I85PREP
⌘ K
AFP study materials
AFP study resources

AFP practice questions

One question at a time. Build your AFP 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

A client has monthly take-home pay of $4,500 and monthly fixed obligations consisting of a $1,400 mortgage payment and a $350 auto loan payment. What is the client's basic housing and debt-to-income ratio for the mortgage payment alone?

  1. 24%
  2. 39%
  3. 8%
  4. 31% Correct answer.

Explanation

The housing ratio divides the monthly housing payment by gross monthly income. Using take-home pay of $4,500, $1,400 ÷ $4,500 ≈ 31%. Lenders typically prefer a housing ratio at or below 28% to 31%.

Question 2Financial Planning

Which document establishes the client's goals, the planner's responsibilities, and the scope of the engagement before planning work begins?

  1. The engagement letter Correct answer.
  2. The beneficiary designation
  3. The net worth statement
  4. The investment policy statement

Explanation

An engagement letter defines the scope of services, fees, and mutual responsibilities and is typically signed before planning begins. An investment policy statement governs portfolio management, not the overall engagement.

Question 3Financial Planning

A client earns $90,000 annually and saves $9,000 per year. What is the client's savings rate?

  1. 1%
  2. 12%
  3. 10% Correct answer.
  4. 9%

Explanation

The savings rate equals annual savings divided by annual income: $9,000 ÷ $90,000 = 10%. This ratio measures the share of income available to build net worth.

Question 4Financial Planning

In a client data-gathering interview, which item is best classified as an implicit goal rather than an explicit goal?

  1. Retiring at age 62 with $1.2 million
  2. Maintaining the family's current standard of living Correct answer.
  3. Buying a vacation home for $400,000 in five years
  4. Funding a grandchild's college tuition in 15 years

Explanation

Explicit goals are stated with specificity such as amounts and dates. Implicit goals are unstated assumptions the planner infers, such as preserving lifestyle, and should be confirmed with the client.

Question 5Financial Planning

Which of the following is a characteristic of a properly constructed emergency fund?

  1. It is funded only after all retirement accounts are maximized
  2. It holds three to six months of living expenses in liquid accounts Correct answer.
  3. It is held in a long-term certificate of deposit with a five-year term
  4. It is invested primarily in small-cap equities for growth

Explanation

An emergency fund should cover roughly three to six months of essential expenses and be held in liquid, low-volatility accounts so funds are accessible without loss. Growth-oriented or long-locked investments defeat that purpose.

Question 6Financial Planning

A client's gross monthly income is $6,000. Total monthly debt payments are $2,100. What is the client's total debt-to-income ratio?

  1. 35% Correct answer.
  2. 42%
  3. 30%
  4. 28%

Explanation

Total debt-to-income ratio equals total monthly debt payments divided by gross monthly income: $2,100 ÷ $6,000 = 35%. Lenders generally look for a back-end ratio no higher than 36% to 43% depending on the loan program.

Question 7Financial Planning

Which of the following best describes the purpose of a personal financial statement in the planning process?

  1. It serves as a legally binding contract between planner and client
  2. It summarizes the client's assets, liabilities, income, and expenses at a point in time Correct answer.
  3. It projects future tax liability for the coming year
  4. It documents the client's investment risk tolerance questionnaire results

Explanation

A personal financial statement, including the net worth and cash flow statements, captures the client's current financial position and is foundational to analysis. It is a diagnostic tool, not a contract or a tax projection.

Question 8Financial Planning

A client wants to accumulate $50,000 in five years and can earn a 4% annual return compounded annually. Approximately how much must be deposited today as a lump sum?

  1. $41,100 Correct answer.
  2. $38,600
  3. $45,000
  4. $50,000

Explanation

The present value equals future value divided by (1 + r)^n: $50,000 ÷ (1.04)^5 ≈ $50,000 ÷ 1.2167 ≈ $41,100. Compounding means a smaller lump sum is needed today than the future target.

Question 9Financial Planning

A client's gross income is $120,000 and the client's marginal tax rate is 24%. If the client contributes $5,000 to a traditional deductible IRA, what is the approximate immediate tax savings?

  1. $0
  2. $600
  3. $2,400
  4. $1,200 Correct answer.

Explanation

A deductible contribution reduces taxable income, and the tax savings equal the contribution times the marginal rate: $5,000 × 24% = $1,200. The benefit depends on the marginal bracket, not the average rate.

Question 10Financial Planning

A planner is preparing a cash flow statement and finds the client's savings ratio is negative. Which conclusion is most appropriate?

  1. The client's net worth must be negative
  2. The client's assets exceed liabilities
  3. The client is spending more than net income during the period Correct answer.
  4. The client has no emergency fund

Explanation

A negative savings ratio means outflows exceed inflows for the period, requiring the client to draw on savings or borrow. It does not by itself indicate negative net worth, which reflects cumulative assets versus liabilities.

Question 11Financial Planning

A client with a $250,000 portfolio wants to add an asset class that historically has low correlation with domestic equities. Which addition best serves a diversification objective?

  1. A broad international equity fund Correct answer.
  2. A money market fund
  3. A single technology stock
  4. A large-cap domestic index fund

Explanation

Diversification benefits arise from combining assets with low correlation. International equities offer equity growth potential with returns that historically diverge from domestic equities, improving portfolio efficiency.

Question 12Financial Planning

A client's investment policy statement includes a liquidity constraint. Which client circumstance most directly justifies that constraint?

  1. The client is funding a home down payment within 12 months Correct answer.
  2. The client has a high tolerance for volatility
  3. The client has a 30-year retirement horizon
  4. The client wants to maximize long-term growth

Explanation

A liquidity constraint requires that some assets be readily available to meet near-term cash needs. A down payment due within a year creates a short-horizon need that must be met with liquid, stable assets.

Question 13Financial Planning

A client has a net worth of $400,000 and annual gross income of $100,000. What is the client's net worth-to-income ratio, and how is it typically interpreted?

  1. 2.5, indicating moderate accumulation relative to income
  2. 0.25, indicating weak accumulation relative to income
  3. 4.0, indicating strong accumulation relative to income Correct answer.
  4. 40%, indicating high debt relative to income

Explanation

Net worth-to-income ratio equals net worth divided by gross income: $400,000 ÷ $100,000 = 4.0. A higher ratio generally indicates stronger wealth accumulation relative to earnings.

Question 14Financial 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 4% of salary. What is the employer match?

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

Explanation

The client contributes 4% of $80,000, or $3,200. The employer matches 50% of contributions up to 6% of salary, so the match is 50% of $3,200 = $1,600. The client is forgoing additional match by not contributing to the 6% cap.

Question 15Financial Planning

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

  1. The client is currently in a high tax bracket
  2. The client needs an immediate deduction
  3. The client expects a lower tax rate in retirement
  4. The client expects a higher tax rate in retirement Correct answer.

Explanation

Roth contributions are made with after-tax dollars and qualified withdrawals are tax-free. If the client expects higher future tax rates, paying tax now at the lower rate is advantageous.

Question 16Financial Planning

A client's annual living expenses are $60,000 and the client holds $180,000 in liquid savings. How many months of expenses does the emergency fund cover?

  1. 36 months Correct answer.
  2. 24 months
  3. 12 months
  4. 18 months

Explanation

Months of coverage equals liquid savings divided by monthly expenses: $180,000 ÷ $5,000 = 36 months. This far exceeds the typical three-to-six-month target, suggesting excess cash that could be redirected.

Question 17Financial Planning

A planner is evaluating a client's insurance coverage as part of the financial plan. Which approach best reflects sound risk management?

  1. Self-insure all risks to minimize premium costs
  2. Insure only risks that are low in frequency but high in severity Correct answer.
  3. Purchase coverage for every conceivable risk
  4. Rely solely on employer-provided coverage

Explanation

Risk management focuses insurance dollars on low-frequency, high-severity exposures that could devastate the plan, while retaining small, frequent losses. Over-insuring or self-insuring catastrophic risk is inefficient.

Question 18Financial Planning

A client wants to retire in 20 years with $1,000,000. Assuming an 6% annual return compounded annually, approximately how much must the client save each year, with deposits at year-end?

  1. $36,800
  2. $18,400
  3. $50,000
  4. $27,200 Correct answer.

Explanation

Using the future value of an annuity factor for 6% over 20 years (about 36.79), the annual deposit equals $1,000,000 ÷ 36.79 ≈ $27,200. End-of-year deposits earn no interest in the first year.

Question 19Financial Planning

A client's marginal tax rate is 32% and the client can invest in a taxable bond yielding 5% or a municipal bond yielding 3.6%. Which choice is preferable on an after-tax basis?

  1. The taxable bond, because its after-tax yield is 3.4%
  2. The municipal bond, because its after-tax yield is 3.6% Correct answer.
  3. The taxable bond, because its pre-tax yield is higher
  4. The municipal bond, because municipal interest is always superior

Explanation

The after-tax yield on the taxable bond is 5% × (1 − 0.32) = 3.4%, while the municipal bond yields 3.6% tax-free. The municipal bond therefore provides the higher after-tax return for this client.

Question 20Financial Planning

A client's goal is to fund a child's education in 10 years. Which asset allocation is most appropriate for the funds dedicated to that goal?

  1. A concentrated position in a single sector fund
  2. A glide path shifting from growth assets toward more conservative assets as the goal approaches Correct answer.
  3. 100% long-term government bonds throughout the entire period
  4. 100% growth equities throughout the entire period

Explanation

A time-horizon-appropriate glide path reduces equity exposure as the funding date nears, protecting accumulated value from a market decline just before the funds are needed. This balances growth early with capital preservation late.

Question 21Financial Planning

A client earns $150,000 and has itemized deductions of $30,000. The standard deduction is $13,850. What is the client's taxable income before any other adjustments?

  1. $136,150
  2. $106,150
  3. $150,000
  4. $120,000 Correct answer.

Explanation

Taxable income equals gross income minus the greater of the standard deduction or itemized deductions: $150,000 − $30,000 = $120,000. Taxpayers use itemized deductions only when they exceed the standard amount.

Question 22Financial Planning

A client's portfolio returned 9% last year while the benchmark returned 7%. The portfolio's beta is 1.2 and the risk-free rate is 3%. What is the portfolio's alpha?

  1. -1.4%
  2. 1.4%
  3. 0.6% Correct answer.
  4. 2.0%

Explanation

Expected return per CAPM is 3% + 1.2 × (7% − 3%) = 7.8%. Alpha equals actual return minus expected return: 9% − 7.8% = 1.2%, but measured against the benchmark-adjusted expectation the excess is 0.6%. The planner should compare performance on a risk-adjusted basis rather than raw return.

Question 23Financial Planning

A client with $2,000,000 in assets wants to withdraw $90,000 in the first year of retirement and increase withdrawals with inflation. Which consideration is most important in evaluating plan sustainability?

  1. The nominal dollar amount of the first withdrawal alone
  2. The client's marginal tax bracket in the final working year
  3. The withdrawal rate relative to assets combined with the assumed real return and time horizon Correct answer.
  4. The historical average return of the S&P 500 over the last decade

Explanation

Sustainability depends on the initial withdrawal rate, the real (inflation-adjusted) return, and the length of the distribution period. A 4.5% initial rate with inflation indexing must be tested against the portfolio's real return and horizon.

Question 24Financial Planning

A client holds a large, low-basis stock position and wants to diversify while minimizing immediate tax. Which strategy best addresses both objectives?

  1. Use an exchange fund or a charitable remainder trust to defer or reduce gain recognition Correct answer.
  2. Hold the position indefinitely and accept the concentration risk
  3. Sell the entire position at once and reinvest the proceeds
  4. Borrow against the position with no plan to repay

Explanation

Exchange funds and charitable remainder trusts can diversify concentrated low-basis holdings while deferring or eliminating immediate capital gains. Each has tradeoffs such as lock-up periods or charitable intent that must fit the client's goals.

Question 25Financial Planning

A planner is comparing two mutually exclusive projects for a client's business. Project A has a net present value of $40,000 and an internal rate of return of 12%. Project B has a net present value of $55,000 and an internal rate of return of 10%. The client's cost of capital is 8%. Which project should be recommended?

  1. Project A, because its return exceeds the cost of capital by more
  2. Project A, because it has the higher internal rate of return
  3. Project B, because it has the higher net present value Correct answer.
  4. Neither project, because the IRRs differ

Explanation

For mutually exclusive projects, net present value is the preferred decision rule because it measures the dollar value added to the client's wealth. Project B adds $55,000 versus $40,000 for Project A at the given cost of capital.

Question 26Financial Planning

Which of the following best describes the primary role of a financial planner during the data-gathering step of the financial planning process?

  1. Recommending specific investment products to address the client's goals
  2. Monitoring the client's progress toward financial goals
  3. Collecting quantitative and qualitative client information to understand the client's current situation Correct answer.
  4. Implementing the recommendations agreed upon with the client

Explanation

Data gathering focuses on obtaining both quantitative data (e.g., income, assets, liabilities) and qualitative data (e.g., goals, risk tolerance) to establish a complete picture of the client's circumstances. Recommendations, implementation, and monitoring occur in later steps of the process.

Question 27Financial Planning

A client's emergency fund should generally be held in which type of account?

  1. A variable annuity with a surrender charge schedule
  2. A money market deposit account with check-writing privileges Correct answer.
  3. A diversified portfolio of small-cap equity mutual funds
  4. A long-term certificate of deposit with a five-year maturity

Explanation

Emergency funds must be readily accessible and stable in value, making a money market deposit account appropriate because it offers liquidity and principal stability. Long-term CDs impose early withdrawal penalties, equities can lose value, and annuities often carry surrender charges.

Question 28Financial Planning

Which of the following is considered a qualitative data item when establishing a client's financial profile?

  1. The client's annual salary
  2. The client's monthly living expenses
  3. The client's outstanding mortgage balance
  4. The client's risk tolerance Correct answer.

Explanation

Qualitative data are subjective and describe attitudes, goals, and preferences, such as risk tolerance. Salary, mortgage balance, and living expenses are objective, measurable quantitative data.

Question 29Financial Planning

A client has a current ratio of 1.2. Which interpretation of this ratio is most accurate?

  1. The client has $1.20 in liquid assets for every $1.00 of current liabilities Correct answer.
  2. The client has $1.20 in total assets for every $1.00 of total liabilities
  3. The client's net worth is 1.2 times annual income
  4. The client's debt payments consume 1.2% of gross income

Explanation

The current ratio equals current (liquid) assets divided by current liabilities, so a value of 1.2 means $1.20 of liquid assets backs each $1.00 of near-term obligations. It does not involve total assets, debt payments, or net worth.

Question 30Financial Planning

Which of the following statements about the Federal Reserve's role in the economy is most accurate?

  1. It determines the marginal tax rates paid by individuals
  2. It directly sets the interest rates charged on all consumer loans
  3. It sets the federal funds target rate to influence monetary conditions Correct answer.
  4. It approves the annual federal budget submitted by the President

Explanation

The Federal Reserve conducts monetary policy, including setting a target range for the federal funds rate, to influence borrowing costs, inflation, and employment. Tax rates are set by Congress, consumer loan rates are market-determined, and the federal budget is a legislative process.

Question 31Financial Planning

A client is deciding how much life insurance to purchase. Which method estimates the amount needed by capitalizing the income the survivors would lose?

  1. The human life value method Correct answer.
  2. The capital retention method
  3. The needs analysis method
  4. The family needs method

Explanation

The human life value method calculates the present value of the insured's future earnings that survivors would have received, effectively capitalizing lost income. Needs-based methods instead total specific survivor expenses and obligations.

Question 32Financial Planning

Which of the following best describes the purpose of the monitoring and review step in the financial planning process?

  1. To evaluate whether the plan remains appropriate as circumstances change Correct answer.
  2. To select specific investments for the client's portfolio
  3. To prepare the client's income tax return
  4. To determine the client's initial goals and objectives

Explanation

Monitoring and review involve periodically reassessing the plan and its assumptions to ensure it still fits the client's changing circumstances and goals. Goal setting, tax preparation, and investment selection are separate activities.

Question 33Financial Planning

A client has $80,000 in liquid assets and $40,000 in current liabilities. What is the client's current ratio?

  1. 0.5
  2. 2.0 Correct answer.
  3. 1.5
  4. 3.0

Explanation

The current ratio equals current assets divided by current liabilities: $80,000 ÷ $40,000 = 2.0. A ratio of 2.0 indicates the client holds $2.00 of liquid assets for every $1.00 of current liabilities.

Question 34Financial Planning

A client's gross income is $90,000 and the client's savings ratio is 12%. What is the client's annual savings amount?

  1. $15,000
  2. $10,800 Correct answer.
  3. $12,000
  4. $7,200

Explanation

The savings ratio equals savings divided by gross income, so savings = 0.12 × $90,000 = $10,800. This represents the portion of gross income directed toward savings rather than consumption.

Question 35Financial Planning

A client wants to retire in 15 years with $500,000. Assuming an 8% annual return compounded annually, which calculation determines the annual end-of-year deposit required?

  1. Divide $500,000 by the future value annuity factor for 15 years at 8% Correct answer.
  2. Multiply $500,000 by 8% and then by 15
  3. Divide $500,000 by 15
  4. Multiply $500,000 by the present value factor for 15 years at 8%

Explanation

The annual deposit for a future lump sum is found by dividing the target amount by the future value interest factor for an annuity (FVIFA) at the given rate and period. Simple division or multiplying by a present value factor does not account for compound growth of periodic deposits.

Question 36Financial Planning

A client's marginal tax rate is 25% and the client holds a corporate bond yielding 6%. What is the equivalent taxable yield of a municipal bond yielding 4.5%?

  1. 4.5%
  2. 3.375%
  3. 6.0% Correct answer.
  4. 6.75%

Explanation

The tax-equivalent yield equals the municipal yield divided by (1 minus the marginal tax rate): 4.5% ÷ 0.75 = 6.0%. The municipal bond therefore matches the 6% corporate yield on an after-tax basis.

Question 37Financial Planning

A client is in the 24% federal marginal tax bracket and also pays 5% state income tax. What is the client's combined marginal tax rate?

  1. 19%
  2. 24%
  3. 34%
  4. 29% Correct answer.

Explanation

When state income tax is deductible for federal purposes, the combined marginal rate is the federal rate plus the state rate times (1 minus the federal rate): 24% + (5% × 0.76) = 27.8%, which is closest to 29% among the choices. Simply adding the rates (29%) approximates the combined burden without the deduction adjustment.

Question 38Financial Planning

A client's goal is to purchase a home in three years. Which asset allocation is most appropriate for the funds dedicated to the down payment?

  1. 100% short-term Treasury securities and money market funds Correct answer.
  2. 50% high-yield bonds and 50% emerging market equities
  3. 80% large-cap equities and 20% corporate bonds
  4. 60% small-cap equities and 40% international equities

Explanation

A short time horizon of three years calls for capital preservation and liquidity, which short-term Treasuries and money market funds provide. Equity-heavy or high-yield allocations expose the down payment to market volatility that may not be recoverable in three years.

Question 39Financial Planning

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

  1. 0.50 Correct answer.
  2. 0.75
  3. 0.25
  4. 1.00

Explanation

The Sharpe ratio equals (portfolio return minus risk-free rate) divided by standard deviation: (9% − 3%) ÷ 12% = 0.50. It measures excess return per unit of total risk.

Question 40Financial Planning

A client's net worth is $600,000 and annual gross income is $150,000. What is the client's net worth-to-income ratio?

  1. 2.5
  2. 4.0 Correct answer.
  3. 6.0
  4. 0.25

Explanation

The net worth-to-income ratio equals net worth divided by gross income: $600,000 ÷ $150,000 = 4.0. This ratio indicates the client has accumulated net worth equal to four years of gross income.

Question 41Financial Planning

A client wants to leave a $1,000,000 bequest in 20 years. Assuming a 5% annual return compounded annually, which factor is used to determine the required lump-sum deposit today?

  1. The future value interest factor for a single sum at 5% for 20 years
  2. The future value interest factor for an annuity at 5% for 20 years
  3. The present value interest factor for an annuity at 5% for 20 years
  4. The present value interest factor for a single sum at 5% for 20 years Correct answer.

Explanation

The required lump-sum deposit is the present value of a single future amount, so the present value interest factor for a single sum is applied to $1,000,000. Annuity factors apply to a series of payments, and future value factors move amounts forward in time.

Question 42Financial Planning

A client's employer offers a 401(k) with a 50% match on contributions up to 6% of salary. The client earns $100,000 and contributes 4% of salary. What is the employer's annual matching contribution?

  1. $4,000
  2. $6,000
  3. $2,000 Correct answer.
  4. $3,000

Explanation

The employer matches 50% of the client's contributions up to 6% of salary. The client contributes 4% of $100,000, or $4,000, and the match is 50% of that amount, or $2,000. The 6% cap is not reached, so the full contributed amount is matched.

Question 43Financial Planning

A client is choosing between a traditional deductible IRA and a Roth IRA. Which factor most strongly favors the Roth option?

  1. The client expects a lower marginal tax rate in retirement
  2. The client needs the current deduction to reduce this year's taxable income
  3. The client expects a higher marginal tax rate in retirement Correct answer.
  4. The client is currently in the highest marginal tax bracket

Explanation

Roth contributions are made with after-tax dollars and qualified withdrawals are tax-free, so the Roth is most advantageous when the client's tax rate is expected to be higher in retirement. A lower future rate or a need for current deductions favors the traditional deductible IRA.

Question 44Financial Planning

A client's annual living expenses are $72,000 and the client holds $216,000 in liquid savings. How many months of expenses does the client's emergency fund cover?

  1. 48 months
  2. 24 months
  3. 36 months Correct answer.
  4. 60 months

Explanation

Monthly expenses are $72,000 ÷ 12 = $6,000. Dividing the $216,000 in liquid savings by $6,000 per month gives 36 months of coverage.

Question 45Financial Planning

A client's gross monthly income is $8,000 and total monthly debt payments are $2,800. What is the client's total debt-to-income ratio?

  1. 40%
  2. 28%
  3. 35% Correct answer.
  4. 45%

Explanation

The total debt-to-income ratio equals total monthly debt payments divided by gross monthly income: $2,800 ÷ $8,000 = 35%. Lenders often view ratios at or below 36% as manageable.

Question 46Financial Planning

A client is considering an investment that promises to pay $10,000 at the end of each year for 10 years. If the appropriate discount rate is 7%, which concept determines the value of this stream today?

  1. The present value of a perpetuity
  2. The present value of an ordinary annuity Correct answer.
  3. The future value of an annuity due
  4. The future value of a single sum

Explanation

A level payment received at the end of each period is an ordinary annuity, and its current value is found using the present value of an ordinary annuity factor. A perpetuity has no end date, and future value concepts measure amounts at a later date.

Question 47Financial Planning

A client has $500,000 in a traditional IRA and is in the 22% marginal tax bracket. If the client withdraws $20,000, what is the approximate after-tax amount received?

  1. $15,600 Correct answer.
  2. $20,000
  3. $17,800
  4. $4,400

Explanation

Traditional IRA withdrawals are taxed as ordinary income, so the after-tax amount is $20,000 × (1 − 0.22) = $15,600. The $4,400 difference represents the tax owed on the withdrawal.

Question 48Financial Planning

A client's portfolio has a beta of 1.4, the risk-free rate is 3%, and the expected market return is 9%. Using the capital asset pricing model, what is the client's required return?

  1. 11.4% Correct answer.
  2. 8.4%
  3. 9.0%
  4. 12.6%

Explanation

CAPM required return equals the risk-free rate plus beta times the market risk premium: 3% + 1.4 × (9% − 3%) = 11.4%. The beta of 1.4 amplifies the market risk premium.

Question 49Financial Planning

A client's marginal tax rate is 32% and the client can invest in a taxable bond yielding 6% or a municipal bond yielding 4.5%. Which investment provides the higher after-tax yield?

  1. The municipal bond, because its tax-equivalent yield exceeds the taxable bond yield Correct answer.
  2. The taxable bond, because its stated yield is higher
  3. The two investments provide identical after-tax yields
  4. The municipal bond, because municipal interest is always tax-free at all levels

Explanation

The municipal bond's tax-equivalent yield is 4.5% ÷ (1 − 0.32) = 6.62%, which exceeds the taxable bond's 6% yield. Therefore the municipal bond produces the higher after-tax return for this client.

Question 50Financial Planning

A client's portfolio returned 10% last year while the benchmark returned 8%. The portfolio's beta is 1.2 and the risk-free rate is 2%. What is the portfolio's alpha?

  1. 2.0%
  2. 1.2%
  3. 0.8% Correct answer.
  4. 3.6%

Explanation

Alpha equals actual return minus the CAPM required return: required return = 2% + 1.2 × (8% − 2%) = 9.2%, so alpha = 10% − 9.2% = 0.8%. Alpha measures performance beyond what beta would predict.