S66 Unit 17 (Client Profile) Quiz
A couple, ages 63 and 66, are long-time clients of your firm and are in good health. They plan to retire from gainful employment in 4 years and wish to discuss decumulation strategies. One of the important factors to consider is the time horizon for this couple. Which of the following would be the best estimate to use? A) 4 years B) 25 years C) 10 years D) 8 years
B) 25 years Explanation Decumulation is the opposite of accumulation. Instead of focusing on how to increase the assets, the focus is on how to make sure they last as long as required. Just how long is that time horizon? Until the death of the second party. Today's statistics would indicate that a couple of these ages would likely have at least one of the two live another 25 years. LO 17.c
Your client often makes irrational financial decisions because she bases her decisions on information that should have no influence on the decision at hand. The client's behavior is known as A) herd mentality. B) anchoring. C) overconfidence. D) confirmation bias.
B) anchoring. Explanation Making irrational decisions based on information that should have no influence on the decision at hand is known as anchoring. Herd mentality is the tendency to follow the actions of a larger group, whether rational or not. Confirmation bias is the tendency to pay attention to information that supports one's preconceived opinions while disregarding accurate, unsupportive information. Overconfidence occurs when an investor considers her abilities to be much better than they actually are. LO 17.a
Caroline considers her investment skills to be much greater than they actually are. She takes credit for many decisions that have positive results but blames the economy when her investments do poorly. Caroline's behavior is an example of A) anchoring. B) confirmation bias. C) overconfidence. D) regret aversion.
C) overconfidence. Explanation Caroline's behavior is an example of overconfidence. Confirmation bias is paying attention to information that supports a preconceived opinion and poorly made decision, while disregarding accurate, unsupportive information. Anchoring is making irrational decisions based on information that should have no influence on the decision at hand. Regret aversion is when the investor prepares herself in such a way as to avoid distress over an adverse outcome. LO 17.a
As part of your annual review for clients, you perform a net worth computation. You have computed a specific client's net worth at $500,000. This client calls you and asks what his net worth will be after withdrawing $4,000 from his savings account to pay off credit cards, taking another $6,000 to deposit to his IRA and buying a $25,000 home theater system using store credit. You would respond that the client's net worth is now A) $491,000 B) $466,000 C) $475,000 D) $500,000
D) $500,000 Explanation In each case, we have an asset offsetting a liability so there is no change to the net worth. LO 17.a
A client is risk averse and is planning on retiring in 16 years. As the client's investment adviser, which of the following would you recommend? A) A high-yield bond fund B) A diversified open-end investment company concentrating in small-cap stocks C) A government bond fund D) 50% in an S&P 500 index fund; 50% in a portfolio of high-quality bonds
D) 50% in an S&P 500 index fund; 50% in a portfolio of high-quality bonds Explanation Even though the government bond fund carries less market risk, with a 16-year retirement goal, some inflation protection is necessary. The index fund carries some market risk, but does offer purchasing power protection. The 50/50 mix would seem to be most appropriate. LO 17.d
A client excitedly calls his investment adviser with the news that he is now going to handle his own investments. "I just read some great investment books and now I know what to do." Based on the study of behavioral finance, it would appear that this individual is A) conservative. B) anchored. C) following the herd. D) overconfident.
D) overconfident. Explanation The behavioral finance bias of overconfidence refers to the observation that experienced (and even some rookie) investors tend to overestimate their ability and the accuracy of the information available to them. LO 17.a
Which of the following funds would you recommend to a moderate-risk client seeking long-term capital gains who also values professional stock selection? A) A small-cap growth fund B) A large-cap growth fund C) An international index fund D) S&P 500 Index fund
B) A large-cap growth fund Explanation A large-cap growth fund is the most appropriate choice for a moderate-risk client because large capitalization stocks are generally less volatile than small-cap stocks and provide long-term capital growth. This is a more appropriate choice than the index fund because there is no stock selection there, only investing to parallel the index. LO 17.d
Which of the following is least likely to be considered an investment constraint when preparing an investment policy statement? A) Liquidity needs B) Legal and regulatory factors C) Risk tolerance D) Tax concerns
C) Risk tolerance Explanation The commonly tested investment constraints are: liquidity needs, time horizon, taxes, legal and regulatory factors, and unique needs and preferences. Risk tolerance is used to help determine what investment objectives will best meet the investor's goals. LO 17.c
Which of the following items would be found on a family balance sheet? A) Dividends and interest received B) Spouse's engagement ring C) Income taxes paid D) Annual salary
B) Spouse's engagement ring Explanation A balance sheet, whether for a family or a business, shows assets and liabilities, not income and expenses. The ring is certainly an asset; the others are income or expenses. LO 17.a
One problem facing agent and client alike is determining how much life insurance is necessary to meet future needs. One tool that is useful for making that determination is A) a mortality table B) a life insurance capital needs analysis C) a premium purchase analysis D) a statement of beneficiary needs
B) a life insurance capital needs analysis Explanation A life insurance capital needs analysis takes into consideration the future needs of the insured and family and then factors in how much needs to be filled in by life insurance. LO 17.c
Pemberton bought a stock share at $50 and wants to earn a profit, so he decided he will never sell it below $52. The company has now underperformed for multiple quarters as per street analysts, and the stock is down to $48. Pemberton continues to hold the stock in line with his original plan. In this case, Pemberton may be exhibiting A) anchoring bias. B) regret aversion bias. C) overconfidence bias. D) herding bias.
A) anchoring bias. Explanation In behavioral finance, an anchoring bias is when people tend to base their decisions on reference points that are often arbitrarily chosen. In this case, Pemberton "anchored" his selling price to the $50 he paid for it and will not recognize changes in the market. LO 17.a
If a customer is in the 15% federal income tax bracket and his main investment objective is current income, which of the following securities should the agent recommend? A) Zero-coupon bond. B) Investment-grade corporate bond. C) City of Milwaukee GO bond. D) U.S. government bond.
B) Investment-grade corporate bond. Explanation The investor is in a low tax bracket, so the tax-exempt municipal bond is not a suitable investment. To maximize income, the best recommendation is the corporate bond which offers a higher yield than a government bond with a similar maturity. LO 17.d
The study of why people often make decisions using rules of thumb rather than rational analysis, basing those decisions on factors economists traditionally don't consider, such as fairness, past events, and aversion to loss, is known as A) behavioral finance B) irrational finance C) systematic risk D) risk tolerance
A) behavioral finance Explanation Today, through the study of behavioral finance, it is accepted that behavioral biases can cause investors to make financial decisions that are irrational. LO 17.a
Which of the following would be appropriate actions when using a model portfolio for a client? I) Gather information from the client to establish his risk tolerance, time horizon, and investment expectations. II) Select a portfolio mix that is appropriate for the client based upon his risk tolerance, time horizon, and investment expectations. III) Place the client's assets into the model portfolio regardless of his comfort level with your recommendation. IV) Periodically review the portfolio to determine if any changes or modifications are necessary. A) I, II, and IV B) I, II, and III C) I, II, III, and IV D) I and II
A) I, II, and IV Explanation Gathering information relating to your client's risk tolerance, time horizon and objectives would all be prudent steps in assisting your clients in the establishment of a model portfolio. It would never be acceptable to place a client into an investment portfolio model that they were uncomfortable with, even if you have determined it to be suitable and appropriate. LO 17.c
The Jones family has scheduled an initial visit with a financial planner. Mr. Jones has an annual salary of $70,000, and this is their first attempt at financial planning. Which of the following should be the first step taken by the financial planner? A) Pay off credit card debt B) Determine a reasonable fee for designing the plan C) Establish an emergency fund D) Set goals and dates for reaching them
C) Establish an emergency fund Explanation There are many questions on the exam where you will be forced to choose between two possible answers, only one of which is correct. In many cases, it is strictly a matter of opinion, but only NASAA's opinion counts. This is one of them. Goal setting is important, but the regulators feel that the first step in any plan is making sure that there is a "rainy day" fund. We can argue about that because some will say that a good plan can be used to establish that fund where none has existed before. But, please go with the right choice. LO 17.a
An elderly widow with no independent income wishes to invest the proceeds from her recently deceased husband's life insurance. Which of the following would be the most suitable recommendation? A) Oil and gas exploration program that you know is going to strike B) Municipal bonds C) High-grade corporate bond mutual fund D) Call options
C) High-grade corporate bond mutual fund Explanation This customer needs income. Of the answers provided, the bond fund would be the most suitable because it would provide income while maintaining relative safety. While the municipal bonds are probably safer, the benefits of their tax-free income would probably be lost on a client with no independent income. LO 17.c
Your married customers are both 42 years old, have 2 children ages 14 and 12, and have spent the past 10 years accumulating money to provide for their children's education. Their oldest child will enter college in 4 years, and the customers are very cautious investors. If they need a safe investment that provides regular income to help them meet tuition payments, which of the following mutual funds is the most suitable for these customers? A) ABC Stock Index Fund B) ATF Overseas Opportunities Fund C) RST Balanced Fund D) LMN Investment-Grade Bond Fund
D) LMN Investment-Grade Bond Fund Explanation These clients cannot afford a downturn in the stock market between now and the time they want to send their children to college. An investment-grade bond fund will provide the income and safety required for accumulating additional funds for college expenses. LO 17.d
Tactical Evaluation and Research (TEAR), a federal covered investment adviser, suggests the purchase of stock in a major tobacco company. The client explains that he doesn't want to invest in tobacco stocks because his father passed away from lung cancer. What kind of reason is this? A) Geographic B) Economic C) Environmental D) Values
D) Values Explanation Because of the negative association with tobacco, this client's values are such that he would avoid owning stock in a tobacco company. Why not environmental? That isn't specific enough because growing tobacco is not an environmental issue and this client's personal experience has shaped his values. LO 17.a
For a trust account not seeking appreciation, which of the following would be recommended? A) Common stock, preferred stock, and debentures B) Highly rated, fixed-income securities C) Large-cap common and preferred stocks D) Common stock in small, highly profitable companies
B) Highly rated, fixed-income securities Explanation The only choice that is prudent and does not have a goal of appreciation is the purchase of highly rated, fixed-income securities. LO 17.d
In projecting future cash requirements, one of the tools is a capital needs analysis. When doing one, all of the following would be considered capital needs except A) a home equity loan with a $15,000 balance B) a $20,000 loan for undergraduate school with a due date in 6 years C) rolling over a 401(k) into an IRA D) a $100,000 loan for law school with a due date in 10 years
C) rolling over a 401(k) into an IRA Explanation A capital needs analysis attempts to determine money that would be needed in the event of an individual's sudden passing. Included would be any outstanding debt obligations, regardless of when they are due (they will have to be paid off sometime). However, an asset such as the 401(k) is not a need; it is something that will help meet the need. LO 17.c
An investment adviser representative prepares a detailed portfolio restructuring for a new client. The client is not impressed with the recommendation, and at least to the IAR, it appears that the rejection is more due to a lack of understanding than a valid dislike. What should be the first step taken by the IAR? A) Prepare a new set of recommendations that will hopefully be received more favorably by the client. B) Attempt to educate the client as to what this portfolio is trying to accomplish for the client while at the same time recognizing that the final decision is clearly in the hands of the client. C) Suggest that if the client will not follow the IAR's recommendations, it would be best to engage the services of another firm. D) Go ahead with the recommendation anyway because the client's lack of understanding should not stand in the way of potentially superior results.
B) Attempt to educate the client as to what this portfolio is trying to accomplish for the client while at the same time recognizing that the final decision is clearly in the hands of the client. Explanation Even when the IAR is convinced that the optimal recommendations have been made, the final decision is always that of the client. However, there is nothing in the laws or policies dealing with ethical conduct that prohibit the IAR from attempting to "sell" the client, especially through an educational approach. LO 17.d
An investment adviser representative (IAR) prepares a comprehensive financial plan for a new client. Part of the plan includes detailed portfolio recommendations. Seeing a negative reaction from the client, it becomes obvious to the IAR that he is dealing with an ignorant person who is filled with many market misconceptions. It would be reasonable for the IAR to A) drop the client B) attempt to educate the client to correct those misconceptions, but leave the final decision up to the client C) tell the client he will make some changes, but keep the original portfolio because that really is in the client's best interest D) prepare a new portfolio that is more in line with what the customer has indicated he is comfortable with
B) attempt to educate the client to correct those misconceptions, but leave the final decision up to the client Explanation All decisions are ultimately up to the client, but there is nothing wrong with the IAR attempting to educate the client, especially when it could lead to greater investment success. LO 17.d
One of your clients has a tendency to follow the actions of a larger group of people when making financial decisions, whether those actions are rational or not. The client's behavior is an example of A) anchoring. B) overconfidence. C) confirmation bias. D) herd mentality.
D) herd mentality. Explanation This behavior is known as herd mentality. Confirmation bias is the tendency to pay attention to information that supports one's preconceived opinions, while disregarding accurate, unsupportive information. Overconfidence occurs when an investor considers his abilities to be much better than they actually are. Anchoring occurs when a person makes an irrational decision based on information that should have no influence on the decision. LO 17.a
