Chapter 19: Client profile

As part of its suitability determination, an IA firm requires that all potential nonbusiness clients complete a family balance sheet. Items that would be included are 1.gold jewelry 2.loan secured by the family automobile 3.the amount paid thus far this year for Botox injections 4.the balance owed to the dentist for new crowns

1. 2. 4. The balance sheet contains assets and liabilities as of a specific point in time. Personal property currently owned, such as jewelry, is an asset. A loan still outstanding, such as the car loan and the debt to the dentist, are liabilities. The amount already paid for the Botox injections is no longer on the balance sheet.

John and Jane have a net worth of $20,000 and total assets of $150,000. If their revolving credit and unpaid bills totals $8,000, how much are their total liabilities?

130,000

It would be CORRECT to state that when an investor has a shorter time horizon, A) the need for liquidity is more important B) the risk level is raised C) the greater the duration D) the exposure to inflation risk is increased

A)

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​

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.

Your client asks for a recommendation for her emergency fund. You would most likely suggest A) a money market mutual fund because of its high degree of liquidity B) a diversified common stock mutual fund because of its high degree of liquidity C) a corporate bond mutual fund because of its high degree of income and liquidity D) a money market mutual fund because of its fixed rate of return

A) 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.

When it comes to creating a client profile, the information obtained is divided into 2 basic categories: objective and subjective. Which of the following is considered to be subjective information? A) Net worth B) Attitude C) Salary D) IRA value

B) Attitude SUbjective information is information that cannot be quantified

If a customer is in the 15% federal income tax bracket and his main investment objective is current income, which of the following securities should the agent recommend? A) City of Milwaukee GO bond. B) Investment-grade corporate bond. C) U.S. government bond. D) Zero-coupon bond.

B) Investment-grade corporate bond The investor is in a low tax bracket, so the tax-exempt municipal bond is not a suitable investment. To maximize income, the best recommendation is the corporate bond which offers a higher yield than a government bond with a similar maturity.

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) large-cap common stock B) a municipal bond mutual fund investing solely in AAA- and AA-rated bonds C) insured bank certificates of deposit D) a growth and income mutual fund

C) insured bank certificates of deposit Whenever you see "low tax bracket" the answer cannot be municipal bonds

If your customer wants to set aside $40,000 for when his child starts college, but does not want to endanger the principal, you should recommend A) municipal bonds for their tax benefits B) common stock C) zero-coupon bonds backed by the U.S. Treasury D) corporate bonds with high rates of interest

C) zero-coupon bonds backed by US treasury Treasury STRIPS are guaranteed by the U.S. government, so there is no chance of default. They are zero-coupon bonds and offer no current income, which is appropriate for a client who wants 100% return paid at a future date for college expenses.

When performing a capital needs analysis for a client, factors to be considered would include which of the following: the client's projected earnings the projected inflation rate projected market volatility the client's age

Client's projected earnings the projected inflation rate The clients age

An investment adviser representative is meeting with a potential advisory client. Among the items of information the IAR needs to obtain in order to develop the proper plan are the prospect's

Current savings and investments Years until retirement

Which of the following items would be found on a family balance sheet? A) Dividends and interest received B) Annual salary C) Income taxes paid D) Spouse's engagement ring

D) A balance sheet, whether for a family or a business, shows assets and liabilities, not income and expenses. The ring is certainly an asset; the others are income or expenses.

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 high-yield bond fund B) A government bond fund C) A diversified open-end investment company concentrating in small-cap stocks D)50% in an S&P 500 index fund; 50% in a portfolio of high-quality bonds

D) 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.

What would be the time horizon for a 65-year-old client who has just retired?

Deoends on his life expectancy

Your married customers are both 42 years old, have 2 children ages 14 and 12, and have spent the past 10 years accumulating money to provide for their children's education. Their oldest child will enter college in 4 years, and the customers are very cautious investors. If they need a safe investment that provides regular income to help them meet tuition payments, which of the following mutual funds is the most suitable for these customers? A) LMN Investment-Grade Bond Fund B) ABC Stock Index Fund C) RST Balanced Fund D) ATF Overseas Opportunities Fund

A) LMN Investment Grade Bond Fund

When a joint account is opened______ financial information must be obtained from all people in it

All

Equity Income fund

An equity fund that aims to achieve both current income and growth of income best suits the objectives and investment profile of the client. A stock index fund does not offer the current income that the client requires. The capital appreciation and biotechnology funds not only fail to provide income; they are too risky for this retired person.

You are doing an investment plan for a new client, age 55, who plans to retire at age 70. The client is somewhat risk averse and wants to preserve capital while at the same time not falling prey to possible inflation. Which of the following portfolios would probably be most suitable? A) 90% large-cap stocks; 10% high-quality bonds B) 60% high-quality bonds; 30% large-cap stocks; 10% cash equivalents C) 40% high-yield bonds; 60% large-cap stocks D) 90% high-quality bonds; 10% large-cap stocks

B) Although it is possible to debate this choice (but don't), NASAA would suggest that the bonds and cash offer sufficient capital preservation while this proportion of equities will combat the risk of inflation. High-yield (junk) bonds have no place in the portfolio of a risk-averse investor.

Your firm's market analyst believes the current bullish market in equities will continue. Which of the following would be most suitable for a growth-oriented investor? A) Preferred stock fund B) Large-cap stock fund C) Bond fund D) GNMA fund

B) Large Cap stock fund A mutual fund investing in large-cap stocks (see Glossary of Terms) would be a reasonable investment for a growth-oriented investor in a bullish economic environment. Bonds are not a growth-oriented investment vehicle, GNMAs provide monthly income (not the growth that the client seeks), and preferred stocks are appropriate for income-oriented investors.

If a client wanted an investment that would eliminate interest risk as to principal, you would recommend

Bank insured CD's Because bank-insured CDs are nonnegotiable (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 91-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.

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) Variable annuities C) Long-term U.S. government bonds D) Bank-insured CDs

D) Bank Insured CD's 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.

A 50-year-old client with modest means wants to construct an investment program. He has no investment experience, his major consideration is saving for retirement, and he has limited risk tolerance. Which of the following would you recommend? A) High-grade bond fund B) Call options on the S&P 500 Index C) Aggressive growth mutual funds D) Growth and income mutual funds

D) Growth and Income mutual funds Mutual funds that offer growth and income best meet the client's needs, offering growth for retirement and current income. A high-grade bond fund would not offer the growth that the client needs for retirement, although the fund would supplement the modest income of the client. A client of modest means may not be able to sustain the risk of principal that accompanies an aggressive growth fund; in addition, this alternative is unsuitable because the client has limited risk tolerance. Index options are a speculative investment.

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

Income securities ONLY 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.

An investment adviser has a client who wants to save for college for her child. The child will be entering college in 5 years. This would be an example of

Investment constraint Time constraints include such conditions as liquidity and time horizon, both of which are in play here. It may be true that the client has started too late, but that is not what the exam would be looking for as the correct answer.

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

Made an unsuitable choice based on clients requests 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.

Of the following securities, which is most commonly recommended to fund a child's college education?

Zero-coupon Treasury bonds Zero-coupon bonds, particularly those carrying the guarantee of the U.S. Treasury, are a favored investment vehicle for saving for a child's higher education. They have the advantage of providing a certain, quantifiable sum at a certain date in the future.

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 life insurance capital needs analysis

A client profile is not complete without a family income statement. A typical one would include dividends credit card debt autos mortgage interest

dividends Mortgage interest

Pat Conway, a risk-averse investor, has never invested money outside of bank instruments. Recognizing Pat's conservative nature, his agent recommends Treasury notes, pointing out that federal government-backed securities are riskless securities. In the above situation, the agent has acted

improperly, because the agent failed to disclose that the customer retains interest rate risk Although Treasury securities (such as T-notes) issued by the federal government do not carry default risk, the customer who buys them retains interest rate risk because the value of the notes will fall if interest rates rise. The agent has acted improperly in not disclosing this to the customer.

Capital needs analysis

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.