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Question 1 of 10
1. Question
Which of the following statements is true regarding buy-and-hold strategy?
Correct
Buy-and-hold strategy
Buy-and-hold strategies are long-term management strategies that involve the manager or investor buying one or more securities and holding them regardless of the current market climate. Active managers eschew this method, as they prefer to make security movements based on market timing. The theory behind the buy-and-hold strategy is that equities have historically provided rising returns despite short-term market movements. Managers who prefer buy-and-hold strategies also expound on the low-fee nature of the strategy and hypothesize that short-term gains are not easily gotten, and the returns are lower in the long term than could be had by using a buy-and-hold strategy. The strategy also provides less tax liability, since long-term capital gains are taxed at a lower rate than short-term capital gains, which are more common in an actively managed strategy. Buy-and-hold strategies, however, do come with practical limitations.Incorrect
Buy-and-hold strategy
Buy-and-hold strategies are long-term management strategies that involve the manager or investor buying one or more securities and holding them regardless of the current market climate. Active managers eschew this method, as they prefer to make security movements based on market timing. The theory behind the buy-and-hold strategy is that equities have historically provided rising returns despite short-term market movements. Managers who prefer buy-and-hold strategies also expound on the low-fee nature of the strategy and hypothesize that short-term gains are not easily gotten, and the returns are lower in the long term than could be had by using a buy-and-hold strategy. The strategy also provides less tax liability, since long-term capital gains are taxed at a lower rate than short-term capital gains, which are more common in an actively managed strategy. Buy-and-hold strategies, however, do come with practical limitations. -
Question 2 of 10
2. Question
Which of the following statements is false regarding constant ratio plan vs. constant dollar plan?
Correct
Constant ratio plan vs. constant dollar plan
Constant ratio plans and constant dollar plans have similar goals in maintaining asset allocation, but the method by which the plans actually do this is quite different. A constant ratio plan achieves asset allocation through rebalancing based on the ratio percentage of equity securities to bond/cash securities. Thus, a 70 percent equities to 30 percent bonds/cash portfolio that had evolved to an 80 percent/20 percent portfolio through market growth would be rebalanced by selling 10 percent equities securities and reinvesting the proceeds into bond/cash securities. This restores the original asset allocation. In contrast, per the name of the strategy, the constant dollar plan seeks to maintain asset allocation based on a fixed dollar amount of equity investments.Incorrect
Constant ratio plan vs. constant dollar plan
Constant ratio plans and constant dollar plans have similar goals in maintaining asset allocation, but the method by which the plans actually do this is quite different. A constant ratio plan achieves asset allocation through rebalancing based on the ratio percentage of equity securities to bond/cash securities. Thus, a 70 percent equities to 30 percent bonds/cash portfolio that had evolved to an 80 percent/20 percent portfolio through market growth would be rebalanced by selling 10 percent equities securities and reinvesting the proceeds into bond/cash securities. This restores the original asset allocation. In contrast, per the name of the strategy, the constant dollar plan seeks to maintain asset allocation based on a fixed dollar amount of equity investments. -
Question 3 of 10
3. Question
Which of the following statements is true regarding value stocks?
Correct
Value stocks
Value stocks are those stocks that portfolio managers determine to be undervalued from a price perspective and out of favor with the general investing public. If the price of a stock is low compared to the fundamental financial valuations shown on the balance sheet, earnings statements, and other financial statements from the company, and other investors are eschewing it for more popular investments, value investors will determine it to be a value stock. These managers believe that there is room for healthy growth in value stocks, as they believe that there is empirical evidence that they are more valuable than current pricing suggests. The price at which value managers are most likely to purchase value stocks is as near to the bottom of their one-year price range as possible. The low purchase price results in low price-to-earnings ratios, and usually a reasonable dividend paid on the stock.Incorrect
Value stocks
Value stocks are those stocks that portfolio managers determine to be undervalued from a price perspective and out of favor with the general investing public. If the price of a stock is low compared to the fundamental financial valuations shown on the balance sheet, earnings statements, and other financial statements from the company, and other investors are eschewing it for more popular investments, value investors will determine it to be a value stock. These managers believe that there is room for healthy growth in value stocks, as they believe that there is empirical evidence that they are more valuable than current pricing suggests. The price at which value managers are most likely to purchase value stocks is as near to the bottom of their one-year price range as possible. The low purchase price results in low price-to-earnings ratios, and usually a reasonable dividend paid on the stock. -
Question 4 of 10
4. Question
Which of the following statements is false regarding growth stocks?
Correct
Growth stocks
Portfolio managers that use the growth style of management are seeking earnings momentum, or the event of a stock’s earnings per share increasing. This is indicative of a growth stock or the stock of a company whose earnings are increasing more quickly than other stocks, and the earnings are expected to keep increasing at an accelerated rate. Since the accelerated rate of growth is considered to be reflected in the price of the stocks, growth managers will buy the stocks at their highest one-year price, because they feel that the faster earnings will continue to be priced into the value of the stock and continue to force the price higher. Usually the preceding factors will result in a high price-to-earnings ratio, and this fact will result in the lack of a dividend.Incorrect
Growth stocks
Portfolio managers that use the growth style of management are seeking earnings momentum, or the event of a stock’s earnings per share increasing. This is indicative of a growth stock or the stock of a company whose earnings are increasing more quickly than other stocks, and the earnings are expected to keep increasing at an accelerated rate. Since the accelerated rate of growth is considered to be reflected in the price of the stocks, growth managers will buy the stocks at their highest one-year price, because they feel that the faster earnings will continue to be priced into the value of the stock and continue to force the price higher. Usually the preceding factors will result in a high price-to-earnings ratio, and this fact will result in the lack of a dividend. -
Question 5 of 10
5. Question
Which of the following statements is true regarding active management vs. passive management?
Correct
Active management vs. passive management
Active investment account management is a hands-on, daily approach to market management. Active managers seek to time the market or buy and sell at the right time to gain returns. An example of this type of management is tactical asset allocation. The advantage to this type of management is that if properly done, the account can exceed normal market returns. Among the disadvantages of this type of account are higher tax rates (than passively managed accounts) due to short-term capital gains, and trading and other fees that can be very high. Passive account management is a long-term management style in which the manager purchases securities and adopts a buy-and-hold strategy regardless of the market. The account may occasionally be rebalanced to maintain asset allocation, but the manager does not attempt to “pick stocks.”Incorrect
Active management vs. passive management
Active investment account management is a hands-on, daily approach to market management. Active managers seek to time the market or buy and sell at the right time to gain returns. An example of this type of management is tactical asset allocation. The advantage to this type of management is that if properly done, the account can exceed normal market returns. Among the disadvantages of this type of account are higher tax rates (than passively managed accounts) due to short-term capital gains, and trading and other fees that can be very high. Passive account management is a long-term management style in which the manager purchases securities and adopts a buy-and-hold strategy regardless of the market. The account may occasionally be rebalanced to maintain asset allocation, but the manager does not attempt to “pick stocks.” -
Question 6 of 10
6. Question
Which of the following statements is true regarding diversification?
Correct
Diversification
Diversification is a very important concept to most investors. Most investors feel, and rightly so, that an undiversified portfolio can lead to high rates of unnecessary risk. Diversification is the practice of spreading one’s assets among a wide selection of investments from different asset classes. Most investors agree that diversification will reduce market risk and increase returns. This is an essential tenet of modern portfolio theory. The securities that make up a diversified portfolio tend to be negatively correlated; that is, the securities’ prices move in opposite directions to hedge against unfavorable market movement. This hedge will provide returns in one asset class as the other asset class moves downward, thereby still providing returns in a declining market and thus proving modern portfolio theory of the relationship of reduced risk/higher return in a diversified portfolio.Incorrect
Diversification
Diversification is a very important concept to most investors. Most investors feel, and rightly so, that an undiversified portfolio can lead to high rates of unnecessary risk. Diversification is the practice of spreading one’s assets among a wide selection of investments from different asset classes. Most investors agree that diversification will reduce market risk and increase returns. This is an essential tenet of modern portfolio theory. The securities that make up a diversified portfolio tend to be negatively correlated; that is, the securities’ prices move in opposite directions to hedge against unfavorable market movement. This hedge will provide returns in one asset class as the other asset class moves downward, thereby still providing returns in a declining market and thus proving modern portfolio theory of the relationship of reduced risk/higher return in a diversified portfolio. -
Question 7 of 10
7. Question
Which of the following statements is true regarding dollar cost averaging?
Correct
Dollar cost averaging
Dollar cost averaging involves investing a set amount of money in some security at regular time intervals. This is most commonly demonstrated bimonthly in 401(k) contributions withheld from employees’ paychecks. Dollar cost averaging serves to lower the overall price the investor pays for securities by buying less of a security when the price is high and being able to obtain more for the same amount of investment when the price is low. This helps the investor combat timing risk, or the risk that all of one’s capital will be invested at the peak of a market and thus not benefit from any upside. The general purpose of dollar cost averaging can be described as reducing the cost to buy a security over a given period compared to its average price.Incorrect
Dollar cost averaging
Dollar cost averaging involves investing a set amount of money in some security at regular time intervals. This is most commonly demonstrated bimonthly in 401(k) contributions withheld from employees’ paychecks. Dollar cost averaging serves to lower the overall price the investor pays for securities by buying less of a security when the price is high and being able to obtain more for the same amount of investment when the price is low. This helps the investor combat timing risk, or the risk that all of one’s capital will be invested at the peak of a market and thus not benefit from any upside. The general purpose of dollar cost averaging can be described as reducing the cost to buy a security over a given period compared to its average price. -
Question 8 of 10
8. Question
Which of the following statements is true regarding clients’ goals that have a specific time frame?
Correct
Clients’ goals that have a specific time frame
When determining clients’ financial goals, it is important to assist them in achieving all of their objectives, not just the ones the advisor may consider most important. These goals may have a long time horizon, such as retirement, or a shorter time horizon, such as saving for a child’s education. These goals should be considered when advising on proper asset allocation. Bonds may not be the best investment for a young worker who is saving for retirement, as they provide little growth, but if that same worker is saving for his children’s college tuition or to buy a house, bonds may be the appropriate investment vehicle. While bonds do not provide the growth (capital appreciation) needed to fund retirement, they may provide the stability of capital needed when saving for a short-term goal.Incorrect
Clients’ goals that have a specific time frame
When determining clients’ financial goals, it is important to assist them in achieving all of their objectives, not just the ones the advisor may consider most important. These goals may have a long time horizon, such as retirement, or a shorter time horizon, such as saving for a child’s education. These goals should be considered when advising on proper asset allocation. Bonds may not be the best investment for a young worker who is saving for retirement, as they provide little growth, but if that same worker is saving for his children’s college tuition or to buy a house, bonds may be the appropriate investment vehicle. While bonds do not provide the growth (capital appreciation) needed to fund retirement, they may provide the stability of capital needed when saving for a short-term goal. -
Question 9 of 10
9. Question
Which of the following statements is false regarding leverage?
Correct
Leverage
Managers who use leverage in their management techniques are effectively borrowing money to amplify the eventual result of their investment. Without question, leverage greatly increases the risk associated with a portfolio. While this strategy may be appropriate for an investor seeking income, a young and sophisticated investor may be ideally suited to leveraged portfolios and securities. While leverage indeed brings a greater degree of risk, the reward is commensurate with the risk involved. When managers decide to leverage a position, a greater return can be had than would be possible if using only the unleveraged capital available to them. By the same token, leverage can amplify losses, making the losses taken on a security greater than those incurred had they used their own capital.Incorrect
Leverage
Managers who use leverage in their management techniques are effectively borrowing money to amplify the eventual result of their investment. Without question, leverage greatly increases the risk associated with a portfolio. While this strategy may be appropriate for an investor seeking income, a young and sophisticated investor may be ideally suited to leveraged portfolios and securities. While leverage indeed brings a greater degree of risk, the reward is commensurate with the risk involved. When managers decide to leverage a position, a greater return can be had than would be possible if using only the unleveraged capital available to them. By the same token, leverage can amplify losses, making the losses taken on a security greater than those incurred had they used their own capital. -
Question 10 of 10
10. Question
Which of the following statements is true regarding regressive taxes vs. progressive taxes?
Correct
Regressive taxes vs. progressive taxes
Taxation falls into two main categories, regressive and progressive. Regressive taxes are flat tax rates that apply to all taxpayers regardless of their income and tax brackets. Taxes that fall under this heading include, but are not limited to, sales taxes, payroll taxes, gasoline taxes, etc. The fact that all taxpayers pay the same percentage on a regressive tax means that wealthier taxpayers pay a lower percentage of their income. This comes from the necessity of lower-income taxpayers spending a greater portion of their income than they save. Alternatively, progressive taxes increase as the taxpayers’ incomes increase. This has the opposite effect of regressive taxes, which tend to be costlier to lower-income taxpayers. Examples of progressive taxes include, but are not limited to, income taxes and estate taxes.Incorrect
Regressive taxes vs. progressive taxes
Taxation falls into two main categories, regressive and progressive. Regressive taxes are flat tax rates that apply to all taxpayers regardless of their income and tax brackets. Taxes that fall under this heading include, but are not limited to, sales taxes, payroll taxes, gasoline taxes, etc. The fact that all taxpayers pay the same percentage on a regressive tax means that wealthier taxpayers pay a lower percentage of their income. This comes from the necessity of lower-income taxpayers spending a greater portion of their income than they save. Alternatively, progressive taxes increase as the taxpayers’ incomes increase. This has the opposite effect of regressive taxes, which tend to be costlier to lower-income taxpayers. Examples of progressive taxes include, but are not limited to, income taxes and estate taxes.