Series 7 - Suitability: Portfolio Construction / Asset Allocation

An investment strategy where a higher price is paid for a stock based upon expected returns is: A growth investing B value investing C conservative investing D passive investing

The best answer is A. A growth investor buys a stock based upon demonstrated growth in earnings or sales over time. The theory is that such companies can continue to grow rapidly, and therefore should command a higher market price.

A new client has been employed as a manager at XYZ Corporation (NYSE listed) for the last 20 years and has a defined contribution pension plan at his employer that he has chosen to invest 100% in XYZ Common stock. The value of the pension plan is now $750,000. The customer is 7 years from retirement and has asked for advice about what steps he should take regarding his retirement account. As the adviser to the customer, your IMMEDIATE concern should be the: A investment outlook for XYZ Corporation over the upcoming 7 years B fact that the customer is concentrated in one stock and lacks diversification in his portfolio C dividend rate paid by XYZ and whether it is sufficient to meet the customer's need for income in retirement D the possibility that XYZ Corporation could go bankrupt prior to the death of the customer

The best answer is B. This is the client's sole investment to fund his retirement. The immediate concern should be the customer's lack of diversification. If the customer were to sell a portion of the XYZ stock and reallocate it to other investments, the client will reduce overall risk. Choices A, C and D are also concerns, but they are longer term concerns in this situation.

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

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

Passive portfolio management is: A buying and holding the investments chosen by the Registered Representative B determining the securities to be bought or sold based on investment research performed by the Registered Representative C managing a portfolio to meet the performance of a benchmark portfolio D managing a portfolio to exceed the performance of a benchmark portfolio

The best answer is C. Passive portfolio management is the management of a portfolio to meet the performance of a benchmark, such as a designated index. Active portfolio management attempts to beat the performance of the benchmark portfolio through better security selection and better investment timing.

A 65-year old widow that is in a low tax bracket and that has a low risk tolerance wishes to make an investment that will provide income. Which is the BEST recommendation? A Growth mutual fund B Emerging markets mutual fund C Long term municipal bond fund D Bank certificates of deposit

The best answer is D. This elderly widow is in a low tax bracket and seeks income. Growth stocks and emerging markets stocks do not provide income; rather, they provide capital gains. Municipal bonds are not appropriate for a low tax bracket investor, since the bonds are exempt from Federal income tax, and the market interest rate is lower than that for taxable investments because of this. Municipal bonds are only suitable for high tax bracket investors, where the exemption from federal tax has real value. Thus, we are left with bank certificates of deposit as the only viable choice. They are low risk and will provide income with a higher "after-tax" return for a person in a low tax bracket than equivalent maturity municipal investments.

A customer has an existing portfolio that is mainly invested in high quality corporate bonds for stable income. As market interest rates have dropped, the customer's income has declined and she would like to reallocate part of the portfolio to corporate bonds that offer potential growth. The BEST recommendation is to buy: A convertible debentures B equipment trust certificates C long term zero coupon bonds D commercial paper

The best answer is A. For a customer who wishes to invest in bonds that offer both income and potential growth, convertible bonds are usually a suitable recommendation. Convertible bonds trade as equivalent to the common stock if the market price of the common rises above the conversion price. Thus, as the market price of the common rises, the convertible bond price will rise as well. This gives the customer the potential for growth.

Which bond recommendation would be the MOST safe for an individual who seeks income that is free from federal income tax? A AA-rated revenue bond that is escrowed to maturity B AAA-rated general obligation bond C AA rated certificate of participation D Double-barreled bond

The best answer is A. A bond that is escrowed to maturity (ETM) is backed by escrowed U.S. Government securities - so it becomes the "safest" municipal bond because it becomes government backed. AAA rated general obligation bonds are extremely safe - they are backed by unlimited tax collections and have a top credit rating. But they are not as safe as bonds backed by escrowed U.S. Government securities.

A customer, age 30, has an investment objective of capital appreciation; but does not need current income. The BEST asset allocation mix to recommend to this customer is: A 100% common stocks B 50% common stocks; 50% bonds C 10% common stocks; 90% bonds D 100% bonds

The best answer is A. A customer who has an objective of growth; and is not concerned with current income; would invest the majority of funds in common stocks; principally growth stocks. The risk associated with such a strategy is that either the stock market takes a dive; taking these stocks with it; or that some of these companies "lose their way" and perform poorly. You can always use the guideline that the customer should invest his or her "age" in bonds, with the balance in equities. This would give 30% bonds; 70% equities, which is not a choice here! Because the investment objective is "capital appreciation" - as long as the customer is risk-tolerant, Choice A best meets the customer's needs.

Which bond portfolio where all investment is made up front would be LEAST negatively affected by a sharp rise in interest rates? A Ladder B Bullet C Barbell D Balloon

The best answer is A. Bullets, Bond Ladders, and Barbells are portfolio constructions that are used to limit interest rate risk. The idea behind a bond ladder is to spread bond maturities in a portfolio over fixed intervals, typically 10 maturities in intervals of 2 years each. A typical ladder might have 10 maturities ranging from 2 to 20 years, with an average maturity of around 10 years. Because of this broad diversification by maturity, a rise in interest rates will not impact the portfolio as negatively as compared to a bullet or barbell portfolio construction. If interest rates rise, the loss on the longer term bonds in the portfolio is offset by the fact that shorter term bonds are maturing soon and the proceeds can be reinvested at higher rates.

A customer owns 1,000 shares of XYZZ stock, purchased at $40 per share. The stock is now at $45, and the customer has become neutral on the stock, but believes that the stock still has good long term growth potential. The client asks her representative for a "conservative recommendation" that will give her a positive portfolio return. The client should be told to: A sell 10 XYZZ 45 Call Contracts B sell 10 XYZZ 45 Put Contracts C sell 1,000 shares of XYZZ and sell 10 XYZZ 45 Call Contracts D sell 1,000 shares of XYZZ and sell 10 XYZZ 45 Put Contracts

The best answer is A. The customer purchased the stock at $40 and it is now trading at $45. The customer is now neutral on the stock, but thinks it is a good long term investment. So the stock should not be sold (eliminating Choices C and D). If the customer sells calls against the stock position (covered call writer), the customer will generate extra premium income in the portfolio. This is a conservative income strategy

A retired customer that has a portfolio of blue chip stocks is looking to supplement his retirement income. An appropriate recommendation would be to: A sell covered calls B sell naked calls C sell covered puts D sell naked puts

The best answer is A. Covered call writing is the most popular retail income strategy in a flat market, and is appropriate for conservative investors that are looking for extra income. The customer sells calls against stock that is already owned, getting premium income. If the stock stays flat, the calls expire and the customer keeps the premium. If the stock rises, the calls are exercised and the stock is called away at no loss to the customer. If the market falls, the calls expire and the customer loses on the stock (which he would have lost on anyway!).

An investor believes that interest rates will be flat or falling into the future; and that prices may deflate. The MOST appropriate investment is: A Long term U.S. Government bonds B Real estate C Gold D Large Capitalization stocks

The best answer is A. In periods of deflation, interest rates fall. A fixed income security's price will go up as interest rates fall. Furthermore, since prices are deflating, the fixed interest payments received are able to buy more and more over time. This is the best investment choice. In times of deflation, real estate prices fall; as do gold prices. Stock prices tend to fall as well, since companies are forced to cut their prices to maintain sales volume.

What is the BEST investment recommendation for an individual in a high tax bracket who is risk averse? A Municipal bonds B Direct participation programs C U.S. Government bonds D Sovereign government bonds

The best answer is A. The income from municipal bonds is exempt from federal income tax, and historically, these have been very safe investments. Thus, municipal bonds are the best recommendation for this customer. Direct participation programs (limited partnership tax shelters) do not meet the objective of low risk - these can be very risky investments. The income from U.S. Government bonds and sovereign government bonds is federally taxable, so these are not the best of the choices offered for an individual that is in a high tax bracket.

The parents of a high school student are planning to send the child to college in one year. The registered representative should recommend a portfolio that: A tiers Treasury notes over a 5-year time frame B emphasizes municipal bonds of the state where the customer resides C emphasizes investment grade preferred stocks paying a high dividend rate D allocates funds among aggressive growth stocks and large capitalization stocks

The best answer is A. This child starts college in 1 year, and has another 4 years beyond that to finish school. Since college tuition, books, room and board, etc. must be paid yearly, the best choice is to construct a portfolio that tiers very safe securities such as Treasuries, with each tier maturing annually over the time frame that the student will attend school.

A customer has $20,000 to invest, but needs immediate access to the funds to pay a variety of bills that will arrive over the next 3 months. The BEST recommendation is for the customer to deposit the funds to a: A Money market checking account B Money market mutual fund C Money market instrument D Treasury Direct account

The best answer is A. This customer needs immediate access to the funds to pay bills as they come due - so a checking account paying money market interest rates is the best recommendation. Money market mutual fund shares must be redeemed to get access to the funds, and this takes time. Money market instruments must be sold to get access to the funds and this takes time as well. A Treasury Direct account allows an investor to buy Treasury securities directly from the U.S. Government without a broker. However, these do not have a checking account feature and are not an appropriate recommendation.

A customer has just received a $100,000 inheritance and wants to know what to do with the money until he decides how to use it. He thinks that he will make his decisions on what to do with the funds within 3 months. The BEST recommendation is for the customer to buy: A Treasury Bills B Treasury Notes C Investment Grade Preferred Stock D Long Term Certificates of Deposit

The best answer is A. This customer wants to use the funds within 3 months. A short-term T-Bill maturing in 3 months or less would be the best recommendation. The other investments have longer investment time horizons and could subject the customer to a loss if sold or redeemed early. This could be loss of principal in the case of a T-Note or preferred stock purchase, if market interest rates rise after the purchase date driving their prices down; or the loss of income in the case of early redemption of a CD.

A customer in the highest tax bracket has $500,000 to invest. The customer is not subject to the AMT. The BEST recommendation would be an investment grade: A Municipal bond yielding 2.50% that is not subject to the AMT B Municipal bond yielding 2.70% that is subject to the AMT C Treasury bond yielding 3.50% D Corporate bond yielding 4.00%

The best answer is B. Because this customer is in the highest tax bracket, a tax-free municipal bond will give the highest "after-tax" return. Because this customer is not subject to the AMT (Alternative Minimum Tax) he does not care about the fact that the higher-yielding municipal bond is subject to this tax. He should choose the higher-yielding municipal bond that is subject to the AMT. The simplified math for this works out as: Choice A yield after federal tax is paid - 2.50% (none of yield is taxed) Choice B yield after federal tax is paid - 2.70% (none of the yield is taxed) Choice C yield after federal tax is paid - 2.21% (37% federal max. tax rate) Choice D yield after federal tax is paid - 2.52% (37% federal max. tax rate)

All of the following are suitable investments for an Individual Retirement Account EXCEPT: A Corporate bonds B Municipal bonds C U.S. Government bonds D Zero coupon bonds

The best answer is B. Municipal bonds are not suitable for tax deferred accounts such as pension plans and IRAs. These accounts are already tax deferred, so putting taxable investments in them that generate a higher rate of return than municipals is appropriate. Furthermore, these higher returns will compound tax deferred as long as they are held in the pension account. Municipals give a lower rate of return than governments or corporates because of the federal tax exemption on their interest income. They are a bad choice for retirement accounts. Finally, zero-coupon governments and corporates give a higher rate of return than municipals, since the annual accretion of the discount on these is taxable; and they are great investments to put in a retirement account; since then the annual accretion of the discount will build tax-deferred.

An 80-year old client lives on his social security payments that total $25,000 per year. 3 years ago, on the advice of the broker, he invested in a technology fund where he lost most of his assets. The remaining balance in his brokerage account is $17,000. The client has annual living expenses of $30,000 and a net worth of $128,000. The customer approaches a new broker to take over management of his account. The representative that receives the account should: A do nothing B sell the holding in the account and invest the proceeds in a more conservative fund within the same family of funds C sell the holding in the account and invest the proceeds in a more conservative fund outside the family of funds D sell the holding in the account and invest the proceeds in a more conservative fund that has a deferred sales charge

The best answer is B. This customer should be invested in a safe income fund that will provide the "extra" $5,000 in annual income needed to meet this customer's income shortfall (the customer is living on $25,000 of social security but has $30,000 of annual living expenses). The question does not give an option of selling the tech fund and investing the proceeds in an income fund! Of the choices offered, Choice B is best because there will be no (or a lower) sales charge for moving assets within a family of funds, as opposed to investing the proceeds in a new fund family. Choice D is not correct because this customer is elderly and has a high probability of dying before the contingent deferred sales charge would be depleted to "0" (this usually occurs over a 7-year time frame, and this customer is now 80 years old). If the customer died, say 2 years later, and the estate liquidated the holding, then the CDSC (Contingent Deferred Sales Charge) would have to be paid.

A constant dollar investment plan requires: A that the same dollar amount be invested periodically in new equities purchases B that the same aggregate dollar amount be kept invested in equities C the constant reinvestment of all dividends and interest received in the same securities D that a constant dollar amount be invested in U.S. securities

The best answer is B. Under a constant dollar plan, a portfolio manager sets a dollar level (say $200,000) to be maintained in equity securities. If the value rises to $230,000, the $30,000 excess is invested in debt securities. Conversely, if the equity market value drops below $200,000, bonds are liquidated and invested in equities to bring the equity balance to the constant $200,000.

The investment strategy that involves paying a lower price for a security based on the expectation that the market is mispricing the issue is: A growth investing B value investing C passive investing D active investing

The best answer is B. Value investing is the selection of equity investments based on finding securities that are fundamentally undervalued in the marketplace. These tend to be solid companies that are currently "out of favor." Value investors look at such fundamental factors as the Price/Earnings ratio; and Price/Book Value ratio to find companies that are undervalued relative to their market sector.

A 25-year old man receives $50,000 and wants to retire at age 65 with an income of $1,500 per month from his investment portfolio. The adviser should invest: A 100% in bonds and 0% in stocks B 65% in bonds and 35% in stocks C 25% in bonds and 75% in stocks D 0% in bonds and 100% in stocks

The best answer is C. As a "rule of thumb," when balancing investments between stocks and bonds, the portion of the portfolio that should be invested in equities is "100% minus that person's age." Since this individual is age 25, 75% should be invested in equities for growth; with the other 25% invested in safe bonds.

What portfolio construction is most appropriate for a retired married couple, ages 60 and 70, for the wife and husband respectively? A 100% common stocks B 70% common stock/30% bonds C 35% common stock/65% bonds D 100% bonds

The best answer is C. As one gets older, portfolio composition should shift to "safer" assets that generate reliable income. The general rule is to take "100 minus the investor's age" to get the appropriate investment portion to be held in stocks. Since these investors are a married couple, ages 60 and 70, this gives either 30% or 40% of the portfolio holding in stocks; with the remaining 60 - 70% of the holding in bonds. Note that a 100% bond holding is not appropriate because people are living much longer and they need the "extra return" that is provided by stocks that can grow in value, on top of the somewhat lower fixed return provided by bonds.

Which of the following investments is LEAST liquid? A Mutual funds B Long term corporate bonds C Private placements D Closed-end funds

The best answer is C. Closed-end funds trade like any other stock, so they are highly liquid. Corporate bonds are traded OTC and have slightly higher liquidity risk than listed securities, but the trading market for these is active. Mutual funds do not trade, but they are redeemable every business day. In contrast, private placement securities cannot be traded in the public markets, either on an exchange or OTC. The only way to "cash out" is to sell the private placement to someone else in a private securities transaction, which is difficult to do. These are the least liquid securities.

Institutional portfolio managers have been allocating an increasing percentage of their funds to cash and cash equivalent positions. This is an indication that their market sentiment is: A bullish B neutral C bearish D cautious

The best answer is C. From a "market sentiment" standpoint, a portfolio manager will increase his or her cash position; and decrease the portion of funds invested in securities, when he or she is bearish on the market. Conversely, if the manager is bullish, he or she will decrease the cash position and increase the invested portion of the portfolio.

Strategic portfolio management is the selection of the: A securities in which to invest B asset classes in which to invest C target asset allocation for each asset class selected for investment D variation permitted in target asset allocation for each asset class selected for investment

The best answer is C. Strategic asset allocation is the determination of the target percentage to be allocated to each asset class (e.g., 25% Treasuries; 25% Corp. Debt; 50% Equities). Tactical asset allocation is the permitted variation around each of the chosen percentages - for example, even though Equities are targeted at 50%, this might be allowed to be dropped to as low as 40%, or as high as 60%, depending on market conditions.

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

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

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

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

A young couple wishes to save $50,000 as the down payment on a new house that they plan to purchase in the next 6 months. Which of the following are suitable investment vehicles to recommend to the couple? I Money market funds II Bank certificates of deposit III Blue chip stocks IV Commercial paper A I only B II and III C I, II and IV D I, II, III, IV

The best answer is C. This couple needs $50,000 cash in 6 months. Clearly, money market funds and bank certificates of deposit are suitable. Blue chip stocks are not suitable, since they are subject to market risk. Commercial paper is usually not marketed to individuals; it is mainly an institutional market. However, some corporations sell commercial paper directly to customers in minimum $10,000 units via their websites. This is another very safe short term investment, and is suitable.

A young widow who works has a $750,000 net worth and a securities portfolio valued at $200,000. The current asset allocation of the portfolio is 80% equity securities; 8% fixed income securities; and 12% money market securities. In which circumstance should she consider reallocating her portfolio? A If she remarries and her new husband is quite wealthy B If she remains employed at the same job C If she becomes unemployed during a recessionary period D If she remarries and her new husband has young children

The best answer is C. This question is very subjective and arguments could be made for each of the choices offered. However, the best answer is Choice C. If she loses her job in a recession and has no spouse, it might be hard to find another job. She will need to use money in the securities portfolio to live and an 80% allocation in equity securities will expose her to stock losses due to the recession and also not give current income. She should reallocate the portfolio, liquidating a good chunk of the equities position and increasing the money market fund allocation so that she can draw on it for income.

A value investor would consider all of the following EXCEPT a company's: A Price / Earnings ratio B Price / Book Value ratio C Stock price growth rate D Market share

The best answer is C. Value investors invest in undervalued companies - as measured by low Price/Earnings ratios and low Price/Book Value ratios - that have good market prospects. Thus, they also consider product line, market share, management, etc. Growth investors select investments based simply on growth in earnings or growth in market price; on the assumption that these will always be the best performing investments.

A customer holds a large portfolio of corporate bonds. The customer is worried about capital risk. Which diversification strategy would be least effective to minimize capital risk for this customer? A Diversification among differing issuers in differing states B Diversification among differing industries C Diversification among differing maturities D Diversification among differing coupon rates

The best answer is D. To diversify a corporate bond portfolio, bonds should be selected: with differing maturities; with differing ratings; in different industries; of issuers in different regions of the country. Diversification among different coupon rates would be the least effective means of minimizing risk. As a generalization, the lower the coupon rate, the more volatile the bond's price movements in response to interest rate movements. However, if market interest rates rise, all of the bonds in the portfolio will drop in value (with the lower coupon rate bonds dropping faster). Thus, this type of diversification really does not protect much against market risk.

A married couple has a teenage child who has expressed interest in going to a vocational school. They both work, have a moderate level of income and would like to save a modest amount each year for this purpose without the concern of paying taxes on annual account earnings. The best recommendation to this couple is to make an annual contribution to a(n): A 529 Plan B UTMA Account C HSA D Coverdell ESA

The best answer is D. Funds in a Coverdell ESA (Education Savings Account) can be used for any type and level of education, so the funds can be used to pay for vocational school. The maximum annual contribution is $2,000, so this matches the couple's desire to save a "modest" amount each year. There is no deduction for the contribution, but the account grows tax-deferred, and distributions to pay for qualified educational expenses are not taxed. Also note that Coverdell ESAs are not available to high earners, which is not a problem here. ****A 529 Plan allows for much bigger contribution amounts and could only be used for college - until the 2018 tax law changes! Now that up to $10,000 per year can be taken from a 529 Plan to pay for lower level education expenses, the 529 Plan would be a correct answer as well. So if you see a similar question on the exam, it probably has not been updated, and to get the point, choose Coverdell ESA - and also complain at the test center so they clean up the question!***** UTMA Custodial accounts do not have the tax benefit of tax-deferred build-up. Earnings in the account are taxable each year. HSAs are Health Savings Accounts and are used to pay for medical expenses, not school expenses.

An IRA is allocated in large cap stocks, TIPS, foreign stocks and municipal bonds. When reviewing this portfolio, you should be MOST concerned about the: A Large cap stock holding B TIPS holding C Foreign stock holding D Municipal bond holding

The best answer is D. Municipal bonds are not suitable for tax deferred accounts such as pension plans and IRAs. These accounts are already tax deferred, so putting taxable investments in them that generate a higher rate of return than municipals is appropriate. Furthermore, these higher returns will compound tax deferred as long as they are held in the pension account. Municipals give a lower rate of return than governments or corporates because of the federal tax exemption on their interest income. They are a bad choice for retirement accounts. TIPS (Treasury Inflation Protection Securities) are great for retirement accounts. Their return is adjusted each year by that year's inflation rate, and this builds tax deferred in a retirement account. Finally, good quality equities have historically given a higher total return than bond investments, so they are good for long term investment in a retirement plan.

An elderly customer seeking extra income who has $100,000 to invest could be recommended which of the following? I The $100,000 purchase of a variable annuity II The $100,000 purchase of dividend paying blue chip stocks in a cash account against which calls are sold III The $200,000 purchase of dividend paying blue chip stocks at 50% margin in a margin account IV The $100,000 purchase of Treasury bonds A I and III B I and IV C II and III D II and IV

The best answer is D. The purchase of a variable annuity is not suitable for an elderly customer. The whole concept behind a variable annuity is that the product has time to build value on a tax deferred basis in the separate account prior to annuitization. An elderly customer needs the income now. Covered call writing is the most popular retail income strategy in a flat market, and is appropriate for conservative investors that are looking for extra income. The customer sells calls against stock that is already owned, getting premium income. This would be suitable. The margining of blue chip stock positions to "double up" on the amount of stock owned (since Regulation T margin is 50%) is not suitable because this does not come for free! The customer is borrowing the extra money to buy the new shareholding, using his existing stock as collateral, and he must pay interest on the loan. The interest charge will eat up any dividends that the stocks pay - so there goes his income. The purchase of Treasury bonds is suitable, since they provide current income and they are safe as it gets.

A wealthy, sophisticated investor with a high risk tolerance has just turned extremely bearish on the market. To profit from this, the BEST recommendation to the client would be to: A buy index calls B buy index puts C buy inverse floaters D buy leveraged inverse ETFs

The best answer is D. This customer has just turned "extremely bearish" on the market, meaning he thinks that equities are going to fall rapidly in price. The customer is wealthy, sophisticated, and has a high risk tolerance. The most aggressive choice offered is the leveraged inverse ETF. Assume it is a 300% leveraged inverse ETF based on the S&P 500 Index. If the index falls by 15%, this ETF should rise by 3 x 15% = 45%. (Of course, if the customer is wrong and the index rises, then the customer loses big time!)

A 60-year old man who is living on social security payments inherits $250,000. He seeks an investment that gives growth and income. The BEST recommendation would be to: A buy a municipal bond fund B write covered calls C buy Treasuries and zero-coupon bonds D buy stocks and bonds

The best answer is D. This customer seeks growth and income. A municipal bond fund gives income, but because this customer is in a low tax bracket, municipals are not suitable. This customer, living on social security, may not be sophisticated enough to sell calls against long stock positions (covered call writing). Furthermore, the sale of covered calls gives income, but it does not give growth. If the stock price appreciates, those shares will be called away. Treasury securities give safety and income; however zero-coupon bonds, while they appreciate based on the discount yield at which they are purchased, do not give "growth." Only equities give growth and bonds give income, so Choice D is the best one offered. This customer should be recommended a portfolio that consists of 60% bonds for income (the customer's age) and 40% stocks.

Active portfolio management is: A buying and holding the investments chosen by the Registered Representative B determining the securities to be bought or sold based on investment research performed by the Registered Representative C managing a portfolio to meet the performance of a benchmark portfolio D managing a portfolio to exceed the performance of a benchmark portfolio

The best answer is D. Active portfolio management practitioners believe that they can outperform a benchmark portfolio (say an index fund) by finding undervalued securities in the marketplace. Passive portfolio managers, in contrast, believe that the market is "efficient" in pricing securities so that one cannot find "undervalued" securities. Passive portfolio managers simply buy index funds (which are managed to match the composition and performance of the chosen index).

Growth investors: A seek to find investments that are undervalued by the market B determine the value of a security through fundamental analysis C invest in securities included in growth funds D make their investment decision based upon the market performance of the security

The best answer is D. Growth investors select investments based simply on growth in earnings or growth in market price; on the assumption that these will always be the best performing investments.

The time horizon to be used when constructing a portfolio to pay for college expenses for a person who is expected to start college in 10 years and finish college in 15 years is: A 5 years B 10 years C 12.5 years D 15 years

The best answer is D. If a portfolio is being constructed to fund a person's college education, it must be able to provide income to pay for college until schooling is finished.

Passive asset management is: A buying securities positions and holding them to the liquidation date of the portfolio B buying securities positions and holding them until pre-established prices are reached C selecting securities to be purchased for each asset class based upon fundamental analysis D using index funds as the investments for each asset class

The best answer is D. Passive asset management does not mean that there is no management. Passive asset management is the use of index funds (which are managed to mirror a chosen index benchmark) as the security selections within an asset class. Thus, the actual specific security selection and management is embedded within the index fund chosen for investment.

Which of the following is the LEAST important factor to consider when constructing an investment portfolio for a high net worth individual? A The portion of the funding that should be allocated to tax-free investments B The portion of the funding that should be maintained in readily accessible funds such as money market instruments C The customer's preference for investing via passively managed index mutual funds or via actively managed mutual funds D The investment philosophy and strategies employed by the fund manager of the chosen mutual fund

The best answer is D. Since this individual is wealthy and is likely to be in a high tax bracket, consideration should be given to allocating a portion of the portfolio to tax-free municipal investments. An emergency fund should always be maintained, so consideration should be given to the amount of funding allocated to money market fund investments. Whether the customer is a believer in passive asset management or active asset management should also be considered. Passive asset managers believe in the use of index funds that have low expenses - the idea being that, over time, no one can do better than the market. Active asset managers believe that the right stock "picking" will allow a manager to outperform the market - but this comes at higher expense. The actual trading strategies employed by an active manager to achieve his results are not relevant to the portfolio construction.