Book 3 -- Investment Planning

Kate, age 35, recently attended a financial planning seminar. Shortly thereafter, she set up a meeting with a local CFP® professional. During the interview, they discussed the investment planning process. Which of the following are steps in this process? 1. Selection of specific assets to be included in the investment portfolio 2. Determination of Kate's ability to invest 3. Implementation of the investment strategy 4. Establishment of a brokerage account with the CFP® professional's firm A)1, 2, and 3 B)2 and 3 C)3 and 4 D)1, 2, and 4

A / / The establishment of a brokerage account is not a necessary step in the investment planning process. However, this may take place during the implementation phase.

Nate, a CFP® professional, is conducting a Monte Carlo analysis (MCA) for his client, Allen. Allen, age 46, is an entrepreneur with an income of $125,000 and assets exceeding $1,000,000. He considers himself to be a moderate to aggressive risk taker. He is concerned that he will not have enough money to retire comfortably. Nate's use of an MCA can help answer which of the following questions for Allen? 1. What are the chances of me reaching my financial goals? 2. What is the proper asset allocation for my portfolio based on my risk tolerance? 3. Will I have to postpone retirement to a later age? 4. How much do I need to accumulate to reach my goal? A)1, 3, and 4 B)1, 2, 3, and 4 C)1 and 2 D)2 and 4

B

Your client, Tiffany, owns a portfolio that earned 12% during the current year. Her portfolio had a beta of 1.3 and a standard deviation of 14%. During the current year, the market (S&P 500) returned 9% and the risk-free rate of return was 5%. Which of the following statements is (are) CORRECT? 1. The Treynor ratio for the market is 0.04000. 2. The Treynor ratio for Tiffany's portfolio is 0.00923. 3. The Treynor ratio for Tiffany's portfolio is 0.05385. 4. Tiffany's portfolio outperformed the market on a risk-adjusted basis. A)1 and 2 B)2 and 3 C)1, 3, and 4 D)1, 2, and 4

C

Which of the following are factors to consider when selecting a mutual fund? 1. The investment objective of the fund 2. The portfolio manager's continuity/tenure 3. The fund's fees and charges 4. The fund's expense ratio A)1 and 3 B)1, 2 and 3 C)4 only D)1, 2, 3, and 4

D // Each is an important factor that should be considered before purchasing a mutual fund.

Clayton is considering a preferred stock that pays an annual dividend of $6 per share. Clayton can earn 10% on other investments with similar risk. What is the price that he should be willing to pay for the preferred stock? A)$84 B)$6.60 C)$54 D)$60

D // Preferred stock with an infinite life is priced as a perpetuity. Therefore, its price is equal to $6 ÷ 0.10, or the annual dividend divided by the required return equaling $60.

Which of the following statements most accurately describes one of the advantages of investing in real estate investment trusts (REITs)? REITs: A) lack of control. B) can pass on tax losses to their investors as deductions from their taxable income. C) have lower price and return volatility than a comparable direct investment in properties. D) limit investor liability to only the amount of the investor's original capital investment.

D // REIT investors have no liability for the REITs in which they invest beyond the original amount invested. REITs usually cannot pass on tax losses to their investors as deductions from taxable income. Because REIT prices and returns are determined by the stock market, the value of a REIT is more volatile that its appraised net asset value.

John's portfolio has $15,000 invested in Security A, $30,000 invested in Security B, and $45,000 invested in Security C. If Securities A, B, and C have betas of 1.5, 1.2, and 0.9, respectively, what is the weighted beta of John's portfolio? A)1.05 B)1.35 C)1.10 D)0.95

c

Danielle, age 42, has a moderate risk tolerance along with a long-term investment time horizon. She would like to purchase an investment that would offer her the opportunity for modest growth with the least amount of risk. Based on this information, her CFP® professional should make which of the following recommendations? A)Asset Allocation Fund B)Foreign Stock Fund C)Corporate Bond Fund D)Emerging Markets Fund

A // An asset allocation fund would offer Danielle a diversified portfolio. This type of fund invests in equity, debt, and money market securities.

Tom owns a taxable investment that earns 8% interest annually. Tom pays taxes at a marginal rate of 24%. What is the after-tax rate of return that Tom will receive on this investment? A) 6.08% B) 6.30% C) 4.24% D) 7.25%

A // The after-tax return is: 8% × (1 − 0.24) = 6.08%.

Todd and Diana Martin are establishing a college fund for their 14-year-old son, Mike. The Martins do not wish to invest aggressively, but are willing to take a reasonable investment risk. They are in the lowest marginal income tax bracket. Which of the following investments is most appropriate for the college fund? A)A series of taxable zero-coupon bonds with maturities matching the time horizon owned by Todd and Diana. B)A small-cap stock mutual fund owned by Mike. C)A global technology fund concentrated in high risk, small capitalization stocks. D)A money market account owned by Todd and Diana.

A // The money market account is too conservative for their goals and risk tolerance. Small-cap stock and global technology funds are too risky based on their investment time horizon. Zero-coupon bonds with maturities that match the tuition payment dates will achieve the Martins' goal.

Bill owns U.S. Treasury bonds worth $34,000, stocks worth $22,500, and mutual funds worth $15,000. If their expected returns are 4%, 8%, and 10%, respectively, what is the overall weighted average expected return on Bill's investments? A)4.38% B)6.52% C)13.09% D)8.05%

B // (A)(B)(A) × (B)FMVE(r)Expected ($)$34,0004%$1,360.00$22,5008%$1,800.00$15,00010%$1,500.00$71,500$4,660.00 Weighted Average Expected Return = $4,660.00 ÷ $71,500 = 6.52%

DEF Company stock has an average long-term return of 11% and a standard deviation of 4%. What is the probability that the stock will earn a return over 15% (round to the nearest whole number and assume a normal distribution)? A)33% B)16% C)13% D)19%

B // Approximately 68% of occurrences will fall within one standard deviation from the mean. Therefore, the probability of a return between 11% and 15% is 34%. Because there is a 50% chance of a return above 11%, the probability of a return in excess of 15% must be 16% (50% − 34%).

Compared to investing in a single security, diversification provides investors a way to A)increase the variance of returns. B)decrease the volatility of returns. C)increase the expected rate of return. D)increase the probability of high returns.

B // Diversification provides an investor reduced risk. However, the expected return is generally similar or less than that expected from investing in a single risky security. Very high or very low returns become less likely.

Lynn's investment portfolio has a standard deviation of 5% and a correlation coefficient of 0.95 when regressed against the market. The market has a standard deviation of 4% and a return of 10%. If the 90-day U.S. Treasury bill rate is 2% and Lynn's portfolio earns a 16% rate of return, what is Jensen's alpha for her portfolio? A)6.4% B)4.5% C)5.4%. D)6.0%

B // Jensen's alpha: rp − [rf + (rm − rf) βp] Calculate beta: βp = (0.95 × 5%) ÷ 4% = 1.1875 Calculate alpha: 16% − [2% + (10% − 2%) 1.1875] = 4.5%

based on the 90-day Treasury bill rate, is 1.55%. The market has returned an average of 6.25% over the past 10 years. The couple is considering the purchase of ABC stock that has a beta coefficient of 1.15. Based on this information, which of the following statements is NOT correct? A)Based on their required return, they should not invest in ABC stock. B)The stock has an expected return of 10.11%. C)The market risk premium is 4.70%. D)The stock risk premium is 5.41%.

B // The expected return on ABC stock of 6.96% is less than their required return of 7.5%; therefore, a purchase of this stock is not warranted. Based on the capital asset pricing model (CAPM), the expected return on ABC stock is 6.96% [1.55% + (6.25% − 1.55%)1.15]. The market risk premium is 4.70% (6.25% − 1.55%), and the stock risk premium is 5.41% (4.70% × 1.15).

A distribution of returns that has a greater percentage of small deviations from the mean and a greater percentage of extremely large deviations from the mean compared to a normal distribution: A) has negative excess kurtosis. B) is negatively skewed. C) has positive excess kurtosis. D) is positively skewed.

C // A distribution that has a greater percentage of small deviations from the mean and a greater percentage of extremely large deviations from the mean will be leptokurtic and will exhibit excess kurtosis (positive). The distribution will be more peaked and have fatter tails than a normal distribution.

Don purchases 100 shares of XYZ stock at $80 per share on margin. The initial margin requirement is 40% and the maintenance margin is 35%. At what stock price will a margin call be triggered? A)$55.00 B)$66.67 C)$73.85 D)$137.14

C // Don's original investment is 40% of $8,000, or $3,200, so he is borrowing $4,800 (debit balance) from the broker-dealer. Debit Balance=$4,800Margin Call = Debit Balance ÷ (1 − Maintenance Margin)=$4,800 ÷ (1 − 0.35)Account value triggering a margin call=$7,385Share price triggering a margin call ($7,385 ÷ 100 shares)=$73.85

Which of the following is a disadvantage of real estate investing? A)Nearly all real estate values decline as inflation increases. B)Real estate returns are highly positively correlated with stock and bond returns. C)Real estate is not easily divisible, making it difficult for investors to purchase real estate investments that match their preferred investment level. D)Properties are typically homogeneous, reducing the diversification benefits of investing in real estate.

C // Real estate returns are not highly correlated with stock and bond returns, which is one of the key reasons to include real estate in a portfolio of traditional assets. Also, real estate can act as an inflation hedge, unlike traditional assets. Finally, properties are heterogeneous, not homogeneous, increasing the complexity of real estate risk analysis. Real estate is not easily divisible.

Samuel's bond has a current market value of $1,056.78 and Macaulay duration of 7.9. If the bond's yield-to-maturity (YTM) changes from 5.5% to 4.0%, what is the expected percent change in the market price of the bond? A)-14.20% B)5.11% C)11.23% D)1.50%

C // The formula for determining the percent change in the price of the bond: ΔP/P = −D(Δy ÷ (1 + y)) ΔP/P = −7.9[(0.04 − 0.055) ÷ (1 + 0.055)] ΔP/P = −7.9(−0.0142) = 0.1123, or 11.23%

Jim Tripp is an investor in the 32% tax bracket. If Jim invests in a 4.75% municipal bond, his taxable equivalent yield (TEY) would be: A)3.23%. B)4.75%. C)6.27% D)6.99%.

D // Jim Tripp is an investor in the 32% tax bracket. If Jim invests in a 4.75% municipal bond, his taxable equivalent yield (TEY) would be: A) 3.23%. B) 4.75%. C) 6.27% D) 6.99%.

Ron owns CPM stock that is currently trading for $22 in the secondary market. The stock's most recent yearly dividend was $0.75 per share. Assume CPM stock's dividend is expected to grow for three years at 3%. After three years, the dividend is expected to grow at a 4% annual rate. Ron's required return is 7.5%. What is the intrinsic value of CPM stock? Is the stock overvalued or undervalued relative to its current market price? A)$26.98, overvalued. B)$18.38, undervalued. C)$24.35, undervalued. D)$21.67, overvalued.

D // Using the multistage growth dividend discount model, the intrinsic value of CPM stock is $21.67. D1 = $0.7500 × 1.03 = $0.7725D2 = $0.7725 × 1.03 = $0.7957D3 = $0.7957 × 1.03 = $0.8195 Use the constant growth dividend discount model to compute the remaining intrinsic value of the stock at the beginning of the year when the dividend growth rate stabilizes (Year 4). D4 = $0.8195 × 1.04 = $0.8523 V = $0.8523 ÷ (0.075 − 0.04) = $24.3514 Use the uneven cash flow method to solve for the net present (intrinsic) value of the stock. CF0 = $0CF1 = $0.7725CF2 = $0.7957CF3 = $0.8195 + $24.3514 = $25.1709I/YR = 7.5%Solve for NPV = $21.67 With an intrinsic value less than the current market price, the stock is considered overvalued in the market place.

William, a CFP® professional, has prepared a comprehensive financial plan for his clients, Harvey and Elaine. The couple is scheduled to come to his office next week to review the documents. During the next meeting, William should cover all of the following points EXCEPT? A)He should present a number of alternatives to the couple. B)He should review the couple's goals and objectives. C)He should provide the couple with his recommendations. D)He should define the scope of the engagement with the couple.

D // William should have previously defined the scope of the engagement with Harvey and Elaine.

Amanda buys 75 shares of BR Enterprise stock for $67 per share on margin. The initial margin is 55%, and the maintenance margin is 40%. If she sells the stock for $78 per share, what is her holding period return (rounded to the nearest percent)? A)30% B)16% C)36% D)23%

A // Proceeds$78Cost($67)Gain$11×75 shares=$825Investment (basis)75 × $67 × 55%=$2,763.75 Therefore, $825 ÷ $2,763.75 = 0.2985, or 29.85% (rounded to 30%)

Which of the following statements least accurately describes the role of portfolio managers in perfectly efficient markets? Portfolio managers should: A)quantify client's risk tolerance, communicate portfolio policies and strategies, and maintain a strict buy and hold policy avoiding any changes in the portfolio to minimize transaction costs. B)construct a portfolio that includes financial and real assets. C)use an Investment Policy Statement to develop a sound investment strategy. D)construct diversified portfolios that include international securities to eliminate unsystematic risk.

A / /A portfolio manager should quantify each client's risk tolerance and communicate portfolio policies and strategies. However, portfolio managers should monitor client's needs and changing circumstances and make appropriate changes to the portfolio.

Which of the following are examples of statements usually contained in an investment policy statement? 1. The objective of this portfolio is to invest funds in a number of low to moderate risk investments. 2. The average risk of this portfolio should not be greater than the S&P 500 Index. 3. Assets must be available in 15 years to fund a child's college education. 4. The investor wishes to exclude tobacco stocks from the portfolio. A)1, 2, 3, and 4 B)2, 3, and 4 C)1, 2, and 3 D)1 and 4

A // All of these are examples of statements that may be contained in an investment policy statement (IPS).

William purchases a 20-year, AA rated corporate subordinated debenture for $1,025. This bond features a 5.75% coupon rate and may be called in 10 years for 105% of par. What is the bond's yield to call (YTC)? A)5.79% B)5.25% C)5.55% D)5.68%

A // The bond's YTC is 5.79%. PV = −1,025FV = 1,050N = 20PMT = 28.75Solve for I/YR = 2.8966 × 2 = 5.7932%

Eugene is considering purchasing shares in XYZ stock that has a 20% probability of experiencing a negative 10% return, a 40% probability of experiencing a positive 8% return, and a 40% probability of experiencing a positive 12% return. If Eugene has a required return of 6.5%, should he invest in the stock? A) No, XYZ stock's expected return of 6.00% is below Eugene's required return of 6.5%. B) No, XYZ stock's expected return of 2.83% is below Eugene's required return of 6.5%. C) Yes, XYZ stock's expected return of 8.33% exceeds Eugene's required return of 6.5%. D) Yes, XYZ stock's expected return of 10.00% exceeds Eugene's required return of 6.5%.

A // The expected return for XYZ stock is 6%, calculated as follows: (0.20 × −0.10) + (0.40 × 0.08) + (0.40 × 0.12) = 0.06, or 6%. Therefore, Eugene should not purchase the stock because the expected return is lower than his required return.

George owns 1,000 shares of XYZ stock. Based on recent analyst projections and George's own research, he believes XYZ's price will remain flat over the next few months. Accordingly, which strategy would George likely employ if one of his objectives was to increase his portfolio's income stream? A)Sell 10 XYZ call option contracts B)Buy 10 XYZ put option contracts C)Buy a warrant D)Buy an index future

A // This is known as the covered call strategy and is used to increase the income of the portfolio when the price of the underlying stock is expected to remain flat for a period of time. Assuming the price of the underlying stock continues to remain flat, there is little chance of the option being exercised and the stock being called away.

Mij Saito, a Japanese investor invested 1,000,000 yen in ABC stock in the U.S. when the exchange rate was 125 yen = $1 and ABC was at $50 per share. After six months ABC was selling at $54 per share and Mij liquidates his investment. However, the Yen depreciated by 10% during this period. Which of the following statements is NOT correct? A)The dollar was selling for 112.5 yen when Mij sold his shares. B)Mij held 160 shares of ABC. C)Mij earned a 20% return on his investment when he converted his sale proceeds into yen. D)ABC yielded an 8% return to U.S. investors.

A // Value of one yen in the beginning = 1 ÷ 125 = $0.008, a 10% depreciation means that one yen = 0.008(1 − 0.10) = $0.0072 or 138.89(1 ÷ 0.0072) yen = $1 when Mij sells his shares. He received 1,000,000 ÷ 125 = $8,000 with which he purchased 160 shares of XYZ ($8,000 ÷ 50). He received $8,640 (160 × $54) from the sale and converted the $8,640 into 1,200,009 yen ($8,640 × 138.89) for a 20% return [(1,200,009 − 1,000,000) ÷ 1,000,000].

Mark is meeting with Gregory, a CFP® professional, to discuss the possibility of moving some of his current assets into a growth stock. The stock is currently trading for $45.36 in the secondary market. The stock is expected to pay a dividend of $2.35 per share next year. This dividend is expected to grow at a 4% rate for the foreseeable future. Mark's required return is 9.5%. What is the intrinsic value of the stock and is it undervalued or overvalued in the secondary market? A)$42.73, overvalued. B)$64.33, undervalued. C)$58.75, overvalued. D)$24.73, undervalued.

A // With a current market price of $45.36, the stock is overvalued. Use the constant growth dividend discount model to solve for the intrinsic value of the stock: V = $2.35 ÷ (0.095 − 0.04) = $42.73

Greg and Wilma, ages 67 and 65 respectively, have come to their CFP® professional seeking an additional investment to add to their portfolio. Wilma received a modest inheritance from her late aunt's estate. They are seeking preservation of capital. Which of the following would be the best investment alternative based on their objective? A)U.S Government Bond Fund B)Certificate of Deposit C)S&P 500 Index Fund D)Aggressive Growth Fund

B // A client seeking preservation of capital should choose a certificate of deposit. The U.S. Government Bond Fund may lose value if interest rates were to increase substantially. The aggressive growth fund and the S&P 500 Index fund may provide growth potential for Greg and Wilma but the volatility within these funds may not always provide preservation of capital.

Jack buys 100 shares of XYZ stock for $60 per share with an initial margin of 50% and a 30% maintenance margin. At what price would Jack receive a margin call? A)$44.00 B)$42.85 C)$43.50 D)$42.00

B // Margin Call=Debit Balance ÷ (1 − Maintenance Margin)=($60 × 0.50) ÷ (1 − 0.30)=$30 ÷ 0.70=$42.85

Sally, Michael, and Anita use different methods for choosing assets for their investment portfolios. Sally uses technical analysis to determine when to buy and sell the stocks in her portfolio. Michael is committed to a passive investment strategy and a well-diversified portfolio of randomly selected stocks. Anita ignores historical volume and price information but reviews the financial statements of the firms in which she is interested. Which of the following statements best describe Sally, Michael, and Anita? 1. Anita accepts the strong form of the efficient market hypothesis (EMH). 2. Michael accepts the semi-strong form of the EMH. 3. Sally accepts the weak form of the EMH. A)1 and 3 B)2 only C)2 and 3 D)3 only

B// Under the weak form of the EMH, access to fundamental analysis and insider information can achieve superior results. Under the semistrong form of the EMH, only access to insider information can achieve superior results. Under the strong form of the EMH, not even access to insider information can achieve superior results. Anita uses fundamental analysis, which is supported only by the weak form of EMH. Michael does not use fundamental or technical analysis. His strategy is supported by the semistrong and strong forms of the EMH. Sally uses technical analysis, which is rejected by all forms of the EMH.

Troy needs a 15% return to meet his financial goals. He is interested in a mutual fund with a beta of 1.3. If the market return has averaged 11% over the past 10 years and the U.S. Treasury bill rate is currently 4%, should Troy invest in this fund? A)Yes, Troy's required return is more than the fund's expected return. B)Yes, the fund's expected return is more than Troy's required return. C)No, the fund's expected return is less than Troy's required return. D)No, Troy's required return is less than the fund's expected return.

C // Expected return for the mutual fund using CAPM: ri = rf + (rm − rf) βi = 4% + (11% − 4%) 1.3 = 13.1%. Because the expected return of 13.1% is less than Troy's required return of 15%, he should not purchase the fund.

in order to sway the prospective client to hire him for a comprehensive wealth management plan. In addition, Brian decides to charge this client a higher than average planning fee to cover the expenses of his upcoming Hawaiian vacation. Which of the following Standards of Conduct has Brian violated? 1. Integrity 2. Confidentiality & Privacy 3. Sound and Objective Professional Judgment 4. Diligence A)4 only B)1, 2, 3, and 4 C)2 and 3 D)1, 2, and 3

D // Brian has violated the Principles of Integrity (Standard A.2), Confidentiality & Privacy (Standard A.9), and Sound and Objective Professional Judgment (Standard A.6). Not only did he place his interests in front of his prospective client's, he disclosed personal client information, and treated this individual unfairly. Brian has not violated Standard A.4, Diligence in this meeting. To uphold the Diligence Standard, "A CFP® professional must provide professional services, including responding to reasonable client inquiries, in a timely and thorough manner."

Which of the following are examples of information provided by a client to a CFP® professional during the investment planning interview to prepare an investment policy statement? 1. The client's investment objective for this portfolio is to invest funds in a number of low to moderate risk investments. 2. The average risk of this portfolio should not be greater than the S&P 500 Index. 3. Assets must be available in 15 years to fund a child's college education. 4. The client wishes to exclude tobacco stocks from the portfolio. A)3 and 4 B)1 and 4 C)1, 2, and 3 D)1, 2, 3, and 4

D // All of these are examples of information that may be provided by a client during the investment planning interview.

Which of the following statements regarding constraints in an investment policy statement is most likely correct? A)Constraints are factors for decisions based on the asset owners that lead to desirable outcomes over undesirable ones. B)External constraints consist of regulations, time horizon, and market conditions. C)Objectives and constraints are interchangeable terms. D)Constraints confine the objectives by providing conditions that must be met by the outcomes.

D //Constraints limit the objectives by providing conditions that must be met by the outcomes. Constraints can be internal, such as liquidity needs and time horizon, or they can be external, such as regulations and market conditions.

Bob is interested in investing in a mutual fund that will provide him with current income without the risk of large swings in the portfolio's value. Bob is in the highest marginal income tax-bracket and has a moderate risk tolerance. Which of the following mutual funds is most appropriate for Bob? A) Intermediate-term municipal bond fund B) Long-term convertible bond fund C) Money market fund D) High-yield bond fund

A // A tax-exempt municipal bond fund may provide a high return to an investor in a high income tax bracket. An intermediate-term municipal bond fund will experience less price fluctuations when interest rates change than would a long-term bond fund. Convertible bonds generally carry a lower coupon than a similar non-convertible bond, and therefore, provide a lower current yield. High-yield bond funds are not suitable for an investor with a moderate risk tolerance.

An investment manager has constructed an efficient frontier based on a client's investable asset classes. The strategic asset allocation for the client should be the asset allocation of one of these efficient portfolios, selected based on: A)the client's investment objectives and constraints. B)the relative valuations of the investable asset classes. C)the investment manager's preferences and biases. D)a risk budgeting process.

A // After defining the investable asset classes and constructing an efficient frontier of possible portfolios of these asset classes, the manager should choose the efficient portfolio that best suits the investor's objectives and constraints as specified in the investment policy statement (IPS). The investor's strategic asset allocation can then be defined as the asset allocation of the chosen portfolio. Tactical asset allocation based on relative valuation of asset classes would require the manager to deviate from the strategic asset allocation. Risk budgeting refers to the practice of determining an overall risk limit for a portfolio and allocating that risk to strategic asset allocation, tactical asset allocation, and security selection decisions.

Sam, a securities analyst for a large wire house, analyzes the history of security trades and stock prices looking for patterns and trends. He has been with the company for five years and has consistently been able to beat the S&P 500 Index by one to two percentage points on a yearly basis. Which of the following techniques would he use to identify stocks for an investor's portfolio? 1. Calculate the intrinsic value of a stock using one of the stock valuation models. 2. Review a stock price's moving average over a given time frame. 3. Review the trend, upward or downward, of the Dow Jones Industrial Average. 4. Calculate, review, and compare financial ratios among stocks in a selected sector. A)2 and 3 B)1 only C)1, 2, and 4 D)3 and 4

A // As a technical analyst (chartist), Sam looks for patterns and trends in stock prices. Calculating the intrinsic value of a stock and ratio analysis are techniques used by fundamental analysts.

Ryan, a CFP® professional, is meeting with Burt to review his current financial plan. Burt has indicated to Ryan that he wishes to save for his daughter's college education. His daughter is two years old. Burt currently has $10,000 in a brokerage account earmarked for this goal. However, he believes his asset allocation may be too conservative given his financial goals and risk tolerance. What should Ryan do next? A)Clarify Burt's goals and expectations for the college savings plan. B)Ask Burt what he thinks is a reasonable rate of inflation for college tuition costs to be used in any planning recommendations. C)Review Burt's current brokerage statement and offer allocation recommendations. D)Recommend a Section 529 plan with an aggressive asset allocation.

A // Before proceeding with any recommendations, Ryan must help Burt clarify his goals and expectations regarding a college savings plan. After gathering this information, Ryan can present a strategy to help maximize Burt's savings and investments for his daughter's college expenses.

A benefit offered by a fund of funds (FoF) over a traditional hedge fund is: A)economies of scale. B)improved investor control. C)less regulation. D)greater transparency.

A // Benefits of FoF over traditional hedge fund investing include expertise and information advantage, monitoring, immediate exposure, improved diversification, economies of scale and accessibility, liquidity, improved access to managers, lower negotiated fees, education, more favorable regulation (not necessarily less regulation), possible currency hedging, and leverage opportunities. FoFs usually result in less investment transparency and FoF investors must give up control through the FoF form of hedge fund investing.

Stock P offers an expected return of 20%, a standard deviation of 6%, and a beta of 1.3. Stock Q offers an expected return of 16%, a standard deviation of 4%, and a beta of 1.1. Based solely on the coefficient of variation, which stock should be recommended? A)Stock Q, because it has a lower coefficient of variation. B)Stock Q, because it has a higher coefficient of variation. C)Stock P, because it has a higher coefficient of variation. D)Stock P, because it has a lower coefficient of variation.

A // Coefficient of variation (CV) = standard deviation ÷ expected return Stock P's CV = 6% ÷ 20% = 0.30 Stock Q's CV = 4% ÷ 16% = 0.25 The better risk-adjusted return is provided by the stock with the lower CV.

When reviewing a client's financial information during the analyzing and evaluating the client's current financial status phase, all of the following should be performed by the financial planner EXCEPT? A) Consider alternatives to meet the client's goals and objectives. B) Perform financial planning simulations to conduct analyses. C) Review the client's asset allocation and investment strategies. D) Evaluate and document the strengths and weaknesses of the client's current financial situation.

A // Considering alternatives takes place in the developing the recommendations phase of the financial planning process.

Ethel is 68 years old and has recently retired. She receives a pension of $1,200 per month and her current investments are expected to provide an additional $300 per month for the remainder of her life. Ethel will inherit $100,000 in a few weeks from her late brother's estate. She would like to invest the funds in U.S. government guaranteed funds and in such a way that her monthly income will increase to $2,000. Which security should Ethel purchase based on her objectives? A)Treasury bonds with a 6.5% coupon B)FNMA securities yielding 8% C)20-year TIPS with a 5% coupon D)30-year STRIPS based on 7% coupon Treasury bonds

A // Ethel needs an additional $500 per month which equals $6,000 per year or a 6% annual coupon/current yield. TIPS, STRIPS, and Treasury bonds are all guaranteed by the U.S. government, but only the Treasury bonds supply the necessary income. STRIPS are zero-coupon bonds.

Joe Farmingham is 38 years old, married, and has two children, ages 12 and 7. He recently received an inheritance of $300,000 and is considering investing "real money" for the first time. Farmingham likes to read the financial press and indicates that if he had money to invest in the past, he could have taken advantage of some undervalued security opportunities. He believes he has an average tolerance for risk-taking in investment activities, but he also enjoys skydiving every other weekend. Farmingham's ability to take risk is most appropriately characterized as A)above average B)cannot be determined C)average D)below average

A // Farmingham appears to have the ability and willingness to take risk. He frequently enjoys risk-seeking activities, such as skydiving. His relatively young age indicates a somewhat long time horizon for his investment portfolio. These facts couple ability and willingness to take an above-average level of risk.

Hedge funds most likely: A)are not offered for sale to the general public. B)hold equal values of long and short securities. C)have stricter reporting requirements than a typical investment firm because of their use of leverage and derivatives. D)undertake a limited range of investment activities.

A // Hedge funds may not be offered for sale to the general public; they can be sold only to qualified investors who meet certain criteria. Hedge funds that hold equal values of long and short securities today make up only a small percentage of funds; many other kinds of hedge funds exist that make no attempt to be market neutral. Hedge funds have reporting requirements that are less strict than those of a typical investment firm. Hedge funds undertake a wider range of investment activities than other funds.

Holly and Jeff Davis have recently retired and are no longer earning an income. They would like to change their asset allocation to provide more income in their retirement years. Which of the following investments may help the couple in achieving their financial objectives? 1. aggressive growth mutual fund 2. AA rated corporate bonds 3. Zero-coupon bonds 4. Equity income mutual fund A)2 and 4 B)1 and 4 C)3 only D)1, 2, and 3

A // Investments 2 and 4 are the only two that will provide current income for the Davis family.

Adam, age 42, considers himself to be an aggressive risk investor. He has a large investment portfolio that he actively manages through fundamental analysis. He is always searching for new and exciting investment ideas to increase the value of his portfolio. Generally, he would prefer which of the following stocks for his investment portfolio? 1. ABC stock with lower risk and high positive skewness. 2. JEM stock with higher risk and low positive skewness. 3. XYZ stock with lower standard deviation and a leptokurtic distribution. 4. CPM stock with higher standard deviation and a platykurtic distribution. A)1 and 3 B)2 and 4 C)1, 2, and 3 D)3 and 4

A // Investors generally seek an investment with low risk (low standard deviation). Also, they would tend to prefer stocks with high positive skewness and a leptokurtic distribution. Stocks exhibiting high positive skewness have a larger than average number of positive price movements. Investments exhibiting a leptokurtic distribution have more observations clustered around the mean, resulting in lower variance (standard deviation).

xSimon and Alexandra Baker are interested in U.S. savings bonds. The couple is expecting their first child in three months. Their financial goals are to save for retirement and the education of their child. The Bakers should purchase: A)Series I bonds for inflation-protected savings for their child's education. B)Series I bonds for tax-free earnings when used exclusively for their retirement. C)Series HH bonds for tax-efficient savings for their child's education. D)Series EE bonds in their child's name to receive tax-free earnings for the child's future education.

A // Series HH bonds cannot be purchased and are no longer available for exchange of Series EE bonds. To receive the tax benefits for qualified higher education, Series EE or I bonds must be purchased by a taxpayer who is at least 24 years old and who uses the proceeds to finance qualified education expenses for himself, his spouse, or a dependent. Series I bonds provide inflation protection because they have a fixed base rate and an inflation adjustment. However, they do not provide tax-free earnings for retirement.

Josh is a broker and a CFP® professional. He has been directed by his supervisor to increase his commissions on stock transactions. Karl is one of Josh's clients and is inexperienced in stock transactions. For this reason, Karl usually follows Josh's advice regarding his stocks. Karl's primary goal is to pay the least amount of taxes on his stock transactions. On January 12, 2018, Karl purchased 5,000 shares of ABC stock. If Josh can convince Karl to sell the shares today (December 12, 2018) at the current FMV of $75 per share, Josh will meet his commission goal. Karl was considering selling the stock in late January of next year but, under pressure from Josh, Karl agrees to allow Josh to sell the stock today. Which of the following best describes Josh's actions? 1. Josh has violated CFP Board's Standard A.1, Fiduciary Duty, that requires CFP® professionals to act in the best interest of the client. 2. Josh has violated Standard A.2, Integrity, because he placed his goals before those of Karl. 3. Josh has not violated Standard A.2, Integrity, because the stock sold at a higher FMV than the purchase price. 4. Josh has not violated Standard A.2, Integrity, because Karl had the option to go against Josh's recommendation that he sell the stock. A)1 and 2 B)3 only C)2, 3, and 4 D)1 and 3

A // Statements 1 and 2 are correct. Josh has violated Standard A.2, Integrity, by subordinating Karl's goals for his personal gain. He has also not acted in compliance with Standard A.1.a, Fiduciary Duty - Duty of Loyalty, by placing his interests above the client. By convincing Karl to sell today just to achieve the desired commission, Karl will be required to pay ordinary income taxes on the gains on the appreciated shares, which is not in line with Karl's goal to minimize taxes. If Karl had waited until January 13, 2019 to sell the stock, the gain would be taxed as a long-term capital gain (LTCG). Even though the stock sold at a FMV higher than the price Karl paid for the stock, his tax reduction goal was not met. Finally, CFP® certificants must follow the Code of Ethics and Standards of Conduct when making recommendations. Clients should not have to determine whether these recommendations are in their best interest; they should be able to be confident that the planner only makes recommendations with their goals in mind.

An assumption of technical analysis is that market prices: A)exhibit identifiable trends and patterns that persist and repeat. B)reflect only irrational investor behavior. C)are the only information necessary to analyze a freely trading market. D)reflect supply and demand conditions because actual transactions reflect rational decisions by buyers and sellers.

A // Technical analysis assumes persistent trends and repeating patterns in market prices can be used to forecast price behavior. Technical analysts believe prices reflect supply and demand, but that buying and selling can be motivated by both rational and irrational causes. Volume, along with price, is important information to a technical analyst.

John believes that he can study the history of security trades and security markets in order to identify buying opportunities. Furthermore, he prepares and studies charts on the past prices of the securities he is most interested in purchasing for his portfolio. He uses these charts to try to predict the future activity of a particular stock. What type of strategy is John using to make his investment decisions? A)Technical analysis B)Ratio analysis C)Fundamental analysis D)Tactical asset allocation

A // Technical analysis is an attempt by an analyst to determine the demand side of the supply-and-demand equation for a particular stock and, therefore, to predict the direction of its future market price. The moving average, trendline, and support and resistance level are then used by an analyst to determine when the time is right to purchase (or sell) the security.

Eugene, who is in the 32% marginal income tax bracket, would like to purchase a bond for his investment portfolio. Which of the following bonds would offer him the highest after-tax yield? A)6.85% corporate bond B)4.25% U.S. Treasury bond C)3.35% municipal bond D)4.00% qualified private activity bond

A // The after-tax yield computation may be used to compare the advisability of investing in taxable issues with that of investing in municipal tax-exempt issues. Eugene should purchase the corporate bond based on the following after-tax yield calculations: U.S. Treasury bond [4.25% × (1 − 0.32)]2.89%Corporate bond [6.85% × (1 − 0.32)]4.66%Municipal bond (tax-free)3.35%Qualified private activity bond (tax-free)4.00%

Lucy and Bobby are concerned about their estate plan. They have contacted a CFP® professional, Mike, to help them with their concerns. During the meeting, Mike discovered that the couple's estate planning documents did not truly reflect their wishes for asset management and transfer. The couple did indicate that they have the name of a top estate planning attorney to assist them with document preparation. As a result, Mike should take which of the following actions? A) Have the couple set up a meeting with their estate planning attorney to discuss their goals. B) Insist the couple speak with his personal estate planning attorney. C) Offer to help the client set up a trust to manage their investments. D) Recommend they transfer any investment brokerage accounts to his firm.

A // The couple should set up a meeting with their attorney to review and modify their current estate plan. This attorney may recommend setting up a trust to help manage their assets and avoid unnecessary transfer expenses. After this step, they may consider working with Mike to manage their assets.

Bob, age 58, is an extremely wealthy, sophisticated investor in great health for his age. He has a very large portfolio of stocks, bonds, and mutual funds and has a high risk tolerance. Bob would like to supplement his large portfolio with a bond having the least volatility in the event of rising interest rates. Which of the following bonds listed below would have the least volatility? A) AA rated, 20-year municipal bond with a yield of 5.9% B) A rated, 5-year high coupon bond with a yield of 6.8% C) B rated, 20-year callable bond with a yield of 7.3% D) AA rated, 30-year zero coupon bond with a yield of 8%

B // A high coupon rate and shorter maturity make the duration of the A rated, 5-year high coupon bond significantly less than 5 years and also less price-volatile when interest rates increase. Both 20- and 30-year bonds have high volatility for Bob's risk tolerance.

Jillian recently purchased a 30-year, investment-grade, state of Louisiana municipal bond, from her broker. She paid $972 plus commission for the bond, which has an annual coupon rate of 3.5% (paid semiannually). Which of the following statements is(are) CORRECT? 1. The bond will be subject to high purchasing power risk. 2. Interest paid by the bond will not be subject to federal income taxation. 3. If the bond is sold in three years for $1,000, the gain will be considered income tax-free. 4. The bond will be subject to a high level of default risk. A)2 and 3 B)1 and 2 C)4 only D)2, 3, and 4

B // A longer-term bond will be subject to greater purchasing power risk. Interest income from a municipal bond will not be subject to federal income taxation. Jillian will have a capital gain resulting from the sale of the bond. An investment-grade bond will be subject to low default risk.

Ben, a manager of local restaurant, is meeting with a CFP® professional, Alana to discuss his investment planning. He is expecting a significant pay increase and would like to increase his savings rate. Currently, Ben has a Section 401(k) plan with his employer to which he contributes 5% of his gross salary. The company provides him with a variety of investment choices and a dollar-for-dollar match up to 2%. At this point in the meeting, Alana is ready to gather information necessary to fulfill the engagement. Which of the following should be accomplished during this phase of the meeting? 1. Ask Ben what money means to him and why. 2. Inquire about Ben's goals, dreams, and aspirations. 3. Seek to understand any obstacles that may prevent Ben from reaching his goals. 4. Conduct a thorough risk tolerance analysis. A)1 and 2 B)1, 2, 3, and 4 C)4 only D)2, 3, and 4

B // All of these are important during the discovery phase of the initial interview. Alana should seek to understand as much as possible about Ben before proceeding with analyzing and evaluating his current financial status.

Mike wants to open an investment account for his granddaughter, Bernice, who is 4 years old. He decides to meet with his CFP® professional, Vicki, to discuss the alternatives. Mike has indicated that he has $2,000 to invest today and would like the opportunity to add funds as necessary. What action should Vicki take next to assist Mike? A)Proceed with opening an UGMA account in Mike's name. B)Vicki should discuss Mike's financial planning needs and expectations. C)Contact Bernice's parents and give them details regarding Mike's generosity. D)Immediately present Mike with a prospectus on an S&P 500 Index Fund.

B // Before opening an account or recommending a specific investment, Vicki should discuss Mike's financial planning needs and expectations. Because Mike is the client, Vicki should not engage Bernice's parents without Mike's permission.

Mike, age 52, works for a technology firm as a computer programmer. His firm is experiencing significant growth and his job outlook is excellent. Recently, his supervisor told him that he would be the lead programmer on a new and exciting project. Mike has set up a meeting with Chris, a CFP® professional, to discuss his financial plan. He has a 401(k) plan invested a conservative life-cycle portfolio, but he told Chris that he is moderate to aggressive risk taker. Also, Mike indicated that he has an extra $700 per month that he could dedicate to his retirement goal. He would like to retire at age 62. As part of Chris's review, he conducts a Monte Carlo analysis (MCA). Which of the following is the least likely course of action for Mike based on the result of the MCA? A)He should consider changing the asset allocation to better reflect his risk tolerance. B)He could contact an executive recruitment firm and look for a new job that could pay him more money. C)He could delay the retirement goal for a few years to allow for additional contributions and the possibility of growth. D)He could increase his savings based on his amount of discretionary income.

B // Changing jobs would be the least likely course of action for Drew. He is currently in a stable company with significant growth prospects.

David and Edith have scheduled a meeting with Rebecca, a CFP® professional, to discuss their current retirement planning strategy. Rebecca has established the relationship and gathered all of the couple's pertinent information. She is currently analyzing and evaluating the couple's information. David and Edith have been diligent savers and have very little debt, except for a car loan and home mortgage. Recently, they have been uneasy about saving for their retirement. Rebecca notices that the couple is nervous, yet she is confident they have made smart choices with their money. What should she do next? 1. Reassure them that they are on the right track. 2. Review their current asset allocation strategy for retirement planning. 3. Discuss the timeline for implementation of recommendations. 4. Have the clients sign the appropriate brokerage account forms to open a new account. A)1, 3, and 4 B)1 and 2 C)3 only D)2, 3, and 4

B // During the analyzing and evaluating the client's current financial status phase, the planner should review the couple's present asset allocation strategy and reassure them of their progress. Discussing the timeline for implementation and having the couple sign brokerage forms occur during the implementation phase.

You compile the following information regarding stocks A and B: Expected return on stock A = 12%Expected return on stock B = 24%What is the expected return of a portfolio that has $30,000 invested in stock A and $70,000 in stock B? A)18.0% B)20.4% C)8.2% D)22.3%

B // Expected return = (w1r1) + (w2r2)Stock A has 30,000 ÷ (30,000 + 70,000) = 0.30, or 30% weightStock B has 70,000 ÷ (30,000 + 70,000) = 0.70, or 70% weightExpected portfolio return = (0.30 × 0.12) + (0.70 × 0.24) = 0.036 + 0.168 = 0.204, or 20.4%

When the market yield is 8%, which of the following equally rated bonds will have the potential for the greatest relative price volatility with regards to changes in interest rates? A)A 12% coupon bond with 12 years to maturity B)An 8% coupon bond with 12 years to maturity C)An 8% coupon bond with six years to maturity D)A 12% coupon bond with six years to maturity

B // Generally, a low coupon bond is more susceptible to price fluctuations than a high coupon bond and a long-term bond is more susceptible to price fluctuations than a short-term bond. The bond with the lowest coupon and highest maturity is subject to the greatest price volatility.

Jack, a 55 year old astute investor, places a market order to sell short 500 shares of ABC stock. The order is filled when the stock is trading at $19.87 per share. If he believes he can cover the short sale when ABC hits $17.50 per share, what would be his total profit or loss? A)$592.50 profit B)$1,185 profit C)$592.50 loss D)$1,185 loss

B // He will make a profit of $1,185 on this short sale of ABC stock, calculated as follows: $19.87 proceeds received− $17.50 cost to cover the short sale= $2.37 profit per share × 500 shares = $1,185 total profit

Ralph bought 400 shares of LOA stock at $36 per share on margin (assume a 50% initial margin percentage). The margin interest was 7.5% annually. He sold the stock after one year for $49.50 per share. LOA did not pay any dividends during the holding period. What was Ralph's holding period return using margin? A)33.75% B)67.50% C)75.00% D)37.50%

B // His HPR using margin was 67.50%, calculated as follows: Ending value = 400 shares × $49.50 per share = $19,800Beginning value = 400 shares × $36.00 per share = $14,400Cash outflow = margin interest = 0.075 × 0.50 × $14,400 = $540Initial investment = 0.50 × $14,400 = $7,200HPR = ($19,800 − $14,400 − $540) ÷ $7,200 = 67.50%

What is going to have to largest impact on a concentrated portfolio of only cash and a single stock? A)Neither asset allocation nor security selection. B)Security selection. C)Both asset allocation and security selection equally. D)Asset allocation

B // In a concentrated portfolio, performance is determined mostly by security selection. If the portfolio is well diversified, security selection has a minimal impact on performance.

In equilibrium, investors should only expect to be compensated for bearing systematic risk because: A)systematic risk can be eliminated by diversification. B)nonsystematic risk can be eliminated by diversification. C)systematic risk is specific to the securities the investor selects. D)individual securities in equilibrium only have systematic risk.

B // In equilibrium, investors should not expect to earn additional return for bearing nonsystematic risk because this risk can be eliminated by diversification. Individual securities have both systematic and nonsystematic risk. Systematic risk is market risk; nonsystematic risk is specific to individual securities.

Which of the following is NOT a reason to expect commodities and traditional assets to be lowly correlated, uncorrelated, or negatively correlated? A)Inflation has a negative impact on traditional assets but a positive impact on commodities. B)Increasing commodity prices have a positive impact on corporate profitability. C)Stocks and bonds are valued on long-term rather than short-term expectations. D)Commodities are driven by supply and demand rather than cash flow expectations.

B // Increasing commodity prices represent an increase in the cost of raw materials to corporations. Thus, higher commodity prices have a negative impact on corporate profitability leading to lower stock prices. The result is negative correlation between commodities and traditional assets.

Mark, age 52, has an investment portfolio comprised of mostly mutual funds and a few individual stocks. He just received a $25,000 inheritance from his recently deceased Aunt Betsy and would like to add a new investment to his portfolio. When choosing among various investment alternatives, he would prefer which of the following? 1. An investment exhibiting a low standard deviation 2. An investment exhibiting a platykurtic distribution 3. An investment exhibiting a high standard deviation 4. An investment exhibiting a leptokurtic distribution A)2 and 3 B)1 and 4 C)1 and 3 D)2 and 4

B // Investments exhibiting a low standard deviation have less variability of actual returns than investments with a high standard deviation. Also, investments exhibiting a leptokurtic distribution have more observations clustered closely around the mean, resulting in a lower variance. Generally, an investor would prefer a large number of positive returns with low risk.

Mark's company, located in Oregon, makes unfinished wood furniture. The company sells their furniture directly to the public from a large warehouse. Theresa's company, located in southern Georgia, grows cotton for t-shirts manufacturers. Which of the following statements correctly identifies hedging strategies for Mark and Theresa? 1. Mark should buy lumber futures. 2. Theresa should sell cotton futures. 3. Mark should sell lumber futures 4. Theresa should buy cotton futures. A)2 and 3 B)1 and 2 C)3 and 4 D)1 and 4

B // Mark is short lumber because he needs lumber to produce his products. A hedge position for Mark would be to go long lumber futures, that is, to purchase lumber futures. Theresa is long cotton because she owns cotton for manufacturing purposes. A hedge position for Theresa is to go short, that is, to sell cotton futures.

Mike expects a certain stock to significantly rise in value in the near future. He owns a corporate bond maturing in two months that could be used to buy the stock. However, he does not want to miss out on any appreciation on the stock while waiting for the funds to become available. Which of the following actions should Mike take? A)Buy a put option B)Buy a call option C)Sell a call option D)Sell a put option

B // Mike can lock in the price of the stock by purchasing a call option with an expiration date exceeding two months.

Which form of investment is most appropriate for a first-time real estate investor that is concerned about liquidity and diversification? A) Direct ownership of a suburban office building B)Shares of a real estate investment trust C)An undivided participation interest in a commercial mortgage D)Limited partnership

B // Of these investment choices, real estate investment trusts (REITs) are the most liquid because the shares are actively traded. Also, REITs provide quick and easy diversification across many properties. Neither the direct investment nor the mortgage participation is liquid, and significant capital would be required to diversify the investments.

Allison and Thomas are meeting with their CFP® professional, Phyllis, to finalize the implementation of their financial plan. They are very excited to be taking this step to ensure their financial security. Phyllis has prepared all of the necessary paperwork for the couple to sign. What should Phyllis do next? A)Implement products and services that provide Phyllis with the highest commission and/or fees. B)Review and confirm all of the planned actions contained in the financial plan with the couple. C)Set up an appointment for the first financial plan review to take place in six months. D)Refer the couple to an estate planning attorney that offers a high referral fee to financial planners.

B // Phyllis should review and confirm all of the planned actions before proceeding with implementation. She should have chosen products and services that place the interests of her clients before her own. After implementation, the couple, along with Phyllis, may consider setting up a follow-up meeting to review the progress of the financial plan.

Jim, a CFP® professional, is meeting with Francis and Nicolas to communicate financial planning recommendations. He has gathered all of the necessary information and has developed a comprehensive financial plan. All of the following should be discussed with the couple at this time EXCEPT? A)Review the couple's goals to make sure they are consistent. B)Set up a review meeting in six months to review the progress of their plan. C)Present alternatives to the couple to meet their goals. D)Communicate any observations and findings regarding their financial data.

B // Setting up a review meeting would occur after implementing the financial plan. All of the other points should be discussed with the couple during the recommendation meeting.

Shelley has been picking stocks for her personal investment portfolio for a number of years. Throughout the past two quarters, she picked a number of big winners and only a few losers. Her confidence has significantly increased as of late, and she has decided to increase her risk tolerance to take advantage of her ability to pick winners. As a financial planner, what advice would you give Shelley? 1. In order to make prudent investment choices with your money, you should recall and analyze both your successes and failures. 2. Based on your continued success, you should make additional risky investments. 3. You should remain highly optimistic as to the growth prospects of your investment portfolio. 4. Even though you are currently picking winners, you should understand that this type of success is difficult to maintain over the long term. A)2 and 4 B)1 and 4 C)3 only D)1, 2, and 3

B // Shelley should not give too much weight to her recent successes. Being able to consistently pick stocks over the long-term that increase in price is very difficult even for the most seasoned portfolio managers.

Which of the following statements would provide evidence against the semistrong form of the efficient market hypothesis? A) Markets react quickly to the Federal Reserve Bank Chairman's address to the Congress. B) Small capitalization firms tend to achieve higher returns than large capitalization firms. C) On average, about 50% of mutual funds outperform the market in any given year. D) Fundamental analysis is not useful in predicting future stock prices.

B // Small-cap stocks tend to outperform large-cap stocks over the long-term indicating that the market has not adjusted to this anomaly and has low expected returns (or underestimates the growth rate) of small-cap stocks. If the market reacts to all public information (and market capitalizations are public information), then this observation tends to discredit the semistrong form of the efficient market hypothesis (EMH). If 50% of mutual funds outperform the market, this would not discredit the semistrong EMH because 50% of mutual funds underperform the market. The market's quick reaction to the Fed Chairman's address is consistent with semistrong form efficiency, as markets quickly react to new information. According to semistrong efficiency, all public information is already discounted in prices. The inability of fundamental analysis to identify mispriced securities is consistent with the semistrong form of the EMH.

What is the duration of a junk bond with a current market price of $948.50 that matures in 5 years and has a coupon rate of 12.5%? (Assume annual coupon payments.) A) 3.948 years B) 3.977 years C) 3.919 years D) 4.006 years

B // Step 1: Solve for YTM to determine the appropriate interest rate. PV= (948.50)N= 5PMT= 125FV= 1,000I/YR= 14% Step 2: Use the cash flow method to solve for duration. YearCFCF × Year112512521252503125375412550051,1255,625 CF00CF1125CF2250CF3375CF4500CF55,625I/YR =14NPV =$3,772.62 Duration = NPV ÷ Bond Market PriceDuration = $3,772.62 ÷ $948.50 = 3.977 years

Harry, a dentist, owns a long-term corporate bond that is presently selling for $1,103.19 in the secondary market. This B rated bond pays an annual coupon of $100 (paid semiannually). What would happen to the price of his 30-year bond if interest rates suddenly rose by 200 basis points? 1. The price of the bond would decrease by $190.44 2. The price of the bond would decrease by $328.68 3. The price of the bond would change to $1,374.17 4. The price of the bond would change to $912.75 A) 2 and 3 B) 1 and 4 C) 2 and 4 D) 1 and 3

B // Step 1: Solve for the YTM on the bond given a 30-year term to maturity.PV = -1,103.19FV = 1,000PMT = 50 (100 ÷ 2)N = 60 (30 × 2)Solve for I/YR = 4.5 × 2 = 9% Step 2: Solve for the new PV of the bond given the YTM found in Step 1.I/YR = 5.5 [(9 + 2) ÷ 2]N = 60 (30 × 2)FV = 1,000PMT = 50Solve for PV = 912.75, or $912.75 Step 3: Solve for the price change.$1,103.19 − $912.75 = $190.44

Mary, age 63, is considering retirement from her job as a Senior Executive with a large technology firm. Over the years, she has purchased a large amount of her company's stock, which has substantially appreciated, in her personally-owned brokerage account. The market value of the stock is approximately 35% of her total assets. She is concerned about her stock dropping significantly based on a potential earthquake causing significant damage to the firm's primary manufacturing plant in China. How should her CFP® professional address her issue? 1. Discuss various financial strategies that may be used to hedge against a significant market downturn. 2. Have her sell all of the stock immediately and reposition the assets in a money market mutual fund. 3. Ignore her concern about an earthquake because of the unlikelihood of one actually occurring. 4. Listen intently to her concerns and encourage her to remain focused on her retirement goal. A)3 only B)1 and 4 C)2 and 4 D)1, 2, and 3

B // The best course of action is to listen to her concerns and explain what can be done to protect her holdings. Recommending that she sell the stock and invest the proceeds in a money market mutual fund would not be the best solution. This specific recommendation could cause a large tax liability. In addition, a money market mutual fund is a low-yielding investment. Planners should not ignore their clients' concerns, but, rather listen intently and focus on understanding and offering guidance.

Nicholas owns 100 shares of XYZ stock. The stock has an expected return of 8.75%. The risk-free rate of return is 3% and expected market rate of return is 9.5%. What is the beta of Nicholas's stock? Is his stock more or less risky than the market? A)With a beta of 1.34, the stock is more risky than the market. B)With a beta of 0.88, the stock is less risky than the market. C)With a beta of 0.76, the stock is less risky than the market. D)With a beta of 1.13, the stock is more risky than the market.

B // The beta of XYZ stock is 0.88, calculated using the capital asset pricing model (CAPM) and solving for beta: 8.75% = 3% + (9.5% - 3%)ßi 5.75% = 6.5%ßi 0.8846 = ßi With a beta of 0.88, the stock is less risky than the market. Note: the market has a beta of 1.00.

Henry, age 46, has $250,000 to invest in a long-term investment portfolio. He has come to his financial planner, Robbie, to ask for advice. He wants a diversified portfolio while simultaneously limiting risk, minimizing transaction costs, and managing taxes. Also, he desires a portfolio that is based on a passive management approach, but he would still like to include an active management component. Which of the following approaches would best suit Henry? A) Index funds B) Core and satellite C) Commodities D) Emerging markets

B // The core and satellite approach is the best choice for Henry. Emerging markets and commodities may be used in the satellite portion of the portfolio. Index funds generally are used in a passive portfolio approach.

Lauren owns a AA rated corporate bond with a current market value of $987.34. The bond's YTM changes from 5.45% to 4.98%. What is the estimated percent change in the price of the bond assuming a Macaulay duration of 4.6 years? A)+0.05% B)+2.05% C)−0.47% D)−2.16%

B // The estimated percent change in the price of Lauren's bond is +2.05%, calculated as follows: ΔP/P = −4.6 × [(0.0498 − 0.0545) ÷ (1 + 0.0545)]ΔP/P = −4.6 × (−0.0047 ÷ 1.0545)ΔP/P = +0.0205, or +2.05%

Mike wants to purchase XYZ stock for his investment portfolio. He has a required return of 11.5%. Assume the risk-free rate of return is 5% and the expected return of the market portfolio is 12%. What is the expected return for XYZ stock with beta of 1.1? Should Mike invest in the stock? A) 12.1%, yes B) 12.7%, yes C) 9.1, no D) 10.8, no

B // The expected return can be found by using the capital asset pricing model (CAPM). ri = rf + (rm − rf)βi= 0.05 + (0.12 − 0.05)1.1= 0.127, or 12.7% Because the expected return, as determined by CAPM, exceeds Mike's required return, he may elect to purchase XYZ stock for his investment portfolio.

A call option to purchase 100 shares of WARCO common stock at an exercise price of $40 is currently priced at $15. WARCO's common stock is currently selling for $50. Which of the following statements are CORRECT? 1. The time value of the call option is $5. 2. The call option is out-of-the-money. 3. A writer of the call option will receive a premium of $1,000. 4. The intrinsic value of the call option is $10. A)1, 2, and 3 B)1 and 4 C)2 and 3 D)1, 3, and 4

B // The time value of the call option is calculated as follows: time value = market price of call option − intrinsic value of call option. Intrinsic value = $50 − $40 = $10. Time value = $15 − $10 = $5. Because the current market price of the stock is greater than the exercise price, the call option is in-the-money. The writer will receive an option premium of $1,500 (100 shares × $15 call option price).

The City of Greensboro issued AA rated bonds with a 15-year maturity, $1,000 par value, and 3.75% coupon (paid semiannually) to fund a new water and sewer infrastructure. Three years after issue, interest rates on similar bonds fell to 3.25%. At what price should these bonds sell for in the marketplace? (Round to the nearest dollar) A)$739 B)$1,049 C)$1,128 D)$1,000

B // These bonds should sell for $1,049 in the secondary market, calculated as follows: FV = 1,000PMT = 18.75 (37.50 ÷ 2)N = 24 (12 × 2)I/YR = 1.625 (3.25 ÷ 2)Solve for PV = 1,049.36, or $1,049.36

Mary Anne is considering the purchase of Davidson stock. The stock has a market price of $35 and is currently paying a dividend of $1.75 per share. The company's dividend is expected to grow 4% annually. If Mary Anne requires a 9% return, should she purchase the stock? A)No, the stock is overvalued by $1.40. B)Yes, the stock is undervalued by $1.40 per share. C)Yes, the dividend is expected to grow at a rate that outpaces inflation. D)Yes, the stock is overvalued by $1.40 per share.

B // Use the constant growth dividend discount model to solve for the intrinsic value of the stock. [$1.75(1.04)] ÷ [0.09 − 0.04] = $36.40 According to the constant growth dividend discount model, the intrinsic value of Davidson stock is $36.40. Because the current market price is lower, a purchase of the stock may be warranted.

Which of the following statements regarding rebalancing is least accurate? A)Rebalancing is important because it provides market liquidity. B)Rebalancing within an allowable allocation range, by default, requires the allocation to be brought to the midpoint of the range. C)Rebalancing to a specific target may occur if the actual asset composition deviates by a certain percentage from the target. D)Rebalancing with derivatives could result in lower transaction costs compared to rebalancing with actual securities.

B // With allowable ranges, rebalancing may occur when the actual asset composition falls outside of the range. The question is to what part of the range will rebalancing occur; it is not necessarily the midpoint. Market liquidity is provided through purchases when prices fall and through sales when prices rise. Using derivatives to rebalance may reduce transaction costs because there is no need to take positions in the actual underlying assets.

XYZ mutual fund is researching the possibility of acquiring shares of a manufacturing company in a foreign country. Which of the following risks should the investment company analyze and review before making the investment? 1. Political risk. 2. Exchange rate risk. 3. Marketability risk. 4. Default risk. A)2, 3, and 4 B)1, 2, and 3 C)4 only D)1 and 2

B // XYZ mutual fund should be concerned with all of these risks except default risk. The investment company is acquiring shares of the company rather than debt, therefore, the investment is not subject to default risk.

Steve, age 44, has $50,000 to invest in a fixed-income security. He has invested in bonds in the past and considers himself to be an aggressive investor. Steve is in the 32% tax bracket and is primarily interested in capital appreciation. Income is a secondary consideration. Steve is reviewing the following securities: 1. 12-year, B rated, non-callable corporate bond trading at par with a yield of 6% 2. 25-year, AA rated, callable general obligation municipal bond selling at a discount and yielding 5% 3. 10-year, Baa rated, callable corporate bond selling at a premium with a yield of 5.5% 4. Treasury bills with a yield of 4% Which one of these fixed-income securities would be the most appropriate choice for Steve? A)Investment 3 B)Investment 1 C)Investment 2 D)Investment 4

C // A tax-exempt municipal bond usually has a higher after-tax yield. The 25-year bond is more likely to generate capital gains if market interest rates fall further. Assuming Steve is an aggressive investor, there is no reason he should invest in Treasuries.

Henry is constructing an asset allocation portfolio for his financial planning client, Gretchen, based on information obtained from a completed risk-profile questionnaire. Which of the following are considerations for Henry to keep in mind when developing portfolio alternatives for Gretchen? 1. Understand her time horizon for investment. 2. Develop portfolios taking her tax situation into consideration. 3. Construct portfolios that match Gretchen's risk tolerance and investment objective. 4. Choose the appropriate benchmark(s) for investment performance comparison. A)1, 2, and 4 B)3 and 4 C)1, 2, 3, and 4 D)2 and 3

C // All of these are considerations that a financial planner should be aware of when constructing and monitoring an investment portfolio for a client.

Louis was recently hired by a local financial planning firm as a junior assistant. He will be involved in the firm's investment consulting department. As part of his training he will learn about the many aspects of the industry. Which of the following areas may be part of his training? 1. How to examine and review a client's goals, risk tolerance, and tax status. 2. How to determine the time horizon for a client's investment portfolio. 3. How to determine the suitability of a particular investment or investment strategy. 4. How to review and analyze a client's financial statements. A)2, 3, and 4 B)1, 3, and 4 C)1, 2, 3, and 4 D)1 and 2

C // All of these are important aspects of financial planning that should be part of a firm's comprehensive training program.

If Mr.Van Reham made a $1,000 investment four years ago that presently has a value of $3,150, the geometric mean return over the four-year investment period is: A)57.50% B)53.75% C)33.22% D)78.75%

C // An investment growing from $1,000 to $3,150 over a four-year period has a geometric mean return equal to 33.22%. PV = −1,000FV = 3,150N = 4Solve for I/YR = 33.2225, or 33.22%

Michael, a Georgia resident, is considering one of the following four bonds for his fixed-income portfolio. He wants an investment grade bond that will provide him with the most income over the next ten years. He is in the 24% marginal federal income bracket. In addition, he is subject to a 6% state income tax. Which of these bonds would be most appropriate for Michael? A) 10-year AA rated 5% XYZ corporate bond callable in 7 years at 101 B) 15-year BB+ rated 8% ABC corporate bond callable in 10 years at 104 C) 30-year A rated 6% corporate bond callable in 15 years at 102 D) 20-year AAA rated 3.25% State of Georgia municipal bond

C // Based on the information provided, the 30-year corporate bond is the best choice for his portfolio. The 20-year municipal bond has a taxable equivalent yield of 4.64% [3.25% ÷ (1 - 0.24 + 0.06)], well below the corporate bond coupon rate. The 15-year bond does not meet Michael's criteria for an investment grade bond. The 10-year bond may be called during his investment time horizon.

Kevin and Angela are both in their mid-40s. Kevin works as a manager at a home improvement store and Angela is an elementary school teacher. They have two school-age children. Both children have college savings plans funded solely by their paternal grandparents. The couple needs to assess the asset allocation of their current investments. After meeting with the couple, their CFP® professional determines they are moderate to aggressive risk takers with a long-term time horizon. Furthermore, they are willing to accept additional risk to achieve higher rates of return. Based on the information provided, their CFP® professional should recommend which of the following allocations? A) Portfolio 2 - 10% Large-Cap Stock Fund, 50% Corporate Bond Fund, 30% Russell 2000 Index Fund, 10% Emerging Markets Fund B) Portfolio 1 - 15% S&P 500 Index Fund, 45% Small-Cap Stock Fund, 10% High-Yield Bond Fund, 30% Municipal Bond Fund C) Portfolio 4 - 65% S&P 500 Index Fund, 15% Foreign Stock Fund, 10% High-Yield Bond Fund, 10% U.S. Government Securities Fund D) Portfolio 3 - 15% Pacific Rim Growth Fund, 30% Small-Cap Venture Growth Fund, 30% Biotechnology Fund, 25% High-Yield Bond Fund

C // Based on their risk profile and time horizon, Portfolio 4 would be the best choice for Kevin and Angela. A couple in their mid-40s, willing to accept additional risk would be suited for a diversified portfolio consisting of 80% stocks and 20% bonds.

Security A has a standard deviation of 23% and the market has a standard deviation of 18%. The correlation coefficient between Security A and the market is 0.80. What percent of the change in Security A's price can be explained by changes in the market? A) 36% B) 80% C) 64% D) 50%

C // Because the correlation coefficient is 0.80, the coefficient of determination (R-squared) is 0.64. Therefore, 64% of investment returns can be explained by changes in the market (i.e., systematic risk represents 64%).

Owen holds XYZ stock. The stock recently increased in value by 50%. He would like to preserve as much of this gain as possible and retain the potential for additional price increases. Which strategy best meets Owen's goal? A) Buy a call option B) Write a call option C) Buy a put option D) Short the stock

C // Buying a put option would allow Owen to hold the stock for additional gain but reserve the right to sell at or near the current value if the stock price plummets. Shorting the stock would lock in Owen's gain but not allow him to take advantage of additional price increases. Additional price increases would be offset by the cost of replacing the shorted stock. Writing a call option would provide some offset to a drop in price but would not allow for potential gain in value. Buying a call option would not provide any downside protection.

Thomas, a wealthy investor, emails his CFP® professional, Vance, regarding a referral to a trust company. Vance promptly provides him with the name of a woman at a local trust company to whom he has referred many clients over the years. Thomas appreciates the referral and tells Vance he will call her. Vance immediately calls his friend at the trust company to discuss Thomas's personal and financial information. What is the consequence of Vance's action? A) By providing the information to the trust company, Vance has performed diligently. B) Thomas will be guaranteed excellent service based on the referral. C) By revealing the client's personal and financial information, Vance violated Standard A.9, Confidentiality & Privacy. D) Vance showed a high level of professionalism by immediately contacting his friend at the trust company to discuss the case.

C // By contacting his friend and divulging personal and financial information, Vance has violated Standard A.9, Confidentiality & Privacy and has not acted in a profession or diligent manner. Thomas is not guaranteed that he will receive excellent service from the referral.

When conducting a Monte Carlo simulation, Charlie, a CFP® professional, intentionally inflates the projected rates of return used in the analysis. As a result, he overestimates the future value of his client's accounts. Though Charlie is fully aware of the inaccuracies within the account projections, he feels he must show the client excellent performance in order to sell his investment products. Have Charlie's actions violated any of the Standards found in CFP Board's Code of Ethics and Standards of Conduct? A)No, he has complied with Standard A.3,Competence. B)Yes, he has violated Standard A.9, Confidentiality & Privacy. C)Yes, he has violated Standard A.2, Integrity. D)No, he has complied with Standard A.7, Professionalism.

C // By inflating the client's projected rates of return, Charlie has violated Standard A.2, Integrity. This Standard demands honesty and candor from CFP® professionals.

Wendy, age 73 and a recent widower, was referred to Frank, a CFP® professional, by her long-time friend, Janice. Wendy's late husband handled most of the finances and Wendy has been overwhelmed with all the paperwork involved in settling her late husband's estate. She had been skeptical in asking for assistance for fear of appearing uninformed about her finances. At a recent lunch, however, Janice offered Wendy reassurance and she ultimately decided to meet with Frank. After contacting his office, Frank instructed her to mail or fax her personal and financial information to expedite the process. In response Wendy indicated her uneasiness with providing confidential personal information via mail or fax. How should Frank proceed with the engagement? A)He should have his assistant contact her to answer any questions or concerns. B)He should demand that she send in the paperwork before the meeting. C)He should set up a face-to-face meeting with Wendy to gather her personal financial information. D)He should disengage from the relationship.

C // Frank should set up a face-to-face meeting with Wendy to collect the information, understand her concerns, and allay her fears. He should not disengage simply based on her resistance to mail or fax her information prior to the first meeting. Finally, he should not have an assistant contact her to persuade her to send in the information.

Michael, a CFP® professional, is meeting with his client of 5 years, Caroline. She has a portfolio consisting of a variety of stocks and bonds. Michael is reviewing her holdings and the economic climate to ensure that her financial plan is still on track. What is the best investment strategy for Caroline if interest rates are currently low and expected to rise in the near future? A)Buy convertible bonds B)Sell T-bills C)Sell long-term bonds D)Buy intermediate bonds

C // If interest rates are expected to rise in the near future, Caroline should sell her long-term bonds and reinvest the proceeds at a higher coupon rate once interest rates actually rise.

Which of the following would NOT be a condition for rebalancing a portfolio? A)Availability of new asset classes B)Changing time horizons C)Impact of trades on security prices D)As asset values change within the portfolio

C // Impact of trades on security prices represents a cost of rebalancing. Changing time horizons may necessitate changes in the asset mix. New securities may allow asset allocation shifts with lower transaction costs or create more efficient portfolios. Adhering to a strict buy and hold policy would not be in the client's best interest. Portfolios need to be rebalanced and changed to meet client's changing needs.

Jeff is interested in BEC stock. BEC's earnings and dividends are expected to grow at a rate of 6% per year for the foreseeable future. If Jeff's required return is 11%, what is the intrinsic value of BEC stock if it is currently paying a dividend of $1.20? A)$10.91 B)$24.00 C)$25.44 D)$20.00

C // Intrinsic value (using the constant growth dividend discount model) = D0(1 + g) ÷ (r − g) = $1.20 (1.06) ÷ (0.11 − 0.06) = $25.44

John, age 45, wants to further diversify his portfolio. His current investments consist of stock mutual funds, collectibles, and U.S. Treasury bonds. He is considering adding real estate to his holdings. Which of the following factors should John consider when making an investment in real estate? 1. The location of the property 2. Sales commissions 3. Projected cash flow and taxes from the operation 4. The cost of capital A)1 and 3 B)2, 3, and 4 C)1, 2, 3, and 4 D)1 and 2

C // Other factors include the cost of operating and maintaining the property, fees, and construction costs.

Owen purchased 100 shares of ABC stock for $32 per share from his stockbroker and CFP® professional, Lucas. One year later, the stock paid a dividend of $1.50, and he purchased an additional 100 shares for $35 per share. At the end of the second year, Owen contacted Lucas to sell all of the stock for $31 per share using a limit order. The order was filled and the stock sold at $31 per share. The stock did not pay a dividend at the end of the second year. What was the dollar-weighted return to Owen over the two-year holding period? A)-6.61% B)1.05% C)-3.63% D)-5.14%

C // Owen earned a −3.63% dollar-weighted return on ABC stock over the two-year period, calculated as follows: CF0 = $32 × 100 = −$3,200 CF1 = ($1.50 × 100) − ($35 × 100) = −$3,350 CF2 = $31 × 200 = $6,200 Solve for the internal rate of return (IRR/YR) = −3.6331% (rounded to −3.63%)

John and Kate, ages 28 and 26 respectively, want to start to save for their retirement. They both are eligible for Section 401(k) plans through their employers. The plans offer a dollar for dollar match up to 3% of salary. If they consider themselves moderate to aggressive risk tolerant investors with a long-term time horizon, which of the following portfolios would be most suitable for their CFP® professional to recommend for their retirement plans? A) Portfolio 4 - 40% S&P 500 Index Fund, 10% International Stock Fund, 10% International Bond Fund, 15% Science and Technology Stock Fund, 25% Money Market Fund B) Portfolio 1 - 50% S&P 500 Index Fund, 30% Science Research Fund, 20% Corporate Bond Fund C) Portfolio 3 - 80% S&P 500 Index Fund, 10% International Stock Fund, 10% Emerging Market Fund D) Portfolio 2 - 60% Corporate Bond, 25% U.S. Government Securities Fund, 15% Money Market Fund

C // Portfolio 3 is the best choice based on their risk tolerance and time horizon. John and Kate are willing to accept a higher level of risk to achieve higher expected returns over the long-term.

Mike, age 49, is meeting with his CFP® professional, Jane, to discuss his retirement planning. He is seeking a diversified investment portfolio for his $500,000 that will offer him returns comparable to the annual returns of the S&P 500 index. Through a risk-profile questionnaire, Jane has determined that he is a moderate to high risk investor with a long-term investment time horizon and a growth objective. Which of the following portfolios would best meet Mike's needs? A)Portfolio C - 40% U.S. Large-Cap Equities, 25% MSCI® EAFE Index Fund, 25% Emerging Market Debt, 10% U.S. Government Bonds B)Portfolio B - 60% S&P 500 Index Fund, 20% Commodities, 20% Futures C)Portfolio A - 50% U.S. Large-Cap Equities, 10% International Equities, 20% U.S. Corporate Bonds, 5% Real Estate, 5% Emerging Markets Equities, 10% Small-Cap Equities D)Portfolio D - 50% Large-Cap Fund, 10% U.S. Corporate Bonds, 10% High-Yield Corporate Bonds, 10% Emerging Market Debt, 20% Money Market Mutual Fund

C // Portfolio A will best suit Mike's needs for a diversified moderate to high risk portfolio with the opportunity for long-term growth. This portfolio is utilizing the core and satellite approach to asset allocation. The core percentage of 80% is comprised of U.S. Large-Cap Equities, International Equities, and U.S. Corporate Bonds. The satellite percentage of 20% is comprised of Real Estate, Emerging Market Equities, and Small-Cap Equities. Portfolio B is too heavily skewed toward commodities and futures. These types of investments are too risky given Mike's risk tolerance. Portfolio C is comprised of 50% international investments which are too risky given Mike's risk tolerance. Portfolio D offers a satellite portion that is comprised of 20% Money Market Mutual Fund, which does not meet Mike's investment objective. In addition, this portfolio offers an additional 30% of fixed-income investments, which will not permit the portfolio the opportunity for long-term growth.

Jasmine has a large paper profit in her Amalgamated Corporation shares, which are currently trading at $42 per share. She does not mind holding on to the stock and understands that positive price movements may not last forever. If she is willing to sell the shares at $50, what is the best strategy for her to implement? A)Place a stop order at $38 B)Place a limit order at $50 C)Sell $50 call options D)Buy $50 put options

C // Selling a call option will allow Jasmine to generate income from the option premium with little risk, because she does not expect the stock to continue to increase in price. If the stock does exceed $50, she would be paid what she wants for the stock. The limit order will neither provide any income nor guarantee fulfillment if the stock price stays below $50. The stop order may help Jasmine in case of the stock falling in price. However, this order will change to a market order when the price reaches $38 and may be filled at a different price.

RST Corporation stock has a mean return of 9% and a standard deviation of 6%. If the historical returns for RST stock are normally distributed, what is the probability the stock will yield a return greater than 15%? A)50% B)32% C)16% D)34%

C // The probability of a return above 9% is 50%. The probability of a return between 9% and 15% is 34% (1/2 of 68% [within 1 standard deviation]). Therefore, the probability of a return above 15% is 16% (50% − 34%).

Jeff purchased a 30-year bond for $977.36 with a stated coupon rate of 8.5%. What is the yield to maturity for this investment if Jeff receives semiannual coupon payments and expects to hold the bond to maturity? A)4.36% B)5.68% C)8.71% D)8.93%

C // The yield to maturity for this bond is 8.71% calculated as follows: PV=-977.36N=60 (30 × 2)PMT=42.50 (85 ÷ 2)FV=1,000I/YR=4.357 × 2 = 8.71%

For a domestic investor purchasing foreign bonds: A) appreciation of the asset and depreciation of the foreign currency benefit the domestic investor. B) depreciation of the asset and appreciation of the foreign currency benefit the domestic investor. C) appreciation of both the asset and the foreign currency benefits the domestic investor. D) depreciation of both the asset and the foreign currency benefits the domestic investor.

C // When the foreign currency appreciates, each foreign currency-denominated cash flow buys more domestic currency units-increasing the domestic currency return from the investment. The appreciation of the foreign asset benefits the investor as well.

Which of the following is least likely to be considered an appropriate schedule for reviewing and updating an investment policy statement? A) When there is a major change in the client's constraints. B) At regular intervals (e.g., every year). C) When there are significant changes in the investor's risk and return objectives. D) Frequently, based on the recent performance of the portfolio.

D // An investment policy statement (IPS) should be updated at regular intervals and whenever there is a major change in the client's objectives or constraints. Updating an IPS based on portfolio performance is not recommended.

arry, age 62, is meeting with Justine, his CFP® professional, to review his bond portfolio. He owns a 15-year AAA rated municipal bond, with 5 years remaining until maturity, featuring a coupon rate of 3.25% (paid semiannually). If the comparable yield for this type of bond is currently 4.05%, what should be the intrinsic value of his bond? A)$984.20 B)$1,000.00 C)$1,053.87 D)$964.12

D // Barry's bond has an intrinsic value of $964.12, calculated as follows: FV = 1,000PMT = 16.25 (3.25% × $1,000 ÷ 2)N = 10 (5 × 2)I/YR = 2.0250 (4.05 ÷ 2)Solve for PV = 964.12, or $964.12

Lucy and Rick, ages 52 and 47 respectively, are concerned that they will not have enough money to retire comfortably at Lucy's age 70. Lucy was recently promoted to district manager of an inventory control company. Along with the promotion, they have an additional $400 per month they would like invest into a new retirement investment portfolio. They consider themselves to be aggressive risk takers with a long-term time horizon. Which of the following portfolios should their CFP® professional recommend for investment? A)Portfolio 3 - 50% Russell 2000 Index Fund, 40% U.S. Government Securities Fund, 10% Money Market Fund B)Portfolio 1 - 20% Balanced Fund, 60% High-Yield Bond Fund, 10% Emerging Markets Fund, 10% International Stock Fund C)Portfolio 4 - 30% S&P 500 Index Fund, 30% Corporate Bond Fund, 40% Municipal Bond Fund D)Portfolio 2 - 70% S&P 500 Index Fund, 20% Corporate Bond Fund, 10% International Stock Fund

D // Based on their risk tolerance and time horizon, Portfolio 2 would be the best choice. This portfolio consists of 80% stocks and 20% bonds with 10% allocated to international stocks. Portfolio 1 consists of 60% high-yield bonds, which is not appropriate for their goal. Portfolio 3 is too conservative with 50% of the allocation in U.S. Government securities and money market securities. Portfolio 4 is too heavily weighted toward bonds.

Annabelle, age 62, enjoys investing in real estate. Along with her numerous residential and commercial real estate properties, she has a number of investment accounts. Her CFP® professional, Roy, has worked with her for the past 15 years in preparing and monitoring her financial plan. Recently, Annabelle communicated to Roy that she would like to purchase a specific property located downtown for commercial development. Shortly after their conversation, Roy discovered that the property was listed for sale in the local business journal and he confirmed this information with a real estate broker. What should Roy do next? A)Purchase the property for his personal portfolio and resell it to Annabelle for a profit. B)Contact the listing agent and provide this person with Annabelle's contact information. C)Wait for Annabelle to contact him to discuss financing alternatives. D)Contact Annabelle and provide the information for her to contact the listing agent on the property.

D // Because Roy knows of the listing and her desire to purchase this property, he should proactively contact her with the contact information of the listing agent. He should not purchase the property for himself and attempt to resell it to Annabelle for a profit because he would be placing his personal interests before those of his client. Also, Roy should not contact the listing agent with Annabelle's personal information without her permission.

Mildred manages a mutual fund whose goal is to provide a return similar to that of the U.S. small capitalization market. Choose the index that would provide the best benchmark for Mildred's fund. A)S&P 500 B)Wilshire 5000 C)DJIA D)Russell 2000

D // The Russell 2000 is an index of small capitalization U.S. stocks. The Dow Jones Industrial Average (DJIA) represents 30 major blue-chip stocks. The S&P 500 is an index of 500 large capitalization U.S. stocks. The Wilshire 5000 is a broad market index.

Sam, a CFP® professional, is conducting an initial interview with Harvey, a prospective client. Harvey told Sam that he will be receiving a large inheritance and would like to set up an account for the benefit of his three adult children. What step should Sam take next? A)Provide Harvey with his firm's advisory agreement. B)Offer client testimonials. C)Discuss his methods of compensation. D)Ask Harvey open-ended questions to ascertain more information.

D // Before proceeding, Sam needs to ask Harvey open-ended questions to clarify Sam's needs, goals, and expectations. During the initial interview, Sam may provide his firm's advisory agreement and discuss his methods of compensation. Sam must make sure that the use of client testimonials is permitted before offering them to his prospective client.

Carla is meeting with her CFP® professional, John, to evaluate the financial strengths and weaknesses of her current situation. Her CPA has prepared a statement of financial position for Carla's reference, which she presents to John for analysis. After the meeting, John discovers that the balance of her traditional IRA on her brokerage statement is $150,000, but on her statement of financial position, the balance is listed as $115,000. What should John do next? A)John should amend the statement of financial position to reflect the $150,000 balance. B)Proceed with developing the financial plan based on the information provided by the client. C)Contact Carla's CPA to discuss the statement of financial position. D)Contact Carla to verify the accuracy of the information on the statement of financial position.

D // During the analyzing and evaluating the client's current financial status phase, the planner should review the statement of financial position for information and clarity. At this point, John should contact Carla for clarification. He should not proceed with developing the plan with contradictory information. Also, he should not contact her CPA without permission.

ABC's stock is currently trading in the secondary market for $80 per share. John purchases an 'in-the-money' call option contract, selling at $11, with an expiry date in two months and an exercise price of $75. If the stock price increases to $88 per share and he exercises the option, which of the following statements are CORRECT? 1. He realized a net profit of $200. 2. He paid $1,100 for the call option contract. 3. He realized a net loss of $800. 4. He paid $7,500 to buy the stock upon exercise. A)2 and 3 B)1, 3, and 4 C)1 and 2 D)1, 2, and 4

D // Each option contract represents 100 shares of the underlying stock. Upon exercise, he will be able to buy 100 shares at the exercise price of $75 per share, or $7,500. The current market price of the 100 shares is $8,800 ($88 × 100). He would have a profit of $1,300 ($8,800 − $7,500) from the option transaction. However, John paid $1,100 to purchase the contract. Therefore, his net profit is $200 ($1,300 − $1,100).

Grant purchased 100 shares of XYZ stock on margin when it was selling for $75 per share. Today, the stock price fell to $52 per share. If the initial margin was 50% and the maintenance margin is 40%, how much will his broker ask him to add to his account to satisfy the margin call? A) $1,150 B) $0 C) $1,380 D) $630

D // Grant's current equity in XYZ: $52 − (50% × $75) = $14.50 Required equity: $52 × 40% = $20.80 Difference: $6.30 × 100 shares = $630

Harvey, a 70-year old retiree, recently purchased a condominium in Florida to be closer to his grandchildren. He receives a pension of $1,500 per month, and his current investments are estimated to provide an additional $250 per month for the remainder of his life. Recently, Harvey was in a car accident and received $250,000 in compensation for his injuries. He would like to invest the funds in a guaranteed investment that will increase his total monthly income to $2,750. Based on this information, which of the following securities should Harvey purchase? A)10-year TIPS with a 4% coupon B)30-year STRIPS based on 5% coupon Treasury bonds C)Series EE savings bonds with a current yield of 1.5% D)30-year U.S. Treasury bonds with a 5.15% coupon

D // Harvey requires an additional $1,000 per month or $12,000 per year on newly invested dollars. This translates into a minimum rate of return of 4.8% ($12,000 ÷ $250,000). TIPS, STRIPS, savings bonds, and Treasury bonds are all guaranteed by the U.S. government, but only the Treasury bonds provide the necessary income to reach his goal. STRIPS and U.S. savings bonds will not provide him with any current income.

By incorporating real estate investments into a portfolio, an investor can expect all of the following EXCEPT: A)illiquidity relative to other investments that trade regularly. B)cash inflows. C)diversification benefits with equity and fixed income investments. D)homogeneity due to the uniqueness of individual real estate assets.

D // Heterogeneity (rather than homogeneity) is the concern with real estate, as every asset is unique based on attributes such as design, use, and location. Cash inflows and diversification are benefits to investing in real estate. Illiquidity is a disadvantage of real estate relative to other investments.

One year ago, Caren bought 200 shares of ACME Corp. at $8.50 per share. During the past year, the stock paid dividends of $0.90 per share. What is her one-year holding period return, if the stock's current price per share is $9.10? (Round to the nearest percent) A)13% B)31% C)24% D)18%

D // Holding period return = (ending value − beginning value ± cash flows) ÷ beginning value. Calculated as: ($9.10 − $8.50 + 0.90) ÷ $8.50 = 0.1765, or 17.65%, rounded to 18%.

Mike and Marcy, ages 45 and 43 respectively, are meeting with their CFP® professional, Jackie, to discuss an investment management strategy. The couple wants to re-evaluate their portfolio to reflect changes in their personal circumstances. While completing a risk-profile questionnaire, Mike and Marcy agreed that the portfolio should be rebalanced on a semiannual basis without their consent. However, any additional transactions will require a consultation. Based on the information provided, all of the following may be contained in the couple's investment policy statement EXCEPT? A) The time horizon for the financial goal will be initially stated at 23 years. B) The portfolio's asset allocation will be consistent with the couple's risk tolerance level. C) To meet the couple's financial goals, the portfolio is expected to produce a 6% annual rate of return. D) The investment manager will have full discretion as to the timing and choice of assets for the portfolio to maintain the proper mix.

D // In this case, the investment manager must consult with the couple before making any significant changes to the dynamics of the account, except periodic rebalancing. An investment policy statement (IPS) is a written document that sets forth a client's objectives and limitations on the investment manager. In addition, the document provides a means for evaluating the investment performance.

Brian, age 40, is concerned about his investment portfolio. His account, which is invested in an aggressive growth portfolio, has a current market value of $156,000. Even though he has told his financial planner that he has a long-term approach to investing, he has been reading about how the market, especially the growth sector, may be overvalued and subject to a financial bubble. His financial planner senses Brian's uneasiness and worry. How should the CFP® professional address Brian's concern? A) Immediately recommend that Brian liquidate his holdings to cash. B) Transfer existing assets into a new portfolio based on a conservative asset allocation. C) Advise Brian to sell all of his holdings and place the funds into a fixed annuity. D) Tell Brian to stay the course and focus on the long-term.

D // In this case, the planner's role is to reinforce the long-term approach to investing. Even though low probability events may adversely affect a client's portfolio in the short-term, a planner should encourage his client to focus on long-run market investments.

Lauren, age 38, is currently in the 32% marginal tax bracket, and expects to be in the 12% bracket when she retires. Making contributions today to a tax-deductible individual retirement account invested in a growth-oriented portfolio of mutual funds is an example of: A)neither minimizing the amount nor deferring the timing of the tax payment. B)deferring the timing of the tax payment. C)minimizing the amount of the tax payment. D)both minimizing the amount and deferring the timing of the tax payment.

D // Lauren's action is an example of both minimizing and deferring. She will minimize taxes by converting income that would have been taxed at a 32% rate today to a lower 12% rate in the future. She will defer taxes payable until the funds are withdrawn from the account in the future.

Ten years ago, Lesley purchased 1,000 shares of XYZ stock for $45,000. She is considering selling these shares to help her mother purchase a new condominium in a retirement community. Her mother needs $50,000 to purchase the unit and make upgrades and improvements. The stock is currently trading at $62.50 per share. Lesley and her CFP® professional agree to sell enough shares to fund this goal. Assuming she sells the stock at the current market price, what is the tax consequence? A)$5,000 short-tem capital gain B)$12,500 long-term capital gain C)$31,000 ordinary income D)$14,000 long-term capital gain

D // Lesley will incur a long-term capital gain of $14,000. Basis per share: $45 ($45,000 ÷ 1,000 shares) Number of shares to be sold to meet goal based on a current market price of $62.50: 800 ($50,000 ÷ $62.50) Basis in shares sold: $36,000 (800 shares × $45) Long-term capital gain: $14,000 ($50,000 - $36,000)

Andy and Harriet, ages 50 and 48 respectively, have two adult children. One of their children, Joseph, has decided to open a bed-and-breakfast located on lakefront property in a tourist region. He has asked his parents for a $25,000 loan to help furnish the building. The couple has a large investment portfolio, but they are concerned about the stock market declining in the near future. They want to refinance an existing high interest rate mortgage with a new lower rate mortgage before interest rates go higher, as predicted. In addition, the couple would like to retire when Andy reaches age 67. Assuming the CFP® professional already has a long-standing planning relationship with this couple, what is the best course of action? A)Identify sources of capital for the loan to Joseph. B)Discuss the impact of the loan on their retirement planning goal. C)Refer the couple to a mortgage broker to handle the refinance and lock in a lower interest rate. D)Offer to review and make appropriate changes and recommendations to their financial plan.

D // Monitoring the financial planning recommendations is a critical part of the client-planner relationship. CFP® professionals should make themselves available to assist clients when circumstances change. After reviewing their existing financial plan, the planner may advise them on ways to refinance, make funds available for the loan, and discuss the impact of the loan on their retirement planning goal.

Adam has a portfolio of bonds worth approximately $125,000. He is concerned that interest rates will increase in the near term. Which of the following would be the least desirable strategy for Adam? A)Sell long-term bonds and buy short-term bonds. B)Sell low-coupon bonds and buy high coupon bonds. C)Sell Treasury bonds and buy Treasury bills. D)Sell low-duration bonds and buy longer duration bonds.

D // Prices decline when interest rates rise. An investor expecting an increase in interest rates should sell more volatile bonds and purchase less volatile bonds. Bonds with large coupons and shorter durations are less price volatile than low coupon, long-term, and long duration bonds.

Kellie is a senior equity analyst for a large brokerage firm. She uses fundamental analysis techniques to pick stocks for her firm's clients. Today, she is reviewing the XYZ Corporation. The company is a manufacturer of computer accessories and is currently going through an expansion phase. Which of the following techniques may Kellie use to determine whether to buy, sell, or hold this company's stock? 1. She may examine the overall state of the economy, the computer industry, and then XYZ Corporation. 2. She may calculate the intrinsic value of the stock using one or more of the stock valuation models. 3. She may consider interest rate trends. 4. She may review the company's stock 200-day moving average. A)2 and 3 B)4 only C)1 and 4 D)1, 2, and 3

D // Reviewing the company's stock 200-day moving average is a technique used by technical analysts (chartists). All of the other techniques are used by fundamental analysts. The process of examining the economy, the specific industry, and the specific company is a reflection of top-down fundamental analysis.

Vince, age 53, recently lost his salaried job in which he earned $95,000 per year, due to his company downsizing the management team. He communicates to his CFP® professional that he is working with an executive placement agency to prepare a resume and search for another position within his field of expertise. In the meantime, he is concerned that he will not have enough liquidity to pay for his current expenses. Which of the following should the CFP® professional recommend to Vince to provide for his current needs? A)Sell his collection of inherited artwork worth $40,000 at auction. B)Elect a Section 72(t) distribution from his traditional IRA worth $73,500. C)Take a loan from his Section 401(k) plan, with a balance of $350,000, and place this money into an interest-bearing money market deposit account. D)Sell a portion of his ABC stock that he purchased five years ago for $25,000, which is currently worth $50,000.

D // Selling the stock would be best choice because the stock is currently trading at a gain and the sale would be taxed at favorable long-term capital gains rates. Because Vince has separated from service, any loan provision in the Section 401(k) plan will not be available. Selling artwork at auction does not guarantee that he will receive full value. In addition, the auction house may take a commission on the sale. Electing a Section 72(t) distribution from his traditional IRA may not provide the necessary funds based on his life expectancy and the impact of taxation.

Johnson Inc. manages a growth portfolio of equity securities that has had a mean monthly return of 1.4% and a standard deviation of returns of 10.8%. Smith Inc. manages a blended equity and fixed income portfolio that has had a mean monthly return of 1.2% and a standard deviation of returns of 6.8%. The mean monthly return on Treasury bills has been 0.3%. Based on the Sharpe ratio, the: A) performance of the Johnson portfolio is preferable to the performance of the Smith portfolio. B) both portfolios have exhibited the same risk-adjusted performance. C) portfolios' risk-adjusted performances have no basis for comparison. D) performance of the Smith portfolio is preferable to the performance of the Johnson portfolio.

D // The Sharpe ratio for the Johnson portfolio is (0.014 − 0.003) ÷ 0.108 = 0.1019The Sharpe ratio for the Smith portfolio is (0.012 − 0.003) ÷ 0.0689 = 0.1324The Smith portfolio has the higher Sharpe ratio, or greater excess return per unit of risk.

David has a separately managed account with the SAW Financial Group. He has asked you to assist him with evaluating the performance of the portfolio manager. Which of the following should be used to evaluate the performance of the SAW Financial Group against other investment managers? 1. Sharpe ratio 2. Correlation with the S&P 500 3. Dollar-weighted return 4. Time-weighted return A)3 only B)2 only C)1, 2, 3, and 4 D)1 and 4

D // The Sharpe ratio uses standard deviation as its measure of risk and is appropriate for comparing risk-adjusted returns of various portfolios. The fund's correlation with the S&P 500 Index is relevant only as a measure of the manager's performance if the fund is tracking the index. The dollar-weighted return for David's account is inappropriate for analyzing the portfolio manager's performance because this measure includes cash flows beyond the manager's control, such as David's contributions to and withdrawals from the account. The time-weighted return includes only cash flows related to the portfolio, such as dividend and interest payments.

Kevin and Catherine, ages 35 and 33 respectively, are ready to implement the investment recommendations proposed by their CFP® professional. All of the following may occur during this phase EXCEPT? A)Transferring Kevin's 401(k) plan from a former employer to a traditional IRA. B)Reallocating money from a money market mutual fund to an S&P 500 Index Fund. C)Opening a new Roth IRA for Catherine. D)Providing the couple with the firm's engagement letter for review.

D // The couple should have been provided with the firm's engagement letter during the initial interview or the establishing and defining the client-planner relationship phase.

Of the four pairs of assets below, which pair provides the highest level of diversification? A)Assets 3 & 4: with a correlation coefficient of +0.37. B)Assets 1 & 2: with a correlation coefficient of +0.92. C)Assets 5 & 6: with a correlation coefficient of 0. D)Assets 7 & 8: with a correlation coefficient of −0.78.

D // The highest level of diversification will occur when the correlation coefficient is closest to −1. Of the four pairs of assets, assets 7 and 8 offer the highest level of diversification because the correlation coefficient of −0.78 is closest to −1. The returns on assets 7 and 8 should generally move in opposite directions because they are negatively correlated.

The investor's investment time horizon and risk tolerance are linked in the asset allocation decision. Which of the following statements correctly illustrate(s) why this distinction is important in determining the proper asset allocation? 1. An investor with a short-term investment horizon will be most likely concerned with safety of principal. 2. An investor with a long-term investment horizon will be more concerned with capital appreciation and will likely be willing to incur more risk. 3. An investor with a short-term investment horizon will want to make the most money in the least amount of time, so he will be more likely to take on significant risk. 4. An investor with a long-term investment horizon will be most concerned with the safety of his long-term investments, so he will tend toward fixed-income investments. A)2 and 3 B)1 and 4 C)3 and 4 D)1 and 2

D // The investor's investment time horizon and risk tolerance are linked in the asset allocation decision. For example, an investor with a short-term investment horizon will be most likely concerned with safety of principal. Therefore, he will be less likely to take on significant risk and will tend toward fixed-income investments. Conversely, an investor with a long-term investment horizon will be more concerned with capital appreciation and may be willing to incur more risk.

Nicholas owns ABC stock which is trading for $35 per share. However, he believes the stock may come under pressure from a negative earnings report. He would like to earn a profit from any potential decline while simultaneously protecting his long position. Which of the following would be the best choice for Nicholas? A)sell the stock short B)sell a put option C)purchase a call option D)purchase a put option

D // The purchase of a put option gives the owner the right to sell the underlying stock at the exercise price. If the stock declines below the exercise price, the put option holder benefits because the owner is able to sell the stock at a price above the current market price. However, if the stock price remains above the exercise price, the put option expires unexercised, and the owner loses the put option premium.

Bobby has the following securities in his portfolio: ABC common stock, XYZ common stock, PQR mutual fund (domestic small cap), DEZ mutual fund (foreign small cap), 30-year Treasury bond, and 5-year Treasury note. Point out the risk that should be of least concern Bobby. A)Systematic risk B)Reinvestment rate risk C)Financial risk D)Default risk

D // Treasuries are considered default risk-free. Financial risk is the uncertainty introduced from the method by which a firm finances its assets (i.e., debt versus equity financing). Reinvestment rate risk is the risk that as cash flows are received they will be reinvested at lower rates of return than the investment that generated the cash flows. Systematic risk is the risk that all securities are subject to and typically cannot be eliminated through diversification.

Franklin is considering investing in bonds. He may purchase a corporate bond paying a 7% coupon or a municipal bond paying a 5.3% coupon. If his marginal federal income tax rate is 35% and his state does not collect income taxes, Franklin would prefer: A) the corporate, because its after-tax yield is 21.21%. B) the municipal, because its taxable equivalent yield is 16.06%. C) the corporate, because its after-tax yield is 10.45%. D) the municipal, because its taxable equivalent yield is 8.15%.

D // We can either compare the taxable equivalent yield (TEY) of the municipal bond with the nominal yield for the corporate bond or compare the after-tax yield of the corporate bond with the nominal yield of the municipal bond. TEY of the municipal bond = 5.3% ÷ (1 − 0.35) = 8.15%, which is more than the nominal yield of the corporate bond. The after-tax yield of the corporate bond = 7% × (1 − 0.35) = 4.55%.