Series 7 Practice Questions by Topic

Answer: Nominal yield, current yield, yield to maturity, yield to call

Yield order is driven by whether the bond trades at a discount or a premium. Below par the seesaw runs nominal < current < YTM < YTC: current yield tops the 5% coupon because the same coupon dollars are divided by a smaller price, YTM climbs higher still by adding the accretion of the discount to par, and YTC is highest because a call realizes that gain over a shorter period. At a premium the entire order reverses, with YTC lowest.

The Trap: Reciting a memorized yield sequence without anchoring it to whether the bond's price is above or below par.

• Yield to call, yield to maturity, current yield, nominal yield: This is the ordering for a premium bond read lowest-to-highest; it tempts anyone who memorized one yield sequence without first checking whether the bond trades above or below par.
• Current yield, nominal yield, yield to maturity, yield to call: This assumes current yield sits below the coupon, but on a discount bond current yield (5 ÷ 92 ≈ 5.43%) exceeds the nominal 5% because the same coupon dollars are divided by a smaller price.
• Nominal yield, yield to maturity, current yield, yield to call: This swaps current yield and YTM; YTM must exceed current yield on a discount bond because it counts the built-in gain to par at maturity on top of the coupon income that current yield measures.

Verified against: FINRA Series 7 Content Outline (Function 3)

Answer: $950

Parity is the bond value that exactly equals the market value of the shares received on conversion. First find the conversion ratio (par divided by conversion price: $1,000 ÷ $40 = 25 shares), then multiply by the stock's market price (25 × $38 = $950). Comparing parity with the bond's actual price shows whether the convertible trades at a premium or discount to its equity value.

The Trap: Confusing the bond's market price with its parity price, or inverting the ratio arithmetic.

• $1,000: This assumes parity is fixed at par. Parity is not the face amount — it floats with the stock price, equaling the conversion ratio times the current share price.
• $980: This is the bond's current market price, not parity; it tempts anyone who equates where the bond happens to trade with the value of the stock it converts into.
• $1,052.63: This inverts the computation ($40 ÷ $38 × $1,000), dividing the conversion price by the stock price instead of first finding the share ratio and multiplying by the market price.

Verified against: FINRA Series 7 Content Outline (Function 3)

Answer: Convert the bond into common stock

Both the call and conversion privileges are terms of the bond's indenture, the contract governed by the Trust Indenture Act of 1939. When a convertible's conversion value ($1,120 here) exceeds its call price ($1,020), calling the issue forces rational holders to convert rather than tender — which is exactly the issuer's goal, since it retires debt with stock instead of cash. Holders should compare conversion value, call price, and market price and take the highest; holding past the redemption date earns nothing further.

The Trap: Assuming the call price is the most a called convertible holder can receive, overlooking that conversion value can exceed it.

• Tender the bond to the issuer at the call price: Tendering collects only $1,020, leaving roughly $100 on the table; this tempts holders who assume a call notice means the call price is the only exit available.
• Put the bond back to the issuer at par: Nothing in the facts gives this bond a put feature, and convertibles do not automatically carry one; even if a put existed, $1,000 would still be less than the $1,120 conversion value.
• Ignore the call notice and hold the bond to 2040 to collect par: Interest stops accruing as of the redemption date and only the call price is payable thereafter; this reflects the misconception that a call is optional for the holder to wait out.

Verified against: Trust Indenture Act of 1939 (indenture call and conversion provisions)

Answer: are stated as annualized discount yields, so the higher bid yield actually represents a lower dollar price than the ask

Treasury bills are issued and traded at a discount from face value and are quoted in annualized discount yields rather than dollar prices. Because yield varies inversely with price, a bid of 4.85 versus an ask of 4.79 means the dealer buys at a lower dollar price and sells at a higher one — a normal, uncrossed market. Notes and bonds, by contrast, are quoted as a percentage of par in 32nds.

The Trap: Treating T-bill yield quotes as dollar prices and concluding the bid/ask is inverted.

• are stated in 32nds of a point of the dollar price: Pricing in 32nds is the convention for Treasury notes and bonds, not bills; applying it here confuses coupon-bearing Treasury quotes with discount-instrument quotes.
• are crossed, and the display must be in error: This reads the yield quotes as if they were dollar prices; the market is not crossed, because in yield terms a higher bid number corresponds to a lower dollar price.
• include accrued interest on the bid side only: T-bills are pure discount instruments that pay no coupon, so no accrued interest exists on either side of the quote; this confuses bills with coupon-bearing debt.

Verified against: 31 CFR Part 356 (U.S. Treasury Uniform Offering Circular)

Answer: $106

TIPS keep the coupon rate fixed and instead adjust the principal for CPI changes; each semiannual payment equals half the fixed rate times the then-current adjusted principal — here $10,600 × 1% = $106. At maturity the holder receives the greater of the adjusted principal or the original par, so deflation cannot push the redemption value below face. Note that annual increases in principal are federally taxable in the year they occur even though not received in cash.

The Trap: Computing TIPS interest on original face value, or forgetting the semiannual payment split.

• $100: This applies the semiannual rate to the original $10,000 face, ignoring that TIPS interest is computed on the inflation-adjusted principal — the adjustment is the entire point of the security.
• $212: This correctly uses the adjusted $10,600 principal but applies the full annual 2% rate instead of half of it; TIPS, like other Treasury notes and bonds, pay semiannually.
• $200: This takes a full year's interest on the unadjusted principal, making two errors: forgetting the semiannual split and ignoring the CPI adjustment to principal.

Verified against: 31 CFR Part 356 (TIPS terms and conditions)

Answer: The accreted value increases each year and is taxed federally as ordinary interest income even though no cash is received, which is why STRIPS often fit best in tax-deferred accounts

STRIPS are Treasury zeros created by separating a note's or bond's coupons and principal; they lock in a compound return to maturity, eliminating reinvestment risk. Under the original issue discount rules of IRC Section 1272, the annual accretion is taxed each year as ordinary interest income even though no cash is paid — so taxable investors face phantom income, making STRIPS a natural fit for IRAs and other tax-deferred accounts.

The Trap: Believing zero-coupon accretion escapes tax until maturity or converts into capital gain.

• The accretion is exempt from federal tax but taxable at the state level: This inverts the Treasury tax treatment: interest on U.S. government obligations, including STRIPS accretion, is federally taxable but exempt from state and local income tax.
• The accretion is not taxed until maturity, when it is treated as a long-term capital gain: This is the common zero-coupon misconception: OID on STRIPS accrues into taxable interest income annually in a taxable account, and the accretion is interest, not capital gain.
• STRIPS pay semiannual interest that must be reinvested at prevailing rates: This confuses STRIPS with the coupon-bearing Treasuries they are stripped from; STRIPS pay nothing until maturity, which is exactly why they carry no reinvestment risk.

Verified against: Internal Revenue Code §1272 (original issue discount)

Answer: The companion tranches absorb the excess principal, shortening their average life while the PAC's schedule remains intact within its collar

A PAC tranche promises a schedule of principal payments that holds as long as prepayment speeds stay within a stated collar; companion (support) tranches make that promise possible by soaking up principal when prepayments run fast and deferring when they run slow. The trade-off: PAC holders get average-life stability and lower yields, while companion holders bear concentrated contraction and extension risk in exchange for higher yields.

The Trap: Assuming the PAC's priority means it receives prepayments first, when its priority is actually schedule protection funded by the companions.

• All tranches receive the excess principal pro rata: Pro-rata pass-along describes an ordinary mortgage pass-through, not a CMO; tranching exists precisely to reallocate prepayment cash flows unevenly among classes.
• The PAC tranches receive the excess prepayments first because they have payment priority: This misreads the PAC's priority: its priority is to a stable schedule, not to prepayment cash. The structure routes prepayments away from the PAC so its planned amortization holds.
• The Z-tranche shields the PAC by absorbing all of the prepayments: The Z (accrual) tranche receives no payments until earlier classes retire — it accretes interest instead — but it is the companion class, not the Z-tranche, that is structured to absorb prepayment variability for the PAC.

Verified against: FINRA Series 7 Content Outline (Function 3)

Answer: $11.50

Under SEC Rule 15c6-1, regular way is T+1, so a Monday trade settles Tuesday. FINRA Rule 11620 prescribes the 30/360 convention for corporate bonds: every month counts as 30 days and the year as 360, with accrual running from the last coupon date up to but excluding settlement. Here that yields 30 + 30 + 9 = 69 days, and $60 annual interest × 69/360 = $11.50 owed to the seller.

The Trap: Applying the government-securities actual-day count (or accruing through the settlement date) to a corporate bond.

• $11.67: This counts 70 days by accruing through the settlement date itself; interest accrues up to but not including settlement, because the buyer starts earning interest on settlement day.
• $11.18: This treats the corporate bond like a government security by counting actual calendar days — 68 days (31 + 28 + 9) — and dividing by a flat 365. Corporates and municipals use the 30-day-month/360-day-year convention; Treasuries, for their part, accrue by actual days elapsed over the actual days in the coupon period, so this figure matches no security's true accrual.
• $11.33: This mixes conventions — counting 68 actual calendar days but dividing by 360. Under 30/360, January and February each count as 30 days regardless of their actual length.

Verified against: FINRA Rule 11620 (Computation of Interest); SEC Rule 15c6-1 (T+1 settlement)

Answer: a newly auctioned 10-year Treasury note

The money market is defined by remaining maturity — high-quality, liquid debt with one year or less to run — not by who issues it. Negotiable CDs, commercial paper, and banker's acceptances all qualify, while a newly issued 10-year Treasury note belongs to the capital market despite its top credit quality. An outstanding note or bond migrates into the money market only in its final year of life.

The Trap: Assuming any Treasury security is a money-market instrument regardless of its remaining maturity.

• a banker's acceptance created to finance an import transaction: Banker's acceptances are short-term time drafts guaranteed by a bank, used chiefly in import/export finance, and trade actively at a discount in the money market; the unfamiliar name makes this a tempting wrong pick.
• a negotiable jumbo certificate of deposit maturing in six months: Negotiable CDs with a year or less to run are core money-market paper; choosing this confuses small retail bank CDs with the large, tradable negotiable CDs institutions buy and sell.
• commercial paper issued at a discount with a 90-day maturity: Commercial paper — short-term unsecured corporate discount paper of 270 days or less — is a textbook money-market instrument; picking it wrongly equates 'corporate issuer' with 'capital market.'

Verified against: FINRA Series 7 Content Outline (Function 3)

Answer: A 30-year Treasury STRIP

Duration measures price sensitivity to rate changes, and it rises with maturity but falls as coupons (or embedded holder puts) return cash sooner. A zero-coupon bond's duration equals its maturity, so the 30-year STRIP dominates a 30-year coupon bond, a 5-year zero, and a long bond whose put feature truncates its effective life. Longest duration means the biggest gain if the rate forecast proves right — and the biggest loss if it proves wrong.

The Trap: Equating stated maturity with duration while ignoring the shortening effect of coupons and embedded put options.

• A 5-year Treasury STRIP: Being a zero does maximize duration for its maturity, but that duration is only 5 years; this pick fixates on 'zero coupon' while overlooking that maturity caps how long duration can be.
• A 30-year 8% Treasury bond: Its large semiannual coupons return cash well before maturity, pulling duration meaningfully below 30 years; this tempts anyone who believes maturity alone determines interest-rate sensitivity.
• A 30-year 6% corporate bond puttable at par in five years: The embedded put lets the holder force early redemption, so the bond's effective duration is far shorter than its 30-year label suggests; this targets the misconception that stated maturity controls when an embedded option exists.

Verified against: FINRA Series 7 Content Outline (Function 3)