November 2022 CFP: Investments (Pt. 2)

Milton has researched four capital investment projects. The following are the internal rate of return (IRR) and net present value (NPV) of each project: (Project, IRR, NPV) Project 1, 12.0%, $9,861 Project 2, 13.7%, $9,690 Project 3, 11.6%, $7,500 Project 4, 12.9%, $8,379 Assuming he only has the capital to choose one of the projects, which project should Milton select? A) Project 1. B) Project 2. C) Project 3. D) Project 4.

A NPV is a better method for evaluating projects than the IRR method. The NPV method: - Employs more realistic reinvestment rate assumptions. - Is a better indicator of profitability and shareholder wealth. - Mathematically will return the correct accept-or-reject decision regardless of whether the project experiences non-normal cash flows or if differences in project size or timing of cash flows exist.

Robert has a margin account with a national brokerage firm. He has been researching the stock of a publicly-traded company, and is interested in the stock because he believes it will increase in value. Robert would like to employ a leveraged investing technique, but wants to limit his downside risk. Which would be the best strategy for Robert? A) Purchase the stock on margin then place a stop-loss order. B) Buy a put option and sell a call option on the stock. C) Short-sell the stock and purchase a call option. D) Sell a call option on the stock and purchase warrants.

A Purchasing the stock on margin would allow Robert to use leverage to purchase the stock. Placing a stop-loss order would minimize his downside risk. (THINK ABOUT "leverage")

Which of the following statements is correct regarding a put option? A) A put option can only be purchased if the investor has a long position in the underlying stock. B) Purchasing a put option is a leveraged alternative to selling short. C) The put option allows an investor to purchase shares at a percentage of the current FMV over a period of time. D) Individuals owning put options will experience a loss upon downward movements of the stock market.

B A is incorrect. A put option can be purchased on a stock the investor has no interest in. C is incorrect. The put option allows an investor to sell (not purchase) shares at a fixed price over a period of time. D is incorrect. Individuals owning put options will experience a gain upon downward movements of the stock market.

Which of the following represents a true statement regarding index mutual funds and exchange traded funds (ETFs)? A) Index fund shares can be purchased at any time during the day, while ETF shares can only be purchased at the end of the trading day. B) Index funds always trade at net asset value, while ETFs can trade at a discount to their net asset value. C) Index funds can be purchased on margin or shorted, whereas ETFs require the full purchase price and can't be shorted. D) Index funds more readily track the underlying index as compared to an ETF.

B A is incorrect. ETF shares can be purchased at any time during the day, while index fund shares can only be purchased at the end of the trading day. C is incorrect. ETFs can be purchased on margin or shorted, whereas index funds require the full purchase price and can't be shorted. D is incorrect. ETFs more readily track the underlying index as compared to an index fund, because the index fund will incur transaction costs, fund cash flows, and changes to the index.

Walt purchased a $1,000 par value bond that matures in 7 years. The bond has a current yield to maturity of 8%, and has a duration of 5.85 years. Walt believes that market interest rates will decrease by 1% in the future. If Walt's forecast is accurate, his bond investment will increase by: A) 4.43%. B) 5.42%. C) 5.67%. D) 5.85%.

B Duration can be used to solve for a change in bond price when interest rates change. The formula to determine the change in bond price is: Change in bond price = -Duration [Change in y / 1 + y] Change in bond price = -5.85 [-.01 / 1.08] Change in bond price = -5.85 x -.009259 Change in bond price = 5.42%

Greg buys 100 shares of ABC Company stock at a cost of $48 per share. He later purchases a put option on ABC Company stock with a strike price of $42. He paid a premium of $100 for the option. On the date of the put option expiration, ABC stock is trading at $35, and Greg exercises the option. What is Greg's net gain or loss on this transaction? A) $400 gain. B) $700 loss. C) $800 loss. D) $1,300 loss.

B Greg buys the stock = $48*100 = 4,800 Greg buys the option to sell = $42*100 = 4,200 When exercised, his loss is = 4,800 - 4,200 = 600 ADD the premium pd. = 100 Total loss = 700

Crystal approached Rob, a CFP® professional, to determine the most appropriate investment for her portfolio. Crystal is a passive investor who seeks a portfolio that follows the S&P 500. Rob is currently reviewing 4 equity mutual fund choices with the following characteristics: (Fund, Beta, R^2) ABC Fund, 1.25, .80 XYZ Fund, 1.10, .88 QRM Fund, .95, .65 FTY Fund, 1.01, .72 Based on the above information, the most appropriate fund for Crystal is the: A) ABC Fund. B) XYZ Fund. C) FTY Fund. D) QRM Fund.

B R-squared (R2) is a statistical measure that represents the percentage of a fund or security's movements that can be explained by movements in a benchmark index. For fixed-income securities, the benchmark is the T-bill. For equities, the benchmark is the S&P 500. A high R2 value (between 85 and 100) indicates the fund's performance patterns have been in line with the index. The higher the R2 value, the less non-systematic risk present.

George is analyzing his investment portfolio. He has an investment in the XYZ Mutual Fund (the fund). Historical returns of the fund, as well as Treasury bills, are as follows: (Year, XYZ Mutual Fund return, Treasury Bill) 1, 4%, 4% 2, -6%, 1% 3, -6%, 3% 4, 12%, 2% 5, -4%, 5% What is the Sharpe ratio of XYZ Mutual fund? A) -0.423 B) -0.381 C) 0.000 D) 1.3970

B Sharpe ratio = (Avg. return of portfolio - Avg. rf rate)/ Std. Deviation of portfolio) Avg return of portfolio = 0 Avg rf rate = 3 Std. Deviation of portfolio = 7.874

Ron repositions his assets during an economic downturn. Ron is exhibiting the behaviors of: A) Dollar cost averaging. B) Tactical asset allocation. C) Strategic asset allocation. D) Value investing.

B Tactical asset allocation is an active management portfolio strategy that rebalances the percentage of assets held in various categories in order to take advantage of market pricing anomalies or strong market sectors. A is incorrect. Dollar cost averaging is a strategy for accumulating wealth. It involves purchasing during market highs and lows. C is incorrect. Strategic asset allocation is more of a "buy and hold" strategy. D is incorrect. Value investing represents the purchasing of stock with low Price/Equity ratios to hold over a long time horizon.

Which benchmark is best to capture the overall U.S. Market as a whole? A) S&P 500. B) MSCI EAFE. C) Wilshire 5000. D) Russell 2000.

C

Which of the following combinations of risk can be reduced through appropriate diversification? A) Market and exchange rate risk. B) Purchasing power risk and interest rate risk. C) Business and financial risk. D) Inflation risk and reinvestment rate risk.

C Business risk and financial risk are unsystematic risks that can be reduced through diversification. The following are systematic risks, which cannot be reduced through diversification (PRIME): - Purchasing power (inflation) risk - Reinvestment rate risk - Interest rate risk - Market risk - Exchange rate risk

Which of the following investments would be most appropriate for an investor wanting to maintain purchasing power while minimizing interest rate risk? A) Laddered short-term CD portfolio. B) Treasury bonds. C) Conservative large-value mutual funds. D) Collateralized mortgage obligations.

C CDs, Treasury bonds, and CMOs all have interest rate risk.

A client is determining which of a series of projects to invest in. The products have a $100,000 cost of entry. The client is comfortable with the market risk necessary to generate a 12% rate of return in today's economic environment. Which of the following should a CFP® professional recommend for the client? A) Project A, with a net present value of $500 using a 10% discount rate. B) Project B, with a net present value of $600 using a 11% discount rate C) Project C, with a net present value of $800 using a 12% discount rate D) Project D, with a net present value of $0 using a 14% discount rate

C It is not necessary to have the individual cashflows to answer this question. The ending NPV is given in each choice. Look to the highest NPV and ensure the level of risk is acceptable. NPV of zero is a break even, meaning you are earning the IRR. D is incorrect. An increased return comes with increased risk. The risk return the client was comfortable with was 12%.

Gabby, a CFP® professional, is working with Debby, a retiree. Debby has a concentrated position in a highly appreciated growth stock, which makes up the majority of her assets. Debby requires income from her portfolio but is hesitant to sell her stock position. Which of the following strategies should Gabby recommend that would provide the least amount of risk to the retiree? A) Purchase put options on the stock. B) Sell covered puts on the stock position. C) Sell covered calls on the stock position. D) Sell the stock position and purchase an immediate annuity.

C Selling covered call options will generate income for Gabby's client. A "covered call" is an income-producing strategy where you sell, or "write", call options against shares of stock you already own. A is incorrect. Put options will not provide income. B is incorrect. Covered puts would create additional portfolio risk if the position decreased in value. D is incorrect. Purchasing an immediate annuity is inconsistent with the fact pattern presented.

Jamal purchased stock today for $100 per share. Last year, the stock paid a dividend of $2 per share. What would be Jamal's holding period return if he sold the stock for $108 one year from today, and the company increased its dividend by 5% during the year? A) 5.9%. B) 10%. C) 10.1%. D) 11.3%.

C Since the dividend grew by 5% during the current year, the dividend would be $2.10 ($2 x 1.05). The holding period return is calculated using the following formula: HPR = [Selling Price - Purchase Price +/- Cash Flows]/Purchase Price Jamal's holding period return = ($108 - $100 + $2.10) / $100 Jamal's holding period return = ($10.10) / $100 Jamal's holding period return = 10.1%

Which of the following would be the best choice for an investor interested in controlling volatility? A) A single stock with a standard deviation of 7%. B) Two equally-weighted investments with a standard deviation of 9% and a correlation of 0. C) Two equally-weighted investments with a standard deviation of 9% and a correlation of -1. D) Two equally-weighted investments with a standard deviation of 9% and a correlation of 1.

C The best way to control volatility is to find investments that are negatively correlated. When assets are negatively correlated, they will move opposite each other.

Rank the following investments in order of expected volatility, from least volatile to most volatile: Bankers acceptances Treasury bills Commercial paper Treasury notes Agency issues A) Treasury bills, Treasury notes, Commercial paper, Bankers acceptances, Agency issues. B) Treasury notes, Treasury bills, Commercial Paper, Agency Issues, Bankers acceptances. C) Treasury bills, Commercial Paper, Bankers acceptances, Treasury notes, Agency issues. D) Agency issues, Treasury bills, Treasury notes, Bankers acceptances, Commercial paper.

C Treasury bills are short duration and backed by the full faith and credit of the United States government. Treasury bills have 4, 13 and 26-week durations. They are least volatile. Commercial Paper is a money market instrument with a 270-day maturity. Bankers Acceptances are money market instruments durations less than or equal to 12 months. Treasury notes have 1-10 year maturities and Treasury bonds have maturities greater than 10 years. Agency issues are not backed by the full faith of the federal government (though in practicality they may be) and are slightly more volatile and pay a higher yield. A is incorrect. Agency issues are the most volatile asset of those given. B is incorrect. Treasury bills are the least volatile asset of those given. D is incorrect. Treasury bills are the least volatile asset of those given.

Jeremy Fulton, CFP® is working with his client, Sally, who recently received an inheritance. Sally is very religious and does not want to invest in any alcohol-related securities. Which of the following represents the best investment alternative for Jeremy to recommend to Sally? A) 25% small cap fund, 75% large cap fund. B) 100% S&P 500 index fund. C) 70% individual stocks, 30% individual bonds. D) 100% Dow Jones index fund.

C Use of individual stocks and bonds allows Sally to pick and choose the companies she invests in. A is incorrect. Although small cap and large cap funds would provide diversification, it is likely the funds would contain one or more alcohol-related stocks. B is incorrect. Index funds would potentially contain one or more alcohol-related stocks. D is incorrect. Index funds would potentially contain one or more alcohol-related stocks.

Which of the following would most likely be considered a cash equivalent? A) Zero coupon municipal bond. B) Global bond mutual fund. C) Four-year certificate of deposit, due in two years. D) Treasury bill.

D A Treasury bill could be liquidated immediately without any risk of loss of principal, or penalty. A certificate of deposit due in two years would result in a penalty if liquidated currently and is therefore less likely to be considered a cash equivalent than a Treasury bill.

If a bond is trading at its par value, the internal rate of return (IRR) of the bond is equal to the bond's: I. Yield to call. II. Current yield. III. Coupon rate. IV. Yield to maturity. A) IV only. B) I and II. C) III and IV. D) I, II, III and IV.

D A bond with a price equal to its par value creates a time value of money situation where the present value is equal to the future value. When this is the case, the coupon rate and yield to maturity will be the same. In addition, the yield to call equals the yield to maturity when no call premium is provided.

Kent and Cassie, a married couple, have taxable income of $125,000. A portion of their taxable income is being generated by the following investments: - $100,000 cash - $325,000 short-term bond fund - $230,000 high-yield bond fund They are interested in possibly repositioning some of the investments to reduce their taxable income. A CFP®professional should recommend they: A) Leave the portfolio as is, since their yield may be compromised with alternative investments. B) Invest in an S Corporation with built-in losses. C) Make annual contributions to Roth IRAs. D) Invest in a municipal bond fund.

D A is incorrect. Leaving the portfolio intact will not help them achieve their goal of reducing taxable income. B is incorrect. An investment in an S corporation would be considered a passive activity investment, and the losses would only be deductible against passive income. C is incorrect. Roth IRA contributions are not deductible and therefore would not reduce their taxable income.

Todd is an aggressive investor who invests exclusively in stocks. He studies odd-lot theory and head-and-shoulder charting patterns when selecting appropriate stocks for investment. He also knows several members of the board of directors of a publicly-traded company and believes inside information he obtains from them will help with his purchase and sell decisions. Todd's use of odd-lot theory and head-and-shoulder charting patterns is consistent with: A) The semi-strong form of the efficient market hypothesis. B) The weak and semi-strong forms of the efficient market hypothesis. C) The strong form of the efficient market hypothesis. D) None of the forms of the efficient market hypothesis.

D Odd-lot theory and the January effect are both examples of technical analysis. No form of the efficient market hypothesis supports technical analysis.

Michael currently owns one stock, ABC Company, in his portfolio. XYZ Company has the same expected rate of return as ABC Company, and has a low correlation to ABC Company. If the investor adds XYZ Company to his portfolio: A) The expected return of the portfolio will increase, and the standard deviation of the portfolio will increase. B) The expected return of the portfolio will increase, and the standard deviation of the portfolio will decrease. C) The expected return of the portfolio will decrease, and the standard deviation of the portfolio will remain the same. D) The expected return of the portfolio will remain the same, and the standard deviation of the portfolio will decrease.

D Since both expected rates of return are the same, the portfolio expected rate of return will remain the same. Since Stock B has a low correlation to Stock A, the addition of Stock B to the portfolio will reduce the portfolio standard deviation.

Cara has entered into a comprehensive planning engagement with Stan, a CFP® professional and registered representative. The letter of engagement that Cara signed indicates that Stan will monitor his investment recommendations on an annual basis, every June. In June of the current year, Cara received the update from Stan's annual review. In September of the current year, the mutual funds that Stan recommended experienced a 20% decline in value due to a market selloff. What additional responsibilities does Stan owe to Cara as a result of the poor investment performance? A) Stan must revise the asset allocation within 30 days. B) Stan must update the letter of engagement to include more frequent monitoring of the investment portfolio. C) Stan must return a portion of his fee since Cara's portfolio lost money. D) Stan has no additional responsibilities with respect to the engagement.

D Since the monitoring standards were established and agreed upon in the letter of engagement, and Stan has satisfied those responsibilities, he is under no further obligation to Cara.