Suitability

Which of the following investment portfolios is LEAST liquid? A An aggressive growth fund B A U.S. Government securities fund C A money market fund D An income fund

The best answer is A. Aggressive growth stocks are usually too small to be NYSE listed; they might be found on NASDAQ, which has lower listing standards than the NYSE; or on the OTCBB - the Over-the-Counter Bulletin Board - which has no listing standards. The OTCBB is a much less liquid market than NASDAQ; and NASDAQ's liquidity is not as good as the NYSE's. Thus, aggressive growth stocks would be the least liquid securities of the choices offered. Government securities and money market securities are actively traded and are extremely liquid. Income funds are composed of high yielding preferred stocks and bonds. These are more liquid than aggressive growth stocks, though not as liquid as NYSE listed issues.

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

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

An investor has $50,000 that she wishes to invest for her child's college expenses, which the child starts next year. The most suitable recommendation to the client is to invest the funds in: A Treasury bills B Intermediate-term bonds maturing in 5 years C Long-term bonds of blue chip companies maturing in 10-30 years D a mutual fund based on the S&P 500 Index

The best answer is A. The client will need access to the funds in 1 year to start paying for college. The client cannot afford an investment loss, so the safest most liquid security listed as a choice is Treasury bills - which have a maximum 1-year maturity limiting interest rate risk and are government guaranteed, limiting credit risk.

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

The best answer is A. A growth investor buys a stock based upon demonstrated growth in earnings or sales over time. The theory is that such companies can continue to grow rapidly, and therefore should command a higher market price. Growth Investing Growth investors select stocks based on growth in sales, earnings, or share price. Growth investors believe that high growth rates in sales, earnings, and share price predict that this trend will continue in the future.

If a portfolio manager's market sentiment is bullish, then which of the following are appropriate actions? I Cash positions will be decreased II Cash positions will be increased III Investments in stock positions will be decreased IV Investments in stock positions will be increased A I and III B I and IV C II and III D II and IV

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

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

The best answer is B. Under a constant ratio plan, a portfolio manager sets a fixed percentage level (say 70% of total asset value) to be maintained in equity securities. If the value rises above 70%, the excess is sold, and invested in debt securities. Conversely, if the equity market value drops below 70% of the portfolio, bonds are liquidated and invested in equities to bring the equity balance to the constant 70%.

Which statements are TRUE about asset classes and investment time horizons? I Equity investments are the better choice for short term time horizons II Interest bearing investments are the better choice for short term time horizons III Equity investments are the better choice for long term time horizons IV Interest bearing investments are the better choice for long term time horizons A I and III B I and IV C II and III D II and IV

The best answer is C. Equity investments typically produce a higher rate of return with higher volatility - thus a long time horizon is needed to achieve consistent results with equity investments. Interest bearing investments produce a lower rate of return with lower volatility - thus they are suitable for portfolios with short time horizons.

A customer has a term loan that is maturing in 3 years in the amount of $100,000. The customer has the cash now, and wants to know the best investment to make for the 3 years until the loan payment is due. The BEST recommendation is to buy: A Blue chip stocks B AA rated debentures with a 3 year maturity C Treasury notes maturing in 3 years D AA general obligation bonds maturing in 3 years

The best answer is C. Treasury securities have no credit risk, so this is the best choice. The customer knows he will get back the $100,000 in 3 years, plus will have earned interest every 6 months until maturity. A corporate debenture that is rated AA sounds good, but companies can get into business trouble quickly and the bonds could be downgraded in 3 years. AA general obligation bonds are safe (though not as safe as Treasuries), but their yield is lower, so they are not the best choice. Stocks prices can be volatile, so this is another bad choice.

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

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

A 70-year old client wants to invest in U.S. Treasury securities. When performing the suitability determination, the client informs the registered representative that he is looking for after-tax income, liquidity, and to avoid market risk. The registered representative should be LEAST concerned with the: A client's tax bracket B client's age C coupon of recommended Treasury securities D maturity of recommended Treasury securities

The best answer is B. Since Treasury securities are the safest security, they are an appropriate recommendation for a 70-year old client. So age really is not a concern with this recommendation. The client's tax bracket is a concern because the income is Federally taxable. If the client is in the highest tax bracket, maybe municipal bonds would be a better recommendation. The coupon of the recommended Treasury securities is important because this client wants income. Regarding the maturity of the recommended Treasury securities, the recommendation of a 30-year bond as opposed to a shorter-term investment could subject the customer to a high level of market risk (loss of market value if interest rates rise). This is another concern, since the customer wants to avoid market risk.

A 60-year old widow is looking for an investment that will provide safety of principal and a moderate level of income. All of the following recommendations are suitable EXCEPT a(n): A Income mutual fund B Income bond C U.S. Government bond D U.S. Government bond fund

The best answer is B. An income bond is a corporate bond that only pays interest if the corporation earns enough income - so this certainly does not meet the widow's requirement for income. Income mutual funds invest in a diversified portfolio of high interest paying bonds and high dividend paying stocks - this is suitable. U.S. Government bonds or funds holding these securities, provide both income and safety, and thus are suitable as well.

A new client who is in the lowest tax bracket has 2 young children. He has just inherited $10,000 and wants to use the money to invest for the college education of both children. The client has never invested before and states that he wants an investment with no risk. What recommendation is appropriate? A Municipal bonds B Treasury bills C Municipal bond fund D Blue chip stocks

The best answer is B. The key wording here is that the customer wants "no risk." The only risk-free security offered as a choice is T-Bills. It could be argued that blue chip stocks would be a better choice to build a college education fund over a long-term time frame, but they are not risk free. Also note that municipal bonds are not appropriate because the customer is in the lowest tax bracket.

A customer account holds the following: 10% Market Index-Linked CDs 20% Plain Vanilla CMOs 20% ACME Drug Company shares 10% REITs 25% Health Care Sector ETFs 15% Growth Fund Shares This portfolio is MOST susceptible to which risk? A market risk B business risk C interest rate risk D purchasing power risk

The best answer is B. This portfolio is concentrated in the Health Care sector, with 25% of the portfolio being in Heath Care ETFs and 20% in a drug company. A portfolio concentrated in one stock or industry is susceptible to business risk - the risk that the business may turn sour. For drug companies, this can result from existing profitable drugs losing patent protection, so prices and profitability drops; class-action lawsuits for selling dangerous drugs, etc.

A growth investor would consider a company's: A Price / Earnings ratio B Price / Book Value ratio C Stock price appreciation rate D Market share

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

A trader liquidates an exchange listed stock position and invests the proceeds in an exchange listed stock index fund. The trader has reduced which risk? A Call risk B Inflation risk C Liquidity risk D Capital risk

The best answer is D. Capital risk is simply the risk of losing money. By increasing the number of stocks in a portfolio, this risk is reduced through diversification. This is a major advantage of investing in stock index funds. Call risk does not apply to stocks (because common stocks are non-callable). Stocks, whether held individually or in an index fund, are not as susceptible to inflation (purchasing power) risk as bonds. In times of inflation, corporations can raise prices and maintain profitability. Liquidity risk is the risk that a security can only be sold by incurring large transaction costs and is essentially not applicable to exchange listed securities because the market is so active.

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

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

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

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

What portfolio construction is most appropriate for a retired school teacher who is age 60? A 100% common stocks B 40% common stock / 60% bonds C 60% common stock / 40% bonds D 100% bonds

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

A customer who is retired wants to select an investment that is marketable, and that provides the highest rate of return. The BEST choice would be to recommend: A Treasury Bills B Treasury Notes C Investment Grade Preferred Stock D Certificates of Deposit

The best answer is C. Certificates of Deposit are non-negotiable - they are non-marketable, so this does not meet the client's needs. Preferred stock is marketable, and Treasury securities are extremely marketable, so any of these meet this requirement. However, investment grade preferred stock issued by a top-shelf corporation will provide a higher investment return than ultra-safe Treasury securities, making this the best choice.

Which asset allocation is BEST for a 35-year old single risk tolerant investor looking to achieve the highest returns? A 25% Stocks / 25% Bonds / 25% REITs / 25% Money Markets B 50% Stocks / 50% Bonds C 60% Stocks / 40% Bonds D 95% Stocks / 5% Money Markets

The best answer is D. The investor is 35 years old, single and risk tolerant. While an argument could be made for any one of the choices offered, the one choice that is clearly different from the others is Choice D - 95% equities and 5% money market instruments. This gives both the greatest growth potential for a relatively young investor along with the greatest risk - and this investor is risk tolerant. The other choices have a fairly large portion of the portfolio allocated to bonds, which do not have any growth potential over a long-term investment time horizon, but also have much lower risk.

An 85-year old retired client has living expenses of $15,000 per year. His portfolio is currently allocated:50% Money Market Fund40% Treasuries Yielding 1.20%10% EquitiesThe customer is complaining that he is not earning enough from his portfolio to meet monthly living expenses. The BEST recommendation to the customer is to: A do nothing B wait until interest rates rise before making any changes C liquidate half of the money market fund and invest it in 5 year corporate debentures yielding 2.70% D liquidate half of the money market fund and invest it in commodity futures

The best answer is C. This customer is looking for more income to live out his remaining years. The only choice offered that provides more income is Choice C.

The overall economic performance of developing countries is expected to outpace that of the United States over the coming years. A customer that wishes to profit from this should receive which recommendation and accompanying risk disclosures? A The customer should be recommended a special situations fund, as long as the customer is willing to assume regulatory risk and market risk B The customer should be recommended a specialty fund, as long as the customer is willing to assume credit risk and extension risk C The customer should be recommended an emerging markets fund, as long as the customer is willing to assume political risk and exchange rate risk D The customer should be recommended a sector fund, as long as the customer is willing to assume unsystematic risk and market risk

The best answer is C. A special situations fund invests in companies that are in turnaround or takeover situations. A specialty fund invests in one industry or geographic area, so this is a possible choice. A sector fund invests in one industry sector. An emerging markets fund invests in securities of countries that are rapidly developing (e.g., a "BRIC" fund - Brazil, Russia, India and China). This is the best of the choices offered.

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

The best answer is A. Value investors believe that the market is not completely efficient at pricing securities and that undervalued securities can be found in the marketplace. Once the market realizes the true worth of these undervalued companies, their prices should rise at a greater rate than the general market.

Investing in a manner that will emulate the performance of the S&P 500 Index as closely as possible is an example of: A active management B passive management C fundamental analysis D technical analysis

The best answer is B. Passive asset management is simply matching a portfolio composition to a recognized index. This is also called benchmarking. The intent is to earn the return of the index, with the theory being that no one can outperform the market over a long period of time. In contrast, active asset management employs a manager to actively decide what to buy and what to sell to produce a superior return. Active management is more expensive than passive management.

A 60-year old man, whose investment objectives are income and capital gains, wishes to buy securities that allow for liquidity during the trading day. The BEST recommendation would be: A ETFs B ETNs C UITs D Mutual Funds

The best answer is A. Both ETFs (Exchange Traded Funds) and ETNs (Exchange Traded Notes) trade, so they allow for liquidity during the trading day. There is no trading of mutual funds and UITs - these are redeemable securities. Mutual funds can be redeemed at NAV based that the close of the trading day; UITs are redeemable with the marketing agent, who will buy them at current NAV and remarket them to another investor for their remaining value. Therefore, we are down to the choice of an ETN or an ETF. This customer is looking for capital gains. This is possible with an ETF, because it holds a portfolio of equity securities that can grow in value over time. An ETN is a fixed income structured product that trades - fixed income securities are not designed to provide capital gains.

Customers A, B, C and D have their portfolio assets allocated as follows: ABCD Money Markets15%5%5%0% Treasury Bonds40%10%20%20% Speculative Bonds10%30%10%30% Blue Chip Equities15%15%20%10% Small Cap. Equities10%10%30%5% Emerging Markets10%20%10%30% REITs0%10%5%5% Which customer's portfolio is MOST susceptible to a cyclical economic downturn? A Customer A B Customer B C Customer C D Customer D

The best answer is C. In a cyclical economic downturn, the hardest hit asset group is stocks. Since earnings fall greatly in a downturn, so do stock prices. Also hard hit are speculative grade bonds, which can default. Portfolio C is the one that is most heavily invested in equities, so it would suffer the most in an economic downturn.

A customer has a $4,000,000 portfolio that is invested in the following: $1,000,000 Blue Chip Stocks $1,000,000 Technology Stocks $1,000,000 Long Term Investment Grade Bonds $1,000,000 High Yield Bonds If the economy enters into a recession, the securities which will suffer the greatest price decline are likely to be the: I Blue Chip Stocks II Technology Stocks III Investment Grade Bonds IV High Yield Bonds A I and III B I and IV C II and III D II and IV

The best answer is D. Blue chip companies and investment grade bonds have the greatest "financial strength" and are able to make it through a recession without taking a big value loss. On the other hand, technology stocks and high yield bonds typically suffer big losses in a recession.

The setting of specific goals for an investment plan to be created for a customer is known as: A Strategic asset management B Tactical asset management C Dollar cost averaging D Portfolio rebalancing

The best answer is A. Strategic asset management is the setting of the investment "strategy" under an asset allocation scheme. Tactical asset management is the permitted variation to the established strategy, to take advantage of market opportunities. Dollar cost averaging is the periodic (say monthly) investment of a fixed dollar amount into a given security. By using dollar cost averaging, the average cost per share purchased can be lower than the arithmetical average cost of the security over the same time frame - as long as the security's price has been moving up and down (as the security's price drops, the fixed periodic dollar amount buys proportionately more shares than when the security's price rises). Portfolio rebalancing is used in an asset allocation scheme when a chosen asset class outperforms the others, so that its percentage allocation increases beyond the strategic limit. The excess in that class is sold off and the proceeds reinvested in the other asset classes to rebalance the portfolio back to its strategically set percentages.

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

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

Defensive stocks included in a portfolio's construction will minimize exposure to: A market risk B credit risk C legislative risk D marketability risk

The best answer is A. Defensive stocks are unaffected by the business cycle, so their prices do not move as much (up or down) compared to the movements of the general market. Thus, these investments reduce market risk in a portfolio.

A 60-year old customer has a 401(k) account with your firm that has $280,000, mainly invested in growth mutual funds. The customer has an elderly widowed aunt who has died, and her estate attorney has contacted him, notifying him that he has been left $100,000 as an inheritance. The customer is single and has an annual income of $100,000 per year. He wants to use the inheritance to buy a retirement home, which he expects to do in 7 years. Over this investment time horizon, the general expectation is that interest rates will rise. The best recommendation to the customer is to invest the $100,000 in: A money market instruments B 7-year Treasury Bonds C 7-year Treasury STRIPS D 30-year Treasury Bonds

The best answer is A. The customer does not need the funds for 7 years. In this scenario, if interest rates are expected to rise over the 7 year time window, if the customer invests now in a 7 year maturity fixed income security, the customer will lock in a lower rate of return for 7 years. This would be the case with investing in either a 7 year Treasury Bond or a 7 year Treasury STRIPS (zero coupon).If the customer were to invest in money market instruments with very short term maturities, then as they matured (say yearly), the proceeds would be reinvested at higher and higher rates. Thus, the customer would capture higher interest income as rates rise.The worst choice would be investing in 30 year T-Bonds. If market interest rates rise over the next 7 years, the value of the T-Bonds would fall. The customer would need to sell those T-Bonds to get the needed funds to buy the house in 7 years, and those T-Bonds would be sold at a loss if interest rates rose substantially.

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

The best answer is A. Convertible bonds trade as equivalent to the common stock if the market price of the common rises above the conversion price. Thus, as the market price of the common rises, the convertible bond price will rise as well. This gives the customer the potential for growth. Equipment trust certificates are a secured bond that pays a fixed rate of interest, backed by airplanes, railroad cars, etc. Long term zero coupon bonds are sold at a deep discount price and the yearly earning of the discount is the interest income - but this is not received until maturity. They are designed for long term investors that wish to avoid reinvestment risk - but note that they do not offer "growth." Commercial paper is a short term corporate IOU that has no growth potential.

Which type of account does NOT grow tax deferred? A UTMA Account B 529 Plan C Coverdell ESA D Health Savings Account

The best answer is A. There is no tax deduction for contributions to custodial accounts (either UGMA or UTMA accounts) and income is taxable each year. In contrast, while there is no tax deduction for contributions to 529 Plans or Coverdell ESAs, the earnings in these accounts grow tax-deferred and when a distribution is taken to pay for qualifying educational expenses, the distribution is tax-free. Health Savings Accounts (HSAs) allow an employee covered by a high-deductible corporate health insurance plan to make a deductible contribution to an HSA; earnings grow tax-deferred; and when distributions are taken to pay for qualifying health care expenses, they are tax-free.

Which bond recommendation is most suitable for a customer who wishes to avoid credit risk? A Pre-refunded bond B G.O. bond C Revenue bond D AAA corporate bond

The best answer is A. When a municipality pre-refunds its debt, it backs those bonds with escrowed U.S. Government and Agency securities, making the credit rating AAA. This is the safest bond of the choices offered, since it is backed by collateral. A General Obligation bond is backed by faith, credit and unlimited taxing power of a municipal issuer, so it is pretty safe as well - but it is not secured. A Revenue bond is backed by a pledge of revenues from an enterprise activity, and these are less safe than G.O. bonds. AAA rated Corporate bonds are also very safe, but if they are long term bonds, a lot can go wrong for a company over a long term time frame. Again, these are not as safe as a pre-refunded bond.

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

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

The use of index funds as investment vehicles for asset classes increases: A diversification B expected rate of return C standard deviation of return D market risk

The best answer is A. Index funds are broadly diversified, since they hold all of the securities in the designated index. This reduces market risk or the standard deviation of returns. The impact of diversification on rate of return should be one of lowering the rate of return compared to the market average, along with lowering the risk associated with that rate of return.

A younger female customer, in the highest tax bracket, already has a substantial investment portfolio that is invested in a balance of quality stocks and bonds. She wants an investment that will provide rapid asset growth and is willing to assume risk. The BEST recommendation would be: A Emerging markets fund B Single stock C Municipal bond D Index fund

The best answer is A. Since this customer already has a balanced quality portfolio and is looking for rapid growth, an emerging markets fund would give the customer the rapid growth she is seeking (along with greater risk).

ABC stock is currently trading at an all-time high price of $150 per share. Your client contacts you about the stock, stating that he believes that the stock is ripe for a sell off after its next quarterly news announcement. He has $10,000 to use for a trade, but does not want to lose more than this amount. The BEST recommendation to the client is to: A Buy ABC Puts B Short ABC stock C Short an ETF that consists of stocks similar to ABC D Sell ABC Calls

The best answer is A. The key piece of information in this question is that the client does not want to lose more than his investment. If puts are purchased to speculate on a market price decline, the customer can only lose the premium paid if the market rises. If the customer shorts stock, there is unlimited loss potential in a rising market. If the customer sells calls, there is unlimited loss potential in a rising market.

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

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

The portfolio management technique that uses a market index as a performance benchmark that the asset manager must exceed is called: A Passive asset management B Active asset management C Strategic asset management D Tactical asset management

The best answer is B. Active asset management is the management of a portfolio to exceed a benchmark return (say the return of a comparable index fund). The manager's "active" return is any incremental return achieved over the benchmark return. In contrast, passive asset management is simply the management of a portfolio to match the benchmark return (the "passive return"). Active managers believe that underpriced securities can be found in the market and that performance of the benchmark can be exceeded. Passive managers believe that the market is efficient at pricing securities and that one cannot do any better than the "market" return as measured by a relevant index.

Customer Name: Joey Jones Age: 30 Marital Status: Single Dependents: None Occupation: VP - Marketing - ACCO Corp. Household Income: $250,000 Net Worth: $110,000 (excluding residence) Own Home: No - Rents Investment Objectives: Aggressive Growth / Early Retirement Investment Time Horizon: 20 years Investment Experience: 0 years Current Portfolio Composition: 401k: $70,000 Cash in Bank: $40,000 The customer informs you that he just got married and that his wife intends to work for the next 5 years before they think about children. In order to make recommendations to the client due to these changed circumstances, the registered representative should: A ask the customer if he wishes to open a joint account with his wife B update the account profile to include the wife's financial information C obtain the wife's social security number and perform a credit check D update the account file with a copy of the customer's marriage certificate

The best answer is B. Getting married is a life-changing event, both from a personal standpoint and a financial planning standpoint. Since the new wife will be working for 5 years, there will be additional income that can be invested. The financial goals and investment time horizon are likely to change as well. The first step is to update the financial profile based on the new circumstances.

A married couple, ages 55 and 52, with no children, are both employed at DEF Corporation. They have asked for an evaluation of their current portfolio. They have a combined annual income of $200,000 per year and a fully paid home worth $500,000. Their current portfolio shows: $50,000Common Stock of DEF Corp in a 401K account $100,000Large Cap Growth Fund $150,000Government Bond Fund $150,000Corporate Bond Fund $200,000Money Market Fund Both intend to retire in 20 years and are conservative investors, looking for moderate growth and moderate risk. Which of the following recommendations is BEST for this couple? A The current portfolio allocation is consistent with their stated investment objective and risk-tolerance level B The portfolio should be reallocated based on their stated investment objective, reducing the cash and bond percentage by 50% and using the proceeds to buy a small or mid-cap growth mutual fund C The portfolio is overweighted in fixed income securities, which should be completely liquidated and the proceeds used to buy aggressive growth stocks D The current portfolio allocation overexposes the couple to stock-specific risk if the fortunes of DEF Corp. decline in the future

The best answer is B. Since this couple has a stated investment objective of growth with moderate risk, a portfolio that only has about 25% equities and that has 75% fixed income securities is inappropriate - since it will provide income; but little growth. The long-term bond and cash allocation should be reduced and replaced with growth stocks to better balance the portfolio. Choice C is way too speculative for a "conservative investor." Choice D is somewhat true since this couple is investing in their employer's stock - but since the stock only represents 8% of the customer's total portfolio, this is not an excessively large percentage.

A 30-year old customer who has two young children wishes to make an investment that will provide for their college tuition. Which would be the BEST recommendation? A Make yearly payments into a variable annuity separate account with a growth objective B Purchase Treasury STRIPS yearly in custodian accounts for the children C Purchase income bonds yearly in custodial accounts for the children D Establish IRA accounts for the children and purchase zero-coupon obligations yearly

The best answer is B. To provide for a child's college education, the purchase of zero-coupon obligations makes sense, since income is not needed until many years into the future. They can be purchased in a custodial account for the benefit of the child. Treasury STRIPS are zero coupon Treasury obligations, and hence are extremely safe. This is the best choice. IRA accounts can only be established based on a person's earned income - which a young child would not normally have. Purchasing a variable annuity for the child makes no sense, since distributions before age 59 1/2 are subject to a penalty tax. The purchase of income bonds is not too bright, since they only pay income if a corporation meets target earnings levels. These are extremely risky investments.

Which bond portfolio construction is based on a phase-in of purchases in installments over time? A Ladder B Bullet C Barbell D Balloon

The best answer is B. Bullets, Bond Ladders, and Barbells are portfolio constructions that are used to limit interest rate risk. The idea behind a bond ladder is to spread bond maturities in a portfolio over fixed intervals, typically 10 maturities in intervals of 2 years each. A typical ladder might have 10 maturities ranging from 2 to 20 years, with an average maturity of around 10 years. Because of this broad diversification by maturity, a rise in interest rates will not impact the portfolio as negatively as compared to a bullet or barbell portfolio construction. If interest rates rise, the loss on the longer term bonds in the portfolio is offset by the fact that shorter term bonds are maturing soon and the proceeds can be reinvested at higher rates. A barbell portfolio only has 2 maturities - a very short term and a very long term - say 2 years and 20 years, for an average life around 10 years (actually 11 years here, but we are simplifying things). The longer term bonds give a higher yield but have higher interest rate risk. This risk is offset by the fact that the 2 year bonds will mature soon and the proceeds can be reinvested at higher rates. The big risk here is that long rates rise sharply as compared to short rates (a steepening of the yield curve). In this scenario, the loss on the long term bonds will be much greater than the fact that the short term bond proceeds can be reinvested in 2 years at somewhat higher rates. A bullet portfolio construction only has a single maturity, typically in an intermediate range of around 10 years. The way that interest rate risk is offset here is that all of the investment is not made at one time - rather, the investment is made in installments at fixed intervals. If market interest rates rise, new investment will be made at higher rates, offsetting any loss on the already purchased bonds. A balloon is a type of bond issue structure, where most of the bonds mature as a "balloon" at a long term maturity date. It is not a type of bond portfolio construction.

Currently, the yield curve is ascending. A customer believes that the Federal Reserve will start to tighten credit by raising short-term interest rates; and also believes that long term yields will move downwards from current levels because of record demand for long-term Treasury obligations by pension funds. To profit from this, the best recommendation would be to: A buy short term T-Bills and sell long term T-Bonds B sell short term T-Bills and buy long term T-Bonds C buy short term T-Bills and buy long term T-Bonds D sell short term T-Bills and sell long term T-Bonds

The best answer is B. If short term interest rates are expected to rise, then short-term fixed income security prices will fall, so the customer will want to sell these (establishing a short position). If long term interest rates are expected to fall, then long-term fixed income security prices will rise, so the customer will want to buy these (establishing a long position).

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

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

A 50-year old customer is in a very low tax bracket. She lives in a state that has one of the highest income tax rates. The customer is seeking income and preservation of capital. She has a 10 year investment time horizon. The best recommendation would be a 10 year maturity: A Treasury Bond B investment grade corporate bond C investment grade municipal bond D Treasury STRIPS

The best answer is B. Remember that interest rates are highest for corporate bonds because the interest income is taxable at both the federal and state level. Because this customer is in a low tax bracket, most of this return will be kept after tax - the customer will have the highest after-tax return with the corporate bond investment. Interest rates for Treasury securities are lower than for investment grade corporate securities, because the interest income is exempt from state and local tax. Because this customer is in a low tax bracket, this does not benefit her. Interest rates for municipal securities are the lowest of all, because the interest income is exempt from both federal income tax and state and local income tax (when purchased by a resident of that state). Again, because the customer is in a low tax bracket, this does not benefit her. As a general rule, customers in low tax brackets should invest in fully taxable bonds (corporates); while customers in very high tax bracket should invest in tax-free municipal bonds.

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

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

A customer calls her registered representative and says the following: "I'm looking for a safe investment for $100,000 that I have, that will give me a moderate level of income. I have 2 children, ages 12 and 13, and I will need to use these monies to pay for their college education, starting in 5 years." All of the following recommendations would be suitable EXCEPT: A Treasury bond mutual fund B Treasury bonds with 5, 6, 7, 8, and 9 year maturities C GNMA pass-through certificates with 5, 6, 7, 8, and 9 year maturities D FNMA debentures with 5, 6, 7, 8, and 9 year maturities

The best answer is C. GNMA pass-through certificates represent an ownership interest in a pool of underlying mortgages. Each month, the mortgage payments made into the pool are "passed through" to the certificate holders. If interest rates drop, then the homeowners in the pool will refinance their mortgages and prepay their old higher rate mortgages. These prepayments are passed through to the certificate holders, who are paid off much earlier than expected. If these payments are reinvested, since interest rates have fallen, the overall rate of return falls, and the anticipated monies needed to fund the college education will not be available. Prepayment risk does not exist with conventional debt securities.

Client A's portfolio consists of the following: Equities:85% Fixed Income:10% Cash:5% The breakdown of these holdings is: Equities 35% DEFF Total Market Index Fund 30% 2,100 shares of ABCD 25% 3,100 shares of XYZZ 10%PDQQ International Small Cap Growth Fund Fixed Income: 75%Investment Grade 25%Speculative Cash: 100% Money Market Fund Client A is 55 years old, single with no children. He is beginning to think about retirement and wishes to modify his portfolio so that he can start receiving an assured income stream starting at age 65. Which recommendation would be the BEST choice to meet the customer's changed investment objective? tment objective? A The ABCD and XYZZ stock holdings should be liquidated in full immediately, with the proceeds invested in 10 year income bonds of companies in special situations B The DEFF Total Market Index Fund holding should be liquidated in full immediately, with the proceeds invested in 10-30 year Treasury bonds C The customer should set minimum and maximum threshold prices at which the ABCD and XYZZ stock positions are to be liquidated; and if this occurs, the proceeds should be invested in 10-30 year maturity Treasuries D The customer should liquidate the ABCD and XYZZ stock holding to purchase 10, 15 and 20 years STRIPs that will mature in even installments

The best answer is C. This customer's portfolio is 85% invested in stocks and only 15% invested in bonds and cash. Since he is looking for income 10 years from now, more of the portfolio mix must be allocated to bond investments. Immediate liquidation of some of the stock investments might cause the customer to sell at a loss; or to miss out on potential stock gains that he or she anticipates. Setting minimum and maximum threshold prices to begin liquidating the stock investments, and reallocating the proceeds to safe income generating bond investments, is the best way to meet the customer's income objective.

Customers who actively trade their listed stock portfolios should have a strong understanding of: A liquidity risk B inflation risk C timing risk D call risk

The best answer is C. Timing risk is the risk that trades will not be performed at the best market prices. Active traders are highly subject to this risk. Active traders will only trade securities in "deep" markets such as NYSE or NASDAQ common issues. They would not trade illiquid securities (e.g., OTCBB or Pink Sheet issues) since they would incur "liquidity risk." Liquidity risk is the risk that a security can only be sold by incurring large transaction costs. Inflation (purchasing power) risk is the risk that inflation will reduce an investor's real returns. Active traders are not concerned with inflation risk because they hold their investments for very short time periods. Since active traders are trading common stocks, call risk is not a consideration (common stocks are non-callable).

Customer Name: Jane Smith Age: 41 Marital Status: Single Dependents: 1 Child, Age 7 Occupation: Corporate Manager Household Income: $120,000 Net Worth: $150,000 (excluding residence) Own Home: Yes Investment Objectives: Saving For College; Saving for Retirement Investment Experience: 10 years Current Portfolio Composition: $140,000 Market Value50% Money Market Fund50% Corporate Bonds This client has just inherited $100,000 and wants to use the funds to pay for her child's college education. She also has asked whether her current portfolio meets her goal of maximizing saving for retirement. Based on this information, the best recommendation to the client is to: A deposit the additional $100,000 to the money market fund to ensure that the funds will be available to pay for college B open a 529 Plan with the $100,000 inheritance, investing in a growth fund; and liquidate both the money market fund holding and the corporate bond holdings, using the proceeds to buy growth stocks C open a 529 Plan with the $100,000 inheritance, liquidate $50,000 of the money market fund and $50,000 of the corporate bonds, using the proceeds to buy growth stocks D open an UGMA account with the $100,000 inheritance investing in growth stocks

The best answer is C. This customer is looking to use her $100,000 inheritance to fund her kid's college education. A 529 plan is best for this, since it grows tax-deferred and distributions used to pay for college are tax free. Since the kid is only age 7, a growth fund investment is most suitable, since the child has 10-11 years before college starts. Note that a UGMA (custodial account) does not allow for tax deferral, so it is not the best choice. The customer also wants to save for retirement and she is only age 41, so she has at least 25 years to go before retiring. Her portfolio is way too conservatively invested for someone this age - it will grow at a very low rate since it is only invested in money market funds and corporate bonds. At this age, the customer should be invested 60-70% in growth stocks, with the balance in safer investments. So the best choice is to liquidate most of the money market fund and corporate bond holding, and invest the proceeds in growth stocks (Choice C). Choice C still leaves the customer with $20,000 in the money market fund (for emergencies) and she still has a small investment in corporate bonds ($20,000), but the remaining $100,000 will now be in growth stocks. This is a good mix for a 41 year old person looking to save for retirement. Also note that Choice B is not the best choice because the customer should still have a small portion of her portfolio in safer and more liquid securities (for emergencies) like a money fund.

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

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

Which of the following would be least important in determining the level of diversification in a corporate bond portfolio? A Bond ratings B Industries represented in portfolio C Domicile of issuers D Maturities of the bonds in the portfolio

The best answer is C. The "domicile" of an issuer is the state where the issuer legally resides. It has no bearing on the quality of the issuer's securities. Bond rating, type of industry, and maturity would all be considered when examining the diversification of a bond portfolio.

A new client with no other investment assets has just come into an inheritance of $500,000 of ABCD stock, a blue chip company listed on the NYSE. As the adviser to this customer, your IMMEDIATE concern should be: A whether the company is a candidate for delisting B the possibility that the value of ABCD stock may decline sharply C the lack of diversification of the customer's investment D whether the customer paid any estate tax liability due

The best answer is C. This is the client's sole investment. Because this is a blue chip company, it is not likely to be delisted. It is also not likely to suffer a sharp price decline, though this could occur. The immediate concern should be the customer's lack of diversification. If the customer were to sell a portion of the ABCD stock and reallocate it to other investments, the client will reduce overall risk.

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

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

An assessment of an existing client's financial status shows the following: Name: Jack/Jill Miller Ages: 57 and 59 Marital Status: Married - 3 Adult Children Income: $80,000 per year Retirement Plan: Yes - Vested Defined Benefit Plan Life Insurance: Yes Risk Tolerance: Low Home Ownership: Yes Client Balance Sheet: Assets Cash on Hand: $22,000 Marketable Securities: $96,000($15,000 in Money Market Fund; $25,000 in Treasury Notes; $56,000 in Blue Chips) Retirement Plans: $458,000(Defined Benefit Plan Valuation) Auto: $39,000 Home Ownership: $404,000 Liabilities Credit Cards Payable: $14,000 Mortgage Payable: $104,000 Net Worth: $901,000 The couple plans to retire in the next year, sell their home and move to a retirement community where a new home will cost $190,000. They wish to supplement their retirement income, which will be approximately $40,000 from their retirement plan and $8,000 from Social Security. The best recommendation to the couple is to take the $300,000 net proceeds from the sale of the home after paying off its mortgage and: A put a $50,000 down payment on the new home, finance the balance of the purchase with a $140,000 mortgage, and invest the remaining cash proceeds of $250,000 in growth common stocks B put a $50,000 down payment on the new home, finance the balance of the purchase with a $140,000 mortgage, and invest the remaining cash proceeds of $250,000 in Treasury STRIPs C pay for the $190,000 new home in full and invest the extra $110,000 in high yield bonds to provide retirement income D pay for the $190,000 new home in full and invest the extra $110,000 in high yielding blue chip preferred stocks to provide retirement income

The best answer is D. The key here is that this couple is looking for additional retirement income. Investing in growth stocks does not provide current income, so this is a bad choice. STRIPs are a zero-coupon government security and also do not provide current income - so this is another bad choice. High yield bond investments provide income (assuming that the bonds do not default); but they are high risk; and this couple has a low risk tolerance. Investing in high yielding blue chip preferred stocks gives income and safety, along with the benefit of a low 15% maximum tax rate on cash dividends received. This is the best of the choices offered.

A self-employed client has an annual income of $200,000 and is in a high tax bracket. He is not covered by a retirement plan and would like to make the maximum contribution to one to reduce his taxable income. He believes that he will be in a lower tax bracket once he retires. The BEST recommendation is to contribute to a: A Traditional IRA B Roth IRA C 401(k) D SEP IRA

The best answer is D. A Roth IRA does not work for 3 reasons - the maximum contribution is only $6,000 (in 2021); the contribution is not deductible; and this person is a high earner and cannot use a Roth. He can use a Traditional IRA, but it only allows for a maximum contribution of $6,000. A 401(k) plan allows for a larger deductible contribution ($19,500 in 2021), but it is really designed for big companies because it is expensive to set up and run. It does not really work for self-employed persons. A SEP (Simplified Employee Pension) IRA is designed for self-employed individuals and small employers. It is easy to set up and administrate and it allows for maximum contribution equal to 20% of income (25% statutory rate), capped at $58,000 in 2021. It would allow this self-employed individual to make a 20% x $200,000 = $40,000 deductible contribution.

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

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

A client has a portfolio of $2,000,000 that consists of $600,000 of an Energy ETF; $600,000 of a Gold/Precious Metals ETF; $600,000 of a Uranium/Oil ETF and $200,000 of short term Treasury securities. This customer's investment objective is: A preservation of capital B income C safety of principal D growth

The best answer is D. Investments in commodities are made for long term capital growth, especially if inflation is expected in the future (though that is not mentioned in the question). Preservation of capital is an investment objective for someone who can't afford to lose principal, such as a retiree. Such an account would only hold the safest short term fixed income securities such as money market instruments, CDs and short term Treasury securities. Income is an investment objective for someone seeking income (duh!). Such an account would hold longer term fixed income securities (bonds and preferred), and could also hold high dividend paying blue chip stocks, augmented by covered call writing for additional income. Safety of principal is an investment objective for someone who is risk averse. Such an account should only be recommended "safe" investments like AAA rated bonds and blue chip stocks.

A customer, age 51, has a 20 year investment time horizon, a moderate risk tolerance, and is looking for investments that provide both income and growth. The best recommendation would be: A money market instruments B mutual funds C bonds D large capitalization growth stocks

The best answer is D. Money market instruments are very safe, but provide little income and no growth. These would be recommended to a customer seeking preservation of capital - not to a customer seeking income and growth. Choice B, mutual funds, is too generic to be a valid choice. There are all kinds of mutual funds out there, for all types of investment objectives. Choice C, bonds, is also too generic to be a valid choice. Also, while bonds provide income, they do not provide growth. Choice D, large capitalization growth stocks, is the best one offered. Large capitalization stocks pay dividends for income, and also offer long term growth potential, meeting both of the customer's objectives.

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

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

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

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

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

The best answer is D. This customer has just turned "extremely bearish" on the market, meaning he thinks that equities are going to fall rapidly in price. The customer is wealthy, sophisticated, and has a high risk tolerance. The most aggressive choice offered is the leveraged inverse ETF. Assume it is a 300% leveraged inverse ETF based on the S&P 500 Index. If the index falls by 15%, this ETF should rise by 3 x 15% = 45%. (Of course, if the customer is wrong and the index rises, then the customer loses big time!) Also note that an inverse floater is a type of bond where when market interest rates rise, its interest rate "floats" and is adjusted downwards by the increase in interest rates. Thus, when interest rates rise, its interest rate will "float" down (and remember that lower coupon bonds lose value more rapidly in a rising interest rate environment). For the exam, just know that an "inverse floater" is a wrong answer.

A customer, age 40, is concerned that the inflation rate is ready to explode, and wishes to invest funds to protect against the consequences of such an event. The BEST asset allocation mix to recommend to this customer is: A 100% common stocks B 100% bonds C 50% common stocks; 50% bonds D 100% money market instruments

The best answer is D. A customer who believes that substantial inflation may occur in the future would invest principally in money market instruments. If there is persistent inflation, this forces interest rates up. Thus, the value of long term bonds and preferred stocks drops. At the same time, if there is inflation, stock prices drop, since the cost of doing business tends to inflate faster than companies can raise prices, putting pressure on profit margins. The safe harbor in times of inflation is money market instruments, which are not affected by these forces.

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

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

An older customer, age 63, who is in the lowest tax bracket, seeks an investment that will give him an income stream. The BEST recommendation would be: A Variable annuity B Municipal bond C Certificate of deposit D AAA Corporate bond

The best answer is D. Because the customer is in a low tax bracket, you would not recommend the municipal bond. Most variable annuity separate accounts are invested in equities for growth to supplement other forms of retirement income. Because they are equity funds, they do not give much of an income stream. The CD and the AAA Corporate bond both provide income, which is the stated objective. However, the AAA corporate bond is top-rated and will give a higher income stream than a CD. This is the best choice. Note that the question tells us nothing about risk tolerance, which would certainly be helpful, but this is typical of "test-like" questions!