Suitability & Investment Risk

Question 1

asset allocation

Answer 1

The process of diversifying a customer’s investments across the three major investment asset classes, which are stocks, bonds, and cash and cash equivalents, in order to reduce overall risk.

Question 2

asset classes

Answer 2

The three major types of investments, which include

1. stocks,
2. bonds, and
3. cash and cash equivalents.

Question 3

currency risk

Answer 3

The risk that an investment denominated in a foreign currency will decline in value as compared to the US dollar due to changes in the exchange rate.

Question 4

current income objective

Answer 4

A customer investment objective that strives to generate cash for the investor with little focus on long-term appreciation. Appropriate investments for this strategy include utility stocks, REITs, preferred stock, and fixed-income securities.

Question 5

customer-specific suitability

Answer 5

Requires that a registered rep has reason to believe that a recommendation is appropriate for a customer based on the customer’s specific investment profile.

Question 6

diversification

Answer 6

A risk management strategy in which an investor mixes a wide variety of investments in different sectors within a portfolio so that the positive performance of some investments will neutralize the negative performance of others. This strategy can help protect against business risk, but not market risk.

Question 7

growth objective

Answer 7

A customer investment objective that seeks capital appreciation for the investor with little focus on earning income. Appropriate investments for this strategy include common stocks and ETFs.

Question 8

know-your-customer (KYC) rules

Answer 8

Require registered reps to gather all the essential information about a customer in order to effectively service the account and make appropriate investment recommendations.

Question 9

liquidity risk

Answer 9

The risk that an investment cannot easily be sold or converted into cash.

Question 10

liquidity objective

Answer 10

A customer investment objective that seeks to maximize the investor’s immediate access to his or her funds. Appropriate investments for this strategy include money market funds and securities.

Question 11

liquidity

Answer 11

The ease with which a security can be bought and sold.

Question 12

portfolio rebalancing

Answer 12

The process of buying and selling the various asset classes, stocks, bonds, and cash and cash equivalents, in order to bring a customer’s overall portfolio into a specified, proportionate mix.

Question 13

political risk

Answer 13

The risk that political unrest or instability can negatively impact the performance of an investment.

Question 14

preservation of capital objective

Answer 14

A customer investment objective that strives for no decline in the value of that customer’s investment. Appropriate investments for this strategy are Treasury securities, money market securities, and bank CDs.

Question 15

quantitative suitability

Answer 15

Requires that a registered rep ensure that the number of trades and the frequency of trading in the customer’s account is appropriate.

Question 16

reasonable-basis suitability

Answer 16

Requires a registered rep to conduct due diligence on a security and conclude that it is appropriate for at least some investors.

Question 17

speculation objective

Answer 17

A customer investment objective that seeks outsized returns in exchange for taking on greater risk. Appropriate investments for this strategy include options, high-yield bonds, penny stocks, and investments in direct participation programs.

Question 18

suitability rule

Answer 18

Requires that recommendations made by registered representatives to customers be appropriate based on the customers’ financial profile and investment objectives.

Question 19

tax-free income objective

Answer 19

A customer investment objective that strives to generate tax-free income for the investor through investments in municipal bonds. This is appropriate for high-net-worth investors who most greatly benefit from tax-free earnings.

Question 20

time of trade disclosures

Answer 20

At or prior to a municipal bond transaction, municipal firms and their registered representatives are required to disclose to customers all material information about the security that is reasonably accessible in the market.

Question 21

total return

Answer 21

A calculation that encompasses all the money gained or lost from an investment. It is calculated as all income derived (including dividends, interest income, and capital gains) divided by the amount invested.

Question 22

What is the FINRA “know your customer” rule?

Answer 22

This rule states that the registered representative and the member firm must use reasonable due dilligence to discover and maintain essential facts about every customer. Name, Social Security Number, Address, and DOB are required. Beyond that, a customer can refuse to provide more information and the firm is under no obligation to try to obtain more.

Question 23

Define:

Suitability Rule

Answer 23

States that the firm or registered representative must have a “reasonable basis” to recommend a strategy or investment.

Question 24

A portfolio manager wishes to construct a portfolio of bonds that will exhibit very little market value sensitivity to changes in interest rates.

Which of the following strategies would be consistent with this desire?

A. The portfolio manager should purchase as many zero coupon bonds as possible.

B. The portfolio manager should purchase bonds with relatively long maturities.

C. The portfolio manager should purchase high coupon bonds with short maturities.

D. The portfolio manager should purchase a wide variety of bonds with exposure to as many maturities as possible. It would also help to obtain a good mix of both high coupon bonds and equal weighting in low and zero coupon bonds.

Answer 24

C

When all other factors are constant, bonds with short maturities and relatively high coupons will be less sensitive to changes in interest rates.

Question 25

An investor has several mortgage-backed securities in their portfolio. If interest rates fall significantly, they would be most concerned with

Answer 25

Prepayment risk

Question 26

James is a low-income investor and is interested in purchasing municipal bonds. His registered representative should tell him

Answer 26

that this is an inapproriate investment as municipal bonds are most suitable for high net worth investors in a high tax bracket.

Question 27

What type of mutual fund is most appropriate for an investor looking to add short-term liquidity to their portfolio?

Answer 27

money market fund

Question 28

Current yield of common stock

Answer 28

Annual dividend/ Stock Price

Question 29

What investor type is best suited for municipal bond funds?

Answer 29

High income investors who will most benefit from the tax-free interest income provided by municipal bonds