Module 3

Question 1

What two statements do financial planners generally use?

Answer 1

(1) the statement of financial position and (2) the cash flow statement.

Question 2

What does the statement of financial position represent?

Answer 2

Also known as a net worth statement, is a profile of what is owned (assets), what is owed (liabilities), and your client’s net worth on a specific date.

Question 3

Cash & Cash Equivalents (Current Assets)

Answer 3

Low-risk assets that may be readily converted to cash. Typically, the cash and cash equivalents category will include assets such as checking accounts, savings accounts, and money market funds and accounts. This category could also include short-term certificates of deposit (CDs) with a maturity date of 90 days or less.

Question 4

Invested Assets

Answer 4

Stocks, bonds, mutual funds, gems, gold and other precious metals, collectibles, investment real estate, fine art, ownership interests in closely held businesses, vested pension benefits, and similar assets. Longer-term CDs would also be considered invested assets.

Question 5

Personal Use Assets

Answer 5

Includes the client’s residence, automobiles, boats, recreational real estate, and personal effects such as furnishings, clothes, jewelry, and similar assets.

Question 6

Fair Market Value

Answer 6

The price at which a willing and knowledgeable buyer would purchase an asset from a willing and knowledgeable seller.

Question 7

Current (short-term) Liabilities

Answer 7

Liabilities due within one year from the statement date, such as a promissory note.

Question 8

Long-term Liabilities

Answer 8

Liabilities due more than one year from the statement date.

Question 9

Net Worth

Answer 9

The difference between assets and liabilities.

Question 10

Footnotes

Answer 10

Clarify items in the statement or indicate values or circumstances not disclosed in the body of the statement. They can also indicate relevant contingencies, such as an inheritance or a pending lawsuit that may affect future assets or liabilities.

Question 11

Cashflow Statement

Answer 11

Reveals the client’s cash receipts and disbursements over a specific period of time—monthly, quarterly, and often over one year.

Question 12

Pro Forma Cash Flow Statement

Answer 12

A planning tool that projects the anticipated inflows and outflows for a future period. It can be prepared on a monthly, quarterly, or annual basis.

Question 13

Consumer Debt Ratio

Answer 13

This is the ratio of monthly consumer debt payments to monthly net income. A generally accepted rule in personal financial planning is that monthly consumer debt payments should not exceed 20% of net monthly income.

Consumer debt ratio = monthly consumer debt payments / monthly net income

Question 14

Housing Cost & Total Debt Ratios

Answer 14

Used to indicate clients’ financial stability—in particular, how they manage their overall debt. They address the amount of monthly housing costs that are incurred, as well as the amount of debt. Housing costs include rent or an individual’s monthly mortgage payment (principal and interest payments on the mortgage, property taxes, homeowners’ insurance premium [PITI]), as well as association fees—should not exceed 28% of gross monthly income. This is also known as the front-end ratio.

Housing cost ratio = monthly housing costs / monthly gross income

Question 15

Total Debt (Back-End Ratio)

Answer 15

Recurring debt including monthly housing costs, consumer debt payments, monthly alimony, child support, and maintenance payments —should not exceed 36% of gross monthly income. It is important to use the minimum required debt payment versus the amount your client may actually be paying.

Total Debt = Total monthly debt / monthly gross income

Question 16

Current Ratio

Answer 16

Represents the ability of an individual to service short-term liabilities in case of a financial emergency. A higher current ratio is preferable, and a ratio of greater than 1.0 indicates that the client can pay off existing, short-term liabilities with readily available, liquid assets such as cash.

Current ratio = current assets / current (short-term) liabilities

Question 17

Net-investment-assets-to-net-worth ratio

Answer 17

Compares the value of investment assets (excluding equity in a home) with net worth. An individual should have a ratio of at least 50%, and the percentage should get higher as retirement approaches. Younger individuals will most likely have a ratio of 20% or less because they have not had the time to build an investment portfolio.

Net-investment-assets-to-net-worth ratio = net investment assets / net worth

Question 18

Creating a Budget

Answer 18

Step 1: Identify the client’s financial goals and determine what is required to meet them.
Step 2: Estimate income
Step 3: Estimate expenses
Step 4: Compare income and expenses to determine if expected expenses are equal to or less than expected income.
Step 5: If expenses are too high, attempt to identify potential sources of additional income or areas in which expenses may be reduced.
Step 6: Present each category of income and expense as a percentage of the total.
Step 7: Once the budget is finalized for the year, establish a process at the end of each month to review the budget and make adjustments.

Question 19

Nondiscretionary Expenses

Answer 19

Recurring or nonrecurring expense that is needed to maintain lifestyle. Examples: mortgage payments, utilities, taxes.

Question 20

Discretionary Expenses

Answer 20

Recurring or nonrecurring expense for a nonessential item or one more expensive than necessary. Examples: vacations, club dues, entertainment, and gifts.

Question 21

3 months of emergency funds should be set aside if:

Answer 21

„ a single wage earner and has a second source of sizable income (e.g., as a beneficiary of a trust fund, as the recipient of rental income, or as an heir who wisely invested the inherited money);
„ married and both spouses are gainfully employed; or
„ married and only one spouse is gainfully employed, but a second source of considerable income is available.

Question 22

6 months of emergency funds should be set aside if:

Answer 22

„ a single wage earner, or
„ married and only one spouse is gainfully employed.

Question 23

Secured Loan

Answer 23

A loan for which the creditor maintains a security interest in property, such as personal property, which serves as collateral for the debt. If the debtor falls behind on secured debt payments, the lender can repossess the property that secures the debt.

Question 24

Unsecured (signature) Loan

Answer 24

A loan for which the client merely promises to repay the debt in exchange for the borrowed funds. In the event of default, lenders can take legal action, but most often will attempt to settle the debt for less than the amount owed. However, this will negatively affect an individual’s credit rating.

Question 25

Fixed-Rate Loan

Answer 25

A loan with an interest rate that remains constant until paid in full. Although initial interest rates are higher than those of variable (adjustable) rate loans (see next), fixed-rate loans offer more security because the underlying interest rates will not increase considerably during the term of the loan.

Question 26

Variable (adjustable) Rate Loan

Answer 26

The interest rate adjusts at various intervals throughout loan term; thus, they are riskier. The initial interest rate on these types of loans is typically lower than those of fixed-rate loans.

Question 27

Short-term Loan

Answer 27

A loan that is due within one year (up to and including one year from a specified date).

Question 28

Installment Loan

Answer 28

A loan for which the client borrows a single amount of money and repays the balance with interest at stated intervals. Most loans are installment loans.

Question 29

Single Payment (bridge) Loan

Answer 29

A loan that provides short-term, temporary financing that is repaid with interest in one lump sum at the end of the term. These types of loans are often used to provide funds for a time period between two transactions (e.g., the purchase of one house and the subsequent sale of another).

Question 30

The Snowball Technique

Answer 30

With this method, smaller balances are paid off first so clients feel encouraged by their success and motivated to continue the process.

Question 31

The Avalanche Technique

Answer 31

Prioritizes high-interest debt to save money, but it may take longer to get the first debt eliminated. When the highest-interest debt is eliminated, your client focuses on eliminating the debt with the next-highest interest rate, and so on, until all of his debt is paid off. This works well for clients who feel successful when saving interest costs.

Question 32

Credit Score Categories

Answer 32

1. Payment history.
2. Amounts owed.
3. Length of credit history.
4. New credit.
5. Credit mix.

Question 33

Fixed-cost Lease

Answer 33

The closed-end lease is one in which the lessee agrees to pay a stated monthly fee for the use of the asset for a specified time period.

Question 34

Open-end Lease

Answer 34

Generally, has a lower monthly payment than a closed-end lease but, at the end of the lease, the lessee may owe the lessor additional money if the asset rents or sells for an amount that is less than the value projected at the time the lease was initiated. Also known as a finance lease or equity lease.

Question 35

Regarding buying or leasing a home, the economics depend primarily on the following factors:

Answer 35

„ The price of existing homes and the level of mortgage interest rates in a particular area
„ The length of time the client expects to live in the home and the degree of uncertainty associated with this issue
„ The extent to which home prices are expected to increase or decrease over the period the client expects to own the home
„ The potential income tax benefits of home ownership

Question 36

Home Mortgage Interest Rates

Answer 36

Are influenced by the prevailing level of long-term interest rates in the economy, which reflect inflationary expectations. Interest rates offered by different lenders vary, so it may pay the borrower to shop around.

Question 37

Lien

Answer 37

The legal right to repossess the property, which serves as collateral in the event the borrower defaults on the loan. When the mortgagor repays the loan, the mortgagee removes the lien.

Question 38

Prime Loans

Answer 38

Mortgages made to borrowers with good credit.

Question 39

Subprime Loans

Answer 39

Mortgages to borrowers of lower credit quality, or that have a lower-priority claim to the collateral in event of default.

Question 40

Federal Housing Administration (FHA) Mortgage Loans

Answer 40

These mortgages appeal to buyers who may not meet the financial underwriting requirements for a conventional home loan (i.e., a 15-or 30-year fixed mortgage or adjustable-rate mortgage).
- A key feature of the FHA mortgage is a very low initial down payment and, sometimes, a lower interest rate because of the federal government’s guarantee of repayment.
- FHA requirements include mortgage insurance primarily for borrowers making a down payment of less than 20%.

Question 41

Private Mortgage Insurance (PMI)

Answer 41

A policy that protects lenders against losses that result from defaults on home mortgages.

Question 42

Veterans Administration (VA) Loans

Answer 42

Feature the same federal guarantee of repayment as that for FHA mortgages, but VA mortgages are for service members and veterans of the U.S. armed services, their spouses, and other eligible beneficiaries.
- An even more favorable attribute of the VA mortgage is that, in certain cases, no initial down payment is required; in other words, the entire purchase price can be borrowed. In addition, no PMI is required, however, there is a funding fee at the start of the loan of 0.5% to 3.6% with most veterans paying 2.3% of the loan amount.

Question 43

Conventional Mortgage Loans

Answer 43

Are those made by commercial lenders in the private sector. These may also be called conforming loans, because they conform to Fannie Mae and Freddie Mac dollar limit requirements. These dollar limits are periodically reevaluated, and certain parts of the country (e.g., Alaska and Hawaii) have higher limits. Loans above that amount are known as jumbo loans or nonconforming loans. Nonconforming loans may also be called subprime loans and have higher down payment and/or higher interest rate requirements. Loans for those with damaged credit may also be considered nonconforming.

Question 44

Fixed-rate Mortgages

Answer 44

Have a level interest rate for the term of the loan and a fixed payment amortization schedule. An amortization schedule details the portion of each payment allocated to interest and principal.

Question 45

Adjustable-Rate Mortgages (ARMs)

Answer 45

The interest rate and payment may change every month, quarter, year, three years, or five years. Interest rate changes are usually tied to a specific index such as the one-year London Interbank Offered Rate (LIBOR).
- Many ARMs have a cap that limits the amount by which the interest rate and, accordingly, the monthly payment can change.
- ARMs can allow for negative amortization to occur. This is the case when the agreed-upon monthly payment is less than the accruing interest charges and unpaid interest is added to the mortgage balance, increasing the debt.

NOTE: A client who wants lower initial monthly payments and does not anticipate remaining in the home for a long time may want to consider an ARM.

Question 46

Interest-only Mortgage

Answer 46

The homeowner tries to keep the mortgage payment at a minimum while hoping that the fair market value of the home will increase so that the principal amount will be paid off by the sale proceeds.

Question 47

Balloon Mortgage

Answer 47

A mortgage in which the borrower makes fixed payments, which are based upon the established interest rate for a long-term mortgage. However, payments are made only for a short duration—frequently five or seven years—and then the borrower is required to pay off the remainder of the mortgage in a lump sum. The payments with some loans may be limited to interest only.
- The interest rate on a balloon mortgage is usually favorable over a typical 30-year mortgage due to the shorter time frame for repayment and the smaller risk to the lender of a variance in the prevailing interest rates.

Question 48

Graduated Payment Mortgage

Answer 48

Payable over a long time period, such as 30 years, and has a fixed interest rate. The payments are lower for the first few years of mortgage repayment (although they sometimes increase annually), then they adjust to a higher fixed payment that continues for the remainder of the loan.

Question 49

Reverse Mortgages

Answer 49

A special type of home loan that allows senior citizens with limited income to stay in their homes. Here, the payment stream is reversed; that is, the lender pays the homeowner a stream of income secured by a considerable amount of equity in the home. The lender makes payments to the homeowner on the basis of the fair market value of the home and the age of the borrower at the time the loan is made.

Question 50

Home Equity Loan

Answer 50

With this type of loan, borrowers repay the loan with equal monthly payments over a fixed term.

Question 51

Home Equity Line of Credit (HELOC)

Answer 51

Provides a set amount of credit from which funds may be drawn as needed. Because a HELOC is a line of credit, borrowers make payments only on the amount they actually borrow, not the full amount available.

Question 52

Identify the item that should be included on the statement of financial position:

A. Auto loan balance
B. Auto loan payment
C. Original mortgage amount
D. Section 401(k) elective deferrals

Answer 52

A. Auto loan balance

Explanation: The auto loan balance should be shown as a liability on the statement of financial position. The auto loan payment is reflected on the statement of cash flows, as are the Section 401(k) elective deferral contributions. The original mortgage amount is not shown on the statement of financial position, but rather the current balance after payments for the year of the statement.

Question 53

A client’s statement of financial position reflects $540,000 in total assets, $40,000 in current liabilities, and $240,000 in long-term liabilities. Calculate the client’s net worth.

A. $260,000
B. $300,000
C. $500,000
D. $540,000

Answer 53

A. $260,000

Explanation: A client’s net worth is computed by subtracting total liabilities from total assets. Accordingly, the answer is $260,000, or total assets of $540,000 less total liabilities of $280,000.

Question 54

A client has a net worth of $900,000 at the beginning of the calendar year. Calculate the client’s net worth at the end of this same calendar year after the following transactions:

„ Repayment of a $25,000 loan using funds from a savings account
„ Purchase of a $40,000 automobile with a $10,000 down payment and the remaining amount financed through a credit union
„ A $12,000 increase in the client’s mutual funds account balances
„ A $15,000 decrease in the client’s bond portfolio

A. $867,000
B. $897,000
C. $922,000
D. $925,000

Answer 54

B. $897,000

Explanation: It is the beginning amount of $900,000 plus the $12,000 increase in the client’s mutual funds account balances less the $15,000 decrease in the value of the client’s bond portfolio ($900,000 + 12,000 – 15,000 = $897,000). The first two transactions neither increase nor decrease net worth because they merely reshuffle existing asset and liability values.

Question 55

Which of the following are NOT listed as outflows on the cash flow statement?

A. Fixed expenses
B. Variable expenses
C. Interest and dividends
D. Savings and investments

Answer 55

C. Interest and dividends

Explanation: Interest and dividends are inflows. While some planners may not list them as inflows if they are being reinvested, they would never be outflows.

Question 56

Which of the following are components of the statement of cash flows?

I. Taxes
II. Variable outflows
III. Net cash flow
IV. Cash and cash equivalents

A. I and III
B. III and IV
C. I, II, and III
D. I, III, and IV

Answer 56

C. I, II, and III

Explanation: Inflows, fixed outflows, variable outflows, taxes, and net cash flow are all components of the statement of cash flows. Cash and cash equivalents are generally an entry on a statement of financial position.

Question 57

Your client, Kamari, needs assistance preparing his statement of financial position and cash flow statement. He has an annual salary of $200,000 and pays $1,200 monthly in alimony to his ex-spouse, Diana. Kamari owns a condo valued at $300,000, which currently has an outstanding mortgage balance of $130,000. He pays annual property taxes of $4,000, and a monthly condo insurance premium of $250. All of the following statements are correct EXCEPT:

A. Kamari’s salary would be considered a cash inflow on his cash flow statement.
B. the alimony Kamari pays would be a cash inflow on Diana’s cash flow statement.
C. taxes paid on his property would be a liability on his statement of financial position.
D. the condo insurance payments would be a fixed outflow on Kamari’s cash flow statement.

Answer 57

C. taxes paid on his property would be a liability on his statement of financial position.

Explanation: The property taxes Kamari pays would be considered a fixed outflow on his cash flow statement. Such tax payments would not be an entry on his statement of financial position.

Question 58

Ollie earns an annual salary of $80,000. From this amount, he makes elective deferrals of 10% to his company’s 401(k) plan. His monthly mortgage payment (PITI) is $1,500. Calculate Ollie’s housing cost ratio.

A. 1.8%
B. 2.0%
C. 22.5%
D. 25.0%

Answer 58

C. 22.5%

Explanation: In calculating the housing cost ratio, do not subtract 401(k) plan contributions to arrive at gross income. Therefore, the amount of Ollie’s gross income is $80,000, not $72,000 ($80,000 – $8,000). Accordingly, his housing cost ratio is 22.5% ($1,500 monthly mortgage payment ÷ $6,666 monthly gross income [$80,000 ÷ 12]).

Question 59

Analyze the following scenario. Caitlin has the following assets: a checking account of $2,500, a savings account of $5,000, and a money market mutual fund of $3,500. She also has mutual fund investments totaling $125,000. She has a personal balloon note liability of $25,000 coming due within the next year. Does Caitlin’s current ratio represent a potential problem with respect to her financial situation?

A. No, her current investments are adequate to cover her current liabilities.
B. No, her current ratio is 1.44, which is very favorable.
C. Yes, her current ratio is only 0.44.
D. Yes, her current ratio is negative.

Answer 59

C. Yes, her current ratio is only 0.44.

Explanation: Caitlin’s current ratio (current assets ÷ current liabilities) is only 0.44 ($11,000 ÷ $25,000). Her mutual fund investments of $125,000 are not considered current assets. Therefore, she should consider selling some of these (a minimum of $14,000 in value) to make her current ratio at least 1.0, which would permit her to pay off the balloon note liability that is coming due in the near future. She also needs to maintain at a minimum of her current balances in the checking account, savings account, and money market mutual fund.

Question 60

Identify the CORRECT statements regarding financial strengths and weaknesses.

I. Very general financial goals are considered a financial strength.
II. Inadequate retirement savings is considered a financial weakness.
III. Determining financial strengths and weaknesses is an objective process.
IV. Lack of a valid will is considered a financial weakness if a will is necessary to protect the interest of heirs.

A. I only
B. II and IV
C. III and IV
D. I, II, III, and IV

Answer 60

B. II and IV

Explanation: Inadequate retirement savings is a financial weakness. The absence of a valid will is considered a financial weakness, especially when such an instrument would protect the interest of heirs. Vague or unarticulated goals also represent a financial weakness. Determining financial strengths and weaknesses is a subjective process.

Question 61

Which of the following can be monitored and evaluated through the use of a budget?

I. Income
II. Net worth
III. Expenses
IV. Spending patterns

A. I and III
B. II and IV
C. I, II, and III
D. I, III, and IV

Answer 61

D. I, III, and IV

Explanation: A budget can help clients assess their income, expenses, and spending patterns. The statement of financial position is used to determine a client’s net worth.

Question 62

Tim and Gina are working with you, their financial planner, to develop a budget. As part of the process, you ask them to list their discretionary and nondiscretionary expenses. Which of the following should Tim and Gina consider to be nondiscretionary cash outflows for planning purposes?

I. Utility bills
II. Loan payments
III. Travel and entertainment expenses
IV. Medical and dental insurance premiums

A. I and II
B. II and IV
C. I, II, and IV
D. I, II, III, and IV

Answer 62

C. I, II, and IV

Explanation: Payments for utilities, loan payments, and medical and dental insurance premiums are considered nondiscretionary expenses. Travel and entertainment expenses, along with gifts, premium cable TV channels, and club dues are considered discretionary expenses.

Question 63

After meeting with you, Janesh and Katie understand the need for an emergency fund. Janesh is a mechanic, and Katie volunteers at a local hospital. They ask you how much they should have in this fund. Which of the following is your best response?

A. An amount equal to 1 month of expenses
B. An amount equal to 3 months of expenses
C. An amount equal to 6 months of expenses
D. An amount equal to 12 months of expenses

Answer 63

C. An amount equal to 6 months of expenses

Explanation: In this case, Katie does volunteer work and Janesh is the sole breadwinner. Six months of expenses should be set aside for couples in which one partner is not gainfully employed. This is the same rule of thumb for a single client. For couples in which both are gainfully employed, an amount equal to three months of expenses should be maintained in an emergency fund.

Question 64

Miguel and Michelle, both age 38, would like to create an emergency fund for major unexpected expenses. Which of the following accounts are appropriate for this fund?

I. Stocks and bonds
II. Savings account
III. Traditional IRA account
IV. Certificate of deposit (CD) with a three-month maturity

A. I and II
B. II and IV
C. III and IV
D. II, III, and IV

Answer 64

B. II and IV

Explanation: The funds that constitute a client’s emergency fund should be kept in liquid assets, which may be quickly accessed by the client without the risk of a significant loss to principal. For Miguel and Michelle, stocks, bonds, and traditional IRA accounts do not meet this criteria and are not appropriate for their emergency fund.

Question 65

You have advised your client, Bette, that she needs to increase her savings. What might you recommend as good savings strategies?

I. Plant a large vegetable and herb garden.
II. Use an overdraft feature on her debit card.
III. Consider a health insurance plan with a lower deductible.

A. I only
B. I and II
C. II and III
D. I, II, and III

Answer 65

A. I only

Explanation: Bette can use the money she saves by planting a large vegetable and herb garden, which can eliminate expensive grocery visits for produce and/or seasonings. Using an overdraft feature on debit cards may tempt Bette to spend money she does not have available in her account. Decreasing insurance deductibles increases premiums; therefore, this would not be a good savings strategy.

Question 66

Over the years, Gabriel has made timely payments on three of his credit card accounts, all which have balances near the available credit limits. He also paid off a fourth credit card account, which he had for 20 years, and immediately closed it. Which of the following statements regarding Gabriel’s credit score is CORRECT?

I. By immediately closing his long-standing account when it was paid off, Gabriel likely increased his credit score.
II. Having three credit card account balances near their available credit limits adversely affects Gabriel’s credit score.

A. I only
B. II only
C. Both I and II
D. Neither I nor II

Answer 66

B. II only

Explanation: Immediately closing long-standing accounts will likely decrease Gabriel’s credit score. Keeping account balances near the available credit limit has a negative effect.

Question 67

What is the best reason that your client, Jennie, should rent an apartment rather than purchase a home?

A. She does not want to do yard work.
B. She does not want to pay real property taxes.
C. She expects to relocate within one to three years.
D. She does not want to purchase homeowners insurance.

Answer 67

C. She expects to relocate within one to three years.

Explanation: This is the best answer because Jennie has only a relatively short time period before she will relocate. Real property taxes are income tax deductible; if the client itemizes, the cost to the buyer is offset somewhat. Finally, with respect to insurance, tenants should purchase an HO-4 (renter’s) policy to protect their contents and provide liability protection.

Question 68

Which mortgage is generally available for lower-income households who would be unlikely to secure a conventional home loan?

A. Reverse mortgage
B. Balloon mortgage
C. Interest-only mortgage
D. Federal Housing Administration (FHA) mortgage

Answer 68

D. Federal Housing Administration (FHA) mortgage

Explanation: With this type of mortgage, the federal government guarantees loans through various FHA programs. These mortgages are for buyers who would not likely be able to secure a conventional home loan (15-or 30-year fixed-rate mortgage or ARM) because they fail to meet the qualifications.

Question 69

Oscar has just joined the faculty of a local college as an associate professor. He and his spouse, Kathy, would like to purchase a new home near the college. They are meeting with their loan officer to determine which mortgage would best suit their needs. Kathy is a stay-at-home mom raising the couple’s four school-age children; she sometimes provides bookkeeping services for her friends. Oscar and Kathy, both age 45, want a mortgage that offers the lowest monthly payment with a fixed interest rate. Based on this information, which mortgage would be the most appropriate choice?

A. Veterans Administration (VA) mortgage
B. Reverse mortgage
C. 15-year conventional mortgage
D. 30-year conventional mortgage

Answer 69

D. 30-year conventional mortgage

Explanation: Generally, the 30-year conventional mortgage will have a lower payment (principal + interest) compared to the 15-year conventional mortgage. A client who currently has stable cash flow and wants to have a predictable mortgage payment each month should use a conventional fixed-rate 30-year mortgage, for which the principal is completely paid off at the end the term. A reverse mortgage is not a good option because they are only available to borrowers who are 62 years or older.

Question 70

Which of the following statements regarding home equity lines of credit (HELOCs) is CORRECT?

I. Borrowers repay the loan with equal monthly payments over a fixed term.
II. Clients are given a set amount of credit from which they can draw from as funds are needed.
III. Borrowers make payments only on the amount they actually borrow, not the full amount available.
IV. HELOCs use the current equity in the homeowner’s primary residence to provide money for home improvements and other purposes.

A. II and IV
B. III and IV
C. I, II, and III
D. II, III, and IV

Answer 70

D. II, III, and IV

Explanation: With a home equity loan, not a HELOC, borrowers repay the loan with equal monthly payments over a fixed term. Clients who secure home equity loans receive a lump sum in the amount of the loan. A HELOC gives clients a specified amount of credit from which they can draw from as funds are needed.

Question 71

Which of the following actions would be appropriate for a homeowner who has a goal to retire debt and reduce the amount of total interest due over the life of his mortgage loan?

I. Replace a 30-year fixed-rate loan with a 15-year fixed-rate loan.
II. Replace a 15-year fixed-rate loan with a 30-year fixed-rate loan.
III. Replace a fixed-rate loan with a lower interest fixed-rate loan of the same term.

A. I only
B. I and III
C. II and III
D. I, II, and III

Answer 71

B. I and III

Explanation: Replacing a 15-year fixed-rate loan with a 30-year fixed-rate loan will lower the homeowner’s monthly payment but will significantly add to the total amount of interest due over the life of the loan. In addition, this option will double the period over which the repayment of principal will occur.

Question 72

Which of the following statements regarding banks is CORRECT?

I. The Office of the Comptroller of the Currency (OCC) makes monetary policy.
II. The FDIC charters, supervises, and regulates national banks and federal branches of foreign banks located in the United States.

A. I only
B. II only
C. Both I and II
D. Neither I nor II

Answer 72

D. Neither I nor II

Explanation: It is the Federal Reserve Board, not the OCC, that makes monetary policy. The OCC charters, supervises, and regulates national banks and federal branches of foreign banks located in the United States. The FDIC insures deposits in U.S. banks and savings and loan associations against bank failures.

Question 73

Larry and Brittany each have an individual account and a joint account with Crestview Bank. What is the maximum amount of FDIC insurance they each can have at the bank?

A. $125,000
B. $250,000
C. $500,000
D. $1,000,000

Answer 73

C. $500,000

Explanation: Remember that a joint account doubles the amount of FDIC coverage. The maximum amount in FDIC-insured accounts Larry and Brittany each can have at Crestview Bank is $500,000.

Question 74

Trust Company

Answer 74

Specializes in managing estates and serving as the trustee for various types of trusts.

Question 75

Brokerage Company

Answer 75

An intermediary that facilitates transactions involving sales of investments or real estate.

Question 76

Mutual Fund Company

Answer 76

Pools money from shareholders and invests these funds in various types of securities (e.g., stocks, bonds, and money market instruments) according to the funds’ prospectus

Question 77

Maria has a net worth of $1,000,000 at the beginning of the calendar year. After the following transactions, what would her net worth be at the end of the same calendar year?

I. A $40,000 increase in her IRA
II. A $100,000 decrease in her bond portfolio
III. Repayment of a $50,000 loan from a savings account
IV. Purchase of a boat priced and valued at $75,000 financed with a $50,000 bank loan and a $25,000 down payment taken from a savings account

Answer 77

$940,000. III & IV cancel themselves out. I & II are the only ones that have an actual affect on total assets (-$60k).

Question 78

Which of the following items should be included on the Statement of Financial Position?

I. Original mortgage balance
II. Contributions to IRAs
III. Credit card balance
IV. Property taxes

Answer 78

III. Credit card balance

The contributions to IRAs are reflected on the statement of cash flows, as are the property taxes. The original mortgage amount is not shown on the statement of financial position, but rather the current balance after payments for the year of the statement.

Question 79

Burt has a $150,000 mortgage on his home (currently valued at $220,000). The original mortgage was for $175,000, and the annual property taxes are $3,500. Burt also has a monthly auto loan payment of $500. Which of the following statements regarding Burt’s statement of cash flows is CORRECT?

A. The current value of the home is an asset.
B. Burt's auto loan balance is an expense. 
C. The original mortgage loan amount is a liability. 
D. Burt's property taxes are an expense.

Answer 79

D. Burt’s property taxes are an expense.

Question 80

What asset listed below should typically NOT be used to establish an emergency fund?

A. Cash in a basement safe
B. Short-term CDs
C. US Govt bonds
D. Money market account

Answer 80

C. US Govt bonds

Question 81

Which of the following areas is the most important to focus on when developing a cash flow statement with clients that will ultimately enable them to meet their long-term goals and objectives?

A. Insurance costs
B. Fixed expenses
C. Variable expenses
D. Savings and investments

Answer 81

D. Savings and investments

Question 82

Raphael would like to pay off his debt, reducing the debt with the highest interest rate first. Compared to the snowball approach of debt reduction, which of the following statements is CORRECT?

I. This approach decreases the total amount of interest paid during the debt reduction process.
II. Compared to the snowball approach, it is relatively easier to pay off the first debt with a high balance quickly.

A. I only
B. II only
C. Both I and II
D. Neither I nor II

Answer 82

A. I only

Question 83

A client comes to you and expresses a desire to increase her credit score over the next few years. What should you advise as the single best way to improve a credit score?

A. Open several new accounts in a short period of time to show that the client can acquire new credit.
B. Make payments in a consistent and timely manner.
C. Get rid of credit cards and close accounts she no longer uses that have zero dollar balances.
D. Keep credit cards near the credit limit and make minimum payments to demonstrate the ability to pay on several accounts.

Answer 83

B. Make payments in a consistent and timely manner.

Question 84

Which one of the following arguments provides the best support for a decision to buy a car rather than lease one?

A. The client needs the lowest monthly payment for a specific car.
B. The average annual distance driven will be less than 10,000 miles.
C. The client does not have 20% or more for a down payment.
D. The client does not want to always be making payments.

Answer 84

D. The client does not want to always be making payments.

Question 85

Noah grew up in the period following the Depression and is very conservative with his finances. He has individual accounts at three separate federally chartered banks with balances of $265,000, $300,000, and $200,000. What is the total amount insured by the FDIC?

A. $250,000
B. $500,000
C. $700,000
D. $765,000

Answer 85

C. $700,000

Question 86

Rock Enterprises is an intermediary that facilitates transactions involving sales of investments or real estate. Rock Enterprises is:

A. A trust company
B. A brokerage company
C. A mutual fund
D. A thrift institution

Answer 86

B. A brokerage company

Question 87

Which one of the following client goals is stated appropriately?

A) A comfortable retirement
B) An adequate emergency fund
C) Enough life insurance to keep the family in its “own world”
D) $14,000 in current dollars, per year, for each child’s education

Answer 87

D) $14,000 in current dollars, per year, for each child’s education

Question 88

Who of the following is most likely to implement a reverse mortgage?

A) A first-time homeowner
B) An individual who expects to relocate soon
C) A 65-year-old homeowner with substantial home equity
D) An individual who wishes to refinance the mortgage

Answer 88

C) A 65-year-old homeowner with substantial home equity

Question 89

John and Kelly recently moved to the East Coast. John is in the Navy and wishes to live off base for his next tour of duty, which is expected to last no more than four years. John and Kelly want to purchase a home; however, they expect to move after his tour of duty. Which of the following mortgages is best for John and Kelly if they want to keep their monthly mortgage payments to a minimum?

A) An adjustable-rate mortgage with an interest rate cap
B) A 30-year fixed-rate mortgage
C) A 15-year fixed-rate mortgage
D) A reverse mortgage

Answer 89

A) An adjustable-rate mortgage with an interest rate cap

Question 90

Which of the following areas is the most important to focus on with clients when developing a cash flow statement that will ultimately enable them to meet their long-term goals and objectives?

A) Insurance costs
B) Fixed expenses
C) Savings and investments
D) Variable expenses

Answer 90

C) Savings and investments

Question 91

Your clients have several long-term goals that will require a fairly significant amount of capital. What is the most effective recommendation you can make to help your clients work toward their long-term goals?

A) Recommend that they implement an ongoing saving and investing plan.
B) Recommend that they increase their insurance deductibles to save on insurance premiums.
C) Recommend that they reduce their variable expenses across all categories.
D) Recommend that they work on paying off any debts they may have as soon as practical.

Answer 91

A) Recommend that they implement an ongoing saving and investing plan.

Question 92

Which of these types of information are important to gather from a client prior to developing financial planning recommendations?

I. Their desired age of retirement
II. Current asset mix within 401(k) or 403(b) plan
III. Potential inheritance from parents
IV. Number of children client and spouse intend to have

A) I and IV
B) I, III, and IV
C) II and III
D) I, II, III, and IV

Answer 92

D) I, II, III, and IV

Question 93

The simple formula to determine the net cash flow (surplus or deficit) of a client is

A) inflows – outflows.
B) inflows + outflows.
C) assets – liabilities.
D) fixed outflows – variable outflows.

Answer 93

A) inflows – outflows.

Question 94

Which one of the following arguments provides the best support for a decision to buy a car rather than lease one?

A) The average annual distance driven will be less than 10,000 miles.
B) The client does not want to regularly make monthly payments.
C) The client does not have 20% or more for a down payment.
D) The client needs the lowest monthly payment for a specific car.

Answer 94

B) The client does not want to regularly make monthly payments.

Question 95

Gerome, a CFP® practitioner, provides a SWOT analysis to all of his financial planning clients. The major advantage of providing this analysis to his clients is that they obtain a broad overview of their personal

A) financial strengths and weaknesses.
B) credit rating and score.
C) vulnerability to longevity risk.
D) risk tolerance.

Answer 95

A) financial strengths and weaknesses.

Question 96

National banks are subject to regulation by which of the following independent federal agencies?

I. Federal Reserve Board
II. Securities and Exchange Commission (SEC)
III. Federal Deposit Insurance Corporation (FDIC)
IV. Office of the Comptroller of the Currency (OCC)

A) I, II, III, and IV
B) I, III, and IV
C) II, III, and IV
D) I and III

Answer 96

B) I, III, and IV

Question 97

The function of an investment bank may include all of the following except

A) raising capital for issuers by distributing new securities.
B) advising corporations regarding the best ways to raise long-term capital.
C) purchasing securities from the public and reselling them to the issuers.
D) distributing large blocks of stock to the public and to institutions.

Answer 97

C) purchasing securities from the public and reselling them to the issuers.

Question 98

The Martins have decided to set up an appointment with Michael, a CFP® professional and an experienced financial planner, to get their finances in order. Up to this point, the Martins had been making their financial decisions as the need arose without a comprehensive strategy. In addition, they believe that their life insurance coverage is inadequate and they need to update their will due to the birth of their second child, Zachary. Lately, they have been spending indiscriminately with very little set aside for savings and investment. What should be the first step that Michael should take in working with the Martins?

A) The Martins should consult with their life insurance agent about purchasing additional policies.
B) The Martins should review their wills with the attorney recommended by their financial planner.
C) Michael should assist the Martins in preparing a budget.
D) The Martins should start an investment plan with their broker.

Answer 98

C) Michael should assist the Martins in preparing a budget.

Question 99

What purpose do footnotes serve on personal financial statements?

I. Used to describe details of assets and liabilities listed on the client’s financial statement
II. List values or circumstances not disclosed in the body of the client’s financial statements
III. Total the cash balance on the client’s financial statements
IV. Total the investment balance on the client’s financial statements

A) II, III, and IV
B) II and III
C) I and III
D) I and II

Answer 99

D) I and II

Question 100

What are some of the potential costs of owning a home?

I. Monthly mortgage payments
II. Annual property taxes
III. Monthly homeowners insurance premiums
IV. Random maintenance expenses

A) II, III, and IV
B) II and III
C) I, II, III, and IV
D) I, II, and III

Answer 100

C) I, II, III, and IV

Question 101

Which of the following statements regarding a personal statement of financial position are CORRECT?

I. Assets − liabilities = net worth.
II. Current liabilities are due within two years.
III. Long-term liabilities are due in more than two years.
IV. Personal use assets include cars and furniture.

A) II, III, and IV
B) II and III
C) I, II, III, and IV
D) I and IV

Answer 101

D) I and IV

Question 102

Which of the following statements concerning a client’s level of savings is CORRECT?

I. A budget should consider the client’s financial goals and serve as a control document for future cash flows, including cash available for savings.
II. If future spending exceeds budget projections, the cash actually saved will be more than anticipated.

A) I only
B) II only
C) Neither I nor II
D) Both I and II

Answer 102

A) I only

Question 103

The ratio of a client’s monthly consumer debt payments to monthly net income should NOT exceed

A) 20%.
B) 30%.
C) 15%.
D) 25%.

Answer 103

A) 20%.

Question 104

Which of the following are considered financial weaknesses?

I. Low risk tolerance level
II. Insufficient insurance coverage
III. Inarticulate financial goals
IV. Weak cash flow management skills

A) I only
B) III and IV
C) II, III, and IV
D) I, II, III, and IV

Answer 104

C) II, III, and IV

Question 105

Which components of the FICO credit score calculation have the greatest impact on the total score?

I. Credit mix
II. Payment history
III. Amounts owed
IV. Length of credit history

A) III and IV
B) II and III
C) II and V
D) I and II

Answer 105

B) II and III

Explanation: Payment history and amounts owed have the greatest impact on total score of the FICO credit score calculation.

Question 106

Your client, Andy, is in need of assistance in preparing his statement of financial position and statement of cash flows. He earns $150,000 annually and pays $1,000 monthly in alimony to his ex-wife, Debbie. Andy owns a condo valued at $230,000, which currently has an outstanding mortgage balance of $100,000. He pays annual property taxes of $3,000, and the condo insurance costs $180 per month. All of the following statements are CORRECT except:

A) the condo insurance payments would be a fixed outflow on Andy’s statement of cash flows.
B) the alimony Andy pays would be a cash inflow on Debbie’s statement of cash flows.
C) taxes paid on his property would be a liability on his statement of financial position.
D) Andy’s salary would be considered a cash inflow on his statement of cash flows.

Answer 106

C) taxes paid on his property would be a liability on his statement of financial position.

The answer is taxes paid on his property would be a liability on his statement of financial position. The property taxes Andy pays would be considered a fixed outflow on his statement of cash flows. Such tax payments would not be an entry on a statement of financial position.

Question 107

Before any of the transactions below, Sid had a net worth of $200,000.

• Took out a $24,000 loan to pay for a European vacation
• Paid off his student loan of $8,000 using funds from his money market deposit account
• Purchased an antique car valued at $18,000 for $15,000 with checking account funds

What is Sid’s net worth after these transactions?

A) $179,000
B) $186,000
C) $173,000
D) $169,000

Answer 107

A) $179,000

The answer is $179,000. Sid’s $24,000 loan for travel increases his liabilities and does not affect his assets. Payment of his student loan will reduce debt by $8,000. However, the use of his money market deposit account to pay off the debt will reduce his assets by $8,000. The net effect of this transaction on his net worth is zero. Purchasing the antique car for $15,000 with funds from his checking account decreases assets by $15,000; however, assets are increased by $18,000 (the value of the car) for a net asset increase of $3,000. Therefore, after the transactions, his net worth decreases to $179,000 ($200,000 – $24,000 + $3,000).

Question 108

Which of these are reasons a client should consider purchasing a home rather than renting one?

I. Mortgage interest is generally income tax deductible
II. Adequate liquid assets are available for a down payment
III. Client plans to live in the home five years or longer

A) I and III
B) I only
C) I, II, and III
D) II and III

Answer 108

C) I, II, and III

The answer is I, II, and III. The deductibility of mortgage interest for clients who itemize deductions is a definite tax advantage in purchasing a home as opposed to renting one. If clients intend to live in their residences for several years (more than five) and have enough money for a down payment (without depleting the emergency fund), they should consider purchasing a home.

Question 109

Which of the following financial statements provides a snapshot of a client’s net worth at any given point in time, usually at the end of a calendar year?

I. Statement of cash flows
II. Statement of financial position
III. Personal tax return
IV. Net worth statement

A) II only
B) II and III
C) I and IV
D) II and IV

Answer 109

D) II and IV

The answer is II and IV. The statement of financial position, also known as a personal balance sheet or net worth statement, provides a snapshot of the client’s net worth (wealth) at any given point in time.

Question 110

Which of the following statements regarding a client’s credit score is CORRECT?

I. Using a high percentage of available credit will positively affect a credit score.
II. Considering a client’s credit history only, the longer the history, the higher credit score.

A) Both I and II
B) I only
C) Neither I nor II
D) II only

Answer 110

D) II only

The answer is II only. When considering a client’s credit history and no other FICO categories, in general, the longer the credit history, the higher the credit score. Using a high percentage of available credit will negatively affect a client’s credit score.

Question 111

The value of a real estate asset for a statement of financial position prepared by a CFP® certificant should be based upon?

A) the basis of the asset, after considering all straight line and accelerated depreciation.
B) the client’s estimate of current value.
C) the value that a well-informed buyer is willing to accept from a well-informed seller and neither is compelled to buy or sell.
D) the asset’s current replacement value.

Answer 111

C) the value that a well-informed buyer is willing to accept from a well-informed seller and neither is compelled to buy or sell.

On a statement of financial position, in the absence of special circumstances, assets are typically valued at fair market value. Fair market value can be defined as what a well informed buyer is willing to accept from a well-informed seller and neither is compelled to buy or sell.

Question 112

What assets should typically NOT be used to establish an emergency fund?

A) U.S. government bonds
B) A money market deposit account
C) Checking accounts
D) Cash in a basement safe

Answer 112

A) U.S. government bonds

The answer is U.S. government bonds. Bonds are not as liquid as other assets and are therefore not typically a good source of emergency funds. Money market deposit accounts are a good source for emergency funds. To the extent that they exceed the regular expenses of the client, checking account balances can be a good source for emergency funds.

Question 113

Which of the following statements regarding a client’s credit score is CORRECT?

I. Too many credit inquiries may lower a credit score, but likely not by much.
II. Opening several new accounts in a short amount of time reflects a good use of credit and therefore can increase a credit score.

A) I only
B) Neither I nor II
C) Both I and II
D) II only

Answer 113

A) I only

The answer is I only. Opening several new accounts over a short period can lower, not increase, a client’s credit score. Too many credit inquiries may lower a client’s credit score but will likely not have a great impact.

Question 114

Which of these is characteristic of the snowball technique of debt reduction?

I. The debt with the lowest balance is eliminated first.
II. Clients are encouraged by paying off the first debt quickly.

A) Both I and II
B) Neither I nor II
C) II only
D) I only

Answer 114

A) Both I and II

The answer is both I and II. The snowball technique of debt reduction involves eliminating the debt with the lowest balance first. Clients are often encouraged by paying off the first debt quickly, which motivates them to continue the process.

Question 115

Joe and Mary believe in stress management. Several times each year, they take a short vacation to relax and recharge as part of their overall approach to maintaining good health. Their regularly planned vacations are an example of what type of expense?

A) Fixed discretionary expense
B) Fixed nondiscretionary expense
C) Variable discretionary expense
D) Variable nondiscretionary expense

Answer 115

C) Variable discretionary expense

The answer is variable discretionary expense. Although Joe and Mary believe the vacations to be important for good health, the vacations are considered a variable discretionary expense.

Question 116

Which of the following statements regarding liabilities on the statement of financial position is CORRECT?

I. They are categorized as fixed or variable.
II. Any outstanding mortgage balance is reported as its original amount.

A) Both I and II
B) Neither I nor II
C) I only
D) II only

Answer 116

B) Neither I nor II

The answer is neither I nor II. Liabilities are categorized as current (short-term) liabilities or long-term on the statement of financial position. The current outstanding mortgage balance as of the date of the statement of financial position, not the original mortgage amount, is reported on this statement.

Question 117

Which of these types of accounts are covered by Federal Deposit Insurance Corporation (FDIC) insurance?

I. Securities
II. Certificates of deposit
III. Money market mutual funds
IV. Money market deposit accounts

A) III and IV
B) I, II, and III
C) II and IV
D) II, III, and IV

Answer 117

C) II and IV

The answer is II and IV. Certificates of deposit are afforded FDIC protection; securities are not. Money market deposit accounts, not money market mutual funds, are covered by FDIC insurance.

Question 118

Which of these statements regarding FICO scores is correct?

A) Length of credit history represents 30% of the credit score.
B) A mix of credit accounts will likely increase a credit score.
C) Payment history accounts for 20% of the credit score.
D) Opening several new accounts in a short time period can increase a credit score.

Answer 118

B) A mix of credit accounts will likely increase a credit score.

It is generally better to have a mix of credit cards, retail accounts, installment loans, and mortgages. Note, however, that too many accounts negatively affect credit scores. Payment history accounts for 35% of the credit score. Opening several new accounts in a short time period will decrease a credit score. Fifteen percent of a credit score is represented by the length of credit history.

Question 119

Allyson would like to pay off her debt, reducing the debt with the highest interest rate first. Compared to the snowball approach of debt reduction, which of the following statements are CORRECT?

I. Compared to the snowball approach, it is relatively more difficult to pay off the first debt with a high balance quickly.
II. This approach increases the total amount of interest paid during the debt reduction process.

A) I only
B) II only
C) Neither I nor II
D) Both I and II

Answer 119

A) I only

The answer is I only. With Allyson’s approach, it often takes longer to pay off the first debt when the highest interest rate has a considerable balance. Less interest paid during the debt reduction process is an advantage of paying off debt in order of interest rate.

Question 120

All of the following items should be included on an individual’s statement of financial position except

A) mortgage balance.
B) mutual fund balance.
C) mortgage payment.
D) fair market value of a home.

Answer 120

C) mortgage payment.

The answer is mortgage payment. The mortgage payment, which is considered a fixed outflow, is included on the statement of cash flows, not the statement of financial position. The mortgage balance should be shown as a liability on the statement of financial position. The fair market value of a home and the balance of a mutual fund should be listed as assets on the statement of financial position.

Question 121

Which of the following actions would most likely decrease an individual’s credit score?

A) Make just the minimum payment on time each month
B) Take advantage of several offers for new credit cards
C) Pay off a balance on a credit card that the individual has had for 10 years
D) Have several different types of credit accounts, such as a car loan, a mortgage, and credit cards

Answer 121

B) Take advantage of several offers for new credit cards

The answer is take advantage of several offers for new credit cards. Taking advantage of several offers for new credit cards would decrease an individual’s credit score.

Question 122

Doug has the following amounts on deposit at the same bank:

Savings account -> Doug -> $200,000
Traditional IRA -> Doug -> $300,000
Certificate of Deposit -> Joint with spouse -> $400,000

How much Federal Deposit Insurance Corporation (FDIC) insurance coverage does Doug have for his accounts at the bank?

A) $900,000
B) $700,000
C) $650,000
D) $450,000

Answer 122

C) $650,000

The answer is $650,000. Each category of ownership (e.g., individual, joint, or retirement account) in the same institution is subject to a separate limit of $250,000. Doug has $200,000 of coverage on his individual savings account, $250,000 of coverage on the traditional IRA, and $200,000 of coverage on the joint account, for a total of $650,000.

Question 123

Alex has a personal emergency requiring him to immediately access $50,000. He expects this need will last for several months. Which of the following assets shown on his statement of financial position is the best choice to pay for his emergency?

A) A money market mutual fund worth $35,000
B) A credit union account totaling $60,000
C) A life insurance cash surrender value in the amount of $55,000
D) Aggressive stocks currently trading at a market value of $65,000

Answer 123

B) A credit union account totaling $60,000

The answer is a credit union account totaling $60,000. Although both the credit union account and the money market mutual fund reflect liquid assets, the best asset to use is the credit union account because it sufficiently covers Alex’s needs.

Question 124

Which of the following items should NOT be included in an individual’s statement of cash flows?

I. Home value
II. Mortgage balance
III. Mortgage payment
IV. Mutual fund balance

A) I and II
B) III only
C) I, II, and IV
D) I and IV

Answer 124

C) I, II, and IV

The answer is I, II, and IV. The mortgage balance should be shown as a liability on the statement of financial position. The value of a home and the balance of a mutual fund should be listed as assets on the statement of financial position. Only the mortgage payment, which is considered a fixed outflow, is included in the statement of cash flows.

Question 125

What is the key to successfully using the snowball technique to eliminate debt?

A) Begin with the debt that has the highest payment
B) Start with the debt that has the highest account balance
C) Developing a plan that the client can commit to executing
D) Begin with the debt that has the highest interest rate

Answer 125

C) Developing a plan that the client can commit to executing

The answer is developing a plan that the client can commit to executing. The key to the effectiveness of using the snowball technique is developing a plan that the client can commit to and execute. The goal is eliminating debt, and the client needs to agree to the process to make that happen. Beginning a debt reduction plan with the debt that has the highest payment is not a typical debt reduction technique.

Question 126

Some rule-of-thumb ratios are helpful in understanding how a client’s debt will be assessed by lenders, which can determine interest rates. Which of these is NOT correct regarding ratio descriptions and the related benchmark?

A) The minimum required payments should be used in the calculation.
B) Monthly housing costs include principal, interest, taxes, fees, and insurance, and should be no more than 28% of the prospective borrower’s net income.
C) Total monthly payment on all debts should be no more than 36% of gross monthly income.
D) Consumer debt is all nonmortgage debt. It should be no more than 20% of monthly net income.

Answer 126

B) Monthly housing costs include principal, interest, taxes, fees, and insurance, and should be no more than 28% of the prospective borrower’s net income.

Monthly housing costs include principal, interest, taxes, fees, and insurance, and should be no more than 36% of the prospective borrower’s net income. Keeping all debt payments under 36% is important in order to qualify for reasonable rates on credit. Helping clients understand what will make future debt more costly can give them motivation to stay within the guidelines. Monthly housing costs should be no more than 28% of the prospective borrower’s gross, not net, income.

Question 127

Which of these statements regarding credit unions are CORRECT?

I. Loans are typically offered at reduced interest rates.
II. Earnings from loan interest and investments are paid to members in the form of shares.
III. Deposits in a credit union are insured up to $100,000 per qualifying account by the National Credit Union Share Insurance Fund (NCUSIF).
IV. Each credit union member may use a vote to elect the board of directors.

A) I and IV
B) I, II, and III
C) II and IV
D) III and IV

Answer 127

A) I and IV

The answer is I and IV. Statement II is not correct because earnings from loan interest and investments are paid to members in the form of dividends, not shares. Statement III is not correct because deposits in a credit union are insured up to $250,000 per qualifying account by the NCUSIF.

Question 128

Which of the following has the least impact on a client’s total FICO score?

A) Length of credit history
B) Amounts owed
C) Payment history
D) Credit mix

Answer 128

D) Credit mix

The answer is credit mix. These categories affect credit scores in the following percentages: credit mix, 10%; length of credit history, 15%; amounts owed, 30%; and payment history, 35%.

Question 129

Which of the following statements regarding the identification of financial strengths and weaknesses is CORRECT?

I. This process is primarily subjective.
II. A planner may rely on financial ratios to assist in making this determination.

A) I only
B) II only
C) Both I and II
D) Neither I nor II

Answer 129

C) Both I and II

The answer is both I and II. During this subjective process, a planner may rely on financial ratios to assist in identifying financial strengths and weaknesses.

Question 130

Brandon and Jessica are in their mid-30s. Both are employed and they have no children. They enjoy international travel and own luxury automobiles. To afford their lifestyle, the couple has accumulated significant debt. In addition to their large car loans, Brandon and Jessica have balances on multiple credit cards and a substantial private loan used to pay for a Mediterranean cruise. Within the next few months, they intend to purchase a home. Both Brandon and Jessica are aware of their need to plan for retirement, but their current debt makes it difficult for them to consistently save money. After meeting with the couple and analyzing their financial statements, you recommend they adopt a savings plan. Assuming they accept your recommendation, which of the following steps would help Brandon and Jessica maximize their savings potential?

I. Begin paying off their debts, giving priority to the debt with the highest interest rate
II. Monitor their spending to ensure they are not using debt to finance a lifestyle they cannot afford

A) Both I and II
B) Neither I nor II
C) I only
D) II only

Answer 130

A) Both I and II

The answer is both I and II. Both of these steps should be implemented as part of the Brandon and Jessica’s savings plan.

Question 131

When preparing a cash flow statement for a client, what is the CORRECT way to indicate the period covered?

A) As of December 31, 20XX
B) For the period January to December 20XX
C) From January 20XX to December 20XX
D) For the period January 1, 20XX to December 31, 20XX

Answer 131

D) For the period January 1, 20XX to December 31, 20XX

The answer is for the period January 1, 20XX to December 31, 20XX. Usually the cash flow statement is prepared for the calendar year period, specifying the dates.

Question 132

Jake and Ashley are working with their financial planner to develop a budget. The financial planner told them to list all their fixed cash outflows and variable cash outflows on a questionnaire. Which of the following would be considered a fixed cash outflow for planning purposes?

A) Food
B) Utilities
C) Mortgage payments
D) Travel and entertainment

Answer 132

C) Mortgage payments

The answer is mortgage payments. Only mortgage payments are considered a fixed cash outflow. Other examples of fixed cash outflows are car payments, insurance premiums, and property taxes.

Question 133

Which of the following statements regarding the identification of financial strengths and weaknesses is CORRECT?

I. This process is primarily objective.
II. A planner may rely on financial ratios to assist in making this determination.

A) I only
B) II only
C) Neither I nor II
D) Both I and II

Answer 133

B) II only

The answer is II only. Although a planner may rely on financial ratios to assist in identifying financial strengths and weaknesses, this analysis is generally subjective.

Question 134

Which of these are tax implications of owning a personal residence?

I. The points paid are tax deductible for the buyer
II. Mortgage interest is generally tax deductible for the buyer
III. Capital gains may be nontaxable within specific limits
IV. Homeowners may depreciate their personal residence

A) I and III
B) II and III
C) I, II, and IV
D) I, II, and III

Answer 134

D) I, II, and III

The answer is I, II, and III. Although I, II, and III are tax implications of home ownership, exceptions and restrictions apply to these benefits. A taxpayer of any age can exclude $250,000 of gain ($500,000 for joint filers) from the sale of a home owned and used by the taxpayer as a principal residence for at least two of the five years immediately preceding the sale. Generally, an individual cannot claim depreciation on a personal residence.

Question 135

It is common practice to refer to the statement of financial position as a ? of the client’s financial circumstances due to the frozen-in-time nature of this statement.

Answer 135

Snapshot.

Question 136

Net worth = ? - ?

Answer 136

Assets - Liabilities

Question 137

Cash and cash equivalents are sometimes listed as invested assets, especially when:

Answer 137

the cash is earning interest.

Question 138

What are two examples of difficult-to-categorize assets?

Answer 138

life insurance & personal residences.

The cash surrender value of life insurance policies creates a problem. Life insurance is a unique asset. It does not fit cleanly into any of the categories. For this reason, some planners and clients put life insurance in its own category. For some clients, whole life insurance is a cash or cash equivalent asset; they want to use it as such. Others, especially those who have a variable life insurance policy, view it as an invested asset.

Question 139

When life insurance needs or estate values are being determined, the cash value of any policy should be ignored, and the ? used instead.

Answer 139

Total death benefit.

Question 140

On the statement of financial position, assets are shown at ?, the price at which a willing and knowledgeable buyer would purchase an asset from a willing and knowledgeable seller.

Answer 140

Fair market value.

Question 141

In the case of assets subject to penalty for early withdrawal, the ? still is presented on the statement of financial position, unaffected by potential penalties.

Answer 141

Fair market value.

Question 142

Benjamin and Abby have a net worth of $100,000 before each of the following transactions:

„ Took out a home equity loan of $12,000 to pay for a trip to Africa
„ Paid off their auto loan of $4,000 using funds from her money market deposit account
„ Purchased a friend’s collection of old travel magazines for $500 with personal savings account funds, though the magazines were of no economic value

What is their net worth after these transactions?

Answer 142

$87,500

The $12,000 home equity loan for travel increases Benjamin and Abby’s liabilities and does not affect their assets. Paying their credit card balance will reduce debt by $4,000. However, using her money market deposit account to pay off the debt will reduce assets by $4,000. The net effect of this transaction on the couple’s net worth is zero. Purchasing their friend’s magazines for $500 with funds from their personal savings account decreases the couple’s assets by $500. Therefore, after the transactions, Benjamin and Abby’s net worth decreases to $87,500 ($100,000 − $12,000 − $500).

Question 143

Note that CFP Board may refer to the statement of financial position as a ?. It is important to know that these are one and the same.

Answer 143

Personal balance sheet.

Question 144

Whereas the statement of financial position indicates what a client owns at a given point in time (a static snapshot), the ? reveals the client’s cash receipts and disbursements over a specific period of time—monthly, quarterly, and often over one year.

Answer 144

Cash flow statement.

Question 145

If funds are withdrawn from savings or if invested assets are liquidated, the planner should list such inflows under a special inflow category of ? to identify clearly the source of the cash.

Answer 145

Savings and investments.

Question 146

It can be helpful to create a ? cash flow statement showing what cash flow will look like after implementing your recommendations.

Answer 146

pro forma.

Question 147

Net income is defined as gross income less ?.

Answer 147

taxes.

Question 148

A generally accepted rule in personal financial planning is that monthly consumer debt payments should not exceed ? of net monthly income.

Answer 148

20%

Question 149

Consumer debt ratio = ? / ?

Answer 149

monthly consumer debt payments / monthly net income.

Question 150

Housing costs include rent or an individual’s monthly mortgage payment (principal and interest payments on the mortgage, property taxes, homeowners insurance premium [PITI]), as well as association fees—should not exceed ? of gross monthly income.

Answer 150

28%

Question 151

The housing cost ratio is also known as what?

Answer 151

The front-end ratio.

Question 152

Housing cost ratio = ? / ?

Answer 152

monthly housing costs / monthly gross income.

Question 153

Be aware that housing costs include items that ARE / ARE NOT debt, such as taxes, insurance, and association fees. However, though they are expenses rather than debt, they are included in this ratio.

Answer 153

ARE NOT.

Question 154

Total debt (recurring debt including monthly housing costs, consumer debt payments, monthly alimony, child support, and maintenance payments)—should not exceed ? of gross monthly income.

Answer 154

36%

Question 155

The total debt ratio is also known as what?

Answer 155

The back-end ratio.

Question 156

In computing the total debt (back-end) ratio, it is important to use the ? payment versus the amount your client may actually be paying.

Answer 156

minimum debt payment.

For example, if your clients are paying $500 to their credit card debt but the minimum payment is $150, then $150 would be used in this ratio. The reason is that even though your clients choose to make a payment greater than the minimum, they would not be required to maintain that payment. For the purposes of this ratio, housing costs include PITI and association fees.

Question 157

Consumer debt ? or less of net monthly income
Housing costs ? or less of gross monthly income
Total debt ? or less of gross monthly income

Answer 157

20%; 28% 36%

Question 158

Unlike the other ratios, which use independent rules of thumb to help estimate a client’s current financial stability, there is no accepted standard for the current ratio. However, a higher current ratio is preferable, and a ratio of greater than ? indicates that the client can pay off existing, short-term liabilities with readily available, liquid assets such as cash.

Answer 158

1.0

Question 159

Current ratio = ? / ?

Answer 159

current assets / current (short-term) liabilities.

Question 160

An individual should have a net-investment-assets-to-net-worth ratio of at least ?, and the percentage should get higher as retirement approaches. Younger individuals will most likely have a ratio of ? or less because they have not had the time to build an investment portfolio.

Answer 160

50%; 20%

Question 161

Net-investment-assets-to-net-worth ratio = ? / ?

Answer 161

net investment assets / net worth

Question 162

Grace, age 30, has an annual gross income of $60,000. Her monthly mortgage payment (PITI) is $1,200 and her monthly consumer debt payments are $800. Grace’s income taxes (federal and state) plus FICA are $1,000 monthly. Her current assets are valued at $200,000, and she has current liabilities of $150,000. Grace has the following assets: a $4,000 savings account and a retirement plan valued at $6,000. She has equity of $10,000 in her home and a net worth of $30,000.

What is her consumer debt ratio?
What is her housing cost ratio?
What is her total debt ratio?
What is her current ratio?
What is her net-investment-assets-to-net-worth ratio?

Answer 162

„ The consumer debt ratio is 20%—this is at the maximum suggested limit of 20%.
Monthly consumer debt payments / monthly net income = $800 / ($60,000 / 12) - $1,000 =
$800 / $4,000 = 0.20 or 20%

„ The housing cost ratio is 24%—this is below the maximum recommended limit of 28%.
Monthly housing costs / monthly gross income = $1,200 / ($60,000 / 12) = $1,200 / $5,000 = 0.24 or 24%

„ The total debt ratio is 40%—this is higher than the upper limit of 36%.
Total monthly debt / monthly gross income = $1,200 + $800 / ($60,000 / 12) = $2,000 / $5,000 = 0.40 or 40%

„ The current ratio is 1.33—this is greater than the minimum recommended limit of 1.
Current assets / current (short-term) liabilities = $200,000 / $150,000 = 1.33

„ The net-investment-assets-to-net-worth ratio is 33.3%—this is adequate, given Grace’s age.
Net investment assets / net worth = $10,000 / $30,000 = 33.3%

Note that the home equity is not included in net investment assets.

Question 163

Many financial planners recommend that clients allocate at least ? of gross income to savings. However, some clients will need to save far in excess of this amount to achieve their set goals. You can determine whether clients have been allocating this amount to savings by reviewing their cash flow statements. Employer contributions to qualified plans count toward this savings ratio, so it is often not as daunting as it seems at first glance.

Answer 163

10%

Question 164

A credit score, often known as a ? score, is determined by an individual’s credit report information.

Answer 164

FICO score (named after Fair Isaac Corporation, the largest and best-known provider of credit scores)

Question 165

? accounts for 35% of the credit score and is most heavily weighted because lenders want to know, first and foremost, whether individuals made payments to past credit accounts on time.

Answer 165

Payment history.

Question 166

? measures how much individuals owe relative to how much credit they have available and accounts for 30% of the credit score.

Answer 166

Amounts owed.

Question 167

? accounts for 15% of the credit score. This takes into consideration how long credit accounts have been established and how recently the individual used certain accounts.

Answer 167

Length of credit history.

Question 168

? accounts for 10% of the credit score and measures how many new accounts the individual owns.

Answer 168

New credit.

Question 169

? accounts for 10% of their credit score. It is generally better to have a mix of these types of credit accounts. Too many accounts can hurt the credit score, but what defines too many varies by individual. It is important to remember that credit cards need to be used responsibly, and closing accounts does not make them go away. The history stays for this part of the credit score.

Answer 169

Credit mix.

Question 170

Generally, the higher the client’s marginal income tax bracket, the greater the advantage of owning a ?

Answer 170

home.

Question 171

In the United States, mortgages made to borrowers with good credit are referred to as ?. Mortgages to borrowers of lower credit quality, or that have a lower-priority claim to the collateral in event of default, are considered ?.

Answer 171

prime loans; subprime loans

Question 172

A key feature of the ? is a very low initial down payment and, sometimes, a lower interest rate because of the federal government’s guarantee of repayment.

Answer 172

FHA mortgage.

Question 173

FHA requirements include mortgage insurance primarily for borrowers making a down payment of less than ?

Answer 173

20%

Question 174

An even more favorable attribute of the ? is that, in certain cases, no initial down payment is required; in other words, the entire purchase price can be borrowed. In addition, no PMI is required, however, there is a funding fee at the start of the loan of 0.5% to 3.6% with most veterans paying 2.3% of the loan amount.

Answer 174

VA mortgage

Question 175

What type of loan is the below blurb referring to?

? are home loans that are not insured or guaranteed by a government agency such as the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), or the U.S. Department of Agriculture (USDA). They are the most common type of mortgage and are typically offered by private lenders like banks, credit unions, or mortgage companies.

Answer 175

Conventional mortgage loans.

Question 176

A client who has a stable cash flow (and anticipates one in the future) and who wants to have a predictable mortgage payment each month should choose a ? mortgage, for which the principal is completely paid off at the end of the term. As the payment term is longer, the 30-year mortgage will have a lower payment. However, a 15-year mortgage usually has the lower interest rate, and much less interest is paid over the life of the loan.

Answer 176

conventional fixed 15 or 30 year mortgage.

Question 177

ARMs can allow for ? to occur. This is the case when the agreed-upon monthly payment is less than the accruing interest charges and unpaid interest is added to the mortgage balance, increasing the debt.

Answer 177

negative amortization.

Question 178

A client who wants lower initial monthly payments and does not anticipate remaining in the home for a long time may want to consider what type of mortgage?

Answer 178

An ARM.

Question 179

With an ? mortgage, the homeowner tries to keep the mortgage payment at a minimum while hoping that the fair market value of the home will increase so that the principal amount will be paid off by the sale proceeds.

Answer 179

Interest-only

Question 180

What type of mortgage may be appropriate for people who anticipate increases in income with some certainty, enabling them to afford a higher payment in the future than they can currently afford?

Answer 180

Graduated payment mortgage.

Question 181

What type of mortgages are available to borrowers who are age 62 or older with a residence that is largely free from indebtedness (with the required percentage owned based on the homeowner’s age)? The homeowner retains title to the home but incurs an increasing amount of debt with each payment from the lender. Once the homeowner no longer occupies the property (e.g., at death or going into a nursing home), the debt must be repaid to the lender, usually by selling the home.

Answer 181

Reverse mortgage.

Question 182

If an older homeowner with a reverse mortgage enters a nursing home, ownership of the residence IS / IS NOT not a barrier to Medicaid eligibility.

Answer 182

is not.

However, once the borrower has been out of the home for 12 months and the home is sold to satisfy the obligation, the remaining cash proceeds are not protected, and this may cause a loss of Medicaid eligibility.

Question 183

Christopher and Erin recently moved to Colorado. Christopher is in the Secret Service and would like to live near the ski slopes until he gets his next work assignment in three years. The couple would like to purchase a home; however, they expect to relocate when Christopher is reassigned. The couple would like to keep their monthly mortgage payments to a minimum.

Given the relatively short time Christopher and Erin plan on staying in their new home and the lower initial interest rate they’re looking for, what would be their best option?

Answer 183

An ARM.

Question 184

A client who secures a ? receives a lump sum in the amount of the loan. With this type of loan, borrowers repay the loan with equal monthly payments over a fixed term.

Answer 184

home equity loan.

Question 185

A ? provides a set amount of credit from which funds may be drawn as needed. Borrowers make payments only on the amount they actually borrow, not the full amount available.

Answer 185

home equity line of credit (HELOC).

Question 186

Which agency charters, supervises, and regulates national banks and federal branches of foreign banks located in the United States?

Answer 186

Office of the Comptroller of the Currency (OCC)

Question 187

Which group makes monetary policy?

Answer 187

Federal Reserve Board.

Question 188

Who insures deposits in U.S. banks and savings and loan associations against bank failures?

Answer 188

Federal Deposit Insurance Corporation (FDIC)

Question 189

The basic FDIC-insured amount of a depositor is ?

Answer 189

$250,000.

Question 190

Savings account -> Joint with sister -> $300,000
Checking account -> Sherri -> $75,000
Money Market Mutual Fund -> Sherri -> $100,000
Traditional IRA -> Sherri -> $250,000*
Certificate of Deposit -> Joint with nephew -> $120,000
Certificate of Deposit -> Sherri -> $200,000

*balance represents cash.

How much cash is currently insured by the FDIC?

Answer 190

The amount currently insured by the FDIC for Sherri is $710,000. The same ownership values total $275,000 ($75,000 checking account + $200,000 solely owned CD); however, the maximum FDIC coverage for assets with the same ownership is $250,000. FDIC insurance covers 50% of the joint savings account ($150,000), 50% of the jointly owned CD ($60,000), and the IRA up to the $250,000 limit. The money market mutual fund is excluded. ($250,000 + $150,000 + $60,000 + $250,000 = $710,000)

Question 191

What is an investment bank?

Answer 191

A financial institution that provides specialized services to corporations, governments, and other entities, primarily focused on helping them raise capital, manage financial risks, and execute complex financial transactions. Unlike commercial banks, which primarily handle deposits, savings, and loans for individuals and businesses, investment banks deal with larger-scale financial activities such as underwriting, mergers and acquisitions (M&A), and trading of securities.

Question 192

What is a mutual fund company?

Answer 192

A financial institution that pools money from multiple investors to create and manage mutual funds. These funds invest in a diversified portfolio of securities, such as stocks, bonds, and other assets, based on specific investment objectives. The mutual fund company is responsible for the administration, management, and distribution of its funds, providing individuals and institutions with an accessible and professionally managed way to invest.

Question 193

The main purpose of a ?, also called a thrift institution, is to accept savings and provide home loans.

Answer 193

savings and loan association (S&L)