Suitability & Analysis
The portfolio management technique that uses a market index as a performance benchmark that the asset manager must meet is called: A. Passive asset management B. Active asset management C. Strategic asset management D. Tactical asset management
The best answer is A. 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.
A 25-year old single client has just started his own small business and is not covered by a retirement plan. He has $5,000 to invest and currently has a low level of income. He wishes to start saving for retirement. The BEST recommendation is a: A. Roth IRA B. SIMPLE IRA C. Traditional IRA D. Roth 401(k)
The best answer is A. Anyone with earned income can open an IRA. Because this individual is in a low tax bracket, a Roth IRA contribution, which is non-deductible, makes sense (there is no real benefit from making a deductible contribution to a Traditional IRA). With $5,000 to invest, this is within the $6,000 contribution limit for 2021. Earnings build "tax-free" in a Roth, and distributions taken at retirement age are non-taxable. Also remember that high-earners cannot open a Roth IRA. In contrast, if a Traditional IRA were opened, this individual would get a tax deduction (he is not covered by another qualified plan), but it would have little value because of his low tax bracket. Earnings would build tax deferred and when distributions are taken at retirement age, they would be taxable, so the Roth is the better deal. A 401(k) is an employer-sponsored salary reduction plan under ERISA that requires major paperwork to establish. It allows a contribution of up to $19,500 in 2021, far more than the $5,000 this individual has to invest. This is not suitable for a very young single person starting a small business. A SIMPLE IRA is another qualified retirement plan that is "simpler" to set up than a 401(k), and that is only available to businesses of 100 or fewer employees. It allows for a larger deductible contribution than an IRA ($13,500 in 2021), which is more than this person needs. Also, it is still not as easy to set up as an IRA.
Which statements are TRUE regarding Treasury debt instruments? I. T-Notes are sold by competitive bidding at auction conducted by the Federal Reserve II. T-Notes are sold by negotiated offering III. T-Notes are issued in book entry form with no physical certificates issued IV. T-Notes are issued in bearer form A. I and III B. I and IV C. II and III D. II and IV
The best answer is A. Treasury Notes are issued in book entry form only. No certificates are issued for book entry securities; the only ownership record is the "book" of owners kept by the transfer agent. U.S. Government debt is sold via competitive bidding at a weekly auction conducted by the Federal Reserve.
A young couple in a low tax bracket have 2 young children and they want to start saving for the kids' college education. The BEST recommendation would be: A. T-Bills B. Growth funds C. Municipal bond funds D. 20 year maturity municipal bonds
The best answer is B. Because the couple is in a low tax bracket, tax-free municipals are not appropriate. They are only suitable for customers in high tax brackets. So we are left with the choice of either T-Bills or Growth funds. T-Bills are safe, but give a very low return. Growth funds over the long term until the kids go to college are the best choice offered.
Preferred stocks are most often suitable investments for the: A individual B corporate investor C partnership investor D fiduciary investor
The best answer is B. Corporations that receive dividends from investments held generally are allowed to exclude 50% of the dividends received from taxation. This exclusion does not apply to individual investors (however, individual investors get the benefit of taxation of cash dividends received at a substantially lower rate - 15% (or 20% for those in the highest tax bracket) - than do corporate investors). Thus, a corporation that receives dividends from common stock holdings, preferred stock holdings, or mutual fund holdings where the fund's income is from common and/or preferred stock investments, is allowed to exclude 50% of that income from taxation.
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.
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).
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: $50,000 Common Stock of DEF Corp in a 401K account $100,000 Large Cap Growth Fund $150,000 Government Bond Fund $150,000 Corporate Bond Fund $200,000 Money 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.
Timing is the important factor in which portfolio management strategy? A. Strategic allocation B. Tactical allocation C. Rebalancing D. Indexing
The best answer is B. Strategic portfolio management is the determination of the percentage allocation to be given to each asset class - for example a portfolio might be strategically allocated as follows: Money Market Instruments 10% Corporate Bonds 30% Large Cap Equities 50% Small Cap Equities 10% Tactical asset management is the permitted variance within each allocation percentage. For example, Large Cap equities are allocated 50%, but the manager may be tactically allowed to lower this percentage to, say, 40% or raise it to 60%. Thus, if the manager believes that Large Cap equities will underperform the market, he or she can lower the allocation to 40%; and if the manager believes that they will outperform the market, he or she can raise the allocation to 60%. This gives the manager some ability to "time the market" when conditions are overbought or oversold.
A registered representative has a client who is an exceptionally intelligent doctor of medicine. The doctor does most of his own investment research and makes many of his own investment decisions. The doctor is married, but his wife is not involved in the investment planning or decision-making process. When constructing a portfolio for this client, the registered representative should: A. choose the investments in the portfolio based solely on the research conducted by the doctor B. balance the portfolio in a manner that addresses the doctor's investment strategy and that customizes the strategy to meet the needs of the spouse C. charge fees on the assets held in the portfolio that were chosen by the representative without using the doctor's research D. disregard the doctor's research because the doctor is not properly licensed to act as a representative
The best answer is B. When constructing a portfolio for a client, the representative can take into account a customer's special expertise in a given area when selecting specific investments. For example, a doctor might have a special insight into the sales prospects for a medical device manufacturer, and could tell the representative that he wants to invest in this company. It is the role of the representative to review this investment decision and, if appropriate, to make sure that it is not overweighted in the portfolio. Because the doctor is married, the representative should construct the portfolio to meet both the needs of the doctor and his wife.
During a period when the yield curve is normal: A. short term bond prices are more volatile than long term bond prices B. long term bond prices are more volatile than short term bond prices C. short term and long term bond prices are equally volatile D. no relationship exists between short term and long term bond price changes
The best answer is B. Whether the yield curve is ascending (normal), flat or descending, long term bond prices always move faster than short term bond prices, as interest rates change. This is due to the compounding effect on the bond's price that occurs, which increases with longer maturities.
A 60-year old man is looking to create a portfolio that will provide current income and preservation of capital. Which of the following portfolios would be the BEST recommendation to the client? A. Long term corporate bonds rated AA or better, high yield corporate bonds and blue chip stocks B. Treasury bills, a money market mutual fund and bank certificates of deposit C. Treasury STRIPS, corporate income bonds and PO tranches D. Growth stocks, defensive stocks and foreign stocks
The best answer is B. This customer wants current income and preservation of capital. Choice A provides current income, but does not provide preservation of capital. Long term bonds are subject to loss of value if interest rates rise; high yield corporate bonds have this risk as well as higher default risk; and blue chip stocks also can lose substantial value in a bear market. Choice B meets both objectives. Treasury bills, money market funds and bank certificates of deposit all provide income (but not high levels of income) and safety of principal. Choice C consists of long term securities that do not provide income, and that also have high levels of interest rate risk. Treasury STRIPS are zero coupon Treasury obligations - they have high levels of interest rate risk and do not provide current income. Corporate income bonds only pay interest if the corporation has enough earnings. PO tranches are CMO tranches that pay "Principal Only." Because mortgage payments in the early years are mostly interest and in the later years are mostly principal, they pay very little in the early years and make most of their payments in their later years. Thus, they are most similar to a long-term zero coupon bond with high levels of interest rate risk. Choice D consists only of common stocks, which do not provide for preservation of capital.
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.
A municipality would issue a GAN in anticipation of receiving: A. property tax collections B. proceeds from a long term bond sale C. federal transit funding D. federal highway funding
The best answer is C. A "GAN" is a municipal "Grant Anticipation Note." A GAN would be issued by a municipality to get immediate access to federal grant monies that are expected to be received months into the future. These grant monies typically are used to support mass transit programs, like buses and subways for cities. Note, in contrast, that a "RAN" - Revenue Anticipation Note - is paid from expected revenues to be received in the future, and that this source of funding is usually federal highway funds.
A self-employed individual makes $200,000 per year. To which type of retirement plan can the maximum contribution be made? A. Traditional IRA B. Roth IRA C. SEP IRA D. SIMPLE IRA
The best answer is C. A SEP (Simplified Employee Pension) IRA is usually set up by small business because it simplifies all of the recordkeeping associated with retirement plans (though there actually no limit of the size of the company to open up a SEP IRA). Contribution amounts made by the employer cannot exceed 25% (statutory rate; effective rate is 20%) of the employee's income, up to a maximum of $58,000 in 2021. SIMPLE IRAs also are relatively "simple" for a business to set up, but they only allow a maximum contribution of $13,500 (in 2021). So the SEP IRA is better. In contrast, the maximum contribution to either a Traditional or Roth IRA in 2021 is $6,000 (plus an extra $1,000 catch-up contribution for individuals age 50 or older). Also note that because this individual is a high-earner, he or she cannot open a Roth IRA.
A self-employed individual makes $200,000 per year. To which type of retirement plan can the maximum contribution be made? A. Traditional IRA B. Roth IRA C. SEP IRA D. SIMPLE IRA
The best answer is C. A SEP (Simplified Employee Pension) IRA is usually set up by small business because it simplifies all of the recordkeeping associated with retirement plans (though there actually no limit of the size of the company to open up a SEP IRA). Contribution amounts made by the employer cannot exceed 25% (statutory rate; effective rate is 20%) of the employee's income, up to a maximum of $58,000 in 2021. SIMPLE IRAs also are relatively "simple" for a business to set up, but they only allow a maximum contribution of $13,500 (in 2021). So the SEP IRA is better. In contrast, the maximum contribution to either a Traditional or Roth IRA in 2021 is $6,000 (plus an extra $1,000 catch-up contribution for individuals age 50 or older). Also note that because this individual is a high-earner, he or she cannot open a Roth IRA.
A 45-year old investor has stated investment objectives of income and growth. Which mutual fund could be added to the customer's portfolio? A. Government income fund B. Sector fund C. Equity income fund D. High yield fund
The best answer is C. An equity income fund invests in stocks that pay dividends and that have growth potential. Fixed income securities provide income, but no growth, making Choices A and D incorrect. A sector fund invests in stocks in one industry or geographic area - the investment choices are not based on the investment objectives of this client.
Diversification among multiple asset classes reduces the: I market risk of the portfolio II marketability risk of the portfolio III standard deviation of portfolio returns A. I only B. II and III only C. I and III only D. I, II, III
The best answer is C. Diversification of a portfolio reduces market risk; and also reduces the variability of investment returns. It does not affect marketability risk - that is, how difficult is it to liquidate given position in the portfolio.
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 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.
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.
Customer Z is a single 26-year-old man who earns $125,000 annually. He informs you that he is getting married and that his new wife's income of $75,000 per year will put them into the highest federal tax bracket. The couple will have investable income of $25,000 per year. The couple wishes to buy a house in 5 years that will be substantially more expensive than the condominium in which they currently reside. To meet the customer's needs for the large cash down payment in 5 years and to reduce taxable income, the BEST recommendation is to: A. open a margin account and invest in income bonds B. open an Individual Retirement Account and invest in tax-deferred variable annuities C. open a cash account and invest in mutual funds holding high yielding common and preferred stocks D. open a trust account and invest in Treasury STRIPs
The best answer is C. Income bonds are not a reliable source of income or principal repayment (since payment depends on earnings of the issuer), and the interest is 100% taxable. Tax-advantaged investments like variable annuities should never be purchased in tax-deferred accounts. The annual accretion on Treasury STRIPS is taxable, unless the bonds are held in a tax-deferred account. Only Choice C makes sense - since cash dividends are taxed at a maximum rate of 15% (reducing taxable income), and the mutual fund shares can be easily liquidated in 5 years to make the house down payment.
Issuers of Federal tax exempt commercial paper include: I. Corporations II. Federal Government III. Municipal Governments A. I only B. II only C. III only D. I, II, III
The best answer is C. Only municipal issues are exempt from Federal income tax on interest income. Corporate and U.S. Government debt interest income is subject to Federal income tax.
If the Federal Reserve enters into repurchase agreements with member banks, the: I. Federal Reserve is tightening credit availability II. Federal Reserve is loosening credit availability III. Federal Funds rate is likely to go down IV. Federal Funds rate is likely to go up A. I and III B. I and IV C. II and III D. II and IV
The best answer is C. The Federal Funds rate is the interest rate charged between Federal Reserve member banks on overnight loans. The Federal Reserve can influence this rate through open market operations. If the Fed enters into repurchase agreements with member banks, it injects cash into the banks, which tends to drive the Fed Funds rate down (because there is more cash available to lend). Conversely, if the Fed enters into reverse repurchase agreements with member banks, it drains the member banks of reserves, tending to drive up the Fed Funds rate (since there is less cash available to lend).
Which of the diversification factors below will not reduce the non-systematic (credit) risk of a bond portfolio? A. Maturity B. Industry in which issuer operates C. Coupon rate D. Geographic location of issuer
The best answer is C. The coupon rate has no bearing on diversification to reduce potential credit risk. In the trading market, the price of a bond is determined by the market yield for that type of security - not the coupon rate. To reduce non-systematic risk (meaning the risk that any one security may be a "bad" investment), diversification of a bond portfolio by choosing different issuers, different industries, different geographic issuer locations, and different maturities (since long term bonds give issuers longer time periods in which they can go broke) are all valid.
A customer with additional funds to invest seeks income, but thinks his portfolio is too heavily weighted in debt securities. The BEST recommendation to the customer is: A. Treasury securities B. Municipal securities C. Preferred stocks D. Industrial development bonds
The best answer is C. This customer does not want to buy any more bonds. Preferred stock is a fixed income equity security, so it meets the customer's requirement that the recommendation not be a bond; and it pays a fixed dividend rate (similar to bonds) for income. Treasury and municipal securities are all debt instruments, and are municipal industrial development bonds.
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 Value 50% Money Market Fund 50% 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.
A 68-year old new customer has investment objectives of preservation of capital and income in retirement. The customer has a low risk tolerance and is in the 35% marginal federal tax bracket and is in the 10% state tax bracket. Which investment recommendation would be most suitable for this client? A. Investment grade corporate bonds with long maturities B. Preferred stocks of blue chip companies C. Pre-refunded general obligation bonds D. General obligation bonds that have been escrowed to maturity
The best answer is C. This customer with a low risk tolerance is looking for preservation of capital and income in retirement. While long-term investment grade corporate bonds will give interest income, they are also highly susceptible to interest rate risk - if market interest rates go up, long time bond prices fall faster than short term bond prices - so this does not meet the customer's other objective of preservation of capital. (Preservation of capital means that the customer does not want to incur a capital loss, generally leading to investment choices of very safe, short-term fixed income securities like Treasury Bills.) Preferred stocks of blue chip companies will also provide dividend income that will be taxed at a preferential rate (15%) for this customer in a high federal tax bracket. However, preferred stock has no stated maturity, so it will pay for as long as the company is in business. This is the longest maturity, and as a fixed income security, it is subject to the highest level of interest rate risk. So this also does not meet the customer's objective of preservation of capital. Tax-free municipal bonds would be suitable for a customer is such a high tax bracket. Pre-refunded municipal bonds have been escrowed by the issuer with Treasury or Agency securities to be retired at the near-term call date. These are the safest municipal bonds (AAA rated) and also the shortest maturity of the choices offered. This meets the customer's 2 objectives - income and safety or principal, because the bond's life has been shortened to the nearest call date. In contrast, a municipal bond that has been escrowed to maturity with Treasury or Agency securities is safe (AAA rated), but it will be redeemed at maturity, not at an earlier call date. It will have a higher level of interest rate risk than a pre-refunded bond.
Customer Name: John Doe Age: 41 Marital Status: Married Dependents: 1 Child, Age 13 Occupation: Engineer Household Income: $140,000 Net Worth: $240,000 (excluding residence) Own Home: Yes Investment Objectives: Total Return / Tax Advantaged Investment Experience: 12 years Current Portfolio Composition: 8% Common Stocks 62% Corporate Bonds 30% Money Market Fund This client has just been informed that he has been promoted and will be earning $190,000 per year instead of $140,000 per year. The customer intends to use this extra income to fund his 13-year old child's college education. Based on the customer's existing asset mix, the best recommendation would be for the customer to invest the extra $50,000 per year into a(n): A. money market fund B. income fund C. growth fund D. inflation protected fund
The best answer is C. This customer's portfolio is 92% invested in cash and bonds with only 8% in equities. Since he has 6 years to fund the child's education, growth stocks would help balance the portfolio and enhance the overall return.
All of the following statements are true regarding municipal bonds that have been called EXCEPT: A. interest ceases to accrue on the bonds B. the call price sets a ceiling on the market price of the bonds C. the holder may redeem the bonds at anytime D. the bonds will continue to trade "and interest"
The best answer is D. If a bond issue is called, interest ceases to accrue as of the date specified in the call. Thus, the bond will now trade "flat" - that is, without accrued interest. The call price will set a ceiling on the market price of the bond. Meaning, the market price of the bond will never go above the call price; if it did and the bonds were called, investors would suffer a loss. The bond can be tendered anytime thereafter, at which point the bondholder will be paid par value plus any specified call premium. The call price would not set the floor on the market price of the bonds as the market could go below the call price (which could occur if market interest rates started to rise).
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.
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.
Which of the following are appropriate investment strategies for a client with a 20-year time horizon? I Holding less cash II Holding more stock III Holding less bonds A. I only B. II only C. I and III D. I, II, III
The best answer is D. This client has a long (20-year) time horizon for holding the investments. In such a case, equity securities are the best investment, earning the highest returns historically over long time periods. Cash would be least suitable; bonds are not much better over the long-term, especially if there is inflation. The best portfolio would be one predominantly holding stocks.
The customer profile for Jack E. Chan is presented below: Age: 60 Marital Status: Married - Spouse is age 55 Dependents: 2 Children - Ages 21 and 23, both graduated from college, still living at home Annual Income: $75,000 per year Investment Objective: Safety of Principal and Retirement Income Risk Tolerance: Low Investment Experience: New Client - No Pre-existing Brokerage Accounts Net Spendable Income Available For Investment: $10,000 Federal Tax Bracket: 28% State Tax Bracket: 5% Client Balance Sheet: Assets Cash on Hand: $60,000 Marketable Securities: 0 Auto: $24,000 Residence Owned: $250,000 Liabilities Bills Payable: $10,000 Auto Loan Payable: $14,000 1st Mortgage: (6% interest rate 5 years left - monthly payment of $900) $52,000 Equity: $258,000 The customer is covered by a company defined benefit plan that will pay about $40,000 per year upon retirement at age 70. This customer wishes to maintain his current living standard upon retirement and intends on living in his current house. The customer will receive annual social security payments of about $8,000 per year. To meet the customer's goal of retiring in 10 years with an annual income of $72,000 per year, the best recommendation is to: A. take out a second mortgage of $100,000 at 8% and invest the proceeds in a tax deferred annuity yielding 5% B. invest $10,000 per year for the next 5 years in emerging markets growth stocks; and increase the annual investment in years 6-10 by another $10,800 per year since there are no more mortgage payments to be made C. pay off the current mortgage from the cash on hand; take out a new $100,000 mortgage at 7% and invest the proceeds in income bonds D. invest $10,000 per year for the next 5 years in Treasury Bonds and increase the annual investment in years 6-10 by another $10,800 per year since there are no more mortgage payments to be made
The best answer is D. This customer is 10 years from retirement, so making risky investments in emerging markets stocks or in income bonds that only pay if the issuer has enough earnings (otherwise no interest payments are made) are completely inappropriate. Taking out a loan at 8% to invest in a security yielding 5% is a fast way to lose money - so Choice A is bad as well. Choice D is clearly the best - investing in nice safe Treasury bonds will give the customer an assured stream of income to supplement the customer's pension and Social Security payments that will be received at retirement.
Customer Name: Charlie Customer Age: 69 Marital Status: Single - Widowed Dependents: None Occupation: Retired Household Income: $31,000 (Social Security and Pension) Net Worth: $130,000 (excluding residence) Own Home: Yes $220,000 Value, No Mortgage Investment Objective: Current Income Risk Tolerance: Low Investment Time Horizon: 20 years Investment Experience: 0 years Current Portfolio Composition: Cash in Bank: $130,000 After reviewing this customer's profile sheet, which recommendation would be most appropriate? A. The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20-year TIPS to meet the customer's desire for current income and his low risk tolerance requirements B. The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20-year STRIPS to meet the customer's desire for current income and his low risk tolerance requirements C. The customer should mortgage his house for $100,000 at current market interest rates and use the proceeds to buy 20 year income bonds to provide current income D. The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20-year Treasury Bonds to meet the customer's desire for current income and his low risk tolerance requirements
The best answer is D. This customer is age 69, with no current investments or investment experience. The customer has a fairly low retirement income and needs additional current income to live comfortably. This customer really only has 2 assets to tap for potential current income. He owns a fully paid house worth $220,000; and has $130,000 of cash in the bank. One way to supplement income is for the customer to get a reverse mortgage on the house, but this is not a banking exam, so we will not go near that possibility! The other way to supplement income is to invest the cash in the bank in an investment that is safe and that gives current income. Treasury Bonds pay interest semi-annually at a higher rate than that earned on bank deposits, and are really safe, so these would be the best recommendation. STRIPS do not provide current income since they are a zero-coupon Treasury obligation so these will not work. TIPS give a lower current interest rate than regular Treasury bonds, in return for protecting the investor against inflation - however the inflation protection is not "paid" until maturity, so again, these will not give the greatest additional current income.
Customer Q, age 40, is married with 3 young children. He earns $120,000 per year and has $10,000 of liquid assets to invest. The customer has no current portfolio, but does own his home, worth $400,000 against which there is a $200,000 mortgage. The customer informs you that his father just died, leaving him an inheritance of $150,000. He wishes to invest the money so that he can retire in 20 years, using the investment's income. The BEST recommendation to the customer is to invest the $150,000 in: A. a large cap stock mutual fund B. CMO companion tranches with a 20 year average life C. TIPs with a 20 year maturity D. a low-load variable annuity separate account with a growth objective
The best answer is D. This customer wishes to fund his retirement 20 years from now. Large capitalization stock mutual funds don't provide a lot of income, and are subject to a greater degree of market risk unless the investment time horizon is very long (which it isn't in this case) - so these are not the best retirement investment for this customer. CMO companion tranches are very risky - not the best idea. Remember, these are the "buffer" tranches that absorb prepayment and extension risk. TIPS provide inflation protection, but the real rate of return is quite low (the price of "safety"), so if the customer lives a long time, the income will not be sufficient for retirement. A variable annuity will pay until the customer dies. Low sales charge variable annuities provide assured retirement income - best meeting the customer's objective.
