Unit 6 Financial Goals/Objectives maat
The separate account sub-accounts chosen by the purchaser of a variable life insurance policy have had outstanding performance over the past 15 years. There would generally be no tax implications in which of the following situations? A) A loan is taken equal to 95% of the policy's cash value B) The policy is surrendered C) There is a cash withdrawal in excess of the cost basis D) The death benefit is paid
Answer: A Funds obtained from a policy loan are not considered taxable income (same as any loan - you owe the money). If the amount received at policy surrender is greater than the cost basis, the excess is taxed as ordinary income. The same is true with the withdrawal. Although the death benefit will always be free of income tax, it could be subject to estate tax.
Any recommendations made to customers by a broker/dealer must be suitable for the customer on the basis of an investigation of the customer's: investment objectives. financial status. ability to pay high commissions. desirability as a customer. A) I and II. B) I and III. C) II and IV. D) III and IV.
Answer: A Recommendations must meet the needs of the customer, not necessarily those of the registered representative or the broker/dealer firm.
Howard is the owner of 4 different insurance policies. Which of the following policies have death benefits proceeds that are NOT subject to income tax upon death of the insured? Policy 1; his wife is the insured. Policy 2; his business partner is the insured. Policy 3; his daughter is the insured. Policy 4; he is the insured. A) I, II, III and IV. B) I, II, and III. C) II and III. D) II and IV.
Answer: A The question is asking for income tax treatment of insurance proceeds, not estate tax treatment. Life insurance proceeds are not income taxable to an original human owner of the policy.
Although NASAA's rules dealing with customer suitability do not specify unique requirements for seniors, it is generally accepted that agents will give greater consideration to which of the following when making recommendations to their senior clients? Age. Life stage. Retirement savings. Tax status. A) III and IV. B) II and III. C) I and II. D) I and IV.
Answer: B All of these are important suitability considerations for all customers. But, when it comes to seniors, it is felt that life stage (including whether the customer is employed, retired, or nearing retirement) and current retirement savings relate particularly to seniors.
A client has a more than average aversion to risk with a primary investment objective of capital preservation. Given the following choices of portfolio allocations, which would probably be the most suitable for this investor? A) A preponderance of growth stocks and limited partnership vehicles. B) A mix of investment-grade bonds and cash/cash equivalents. C) A preponderance of speculative stocks and high-yield bonds. D) A mix of high yield bonds and cash/cash equivalents.
Answer: B An individual with an investment objective of capital preservation should be investing in a mix of investment grade bonds and cash/cash equivalents. Lower risk capital appreciation vehicles, such as large-cap common stock, should also be considered. The other choices noted are too risky for a risk-averse investor.
An investor diversifying a corporate bond portfolio does NOT consider: A) issuer. B) quality. C) maturity. D) domicile of the investor.
Answer: D Domicile, or geographic location of the investor, is not relevant in diversifying a corporate bond portfolio. For example, it is irrelevant if the client is located in Michigan or New Jersey or any other state; that will have no impact upon the risks facing the issue. This could be a factor for municipal bond investors due to the possibility of avoiding state income tax. A corporate bond portfolio can be diversified by issuer, quality (rating), domicile of the issuer and maturity.
In projecting future cash requirements, one of the tools is a capital needs analysis. When doing one, all of the following would be considered capital needs EXCEPT A) rolling over a 401(k) into an IRA B) a home equity loan with a $15,000 balance C) a $20,000 loan for undergraduate school with a due date in six years D) a $100,000 loan for law school with a due date in 10 years
Answer: A A capital needs analysis attempts to determine money that would be needed in the event of an individual's sudden passing. Included would be any outstanding debt obligations, regardless of when they are due (they will have to be paid off sometime). However, an asset, such as the 401(k), is not a need; it is something that will help meet the need.
If a customer's chief concern is to shelter as much of his portfolio earnings from tax as possible, which of the following securities would be most suitable? A) Municipal GOs. B) High-yield bonds. C) Treasury receipts. D) Money market instruments.
Answer: A The interest on municipal GOs is exempt from federal income tax and perhaps state income tax, depending on the investor's residency.
Which of the following would be most suitable for a young couple investing the assets of their IRAs? A) Oil and gas exploration programs. B) Growth mutual funds. C) Penny stocks. D) Call options on large-cap stocks.
Answer: B IRA accounts are designed to provide for future retirement needs. An IRA is a personal pension plan for anyone who receives earned income. While the rules are fairly liberal regarding suitable investments for IRAs, penny stocks, options, or oil and gas programs would not likely be suitable because of the high risks inherent in these securities. However, growth mutual funds are suitable.
Having sufficient funds to pay off a 30-year mortgage on a home with an initial loan amount of $200,000 would be A) decreasing term insurance B) taking too much risk for most clients C) a capital need D) an investment constraint
Answer: C A capital need is generally for one of three purposes: payoff of a mortgage and other debts, providing education for dependents, and a stream of income for survivors. It is generally shown with a specific dollar amount, and that is the easiest way to recognize that it is not an investment constraint. Decreasing term insurance may be the best way to provide the funds, but that doesn't answer the question.
A client with a sizeable estate would probably find it most efficient to pay estate taxes with A) proceeds from the liquidation of a tax-deferred retirement plan B) proceeds from the liquidation of a diversified portfolio C) proceeds from a life insurance policy D) cash
Answer: C In general, people with estates where there is a potentially large estate tax liability, find that the most efficient way to pay those taxes is through a life insurance policy.
It would be correct to state that when an investor has a shorter time horizon: A) the exposure to inflation risk is increased. B) the greater the duration. C) the need for liquidity is more important. D) the risk level is raised.
Answer: C When the time horizon is short, there is a greater need for access to the funds now. Therefore, liquidity is a major consideration. With a short time horizon, the investor can take less risks (and won't have to because there will be less exposure to inflation risk).
A client with 25 years until retirement should invest primarily in: A) preferred stocks. B) private placements. C) common stocks. D) bonds.
Answer: C With 25 years until retirement, the customer should invest primarily in stocks. Historically, over long time periods, equity securities have provided the greatest returns.
Which of the following is generally NOT an appropriate product for retirement planning? A) Life insurance. B) Mutual funds. C) Bonds. D) Commodities.
Answer: D Commodities are among the most speculative investments and not generally an element in retirement planning.
Which of the following funds would you recommend to a moderate-risk client seeking long-term capital gains who also values professional stock selection? A) A large-cap growth fund. B) S&P 500 Index fund. C) An international index fund. D) A small-cap growth fund.
Answer: A A large-cap growth fund is the most appropriate choice for a moderate-risk client because large capitalization stocks are generally less volatile than small-cap stocks and provide long-term capital growth. This is a more appropriate choice than the index fund because there is no stock selection there, only investing to parallel the index.
Insurance agents frequently use a capital needs analysis to help determine the correct amount of life insurance needed by their clients. That analysis would look at all of these EXCEPT: A) future earnings. B) market volatility. C) life expectancy. D) the inflation rate.
Answer: B Of these choices, the only one that we cannot in anyway predict is market volatility. We can factor in an estimated inflation rate, project future earnings and look at the mortality tables to obtain life expectancy. But, nothing can project market volatility with any degree of accuracy.
When making recommendations to an advisory client, which of the following carry the most weight? The client's risk tolerance. Past performance of the adviser representative's recommendations. The client's investment needs and objectives. The client's previous investment experience with other advisers. A) II and III. B) II and IV. C) I and III. D) I and IV.
Answer: C Investment objectives and risk tolerance should determine recommendations to an individual advisory client.
If a new client has $200,000 to invest and wants to retire in 15 years, which of the following client information is least necessary for an adviser to recommend a suitable investment program? A) Tolerance toward risk. B) The age of the client. C) Current income and cash flow requirements. D) The amount of income he requires for his retirement years.
Answer: C While current income and cash flow requirements are ordinarily important considerations, in this question we are being asked about the investment of a lump sum, not periodic additional investments. The amount of income required will determine the types of investments and how they must be structured in order to achieve the retirement income desired. The client's age is necessary to determine the time horizon. That is, if the client is currently 35 and wishes to retire at age 50, the money will have to last a lot longer than if we are dealing with a 55-year-old who wishes to retire in 15 years at 70. A client's tolerance toward risk is among the most important non-financial considerations in determining investment suitability.
A married couple in their early fifties saving for retirement would most likely have which of the following objectives? A) Low risk, high safety, high liquidity. B) Moderate risk, low safety, high liquidity. C) High risk, moderate safety, low liquidity. D) Moderate risk, moderate safety, low liquidity.
Answer: D A middle-aged couple planning for their retirement is most likely interested in moderate risk, moderate safety, and low liquidity. A couple of their age should be planning for retirement and the demands for liquidity should be low; they need to take moderate risk to earn above-inflation returns. Moderate safety is appropriate for a middle-aged couple. Additionally, a middle-aged couple should not be invested in high-risk securities.
If ABC Fund pays regular dividends, offers a high degree of safety of principal, and appeals especially to investors seeking tax advantages, ABC is a(n) A) corporate bond fund B) money market fund C) aggressive growth fund D) municipal bond fund
Answer: D Municipal bonds are considered second only to U.S. government securities in terms of safety. Also, interest received from the bonds is generally exempt from federal income tax.
An investor with a well-established portfolio would like to add some more speculative investments in an effort to increase his returns. Which of the following would be appropriate? Corporate bonds. Options. Commodities. Large capitalization stocks. A) I and II. B) II, III and IV. C) I, II, III and IV. D) II and III.
Answer: D Once a financial base has been established with cash and cash equivalents, the client would begin to add various debt and equity instruments. A well-established investor who would like to increase performance through speculation would consider products such as options and commodities.
Which of the following mutual funds should an investment adviser representative recommend to a client whose objective is current income with moderate risk? A) Aggressive growth fund B) Money market fund C) High-yield bond fund D) Preferred stock fund
Answer: D Preferred stock generates current income in the form of dividends. Aggressive growth funds strive for capital appreciation rather than current income. Money market funds have low yields, not the high yields that an income investor wants. While high-yield bonds provide current income, they entail a high, rather than a moderate, degree of risk.
What would be the time horizon for a 65-year-old client who has just retired? A) None, as 65 is the age for retirement. B) It depends on the individual's available assets. C) It depends on the individual's insurance company's actuarial tables. D) It depends on the individual's life expectancy.
Answer: D The time horizon for an individual who has just retired is the balance of expected life.
A customer has a financial commitment of $200,000 that will come due in 2 years. In the interim, the customer wishes to invest the $200,000 to maximize income and have the money available for the obligation in 2 years. You should recommend investments in: A) municipal bonds purchased at par with 20-year maturities. B) preferred stock purchased in a private placement. C) large-cap stocks. D) government securities with two year maturities.
Answer: D The Uniform Securities Act requires that all recommendations to a customer be consistent with that customer's investment objectives and financial situation. This particular customer needs to have principal available in 2 years and wants to invest for income in the interim. Of the choices listed, only government securities with 2-year maturities meet both criteria.
An elderly widow with no independent income wishes to invest the proceeds from her recently deceased husband's life insurance. Which of the following would be the most suitable recommendation? A) Oil and gas exploration program that you know is going to strike. B) High grade corporate bond mutual fund. C) Call options. D) Municipal bonds.
Answer: B This customer needs income. Of the answers provided, the bond fund would be the most suitable because it would provide income while maintaining relative safety. While the municipal bonds are probably safer, the benefits of their tax-free income would probably be lost on a client with no independent income.
Otto and Lucy Wright set up a 529 plan for the benefit of their daughter, Marangue, who is 14. What is the most suitable investment for the largest portion of their contribution? A) A long-term bond fund. B) An intermediate term bond fund. C) A growth stock fund. D) A large-cap stock fund.
Answer: B This is a straight suitability question; match the time horizon to the investment offered, and an intermediate term bond fund is the only logical answer.
Which of the following items are NOT included in the gross estate of a decedent? A) Proceeds from a life insurance policy owned by the deceased's spouse B) Proceeds from a life insurance policy held in a revocable trust C) The first $250,000 of a primary residence if owned singly, $500,000 if owned jointly with spouse D) Property held in an account registered tenants in common
Answer: A One popular estate planning technique is to have life insurance owned by (and premiums paid by) someone other than the insured. In that case, proceeds are generally excluded from the gross estate of the deceased. If the trust was irrevocable, that same benefit might be achieved, but not with one that is revocable. There is an exclusion for income tax purposes on the sale of a primary residence, but that has nothing to do with the estate. Finally, when property is owned tenants in common, the percentage belonging to the deceased is part of the gross estate.
Relatively high portfolio volatility is most tolerable to investors with: A) a diversified portfolio. B) a long-term time horizon. C) a short-term time horizon. D) an intermediate-term time horizon.
Answer: B Relatively high portfolio volatility is generally associated with stocks whose long-term returns outpace less volatile investments. Therefore, high portfolio volatility is suitable for investors with a long-term time horizon.
The longer an individual's investment horizon, the: A) more conservative he should be with the choice of investment products. B) less need there is for a retirement plan. C) less risk he can afford to take. D) more aggressive he can be with the choice of investment products.
Answer: D Over a long period of time, losses in riskier investments tend to be made up by gains. Investments that are high-risk in the short term are consequently a lower risk in the longer term.
The two general categories of investment objectives are income and capital growth. An investor primarily seeking income would be least interested in which of the following? A) Interest. B) Capital gains. C) A stock paying a high dividend. D) U.S. treasury bonds.
Answer: B Capital gains is an example of capital growth. An investor who is primarily interested in generating income will be less interested in the potential capital gains provided by an investment than its potential interest and dividends.
One problem facing agent and client alike is determining how much life insurance is necessary to meet future needs. One tool that is useful for making that determination is a: A) mortality table. B) statement of beneficiary needs. C) life insurance capital needs analysis. D) premium purchase analysis.
Answer: C A life insurance capital needs analysis takes into consideration the future needs of the insured and family and then factors in how much needs to be filled in by life insurance.
Which of the following is (are) advantages of irrevocable insurance trusts? Provide estate liquidity. Insurance proceeds are removed from the estate of the insured for tax purposes. The insured has the flexibility to alter the trust arrangements. Once set up, no changes may be made. A) I and III. B) II and IV. C) III and IV. D) I and II.
Answer: D As with all life insurance, the proceeds are available almost immediately upon death providing estate liquidity. When done properly, the proceeds of the policy are not included in the deceased's estate thereby saving estate taxes. The trust is irrevocable - no changes can be made, and this is one of the few disadvantages.
If an elderly widow with no independent income other than Social Security payments wishes to invest the proceeds from her recently deceased husband's life insurance, which of the following would be the most suitable recommendation? A) Municipal bonds with short-term maturities. B) Oil and gas exploration program that is going to strike. C) High quality dividend paying preferred stocks. D) Purchasing call options.
Answer: C High quality dividend paying preferred stocks will give her a reasonable income without great risk. Options are not income vehicles and are not income producing. Municipal bonds are not generally appropriate for low income clients because there would be little after-tax benefits. Oil and gas programs are speculative and not appropriate.
Investors who buy shares in state-specific municipal bond funds may be subject to: A) out-of-state property tax. B) no taxation. C) capital gains tax. D) federal income tax.
Answer: C Interest received from municipal bonds and municipal bond funds is generally income tax free on a federal basis, but taxable in states other than the state of issue. State-specific funds avoid that problem. These investments are subject to capital gains taxes if sold at prices above investors' cost.
An investor concerned about preservation of capital would be most apt to purchase: A) call options. B) common stock. C) warrants. D) investment grade corporate bonds.
Answer: D Capital risk is the danger of losing principal. Corporate bonds have the least capital risk because of the issuer's legal obligation to pay principal and their higher priority in the event of bankruptcy. Options are a wasting asset that can expire in a short time with total loss of capital. Common stock bears a higher capital risk than corporate bonds because bonds have a higher priority in the event of bankruptcy; common stock has only a residual claim in the event of bankruptcy. Warrants bear risk similar to that of options; they can be viewed as long-term call options.
For a trust account not seeking appreciation, which of the following would be recommended? A) Common stock in small, highly profitable companies. B) Large-cap common and preferred stocks. C) Common stock, preferred stock, and debentures. D) Highly-rated, fixed-income securities.
Answer: D The only choice that is prudent and does not have a goal of appreciation is the purchase of highly rated, fixed-income securities.
A new client wants your recommendation on available investment options. You prepare a client profile which reveals that the investor is 66 years of age, has a low risk tolerance and is in a low tax bracket. The investor's primary objectives are safety and income. Of the following, the most suitable choice would be A) a municipal bond mutual fund investing solely in AAA and AA rated bonds B) large cap common stock C) a growth and income mutual fund D) insured bank certificates of deposit
Answer: D Whenever you see "low tax bracket," the answer cannot be municipal bonds. With a low risk tolerance, the only suitable choice for "safe" income would be insured bank CDs.
An elderly client explains to you that he is risk averse and wishes to find an investment that will provide him with preservation of capital. Which of the following might you recommend? A) An index fund. B) Bank insured CDs. C) Long-term U.S. Government bonds. D) Variable annuities.
Answer: B Preservation of capital is almost always a sign that the client needs CDs. Sure, the U.S. Government bonds will pay back the principal when due, but, with long-term maturities, there will be plenty of interest rate risk that could affect the client if he needs the capital prior to maturity.
Which of the following should be considered by an investment adviser in determining whether a specific investment is suitable for an individual investor? The past performance of the investment. The investor's anticipated time horizon. The amount of remuneration to the broker/dealer and to the agent. The level of the investor's acceptance of risk and volatility. A) II and III. B) II and IV. C) I and III. D) I and IV.
Answer: B Time horizon and risk tolerance are essential factors that advisers must consider to determine whether an investment is suitable for a given individual investor. Although past performance is important to know, it cannot be used to indicate future results.
A client is risk averse and is planning on retiring in 16 years. The client is rolling over $100,000 from his 401(k) plan, all of which is currently invested in his former employer's stock. As the client's investment adviser, which of the following would you recommend? A) Highly rated preferred stocks paying liberal dividends. B) Keeping the money in the employer's stock. C) AAA rated zero-coupon bonds maturing in 16 years. D) Laddering US Treasury bills.
Answer: C Because the assets are in a rollover IRA, the "phantom" tax on zero coupon bonds is not an issue here. Being risk averse, the safety of AAA bonds with the guaranteed return of increased principal in 16 years makes this the most appropriate investment. The T-bills will probably not offer as much return and will be subject to continual reinvestment risk. Dividends on preferred stock are not guaranteed, even with a highly rated company, and the current tax advantage offered to dividends is wasted in an IRA. Most would agree that the worst option would be to keep the money in one single stock.
Mr. and Mrs. Williams are a retired couple receiving most of their income from a diversified portfolio of high quality bonds and preferred stock. One of the reasons that life insurance might be a useful addition to their overall planning is that: A) the proceeds of a life insurance policy are free of income tax. B) the premiums can be paid directly from their brokerage account. C) dividends received on a life insurance policy are tax-free. D) upon the death of the insured, the insurance provides liquidity to preserve income-producing assets from having to be liquidated to cover death expenses.
Answer: D Even for those whose estate is not large enough to incur estate tax, life insurance proceeds provide liquidity to cover the expenses incurred at death without having to sell assets out of the portfolio. It is true that the proceeds are free of income tax, but that is not the major reason to own life insurance.
In preparing a financial plan for a client couple, you are asked about the role of certificates of deposit available at their local bank branch. You could state that the bank CD: A) is a savings account with a maturity date. B) can only be purchased in $1,000 increments. C) must be for at least 3 months. D) eliminates interest rate risk.
Answer: D Interest rate risk, the uncertainty that the price of a security will rise or fall based upon changes in interest rates, is eliminated with a certificate of deposit. Regardless of changes in the market, the CD's value remains fixed. It is not the same as a savings account because regular additions and withdrawals are not made. Minimums are set by the bank itself as are any minimum time periods and can be as low as $100 and one week. This is not the negotiable (jumbo) CD traded in the money market.
Which of the following would be the most appropriate portfolio mix for an aggressive investor? A) 20% cash equivalents, 30% bonds, and 50% stocks. B) 10% cash equivalents, 20% bonds, and 70% stocks. C) 60% cash equivalents, 25% bonds, and 15% stocks. D) 30% cash equivalents, 50% bonds, and 20% stocks.
Answer: B Assuming that an aggressive investor typically is willing to assume the most risk, it would be logical for him to have the largest allocation in equities.
Among investor objectives is preservation of capital. Which of the following would be most appropriate for inclusion in the portfolio of this kind of investor? A) U.S. Treasury bonds. B) International funds. C) A money market fund. D) Blue chip stocks.
Answer: C Preservation of capital means no fluctuations. Money market funds are the only logical choice here. True, the treasury bonds do not have default risk, but, because they can have maturities as long as 30 years, they are subject to interest rate risk.
If a client wanted an investment that would eliminate interest risk as to principal, you would recommend A) a 90-day Treasury bill B) TIPS C) preferred stock D) a bank insured certificate of deposit
Answer: D Because bank insured CDs are non-negotiable (we're not discussing the $100k minimum jumbos), there is no market fluctuation caused by changes in interest rates as with marketable securities. If you invest $10,000, you will always get back that $10,000 whenever you cash in the CD, regardless of current interest rates. This is true even when cashing in early. There may be a prepayment penalty, but that is considered separate from interest rate risk. TIPS offer inflation protection and preferred stock is interest rate sensitive in the same manner as a bond. The 90-day T-bill doesn't have much interest rate risk, but, if an investor was to attempt to liquidate the holding prior to maturity and interest rates increased, there could be a loss.
A 68 year-old client of yours indicates that he is interested in changing the portfolio mix of his IRA to become largely invested in noninvestment grade bonds. You would probably infer from this that the client: A) is risk averse. B) is now in a lower tax bracket. C) has insufficient retirement savings. D) has recently come into a large inheritance
Answer: C Most studies have indicated that seniors with insufficient retirement savings attempt to compensate by being tempted to reach for higher yields to maximize retirement income without full consideration of the increased risk that comes along with the possibility of higher returns.
It would be correct to state that when an investor has a longer time horizon: A) the risk level is lowered. B) the exposure to inflation risk is lessened. C) the greater the initial deposit to reach a projected future goal. D) the need for liquidity is less important.
Answer: D When the time horizon is long, there is little need for access to the funds now. Therefore, liquidity is a minor consideration. With a long time horizon, the investor can take greater risks (and should because it will be necessary to combat the higher inflation risk).
When performing a capital needs analysis for a client, factors to be considered would include the client's projected earnings the projected inflation rate projected market volatility the client's age A) III and IV B) I, II, and IV C) I, II, III, and IV D) I and II
Answer: B A capital needs analysis is used to help determine the proper amount of life insurance that will provide for the family's needs in the event of premature death of the primary breadwinner. The agent would factor in the client's projected earnings until retirement and, in order to do that, would need to know the current age. In addition, to be sure to allow for enough to keep up with the rising cost of living, the projected inflation rate is needed. However, market volatility does not impact the analysis because the amount of the selected death benefit will remain constant, regardless of changes to the market.
An individual purchased a variable life insurance policy 10 years ago with a guaranteed death benefit of $100,000. The annual premium for this policy was $2,000 per year. The individual dies and, due to outstanding performance of the separate account, leaves a death benefit to the beneficiary of $121,000. What are the income tax consequences to that beneficiary? A) Ordinary income tax is due on the $1,000. that exceeds the original cost. B) No tax is due. C) Ordinary income tax is due on $21,000. D) There is a long-term capital gain of $1,000.
Answer: B One of the nice things about life insurance proceeds is that even when the death benefit is increased due to separate account performance, it is still free of income tax.
Your client asks for a recommendation for her emergency fund. You would most likely suggest a: A) corporate bond mutual fund because of its high degree of income and liquidity. B) money market mutual fund because of its high degree of liquidity. C) money market mutual fund because of its fixed rate of return. D) diversified common stock mutual fund because of its high degree of liquidity.
Answer: B The most appropriate vehicle for the emergency fund is the money market mutual fund because of its safety and high degree of liquidity. A money market mutual fund does not have a fixed rate of return. A common stock fund is too volatile and not appropriate for an emergency fund. A bond fund is subject to market volatility.
Years ago, following your advice, a client opened a 529 Plan to save for their son's college education. The child is now about three years from beginning his freshman year. The client, believing that the stock market is currently undervalued, wishes to reallocate the Plan assets so that most of the funds are in a broad stock market index portfolio. At this time, your advice would probably be against this allocation because of: A) liquidity risk. B) market risk. C) business risk. D) interest rate risk.
Answer: B With this short a time horizon, a portfolio that is largely equities, subjects the account to too much market risk. If the child had been 5 years of age, giving the client a 13 year time horizon, this would have made more sense.
A 27-year-old client is in the lowest tax bracket and seeks an aggressive long-term growth investment. If his investment adviser representative recommends a high-rated general obligation municipal bond, the IAR has: A) committed no violation because municipal bonds are well suited for the market's volatility. B) made an unsuitable recommendation, since a municipal revenue bond would have been more appropriate. C) made an unsuitable recommendation based on the client's needs and objectives. D) recommended a suitable investment because GOs are good long-term investments.
Answer: C In recommending a conservative, tax-exempt investment to this customer, the investment adviser representative has failed to make a suitable recommendation given the client's objectives. Municipal bonds are better suited for individuals in high tax brackets and offer little upside appreciation potential.
A 55-year-old customer in the 18% tax bracket wants to maximize current return with a moderate degree of risk. He has just inherited $25,000 and seeks a bond investment. A suitable bond would have which of the following features? A) Tax-exempt status. B) Rating below Ba but above D. C) Little or no call protection. D) Relatively high rating.
Answer: D The investor's tax bracket is not high enough to take advantage of a bond's tax-exempt status, but a bond with a low rating is not suitable because the investor is willing to bear only moderate risk. A bond with call protection and a relatively high rating would meet this customer's needs.
An individual has just received a bonus of $12,473 and wishes to generate some income without risking loss of capital. Assuming the client is in a low tax bracket, which of the following would be the most suitable choice? A) Growth stocks. B) Public utility stocks. C) Insured municipal bonds. D) Bank insured CDs.
Answer: D The only choice here with no risk to capital is the bank insured CD. Although the insured municipal bond is guaranteed to repay principal at maturity, the bond will still be subject to interest rate risk and, with the client in a low tax bracket, municipal bonds are generally unsuitable investments.
If a widow with no outside source of income and moderate financial resources asked you for investment advice, the most appropriate recommendation(s) would be: new issues of common stocks. growth stocks. speculative issues. income securities. A) IV only. B) I, II and IV. C) II and III. D) II, III and IV.
Answer: A A customer with no source of income needs an investment portfolio to generate income. Suitable investments would be income securities that pay interest (bonds) or dividend-oriented stocks (preferred stocks and the common stock of public utility companies). Speculative stocks and growth stocks typically pay little or no dividends because any profits generated are being reinvested in the company's growth by the board of directors instead of distributed to the shareholders.
One of your customers purchased a variable life insurance contract through your firm. After 14 years, he had deposited $15,000 in premiums, and his death benefit had grown to $80,000. Shortly after taking out a loan against cash value of $10,000, he was killed in an automobile accident. What will be the consequences of this situation to the death benefit? His beneficiary must agree in writing to pay off the loan before collecting the death benefit. His beneficiary will receive the death benefit minus the value of the loan. His beneficiary need not pay taxes on the death benefit. His beneficiary must pay taxes on the amount of the death benefit that is over and above the cost base of $15,000. A) II and III. B) I and III. C) I and IV. D) II and IV.
Answer: A A death benefit payable on a life insurance policy or contract is not subject to taxation. The insurance company will deduct the balance of the $10,000 loan before it releases the death benefit to the beneficiary.
Jean owns a $1 million life insurance policy on her mother, Clara. Jean is named as sole beneficiary, and so far she has paid $150,000 in premiums. If Clara dies, which of the following will occur? The proceeds will be exempt from income tax. $850,000 of the proceeds will be subject to income tax. The proceeds will be included in Clara's estate for estate tax purposes. The proceeds will not be included in Clara's estate. A) I and IV B) I and III C) II and III D) II and IV
Answer: A Life insurance proceeds are generally free from income taxes and will be free from estate taxes, if the insured possesses no incidence of ownership. In other words, a beneficiary other than the deceased's estate has been named, and the owner is someone other than the insured.
Liquidity risk is the risk that when an investor wishes to dispose of an investment, no one will be willing to buy it, or that a very large purchase or sale would not be possible at the current price. With that in mind, which of the following would likely have the lowest degree of exposure to liquidity risk? A) Money market mutual funds B) RELPs C) REITs D) Investment grade municipal bonds
Answer: A RELPs (real estate limited partnerships) would have high liquidity risk because there is generally no secondary market for them. Municipal bonds, even highly rated ones, can have liquidity issues. Even though many REITs are listed on exchanges, there are a growing number of non-traded ones where liquidity can be an issue. However, money market funds with their check-writing privilege, are about as liquid as you can get.
If a 65-year-old woman of substantial means is seeking income and preservation of capital, which of the following should you recommend? A) Government bond fund, corporate bond fund, municipal bond fund. B) Small-cap fund, mid-cap fund, government bond fund. C) Aggressive growth fund, mid-cap fund, growth and income fund. D) Large-cap fund, small-cap fund, government bond fund.
Answer: A The most suitable of these choices for a 65-year-old woman seeking income and preservation of capital is a portfolio of a government bond fund, corporate bond fund, and municipal bond fund. Small-cap and mid-cap stock funds contain too much risk or volatility for this client.
An investment adviser using an insurance approach to capital needs analysis would: A) only invest in securities guaranteed by the FDIC. B) determine the insurance coverage needed to complete the customer's financial objective should the customer die before the objective is met. C) invest exclusively in insured securities such as insured municipal bonds or Ginnie Maes. D) select securities based upon the customer's investment experience.
Answer: B An insurance approach to a customer's capital needs analysis involves purchasing life insurance sufficient to complete the customer's financial objective should he die before it is met.
An investor who purchases stock in two technology companies with high projected earnings and growth potential but little performance history is considered a(n): A) conservative investor. B) aggressive investor. C) defensive investor. D) passive investor.
Answer: B An investor is taking an aggressive investment posture in investing in a growth company with little history and is willing to take on high risk for high potential returns.
A client is risk averse and is planning on retiring in 16 years. As the client's investment adviser, which of the following would you recommend? A) A government bond fund. B) 50% in an S&P 500 index fund; 50% in a portfolio of high quality bonds. C) A diversified open-end investment company concentrating in small-cap stocks. D) A high-yield bond fund.
Answer: B Even though the government bond fund carries less market risk, with a 16-year retirement goal, some inflation protection is necessary. The index fund carries some market risk, but does offer purchasing power protection. The 50/50 mix would seem to be most appropriate.
Dr. Howard dies. Which of the following life insurance policies will be included in his gross estate? Policy I-owned by Dr. Howard, he is the insured and his wife is the beneficiary. Policy II-owned by Mrs. Howard and she is the beneficiary. Policy III-originally owned by Dr. Howard, Mrs. Howard is the insured and he gave the policy to his daughter 5 years ago. Policy IV-owned by Dr. Howard, Mrs. Howard is the insured and he is the beneficiary. A) I, II, III and IV. B) I and IV. C) I and II. D) II and III.
Answer: B The question asks which will be included in the gross estate, not which policies will be part of the taxable estate. Any policies which are owned by the decedent at the date of death will be included in the decedent's gross estate. Of course, there may be a deduction from the gross estate for anything left to a spouse. Policy II was never owned by the decedent, therefore it is not included. Policy III is not included because it was given away more than three years before Dr. Howard's death.
One of your prospective clients is considered a key employee at his place of business. This individual has a net worth of almost $6 million, currently earns in excess of $500,000 per year, and is married with two teenage children. He currently has a little over $1 million in his 401(k), more than half of which is invested in his employer's common stock. The company is the beneficiary of a $1.5 million key person life insurance policy on his life. Given these facts, what is your greatest concern as his adviser? A) Inadequate funding for college savings. B) Alternative minimum tax. C) Inadequate life insurance coverage. D) Too high a percentage of the retirement plan invested in the company's stock.
Answer: C Since the client's only life insurance seems to be that with the company as beneficiary, it does not appear that he has adequately planned for his premature death and the potential estate taxes.
An employed individual who becomes unable to work due to a disability would probably be able to replace the lost income through all of the following EXCEPT A) Social security disability payments. B) Workers' compensation. C) Proceeds of a life insurance policy. D) Disability income insurance.
Answer: C Those injured on the job are usually eligible for workers' compensation. Those who have enough eligible credits may apply for Social Security disability benefits. If the individual owns private disability insurance and/or is covered under an employer-sponsored policy, he may claim benefits. Although there is a trend towards making life insurance benefits available for use in certain instances, for test purposes the proceeds are generally only available upon the death of the insured.
Which of the following would be appropriate actions when using a model portfolio for a client? Gather information from the client to establish his risk tolerance, time horizon, and investment expectations. Select a portfolio mix that is appropriate for the client based upon his risk tolerance, time horizon, and investment expectations. Place the client's assets into the model portfolio regardless of his comfort level with your recommendation. Periodically review the portfolio to determine if any changes or modifications are necessary. A) I and II. B) I, II and III. C) I, II, III and IV. D) I, II and IV.
Answer: D Gathering information relating to your client's risk tolerance, time horizon and objectives would all be prudent steps in assisting your clients in the establishment of a model portfolio. It would never be acceptable to place a client into an investment portfolio model that they were uncomfortable with, even if you have determined it to be suitable and appropriate.
Your retired 72 year-old client still lives in the home he purchased 35 years ago for $40,000. It is currently valued at $700,000 and there is no mortgage. The client has almost $500,000 in his self-directed IRA rollover account. When determining suitable investments for this client, you would base your recommendations on the fact that: the client is an accredited investor having a net worth in excess of $1 million. a home equity loan could more than double the amount of funds available to invest. as a retiree, any losses suffered cannot be made up from current income. the client's time horizon could be as long as 20 years. A) I and II. B) I and IV. C) II and III. D) III and IV.
Answer: D One of the risks facing senior investors who are retired is that, unlike those still employed, loss of principal can be devastating. With today's medical advances, a 72 year-old can be looking at 15 to 20 additional years of life. Therefore, recommendations must be made to maximize the probability of the client's assets lasting that long. Effective with the Dodd-Frank Bill of 2010, this investor is no longer accredited because the value of the primary residence must be excluded from the net worth computation. And, even if he were, eligibility does not equal suitability.
A professional tennis player seeking advice regarding the purchase of life insurance would like to avoid inclusion in her taxable estate at death, and would like the death proceeds to be income tax free to her beneficiary 9-year-old daughter. What do you suggest? A) Purchase the policy herself so that she will get the insurance. Then have her gift the policy and the premiums needed to pay for it to her daughter until she turns 19. B) Purchase the policy herself and sell it to her daughter at a price the daughter can afford when she is over 19 years old. C) Purchase the policy herself and gift the policy to an irrevocable trust (with her daughter as beneficiary) at least 3 years after purchase. D) Use an Irrevocable Life Insurance trust (ILIT) to purchase the policy. She will gift the premiums to the trust.
Answer: D Only an ILIT can provide the features which she desires. A direct purchase will subject the proceeds to inclusion in the gross estate if she transfers or gifts the policy to the daughter within three years before she dies. A sale will trigger transfer for value rules and subject the beneficiary to income tax on the proceeds upon the death of the insured.
A 74 year-old widower has been your client since his early 50s. He is a well-informed investor and has always seemed capable of understanding most investment concepts you have presented. At least twice a year, the two of you meet to evaluate his current financial situation and objectives. In your last meeting, it seemed to you that he was distracted and somewhat forgetful. It would be appropriate for you to do all of the following EXCEPT: A) take detailed notes on future conversations and meetings with him. B) inform your supervisor of your concerns about his memory loss. C) ask him to invite a friend or family member to accompany him to appointments with you. D) wait to see if there are further causes for concern about his capabilities.
Answer: D Taking action in advance could help protect you and your firm should a client subsequently indicate that he does not remember having agreed to a recommendation. Taking detailed notes can help verify what has been discussed in conversations or at meetings. Having others present may help to verify what has been discussed and agreed upon.
A newlywed couple with a combined income of $46,000 recently opened 2 IRA accounts with you. You receive a call from them asking for advice on the best investment for a sizable and unexpected inheritance they have just received. The most suitable recommendation for the couple is: A) immediately purchase two lump-sum variable annuities to secure their retirement future. B) pay off all outstanding debts and invest the rest in municipal bonds. C) invest the funds in an aggressive stock fund. D) invest $5,000 into a stock index fund in both IRA accounts and place the remaining funds in a money market account until their new financial situation can be evaluated.
Answer: D The couple's new IRA accounts are an indicator that retirement savings is a primary goal, therefore making maximum contributions as soon as possible is suitable. Because the funds were unexpected, it would be prudent for the couple to place any additional funds in a liquid money market account until they have time to re-evaluate how this windfall may change their financial objectives and time horizon. There is no indication that the couple has a high risk tolerance, so an aggressive stock fund would be unsuitable, as would tax-free municipal bonds based on the couple's income level. Variable annuities may be suitable, but it is not the most suitable answer choice in this case.
Which of the following investment strategies would be appropriate for an advisory client with a 20-year time horizon before retirement? Holding more stock. Holding less cash. Holding fewer bonds. A) II and III. B) I, II and III. C) I only. D) II only.
nswer: B With a long time horizon before retirement, equity securities such as common stock would offer the highest potential return and cash would be least suitable. Given purchasing power risk, bonds would not provide the returns associated with common stock.
