end of chapter 1

Question 1

What does the asset component of net worth represent?

Answer 1

What a customer owns, including:
* Primary residence and other real estate
* Automobiles
* Personal possessions
* Government and corporate bonds
* Stocks
* Mutual funds and annuities
* Pension plans and 401(k) plans
* Individual retirement accounts
* Money-market funds and CDs
* Savings accounts
* Cash in checking accounts

Question 2

How can customer assets be classified?

Answer 2

Assets may be classified as:
* Tangible assets (e.g., real estate and personal possessions)
* Investments (e.g., stocks, bonds, and retirement plans)
* Savings (e.g., money-market funds, checking and savings accounts)

Question 3

Why is knowing a customer’s current portfolio important for an RR?

Answer 3

It helps the RR recommend investments and adequately diversify the customer’s portfolio.

Question 4

What are the components of liabilities in the net worth formula?

Answer 4

Liabilities include:
* Mortgages and home equity loans
* Automobile loans
* Credit card balances
* Student loans
* Debit balances used to buy stock on margin

Question 5

What is net worth?

Answer 5

The difference between what a customer owns and what she owes.

Question 6

What does liquid net worth exclude?

Answer 6

Assets that are not readily convertible into cash, such as real estate, limited partnership interests, and stock in small companies.

Question 7

What does age indicate about an investor’s risk tolerance?

Answer 7

Generally, younger investors can tolerate more risk than those closer to retirement.

Question 8

How can time horizon affect investment strategies?

Answer 8

A longer time horizon allows for more volatility; shorter time horizons require more stable, conservative investments.

Question 9

Who would likely have a shorter time horizon: a mid-20s single person or a mid-50s married person with children in college?

Answer 9

The mid-50s married person (Larry) would likely have a shorter time horizon.

Question 10

What does investment experience provide insight into?

Answer 10

A customer’s ability to understand an RR’s investment recommendations and the accompanying risks.

Question 11

Define risk in the context of investments.

Answer 11

The chance taken that an investment’s actual return may be different from its expected return.

Question 12

True or False: Risk tolerance is solely based on financial resources.

Answer 12

False.

Question 13

What is a common method RRs use to assess a customer’s risk preferences?

Answer 13

Questionnaires to help customers understand their risk preferences.

Question 14

What are social values in investing?

Answer 14

Concerns about the social and environmental impacts of companies in investment portfolios.

Question 15

What should be the minimum cash reserve for most persons?

Answer 15

At least three months’ living expenses.

Question 16

What type of investments do customers focused on preservation of capital typically choose?

Answer 16

U.S. government securities, insured certificates of deposit, or money-market funds.

Question 17

What is the primary goal of current income investors?

Answer 17

To achieve a steady, reliable stream of cash.

Question 18

What are common growth investments?

Answer 18

Common stocks and equity mutual funds.

Question 19

What is the purpose of a college funding investment program?

Answer 19

To provide for children’s college education.

Question 20

What is the recommended strategy for retirement funding?

Answer 20

Maximize contributions to a tax-deferred retirement plan, such as a 401(k).

Question 21

What is speculation in investment objectives?

Answer 21

Seeking investments that have the potential for above-average returns.

Question 22

What is the tax advantage of municipal bonds?

Answer 22

They produce income that’s tax-exempt.

Question 23

What does a tax credit provide?

Answer 23

A dollar-for-dollar reduction of the investor’s tax liability.

Question 24

What is the importance of meeting fiduciary obligations?

Answer 24

Assets may be invested for the benefit of a third party.

Question 25

What are traditional IRAs and employer-sponsored retirement plans classified as?

Answer 25

Tax-deferred investments ## Footnote Investors are not required to pay taxes on the income produced until a later date.

Question 26

What is a tax credit?

Answer 26

A dollar-for-dollar reduction of the investor’s tax liability ## Footnote It directly reduces the amount of tax owed.

Question 27

What is a tax deduction?

Answer 27

A reduction in an investor’s taxable income ## Footnote It lowers the overall income that is subject to taxation.

Question 28

When investing for a third party, what must a registered representative (RR) consider?

Answer 28

The profile and objective of the beneficiary ## Footnote Not the person making the ultimate investment decisions.

Question 29

What are the goals of customer interaction regulations?

Answer 29

* Promotion and enforcement of just and equitable principles of trade * Maintenance of high standards of commercial honor * Prevention of fraudulent and manipulative activities * Prevention of unreasonable profits and charges * Protection of investors and public interest * Collaboration to promote fair practices ## Footnote These rules are designed to ensure ethical behavior in the securities industry.

Question 30

What must all recommendations made by RRs be based on?

Answer 30

The facts disclosed by customers regarding their financial situation and needs ## Footnote Suitability is the determinant of fair dealings, not profitability.

Question 31

What items are included in a customer’s investment profile?

Answer 31

* Age * Other investments * Financial situation and needs * Tax status * Investment objectives and experience * Investment time horizon * Liquidity needs * Risk tolerance ## Footnote Educational background is not considered in determining suitability.

Question 32

What does the reasonable-basis obligation require from broker-dealers?

Answer 32

To have a reasonable basis to believe that a recommendation is suitable for at least some investors ## Footnote If a product is not understood, it shouldn't be recommended.

Question 33

What is the customer-specific obligation?

Answer 33

To have a reasonable basis to believe that a recommendation is suitable for a particular customer ## Footnote It is based on the customer’s investment profile.

Question 34

What does the quantitative obligation entail?

Answer 34

To have a reasonable basis to believe that recommended transactions are not excessive based on the customer’s investment profile ## Footnote This ensures that the recommendations are appropriate in scale and risk.

Question 35

What should a broker-dealer consider regarding institutional customers?

Answer 35

* The capability of the institutional customer to evaluate investment risks independently * The institutional customer must affirmatively state it’s exercising independent judgment ## Footnote These considerations help determine the extent of suitability obligations.

Question 36

What is required for an investor to be considered accredited?

Answer 36

A minimum net worth or level of earnings, and an understanding of risk and reward ## Footnote Broker-dealers must verify these standards before allowing investments.

Question 37

What methods can be used to verify an investor's accredited status?

Answer 37

* Review of IRS tax forms * Review of bank and brokerage statements * Obtain written confirmation from professionals ## Footnote There is flexibility in the methods used, as long as reasonable steps are taken.

Question 38

What defines an investment analysis tool?

Answer 38

An interactive technology tool that produces simulations and statistical analysis for investment outcomes ## Footnote It helps customers with asset allocation based on entered information.

Question 39

What disclosures must be provided when using an investment analysis tool?

Answer 39

* Criteria and methodology of the tool * Limitations and key assumptions * Universe of investments considered * Explanation of security selection * A statement about the hypothetical nature of projections ## Footnote These disclosures help ensure transparency and inform customers about potential biases.

Question 40

True or False: Receiving a customer's acceptance of a recommendation relieves a firm of its suitability obligation.

Answer 40

False ## Footnote Firms must prioritize the customer's interests above their own.