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AAMS practice questions

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Question 1Financial Planning Process and Client Relationship Management

Which activity marks the first step of the financial planning process?

  1. Establishing the client-planner relationship and scope Correct answer.
  2. Comparing portfolio performance with a benchmark index
  3. Recommending an asset allocation based on risk tolerance
  4. Gathering the client's tax returns and brokerage statements

Explanation

The planning process opens with defining the engagement: who is responsible for what, how the planner is compensated, and what services will be delivered. Data gathering, analysis, and recommendations all depend on a clearly understood scope established up front.

Question 2Financial Planning Process and Client Relationship Management

What is the primary purpose of a written investment policy statement?

  1. To record objectives and constraints that guide decisions Correct answer.
  2. To satisfy the SEC custody rule for advisory clients and their accounts
  3. To eliminate the need for periodic portfolio reviews and client meetings
  4. To guarantee a minimum annual return for the client

Explanation

An investment policy statement sets out the client's return objective, risk tolerance, time horizon, liquidity needs, tax situation, and any unique constraints. It serves as the governing document that keeps both planner and client disciplined when markets move.

Question 3Financial Planning Process and Client Relationship Management

Before recommending an investment, what must a representative gather from a retail client?

  1. The client's finances, objectives, risk tolerance, and horizon Correct answer.
  2. Only the client's stated target return and current account holdings
  3. Only the client's net worth and annual income
  4. The client's employer, job title, and length of service

Explanation

Know-your-client obligations require a reasonable understanding of the customer's financial situation, investment experience, objectives, time horizon, and risk tolerance. A recommendation is only suitable if it fits that full profile, not a single data point.

Question 4Financial Planning Process and Client Relationship Management

A 28-year-old client is investing for retirement at age 65. Her time horizon is best described as:

  1. Indeterminate, because retirement age may change
  2. Long term, generally more than ten years Correct answer.
  3. Intermediate, generally three to ten years
  4. Short term, generally under three years

Explanation

Time horizons are commonly grouped into short term (under roughly three years), intermediate (roughly three to ten years), and long term (more than ten years). A 37-year gap to retirement places this client firmly in the long-term category.

Question 5Financial Planning Process and Client Relationship Management

Risk tolerance is best described as:

  1. The largest loss the client's finances could absorb without derailing the plan
  2. The volatility of the client's current portfolio
  3. The return the client must earn to reach the stated goal
  4. The client's willingness to accept uncertainty for higher potential returns Correct answer.

Explanation

Risk tolerance is an attitudinal measure: how much uncertainty and interim volatility the client is psychologically willing to accept. It differs from risk capacity, which is the financial ability to absorb loss, and from the required return dictated by the goals.

Question 6Financial Planning Process and Client Relationship Management

Why should an advisor keep a written record of each client meeting?

  1. To record what was discussed and agreed, aiding continuity Correct answer.
  2. To satisfy the client's own reporting duty to federal regulators
  3. To avoid the need for a written engagement letter and reduce paperwork
  4. To justify an increase in the advisory fee

Explanation

Contemporaneous notes create an accurate history of what was recommended, what the client accepted or declined, and what changed. This supports service continuity across the team and provides evidence of a reasonable process if the advice is later questioned.

Question 7Financial Planning Process and Client Relationship Management

A reserve of three to six months of living expenses held in a money market fund is best classified as:

  1. A tax-deferral goal
  2. A short-term liquidity goal Correct answer.
  3. A speculative growth goal
  4. A retirement income goal

Explanation

Emergency reserves exist to meet unexpected cash needs, so principal stability and immediate access take priority over return. That makes them a short-term liquidity objective funded with low-volatility, readily accessible vehicles.

Question 8Financial Planning Process and Client Relationship Management

Which step of the financial planning process follows implementation of the recommendations?

  1. Developing the recommendations and presenting them
  2. Monitoring the plan and updating it as needed Correct answer.
  3. Analyzing the client's current financial position
  4. Defining the scope of the engagement

Explanation

Once recommendations are implemented, the planner monitors performance, tracks progress toward goals, and revisits the plan as circumstances or assumptions change. Monitoring closes the loop and feeds back into the earlier steps.

Question 9Financial Planning Process and Client Relationship Management

Which of the following is qualitative rather than quantitative client information?

  1. The balance on the client's mortgage
  2. The client's annual gross salary
  3. The client's personal attitude toward risk Correct answer.
  4. The value of the client's 401(k) account and other retirement savings

Explanation

Quantitative data are numeric facts such as income, account balances, and liabilities. Qualitative data are non-numeric attributes such as attitudes, values, health, family circumstances, and preferences that shape how a recommendation will be received.

Question 10Financial Planning Process and Client Relationship Management

A client refuses to sell a stock that has fallen sharply, insisting it will return to the price he originally paid. This behavior best illustrates:

  1. Regret aversion over past losses
  2. Mental accounting of separate money buckets
  3. Anchoring to the original purchase price Correct answer.
  4. Hindsight bias about past market calls

Explanation

Anchoring occurs when a person fixes on an initial reference value, such as a purchase price, and treats it as the true worth despite new information. The client is judging the position against his cost basis rather than against its current fundamentals.

Question 11Financial Planning Process and Client Relationship Management

A client keeps $30,000 in a low-yield savings account earmarked 'for college' while carrying a high-interest credit card balance, saying the college money cannot be touched. This behavior best illustrates:

  1. Confirmation of existing beliefs
  2. Overconfidence in one's own judgment
  3. Mental accounting of separate buckets Correct answer.
  4. Framing of the same choice in different ways

Explanation

Mental accounting means treating money differently depending on which mental category it belongs to, even though dollars are fungible. Here the college label prevents the client from using the cash to retire expensive debt, which is economically irrational.

Question 12Financial Planning Process and Client Relationship Management

An advisor is paid a commission if a client purchases a particular annuity. The most appropriate first step in managing this conflict is to:

  1. Disclose the conflict in writing and document the basis for the recommendation Correct answer.
  2. Refuse to make any commission-based recommendation to any client
  3. Ask the client to sign a waiver releasing the advisor from liability for the choice
  4. Recommend the annuity only if it is the lowest-cost product on the market

Explanation

Compensation that varies by product creates a conflict of interest that must be identified, disclosed, and mitigated through a documented, client-focused rationale. Written disclosure plus a recorded basis for the recommendation shows the advice rests on the client's needs rather than the payout.

Question 13Financial Planning Process and Client Relationship Management

Which item belongs in an engagement letter?

  1. A complete copy of the client's medical history
  2. A guarantee of investment performance
  3. The scope of services, fees, and each party's duties Correct answer.
  4. A list of the advisor's own personal holdings and outside activities

Explanation

The engagement letter defines the relationship: services to be provided, the fee arrangement, the responsibilities of the advisor and the client, the term, and how the relationship may be terminated. It is the reference point for later disputes about what was promised.

Question 14Financial Planning Process and Client Relationship Management

Which statement is the best-written financial goal?

  1. Make better investment choices and avoid losses in down markets
  2. Save as much money as possible this year from salary and bonuses
  3. Accumulate $1,000,000 by age 62 to support $60,000 of annual retirement income Correct answer.
  4. Retire comfortably at a reasonable age with enough income to maintain the current lifestyle

Explanation

A well-stated goal is specific, measurable, and tied to a date and a dollar amount so progress can be tracked. This statement gives a target capital sum, a deadline, and the income it is meant to produce.

Question 15Financial Planning Process and Client Relationship Management

A client's goals require more capital than she is projected to have. The advisor's most appropriate first response is to:

  1. Recommend a leveraged portfolio to close the projected shortfall
  2. Help the client rank goals and quantify the trade-offs Correct answer.
  3. Raise the assumed investment return until the plan balances
  4. Remove the least important goal without telling the client

Explanation

When resources cannot fund every objective, the client must decide which goals matter most and what each choice costs in forgone alternatives. The advisor's job is to frame those trade-offs transparently rather than to resolve them unilaterally.

Question 16Financial Planning Process and Client Relationship Management

Which behavior best demonstrates active listening during a client discovery meeting?

  1. Explaining the recommendation while the client takes notes
  2. Recording the conversation without informing the client
  3. Handing the client a standardized data questionnaire to complete
  4. Restating the client's concerns and asking follow-up questions Correct answer.

Explanation

Active listening involves reflecting back what was heard and probing for clarification so the client feels understood and the advisor captures accurate information. It is a two-way process rather than a data-collection or presentation exercise.

Question 17Financial Planning Process and Client Relationship Management

In a tiered service model, clients are segmented primarily by:

  1. The alphabetical order of client surnames
  2. The advisor's personal liking of each client
  3. The number of meetings the client requested last year
  4. The relationship's value and the client's complexity Correct answer.

Explanation

Service tiers are built on the economic value of the relationship, typically assets or revenue, combined with the complexity of the client's needs. That combination determines how much planning depth and contact frequency the relationship can support.

Question 18Financial Planning Process and Client Relationship Management

Which of the following is a capital market assumption typically documented in a financial plan?

  1. The client's projected credit score next year
  2. The expected long-run inflation rate and asset class returns Correct answer.
  3. The client's exact salary in each future year
  4. The number of beneficiaries the client will eventually name and their ages

Explanation

Capital market assumptions are the planner's forward-looking estimates of inflation and returns for each asset class. They drive the projections and should be disclosed so the client understands the basis for the plan and can revisit it if conditions change.

Question 19Financial Planning Process and Client Relationship Management

Which event most clearly calls for a full review of the client's risk profile and investment policy statement?

  1. A change in the advisor's firm marketing materials
  2. A rise in the broad stock market index
  3. The death of the client's spouse Correct answer.
  4. A shift in the client's interest toward a different industry sector

Explanation

A change in marital status alters income, expenses, tax filing, estate documents, and often the ability to bear risk, so the entire profile should be revisited. Life events of this magnitude trigger a formal update rather than routine monitoring.

Question 20Financial Planning Process and Client Relationship Management

When an advisor decides to end a client relationship, the best practice is to:

  1. Delete the client's files to protect confidentiality
  2. Notify the client in writing, transfer open items, and document the reason Correct answer.
  3. Liquidate the client's accounts immediately without any advance notice to the client
  4. Stop returning the client's telephone calls and emails

Explanation

Termination should be orderly and documented: written notice, a clear effective date, arrangements for open positions or pending work, and a record of why the relationship ended. Abrupt action can harm the client and expose the advisor to claims.

Question 21Financial Planning Process and Client Relationship Management

A client says she is comfortable with sharp market swings, but she is two years from retirement, has no pension, and her savings will fund nearly all of her spending. Her situation is best described as:

  1. High risk tolerance and high risk capacity
  2. High risk tolerance, limited risk capacity Correct answer.
  3. Low risk tolerance and low risk capacity
  4. High risk capacity but a low tolerance for risk

Explanation

Risk tolerance is the client's willingness to bear volatility, while risk capacity is her financial ability to absorb loss without impairing goals. Here willingness is high but the short horizon and dependence on savings leave little ability to recover from a drawdown, and the more binding constraint governs the allocation.

Question 22Financial Planning Process and Client Relationship Management

An advisor recommends a mutual fund share class that pays the firm a larger 12b-1 fee than an otherwise identical lower-cost class the client also qualifies for. Under Regulation Best Interest, this recommendation:

  1. Raises a conflict that must be mitigated and disclosed Correct answer.
  2. Is acceptable if the added fee is disclosed orally at the meeting
  3. Is prohibited in every circumstance, regardless of the size of the cost difference
  4. Is acceptable because share classes are standardized regulated products

Explanation

Regulation Best Interest requires the recommendation to be in the retail customer's best interest and obliges firms to identify, disclose, and mitigate or eliminate conflicts. Selecting a costlier share class that pays the firm more is a classic conflict that must be justified by factors other than compensation.

Question 23Financial Planning Process and Client Relationship Management

Prospect theory describes investor decision making as:

  1. Judging outcomes against a reference point and weighting losses more heavily Correct answer.
  2. Uniformly avoiding all forms of risk regardless of the return offered
  3. Driven mainly by the tax consequences of each trade
  4. Always rational and fully consistent with expected utility maximization theory

Explanation

Prospect theory holds that people evaluate outcomes relative to a reference point such as a purchase price or prior wealth level, and that losses loom larger than comparable gains. This loss aversion helps explain reluctance to realize losses and the appeal of certain income guarantees.

Question 24Financial Planning Process and Client Relationship Management

An elderly client begins making large, uncharacteristic gifts and seems confused about her account balances. The advisor's most appropriate action is to:

  1. Execute the requests promptly and say nothing to avoid embarrassing the client
  2. Freeze all of the client's accounts permanently without informing anyone
  3. Follow the firm's escalation policy and contact the trusted contact person Correct answer.
  4. Report the client to the SEC in every such case without exception

Explanation

Signs of diminished capacity or possible exploitation call for the firm's documented escalation procedures, which typically include supervisory review and outreach to a trusted contact person or other designated party. This protects the client while preserving the relationship and the record.

Question 25Financial Planning Process and Client Relationship Management

An advisor believes a client's investment policy statement, which permits a 60/40 allocation, is too conservative for the client's long horizon. The advisor should:

  1. Resign from the relationship rather than follow a policy he disagrees with
  2. Implement a more aggressive allocation and inform the client afterward
  3. Follow the policy as written and formally propose an update to the client Correct answer.
  4. Wait for the client to raise the subject at the next annual review meeting

Explanation

The policy statement is the client's governing document, so the advisor must manage assets within its terms until the client approves a change. The appropriate path is to recommend the revision with supporting analysis and document the client's decision.

Question 26Investment Vehicles and Asset Classes

In a corporate bankruptcy liquidation, which of the following security holders is paid last?

  1. Holders of subordinated debentures
  2. Holders of common stock Correct answer.
  3. Holders of secured corporate bonds
  4. Holders of preferred stock

Explanation

The liquidation priority runs from secured creditors to senior unsecured creditors, then subordinated debt, then preferred shareholders, and finally common shareholders. Common stockholders hold a residual claim, receiving only what remains after every higher-priority claim is satisfied, which is why they bear the greatest risk of loss.

Question 27Investment Vehicles and Asset Classes

Which of the following is a money market instrument?

  1. A 10-year municipal revenue bond
  2. A 26-week Treasury bill Correct answer.
  3. A large-cap equity index mutual fund
  4. A 20-year Treasury bond

Explanation

Money market instruments have original maturities of one year or less, and a 26-week Treasury bill matures in roughly six months. Long-dated bonds and equity funds are capital market investments whose prices are driven by long-term growth and rate expectations.

Question 28Investment Vehicles and Asset Classes

A mutual fund reports total assets of $520 million and total liabilities of $20 million, with 25 million shares outstanding. What is the fund's net asset value per share?

  1. $20.80
  2. $20.00 Correct answer.
  3. $21.60
  4. $19.20

Explanation

Net asset value per share equals total assets minus total liabilities, divided by shares outstanding: ($520 million − $20 million) ÷ 25 million = $20.00. Liabilities must be subtracted because shareholders own only the net assets of the fund.

Question 29Investment Vehicles and Asset Classes

Which statement describes how an exchange-traded fund differs from a traditional open-end mutual fund?

  1. Shares trade on an exchange intraday at market-determined prices. Correct answer.
  2. Holdings are disclosed to the public only once every five years.
  3. Shares are bought and sold only at the end-of-day net asset value.
  4. Shares may not be sold short or purchased on margin.

Explanation

ETF shares are listed on an exchange and trade throughout the day at prices set by supply and demand, while open-end mutual fund shares are purchased and redeemed at the next computed NAV. ETFs also publish their portfolio holdings daily and can be sold short or bought on margin.

Question 30Investment Vehicles and Asset Classes

A key feature of preferred stock relative to common stock is that preferred shareholders:

  1. are guaranteed a dividend that cannot be suspended
  2. have voting rights that exceed those of common shareholders
  3. share in residual earnings growth without limit
  4. receive a stated dividend paid ahead of common dividends Correct answer.

Explanation

Preferred stock carries a stated dividend rate that has priority over common dividends, which the board may cut or omit. Preferred dividends are not guaranteed, are often cumulative, and preferred shares usually carry limited or conditional voting rights.

Question 31Investment Vehicles and Asset Classes

Treasury bills are sold:

  1. at a premium to face value
  2. at a discount to face value Correct answer.
  3. with a variable coupon reset weekly
  4. at par with semiannual interest payments

Explanation

Treasury bills are short-term discount instruments: the investor buys below face value and receives par at maturity, with the difference serving as the return. No coupon is paid during the life of the bill.

Question 32Investment Vehicles and Asset Classes

An American Depositary Receipt (ADR) represents:

  1. a currency hedge contract traded on a U.S. futures exchange
  2. a direct ownership stake in a U.S. Treasury security held in trust
  3. a foreign company's shares held by a U.S. depositary bank Correct answer.
  4. a bond issued by a foreign government and sold to U.S. investors

Explanation

An ADR is a negotiable certificate issued by a U.S. depositary bank that represents shares of a foreign company held in custody abroad. The ADR trades in U.S. markets and is priced in dollars, giving domestic investors foreign equity exposure without trading on an overseas exchange.

Question 33Investment Vehicles and Asset Classes

To qualify as a real estate investment trust (REIT) under U.S. tax rules, a company must:

  1. limit its shareholder base to fewer than 100 investors
  2. invest at least 90% of its assets in U.S. Treasuries
  3. reinvest all of its earnings in new construction
  4. distribute at least 90% of taxable income Correct answer.

Explanation

A REIT must distribute at least 90% of its taxable income to shareholders, which explains the high dividend yields typical of the sector. It must also satisfy asset and income tests tied to real estate and have at least 100 shareholders.

Question 34Investment Vehicles and Asset Classes

A $1,000 par convertible bond may be converted into 25 shares of common stock. If the stock is trading at $36 per share, what is the bond's conversion value?

  1. $720
  2. $1,000
  3. $900 Correct answer.
  4. $1,250

Explanation

Conversion value equals the number of shares received multiplied by the current stock price: 25 × $36 = $900. If the bond trades above that figure, the excess reflects the value of the remaining coupon stream and any conversion premium.

Question 35Investment Vehicles and Asset Classes

The primary risk that Treasury Inflation-Protected Securities (TIPS) are designed to address is:

  1. Credit risk
  2. Currency risk
  3. Inflation risk Correct answer.
  4. Liquidity risk

Explanation

TIPS principal is adjusted for changes in the consumer price index, and interest is paid on the adjusted principal, so the investor is compensated as the price level rises. Credit risk is minimal because the securities are direct Treasury obligations, and they are dollar-denominated.

Question 36Investment Vehicles and Asset Classes

A municipal revenue bond is backed by:

  1. a guarantee from the U.S. Treasury
  2. the full faith and credit of the issuing municipality
  3. revenues from a specific project or enterprise Correct answer.
  4. the taxing power of the state government

Explanation

Revenue bonds are payable solely from the revenues of the financed project, such as a toll road or water utility, and carry no claim on the issuer's taxing power. General obligation bonds, by contrast, pledge the full faith, credit, and taxing authority of the issuer.

Question 37Investment Vehicles and Asset Classes

Which statement about zero-coupon bonds is accurate?

  1. They carry no interest rate risk because no coupons are paid.
  2. They are exempt from federal income tax.
  3. They accrete in value and the accretion is taxed annually. Correct answer.
  4. They pay semiannual coupons and are typically issued at par.

Explanation

Zero-coupon bonds are issued at a deep discount and accrete toward par, paying no cash interest along the way. In taxable accounts the annual accretion is treated as original issue discount and taxed as interest even though the investor receives nothing. With no interim cash flow, their duration equals their maturity, so interest rate risk is high.

Question 38Investment Vehicles and Asset Classes

A closed-end fund differs from an open-end fund in that closed-end fund shares:

  1. never charge management fees
  2. are redeemed by the fund each business day at net asset value
  3. cannot be purchased by individual investors
  4. trade on an exchange at prices that can differ from NAV Correct answer.

Explanation

A closed-end fund raises a fixed amount of capital in an initial offering, after which its shares trade on an exchange and can sell at a premium or discount to net asset value. Open-end funds continuously issue and redeem shares at NAV.

Question 39Investment Vehicles and Asset Classes

Hedge funds are typically offered:

  1. only to government pension plans
  2. to retail investors through an SEC-registered prospectus
  3. through private placements to accredited investors Correct answer.
  4. with daily redemption at net asset value

Explanation

Hedge funds are private pools sold through private placements, generally limited to accredited investors or qualified purchasers and often organized under Section 3(c)(1) or 3(c)(7). They avoid public prospectus registration and commonly impose lock-up periods.

Question 40Investment Vehicles and Asset Classes

An investor who purchases a put option on a stock:

  1. faces unlimited loss if the stock price rises
  2. may sell the stock at the strike price before expiration Correct answer.
  3. is obligated to sell the stock at the strike price if assigned
  4. profits most if the stock price rises sharply

Explanation

A put buyer holds the right, but not the obligation, to sell the underlying at the strike price before expiration, and the position gains value as the stock falls. The maximum loss is limited to the premium paid.

Question 41Investment Vehicles and Asset Classes

In a futures account, daily mark-to-market gains and losses are settled through:

  1. the margin account, marked to market daily Correct answer.
  2. the exchange clearing fund, which absorbs all losses
  3. dividend payments made by the underlying asset
  4. a single settlement payment at contract expiration

Explanation

Futures positions are marked to market at the close of each trading day, with gains credited and losses debited to the margin account. A drop below the maintenance margin level triggers a call for additional funds.

Question 42Investment Vehicles and Asset Classes

A master limited partnership (MLP) typically:

  1. pays corporate-level income tax before distributing to unit holders
  2. passes income through to unit holders on a Schedule K-1 Correct answer.
  3. must distribute all earnings as fully taxable dividends
  4. may only be owned by institutional investors

Explanation

An MLP is a publicly traded limited partnership whose income and deductions flow through to unit holders, who report them on Schedule K-1, avoiding entity-level tax. Units are exchange-listed and widely held by individual investors.

Question 43Investment Vehicles and Asset Classes

A unit investment trust (UIT):

  1. must invest only in money market instruments
  2. is actively managed by a portfolio manager who trades frequently
  3. has no stated termination date
  4. holds a fixed, unmanaged portfolio with a set termination date Correct answer.

Explanation

A UIT holds a portfolio selected at inception, is not actively managed, and terminates on a specified date when proceeds are distributed to unit holders. Holdings change only through limited substitution provisions.

Question 44Investment Vehicles and Asset Classes

During the accumulation phase of a variable annuity, contract values are invested:

  1. in U.S. Treasury securities held in trust
  2. only in money market instruments
  3. in the insurer's general account at a fixed guaranteed rate
  4. in separate-account subaccounts chosen by the contract owner Correct answer.

Explanation

Variable annuity premiums are allocated among subaccounts inside the insurer's separate account, and the contract owner selects the subaccounts, so contract value fluctuates with the underlying investments. The insurer's general account is used for fixed annuities.

Question 45Investment Vehicles and Asset Classes

Private equity and venture capital investments are characterized by:

  1. low minimum investment requirements
  2. guaranteed returns backed by collateral
  3. daily NAV pricing and same-day redemption
  4. illiquidity and long lock-up periods Correct answer.

Explanation

Private equity and venture capital funds lock up investor capital for years, draw capital as needed, and return proceeds only when portfolio companies are sold or taken public. They generally require large minimum investments and are offered to accredited or qualified investors.

Question 46Investment Vehicles and Asset Classes

A bond portfolio has an effective duration of 6.5. If interest rates fall by 50 basis points, the portfolio's price is expected to:

  1. decrease by about 0.65%
  2. increase by about 3.25% Correct answer.
  3. decrease by about 3.25%
  4. increase by about 0.33%

Explanation

The approximate price change equals duration multiplied by the change in yield: 6.5 × 0.50% = 3.25%. Because yields fell, the price rises by roughly that percentage, with convexity making the actual gain slightly larger for a decline of this size.

Question 47Investment Vehicles and Asset Classes

A long-only commodity fund that gains exposure by holding futures contracts will most likely experience a negative roll yield when the futures curve is:

  1. in contango Correct answer.
  2. flat
  3. in backwardation
  4. inverted

Explanation

In contango the futures price exceeds the spot price, so as the near contract approaches expiration the fund rolls into a more expensive deferred contract and loses value, producing negative roll yield. Backwardation produces the opposite effect and generates positive roll yield.

Question 48Investment Vehicles and Asset Classes

In a collateralized debt obligation (CDO), which tranche absorbs the first credit losses on the underlying portfolio?

  1. The unrated equity tranche Correct answer.
  2. The AAA-rated tranche
  3. The senior tranche
  4. The mezzanine tranche

Explanation

Losses in a CDO are allocated from the bottom up: the unrated equity tranche takes the first credit losses, followed by mezzanine tranches and finally the senior tranches. Equity holders accept that first-loss exposure in exchange for the highest expected return.

Question 49Investment Vehicles and Asset Classes

An investor in the 32% federal income tax bracket is considering a municipal bond yielding 3.6%. What is the taxable-equivalent yield?

  1. 2.45%
  2. 4.75%
  3. 5.29% Correct answer.
  4. 11.25%

Explanation

Taxable-equivalent yield equals the tax-exempt yield divided by one minus the marginal tax rate: 3.6% ÷ (1 − 0.32) = 5.29%. A taxable bond would need to yield more than that figure to produce a higher after-tax return.

Question 50Investment Vehicles and Asset Classes

Compared with an otherwise identical option-free bond, a bond with a put provision will most likely offer:

  1. a higher yield, because puts increase default risk
  2. a lower yield, since the put favors the holder Correct answer.
  3. a higher yield, because the put benefits the issuer
  4. the same yield, because the put is priced at zero

Explanation

A put provision lets the bondholder sell the bond back to the issuer at a set price, protecting the holder if rates rise. Because that right has value to the investor, the issuer can pay a lower yield than on an otherwise identical bond without the feature.