Suitability: Portfolio Construction / Asset Allocation
Asset Allocation 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
Asset Allocation - Summary Examples 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
Suitable Recommendations - Customer Seeking Income A customer in the highest tax bracket has $500,000 to invest. The customer is subject to the AMT. The BEST recommendation would be an investment grade: A Municipal bond yielding 2.50% that is not subject to the AMT B Municipal bond yielding 2.70% that is subject to the AMT C Treasury bond yielding 3.50% D Corporate bond yielding 3.75%
A
Suitable Recommendations - Options A customer owns 1,000 shares of XYZZ stock, purchased at $40 per share. The stock is now at $45, and the customer has become neutral on the stock, but believes that the stock still has good long term growth potential. The client asks her representative for a "conservative recommendation" that will give her a positive portfolio return. The client should be told to: A sell 10 XYZZ 45 Call Contracts B sell 10 XYZZ 45 Put Contracts C sell 1,000 shares of XYZZ and sell 10 XYZZ 45 Call Contracts D sell 1,000 shares of XYZZ and sell 10 XYZZ 45 Put Contracts
A
Suitable Recommendations - Shorter Term Investment Time Horizon A customer has $20,000 to invest, but needs immediate access to the funds to pay a variety of bills that will arrive over the next 3 months. The BEST recommendation is for the customer to deposit the funds to a: A Money market checking account B Money market mutual fund C Money market instrument D Treasury Direct account
A
Suitable Recommendations A customer is in the highest tax bracket and will possibly be subject to the AMT. Which of the following is the BEST investment recommendation? A 5.40% Municipal bond that is not subject to the AMT B 5.60% Municipal bond that is subject to the AMT C 6.00% Treasury bond with a long expiration D 6.00% Corporate bond mutual fund
A For a customer looking for income in retirement, increased allocations to fixed income securities should be made - remember the basic rule for the "typical" customer is that the customer's age should be invested in fixed-income securities. For a customer looking for life-long income in retirement, an annuity is usually a suitable recommendation. For a customer seeking income who is in a high tax bracket, a municipal bond it typically a suitable recommendation. For a customer who wishes to invest in bonds that offer both income and potential growth, convertible bonds are usually a suitable recommendation. For a customer looking for income, you would not recommend an income bond - remember, this is a corporate bond that only pays interest if the issuer has enough earnings (income).
Suitable Recommendations - Changing Interest Rate Expectations An investor believes that interest rates will be flat or falling into the future; and that prices may deflate. The MOST appropriate investment is: A Long term U.S. Government bonds B Real estate C Gold D Large Capitalization stocks
A In a period when interest rates are rising, the best recommendation is shorter-term debt instruments. In a period when interest rates are falling, the best recommendation is long-term debt instruments.
Active The portfolio management technique that uses a market index as a performance benchmark that the asset manager must exceed is called: A Passive asset management B Active asset management C Strategic asset management D Tactical asset management
B
Constant Dollar / Ratio Plans A constant dollar investment plan requires: A that the same dollar amount be invested periodically in new equities purchases B that the same aggregate dollar amount be kept invested in equities C the constant reinvestment of all dividends and interest received in the same securities D that a constant dollar amount be invested in U.S. securities
B
Suitable Asset Allocations - Younger Customers 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
Suitable Recommendations - Aggressive Clients 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
Suitable Recommendations - High Tax Bracket Customers 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 Review
B
Suitable Recommendations - Older Customers IV 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
Suitable Recommendations - Retirement Plans All of the following are suitable investments for an Individual Retirement Account EXCEPT: A Corporate bonds B Municipal bonds C U.S. Government bonds D Zero coupon bonds
B
Suitable Recommendations - Saving for College A young couple in a low tax bracket have 2 young children and they want to start saving for the kids' college education. The BEST recommendation would be: A T-Bills B Growth funds C Municipal bond funds D 20 year maturity municipal bonds
B
Suitable Recommendations - Older Customers III A customer who is retired wants to select an investment that is liquid, marketable, and that provides regular income. The BEST choice would be to recommend: A Treasury Bills B Treasury Notes C Preferred Stock D Certificates of Deposit
B Investment allocations must be biased towards safe securities such as Treasuries and investment grade corporate bonds, to provide both income and safety of principal. Note that longer maturity debt instruments can expose to the client to substantial interest rate risk, so maturities used should be no longer than intermediate term (10 years or less).
Suitable Recommendations - Older Customers I A 79-year old customer in the highest tax bracket with $1,000,000 to invest is risk averse. Which investment recommendation would be appropriate? A Money market funds B Municipal bonds C A Dow Jones Industrial Average index fund D Certificates of deposit
B Older customers in low tax brackets seeking income should be recommended corporate bonds; if the customer is in a high tax bracket, then a municipal bond is appropriate.
Diversification Impact on Portfolio 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 To diversify a corporate bond portfolio, bonds should be selected: with differing maturities; with differing ratings; in different industries; of issuers in different regions of the country.
Basic Recommendation Examples The overall economic performance of developing countries is expected to outpace that of the United States over the coming years. A customer that wishes to profit from this should receive which recommendation and accompanying risk disclosures? A The customer should be recommended a special situations fund, as long as the customer is willing to assume regulatory risk and market risk B The customer should be recommended a specialty fund, as long as the customer is willing to assume credit risk and extension risk C The customer should be recommended an emerging markets fund, as long as the customer is willing to assume political risk and exchange rate risk D The customer should be recommended a sector fund, as long as the customer is willing to assume unsystematic risk and market risk
C
Growth Investing A growth investor would consider a company's: A Price / Earnings ratio B Price / Book Value ratio C Stock price appreciation rate D Market share
C
Investment Selection Impact on Portfolio Which of the following investment portfolios is MOST stable? A An aggressive growth fund B An income fund C A balanced fund D A specialty fund
C
Rebalancing 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
Strategic Strategic portfolio management is the selection of the: A securities in which to invest B asset classes in which to invest C target asset allocation for each asset class selected for investment D variation permitted in target asset allocation for each asset class selected for investment
C
Suitable Asset Allocations - Older Customers What portfolio construction is most appropriate for a retired married couple, ages 60 and 70, for the wife and husband respectively? A 100% common stocks B 70% common stock/30% bonds C 35% common stock/65% bonds D 100% bonds
C
Suitable Recommendations - Asset Concentrations A new client with no other investment assets has just come into an inheritance of $500,000 of ABCD stock, a blue chip company listed on the NYSE. As the adviser to this customer, your IMMEDIATE concern should be: A whether the company is a candidate for delisting B the possibility that the value of ABCD stock may decline sharply C the lack of diversification of the customer's investment D whether the customer paid any estate tax liability due
C
Suitable Recommendations - Situations A young widow who works has a $750,000 net worth and a securities portfolio valued at $200,000. The current asset allocation of the portfolio is 80% equity securities; 8% fixed income securities; and 12% money market securities. In which circumstance should she consider reallocating her portfolio? A If she remarries and her new husband is quite wealthy B If she remains employed at the same job C If she becomes unemployed during a recessionary period D If she remarries and her new husband has young children
C
Suitable Recommendations - Younger Customers 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
Tactical 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
Bond Portfolios Which bond portfolio where all investment is made up front would be MOST negatively affected by a sharp rise in interest rates? A Ladder B Bullet C Barbell D Balloon
C Least- Ladder
Asset Allocation - Summary Institutional portfolio managers have been allocating an increasing percentage of their funds to cash and cash equivalent positions. This is an indication that their market sentiment is: A bullish B neutral C bearish D cautious
C Stocks - Bullish
Value Investing 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 The investment strategy that involves paying a lower price for a security based on the expectation that the market is mispricing the issue is: 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.
Suitable Recommendations - Older Customers II A Registered Investment Adviser has a retired client who wishes to put aside funds for the purchase of a car 5 years from now. Preservation of capital is important to this client. The RIA should recommend investments in: I Money market funds II Bank certificates of deposit III 5 Year Treasury Bonds IV 30 Year Treasury STRIPS A I and II only B III and IV only C I, II, III D I, II, III, IV
C This customer needs funds in 5 years and preservation of capital is important to the client. Money market funds and bank certificates of deposit are clearly suitable. The 5 year Treasury Bond works as well, since the funds are needed in 5 years and this bond will mature at that time. The 30 year Treasury STRIPS is clearly unsuitable, since in 5 years, its value may have dropped sharply if interest rates rise (bonds with low coupons and long maturities are most affected by interest rate risk).
Risks - Examples A customer has a $4,000,000 portfolio that is invested in the following: $1,000,000Blue Chip Stocks $1,000,000Technology Stocks $1,000,000Long Term Investment Grade Bonds $1,000,000High Yield Bonds If the economy enters into a recession, the securities which will suffer the greatest price decline are likely to be the: I Blue Chip Stocks II Technology Stocks III Investment Grade Bonds IV High Yield Bonds A I and III B I and IV C II and III D II and IV
D
Suitable Recommendations - Inherited Funds 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
Suitable Recommendations Among Types of Education Savings Plans A married couple has a teenage child who has expressed interest in going to a vocational school. They both work, have a moderate level of income and would like to save a modest amount each year for this purpose without the concern of paying taxes on annual account earnings. The best recommendation to this couple is to make an annual contribution to a(n): A 529 Plan B UTMA Account C HSA D Coverdell ESA
D
Time Horizon The time horizon to be used when constructing a portfolio to pay for college expenses for a person who is expected to start college in 10 years and finish college in 15 years is: A 5 years B 10 years C 12.5 years D 15 years Review
D
Suitable Recommendations - Types of Municipal Bonds Which bond recommendation would be the LEAST safe for an individual who seeks income that is free from federal income tax? A AA-rated revenue bond that is escrowed to maturity B AAA-rated general obligation bond C PHA bond D Double-barreled bond
D Most - C
Suitability Concerns An IRA is allocated in large cap stocks, TIPS, foreign stocks and municipal bonds. When reviewing this portfolio, you should be MOST concerned about the: A Large cap stock holding B TIPS holding C Foreign stock holding D Municipal bond holding
D Municipal bonds are not suitable for tax deferred accounts such as pension plans and IRAs. These accounts are already tax deferred, so putting taxable investments in them that generate a higher rate of return than municipals is appropriate.
Passive Asset Management Passive asset management is: A buying securities positions and holding them to the liquidation date of the portfolio B buying securities positions and holding them until pre-established prices are reached C selecting securities to be purchased for each asset class based upon fundamental analysis D using index funds as the investments for each asset class
D Passive asset management does not mean that there is no management. Passive asset management is the use of index funds
Suitable Recommendations - Low Tax Bracket Customers A 65-year old widow that is in a low tax bracket and that has a low risk tolerance wishes to make an investment that will provide income. Which is the BEST recommendation? A Growth mutual fund B Emerging markets mutual fund C Long term municipal bond fund D Bank certificates of deposit Review
D This elderly widow is in a low tax bracket and seeks income. Growth stocks and emerging markets stocks do not provide income; rather, they provide capital gains. Municipal bonds are not appropriate for a low tax bracket investor, since the bonds are exempt from Federal income tax, and the market interest rate is lower than that for taxable investments because of this. Municipal bonds are only suitable for high tax bracket investors, where the exemption from federal tax has real value. Thus, we are left with bank certificates of deposit as the only viable choice.
