WMCP Practice Exam - Missed Question

A risky asset and a safe asset each have an expected payout of $1,000. The safe asset has a price of $950. The price of the risky asset will be: a) less than $950. b) more than $950. c) $950 if markets are strong-form efficient. d) higher or lower than $950 depending on the risk aversion of the investor.

a) less than $950. -Because investors are risk averse, they will pay less for a risky asset with the same payout as a safe asset.

Prospect theory is associated with the risk-related financial concept of a) loss aversion. b) risk-neutrality. c) risk aversion. d) risk tolerance.

a) loss aversion. -Risk aversion is a concept from traditional economic theory. Prospect theory suggests that individuals tend to overweight losses.

Price stability means a) low rates of inflation. b) prices of key commodities stay the same. c) stable interest rates. d) no changes in prices.

a) low rates of inflation. -Individual prices are immaterial when considering the overall level of prices.

The process of packaging loans together and selling the loans through a market transaction is known as a) securitization. b) investment banking. c) collateralization. d) community banking.

a) securitization. -Investment banking involves linking lenders and corporate borrowers, but securitization is the process of packing loans together.

Understanding the client's needs and showing a commitment to making recommendations that fulfill these needs is associated with developing a) credibility. b) trust. c) mutuality. d) empathy.

b) trust. -Empathy means that an advisor is able to put themselves in the position of the client in order to understand the client's feelings and motivations. Trust is developed when a wealth manager is committed to making recommendations and fulfills the needs of a client.

Jack is a WMCP™ whose practice is 100% devoted to recommending investments or portfolios of investments. He operates on a fee-only basis within an investment advisory firm. What is his seat at the planning table? a) Trusted advisor b) Salesperson c) Mentor d) Expert

d) Expert -Jack is not playing a salesperson role. He is not trying to persuade a client to buy a particular product; rather, he is an expert providing a professional service drawing on his specialized expertise.

Which of the following is NOT consistent with the concept of certainty equivalence? a) The risk premium must be higher when the marginal investor is not risk tolerant. b) Investors are risk-averse. c) The present value of a safe asset is higher than a risky asset. d) Investors will always prefer assets with a higher expected return.

d) Investors will always prefer assets with a higher expected return. -If the marginal investor is risk tolerant then the risk premium will be higher.

If the index of leading indicators is flat, the index of coincident indicators is falling, and the index of lagging indicators is also flat, then the business cycle is most likely in which phase? a) Stable b) Trough c) Expansion d) Recession

d) Recession -If leading indicators are flat, then the economy is either at a trough or at the peak. But as the coincident indicators are falling and the lagging are flat, this can only represent a recession

Which of the following best describes a registered representative of a broker-dealer? a) Registered representatives are often referred to as wearing three hats. b) Registered representatives must act as fiduciaries. c) Registered representatives of broker-dealers may not also be investment advisors. d) Registered representatives are subject to licensing and the rules set by FINRA.

d) Registered representatives are subject to licensing and the rules set by FINRA. -Registered representatives of brokers and dealers who are also investment adviser representatives ar subject to both FINRA and SEC standards of care. These advisors are referred to as dually registered, and sometimes described as wearing two hats—one in which they are subject to a fiduciary standard of care when providing ongoing advice and a second hat in which they are subject to a suitability standard of care when brokering the sale of a financial product.

An investor loses 15% in her portfolio during the prior month. According to prospect theory, what would she be more inclined to do? a) Maintain a constant allocation of risky and safe assets b) Shift assets to commodities c) Stop taking risk and shift her portfolio to safe investments d) Take greater risk in order to get back to a positive return

d) Take greater risk in order to get back to a positive return -Prospect theory suggests that when investors experience a loss, they will seek greater risk in order to return to a positive return from a reference point. They will be risk averse in gains, but risk seeking in losses.

What is the key trade-off if an investor uses cash-type vehicles to fund a child's education expenses in 15 years, as opposed to other investments? a) The investor will likely achieve his or her savings goal sooner than if he or she had invested in equities. b) The investor will be more likely to keep up with prices increases in tuition. c) The investor will have less certainty about the savings balance available to pay the education expenses. d) The investor will end up with a lower average balance than a riskier investment might achieve.

d) The investor will end up with a lower average balance than a riskier investment might achieve. -Safe investments such as cash will reduce uncertainty about the final savings balance but will probably result in a lower average balance.

Compared with a mortality table for the overall population, how would the use of a mortality table based on average longevity for a higher-income individual affect life-cycle planning? a) The optimal amount of lifetime spending would increase. b) The optimal amount of retirement spending would increase. c) The optimal amount of retirement saving before retirement would decrease d) The optimal amount of saving before retirement would increase.

d) The optimal amount of saving before retirement would increase. -The optimal amount of retirement spending would decrease. Because a longer lifetime means higher saving and lower spending before retirement, the individual would seek to maintain this lower level of spending after retirement.

What is meant by 'life insurance is a risk pooling financial product'? a) Life insurance pools investment risk over time. b) Life insurance pools the risk of living longer than expected by collecting premiums during a lifetime. c) Life insurance pools interest rate risk in old age. d) Those who die earlier than expected are supported by the pool of those who live longer than expected.

d) Those who die earlier than expected are supported by the pool of those who live longer than expected. -Life insurance pools the risk of premature death, not of living longer than expected.

You suggested that a 45-year-old female client purchase term insurance to protect against the loss of human capital from premature death. She has a .1072% chance of dying in her 45th year. If the desired death benefit amount is $2.5 million and the expected load is 6%, what is the annual cost of term life insurance? a) $2,851 b) $2,840 c) $2,506 d) $2,680

a) $2,851 -0.1072% can be expressed as 0.001072, and then multiplied by 2,500,000 to calculate an actuarially fair insurance cost of $2,680. Divide by 1 minus the load (.06) to estimate a retail insurance cost of $2,851.

The downside and upside potential returns of a risky asset are -3% and 8%. The average return of a safe asset is 2%. The client has $20,000 to invest today. He invests 70% in the safe asset and the rest in the risky asset. What are the minimum and maximum portfolio values in 5 years? a) $20,609 and $ 24,273 b) $20,500 and $ 23,800 c) $18,646 and $ 27,195 d) $20,000 and $25,000

a) $20,609 and $ 24,273 -The 70% invested in the safe asset is $14,000, which grows to $14,000 x (1 + .02)^5 or $15,457 in five years. As $6,000 is then invested in the risky asset, its lowest value = $6,000 x (1 - .03)^5 = $5,152 and the highest value = $6,000 x (1 + .08)^5 = $8,816. Keystrokes for the safe asset value: SHIFT, C ALL, 14000, +/-, PV, 3, +/-, I/YR, 5, N, FV. So the minimum value will be the sum of the $15,457 certain value plus the $5,152 low value for the risky asset, or $20,609. And the maximum value will be the sum of the $15,457 certain value plus the $8,816 high value for the risky asset, or $24,273.

How much would a client pay for a risky investment with a 50% probability of it being worth $3,000 and 50% probability of it being worth $8,000 in one year assuming a natural log utility function? a) $4,898.98 b) $5,500.00 c) $5,588.23 d) $4,682.00

a) $4,898.98 -You are calculating the expected value of the investment. What the client is willing to pay is the amount such that the utility of the perfectly certain payout is equal to the expected utility of the risky payouts. This means the value of the risky investment is based on its expected utility, not its expected value. [0.5 x ln(3,000)] + [0.5 x ln(8,000)] = 8.4967822. Because both outcomes have a 50% probability, multiplying each outcome by 0.5 gives us the weighted average. Then calculate e8.4967822, which gives you $4,898.98.

Your client used to be a smoker but quit 10 years ago. She now goes to the gym regularly and eats well, and her health is average for her age group. She wants to retire at age 65, and her estimated monthly Social Security benefit is $1,600. Given that her life expectancy is about 21 years, what would be the total value of her projected Social Security benefit assuming a discount rate of zero? a) $403,200 b) $399,600 c) $33,600 d) $430,900

a) $403,200 -$1,600 x 21 fails to take into account that the time unit of measure is months. The correct calculation is $1,600 x 12 x 21.

The annual downside and upside potential returns of a risky asset are -5% and 10%. The average return of a safe asset is 3%. The client has $50,000 to invest today. She invests 50% in the safe asset and the rest in the risky asset. What is the range of downside and upside returns over a 10-year investment horizon the investor should consider? a) $48,566 and $98,441 b) $25,000 and $115,000 c) $33,598 and $64,844 d) $14,968 and $64,844

a) $48,566 and $98,441 -The 50% invested in the safe asset is $25,000, which grows to $25,000 x (1 + .03)^10 or $33,598 in ten years. As $25,000 is then invested in the risky asset, its lowest value = $25,000 x (1 - .05)^10 = $14,968 and the highest value = $25,000 x (1 + .10)^10 = $64,346. Keystrokes for the safe asset value: SHIFT, C ALL, 25000, +/-, PV, 3, +/-, I/YR, 10, N, FV. So the minimum value will be the sum of the $33,598 certain value plus the $14,968 low value for the risky asset, or $48,566. And the maximum value will be the sum of the $33,598 certain value plus the $64,843 high value for the risky asset, or $98,441.

Ernest has an investment portfolio worth $500,000 that earns a fixed 4 percent each year. He hopes this portfolio will last him at least 10 more years. How much can he pull from the portfolio at the beginning of each year? a) $59,274 b) $50,000 c) $61,645 d) $143,396

a) $59,274 -Make sure that your calculator is in BEGIN mode and then use the following factors to solve for FV: PV =<500,000> FV = 0 i = 4 N = 10 This will result in a PMT of $59,274.

Deshawn is saving money so that he can buy a new elliptical machine. He currently has $1,200 in his account that earns 3 percent, compounded monthly. The new elliptical machine costs $4,500. Assuming that Deshawn deposits $100 in his account each month, how many months will it take for his account to have enough money to purchase the new elliptical machine? a) 31 months b) 24 months c) 29 months d) 33 months

a) 31 months Use the following figures to solve for N: P/YR = 12 PV = <1,200> FV = 4,500 PMT = <100> i = 3 This will result in a period of 31 months.

After meeting with your new client, Sid, you prepared his current financial statements. In which part of the financial planning process were you engaged when you prepared the statements? a) Analyzing the client's current course of action and potential alternative courses of action. b) Developing the financial planning recommendations. c) Implementing the financial planning recommendations. d) Monitoring progress and updating.

a) Analyzing the client's current course of action and potential alternative courses of action. -Preparing financial statements is part of step 3 of the financial planning process, Analyzing the Client's Current Course of Action and Potential Alternative Course(s) of Action.

Which of the following is an example of an advisor using psychological distance to improve client decisions? a) Asking a client to imagine the details of a day in their life in retirement. b) Creating a plan that reduces a client's attention on near-term investment risks. c) Asking a client to focus more on goals that occur in the near future rather than goals that occur in the more distant future. d) Explaining to a client that volatility is often high in the present but is reduced in more distant time periods.

a) Asking a client to imagine the details of a day in their life in retirement. -. Since goals in the more distant future are seen as less clear, and advisor can help motivate a client to save for these goals through the concept of psychological distance by helping them imagine the goal in greater detail

Which of the following trends appears to be influencing the design of financial products in recent decades? a) Commoditization to accommodate distribution through multiple advisor channels. b) Increased siloing of distribution channels such as insurance and brokers. c) The reduced importance of technology. d) A movement away from the application of fiduciary principles to advisors.

a) Commoditization to accommodate distribution through multiple advisor channels. -As financial products like mutual funds are increasingly distributed through multiple channels of financial professionals, they are increasingly becoming commoditized.

Where on a financial statement would you place the outstanding balance of a mortgage? a) In the long-term liabilities of a balance sheet b) In the fixed expenses of an income and expense statement c) In the variable expenses of an income and expense statement d) In the tangible assets of a balance sheet

a) In the long-term liabilities of a balance sheet -Since the outstanding balance of a mortgage is not a flow of funds, it should be placed in the balance sheet rather than the income and expense statement. The mortgage is a liability that is paid today and in the more distant future, so it is considered a long-term liability.

If the index of leading indicators is flat, the index of coincident indicators is falling, and the index of lagging indicators is also flat, then the business cycle is most likely in which phase? a) Recession b) Stable c) Trough d) Expansion

a) Recession -If leading indicators are flat, then the economy is either at a trough or at the peak. But as the coincident indicators are falling and the lagging are flat, this can only represent a recession

Which of the following is associated with the use of a longer elimination period on a disability insurance policy? a) Reduced adverse selection. b) A significant reduction in protection against a loss in human capital. c) An increase in the insurance premium. d) Increased adverse selection.

a) Reduced adverse selection. -The primary purpose of a longer elimination period is to retain more risk of a small loss in human capital and reduce adverse selection costs, resulting in a lower premium while preserving a significant amount of protection against a large loss in human capital.

A client wishes to leave a $250,000 inheritance to her children. You ask whether the client wishes to leave the inheritance in nominal dollars or in real dollars. Assuming that investors can expect a positive inflation, what is the implication of leaving a $250,000 real inheritance instead of a $250,000 nominal inheritance? a) The client will need to purchase a policy with a death benefit greater than $250,000. b) The beneficiaries will have less certainty about the spending power of their inheritance. c) The client will spend more in retirement in order to meet the real inheritance goal. d) The client will need to save less in their lifetime to meet a real inheritance goal.

a) The client will need to purchase a policy with a death benefit greater than $250,000. -The with a real spending goal, the beneficiaries can expect to receive the same purchasing power as $250,000 today.

An advisor recommends paying off the remaining $50,000 of a home mortgage using extra cash from a checking account. This will have what impact on the client's financial ratios? a) The liquidity ratio will decrease. b) The debt-to-asset ratio will increase. c) The savings ratio will decrease. d) The debt-to-income ratio will increase

a) The liquidity ratio will decrease. -Since the client's liquid assets are reduced by $50,000, their liquidity ratio, or the total liquid (cash) assets divided by monthly expenses, will decrease.

What interest rate should be used when calculating the present value in a financial plan? a) The risk-free rate. b) The historical rate of return for the asset class for which you are investing. c) The rate of inflation. d) The variable interest rate.

a) The risk-free rate. -The risk-free rate is the rate that should be used when calculating present values in a financial plan.

If the index of leading indicators is rising, the index of coincident indicators is flat, and the index of lagging indicators is falling, then the business cycle is most likely in which phase? a) Trough b) Recession c) Peak d) Expansion

a) Trough -That the coincident indicators are flat rules out an expansion. If leading indicators are rising, then the economy is either in an expansion or at the trough. But as the coincident indicators are flat and the lagging are falling, this can only represent a trough.

A good question for opening a conversation of purpose with a client would be: a) What principles have guided your planning to date? b) What are your financial goals for the next 12 months? c) If I could show you a plan to reduce your taxes and achieve your retirement goal more efficiently, would you be interested? d) Do you consider yourself a long-term investor?

a) What principles have guided your planning to date? -To understand the client's risk-return profile, and investment horizon, are important, but these are the routine questions asked by any expert. They do not set you apart as a planner for higher purpose.

When calculating the Social Security benefits for a married couple, a key feature to note is that a) both spouses receive their benefits, and the smaller benefit expires when the first spouse dies. b) one can add 50% of a spouse's Social Security benefit to the calculation of the client's benefit value. c) a widow is only eligible to receive benefit if married for over 5 years. d) a widow or widower will receive two benefits after the death of a spouse.

a) both spouses receive their benefits, and the smaller benefit expires when the first spouse dies. -If the lower earning spouse dies first, nothing is added to the survivor's benefit. Only if a client did not work, or had a lower benefit, can that person claim half of the other spouse's work benefit when that spouse dies.

A typical utility curve is a) concave based on a decreasing marginal utility of consumption. b) convex based on a decreasing marginal utility of consumption. c) convex based on an increasing marginal utility of consumption. d) concave based on an increasing marginal utility of consumption.

a) concave based on a decreasing marginal utility of consumption. -A concave curve expresses the exact opposite concept. It is based on a decreasing marginal utility of consumption.

Contingent claims trade a small loss in expected wealth for expected a) gains in utility. b) gains in financial assets. c) gains in lifetime income. d) gains in human capital

a) gains in utility. -Human beings are not risk neutral, and buy claims to protect downside risk. Contingent claims are not positive return assets.

You are asked to consider lending to a company that is willing to pay 10% on new loans. In doing due diligence, you ask why the company instead did not seek capital from a financial institution that specializes in obtaining financing for companies. This type of lender is known as a(n) a) investment bank. b) shadow bank. c) credit union. d) commercial bank.

a) investment bank. -A shadow banking system refers to financial intermediaries that are not subject to normal regulatory oversight. Examples include hedge funds, money market funds, mortgage companies, and even payday loan companies.

Olivia purchased a new house for $450,000. She put 20 percent down and will finance the rest over 30 years at 3.5 percent. What is her monthly payment? a) $2,021 b) $1,617 c) $1,612 d) $2,015

b) $1,617 Use the following figures to solve for PMT: P/YR = 12 PV = 360,000 (that is, 450,000 x 80%) FV = 0i = 3.5N = 360 (that is, 30 x 12) This will result in a payment of $1,617.

A client born after 1960 plans to retire at age 64. Her estimated Social Security income at full retirement age is $26,000. How much more income will she receive by waiting until age 70 to claim rather than claiming at age 64? a) $5,200 b) $11,440.00 c) $32,240 d) $6,240

b) $11,440.00 -The client's full retirement age is 67. If she would receive $26,000 by claiming at age 67, she would receive 80% of this amount by claiming at age 64 (or 0.8\*$26,000 = $20,800) and 124% of this amount by claiming at age 70 (1.24\*$26,000 = $32,240). The difference is $32,240 - $20,800 = $11,440.

A client has $1 million saved and expects to earn $125,000 each year for the next 20 years, at which point the client retires. If the client plans to be retired for 30 years and will have Social Security and pension income of $50,000 per year, how much should the client save each year during his or her working years in order to smooth consumption assuming there is no bequest motive or interest rate? a) $30,000 b) $25,000 c) $27,500 d) $20,000

b) $25,000 -First, figure out the smoothed annual spending. To do this, add together the $1 million that is saved, plus the product of 20 years times $125,000 per year of income, plus the product of 30 years times the pension of $50,000 per year. The sum is $5 million. Then divide by the projected life of 50 years, which is the sum of the 20 years of working and 30 years of retirement. This says annual spending should be $100,000. Subtract the $100,000 from the $125,000 of annual income during their working years and the answer is an annual savings of $25,000.

Sadie deposits $1,500 into an account at the beginning of each year. If she earns 5 percent, compounded annually, how much will the account be worth in 17 years? a) $38,760.55 b) $40,698.58 c) $41,386.96 d) $48,279.62

b) $40,698.58 -Make sure that the calculator is in Begin Mode and then use the following figures to solve for FV: PV = 0 PMT = <1,500> i = 5 N = 17 This will result in a future value of $40,698.577, or about $40,698.58.

How much would a client pay for a risky investment with a 50% probability of being worth $500 and 50% of being worth $1,000 assuming a natural log utility function? a) $750.00 b) $756.27 c) $707.11 d) $794.32

b) $756.27 -What the client is willing to pay is the amount such that the utility of the perfectly certain payout is equal to the expected utility of the risky payouts. This means the value of the risky investment is based on its expected utility, not its expected value. [0.5 ln(500)] + [0.5 ln(1,000)] = 6.561182 Because both outcomes have a 50% probability, multiplying each outcome by 0.5 gives us the weighted average. Then calculate e^6.561182, which gives you $707.11.

Starting today, Jamie deposits $100 in a savings account at the beginning of each month. If the account earns 6 percent annually, what will the account value be after 6 years? a) $739.38 b) $8,684.09 c) 8,640.89 d) $697.53

b) $8,684.09 -Make sure that your calculator is in Begin Mode and then use the following figures to solve for FV: P/YR = 12 PV = 0 PMT = <100> i = 6 N = 72 (that is, 12 x 6) This will result in a future value of $8,684.09.

Over the last 25 years, the annual inflation rate has been approximately ____% with a ____% standard deviation. a) 1.5%/3% b) 2.25%/1% c) 4%/1% d) 3.50%/2%

b) 2.25%/1% -The correct answer is 2.25%/1%. This is lower than the long-term average since 1926 of 3.25% and standard deviation of 4.90%.

A corporate bond investment earns 8% during the year and earnings are taxed at a 25% rate. If the inflation rate is 2%, what is the real, after-tax return on the bond? a) 4.4% b) 3.9% c) 4% d) 5.9%

b) 3.9% -An investment that earns a 8% nominal return taxed at 25% will have a 6% after-tax return (.08\*(1-.25)) = .06, or 6%. The real after-tax return (adjusted for inflation) will be 1.06/1.02 = 3.9%

A $10,000 investment grows to $11,500 over a year. The growth is taxed at a capital gains rate of 20%. Inflation is 4.8% during the year. What is the real, after-tax return on the investment? a) 8.2% b) 6.9% c) 7.2% d) 10.2%

b) 6.9% -The nominal return on the investment is (($11,500 - $10,000))/$10,000) = 15%. The $1,500 of growth is taxed at a rate of 20%, so the after-tax value is .15*(1-0.2) = .15* .8 = 12%. The real after-tax return (adjusted for inflation) will be 1.12/1.048 = 6.9%.

Yang needs to save for a $35,000 down payment in 3 years. She currently has $15,000 and will contribute $5,000 at the end of each year toward this goal. What interest rate must she earn on her investment account in order to meet her goal? a) 8.24% b) 7.81% c) 6.31% d) 7.11%

b) 7.81% Use the following factors to solve for FV: PV =<15,000> PMT =<5,000> N = 3 FV = 35,000 This will result in an I/YR of 7.81%.

Which is the most defensible reason not to delay claiming Social Security? a) The government will run out of money to fund Social Security. b) A client is single and in poor health. c) A client retires before their full retirement age and has ample IRA savings. d) A married client has a younger, lower-earning spouse.

b) A client is single and in poor health.

Which of the following is an advantage of a commission-based model compared to an advisor compensation model that charges fees? a) Commission-based advice is more appropriate for ongoing advising services. b) A client who believes that they currently do not pay for financial advice may be resistant to paying fees. c) Commission-based compensation is appropriate for those who need periodic comprehensive financial advice. d) Commission-based advice demands a deeper knowledge of a range of planning services.

b) A client who believes that they currently do not pay for financial advice may be resistant to paying fees. -Ongoing services should be compensated for through regular compensation, such as an asset-based payment model.

The form CRS in the 2019 best interest regulation (Reg BI) provides which of the following? a) A review of the fiduciary responsibilities a broker-dealer holds toward their client b) A shortened summary disclosure document that both RIAs and brokers have to provide to clients c) An overview of performance characteristics of investment recommended by an advisor d) A summary of investment costs that only brokers are required to provide for clients

b) A shortened summary disclosure document that both RIAs and brokers have to provide to clients -The form CRS is a summary disclosure document that both RIAs and brokers provide to clients.

Which of the following will result in higher optimal annual spending? a) The desire to leave a larger bequest. b) An expected increase in future income. c) The use of a longer planning horizon. d) The use of a joint instead of individual mortality table to estimate the planning horizon.

b) An expected increase in future income. -A joint mortality table is based on expected longevity for both partners, which will be longer than that derived from an individual mortality table. An expected increase in future income would be associated with higher optimal annual spending.

Ethical fading refers to: a) The erosion of ethical values in society amid the growth of social media and robo-advising b) The means through which workplace pressures or momentum can weaken ethical awareness and decision-making c) Forgetting ethical lessons when you're in a new workplace, new country or new situation d) Ignoring ethical principles in order to chase tangible rewards such as bonuses

b) The means through which workplace pressures or momentum can weaken ethical awareness and decision-making

News of an unexpected inheritance will most likely result in which of the following? a) An increase in permanent income with no change to the amount of savings needed before retirement b) An increase in permanent income and a reduction in the savings needed before retirement c) Permanent income will remain unchanged and the amount of savings needed before retirement will increase d) A reduction in permanent income and an increase in the savings needed before retirement

b) An increase in permanent income and a reduction in the savings needed before retirement -With an increased permanent income, the savings (the gap between the current income and permanent income) is smaller.

An advisor explains that, on average, stocks can be expected to provide a higher return than bonds. Two years after developing an investment plan, the client complains that her stock investments have performed worse than her bonds. This is an example of what communication problem? a) Paternalism b) Critical interpretation c) Repetition d) Interruption

b) Critical interpretation -It is common for a client to misinterpret complex information, retaining general information (stocks outperform bonds) that may conform to prior beliefs while failing to interpret the qualifications (on average, higher expected return). This phenomenon is known as critical interpretation.

The ethics materials for this class refer to the concept of "living in the gray". What does this mean in the context of wealth management practice? a) If there's an ethical dilemma in your wealth management firm, you should probably leave the firm. b) Ethical decisions are not always clear-cut. Sometimes they involve trade-offs between various stakeholders and therefore it's important to carefully consider those implications and how you can mitigate the impact while fully disclosing the ethical challenges. c) If you're living in the gray, then you probably cannot be trusted to do the right thing. d) Gray is a good brand color for a wealth management firm.

b) Ethical decisions are not always clear-cut. Sometimes they involve trade-offs between various stakeholders and therefore it's important to carefully consider those implications and how you can mitigate the impact while fully disclosing the ethical challenges.

Which of the following is a consequence of setting a higher risk retention limit? a) Reduced need to hold significant liquid assets. b) Higher expected lifetime wealth. c) Greater satisfaction from loss averse clients. d) Reduction in insurance loads.

b) Higher expected lifetime wealth. -A greater risk retention limit will increase the need to hold more liquid assets to cover modest unexpected loss exposures.

Warren Buffett said that when it comes to stock valuation, "the most important thing is future interest rates" How do high interest rates impact the valuation of stocks? a) Higher interest rates increase the psychic income from the purchase of stocks. b) Higher interest rates reduce the expected value of future cash flows. c) An increase in interest rates by the Federal Reserve is associated with higher stock performance. d) Companies can raise prices when interest rates increase.

b) Higher interest rates reduce the expected value of future cash flows. -Consumer demand may fall for goods that must be purchased with credit when interest rates rise. The value of a stock is based on the expectation of future cash flows. When interest rates rise, the value of more distant cash flows declines.

You are meeting with two of your clients, James and Marvin. During the meeting, they call their benefits office to adjust their tax withholding in a way that better suits their financial needs. In which part of the financial planning process are you engaged? a) Understanding the Client's Personal and Financial Circumstances b) Implementing the Financial Planning Recommendation(s) c) Analyzing the Client's Current Course of Action and Potential Alternative Course(s) of Action d) Identifying and Selecting Goals

b) Implementing the Financial Planning Recommendation(s)

Decreasing marginal utility means that which type of saving and spending path is optimal? a) One that reduces consumption early in life in order to live well in retirement. b) One that results in roughly equal consumption each year. c) One that results in consuming more in years in which marginal utility is lower. d) One that results in consumption increasing proportionally with income.

b) One that results in roughly equal consumption each year. -If marginal utility is decreasing, the goal is to consume about the same each year. It may make sense to save for retirement if one's income falls later in life, but consumption should be roughly equal in both time periods.

Which of the following insurance recommendations will result in a positive cash flow? a) Increase the amount of current coverage. b) Raise insurance deductibles. c) Change the name of the beneficiary to someone with a better credit score. d) Purchase a new life insurance policy.

b) Raise insurance deductibles. -By raising the insurance deductibles, the premiums will decrease and cash flow will increase.

An investor loses 15% in her portfolio during the prior month. According to prospect theory, what would she be more inclined to do? a) Shift assets to commodities b) Take greater risk in order to get back to a positive return c) Maintain a constant allocation of risky and safe assets d) Stop taking risk and shift her portfolio to safe investments

b) Take greater risk in order to get back to a positive return -Prospect theory suggests that when investors experience a loss, they will seek greater risk in order to return to a positive return from a reference point. They will be risk averse in gains, but risk seeking in losses.

Which of the following best describes the gain from deferring Social Security for an additional year? a) The gain from delayed claiming is equal each year because the assumptions are updated annually. b) The annual expected gain is highest for a healthy female when delaying from age 64 to 65. c) The annual expected gain is highest for a healthy male when delaying from age 69 to age 70. d) The annual expected gain is highest for an average female when delaying from age 69 to age 70.

b) The annual expected gain is highest for a healthy female when delaying from age 64 to 65. -The greatest benefit from delayed claiming occurs for a healthy female between age 64 and 65. This is because the annual increase in lifetime income jumps from 5% to 6.66%.

You ask a client if they are willing to accept a 5% chance of outliving savings in retirement or a 10% chance of outliving savings. When building a spending plan, what are the implications of choosing a lower chance of outliving savings? a) The client will benefit less from annuitization. b) The client will need to spend less each year. c) The client can expect to leave a lower bequest. d) The client will have a higher permanent income.

b) The client will need to spend less each year.

If the risk of stocks is consistent with traditional investment theory, which of the following would we observe in historical asset return data? a) Cash is the preferred asset for a 5-year investing goal. b) There will be historical time periods where stocks underperform bonds over a 20-year time horizon. c) Returns at the 95th percentile for cash will be higher than for bonds. d) The standard deviation of stock returns will be lower for longer time horizons than for shorter ones.

b) There will be historical time periods where stocks underperform bonds over a 20-year time horizon. -The standard deviation of stock returns would be higher for longer time horizons. In reality, the standard deviation of stocks is not as high as predicted by traditional investment theory, making stocks comparatively less risky than we would expect for long-run goals. According to economic theory, investors are rewarded with higher expected returns only if they take greater risk across any time horizon. This higher risk means that we would expect to see a few historical periods where bonds and cash outperformed stocks even over a long time horizon.

Which of the following activities is part of the final step in the financial planning process? a) Analyzing client data b) Updating client and planner responsibilities c) Implementing recommendations d) Presenting recommendations to clients

b) Updating client and planner responsibilities -The final step of the financial planning process is "Monitoring Progress and Updating." During this step, planners will update client and planner responsibilities, check on goal progress, and gather up-to-date client information.

Higher real interest rates prevent a) an investor from living better today. b) a borrower from living better in the future. c) a borrower from borrowing today. d) an investor from living better in the future.

b) a borrower from living better in the future. -With higher real interest rates, investors will live better in the future as their current savings will grow but it will cost more to borrow. As a result, a borrower will not live better in the future.

An advisor who only uses real dollars when planning, and expects positive rates of future inflation, will treat a fixed-rate mortgage as: a) a constant future liability b) a decreasing future expense. c) an asset with a rising value over time. d) an increasing future expense.

b) a decreasing future expense. -A fixed mortgage has a constant real cost, but the amount of purchasing power needed to fund the mortgage will fall in the future if inflation is positive.

A heuristic is a) a method for determining personal risk. b) a simple rule or shortcut that allows for quick decision making. c) an emotional response to an uncertain outcome. d) the gray matter, outside of our brain, that is responsible for processing information.

b) a simple rule or shortcut that allows for quick decision making.

The first step in planning for abundance is to a) evaluate how much wealth a client wishes to pass on to children. b) estimate how much wealth is needed to fund spending goals. c) establish a private foundation. d) evaluate whether a client wishes to transfer assets prior to death.

b) estimate how much wealth is needed to fund spending goals. -While the discussion of planning for abundance certainly involves developing a plan for giving, the first step is determining how much of a client's wealth is truly abundance and can be used to fulfill non-spending goals.

Contingent claims trade a small loss in expected wealth for expected a) gains in human capital. b) gains in utility. c) gains in lifetime income. d) gains in financial assets.

b) gains in utility. -Contingent claims help smooth losses, but do not increase income.

The three elements of a financial goal are a) goal amount, time horizon, and investment risk. b) goal amount, time horizon, and goal flexibility. c) goal amount, investment risk, and investment vehicle. d) goal amount, investment risk, and goal flexibility

b) goal amount, time horizon, and goal flexibility. -Investment risk is related to the elements of a financial goal. But investment risk itself is not an element of a financial goal. The three elements of a financial goal are goal amount, time horizon, and goal flexibility.

The primary purpose of a financial intermediary is to a) securitize loans and sell them as financial products. b) identify lenders to provide capital and evaluate the credit quality of borrowers. c) lend funds to banks in order to provide capital to borrowers. d) collect money from loans and lend it to investors.

b) identify lenders to provide capital and evaluate the credit quality of borrowers. -Loan securitization is a shadow banking activity. The primary purpose of a financial intermediate is to collect capital from lenders and then identify borrowers who are most likely to repay loans.

An advisor demonstrates how taking greater investment risk affects future goal outcomes and asks the client to choose the risk they feel comfortable taking. This is an example of: a) paternalism. b) mutuality. c) trust. d) empathy.

b) mutuality -An advisor who practices mutuality uses their expertise to present choices that are easily understood by a client and allows them to select the plan of action that they prefer. A paternalistic advisor would make their own recommendation with allow the client to make the choice.

It is appropriate to select a riskier portfolio for funding spending goals in the more distant future if: a) sentiment does not affect stock prices. b) stocks reliably exhibit mean reversion. c) stock returns behave as economic theory would predict. d) stocks have a higher expected return than bonds.

b) stocks reliably exhibit mean reversion. -economic theory does not predict that time horizon should influence asset allocation. For time horizon to be considered when selecting an investment portfolio, an advisor must believe that stocks will continue to exhibit mean reversions.

The cost of protecting against a loss in human capital rises with age because a) the amount of financial wealth increases with age. b) the probability of death increases with age. c) income generally rises with age. d) the value of human capital generally increases over time.

b) the probability of death increases with age. -Financial wealth refers to assets already owned, and this does not affect the cost of protecting against a loss in human capital.

The purpose of investment planning is a) to maximize the expected return from investments. b) to maximize one's expected lifetime utility. c) to maximize one's wealth upon retirement. d) to preserve assets over a lifetime.

b) to maximize one's expected lifetime utility. -The goal of investment planning is to maximize expected lifetime utility, and not necessarily to preserve assets.

Let's say a client has $1,500,000 saved and expects to earn $150,000 each year for the next 25 years, at which point the client will retire. If the client plans to be retired for 35 years and will have a pension of $50,000 per year, how much should the client spend each year in order to smooth consumption? Assume no inflation and that there's no bequest motive. a) $125,000 b) $91,667 c) $116,667 d) $200,000

c) $116,667 -Add together the $1,500,000 that is saved, plus the product of 25 years times $150,000 per year of income, plus the product of 35 years times the pension of $50,000 per year. The sum is $7,000,000. Then divide this by the projected life of 60 years, which is the sum of the 25 years of working and 35 years of retirement.

Five years ago today, Dean purchased a stock for $45. Over the past 5 years, the stock has paid the following dividends:Year 1: $1.25Year 2: $2.00Year 3: $2.50Year 4: $3.25Year 5: $1.75At the end of the fifth year, Dean sold the stock for $47. What was Dean's compounded rate of return (IRR)? a) 4.69% b) 3.85% c) 5.52% d) 6.32%

c) 5.52% -Use the following figures to calculate for IRR: CF0 = <45> CF1 = 1.25 CF2 = 2.00 CF3 = 2.50 CF4 = 3.25 CF5 = 48.75 (that is, $47 + $1.75) This result in a compounded rate of return of 5.5175, or about 5.52%.

Which of the following will result in higher optimal annual spending? a) The use of a joint instead of individual mortality table to estimate the planning horizon. b) The desire to leave a larger bequest. c) An expected increase in future income. d) The use of a longer planning horizon.

c) An expected increase in future income. -A joint mortality table is based on expected longevity for both partners, which will be longer than that derived from an individual mortality table. An expected increase in future income would be associated with higher optimal annual spending.

A client has two long-term saving goals with a time horizon of 25 years. Each goal requires an estimated $200,000 of saving. One goal is considered essential, and the other is flexible. When estimating monthly savings to meet each goal, which is correct? a) The client should only begin funding the flexible goal once the essential goal is fully funded. b) The client should save the same amount each month to fund each goal. c) The client should initially expect to save more each month to fund the essential goal. d) The client should save more each month to fund the more flexible goal.

c) The client should initially expect to save more each month to fund the essential goal. -The client can save for both goals at once, though the essential goal should be funded with safer investments that have a lower expected return. Because there is a risk and expected return tradeoff, the client will use a lower expected rate of return when estimating monthly spending needed to reach the future $200,000 spending goal in 25 years.

Which one of the following statements correctly describes marginal utility? a) Marginal utility increases as wealth and income rise. b) The total amount of satisfaction received from spending annual income. c) The satisfaction received from an additional unit of consumption. d) An incremental amount of money received for performing an additional amount of work.

c) The satisfaction received from an additional unit of consumption. -Marginal utility decreases as wealth or income rises.

Which one of the following is a good benchmark to estimate the expected rate of return of a safe asset? a) Current yield on Treasury bonds b) Current yield on Treasury notes c) The yields on TIPS d) Historical stock returns

c) The yields on TIPS -The current yield on Treasury bonds incorporates some elements of risk.The yields on TIPS can be used to estimate the expected return of a safe asset.

Which of the following is a market risk to the value of human capital? a) Retiring early b) A premature death eliminating future income c) Working in an occupation whose profits are closely tied to interest rates d) An injury that diminishes the value of a person's market productivity

c) Working in an occupation whose profits are closely tied to interest rates -This is an example of a life (or premature death) risk. A market risk to the value of human capital could come from working in an industry, such as real estate, where profits are closely tied to interest rates, which could result in high volatility of earnings and a possible drop in human capital value

The best formula for determining the total value of Social Security payments to be received is a) life expectancy times average monthly benefit times 12 based on earnings times a 3% interest rate. b) life expectancy times average monthly benefit times 10 based on earnings times a 2% interest rate. c) average life expectancy times average monthly benefit times 12 based on earnings. d) average monthly benefit based on earnings times average life expectancy.

c) average life expectancy times average monthly benefit times 12 based on earnings.

When calculating the Social Security benefits for a married couple, a key feature to note is that a) a widow or widower will receive two benefits after the death of a spouse. b) one can add 50% of a spouse's Social Security benefit to the calculation of the client's benefit value. c) both spouses receive their benefits, and the smaller benefit expires when the first spouse dies. d) a widow is only eligible to receive benefit if married for over 5 years.

c) both spouses receive their benefits, and the smaller benefit expires when the first spouse dies. -If the lower earning spouse dies first, nothing is added to the survivor's benefit. Only if a client did not work, or had a lower benefit, can that person claim half of the other spouse's work benefit when that spouse dies.

Utilizing a Monte Carlo simulator is most beneficial for clients when a) showing how much of a bequest a client might leave to heirs when they die. b) determining when a client can retire. c) modeling how a client's income may fluctuate annually. d) predicting future portfolio investment returns.

c) modeling how a client's income may fluctuate annually. -Clients care more about the variability of their annual spending than how much may be left over when they die.

It is appropriate to select a riskier portfolio for funding spending goals in the more distant future if: a) sentiment does not affect stock prices. b) stock returns behave as economic theory would predict. c) stocks reliably exhibit mean reversion. d) stocks have a higher expected return than bonds.

c) stocks reliably exhibit mean reversion. -The risk premium concept is not the same as time diversification. Stocks can exhibit a higher expected return than bonds, but the allocation to stocks and bonds should theoretically depend on an investors willingness to accept variation in outcomes and not be based on time horizon. For time horizon to be considered when selecting an investment portfolio, an advisor must believe that stocks will continue to exhibit mean reversions

With regard to the standard of care that registered representatives of broker-dealers have to their clients, the registered representatives must always uphold a a) prudent standard of care. b) negligent standard of care. c) suitability duty of care. d) fiduciary duty of care.

c) suitability duty of care. -Prudence is a function of a fiduciary standard, not a suitability standard.

All of the following are examples of qualitative information that should be collected by the financial planner EXCEPT: a) the client's risk tolerance level. b) the client's general attitude about spending. c) the client's age and number of children. d) the client's education goals.

c) the client's age and number of children.

The primary value of owning stocks is: a) the psychic income from the purchase of a financial asset. b) the conspicuous consumption value of ownership. c) the expected future cash flows from the stock investment. d) the variation in returns relative to safer assets.

c) the expected future cash flows from the stock investment. -Investors receive little or no psychic value from owning stocks, so the value comes from the expected payouts in the form of future cash flows.

Which of the following is a skill an advisor develops in order to demonstrate that they understand and are sympathetic to a client's unique needs? a) Mutuality b) Credibility c) Paternalism d) Empathy

d) Empathy -An advisor who exhibits empathy has developed the skills to more deeply understand and share the feelings and perspectives of his or her clients.

Olivia purchased a new house for $450,000. She put 20 percent down and planned to finance the rest over 30 years at 3.5 percent. After 10 years, she is surprised by how much she still owes. You tell her that she still owes so much because so much of her monthly payment has been going toward interest. How much interest has she paid over this 10-year period? a) $111,349 b) $139,187 c) $140,905 d) $112,724

d) $112,724 -Use the following figures to solve for interest paid in the first year: P/YR = 12 PV = 360,000 (that is, 450,000 x 80%) FV = 0 i = 3.5 N = 360 (that is, 30 x 12) This will result in a payment of $1,617. The interest paid can be determined using the AMORT function and the following keystrokes: 1 INPUT 120 SHIFT AMORT=The interest paid over the first 10 years will be shown as $112,724.

Which one of the following is a reason to defer claiming Social Security until age 70? a) A client wants to receive benefits as soon as possible. b) A client wishes to receive 100% of his primary insurance amount. c) A divorced spouse would like to maximize the spousal benefit. d) A client wishes to maximize the retirement benefit to a surviving spouse.

d) A client wishes to maximize the retirement benefit to a surviving spouse. -A client will receive 100% of their primary insurance amount at full retirement age, which occurs years before age 70. A surviving spouse will receive a larger benefit if the primary earner defers claiming.

Which of the following is correct regarding contingent claims? a) A contingent claim should nearly always result in a net profit. b) A contingent claim results in lower expected lifetime utility. c) A contingent claim adds to the risk of a household portfolio. d) A contingent claim has a negative expected return.

d) A contingent claim has a negative expected return. -A contingent claim should protect against random, infrequent losses. This means that most of the time the payout will be less than the premiums paid.

Adjustments to Social Security benefits are tied to the a) Consumer Price Index for All Urban Consumers, or CPI-U. b) Consumer Price Index for the Elderly (62 and older), or CPI-E. c) Current 10-Year Treasury Bill Yield. d) Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W.

d) Consumer Price Index for Urban Wage Earners and Clerical Workers, or CPI-W. -Adjustments to Social Security benefits are currently based on the percentage change in the CPI-W, measured from the average of the third quarter of one year to the third quarter of the succeeding year.

An advisor recommends a financial product because it provides "significant tax deferral benefits." A client is dissatisfied to find that her tax bill did not decrease the following year. This disappointment demonstrates a failure in: a) tax planning strategy. b) credibility. c) mutuality. d) critical interpretation.

d) critical interpretation. -The tax planning strategy may be perfectly sound. An advisor who recommends an investment whose growth is tax deferred needs to ensure that the client recognizes that there will be no immediate benefit seen on their income taxes. If an advisor fails to ensure that the client correctly interprets the consequences of their recommendation, their client may be disappointed by the outcome.

An investment advisor tells a client to be patient after the value of her stocks has fallen in the middle of a recession because the market will eventually recover. The advisor is likely basing this recommendation on the phenomenon of a) modern portfolio theory. b) time diversification. c) the capital asset pricing model. d) equity mean reversion.

d) equity mean reversion. -The tendency of stocks to revert back to their historical average after a bear market is known as mean reversion.

Clients benefit from setting goals across the client lifecycle in that a) the clients are more likely to retire before age 65. b) annual portfolio volatility is reduced. c) it allows an advisor to immunize goals for a risk tolerant investor. d) fewer investment decisions will be based on short-term investment performance.

d) fewer investment decisions will be based on short-term investment performance. -. Goals can be immunized using safe investments for expenses that are inflexible, but a risk tolerant investor will not prefer a completely immunized portfolio.

A histogram of historical returns and standard deviations for equities, bonds and cash illustrates that a) stock volatility is far lower than modern portfolio theory would predict. b) stock returns are far different than modern portfolio theory would predict. c) bonds have exhibited a higher risk premium than stocks. d) the annual returns on cash have been between 0% and 5% far more frequently than for stocks.

d) the annual returns on cash have been between 0% and 5% far more frequently than for stocks. -Stock volatility is broadly consistent with the prediction of modern portfolio theory that financial assets with higher returns will also have higher standard deviations.

A client is upset after seeing that the value of his investment portfolio has declined. An advisor is able to encourage the client to focus on the minimal future consequences of this temporary loss and address the loss using reason rather than emotion. The client response and advisor recommendation are consistent with a) the bounded rationality model. b) a traditional economic model of utility-maximization. c) adverse thinking. d) the dual-self model.

d) the dual-self model. -According to the bounded rationality model, cognitive limitations affect our ability to make rational choices. In this example, the client has an emotional response and the advisor appeals to the rational self in order to moderate this response in a manner consistent with the dual-self model.

Time diversification is considered controversial because a) it is consistent with modern portfolio theory, which has been shown to be irrelevant. b) historically, stocks have outperformed bonds. c) it is consistent with economic theory. d) the investment time horizon should not affect the optimal asset allocation for a household.

d) the investment time horizon should not affect the optimal asset allocation for a household. -It is true that historically stocks have outperformed bonds, and economic theory predicts that riskier assets such as stocks should outperform bonds. But, historical data provides evidence that they tend to mean revert, making them less risky when funding long-term goals. This is inconsistent with economic theory which predicts that investors are only rewarded for accepting greater variability of returns.

The equity risk premium can be described as a) the guaranteed return an investor receives by investing in Treasuries. b) only applying to assets with a geometric return greater than the arithmetic return. c) the risk-adjusted premium an investor receives when they invest in equities. d) the potential bonus an investor may receive for taking on greater investment risk.

d) the potential bonus an investor may receive for taking on greater investment risk. -Investors who take greater risk receive a reward in the form of an equity risk premium.

Achieving long-term goals by breaking them down into achievable, smaller short-term tasks is a method used to achieve a) vision. b) values. c) veracity. d) velocity.

d) velocity. -The three Vs of financial therapy include a concept known as velocity, which encompasses techniques used to break down barriers to goal achievement.