series 7 – suitability UPDATED ACTUAL
Exam Questions and CORRECT Answers
The use of index funds as investment vehicles for asset classes increases: - CORRECT
ANSWER - diversification
Which of the diversification factors below will not reduce the non-systematic (credit) risk of a
bond portfolio? - CORRECT ANSWER - coupon rate
(To reduce non-systematic risk (meaning the risk that any one security may be a "bad"
investment), diversification of a bond portfolio by choosing different issuers, different industries,
different geographic issuer locations, and different maturities (since long term bonds give issuers
longer time periods in which they can go broke) are all valid.)
The portfolio management technique that uses a market index as a performance benchmark that
the asset manager must meet is called: - CORRECT ANSWER - passive asset management
Passive asset management is: - CORRECT ANSWER - using index funds as the
investments for each asset class
Active portfolio management is: - CORRECT ANSWER - managing a portfolio to exceed
the performance of a benchmark portfolio
Establishing the structure of a portfolio to meet specific financial goals is called: - CORRECT
ANSWER - strategic allocation
The target allocation for a specific asset class has been set at 20% of total assets under an asset
allocation scheme. The manager is permitted to reduce this percentage to 15%; and can increase
it to 25%; as he or she sees fit. If this action is taken by the manager, this is termed: - CORRECT
ANSWER - tactical asset management
The time horizon to be used when constructing a portfolio for a person who will retire in a few
years is the: - CORRECT ANSWER - expected lifetime of that person
,Which statements are TRUE about asset classes and investment time horizons?
I Equity investments are the better choice for short term time horizons
II Interest bearing investments are the better choice for short term time horizons
III Equity investments are the better choice for long term time horizons
IV Interest bearing investments are the better choice for long term time horizons - CORRECT
ANSWER - II and III
Growth investors: - CORRECT ANSWER - make their investment decision based on the
market performance of that security
When a manager liquidates securities out of one asset class and invests the proceeds in another
asset class to maintain the desired asset allocation percentages as market prices move, the
manager is: - CORRECT ANSWER - rebalancing the portfolio
Which bond portfolio construction is based on a phase-in of purchases in installments over time?
- CORRECT ANSWER - bullet
Which bond portfolio where all investment is made up front would be MOST negatively affected
by a sharp rise in interest rates? - CORRECT ANSWER - barbell
(A barbell portfolio only has 2 maturities - a very short term and a very long term - say 2 years
and 20 years, for an average life around 10 years (actually 11 years here, but we are simplifying
things). The longer term bonds give a higher yield but have higher interest rate risk. This risk is
offset by the fact that the 2 year bonds will mature soon and the proceeds can be reinvested at
higher rates. The big risk here is that long rates rise sharply as compared to short rates (a
steepening of the yield curve). In this scenario, the loss on the long term bonds will be much
greater than the fact that the short term bond proceeds can be reinvested in 2 years at somewhat
higher rates.)
Which bond portfolio where all investment is made up front would be LEAST negatively
affected by a sharp rise in interest rates? - CORRECT ANSWER - ladder
, A customer is in the highest tax bracket and will possibly be subject to the AMT. Which of the
following is the BEST investment recommendation? - CORRECT ANSWER - )5.40%
municipal bond that is not subject to the AMT
(Since this customer is in the highest Federal tax bracket (currently 37%), 37% of the return
offered by taxable Treasury Bonds or Corporate Bonds would go to tax, and only 63% of the 6%
return (3.78%) offered by these would be kept after-tax. Thus, the 5.40% or 5.60% tax-free
municipal bonds are the best choices. Since this customer is possibly subject to the AMT
(Alternative Minimum Tax), which adds back "tax preferences" to reported income and taxes the
adjusted-up figure at a flat 26-28%, buying the bond that is NOT subject to the AMT is the way
to go!)
A 60-year old customer desires an investment that will provide for retirement income when she
reaches age 65. The customer is able to invest $1,000 per month over that time period. Which of
the following recommendations is most suitable? - CORRECT ANSWER - the purchase of
a variable annuity contract
(A variable annuity contract places no dollar limit on contributions; and the income earned on
investments is tax deferred during the accumulation period. Thus, the customer would be allowed
to contribute $12,000 per year; and would receive the benefit of the tax deferred build up. At age
65, she could annuitize and convert the value of the account into an annuity contract that would
make payments for her life. This is the best choice offered.)
An investor has a long-term investment time horizon, no liquidity needs and is very risk averse.
Your main concern when making a recommendation to this client is: - CORRECT
ANSWER - safety of principal
A customer, age 25, is looking to invest in securities with the objective of growth to protect
against the effect of long term inflation on his portfolio's value. The customer believes that active
asset management, along with its higher fees, is not worthwhile. Which recommendation is
MOST suitable for this customer? - CORRECT ANSWER - S&P 500 index fund
(This customer is looking for long term growth, so common equities are an appropriate
investment rather than long term bonds. Since the customer does not believe in active asset
management, a passive approach is best - that is, an index fund that has very low ongoing fees)
A 79-year old customer in the highest tax bracket with $1,000,000 to invest is risk averse. Which
investment recommendation would be appropriate? - CORRECT ANSWER - municipal
bonds
Exam Questions and CORRECT Answers
The use of index funds as investment vehicles for asset classes increases: - CORRECT
ANSWER - diversification
Which of the diversification factors below will not reduce the non-systematic (credit) risk of a
bond portfolio? - CORRECT ANSWER - coupon rate
(To reduce non-systematic risk (meaning the risk that any one security may be a "bad"
investment), diversification of a bond portfolio by choosing different issuers, different industries,
different geographic issuer locations, and different maturities (since long term bonds give issuers
longer time periods in which they can go broke) are all valid.)
The portfolio management technique that uses a market index as a performance benchmark that
the asset manager must meet is called: - CORRECT ANSWER - passive asset management
Passive asset management is: - CORRECT ANSWER - using index funds as the
investments for each asset class
Active portfolio management is: - CORRECT ANSWER - managing a portfolio to exceed
the performance of a benchmark portfolio
Establishing the structure of a portfolio to meet specific financial goals is called: - CORRECT
ANSWER - strategic allocation
The target allocation for a specific asset class has been set at 20% of total assets under an asset
allocation scheme. The manager is permitted to reduce this percentage to 15%; and can increase
it to 25%; as he or she sees fit. If this action is taken by the manager, this is termed: - CORRECT
ANSWER - tactical asset management
The time horizon to be used when constructing a portfolio for a person who will retire in a few
years is the: - CORRECT ANSWER - expected lifetime of that person
,Which statements are TRUE about asset classes and investment time horizons?
I Equity investments are the better choice for short term time horizons
II Interest bearing investments are the better choice for short term time horizons
III Equity investments are the better choice for long term time horizons
IV Interest bearing investments are the better choice for long term time horizons - CORRECT
ANSWER - II and III
Growth investors: - CORRECT ANSWER - make their investment decision based on the
market performance of that security
When a manager liquidates securities out of one asset class and invests the proceeds in another
asset class to maintain the desired asset allocation percentages as market prices move, the
manager is: - CORRECT ANSWER - rebalancing the portfolio
Which bond portfolio construction is based on a phase-in of purchases in installments over time?
- CORRECT ANSWER - bullet
Which bond portfolio where all investment is made up front would be MOST negatively affected
by a sharp rise in interest rates? - CORRECT ANSWER - barbell
(A barbell portfolio only has 2 maturities - a very short term and a very long term - say 2 years
and 20 years, for an average life around 10 years (actually 11 years here, but we are simplifying
things). The longer term bonds give a higher yield but have higher interest rate risk. This risk is
offset by the fact that the 2 year bonds will mature soon and the proceeds can be reinvested at
higher rates. The big risk here is that long rates rise sharply as compared to short rates (a
steepening of the yield curve). In this scenario, the loss on the long term bonds will be much
greater than the fact that the short term bond proceeds can be reinvested in 2 years at somewhat
higher rates.)
Which bond portfolio where all investment is made up front would be LEAST negatively
affected by a sharp rise in interest rates? - CORRECT ANSWER - ladder
, A customer is in the highest tax bracket and will possibly be subject to the AMT. Which of the
following is the BEST investment recommendation? - CORRECT ANSWER - )5.40%
municipal bond that is not subject to the AMT
(Since this customer is in the highest Federal tax bracket (currently 37%), 37% of the return
offered by taxable Treasury Bonds or Corporate Bonds would go to tax, and only 63% of the 6%
return (3.78%) offered by these would be kept after-tax. Thus, the 5.40% or 5.60% tax-free
municipal bonds are the best choices. Since this customer is possibly subject to the AMT
(Alternative Minimum Tax), which adds back "tax preferences" to reported income and taxes the
adjusted-up figure at a flat 26-28%, buying the bond that is NOT subject to the AMT is the way
to go!)
A 60-year old customer desires an investment that will provide for retirement income when she
reaches age 65. The customer is able to invest $1,000 per month over that time period. Which of
the following recommendations is most suitable? - CORRECT ANSWER - the purchase of
a variable annuity contract
(A variable annuity contract places no dollar limit on contributions; and the income earned on
investments is tax deferred during the accumulation period. Thus, the customer would be allowed
to contribute $12,000 per year; and would receive the benefit of the tax deferred build up. At age
65, she could annuitize and convert the value of the account into an annuity contract that would
make payments for her life. This is the best choice offered.)
An investor has a long-term investment time horizon, no liquidity needs and is very risk averse.
Your main concern when making a recommendation to this client is: - CORRECT
ANSWER - safety of principal
A customer, age 25, is looking to invest in securities with the objective of growth to protect
against the effect of long term inflation on his portfolio's value. The customer believes that active
asset management, along with its higher fees, is not worthwhile. Which recommendation is
MOST suitable for this customer? - CORRECT ANSWER - S&P 500 index fund
(This customer is looking for long term growth, so common equities are an appropriate
investment rather than long term bonds. Since the customer does not believe in active asset
management, a passive approach is best - that is, an index fund that has very low ongoing fees)
A 79-year old customer in the highest tax bracket with $1,000,000 to invest is risk averse. Which
investment recommendation would be appropriate? - CORRECT ANSWER - municipal
bonds
