Series 6: Customer Accounts (Suitability Factors)

An investment objective of current income will be most appropriate for which of the following customers?

A retired couple who want to spend more on their standard of living A retired couple who want to improve their standard of living will need additional income to spend, so their investment objective should be current income. A family planning for college expenses for infant children can invest long term and does not need the income currently. It would most likely invest for capital appreciation, since there is a long-term time horizon before the college bills come due. As the kids get closer to college age, the portfolio would need to be reallocated to "safer" investments such as Treasuries to insure that there is no loss of principal due to a market downturn - since this money is needed to pay college bills! A young professional who has a growing income and who is able to take some risk should invest for capital appreciation. A middle aged couple investing for retirement should similarly invest more for capital appreciation than for current income.

Recommendations of low-price speculative securities to customers are-

permitted only if information is collected about the customer's other financial holdings and financial situation and needs FINRA does not prohibit the recommendation of low-price speculative securities - as long as the recommendation is "suitable" for that customer. It does prohibit, however, "blanket" recommendations of low-price speculative securities, such as through a telephone campaign, since this means that a suitability determination is not being completed for each customer to whom the security is being recommended.

A registered representative can determine a customer's net worth from a customer's:

personal balance sheet A personal balance sheet discloses all customer assets and all customer liabilities, so the customer's net worth can be computed. The personal income statement reveals the customer's discretionary income. A list of current investments only shows those assets; not all customer assets. Similarly, a bank statement only shows a customer's bank balance and not all customer assets.

Which of the following investment objectives is only appropriate for an investor with a high risk tolerance?

Aggressive growth An aggressive growth investment objective will only be appropriate for an investor with a high tolerance for risk.

If a customer refuses to disclose income, net worth or other financial information when a representative makes a suitability determination, which statement is true?

An account may be opened, but only unsolicited trades can be accepted from the customer If a customer refuses to disclose personal financial information that is requested during a suitability determination, then the account can be opened, but the representative cannot make recommendations to that customer. Only unsolicited trades can be accepted from such a customer.

Under FINRA rules, a registered representative must obtain and retain which of the following information relating to the customer's account?

Customer Address Country of Citizenship Financial Status FINRA rules require that a registered representative obtain a customer's name and address (makes sense!) Country of citizenship is required as well, since if the customer is a non-U.S. citizen, a copy of the customer's passport must be obtained. Customer financial information must be obtained to perform a suitability determination under the requirements of the "Know Your Customer" rule.

An older female customer, in the lowest tax bracket, wants an investment that will provide asset growth for retirement. The best recommendation would be:

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

After helping a client to prepare a personal balance sheet, you determine that the client's net worth is negative. Which of the following is the most logical investment program or strategy for this person to follow?

Make no investments at this time and first reduce debt Debt reduction is the first priority for a client with negative net worth.

Total assets minus total liabilities is:

Net worth Net worth is all assets minus all liabilities. Both current and long-term assets; and current and long-term liabilities are included in the formula. Net working capital is current assets less current liabilities. A current asset is an asset that can be turned to cash within 1 year. This includes customer savings account, checking accounts and securities accounts. A current liability is a bill that the customer must pay within 1 year.

Louise is a 63 year old widow who has just retired. Louise owns her home, has no debt, and lives on Social Security payments, a pension, interest from her Certificates of Deposit, and a passbook savings account at a local bank. Two of her CDs are due to mature, and interest rates have dropped. Louise would like an investment that will provide more in monthly income than her CDs will at the new lower interest rate. She is concerned about meeting her expenses if her income drops, and she is risk averse. Her representative recommends ABC Equity Asset Allocation Fund to Louise. The fund has had outstanding performance over the past 3 years and is managed by a well known money manager. Is the representative's recommendation suitable for this client?

No, the fund will not meet the client's objective of monthly income The client's stated investment objective is monthly income. The asset allocation fund does not meet this objective because it is a growth fund. A low-risk income fund would be appropriate for this client.

The Clarks are both 34 and own a very successful software development company. They have no children and would like to retire at about 50 years of age. They have taken an active role in their investments. They have a substantial retirement portfolio that should be able to accommodate an early retirement. Other than a mortgage on their home, they have no debt. Their combined income is $400,000 a year plus bonuses. They have $50,000 to invest and have inquired about XYZ Environmental Technology Fund that invests in "green" technologies to support environmental causes. As they said in your meeting with them: "Our motto is to go for it." All of the following statements are appropriate when describing this investment to the Clarks EXCEPT:

"Investors in this fund must have a low tolerance for risk" The Clarks have a high tolerance for risk and are financially able to make large investments in aggressive growth funds. The Clarks are not interested in income from this investment, since they already have a large income stream. The fund as described is a sector fund and an aggressive growth fund because it invests in environmental technology companies. It is unlikely to pay any distributions for years. This investment is only suitable for customers that can assume a high level of risk.

Customer Name: Joey Jones Age: 30 Marital Status: Single Dependents: None Occupation: VP - Marketing - ACCO Corp. Household Income: $250,000 Net Worth: $60,000 (excluding residence) Own Home: No - Rents Investment Objectives: Aggressive Growth / Early Retirement at age 50 Investment Time Horizon: 20 years Investment Experience: 0 years Current Portfolio Composition: 401k: $30,000 Cash in Bank: $30,000 When reviewing this customer's profile sheet, the most immediate question that should be considered is:

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

A customer has the following balance sheet: Cash: $ 20,000 Marketable Securities - Money Fund: $ 50,000 Market Value Retirement Portfolio: $100,000 Market Value - Cars: $ 30,000 Market Value - Home: $400,000 Market Value - Personal Items and Furnishings: $ 60,000 Bills Payable: $ 50,000 Car Loan: $ 15,000 Mortgage on Home: $250,000 The amount that the customer has available for investment, assuming a $20,000 cash reserve, is:

$0 Both the automobile and home are long-term assets with loans against them - these are excluded from assets that can be invested. Even though there is equity in these long-term assets, they are not liquid and thus not part of the available funds for investment. The retirement portfolio is already invested, so this is not available for investment either. There is $70,000 of cash and equivalents (the money fund shares) available; and $50,000 of short-term liabilities; leaving $20,000 that could be invested, less a cash reserve. Assuming a $20,000 cash reserve, that leaves nothing available for investment.

Fred and Ethel, ages 64 and 62, have worked hard to save money while putting their children through college. Their youngest child has just graduated and the couple is eager to retire. They want to travel and continue to collect antiques in retirement. Fred and Ethel recently sold their successful business and have a substantial amount to invest. They want to maintain their lifestyle and be able to pursue their interests in travel and antiques. They are willing to accept some risk to achieve their objective. An inappropriate recommendation for these clients would be:

ABC Global Markets Fund These clients want current income to maintain their lifestyle and to pursue their interests in retirement. They are willing to accept moderate risk. The global markets fund is an investment for capital appreciation and will generate little or no income. Thus, it is an inappropriate recommendation for the client. The balanced fund invests in a balance of stocks and bonds for both growth and income, so it fits their objectives. The corporate bond fund pays a higher level of current income, so it will meet the client's needs. Finally, the blue chip fund will provide dividend income and capital appreciation. It is not as good a "fit" as the balanced fund or the corporate bond fund, but it is a much better choice than the global markets fund!

Tom and Mary Grant plan to use the proceeds from the sale of their home to build their dream house. They have not yet purchased a building lot or contacted an architect. While they are building the new house, they plan to live in a condo that Tom inherited from his mother. They anticipate that the planning and building of their house could take two years. They will pay expenses for the house as they occur during that time. The Grants come to you for advice on an investment that is both liquid and safe. Which of the following is the most suitable recommendation for these clients?

Acme Money Market Fund The need for liquidity and safety make a money market fund the only suitable recommendation. The customers will need to access this money during a two year period. The other funds do not offer the safety or liquidity of the money market fund.

Your customer is the executor of his father's estate and wants to invest his father's remaining assets for his mother's care. His elderly mother is in very poor health and recently moved into a nursing home. She has long-term care insurance and pension income that pay most of her monthly expenses. The customer is interested in supplementing his mother's current monthly income with a low risk investment. What is the most suitable recommendation for this client?

Acme U.S. Treasury Fund A U.S. Treasury Fund holds Treasury notes and bonds, which are AAA rated, so these are as safe as it gets, and they generate a decent level of income since the bonds and notes pay interest semi-annually. The corporate bond fund is not as safe, so it does not meet the objective of a "low risk" investment. The blue chip fund is invested in large capitalization growth stocks for capital gains potential with some dividend income. It has higher risk than the corporate bond fund, so it does not meet the customer's "low risk" objective. Finally, a "value" fund invests in stocks that are "undervalued" for capital gain potential, but it will generate little or no income, so it does not meet the income requirement (and this fund is not "low risk" either).

Nicole is 23 years old and a recent college graduate. She is single with no children and has an annual income of $28,000. She is renting an apartment and saving to buy a condominium within the next 3 years. She carries a $28,000 group life policy through her employer and has saved $3,400. She is considering investing the $3,400. Which variable annuity product should her registered representative recommend?

An annuity is inappropriate for this client Nicole's immediate investment goal, to purchase a condominium, is short-term. Her $3,400 nest egg should be invested in a very safe product like a money market fund or a short-term Treasury securities fund. She is too young to even consider buying an annuity. If she does buy an annuity, withdrawals made in 3 years will be subject to surrender charges and a 10 % penalty on earnings. This is a bad recommendation.

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. All of the following are suitable investment vehicles to recommend to the couple EXCEPT:

Blue chip stock funds This couple needs $50,000 cash in 6 months. Clearly, money market funds and bank certificates of deposit are suitable. Blue chip stock funds 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.

Which one of the following is an appropriate investment for a customer with an objective of growth and income?

Blue-chip stocks This customer's objective is growth and income, which blue chip stocks will provide. Small company growth stocks, which can rise rapidly in price in an appreciating market, pay little or no dividends, so they do not provide income. Bond investments do not provide growth - they provide a higher level of income and a higher level of safety than common stock investments.

Which statement concerning ex-dates is TRUE?

Buying shares just before the ex-date to receive the dividend is not advantageous Selling dividends is the prohibited practice of telling a customer something like: "Better hurry and buy those fund shares now. It is about to go ex-dividend and you will lose out if you don't buy now!" The representative is trying to "stampede" the customer to buy, but the customer really gets "nothing" except a tax bill for that dividend! If the customer buys the shares PRIOR to the ex-date, the customer will be on record to receive the dividend. The dividend value is included in the shares being purchased. If the customer buys the shares ON the ex-date or AFTER, the customer will not be on record to receive the dividend. However, because the price of the shares is reduced for the dividend amount on ex-date, the customer does not pay for that dividend that he or she is not getting.

Which of the following terms describes excessive trading in a customer's account?

Churning "Churning" is excessive trading in a customer's account for the sole purpose of generating commissions and is a prohibited practice under the FINRA Conduct Rules.

A customer believes the stock market will rise over the next few years. Which of the following investments would give the greatest asset appreciation in a rising market?

Common stock fund A "rising market" means the stock market is appreciating. Of the choices offered, common stock funds would offer the greatest appreciation in a rising market. A rising stock market does not mean that bond prices are appreciating. Bond prices will only appreciate if market interest rates fall. A balanced fund invests in a balance of both stocks and bonds. The equities portion of the portfolio will do well in a rising stock market; but the bond portion of the portfolio would only appreciate if market interest rates fall. It would be expected to appreciate in a rising market due to the equities price rise, but the percentage growth would be lower than investing in a common stock fund.

Total income minus taxes and expenses is:

Discretionary income Discretionary income subtracts both taxes and expenses from income. Current liabilities are short-term obligations that are due within a year. Fixed liabilities are longer term obligations such as a mortgage. Disposable income is income less taxes but not expenses - it is the income that the customer has available to pay for remaining expenses.

Cindy, age 60, is retired with a pension. She recently bought a condo in a large retirement community. The community provides trash collection, lawn maintenance, and snow removal for an annual fee of $1,600. Cindy's income tax refund was much larger than she expected and she is interested in investing the $4,000 refund. Her pension makes up her entire income. She has a small IRA and had planned to take a distribution from the account to pay the annual condo maintenance fee. She has a checking account with a low balance and no other savings. Her credit card balances equal $8,000. Which of the following is the most suitable recommendation for this client?

Do not invest at this time This client is retired and living on a pension, and does not have enough discretionary income to pay her annual condo maintenance bill that is now due. She has no emergency fund and planned to take a distribution from her tax-deferred IRA to pay the condo maintenance fee. She has $8,000 of credit card debt and a $1,600 payable for the condo; and has no cash on hand. Her $4,000 tax refund should be used to pay down her debt. She has no funds available for investment.

During a seminar on annuities, a retiree approaches you to ask about an investment that could provide a particular amount of additional income for life. He is not concerned about inflation. His current income is from Social Security and a small pension. His home is mortgage free. He does not want to take risks with this investment. Which product most closely matches this client's investment objective?

Fixed annuity This client's stated investment objective is a low risk, fixed dollar income for life. A fixed annuity provides a guaranteed fixed payout for life - this meets the client's objectives since he is not concerned about inflation. A variable annuity offers lifetime payments, but the payment amount is not fixed - it might increase or it might decrease, depending on the performance of the mutual fund held in the separate account. The mutual funds neither offer lifetime payouts nor a fixed rate of return, both of which are requirements of the client.

A registered representative has received an inquiry from a young investor who is looking for a stable investment (preservation of capital) during periods of rising interest rates. To make a recommendation to the customer, the representative should inquire about the customer's: I Investment objectives II Annual income III Existing portfolio of investments IV Tax bracket

I, II, III, and IV To make suitable recommendations to the customer, the representative should make inquiry about all items listed - the customer's investment objective, income, existing portfolio of investments, and income tax bracket.

Upon receipt of a large customer order that is likely to have positive market impact, a registered representative first places an order to buy that stock for his or her personal account. This is: I a permitted practice II a prohibited practice III known as front running IV known as shadowing

II and III Front running a customer order that is likely to have a market impact is a prohibited practice. If the representative places an order to buy a stock for his or her account prior to placing a large customer order to buy that stock (which is likely to make that stock move up), this is "front running". If the representative places an order to buy a stock for his or her account just after placing a large customer order to buy that stock (which is likely to make that stock move up), this is "shadowing" and is prohibited as well.

Under the Know Your Customer Rule, in order to open and maintain a customer account, each registered representative: I must know "every" fact concerning the customer II must know "every essential fact" concerning the customer III must follow KYC procedures as part of an effective Anti-Money Laundering (AML) Program IV must follow KYC procedures as part of an effective Customer Privacy program

II and III The Know Your Customer rule is separate from the "Suitability" rule. The KYC rule requires that the essential facts about the customer be collected at account opening, so that the member firm can: effectively service the customer's account; act in accordance with any special handling instructions for the account; understand the authority of each person acting for the customer; and comply with applicable laws and regulations. This is a very general rule regarding collection of customer account information and it applies whether trades are recommended or not in the account. For example, the PATRIOT Act requires that customer citizenship be obtained, because if a non-U.S citizen opens an account, a copy of their foreign passport must be obtained. Thus, citizenship becomes an essential fact in order to "comply with applicable laws and regulations." In contrast, the Suitability rule only applies when recommendations are made.

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

II and IV 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.

Which of the following statements about the purchases of mutual fund shares before and after the ex-dividend date are correct? I A representative may recommend purchases before the ex-dividend date to obtain the dividend, provided the rep verifies that the fund meets the investor's current objectives II For a share purchase after the ex-dividend date, the fund pays the buyer the amount of the dividend distribution III Before the ex-dividend date, the fund includes the amount of the dividend distribution in the net asset value IV On the ex-dividend date, the public offering price (POP) is reduced by the amount of the dividend

III & IV only Selling dividends is the prohibited practice of telling a customer something like: "Better hurry and buy those fund shares now. It is about to go ex-dividend and you will lose out if you don't buy now!" The representative is trying to "stampede" the customer to buy, but the customer really gets "nothing" except a tax bill for that dividend! If the customer buys the shares PRIOR to the ex-date, the customer will be on record to receive the dividend. The dividend value is included in the shares being purchased. If the customer buys the shares ON the ex-date or AFTER, the customer will not be on record to receive the dividend. However, because the price of the shares is reduced for the dividend amount on ex-date, the customer does not pay for that dividend that he or she is not getting.

All of the following investments will be appropriate to recommend for an investor whose objective is aggressive growth EXCEPT:

Large company stocks Aggressive growth investments are common stocks of newly-formed companies in rapidly expanding industries or rapidly expanding economies. These would include small company stocks, technology stocks and emerging markets stocks. They do not pay dividends, have a very high capital appreciation potential, but also have a very high level of business risk and market risk Large company (blue chip) stocks are for more conservative growth or growth and income investors and are not looking for aggressive growth.

A customer account holds $100,000 of Negotiable Certificates of Deposit that are maturing. The customer has inquired about alternative investments that can be made with these funds. To make a suitable recommendation, inquiry should be made as to the customer's:

Liquidity requirements Tax bracket Other investments Common sense dictates that to make any recommendation to a customer, all of the choices should be evaluated - the customer's liquidity requirements, tax bracket, and other investments.

If interest rates are rising which mutual fund that will best match an investor's investment objective of preservation of capital?

Money market fund Money market funds are invested mainly in T-Bills - these have no default risk and have virtually no market risk due their short maturity. This is the best investment if the objective is preservation of capital. Investments in U.S. Treasuries and most municipals have low default risk, but if the funds are invested in long-term maturities, the funds will have substantial interest rate risk. If market interest rates rise, the value of the long-term securities held in these portfolios will fall. The balanced fund is conservative, but it is invested in corporate bonds and stocks. The stocks are subject to market risk in a recession, as are the bonds. In a sharp recession, this fund can experience large losses.

Which of the following investments should be recommended to a customer whose investment objective is tax exempt income?

Municipal bond fund Municipal bonds will provide an investor with income that is exempt from federal income tax. The other investments generate taxable income.

The FINRA suitability rule requires all of the following EXCEPT:

Once a reasonable basis suitability determination has been completed, the product cannot be recommended to a client unless the registered representative has completed a CE (Continuing Education) program on that investment FINRA requires that suitability determinations include multiple levels of review. These are: Reasonable Basis Suitability: This is a review of the features, returns, costs and risks of the recommended product or strategy. Only those products with the best combination can be recommended to clients. In essence, this rule requires that firms have an internal "recommended list" that has completed this review. In addition, in order to recommend the product, the registered representative must understand, and be able to communicate, the investment's features, returns, costs, and risks. Customer-Specific Suitability: Once the recommendation has completed "reasonable basis" suitability, that does not mean that it can be recommended to all customers. To recommend it to a customer requires that "customer-specific" suitability be determined. Quantitative Suitability: A single recommendation might be suitable for a customer, however a large number of similar recommendations might not be. It all depends of the customer's objectives, needs, and ability to pay for the recommended transactions. Note that the "Suitability" rule only applies to recommended transactions. It explicitly does not apply to unsolicited trades; and it also does not apply to institutional customers - only to retail customers.

A customer is looking for mutual fund investments that will provide both income and growth, along with inflation protection. Which two of the following are appropriate recommendations?

REIT fund and Balanced fund An REIT fund invests in Real Estate Investment Trusts. REITs invest in real estate for both income from the properties and capital gains as the properties appreciate in value. In addition, real estate investment tend to keep pace with inflation, so there is a bit of inflation protection. A balanced fund is invested in a balance of stocks and bonds for both income and growth. In addition, the equities portion of the portfolio provides some inflation protection. A Treasury securities fund offers safety and income, but no inflation protection. If market interest rates rise, the bonds held in the fund portfolio will drop in value. A special situations fund invests in companies that are in trouble (such as bankruptcy), with the hopes that some will turn around and become successful. This is a pure capital gains strategy - there is no income.

The FINRA Conduct Rules prohibit which of the following actions by a registered representative?

Recommending that clients frequently trade mutual fund shares on a short-term basis to lock in profits FINRA states that trading of mutual fund shares is a prohibited practice. Mutual funds are not short-term investments (with the exception of money market funds) and frequent "trading" of mutual shares incurs both sales charges and possible tax consequences. Also note that there really is no "trading" of these shares - the shares are bought from the fund and redeemed with the fund. Appropriate reasons to recommend existing fund holdings and using the proceeds to buy other fund(s) include changes in investment objectives, investment needs, investment time horizon, and a customer's desired asset allocation mix.

All of the following are violations of FINRA mutual fund rules EXCEPT:

Redemption charges FINRA permits redemption charges or fees - however, the total of up-front sales charges and redemption fees cannot exceed the FINRA 8 1/2% maximum. Breakpoint sales are sales to customers in amounts just below breakpoints offered by the fund. They are a violation of FINRA rules. The representative must tell the customer that investing a small additional amount will place the account over the breakpoint and result in a lower sales charge. FINRA does not allow trading of mutual fund shares. These are redeemable securities designed for long-term investment - they cannot be "traded." Selling dividends is the prohibited practice of "pushing" a customer to buy just before an "ex-date" to receive a dividend. This practice is of no benefit to the customer, since the share price will be reduced on the ex-date for this distribution. The customer really gets nothing and must pay tax on the dividend when received.

Which of the following reasons for holding an investment over a long period of time is to an investor's advantage?

The market prices of investment assets fluctuate even as growth occurs Precipitous sales of assets may often result in losses Regardless of income level, investors have a tax incentive to make long-term investments Market prices for investments will rise and fall, even though there is overall long-term growth. Sales of assets during a sudden drop in the market can result in losses to an investor. For investors with income taxed at the highest marginal income tax rate, there is an incentive to make long-term investments that the investor will hold for more than 12 months. Taxes on long-term capital gains are at the maximum capital gains rate of only 15% or 20% (as opposed to a maximum rate of 37% for short-term capital gains and ordinary income). Note 15% for individuals who are not in the maximum tax bracket; 20% for individuals who are in the maximum tax bracket.

A working couple has saved $6,000 for college educations for their children, who are 3 and 4 years of age. They would like their children to be able to select private colleges if they wish. They understand that this choice will be very expensive and that they must accept some risk in their investments to achieve this objective. They have no other current savings, but they will be able to contribute $3,000 each year to the college education fund for their children. Which is the most suitable recommendation for this couple?

XYZ Growth Fund The clients have a long investment time horizon and are seeking capital appreciation to fund education for their young children. The Growth Fund offers capital appreciation, and the clients are willing to accept the fund's moderate risk to achieve their objective. The Energy Fund is a sector fund and is an aggressive growth investment. The Morrises are willing to take some risk for increased returns, but they do not appear to be aggressive investors with a high risk tolerance. They cannot afford to risk their children's education funds on aggressive investments. The Equity Income Fund is primarily for investors seeking income and offers reduced growth potential. Although the High Yield fund offers current income at a higher level of risk, income is not the client objective.

Your customer is a 30-year old professional with an annual income of $200,000. He has no debt except his mortgage and has put away a substantial emergency fund "just in case" he needs it one day. This customer makes the maximum contribution to his firm's 401(k) plan. He recently received a $40,000 bonus for his outstanding work and comes to you for investment advice. He tells you that he is looking for growth but is not willing to accept much risk and that he plans to leave the investment for at least 10 years. Which is the most suitable recommendation?

Zenith Asset Allocation Fund Although Jerry is young and financially secure, he is seeking a growth investment that carries low risk. An asset allocation fund meets his investment objective, risk profile, and time horizon, because an asset allocation fund is designed to provide capital appreciation, or growth, with a low level of risk. The Ginnie Mae fund is generally categorized as a low risk, income investment. It will not provide growth. Emerging markets funds are aggressive growth investments and not suitable for a client whose objective is capital appreciation without much risk. An international growth fund seeks capital appreciation, but is only suitable for an investor with a high risk tolerance.

Johnny is a 35-year old professional with an annual income of $150,000. He has no debt except his mortgage and has put away a substantial emergency fund "just in case" he needs it one day. Johnny makes the maximum contribution to his firm's 401(k) plan. He recently received a $50,000 bonus for his outstanding work on a project at his firm. He comes to you for investment advice for the bonus. He tells you that he is looking for growth with a bit of income, but is not willing to accept much risk and that he plans to keep the investment for at least 10 years. Which is the LEAST suitable recommendation?

Zenith Emerging Markets Fund Although Johnny is young and financially secure, he is seeking a growth investment that carries low risk. Emerging markets funds are aggressive growth funds that carry a high level of risk. This recommendation is clearly inappropriate. An asset allocation fund meets his investment objective, risk profile, and time horizon, because an asset allocation fund is designed to provide capital appreciation, or growth, with a low level of risk. The balanced fund invests in a balance of stocks and bonds for both growth and income. Because stocks and bond prices often move opposite to each other in response to market events, their price movements tend to "balance" each other out - so there is lowered risk. This would also fit Johnny's profile. Finally, the blue chip equities fund gives dividend income and long-term capital gains potential, so this is another good recommendation.

A customer has planned carefully for her retirement. She has adequate monthly income, no mortgage, no credit card debt, and an emergency fund. The customer comes to your office with $25,000 she would like to invest so that she can travel more frequently. She would like an investment that pays higher income and is willing to accept greater risk. Which is the most suitable recommendation for this client?

Zenith High Yield Fund The high yield fund pays a high level of income - as long as the client is willing to assume a much greater risk of default. This client has adequate income, no debt, no mortgage, and has an emergency fund. She is willing to assume greater risk for greater income, so the high yield fund appears to fit the bill. The growth fund invests in equities for capital gains and will not provide current income. The asset allocation fund spreads investments across a variety of asset classes of differing risk categories, so this will dilute income earned. The equity income fund invests in high dividend paying common and preferred stocks; and will also sell options against the positions for extra income. This is not a bad choice, but it will not generate as high a level of income as the high yield fund.

A customer is a 79-year old grandmother who is interested in an investment that will provide for income during her lifetime. She has substantial annual income and no debt. She is interested in reducing her taxes if possible and is not inclined to take risk. Which is the most suitable recommendation for this client?

Zenith Municipal Bond Fund The municipal bond fund will provide this client with the tax-exempt income she seeks during her lifetime. The client's low tolerance for risk also makes the investment appropriate. The risk level of the high yield fund is too high for this client and the distributions are not tax-exempt. The growth and income and value funds do not pay monthly income, nor are they tax-exempt.

Your clients, Joe and Sarah Smith, wish to open accounts to pay for the college educations of their 2-year old twin daughters. The girls were in the hospital for several weeks after they were born, and Joe and Sarah are paying off some large medical bills. Money is tight right now, but the Smiths think it is very important to begin a college savings program. Joe's income is $43,000 annually, and Sarah stays home to care for the twins, although she plans to return to work as a pediatric nurse in three years. After the medical bills are paid and Sarah is back in the workforce, the Smiths plan to make regular investments. At this time, they are looking for a "big bang for the buck" to start the college savings and are willing to assume risk because the girls are so young. Which of the following types of bonds should you consider recommending to the Smiths?

Zero coupon bonds Zero coupon bonds sell at a steep discount, can be either long or short term, and the interest is the difference between the purchase price and face value paid at maturity. Since the children have 16 years until they start college, buying zero coupon bonds with a 16-year maturity is the best choice. They will sell at a steep discount because the maturity is so long, so the cash outlay will not be large. And because the couple earns only $43,000 per year, the annual tax bill on the accretion of the discount (the imputed interest) will be fairly small. The ABC debentures are short term and not suitable for these children since they have about 16 years before college. The XYZ bonds are income bonds (also called adjustment bonds) that are issued to existing bondholders in exchange for their "old" bonds when a company in financial trouble is trying to reorganize. Income bonds only pay interest if a company earns enough "income," and have a very high risk of default, so these are not appropriate recommendations. Finally, municipal bonds are only suitable for high income taxpayers that are in high tax brackets.

Selling mutual funds at an amount just below the amount that qualifies for a reduced sales charge is:

a breakpoint sale Breakpoint sales, or selling mutual funds at a dollar amount just below the amount that qualifies for a reduced sales charge, is a defined FINRA rule violation. If the customer is "close" to a breakpoint, he or she must be told that increasing the purchase amount to that level will qualify for the lower sales charge; and if the customer does not have the additional funds right now to complete the breakpoint, the customer should be offered a Letter of Intent, which gives 13 months to complete the breakpoint.

All of the following are permissible in connection with an offering of mutual fund shares EXCEPT:

a member of the selling group sells fund shares to the public at a discount from POP Because mutual fund shares are a prospectus offering, the issue must be sold to the public at the POP stated in the prospectus. The public may not receive any discounts other than breakpoint formulas in the prospectus. Note that a member firm can sell a mutual fund share to another member at a discount from POP. The fund distributor is a FINRA member firm, that signs up a selling group of other FINRA member firms to market the fund shares. Selling group members can buy the shares from the sponsor at a discount to POP, since this is the only way that they can make a profit when they sell shares to a customer. Thus, the bottom line is that customers buy mutual fund shares from member firms at the POP as stated in the prospectus; a member can only give a discount other than that stated in the prospectus to another member firm - not to a public customer. Note that no-load funds are directly sold from the fund underwriter to the public. They are sold and redeemed at NAV. This does not violate the "no discount to the public" prohibition since there is no sales load on these shares anyway.

A member firm is permitted to sell a mutual fund at a discount from the Public Offering Price to:

another member firm Mutual fund shares must be sold to customers at the POP (Public Offering Price) as stated in the prospectus. They cannot be sold to customers at a discount to POP. In the prospectus will be a breakpoint schedule of reduced sales charges for large dollar purchases. The POP is calculated using the sales charge at the appropriate breakpoint level. The customer cannot be given "better" sales charge than that stated in the prospectus. Note that a member firm can sell a mutual fund to another member at a discount to the POP as stated in the prospectus. The prohibition on giving discounts from POP only applies to customer purchases of mutual funds.

A representative makes the following recommendation to a customer: "You should buy 1000 shares of ABCD stock which is currently trading at $40 because it has the potential to appreciate by 25% in the near term." The customer likes the recommendation, but explains that he only has $4,000 available for investment right now. The representative should tell the customer to:

buy 100 shares of ABCD instead of the recommended amount of 1000 shares FINRA rules prohibit representatives from recommending purchases to customers that are too large - this is called "making recommendations that are beyond the customer's financial capacity."

All of the following recommendations are appropriate for a customer seeking defensive investments EXCEPT:

defense company stocks A defensive investment is one that is relatively unaffected by a cyclical economic downturn. Thus, when the economy is in a recession, these investments are not affected as strongly. They preserve principal and provide stable income with minimal exposure to a downturn in the market cycle. Money market funds are strongly defensive - they really are not subject to business risk or market risk. Utility stocks and food company stocks are also defensive - in a cyclical downtown, electricity use declines, but not by that much (we still need to keep the lights on) and people still have to eat! Defense company stocks are not defensive. The amount of money the federal government spends on buying equipment for armed forces depends on war needs, security needs and fiscal policy. The amount of spending can vary widely from year-to-year.

The primary reason for a registered representative to inquire about a customer's net worth is to:

determine the customer's ability to invest Inquiry about the customer's net worth is used to determine if the customer has funds available for investment. Investment objective, risk tolerance, investment time horizon, and tax status are all items of information needed to make suitable recommendations.

A 35-year old customer in the 15% tax bracket tells her representative that she wants to buy a tax-sheltered investment. The representative explains that this is not suitable, but the customer insists that the representative execute the trade, The representative should:

execute the order, but note his or her exception in the customer account file If the customer tells you to do something, do it! It's the customer's account, not yours. Since you don't agree with the customer's decision, cover your actions by documenting your exception to the trade in the customer file.

A 62-year old investor in the 31% income tax bracket has a net worth of $250,000. She expects to retire in 3 years. She is a conservative investor seeking defensive investments. All of the following recommendations are appropriate EXCEPT:

growth stocks A defensive investment is one that is relatively unaffected by a cyclical economic downturn. Thus, when the economy is in a recession, these investments are not affected as strongly. They preserve principal and provide stable income with minimal exposure to a downturn in the market cycle. Defensive investments include U.S. governments and municipal bonds and investment grade corporate bonds. Equity investments are not as strongly defensive as quality bond investments, but among equity investments, the ones that are less susceptible to the effects of an economic downturn are public utility stocks and blue chip stocks. Growth stocks are not defensive investments. These are companies that do not have a long-term track record and a deep existing customer base. While they grow rapidly in an expanding economy; they fall more rapidly in a declining economy.

A customer that is willing to assume risk in return for achieving a high level of current income would invest in a(n):

high yield bond fund A high yield bond fund invests in bonds rated BB or lower - these are "junk" bonds that pay a much higher yield; but they also have a higher risk of default. Since this customer is willing to assume risk, this is the best recommendation of the choices offered. The emerging markets fund invests in stocks of companies in rapidly growing countries for capital appreciation - there is little or no income. The convertible bond fund gives a lower yield than a non-convertible bond fund; but in return, there is the possibility of capital gains if the market price of the common stocks into which the bonds are convertible increases. A municipal bond fund is only suitable for a customer in a high tax bracket that seeks tax-free income.

Under FINRA rules, "suitability" means that:

investment recommendations made to a customer are appropriate for that investor "Suitability" means that securities which are recommended to a customer are appropriate for that customer.

A wealthy retired customer has no debt and seeks to enhance her income level so that she can engage in her favorite pastime - gambling in Las Vegas. She has a portfolio that has $1,500,000 of investments that is divided evenly between a blue chip stock fund and a Treasury securities fund. Her pension income covers all of her day-to-day needs. She wishes to take $100,000 from her portfolio and use it to generate extra income for "play" and is willing to assume extra risk for the higher return. The best recommendation is to:

liquidate $100,000 of blue chip equities and invest the proceeds in a high-yield bond fund This customer has her portfolio invested in a fairly prudent manner - blue chip stocks for capital appreciation with some income and a reasonable level of safety; and Treasury securities for complete safety with no appreciation potential but a reasonable level of income. To enhance her income level, the best recommendation is to liquidate $100,000 of the blue chip equities fund and invest the proceeds in a high-yield bond fund. This is OK because she is willing to assume a higher level of risk and we are not allocating too much of her portfolio to the risky investment. We would not liquidate $100,000 of the Treasury securities fund because this would reduce current income; and investing in a money market fund is not what the customer wants, since it would provide a low level of current income (with complete safety).

A client, age 68, currently has an investment portfolio worth $600,000, which consists of $200,000 invested in an emerging markets fund, $200,000 invested in a growth fund, and $200,000 invested in a Treasury securities fund. The client informs you that he has just retired and wants to increase the income that he earns from his investments, and that he wants a high level of safety due to his advanced age. The best recommendation would be for the customer to:

liquidate the emerging markets fund and invest the proceeds in an income fund Because the customer wants to increase income and reduce risk, the best choice is to liquidate the emerging markets fund (since this is a speculative holding meant to achieve large capital gains, but also has a high level of market risk) and invest the proceeds in an income fund. The income fund will be primarily invested in quality corporate bonds for income and safety. Liquidating the Treasury securities fund and investing the proceeds in a high yield bond fund will increase potential income, but at the cost of greatly increasing risk - this does not meet the customer's changed objectives. Liquidating the growth fund and investing the proceeds in an aggressive growth fund will also increase risk - again, this does not meet the customer's changed objectives.

A client, age 38, currently has an investment portfolio worth $300,000, which consists of $100,000 invested in a blue chip equities fund, $100,000 invested in a growth fund, and $100,000 invested in a Treasury securities fund. The client informs you that he has just lost his job and will need to liquidate $100,000 to pay for the next 6 months' worth of bills while he is job hunting. He is worried that the economy might be entering a slow period and thinks that finding a job may be difficult, but, so far, he has not lost money on any of his investment holdings. Based on this information, the best recommendation for the customer to raise $100,000 is to:

liquidate the growth fund Because the customer expects the economy to slow, the growth fund will probably show a loss - this would be the one to liquidate now. The blue chip fund is not as susceptible to market risk in an economic turndown; while the Treasury securities fund will probably show a gain in an economic turndown (since market interest rates will be lowered to stimulate the economy, making bond prices rise).

A registered representative that wishes to recommend a variable annuity to a customer must make reasonable efforts to obtain the customer's:

liquidity needs investment time horizon existing assets including insurance holdings To recommend a variable annuity, the representative should make reasonable efforts to obtain the customer's age, annual income, financial situation and needs, investment experience, investment objectives, intended use of the deferred annuity, investment time horizon, existing assets including life insurance, liquidity needs, liquid net worth, risk tolerance, tax status and any other information that is needed to make a recommendations to the customer. Just to make sure that this happens, FINRA requires that the representative sign a statement that this was done.

A customer sells stock out of an account, receiving net proceeds of $38,000. The customer wishes to use the proceeds to buy ACME mutual fund shares. The fund has a breakpoint at $40,000. The customer has no additional funds available for investment. You should recommend that the customer:

sign a Letter of Intent to buy $40,000 of ACME fund The customer needs to invest $40,000 to achieve the breakpoint. The customer has $38,000 now, so the customer must invest an additional $2,000. If the customer signs a Letter of Intent (LOI) to complete the $40,000 breakpoint, the customer has 13 months to make payment of the additional $2,000. In the meantime the customer pays the lower sales charge. If the customer fails to complete the additional payment, the worst that happens is that the customer loses the discount. Note that failing to tell the customer that he or she is close to the "breakpoint" and that they should take advantage of the LOI provision is a violation of FINRA rules known as a "breakpoint" sale.

All of the following mutual fund investments would be appropriate for a customer who seeks both income and growth EXCEPT a(n):

specialty fund An REIT fund invests in Real Estate Investment Trusts. REITs invest in real estate for both income from the properties and capital gains as the properties appreciate in value. A convertible bond fund provides current income from the bond interest payments but also has capital gains potential if the stock into which the bond is convertible increases in price. A balanced fund is invested in a balance of stocks and bonds for both income and growth. A specialty fund invests in companies in one geographic area or industry. It is more of a growth fund and is not likely to provide much current income.

While meeting with a new client, you discover that she is 82 years old and is new to investing. The client is retired, lives on Social Security and a small pension, and does not have a mortgage on her home. She recently sold some property that was her only major asset except for her home. She does not have a will, and her health is poor. As her registered representative, you should:

take particular care in making suitable investments and thoroughly explain any potential investments The responsibility for making appropriate investment recommendations rests on the registered representative. When making a recommendation to a senior citizen, FINRA requires that the representative take extra care in making sure that the senior citizen customer understands the merits and risks of the investment and that the representative take into account the customer's shortened investment time horizon and lower risk tolerance (unless the customer is quite wealthy), which is not the case here. The presence of an accountant or other individual at client meetings does not change that responsibility. Preparing a will for a client is practicing law without a license - you as a representative cannot prepare a will for a customer.