Investment Planning Flashcards by Michael cherry

Which of the following is considered a financial asset?
-Truck
-Bond (debt obligation)
-Iron ore
-Building

Bond (debt obligation)

A bond is a fixed-income security.

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Sharon owns a contract that gives her the right to purchase 50 head of cattle on June 20th for $1,000 per head. This is an example of which of the following?
-Real asset
-Fixed income security
-Derivative
-Commodity
-Equity security

Derivative

The commodity is the underlying asset here.

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If the nominal return on Derrick’s Roth IRA portfolio is 7%, and inflation is currently 4%, what is Derrick’s real return?
-2.9%
-3.0%
-3.1%
-7.0%

2.9%

Use the inflation-adjusted total return formula: [(1.07) / (1.04)] – 1 = .029, i.e., 2.9%.

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Which of the following equations is correct?
-Yield – Growth = Total Return
-Yield + Growth = Annual Yield
-Growth – Yield = Annual Return
-Yield + Growth = Total Return

Yield + Growth = Total Return

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Calculate the arithmetic mean of an investment with the following returns.
Year 1: 4.7%
Year 2: 3.1%
Year 3: 9.1%
Year 4: 0.4%
-3.41%
-4.33%
-4.51%
-4.89%

4.33%

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The geometric mean is often used to measure the uniform rate at which money actually grew over time per period.
-True
-False

True

The geometric mean reflects the steady growth rate of investment funds over some past period.

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In general, absolute risk can be diversified away.
-True
-False

False

Absolute risk is not diversifiable because there is always the possibility that an investment can fail.

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All investors are subject to which of the following risks?
-Systematic risk
-Non-systematic risk
-Concentration risk
-Outcome risk
-Interest rate risk

Systematic risk

Systematic risk affects all investors.

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Stock XYZ has a beta coefficient of 1.1. For an investor looking to invest in a stock with relative risk that is similar to that of the market, would stock XYZ be a good choice?
-Yes
-No

Yes

Since a beta of 1.0 means the stock would generally move in the same direction and to the same degree as the market, a stock with a beta of 1.1 would be expected to perform quite similar to the performance of the market as a whole.

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The stock for ABC Corporation has had an average annual return of 14% over the past 25 years. If the standard deviation of the stock over the same time has been 3%, what are the chances that the return in the upcoming year will fall between 8% and 20%?
-68%
-85%
-95%
-99%

95%

Returns should fall within two standard deviations of the average return 95% of the time.

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Which of the following is a true statement?
A. “Covariance” and “correlation coefficient” are closely related terms.
B. Positively correlated securities move in the same direction.
C. A correlation coefficient of 1 is an indication that a stock is less risky than the overall market.
D. All of the above are true statements

A and B

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The risk premium concept argues that investors will require a higher return for investing in securities with higher degrees of risk.
-True
-False

True

Investors want to be rewarded for taking on risk.

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Which of the following assets would be considered the most illiquid?
-A stock
-A bond
-Cash
-A yacht

A yacht

A yacht is neither marketable nor liquid.

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ABC Corporation has been a privately-owned company for the past 15 years. This year, Bill, the owner of the corporation, has decided to issue shares of ABC for the first time. In so doing, he would like to only offer the shares to a limited number of private investors. Bill’s best course of action would be which of the following?
-To have an initial public offering on the primary market
-To take the shares of his company to the secondary market
-To sell the shares on an auction market
-To sell the shares on an OTC market
-None of the above

None of the above

If Bill is concerned about selling his shares to a limited number of private investors, he would want to utilize a private placement.

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All of the following statements about auction markets are true except:
-They are a type of secondary market
-Specialists facilitate an efficient market
-Each transaction is negotiated between buyer and seller
-The auction market has a physical location

Each transaction is negotiated between buyer and seller

Negotiated transactions are characteristic of OTC markets. In an auction market, competitive bids and offers are offered up by buyers and sellers.

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The responsibilities of the Financial Industry Regulatory Authority (FINRA) include which of the following?
A) License brokers
B) Provide automated market surveillance
C) Monitor specialists on the market floor
D) A and B only
E) All of the above

A and B

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Mike created a fictional index that he uses to track certain stocks on the NYSE. If each stock affects Mike’s index in proportion to its share price, which type of index would it be?
-Index-weighted
-Price-weighted
-Value-weighted
-None of the above

Price-weighted

If the index is based on the price of one share of each of the underlying stocks in the index, it would be a price-weighted index.

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Which of the following legislative Acts created the Securities Exchange Commission?
-ERISA
-The Securities Act of 1933
-The Banking Act of 1933
-The Securities Exchange Act of 1934

The Securities Exchange Act of 1934

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The Fed has deemed it necessary to stimulate the economy. Which of the following actions would you expect the Fed to take?
-Lower taxes
-Increase the federal funds rate
-Purchase government securities
-None of the above

Purchase government securities

Purchasing government securities would add liquidity to the market.

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Fiscal policy is established by:
-The Federal Reserve Banks
-The Federal Reserve Board
-Office of Management and Budget
-Congress and the President

Congress and the President

The federal government makes decisions regarding fiscal policy components such as taxation and government spending.

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Reg BI requires that a broker-dealer or investment advisor providing products or services to a retail investor must:
-Eliminate all commission-based compensation methods
-Provide only suitable recommendations to the client
-Place the client’s interests first
-Refrain from recommending high-yield fixed income investments to any client

Place the client’s interests first

The client’s best interest must be placed ahead of the broker-dealer and investment advisor.

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Which of the following is NOT a reason corporations issue equity shares of ownership?
-To raise capital
-To expand their business
-To provide liquidity
-To further community relations

To further community relations

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Investors purchase equity securities for which of the following reasons?
-Growth potential
-Dividends
-Income-producing capabilities
-All of the above
-None of the above

All of the above

Investors purchase equity securities for their income producing capabilities via dividends, the growth potential of the company, and the value of their share of ownership.

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Assume that Bill and Jim both own shares in Stanton Corporation, a producer of glass bottles. In the following questions, identify who owns common stock and who owns preferred stock. Note: In each question, one will own common, and one will own preferred. Who owns each may vary for each question.
If Stanton Corporation is forced to liquidate all its assets, including all their stock, Bill will have a claim to his shares of stock before Jim has a claim to his shares. Which type of stock does Bill own?
-Common stock
-Preferred stock

Preferred stock

Preferred shareholders have a claim to assets that precedes those of common shareholders.

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Common stock Common stock ownership generally includes voting privileges.

Common stock Dividends to common shareholders are paid only when the company decides to do so.

Most online brokerage houses are considered to be _____________ because they generally offer only basic trading services. -Full service brokers -Discount brokers

Discount brokers

Discount brokers charge a higher commission because it is their only form of income. -True -False

False Discount brokers charge lower commissions.

Sharon has an account with her brokerage firm in which they manage her portfolio for a flat fee. What type of brokerage account does she most likely have? -Margin account -Wrap account -Cash account

Wrap account

When Sam opened his margin account with his brokerage firm, his initial margin call was set at 55%. He funded his account by writing a check, and then promptly purchased stocks. If Sam purchased a total of $120,000 of stock in his account, what is the minimum he had to deposit into the account? -$30,000 -$54,000 -$60,000 -$66,000

$66,000 If Sam’s initial margin call is 55%, then Sam must have placed at least .55 x $120,000, or $66,000, in his margin account.

Reg. T requires which of the following? -Margin calls must be set at 50% -A minimum margin deposit of $2,000 -The initial margin call must be no lower than 50% -All of the above

The initial margin call must be no lower than 50%

Dale owns 1,000 shares of Weiss Incorporated, currently trading at $23. Dale places a limit order to purchase more shares of the stock at $18. Just before the last bell, the current bid price for Weiss Inc is $17.50, and the ask price is $18.50. Will Dale’s broker purchase additional shares of Weiss Inc. for him? -Yes -No -There is not enough information to answer this question

No The ask price is the price at which a seller is willing to sell equity securities. Therefore, having placed a limit order to purchase shares, Dale is in effect telling his broker to purchase shares of Weiss Incorporated at a price of $18 or lower. Because that price was not reached, Dale’s broker would not execute the order.

A dividend reinvestment plan offers investors the ability to use their dividends to purchase additional shares at a guaranteed price. -True -False

False A DRIP enables investors to reinvest their dividends to purchase additional shares, but they are not guaranteed a price. This is the primary drawback to DRIP plans. Shares will be purchased at the effective price when dividends are distributed.

Which of the following is a commonly used benchmark to measure international stocks? -Dow Jones Industrial Average -Standard and Poor’s 500 -NASDAQ -Morgan Stanley EAFE Index

Morgan Stanley EAFE Index

International markets can be classified by both their geographic position and their position in the economic world. -True -False

True

Steve’s approach to international investing is to target specific areas of the world. Steve is using which approach to international investing? -Country-specific approach -Country concentration approach -Diversified approach -Regional approach

Regional approach An investor using the regional approach would be holding a concentration of stocks in specific regions of the world.

What risk would an individual be ignoring if making an investment in a country with a highly unstable government? -Country risk -Liquidity risk -Currency risk -Information risk

Country risk

Steve, wishing to generate exposure in his portfolio to the Japanese market, has invested $45,000 in the form of an instrument that tracks the Nikkei Index. Which of the following is Steve most likely invested in? -ADR -ETF -Individual Stock -Mutual Funds

ETF ETFs track stock indices via a basket of stocks.

The present value of a future stream of cash flows is called: -Dividends -Intrinsic Value -Fundamental Value -Required Rate of Return

Intrinsic Value

The current rate quoted for U.S. Treasury Bills is 2%. If an investor determines the risk premium for ABC stock to be 11%, then what is the required rate of return for ABC stock according to this investor? -The same as the discount rate -The same as the capitalization rate -13% -All of the above

All of the above The required rate of return, also called the discount rate or capitalization rate, is equal to the risk-free rate plus a risk premium.

Given the following information, what did this investor assign as the risk premium for ABC stock? Current price of ABC stock = $25 Intrinsic value of ABC stock = $20 Last ABC dividend = $3 Risk-free rate = 3% Dividends will remain constant -12% -15% -7% -Not enough information

12 % Based on the information, you should have been able to determine that the required rate of return was 15%. Po = D o k 20 = 3/k K = .15 After subtracting the risk-free rate, the risk premium of 12% remains.

XYZ Corporation’s dividend payments are expected to grow at a constant rate of 5% per year. If the last dividend paid was $2.50, and investors require a 12% rate of return, what is the intrinsic value of XYZ’s stock? -$20.83 -$21.88 -$35.21 -$37.50

$37.50 The following formula is used: Po = D o (1+g) k - g = 2.50 (1.05) / .12 - .05 = $37.50

Net Income = $4,530 Owner’s Equity = $61,240 Total Assets = $71,900 Sales = $59,215 What is the ROA for Thebert Inc.? -6.3% -6.8% -7.3% -7.6%

6.3% ROA = Net Income ÷ Total Assets = 4,530 ÷ 71,900 = 6.3%

Net Income = $4,530 Owner’s Equity = $61,240 Total Assets = $71,900 Sales = $59,215 What is the ROE for Thebert Inc.? -6.3% -6.8% -7.4% -7.6%

7.4% ROE = Net Income ÷ Owner’s Equity = 4,530 ÷ 61,240 = 7.4%

Net Income = $4,530 Owner’s Equity = $61,240 Total Assets = $71,900 Sales = $59,215 What is the net profit margin for Thebert Inc.? -6.3% -6.8% -7.3% -7.7%

7.7% Net Profit Margin = Net Income ÷ Sales = 4,530 ÷ 59,215 = 7.7%

Current stock price = $17.50 Common equity = $185,300 Earnings = $110,000 Shares outstanding = 10,000 What is the book value of Somerville Ad Agency? -$13.41 -$18.53 -$19.32 -$20.13

$18.53 Book value = owner’s equity ÷ shares outstanding = 185,300 ÷ 10,000 = $18.53

Current stock price = $17.50 Common equity = $185,300 Earnings = $110,000 Shares outstanding = 10,000 What is Somerville’s EPS? -$1.75 -$10.00 -$11.00 -$15.00

$11,000 EPS = earnings ÷ shares outstanding = 110,000 ÷ 10,000 = $11.00

Current stock price = $17.50 Common equity = $185,300 Earnings = $110,000 Shares outstanding = 10,000 What is Somerville’s price-to-book ratio? -.87 -.94 -1.03 -1.21

.94 Price-to-Book ratio = Stock price ÷ Book value = 17.50 ÷ (185,300 ÷ 10,000) = .94

A debt ratio of .37 would indicate which of the following? -More than half of the firm’s assets are financed with debt. -For every dollar invested by shareholders, the firm has borrowed $0.37. -The firm could pay its interest owed 37 times over. -All of the above -None of the above

None of the above A debt ratio of .37 indicates that 37% of the firm’s assets are financed with debt.

Bill, the owner of a company that produces Widgets, is concerned about his business because of what he is witnessing in his industry. He is seeing many business closings because there are too many companies trying to sell Widgets. He hopes his company is strong enough to survive this current gluttony of competitors. In which stage of the industry life cycle is the Widget industry currently in? -Pioneering -Expansion -Stabilization -Declining

Pioneering In the pioneering stage, increased competition leads to many firms going out of business.

Which type of industries are generally unaffected by recessions and downturns? -Growth -Cyclical -Interest rate sensitive -Defensive

Defensive Industries such as food & beverage or utilities are the least affected by downturns in the economy.

Historically, each _____ tends to be higher than the previous one, and are followed by ______. -Trough; peak -Expansion; trough -Peak; contraction -Contraction; peak

Peak; contraction

Shawn has noticed that new orders for manufactured goods has made a sharp upward turn recently. This is most likely an indication that: -The economy is headed toward an expansion -The economy is headed towards a decline -The economy is currently in an expansion -The economy has just been through an expansion

The economy is headed toward an expansion As a leading indicator, an increase in manufactured goods orders would indicate an oncoming expansion.

Which of the following is NOT a leading economic indicator? -Average hours worked per week by production workers -Building permits and housing starts -Stock prices -Manufacturing inventories

Manufacturing inventories Manufacturing inventories is a lagging indicator.

The average duration of unemployment has increased consistently over the past six months. That trend is most likely to signal a (an) ______. -Recession -Expansion

Recession Increased unemployment duration signals a slowing economy.

The bull market of the 1990’s would be considered which type of trend? -Primary -Secondary -Minor

Primary

ABC Stock has recently increased in price by more than 70%. At the same time, the number of shares traded has decreased by roughly 20%. As an investor monitoring only the price–to-volume relationship of ABC stock, would you predict the increase in ABC’s stock price to continue? -Yes. Rising prices and decreasing volume signals strength. -No. Rising prices and decreasing volume is not an indicator of strength.

No. Rising prices and decreasing volume is not an indicator of strength. Rising prices should generally be accompanied by an increase in volume for the run-up to be considered healthy.

An EMA would weigh recent prices more heavily than would an SMA. -True -False

True The exponential moving average places more emphasis on recent prices in order to better reflect current conditions.

Ryan is buying ABC stock today because he noticed that its RSI is currently at 75. Is this a good idea? -Yes. A relative strength index reading above 70 is a buy signal. -Yes. A relative strength index reading above 70 indicates the stock has been overbought and should, therefore, be purchased. -No. While an RSI reading above 70 is an indication to buy, Ryan should make sure the volume of ABC shares is increasing. -No. An RSI reading greater than 70 indicates the stock is overbought and should, therefore, be sold.

No. An RSI reading greater than 70 indicates the stock is overbought and should, therefore, be sold. An RSI reading of 75 would indicate that ABC stock is currently overbought, and Ryan should sell, not buy.

Technicians following insider trading activity are doing so illegally because insider trading is illegal. -True -False

False Insiders are only performing illegal deeds when they act on information that is not yet public.

Insider trading is one indicator that works best if the technician follows individual transactions. -True -False

False Individual sales should never be used as an indicator because stocks can be sold for various reasons. Insider trading activity most definitely works best in the aggregate.

Sarah has observed that a great number of the transactions for ABC stock have not been in round lots. Odd lot theorists would: -Take this as an indication that ABC stock should be sold -Take this as an indication that ABC stock should be purchased -Take this as an indication that most of the transactions are from institutional investors -Take this as an indication that most of the transactions are from persons not “in the know.”

Take this as an indication that most of the transactions are from persons not “in the know.” Odd-lot theorists would recognize that a majority of these transactions are by individuals, thus an indicator to do the opposite.

Which of the following is true about the Put/Call ratio? -The put/call ratio is stable on a day-to-day basis -The put/call ratio may be interpreted as a contrarian indicator at its extremes -A reading of .80 is a strong sell signal -Comparing moving averages over time does not show trends

The put/call ratio may be interpreted as a contrarian indicator at its extremes

If the short interest ratio is moving upward, it is an indication of which of the following? -A bearish stance by investors -A bullish stance by investors

A bearish stance by investors When the ratio is moving upward, this means investors are making short sales more rapidly than normal. Short sales are an anticipation of falling prices.

The primary assumption of the Dow Theory is that the primary trend cannot be manipulated. -True -False

True Primary trends can’t be manipulated, which is why they are so important in the Dow Theory.

Which of the following statements is FALSE regarding the Dow Theory? -A major upward move has occurred when rallies penetrate previous highs. -The Dow Theory assumes that the market reflects all available information. -A decline occurs when previous lows are penetrated. -None of the above is true. -All of the above are true.

All of the above are true.

If ABC stock has just reached the end of the handle in a “cup and handle” charting pattern, this would be an indication to buy. -True -False

True

A bar chart reflects the daily price movement of a security. -True -False

True

ABC stock is approaching its resistance level. Which of the following could occur? -It could hit the resistance level and then decline. -It could break through the resistance level, immediately creating a new resistance level. -It could break through the resistance level, immediately creating a new support level. -Both A and B -Both A and C

Both A and C

In general, sectors of the market tend to produce widely divergent returns on a year-to-year basis. -True -False

True

According to a University of Michigan study, portfolios with what number of stocks are normally considered to be well-diversified (as to security-level diversification). -5-10 -15-20 -25-50 -50-75

25-50

Jim’s buddy told him that Widgets were going to be the next big thing and that if he wanted to make some money, he needed to buy stock in Widgets Inc. Jim, being a savvy investor, thought it would be even wiser to also invest in the companies that produce the components for the Widget. Therefore, Jim went out and bought shares of the 30 different companies that supply the different components needed to produce Widgets. These companies, located in Europe, Asia, and North America, range in size from small to large capitalization. In this example, Jim has failed to account for which type of diversification? -Security -Geographic -Sector and/or industry -Market capitalization

Sector and/or industry It is most likely the case that these 30 companies will at least be in the same sector, and most likely also in the same industry.

The total market capitalization of a company at a price of $20 with 500,000 shares outstanding is: -$10 Million -$100 Million -$1 Billion

$10 Million

As an investor, Sandra seeks companies that she believes have the potential to substantially increase returns in the future. She is not really concerned with whether or not they are undervalued in the current market. Sandra employs which portfolio management style? -Core value -Core growth -Indexing

Core Growth The Core Growth approach attempts to identify stocks with the potential to grow faster than the market.

Steve’s favorite investment technique is to buy stocks that are out of favor in the market, including stocks of bankrupt companies that have the potential for a rebound. Which variation to the Core Value approach does Steve practice? -Contrarian approach -Valuation approach

Contrarian approach

Dan and David are arguing over ABC stock. David argues it is not worth purchasing because the PEG ratio is way too high. Dan is of the opinion that this does not matter because over the last three weeks ABC stock has been consistently adding to its share price. In this example, David would be considered a(n) ___________ investor, while Dan a __________ investor. -Rapid growth; core value -Indexing; price momentum -Price momentum; contrarian -Growth at a reasonable rate; price momentum

Growth at a reasonable rate; price momentum

Core growth investors focus on which of the following factors? -Story stocks -Low dividend yields -Earnings growth rate -P/E ratio -All of the above

All of the above

The value of an open-end mutual fund is always changing as investors are constantly purchasing new shares and other investors are selling shares. -True -False

True The open-end mutual fund is named “open-end” because investors are free to continually purchase new shares. Purchasing a new share allows the investment company to purchase additional securities and grow the fund.

Charges paid when an investor sells the fund shares are commonly known as which of the following? -Front-end loads -Back-end loads -12b-1 fees -Management fees

Back-end loads

Which of the following fees is an annual charge to shareholders paid to offset the sales and marketing expenses of the fund? -Front-end loads -Back-end loads -Redemption fees -12b-1 fees -Management fees

12b-1 fees

Investors considering the placement of all their investments in open-end funds should be aware of which of the potential issues? -Managing tax consequences of gains and losses of funds -Perpetual maturity of most bond funds -Difficulty in effectively selecting funds -All of the above -None of the above

All of the above

Which of the following are true statements regarding unit investment trusts? A. A UIT portfolio is unmanaged because it is not changed after it is first constructed. B. Payments to unit holders can include both interest and principal as bonds mature or are called. C. Units are generally redeemed by the UIT. D. UITs can invest in fixed income and equity securities.

All of the Above

Given the following information for XYZ Mutual Fund, calculate its Net Asset Value. Total assets = $2.3 million Total Liabilities = $700,000 Shares outstanding = 240,000 -$6.67 -$7.67 -$11.50 -$12.50

$6.67

Which of the following is not a characteristic of unit investment trusts? -The portfolio is unmanaged after original construction. -There is no termination date. -The UIT is offered as a one-time public offering. -Units are redeemable by the UIT.

There is no termination date. One of the defining characteristics of UITs is the termination date.

What cautions would you express to a client considering a hedge fund investment? -Hedge funds are generally subject to SEC regulation -Speculative investment strategies cannot be used -Transparency may be limited -Redemption must be offered within 15 days of the investor’s request.

Transparency may be limited

Which of the following, if any, is NOT a reason for a client choose an ETF over a traditional mutual fund? -Significantly lower annual expenses -Intra-day trading capability -More control over recognition of taxable gain and loss -Ability to margin the original purchase -None of the above

None of the Above

Which of the following is NOT a potential advantage of investing in a Private Equity Fund? -Higher gains than in the publicly traded market -High liquidity -No double income taxation -Access to investment opportunities not available in the publicly traded market

High liquidity These funds are wholly invested for the medium-to-long term and there may be little cash available.

When bond prices rise, interest rates are likely _________. -Rising -Falling -Stable

Falling

The federal government issues long-term securities called _________ to finance the spending of the government. These issues offer investors interest payments that are generally considered free from risk. -Corporate bonds -U.S. Treasury bonds -Municipal bonds -Agency bonds -Treasury bills

U.S. Treasury bonds

Securities issued by federal mortgage associations are referred to as which of the following? -Corporate bonds -U.S. Treasury bonds -Municipal bonds -Agency bonds -Treasury bills

Agency bonds

Which of the following is generally considered the riskiest of bond issues, offering investors higher yields with relatively more risk? -Corporate bonds -U.S. Treasury bonds -Municipal bonds -Agency bonds -Treasury bills

Corporate bonds

Which of the following is a short-term debt instrument issued by the federal government offering no periodic interest payments to investors? -Corporate bonds -U.S. Treasury bonds -Municipal bonds -Agency bonds -Treasury bills

Treasury bills

Bonds issued by state and local governments for the purpose of financing local expansion or other activities are commonly known as which of the following? -Corporate bonds -U.S. Treasury bonds -Municipal bonds -Agency bonds -Treasury bonds

Municipal bonds

For an individual in the 34% tax bracket, a muni yielding 6% would have a tax equivalent yield of what? -6% -7.34% -9.09% -9.59%

9.09% The calculation is shown below. (.06) ÷ (1 - .34) = .06 ÷ .66 = .090909 = 9.09%

Which of the following statements is true? -The coupon rate is the percent of interest the bond pays, expressed as a percentage of the par value. -The coupon rate is the percent of interest the bond pays based on its current market price. -The coupon rate equals the coupon amount divided by the current market price. -The coupon rate is the percent of interest the bond pays based on its purchase price.

The coupon rate is the percent of interest the bond pays, expressed as a percentage of the par value.

Bill has just purchased a $1,000 par bond with a 6.5% coupon rate for $950. Bill has purchased this bond at a: -Discount -Premium

Discount

The yield to maturity of a discount bond is greater than the current yield. -True. This is true because it includes the current yield less depreciation. -True. This is true because it includes the current yield plus appreciation. -False. This is false because it includes the current yield less depreciation. -False. This is false because it includes the current yield plus appreciation.

True. This is true because it includes the current yield plus appreciation. A discount bond appreciates toward the par value until maturity. Therefore, the yield to maturity of a discount bond is greater than the current yield because it includes the appreciation.

Which of the following correctly describes the yield spread? -The difference between the current yield and the current market price. -The difference between the current market price and the risk-free yield. -The risk premium paid to the bondholder as compensation for added risk of a corporate bond over a risk-free bond. -The risk premium paid to investors as compensation for the added risk of purchasing a long-term government bond.

The risk premium paid to the bondholder as compensation for added risk of a corporate bond over a risk-free bond. The yield spread is the difference between the yield offered and the risk-free yield.

Assume the current yield curve has yields of short-term securities very low compared to long-term rates so that investors in long-term bonds receive a much higher yield than investors in short-term securities. Which of the following yield curves would this be? -Normal -Steep -Flat -Inverted

Steep

The expectations theory states which of the following? -The shape of the yield curve reflects expectations of future interest rates. -The shape of the yield curve reflects expectations of future GDP growth. -A liquidity premium causes long-term bonds to have higher yields than short-term bonds. -The shape of the yield curve is a reflection of investor expectations of the future supply and demand curve for securities within each of the maturity sectors.

The shape of the yield curve reflects expectations of future interest rates.

Duration is a more accurate representation of when investors get their money back from a bond because duration takes into account not only the replacement of principal, but also takes into account a bond’s coupon payments or yield. -True -False

True

You are a CFP® Professional. Your best client just called to ask what would happen to the value of her bond portfolio if interest rates doubled in the next month. She holds 50% of her bond portfolio in 52-week Treasury Bills and 50% in Zero Coupon Bonds maturing in 30 years. Which of the following represents appropriate general guidance? -The Treasury Bills and the Zero Coupon Bonds will fall in value by approximately the same percentage. -The Treasury Bills and the Zero Coupon Bonds will rise in value by approximately the same percentage. -The Treasury Bills may fall in value slightly and the Zero Coupon bonds will fall in value significantly. -The Treasury Bills will rise in value slightly and the Zero Coupon bonds will rise in value significantly.

The Treasury Bills may fall in value slightly and the Zero Coupon bonds will fall in value significantly. Bond prices will fall when interest rates rise and high duration bond prices will fall much more than short duration bond prices.

Your client Bob just purchased a bond for $1,100. The bond matures in 10 years and has a coupon rate of 7%. Dividends are paid at the beginning of each six-month period. (Note: in this and similar questions, you should assume that bonds mature at $1,000 and that interest is paid semiannually unless directed otherwise.) The approximate yield to maturity is likely to be which of the following? -More than 7% -7% -Less than 7% -Cannot determine from facts presented

Less than 7% The bond was purchased at a premium, yet pays 7% interest on the par value of $1,000.

Your client Bob just purchased a bond for $1,100. The bond matures in 10 years and has a coupon rate of 7%. Dividends are paid at the beginning of each six-month period. (Note: in this and similar questions, you should assume that bonds mature at $1,000 and that interest is paid semiannually unless directed otherwise.) What is the exact yield to maturity? -2.93% -5.87% -3.29% -6.57%

5.87% BEG/END Set calculator to begin mode -1100 PV Record the purchase as a cash outflow 1000 FV Record the maturity as a cash inflow 1000 x .07 ÷ 2 PMT Calculate semiannual bond dividend payments, result is 35 20 N 20 six-month periods in 10 years i/YR Solve for i - result is 2.93%. THIS IS A SEMIANNUAL yield - the question asked for annual yield! This is a common examiner’s trick. x 2 = Current annual yield is 5.87%

All of the following are reasons for buying fixed income securities EXCEPT: -Generating income -Reducing risk -Capital appreciation -No exception. All of the above are reasons for buying fixed income securities

No exception. All of the above are reasons for buying fixed income securities

Bond A matures in 10 years; Bond B in 20. Which will generally be more sensitive to changes in interest rates? -Bond A -Bond B -They will both be equally sensitive to interest rate changes -Cannot be determined

Bond B The longer the maturity, the more sensitive the price of a bond will be to changes in interest rates.

Which of the following lists bond ratings from best quality to worst? Hint: Rating scales from both Moody's and the S&P are used. -Aaa, Ba, Baa, D -D, C, BB, CC -AAA, AA, B, D -Aa, Caa, D, Baa

AAA, AA, B, D

Sector spreads represent the risk premium an investor expects to receive for their willingness to invest in a sector of greater risk. -True -False

True

Municipal bonds always give the investor a tax break on the interest earned over the life of the bond. -True -False

False While municipal bonds are exempt from regular income tax, some municipal bonds are subject to the alternative minimum tax.

Inflation-indexed bonds have interest payments that fluctuate based on changes in inflation. -True -False

True The U.S. Treasury makes interest payments on inflation-indexed bonds based on the principal amount, just like other bonds. However, the interest payments fluctuate because the principal amount is continuously adjusted to mirror changes in inflation.

Fred has bonds with maturities of 1, 3, 5, 7, and 9 years. It is most likely that Fred is employing which of the following bond managers. -Ted. Ted likes to use the barbell strategy of bond investment. -Jill. Jill is an expert in the laddered approach to bond management. -Scott. Scott currently has all his portfolios in line to fight inflation by using an inflation-indexed bond approach.

Jill. Jill is an expert in the laddered approach to bond management.

Benefits of an Investment Policy Statement include all of the following EXCEPT: -Provides a paper trail -Keeps the investment process intact during times of market upheaval -Provides guidance in the estate planning process -Empowers the account manager to transfer the assets into the manager's name

Empowers the account manager to transfer the assets into the manager's name Only in a Trust would the assets be transferred.

James thinks of himself as a fairly conservative investor and has never invested in the stock market. For years, he has only invested in bonds, with an average maturity of 20 years in his portfolio. The bond ratings range from AAA to B. He has always done his own investing and is quite satisfied with the historical performance of his portfolio. James would be classified as a: -Risk-averse investor -Risk-tolerant investor -Risk-seeking investor

Risk-tolerant investor Even though James avoids the stock market, his willingness to hold a long-term bond portfolio that includes junk bonds makes him a risk-tolerant investor.

Janice loves to talk about the stock market. She spends hours every week online in investor chat rooms looking for "bargains." She defines a bargain as small "upstart" companies selling for less than $2.00 per share or companies that have been around for a few years, but whose prices have declined to around a dollar or less. Her greatest success story is the time she bought 5,000 shares of a company at 20 cents per share, only to sell it 4 months later for $2.80 per share. You would classify Janice as a: -Risk-averse investor -Risk-tolerant investor -Risk-seeking investor

Risk-seeking investor Janice's desire to invest in "penny stocks" makes her a risk-seeking investor.

Ralph, who is 32, has a portfolio consisting of the following funds: % of Portfolio Fund 30% S&P Index Fund 15% NASDAQ Index Fund 15% EAFE Index Fund 15% Short-Term Government Bond Fund 15% Mid-Term Government Bond Fund 10% Money Market Fund You would classify Ralph as a: -Risk-averse investor -Risk-tolerant investor -Risk-seeking investor

Risk-averse investor Ralph has a well-diversified portfolio, which is weighted toward equities because of his young age. Ralph is clearly trying to diversify risk across different sectors and asset types, and is seeking to achieve reasonable growth while minimizing his risk.

As a rule of thumb, a rebalancing limit of plus or minus _____% would be sufficient to maintain the risk/return profile of an investment policy while only requiring rebalancing once or twice per year. -5% -10% -15% -20%

Over the past 25 years, the annual rate of inflation has been approximately: -0% ->1% -2-3% -6%

2-3%

Asset allocation attempts to diversify away market risk without compromising return. -True -False

False Market risk cannot be eliminated.

__________ outperformed __________ over the last 25 years. -Bonds, stocks -Stocks, bonds -T-Bills, bonds -T-Bills, stocks

Stocks, Bonds

In quantifying market risk, what percentage of returns will fall within one standard deviation of the mean in a normal distribution? -15% -33% -50% -68% -95%

68%

__________ describes the relationship between risk and return. -CAPM -Beta -Coefficient -Covariance

CAPM

The Capital Asset Pricing Model states that the expected return of a security or portfolio equals: -The tax-free rate plus a risk premium -The risk-free rate plus a premium for the time value of money -The risk-free rate plus a risk premium -The market rate plus a risk premium

The risk-free rate plus a risk premium

The Capital Asset Pricing Model assumes the market is: -Efficient -Inefficient -Stable -Best understood through fundamental analysis of securities

Efficient

A beta __________ than 1.0 implies the stock is __________ than the market; a beta __________ than one implies the stock is __________ than the market. -Less, riskier; greater, less risky -Less, less risky; greater, riskier

Less, less risky; greater, riskier

An investor comes to you with the following data regarding his portfolio and asks you to provide your assessment and commentary on the following issues. Market Exposure Measurement Portfolio S&P 500 Index Beta 1.4 1.0 Alpha 7.2 0 R2 77% 100% The prospect wants to know your assessment of the risk profile of the portfolio. Based on the table above, your assessment is that the portfolio’s risk profile is: -Lower than the market -Same as the market -Higher than the market -Cannot make a rational assessment

Higher than the market Because the beta of the portfolio is 1.4, the portfolio shows volatility greater than the S&P 500.

Market Exposure Measurement Portfolio S&P 500 Index Beta 1.4 1.0 Alpha 7.2 0 R2 77% 100% The prospect also would like your opinion on the effectiveness of this portfolio to generate “value added.” Based on nothing more than the information in the table above, what can you tell the prospect? -The portfolio is too risky and is not generating value. -The portfolio has shown performance results above what would be expected based on the risk profile relative to the S&P. -The portfolio is poorly structured/managed as indicated by the R2 of 77%. -It is impossible to tell without looking at the portfolio holdings.

The portfolio has shown performance results above what would be expected based on the risk profile relative to the S&P. A positive alpha value indicates that the portfolio has delivered returns above what would be expected based on the portfolio's exposure to systematic risk (index-related exposure).

Market Exposure Measurement Portfolio S&P 500 Index Beta 1.4 1.0 Alpha 7.2 0 R2 77% 100% What does an R2 of 77% indicate to you? -Given the limited amount of data you have, the R2 here does not have any real relevance -R2 of 77% shows that the portfolio is not effectively diversified. -The R2 provides a low level of confidence in the alpha and beta figures. -You can have reasonable confidence that the quantified alpha and beta listed are accurate reflections of the portfolio characteristics.

You can have reasonable confidence that the quantified alpha and beta listed are accurate reflections of the portfolio characteristics. The R2 of 77% provides a reasonable, albeit not definitive, level of confidence that the listed portfolio characteristics are accurate.

The risk associated with this portfolio that is completely independent of its participation in the overall stock market is called: A. Systematic Risk B. Nonsystematic Risk C. Specific Risk D. Both A and C E. Both B and C

Both B and C The risk that is unique to an asset or portfolio is called Nonsystematic Risk or Specific Risk.

The Modern Portfolio Theory measures risk: -Using Beta -By its relationship to the market -Using average volatility -Irrespective of association to the general market

Irrespective of association to the general market

Which of the following inputs is required to calculate Mean-Variance Optimization for a portfolio? I. Expected returns of each asset II. Standard deviation of each asset III. Correlation coefficient for every pair of assets

I, II, and III

Which of the following pairs would you expect to have a correlation coefficient close to +1? -30-year Treasuries and the S&P 500 -90-day T-Bills and the Dow Jones Industrial Average -The S&P 500 and the Dow Jones Industrial Average -The Lehman Brothers / Barclays Corporate Bond Index and NASDAQ

The S&P 500 and the Dow Jones Industrial Average

Mean-Variance Optimization is used to identify: -Standard Deviations -The Efficient Frontier -Correlation Coefficients -The Average Return of all Assets

The Efficient Frontier

Monte Carlo Sensitivity Analysis allows you to: -Determine the success rate of a plan -Determine a portfolio's beta -Utilize the Capital Asset Pricing Model -Estimate the correlation of multiple securities

Determine the success rate of a plan

Asset allocation is a process of diversification achieved by blending assets or asset classes. -True -False

True

Complete each statement by selecting the correct response. A. __________ is short-term oriented. -Strategic Asset Allocation -Tactical Asset Allocation

Tactical Asset Allocation

Investment activity using __________ is geared towards portfolio rebalancing. -Strategic Asset Allocation -Tactical Asset Allocation

Strategic Asset Allocation

__________ maintains a strong focus on market projections. -Strategic Asset Allocation -Tactical Asset Allocation

Tactical Asset Allocation

Investment activity using __________ is geared towards active trading based on market conditions. -Strategic Asset Allocation -Tactical Asset Allocation

Tactical Asset Allocation

_________ is long-term oriented. -Strategic Asset Allocation -Tactical Asset Allocation

Strategic Asset Allocation

__________ maintains a strong focus on client goals. -Strategic Asset Allocation -Tactical Asset Allocation

Strategic Asset Allocation

Mitch has a portfolio that is very heavily weighted toward international equity securities. Which of the following indices should Mitch be using as a benchmark? -10-year U.S. Treasury bond -EAFE -S&P 500 -Barclays Capital Aggregate Bond Index

EAFE

Sandra would like to evaluate the performance of her portfolio manager. Which of the following measures should she use? -Time-weighted return -Dollar-weighted return

Time-weighted return

Place the names of each of the following equations in the same order as the listing of the equations. A. Portfolio return in excess of the risk free rate ÷ standard deviation of the portfolio B. Actual portfolio return – expected portfolio return C. Required rate of return of portfolio = risk free rate + risk premium D. Portfolio return in excess of the risk free rate ÷ beta of the portfolio

Sharpe Ratio, Jensen's Alpha, CAPM, Treynor Index

Nathan has just cashed out on a portfolio worth $350,000. The portfolio, which he owned for 25 years, had an average total return of 10.4%. The beta of the portfolio was 1.07. While Nathan held this portfolio, the return on the market was 6.5%, and the risk-free rate averaged 3.5%. What was Jensen's Alpha for Nathan's portfolio? -2.21% -3.21% -3.69% -4.41%

3.69% The calculation is below. Expected rate of return: r p = .035 + 1.07(.065 - .035) r p = .035 + 1.07(.03) r p = .035 + .0321 r p = .0671 r p = 6.71% Jensen's Alpha: α = 10.4% - 6.71% = 3.69%

You are a CFP® Professional. Your client Ann Dailey presents the following information. Based solely of the information presented, which security would you recommend to Ann and why? PORTFOLIO-TREYNOR PERFORMANCE INDEX-SHARPE RATIO-CORRELATION COEFFICIENT (r) A 5.2% .65 .6 B 5.4% .85 .8 -Portfolio A because it is diversified and the Treynor Performance Index is higher. -Portfolio A because there is less total risk per unit of return. -Portfolio B because the portfolio is not diversified and the Sharpe Ratio is higher. -Portfolio B because the portfolio is diversified and both the Sharpe Ratio and the Treynor Performance Index are higher. -Portfolio A because there is less systematic risk per unit of return.

Portfolio B because the portfolio is not diversified and the Sharpe Ratio is higher. The Treynor Index is not valid because r2 is below .7 for both.

Mutual funds with higher turnover ratios potentially expose shareholders to higher realized capital gains and taxes. -True -False

True

In 20X1, Shawn cashed in stock ABC at a loss of $7,000 and stock XYZ at a gain of $5,000. How much can Shawn deduct from income in 20X1? -$1,000 -$2,000 -$7,000 -Shawn cannot deduct any losses

$2,000 Shawn can balance out his gains and losses, and then deduct up to $3,000 in any given year.

Continuing the example from the previous question, now assume Shawn only had a gain of $3,000 in XYZ. How much could Shawn deduct in 20X1? How much could he deduct in 20X2? -$1,000; $6,000 -$3,000; $3,000 -$3,000, $1,000 -$0; $7,000

$3,000, $1,000

Sandy owns 300 shares of ABC, currently valued at $35 per share. Effective March 1st, ABC will split 2 for 1. How many shares does Sandy now own? -150 -300 -450 -600

600

What is the value of each share? -$17.50 -$35.00 -$52.50 -$70.00

$17.50 In a 2 for 1 split, the number of shares doubles and the value per share is cut in half.

Wash sale rules disallow loss deductions for disposition of securities if, within a period of 60 days before and 60 days after the trade, the taxpayer purchases the same or a substantially identical security. -True -False

False The time period is 30 days before and after, not 60.

You are a CFP® professional. Your client, Courtney Smith, has an unrealized capital loss in her Orange, Inc. stock. She believes the stock has great upside potential. She plans to sell the stock, take the capital loss to offset other capital gains in her portfolio, and then repurchase the stock. If she sells Orange, Inc. on October 11, 20X1, and repurchases identical Orange, Inc. stock on November 9, 20X1 what will be the income tax result? -She may use the loss on her tax return because she waited 30 days to repurchase. -She may use the loss because individuals are not subject to the wash sale rules - only professional broker/dealers. -The loss will be disallowed because she did not comply with the 30-day requirement for repurchasing the identical security.

The loss will be disallowed because she did not comply with the 30-day requirement for repurchasing the identical security. November 9 is only 29 days after October 11. *Test Tip* Count the days and exclude the day of sale!

Which of the following options is most commonly traded? -American options -European options

American options

What specific characteristic distinguishes the American option from the European option? -American options have a definitive expiration and the European option does not -European options can only be exercised on a specific date while the American option can be exercised at any time -European options can be exercised at any time while American options can only be exercised on a specific date -Underlying securities for American options are restricted to commodities while European options are not

European options can only be exercised on a specific date while the American option can be exercised at any time

Bill owns an American-style call option on ABC Stock with a strike price of $45 and an exercise date 3 months from now. If ABC is currently trading at $55, but expected to drop back down to $50 in one month, and back below $45 by the expiration, when should Bill exercise his option? -Today -In one month -The day before expiration -Never

Today A call option gives the investor the right to buy. Therefore, Bill should exercise his option today and then sell his shares because the value of the stock is at its short-term peak.

A put option is in-the-money when: -A. The current stock price is less than the strike price. -B. The current stock price is greater than the strike price. -C. The strike price is greater than the current stock price. -D. Both A and B -E. Both A and C

Both A and C

Which of the following is true? -An opening transaction relates to establishing a position in the market. -The seller of an option is referred to as the "writer" of an option. -A cash settlement is one way to settle an option transaction. -All of the above are true statements -None of the above are true statements

All of the above are true statements

Carl owns shares of Microsoft, which is currently trading at $90. Carl's intuition tells him that it will be moving to $110 over the next 6 months, but all financial indicators say it will move to only $95 with almost no chance of going lower than $90. If Carl has only the following choices, which would be his best course of action? -Go long on a put option with a strike price of $90 -Go long on a call option with a strike price of $95 -Short a call option with a strike price of $95

Go long on a call option with a strike price of $95 While there would be many more options than just these three, to purchase an option to buy more shares at $95 would be Carl's best move. If the shares go to $110, Carl will be able to exercise his option. If the shares only move to $95, Carl will simply let the option expire.

Derrick owns stock on which he has just written a call option. This would be called: -A covered call -A naked call -An uncovered call

A covered call

What is the maximum potential gain for an investor who is long a call? -It is limited to the amount paid for the option -Capped by the exercise price -It is equal to the loss of a similar short put position -Unlimited

Unlimited The long call position appreciates with a rising stock price and is unlimited in profit potential.

A long put position has a maximum risk exposure (loss potential) of: -The exercise price minus the value of the option -The premium -Unlimited -Limited to the amount of the exercise price

The premium

If you are bearish on the S&P 500 Index, which of the following would be the most appropriate transaction? -Short a put -Long a call -Long a put -Long the index

Long a put This allows the investor to benefit from the potential decline of the index.

Both put options and call options have unlimited potential for gain for the holder of the option. -True -False

False

Call options have unlimited potential for gain for both the short and long positions, while put positions only have limited potential for gain in both the short and long positions. -True -False

False While long call positions have unlimited potential for gain, short call positions only have a limited potential for gain (but unlimited potential for loss).

The breakeven point for a long call is the strike price plus the premium, while the breakeven point for a short call is the strike price minus the premium. -True -False

False

Which of the following is not one of the assumptions of the Black-Scholes model? -Efficient markets -The underlying security pays no dividends -American option terms are used -No commissions are charged -Interest rates remain known and unchanged

American option terms are used European terms are used.

Which model can most easily adjust for American options? -Black-Scholes Model -Binomial Pricing Model

Binomial Pricing Model Because the Binomial Pricing Model can check for the possibility of early exercise at every point of the option's life, it is better suited for American options.

Which of the following statements regarding futures contracts is FALSE? -Futures contracts trade on a formal exchange. -Futures contracts are regulated by clearinghouses. -Futures contracts contain standardized terms. -Futures contracts are traded on currencies, but not on equities and debt instruments. -Futures trading is a zero-sum game.

Futures contracts are traded on currencies, but not on equities and debt instruments. Futures contracts are traded on equities and debt instruments.

If Eric wanted to have the choice of buying 100 shares of ABC stock in the future, which of the following contracts could he purchase? -A. A call option -B. A forward contract -C. A futures contract -D. Both A and B -E. Both A and C

A call option A call option is the only choice here that provides Eric the option of purchasing the shares. Both forward and futures contracts require Eric to purchase the shares.

All futures contracts go through a clearinghouse. -True -False

True

What would the position be of a seller of a futures contract? -Short position -Long position

Short Position

A ___________ is selling a futures contract while holding the underlying asset. -Short hedge -Long hedge

Short hedge

Term life insurance has significant cash value to the owner. -True -False

False Term life insurance has no cash value.

The cash value is the amount against which loans can be obtained on a life insurance policy. -True -False

True

Which of the following types of whole life insurance policies will have the highest cash value? -Single premium -Continuous premium -Modified premium -Cannot be determined

Single premium Since single-premium policies are paid-up upon purchase, they will have the highest cash value at any point in time.

The TEFRA Corridor imposes limits on the cash value allowed in a Universal Life Insurance Policy. -True -False

True

The death benefit and cash value of which type of policy are allowed to vary? -Whole life -Variable -Universal -None of the above

Variable

Which of the following statements about an annuity is FALSE? -It is an insurance product. -The longer the investments have to build in value before distributions begin, the larger the amount of annuity payments. -The accumulation period is the span of time after the annuity payments begin. -None of the above

The accumulation period is the span of time after the annuity payments begin. The accumulation period is the span of time BEFORE the annuity payments begin. This is when the investment returns accumulate in order to support the annuity payments.

Which of the following is NOT an example of direct real estate ownership? -Home ownership -Equity REIT -Unimproved land -Improved land

Equity REIT A Real Estate Investment Trust is an example of indirect real estate ownership.

Bill and Jane purchased their home in 1998 for $230,000. If Bill and Jane sell the home today for $450,000, how much of the gain will be excluded from taxation if they file a joint return? -$100,000 -$150,000 -$200,000 -$220,000 -$450,000

$220,000 For joint filers, gains up to $500,000 on the sale of a principal residence are excludable, so Bill and Jane would be able to exclude the entire amount of their gain.

Which of the following is NOT a type of improved land? -Residential -Commercial -Industrial -Traditional

Traditional

Shawn is considering purchasing an office building. On other similar real estate investments, Shawn has required a 13% rate of return on his investment. If the office building has a net operating income (NOI) of $450,000, how much would Shawn be willing to pay? -$58,500 -$450,000 -$2.78 million -$3.46 million

$3.46 million

Investment Planning Flashcards

(182 cards)