Suitability

A customer, age 30, has an investment objective of capital appreciation; but does not need current income. The BEST asset allocation mix to recommend to this customer is: A 100% common stocks B 50% common stocks; 50% bonds C 10% common stocks; 90% bonds D 100% bonds

The best answer is A. A customer who has an objective of growth; and is not concerned with current income; would invest the majority of funds in common stocks; principally growth stocks. The risk associated with such a strategy is that either the stock market takes a dive; taking these stocks with it; or that some of these companies "lose their way" and perform poorly. You can always use the guideline that the customer should invest his or her "age" in bonds, with the balance in equities. This would give 30% bonds; 70% equities, which is not a choice here! Because the investment objective is "capital appreciation" - as long as the customer is risk-tolerant, Choice A best meets the customer's needs.

An investment strategy where a higher price is paid for a stock based upon expected returns is: A growth investing B value investing C conservative investing D passive investing

The best answer is A. A growth investor buys a stock based upon demonstrated growth in earnings or sales over time. The theory is that such companies can continue to grow rapidly, and therefore should command a higher market price.

The portfolio management technique that uses a market index as a performance benchmark that the asset manager must meet is called: A Passive asset management B Active asset management C Strategic asset management D Tactical asset management

The best answer is A. Active asset management is the management of a portfolio to exceed a benchmark return (say the return of a comparable index fund). The manager's "active" return is any incremental return achieved over the benchmark return. In contrast, passive asset management is simply the management of a portfolio to match the benchmark return (the "passive return"). Active managers believe that underpriced securities can be found in the market and that performance of the benchmark can be exceeded. Passive managers believe that the market is efficient at pricing securities and that one cannot do any better than the "market" return as measured by a relevant index.

A retired customer that has a portfolio of blue chip stocks is looking to supplement his retirement income. An appropriate recommendation would be to: A sell covered calls B sell naked calls C sell covered puts D sell naked puts

The best answer is A. Covered call writing is the most popular retail income strategy in a flat market, and is appropriate for conservative investors that are looking for extra income. The customer sells calls against stock that is already owned, getting premium income. If the stock stays flat, the calls expire and the customer keeps the premium. If the stock rises, the calls are exercised and the stock is called away at no loss to the customer. If the market falls, the calls expire and the customer loses on the stock (which he would have lost on anyway!).

Defensive stocks included in a portfolio's construction will minimize exposure to: A market risk B credit risk C legislative risk D marketability risk

The best answer is A. Defensive stocks are unaffected by the business cycle, so their prices do not move as much (up or down) compared to the movements of the general market. Thus, these investments reduce market risk in a portfolio.

An investor believes that interest rates will be flat or falling into the future; and that prices may deflate. The MOST appropriate investment is: A Long term U.S. Government bonds B Real estate C Gold D Large Capitalization stocks

The best answer is A. In periods of deflation, interest rates fall. A fixed income security's price will go up as interest rates fall. Furthermore, since prices are deflating, the fixed interest payments received are able to buy more and more over time. This is the best investment choice. In times of deflation, real estate prices fall; as do gold prices. Stock prices tend to fall as well, since companies are forced to cut their prices to maintain sales volume.

the use of index funds as investment vehicles for asset classes increases: a. diversification b. expected rate of return c. standard deviation of return d. market risk

The best answer is A. Index funds are broadly diversified, since they hold all of the securities in the designated index. This reduces market risk or the standard deviation of returns. The impact of diversification on rate of return should be one of lowering the rate of return compared to the market average, along with lowering the risk associated with that rate of return.

Customers A, B, C and D have their portfolio assets allocated as follows: ABCD Money Markets15%5%5%0% Treasury Bonds40%10%20%20% Speculative Bonds10%30%10%30% Blue Chip Equities15%15%20%10% Small Cap. Equities10%10%30%5% Emerging Markets10%20%10%30% REITs0%10%5%5% Which customer's portfolio is MOST susceptible to interest rate risk? A Customer A B Customer B C Customer C D Customer D

The best answer is A. Interest rate risk is the risk that rising market interest rates will force bond values to fall. Long term and low coupon bonds are most susceptible to this risk. Thus, Customer A, who has the greatest percentage of assets in Treasury Bonds - which are long term fixed income securities - is most exposed to this risk.

An elderly investor has a short-term investment time horizon, is very concerned about loss of liquidity and is very risk averse. Your main concern when making a recommendation to this client is: A preservation of capital B safety of principal C growth of principal D tax benefit

The best answer is A. Preservation of capital is a concern for client who has no buffer if investment values decline. Such a client cannot afford to lose any money and should only be recommended CDs and money market funds as an investment. Because this client has " liquidity needs," he or she is in this situation. Safety of principal a concern for a client doesn't want his or her principal put at risk - he or she is just averse to taking on risk, but can afford to do so. Such a client could be recommended CDs, money market funds, short term bonds and laddered bond portfolios.

A younger female customer, in the highest tax bracket, already has a substantial investment portfolio that is invested in a balance of quality stocks and bonds. She wants an investment that will provide rapid asset growth and is willing to assume risk. The BEST recommendation would be: A Emerging markets fund B Single stock C Municipal bond D Index fund

The best answer is A. Since this customer already has a balanced quality portfolio and is looking for rapid growth, an emerging markets fund would give the customer the rapid growth she is seeking (along with greater risk).

An assessment of an existing client's financial status shows the following: Name:Mack McCool Age:41 Marital Status:Single Income:$160,000 per year Retirement Plan:Yes - 401(k) and IRA Life Insurance:No Risk Tolerance:High Home Ownership:No - Currently rents at $3,000 per month Client Balance Sheet: Assets Cash on Hand:$20,000 Marketable Securities:$220,000($10,000 in Money Market Fund; $40,000 in Treasury Notes; $70,000 in Blue Chips; $100,000 in Growth Stocks) Retirement Plans:$158,000(Invested in Equity Mutual Funds) Auto:$58,000 Home Ownership:None Liabilities Credit Cards Payable:$10,000 Auto Loan:$50,000 Net Worth: $396,000 The customer has decided to purchase a home instead of renting. The price of the home is $750,000 and the customer intends to put down 20% and obtain a mortgage for the balance. The customer explains that he will need the $150,000 down payment in 30 days. The best recommendation to the customer is to liquidate his: A growth stocks and blue chip stocks immediately in the amount of $150,000 to obtain the necessary cash down payment B growth stocks and blue chip stocks in 30 days in the amount of $150,000 to obtain the necessary cash down payment C retirement accounts in the amount of $150,000 to obtain the necessary cash down payment D Net Worth in the amount of $150,000 to obtain the necessary cash down payment

The best answer is A. Since this customer needs $150,000 in cash within 30 days for the down payment on the house, the best thing to do is to liquidate his stock positions now (not in 30 days) to get the funds for the down payment. If the customer waited 30 days, these stock positions could suffer a market loss, making it hard to fund the down payment. Liquidation of the pension assets makes no sense, since the customer is 41 years old and must pay regular income tax plus a 10% penalty tax on the liquidation. Net Worth cannot be "liquidated" - it is simply the value left over when all assets are subtracted from all liabilities.

Establishing the structure of a portfolio to meet specific financial goals is called: A Strategic allocation B Tactical allocation C Rebalancing D Risk adjustment

The best answer is A. Strategic portfolio management is the determination of the percentage allocation to be given to each asset class - for example a portfolio might be strategically allocated as follows: Money Market Instruments10%Corporate Bonds30%Large Cap Equities50%Small Cap Equities10% Changing these percentages as conditions change is part of ongoing strategic asset management. Tactical asset management is the permitted variance within each allocation percentage. For example, Large Cap equities are allocated 50%, but the manager may be tactically allowed to lower this percentage to, say, 40% or raise it to 60%. Thus, if the manager believes that Large Cap equities will underperform the market, he or she can lower the allocation to 40%; and if the manager believes that they will outperform the market, he or she can raise the allocation to 60%. This gives the manager some ability to "time the market" when conditions are overbought or oversold.

The parents of a high school student are planning to send the child to college in one year. The registered representative should recommend a portfolio that: A tiers Treasury notes over a 5-year time frame B emphasizes municipal bonds of the state where the customer resides C emphasizes investment grade preferred stocks paying a high dividend rate D allocates funds among aggressive growth stocks and large capitalization stocks

The best answer is A. This child starts college in 1 year, and has another 4 years beyond that to finish school. Since college tuition, books, room and board, etc. must be paid yearly, the best choice is to construct a portfolio that tiers very safe securities such as Treasuries, with each tier maturing annually over the time frame that the student will attend school.

A customer in a low tax bracket has just inherited $10,000 and is looking for an investment that will provide current income and liquidity. The BEST recommendation is a: A Corporate Bond ETF B Variable Rate Bond C Municipal Bond Fund D Treasury STRIPS

The best answer is A. The Corporate Bond ETF is liquid because it is exchange traded, and it provides taxable income from its bond investments. Because the customer is in a low tax bracket, lower yielding tax-free municipal bond investments are not appropriate. Variable rate bonds would be good investment if it is expected that interest rates would rise (a point not addressed in this question), but direct bond investments are not that liquid, unless they are Treasury or Agency bonds. Treasury STRIPS are a liquid investment (a ready market exists at all times and they are easy to trade with low transaction costs), but they do not give current income. These are zero-coupon issues.

An investor has $50,000 that she wishes to invest for her child's college expenses, which the child starts next year. The most suitable recommendation to the client is to invest the funds in: A Treasury bills B Intermediate-term bonds maturing in 5 years C Long-term bonds of blue chip companies maturing in 10-30 years D a mutual fund based on the S&P 500 Index

The best answer is A. The client will need access to the funds in 1 year to start paying for college. The client cannot afford an investment loss, so the safest most liquid security listed as a choice is Treasury bills - which have a maximum 1-year maturity limiting interest rate risk and are government guaranteed, limiting credit risk.

A 60-year old customer has a 401(k) account with your firm that has $280,000, mainly invested in growth mutual funds. The customer has an elderly widowed aunt who has died, and her estate attorney has contacted him, notifying him that he has been left $100,000 as an inheritance. The customer is single and has an annual income of $100,000 per year. He wants to use the inheritance to buy a retirement home, which he expects to do in 7 years. Over this investment time horizon, the general expectation is that interest rates will rise. The best recommendation to the customer is to invest the $100,000 in: A money market instruments B 7-year Treasury Bonds C 7-year Treasury STRIPS D 30-year Treasury Bonds

The best answer is A. The customer does not need the funds for 7 years. In this scenario, if interest rates are expected to rise over the 7 year time window, if the customer invests now in a 7 year maturity fixed income security, the customer will lock in a lower rate of return for 7 years. This would be the case with investing in either a 7 year Treasury Bond or a 7 year Treasury STRIPS (zero coupon).If the customer were to invest in money market instruments with very short term maturities, then as they matured (say yearly), the proceeds would be reinvested at higher and higher rates. Thus, the customer would capture higher interest income as rates rise.The worst choice would be investing in 30 year T-Bonds. If market interest rates rise over the next 7 years, the value of the T-Bonds would fall. The customer would need to sell those T-Bonds to get the needed funds to buy the house in 7 years, and those T-Bonds would be sold at a loss if interest rates rose substantially.

A customer owns 1,000 shares of XYZZ stock, purchased at $40 per share. The stock is now at $45, and the customer has become neutral on the stock, but believes that the stock still has good long term growth potential. The client asks her representative for a "conservative recommendation" that will give her a positive portfolio return. The client should be told to: A sell 10 XYZZ 45 Call Contracts B sell 10 XYZZ 45 Put Contracts C sell 1,000 shares of XYZZ and sell 10 XYZZ 45 Call Contracts D sell 1,000 shares of XYZZ and sell 10 XYZZ 45 Put Contracts

The best answer is A. The customer purchased the stock at $40 and it is now trading at $45. The customer is now neutral on the stock, but thinks it is a good long term investment. So the stock should not be sold (eliminating Choices C and D). If the customer sells calls against the stock position (covered call writer), the customer will generate extra premium income in the portfolio. This is a conservative income strategy. The risk here is that if the stock rises immediately, the stock will be called away and the customer will not enjoy the upside gain. If the stock falls, the customer loses on the stock (same as before), reduced by the collected premiums. The sale of puts will also produce premium income. If the stock rises, the puts expire and the customer still owns the stock, but if the stock drops, the short puts will be exercised, obligating the customer to buy the stock (in addition to the shares already owned). Thus, in a falling market, the customer will lose twice as fast! This is not a "conservative" strategy.

What is the BEST investment recommendation for an individual in a high tax bracket who is risk averse? A Municipal bonds B Direct participation programs C U.S. Government bonds D Sovereign government bonds

The best answer is A. The income from municipal bonds is exempt from federal income tax, and historically, these have been very safe investments. Thus, municipal bonds are the best recommendation for this customer. Direct participation programs (limited partnership tax shelters) do not meet the objective of low risk - these can be very risky investments. The income from U.S. Government bonds and sovereign government bonds is federally taxable, so these are not the best of the choices offered for an individual that is in a high tax bracket.

A client with young children wants to invest $1,500 a year to pay for their ongoing educational expenses. Which recommendation would give the customer tax-free growth and tax-free distributions if these distributions are used to pay for educational expenses? A Coverdell ESA B 529 Plan C 457 Plan D UGMA Account

The best answer is A. The maximum annual contribution to a Coverdell ESA is $2,000 per year per child, so this fits the customer's $1,500 per year contribution amount. Coverdell ESA contributions grow tax-deferred and are tax-free as long as they are used to pay for qualified educational expenses - which includes all school levels (grade school, secondary school, post-secondary school, etc.). A 529 Plan allows for much bigger contribution amounts and could only be used for college - until the 2018 tax law changes! Now that up to $10,000 per year can be taken from a 529 Plan to pay for lower level education expenses, the 529 Plan would be a correct answer as well. So if you see a similar question on the exam, it probably has not been updated, and to get the point, choose Coverdell ESA - and also complain at the test center so they clean up the question! Income in UGMA (Custodial) accounts is taxable annually, so they do not fit the customer's needs. Finally, 457 Plans are retirement plans, not education savings plans. Also note that the question does not address the fact that a Coverdell is not available to high-earning individuals.

A customer has $20,000 to invest, but needs immediate access to the funds to pay a variety of bills that will arrive over the next 3 months. The BEST recommendation is for the customer to deposit the funds to a: A Money market checking account B Money market mutual fund C Money market instrument D Treasury Direct account

The best answer is A. This customer needs immediate access to the funds to pay bills as they come due - so a checking account paying money market interest rates is the best recommendation. Money market mutual fund shares must be redeemed to get access to the funds, and this takes time. Money market instruments must be sold to get access to the funds and this takes time as well. A Treasury Direct account allows an investor to buy Treasury securities directly from the U.S. Government without a broker. However, these do not have a checking account feature and are not an appropriate recommendation.

Portfolios A, B, C and D are allocated as follows: ABCD Money Markets15%5%5%0% Treasury Bills40%10%20%20% Speculative Bonds10%30%10%30% Blue Chip Equities15%15%20%10% Small Cap. Equities10%10%30%5% Emerging Markets10%20%10%30% REITs0%10%5%5% Which asset allocation is MOST appropriate for a married client that has 2 children that will start attending college in 4 years, if the client must use income from the portfolio, as well as part of the portfolio capital base, to pay for college tuition expenses? A Portfolio A B Portfolio B C Portfolio C D Portfolio D

The best answer is A. This customer needs to start paying college bills in 4 years, so the asset mix that is readily convertible to cash, and that has minimal risk, is most appropriate. Portfolio A is most heavily weighted in Treasury Bills and cash; whereas the other portfolios are weighted more speculatively.

A 60-year old man seeks an investment that gives safety, liquidity and income. The BEST recommendation would be: A Short-term Treasury Note B Blue Chip Stock C Bank CD D Zero-Coupon Bond

The best answer is A. This customer seeks safety, liquidity and income. Liquidity means that the customer can easily cash-out the investment. A zero-coupon bond gives no income, so we can rule that one out. A bank CD gives income but is not liquid, in the sense that it cannot be sold in the market. Of course, it can be redeemed with the bank issuer, but the customer typically loses a few months of interest to do so. A blue chip stock is liquid, but the dividend income is not as great as that provided by a fixed income security. A Treasury note gives a fixed rate of income and also is highly liquid. It also is AAA rated, so credit risk is minimal. It is the best choice, (though a good argument could also be made for a bank CD!).

A customer has just received a $100,000 inheritance and wants to know what to do with the money until he decides how to use it. He thinks that he will make his decisions on what to do with the funds within 3 months. The BEST recommendation is for the customer to buy: A Treasury Bills B Treasury Notes C Investment Grade Preferred Stock D Long Term Certificates of Deposit

The best answer is A. This customer wants to use the funds within 3 months. A short-term T-Bill maturing in 3 months or less would be the best recommendation. The other investments have longer investment time horizons and could subject the customer to a loss if sold or redeemed early. This could be loss of principal in the case of a T-Note or preferred stock purchase, if market interest rates rise after the purchase date driving their prices down; or the loss of income in the case of early redemption of a CD.

A customer, age 60, is ready to retire, and has an investment objective of preservation of capital and current income. The BEST asset allocation mix to recommend to this customer is: A 100% common stocks B 50% common stocks; 50% bonds C 10% common stocks; 90% bonds D 100% bonds

The best answer is B. A customer who has an objective of both income and capital preservation would invest in a balance of common stocks and fixed income securities. The fixed income securities provide income; while the common stocks provide little current income. The common stock values will tend to increase over time, as the economy grows, preserving the customer's capital. However, if interest rates rise, forcing the value of the fixed income securities down; the common stock portion of the portfolio would be minimally affected. If economic conditions deteriorate, forcing the value of the common stocks down; then interest rates would tend to fall. This would push up the prices of the fixed income securities in the portfolio, countering the loss in value of the common stocks. Thus, a relatively even mix of common stocks and fixed income securities best meets this customer's needs. You can always use the guideline that the customer should invest his or her "age" in bonds, with the balance in equities. This would give 60% bonds; 40% equities, which is not a choice here! However Choice B is the closest to this allocation

A 60-year old customer desires an investment that will provide for retirement income when she reaches age 65. The customer is able to invest $2,000 per month over that time period. Which of the following recommendations is most suitable? A The purchase of income bonds B The purchase of a variable annuity contract C The purchase of government bonds in an IRA account D The purchase of high yield bonds

The best answer is B. A variable annuity contract places no dollar limit on contributions; and the income earned on investments is tax deferred during the accumulation period. Thus, the customer would be allowed to contribute $12,000 per year; and would receive the benefit of the tax deferred build up. At age 65, she could annuitize and convert the value of the account into an annuity contract that would make payments for her life. This is the best choice offered. Income bonds only pay income if the corporation earns enough, so these are not suitable for retirement income. An IRA account only allows a $6,500 contribution for an individual in 2023, so this does not meet the customer's desire to invest $24,000 per year. Finally high yield bonds are speculative, and are not suitable for retirement income.

A 60-year old widow is looking for an investment that will provide safety of principal and a moderate level of income. All of the following recommendations are suitable EXCEPT a(n): A Income mutual fund B Income bond C U.S. Government bond D U.S. Government bond fund

The best answer is B. An income bond is a corporate bond that only pays interest if the corporation earns enough income - so this certainly does not meet the widow's requirement for income. Income mutual funds invest in a diversified portfolio of high interest paying bonds and high dividend paying stocks - this is suitable. U.S. Government bonds or funds holding these securities, provide both income and safety, and thus are suitable as well.

Which bond portfolio construction is based on a phase-in of purchases in installments over time? A Ladder B Bullet C Barbell D Balloon

The best answer is B. Bullets, Bond Ladders, and Barbells are portfolio constructions that are used to limit interest rate risk. The idea behind a bond ladder is to spread bond maturities in a portfolio over fixed intervals, typically 10 maturities in intervals of 2 years each. A typical ladder might have 10 maturities ranging from 2 to 20 years, with an average maturity of around 10 years. Because of this broad diversification by maturity, a rise in interest rates will not impact the portfolio as negatively as compared to a bullet or barbell portfolio construction. If interest rates rise, the loss on the longer term bonds in the portfolio is offset by the fact that shorter term bonds are maturing soon and the proceeds can be reinvested at higher rates. A barbell portfolio only has 2 maturities - a very short term and a very long term - say 2 years and 20 years, for an average life around 10 years (actually 11 years here, but we are simplifying things). The longer term bonds give a higher yield but have higher interest rate risk. This risk is offset by the fact that the 2 year bonds will mature soon and the proceeds can be reinvested at higher rates. The big risk here is that long rates rise sharply as compared to short rates (a steepening of the yield curve). In this scenario, the loss on the long term bonds will be much greater than the fact that the short term bond proceeds can be reinvested in 2 years at somewhat higher rates. A bullet portfolio construction only has a single maturity, typically in an intermediate range of around 10 years. The way that interest rate risk is offset here is that all of the investment is not made at one time - rather, the investment is made in installments at fixed intervals. If market interest rates rise, new investment will be made at higher rates, offsetting any loss on the already purchased bonds. A balloon is a type of bond issue structure, where most of the bonds mature as a "balloon" at a long term maturity date. It is not a type of bond portfolio construction.

A customer who is retired wants to select an investment that is liquid, marketable, and that provides regular income. The BEST choice would be to recommend: A Treasury Bills B Treasury Notes C Preferred Stock D Certificates of Deposit

The best answer is B. Certificates of Deposit are non-negotiable - they are non-marketable, so this does not meet the client's needs. Preferred stock is marketable, but not as marketable as Treasury securities, making Treasury securities the better choice. So we are left with either a T-Bill or a T-Note. Treasury notes pay interest semi-annually; while Treasury Bills do not provide a regular income stream, so a T-Note is the better choice. (One could argue that buying T-Bills at a discount and letting them mature at par and then rolling over the original investment amount into a new T-Bill purchase will also provide an income stream, but this requires continuous reinvestment on the part of the customer. Buying a T-Note is a completely passive investment in terms of the customer's needs.)

The use of multiple asset classes when constructing a portfolio reduces: A regulatory (legislative) risk B market (capital) risk C interest rate risk D purchasing power risk

The best answer is B. Diversification of a portfolio across differing asset classes reduces market risk and also reduces the variability of investment returns. Market or capital risk is simply the risk of losing money. By increasing the number of asset classes in a portfolio, this risk is reduced through diversification. It can be argued that diversification will also reduce the impact of the other risks listed, however, capital or market risk actually encompasses these risks, and thus, is the best choice.

Customer Name:Jack and Jill CustomerAges:62 and 57 Marital Status:Married - 39 years Dependents:None Occupations: Jack - Manufacturing Manager - Dyno-Mite Corp. Jill - Marketing Consultant - Self Employed Household Income:$140,000 Joint Income($100,000 for Jack and $40,000 for Jill) Net Worth:$1,100,000 (excluding residence) Own Home:Yes $420,000 Value, No Mortgage Investment Objectives:Income / Tax Advantaged Risk Tolerance:Moderate Investment Time Horizon:25 years Investment Experience:30 years Tax Bracket:30% Current Portfolio Composition: Cash in Bank:$30,000 Growth Fund:$50,000 Variable Annuity:$50,000 Growth Stocks:$150,000 Retirement Accounts: Jack's IRA:$100,000 invested in growth stocks Jack's 401(k):$600,000 invested in Dyno-Mite Corp. stock Jack's 529 Plan for Grandchild:$20,000 in growth mutual fund To meet the customer's investment objective of tax advantaged income, the BEST recommendation is for the customer to: A immediately liquidate the entire Dyno-Mite position and invest the proceeds in high yield bonds B set a minimum and maximum threshold price to liquidate as much of the Dyno-Mite stock as the customer will permit, and invest the proceeds in high yielding common and preferred stocks C liquidate the IRA without penalty since Jack is past age 59 1/2, and use the proceeds to buy corporate income bonds D consider early retirement, since Jack is old enough to receive Social Security as a means of supplementing income

The best answer is B. Dividend income is currently taxed at the preferential rate of 15%, so investments in high yielding common and preferred stocks will meet the customer's objective of tax advantaged income. High yield bonds come with a high potential risk of default, and this customer has a "moderate" risk tolerance level. If Jack liquidates his IRA, he will have to pay regular income tax on the liquidation amount at his 30% bracket; and income bonds do not give current income (they only pay if the company has enough earnings), so Choice C is particularly bad. If Jack retires now, his income will be cut substantially since he will not have his employment income anymore - and the small annual amount that Social Security pays will not offset this loss - making Choice D really bad as well!

A customer holds a large portfolio of corporate bonds. The customer is worried about capital risk. Which diversification strategy would be least effective to minimize capital risk for this customer? A Diversification among differing issuers in differing states B Diversification among differing denominations C Diversification among differing industries D Diversification among differing maturities

The best answer is B. Effective methods of diversifying away the unsystematic risk of a portfolio would be to diversify among different issuers, different states, and different industries. Thus, if one issuer, industry or economic region has problems, this would only affect a small portion of the portfolio. Diversification among differing maturities also provides a measure of risk management. If market interest rates rise, short term maturities (under 1 year) will decline in price by a minimal amount compared with longer maturities. Thus, a mix of maturities helps to minimize capital risk. Bond denominations have no bearing on diversification.

A customer has a $1,000,000 portfolio that is invested in the following: $200,000 Blue Chip Stocks $200,000 Technology Stocks $200,000 Long Term Investment Grade Bonds $200,000 High Yield Bonds $200,000 REITs The portfolio is LEAST susceptible to: A interest rate risk B political risk C market risk D default risk

The best answer is B. Foreign stocks have political risk - e.g., you have bought stocks in companies based in Russia, and the Russian government decides to nationalize some of your stock holdings! U.S. stock holdings do not have political risk. This portfolio has interest rate risk because it holds long term bonds. It has market risk because it holds stocks. And it has a good deal of default risk because it holds high yield (junk) bonds.

A 45-year old investor has stated investment objectives of income and growth. Which mutual fund could be added to the customer's portfolio? A Government income fund B Sector fund C Equity income fund D High yield fund

The best answer is C. An equity income fund invests in stocks that pay dividends and that have growth potential. Fixed income securities provide income, but no growth, making Choices A and D incorrect. A sector fund invests in stocks in one industry or geographic area - the investment choices are not based on the investment objectives of this client.

Customer Name:Joey Jones Age:30 Marital Status:Single Dependents:None Occupation:VP - Marketing - ACCO Corp. Household Income:$250,000 Net Worth:$110,000 (excluding residence) Own Home:No - Rents Investment Objectives:Aggressive Growth / Early Retirement Investment Time Horizon:20 years Investment Experience:0 years Current Portfolio Composition: 401k:$70,000 Cash in Bank:$40,000 The customer informs you that he just got married and that his wife intends to work for the next 5 years before they think about children. In order to make recommendations to the client due to these changed circumstances, the registered representative should: A ask the customer if he wishes to open a joint account with his wife B update the account profile to include the wife's financial information C obtain the wife's social security number and perform a credit check D update the account file with a copy of the customer's marriage certificate

The best answer is B. Getting married is a life-changing event, both from a personal standpoint and a financial planning standpoint. Since the new wife will be working for 5 years, there will be additional income that can be invested. The financial goals and investment time horizon are likely to change as well. The first step is to update the financial profile based on the new circumstances.

Currently, the yield curve is ascending. A customer believes that the Federal Reserve will start to tighten credit by raising short-term interest rates; and also believes that long term yields will move downwards from current levels because of record demand for long-term Treasury obligations by pension funds. To profit from this, the best recommendation would be to: A buy short term T-Bills and sell long term T-Bonds B sell short term T-Bills and buy long term T-Bonds C buy short term T-Bills and buy long term T-Bonds D sell short term T-Bills and sell long term T-Bonds

The best answer is B. If short term interest rates are expected to rise, then short-term fixed income security prices will fall, so the customer will want to sell these (establishing a short position). If long term interest rates are expected to fall, then long-term fixed income security prices will rise, so the customer will want to buy these (establishing a long position).

A trader maintains a position in a small capitalization stock that has low trading volume. The trader has a high level of which of the following risks? A Market risk B Liquidity risk C Interest rate risk D Business risk

The best answer is B. Liquidity risk is the risk that a security can only be sold by incurring large transaction costs. The easiest securities to sell (meaning the most liquid) are large capitalization issues listed on the NYSE. Small cap stocks that are inactively traded have a high level of liquidity risk. Market risk (also known as systematic risk) is the risk that the market as a whole will drop. This risk affects small cap issues more acutely than large cap issues, but liquidity risk is still the best of the choices offered. Interest rate risk is the risk of price volatility for fixed income securities due to interest rate movements and does not apply to common stocks. Business risk is the risk that an issuer's business declines and, in turn, the value of the issuer's securities declines. This is a consideration, but once again, liquidity risk is the most important of the choices offered.

A 50-year old customer is in a very low tax bracket. She lives in a state that has one of the highest income tax rates. The customer is seeking income and preservation of capital. She has a 10 year investment time horizon. The best recommendation would be a 10 year maturity: A Treasury Bond B investment grade corporate bond C investment grade municipal bond D Treasury STRIPS

The best answer is B. Remember that interest rates are highest for corporate bonds because the interest income is taxable at both the federal and state level. Because this customer is in a low tax bracket, most of this return will be kept after tax - the customer will have the highest after-tax return with the corporate bond investment.Interest rates for Treasury securities are lower than for investment grade corporate securities, because the interest income is exempt from state and local tax. Because this customer is in a low tax bracket, this does not benefit her.Interest rates for municipal securities are the lowest of all, because the interest income is exempt from both federal income tax and state and local income tax (when purchased by a resident of that state). Again, because the customer is in a low tax bracket, this does not benefit her.As a general rule, customers in low tax brackets should invest in fully taxable bonds (corporates); while customers in very high tax bracket should invest in tax-free municipal bonds.

A 70-year old client wants to invest in U.S. Treasury securities. When performing the suitability determination, the client informs the registered representative that he is looking for after-tax income, liquidity, and to avoid market risk. The registered representative should be LEAST concerned with the: A client's tax bracket B client's age C coupon of recommended Treasury securities D maturity of recommended Treasury securities

The best answer is B. Since Treasury securities are the safest security, they are an appropriate recommendation for a 70-year old client. So age really is not a concern with this recommendation. The client's tax bracket is a concern because the income is Federally taxable. If the client is in the highest tax bracket, maybe municipal bonds would be a better recommendation. The coupon of the recommended Treasury securities is important because this client wants income. Regarding the maturity of the recommended Treasury securities, the recommendation of a 30-year bond as opposed to a shorter-term investment could subject the customer to a high level of market risk (loss of market value if interest rates rise). This is another concern, since the customer wants to avoid market risk.

What portfolio construction is most appropriate for a retired married couple, ages 60 and 70, for the wife and husband respectively? A 100% common stocks B 70% common stock/30% bonds C 35% common stock/65% bonds D 100% bonds

The best answer is C. As one gets older, portfolio composition should shift to "safer" assets that generate reliable income. The general rule is to take "100 minus the investor's age" to get the appropriate investment portion to be held in stocks. Since these investors are a married couple, ages 60 and 70, this gives either 30% or 40% of the portfolio holding in stocks; with the remaining 60 - 70% of the holding in bonds. Note that a 100% bond holding is not appropriate because people are living much longer and they need the "extra return" that is provided by stocks that can grow in value, on top of the somewhat lower fixed return provided by bonds.

A registered representative has managed the account of her client for over 10 years. The client recommends her mother to the registered representative as a potential client. Mom, age 65, has just moved out of her house into a smaller condominium, and has netted a $200,000 profit from doing this. The client tells the representative that her mother should invest conservatively. When the representative reaches out to the mother, she tells her that she is retired and that her current pension, plus social security that will be received in a few years, will give her more income than she needs. She wants to invest the $200,000 for growth, with the intention of leaving that money to her grandchildren when she dies. What would be the best recommendation? A Zero-coupon bonds B Aggressive growth fund C Intermediate term bond fund D Corporate income fund

The best answer is B. Since it is the mother's money and the mother's account, the investment objective to be followed is that of the mother - she wants the money invested for growth, with that investment going to her grandchildren when she dies. The investments that provide growth are equities, and an aggressive growth fund would invest more heavily in technology and emerging industries. That is fine for long-term investing, with an investment time horizon that is actually determined by the grandchildren's needs after the grandmother dies. Choices C and D are fixed income funds - they do not offer growth. Zero coupon bonds are not a bad choice but the "imputed income" is taxable each year, even though no money is received from the issuer until maturity. These are really only suitable for retirement accounts, where the holding vehicle is tax deferred. That is not the case with this investment account.

An elderly female client has income from her pension plan and social security that meets her needs. She has extra money available that she would like to use to help fund her favorite 8-year old grandson's college education. Which investment would be the best recommendation? A 10 year Treasury notes B Growth stocks C S&P 500 Index fund D Income bonds

The best answer is B. Since the child will be starting college in 10 years, growth stocks would be the best recommendation. These will grow the greatest amount over 10 years and this is sufficient time for the portfolio to absorb market volatility and recover. The second best choice would be the S&P 500 Index fund, but this would provide a lower return (and lower risk). Treasury notes and bonds give a much lower yield in return for absolute safety. Income bonds are corporate bonds that only pay interest if the corporation has enough "income." These are risky investments. Don't confuse the female client's needs with the child's needs in this question. The female client's needs are covered. This question asks what is appropriate for the child.

A 79-year old customer in the highest tax bracket with $1,000,000 to invest is risk averse. Which investment recommendation would be appropriate? A Money market funds B Municipal bonds C A Dow Jones Industrial Average index fund D Certificates of deposit

The best answer is B. Since this customer is in the highest tax bracket, and appears to be wealthy (with $1,000,000 to invest), tax-free municipal bonds are the best recommendation.

Timing is the important factor in which portfolio management strategy? A Strategic allocation B Tactical allocation C Rebalancing D Indexing

The best answer is B. Strategic portfolio management is the determination of the percentage allocation to be given to each asset class - for example a portfolio might be strategically allocated as follows: Money Market Instruments10%Corporate Bonds30%Large Cap Equities50%Small Cap Equities10% Tactical asset management is the permitted variance within each allocation percentage. For example, Large Cap equities are allocated 50%, but the manager may be tactically allowed to lower this percentage to, say, 40% or raise it to 60%. Thus, if the manager believes that Large Cap equities will underperform the market, he or she can lower the allocation to 40%; and if the manager believes that they will outperform the market, he or she can raise the allocation to 60%. This gives the manager some ability to "time the market" when conditions are overbought or oversold.

A retired married customer, age 74, has a portfolio that is invested in Blue Chip stocks and Treasury bonds that provides current income. The customer is concerned that he is paying a very high Federal and State combined income tax rate. An appropriate recommendation for this customer would be to diversify part of his portfolio into an investment in: A tax-qualified annuities B municipal bonds C securities held in offshore accounts D short-term promissory notes

The best answer is B. This customer is concerned about paying a high Federal income tax rate and a high State income tax rate. By purchasing municipal bonds of his State of residence, the income from those bonds would be free of Federal, State and Local income taxes. This customer is too old to be able to contribute to tax-qualified retirement plans (the cut-off is age 73), making Choice A incorrect. Note that the customer could buy a non-tax qualified annuity, but the income from the annuity would be taxable anyway. The income from securities held in offshore accounts must still be reported on the customer's U.S. tax return and taxes paid in the U.S. on that income. Finally, the income from promissory notes is fully taxable at the Federal and State levels.

A customer, age 25, is looking to invest in securities with the objective of growth to protect against the effect of long term inflation on his portfolio's value. The customer believes that active asset management, along with its higher fees, is not worthwhile. Which recommendation is MOST suitable for this customer? A Long-Term U.S. Government Bond Fund B S&P 500 Index Fund C High Technology Growth Fund D Special Situations Fund

The best answer is B. This customer is looking for long term growth, so common equities are an appropriate investment rather than long term bonds. Since the customer does not believe in active asset management, a passive approach is best - that is, an index fund that has very low ongoing fees.

Customers A, B, C and D have their portfolio assets allocated as follows: A B C D Money Markets 15%5%5%0% Treasury Bonds 40%10%20%20% Speculative Bonds 10%30%10%30% Blue Chip Equities 15%15%20%10% Small Cap. Equities 10%10%30%5% Emerging Markets 10%20%10%30% REITs 0%10%5%5% Which customer's portfolio is MOST susceptible to a cyclical economic downturn? A Customer A B Customer B C Customer C D Customer D

The best answer is C. In a cyclical economic downturn, the hardest hit asset group is stocks. Since earnings fall greatly in a downturn, so do stock prices. Also hard hit are speculative grade bonds, which can default. Portfolio C is the one that is most heavily invested in equities, so it would suffer the most in an economic downturn.

A 60-year old man is looking to create a portfolio that will provide current income and preservation of capital. Which of the following portfolios would be the BEST recommendation to the client? A Long term corporate bonds rated AA or better, high yield corporate bonds and blue chip stocks B Treasury bills, a money market mutual fund and bank certificates of deposit C Treasury STRIPS, corporate income bonds and PO tranches D Growth stocks, defensive stocks and foreign stocks

The best answer is B. This customer wants current income and preservation of capital. Choice A provides current income, but does not provide preservation of capital. Long term bonds are subject to loss of value if interest rates rise; high yield corporate bonds have this risk as well as higher default risk; and blue chip stocks also can lose substantial value in a bear market. Choice B meets both objectives. Treasury bills, money market funds and bank certificates of deposit all provide income (but not high levels of income) and safety of principal. Choice C consists of long term securities that do not provide income, and that also have high levels of interest rate risk. Treasury STRIPS are zero coupon Treasury obligations - they have high levels of interest rate risk and do not provide current income. Corporate income bonds only pay interest if the corporation has enough earnings. PO tranches are CMO tranches that pay "Principal Only." Because mortgage payments in the early years are mostly interest and in the later years are mostly principal, they pay very little in the early years and make most of their payments in their later years. Thus, they are most similar to a long-term zero coupon bond with high levels of interest rate risk. Choice D consists only of common stocks, which do not provide for preservation of capital.

A customer account holds the following: 10%Market Index-Linked CDs 20%Plain Vanilla CMOs 20%ACME Drug Company shares 10%REITs 25%Health Care Sector ETFs 15%Growth Fund Shares This portfolio is MOST susceptible to which risk? A market risk B business risk C interest rate risk D purchasing power risk

The best answer is B. This portfolio is concentrated in the Health Care sector, with 25% of the portfolio being in Heath Care ETFs and 20% in a drug company. A portfolio concentrated in one stock or industry is susceptible to business risk - the risk that the business may turn sour. For drug companies, this can result from existing profitable drugs losing patent protection, so prices and profitability drops; class-action lawsuits for selling dangerous drugs, etc.

The investment strategy that involves paying a lower price for a security based on the expectation that the market is mispricing the issue is: A growth investing B value investing C passive investing D active investing

The best answer is B. Value investing is the selection of equity investments based on finding securities that are fundamentally undervalued in the marketplace. These tend to be solid companies that are currently "out of favor." Value investors look at such fundamental factors as the Price/Earnings ratio; and Price/Book Value ratio to find companies that are undervalued relative to their market sector.

An individual who is 25 years from retirement has $500,000 to invest today. He is risk tolerant and is looking to withdraw $80,000 per year once he retires. Which asset allocation is BEST for this client? A 25% Stocks / 25% Bonds / 25% REITs / 25% Money Markets B 50% Stocks / 40% Bonds/ 10% Cash C 100% Bonds D 100% Stocks

The best answer is B. We are not given the age of this customer, but since he or she is 25 years from retirement, we can guess that the customer is around 40-50 years old. Based on the rule of thumb that "100% minus the customer's age" should be allocated to stocks for growth, a stock allocation of 40-50% is about right. This makes Choice B the best offered. No asset class diversification (Choices C and D) is not the way to go (100% stocks is too risky and 100% bonds is too conservative). The asset allocation offered in Choice A is not weighted heavily enough in stocks and is too conservative to meet the customer's goal. Also note, that while not relevant to the question, if the $500,000 invested earns 5% per year, after 25 years, the account will be worth about $1,700,000. If the customer is now age 65 or so, this would give retirement income for around 20 years at the rate of $80,000 per year.

A registered representative has a client who is an exceptionally intelligent doctor of medicine. The doctor does most of his own investment research and makes many of his own investment decisions. The doctor is married, but his wife is not involved in the investment planning or decision-making process. When constructing a portfolio for this client, the registered representative should: A choose the investments in the portfolio based solely on the research conducted by the doctor B balance the portfolio in a manner that addresses the doctor's investment strategy and that customizes the strategy to meet the needs of the spouse C charge fees on the assets held in the portfolio that were chosen by the representative without using the doctor's research D disregard the doctor's research because the doctor is not properly licensed to act as a representative

The best answer is B. When constructing a portfolio for a client, the representative can take into account a customer's special expertise in a given area when selecting specific investments. For example, a doctor might have a special insight into the sales prospects for a medical device manufacturer, and could tell the representative that he wants to invest in this company. It is the role of the representative to review this investment decision and, if appropriate, to make sure that it is not overweighted in the portfolio. Because the doctor is married, the representative should construct the portfolio to meet both the needs of the doctor and his wife.

If one asset class greatly underperforms another class in an asset allocation plan, the portfolio must be: A renegotiated B rebalanced C repositioned D realigned

The best answer is B. When investment performance varies over time from one asset class to another, the target percentage allocations will shift from their optimal setting. To bring the portfolio back to these targets, it must be rebalanced - that is, a portion of the overperforming class(es) must be sold off and the proceeds reinvested in the underperforming class(es).

A self-employed individual makes $200,000 per year. To which type of retirement plan can the maximum contribution be made? A Traditional IRA B Roth IRA C SEP IRA D SIMPLE IRA

The best answer is C. A SEP (Simplified Employee Pension) IRA is usually set up by small business because it simplifies all of the recordkeeping associated with retirement plans (though there actually no limit of the size of the company to open up a SEP IRA). Contribution amounts made by the employer cannot exceed 25% (statutory rate; effective rate is 20%) of the employee's income, up to a maximum of $66,000 in 2023. SIMPLE IRAs also are relatively "simple" for a business to set up, but they only allow a maximum contribution of $15,500 (in 2023). So the SEP IRA is better. In contrast, the maximum contribution to either a Traditional or Roth IRA in 2023 is $6,500 (plus an extra $1,000 catch-up contribution for individuals age 50 or older). Also note that because this individual is a high-earner, he or she cannot open a Roth IRA.

Which bond portfolio where all investment is made up front would be MOST negatively affected by a sharp rise in interest rates? A Ladder B Bullet C Barbell D Balloon

The best answer is C. Bullets, Bond Ladders, and Barbells are portfolio constructions that are used to limit interest rate risk. A bullet portfolio construction only has a single maturity, typically in an intermediate range of around 10 years. The way that interest rate risk is offset here is that all of the investment is not made at one time - rather, the investment is made in installments at fixed intervals. If market interest rates rise, new investment will be made at higher rates, offsetting any loss on the already purchased bonds. The idea behind a bond ladder is to spread bond maturities in a portfolio over fixed intervals, typically 10 maturities in intervals of 2 years each. A typical ladder might have 10 maturities ranging from 2 to 20 years, with an average maturity of around 10 years. Because of this broad diversification by maturity, a rise in interest rates will not impact the portfolio as negatively as compared to a bullet or barbell portfolio construction. If interest rates rise, the loss on the longer term bonds in the portfolio is offset by the fact that shorter term bonds are maturing soon and the proceeds can be reinvested at higher rates. A barbell portfolio only has 2 maturities - a very short term and a very long term - say 2 years and 20 years, for an average life around 10 years (actually 11 years here, but we are simplifying things). The longer term bonds give a higher yield but have higher interest rate risk. This risk is offset by the fact that the 2 year bonds will mature soon and the proceeds can be reinvested at higher rates. The big risk here is that long rates rise sharply as compared to short rates (a steepening of the yield curve). In this scenario, the loss on the long term bonds will be much greater than the fact that the short term bond proceeds can be reinvested in 2 years at somewhat higher rates. A balloon is a type of bond issue structure, where most of the bonds mature as a "balloon" at a long term maturity date. It is not a type of bond portfolio construction.

Which of the following investment portfolios is MOST liquid? A An aggressive growth fund B A U.S. Government bond fund C A money market fund D An income fund

The best answer is C. By definition, a money market instrument is liquid. They are readily traded at a discount equal to the market rate of interest because any purchaser knows that he or she will be paid when it matures in the near future. Long term governments are not as liquid - there is not nearly as much long term government debt outstanding as there are T-Bills (the biggest of the money market instruments), making these somewhat less liquid. Income funds are composed mainly of high yielding preferred stocks and corporate bonds. These are not as liquid as U.S. Government issues. Finally, aggressive growth stocks are the least liquid of the choices offered, since they are not traded on the NYSE, but rather OTC - which is a less liquid marketplace.

A customer who is retired wants to select an investment that is marketable, and that provides the highest rate of return. The BEST choice would be to recommend: A Treasury Bills B Treasury Notes C Investment Grade Preferred Stock D Certificates of Deposit

The best answer is C. Certificates of Deposit are non-negotiable - they are non-marketable, so this does not meet the client's needs. Preferred stock is marketable, and Treasury securities are extremely marketable, so any of these meet this requirement. However, investment grade preferred stock issued by a top-shelf corporation will provide a higher investment return than ultra-safe Treasury securities, making this the best choice

Diversification among multiple asset classes reduces the: I market risk of the portfolio II marketability risk of the portfolio III standard deviation of portfolio returns A I only B II and III only C I and III only D I, II, III

The best answer is C. Diversification of a portfolio reduces market risk; and also reduces the variability of investment returns. It does not affect marketability risk - that is, how difficult is it to liquidate given position in the portfolio

Diversification of a portfolio among asset classes: A increases the rate of return achieved over the investment time horizon B reduces the rate of return achieved over the investment time horizon C reduces the variability of the rate of return over the investment time horizon D increases the variability of the rate of return over the investment time horizon

The best answer is C. Diversification reduces the variability of investment returns over the investment time horizon. In a diversified portfolio, some investments will be under-performing and some will be over-performing, tending to average out the rate of return. Thus, variability of the rate of return is reduced.

A customer account holds the following: 20%U.S. Stock Fund 20%International Stock Fund 40%Emerging Markets Stock Fund 20%Investment Grade Corporate Bonds Which asset classes are subject to currency risk (exchange rate risk)? I U.S. Stock Fund II International Stock Fund III Emerging Market Stock Fund IV Investment Grade Corporate Bonds A I and III B I and IV C II and III D II and IV

The best answer is C. Exchange rate, or currency risk, is associated with holding foreign investments, such as the International and Emerging Markets investments. The value of these holdings must be converted to U.S. dollars. If the foreign currency depreciates against the U.S. dollar (meaning that the U.S. dollar strengthens), then when the investment is converted in value from the local currency to the U.S. dollar, it "buys" fewer U.S. dollars. Thus, the reported value in the U.S. of these holdings will decrease.

If a portfolio manager's market sentiment is bearish, then which of the following are appropriate actions? I Cash positions will be decreased II Cash positions will be increased III Investments in stock positions will be decreased IV Investments in stock positions will be increased A I and III B I and IV C II and III D II and IV

The best answer is C. From a "market sentiment" standpoint, a portfolio manager will increase his or her cash position; and decrease the portion of funds invested in securities, when he or she is bearish on the market. Conversely, if the manager is bullish, he or she will decrease the cash position and increase the invested portion of the portfolio.

A growth investor would consider a company's: A Price / Earnings ratio B Price / Book Value ratio C Stock price appreciation rate D Market share

The best answer is C. Growth investors select investments based simply on growth in earnings or growth in market price; on the assumption that these will always be the best performing investments. Value investors invest in undervalued companies - as measured by low Price/Earnings ratios and low Price/Book Value ratios - that have good market prospects. Thus, they also consider product line, market share, management, etc.

The time horizon to be used when constructing a portfolio for a person who will retire in a few years is the: A time remaining until retirement B expected time till the person cannot care for him or herself C expected lifetime of that person D expected lifetime of that person's beneficiaries

The best answer is C. If a portfolio is being constructed to fund a person's retirement in a number of years, it must be able to provide retirement income to that person for his or her lifetime. This is the appropriate time horizon.

A customer has a $1,000,000 portfolio that is invested in the following: $250,000 Large Cap Growth Stocks $250,000 Large Cap Defensive Stocks $250,000 U.S. Government Bonds $250,000 Investment Grade Corporate Bonds During a period of economic recession, the securities which will depreciate the least are likely to be the: I Large Cap Growth Stocks II Large Cap Defensive Stocks III U.S. Government Bonds IV Investment Grade Corporate Bonds A I and III B I and IV C II and III D II and IV

The best answer is C. In a period of economic recession, defensive companies (which are those that are unaffected by the general economy, such as drug companies) remain profitable and their stock prices usually do not decline. In contrast, growth company profits can be hard hit by a recession, so their stock prices fall. In times of recession, investors "flee to safety." They sell their corporate bonds and use the proceeds to buy safe U.S. Government issues. This pushes corporate bond prices down, and U.S. Government bond prices up.

An investor believes that interest rates will be rising in the future. The MOST appropriate investment is: A Long term U.S. Government Bonds B Real Estate C Money Market Instruments D Blue Chip Stocks

The best answer is C. In a period of rising interest rates, long term bond prices fall, as do stock prices. Real estate prices also fall because mortgage loans are more expensive. Money market instruments are best because the funds are invested short term, and as the money market instruments mature, the proceeds are reinvested at higher interest rates.

Customer Z is a single 26-year-old man who earns $125,000 annually. He informs you that he is getting married and that his new wife's income of $75,000 per year will put them into the highest federal tax bracket. The couple will have investable income of $25,000 per year. The couple wishes to buy a house in 5 years that will be substantially more expensive than the condominium in which they currently reside. To meet the customer's needs for the large cash down payment in 5 years and to reduce taxable income, the BEST recommendation is to: A open a margin account and invest in income bonds B open an Individual Retirement Account and invest in tax-deferred variable annuities C open a cash account and invest in mutual funds holding high yielding common and preferred stocks D open a trust account and invest in Treasury STRIPs

The best answer is C. Income bonds are not a reliable source of income or principal repayment (since payment depends on earnings of the issuer), and the interest is 100% taxable. Tax-advantaged investments like variable annuities should never be purchased in tax-deferred accounts. The annual accretion on Treasury STRIPS is taxable, unless the bonds are held in a tax-deferred account. Only Choice C makes sense - since cash dividends are taxed at a maximum rate of 15% (reducing taxable income), and the mutual fund shares can be easily liquidated in 5 years to make the house down payment.

Which of the following is NOT a suitable investment for Individual Retirement Accounts? A U.S. Government bonds B Corporate bonds C Municipal bonds D Zero coupon bonds

The best answer is C. Municipal bonds are not suitable for tax deferred accounts such as pension plans and IRAs. These accounts are already tax deferred, so putting taxable investments in them that generate a higher rate of return than municipals is appropriate. Furthermore, these higher returns will compound tax deferred as long as they are held in the pension account. Municipals give a lower rate of return than governments or corporates because of the federal tax exemption on their interest income. They are a bad choice for retirement accounts. Finally, zero-coupon governments and corporates give a higher rate of return than municipals, since the annual accretion of the discount on these is taxable; and they are great investments to put in a retirement account; since then the annual accretion of the discount will build tax-deferred.

Customers A, B, C and D have their portfolio assets allocated as follows: A B C D Money Markets15%10%5%0% Treasury Bonds40%20%10%20% Speculative Bonds10%20%10%30% Blue Chip Equities15%15%25%10% Small Cap. Equities10%10%35%5% Emerging Markets10%20%10%30% REITs0%5%5%5% Which asset allocation is MOST appropriate for a risk-tolerant young customer with a long investment time horizon? A Customer A B Customer B C Customer C D Customer D

The best answer is C. Over the long term, equities provide the greatest overall return, along with higher risk, than fixed income securities. For an investor that is young and risk tolerant, a portfolio allocation that is heavily weighted in equities is the best recommendation (which is the case with Customer C with 75% of the portfolio in equities).

A customer has the following investment mix: 25%Growth Stocks 25%U.S. Government Bonds 25%Investment Grade Corporate Bonds 25%Speculative Stocks Which asset classes have the greatest reinvestment risk? I Growth Stocks II U.S. Government Bonds III Investment Grade Corporate Bonds IV Speculative Stocks A I and III B I and IV C II and III D II and IV

The best answer is C. Reinvestment risk is associated with fixed income securities that make periodic payments to investors. Bond interest payments are made every 6 months, and the investor that receives these will "reinvest" them into additional bond holdings. If interest rates are falling over the long term, then these interest payments are reinvested at lower and lower rates, resulting in an "averaging down" of the portfolio's rate of return. This is reinvestment risk. Securities that do not make periodic interest or dividend payments do not have this risk. Growth stocks and speculative stocks generally do not pay dividends, so they have no reinvestment risk.

Strategic portfolio management is the selection of the: A securities in which to invest B asset classes in which to invest C target asset allocation for each asset class selected for investment D variation permitted in target asset allocation for each asset class selected for investment

The best answer is C. Strategic asset allocation is the determination of the target percentage to be allocated to each asset class (e.g., 25% Treasuries; 25% Corp. Debt; 50% Equities). Tactical asset allocation is the permitted variation around each of the chosen percentages - for example, even though Equities are targeted at 50%, this might be allowed to be dropped to as low as 40%, or as high as 60%, depending on market conditions.

Which of the following would be least important in determining the level of diversification in a corporate bond portfolio? A Bond ratings B Industries represented in portfolio C Domicile of issuers D Maturities of the bonds in the portfolio

The best answer is C. The "domicile" of an issuer is the state where the issuer legally resides. It has no bearing on the quality of the issuer's securities. Bond rating, type of industry, and maturity would all be considered when examining the diversification of a bond portfolio.

A couple wants to invest for the college education of their 4 children. The children are 1, 5, 10, and 16 years old. What is the biggest suitability concern when making an investment recommendation? A Tax deferral B Investment growth C Investment time horizon D Liquidity

The best answer is C. The oldest child is 16 years old and will be entering college in 2 years. Any investment recommendation must take into account that liquidation of positions to pay for college must commence in 2 years. This is the investment time horizon that must be used for any recommendation. Liquidity is also a concern - any assets chosen as an investment must be able to be liquidated quickly when funds are needed in 2 years. However, first we must choose assets with a 2-year investment time horizon, and then second, these must be assets that can be liquidated easily (little liquidity risk)

What would be the BEST investment recommendation for a single mother who is in a low tax bracket who wishes to start saving for her young child's college education? A Municipal bonds B Treasury bills C Growth stocks D Speculative stocks

The best answer is C. There is not much information here, but since the child is young, over the long term, growth stocks offer the best investment to fund the kid's college education - since they offer growth over time. Speculative stocks are a reasonable second choice, but they are high risk, so all the money for college could be lost if the speculative investments turn sour. Municipal bonds are not appropriate, since the customer is in a low tax bracket. T-bills are the safest investment, but they are short term and give the lowest yield.

A young couple wishes to save $50,000 as the down payment on a new house that they plan to purchase in the next 6 months. Which of the following are suitable investment vehicles to recommend to the couple? I Money market funds II Bank certificates of deposit III Blue chip stocks IV Commercial paper A I only B II and III C I, II and IV D I, II, III, IV

The best answer is C. This couple needs $50,000 cash in 6 months. Clearly, money market funds and bank certificates of deposit are suitable. Blue chip stocks are not suitable, since they are subject to market risk. Commercial paper is usually not marketed to individuals; it is mainly an institutional market. However, some corporations sell commercial paper directly to customers in minimum $10,000 units via their websites. This is another very safe short term investment, and is suitable.

A customer with additional funds to invest seeks income, but thinks his portfolio is too heavily weighted in debt securities. The BEST recommendation to the customer is: A Treasury securities B Municipal securities C Preferred stocks D Industrial development bonds

The best answer is C. This customer does not want to buy any more bonds. Preferred stock is a fixed income equity security, so it meets the customer's requirement that the recommendation not be a bond; and it pays a fixed dividend rate (similar to bonds) for income. Treasury and municipal securities are all debt instruments, and are municipal industrial development bonds.

An 85-year old retired client has living expenses of $15,000 per year. His portfolio is currently allocated: 50% Money Market Fund 40% Treasuries Yielding 1.20% 10% Equities The customer is complaining that he is not earning enough from his portfolio to meet monthly living expenses. The BEST recommendation to the customer is to: A do nothing B wait until interest rates rise before making any changes C liquidate half of the money market fund and invest it in 5 year corporate debentures yielding 2.70% D liquidate half of the money market fund and invest it in commodity futures

The best answer is C. This customer is looking for more income to live out his remaining years. The only choice offered that provides more income is Choice C.

Customer Name:Jane Smith Age:41 Marital Status:Single Dependents:1 Child, Age 7 Occupation:Corporate Manager Household Income:$120,000 Net Worth:$150,000 (excluding residence) Own Home:Yes Investment Objectives:Saving For College; Saving for Retirement Investment Experience:10 years Current Portfolio Composition: $140,000 Market Value 50% Money Market Fund 50% Corporate Bonds This client has just inherited $100,000 and wants to use the funds to pay for her child's college education. She also has asked whether her current portfolio meets her goal of maximizing saving for retirement. Based on this information, the best recommendation to the client is to: A deposit the additional $100,000 to the money market fund to ensure that the funds will be available to pay for college B open a 529 Plan with the $100,000 inheritance, investing in a growth fund; and liquidate both the money market fund holding and the corporate bond holdings, using the proceeds to buy growth stocks C open a 529 Plan with the $100,000 inheritance, liquidate $50,000 of the money market fund and $50,000 of the corporate bonds, using the proceeds to buy growth stocks D open an UGMA account with the $100,000 inheritance investing in growth stocks

The best answer is C. This customer is looking to use her $100,000 inheritance to fund her kid's college education. A 529 plan is best for this, since it grows tax-deferred and distributions used to pay for college are tax free. Since the kid is only age 7, a growth fund investment is most suitable, since the child has 10-11 years before college starts. Note that a UGMA (custodial account) does not allow for tax deferral, so it is not the best choice. The customer also wants to save for retirement and she is only age 41, so she has at least 25 years to go before retiring. Her portfolio is way too conservatively invested for someone this age - it will grow at a very low rate since it is only invested in money market funds and corporate bonds. At this age, the customer should be invested 60-70% in growth stocks, with the balance in safer investments. So the best choice is to liquidate most of the money market fund and corporate bond holding, and invest the proceeds in growth stocks (Choice C). Choice C still leaves the customer with $20,000 in the money market fund (for emergencies) and she still has a small investment in corporate bonds ($20,000), but the remaining $100,000 will now be in growth stocks. This is a good mix for a 41 year old person looking to save for retirement. Also note that Choice B is not the best choice because the customer should still have a small portion of her portfolio in safer and more liquid securities (for emergencies) like a money fund.

A Registered Investment Adviser has a retired client who wishes to put aside funds for the purchase of a car 5 years from now. Preservation of capital is important to this client. The RIA should recommend investments in: I Money market funds II Bank certificates of deposit III 5 Year Treasury Bonds IV 30 Year Treasury STRIPS A I and II only B III and IV only C I, II, III D I, II, III, IV

The best answer is C. This customer needs funds in 5 years and preservation of capital is important to the client. Money market funds and bank certificates of deposit are clearly suitable. The 5 year Treasury Bond works as well, since the funds are needed in 5 years and this bond will mature at that time. The 30 year Treasury STRIPS is clearly unsuitable, since in 5 years, its value may have dropped sharply if interest rates rise (bonds with low coupons and long maturities are most affected by interest rate risk).

Which of the following are appropriate investment strategies for a client with a 20-year time horizon? I Holding less cash II Holding more stock III Holding less bonds A I only B II only C I and III D I, II, III

The best answer is D. This client has a long (20-year) time horizon for holding the investments. In such a case, equity securities are the best investment, earning the highest returns historically over long time periods. Cash would be least suitable; bonds are not much better over the long-term, especially if there is inflation. The best portfolio would be one predominantly holding stocks.

A retired customer has an existing stock portfolio held in a cash account. He has heard that "leveraging" his portfolio can increase his return. The portfolio holds blue chip stocks that pay current dividends. He wants to transfer the positions to a margin account and use them as collateral to buy more stocks of the same blue chip companies. Which statement is TRUE? A This is an appropriate strategy that will increase the customer's income B This is not an appropriate strategy because the customer's tax liability will increase if the securities appreciate and are sold C This is not an appropriate strategy because the customer's income will decline D This is an appropriate strategy because the customer has the potential for larger capital gains

The best answer is C. This customer needs income. If he margins the blue chip stock positions to "double up" on the amount of stock owned (since Regulation T margin is 50%), this does not come for free! He is borrowing the extra money to buy the new shareholding, using his existing stock as collateral, and he must pay interest on the loan. The interest charge will eat up any dividends that the stocks pay - so there goes his income!

Client A's portfolio consists of the following: Equities:85% Fixed Income:10% Cash:5% The breakdown of these holdings is: Equities 35% DEFF Total Market Index Fund 30% 2,100 shares of ABCD 25% 3,100 shares of XYZZ 10% PDQQ International Small Cap Growth Fund Fixed Income: 75% Investment Grade 25% Speculative Cash: 100% Money Market Fund Client A is 55 years old, single with no children. He is beginning to think about retirement and wishes to modify his portfolio so that he can start receiving an assured income stream starting at age 65. Which recommendation would be the BEST choice to meet the customer's changed investment objective? A The ABCD and XYZZ stock holdings should be liquidated in full immediately, with the proceeds invested in 10 year income bonds of companies in special situations B The DEFF Total Market Index Fund holding should be liquidated in full immediately, with the proceeds invested in 10-30 year Treasury bonds C The customer should set minimum and maximum threshold prices at which the ABCD and XYZZ stock positions are to be liquidated; and if this occurs, the proceeds should be invested in 10-30 year maturity Treasuries D The customer should liquidate the ABCD and XYZZ stock holding to purchase 10, 15 and 20 years STRIPs that will mature in even installments

The best answer is C. This customer's portfolio is 85% invested in stocks and only 15% invested in bonds and cash. Since he is looking for income 10 years from now, more of the portfolio mix must be allocated to bond investments. Immediate liquidation of some of the stock investments might cause the customer to sell at a loss; or to miss out on potential stock gains that he or she anticipates. Setting minimum and maximum threshold prices to begin liquidating the stock investments, and reallocating the proceeds to safe income generating bond investments, is the best way to meet the customer's income objective.

Customer Name:John Doe Age:41 Marital Status:Married Dependents:1 Child, Age 13 Occupation:Engineer Household Income:$140,000 Net Worth:$240,000 (excluding residence) Own Home:Yes Investment Objectives:Total Return / Tax Advantaged Investment Experience:12 years Current Portfolio Composition: 8% Common Stocks 62% Corporate Bonds 30% Money Market Fund This client has just been informed that he has been promoted and will be earning $190,000 per year instead of $140,000 per year. The customer intends to use this extra income to fund his 13-year old child's college education. Based on the customer's existing asset mix, the best recommendation would be for the customer to invest the extra $50,000 per year into a(n): A money market fund B income fund C growth fund D inflation protected fund

The best answer is C. This customer's portfolio is 92% invested in cash and bonds with only 8% in equities. Since he has 6 years to fund the child's education, growth stocks would help balance the portfolio and enhance the overall return.

A 60-year old retiree is in a very low tax bracket. He has a low risk tolerance and wishes to make an investment that will provide income. Which is the BEST recommendation? A Mid-cap common stock B Municipal bond C Bank CD D Treasury STRIPS

The best answer is C. This elderly retiree is in a low tax bracket and seeks income with low risk.Mid-cap common stocks may, or may not pay a dividend. Their income stream is not reliable, so this does not meet the objective of income.Treasury STRIPS are zero-coupon Treasury securities - they are safe, but they do not provide annual income.Municipal bonds are not appropriate for a low tax bracket investor, since the bonds are exempt from Federal income tax, and the market interest rate is lower than that for taxable investments because of this. Municipal bonds are only suitable for high tax bracket investors, where the exemption from federal tax has real value. Thus, we are left with bank certificates of deposit as the only viable choice. They are low risk and will provide income with a higher "after-tax" return for a person in a low tax bracket than equivalent maturity municipal investments.

A new client with no other investment assets has just come into an inheritance of $500,000 of ABCD stock, a blue chip company listed on the NYSE. As the adviser to this customer, your IMMEDIATE concern should be: A whether the company is a candidate for delisting B the possibility that the value of ABCD stock may decline sharply C the lack of diversification of the customer's investment D whether the customer paid any estate tax liability due

The best answer is C. This is the client's sole investment. Because this is a blue chip company, it is not likely to be delisted. It is also not likely to suffer a sharp price decline, though this could occur. The immediate concern should be the customer's lack of diversification. If the customer were to sell a portion of the ABCD stock and reallocate it to other investments, the client will reduce overall risk.

A young widow who works has a $750,000 net worth and a securities portfolio valued at $200,000. The current asset allocation of the portfolio is 80% equity securities; 8% fixed income securities; and 12% money market securities. In which circumstance should she consider reallocating her portfolio? A If she remarries and her new husband is quite wealthy B If she remains employed at the same job C If she becomes unemployed during a recessionary period D If she remarries and her new husband has young children

The best answer is C. This question is very subjective and arguments could be made for each of the choices offered. However, the best answer is Choice C. If she loses her job in a recession and has no spouse, it might be hard to find another job. She will need to use money in the securities portfolio to live and an 80% allocation in equity securities will expose her to stock losses due to the recession and also not give current income. She should reallocate the portfolio, liquidating a good chunk of the equities position and increasing the money market fund allocation so that she can draw on it for income.

A customer has a term loan that is maturing in 3 years in the amount of $100,000. The customer has the cash now, and wants to know the best investment to make for the 3 years until the loan payment is due. The BEST recommendation is to buy: A Blue chip stocks B AA rated debentures with a 3 year maturity C Treasury notes maturing in 3 years D AA general obligation bonds maturing in 3 years

The best answer is C. Treasury securities have no credit risk, so this is the best choice. The customer knows he will get back the $100,000 in 3 years, plus will have earned interest every 6 months until maturity. A corporate debenture that is rated AA sounds good, but companies can get into business trouble quickly and the bonds could be downgraded in 3 years. AA general obligation bonds are safe (though not as safe as Treasuries), but their yield is lower, so they are not the best choice. Stocks prices can be volatile, so this is another bad choice.

A constant ratio investment plan is one which: A invests a fixed percentage amount periodically in equity securities B invests a fixed percentage amount periodically in debt securities C maintains a fixed percentage amount of a portfolio's assets in equities D maintains a dollar amount of a portfolio's assets in debt

The best answer is C. Under a constant ratio plan, a portfolio manager sets a fixed percentage level (say 70% of total asset value) to be maintained in equity securities. If the value rises above 70%, the excess is invested in debt securities. Conversely, if the equity market value drops below 70% of the portfolio, bonds are liquidated and invested in equities to bring the equity balance to the constant 70%.

A value investor would consider all of the following EXCEPT a company's: A Price / Earnings ratio B Price / Book Value ratio C Stock price growth rate D Market share

The best answer is C. Value investors invest in undervalued companies - as measured by low Price/Earnings ratios and low Price/Book Value ratios - that have good market prospects. Thus, they also consider product line, market share, management, etc. Growth investors select investments based simply on growth in earnings or growth in market price; on the assumption that these will always be the best performing investments.

A self-employed client has an annual income of $200,000 and is in a high tax bracket. He is not covered by a retirement plan and would like to make the maximum contribution to one to reduce his taxable income. He believes that he will be in a lower tax bracket once he retires. The BEST recommendation is to contribute to a: A Traditional IRA B Roth IRA C 401(k) D SEP IRA

The best answer is D. A Roth IRA does not work for 3 reasons - the maximum contribution is only $6,500 (in 2023); the contribution is not deductible; and this person is a high earner and cannot use a Roth. He can use a Traditional IRA, but it only allows for a maximum contribution of $6,500. A 401(k) plan allows for a larger deductible contribution ($22,500 in 2023), but it is really designed for big companies because it is expensive to set up and run. It does not really work for self-employed persons. A SEP (Simplified Employee Pension) IRA is designed for self-employed individuals and small employers. It is easy to set up and administrate and it allows for maximum contribution equal to 20% of income (25% statutory rate), capped at $66,000 in 2023. It would allow this self-employed individual to make a 20% x $200,000 = $40,000 deductible contribution.

A customer, age 40, is concerned that the inflation rate is ready to explode, and wishes to invest funds to protect against the consequences of such an event. The BEST asset allocation mix to recommend to this customer is: A 100% common stocks B 100% bonds C 50% common stocks; 50% bonds D 100% money market instruments

The best answer is D. A customer who believes that substantial inflation may occur in the future would invest principally in money market instruments. If there is persistent inflation, this forces interest rates up. Thus, the value of long term bonds and preferred stocks drops. At the same time, if there is inflation, stock prices drop, since the cost of doing business tends to inflate faster than companies can raise prices, putting pressure on profit margins. The safe harbor in times of inflation is money market instruments, which are not affected by these forces.

Active portfolio management is: A buying and holding the investments chosen by the Registered Representative B determining the securities to be bought or sold based on investment research performed by the Registered Representative C managing a portfolio to meet the performance of a benchmark portfolio D managing a portfolio to exceed the performance of a benchmark portfolio

The best answer is D. Active portfolio management practitioners believe that they can outperform a benchmark portfolio (say an index fund) by finding undervalued securities in the marketplace. Passive portfolio managers, in contrast, believe that the market is "efficient" in pricing securities so that one cannot find "undervalued" securities. Passive portfolio managers simply buy index funds (which are managed to match the composition and performance of the chosen index).

An older customer, age 63, who is in the lowest tax bracket, seeks an investment that will give him an income stream. The BEST recommendation would be: A Variable annuity B Municipal bond C Certificate of deposit D AAA Corporate bond

The best answer is D. Because the customer is in a low tax bracket, you would not recommend the municipal bond. Most variable annuity separate accounts are invested in equities for growth to supplement other forms of retirement income. Because they are equity funds, they do not give much of an income stream. The CD and the AAA Corporate bond both provide income, which is the stated objective. However, the AAA corporate bond is top-rated and will give a higher income stream than a CD. This is the best choice. Note that the question tells us nothing about risk tolerance, which would certainly be helpful, but this is typical of "test-like" questions!

When making a recommendation of corporate commercial paper to a customer, which risk is the MOST important consideration? A Inflation (purchasing power) risk B Call risk C Market risk D Credit risk

The best answer is D. Credit risk is the risk that the issuer cannot make interest and principal payments as due. Since Commercial Paper is unsecured, investors are buying a security backed only by "faith and credit" - so credit quality is the major consideration. Because commercial paper is short term, there is minimal purchasing power risk and market risk. Over a short term time horizon, short term interest rates cannot rise much. Commercial Paper, like all money market instruments, is non-callable so this risk is not a factor.

A customer holds a large portfolio of corporate bonds. The customer is worried about capital risk. Which diversification strategy would be least effective to minimize capital risk for this customer? A Diversification among differing issuers in differing states B Diversification among differing industries C Diversification among differing maturities D Diversification among differing coupon rates

The best answer is D. Effective methods of diversifying away the unsystematic risk of a portfolio would be to diversify among different issuers, different states, and different industries. Thus, if one issuer, industry or economic region has problems, this would only affect a small portion of the portfolio. Diversification among differing maturities also provides a measure of risk management. If market interest rates rise, short term maturities (under 1 year) will decline in price by a minimal amount compared with longer maturities. Thus, a mix of maturities helps to minimize capital risk. Diversification among different coupon rates would be the least effective means of minimizing risk. As a generalization, the lower the coupon rate, the more volatile the bond's price movements in response to interest rate movements. However, if market interest rates rise, all of the bonds in the portfolio will drop in value (with the lower coupon rate bonds dropping faster). Thus, this type of diversification really does not protect much against market risk.

A married couple has a teenage child who has expressed interest in going to a vocational school. They both work, have a moderate level of income and would like to save a modest amount each year for this purpose without the concern of paying taxes on annual account earnings. The best recommendation to this couple is to make an annual contribution to a(n): A 529 Plan B UTMA Account C HSA D Coverdell ESA

The best answer is D. Funds in a Coverdell ESA (Education Savings Account) can be used for any type and level of education, so the funds can be used to pay for vocational school. The maximum annual contribution is $2,000, so this matches the couple's desire to save a "modest" amount each year. There is no deduction for the contribution, but the account grows tax-deferred, and distributions to pay for qualified educational expenses are not taxed. Also note that Coverdell ESAs are not available to high earners, which is not a problem here. A 529 Plan allows for much bigger contribution amounts and could only be used for college - until the 2018 tax law changes! Now that up to $10,000 per year can be taken from a 529 Plan to pay for lower level education expenses, the 529 Plan would be a correct answer as well. So if you see a similar question on the exam, it probably has not been updated, and to get the point, choose Coverdell ESA - and also complain at the test center so they clean up the question! UTMA Custodial accounts do not have the tax benefit of tax-deferred build-up. Earnings in the account are taxable each year. HSAs are Health Savings Accounts and are used to pay for medical expenses, not school expenses.

Growth investors: A seek to find investments that are undervalued by the market B determine the value of a security through fundamental analysis C invest in securities included in growth funds D make their investment decision based upon the market performance of the security

The best answer is D. Growth investors select investments based simply on growth in earnings or growth in market price; on the assumption that these will always be the best performing investments.

The time horizon to be used when constructing a portfolio to pay for college expenses for a person who is expected to start college in 10 years and finish college in 15 years is: A 5 years B 10 years C 12.5 years D 15 years

The best answer is D. If a portfolio is being constructed to fund a person's college education, it must be able to provide income to pay for college until schooling is finished.

Which of the following is the LEAST important factor to consider when constructing an investment portfolio for a high net worth individual? A The portion of the funding that should be allocated to tax-free investments B The portion of the funding that should be maintained in readily accessible funds such as money market instruments C The customer's preference for investing via passively managed index mutual funds or via actively managed mutual funds D The investment philosophy and strategies employed by the fund manager of the chosen mutual fund

The best answer is D. Since this individual is wealthy and is likely to be in a high tax bracket, consideration should be given to allocating a portion of the portfolio to tax-free municipal investments. An emergency fund should always be maintained, so consideration should be given to the amount of funding allocated to money market fund investments. Whether the customer is a believer in passive asset management or active asset management should also be considered. Passive asset managers believe in the use of index funds that have low expenses - the idea being that, over time, no one can do better than the market. Active asset managers believe that the right stock "picking" will allow a manager to outperform the market - but this comes at higher expense. The actual trading strategies employed by an active manager to achieve his results are not relevant to the portfolio construction.

An elderly customer seeking extra income who has $100,000 to invest could be recommended which of the following? I The $100,000 purchase of a variable annuity II The $100,000 purchase of dividend paying blue chip stocks in a cash account against which calls are sold III The $200,000 purchase of dividend paying blue chip stocks at 50% margin in a margin account IV The $100,000 purchase of Treasury bonds A I and III B I and IV C II and III D II and IV

The best answer is D. The purchase of a variable annuity is not suitable for an elderly customer. The whole concept behind a variable annuity is that the product has time to build value on a tax deferred basis in the separate account prior to annuitization. An elderly customer needs the income now. Covered call writing is the most popular retail income strategy in a flat market, and is appropriate for conservative investors that are looking for extra income. The customer sells calls against stock that is already owned, getting premium income. This would be suitable. The margining of blue chip stock positions to "double up" on the amount of stock owned (since Regulation T margin is 50%) is not suitable because this does not come for free! The customer is borrowing the extra money to buy the new shareholding, using his existing stock as collateral, and he must pay interest on the loan. The interest charge will eat up any dividends that the stocks pay - so there goes his income. The purchase of Treasury bonds is suitable, since they provide current income and they are safe as it gets.

A wealthy, sophisticated investor with a high risk tolerance has just turned extremely bearish on the market. To profit from this, the BEST recommendation to the client would be to: A buy index calls B buy index puts C buy inverse floaters D buy leveraged inverse ETFs

The best answer is D. This customer has just turned "extremely bearish" on the market, meaning he thinks that equities are going to fall rapidly in price. The customer is wealthy, sophisticated, and has a high risk tolerance. The most aggressive choice offered is the leveraged inverse ETF. Assume it is a 300% leveraged inverse ETF based on the S&P 500 Index. If the index falls by 15%, this ETF should rise by 3 x 15% = 45%. (Of course, if the customer is wrong and the index rises, then the customer loses big time!) Also note that an inverse floater is a type of bond where when market interest rates rise, its interest rate "floats" and is adjusted downwards by the increase in interest rates. Thus, when interest rates rise, its interest rate will "float" down (and remember that lower coupon bonds lose value more rapidly in a rising interest rate environment). For the exam, just know that an "inverse floater" is a wrong answer.

A wealthy, sophisticated investor with a high risk tolerance has just turned extremely bullish on the market. To profit from this, the BEST recommendation to the client would be to: A sell index calls B sell index puts C sell inverse floaters D sell leveraged inverse ETFs

The best answer is D. This customer has just turned "extremely bullish" on the market, meaning he thinks that equities are going to rise rapidly in price. The customer is wealthy, sophisticated, and has a high risk tolerance. The most aggressive choice offered is to short the leveraged inverse ETF. Assume it is a 300% leveraged inverse ETF based on the S&P 500 Index. If the index rises by 15%, this ETF should fall by 3 x 15% = 45%. This would give the customer a large profit on a short position in that ETF. (Of course, if the customer is wrong and the index falls, then the customer loses big time!) Also note that an inverse floater is a type of bond where when market interest rates rise, its interest rate "floats" and is adjusted downwards by the increase in interest rates; and vice versa. When interest rates rise, its interest rate will "float" down; and when interest rates fall, its interest rate will "float" up. These bonds will be more volatile in price movement than fixed rate bonds, but they are not tested, other than being a wrong answer!

The customer profile for Jack E. Chan is presented below: Age:60 Marital Status:Married - Spouse is age 55 Dependents:2 Children - Ages 21 and 23, both graduated from college, still living at home Annual Income:$75,000 per year Investment Objective:Safety of Principal and Retirement Income Risk Tolerance:Low Investment Experience:New Client - No Pre-existing Brokerage Accounts Net Spendable Income Available For Investment:$10,000 Federal Tax Bracket:28% State Tax Bracket:5% Client Balance Sheet: Assets Cash on Hand:$60,000 Marketable Securities:0 Auto:$24,000 Residence Owned:$250,000 Liabilities Bills Payable:$10,000 Auto Loan Payable:$14,000 1st Mortgage:(6% interest rate 5 years left - monthly payment of $900)$52,000 Equity:$258,000 The customer is covered by a company defined benefit plan that will pay about $40,000 per year upon retirement at age 70. This customer wishes to maintain his current living standard upon retirement and intends on living in his current house. The customer will receive annual social security payments of about $8,000 per year. To meet the customer's goal of retiring in 10 years with an annual income of $72,000 per year, the best recommendation is to: A take out a second mortgage of $100,000 at 8% and invest the proceeds in a tax deferred annuity yielding 5% B invest $10,000 per year for the next 5 years in emerging markets growth stocks; and increase the annual investment in years 6-10 by another $10,800 per year since there are no more mortgage payments to be made C pay off the current mortgage from the cash on hand; take out a new $100,000 mortgage at 7% and invest the proceeds in income bonds D invest $10,000 per year for the next 5 years in Treasury Bonds and increase the annual investment in years 6-10 by another $10,800 per year since there are no more mortgage payments to be made

The best answer is D. This customer is 10 years from retirement, so making risky investments in emerging markets stocks or in income bonds that only pay if the issuer has enough earnings (otherwise no interest payments are made) are completely inappropriate. Taking out a loan at 8% to invest in a security yielding 5% is a fast way to lose money - so Choice A is bad as well. Choice D is clearly the best - investing in nice safe Treasury bonds will give the customer an assured stream of income to supplement the customer's pension and Social Security payments that will be received at retirement.

Customer Name:Charlie Customer Age:69 Marital Status:Single -Widowed Dependents:None Occupation:Retired Household Income:$31,000 (Social Security and Pension) Net Worth:$130,000 (excluding residence) Own Home:Yes $220,000 Value, No Mortgage Investment Objective:Current Income Risk Tolerance:Low Investment Time Horizon:20 years Investment Experience:0 years Current Portfolio Composition:Cash in Bank:$130,000 After reviewing this customer's profile sheet, which recommendation would be most appropriate? A The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20-year TIPS to meet the customer's desire for current income and his low risk tolerance requirements B The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20-year STRIPS to meet the customer's desire for current income and his low risk tolerance requirements C The customer should mortgage his house for $100,000 at current market interest rates and use the proceeds to buy 20 year income bonds to provide current income D The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20-year Treasury Bonds to meet the customer's desire for current income and his low risk tolerance requirements

The best answer is D. This customer is age 69, with no current investments or investment experience. The customer has a fairly low retirement income and needs additional current income to live comfortably. This customer really only has 2 assets to tap for potential current income. He owns a fully paid house worth $220,000; and has $130,000 of cash in the bank. One way to supplement income is for the customer to get a reverse mortgage on the house, but this is not a banking exam, so we will not go near that possibility! The other way to supplement income is to invest the cash in the bank in an investment that is safe and that gives current income. Treasury Bonds pay interest semi-annually at a higher rate than that earned on bank deposits, and are really safe, so these would be the best recommendation. STRIPS do not provide current income since they are a zero-coupon Treasury obligation so these will not work. TIPS give a lower current interest rate than regular Treasury bonds, in return for protecting the investor against inflation - however the inflation protection is not "paid" until maturity, so again, these will not give the greatest additional current income.

Customer Q, age 40, is married with 3 young children. He earns $120,000 per year and has $10,000 of liquid assets to invest. The customer has no current portfolio, but does own his home, worth $400,000 against which there is a $200,000 mortgage. The customer informs you that his father just died, leaving him an inheritance of $150,000. He wishes to invest the money so that he can retire in 20 years, using the investment's income. The BEST recommendation to the customer is to invest the $150,000 in: A a large cap stock mutual fund B CMO companion tranches with a 20 year average life C TIPs with a 20 year maturity D a low-load variable annuity separate account with a growth objective

The best answer is D. This customer wishes to fund his retirement 20 years from now. Large capitalization stock mutual funds don't provide a lot of income, and are subject to a greater degree of market risk unless the investment time horizon is very long (which it isn't in this case) - so these are not the best retirement investment for this customer. CMO companion tranches are very risky - not the best idea. Remember, these are the "buffer" tranches that absorb prepayment and extension risk. TIPS provide inflation protection, but the real rate of return is quite low (the price of "safety"), so if the customer lives a long time, the income will not be sufficient for retirement. A variable annuity will pay until the customer dies. Low sales charge variable annuities provide assured retirement income - best meeting the customer's objective.

A 65-year old widow that is in a low tax bracket and that has a low risk tolerance wishes to make an investment that will provide income. Which is the BEST recommendation? A Growth mutual fund B Emerging markets mutual fund C Long term municipal bond fund D Bank certificates of deposit

The best answer is D. This elderly widow is in a low tax bracket and seeks income. Growth stocks and emerging markets stocks do not provide income; rather, they provide capital gains. Municipal bonds are not appropriate for a low tax bracket investor, since the bonds are exempt from Federal income tax, and the market interest rate is lower than that for taxable investments because of this. Municipal bonds are only suitable for high tax bracket investors, where the exemption from federal tax has real value. Thus, we are left with bank certificates of deposit as the only viable choice. They are low risk and will provide income with a higher "after-tax" return for a person in a low tax bracket than equivalent maturity municipal investments.

Which bond recommendation would be the LEAST safe for an individual who seeks income that is free from federal income tax? A AA-rated revenue bond that is escrowed to maturity B AAA-rated general obligation bond C PHA bond D Double-barreled bond

The best answer is D. This one is special! A bond that is escrowed to maturity (ETM) is backed by escrowed U.S. Government securities - so it becomes the "safest" municipal bond because it becomes government backed. A PHA bond is a Public Housing Authority revenue bond - this is backed by the rental income from subsidized housing, and also backed by the full faith and credit of the U.S. Government to make it marketable. Again, this is another "safest" municipal bond because it is government backed. AAA rated general obligation bonds are extremely safe - they are backed by unlimited tax collections and have a top credit rating. Finally, a double-barreled bond is a revenue bond that is additionally backed by a municipality's "full faith and credit" if the revenues fall short, so it has a back-up G.O. backing. It is also extremely safe - just not as safe as the other choices. Note that this choice does not have a credit rating as a guide - if it did, it would be much easier to answer this question!

When the investment performance of each asset class varies from the anticipated rate of return, the: A selection of the type and number of asset classes used for the portfolio must be changed B target allocation percentages assigned to each asset class must be changed C tactical limits on target allocation percentages for each asset class must be changed D portfolio must be rebalanced by liquidating portions of overperforming classes and investing the proceeds in underperforming classes

The best answer is D. When investment performance varies over time from one asset class to another, the target percentage allocations will shift from their optimal setting. To bring the portfolio back to these targets, it must be rebalanced - that is, a portion of the overperforming class(es) must be sold off and the proceeds reinvested in the underperforming class(es).