Unit 17
What is the net worth of a customer with the following personal balance sheet? Cash $20,000 Municipal bonds $75,000 401(k) account value $150,000 Salary $80,000 per year Cars $30,000 Home $250,000 Miscellaneous (jewelry, etc.) $50,000 Personal loan $10,000 Car loan $20,000 Mortgage $150,000 Monthly mortgage payment $1,500 A) $95,000 B) $473,500 C) $395,000 D) $245,000
C) $395,000 A customer's net worth equals assets minus all liabilities ($575,000 − $180,000 = $395,000). Salary and mortgage payments are income and expense items and are not part of net worth.
Otto and Lucy set up a 529 plan to save funds for the college education of their daughter, Marangue, who is 14. What is the most suitable investment for the largest portion of their contribution? A) A long-term bond fund B) A large-cap stock fund C) An intermediate term bond fund D) A growth stock fund
C) An intermediate term bond fund This is a straight suitability question. Match the time horizon to the investment offered, and an intermediate term bond fund is the only logical answer.
When it comes to creating a client profile, the information obtained is divided into 2 basic categories: objective and subjective. Which of the following is considered to be subjective information? A) Salary B) Net worth C) Attitude D) IRA value
C) Attitude Subjective information is that which cannot be quantified. The investor's attitude is an example of this, while the other choices are all objective (you can attach a number to them).
An investor is in a low tax bracket and wishes to invest a moderate sum in an investment that will provide some protection from inflation. Which of the following should you recommend? A) Ginnie Mae fund B) Money market mutual fund C) Mid-cap common stock mutual fund D) Municipal unit investment trust
C) Mid-cap common stock mutual fund Mid-cap stocks (see Glossary of Terms) have historically provided good hedges against inflation making them appropriate for an investor seeking long-term growth and inflation protection. There are several key words here to remember for the exam. Whenever you see "low tax bracket," the answer cannot be a municipal bond. Likewise, whenever you see "inflation protection," the answer will be common stock (unless a TIPS is given as a choice).
The study of why people often make decisions using rules of thumb rather than rational analysis, basing those decisions on factors economists traditionally don't consider, such as fairness, past events, and aversion to loss, is known as A) systematic risk B) risk tolerance C) behavioral finance D) irrational finance
C) behavioral finance Today, through the study of behavioral finance, it is accepted that behavioral biases can cause investors to make financial decisions that are irrational.
In making suitable investment recommendations, the least significant element would be the client's A) death and disability needs B) current income C) educational level D) retirement needs
C) educational level A client's educational level is not as important as retirement needs, death and disability needs, and current income. However, the agent should take note of the client's educational level to ensure that the client fully understands the investments recommended. Also, a person with a professional educational background may have more employment opportunities and be able to take more risk as a result.
All of the following are reasons why broker-dealers and investment advisers gather information about their customers except A) to use in determining suitability. B) to comply with BSA requirements. C) for use in advertising. D) to maintain accurate customer records.
C) for use in advertising. It would generally be considered a violation of privacy rights to use specific customer data in advertising without express consent. This is particularly true for investment advisers where testimonials are prohibited. Information must be gathered in order to make suitable recommendations, and the Bank Secrecy Act as well as federal and state law have recordkeeping requirements.
An investment advisory firm requires all new clients to complete a 4-page questionnaire before conducting the first meeting. This would be known as A) the client disclosure document. B) the investment adviser's brochure. C) the information-gathering stage. D) fulfilling the requirements of the CIP.
C) the information-gathering stage. The first step in any adviser's relationship with a client is information gathering. A popular way of doing this is by using a questionnaire.
John and Jane have a net worth of $20,000 and total assets of $150,000. If their revolving credit and unpaid bills totals $8,000, how much are their total liabilities? A) $130,000 B) $150,000 C) $122,000 D) $138,000
A) $130,000 The balance sheet formula is assets − liabilities = net worth. Therefore, $150,000 − liabilities = $20,000, where liabilities = $130,000. Did you answer $122,000? That is the amount of the liabilities other than the revolving credit, but that is not what the question is asking for.
Your 47-year-old client plans to retire at age 65. When constructing a recommendation for the client's $850,000 IRA rollover account, your first consideration should be the client's A) tax status B) planned retirement age C) liquidity needs D) risk tolerance
D) risk tolerance Explanation While tax status, planned retirement age, and liquidity needs are important considerations in determining a client's investment profile, the first concern that should be addressed in this case is the client's risk tolerance.
An investment adviser representative prepares a detailed portfolio restructuring for a new client. The client is not impressed with the recommendation, and at least to the IAR, it appears that the rejection is more due to a lack of understanding than a valid dislike. What should be the first step taken by the IAR? A) Attempt to educate the client as to what this portfolio is trying to accomplish for the client while at the same time recognizing that the final decision is clearly in the hands of the client. B) Go ahead with the recommendation anyway because the client's lack of understanding should not stand in the way of potentially superior results. C) Suggest that if the client will not follow the IAR's recommendations, it would be best to engage the services of another firm. D) Prepare a new set of recommendations that will hopefully be received more favorably by the client.
A) Attempt to educate the client as to what this portfolio is trying to accomplish for the client while at the same time recognizing that the final decision is clearly in the hands of the client. Even when the IAR is convinced that the optimal recommendations have been made, the final decision is always that of the client. However, there is nothing in the laws or policies dealing with ethical conduct that prohibit the IAR from attempting to "sell" the client, especially through an educational approach.
An investment adviser representative's client lost her father to lung cancer. Among the assets bequeathed to her were 2,000 shares of a tobacco stock. Which of the following is most likely not a consideration when recommending to her what to do with the stock? A) Her father's years of investment experience B) The cause of her father's death C) Her financial goals D) Her employment situation
A) Her father's years of investment experience An adviser's recommendations to a client are not impacted by the degree of someone else's investment experience or knowledge. In this case, it is not unreasonable to expect some resentment towards holding shares of a tobacco company when the cause of a loved one's death is lung cancer.
For a trust account not seeking appreciation, which of the following would be recommended? A) Highly rated, fixed-income securities B) Large-cap common and preferred stocks C) Common stock, preferred stock, and debentures D) Common stock in small, highly profitable companies
A) Highly rated, fixed-income securities The only choice that is prudent and does not have a goal of appreciation is the purchase of highly rated, fixed-income securities.
What would be the time horizon for a 65-year-old client who has just retired? A) It depends on the individual's life expectancy. B) It depends on the individual's available assets. C) None, because 65 is the age for retirement. D) It depends on the individual's insurance company's actuarial tables.
A) It depends on the individual's life expectancy. The time horizon for an individual who has just retired is the balance of expected life.
Which of the following would be considered an investment constraint rather than an investment goal? A) Liquidity B) Current income C) Capital preservation D) Growth of capital
A) Liquidity Investment constraints are those things that limit our ability to reach our goals. If the investor needs high liquidity, that factor will affect the investment selection process and place a limit on the available investment options.
A new client indicates a desire to avoid investing in mid-cap stocks because of large losses suffered several years ago. What type of consideration would this be? A) Nonfinancial B) Financial C) Systematic D) Unsystematic
A) Nonfinancial There are 2 basic investment considerations, financial and nonfinancial. The former deals largely with quantifiable items and the latter with attic attitudinal ones. Wanting to avoid a certain type of asset is generally considered to be attitudinal. The fact that the mid-cap stocks lost money is probably a systematic risk, but that isn't what the question is asking.
When preparing a client's personal profile, it is generally accepted that there are both financial and non-financial considerations evaluated in order to issue appropriately suitable recommendations. Which of the following would not be included in the list of financial considerations? A) Risk tolerance B) Income from rental properties C) Vested interest in the employer's 401(k) plan D) The client's marginal tax bracket
A) Risk tolerance A client's risk tolerance is a non-financial consideration; it is an attitude. Income from a rental property, tax obligations, and available retirement funds are all financial considerations that contribute to determining suitability.
Which of the following best describes the determination of a client's risk tolerance? A) The client's ability and willingness to take risk B) The client's willingness to take risk C) The client's ability to take risk D) The client's net worth
A) The client's ability and willingness to take risk Risk tolerance is a combination of two factors. One is the emotional willingness to face a loss and the other financial capacity to absorb a loss without a change in lifestyle. The client's net worth gives an indication of the capacity, but says nothing about the emotion.
Gathering information about a prospective advisory client would probably not be done by A) using a third party interviewer. B) chat over a lunch. C) use of a questionnaire. D) personal interview.
A) using a third party interviewer. Because of the confidentiality of the kind of information an investment adviser needs to properly act as a fiduciary in handling a new client's account, it is unlikely that the role would be delegated to an outside third party.
If a new client has $200,000 to invest and wants to retire in 15 years, which of the following client information is least necessary for an adviser to recommend a suitable investment program? A) The age of the client B) Current income and cash flow requirements C) Tolerance toward risk D) The projected annual income needed during those retirement years
B) Current income and cash flow requirements While current income and cash flow requirements are ordinarily important considerations, in this question we are being asked about the investment of a lump sum, not periodic additional investments. The amount of income required will determine the types of investments and how they must be structured in order to achieve the retirement income desired. The client's age is necessary to determine the time horizon. That is, if the client is currently 35 and wishes to retire at age 50, the money will have to last a lot longer than if we are dealing with a 55-year-old who wishes to retire in 15 years at 70. A client's tolerance toward risk is among the most important non-financial considerations in determining investment suitability.
Which of the following investment strategies would be appropriate for an advisory client with a 20-year time horizon before retirement? Holding more stock Holding less cash Holding fewer bonds A) I only B) I, II, and III C) II only D) II and III
B) I, II, and III With a long time horizon before retirement, equity securities such as common stock would offer the highest potential return and cash would be least suitable. Given purchasing power risk, bonds would not provide the returns associated with common stock.
Investment advisers must recognize the difference between their client's goals and objectives and investment constraints. Which of the following would be considered an objective rather than a constraint? A) Time horizon B) Income in retirement C) Changes to laws and regulations D) Tax concerns
B) Income in retirement Income, whether for current or future needs, is an objective. The other choices represent investment constraints: things that must be dealt with in order to reach the goal of meeting the objective.
What would be the time horizon for a 65-year-old client who has just retired? A) It depends on the individual's available assets. B) It depends on the individual's life expectancy. C) None, because 65 is the age for retirement. D) It depends on the individual's insurance company's actuarial tables.
B) It depends on the individual's life expectancy. The time horizon for an individual who has just retired is the balance of expected life.
A 45-year-old investor wants the greatest possible monthly income with the preservation and stability of capital as secondary objectives. Which of the following investments would you recommend? A) Money market mutual fund B) Long-term bond fund C) Growth mutual fund D) Growth and income fund
B) Long-term bond fund The only choice that provides stability of capital is the money market fund, but that is not the investor's primary objective and the monthly income is quite low. Although the two other funds don't offer stability, they certainly don't provide a high income (even the growth and income fund). If you want income, you invest in bonds, especially those with longer maturities.
Your client is 75 years old and has $100,000 to invest. He enjoys a relatively high income and is not concerned with immediate liquidity, although he is risk averse. The most suitable asset allocation strategies listed below would be A) a 50% municipal bond fund, 40% money market fund, 10% large-cap common stock fund B) a 50% municipal bond fund, 40% government bond fund, 10% large-cap common stock fund C) a 50% municipal bond fund, 40% government bond fund, 10% money market fund D) a 50% municipal bond fund, 50% large-cap common stock fund
B) a 50% municipal bond fund, 40% government bond fund, 10% large-cap common stock fund The allocation of 50% municipal bond fund, 40% government bond fund, and 10% large-cap common stock is appropriate for a high-income person of age 75 who is not concerned with liquidity. The 10% large-cap fund provides some inflation protection with very moderate downside risk.
An investment adviser representative meets with a couple who explains that they wish to be able to pay for their daughter's college education. The IAR is told that the child will be starting school in 5 years. This 5-year time period would be considered A) a capital need B) an investment constraint C) an investment policy statement (IPS) D) the present value needed
B) an investment constraint Investment constraints are limitations on the ability to make use of particular investments. They can be liquidity, time horizon, tax concerns, legal and regulatory factors, and unique circumstances (ethical objectives or social responsibility considerations). The easiest way to determine if it is a constraint or a capital need is if a dollar amount is stated. When a specific sum is mentioned, it is a capital need. The IAR might use a present value computation to determine the amount to be deposited,, and this may be part of the client's IPS, but neither of those answers the question posed.
All of the following statements regarding a client's attitudes, beliefs, and values are correct except A) the client's attitudes reflect the client's opinions, values, and wants. B) the IAR should pay little attention to a client's attitudes, beliefs, and values during the information gathering process. C) beliefs are a type of attitude because they reveal the client's understanding of some aspect of his life. D) values are attitudes and beliefs for which the client feels strongly.
B) the IAR should pay little attention to a client's attitudes, beliefs, and values during the information gathering process. The IAR must take into account the impact the client's attitudes, values, and beliefs may have throughout the information gathering process. These nonfinancial considerations must be evaluated when developing and presenting any recommendations.
You are doing an investment plan for a new client, age 55, who plans to retire at age 70. The client is somewhat risk averse and wants to preserve capital while at the same time not falling prey to possible inflation. Which of the following portfolios would probably be most suitable? A) 40% high-yield bonds; 60% large-cap stocks B) 90% high-quality bonds; 10% large-cap stocks C) 90% large-cap stocks; 10% high-quality bonds D) 60% high-quality bonds; 30% large-cap stocks; 10% cash equivalents
D) 60% high-quality bonds; 30% large-cap stocks; 10% cash equivalents Explanation Although it is possible to debate this choice (but don't), NASAA would suggest that the bonds and cash offer sufficient capital preservation while this proportion of equities will combat the risk of inflation. High-yield (junk) bonds have no place in the portfolio of a risk-averse investor.
Any recommendations made to customers by a broker-dealer must be suitable for the customer on the basis of an investigation of the customer's I. investment objectives II. financial status III. ability to pay high commissions IV. desirability as a customer A) II and IV B) I and III C) III and IV D) I and II
D) I and II Explanation Recommendations must meet the needs of the customer, not necessarily those of the agent or the broker-dealer firm.
As part of its suitability determination, an IA firm requires that all potential nonbusiness clients complete a family balance sheet. Items that would be included are I. gold jewelry II. loan secured by the family automobile III. the amount paid thus far this year for Botox injections IV. the balance owed to the dentist for new crowns A) I and IV B) I, II, III and IV C) II and III D) I, II and IV
D) I, II and IV Explanation The balance sheet contains assets and liabilities as of a specific point in time. Personal property currently owned, such as jewelry, is an asset. A loan still outstanding, such as the car loan and the debt to the dentist, are liabilities. The amount already paid for the Botox injections is no longer on the balance sheet.
An individual investor specifies to her investment adviser representative that her portfolio must produce a minimum amount of cash each year. This would be considered A) a tax constraint. B) a legal and regulatory constraint. C) a unique circumstance. D) a liquidity constraint.
D) a liquidity constraint. Liquidity constraints arise from an investor's need for spendable cash.
A new client wants your recommendation on available investment options. You prepare a client profile, which reveals that the investor is 66 years of age, has a low risk tolerance, and is in a low tax bracket. The investor's primary objectives are safety and income. Of the following, the most suitable choice would be A) large-cap common stock B) a growth and income mutual fund C) a municipal bond mutual fund investing solely in AAA- and AA-rated bonds D) insured bank certificates of deposit
D) insured bank certificates of deposit Explanation Whenever you see "low tax bracket," the answer cannot be municipal bonds. With a low risk tolerance, the only suitable choice for "safe" income would be insured bank CDs.
An adviser always inquires into her clients' investment objectives, financial situations, and needs. The investment adviser is A) giving herself an unethical advantage regarding how much the client can afford to spend on an advisory fee. B) violating her ethical obligation regarding confidentiality of client information. C) determining whether she has any inherent conflicts of interest with her clients. D) obtaining the information required to fulfill her professional obligation regarding suitability.
D) obtaining the information required to fulfill her professional obligation regarding suitability. Explanation Investment advisers are under a professional obligation to inquire into a client's investment objectives, financial situation, and needs, and to make recommendations consistent with that information. Conflicts of interest would not arise based on an individual client's suitability profile. Conflicts of interest result from actions of the adviser, regardless of the needs of the client.
One of your clients excitedly calls to inform you that his daughter has just been accepted for the coming year into the engineering program at one of the most respected universities in the country. She has been given a generous scholarship but that will leave the family short by about $100,000 for the four-year program. You check the client's college savings account and see that the current value is $25,000. The client offers to add another $25,000 and asks you if you think the account performance over the next four years can provide the necessary funds. You would probably reply A) that the goal seems attainable if the client is willing to assume the necessary risk. B) this is wonderful news and you are pleased that the client has selected such a worthwhile goal. C) his daughter should consider attending a community college instead. D) the short time horizon is an investment constraint that will make reaching this goal highly unlikely.
D) the short time horizon is an investment constraint that will make reaching this goal highly unlikely. Investment constraints are those things that get in the way of reaching our goals. One of the most important of these constraints is the time horizon. If this client had more time, it is possible that the goal could be reached, but, under the current conditions, the risk that would have to be taken would likely be far beyond an acceptable one.
