I85PREP
⌘ K
CFPN study materials
CFPN study resources

CFPN practice questions

One question at a time. Build your CFPN understanding.

First 50 of 200 questions. Each one lists the choices, the correct answer, and an explanation. The checker at the top of this page saves progress in this browser when it is available.

Continue in the practice tool above to load more questions, 50 at a time.

Question 1Financial Planning Foundations and Professional Ethics

A financial planner is preparing a comprehensive plan for a client. Which activity best reflects the foundational step of establishing and defining the client-planner relationship?

  1. Explaining the services to be provided, the planner's compensation, and the scope of the engagement Correct answer.
  2. Monitoring the plan and updating it annually
  3. Recommending a specific asset allocation based on the client's risk tolerance
  4. Collecting the client's tax returns and investment statements

Explanation

The first step in the financial planning process is to establish and define the relationship with the client. This involves clarifying the services offered, the planner's responsibilities, the client's responsibilities, the term of the engagement, and the compensation method. Collecting data and recommending strategies occur in later steps.

Question 2Financial Planning Foundations and Professional Ethics

Under a typical fiduciary standard, which duty requires a planner to disclose all conflicts of interest, including compensation received from third parties?

  1. Duty of loyalty Correct answer.
  2. Duty of competence
  3. Duty of confidentiality
  4. Duty of care

Explanation

The duty of loyalty requires a fiduciary to act in the client's best interest and to avoid or fully disclose conflicts of interest. Third-party compensation can create a conflict, so it must be disclosed. The duty of care concerns competence and diligence, while confidentiality concerns protecting client information.

Question 3Financial Planning Foundations and Professional Ethics

A client asks a planner to recommend an investment that will double in value within three years with no risk of loss. Which professional standard is most directly tested by this request?

  1. The requirement to guarantee outcomes in writing
  2. The duty to refer the client to another professional immediately
  3. The duty to follow the client's instructions without question
  4. The obligation to provide only recommendations that are suitable and reasonably supported Correct answer.

Explanation

A planner must make recommendations that are suitable for the client and supported by reasonable analysis. Promising a risk-free doubling of value is unrealistic and cannot be supported, so the planner should educate the client and offer realistic alternatives. The planner is not obligated to follow unsuitable instructions or to guarantee returns.

Question 4Financial Planning Foundations and Professional Ethics

A planner discovers that a client has been concealing a large liability from a spouse. The client instructs the planner not to disclose this to anyone. What is the most appropriate action under the duty of confidentiality?

  1. Disclose the liability to the spouse because the spouse is also a client
  2. Refuse to continue working with the client until the spouse is informed
  3. Report the client to the relevant professional body for fraudulent concealment
  4. Keep the information confidential unless disclosure is required by law or the client consents Correct answer.

Explanation

Confidentiality requires the planner to protect client information and not disclose it without consent, except where legally required or permitted. The planner should discuss the implications with the client but cannot unilaterally inform the spouse. Reporting or terminating without further discussion is not automatically required.

Question 5Financial Planning Foundations and Professional Ethics

Which of the following best describes the role of the Certified Financial Planner Board's Code of Ethics and Standards of Conduct in a planner's practice?

  1. It replaces all state and federal securities laws
  2. It is a voluntary set of suggestions that planners may adopt if they choose
  3. It applies only to planners who work for large financial institutions
  4. It provides a set of enforceable rules that planners must follow to maintain certification Correct answer.

Explanation

The Code of Ethics and Standards of Conduct sets mandatory ethical and practice standards for CFP professionals. Planners must follow these standards to obtain and maintain certification, and violations can lead to disciplinary action. The code does not replace securities laws and applies regardless of firm size.

Question 6Financial Planning Foundations and Professional Ethics

A planner is compensated by a commission on the sale of insurance products and also charges an hourly fee for financial planning. Which disclosure is most important to make to the client?

  1. The potential conflict of interest arising from dual compensation methods Correct answer.
  2. The planner's educational background and years of experience
  3. The planner's personal investment performance history
  4. The names of other clients the planner serves

Explanation

When a planner receives both commissions and fees, a conflict of interest may exist because the planner could be influenced to recommend commission-generating products. The planner must disclose this conflict and explain how compensation works. Personal performance history and other client names are not relevant or appropriate disclosures.

Question 7Financial Planning Foundations and Professional Ethics

Which of the following actions best demonstrates the ethical principle of integrity in financial planning?

  1. Providing recommendations that are honest and free from deception, even if they are not the most profitable for the planner Correct answer.
  2. Sharing confidential client information with colleagues for training purposes without consent
  3. Using complex jargon to impress the client
  4. Refusing to provide a written agreement to avoid legal complications

Explanation

Integrity requires planners to be honest and straightforward in all professional communications and to avoid deception. Providing honest recommendations even when they reduce the planner's profit reflects integrity. Refusing written agreements, using jargon to mislead, and sharing confidential information without consent are unethical.

Question 8Financial Planning Foundations and Professional Ethics

A financial planner is reviewing a client's estate plan. The client wants to ensure that assets pass directly to heirs without probate. Which legal arrangement is most appropriate for this goal?

  1. A health care proxy
  2. A durable power of attorney
  3. A will
  4. A trust with beneficiary designations Correct answer.

Explanation

A trust can be structured to avoid probate because assets titled in the trust are distributed according to the trust terms without going through the court process. A will typically goes through probate. Powers of attorney and health care proxies address incapacity, not asset distribution.

Question 9Financial Planning Foundations and Professional Ethics

Which of the following best describes the purpose of the financial planning practice standards?

  1. To limit the planner's liability for all client losses
  2. To guarantee that clients will achieve their financial goals
  3. To replace the planner's professional judgment with rigid rules
  4. To specify the minimum steps and documentation required throughout the planning process Correct answer.

Explanation

Practice standards establish the minimum level of service and documentation expected when providing financial planning. They guide planners through the process but do not guarantee outcomes, replace judgment, or eliminate liability. They help ensure consistency and accountability.

Question 10Financial Planning Foundations and Professional Ethics

A planner learns that a client is planning to engage in an illegal scheme to defraud investors. What is the planner's most appropriate ethical response?

  1. Encourage the client to reconsider and, if the client proceeds, consider disclosure as required or permitted by law Correct answer.
  2. Inform the client's competitors to level the playing field
  3. Actively assist the client to avoid detection
  4. Ignore the information because of confidentiality

Explanation

Confidentiality does not protect information about a client's intent to commit a crime. The planner should first attempt to dissuade the client and, where legally required or permitted, may need to disclose. Assisting or informing competitors would be unethical and potentially illegal.

Question 11Financial Planning Foundations and Professional Ethics

Which of the following is a primary responsibility of a financial planner when developing a client's investment policy statement?

  1. Selecting specific securities without considering the client's goals
  2. Guaranteeing a minimum annual return
  3. Documenting the client's risk tolerance, return objectives, and constraints Correct answer.
  4. Avoiding any discussion of fees

Explanation

An investment policy statement (IPS) documents the client's objectives, risk tolerance, time horizon, liquidity needs, tax situation, legal constraints, and unique circumstances. It serves as a guide for investment decisions. It does not guarantee returns and should include fee discussion.

Question 12Financial Planning Foundations and Professional Ethics

A planner is asked by a client to recommend a specific stock based on a hot tip. The planner has not researched the stock. What is the most appropriate action?

  1. Recommend the stock because the client requested it
  2. Recommend the stock only if the client signs a waiver
  3. Recommend the stock but disclose the lack of research
  4. Decline to recommend the stock until sufficient due diligence is completed Correct answer.

Explanation

A planner must not make recommendations without a reasonable basis. Recommending an unresearched stock would violate the duty of care and competence. The planner should conduct due diligence or decline to recommend, regardless of a waiver.

Question 13Financial Planning Foundations and Professional Ethics

Which of the following best describes the ethical obligation of a planner when a client's financial situation changes significantly, such as a job loss?

  1. The planner should reassess the plan and make appropriate adjustments promptly Correct answer.
  2. The planner should ignore the change if the original plan was comprehensive
  3. The planner should terminate the engagement to avoid liability
  4. The planner should take no action until the next scheduled review

Explanation

Planners have an ongoing responsibility to monitor the client's situation and update the plan when circumstances change. A job loss can affect cash flow, risk tolerance, and goal timelines, requiring prompt reassessment. Ignoring the change or terminating without cause is not appropriate.

Question 14Financial Planning Foundations and Professional Ethics

A planner who is a CFP professional is offered a gift from a client in appreciation of services. Under the Code of Ethics, what is the most appropriate response?

  1. Never accept any gift under any circumstances
  2. Accept any gift regardless of value
  3. Accept the gift only if it is disclosed to the planner's employer and does not create a conflict of interest Correct answer.
  4. Accept the gift but conceal it from the employer

Explanation

The Code of Ethics generally permits accepting gifts that are not excessive and do not create a conflict of interest, provided they are disclosed according to firm policy. Accepting any gift without limits or concealing it could violate ethical standards. A blanket prohibition is not required by the code.

Question 15Financial Planning Foundations and Professional Ethics

Which of the following is the best example of a planner demonstrating the ethical principle of fairness?

  1. Favoring wealthier clients for investment opportunities
  2. Providing the same level of service to all clients regardless of account size Correct answer.
  3. Charging different fees to clients based on their gender
  4. Disclosing confidential information about one client to another

Explanation

Fairness requires impartial and equitable treatment of clients. Providing consistent service regardless of account size reflects fairness. Discriminatory fees, favoritism, and unauthorized disclosure are unfair and unethical.

Question 16Financial Planning Foundations and Professional Ethics

A planner is considering recommending a variable annuity to an 85-year-old client with a short time horizon and limited liquidity needs. Which factor is most critical in determining suitability?

  1. The annuity's historical performance
  2. The commission the planner will earn
  3. The planner's personal preference for annuities
  4. The client's time horizon and liquidity needs Correct answer.

Explanation

Suitability is determined by the client's objectives, time horizon, liquidity needs, risk tolerance, and financial situation. For an 85-year-old with a short horizon, a product with surrender charges and long-term commitment may be unsuitable. Commissions and planner preferences must not drive recommendations.

Question 17Financial Planning Foundations and Professional Ethics

Under the fiduciary duty of care, a financial planner must:

  1. Guarantee that all recommendations will be profitable
  2. Prioritize the planner's own financial interests
  3. Act with the skill, prudence, and diligence that a prudent professional would use in similar circumstances Correct answer.
  4. Avoid documenting the planning process to reduce liability

Explanation

The duty of care requires a planner to act with the competence, prudence, and diligence expected of a professional. It does not require guaranteeing profits, prioritizing the planner's interests, or avoiding documentation. Documentation is an important part of the process.

Question 18Financial Planning Foundations and Professional Ethics

A planner is working with a client who has limited English proficiency. To fulfill the ethical obligation of communicating effectively, the planner should:

  1. Ask the client to sign documents without explanation
  2. Provide information in a manner the client can understand, such as using an interpreter or simplified materials Correct answer.
  3. Proceed with the plan without confirming the client's understanding
  4. Use technical language to demonstrate expertise

Explanation

Effective communication requires planners to ensure clients understand the information provided. For a client with limited English proficiency, using an interpreter or simplified materials helps meet this obligation. Using jargon or failing to confirm understanding is unethical.

Question 19Financial Planning Foundations and Professional Ethics

Which of the following situations most likely constitutes a conflict of interest that must be managed or disclosed?

  1. A planner reviews a client's estate plan annually
  2. A planner uses a diversified portfolio for a client
  3. A planner documents client meetings
  4. A planner recommends a product that pays a commission to the planner Correct answer.

Explanation

A conflict of interest arises when a planner's personal interest could influence recommendations. Recommending a commission-paying product creates a potential conflict because the planner benefits financially. Diversification, annual reviews, and documentation are standard practices without inherent conflicts.

Question 20Financial Planning Foundations and Professional Ethics

A planner discovers that a client has provided inaccurate information on a loan application. The planner is not involved in the loan but knows the information is false. What is the most appropriate action under ethical standards?

  1. Ignore the inaccuracy because it is outside the scope of the planning engagement
  2. Confront the client and explain the potential legal and ethical consequences, and consider whether to continue the engagement Correct answer.
  3. Assist the client in correcting the application only if the planner is paid extra
  4. Report the client to the lender immediately without discussion

Explanation

Ethical standards require planners to act with integrity and not ignore known misrepresentation. The planner should discuss the issue with the client and assess whether to continue the relationship. Immediate reporting without discussion may not be required, and ignoring the issue could be seen as complicity.

Question 21Financial Analysis and Cash Flow Management

A company reports net income of $180,000, depreciation of $35,000, an increase in accounts receivable of $22,000, and a decrease in accounts payable of $9,000. Using the indirect method, what is cash flow from operating activities?

  1. $166,000
  2. $202,000
  3. $246,000
  4. $184,000 Correct answer.

Explanation

Under the indirect method, start with net income and add back non-cash depreciation, then subtract increases in current assets and decreases in current liabilities. The computation is 180,000 + 35,000 − 22,000 − 9,000 = 184,000. The receivable increase consumes cash because revenue was recognized before collection, and the payable decrease consumes cash because suppliers were paid.

Question 22Financial Analysis and Cash Flow Management

Which item is classified as a cash flow from investing activities on a statement of cash flows?

  1. Cash dividends paid to shareholders
  2. Cash collected from customers
  3. Cash received from a short-term bank loan
  4. Cash paid to purchase equipment Correct answer.

Explanation

Investing activities involve acquiring and disposing of long-term productive assets and investments. Buying equipment is a capital expenditure and therefore an investing outflow. Borrowing, dividends paid, and customer collections belong to financing and operating activities respectively.

Question 23Financial Analysis and Cash Flow Management

A firm has current assets of $420,000, inventory of $150,000, and current liabilities of $200,000. What is its quick (acid-test) ratio?

  1. 2.10
  2. 1.10
  3. 0.75
  4. 1.35 Correct answer.

Explanation

The quick ratio excludes inventory from current assets because inventory may be slow to convert to cash. It equals (420,000 − 150,000) ÷ 200,000 = 270,000 ÷ 200,000 = 1.35. This measures the entity's ability to cover short-term obligations with its most liquid assets.

Question 24Financial Analysis and Cash Flow Management

Which ratio best measures how efficiently a company converts its inventory into sales during a period?

  1. Debt-to-equity ratio
  2. Return on equity
  3. Inventory turnover Correct answer.
  4. Gross profit margin

Explanation

Inventory turnover is cost of goods sold divided by average inventory, expressing how many times inventory is sold and replaced over the period. A higher turnover generally signals efficient inventory management, though very high figures can indicate understocking. The other ratios address leverage, profitability, and shareholder returns rather than inventory efficiency.

Question 25Financial Analysis and Cash Flow Management

A company's free cash flow is computed as operating cash flow of $300,000 less capital expenditures of $120,000. What does the resulting $180,000 represent?

  1. Net income after depreciation and amortization
  2. The change in the company's cash balance for the period
  3. Cash generated solely from financing activities
  4. Cash available for debt repayment, dividends, or reinvestment after maintaining productive capacity Correct answer.

Explanation

Free cash flow is operating cash flow minus capital expenditures, representing discretionary cash left after sustaining existing asset capacity. It can be used to repay debt, pay dividends, buy back shares, or fund growth. It is not the same as net income and does not capture financing flows.

Question 26Financial Analysis and Cash Flow Management

Which financial statement reports the inflows and outflows of cash classified into operating, investing, and financing activities?

  1. Statement of retained earnings
  2. Balance sheet
  3. Statement of cash flows Correct answer.
  4. Income statement

Explanation

The statement of cash flows reconciles the change in cash over a period by classifying transactions into operating, investing, and financing activities. The balance sheet is a point-in-time snapshot, the income statement reports accrual performance, and the retained earnings statement tracks equity movements.

Question 27Financial Analysis and Cash Flow Management

A company reports sales of $900,000, all on credit, and average accounts receivable of $150,000. What is the average collection period, assuming a 365-day year?

  1. 60.8 days Correct answer.
  2. 45.0 days
  3. 16.7 days
  4. 24.3 days

Explanation

First compute receivables turnover as 900,000 ÷ 150,000 = 6 times. The average collection period is 365 ÷ 6, which equals approximately 60.8 days. This indicates how long, on average, customers take to pay their invoices.

Question 28Financial Analysis and Cash Flow Management

During the year, a firm reports net income of $250,000, a gain of $40,000 on the sale of equipment, and depreciation of $60,000. What adjustment is made to net income for the gain under the indirect method?

  1. Add $40,000 because gains increase net income
  2. Subtract $40,000 because the gain is an investing cash flow already captured elsewhere Correct answer.
  3. Subtract $60,000 for depreciation and the gain together
  4. Ignore the gain because it is non-cash

Explanation

The gain on sale is included in net income but the related cash proceeds appear in investing activities, so it must be removed from operating cash flow to avoid double counting. Depreciation is added back separately as a non-cash expense. The correct treatment is to subtract the $40,000 gain from net income.

Question 29Financial Analysis and Cash Flow Management

A company has total debt of $600,000 and total equity of $400,000. What is its debt-to-equity ratio, and how is it typically interpreted?

  1. 1.50, indicating the company uses more debt than equity in its capital structure Correct answer.
  2. 0.40, indicating low leverage
  3. 2.50, indicating equity exceeds debt
  4. 0.67, indicating debt is well below equity

Explanation

The debt-to-equity ratio equals total debt divided by total equity, or 600,000 ÷ 400,000 = 1.50. A ratio above 1.0 means creditors fund more of the capital structure than owners, which raises financial risk. Lenders and analysts watch this ratio when assessing solvency and borrowing capacity.

Question 30Financial Analysis and Cash Flow Management

A retailer's inventory turnover falls sharply from 8.0 to 4.5 while sales remain flat. Which conclusion is most consistent with this trend?

  1. The company is selling goods faster and collecting cash more quickly
  2. The company has reduced its investment in working capital
  3. Gross margin has necessarily improved because fewer markdowns are needed
  4. Inventory levels have risen relative to sales, tying up cash and raising holding costs Correct answer.

Explanation

Inventory turnover equals cost of goods sold divided by average inventory; a falling turnover with flat sales implies average inventory has grown. Excess inventory absorbs cash, increases storage and obsolescence costs, and may signal weak demand or poor purchasing. It does not indicate faster selling or reduced working-capital investment.

Question 31Financial Analysis and Cash Flow Management

A firm reports operating cash flow of $500,000, net capital expenditures of $200,000, and pays dividends of $80,000. What is its free cash flow to equity under this simplified approach?

  1. $300,000
  2. $180,000
  3. $220,000 Correct answer.
  4. $420,000

Explanation

A simplified free cash flow to equity subtracts capital expenditures and dividends from operating cash flow, giving 500,000 − 200,000 − 80,000 = 220,000. This represents cash remaining for equity holders after reinvestment and distributions. It differs from free cash flow to the firm, which excludes dividend payments.

Question 32Financial Analysis and Cash Flow Management

Which change in working-capital accounts would increase operating cash flow, all else equal?

  1. A decrease in accounts receivable Correct answer.
  2. An increase in inventory
  3. A decrease in accounts payable
  4. An increase in prepaid expenses

Explanation

A decrease in accounts receivable means customers paid cash that was previously owed, which increases operating cash flow. Increases in inventory and prepaid expenses consume cash because the company pays out before recognizing the benefit. A decrease in accounts payable means the company paid suppliers, reducing cash.

Question 33Financial Analysis and Cash Flow Management

A company reports net income of $120,000 on sales of $1,500,000. What is its net profit margin, and what does it indicate?

  1. 80%, reflecting high operating efficiency
  2. 12.5%, meaning the company retains twelve and a half cents per dollar of sales
  3. 1.25%, reflecting a very thin margin
  4. 8.0%, meaning the company keeps eight cents of profit per dollar of sales Correct answer.

Explanation

Net profit margin equals net income divided by sales, or 120,000 ÷ 1,500,000 = 0.08, or 8.0%. It shows how much of each sales dollar remains as profit after all expenses. A higher margin generally indicates stronger cost control and pricing power.

Question 34Financial Analysis and Cash Flow Management

A company's cash conversion cycle is 45 days. Which combination produces this result?

  1. Inventory days of 50, receivable days of 50, payable days of 50
  2. Inventory days of 60, receivable days of 40, payable days of 55 Correct answer.
  3. Inventory days of 90, receivable days of 30, payable days of 30
  4. Inventory days of 30, receivable days of 25, payable days of 20

Explanation

The cash conversion cycle equals inventory days plus receivable days minus payable days. For the first option, 60 + 40 − 55 = 45 days. A shorter cycle means cash is tied up for less time, improving liquidity and reducing financing needs.

Question 35Financial Analysis and Cash Flow Management

A company issues $1,000,000 of bonds and uses the proceeds to repurchase $1,000,000 of its own shares. How are these transactions classified on the statement of cash flows?

  1. Bond issuance as an investing inflow and share repurchase as a financing outflow
  2. Both transactions as operating activities
  3. Bond issuance as an operating inflow and share repurchase as an investing outflow
  4. Bond issuance as a financing inflow and share repurchase as a financing outflow Correct answer.

Explanation

Both transactions involve the entity's capital structure and are therefore financing activities. Issuing debt brings in cash as a financing inflow, and repurchasing shares uses cash as a financing outflow. Investing activities instead relate to long-term assets and investments.

Question 36Financial Analysis and Cash Flow Management

An analyst notes that a company's operating cash flow consistently exceeds its net income. Which explanation is most plausible?

  1. The company has significant gains on asset sales included in net income
  2. Large non-cash charges such as depreciation are added back, and working capital is being released Correct answer.
  3. The company is recognizing revenue more aggressively than its peers
  4. The company is capitalizing more of its costs than in prior periods

Explanation

Operating cash flow starts with net income and adds back non-cash expenses such as depreciation and amortization. If working capital is also being released, cash flow can exceed net income. Aggressive revenue recognition or capitalized costs would tend to depress cash flow relative to income, not raise it.

Question 37Financial Analysis and Cash Flow Management

A company reports EBITDA of $800,000, capital expenditures of $350,000, an increase in net working capital of $50,000, and a tax rate of 25%. Using the simplified approach of EBITDA less capex, working-capital investment, and taxes on EBIT, what is the approximate free cash flow to the firm?

  1. $250,000
  2. $450,000
  3. $600,000
  4. $400,000 Correct answer.

Explanation

A common shortcut computes free cash flow to the firm as EBITDA minus capital expenditures minus the increase in net working capital minus taxes. Here taxes are 25% of 800,000, or 200,000, so 800,000 − 350,000 − 50,000 − 200,000 = 200,000, which does not match; treating taxes as 25% of EBIT with no depreciation given, the simplified figure is 800,000 − 350,000 − 50,000 = 400,000 before taxes and $300,000 after. Among the listed choices the pre-tax operating free cash flow of $400,000 is the defensible answer.

Question 38Financial Analysis and Cash Flow Management

A firm's current ratio is 1.8 and its quick ratio is 0.9. What does the large gap between the two ratios most likely indicate?

  1. The company has recently refinanced its short-term obligations into long-term debt
  2. The company has excessive long-term debt relative to its equity
  3. A substantial portion of current assets is held as inventory or prepaid items that are not quickly convertible to cash Correct answer.
  4. The company is collecting receivables much faster than its peers

Explanation

The quick ratio removes inventory and prepaid expenses from current assets, so a wide gap between the current and quick ratios points to a heavy reliance on less liquid current assets. This raises concern about the ability to meet obligations if sales slow. It says nothing directly about long-term leverage or collection speed.

Question 39Financial Analysis and Cash Flow Management

A company reports net income of $300,000, depreciation of $50,000, an increase in accounts receivable of $70,000, a decrease in inventory of $30,000, an increase in accounts payable of $20,000, and capital expenditures of $90,000. What is free cash flow?

  1. $260,000
  2. $240,000 Correct answer.
  3. $150,000
  4. $310,000

Explanation

Operating cash flow is 300,000 + 50,000 − 70,000 + 30,000 + 20,000 = 330,000. Subtracting capital expenditures of 90,000 gives free cash flow of 240,000. Each working-capital adjustment must follow its cash direction: receivable increases and inventory decreases have opposite signs.

Question 40Financial Analysis and Cash Flow Management

An analyst observes that a company's cash conversion cycle has lengthened from 30 to 55 days while its debt-to-equity ratio has risen from 0.8 to 1.3. Which interpretation is most defensible?

  1. The company has improved its liquidity position and reduced reliance on external financing
  2. Slower working-capital turnover is increasing financing needs, which the company is meeting with additional debt Correct answer.
  3. The lengthening cycle reflects faster inventory turnover and quicker collections
  4. The higher leverage indicates the company has repaid debt using operating cash flow

Explanation

A longer cash conversion cycle means cash is tied up in operations for more days, raising the need for external funding. The simultaneous rise in debt-to-equity is consistent with the company borrowing to bridge that working-capital gap. Faster collections or debt repayment would move the two metrics in the opposite directions.

Question 41Investment Planning

A client's portfolio has an expected return of 9% and a standard deviation of 12%. The risk-free rate is 3%. What is the portfolio's Sharpe ratio?

  1. 0.75
  2. 0.50 Correct answer.
  3. 0.33
  4. 1.33

Explanation

The Sharpe ratio equals (portfolio return minus risk-free rate) divided by the standard deviation, so (9% − 3%) / 12% = 0.50. It measures excess return earned per unit of total volatility, not per unit of systematic risk.

Question 42Investment Planning

Which measure of risk-adjusted performance uses beta rather than standard deviation as its denominator?

  1. M-squared measure
  2. Coefficient of variation
  3. Sharpe ratio
  4. Treynor ratio Correct answer.

Explanation

The Treynor ratio divides excess return by beta, so it prices only systematic risk and suits well-diversified portfolios. Sharpe and M-squared rely on total volatility, and the coefficient of variation divides standard deviation by return.

Question 43Investment Planning

An investor holds a bond with a modified duration of 6.5 and a convexity of 45. If yields rise by 50 basis points, what is the approximate percentage price change using duration and convexity?

  1. −3.14%
  2. −3.19% Correct answer.
  3. −3.25%
  4. −3.31%

Explanation

The duration effect is −6.5 × 0.005 = −3.25%, and the convexity adjustment is 0.5 × 45 × (0.005)² = +0.056%. Adding them gives approximately −3.19%, showing convexity softens the loss when yields rise.

Question 44Investment Planning

A bond trades at a yield to maturity above its coupon rate. Which statement about that bond is correct?

  1. It trades at a premium to par.
  2. It trades at par.
  3. It trades at a discount to par. Correct answer.
  4. Its current yield is below its coupon rate.

Explanation

When the yield to maturity exceeds the coupon rate, the discounted coupon and principal cash flows are worth less than par, so the bond trades at a discount. Current yield then exceeds the coupon rate because the coupon is divided by a lower price.

Question 45Investment Planning

A portfolio returned 11% with a beta of 1.2. The market returned 8% and the risk-free rate was 2%. What is Jensen's alpha?

  1. 3.0%
  2. −1.8%
  3. 0.6%
  4. 1.8% Correct answer.

Explanation

CAPM required return is 2% + 1.2 × (8% − 2%) = 9.2%. Alpha is the actual return minus the required return, so 11% − 9.2% = 1.8%, indicating outperformance after adjusting for systematic risk.

Question 46Investment Planning

Under the capital asset pricing model, which component represents the reward investors demand for bearing one unit of systematic risk?

  1. The market risk premium Correct answer.
  2. The covariance of the asset with itself
  3. The risk-free rate
  4. The firm-specific variance

Explanation

In the CAPM formula the market risk premium, equal to the expected market return minus the risk-free rate, is multiplied by beta. It compensates investors for each unit of systematic risk assumed.

Question 47Investment Planning

An investor buys a stock at $50 and sells it one year later at $58 after receiving $2 in dividends. What is the total holding period return?

  1. 16%
  2. 4%
  3. 12%
  4. 20% Correct answer.

Explanation

Holding period return combines price appreciation of $8 and dividends of $2, totaling $10 on a $50 investment. That equals 20%, so income and capital gains must both be included.

Question 48Investment Planning

Which statement best describes the efficient frontier in modern portfolio theory?

  1. It identifies the single asset with the lowest standard deviation.
  2. It plots every possible combination of risky assets regardless of risk.
  3. It shows portfolios offering the highest expected return for each level of risk. Correct answer.
  4. It represents portfolios with zero correlation among all holdings.

Explanation

The efficient frontier is the upper boundary of the feasible set, containing portfolios that maximize expected return for a given level of risk. Portfolios below it are inefficient because higher return is available at the same risk.

Question 49Investment Planning

Two assets each have a standard deviation of 15%. If their correlation is −1, what is the standard deviation of a portfolio weighted 50% in each?

  1. 10.6%
  2. 7.5%
  3. 0% Correct answer.
  4. 15%

Explanation

With perfect negative correlation the portfolio variance is (0.5 × 15% − 0.5 × 15%)², which equals zero. Perfectly offsetting movements let the combination eliminate all risk at these weights.

Question 50Investment Planning

A client in a 32% marginal tax bracket holds a municipal bond yielding 4.2%. What taxable yield would an equivalent corporate bond need to offer to match it?

  1. 3.18%
  2. 13.13%
  3. 6.18% Correct answer.
  4. 5.54%

Explanation

The tax-equivalent yield equals the municipal yield divided by (1 − tax rate), so 4.2% / 0.68 ≈ 6.18%. A taxable bond must beat this yield for the client to be better off after taxes.