Try 10 focused Series 162 questions on Reasonable Basis Review, with explanations, then continue with the full Securities Prep practice test.
Series 162 Reasonable Basis Review questions help you isolate one part of the FINRA outline before returning to a mixed practice test. The questions below are original Securities Prep practice items aligned to this topic and are not copied from any exam sponsor.
| Item | Detail |
|---|---|
| Exam | FINRA Series 162 |
| Official topic | Function 2 — Review the Content of the Report to Ensure a Reasonable Basis Exists for the Analyst’s Conclusions |
| Blueprint weighting | 68% |
| Questions on this page | 10 |
A supervisory analyst reviews an update on a U.S. specialty retailer. The analyst cuts FY EPS from $5.00 to $4.10 and lowers the 12-month price target from $72 to $66, citing soft April channel checks and a weaker consumer backdrop. Management reaffirmed FY EPS guidance of $4.90-$5.10 two days earlier, the report’s GDP and unemployment assumptions are unchanged from the prior note, and the report gives no bridge from those inputs to revised same-store sales, gross margin, or markdown assumptions. Which issue should concern the supervisory analyst most before approval?
Best answer: C
Explanation: The estimate cut lacks reasonable-basis support because the note never links the cited checks and macro view to the specific model drivers that were reduced.
The central problem is missing estimate-change support. The report cites soft channel checks and a weaker consumer backdrop, but management guidance and the analyst’s own macro assumptions do not corroborate the full-year EPS cut, and the note never shows how revenue or margin drivers changed.
Under Series 162’s reasonable-basis review, the supervisory analyst must determine whether the evidence cited for an estimate revision is actually translated into the model. Here, management guidance was reaffirmed, the macro inputs were left unchanged, and the only negative support is soft April channel checks. That mix does not automatically make the revision wrong, but it requires a clear bridge showing why the checks are representative and how they reduce same-store sales, gross margin, or markdown assumptions enough to justify the new EPS forecast. Without that explanation, the revision looks like an unsupported override rather than an analytically grounded change. Valuation-table updates and market-data housekeeping are secondary until the estimate revision itself is supported.
A supervisory analyst reviews this macro section of an equity report supporting a price target:
Current U.S. 10-year yield: 4.20%
Current euro-area 10-year yield: 2.70%
Expected Fed effect on U.S. 10-year yield: -75bp
Expected fiscal-expansion effect on U.S. 10-year yield: +40bp
Analyst's year-end U.S. 10-year yield assumption: 3.85%
Analyst's currency conclusion: USD will appreciate because
the U.S.-euro-area 10-year yield spread will widen
Which supervisory analyst conclusion is most appropriate before approving the report?
Best answer: A
Explanation: The stated rate assumption reconciles, but the report’s own numbers show a narrower yield spread, not a wider one, so the currency explanation lacks reasonable support.
The combined policy inputs support a 3.85% U.S. 10-year yield: 4.20% minus 75bp plus 40bp equals 3.85%. But with the euro-area yield unchanged at 2.70%, the U.S.-euro-area spread falls from 1.50% to 1.15%, so the report does not adequately support its USD appreciation rationale.
A supervisory analyst must check both the arithmetic of the market assumption and the logic connecting policy inputs to the report’s currency or rate conclusion. Here, the analyst’s U.S. rate assumption is numerically consistent: the Fed effect and fiscal effect produce a net 35bp decline in the U.S. 10-year yield, taking it from 4.20% to 3.85%.
Because the spread narrows by 35bp, the report’s stated reason for USD appreciation—wider U.S.-euro-area yield spread—is not supported by its own assumptions. The problem is not the 3.85% yield forecast itself; it is the missing reconciliation between combined monetary and fiscal policy effects and the currency conclusion.
A supervisory analyst reviews a fixed-income report comparing two noncallable senior unsecured notes of the same issuer on a 12-month horizon.
Exhibit: Review file excerpt
Bond A: 3-year maturity | YTM 4.80% | spread 95bp | duration 2.7
Bond B: 8-year maturity | YTM 5.30% | spread 105bp | duration 6.4
Conclusion: Prefer Bond B because 'the Fed is likely to cut 75bp over the next year,
so the longer bond should outperform.'
Support included: current Treasury curve, current spreads, issuer credit memo
Support missing: no forecast for the 8-year Treasury point; no duration-based
12-month total return sensitivity for either bond
Before the report can be approved, which missing review step is most important?
Best answer: A
Explanation: The recommendation depends on a rate view, so the file must show how that view affects the relevant curve point and expected return for each bond.
The decisive gap is the missing link between the report’s interest-rate forecast and its bond preference. A supervisory analyst should require a maturity-matched curve assumption and a 12-month total return comparison that applies duration and spread assumptions consistently to both notes.
When a report uses interest-rate forecasting to support fixed-income relative value, the forecast must be applied consistently to the securities being compared. Here, the analyst cites expected Fed cuts to justify preferring the 8-year note, but the file only shows a general policy view. It does not show how that view translates to the 8-year Treasury point or how the assumed rate move, carry, and spread effect change each bond’s 12-month total return.
A reasonable-basis review should confirm:
Because the notes are from the same issuer and are noncallable, the missing rate-to-return bridge is the key approval issue. Extra market color may help context, but it does not cure the unsupported conclusion.
During supervisory review, a fixed-income report recommends swapping from Alpha Utility 2032 notes (A-, OAS 110bp, duration 6.1) into Beta Power 2032 notes (BBB, OAS 155bp, duration 6.0) for additional spread. The analyst’s credit discussion says Beta will remain more leveraged than peers, interest coverage will decline, and free cash flow will likely stay negative through next year, but gives no analysis of why the extra 45bp offsets that weaker credit profile. You have already verified the ratings, spreads, and duration figures. What is the best next step before approving the report?
Best answer: C
Explanation: The missing step is an explicit reasonable-basis analysis showing why Beta’s wider spread adequately compensates for its weaker credit profile.
The data inputs have already been checked, so the unresolved issue is analytical support. Before approval, the supervisory analyst should require a clear bridge showing why the additional spread compensates for Beta’s weaker credit quality and supports the swap call.
In a supervisory analyst review, once market data and basic comparability are verified, the next question is whether the report’s conclusion has a reasonable basis. Here, the report describes Beta as having weaker leverage, lower coverage, and negative free cash flow, yet still recommends swapping into the bond for only 45bp of extra spread. That creates a missing relative-value bridge.
The analyst should explain why the spread pickup is sufficient compensation for the added credit risk, and how that conclusion fits the stated credit profile and rating logic. Until that support is added, the swap recommendation is not fully grounded in the report’s own discussion. Verified quotes and matched duration do not cure an unsupported credit-quality conclusion.
A supervisory analyst compares two draft DCF price-target packages for the same issuer. Both models produce enterprise value of $6.0 billion from unlevered free cash flow. Latest balance-sheet inputs are debt of $1.4 billion, cash of $0.4 billion, 90 million basic shares, and 100 million diluted shares.
Which review conclusion best matches these facts?
Best answer: A
Explanation: Model A keeps the diluted-share denominator aligned across the model and exhibit, while Model B switches to basic shares and breaks internal consistency.
Model A is the consistent package. In an enterprise-value DCF, showing the bridge as minus net debt or minus debt plus cash is equivalent, so that presentation change alone is not a problem. Model B fails because the report exhibit switches from 100 million diluted shares to 90 million basic shares.
In an enterprise-value DCF built from unlevered free cash flow, enterprise value must be converted to equity value before a per-share price target is shown. That bridge can be written either as enterprise value minus net debt or as enterprise value minus debt plus cash; those are economically identical if the same balance-sheet inputs are used. The key control point is the share denominator. Model A uses 100 million diluted shares in both the valuation tab and the report exhibit, so the assumption flow is consistent. Model B uses diluted shares in the model but basic shares in the exhibit, which raises the displayed per-share value and breaks internal consistency. A supervisory analyst should require that share basis to reconcile before approval. Equivalent debt/cash presentation is acceptable; inconsistent shares are not.
An analyst updates a report on a stable industrial issuer and keeps a Buy recommendation with a 12-month price target of $40.50. The stock closed at $40.00, no dividend is expected over the next 12 months, and the revised model changed only modestly from the prior report. The report says the long-term thesis is intact but does not explain why a Buy call is reasonable with roughly 1.3% implied upside; what is the best supervisory analyst action before approval?
Best answer: B
Explanation: A Buy recommendation needs a reasonable expected-return basis, so near-flat upside with no dividend support must be reconciled before approval.
A positive recommendation should align with the return implied by the stated price target and horizon. Here, the 12-month target is only slightly above the current price, and there is no dividend to add to total return. The supervisory analyst should require the analyst to reconcile that mismatch before approving the report.
A supervisory analyst must check that the recommendation, price target, and stated time horizon are logically consistent. In this scenario, a 12-month target of $40.50 versus a $40.00 current price implies about 1.25% upside, and the stem says there is no dividend to increase expected total return. That is generally negligible support for a Buy recommendation unless the report clearly documents another reason the call remains reasonable, such as a different return framework or a specific catalyst not captured by the target. The best action is to require the analyst to reconcile the positive recommendation to the near-flat expected return before approval; that may result in a rating change, a target change, or added support. More detail on model inputs or risks does not cure the core alignment problem.
Exhibit: Target support excerpt
DCF enterprise value USD 4.8 billion
Target price formula EV / 150 million diluted shares
Total debt USD 900 million
Cash USD 300 million
Preferred stock USD 100 million
A supervisory analyst is reviewing this DCF-based target table. Which action best aligns with durable valuation-review standards before the report is approved?
Best answer: D
Explanation: Because enterprise value includes claims above common equity, the report needs an explicit EV-to-equity bridge before any per-share target is shown.
A DCF based on unlevered cash flow and WACC produces enterprise value, not common equity value. Before approval, the supervisory analyst should require a reconciliation that removes debt and preferred claims, adds cash, and then applies a consistent diluted share count.
When a DCF discounts unlevered operating cash flow at WACC, the output is enterprise value. Enterprise value represents value to all capital providers, so a common-stock target cannot be obtained by dividing EV directly by shares.
Here, the table skips that bridge even though debt, cash, and preferred stock are disclosed. Better sourcing of WACC or additional corroboration may improve the broader analysis, but they do not fix the core valuation-bridge error.
A supervisory analyst is reviewing a report that recommends swapping from an 8-year A-rated utility bond with a 120bp spread and 6.5 duration into an 8-year BBB-rated utility bond with a 185bp spread and 6.4 duration. The report argues that utility fundamentals are improving and BBB spreads should tighten relative to A spreads over the next 12 months. Which statement is most accurate?
Best answer: B
Explanation: With durations nearly matched, the swap mainly expresses a credit-spread view, so expected BBB spread tightening can support the rationale.
This bond-swap thesis can be reasonable because the two bonds have nearly the same duration, so interest-rate sensitivity is largely matched. That makes the expected tightening of BBB utility spreads relative to A utility spreads the main source of potential outperformance.
A reasonable bond-swap rationale should match the stated market view to the risk being added or removed. Here, the report is making a credit-spread call, not mainly an interest-rate call. Because the two utility bonds have almost identical duration, a broad move in Treasury yields should affect them similarly, so the relative result depends more on whether the BBB bond’s spread narrows versus the A bond’s spread.
If utility fundamentals are improving and the analyst reasonably expects BBB spreads to tighten, the BBB bond could outperform through spread compression plus additional carry. A separate prediction of sharply rising Treasury yields is not required for that relative-value thesis. The key review point is whether the spread-tightening expectation has adequate support, not whether the bonds have different duration exposure.
A research report says a stronger U.S. dollar should increase a manufacturer’s export demand, but it gives no discussion of pricing power, demand elasticity, or cost pass-through. This supervisory concern is best described as:
Best answer: B
Explanation: The claim lacks the issuer-specific causal bridge needed to support an FX-driven increase in export demand.
This is a reasonable-basis issue, not just an economics vocabulary issue. The report asserts that currency strength will raise export demand, but it does not explain the mechanism that would make that outcome plausible for this issuer.
Under Part II review, a supervisory analyst must determine whether the analyst’s conclusion has a reasonable basis. When a report claims that a stronger domestic currency will increase export demand, the report should explain the economic channel for that result. That support might include evidence of unusual pricing power, lower input costs that allow price cuts abroad, local production that changes cost exposure, or highly inelastic end demand. Without that bridge, the statement is an unsupported causal linkage. It is not primarily a sourcing problem, a math problem, or a missing sensitivity table. The key point is that macroeconomic conclusions need a coherent issuer-specific mechanism, not just a stated direction.
A supervisory analyst is reviewing a draft valuation note on packaged securities and equity-linked instruments. Which conclusion is INCORRECT and should be revised before approval?
Best answer: D
Explanation: A warrant can retain time value until expiration even when it is already in the money.
The inaccurate conclusion is the claim that an in-the-money warrant has no time value once the stock exceeds the exercise price. Warrants are option-like securities, so remaining life still affects value until expiration.
A supervisory analyst should confirm that the report’s conclusion matches the economics of the specific security type being discussed. A warrant is an equity-linked instrument with both an exercise price and an expiration date. If the underlying common stock trades above the strike price, the warrant has intrinsic value, but it also usually retains time value because additional upside can occur before expiration. That means remaining term still matters to valuation, price-target support, and recommendation logic.
By contrast, ETF prices generally stay close to NAV because the creation/redemption process helps arbitrage away large gaps, closed-end funds can trade for extended periods at discounts or premiums to NAV, and ADR analysis should consider the underlying local-share price plus currency effects and depositary costs. The key flaw is treating a warrant as if its option value disappears as soon as it moves in the money.
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