Series 7 Suitability/Recommendation Q'S
An investor purchases zero-coupon bonds issued by the U.S. Treasury due to mature in 18 years at $100,000. Which of the following might describe the primary reason for selecting that investment vehicle? 1. The investor is 65 years old and needs the reliability of current income. 2. The investor is 45 years old and has purchased these in an IRA rollover account and wants the assurance of funds for retirement. 3. The investor is 30 years old and has a newborn child and wishes to assure funds for a college education. 4. The investor is 20 years old, has just received an inheritance, and wishes to shelter income for as long as possible.
2 & 3 Zero-coupon bonds maturing in 18 years would assure the 45-year-old of the face value at age 63. Being in an IRA, there would be no current taxation, and upon maturity, if desired, the funds could be distributed without the 10% penalty. Zero-coupon bonds are one way to guarantee funds for college education. However, with no current income, they would not be suitable for the 65-year-old and would not offer any tax shelter to the 20-year-old.
If a new customer is preparing to buy his first home within the next year, and his investment objective is aggressive growth, which of the following investments would be most suitable for your customer's portfolio? A)T-bills B)Growth stocks C)High-yield bond fund D)Blue-chip equity fund
A)T-bills While his profile indicates aggressive growth, the fact that he will need his funds in a year or less to purchase a home is the major consideration. With such a short time horizon, any equity investment involves too much risk, as does an investment in a high-yield bond fund. Of the choices, T-bills make the most sense.
A customer, age 62, wants to retire at age 64 and has accumulated investments in an IRA currently valued at $500,000. The IRA portfolio consisting of all mutual funds is allocated as follows: 70% growth funds, 10% corporate bond funds, and 20% sector funds. Still wanting to use mutual funds, which might be the most suitable reallocation of the portfolio as this customer nears retirement? A)60% U.S. government bond funds, 30% broad market index funds, 10% growth funds B)70% municipal bond funds, 20% broad market index funds, 10% sector funds C)80% broad market index funds, 10% corporate bond funds, 10% U.S. government bond funds D)30% municipal bond funds, 30% corporate bond funds, 40% growth funds
A)60% U.S. government bond funds, 30% broad market index funds, 10% growth funds Moving toward retirement, the reallocation should move the portfolio away from equities and sector funds toward fixed-income funds. U.S. government securities funds accommodate that, and the U.S. government securities within the fund are considered safe with no default risk. Coupling the U.S. government bond funds with smaller percentages in broad market index and growth funds that mirror the market can help the portfolio keep pace with inflation. Remember that utilizing municipal securities in a tax-favored account, such as an IRA, would be considered unsuitable because the interest paid by municipal bonds is already tax free.
An investor with a relatively low risk tolerance for loss of principal wishes to make a long-term investment that will meet his needs and provide some protection against inflation. Which of the following mutual funds is likely the most suitable for him? A)A balanced fund B)A U.S. government bond fund C) A municipal bond fund D)An S&P 500 index fund
A)A balanced fund Although suitability questions are rarely "cut and dried," we attempt to show you what the regulators are looking for. Balanced funds, with their mix of equities and fixed-income securities, offer some downside protection with the bonds and upside (inflation-beating) growth from the equities. Neither of the bond funds will protect against inflation. Furthermore, municipal bonds are never going to be a suitable choice unless something in the question refers to a high-tax-bracket investor. The index fund will surely provide the inflation protection, but as history demonstrated in 2008 and again in the spring of 2020, losses of 30% or more are possible.
A married couple with a two-year-old child have $25,000 to deposit towards an investment to help meet the financial obligations for the child's college education. Given the following choices, which of the following is likely the most suitable investment? A)A treasury STRIP scheduled to mature in 16 years B)A collateralized mortgage obligation (CMO) tranche rated AAA and scheduled to mature in five years C)A money market mutual fund D)A diversified portfolio of insured municipal bonds with an average duration of 18 years
A)A treasury STRIP scheduled to mature in 16 years Treasury STRIPs are zero-coupon bonds, backed in full by the U.S. government. Purchased at a discount and maturing at face value in the future, they are suitable investments for those wishing to save for anticipated future expenses, such as college tuition. A CMO maturing in five years doesn't align with the time horizon for this child's college education and carries other unsuitable risks. A money market fund would hardly meet the growth requirement needed to meet college tuition needs. For exam purposes, municipal bonds are a suitable choice only when something in the question indicates that the investor is in a high income tax bracket.
Your customer lists liquidity as an important investment objective. Which of the following would be least suitable to meet the liquidity requirement? A)Hedge funds B)Money market fund C)A real estate investment trust (REIT) D)Preferred stock mutual fund
A)Hedge funds Of the choices listed, hedge funds would be the least liquid. Because they are unregulated, they can require minimum holding periods, during which time, shareholders cannot make withdrawals. Mutual fund and money market fund shares can be readily redeemed, and REITs are equity securities trading on exchanges, and therefore, are considered liquid.
An investor wants to invest $20,000 but anticipates needing those funds in five years for a business investment. Currently, with inflation rising, the government is expected to take action to push interest rates up to reduce the money supply. Given these conditions, which of the following securities would be the least suitable for this investor who needs a specific amount of money in five years? A)Zero-tranche collateralized mortgage obligation (CMO) with an estimated five years of life B)Zero-coupon bond maturing in four years C)Corporate bonds maturing in five years D)U.S. Treasury bonds maturing in six years
A)Zero-tranche collateralized mortgage obligation (CMO) with an estimated five years of life A zero-tranche CMO is subject to interest rate risk as well as extension risk when interest rates rise, and therefore, it would not be suitable for a customer that needs her investment back at a specific point in the future. By contrast, a four-year zero coupon bond will mature within the anticipated time frame for needing the funds and would be the most suitable choice of the answers given.
An investor who wants a long-term tax-free bond with the highest possible safety should invest in A)a New Housing Authority bond. B)a double-barreled bond. C)a Aaa-rated revenue bond. D)a AAA-rated general obligation bond.
A)a New Housing Authority bond. The one advantage that NHA bonds (sometimes called PHAs) have is that they are the only municipal bonds with the full backing of the U.S. government. Even a GO or revenue bond with the highest S&P or Moody's rating doesn't have that safety.
All of the following are used to determine the suitability of recommendations made to a municipal bond customer except A)the customer's marital status. B)the customer's tax bracket. C)the customer's state of residence. D)the structure of the customer's existing portfolio.
A)the customer's marital status. To determine suitability when recommending municipal bonds, an agent would consider the customer's tax bracket, state of residence (intrastate issues may be double or triple tax exempt), and existing portfolio structure. Some students ask us, "Doesn't the marital status affect the customer's tax bracket?" Yes, it does, but that information is included in the choice the customer's tax bracket.
A customer is very concerned about investments that may not keep pace with inflation. He asks which securities would have the least exposure to inflation risk. Which of the following would be the best answer? A)Cash B)Common stock C)Fixed annuity D)Preferred stock
B) Common Stock Exp: The returns on common stock have historically outperformed inflation, making them less vulnerable to loss of purchasing power than the other choices presented. Cash is a store of present purchasing power that inflation will erode. Fixed annuities have more exposure to inflation than common stock because their payments are fixed in nominal dollars. Preferred stock has the same exposure to inflation risk as do all fixed-income instruments.
Gerry Logan has been managing his own securities portfolio for the past 15 years. His returns have been about the same as the S&P 500, and as he gets older, he does not want to have to spend the time and effort to keep up the performance. Logan is currently 55 years old and has sufficient discretionary income and savings that enable him to take moderate risks. He is of the belief that his own experience proves that you can't beat the market. Which of the following would you suggest for him? A)50% into an S&P 500 index fund (or ETF), 50% into an investment-grade bond fund B)50% into an S&P 500 index fund (or ETF), 30% into an international index fund and 20% into an investment-grade bond fund C)50% into an S&P 500 index fund (or ETF), 50% into a money market mutual fund D)100% into an S&P 500 index fund (or ETF)
B)50% into an S&P 500 index fund (or ETF), 30% into an international index fund and 20% into an investment-grade bond fund Index funds (or ETFs) are appropriate investment vehicles for investors who believe that active management does not produce returns above the cost. Investing in the S&P 500 would give him returns comparable to what he has enjoyed in the past. However, in recognition of his advancing age, it would appear prudent to diversify by placing some of the money into the international sphere and a portion into the safety of high-grade debt securities.
Which of the following investments is most suitable for an investor seeking monthly income A)Growth stock B)Money market mutual fund C)Zero-coupon bond D)Mutual fund investing in small-cap issues
B)Money market mutual fund The money market mutual fund is the most suitable investment for an investor seeking monthly income. The other securities offer higher long-term growth potential, but they are not designed to provide monthly income.
A customer who seeks to supplement his retirement income and has a high risk tolerance would find which of the following securities most suitable? A)Investment-grade bond funds B)Treasury STRIPS C)High-yield bond funds D)Municipal GOs
C) High-yield bonds- bc they yield more than investment-grade bonds. Because the client has a high risk tolerance, these bonds are more appropriate than investment-grade bonds, which yield less. Treasury STRIPS provide zero income, but they certainly are not suitable for those with a high risk tolerance. Similarly, the municipal GO bonds are generally quite safe and, at least for test purposes, municipal bonds are never a suitable investment unless the investor is in a high tax bracket.
While reviewing a new customer's investment profile, you determine that the customer is willing to tolerate a high degree of risk and does not anticipate utilizing the invested funds for at least 15 years. What would be a suitable recommendation regarding asset allocation for the customer's portfolio, given the customer's risk tolerance and time horizon criteria? A)25% debt, 25% equities, 25% money market instruments, and 25% real estate B)45% debt, 45% equities, and 10% money market instruments C)70% equities, 20% debt, and 10% money market instruments D)65% debt and 35% equities
C)70% equities, 20% debt, and 10% money market instruments For an investor who has a long-term investment time horizon and is willing to tolerate higher levels of risk, a recommendation having a higher percentage of the portfolio in equities would be suitable. Of the asset mixes presented, only one has a majority percentage in equities. The remaining choices with higher percentages in debt securities are too conservative.
Which of the following accounts would a collateralized mortgage obligation (CMO) Z-tranche be best suited for? A)An IRA account for a middle aged client B)A joint account with a nonworking spouse C)A professionally managed hedge fund specializing in real estate portfolio securities D)A custodial account set up under the Uniform Transfer to Minors Act
C)A professionally managed hedge fund specializing in real estate portfolio securities A zero-tranche (Z-tranche) CMO is considered to be among the most volatile CMO tranches because they receive no payments until all preceding tranches of the CMO are retired. Generally, CMO tranches are not suitable for smaller or unsophisticated investors, which is why customers are required to sign a suitability statement before purchasing any CMO tranche. Of the answer choices given, the best suited account would be the one that is professionally managed and already specializing in real estate investments.
An investor wants to maximize income using debt securities. Which of the following lists rank securities from the least suitable to the most suitable recommendation if income is the investment objective? A)Nonconvertible bond, convertible bond, income bond B)Treasury bills, convertible bond, income bond C)Income bond, convertible bond, nonconvertible bond D)Convertible bond, income bond, nonconvertible bond
C)Income bond, convertible bond, nonconvertible bond The income (or adjustment) bond is the least suitable because it is issued by companies coming out of bankruptcy with interest payable only if the money is available. Therefore, it is not suitable given the objective. A convertible bond has a lower coupon than a nonconvertible bond because of the convertibility feature. Therefore, if seeking to maximize income, the corporate bond would be the most suitable of the three choices (from least to most: income bond, convertible bond, and nonconvertible bond).
One of your clients was at a recent social gathering and heard a friend talking about a recent investment in an interval fund. How would you describe this investment? A)It is an investment company where an investor's money market account is debited at certain specified intervals to purchase shares of the fund. B)It is an option available in many qualified retirement plans where, as certain specified intervals, the asset allocation is changed as the investor ages. C)It is a closed-end investment company where, at certain specified intervals, investors are able to sell their shares back to the company at net asset value. D)It is a closed-end investment company that computes its net asset value at certain specified intervals.
C)It is a closed-end investment company where, at certain specified intervals, investors are able to sell their shares back to the company at net asset value. Interval funds are closed-end investment companies that permit shareholders to sell their shares back to the company at net asset value. The frequency varies by fund and can range from monthly to annually.
An investor with no current holdings wants to invest $110,000 in the stock of a company she feels looks sound with good upside potential. A history of small dividend distributions is another reason she likes it. This scenario should prompt a discussion of which of the following first? A)Reinvestment risk B)Tax consequences regarding dividends C)Lack of diversification D)Interest rate risk
C)Lack of diversification Currently with no other holdings, a single stock investment with a substantial sum would not be deemed suitable. While there may be a number of suitability issues to discuss, including tax consequences regarding dividends, lack of diversification would be an obvious starting point.
If a client prefers mutual fund investments in companies that primarily generate capital appreciation to companies that pay a steady dividend, what type of mutual fund and associated investment objective would you recommend? A) An index fund B)A growth and income fund C)An income fund D)A growth fund
D) A growth fund
If an investor expects to have a large amount of passive income over the next two years, which of the following programs listed will most likely lead to the largest amount of shelter? A)Undeveloped land purchasing B)Equipment leasing C)Real estate income D)Oil and gas drilling
D) Oil & gas drilling Passive income can only be sheltered by passive loss, so the real estate income program will only add to the income. Oil & gas drilling programs allocate the majority of investment dollars to drilling. These are intangible drilling costs, which are 100% deductible when drilling occurs. Underdeveloped land has very little in the way of losses & equipment leasing programs usually generate income shortly after starting.
A married couple both hoping to retire within the next five to seven years have expressed having a low-risk tolerance regarding the stock market. They have a combined income of $350,000. Given this information, which of the following portfolio mixes would be most suitable? A)Treasury bills, corporate bonds, preferred stock B)Treasury bills, common stock, options C)Direct participation programs, real estate investment trusts, preferred stock D)Treasury notes, municipal bonds, GNMAs
D)Treasury notes, municipal bonds, GNMAs In light of their low risk tolerance, U.S. government securities would certainly be suitable, and the time frame noted for retirement allows for middle term T-notes to be useful. Given their higher income level, tax-free municipal bonds could also have a place in the portfolio. Longer term GNMAs would accommodate monthly income, should that be desirable upon retirement. The remaining product suggestions are either illiquid (DPPs) or do not align with their risk aversion (common, preferred, options, and REITs).
If a customer is in a low federal income tax bracket and his main investment objective is current income, which of the following securities should the agent recommend? A)City of Milwaukee general obligation bond B)U.S. government bond C)Investment-grade corporate bond D)Zero coupon bond
Investment-grade corporate bond If an investor is in a low-tax bracket, any benefit from receiving tax-free municipal bond interest is diminished, making municipal bonds a less suitable investment. Zero-coupon bonds pay no interest until maturity, and therefore, are not suitable for someone seeking current income. To maximize income, the best recommendation of the choices listed is the corporate bond, which offers a higher yield than a government bond with a similar maturity.
