Series 6 Chapter 4

Which of the following would be found on a customer's balance sheet?

The value of the customer's 401(k) account Information on a balance sheet will be financial assets and liabilities. Income and expense information is on the income statement. Education is a non-financial consideration

Which of the following would be appropriate recommendations for a customer looking for income?

Utility fund Many securities are purchased for income; these include stocks, bonds, and mutual funds that pay consistent dividends such as a utility fund. The other answer choices are not purchased for income purposes: A long call option gives the right to buy stock at a designated price. An income bond is issued by a company coming out of bankruptcy and pays interest only if the corporation has enough income. A warrant is a certificate granting its owner the right to buy securities from the issuer at a specified price, normally higher than the market price when issued.

Mesa Verde Coffee Company (a mid-sized company) stock has a beta of 1.5 when compared to the mid-cap index. Last year the index increased 10% and Mesa Verde grew 13% over the same period. What is Mesa Verde's alpha?

-2% Alpha is calculated by first finding the expected return by multiplying the index return by the security's beta (10% × 1.5 = 15%). Then subtract the expected return from the actual return (13% - 15% = -2).

A moderate-risk customer who has been funding a self-directed IRA since her late 20s is now in her early 60s. The investment vehicle currently weighted heavily toward equities for growth has allowed her to accumulate a robust nest egg to be used during retirement. Hoping to keep the IRA investments limited to mutual funds, she asks for a more conservative allocation given her age. Which of the following is suitable and conservative allocation?

70% balanced fund, 30% U.S. government bond funds As this customer gets closer to retirement, the need to move away from equities toward fixed income should be evident. A balanced fund that is split between equities and debt securities coupled with U.S. government bonds that are considered safe and with no default risk is appropriate. An immediate red flag should arise regarding the use of municipal bonds (or funds) in a tax-favored account. With tax-free interest, there is no suitable reason to utilize such assets in an IRA. A 60% position in high-yield bond funds are speculative and not suitable for a conservative portfolio.

Which of the following funds would you recommend to a moderate-risk client seeking long-term capital gains who also values professional stock selection?

A large-cap growth fund A large-cap growth fund is the most appropriate choice for a moderate-risk client because large capitalization stocks are generally less volatile than small-cap stocks and provide long-term capital growth. This is a more appropriate choice than the index fund because there is no stock selection there, only investing to parallel the index.

If a retired individual seeking income has $200,000 to invest, which of the following mutual funds would be the most suitable?

High-grade bond fund Of the choices listed, an investor seeking income would benefit from investing in a high-grade bond fund.

Your customer, age 32, makes $48,000 annually and has $15,000 to invest. Although he has never invested before, he wants to invest in something exciting, with investment returns in the 20%+ range. Which of the following should you suggest?

It is necessary to get more information about this customer and his definition of an exciting investment opportunity before making any recommendations. A suitability and risk-tolerance analysis should be performed before a recommendation is made.

An investor is in a low tax bracket and wishes to invest a moderate sum in an investment that will provide some protection from inflation. Which of the following should you recommend?

Mid-cap common stock mutual fund Mid-cap stocks have historically provided good hedges against inflation, making them appropriate for an investor seeking long-term growth and inflation protection.

Which of the following mutual funds would be suitable for an investor who requires tax-exempt dividends?

Municipal bond fund Municipal bonds pay tax-exempt interest. When the portfolio of the mutual fund is composed of municipal bonds, the fund's dividend is also tax exempt.

If you heard a portfolio manager bragging that the portfolio generated excess returns, it means that there was

a positive alpha. The term excess returns is used to describe when an investment has a positive alpha. It means that this manager's portfolio generated returns in excess of what would have been the expected rate of return. A positive alpha means that the manager is doing a good job. Beta measures the extent to which a portfolio is more or less volatile than a stated benchmark. It can be positive or negative but does not reflect returns. In general terms, this portfolio would have a return in excess of the risk-free rate, but that is not nearly specific enough to answer the question.

A measure of a security's sensitivity to market risk is called

beta. Beta reflects a security's volatility in relation to the security's market. Another way to say this is how sensitive a security is to its market's movement.

Industries that tend to be highly sensitive to inflation, deflation, and the ups and downs of business trends would best be described as

cyclical. Cyclical industries are highly sensitive to business cycles (the ups and downs of business trends) and inflationary or deflationary trends. Most cyclical industries produce durable goods, such as heavy machinery, or material such as steel to be utilized by other industries like the automobile industry. Demand for such goods increases when we are in periods of prosperity, but during recessions, the demand for such products declines as manufacturers postpone investments in new capital goods and consumers postpone purchases of these goods.

The investment theory that focuses on the relationships among all the investments in a portfolio is

modern portfolio theory. MPT focuses on the relationships among all the investments in a portfolio. This theory holds that specific risks can be diversified away by building portfolios of securities whose returns are not correlated.