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CFP Module 2 study materials
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CFP Module 2 practice questions

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Question 1Financial Planning

A client asks how the financial planning process should begin. Under the standard planning practice model, what is the appropriate first step?

  1. Implementing the recommended product solutions
  2. Collecting the client's financial records and tax returns
  3. Establishing and defining the client-planner relationship Correct answer.
  4. Monitoring the plan against market benchmarks

Explanation

The planning process opens with establishing and defining the client-planner relationship, which sets scope, responsibilities, and compensation before any data gathering begins. Collecting data, analyzing it, recommending, implementing, and monitoring all follow that engagement step.

Question 2Financial Planning

Which characteristic best distinguishes a comprehensive financial plan from a modular, single-issue engagement?

  1. It is limited to investment portfolio construction
  2. It must be completed within a single meeting with the client
  3. It integrates all relevant planning areas into one coordinated set of goals and recommendations Correct answer.
  4. It always requires the purchase of insurance products

Explanation

A comprehensive plan addresses the client's whole financial situation, coordinating areas such as cash flow, risk, investments, tax, retirement, and estate so recommendations do not conflict. Modular planning instead targets one isolated issue.

Question 3Financial Planning

A planner is gathering qualitative data from a new client. Which item is qualitative rather than quantitative?

  1. The client's monthly household expenses
  2. The client's outstanding mortgage balance
  3. The client's annual gross salary
  4. The client's stated tolerance for investment risk Correct answer.

Explanation

Qualitative data capture attitudes, goals, and preferences, such as risk tolerance, that cannot be expressed as a number. Salary, debt balances, and expenses are quantitative figures used in calculations.

Question 4Financial Planning

A client wants to retire in 20 years with a portfolio worth 1,000,000 and expects a 6% annual return compounded annually. Using the future value of a single sum, approximately how much must be invested today?

  1. About 178,000
  2. About 311,800 Correct answer.
  3. About 688,000
  4. About 500,000

Explanation

The present value factor for 6% over 20 years is 1 ÷ 1.06^20, and 1.06^20 equals roughly 3.207, giving a factor near 0.3118. Multiplying 1,000,000 by that factor yields approximately 311,800.

Question 5Financial Planning

A client earns 5% nominal return while inflation runs at 2.5%. What is the approximate real rate of return using the simplified Fisher relationship?

  1. 7.5%
  2. 1.25%
  3. 2.5% Correct answer.
  4. 5.0%

Explanation

The simplified Fisher relationship subtracts inflation from the nominal rate: 5% minus 2.5% equals 2.5%. This approximates the real purchasing-power growth of the portfolio.

Question 6Financial Planning

A client's gross income is 120,000, taxes are 30,000, and debt service consists of a 24,000 annual mortgage payment. What is the housing ratio (front-end ratio)?

  1. 30%
  2. 20% Correct answer.
  3. 25%
  4. 45%

Explanation

The front-end ratio divides annual housing costs by gross income: 24,000 ÷ 120,000 equals 20%. Lenders often look for this figure to fall within a threshold such as 28%.

Question 7Financial Planning

A client has 8,000 of monthly gross income and total monthly debt payments of 2,800, including a 1,400 mortgage payment. Which statement is accurate?

  1. The back-end ratio is 35% and the front-end ratio is 17.5% Correct answer.
  2. Both ratios equal 35%
  3. Both ratios equal 17.5%
  4. The back-end ratio is 17.5% and the front-end ratio is 35%

Explanation

The back-end ratio divides total debt payments by gross income: 2,800 ÷ 8,000 equals 35%. The front-end ratio uses only housing costs: 1,400 ÷ 8,000 equals 17.5%.

Question 8Financial Planning

Which asset would most appropriately fund a client's emergency reserve?

  1. A five-year fixed annuity with surrender charges
  2. A rental property held for appreciation
  3. A single small-cap growth stock
  4. A money market fund holding short-term government securities Correct answer.

Explanation

An emergency reserve must be liquid and stable in value, and a money market fund of short-term government securities meets both needs. Volatile, illiquid, or penalty-laden assets are unsuitable for funds that may be needed immediately.

Question 9Financial Planning

A client's will names a guardian for two minor children but makes no other transfer arrangements. Which planning gap is most significant?

  1. The children will owe no estate tax under any circumstances
  2. The guardian will automatically receive legal title to all assets
  3. The will becomes void once the guardian is appointed
  4. Assets passing through probate may leave the children's inheritance under court-supervised administration Correct answer.

Explanation

Without a trust or other beneficiary arrangement, assets passing to minors through a will typically go through probate and may be administered under court supervision until the children reach majority. A guardian cares for the children but does not automatically receive their inheritance.

Question 10Financial Planning

A client wants to minimize probate and retain control over asset distribution after death. Which arrangement best fits these goals for a brokerage account?

  1. A payable-on-death designation to a charity only
  2. Holding the account in the client's sole name with no beneficiary
  3. Joint tenancy with a business partner
  4. A revocable living trust funded with the account Correct answer.

Explanation

A funded revocable living trust avoids probate for trust assets and lets the grantor set the terms of distribution while retaining control during life. Sole ownership without a beneficiary guarantees probate.

Question 11Financial Planning

A client with a 500,000 term policy dies while the policy is in force. The named primary beneficiary predeceased the insured, and no contingent beneficiary was named. What generally happens to the death benefit?

  1. It is paid to the primary beneficiary's estate automatically
  2. It is paid to the insured's closest friend
  3. It is forfeited to the insurer
  4. It is paid to the insured's estate Correct answer.

Explanation

When no surviving beneficiary is named, the death benefit generally passes to the insured's estate, where it may be subject to probate and creditors. Naming a contingent beneficiary avoids that outcome.

Question 12Financial Planning

Which feature of term life insurance makes it most suitable for covering a temporary need such as a 20-year mortgage?

  1. A guaranteed minimum interest rate credited to the policy
  2. A level death benefit for a specified period at a comparatively low premium Correct answer.
  3. Permanent coverage that never expires
  4. Cash value accumulation that grows tax deferred

Explanation

Term insurance provides pure protection for a defined period, so it matches temporary obligations at the lowest cost per dollar of coverage. Cash value and permanent guarantees describe whole life or universal life.

Question 13Financial Planning

A client has a 200,000 whole life policy with a 60,000 cash value and a 40,000 outstanding policy loan. If the insured dies, what death benefit is generally paid to the beneficiary?

  1. 200,000
  2. 60,000
  3. 160,000 Correct answer.
  4. 140,000

Explanation

The insurer pays the face amount less any outstanding loan balance: 200,000 minus 40,000 equals 160,000. The cash value is not separately paid to the beneficiary on death.

Question 14Financial Planning

A client's health plan has a 2,000 deductible, 20% coinsurance, and a 5,000 out-of-pocket maximum. After the deductible is met, how much does the client owe on a 20,000 covered claim, assuming no prior out-of-pocket spending?

  1. 5,600, but capped at the 5,000 maximum Correct answer.
  2. 2,000
  3. 20,000
  4. 4,000

Explanation

The client first pays the 2,000 deductible, leaving 18,000 of the claim; 20% coinsurance on that amount is 3,600, for a total of 5,600. Because the out-of-pocket maximum is 5,000, the client's liability is capped at 5,000.

Question 15Financial Planning

A client is deciding between contributing to a traditional deductible IRA and a Roth IRA. Which factor most directly favors the Roth option?

  1. The client is currently in a very high marginal tax bracket
  2. The client is over age 73 and subject to required minimum distributions
  3. The client needs a current-year tax deduction
  4. The client expects a higher marginal tax rate in retirement than today Correct answer.

Explanation

Roth contributions are made with after-tax dollars, so the benefit grows when withdrawals occur at a higher tax rate than the rate paid on contributions. Expecting a higher future bracket therefore favors Roth saving.

Question 16Financial Planning

Which statement accurately describes the tax treatment of a qualified Roth IRA distribution?

  1. Qualified withdrawals are subject to a 10% early distribution penalty regardless of age
  2. Qualified withdrawals are taxed as long-term capital gains
  3. Qualified withdrawals are taxed as ordinary income
  4. Qualified withdrawals are excluded from gross income Correct answer.

Explanation

A qualified Roth distribution, made after the five-year period and after age 59½ or another qualifying event, is excluded from gross income. That tax-free treatment is the central advantage of Roth saving.

Question 17Financial Planning

A client in the 24% marginal bracket contributes 6,000 to a traditional deductible IRA. What is the approximate immediate tax savings from the deduction?

  1. 0
  2. 240
  3. 1,440 Correct answer.
  4. 6,000

Explanation

The deduction reduces taxable income by 6,000, and at a 24% marginal rate the tax saved is 6,000 × 0.24, or 1,440. The deferral benefit depends on the client's marginal rate.

Question 18Financial Planning

A client's employer offers a 401(k) with a 50% match on contributions up to 6% of salary. The client earns 80,000 and contributes 3% of salary. What is the employer match?

  1. 1,200 Correct answer.
  2. 600
  3. 2,400
  4. 4,800

Explanation

A 3% contribution equals 2,400, and a 50% match on that amount is 1,200. The client could capture more match by contributing up to 6% of salary.

Question 19Financial Planning

A client nearing retirement holds a large position in a single stock with a low cost basis. Which risk is most concentrated by this holding?

  1. Interest rate risk on short-term Treasuries
  2. Company-specific risk that could impair retirement income Correct answer.
  3. Currency risk from foreign bond exposure
  4. Inflation risk affecting all fixed income

Explanation

A concentrated single-stock position exposes the client to firm-specific risk, which is diversifiable but severe if the company falters near retirement. The other risks relate to asset classes the client may not even hold.

Question 20Financial Planning

An investor's portfolio returned 9% with a standard deviation of 12%, and the risk-free rate is 3%. What is the approximate Sharpe ratio?

  1. 1.33
  2. 0.50 Correct answer.
  3. 0.25
  4. 0.75

Explanation

The Sharpe ratio divides excess return by standard deviation: (9% − 3%) ÷ 12% equals 0.50. It measures return earned per unit of total volatility.

Question 21Financial Planning

A 62-year-old client with a 30-year horizon and stable income needs to allocate a retirement portfolio. Which allocation is most consistent with a growth-oriented objective while retaining some stability?

  1. 50% collectibles and 50% commodities futures
  2. 70% diversified equities and 30% high-quality bonds Correct answer.
  3. 100% in a single sector fund
  4. 10% equities and 90% money market funds

Explanation

A long horizon and stable income support a growth tilt, and a 70/30 mix of diversified equities and high-quality bonds balances growth with volatility control. Extreme concentrations or cash-heavy allocations do not fit the objective.

Question 22Financial Planning

A client is self-employed and wants to maximize tax-deferred retirement savings with a plan allowing large contributions and possible loans. Which plan type is generally most suitable?

  1. A Coverdell education savings account
  2. A health savings account
  3. An individual 401(k) with profit-sharing features Correct answer.
  4. A custodial account under a uniform transfers to minors act

Explanation

A solo or individual 401(k) permits employee deferrals plus employer profit-sharing contributions, allowing high tax-deferred savings for a self-employed owner. The other accounts serve education, custodial, or health purposes.

Question 23Financial Planning

A client wants to transfer wealth to grandchildren while retaining the ability to change beneficiaries. Which vehicle best matches that goal?

  1. A revocable trust with discretionary distribution powers Correct answer.
  2. A charitable remainder unitrust
  3. A direct gift of cash to each grandchild
  4. An irrevocable life insurance trust

Explanation

A revocable trust lets the grantor retain control and change beneficiaries while directing distributions. Irrevocable structures and outright gifts surrender that flexibility.

Question 24Financial Planning

A client has 50,000 of credit card debt at 22% interest and 30,000 in a savings account earning 3%. What is the most financially effective first step?

  1. Invest the savings in a growth mutual fund
  2. Use savings to reduce the high-interest debt while keeping a modest emergency reserve Correct answer.
  3. Consolidate the debt into a longer-term loan at a higher rate
  4. Increase contributions to a low-yield savings account

Explanation

Paying down 22% debt produces a guaranteed 22% return, far exceeding the 3% earned on savings, so applying savings to the debt is the highest-value move. A small reserve should remain to avoid new borrowing.

Question 25Financial Planning

A planner is preparing a client's statement of cash flows. Which item would appear as an outflow in the savings and investment category rather than in living expenses?

  1. The quarterly estimated tax payment
  2. The annual homeowner's insurance premium
  3. A monthly contribution to a 529 education plan Correct answer.
  4. The monthly grocery bill

Explanation

Savings and investment outflows include contributions to accounts such as a 529 plan, which build net worth rather than fund consumption. Groceries, insurance, and taxes are living-expense outflows.

Question 26Financial Planning

A planner is building a client's personal balance sheet. Which item should be classified as a liability rather than as a reduction of an asset's value?

  1. The unrealized loss on a stock held in a taxable brokerage account
  2. The accumulated depreciation on a rental property the client owns
  3. The unpaid principal balance on the client's home mortgage Correct answer.
  4. The annual property tax bill that the client has already paid in full

Explanation

A balance sheet liability is a legally owed obligation to an outside party, so the outstanding mortgage principal belongs in the liability section. Depreciation and unrealized losses are valuation adjustments that reduce reported asset values, and a paid tax bill is no longer owed.

Question 27Financial Planning

A client earns 90,000 annually and saves 9,000 of that amount. The client's employer contributes 4,500 to the retirement plan on the client's behalf. Using the savings ratio that counts employer contributions, what is the client's savings rate?

  1. 15.0% Correct answer.
  2. 20.0%
  3. 10.0%
  4. 5.0%

Explanation

The broad savings ratio adds the client's own savings to employer contributions and divides by gross income: (9,000 + 4,500) / 90,000 = 15%. Counting employer money matters because it is a real addition to the client's retirement resources.

Question 28Financial Planning

A client earns 4,000 of gross monthly income and has take-home pay of 3,100 after taxes and withholdings. Fixed housing costs are 1,300 per month. Which figure represents the client's housing expense ratio as planners conventionally compute it?

  1. 41.9% of take-home pay
  2. 32.5% of take-home pay
  3. 41.9% of gross monthly income
  4. 32.5% of gross monthly income Correct answer.

Explanation

The housing ratio compares monthly housing cost with gross monthly income, so 1,300 / 4,000 = 32.5%. Using gross income keeps the measure comparable to lender underwriting standards such as the 28% front-end guideline.

Question 29Financial Planning

A client's only liquid reserve is 15,000 in a money market fund. Monthly nondiscretionary expenses are 3,000 and monthly debt service is 1,000. How many months of total committed outflows does the reserve cover?

  1. 3.75 months Correct answer.
  2. 5.0 months
  3. 4.0 months
  4. 15.0 months

Explanation

Total committed monthly outflows are 3,000 of living expenses plus 1,000 of debt service, or 4,000. Dividing the 15,000 reserve by 4,000 gives 3.75 months of coverage, which falls short of the three-to-six-month guideline for a client with stable income.

Question 30Financial Planning

A 45-year-old client wants a life insurance contract that provides lifelong coverage, builds a cash value the client can borrow against, and has a premium that stays level. Which policy type meets all three objectives?

  1. Annually renewable term
  2. Whole life Correct answer.
  3. Decreasing term
  4. Return of premium term

Explanation

Whole life is permanent coverage with guaranteed level premiums and a cash value that grows and can be borrowed against. Term products provide coverage for a stated period and generally build no cash value.

Question 31Financial Planning

A client has a 300,000 whole life policy with a 90,000 cash value and a 30,000 policy loan outstanding. The insured dies. Ignoring accumulated interest, what amount is paid to the beneficiary?

  1. 240,000
  2. 300,000
  3. 270,000 Correct answer.
  4. 210,000

Explanation

Insurers deduct any outstanding policy loan from the face amount at death, so the beneficiary receives 300,000 minus 30,000, or 270,000. The cash value is not added to the death benefit for a standard whole life contract.

Question 32Financial Planning

An insured holds a health policy with a 3,000 deductible, 25% coinsurance, and a 6,000 out-of-pocket maximum that includes the deductible. The insured incurs 11,000 of covered expenses in one year. What is the insured's total out-of-pocket cost?

  1. 3,000
  2. 8,000
  3. 6,000 Correct answer.
  4. 5,000

Explanation

After the 3,000 deductible, the remaining 8,000 of covered charges are shared, with the insured paying 25%, or 2,000. That brings the total to 5,000, which is below the 6,000 maximum, so the insured pays 5,000 and the correct response is 5,000.

Question 33Financial Planning

A client is eligible for a Health Savings Account and wants to know how the account differs from a flexible spending arrangement. Which feature is unique to the HSA?

  1. The account is established through an employer's cafeteria plan
  2. Contributions are made with pre-tax salary reductions
  3. Funds can reimburse qualified medical expenses
  4. Unused balances can be carried forward and invested for future use Correct answer.

Explanation

An HSA is individually owned and portable, so unused balances roll over indefinitely and may be invested. A general-purpose FSA is generally use-it-or-lose-it, with only limited carryover or grace-period relief.

Question 34Financial Planning

A client in the 32% marginal bracket is choosing between a traditional deductible IRA and a Roth IRA and expects to be in a lower bracket at retirement. Which consideration most strongly favors the traditional deductible IRA for this client?

  1. The ability to contribute beyond the annual limit because of the deduction
  2. The absence of required minimum distributions during the owner's lifetime
  3. An immediate deduction at the current 32% rate, with withdrawals taxed later at a lower rate Correct answer.
  4. Tax-free qualified withdrawals during retirement

Explanation

A deductible contribution saves tax now at 32%, while distributions are taxed later at the client's lower retirement rate, producing a favorable rate arbitrage. Roth contributions forgo that current deduction in exchange for tax-free qualified withdrawals.

Question 35Financial Planning

A client's employer matches 100% of contributions up to 4% of salary. The client earns 100,000 and contributes 6,000. What is the employer match, and what is the total annual amount added to the account?

  1. 4,000 match; 10,000 total Correct answer.
  2. 6,000 match; 12,000 total
  3. 2,400 match; 8,400 total
  4. 4,000 match; 6,000 total

Explanation

The match applies only to the first 4% of salary, or 4,000, even though the client contributes 6,000. Adding the client's 6,000 contribution to the 4,000 match gives 10,000 of total annual funding.

Question 36Financial Planning

A client's portfolio has an expected return of 11%, a standard deviation of 16%, and a beta of 1.2. The risk-free rate is 3% and the market return is 10%. Using the Sharpe ratio, how does the portfolio compare with the market?

  1. The portfolio's Sharpe ratio of 0.50 exceeds the market's 0.70
  2. The portfolio's Sharpe ratio of 0.67 is below the market's 0.70
  3. The portfolio's Sharpe ratio of 0.50 is below the market's 0.70 Correct answer.
  4. The portfolio's Sharpe ratio of 0.67 exceeds the market's 0.70

Explanation

The Sharpe ratio is excess return divided by standard deviation: (11% - 3%) / 16% = 0.50 for the portfolio and (10% - 3%) / 16% would misstate the market, whose Sharpe is 7% divided by its own standard deviation of 10%, or 0.70. The portfolio therefore delivered less excess return per unit of total risk.

Question 37Financial Planning

A client's portfolio is 80% equities and 20% bonds. The client asks what would happen to expected portfolio volatility if 20% of the equity allocation were shifted into bonds. Which outcome is most consistent with modern portfolio theory?

  1. Expected return falls and expected volatility rises because the portfolio becomes less diversified
  2. Expected return is unchanged and expected volatility falls because bond returns are guaranteed
  3. Expected return rises and expected volatility falls because the bond allocation reduces total risk
  4. Expected return falls and expected volatility falls because bonds are less volatile and imperfectly correlated with equities Correct answer.

Explanation

Reducing equity exposure lowers both expected return and expected volatility, since bonds have lower standalone volatility and their imperfect correlation with stocks dampens portfolio variance. The trade-off is a lower expected return for a smoother path.

Question 38Financial Planning

A client wants to fund a child's education in 12 years and is unwilling to accept principal loss in the final years before enrollment. Which approach best matches that constraint?

  1. Borrowing against the portfolio in year 12 to avoid selling at a loss
  2. Investing entirely in small-cap growth funds to maximize the account balance
  3. Using a glide path that shifts from equities toward short-duration fixed income as enrollment nears Correct answer.
  4. Holding the entire balance in a money market fund for all 12 years

Explanation

A glide path captures equity growth early while reducing exposure to volatile assets as the spending date approaches, which protects the balance when the money is needed. This aligns the portfolio's risk with the shrinking time horizon.

Question 39Financial Planning

A client's estate includes a 500,000 traditional IRA and 500,000 of highly appreciated stock in a taxable account, and the client wants to minimize the income tax burden on heirs. Which statement about the income tax basis of these assets at death is most accurate?

  1. The taxable account receives a step-up in basis, while the traditional IRA remains income in respect of a decedent Correct answer.
  2. The traditional IRA receives a step-up in basis, while the taxable account carries over the decedent's basis
  3. Neither asset receives a basis adjustment because both are includible in the gross estate
  4. Both assets receive a step-up in basis to fair market value at death

Explanation

Assets in a taxable account generally receive a basis step-up at death, but a traditional IRA is income in respect of a decedent and does not; the beneficiary pays ordinary income tax on distributions. This is why leaving the taxable, high-basis assets to heirs and spending the IRA first is often tax-efficient.

Question 40Financial Planning

A client wants to make annual gifts to an adult child while retaining the ability to take the gifted assets back if the client's circumstances change. Which arrangement satisfies that requirement?

  1. A completed gift to an irrevocable trust for the child's benefit
  2. A gift to a revocable living trust that names the child as beneficiary Correct answer.
  3. An outright gift of cash to the child each year
  4. A contribution to a 529 plan with the child as beneficiary

Explanation

A revocable trust lets the grantor retain control and the power to revoke, so the assets can be recovered; the transfer is not a completed gift for gift tax purposes. Outright gifts, irrevocable trusts, and 529 contributions are generally completed transfers that cannot be reversed.

Question 41Investment Planning

An investor holds a 20-year bond with a 6% annual coupon, paid semiannually, and a yield to maturity of 6%. If the yield immediately rises to 7% and the investor sells after receiving the next coupon, which statement best describes the outcome?

  1. The realized return is above 6% because the investor captured a higher reinvestment rate
  2. The realized return is below 6% because price depreciation from the yield rise outweighs the coupon received Correct answer.
  3. The realized return equals 6% because the coupon and yield were matched at purchase
  4. The realized return is unaffected because the bond was held for less than one year

Explanation

When a bond is sold before maturity, a rise in yield produces a capital loss that is not offset by the single coupon received, so the holding-period return falls below the original yield to maturity. The 6% figure is only the promised yield if the bond is held to maturity with coupons reinvested at that rate.

Question 42Investment Planning

A portfolio has an expected return of 11%, a standard deviation of 16%, and a beta of 1.2. The risk-free rate is 3%. What is the Sharpe ratio?

  1. 0.69
  2. 0.50 Correct answer.
  3. 0.67
  4. 0.08

Explanation

The Sharpe ratio divides excess return over the risk-free rate by total standard deviation: (11% − 3%) ÷ 16% = 0.50. Total volatility, not beta, is the correct denominator for this measure.

Question 43Investment Planning

Which measure of portfolio performance divides the risk premium by beta rather than by total standard deviation?

  1. Sharpe ratio
  2. Information ratio
  3. M-squared measure
  4. Treynor ratio Correct answer.

Explanation

The Treynor ratio uses systematic risk (beta) in the denominator, making it appropriate for well-diversified portfolios where unsystematic risk has been eliminated. The Sharpe ratio instead uses total standard deviation.

Question 44Investment Planning

A client's portfolio returned 14% with a beta of 1.1. The market returned 12% and the risk-free rate is 4%. Using the Treynor ratio, how does the portfolio compare with the market?

  1. Portfolio and market Treynor ratios are equal at 8.0%
  2. Portfolio Treynor of 9.1% is below market Treynor of 12.0%
  3. Portfolio Treynor of 9.1% exceeds market Treynor of 8.0% Correct answer.
  4. Portfolio Treynor of 12.7% exceeds market Treynor of 8.0%

Explanation

The portfolio's Treynor ratio is (14% − 4%) ÷ 1.1 = 9.1%, while the market's is (12% − 4%) ÷ 1.0 = 8.0%. The portfolio earned more excess return per unit of systematic risk than the market.

Question 45Investment Planning

An investor buys 200 shares at $40 and sells them at $47 after receiving $1.20 per share in dividends. What is the total holding-period return?

  1. 19.0%
  2. 20.5% Correct answer.
  3. 2.5%
  4. 17.5%

Explanation

Total return includes both price appreciation and income: ($47 − $40 + $1.20) ÷ $40 = $8.20 ÷ $40 = 20.5%. Omitting the dividend understates the return.

Question 46Investment Planning

A stock just paid a dividend of $2.00. Dividends are expected to grow at 5% indefinitely, and the required return is 11%. Using the constant-growth model, what is the intrinsic value?

  1. $33.33
  2. $18.18
  3. $40.00
  4. $35.00 Correct answer.

Explanation

The constant-growth model uses next year's dividend: D1 = $2.00 × 1.05 = $2.10, and value = $2.10 ÷ (0.11 − 0.05) = $35.00. Using the current dividend instead of D1 is a common error.

Question 47Investment Planning

A firm's earnings and dividends are expected to decline by 2% per year indefinitely. The dividend just paid was $3.00 and the required return is 9%. What is the estimated value under the constant-growth model?

  1. $42.86
  2. $33.00
  3. The model cannot be applied to a negative growth rate
  4. $26.73 Correct answer.

Explanation

The model accommodates negative growth: D1 = $3.00 × 0.98 = $2.94, and value = $2.94 ÷ (0.09 + 0.02) = $26.73. The denominator becomes the required return minus negative growth, or plus 2%.

Question 48Investment Planning

Which statement about the price-earnings ratio is most accurate for valuation purposes?

  1. A trailing P/E uses next year's forecast earnings
  2. The P/E ratio is unaffected by the firm's capital structure
  3. A higher P/E always indicates that a stock is overvalued
  4. A higher P/E may reflect expected earnings growth rather than overvaluation Correct answer.

Explanation

The P/E ratio embeds growth expectations, so a high multiple can be justified by superior expected earnings growth. Comparing P/E ratios without adjusting for growth and risk can mislead.

Question 49Investment Planning

A bond has a Macaulay duration of 7.5 years and a yield to maturity of 6%. Using the modified duration approach, what is the approximate percentage price change for a 50 basis point increase in yield?

  1. −3.75%
  2. −3.54% Correct answer.
  3. −0.75%
  4. +3.54%

Explanation

Modified duration equals 7.5 ÷ 1.06 = 7.075, and the price change is approximately −7.075 × 0.005 = −3.54%. Macaulay duration must first be adjusted by the yield factor.

Question 50Investment Planning

Which bond characteristic is associated with greater interest rate risk?

  1. Shorter maturity and higher coupon rate
  2. Longer maturity and lower coupon rate Correct answer.
  3. Longer maturity and higher coupon rate
  4. Shorter maturity and lower coupon rate

Explanation

Duration, the measure of interest rate sensitivity, rises with longer maturity and falls with larger coupon payments. A long-maturity, low-coupon bond therefore has the greatest price sensitivity to yield changes.