SERIES 6: Section 6 ... Suitability and Risk
A retired man has $100,000 to invest for growth. He also owes a $10,000 note due in 6 months, a $20,000 note due in one year and a $25,000 note due in two years. How much of the $100,000 should he allocate to growth investments?
$45,000.
Which investment is exposed to the greatest risk when interest rates increase?
20 year bond with a 4% coupon
If a customer is concerned about interest rate risk, which of the following securities is least appropriate?
25-year municipal bonds.
Which of the following investments is most susceptible to interest rate risk?
30-year Treasury bond
Which of the following best defines credit risk?
A risk associated with default of a debt security.
Mr. and Mrs. Smith, both nearing retirement, want to maximize their income. They want to reallocate $100,000 of their $400,000 portfolio of securities for this purpose. Of the possible investment choices below, which would be the LEAST suitable recommendation given their investment objective?
AAA convertible corporate bonds
Loss of purchasing power has the greatest impact on which of the following investor profiles?
An elderly person living on a fixed retirement income with little savings.
A young, recently married couple, would like to purchase a home within five years. They have $2,000 in savings and $400 a month to invest. In addition, they owe $35,000 on student loans to be repaid over the next ten years. What type of mutual fund investment would likely be the BEST recommendation?
Build up cash reserves and then save for a down payment on the new home. Investing must wait.
An investor purchased the stock of a very well-performing technology company, expecting to receive substantial growth in the future. Shortly after he purchased the stock, the company was sued for patent infringement and lost. This reduced its product line and made serious inroads into its working capital, so that the stock declined greatly in value. This is an example of what kind of risk?
Business risk.
An investor purchased the stock of an 80 year old blue-chip stock company as a core investment in her portfolio. After several years of steady growth, a major class action law suit was filed that could cost the company billions of dollars. This litigation resulted in a 40% loss in market capitalization. What kind of risk is this?
Business risk.
In a fiduciary account with stated investment objectives of preserving capital and generating income, which of the following investment trading strategies is the most suitable?
Buying Treasury bonds.
A complete customer profile includes both financial and nonfinancial investment considerations. Which of the following is considered financial investment information?
Discretionary income
All of the following information would be helpful to have in a customer profile EXCEPT
Educational achievement of a BA from an accredited college
Which of the following would be the least important to have in a customer profile?
Educational degrees earned by the customer.
Which of the following is the least suitable mutual fund transaction?
Encouraging a mutual fund shareholder to sell an income fund purchased two years ago and use the proceeds to purchase another income fund from a better managed fund family.
Your client has $50,000 to invest. His objective is monthly income that he can receive after he retires. Part of his customer profile stresses that he has had uncomfortable experiences in the past with the stock market and is not inclined to invest in anything that is based on stock market performance and would opt for principal protection instead. Based on the clients profile which of the following would be the best recommendation?
Fixed Annuity
Which of the following activities are a registered representative's responsibilities? I. Determining the suitability of various investments for individual customers. II. Describing the characteristics and benefits of various securities products. III. Offering tax advice and assisting customers in completing tax returns. IV. Personally holding a customer's securities for a future transaction.
I and II.
Which of the following statements regarding the suitability of investment recommendations are TRUE? I. A client's investment objectives, prior investment experience, financial profile, and risk tolerance aid in determining suitability. II. Suitability will vary with each investor. III. Only the client is responsible for learning about the investments that are purchased. IV. Growth and income mutual funds are suitable for all investors.
I and II.
Which of the following would be valid when recommending investments for a client that does not believe in professional money management and is interested in long-term capital appreciation? I. Gather financial information from the client. II. Consider index funds for a portfolio mix that is appropriate for the client based upon risk tolerance, time horizon, and investment expectations. III. Place the client's assets in an asset allocation fund, providing diversification and reduced risk under most economic conditions. IV. Review the portfolio at least once every month to determine whether any changes or modifications are necessary.
I and II.
You are reviewing an investor's balance sheet. Which of the following items would be found on a balance sheet and help you determine the client's net worth? I. 401(k) balance II. Credit card balance III. Monthly income IV. Electric bill
I and II.
Your 70-year old client with $400,000 wishes to assemble a portfolio that will provide her with a consistent cash flow for her projected life expectancy. She would like to maximize her return, but is not willing to assume a high degree of risk. Which of the following securities might you suggest for this portfolio? I. ABC Corporation debenture, S&P rating AAA. II. XYZ Railroad equipment trust certificate, rated AA. III. MNO Corporation convertible bond, rated AAA. IV. DEF Corporation common stock.
I and II.
When making recommendations to an advisory client, which of the following carry the most weight? I. The client's risk tolerance. II. Past performance of the adviser representative's recommendations. III. The client's investment needs and objectives. IV. The client's previous investment experience with other advisers.
I and III.
Your customer has heard that the price differential between low-risk and high-risk debt instruments is wider than expected. You tell him that this: I. is a bad economic indicator. II. is a good economic indicator. III. means investors will be more insistent on safety. IV. means investors will be less insistent on safety.
I and III.
Diversification helps protect against which of the following types of risk? I. Nonsystematic II. Systematic III. Market IV. Business
I and IV
An investment representative recommended a variable annuity to a client who declined the investment. The same client called a year later and wanted to buy the annuity and invest all of the funds in the aggressive growth portfolio, which had had a remarkable three-year performance streak. The client is one year away from retirement. Which of the following statements are TRUE? I. The client's profile must be updated to ensure suitability before selling him the variable annuity. II. Because suitability was established a year ago, there is no need to update the client's information. III. The aggressive growth portfolio selection is suitable because the client does not need income until he retires in a year. IV. The aggressive growth portfolio is not suitable because the client will retire in a year.
I and IV.
In order to minimize liquidity risk, you recommend which of the following to a 37-year-old prospect? I. A growth mutual fund II. A fixed annuity III. Real estate rental property IV. Listed stock on the NYSE
I and IV.
Which of the following statements regarding interest rates and price fluctuations of debt securities are TRUE? I. Short-term prices fluctuate more than long-term prices. II. Long-term prices fluctuate more than short-term prices. III. Short-term interest rates fluctuate more than long-term rates. IV. Long-term interest rates fluctuate more than short-term rates.
II and III
An investment in an international equity fund carries: I. Reinvestment risk II. Political risk III. Currency risk IV. Credit risk
II and III.
The two most important factors in determining a member's suitability obligations when making recommendations to institutional customers are: I. the relationship of the customer with the investment banking department of the firm. II. the customer's capability to evaluate investment risk independently. III. the extent to which the customer intends to exercise independent judgment in evaluating a member's recommendations. IV. the number of transactions completed during the previous 12 months.
II and III.
During a fact-finding interview with a potential client, your client information sheet is used to list detailed financial information. Which of the following items would be relevant in determining a prospect's net worth? I. $225,000 annual income. II. $78,000 current IRA balance. III. recently paid off a $3,000 credit card balance. IV. just installed a $25,000 home entertainment center.
II and IV.
Rank the following from least to most capital risk:GNMATreasury BillAdjustable preferred stockZero-coupon bond
II, I, IV, III
When comparing a short-term bond fund to a long-term bond fund, which of the following is generally true? I. The short-term fund has a higher yield. II. The long-term fund is less volatile. III. The long-term fund has a higher yield. IV. The short-term fund is less volatile.
III and IV.
A single premium immediate annuity will pay $2,000 a month for life. What is the annuitant's greatest risk?
Inflation risk
Your customer has $200 per month of discretionary income and currently invests $200 monthly into a mutual fund. His daughter plans to enter college soon, and he would like to send her $100 monthly. Which of the following actions should you recommend to him?
Invest $100 monthly into the mutual fund and send his daughter $100 monthly.
Your customer, age 37, makes $60,000 per year and wants to invest $10,000. He wants a conservative investment with annual returns in the 10-20% range. Which of the following should you suggest?
Managing and lowering your customer's expectations.
A married couple in their early 50's saving for retirement would most likely have which of the following objectives?
Moderate risk, moderate safety, low liquidity.
Which of the following is a customer probably referring to when he speaks of safety in investments?
Preservation of capital
Which of the following is the best recommendation for someone extremely averse to risk?
Principal protected fund
Which of the following mutual funds is likely to carry the greatest credit risk in its portfolio?
The Keppel High-Yield Bond fund.
A registered representative is preparing a profile on one of his customers. Which of the following should he list as a nonfinancial consideration?
The amount of money the customer is willing to risk.
Three 3% bonds are listed in the newspaper. One bond will mature in one year, another bond will mature in ten years, and the third bond will mature in 20 years. If interest rates are going up, which bond will have the greatest decrease in value?
The bond with the 20-year maturity.
Which of the following would be appropriate recommendations for a customer looking for income?
Utility fund
Your customer, age 32, makes $48,000 annually and has $15,000 to invest. Although he has never invested before, he wants to invest in something exciting, with investment returns in the 20%+ range. Which of the following should you suggest?
Your customer should provide more information before you can make a suitable recommendation.
If an elderly widower wants his investments to provide high current income, the representative should recommend:
a mutual fund that matches the investor's stated objective.
A customer would like to invest with an objective of current income. All of the following are suitable recommendations EXCEPT
a periodic payment immediate annuity
When a registered representative is deciding on the suitability of a particular investment for a customer, that customer's need for liquidity is:
an important element to be considered.
A new company starting operations in the highly competitive computer industry subjects an investor to:
business risk.
An investor purchased 1,000 shares of the KLP Corporation common stock. KLP was late in introducing a new product and lost half of its market to a competitor, resulting in the investor's shares losing substantial value. This is an example of:
business risk.
Your new client is interested in purchasing corporate bonds. When speaking about the different risks associated with this investment, you explain that reinvestment risk is the risk that, between now and when the bond matures or is called, interest rates will:
fall.
All of the following are true about the alternative minimum tax (AMT) EXCEPT
it is a tax on alternative income such as that received from direct participation programs or REITS
Phyllis purchased stock in a tobacco company several years ago. Last month the cigarette tax was increased by 25% and the stock price dropped significantly. Phyllis's investment was subject to:
legislative risk.
Albert, an accredited investor, invested $100,000 into a hedge fund last year. His investment is now valued at $110,000. An unfortunate set of circumstances requires him to sell his shares immediately. Albert's need to turn his investment into cash quickly results in
liquidity risk
A 54-year-old client is in the highest tax bracket and seeks a conservative investment for retirement. If his investment adviser representative recommends a general obligation municipal bond for the client's IRA, the IRA has
made an unsuitable recommendation based on the client's needs and objectives.
A type of systematic risk is
market risk
A customer wishes to open a new account but refuses to provide suitability information. Under FINRA rules, the member
may open the account but may not make any recommendations.
An accredited investor, age 39, would like to invest $10,000 and wants an investment that is liquid. You recommend a(an)
mutual fund that invests in both stocks and bonds
While prospecting for clients, you discover a potential investor who is 88 years old, retired, living on his savings, has never invested, and has very high medical expenses. As a registered representative, you would recommend:
no investment account be opened due to his financial situation.
Credit risk involves:
possibility of issuer default.
A 40-year-old client with an annual income of $25,000 has been investing $100 per month in XYZ mutual fund through a dollar-cost-averaging strategy for the last 10 years. After winning the lottery, the client asks for investment recommendations for his $1 million winnings. The representative should recommend
reevaluating the customer's goals and objectives in light of his new financial situation
Archie has just been informed that the AA 7% bonds he purchased 5 years ago are being called next month as the issuer would like to take advantage of lower interest rates. If Archie wants to purchase 7% AA bonds after the call, he will experience
reinvestment risk
Liquefying home equity to generate funds for investment purposes
requires communication of the unique risks associated with this investment strategy by the broker-dealer
A prospect is heavily invested in the common stock of an employer's company, ABC, relative to other investments. The stock has performed well over the last 15 years and the prospect is very happy with the investment. After reviewing financial and nonfinancial criteria, you have determined that
selling a portion of ABC and using the proceeds to purchase mutual funds will reduce his nonsystematic risk
A customer of yours owns a corporate bond fund with a long duration. Mortgage rates are going up. What impact will this have on the investment?
the current yield will increase since the price of the shares can be expected to fall.
If interest rates are dropping, an investor with a maturing bond will be most concerned with:
the difficulty in finding another investment with a like yield.
Investors should consider all of the following when investing in a mutual fund EXCEPT the:
underwriter
A 78-year-old retiree had a $100,000 CD maturing and was dissatisfied with current yields on new CDs. Aside from Social Security and a small monthly pension, the $100,000 is his total potential source of income. The registered representative recommended investing the funds in a single premium immediate variable annuity, allocating funds to the separate account as follows: $10,000 Medical Technology, $40,000 High-Yield Corporate Bond, and $50,000 Growth & Income. The registered representative's recommendation is:
unsuitable because of the aggressive nature of the portfolio choices.
A widowed customer with no children has a portfolio invested in mutual funds valued at $250,000. The portfolio generates a monthly income of $1,600, an amount that exceeds her living expenses by $300. The investment portfolio is her sole source of income. Her agent recommends she sell $30,000 worth of her mutual funds and purchase a variable life insurance policy to take advantage of the tax deferral and death benefit features. This recommendation is:
unsuitable, since she has no need of the death benefit.
