Securities Industry Essentials (SIE) Exam

Correct: Duration is the standard measure used to evaluate a fixed-income security’s price sensitivity to changes in interest rates. In a comparative analysis where interest rate risk is the primary concern, evaluating duration allows the IAR to quantify which portfolio is more stable. This aligns with the updated NASAA content outline (Effective June 12, 2023) which emphasizes the application of valuation factors for fixed income securities. Incorrect: Mean and median are measures of central tendency and provide historical performance data but do not measure price sensitivity or interest rate risk. The quick ratio is a financial ratio used to measure a corporation’s ability to meet short-term obligations with its most liquid assets; it does not indicate how a bond’s market price will react to interest rate changes. Future value calculations help determine the value of cash flows at a specific point in the future but do not address the immediate risk of principal loss due to interest rate hikes. Takeaway: Duration is the essential analytical tool for comparing the interest rate sensitivity and price volatility of different fixed-income investments.

Correct: Exchange-listed REITs trade on national exchanges, offering high liquidity and transparent, real-time pricing. Non-traded REITs, while registered with the SEC, do not trade on exchanges. They typically have high fees, limited secondary markets, and valuations (NAV) that are calculated periodically rather than daily. For a client who may need to access 20% of their principal within 24 months, the illiquidity and potential redemption caps of a non-traded REIT pose a significant suitability risk. Incorrect: The claim that non-traded REITs have different tax distribution requirements is incorrect; both types must distribute at least 90% of taxable income to shareholders to qualify as a REIT. The suggestion that exchange-listed REITs are required to use higher leverage is false, as leverage is a management decision rather than a regulatory requirement distinguishing the two. Finally, non-traded REITs actually offer less transparency regarding daily value because their prices are not market-driven and NAV is updated infrequently, unlike exchange-listed REITs which have continuous price discovery. Takeaway: The fundamental difference between listed and non-traded REITs lies in their liquidity and the frequency of valuation, which are critical factors in determining client suitability for those with potential short-term cash needs.

Correct: Demand deposits, such as checking and savings accounts, are characterized by their immediate availability, meaning the depositor has the legal right to withdraw funds at any time. In contrast, certificates of deposit (CDs) are time deposits where the investor agrees to leave the funds with the institution for a specific period (the term). Accessing these funds before the maturity date usually results in an early withdrawal penalty, which represents a significant difference in liquidity and risk profile that must be disclosed to investors. Incorrect: The assertion that certificates of deposit are more liquid than demand deposits is incorrect because CDs have fixed terms and penalties for early access. The claim that demand deposits are only insured if non-interest-bearing is a misunderstanding of FDIC rules, which cover both interest-bearing and non-interest-bearing accounts up to the $250,000 limit. Finally, classifying these deposits as equity or derivatives is factually incorrect; both are considered cash equivalents or debt-like obligations of the financial institution. Takeaway: The primary regulatory distinction between demand deposits and certificates of deposit is that demand deposits offer immediate liquidity while CDs require a time commitment and carry penalties for early withdrawal.

Correct: Under SEC Rule 144, restricted securities—those acquired in unregistered, private sales from the issuer or an affiliate—must be held for a minimum of six months if the issuing company is a reporting company before they can be sold in the public marketplace. Because the executive has only held the shares for five months, the securities are not yet eligible for resale, making the immediate liquidation a violation of federal securities laws. Incorrect: Volume limitations apply to the amount of stock an affiliate can sell within a 90-day period, but only after the initial holding period is satisfied. The restriction to Qualified Institutional Buyers (QIBs) is a characteristic of Rule 144A, not standard Rule 144 public resales. Form 144 must be filed concurrently with the placement of the sell order, not ninety days in advance, and filing it does not waive the mandatory holding period. Takeaway: Restricted securities acquired through private placements must satisfy a minimum holding period, generally six months for reporting companies, before they can be legally resold in the public market.

Correct: The Income-Related Monthly Adjustment Amount (IRMAA) is typically based on the tax return from two years prior. However, if a client experiences a qualifying ‘Life-Changing Event’ (LCE), such as retirement, divorce, or work reduction, they can file Form SSA-44 to request that their premiums be calculated based on their current, lower income instead of the older tax data. Incorrect: The Social Security Administration does not have a mechanism for automatic real-time adjustments based on payroll data; it relies on tax returns and manual appeals. IRMAA is specifically calculated based on Modified Adjusted Gross Income (MAGI), not total net worth. While the two-year look-back is the standard procedure, it is not an unchangeable requirement, as the appeals process for life-changing events is a core component of the regulation. Takeaway: Investment advisers should know that clients can appeal IRMAA surcharges by documenting a qualifying life-changing event that results in a significant reduction in income.

Correct: The quick ratio (or acid-test ratio) excludes inventory from current assets because inventory is generally the least liquid current asset. A current ratio significantly higher than the quick ratio (2.2 vs 0.7) indicates that the majority of the firm’s current assets are tied up in inventory. If the merchant cannot convert that inventory to cash quickly, they may face a liquidity crisis despite appearing healthy on a current ratio basis. Incorrect: The debt-to-equity ratio measures long-term solvency and leverage, not short-term liquidity represented by current and quick ratios. High cash reserves would result in both ratios being high, not a large discrepancy between them. Accounts payable management affects the denominator (current liabilities) of both ratios equally and does not explain the gap between the current and quick ratios. Takeaway: The quick ratio provides a more conservative view of liquidity than the current ratio by excluding inventory, highlighting potential risks in firms with slow-moving stock.

Correct: In a corporate liquidation, the absolute priority rule dictates the hierarchy of claims. Secured creditors, such as holders of senior secured notes, have the highest priority and are paid from the proceeds of the specific collateral. Unsecured creditors follow, with subordinated debentures being junior to senior debt. Equity holders are the last to receive any remaining assets, with preferred stockholders having a preference over common stockholders. Incorrect: The claim that preferred stock is satisfied before debt is incorrect because all creditors must be paid in full before equity holders receive any distribution. The suggestion that senior and subordinated debt are treated equally is incorrect because ‘subordinated’ specifically denotes a lower priority in the capital structure. The idea that subordinated debt is paid before secured debt reverses the standard legal priority of claims. Takeaway: The liquidation hierarchy always prioritizes secured debt over unsecured debt, and all debt obligations over equity interests.

Correct: In community property states, while inheritances are generally considered separate property, commingling those funds with community assets (like marital wages) in a joint account can lead to ‘transmutation.’ If the separate funds can no longer be clearly traced or identified due to the mixing of assets, the law typically presumes the entire pool has become community property. Incorrect: The claim that inheritances remain separate property indefinitely regardless of titling is incorrect because commingling is a standard legal trigger for changing property status. Tenancy by the Entirety is a specific form of joint ownership for spouses that is not available in all states and does not automatically preserve the separate nature of commingled funds. Forcing a Tenancy in Common structure is not a regulatory requirement for banks in this context, and TIC does not inherently resolve the legal characterization of commingled community property. Takeaway: In community property jurisdictions, separate property such as an inheritance can lose its protected status and become community property if it is commingled with marital assets.

Correct: Net Present Value (NPV) is a capital budgeting tool that calculates the difference between the present value of cash inflows and the present value of cash outflows. A positive NPV indicates that the investment’s projected earnings (in present dollars) exceed the anticipated costs, meaning the project’s expected return is higher than the discount rate (the required rate of return). Therefore, the investment is expected to add value to the entity. Incorrect: Option B is incorrect because the internal rate of return (IRR) equals the discount rate only when the NPV is zero, not when it is positive. Option C is incorrect because NPV specifically accounts for the time value of money by discounting future cash flows; it does not look at nominal (undiscounted) values. Option D is incorrect because NPV is highly sensitive to the discount rate; if the cost of capital increases significantly, a previously positive NPV could become negative, meaning profitability is not guaranteed under changing rates. Takeaway: A positive NPV signifies that an investment is expected to yield a return greater than the required discount rate, thereby increasing the firm’s value.

Correct: In fixed-income analysis, the credit spread represents the additional yield investors demand for taking on the credit risk of a non-government issuer. When credit spreads widen, it indicates that the market perceives higher risk in the corporate sector or expects economic conditions to deteriorate. This often leads to a ‘flight to quality’ where investors move capital from corporate bonds into safer assets like U.S. Treasuries, driving Treasury yields down and corporate yields up relative to each other. Incorrect: Viewing widening spreads as a sign of overvaluation is incorrect because widening usually implies that prices of corporate bonds are falling relative to Treasuries due to higher risk premiums. Attributing the spread change to falling inflation is a misunderstanding of the metric, as inflation generally affects all nominal yields rather than just the spread between credit tiers. Suggesting that the spread reflects a decrease in Treasury liquidity is inaccurate, as Treasuries are the most liquid market; spreads widen because of credit concerns, not a lack of Treasury attractiveness. Takeaway: Widening credit spreads typically signal a lack of market confidence in the economy and an increase in the perceived risk of default for corporate borrowers.

Correct: Duration measures a bond’s price sensitivity to interest rate changes. Bonds with lower coupon rates have higher durations because a larger portion of their total cash flow is weighted toward the final maturity payment. Consequently, these bonds are more sensitive to interest rate fluctuations and carry higher interest rate risk. Incorrect: The duration of a zero-coupon bond is exactly equal to its maturity, not less, because there are no intermediate payments to shorten the weighted average time. A higher yield to maturity actually results in a lower duration because the present value of the later cash flows is discounted more heavily. As a bond approaches maturity, its duration decreases because the time remaining to receive all cash flows is shortening. Takeaway: Duration is inversely related to coupon rates and yields, serving as the primary metric for assessing a bond’s interest rate sensitivity.

Correct: According to the NASAA Model Rule on Investment Adviser Representative Ethics, an access person must submit an initial holdings report no later than 10 days after the person becomes an access person. In this scenario, the IAR submitted the report 12 days after joining, which is a violation of the 10-day deadline. The rule also specifies that the information must be current as of a date no more than 45 days prior to the date the person becomes an access person; therefore, data that is 30 days old is compliant. Incorrect: The requirement for data currency is 45 days, not 10 days, making the 30-day-old data in the scenario acceptable. Personal brokerage accounts must be disclosed in the initial holdings report to provide a baseline for monitoring. There is no regulatory requirement for a CCO from a previous firm to attest to the accuracy of an individual’s personal holdings report. Takeaway: Initial holdings reports must be submitted within 10 days of an individual becoming an access person and must reflect data no older than 45 days.

Correct: Under FINRA Rule 2210, all retail communications must be fair, balanced, and provide a sound basis for evaluating the facts regarding any particular security or service. Omitting material risks, such as interest rate volatility or tax implications like the Alternative Minimum Tax (AMT), fails the fair and balanced standard. Furthermore, Regulation Best Interest (Reg BI) requires that any recommendation made to a retail customer be in their best interest and not place the firm’s interests ahead of the customer’s. When a representative adds personal insights that encourage investment, these interactive electronic communications often cross the line from general information to a recommendation. Therefore, the firm must ensure a qualified principal reviews and approves these communications, that the content is balanced with risk disclosures, and that Written Supervisory Procedures (WSPs) are updated to capture and monitor these digital interactions effectively. Incorrect: Relying solely on a standard legal disclaimer or labeling recommendations as educational material is insufficient because it does not correct the lack of balanced risk disclosure within the specific communication itself. Filing every interactive social media comment with FINRA is generally not a regulatory requirement for established firms, and attempting to reclassify retail clients as institutional investors to avoid suitability rules is a violation of client classification standards and does not remediate the underlying supervisory failure. While a retrospective review is a common part of an audit, issuing a blanket rescission offer is an extreme measure typically reserved for specific legal settlements and does not address the prospective need for improved principal oversight and updated supervisory procedures. Takeaway: To comply with FINRA Rule 2210 and Regulation Best Interest, firms must maintain robust supervisory procedures that include principal approval of retail communications and ensure all investment recommendations provide a fair and balanced presentation of both risks and benefits.

Correct: SIPC provides protection for customers of failed broker-dealers up to $500,000 per separate customer capacity. Within that $500,000, there is a specific sub-limit of $250,000 for cash claims. In this scenario, since the individual account has $300,000 in cash, only $250,000 of that cash is covered. The remaining $50,000 of cash, plus the $400,000 in securities, exceeds the $500,000 total limit. Therefore, the client receives $500,000 in total protection ($250,000 for cash and $250,000 toward the securities), and the remaining $200,000 becomes a claim as a general creditor against the firm’s remaining assets. Incorrect: Treating securities and cash as separate additive pools of $500,000 and $250,000 respectively is incorrect because the $250,000 cash limit is a subset of the total $500,000 per-customer limit. Suggesting the full $700,000 is covered ignores the statutory maximums established by the Securities Investor Protection Act. Claiming that cash coverage is dependent on a 60-day window from a securities sale is a misunderstanding of the eligibility criteria; while cash must be held for the purpose of purchasing securities, there is no specific 60-day lookback period for its generation under standard SIPC liquidation rules. Takeaway: SIPC coverage is capped at $500,000 per separate customer capacity, which includes a maximum of $250,000 for cash claims, with any excess amounts becoming general creditor claims.

Correct: Commercial paper is defined as short-term, unsecured corporate debt. To qualify for the registration exemption under the Securities Act of 1933 and to be generally treated as a money market instrument or cash equivalent in most regulatory frameworks, the maximum maturity is 270 days. An instrument with a 300-day maturity exceeds this threshold and would typically require registration and be classified as a corporate bond rather than a money market instrument. Incorrect: The unsecured nature of the debt is actually a standard characteristic of commercial paper, not a reason for disqualification. Corporate issuance is perfectly acceptable for cash equivalents, provided the maturity and liquidity requirements are met. While liquidity and secondary markets are important for certain instruments, the 270-day maturity rule is the primary legal and regulatory boundary that distinguishes commercial paper from longer-term corporate debt. Takeaway: To be classified as commercial paper and exempt from registration, the instrument must have a maximum maturity of 270 days.

Correct: Duration is the most critical metric for assessing interest rate risk because it measures the sensitivity of a bond’s price to changes in interest rates. Unlike maturity, which only considers the final payment date, duration accounts for the timing and size of all cash flows, making it the standard tool for managing price volatility in a changing rate environment. Incorrect: Evaluating maturity dates is insufficient because two bonds with the same maturity can have different price sensitivities depending on their coupon rates. Price-to-earnings ratios are valuation metrics for equity securities, not fixed-income risk assessment tools. The current ratio is a measure of a corporation’s short-term liquidity and does not provide information regarding the interest rate sensitivity of its issued bonds. Takeaway: Duration is the primary conceptual measure used to evaluate and manage the price sensitivity of fixed-income securities to interest rate fluctuations.

Correct: When the underlying common stock price rises above the conversion price, the convertible bond is considered ‘in the money.’ In this state, the bond’s market price will track the movement of the stock because the bond can be exchanged for a fixed number of shares. The parity price represents the total market value of those shares, and failing to report this value on client statements results in an inaccurate representation of the portfolio’s worth. Incorrect: Valuing the bond at face value plus interest is incorrect because it ignores the equity-linked appreciation that occurs when the stock price exceeds the conversion price. The conversion premium is the amount by which the bond’s market price exceeds its parity value, not the primary valuation driver itself. Yield-to-call is a fixed-income metric that measures the return if the bond is redeemed early, but it does not account for the conversion value which is the dominant factor in this scenario. Takeaway: Convertible securities must be valued based on parity when the underlying stock price exceeds the conversion price to ensure accurate and fair financial reporting to clients.

Correct: MSRB Rule G-8(a)(xii) mandates that every municipal securities dealer maintain a specific record of all written customer complaints. This record must be centralized and include the date the complaint was received, the complainant’s name and address, the name of the person to whom the complaint was addressed, a description of the grievance, and a record of the action taken by the dealer. Even if a complaint is resolved quickly or through a refund, the firm is not relieved of its duty to maintain this specific record for the required retention period, which is six years for complaint records. Relying on scattered correspondence or general ledger entries does not meet the regulatory standard for a dedicated complaint log. Incorrect: The approach suggesting that existing correspondence files are sufficient fails because MSRB Rule G-8 specifically requires a dedicated record or log containing specific data points, such as the action taken, which cannot be scattered across disparate files. The suggestion that only complaints involving fair pricing violations or specific monetary thresholds must be recorded is incorrect, as the rule applies to all written grievances regardless of the subject matter or settlement value. Finally, the distinction that documentation is only required for fiduciary breaches is a misunderstanding of the broad scope of recordkeeping requirements, which cover all aspects of municipal securities activities for both dealers and advisors. Takeaway: MSRB Rule G-8 requires a centralized record of all written customer grievances and the firm’s subsequent actions, regardless of the resolution status or the specific nature of the complaint.

Correct: Incentive Stock Options (ISOs) provide a distinct tax advantage where the profit (the bargain element) can be taxed at long-term capital gains rates rather than ordinary income rates. To qualify for this treatment, the IRS requires a specific holding period: the individual must hold the shares for at least two years from the date the option was granted and at least one year from the date the option was exercised. If these conditions are met, the entire gain is taxed as a long-term capital gain. Incorrect: Selling the shares in the same year as exercise (option b) is considered a disqualifying disposition, which causes the bargain element to be taxed as ordinary income, though it does avoid the AMT adjustment. Option c describes the tax treatment of Non-qualified Stock Options (NSOs) or a disqualifying disposition of ISOs, not the standard favorable treatment. Option d is incorrect because the standard holding period for long-term capital gains is generally more than one year, and ISOs specifically require the 2-year/1-year rule. Takeaway: To receive favorable long-term capital gains treatment on Incentive Stock Options, the shares must be held for more than two years from the grant date and more than one year from the exercise date.

Correct: For non-qualified variable annuities, the IRS stipulates that withdrawals during the accumulation period follow LIFO (Last-In, First-Out) accounting. This means that the first dollars withdrawn are considered to be the earnings, which are taxed as ordinary income. Additionally, because the client is under 59.5, these earnings would also be subject to a 10% tax penalty. Incorrect: The suggestion that the entire monthly payment is taxable during annuitization is incorrect because the exclusion ratio applies, allowing a portion of each payment to be a tax-free return of the original cost basis. The idea that internal growth is taxed annually is incorrect because variable annuities provide tax-deferred growth. The claim that death benefits are entirely tax-free is incorrect; while the cost basis is returned tax-free, any earnings above the cost basis are taxed as ordinary income to the beneficiary. Takeaway: Variable annuity withdrawals during the accumulation phase are taxed as ordinary income on a LIFO basis, while annuitized payments are partially tax-free based on an exclusion ratio.

Correct: According to FINRA Rule 2231 (formerly NYSE Rule 409), a member firm may hold mail for a customer who provides written instructions. While the rule generally suggests a three-month limit, a firm may hold mail for a longer period if the customer provides an acceptable reason, such as safety or security concerns. The firm must also ensure that the mail is not being held to hide any activity and must inform the customer of alternative ways to monitor the account. Incorrect: Denying the request is incorrect because firms are permitted to hold mail under specific conditions. Holding mail indefinitely via power of attorney is not the standard regulatory procedure for mail holding and does not address the specific timeframe requirements. Holding mail for six months without specific justification or based solely on a liability waiver is incorrect, as the firm must have a valid reason for exceeding the standard three-month window and must continue to provide oversight of the account. Takeaway: Firms can hold customer mail for more than three months if they receive written instructions and a valid reason, such as security concerns, while maintaining oversight of the account.

Correct: The primary distinction between cash and stock dividends lies in their immediate tax treatment and the impact on the investor’s cost basis. Cash dividends are generally taxable as income in the year they are received, regardless of whether they are reinvested. Conversely, stock dividends are typically not taxable at the time of receipt because the investor’s proportionate ownership in the company remains unchanged. Instead, the Internal Revenue Service requires the investor to adjust their cost basis per share downward to account for the additional shares, effectively deferring any tax consequences until the shares are eventually sold. Incorrect: The suggestion that stock dividends increase the total market value of a position immediately is a common misconception; in reality, the market price per share is reduced proportionally on the ex-dividend date, leaving the total value of the holding unchanged. The belief that market prices only adjust for cash dividends is incorrect, as self-regulatory organizations like FINRA and exchanges require price adjustments for both cash and stock distributions to prevent arbitrage. Finally, treating a stock dividend as a primary market offering is a regulatory misunderstanding, as stock dividends do not involve the issuance of new equity to raise capital from the public but rather a restructuring of the existing equity accounts on the balance sheet. Takeaway: Cash dividends trigger immediate tax liabilities and provide liquidity, whereas stock dividends are tax-deferred events that require a downward adjustment of the cost basis per share.

Correct: SEC Rule 15g-4 requires that a broker-dealer disclose the aggregate amount of any compensation received in connection with a penny stock transaction. This disclosure must be made to the customer prior to effecting the transaction (either orally or in writing) and must also be included in the written confirmation. This ensures the customer is fully aware of the incentives and costs associated with the trade before it is finalized. Incorrect: Providing generalized ranges or delaying disclosure until the monthly statement is insufficient because the rule requires transaction-specific disclosure prior to execution. Waiting until 48 hours before settlement is too late, as the trade has already been effected and the rule requires pre-trade notification. There is no de minimis 5% threshold for the disclosure requirement under 15g-4; the compensation must be disclosed regardless of the amount for any penny stock transaction. Takeaway: SEC Rule 15g-4 requires both pre-trade and post-trade disclosure of the specific compensation received by a broker-dealer for penny stock transactions.

Correct: According to MSRB Rule G-15, which governs trade confirmations, the yield disclosed must be the lower of the yield to maturity or the yield to call. When a bond is purchased at a premium, the yield to call is lower than the yield to maturity. This ‘yield to worst’ ensures the customer is informed of the most conservative potential return on their investment. Incorrect: Requiring only the yield to maturity for premium bonds is a violation because it presents a more favorable and potentially misleading return to the customer. Sinking fund redemptions are typically not used for the yield-to-worst calculation on a confirmation. For bonds trading at a discount, the yield to maturity is actually the lower yield, so the yield to call would not be the primary disclosure. Generic disclaimers are never a substitute for the specific yield calculations required by regulatory standards. Takeaway: Municipal bond confirmations must disclose the lower of yield to maturity or yield to call to provide the customer with the most conservative yield estimate.

Correct: SEC Rule 145 governs the registration of securities issued in connection with mergers, consolidations, and reclassifications. The rule specifically excludes certain types of reclassifications from the definition of an ‘offer to sell’ or ‘sale,’ including stock splits, changes in par value, and changes in the issuer’s state of incorporation (domicile). Because these actions do not fundamentally change the nature of the investment or the entity in a way that requires new disclosure, they do not require a registration statement. Incorrect: Mergers, consolidations, and transfers of assets where securities are issued as consideration are explicitly defined as ‘sales’ under Rule 145. These transactions involve a significant change in the investment held by the security holders and typically require a shareholder vote, thus necessitating the protections and disclosures provided by a registration statement (usually Form S-4). Takeaway: Rule 145 requires registration for most mergers and consolidations but provides specific exemptions for simple reclassifications such as stock splits and changes in par value.

Correct: In a limited partnership, limited partners (LPs) are granted limited liability—meaning they can only lose the amount they have invested—on the condition that they remain passive investors. If an LP takes an active role in the day-to-day management or control of the business, such as negotiating contracts or approving expenditures, they risk being treated as a general partner by creditors and the courts, thereby losing their limited liability protection. Incorrect: Registering the limited partner as a general partner is not a regulatory requirement; rather, the LP’s actions create a legal vulnerability regardless of registration. Automatic dissolution is not a standard regulatory consequence for an LP overstepping their role, though it may lead to internal legal disputes. Reclassifying equity as debt is not a standard remedy for a breach of partnership roles and does not address the liability concerns raised by the LP’s management activities. Takeaway: Limited partners must maintain a passive role in management to preserve their limited liability status under the Uniform Limited Partnership Act.

Correct: MSRB Rule G-47 (Time of Trade Disclosure) mandates that a broker, dealer, or municipal securities dealer must disclose to a customer all material information about a security that is reasonably accessible to the market. This disclosure must occur at or prior to the time of trade. The availability of information on the EMMA system does not relieve the firm of its obligation to proactively disclose that information to the retail client during the sales process. Incorrect: Relying on constructive notice via EMMA is incorrect because MSRB rules require affirmative disclosure by the dealer to the customer. Providing information on a trade confirmation is insufficient because it occurs after the trade has been executed, failing the ‘at or prior to’ requirement. While SEC Rule 15c2-12 governs issuer obligations for continuing disclosure, the dealer’s obligation to disclose material facts to customers applies to all transactions, including those in the secondary market. Takeaway: Broker-dealers must affirmatively disclose all material facts to municipal bond customers at or before the time of trade, regardless of the information’s public availability on EMMA.