Solomon Poll: Inflation Expectations for 2022

What are inflation and inflation expectations, and why are they important? Learn what these terms mean and the results of the latest Solomon poll. Continue reading

Can you predict what the economic future of the U.S. will be next month? How about next year? If you’re not sure, Solomon Exam Prep suggests you look at leading indicators, which are economic measures that have been found to anticipate a change in the economy. They are also tested subjects on securities licensing exams such as the FINRA Securities Industry Essentials (SIE) exam and the NASAA Investment Adviser (Series 65) exam. 
One important leading indicator is inflation. So, we asked Solomon LinkedIn followers to predict whether the rate of inflation in 2022 will increase, decrease, or stay the same. According to the poll, a whopping 81% of respondents believe that inflation will increase in 2022. Ten percent predict that inflation will stay the same, and nine percent think it will decrease.  
For securities licensing exams, leading indicators are important to understand because they are believed to have predictive power, and therefore, allow economists to see what the economic future may hold. That is why Solomon Exam Prep study guides for the Securities Industry Essentials (SIE), Series 7, Series 65, and Series 66 all discuss inflation. So, what exactly is inflation and why does it occur? 

What is inflation and why does it happen?

Inflation means an increase in the prices of goods and services and a decline in the purchasing power of a currency. It can be understood as a part of business cycles, which are fluctuations in the economy. A business cycle has four phases. The first phase, expansion, is characterized by an increase in economic activity and above-average economic growth. In this phase, the production of goods rises and unemployment falls. Lenders make credit more available because they believe businesses and people will be able to repay their loans. Available credit means lower interest rates, which fuels expansion, resulting in more jobs. 
The expansion phase feels good because jobs are plentiful, and wages rise. But a risk of the expansion phase is the possibility of inflation because increasing wages and available credit tend to boost prices.  Inflation can result when demand for goods and services outstrips their supply. This usually occurs near the end of an expansionary phase, when too much money is chasing too few goods. Inflation can occur because of:

    • High consumer confidence in the economy
    • An economy that has reached its production potential
    • Excess money in the economy
    • Increases in wages and other production costs, such as a rise in commodity prices

What does inflation mean for investors?

With rising prices come rising interest rates. For example, if the cost of living is increasing at 5%, as measured by the Consumer Price Index (CPI), investors will be unwilling to purchase a bond paying 4% and lose purchasing power. Lenders will need to raise interest rates to keep up with inflation. 
In an inflationary environment, investors may be less inclined to make long-term investments. The possibility that a long-term bond or other long-term investment will not keep up with inflation may drive investors to short-term and variable-rate bonds. Unfortunately, to grow, many businesses, especially capital-intensive companies such as oil and gas refineries, airlines, and telecommunications companies need to borrow for the long-term. As a result, an inflationary environment can reduce business investment and cause an economic downturn.

What are inflation expectations?

To return to the Solomon LinkedIn poll – does it matter what people think will happen with inflation in the future? The short answer is yes, and there’s even a term for this: inflation expectations. Inflation expectations refer to the rate at which people and businesses expect prices to rise in the future. Inflation expectations are important because they can actually affect the real rate of inflation. For example, if everyone expects prices to increase by two percent over the next year, then businesses will likely raise their prices by two percent or more, and workers will want comparable salary increases.  
If the Solomon LinkedIn poll results are any indication, inflation expectations for the next year are that prices will increase. Do you agree that 2022 will see a rise in the rate of inflation? Comment below to share your thoughts on the topic. 
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How to Pass the NASAA Series 65 Exam

What is the Series 65 exam and how should you prepare for it? Read Solomon Exam Prep’s guide to the NASAA Series 65 exam. Continue reading

What does the NASAA Series 65 allow me to do?

The Series 65, also known as the Uniform Investment Adviser Law Examination, qualifies individuals to give investment advice for a fee. Investment adviser representatives (IARs) use their knowledge to give financial advice and help clients build investment portfolios. IARs might provide general investment advice or recommend a client to invest in a specific security. IARs can also manage client accounts and supervise other IARs.

The organization that creates the test—the North American Securities Administrators Association, or NASAA—works to protect investors in every state, territory, the District of Columbia, Canada, and Mexico. Requiring investment adviser representative candidates to pass the Series 65 is a key tool in the NASAA’s investor protection arsenal. Regulators want to make sure people who are giving investment advice in their state or jurisdiction are competent and will behave legally and ethically.

About the Exam

The Series 65 exam consists of 130 scored and 10 unscored multiple-choice questions covering the four sections of the NASAA Series 65 exam outline. The 10 additional unscored questions are ones that the exam committee is trying out. These are unidentified and are distributed randomly throughout the exam. NASAA updates its exam questions regularly to reflect the most current rules and regulations.

Note: Scores are rounded down to the lowest whole number (e.g. 71.9% would be a final score of 71%–not a passing score for the Series 65 exam).

Topics Covered on the Exam

The NASAA divides the Series 65 exam into four sections:

The Series 65 exam covers many topics including the following:

    • Economics
    • Financial reporting
    • Quantitative methods
    • Risks
    • Cash investments
    • Fixed income
    • Equities
    • Pooled investments, such as mutual funds, ETFs, and REITs
    • Derivatives
    • Alternatives
    • Annuities and other insurance-based investments
    • Client types
    • Client profiles
    • Capital market theory
    • Portfolio management
    • Taxes
    • Retirement plans
    • ERISA
    • Special accounts, such as college savings plans
    • Trading securities
    • Performance measures
    • State and federal securities acts and regulations
    • Ethical practices and fiduciary obligations

Question Types on the Series 65

The Series 65 exam consists of multiple-choice questions, each with four options. You will see these question structures:

Closed Stem Format:

This item type asks a question and gives four possible answers from which to choose.

Which of the following actions might the Federal Reserve take if it wishes to stimulate the economy?

    1. Buy Treasuries
    2. Raise the discount rate
    3. Raise the bank reserve requirements
    4. Raise the margin requirements
Incomplete Sentence Format:

This kind of question has an incomplete sentence followed by four options that present possible conclusions.

A recession is a protracted period of decline in the national economy, typically defined as:

    1. More than two quarters of decreasing GDP
    2. More than two quarters of decline in the housing market
    3. More than two quarters of shrinking M1
    4. More than two quarters of a falling PPI
“EXCEPT” Format:

This type requires you to recognize the one choice that is an exception among the four answer choices presented.

All of the following are tools that the Federal Reserve uses to implement monetary policy except:

    1. Open market operations
    2. Discount window lending
    3. Altering bank reserve requirements
    4. Altering the value of the dollar
Fill-in-the-Blank Format:

This question type has a missing word or phrase, which you must select from the four options provided.

A situation in which short-term securities pay higher yields than long-term securities is considered a(n) _____ yield curve.

    1. Normal
    2. Inverted
    3. Flat
    4. Barbell
Complex Multiple-Choice (“Roman Numeral”) Format:

For this question type, you see a question followed by two or more statements identified by Roman numerals. The four answer choices represent combinations of these statements. You must select the combination that best answers the question.

A stronger dollar benefits which group?

    1. U.S. exporters
    2. U.S. importers
    3. U.S. investors who want to invest in foreign assets
    4. Overseas investors who want to invest in U.S. assets
    1. I and II
    2. II and III
    3. III and IV
    4. I and IV

This format is also used in items that ask you to rank or order a set of items from highest to lowest (or vice versa), or to place a series of events in the proper sequence.

Order the following from lowest to highest:

    1. Broker call rate
    2. Federal funds rate
    3. Prime rate
    4. Discount rate
    1. I, IV, III, I
    2. III, II, I, IV
    3. IV, III, I, II
    4. II, IV, I, III

How to Study for the Series 65

Follow Solomon Exam Prep’s proven study system:
    • Read and understand. It’s simple: read the Solomon Study Guide, carefully. The Series 65 is a knowledge test, not an IQ test. Many students read the Study Guide two or three times before taking the exam. To increase your ability to focus while reading, or as an alternative to reading, listen to the Solomon Audiobook, which is a word-for-word reading of the Solomon Study Guide.
    • Answer practice questions in the Solomon Exam Simulator. When you’re done with a chapter in the Study Guide, take 4 – 6 chapter quizzes in the Solomon Online Exam Simulator. Use these quizzes to give yourself practice and to find out what you need to study more. Make sure you read and understand the question rationales. When you’re finished reading the entire Study Guide, review your handwritten notes once more. Then, and only then, start taking full practice exams in the Exam Simulator. Aim to pass at least six full practice exams and try to get your average score to at least an 80; when you reach that point, you are probably ready to sit for the Series 65 exam.
Use these effective study strategies:
    • Take handwritten notes. As you read the Study Guide, take handwritten notes and review your notes every day for 10 to 15 minutes. Studies show that the act of taking handwritten notes in your own words and then reviewing them strengthens learning and memory.
    • Make flashcards. Making your own flashcards is another powerful and proven method to reinforce memory and strengthen learning. Solomon also offers digital flashcards for the Series 65 exam.
    • Research. Research anything you do not understand. Curiosity = learning. Students who take responsibility for their own learning by researching anything they do not understand get a deeper understanding of the subject matter and are much more likely to pass.
    • Become the teacher. Studies show that explaining what you are learning greatly increases your understanding of the material. Ask someone in your life to listen and ask questions. If you don’t have anyone, explain it to yourself. Studies show that helps almost as much as explaining to an actual person (see Solomon’s recent post to learn more about this strategy!).
Take advantage of Solomon’s supplemental tools and resources:
    • Use all the resources. The Resources folder in your Solomon student account has helpful information, including a detailed study schedule that you can print out – or use the online study schedule and check off tasks as you complete them.
    • Watch the Video Lecture. This provides a helpful review of the key concepts in each chapter after reading the Solomon Study Guide. Take notes to help yourself stay focused.
  • Good practices while studying:
    • Take regular breaks. Studies show that if you are studying for an exam, taking regular walks in a park or natural setting significantly improves scores. Walks in urban areas or among people did not improve test scores.
    • Get enough sleep during the period when you are studying. Sleep consolidates learning into memory, studies show. Be good to yourself while you are studying for the Series 65: exercise, eat well, and avoid activities that will hurt your ability to get a good night’s sleep.

You can pass the NASAA Series 65! It just takes work and determination. Solomon Exam Prep is here to support you on your journey to becoming a registered Investment Adviser Representative.

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How to Calculate Gains and Losses on Exercised Options

Options are a common topic on the Series 6, Series 7, Series 65, Series 66, and SIE exams. Read our guide to calculating gains and losses on exercised options. Continue reading

Options are a topic that many taking the Series 6, Series 7, Series 65, Series 66, and SIE exams have to deal with. One of the biggest problems that students have with options questions occurs when they are asked to calculate gains and losses on exercised options. As long as you understand a few basic points, these types of questions can be a breeze and definitely nothing to lose sleep over.  

First of all, let’s remind ourselves of what an option is.  An option is a contract between two parties that gives the buyer of the contract the right to buy or sell an underlying asset to the other party in the future for a specific price. The specific price is called the “exercise” or “strike” price.  The seller of the option, on the other hand, is obligated to buy or sell, at the strike price. The option to buy is a “call” option, the option to sell is a “put” option.   

To calculate gains and losses on exercised options, you first need to understand what is happening as a result of an options transaction.  When an option is exercised, that means its holder chooses to either buy or sell the underlying security at the strike price. With an exercised call option, the holder purchases shares of the underlying security from the options seller; with an exercised put option, the holder sells shares of the underlying security to the options seller. The sale in each case occurs at the option’s strike price.

Buying – Exercised Call Option

When a call options holder exercises her option by purchasing the underlying shares, she must add the cost of those shares to the premium she paid to obtain the option in the first place. This sum represents the option holder’s total money spent as a result of her options transaction. If the option holder then elects to sell the underlying securities she’s just purchased at their current market price, the money she receives from the sale will be money she takes in. To calculate her gain or loss, subtract the money she paid out from the money she took in. It’s as simple as that. 

So, if, for instance, Marie paid $200 in premiums to purchase a call option with a strike price of $20 and then exercised the option by purchasing 100 shares of the underlying stock, the money she spent as a result of her options transaction will be $2,200 ($200 premium paid + $2,000 purchase price for underlying securities). If she then sells those 100 shares at the market price of $25, she will receive $2,500 in sales proceeds. Subtracting the money she spent from the amount she received will result in a $300 gain ($2,500 sale proceeds – $2,000 purchase price – $200 premium paid = $300 gain.)

Buying – Exercised Put Option

In order for a put options holder to exercise his option, he must have 100 shares of the underlying security to sell to the options seller. That means he needs to go out in the market and purchase shares at their market price. The money he pays for those securities plus the premium he paid to purchase his put option in the first place represents money spent as a result of his options transaction. The options holder will then sell those 100 shares to the options seller at the strike price. When he does this, he receives the sale proceeds. Subtracting the money spent on the put from the sale proceeds will result in the put investor’s gain or loss.   

So, if, for instance, Pierre paid $300 in premiums to purchase a put option with a strike price of $30 and then purchases 100 shares of the underlying stock when its market price drops to $25, he will have spent $2,800 as a result of his options transaction ($300 premium + $2,500 purchase price for underlying shares). He will then sell those 100 shares to the options seller at their strike price of $30 and take in $3,000 from his sale. Thus, Pierre will make a total of $200 on his options transaction ($3,000 sale proceeds - $300 premium – $2,500 purchase price = $200 gain). 

Selling an Option

Now let’s look at gains or losses from the perspective of an options seller. Remember that when someone sells an option, he receives the premium from the options buyer. If the option expires unexercised, the seller gets to keep his entire premium received, which represents his maximum potential gain. If the option is exercised, he will either be required to sell shares of the underlying security to the option holder in the case of a call option or buy shares from the option holder in the case of a put option. Each of an exercised call or an exercised put option transaction is made at the option’s strike price.

Selling – Exercised Call Option

When a call option is exercised, the option seller must obtain 100 shares of the underlying stock to sell to the options holder. To do so, he will have to purchase the shares at their current market price, which will be higher than the option’s strike price. He will then sell them to the option holder at the strike price. The money he takes in from the sale is added to the premiums he received when shorting the option, and this totals the money he takes in as part of his options transaction. The money he paid to obtain the underlying securities is the money he pays out. Subtracting the money he pays out from the money he takes in results in his overall gain or loss.

For example, let’s say Michael sells a call option with a strike price of $50 and receives premiums totaling $500. If the option is exercised, and Mike purchases the underlying shares at $55, he will have paid out $5,500 as a result of his options transaction. At the same time, he will have received $5,500 ($500 premium + $5,000 strike price). Thus, Mike will break even on this transaction; money taken in will be equal to money paid out.

Buying – Exercised Put Option

When a put option is exercised, the option seller must purchase 100 shares of the underlying security from the options holder at the strike price. This represents money the options seller pays out. The options holder has already received the premium when she sold the option, and after purchasing the 100 shares, she can sell them for their current market price. The combination of the seller’s sale proceeds and the premium received represents money taken in. Subtracting money paid out from money taken in will result in the investor’s gain or loss. 

Let’s say Maribel shorts a put option and receives premiums totaling $400. The option has a strike price of $40, and the option holder exercises it when the underlying stock is trading at $35. This means Maribel is obligated to pay $4,000 total for the 100 underlying shares. This is money she pays out. She has already taken in $400, and if she chooses to sell the underlying stock at its current market price, she will take in an additional $3,500 in sales proceeds. This means she will receive a total of $3,900 from his options transaction ($3,500 sale proceeds + $400 premium) and paid out a total of $4,000. As a result, she has lost $100 on his options transaction ($3,900 money in – $4,000 money out = -$100).

As long as you understand what is occurring when an option is exercised, calculating gains and losses is as simple as comparing the money the investor takes in to the money she pays out. Calculating gains and losses on exercised options requires an understanding of the transaction and some simple math. Follow the guidance above and you will be able to correctly answer this type of question on your securities licensing exam.

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What Are QIBs and Accredited Investors? What’s the Difference?

If you’re studying for securities licensing exams, such as the SIE or the Series 7, then you should understand the terms “accredited investor” and “QIB.” Continue reading

If you’ve been studying for the Series 7, 6, 14, 22, 24, 65, 79, or 82, or the Securities Industry Essentials (SIE), then you’ve had to learn about Regulation D private placements and Rule 144A sales. Regulation D private placements are securities offerings that are exempt from the normal SEC registration process and in many cases are sold only to “accredited investors” or limit the involvement of investors who are not accredited. Rule 144A sales are sales of unregistered securities to large institutional investors known as “qualified institutional buyers” or QIBs for short. 
You may have wondered about the difference between accredited investors and QIBs. On the surface, these may seem similar. Each refers to a category of investor with resources and/or knowledge above and beyond the average retail investor. So why not just have one standard for buyers under both Rule 144A and Regulation D? After all, the purpose of both Regulation D and Rule 144A is the same: to allow wealthier and more sophisticated investors easier access to investments that may be too risky for the average investor.  
To begin to answer this question, we have to start with the fact that wealth and sophistication fall on a spectrum. Investors aren’t neatly divided between small retail investors and huge financial institutions that move millions around without blinking an eye. 

Accredited Investors

You could think of accredited investors as a middle ground between these two extremes. Accredited investors are investors whose financial status or investment knowledge may give them a greater ability to handle the risks inherent in a private placement. There are many ways to qualify as an accredited investor but they all have one thing in common, which is that the SEC believes they indicate an ability to take on risks that regulators believe are unsuitable for most retail investors.

Accredited investors are investors whose financial status or investment knowledge may give them a greater ability to handle the risks inherent in a private placement.

All of the following are considered accredited investors:
  • Banks, broker-dealers, investment advisers, insurance companies, and investment companies
  • Corporations, trusts, partnerships, and LLCs with more than $5 million in assets
  • Most employee benefit plans with more than $5 million in assets
  • The issuer’s directors, executive officers, and general partners
  • If the issuer is a privately owned fund, (such as a hedge fund), a knowledgeable employee of the fund, which means an employee with at least 12 months’ experience working on the fund’s investment activities
  • Individuals with income of $200,000 in each of the last two years, or $300,000 in combination with a spouse or spousal equivalent such as a domestic partner
  • Individuals with a net worth more than $1 million, alone or with a spouse or spousal equivalent, not including primary residence
  • Individuals who hold any of these three designations in good standing:
    • Licensed General Securities Representative (Series 7)
    • Licensed Investment Adviser Representative (Series 65)
    • Licensed Private Securities Offerings Representative (Series 82)
  • Any firm where all owners are accredited investors (e.g., venture capital firms)
  • Any other entity with more than $5 million in investments that was not formed specifically to qualify as an accredited investor; the purpose of this category is to include entities that don’t neatly fit into any of the above categories, such as:
    • Native American tribes
    • Labor unions
    • Government bodies, including those of foreign governments
    • Investment funds created by government bodies
    • New types of business entities that may be introduced by new laws

An accredited investor that is not an individual—such as a business, governmental, or nonprofit entity—is sometimes called an institutional accredited investor (IAI).

Qualified Institutional Buyers

QIBs are a narrower group of large institutional investors. A QIB is a large institutional investor that owns at least $100 million worth of securities, not counting securities issued by its affiliates. For registered broker-dealers, the threshold is lower, just $10 million. A bank must also have a net worth of at least $25 million in order to be considered a QIB. 
If a firm has discretionary authority to invest securities owned by a QIB, those securities count toward whether the firm itself is considered a QIB. So if a broker-dealer has $9 million worth of securities in its own accounts, and holds $1 million worth of securities in a discretionary account belonging to a QIB, then the broker-dealer is itself a QIB.  

Common examples of QIBs include broker-dealers, insurance companies, investment companies, pension plans, and banks. However, any corporation, partnership, or LLC could qualify as a QIB. So can an IAI that owns at least $100 million in securities. Individuals can never be QIBs, regardless of their assets or financial sophistication.

Individuals can never be QIBs, regardless of their assets or financial sophistication.

Rule 144A allows QIBs to buy unregistered securities at any time, and freely trade these shares to other QIBs. In effect, QIBs can trade unregistered shares among themselves with almost the same ease as trading registered shares. Selling unregistered securities to anyone other than a QIB commonly requires a the seller to hold the securities for a period of up to 12 months. 

A QIB will virtually always meet the criteria to be an accredited investor, whereas an accredited investor may fall well short of QIB status.

Over time, other securities laws and regulations have made use of these two well-known categories. For example, in 2019 the SEC gave issuers more flexibility to test the waters with potential investors before deciding whether to go through with a public offering. When deciding which investors were sophisticated enough to receive test-the-waters communications, the SEC limited these communications to QIBs and institutional accredited investors. Additionally, references to institutional accredited investors have become more common, such as when the SEC revamped its rules around integration of offerings in March 2021.  
Know your QIBs from your accredited investors and be ready to pass your securities exam with Solomon Exam Prep.

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Solomon Exam Prep Offers Powerful New AI Feature: Remediation Reporting

Learn about the Solomon Remediation Report, a new analytical feature designed to help students pass their securities licensing exams the first time. Continue reading

Solomon Exam Prep is delighted to announce an advanced analytical feature called a Remediation Report. The Solomon system analyzes a student’s five most recent practice exams and determines whether a student is ready to take his or her exam. If Solomon AI determines that a student is not ready to sit for their exam, then it creates an individual report with personalized guidance on how to remediate and prepare to pass. This custom Remediation Report is sent to the Solomon student’s email inbox.

The Solomon Remediation Report is connected to the Solomon Pass Probability tool, the industry-leading measure of a security exam prep student’s readiness to pass an exam. Solomon Pass Probability is based on thousands of student data points. Once a Solomon student has taken at least five practice exams, the Solomon Pass Probability feature is activated, and the Pass Probability metric is available in the student’s dashboard. The Solomon Remediation Report provides an additional level of customized study support by helping students focus their efforts and remediate before they sit for their exam.

Solomon Pass Probability and Remediation Reports are currently available for the following exams: SIE, Series 6, Series 7, Series 63, Series 65, Series 66, Series 79, and Series 82.

To learn about all the features of the Solomon Exam Prep learning system, watch the video overview.

Curious about the Solomon Learning System? Watch the video overview!

Watch the latest Solomon Exam Prep video for a complete look at the Solomon learning system and what it offers students and firms. Continue reading

Solomon Exam Prep has helped thousands of financial professionals pass their FINRA, NASAA, MSRB, and NFA licensing exams. Watch the video for a complete look at the Solomon learning system and what it offers students and firms.

To explore Solomon Exam Prep study materials for 21 different securities licensing exams, including the SIE and the Series 3, 6, 7, 14, 22, 24, 26, 27, 28, 50, 51, 52, 53, 54, 63, 65, 66, 79, 82, and 99, visit the Solomon website.

Simplifying After-Tax and Tax-Equivalent Yields

For many when choosing bonds the most important factor is the tax implications. Knowing the after-tax yield and tax-equivalent yield calculations is critical. Continue reading

Bonds can be nice, reliable investments. Pay some money to an issuing company or municipality, receive interest payments twice a year, and then get all of your original investment back sometime down the road. Sounds like a plan.

But which bonds are best for a specific investor? There are many factors for bond investors to consider when choosing which bond to buy, but for many the most important is the tax implications of investing in one bond instead of another. This concern is most prominent when an investor compares a corporate bond to a municipal bond. For reference, a corporate bond is one issued by a corporation or business, while a municipal bond is one issued by a state, city, or municipal agency.

Comparing the tax implications of these bonds is important because the interest payments that investors receive from municipal bonds are typically not taxed at the federal level. Conversely, interest payments on all corporate bonds are subject to federal taxation. This means that someone in the 32% tax bracket will have to give Uncle Sam 32% of his interest received from a corporate bond, while he will not give up any of his interest received from a municipal bond. Additionally, an investor does not pay state taxes on municipal bond interest if the bond is issued in the state in which the investor lives. Corporate bond interest, on the other hand, is always subject to state tax.

  • interest payments taxed federally
  • interest payments subject to state tax
  • interest payments not federally taxed
  • interest payments not taxed by state if issued in state local to investor

For these reasons, when comparing a corporate bond to a municipal bond, understanding the after-tax yield and the tax-equivalent or corporate-equivalent yield is essential. This is true both for investors and for those who will be taking many of the FINRA, NASAA, and MSRB exams. So let’s look at how to calculate those yields.

After-Tax Yield

First the after-tax yield. The after-tax yield tells you the amount of a corporate bond’s annual interest payment that an investor will take home after accounting for taxes he will be assessed on that interest. Once that amount is known, the investor can compare it to the yield he would receive from a specific municipal bond and see which potential investment would put more money in his pocket. When calculating the after-tax yield, start with the annual interest percentage (a.k.a. coupon percentage) of the corporate bond, which represents the percent of the bond’s par value that an investor receives each year in interest. For instance, a corporate bond that has a $1,000 par value and an interest rate of 8% will pay an investor $80 dollars in annual interest ($1,000 x 0.08 = $80). You then multiply the coupon percentage by 1 minus the taxes an investor will pay on the corporate bond that he will not pay on the municipal bond that he is considering.

This is where it sometimes gets tricky. What taxes will an investor not pay when investing in a municipal bond that he will pay when investing in a corporate bond? Remember that for just about all municipal bonds, investors do not pay federal tax on interest received.

The formula for after tax yield is:

After-tax yield = Corporate Bond Annual Interest Rate x
( 1 – Taxes Investor Does Not Pay By Investing in Municipal Bond)

On the other hand, an investor always pays federal taxes on interest received from a corporate bond. Additionally, an investor does not pay state taxes on interest payments from a municipal bond issued in the state in which the investor lives.

On the other hand, an investor always pays state taxes on interest received from corporate bonds. So if you see an exam question in which you need to calculate the after-tax yield of a corporate bond to compare it the yield on a municipal bond, you will always subtract the investor’s federal income tax rate from 1 in the equation. You will also subtract the investor’s state tax rate from 1 if the municipal bond is issued in the investor’s state of residence.

Seems simple, right? Here’s a question to provide context:

Marilyn is a resident of Kentucky. She is considering a bond issued by XYZ Corporation. The bond comes with a 7% annual interest rate. Marilyn is also interested in purchasing municipal bonds issued in Ohio. If Marilyn has a federal tax rate of 28% and Kentucky’s state tax rate is 4%, what is the after-tax yield on XYZ’s bond?

To answer this question, begin with the interest rate on the XYZ bond, which is 7%. Then subtract from 1 the taxes Marilyn will not pay if she invests in the municipal bond in question. She will not pay federal taxes on the municipal bond interest, so you would subtract 28%, or .28. However, because Marilyn is a resident of Kentucky and the municipal bonds she is considering are issued in Ohio, she will pay state taxes on the bond. That means you would not subtract her state tax rate (0.04) from 1. After subtracting .28 from 1 to get 0.72, you multiply that amount by the 7% coupon payment. Doing so gives you a value of 5.04 (7 x 0.72 = 5.04%). This means that the interest amount she would take home from the XYZ bond would be equivalent to what she would receive from a municipal bond issued in Ohio that has a 5.04% interest payment. If she can get a bond issued in Ohio that has a higher interest payment than 5.04%, she would take home more money in annual interest payments than she would from the XYZ bond.

Tax-Equivalent Yield

The second approach an investor can take to compare how a potential bond investment will be affected by taxation is to calculate the tax-equivalent yield (TEY). This calculation is also known as the corporate-equivalent yield (CEY). The TEY/CEY measures the yield that a corporate bond will have to pay to be equivalent to a given municipal bond after accounting for taxes due. To calculate this yield, you take the annual interest of the given municipal bond and divide it by 1 minus the taxes the investor will not pay if she invests in the municipal bond that she would pay if she invested in a corporate bond.

Here’s the formula for tax-equivalent yield:

Tax-equivalent yield = Municipal Bond Annual Interest Rate /
(1 – Taxes Investor Does Not Pay By Investing in Municipal Bond)

When determining what tax rates to subtract from 1 in the denominator, the same principal as described above applies. That is, the investor will not have to pay federal tax on the municipal bond, so her federal rate is always subtracted from 1. The investor will also not have to pay state tax on the bond if it is issued in the state in which she lives. If that is the case, the investor’s state tax rate should also be subtracted from 1. However, if the investor lives in a different state than the state in which the bond is issued, she will have to pay state taxes on the interest payments. In that case, her state tax rate would not be subtracted from 1.

Here’s another question to provide context.

Franz, a resident of Michigan, has purchased a Michigan municipal bond that pays 4% annual interest. If his federal tax bracket is 30% and the Michigan state tax rate is 4%, what interest rate would he need to receive on a corporate bond to have a comparable rate after accounting for taxes owed?

To answer this question, begin with the interest rate on the Michigan municipal bond, which is 4%. Then subtract from 1 the taxes that Franz will not pay on that bond that he would pay if he invested in a corporate bond. He wouldn’t pay federal taxes on the municipal bond interest, so you would subtract 0.30 from 1. Additionally, since the bond is issued in Michigan and he is a Michigan resident, Franz will not pay state taxes on the bond. So you subtract Michigan’s state tax rate of 4%, or 0.04, from 1 as well. After subtracting 0.30 and 0.04 from 1 to get 0.66, you divide that number into the 4% municipal bond annual interest. Doing so gives a value of 6.06 (4 / 0.66 = 6.06). This means Franz would need to find a corporate bond that pays 6.06% in annual interest to match the amount of interest he will take home annually from the Michigan municipal bond after accounting for taxes.

Many people are confused by the concepts of the after-tax and tax-equivalent yields. But you don’t have to be one of them. Just follow this simple approach and any questions you see on this topic will not be overly taxing.

Mastering these equations will help you succeed in passing the Series 6, Series 7, Series 50, Series 52, Series 65, Series 66, and Series 82.

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How to answer state registration questions on the Series 63, Series 65, and Series 66

Read Solomon Exam Prep’s expert guide for answering state registration questions on the Series 63, Series 65, and Series 66 exams. Continue reading

If you’re planning to take the NASAA Series 63Series 65, or Series 66 exam, you can expect to see questions about when broker-dealers and their securities agents need to register in a particular state. You can also expect to see questions about when investment advisers and investment adviser representatives need to register in a state. Instead of feeling intimidated when confronted with such questions, you should relax, smile, and feel confident. That’s because if you follow the simple rules that we’re about to describe, you should get each of these questions right.

Broker-Dealers and Their Agents

First let’s deal with questions about state registration for broker-dealers (BDs) and their agents. Rule number one here is that when a U.S.-based BD or one of its agents has an office located in a state, that BD or agent must register in the state. It does not matter which types of clients a BD or BD agent with an office in a state has or what types of securities those clients buy from the BD or agent. A BD or agent with an office in a state must register in that state. Period.  

What about a BD or BD agent that doesn’t have an office in a state? If a BD or BD agent without an office in a state has any non-institutional clients in that state, the BD or agent must register there. However, if the BD or agent without an office in a state has only institutional clients in the state, no registration in that state is required. Institutional clients include the issuers of securities involved in a specific transaction; other broker-dealers; and institutional buyers, which are big-money entities such as banks, insurance companies, mutual funds, and pension and profit-sharing plans.   

Key takeaway:

So when presented with a question about whether a specific broker-dealer or one of its agents must register in a given state or states, there are two potential questions to ask yourself. The first question is: “Does the broker-dealer or BD agent have an office in the state?” If the answer is yes, it’s simple: the BD or agent must register in that state. End of questions. However, if the answer is no, move on to the second question: “Does the BD or BD agent have any non-institutional clients in the state?” If the answer is yes, the BD or agent must register in the state; if the answer is no, they do not need to register in the state.

Here’s a flowchart to help you remember the question-answering process:

Investment Advisers and Their Representatives

Now let’s look at the state registration requirements for investment advisers that do not register with the SEC. If the investment adviser has an office in the state, it must register there. If the investment adviser doesn’t have an office in the state but has had more than five non-institutional clients in the state during the past twelve months, it also must register there. The rules are the same for investment adviser representatives who work for an investment adviser that does not register with the SEC.

Investment adviser representatives who work for investment advisers that register with the SEC — also known as federal covered advisors — may need to register with the state if they have an office in the state.

Key takeaway:

So if you see a question about state registration requirements for non-SEC registered investment advisers or their investment adviser representatives, the first question to ask yourself is: “Does the IA or IAR have an office in the state?” If the answer is yes, you know the IA or IAR must register there. If the answer is no, move on to the second question: “Has the IA or IAR had more than five non-institutional clients in the state during the preceding twelve months?” If the answer is yes, they must register in the state; if the answer is no, they don’t need to register in the state.    

Here’s another flowchart to help you with this type of question:

Remember that if an investment adviser registers with the SEC, it is a federal covered adviser and does not need to register in any state. Instead, a federal covered adviser must notice file to provide investment advice to residents of that state. When it comes to notice filing requirements for federal covered advisers, follow the same thought process as that described above. If the federal covered adviser has an office in a state, it must notice file there. If it has no office in the state but it has had more than five non-institutional clients in the state in the past twelve months, the firm must also notice file there.  

Practice question

Simple, right? So let’s put the suggested thought process into practice by looking at a question like one you may see on your exam.  

XYZ Broker Dealer has its main office in State A. It also has offices in States B and C. ABC has non-institutional clients in states A and B, but it only has institutional clients in State C. It does not have an office in State D, but it has three non-institutional clients there. In which states does XYZ need to register? 

A. State A only  

B. States A and B only  

C. States A, B, and C only  

D. States A, B, C, and D  

Remember the process to follow when you see questions about where a BD must register. There are two possible questions to address as part of that process.  

First question: Does the broker-dealer have an office in a state? Answer: XYZ has offices in each of States A, B, and C. Recall that if the answer the first question is “yes, the BD has an office in the state”, then the BD must register in that state. So XYZ needs to register in States A, B, and C.   

If the answer to the first question is no, as it is for State D, you move on to the second question: Does the BD have any non-institutional clients in the state? XYZ has non-institutional clients in State D, so the answer is yes to that question. If the answer to the second question is yes, this means the BD must register in the state. Thus, XYZ has to register in State D as well as States A, B, and C. So Choice D is the correct answer.  

So now you’re an expert, and you’re one step closer to passing your Series 63, Series 65, or Series 66 exam!

Want more exam tips?

Watch a video version of “How to Answer State Registration Questions on the Series 63, Series 65, and Series 66” on the Solomon YouTube channel, where you’ll find even more exam and study tips!

Solomon Exam Prep has helped thousands pass their securities licensing exams, including the SIE and the Series 3, 6, 7, 14, 22, 24, 26, 27, 28, 50, 51, 52, 53, 54, 63, 65, 66, 79, 82 and 99.

Broker-Dealer vs. Investment Adviser: What’s the Difference?

Do your customers know the difference between an IA and BD? Do you know the importance of this distinction and how it may affect your registration status? Continue reading

Do your customers know the difference between an investment adviser and broker-dealer? Do you know the importance of this distinction and how it may affect your registration status? 

Investment Adviser or Broker-Dealer at work.

For many retail customers, the difference between an investment adviser (IA) and a broker-dealer (BD) may not seem important. A customer may have received an investment recommendation from a BD, or owned securities through an IA account. However, which kind of firm you work for is important for knowing which services you may provide, how you may provide them, and which qualification exams you must pass.

Investment Advisers

Investment advisers are usually firms, though they can be an individual operating as a sole proprietor, whose primary business is providing investment advice, and who are paid for the advice itself. Investment adviser representatives (IARs) are individuals who work for IAs and advise the IA’s clients on the IA’s behalf. IAs and IARs are not “stockbrokers” and cannot directly buy or sell securities for their customers. While many have IA accounts through which they own stocks, mutual funds, and other securities, in fact these are accounts an IA opens on the customer’s behalf with a BD. 


Broker-dealers are usually firms, though they can be an individual operating as a sole proprietor, that execute securities transactions for customers. An individual who is employed by a BD to handle customer accounts is called an “agent of a broker-dealer” on some exams, or a “registered representative” (RR) on others. BDs can offer investment advice incidental to their work with customers but cannot be compensated for the advice itself. If a BD acts as an intermediary between a buyer and a seller, then the BD can charge a commission on the trade. If a BDs buys or sells from its own inventory, then the BD makes money by charging a markup on securities that they sell and taking a markdown on securities that they buy.

So, if you’re an IAR, you… 
  • …can provide advice
  • …can be paid for that advice
  • …cannot execute trades
  • …cannot charge commissions or markups on your customer’s trades
If you’re a BD agent (also known as a registered representative), you…
  • …can provide advice
  • …cannot be paid for that advice
  • …can execute trades
  • …can charge commissions or markups on your customer’s trades

Testing and Licensing

Finally, many firms, especially larger ones, maintain both IA and BD registrations. When working for these “dual registrants,” you may be asked to qualify as an IAR, BD agent, or both, depending on your role.

In fact, an increase in dual registrations is one of the note-worthy trends Solomon discusses in our recent white paper, “Optimizing On-Boarding in 2021: 7 Key Trends for the Securities Industry,” available for download from this blog post

To become an agent of a broker-dealer (registered representative), you must pass the Securities Industry Essentials (SIE), and a “top-off” exam such as the Series 6 or Series 7, and for state registration usually the Series 63. To become an IAR, you must pass either the Series 65, or, if you work for a dually registered firm, the SIE, the Series 7, and the Series 66.

SEC Overhauls Marketing Rules for Investment Advisers

On December 22, the SEC announced a major rule change that it hopes will clarify what investment advisers can and can’t do when it comes to marketing their services. Continue reading

On December 22, the SEC announced a major rule change that it hopes will clarify what investment advisers are permitted to do when it comes to marketing their services.

The SEC cited the need to adapt its rules to changing communications technology. “The marketing rule reflects important updates to the traditional advertising and solicitation regimes, which have not been amended for decades, despite our evolving financial markets and technology,” said SEC Chairman Jay Clayton in announcing the overhaul.

The SEC’s current rules about advertisements and paying for client referrals will be consolidated into a single rule. Paying a third party to solicit new clients will now be considered a form of advertising, as will paid testimonials and endorsements and some one-on-one communications with clients.

Currently, each of these activities is subject to a separate set of requirements. By bringing them under the definition of advertising, the new rule replaces this complex system with a set of six broad principles that all forms of IA advertising must adhere to:

  1. No untrue statements or omissions of material facts
  2. No unsubstantiated statements
  3. No statements that imply something untrue or misleading
  4. When the benefits of the IA’s services are discussed, there must be a fair and balanced discussion of material risks
  5. “Anti-cherry picking”: the IA must present its track record in a fair and balanced way
  6. No advertisements that are otherwise materially misleading (intended as a “catch-all provision” for misleading advertising not covered above)

The rule change is expected to take effect sometime in the spring of 2021 and will affect the Series 65 and Series 66 exams.