Unit 19: Client Profile

Question 1

A family balance sheet is used to:

Answer 1

determine the overall net worth and liquidity of that client. It only includes assets and liabilities, not income, such as salary, dividends, or interest, or amounts paid for expenses.

Question 2

An individual’s net worth is

Answer 2

the difference between the individual’s assets and the individual’s liabilities.

Question 3

Behavioral finance

Answer 3

the theory that people frequently fail to fully analyze situations where they must make complex judgements

Question 4

Overconfidence

Answer 4

experienced investors tend to overestimate their abilities

Question 5

Conservatism

Answer 5

many investors have a hard time changing their existing beliefs, even when new information is presented to them

Question 6

Herd behavior

Answer 6

A market drop may be followed by panic selling

Question 7

Anchoring

Answer 7

the tendency to base expectations upon the first information received which may or may not be accurate. Once a thought has anchored in your mind, it is difficult to move away from it.

Question 8

Regret aversion

Answer 8

The investor prepares himself in such a way as to avoid distress over an adverse outcome.

Question 9

Aggressive Risk Tolerance

Answer 9

Investors are willing to risk greater amounts and withstand market volatility in exchange for the change to realize substantial returns

• May be willing to sustain losses of 10%, 25%, or even 50% on an investment

Question 10

Moderate Risk Tolerance

Answer 10

Investors can tolerate some loss but not nearly at the level of the aggressive investor

Question 11

Conservative Risk Tolerance

Answer 11

want the relative safety of guaranteed income with low risk to loss of principal

Question 12

Preservation of Capital

Answer 12

bank-insured CDs, savings accounts, and money market funds

Investor is sacrificing the opportunity for higher income and is exposed to inflation (purchasing power) risk.

Question 13

Bank Insured CDs

Answer 13

• Eliminate interest rate risk (value remains constant)
• They are NOT savings accounts with a maturity date
• They would be included as an asset on a family balance sheet
• They are insured by the FDIC up to the current limit (limits are not tested)
• Each bank sets the interest rate it will pay on those CDs with smaller banks typically offering more competitive rates

Question 14

On the exam, the first choice for the preservation of capital should always be:

Answer 14

bank-insured CDs

Question 15

Current Income

Answer 15

investors seeking current income will normally focus on individual securities or mutual funds that invest in fixed-income investments such as: government bonds/notes and agency bonds, corporate bonds, preferred stock, and utility company common stock.

Question 16

Capital growth

Answer 16

common stock investments generally provide a means to preserve and increase the buying power of an investors money over and above the inflation rate.

Although subject to short-term volatility, the equity market tends to provide investment returns over time.

Question 17

Speculation

Answer 17

speculative investments offer the opportunity to earn substantial returns but carry a commensurate amount of risk

• High volatile stocks, high-yield junk bonds, options on stocks or stock indexes, commodity futures

Question 18

College Tuition

Answer 18

• Investors planning for college tuition often invest in 0-coupon bonds that mature when the tuition expenses are due
• Coverdell ESAs and Section 529 plans because of their tax advantages

Question 19

Old-Age Survivors and Disability Income (OASDI)

Answer 19

provides monthly benefits designated to replace, in part, the loss of income due to retirement, disability, or death

Question 20

To receive Old-Age Survivors and Disability Income (OASDI):

Answer 20

• To qualify for full benefits, an individual must have at least 40 quarters of employment
• Waiting until age 70 to claim benefits gives the individual an 8% compound return from full retirement age. If you don’t need the funds and are in health, it is generally worth the wait.

Question 21

Benefits for an ex-spouse.

Answer 21

• If a person has an ex-spouse and a current spouse, both spouses are entitled to the benefits when the man is still alive and both can be entitled to survivor’s benefits.
• If you’re divorced and were married to the man for at least 10 years, you’re eligible for some of your ex’s Social Security. But you you must be unmarried at the time you become eligible to claim on your ex’s Social Security.

Any benefits paid to a divorced spouse do not reduce any payments due the ex’s current spouse if he remarried. That can mean two (or more) spouses receiving identical benefits while the man receives his as well

Question 22

Capital Needs Analysis

Answer 22

used to determine how much life insurance is necessary to meet future needs. Factors used for computation:

• Project client’s future earnings
• Estimate life expectancy
• Account for inflation
• Existing assets

Question 23

Should a client become disabled, there are 3 possible sources of replacement income:

Answer 23

workers comp, social security, disability insurance

Question 24

Workers’ Compensation

Answer 24

if an employee is injured on the job, WC can provide protection to cover medical expenses, replace lost income, and provide death benefits to the family

Question 25

Social Security

Answer 25

to receive payments, you must meet their strict definition of disabled which is:

You must not be able to engage in any substantial gainful activity (SGA) because of a medically-determinable physical or mental impairment:

• That is expected to result in death, or
• That has lasted or is expected to last for a continuous period of at least 12 months

Question 26

Disability Insurance

Answer 26

most agree that it is wise to purchase a private disability insurance policy. Waiting and benefit periods can be adjusted based on the client’s needs and finances. The amount of insurance can be determined by the information derived from the client’s income, assets, and occupation.

• An application for disability insurance coverage can be denied in the case of a hazardous occupation

Question 27

Taxes may be reduced by using the following three strategies

Answer 27

1. Assets and Income Shifting
2. Tax Deferral
3. Tax-Free Income

Question 28

Asset and Income Shifting

Answer 28

shift investment assets and income to a person in a lower tax bracket, trusts may also be used to shift assets and income

Question 29

Tax Deferral

Answer 29

contributions to a qualified retirement plan or tax-sheltered annuity are not taxed until withdrawn. Investing funds that have not been taxed allows a substantially larger portion of the investor’s money to earn income or capital gains, also not taxed until withdrawn.

Question 30

Tax-Free Income

Answer 30

Most muni bonds pay interest that is free from federal taxation, although they are generally subject to state income tax unless issued in the taxpayer’s state of residence. Depending on the investor’s tax bracket, muni bonds may result in higher returns on an after-tax basis.

• Other potential sources of tax-free earnings are Section 529 plans, Roth IRAs, and Coverdell ESAs

Question 31

Time Horizon

Answer 31

an investor’s time horizon and liquidity needs will determine the level of volatility the client should assume. Over a 20- or 30-year time frame, dramatic short-term volatility is acceptable, even to those who are risk averse. Money that is needed within 3-5 years should be invested for safety and liquidity.

Question 32

The longer the time horizon,

Answer 32

the more market risk the account can accept and vice versa.

Question 33

Time horizon does not end

Answer 33

at retirement age. The portfolio has to last throughout retirement until death.

Question 34

Life Cycle Considerations

Answer 34

an investor’s goals may change over time, especially as they move from one phase of life to another

Question 35

Small cap

Answer 35

market cap $300 mil to $2 bil

Question 36

Large cap

Answer 36

market cap of more than $10 bil

• Generally felt that the larger the market cap, the more conservative the investment

Question 37

Growth Funds

Answer 37

focus on generating capital gains rather than income

Question 38

Income Funds

Answer 38

focus on income

Question 39

Combination Funds

Answer 39

combines the objectives of growth and current income

Question 40

Specialized (Sector) Funds

Answer 40

specialize in particular economic sectors or industries. They offer high appreciation potential but may also pose higher risks to the investor because of their lack of diversification among industries or geographic areas

• Examples: gold funds, insurance funds, technology funds, and utility funds

Question 41

Special Situation Funds

Answer 41

buy securities of companies that may benefit from a change within the corporations or in the economy

Question 42

Index Funds

Answer 42

invest in securities to mirror a market index and reflect the passive style of portfolio management. Turnover of securities is minimal therefore, it generally has lower management costs and minimal taxable capital gains.

Question 43

Foreign Stock Funds

Answer 43

long-term capital appreciation is their primary objective although some funds also seek current income. Involve foreign currency risk.

Question 44

International funds

Answer 44

have their entire portfolio invested in securities issued outside the United States. Remember, if you will be traveling international, you’ll be outside the United States.

Question 45

Global funds

Answer 45

have the portfolio invested around the globe,including U.S. securities.

Question 46

Bonds Funds

Answer 46

primary investment objective is income.

• Some invest solely in investment-grade corporate bonds.
• Others invest only in government issues for added safety or seek to maximize income with lower-rated issues that entitle greater risk but potential higher returns.

Question 47

Tax-free (Tax-Exempt) Bond Funds

Answer 47

invest in muni bonds that produce income exempt from federal income tax. Only suitable for those in higher tax brackets.

Question 48

U.S. Government and Agency Securities Funds

Answer 48

purchase securities issued by the U.S. Treasury or an agency of the U.S. Government such as Ginnie Mae.

Question 49

Foreign Bond Funds

Answer 49

invest in foriegn sovereign and/co corporate debt issues

Question 50

Balanced Funds

Answer 50

invest in stocks for appreciation and bonds for income

• Might contain 60% stocks and 40% bonds

Question 51

Asset Allocation Funds

Answer 51

split investments between stocks for growth, bonds for income, and money market instruments (or cash) for stability. The fund adviser switches the % of holdings in each asset category to the performance of that group.

Question 52

Money Market Funds

Answer 52

no-load, mutual funds that serve as temporary holding accounts for investors’ money

• money market instruments have a max maturity of 397 days
• most suitable for investors whose financial goals require liquidity above all

Question 53

An investment in a money market fund is not

Answer 53

insured or guaranteed by the FDIC or any other government agency. Although a MMF seeks to preserve the value of the investment at $1 per share, it is possible to lose money by investing in a MMF.