In this appendix, you will find definitions of key terms critical for understanding and passing the FINRA Series 7 exam. Familiarity with these terms will help you navigate the exam’s complex content, ranging from security transactions to investment strategies. Each term is supported by quizzes that help reinforce your learning and ensure you’re well-prepared for the exam.
Accretion
Accretion refers to the method of adjusting the cost basis of a bond purchased at a discount so it moves upwards towards its par value as it nears maturity. This adjustment occurs annually and reflects the annual gain in value which investors must consider, particularly when dealing with taxable accounts.
Accumulation Phase
The accumulation phase is the period during which an investor focuses on building the value of investments. This phase often involves making regular contributions to retirement accounts or variable annuities. The aim is to accumulate enough wealth to sustain a comfortable retirement.
American Depositary Receipt (ADR)
An ADR is a negotiable certificate issued by a U.S. bank that represents shares in a foreign corporation. ADRs enable Americans to invest in non-U.S. companies without the complexities of foreign markets. They are traded on U.S. exchanges, making international investments more accessible and easier to trade.
Amortization
Amortization involves the process of systematically reducing the cost basis of a bond that was purchased at a premium. The goal is to allocate the premium paid over the life of the bond, resulting in a reduced cost basis until maturity.
Asset Allocation
Asset allocation is an investment strategy that seeks to balance risk and reward by distributing an investor’s portfolio across different asset classes. The allocation reflects an individual’s financial goals, risk tolerance, and investment timeline, making it a foundational aspect of portfolio management.
Supplementary Materials
- Yield: The income return on an investment.
- Premium: The amount by which the price of a bond exceeds its face value.
- Par Value: The face value of a bond, typically $1,000, paid at maturity.
Additional Resources for Further Study
- FINRA’s own resources on securities and regulations
- Investment books on modern portfolio theory
- Workshops and webinars on Series 7 preparation
Quizzes
To further reinforce your understanding of these terms, please take the following quizzes which simulate Series 7 exam questions.
### What does "accretion" refer to in bond investment?
- [x] Adjusting a bond's cost basis upward toward par value
- [ ] Reducing a bond's cost basis toward its premium
- [ ] Issuing new bonds at a lower interest rate
- [ ] A strategy of decreasing interest rates
> **Explanation:** Accretion adjusts the cost basis of a discount bond upwards as it approaches its par value, reflecting its increased value over time.
### During the "accumulation phase," what is the primary focus for investors?
- [x] Building the value of their investment
- [ ] Distributing income from their investment
- [x] Making regular contributions to accounts
- [ ] Paying down debts using investment funds
> **Explanation:** The accumulation phase focuses on growing investment value through regular contributions, essential for future financial security.
### How do American Depositary Receipts (ADRs) benefit U.S. investors?
- [x] They provide easier access to foreign investments
- [ ] They eliminate all foreign exchange risk
- [ ] They require handling foreign market regulations
- [ ] They provide tax-free foreign investment returns
> **Explanation:** ADRs simplify investing in foreign companies by eliminating the need to deal with foreign markets directly, trading on U.S. exchanges.
### What does "amortization" do to the cost basis of a bond?
- [x] Reduces the premium over the bond's life
- [ ] Increases the bond's par value
- [ ] Adjusts the bond's interest rate
- [ ] Matches the bond's face value at maturity
> **Explanation:** Amortization involves spreading out the bond's premium cost, thus reducing the basis over time as the bond approaches maturity.
### What is the primary goal of asset allocation?
- [x] Balancing risk and reward in a portfolio
- [ ] Maximizing short-term trading profits
- [x] Reflecting investor goals and risk tolerance
- [ ] Minimizing transaction costs
> **Explanation:** Asset allocation balances risk versus reward by diversifying investments to align with an investor's financial goals and tolerance for risk.
### Why is understanding "par value" essential for bond investments?
- [x] It's the amount paid back at bond maturity
- [ ] It's the coupon rate earned annually
- [ ] It's the market price of the bond
- [ ] It's the dividend rate of the bond
> **Explanation:** Par value is crucial as it's the face value, or amount repaid to investors at maturity, affecting profitability.
### What effect does a bond's "premium" have at purchase?
- [x] Increases initial cost above par value
- [ ] Decreases the bond's yield rate
- [x] Necessitates cost basis reduction over time
- [ ] Guarantees a fixed income return
> **Explanation:** Premium bonds are purchased above par value, requiring cost basis adjustment through amortization.
### What term describes income return on investments?
- [x] Yield
- [ ] Premium
- [ ] Discount
- [ ] Principal
> **Explanation:** Yield represents the earnings generated and realized on an investment over a specified period of time, expressed usually as a percentage.
### How does asset allocation relate to risk management?
- [x] It diversifies holdings to minimize risk
- [ ] It focuses solely on high-risk investments
- [ ] It ignores investor risk tolerance
- [ ] It consolidates assets into single securities
> **Explanation:** Asset allocation strategically spreads investments across various assets, reducing risk by not being dependent on a single market or sector.
### True or False: Amortization is used to increase a bond's cost basis over time.
- [ ] True
- [x] False
> **Explanation:** False. Amortization is used to decrease a bond's cost basis by allocating the premium paid over its lifespan.
Conclusion
Understanding and memorizing these glossary terms will solidify your comprehension and application skills for the Series 7 exam. Practice frequently with quizzes and explore further resources to expand your knowledge.
With consistent study and engagement with these essential concepts, you will be well-prepared to succeed on the FINRA Series 7 exam. Remember, clarity in these foundational topics is crucial to navigating the broader scope of securities regulations and practices effectively.