DPPs

A sharing arrangement in which the sponsor bears capitalized costs such as the oil rig while limited partners take a share of intangible drilling costs is known as a(an)
A. functional allocation
B. overriding royalty interest
C. reversionary working interest
D. disproportionate sharing arrangement

EXPLANATION: too many Series 7 candidates put too much effort on options and debt securities to the detriment of everything else. Topics such as DPPs, which account for about 10 questions, also need your attention. A question like this really requires that you've studied--I don't see a lot of obvious things to be eliminated. What the GP and LPs are doing here is allocating the costs according to their function (capitalized vs. intangible). Functional allocation.

ANSWER: a

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Another options question

Juan buys 100 ABC @80 then sells 1 ABC Nov 80 call @2 and 1 ABC Nov 80 put @1.50. His maximum gain is, therefore

A. $8,000
B. $350
C. zero
D. $200

EXPLANATION: can't imagine why Juan--or anyone--would establish this weird position. But, if the stock goes up at all, it gets called away at $80. If so, he would only make the premiums of $350.



ANSWER: b

Difficult options question

The so-called "T-chart" is useful when you have to track money-in and money-out on an actual series of transactions, or a series of potential transactions. The following question requires a T-chart and some good, creative problem-solving:

If an investor purchases 100 ABC @44, then writes 1 ABC Aug 45 call @2 and 1 ABC Aug 45 put @2.50, his maximum loss is
A. $450
B. $100
C. $8,450
D. $4,400

EXPLANATION: if the stock goes up and gets called away at $45, that's actually the best that can happen and would be his maximum gain. The worst that can happen is that the stock drops to zero, a loss of $4,400. Then, he'd have to give some clown $4,500 for a worthless stock when the put is exercised. That's $8,900 out, with only $450 coming in for selling the straddle.



ANSWER: c

Options orders

Many of the options questions on the Series 7 have nothing to do with numbers.
Like this:

If one of your investing clients wrote put options a few weeks ago and would now like to liquidate the position, you would enter which of the following orders on his behalf?
A. opening sale
B. closing sale
C. closing purchase
D. opening purchase

EXPLANATION: a registered rep could really mess things up by checking off the wrong box among the four choices above. For example, if your customer wanted to buy call options, you could really do damage if you checked "opening sale" when you meant "opening purchase." Suddenly, because of your mistake, the guy is subject to huge and even unlimited losses by writing naked calls. A "long" position is initiated with an opening purchase. A short position is initiated with an opening sale. Here, the client has written options, so he's already done an opening sale. He needs to close out by buying them back--closing purchase. Some students will read this explanation and think, "Okay, I have to memorize these four things." To which I would say, "No. You have to understand them." If you understand the concepts surrounding options, you will get 90% or more of those questions right on the exam. Which is a good thing.



ANSWER: c

Today I REALLY Feel Your Pain

We now intend to update each of the five books every year, and I made the decision to start with the Big Kahuna, the Series 7. In order to see what we might be missing that the "big companies" are covering, I have to go through their practice questions and their . . . well, let's call them "books" for lack of a better name.

OMG! WTF?

If you've ever felt overwhelmed and discouraged about studying for your Series 7, I now know why. What a bunch of soulless, joyless, ugly nonsense your firms are forcing you to read. It's as if the writers of the so-called "books" are convinced that their superiority to you is in direct proportion to your confusion. First, they're not superior. You will make more money selling financial services than they do writing mindless drivel about DPPs and variable-rate demand notes. Second, who the heck said that finance and investing are dull topics? Warren Buffett and Charlie Munger hold the Qwest Center overflow audience's attention for 5 or 6 hours . . . why can't these Series 7 "license exam manuals" explain how corporations raise capital without making you want to jam a hot needle in your eye socket every couple of minutes?

Oh well. No use complaining. In fact, I should send the "big guys" a big thank-you note today for guaranteeing that there will always be a market space for us, for readers who want to learn without losing their sanity. Just wanted you to know that if you find your "license exam manual" to be boring and poorly written, it's not just you.

Trust me.

Taxation and Mutual Funds

Let's take a look at a question about mutual fund taxation . . .

All of the following are taxable in relation to a mutual fund investment except
A. undistributed capital gains
B. unrealized capital gains
C. reinvested capital gains distributions
D. capital gains distributions from a tax-exempt municipal bond fund

EXPLANATION: a surprising fact about capital gains that a mutual fund portfolio manager realizes is that even if they're not paid out to shareholders, the shareholders are taxed on their fair share of the gains. If the fund does distribute capital gains, the investor is taxed whether she cashes the check or reinvests automatically. And, municipal bonds are subject to capital gains taxes just like other securities. Of course, if a capital gain is "unrealized," there is no capital gain.



ANSWER: b