline — equity securities (preferred stock features)Report a problem with this question
2. An investor owns 200 shares of common stock in a company that uses cumulative voting. Four seats on the board of directors are up for election. What is the maximum number of votes the investor may cast for a single candidate?
- A.200 votes
- B.400 votes
- C.800 votes✓ Answer
- D.50 votes
Under cumulative voting a shareholder receives a total number of votes equal to shares owned multiplied by the number of seats being elected (200 x 4 = 800) and may concentrate them all on one candidate or spread them among candidates. This method favors minority shareholders; under statutory voting the same investor could cast no more than 200 votes per candidate.
Source: FINRA Series 7 content outline — equity securities, shareholder voting rightsReport a problem with this question
3. Which statement correctly distinguishes a warrant from a preemptive right at the time each is issued?
- A.A warrant is long-term and carries a subscription price above the current market price of the stock, while a right is short-term with a subscription price below the market price.✓ Answer
- B.A right is long-term and carries a subscription price above the current market price of the stock.
- C.A warrant obligates the holder to purchase the underlying shares, while exercising a right is optional.
- D.Both carry subscription prices below the current market price, but only a warrant may be sold to another investor.
Preemptive rights are distributed to existing shareholders so they can maintain proportionate ownership in a new offering; they expire within weeks and are priced below the market, so they have immediate intrinsic value. Warrants are long-term instruments whose subscription price is set above the market when issued, which is why they are typically attached to bonds or preferred stock as a sweetener rather than distributed to shareholders.
Source: FINRA Series 7 content outline — rights and warrantsReport a problem with this question
4. Which statement about American Depositary Receipts (ADRs) is correct?
- A.ADRs are obligations of the U.S. Treasury and therefore carry no issuer credit risk.
- B.ADR holders generally receive the same preemptive rights as holders of the underlying ordinary shares.
- C.Because an ADR trades and pays in U.S. dollars, the holder has no exposure to exchange-rate movements.
- D.Dividends are declared by the foreign issuer in its own currency and converted into U.S. dollars for the ADR holder, so the holder bears currency risk.✓ Answer
An ADR is a dollar-denominated receipt issued by a depositary bank against shares of a foreign issuer held abroad. The underlying dividend is paid in the issuer's home currency and converted at the exchange rate in effect at conversion, so a decline in that currency reduces the dollars received — currency risk stays with the ADR holder. ADR holders also normally do not receive preemptive rights, and the security carries the credit and business risk of the foreign issuer.
Source: FINRA Series 7 content outline — American Depositary ReceiptsReport a problem with this question
5. A callable corporate bond is trading in the secondary market at a discount to par. Which sequence lists its yields from lowest to highest?
- A.Current yield, nominal yield, yield to call, yield to maturity
- B.Nominal yield, current yield, yield to maturity, yield to call✓ Answer
- C.Yield to call, yield to maturity, current yield, nominal yield
- D.Yield to maturity, yield to call, current yield, nominal yield
When a bond is priced below par, dividing the fixed annual coupon by a lower market price raises the current yield above the nominal (coupon) yield, and yield to maturity adds the discount that is recovered when par is paid at maturity. If the bond is called before maturity, that same discount is earned over a shorter period, making yield to call the highest measure. The entire ordering reverses for a bond trading at a premium.
Source: FINRA Series 7 content outline — debt securities, yield calculationsReport a problem with this question
6. A convertible debenture with a $1,000 par value is convertible into common stock at $50 per share. The common stock is trading at $58 per share. What is the parity price of the bond?
- A.$1,160✓ Answer
- B.$1,208
- C.$862
- D.$1,000
The conversion ratio is the par value divided by the conversion price: $1,000 / $50 = 20 shares per bond. Parity is the price at which the bond and the stock received on conversion are worth the same amount, so the parity price of the bond is 20 shares x $58 = $1,160. If the bond traded below parity an arbitrage opportunity would exist.
Source: FINRA Series 7 content outline — convertible securitiesReport a problem with this question
7. Which statement accurately describes U.S. Treasury bills?
- A.They are sold at a discount from face value, carry no stated coupon rate, and are quoted on a discount-yield basis.✓ Answer
- B.Their interest is exempt from federal income tax but fully taxable by the states.
- C.Their principal is adjusted for changes in the Consumer Price Index.
- D.They pay a fixed semiannual coupon and are quoted in 32nds of a point.
Treasury bills are the shortest Treasury obligation and are issued at a discount rather than with a coupon; the investor's return is the difference between the discounted purchase price and the face amount received at maturity, which is why they are quoted on a discount-yield basis instead of as a price plus accrued interest. Principal indexing to the CPI is a feature of TIPS, and interest on all Treasury securities is taxable federally but exempt from state and local income tax.
Source: FINRA Series 7 content outline — U.S. Treasury securitiesReport a problem with this question
8. An investor holds Treasury STRIPS in a taxable account. Which statement is correct?
- A.STRIPS show less price volatility than a coupon-paying Treasury bond of the same maturity.
- B.No federal income tax is due until the STRIPS mature, because no cash interest is paid along the way.
- C.STRIPS pay semiannual interest at a rate that floats with prevailing short-term rates.
- D.The annual accretion of the discount is taxable as interest income each year even though the investor receives no cash, and holding the STRIPS to maturity eliminates reinvestment risk.✓ Answer
A STRIPS is a zero-coupon obligation created by separating the coupon and principal payments of a Treasury security. Because there are no interim coupon payments, there is nothing to reinvest and reinvestment risk is eliminated for an investor who holds to maturity; however, the imputed annual accretion of the original issue discount is taxed currently as interest income, the so-called phantom income problem. Zero-coupon instruments also have the greatest price sensitivity to interest-rate changes for a given maturity.
Source: Internal Revenue Code Section 1272 (original issue discount); FINRA Series 7 content outline — zero-coupon securitiesReport a problem with this question
9. A customer wants a mortgage-backed pass-through security whose timely payment of principal and interest is directly guaranteed by the full faith and credit of the U.S. government. Which statement is correct?
- A.Only Ginnie Mae (GNMA) pass-through certificates carry that direct guarantee; Fannie Mae and Freddie Mac securities are obligations of publicly traded corporations.✓ Answer
- B.Only Freddie Mac (FHLMC) participation certificates carry that direct guarantee.
- C.All agency mortgage-backed securities carry the full faith and credit of the U.S. government.
- D.No mortgage-backed security carries any guarantee of principal or interest.
Ginnie Mae is a government corporation, and its pass-through certificates are the only mortgage-backed securities directly backed by the full faith and credit of the United States. Fannie Mae and Freddie Mac are shareholder-owned, publicly traded corporations whose guarantees are their own corporate obligations rather than government obligations — a distinction candidates frequently miss. All pass-throughs, including Ginnie Mae, still expose the holder to prepayment risk when rates fall and extension risk when rates rise.
Source: FINRA Series 7 content outline — U.S. government agency securities (GNMA, FNMA, FHLMC)Report a problem with this question
10. Assume four bonds have the same credit rating and are each priced at par. Which one will experience the largest percentage price change when market interest rates move?
- A.A 5-year bond with an 8% coupon
- B.A 20-year bond with a 3% coupon✓ Answer
- C.A 20-year bond with an 8% coupon
- D.A 5-year bond with a 3% coupon
Price volatility rises with duration, and duration lengthens as maturity increases and as the coupon decreases, because a larger share of the bond's total value is received further in the future and is therefore discounted more heavily when rates change. The bond with the longest maturity combined with the lowest coupon has the greatest duration and thus the greatest price sensitivity to a given change in interest rates.
Source: FINRA Series 7 content outline — duration and interest-rate riskReport a problem with this question
11. Which statement correctly contrasts a general obligation bond with a revenue bond?
- A.Neither type is subject to a statutory debt limit, and both require a feasibility study before issuance.
- B.A GO bond is secured by the issuer's taxing power and normally requires voter approval, while a revenue bond is secured only by the earnings of the financed facility and is not subject to statutory debt limits.✓ Answer
- C.Both are secured by the issuer's full faith and credit, but only revenue bonds require voter approval.
- D.A revenue bond is secured by the issuer's taxing power, while a GO bond is secured by user charges on a facility.
A general obligation bond pledges the full faith, credit and taxing power of the issuer, so it typically requires voter approval and counts against statutory debt limits; the credit analysis focuses on the tax base, debt per capita, net overall debt to assessed valuation and tax collection ratios. A revenue bond is payable solely from the revenues of the project it finances, so no voter approval or debt limit applies and the analysis centers on the feasibility study, the flow of funds, the rate covenant and debt service coverage.
Source: FINRA Series 7 content outline — municipal securities (general obligation and revenue bonds)Report a problem with this question
12. A revenue bond issue is secured by a net revenue pledge. Under the flow of funds, gross revenues are applied in which order?
- A.The surplus fund first, then operation and maintenance, then debt service
- B.Operation and maintenance expenses first, then debt service✓ Answer
- C.The renewal and replacement fund first, then debt service, then operation and maintenance
- D.Debt service first, then operation and maintenance expenses
Under a net revenue pledge, gross revenues first pay the operation and maintenance expenses of the facility; what remains is net revenue, which then flows to the debt service account, followed by the debt service reserve, the renewal and replacement fund, and finally the surplus fund. A gross revenue pledge reverses the first two steps by directing revenues to debt service ahead of operating expenses, which is more protective of bondholders.
Source: FINRA Series 7 content outline — municipal revenue bond flow of funds (net revenue pledge)Report a problem with this question
13. An investor in the 30% federal tax bracket is comparing a municipal bond yielding 3.5% with taxable corporate bonds. Ignoring state and local taxes, what taxable yield would be equivalent to the municipal bond's yield?
- A.11.67%
- B.5.00%✓ Answer
- C.2.45%
- D.4.55%
Because interest on a municipal bond is generally exempt from federal income tax, the tax-equivalent yield is the municipal yield divided by one minus the investor's marginal tax rate: 3.5% / (1 - 0.30) = 3.5% / 0.70 = 5.00%. Multiplying instead of dividing (3.5% x 0.70 = 2.45%) is the classic error and produces the after-tax yield of a taxable bond, not the equivalent taxable yield.
Source: Internal Revenue Code Section 103; FINRA Series 7 content outline — taxable equivalent yieldReport a problem with this question
14. An investor buys a municipal bond in the secondary market and later sells it for more than the purchase price. How is that gain treated for federal income tax purposes?
- A.The gain is taxable as a capital gain, even though the bond's interest is exempt from federal income tax.✓ Answer
- B.The gain is reported as tax-exempt interest and is therefore not taxed.
- C.The gain is exempt from federal income tax, just as the bond's interest is.
- D.The gain is exempt only if the investor resides in the state that issued the bond.
Section 103 of the Internal Revenue Code exempts the interest paid on state and local government obligations from federal income tax; it says nothing about gains realized on the sale of the bond. A capital gain on a municipal bond is therefore taxed like any other capital gain, and the state-of-residence exemption that can make interest triple tax-exempt likewise applies to the interest, not to the gain.
Source: Internal Revenue Code Section 103Report a problem with this question
15. An open-end investment company's net asset value per share is $9.20 and its sales charge is 8% of the public offering price. What is the public offering price per share?
- A.$10.00✓ Answer
- B.$10.20
- C.$10.02
- D.$9.94
A mutual fund's sales charge is expressed as a percentage of the public offering price, not of net asset value, so POP = NAV / (100% - sales charge %): $9.20 / 0.92 = $10.00. Simply adding 8% to the NAV gives $9.94, which understates the offering price because it applies the percentage to the wrong base.
Source: Investment Company Act of 1940, Section 22; FINRA Rule 2341 (Investment Company Securities)Report a problem with this question
16. Which statement distinguishes a closed-end management company from an open-end management company?
- A.Closed-end shares are redeemable with the issuer at the net asset value next computed after the order is received.
- B.Closed-end shares trade in the secondary market at a price set by supply and demand, which may be above or below net asset value, and the company may issue both bonds and preferred stock.✓ Answer
- C.Open-end funds issue a fixed number of shares in a single offering and then stop issuing new shares.
- D.Only closed-end companies are permitted to impose a sales charge on investors.
An open-end fund continuously offers redeemable shares priced by forward pricing at the next net asset value computed after the order, may issue only one class of security (common stock), and may not issue senior securities. A closed-end company sells a fixed number of shares in an initial offering, after which those shares trade in the secondary market at a market price that may be at a premium or a discount to NAV, and it is permitted to issue debt and preferred stock.
Source: Investment Company Act of 1940, Section 5 (open-end and closed-end management companies)Report a problem with this question
17. Which characteristic identifies a unit investment trust (UIT) under the Investment Company Act of 1940?
- A.It has a board of directors that hires an investment adviser to actively manage the portfolio.
- B.It is a management company that may issue both common stock and bonds.
- C.It is organized without a board of directors and without an investment adviser actively managing the portfolio, holds a largely fixed portfolio, and issues redeemable units.✓ Answer
- D.It issues a fixed number of non-redeemable units that trade on an exchange at a premium or discount.
The Investment Company Act of 1940 classifies investment companies into three types: face-amount certificate companies, unit investment trusts, and management companies. A UIT is created under a trust indenture rather than with a board of directors, is not actively managed by an investment adviser, holds a fixed or merely supervised portfolio, and issues redeemable units of beneficial interest.
Source: Investment Company Act of 1940, Section 4(2)Report a problem with this question
18. How does a real estate investment trust (REIT) differ from a real estate direct participation program (DPP)?
- A.Neither distributes income to investors; both are required to reinvest all earnings.
- B.A REIT passes both income and operating losses through to its shareholders, while a DPP passes through income only.
- C.A REIT does not pass operating losses through to its shareholders, while a limited partnership interest in a DPP passes both income and losses through to the limited partners.✓ Answer
- D.Both are flow-through vehicles for losses, but only a REIT is required to distribute its income.
A REIT that qualifies under the Internal Revenue Code avoids taxation at the trust level by distributing at least 90% of its taxable income, but it is not a partnership, so operating losses stay inside the REIT and cannot be passed to shareholders. A direct participation program is a flow-through entity in which both income and losses flow to the limited partners, although passive losses may generally be used only against passive income.
Source: Internal Revenue Code Section 856 (REITs); FINRA Series 7 content outline — direct participation programsReport a problem with this question
19. During the annuity payout phase of a variable annuity, which statement is correct?
- A.The number of annuity units credited to the annuitant increases each month as the separate account grows.
- B.The annuitant holds a fixed number of accumulation units whose value varies each period.
- C.Each payment is guaranteed by the insurance company and can never decline.
- D.The annuitant holds a fixed number of annuity units, and the size of each payment varies with the separate account's performance relative to the assumed interest rate (AIR).✓ Answer
At annuitization the contract's accumulation units are converted into a fixed number of annuity units. Each payment equals that fixed unit count multiplied by the fluctuating annuity unit value, which rises when separate account performance exceeds the assumed interest rate and falls when performance is below the AIR — the comparison is always against the AIR and against the immediately preceding period, so payments are not guaranteed.
Source: FINRA Series 7 content outline — variable annuities (assumed interest rate)Report a problem with this question
20. A portfolio manager holds 60 different common stocks spread across many unrelated industries. Which risk remains essentially unchanged as still more stocks are added to the portfolio?
- A.The risk that one company's management makes a poor operating decision
- B.Systematic (market) risk, measured by beta✓ Answer
- C.Unsystematic risk
- D.The business risk of an individual issuer
Diversification reduces unsystematic risk — the issuer-specific and industry-specific risks such as business and financial risk — because unfavorable developments at one company are offset by others. Systematic risk is the risk that the market as a whole declines; it affects every security, cannot be diversified away, and is measured by beta.
Source: FINRA Series 7 content outline — portfolio analysis, systematic and unsystematic riskReport a problem with this question
21. A retiree depends on the fixed semiannual coupon payments of a 25-year bond for living expenses. Over the following decade, consumer prices rise steadily. The decline in what those unchanged coupon payments can buy illustrates which risk?
- A.Credit risk
- B.Liquidity risk
- C.Purchasing-power (inflation) risk✓ Answer
- D.Call risk
Purchasing-power risk is the risk that inflation erodes the real value of a fixed stream of payments. It falls hardest on long-term fixed-income securities because the coupon amount is contractually fixed for decades while the general price level rises. Credit risk concerns the issuer's ability to pay, liquidity risk concerns selling at a fair price, and call risk concerns early redemption by the issuer.
Source: FINRA Series 7 content outline — investment risks (purchasing-power risk)Report a problem with this question
22. An investor holds a limited partnership interest in a non-traded real estate direct participation program and needs cash quickly, but finds no established secondary market and can sell only at a steep concession, if at all. This situation best illustrates which risk?
- A.Reinvestment risk
- B.Liquidity (marketability) risk✓ Answer
- C.Currency risk
- D.Legislative risk
Liquidity risk is the risk that a security cannot be converted into cash quickly at a price close to its fair value. Direct participation program interests are characteristically illiquid: transfers typically require general partner consent and there is no active secondary market, which is why a customer's need for liquidity is a central factor in evaluating whether a DPP is an appropriate recommendation.
Source: FINRA Series 7 content outline — investment risks (liquidity risk); direct participation programsReport a problem with this question

Practice questions based on the FINRA Series 7 content outline and on named federal securities statutes and FINRA, MSRB and SEC rules. Not affiliated with or endorsed by FINRA, and not investment advice. Amounts that are re-set periodically — rates, fee schedules, contribution limits and penalty amounts — are deliberately kept out of the answers; where a computation needs such a figure, the question supplies it. Confirm current requirements with FINRA and your firm before testing. About the Series 7 exam (FINRA) →

1. A corporation has outstanding 8% cumulative preferred stock with a par value of $100. The corporation paid no preferred dividend in either of the two preceding years. Before it may pay any dividend on its common stock this year, what amount must it pay on each preferred share?

2. An investor owns 200 shares of common stock in a company that uses cumulative voting. Four seats on the board of directors are up for election. What is the maximum number of votes the investor may cast for a single candidate?

3. Which statement correctly distinguishes a warrant from a preemptive right at the time each is issued?

4. Which statement about American Depositary Receipts (ADRs) is correct?

5. A callable corporate bond is trading in the secondary market at a discount to par. Which sequence lists its yields from lowest to highest?

6. A convertible debenture with a $1,000 par value is convertible into common stock at $50 per share. The common stock is trading at $58 per share. What is the parity price of the bond?

7. Which statement accurately describes U.S. Treasury bills?

8. An investor holds Treasury STRIPS in a taxable account. Which statement is correct?

9. A customer wants a mortgage-backed pass-through security whose timely payment of principal and interest is directly guaranteed by the full faith and credit of the U.S. government. Which statement is correct?

10. Assume four bonds have the same credit rating and are each priced at par. Which one will experience the largest percentage price change when market interest rates move?

11. Which statement correctly contrasts a general obligation bond with a revenue bond?

12. A revenue bond issue is secured by a net revenue pledge. Under the flow of funds, gross revenues are applied in which order?

13. An investor in the 30% federal tax bracket is comparing a municipal bond yielding 3.5% with taxable corporate bonds. Ignoring state and local taxes, what taxable yield would be equivalent to the municipal bond's yield?

14. An investor buys a municipal bond in the secondary market and later sells it for more than the purchase price. How is that gain treated for federal income tax purposes?

15. An open-end investment company's net asset value per share is $9.20 and its sales charge is 8% of the public offering price. What is the public offering price per share?

16. Which statement distinguishes a closed-end management company from an open-end management company?

17. Which characteristic identifies a unit investment trust (UIT) under the Investment Company Act of 1940?

18. How does a real estate investment trust (REIT) differ from a real estate direct participation program (DPP)?

19. During the annuity payout phase of a variable annuity, which statement is correct?

20. A portfolio manager holds 60 different common stocks spread across many unrelated industries. Which risk remains essentially unchanged as still more stocks are added to the portfolio?

21. A retiree depends on the fixed semiannual coupon payments of a 25-year bond for living expenses. Over the following decade, consumer prices rise steadily. The decline in what those unchanged coupon payments can buy illustrates which risk?

22. An investor holds a limited partnership interest in a non-traded real estate direct participation program and needs cash quickly, but finds no established secondary market and can sell only at a steep concession, if at all. This situation best illustrates which risk?