finals - suitability

Which of the following investment portfolios is MOST stable? An aggressive growth fund An income fund A balanced fund A specialty fund

A balanced fund Balanced funds are composed of a balance of common stocks (market cycle sensitive) and fixed income securities (interest rate sensitive). The idea is that these factors operate somewhat opposite to each other, and therefore balance each other out. When the economy is bubbling along, common stocks do well, but bonds do not as the Fed begins to raise interest rates to slow down growth. When the economy is slowing down, common stocks do poorly, but bonds do well as the Fed drops interest rates to re-stimulate the economy, etc. Thus, this is the most stable portfolio of the choices offered.

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

A) 100% common stocks 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.

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

A) Passive asset management 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.

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

A) diversification 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.

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

A) tiers Treasury notes over a 5-year time frame 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 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? Mid-cap common stock Municipal bond Bank CD Treasure STRIPS

Bank CD 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.

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 BESTrecommendation 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

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 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!

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

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 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 Dreally bad as well!

Customer Name:Joey Jones Age:30 Marital Status:Single Dependents:None Occupation:VP - Marketing - ACCO Corp. Household Income:$250,000 Net Worth:$60,000 (excluding residence) Own Home:No - Rents Investment Objectives:Aggressive Growth / Early Retirement at Age 50 Investment Time Horizon:20 years Investment Experience:0 years Current Portfolio Composition: 401(k):$30,000 Cash in Bank:$30,000 When reviewing this customer's profile sheet, the most immediate question that should be considered is: A) "Does the customer intend to buy a home?" B) "Does the customer intend to get married?" C) "Since the customer earns $250,000 per year, how come he only has $60,000 in his portfolio?" D) "Since this customer is age 30, why does he want to retire by age 50?"

C) "Since the customer earns $250,000 per year, how come he only has $60,000 in his portfolio?" This customer, age 30, is a high earner, yet he only has $60,000 put away in his 401(k) and in cash. It sure looks like he is a big spender! Beginning a systematic plan of putting away money for retirement is critical when formulating an investment plan for a customer - especially one that wants to retire in 20 years. The customer must be made aware of the fact that, probably, his current spending pattern needs to be curtailed. This customer needs to start socking away money now to meet his early retirement goal!

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

C) SEP IRA 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 $57,000 in 2020. SIMPLE IRAs also are relatively "simple" for a business to set up, but they only allow a maximum contribution of $13,500 (in 2020). So the SEP IRA is better. In contrast, the maximum contribution to either a Traditional or Roth IRA in 2020 is $6,000 (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.

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

C) maintains a fixed percentage amount of a portfolio's assets in equities 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 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

D) SEP IRA A Roth IRA does not work for 3 reasons - the maximum contribution is only $6,000 (in 2020); 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 $6,000. A 401(k) plan allows for a larger deductible contribution ($19,500 in 2020), 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 $57,000 in 2020. It would allow this self-employed individual to make a 20% x $200,000 = $40,000 deductible contribution.

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

I Money market funds II Bank certificates of deposit IV Commercial paper 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 has the following investment mix: 25%Growth Stocks 25%U.S. Government Bonds 25%Investment Grade Corporate Bonds 25%Speculative Stocks Which asset classes are MOST susceptible to interest rate risk? I Growth Stocks II U.S. Government Bonds III Investment Grade Corporate Bonds IV Speculative Stocks

II U.S. Government Bonds III Investment Grade Corporate Bonds Interest rate risk is the risk that market interest rates rise, forcing down the price of fixed income securities - meaning preferred stocks and bonds.

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

Short-term Treasury Note 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!).

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

rebalanced 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 couple wants to invest for the college education of their 2 children, currently ages 1 and 3. They estimate they will need to start using the funds to pay for college in 15 years. The BEST recommendation is to invest in: Treasury Bills 10-Year Treasury Notes 20-Year Treasury Bonds 30-Year Treasury Bonds

10-Year Treasury Notes Since all of the choices are U.S. Government obligations, there is no difference in credit risk, so this is not a factor. The question hinges on when the funds are needed to start paying for college (in 15 years). Treasury Bills have a maximum maturity of 1 year and give the lowest return. They would provide the funds needed to pay for college when they mature each year, but at the expense of a lower return. 30-year Treasury Bonds give the highest return, but they do not mature for 30 years. They could be sold starting in 15 years to pay for college tuition, but if market interest rates rise, their price will have fallen. The same issue exists for 20-year Treasury bonds. The best choice is 10-year Treasury Notes. These will give a higher return than an investment in a short-maturity Treasury, and when they mature in 10 years, the proceeds could be invested in 5-year Treasury Notes, so that they mature in time to start paying for college. Of course, the answer we would really like to see - a 15 year maturity - is not here!

Customer Name: Jack and Jill Customer Ages: 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 Objective: Additional Income Risk Tolerance: Moderate Investment Time Horizon: 25 years Investment Experience: 30 years 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 stocksJack's 401(k):$600,000 invested in Dyno-Mite Corp. stock Jack's 529 Plan for Grandchild: $20,000 in growth mutual fund As the representative for this customer, your main concern would be that: A) Jack has too much of his portfolio concentrated in the common stock of a single company - Dyno-Mite Corporation, which happens to be the customer's employer B) Jill has not set up a retirement account based upon her income C) Jack has too much of his portfolio invested in growth stocks that have a higher risk level than Jack's stated tolerance D) Jack is maximizing his annual permitted contributions to his IRA and 401(k) accounts, since he is nearing retirement age

A) Jack has too much of his portfolio concentrated in the common stock of a single company - Dyno-Mite Corporation, which happens to be the customer's employer Jack's portfolio is overloaded with growth investments, which does not fit his current objective of receiving income. However, $600,000 of Jack's $1,000,000 portfolio value is in a single stock - Dyno-Mite Corporation that is also Jack's employer. It is quite noble to own your own company's stock; but it is also pretty reckless to stake your future on that single company's fortunes. Jack should be informed that he is pursuing a very risky strategy with such a large Dyno-Mite holding and may want to liquidate a portion of that holding and reallocate it to income yielding investments to better meet his investment objective.

A 25-year old single client has just started his own small business and is not covered by a retirement plan. He has $5,000 to invest and currently has a low level of income. He wishes to start saving for retirement. The BEST recommendation is a: A) Roth IRA B) SIMPLE IRA C) Traditional IRA D) Roth 401(k)

A) Roth IRA Anyone with earned income can open an IRA. Because this individual is in a low tax bracket, a Roth IRA contribution, which is non-deductible, makes sense (there is no real benefit from making a deductible contribution to a Traditional IRA). With $5,000 to invest, this is within the $6,000 contribution limit for 2020. Earnings build "tax-free" in a Roth, and distributions taken at retirement age are non-taxable. Also remember that high-earners cannot open a Roth IRA. In contrast, if a Traditional IRA were opened, this individual would get a tax deduction (he is not covered by another qualified plan), but it would have little value because of his low tax bracket. Earnings would build tax deferred and when distributions are taken at retirement age, they would be taxable, so the Roth is the better deal. A 401(k) is an employer-sponsored salary reduction plan under ERISA that requires major paperwork to establish. It allows a contribution of up to $19,500 in 2020, far more than the $5,000 this individual has to invest. This is not suitable for a very young single person starting a small business. A SIMPLE IRA is another qualified retirement plan that is "simpler" to set up than a 401(k), and that is only available to businesses of 100 or fewer employees. It allows for a larger deductible contribution than an IRA ($13,500 in 2020), which is more than this person needs. Also, it is still not as easy to set up as an IRA.

A client, age 67, owns his own home free and clear. The customer has an annual income of $25,000, mainly from social security and interest on funds held in a bank savings account. The customer has never invested and is told by his nephew that the technology company that he works for is coming out with a hot new product that will really increase the company's stock price. TheBESTrecommendation to be made to this client is to: A) do nothing B) only invest enough of his savings account in the technology company's stock so that his reduced income still covers his bills as they come due C) take out a mortgage on his fully paid house and use the proceeds to make the investment in the technology company and then pay off the mortgage from the profits on the investment D) liquidate the entire savings account and use the proceeds to make the technology company investment because the customer can still live on this social security

A) do nothing This customer is age 67 and has very little income and no other liquid assets. He cannot afford to lose a bunch of money and he should do nothing!

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

A) growth stocks and blue chip stocks immediately in the amount of $150,000 to obtain the necessary cash down payment 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.

Active asset managers select investments based primarily upon: A) inefficient market pricing of the investment B) efficient market pricing of the investment C) minimum time needed to achieve projected investment returns D) minimum number of investments needed to achieve projected investment returns

A) inefficient market pricing of the investment Active asset managers believe that by performing fundamental analysis, they can find undervalued companies - that is, companies that are not "efficiently priced". Passive asset managers believe that the market is basically efficient, and that one cannot consistently find "undervalued securities" - so why bother? Instead, just invest in an asset that mimics the index - that is, an index fund. This will do as well as the "market" with much lower expenses that those associated with "active" asset management.

The portfolio management technique that uses a performance benchmark such as a market index that any investments must match is called: A) passive management B) active management C) fundamental management D) technical management

A) passive management Passive portfolio management relies on the belief that market pricing is efficient and that stock prices are always properly valued. Thus, finding "bargains" is impossible and index funds are appropriate investments for each asset class. Active asset managers believe that specific stocks can be undervalued in the market, and that by selecting these investments in a given asset class, investment performance can be improved.

A 30-year old single individual wishes to invest for retirement. He is employed at a high paying job at a stable employer, has a high risk tolerance and, has no current income needs from his investments. The BEST asset allocation to recommend to the customer is: A) 50% common stocks / 50% bonds B) 100% common stocks / 0% bonds C) 0% common stocks / 100% bonds D) 33% common stocks / 33% bonds / 33% cash

B) 100% common stocks / 0% bonds This customer can assume risk, has no current income needs, and has a 40-50 year investment time horizon. The best answer is Choice B, since the customer should be weighted at least 70% in common stocks (100% minus one's age as a general guide). This is not offered as an answer, but because this individual has a "high risk" tolerance and a stable job, the equity allocation can be increased.

A high P/E stock would be a suitable investment for which of the following investors? A) A recent college graduate who is currently renting an apartment and who wishes to buy a house in 5 to 10 years B) A recently retired client who has a comfortable level of income from her pension, does not need additional income and is looking for aggressive investing C) A young married couple with 3 children ages 10, 12, and 14, who have minimal savings but wish to start putting away money to pay for their kids' college education D) A middle-aged single man who was just diagnosed with a disabling medical condition that will likely require him to need nursing care for his remaining lifespan that is not covered by his medical insurance

B) A recently retired client who has a comfortable level of income from her pension, does not need additional income and is looking for aggressive investing High P/E stocks are risky. These are high growth stocks that typically pay minimal dividends, and which are expected to grow rapidly in the future. If their growth starts to slow, the price of these stocks can fall dramatically - a risk that should not be assumed in Choices A, C, and D. In Choice B, the customer has plenty of income and wants to take on risk - so a high P/E stock recommendation meets her objective.

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

B) Bullet 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, age 69, has never invested in securities. She is retired with no dependents, living on a fixed pension of $35,000 per year. She has a savings account with $160,000 and her home is fully paid. She desires to supplement her retirement income, assuming minimal risk. The BEST recommendation would be for the customer to invest $100,000 of her cash savings into a(n): A) variable annuity contract B) CMO planned amortization class tranche C) SPDR D) income (adjustment) bond

B) CMO planned amortization class tranche CMO planned amortization classes give a good yield that is 50 or so basis points higher than equivalent maturity Treasuries and are extremely safe. These meet the customer's objective of additional income with low risk. Since this customer is only earning $35,000 per year, she is in a low tax bracket - making tax-deferred variable annuities unattractive. SPDRs - Standard and Poor's 500 Depository Receipts are an exchange traded fund that consists of equities - which don't provide much income. Income bonds only pay interest if the corporation has enough "income" - so these are not appropriate either.

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

B) Diversification among differing denominations 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 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

B) Treasury bills, a money market mutual fund and bank certificates of deposit 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 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

B) client's age 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.

A customer, age 55, has a diversified portfolio of blue chip equity investments that pay a reliable cash dividend. The customer would like to retire at age 65. The customer has an expensive lifestyle, and even though he makes a good income, he uses the dividend income from his investments to pay his large monthly bills. The main problem that is evident here is that the: A) portfolio should be rebalanced to include a percentage allocation to fixed income securities because of the customer's age B) customer is unable to take advantage of the compounding effect of reinvesting dividends C) customer increases his tax liability by spending the dividends rather than reinvesting them D) customer needs to change his spending habits

B) customer is unable to take advantage of the compounding effect of reinvesting dividends Well - there are so many good correct choices here, and you have to pick only 1 of them! Choice A is pretty good - this guy is 55 and has his whole portfolio allocated to equities and nothing to bonds. If we were to use the simple "Take your age and subtract it from 100 rule" to get the equities allocation, we would get a proper allocation of 45% equities and 55% bonds. Choice B is good too - by continually spending the dividends instead of reinvesting them, the customer gives up the compounding effect of adding to his investments each year, which increases dividends received, which can then be reinvested in more shares, which earns even more dividends, etc. Choice C is clearly wrong - whether cash dividends are spent or reinvested, they are taxable. Choice D is pretty good too - this customer spends too much. Of the 3 remaining possible choices, Choice Dis eliminated first, because this is not a psychology test. Getting the customer to change his spending habits is not your role, though you could certainly bring this up in conversation! Choice Ais eliminated next because this customer is invested in blue chip, high dividend paying stocks, so based on his age, having a portfolio 100% invested in these is actually reasonable. We are left with Choice Bas the best answer - by spending the dividends, this customer is giving up the wonderful, magical effect of compounding of investment returns! (Of course, you knew this was where the question was going from the first reading.......right?)

A retired married customer, age 73, 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

B) municipal bonds 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 72), 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.

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

B) sell short term T-Bills and buy long term T-Bonds 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 single 30-year old investor has no current investments and $20,000 in a savings account. The customer earns $150,000 per year and has discretionary investment funds of $25,000 per year. Which of the following is an appropriate asset allocation for this customer? A) 80% Aggressive Growth Fund, 20% Emerging Markets Fund B) 80% Emerging Markets Fund, 20% Aggressive Growth Fund C) 30% Aggressive Growth Fund, 30% Emerging Markets Fund, 30% Growth Fund, 10% Money Market Fund D) 30% Money Market Fund, 30% Treasury Securities Fund, 30% Blue Chip Stock Fund, 10% Aggressive Growth Fund

C) 30% Aggressive Growth Fund, 30% Emerging Markets Fund, 30% Growth Fund, 10% Money Market Fund Since this customer is only 30 years old and is single, he has a long investment time horizon. The question does not provide any detail in terms of the customer's investment objectives and risk tolerance level. However, the concept of asset allocation is that by diversifying across asset classes, overall risk can be reduced while still achieving the customer's objective. A younger customer should be allocated more heavily into growth stocks. Choice C, with a 30% allocation to an Aggressive Growth Fund, 30% to an Emerging Markets Fund, 30% to a Growth Fund, and 10% to a Money Market Fund gives the customer a heavy concentration in growth stocks, but spread across 3 types of growth investment vehicles. Choices A and B are too concentrated in a single investment vehicle; and Choice D is better for an older investor, not a young investor.

A 25-year old client with a low risk tolerance wishes to invest in bonds. The client has invested in equities before, but has no experience investing in bonds. The BEST recommendation would be: A) BB-rated short-term bonds B) BB-rated intermediate-term bonds C) AA-rated short-term bonds D) AA-rated long-term bonds

C) AA-rated short-term bonds This client has a low risk tolerance. Therefore, to minimize credit risk, investment grade bonds are appropriate (BBB or higher). To minimize interest rate risk, short-term maturities are better than long-term maturities. Both of these factors will result in a safer bond investment. However, the customer will get a lower yield, but that is not addressed in the question.

Which of the diversification factors below will not reduce the non-systematic (credit) risk of a bond portfolio? A) Maturity B) Industry in which issuer operates C) Coupon rate D) Geographic location of issuer

C) Coupon rate The coupon rate has no bearing on diversification to reduce potential credit risk. In the trading market, the price of a bond is determined by the market yield for that type of security - not the coupon rate. To reduce non-systematic risk (meaning the risk that any one security may be a "bad" investment), diversification of a bond portfolio by choosing different issuers, different industries, different geographic issuer locations, and different maturities (since long term bonds give issuers longer time periods in which they can go broke) are all valid.

A 68-year old new customer has investment objectives of preservation of capital and income in retirement. The customer has a low risk tolerance and is in the 35% marginal federal tax bracket and is in the 10% state tax bracket. Which investment recommendation would be most suitable for this client? A) Investment grade corporate bonds with long maturities B) Preferred stocks of blue chip companies C) Pre-refunded general obligation bonds D) General obligation bonds that have been escrowed to maturity

C) Pre-refunded general obligation bonds This customer with a low risk tolerance is looking for preservation of capital and income in retirement. While long-term investment grade corporate bonds will give interest income, they are also highly susceptible to interest rate risk - if market interest rates go up, long time bond prices fall faster than short term bond prices - so this does not meet the customer's other objective of preservation of capital. (Preservation of capital means that the customer does not want to incur a capital loss, generally leading to investment choices of very safe, short-term fixed income securities like Treasury Bills.) Preferred stocks of blue chip companies will also provide dividend income that will be taxed at a preferential rate (15%) for this customer in a high federal tax bracket. However, preferred stock has no stated maturity, so it will pay for as long as the company is in business. This is the longest maturity, and as a fixed income security, it is subject to the highest level of interest rate risk. So this also does not meet the customer's objective of preservation of capital. Tax-free municipal bonds would be suitable for a customer is such a high tax bracket. Pre-refunded municipal bonds have been escrowed by the issuer with Treasury or Agency securities to be retired at the near-term call date. These are the safest municipal bonds (AAA rated) and also the shortest maturity of the choices offered. This meets the customer's 2 objectives - income and safety or principal, because the bond's life has been shortened to the nearest call date. In contrast, a municipal bond that has been escrowed to maturity with Treasury or Agency securities is safe (AAA rated), but it will be redeemed at maturity, not at an earlier call date. It will have a higher level of interest rate risk than a pre-refunded bond.

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

C) Preferred stocks 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.

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

C) Stock price growth rate 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.

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 BESTchoice 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

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 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.

A young aggressive investor gets laid off from her job. She has a net worth of $80,000 and has received a 1-time severance payment of 3 times her annual salary ($240,000 payment). In addition, she gets medical coverage for 1 year. The appropriate action for the registered representative to take is to: A) change the account investment objective to income and safety and invest the $240,000 severance payment based on these objectives B) do nothing unless written instructions are received from the customer C) discuss the situation with the client to determine if it is appropriate to change the investment objective before making any further investments D) recommend a balanced mutual fund investment that will give this younger client moderate income in addition to growth

C) discuss the situation with the client to determine if it is appropriate to change the investment objective before making any further investments There has been a change in the client's financial situation. Before doing anything in the account, the situation should be discussed with the client to see what her current needs are. Then an appropriate recommendation can be made. At this point, we don't know if Choices A and D might be appropriate for the client - they could be, but only after the representative has a talk with the client.

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

C) growth fund 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.

Customer Jane Jennings' suitability information is presented below: Age:39 Marital Status:Single Dependents:1 Child - Age 10 Annual Income:$80,000 Tax Bracket:28% Net Worth:$510,000 excluding home Home:$350,000 fully paid Investment Portfolio:$422,000 (60% equities; 20% long bonds; 20% money market) The customer wants to start a college fund for her child. The anticipated tuition, starting 8 years from now, is $50,000 per year ($200,000 total tuition). Which of the following recommendations is most appropriate for this customer? A) liquidate $200,000 of common stock in the client's portfolio and invest the entire proceeds in 8-year Treasury Notes B) take out a second mortgage on the customer's residence in the amount of $200,000 and invest the proceeds in a tax-deferred annuity funded by an income separate account C) liquidate $160,000 of the common stock and invest the proceeds in laddered Treasury Notes and Bonds of $40,000 amounts maturing 8, 9, 10 and 11 years from now D) liquidate $100,000 of the bonds in the customer's portfolio and $100,000 of common stock in the customer's portfolio and invest the entire proceeds in 8-year Adjustment Bonds

C) liquidate $160,000 of the common stock and invest the proceeds in laddered Treasury Notes and Bonds of $40,000 amounts maturing 8, 9, 10 and 11 years from now To fund this child's college education, payments of $50,000 per year are needed over a period of 4 years, starting 8 years from now. There is no reason to fund the entire $200,000 right now, since this amount will grow over the next 8 years - making Choices A, B and D incorrect. Also, please note that this customer is only 39 years old - a fairly young age. She should keep as much of her portfolio in growth stocks as possible.

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

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 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 Cstill 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 Bis 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.

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

C) open a cash account and invest in mutual funds holding high yielding common and preferred stocks 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.

When a manager liquidates securities out of one asset class and invests the proceeds in another asset class to maintain the desired asset allocation percentages as market prices move, the manager is: A) strategically managing the portfolio B) tactically managing the portfolio C) rebalancing the portfolio D) optimizing the portfolio

C) rebalancing the portfolio Once asset allocation percentages are set in a portfolio and funding is complete; the actual percentage composition of the portfolio can shift due to the relative performance of each asset class. For example, assume that equities are set at 30%; and fixed income securities are set at 70%; of the portfolio's value. Also assume, that over the next 6 months, there is a bull market, and the stock portion of the portfolio rises to 45% of total value; while fixed income investments now are at 55% of total value. The portfolio must be rebalanced by selling equities and investing the proceeds in fixed income securities to bring the relative percentages back to 30/70.

The target allocation for a specific asset class has been set at 20% of total assets under an asset allocation scheme. The manager is permitted to reduce this percentage to 15%; and can increase it to 25%; as he or she sees fit. If this action is taken by the manager, this is termed: A) portfolio rebalancing B) strategic asset management C) tactical asset management D) active asset management

C) tactical asset management The selection of the percentage of total assets to be allocated to a given asset class is called "strategic asset management" - that is, setting the investment strategy. The permitted variation from this percentage that is given to the asset manager, so that the manager can take advantage of market opportunities, is called "tactical asset management".

A married couple, the husband is age 27 and the wife is 25, have 2 young children, no retirement plan and no investments. Based on this information, an agent should: A) tell the clients to establish a Roth IRA B) tell the clients to establish 529 plans for their children C) talk to the clients about their financial goals D) determine that the clients have cash available for investment

C) talk to the clients about their financial goals We certainly don't know much here from the information given. The best of the choices offered is to talk to the clients about their financial needs and goals and then establish an investment plan to get them there, based on the funds that they have available for investment, their risk tolerance, investment time horizon, etc. While determining that the customers have (or will have) cash available for investment is part of the process, Choice C is the better answer. Also note that specific investments (Choices A and B) cannot be recommended until the investment plan is completed.

A trader liquidates an exchange listed stock position and invests the proceeds in an exchange listed stock index fund. The trader has reduced which risk? Call risk Inflation risk Liquidity risk Capital risk

Capital risk Capital risk is simply the risk of losing money. By increasing the number of stocks in a portfolio, this risk is reduced through diversification. This is a major advantage of investing in stock index funds. Call risk does not apply to stocks (because common stocks are non-callable). Stocks, whether held individually or in an index fund, are not as susceptible to inflation (purchasing power) risk as bonds. In times of inflation, corporations can raise prices and maintain profitability. Liquidity risk is the risk that a security can only be sold by incurring large transaction costs and is essentially not applicable to exchange listed securities because the market is so active.

A customer who earns $80,000 per year is 35 years old, married to a non-working spouse, has a 5-year-old child, has no retirement savings and does not have a will. This customer receives $250,000 in a single stock as an inheritance from her deceased aunt. What is the first thing that the customer should do? A) Set up an IRA account to begin to fund her retirement B) Establish a will C) Pay any capital gains tax due on the stock position, if this cannot be avoided D) Diversify the stock position, because it should not be in a single stock holding

D) Diversify the stock position, because it should not be in a single stock holding What is concerning about this customer is 2 things - the fact that she does not have a will and the fact that her only investment holding is now $250,000 in a single stock position, which if the stock tanks, will result in a big loss. The first thing to do is to diversify the stock holding, to reduce the risk of loss of capital. This is more immediate than establishing a will, which usually takes some thought, lawyer's advice and a bit of time. There will be no capital gains tax on the stock position, since securities are inherited at the market value as of the date of death with no tax due by the recipient. If there was any appreciation in the stock until the date of death, that position's value is included in the estate and estate tax may be due - but this is paid by the estate.

An older female customer, in the lowest tax bracket, wants an investment that will provide asset growth for retirement. The best recommendation would be: A) Emerging markets fund B) Single stock C) Municipal bond D) Index fund

D) Index fund A municipal bond is not appropriate for a low tax bracket customer and it does not give growth. An emerging markets fund certainly offers high growth, but it also high risk and this customer is "older." A single stock might be a great investment, but there is no diversification. An index fund gives growth potential with diversification and is the best of the choices offered.

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

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 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.

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) buy index calls B) buy index puts C) buy inverse ETFs D) buy leveraged ETFs

D) buy leveraged ETFs 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 the leveraged ETF. Assume it is a 300% leveraged ETF based on the S&P 500 Index. If the index rises by 15%, this ETF should rise by 3 x 15% = 45%. (Of course, if the customer is wrong and the index falls, then the customer loses big time!) The purchase of an inverse ETF is not appropriate because it moves opposite to the general market, so if the market rises, it falls. Of course, if the customer were to short an inverse ETF, then if the market moved up, the inverse ETF would fall in value, for a profit on the short position - but this is not offered as a choice.

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

D) buy leveraged inverse ETFs 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.

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

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 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.

A customer, age 51, has a 20 year investment time horizon, a moderate risk tolerance, and is looking for investments that provide both income and growth. The best recommendation would be: A) money market instruments B) mutual funds C) bonds D) large capitalization growth stocks

D) large capitalization growth stocks Money market instruments are very safe, but provide little income and no growth. These would be recommended to a customer seeking preservation of capital - not to a customer seeking income and growth. Choice B, mutual funds, is too generic to be a valid choice. There are all kinds of mutual funds out there, for all types of investment objectives. Choice C, bonds, is also too generic to be a valid choice. Also, while bonds provide income, they do not provide growth. Choice D, large capitalization growth stocks, is the best one offered. Large capitalization stocks pay dividends for income, and also offer long term growth potential, meeting both of the customer's objectives.

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

II Large Cap Defensive Stocks III U.S. Government Bonds 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.

Which statements are TRUE regarding the account of a customer who has an investment objective of making short term trading profits from investments in equity securities? I Such a strategy will cause the customer to be subject to a lower level of market risk as compared to a "buy and hold" strategy maintained over a long term time frame II Such a strategy will cause the customer to be subject to a higher level of market risk as compared to a "buy and hold" strategy maintained over a long term time frame III Such a strategy will have more favorable tax consequences as compared to a "buy and hold" strategy maintained over a long term time frame IV Such a strategy will have less favorable tax consequences as compared to a "buy and hold" strategy maintained over a long term time frame

II Such a strategy will cause the customer to be subject to a higher level of market risk as compared to a "buy and hold" strategy maintained over a long term time frame IV Such a strategy will have less favorable tax consequences as compared to a "buy and hold" strategy maintained over a long term time frame Equity returns can vary greatly over a short-term time frame, so this person is taking on a higher level of market risk. Over a long-term time frame, market risk is not a major issue for equity holders, since, historically equities have performed the best of all asset classes over a long periods of time. Any gains on securities held short term (1-year or less) are taxed at much higher rates (up to 37%) than long term gains (15%, or 20% for high earners).

Which statements are TRUE about defensive stocksthat are included in a portfolio allocation model? Defensive stocks have: I higher expected returns than other equities included in the portfolio II lower expected returns than other equities included in the portfolio III higher standard deviations (risk) than other equities included in the portfolio IV lower standard deviations (risk) than other equities included in the portfolio

II lower expected returns than other equities included in the portfolio IV lower standard deviations (risk) than other equities included in the portfolio Defensive stocks are minimally affected by the business cycle, with classic defensive stocks being food and pharmaceuticals (in bad times, people must still eat, and must still take prescription drugs for their illnesses or suffer the consequences!) Because their earnings stream is so stable, defensive stocks have lower risk (as measured by variability of returns - AKA standard deviation) than other equity securities. Because of their lower risk, their returns are correspondingly lower as well.