0 CFP Investment Cards

Note
The following memorization cards are a compilation of

various topics you will need to know for the CFP Exam.
The cards cover the calculator, economics, and
investment topics.
You will want to use this format to add topics you need
to memorize for the exam.
Revised 7-22-2007, Always watch for numbers that change as tax laws change!
Page: 1
Using the Formulas
Assume a client wants to know the Future Value of an investment of $500

in an investment with an interest rate of 6%, which they will sell in 4
years.
1. First what is the Multiplication Factor?
2. What is the Future Value?
FV = PV (1+i )n
Using the
(yx) Key
1.06 yx 4 =, you will see the factors is: 1.2625

If you multiply the $500 by the factor you get the following answer:
$500 x 1.2625 = $631.25
You can check it with your calculator: 500 +/- PV, 4 n, 6 i, FV = $632.2385
Page: 2
Using TVM Tables
Assume a client wants to know the Future Value of an investment of $500 in an investment with an
interest rate of 6%, which they will sell in 4 years.
1. First what is the Multiplication Factor?
2. What is the Future Value?
n
1
2
3
4
5
0
1.0000
1.0000
1.0000
1.0000
1.0000
1
1.0100
1.0201
1.0303
1.0406
1.0510
Future Value Table

Interest Rate
2
3
4
1.0200 1.0300 1.0400
1.0404 1.0609 1.0816
1.0612 1.0927 1.1249
1.0824 1.1255 1.1699
1.1041 1.1593 1.2167
6
1.0600
1.1236
1.1910
1.2625
1.3382
8
1.0800
1.1664
1.2597
1.3605
1.4693
10
1.1000
1.2100
1.3310
1.4641
1.6105
First remember to use the correct table. There are different tables for different types of problems.
Here if you cross-reference the 6% and the 4 periods, you will see the factors is: 1.2625
If you multiply the $500 by the factor you get the following answer, $500 x 1.2625 = $631.25
You can check it with your calculator: 500 +/- PV, 4 n, 6 i, FV = $632.2385
Page: 3
Setting Up Your HP-10BII Calculator
Setting the number of Decimals (to 4 places)
SHIFT DISP 4
Setting the Compounding Periods Per Year To 1
1 SHIFT P/YR
Setting Your Calculator to END Mode (for an Ordinary Annuity)
SHIFT BEG/END
Clearing the Memory
SHIFT CLEAR ALL
Page: 4
Using Your Financial Calculator

Only think in terms of Number of Periods (Not years or
quarters)
1. Identify what you are

solving for.
2. Is it an Annuity?
3. Clear Calculator (Set to OA)
You only need to take a small number of different factors into

consideration from each TVM Problem, and plug them into your calculator:
PV
FV
PMT
n (Remember, this is not necessarily the number of years)
i (Also, this is not necessarily the annual rate)
Begin
Cash Flow Keys Include (note that these keys are not used with the others and vice versa):
CFj
NPV
Nj
IRR
For both problems you will need the:
+/-, This key tells the calculator that money is going INTO the problem.
The easy
way to remember this is to: Always use the +/- key when you are taking money out
of your pocket and putting it into the problem!
Serial Interest Rate: (1 + Growth Rate 1 + Inflation Rate) 1 x 100 =
Page: 5
Things to REMBER!!! When Using Your Financial Calculator
Always Clear Your Calculator before and after doing each

problem!
Pay attention to when cash flows are happening. Are they
Annuity Due or Ordinary Annuity Problems? Then always
set your calculator back to Ordinary Annuity when finished.
For Semi-Annual, Quarterly, Monthly and DAILY problems
you must adjust both the Number of Periods and the Interest
Rate!
All Bond problems (including Zero Coupon Bonds) are Semi-Annual based on
$1,000 Par Value, unless told otherwise!
Remember to correctly use the +/- key

Page: 6
FV Single Sum
Today, Bill purchased a large ring for $50,000. He expects it to increase in value at a rate of 15% compound
Annually for the next 5 years. How much will his ring be worth at the end of the 5th year?
Clear Your Calculator

50,000 +/15 i
5 n
FV
PV
$100,567.86
Page: 7
Future Value of a Single Sum
$1,000 is invested at 8% compounded annually for 3 years. What will its

value be?
1,000
8 I
3 n
FV
+/-
PV
$1,259.71
Page: 8
Present Value of a Single Sum
Client will receive $1,000 in 3 years.

opportunity cost is 8%.
What will it be worth today if the

1,000
8 i
3 n
PV
FV
-793.83
Page: 9
Future Value
Today Bob Jones purchased an investment grade gold coin for $50,000. He expects the coin to increase in
value at a rate of 12% compounded annually for the next 5 years. How much will the coin be worth at the end
of the fifth year if his expectations are correct?
a.
b.
c.
d.
e.
$89,792.82
$6691 1.28
$88,117.08
$89,542.38
None of the above
50,000 +/- PV
5 n
12 i
0 PMT
FV = $88,117.08
Page: 10
Future Value
A client invested $10,000 in an interest-bearing promissory note earning an 11% annual rate of interest
compounded monthly. How much will the note be worth at the end of 7 years assuming all interest is
reinvested at the 11% rate?
a.
b.
c.
d.
e.
$13,788.43
$20,762.60
$21,048.52
$21,522.04
None of the above
10,000 +/- PV
11 12 = 0.91666
7 x 12 = 84 n
0 PMT
FV = $21,522.04
Page: 11
Future Value
Bill Barrett purchased $60,000 worth of silver coins 8 years ago. The coins have appreciated 7.5%
compounded annually over the last 8 years. How much are the coins worth today?
a.
b.
c.
d.
e.
$107,008.67
$102,829.46
$99,719.03
$99,542.95
None of the above
60,000 +/- PV
8 n
7.5 i
0 PMT
FV = $107,008.67
Page: 12
Present Value
Sarah Attaya wants to give her daughter $25,000 in 8 years to start her own business. How much should
she invest today at an annual interest rate of 8% compounded annually to have $25,000 in 8 years?
a.
b.
c.
d.
e.
$12,802.95
$13,506.72
$13,347.70
$13,210.34
None of the above
25,000 +/- FV
8 n
8 i
0 PMT
PV = $13,506.72
Page: 13
Present Value
Cassie expects to receive $75,000 from a trust fund in 6 years. What is the current value of this fund if it is
discounted at 9% compounded semiannually?
a.
b.
c.
d.
e.
$57,592.18
$44,720.05
$44,224.79
$42,794.31
None of the above
75,000 +/- FV
9 2 = 4.5 i
6 x 2 = 12 n
0 PMT
PV = $44,224.79
Page: 14
Present Value
Bill McDowell expects to receive $75,000 in 5 years.
What is this sum worth to Bill today?
a.
b.
c.
d.
e.
His opportunity cost is 10% compounded monthly.
$45,584.14
$46,043.49
$46,569.10
$48,542.09
None of the above
75,000 +/- FV
10 12 = 0.8333 i
5 x 12 = 60 n
0 PMT
PV = $45,584.14
Page: 15
Present Value
Mary Sue wants to accumulate $57,000 in 8.5 years to purchase a boat. She expects an annual rate of
return of 10.5% compounded quarterly. How much does Mary Sue need to invest today to meet her goal?
a.
b.
c.
d.
e.
$23,529.87
$23,619.30
$23,883.56
$24,364.33
None of the above
57,000 +/- FV
10.5 4 = 2.625 i
8.5 x 4 = 34 n
0 PMT
PV = $23,619.30
Page: 16
Present Value of a Single Sum

(more frequent compounding)
Client will receive $1,000 in 5 years. What will it be worth today, if the
opportunity cost is 8% compounded monthly.
1,000
FV
8 12= i
5 x 12= n
PV
$671.21
Page: 17
Future Value
Your Client found $12,000 on the sidewalk and wants to invest it. He can
get 10% compounded annually on his money for the first 4 years, 12% for
the next 3 years and 15% for the last 5 years. How much will Client have
after 4 years, then 7 years, and last 12 years?
Using TVM Tables
Table (1.46410) x 12,000
Table (1.46410) x 12,000

Table (1.40493) x 17,569 = 24,683
Table (1.46410) x 12,000

Table (1.40493) x 17,569 = 24,683
Table (2.01136) x 24,683 = 49,646.398
Using a Financial Calculator

12,000 +/- PV
10 i
4 n
FV
$17,569.20
17,569 +/- PV
12 i
3 n
FV
$24,683
24,683 +/- PV
15 i
5 n
FV
$49,646.33
Page: 18
Future Value of Annuities

(more frequent compounding)
Your Client Barney Phife invests $500 at the END of each 6 month period
for 3 years. He can get 8% compound semi-annually. What will be the
value 3 years?
(Not BGN)
500 +/- PMT
3 x 2 = n
8 2 = i
FV
$3,316.49
Page: 19
FV of Single Sums and Annuities
An investor deposits $20,000 into a fund. Also another $2,500, each year
there-after. What will be the value in 8 years at 9% annually?
20,000 +/- PV
2,500 +/- PMT
9 i
8 n
FV
$67,422.44
The initial deposit is treated as a Single Sum, then annual payments are
treated as an Annuity.
Page: 20
Future Value of an Annuity
Client invests $1,000 at the Beginning of each of the next 3 years, and can
earn 8% annually. What will be the value in 3 years?
1,000 +/8 I
3 n
FV
PMT
$3,506.11
Page: 21
PV of Single Sums and Annuities
A client would like to have $300,000 in 10 years. He can invest $10,000 at the END of each year, in an
account at 8% annually. What initial lump sum is required additionally now, to attain his goal?

300,000 FV
10,000 +/- PMT
8 i
10 n
PV
$71,857.23
Page: 22
Present Value of an Annuity
Client expects payments of $1,000 at the End of each of the next 3 years, if opportunity costs are 8%
annually. What is the Annuity worth today?

(Not BGN)
1,000 PMT
8 I
3 n
PV
$-2577.10
Page: 23
Future Value of an Ordinary Annuity
Client Invests $100 at the end of each year for 5 years, with a 10% interest
rate.
TVM Table: (6.10510) x 100 = $610.51
100 +/10 i
5 n
FV
$610.51
PMT
Page: 24
Future Value of an Annuity
Client Invests $100 at the Beginning of each year for 5 years, with a 10%
interest rate.
TVM Table: (6.71561) x 100 = $671.56
Set Calculator to: BGN
100 +/10 i
5 n
FV
$671.56
PMT
Page: 25
Compounding Periods of Single Sums/Annuities
A client wants to save $125,000. Has $26,000 to invest now, and can save $10,000
at the END of each year. He can get 10% annually. How many years will he have to
save?
125,000
FV
26,000 +/- PV
10,000 +/- PMT
10 i
n
6.08 years
Page: 26
Number of Compounding Periods
Client has $1000 to invest. He wants $3670. He can get 8%, how many years will it
take.
1,000 +/3670 FV
8 i
n
PV
16.89 years
Page: 27
Number of Compounding Periods (More Frequent Compounding)
Client has $1000 to invest. He wants $3670. He can get 8% compounded semiannually, how many years will it take.
1,000
3,670
8 2
n
33.15
+/FV
= i
PV
16.58 years
Page: 28

Joe purchased 10 shares of an aggressive growth mutual fund at $90 per share 7 years ago. Today he sold
all 10 shares for $4,500. What was his average annual compound rate of return on this investment before
tax?
a.
b.
c.
d.
e.
17.46%
19.58%
21 .73%
25.85%
None of the above
900
+/- PV
4,500 FV
7 n
0 PMT
i = 25.8499%
Page: 29

John borrowed $800 from his father to purchase a mountain bike. John paid back $1200 to his
father at the end of 5 years. What was the average annual compound rate of interest on Johns loan
from his father?
a. 11.5646%
b. 8.4472%
c. 7.7892%
d. 5.1990%
e. None of the above
B
800
+/- PV
1,200 FV
5 n
0 PMT
i = 8.4472%
Page: 30

Susan Jones purchased a zero-coupon bond 6.5 years ago for $525. If the bond matures today and
the face value is $1,000, what is the average annual compound rate of return (calculated
semiannually) that Susan realized on her investment?
a.
b.
c.
d.
e.
11.3372%
10.5713%
10.400%
10.163%
None of the above
525
+/- PV
1,000 FV
6.5 x 2 = 13 n
0 PMT
i = 5.0815
Annual Rate of Return = 5.0815 x 2 = 10.163%
Page: 31
Present Value of a Serial Payment
Client wants to receive an equivalent of $10,000 in todays dollars at the

BEGINNING of each of the next 4 years. Inflation will average 5%, and he
can get 8% compounded annually after tax return. He wants to invest a
lump sum today to fund this need and dissipate the funds at the beginning
of the 4th year, to maintain a constant standard of living.
BGN
1.08 1.05 10,000 PMT
4 n
PV
1 x 100 = i
$38,363.98
Page: 32
NPV
Your clients want to have $10,000 at the end of each of the next 2 years and $25,000
at the end of the 3rd year to provide for travel. Assume that the clients will use
lump-sum assets to achieve this goal.
What is the amount that must be deposited
in an investment returning 7.5% annually to have $10,000 available at the end of
each of the next 2 years and $25,000 available at the end of the third year.
0 CF0
10,000 CFj
10,000 CFj
25,000 CFj
7.5 i
NPV
Note: Multiple repetitious cash flows can be

entered as follows:
(HP10B) 10,000 CFj 2 Nj

(HP12c) 10,000 g CFj 2 g Nj
$38,079.66
The rate of return provided is on an after-tax basis. Unless otherwise noted, both
principal and earnings are used to achieve financial goals.
Page: 33
NPV of Unequal Cash Flows
What is the Present Value of an investment, for which the following cash flows are expected
assuming the clients required annual rate of return for an investment at this level of risk is 10.5%?
End of year 1:
End of year 2:
End of year 3:
End of year 4:
End of year 5:
End of year 6:
Cash Inflow
$100
0
0
0
0
$300
Cash Outflow
0
$50 +/$50 +/$50 +/0
0

0 CF0
Note: Multiple repetitious cash flows can be entered
100 CFj
as follows:
50 +/- CFj
(HP10B) 50 +/- CFj 3 Nj
50 +/- CFj
50 +/- CFj
?(HP12c) 50 +/- g CFj 3 g Nj
0 CFj
300 CFj
10.5 i
NPV
Present Value, or the price that will allow a 10.5% return on this investment, is $143.75
Page: 34
Uneven Cash Flows

Your client is considering purchasing a real estate rental property. Her Required Rate of Return for this investment is 10.5% per
year. (She can invest her money elsewhere, at a equal level of risk, and earn 10.5%).
So, she wants to know how much the
property should cost for her to earn an average annual compound return of 10.5%. She predicts the following net cash flows.
If those cash flows occur, what should your client pay for the property (NPV) to earn a 10.5% average annual compounded return
IRR?
Outflows
Inflows
0 CF0
End of Year 1:
- 15,000
15,000 +/CFi
End of Year 2:
0
0 CFj
End of Year 3:
0
0 CFj
End of Year 4:
0
End of Year 5:
+ 15,000
and 175,000
0 CFj
The last cash flow occurs at the same time the client expects that
15,000 +
175,000 =
CFi
the property could be sold for $175,000; therefore, the total net
10.5i
cash flow for the end of Year 5 is $175,000 + $15,000 = $190,000.
NPV
101,755.31778 or $101,755.32
Your client is still considering purchasing the real estate rental property. She submitted a bid of $100,000 based on the results of the
last calculation. The seller, however, did not accept and countered with an offer to sell at $110,000. If your client pays $110,000 for
the property and expects the same cash flows, What will be the IRR for this investment?
110,000
+/CF0
15,000 +/- CFj
0 CFj
0 CFj
0 CFj
15,000 +
175,000 = CFj
IRR
8.9595
or 8.95%

as follows:
(HP10B) 0
(HP12c) 0
CFj 3 Nj
g CFj 3 g Nj
Page: 35
Price (Or Intrinsic Value) Of A Bond
What is the price (or Intrinsic Value) of a bond with $1,000 face value, a 10%
coupon, and 3 years to maturity, if comparable bonds of the same maturity and grade
are yielding 11.5%?
Coupon: [1,000 x .10] 2 = 50
0 CF0
50 CFj
50 CFj
50 CFj
50 CFj
50 CFj
1,000 + 50 = CFi
11.5 2 = i
NPV
962.8286
or

as follows:
(HP10B) 50
(HP12c) 50
CFj 5 Nj
g CFj 5 g Nj
962.83
Page: 36
NPV
What is the PV of an investment, for which the following cash flows are expected
assuming the client's required annual rate of return for an investment at this level of
risk is 11%?
End of year 1:
End of year 2:
End of year 3:
End of year 4:
End of year 5:
Cash Inflow
$50
$60
0
0
$600
Cash Outflow
0
0
$100
0
0
0 CF0
50 CFj
60 CFj
100 +/- CFj
0 CFj
600 CFj
11 i
NPV
376.69
Page: 37
Present Value
Your client's goal is to have $200,000 in 7 years to buy a partnership interest in her
father's veterinary clinic. One plan your client is considering is to use lump-sum
assets only and invest in 2 different securities that have different rates of return.
If
she deposits $100,000 into an investment returning 7% annually, what is the amount
of the additional lump-sum deposit that would be required in an investment returning
9% annually to accumulate a total of $200,000 in 7 years?
7
n
7
i
100,000 +/PV
FV
200000 =
9 i
PV = 21,565
+/-
FV
The rate of return provided is on an after-tax basis. Unless otherwise noted, both
principal and earnings are used to achieve financial goals.
Page: 38
Annuity Due
Your client's goal is to have $200,000 in 7 years to buy a partnership interest in her father's veterinary clinic.
One plan your client is considering to achieve the goal is to invest $11,000 at the beginning of each of the
next 7 years, starting today, in an investment returning 7% annually.
If your client decides to make these annual deposits, what is the size of the additional annual payments that
would be required, starting today, in an investment returning 9% to accumulate a total of $200,000 in 7
years?
BGN
11000 +/7
n
7
i
FV
- 200000 =
7
n
9
i
PMT
=
PMT
FV
$9,786.35
The rate of return provided is on an after-tax basis. Unless otherwise noted, both principal and earnings are
used to achieve financial goals.
Page: 39
Lump Sum with a Annuity Due

Your client decides to use both a lump-sum deposit and periodic payments to achieve her goal of $200,000 in 7 years.
She will use a onetime lump-sum amount of $66,900, and, in addition make annual payments, starting today, to achieve
her goal. What annual deposit will she need to make in an investment with an annual return of 8.5%?
BGN
Long Method
66,900 +/PV
7
n
8.5 i
FV
= $118,422.52
Short Method
66,900 +/PV
7
n
8.5 i
200,000 FV
PMT
= $8,298
118,422.52 - 200000 = FV
0
PV
7 n
8.5 i
PMT
= $8,298
The rate of return provided is on an after-tax basis.
Unless otherwise noted, both principal and earnings are used to achieve financial goals.
0
66,900
200,000
7
118,422
Page: 40
Present Value
Assume your clients would consider receiving $6,800 every 6 months during the 3
years, with the 1st payment to be received 6 months from today. Use a 6% annual
return in calculating the amount that must be deposited today to provide for these
cash flows.
0 CF0
6,800 CFj
6,800 CFj
6,800 CFj
6,800 CFj
6,800 CFj
6,800 CFj
6 2 =
i
NPV
6,800 PMT
3 x 2 =
6 2 =
PV
n
i
entered as follows:
(HP10B) 6,800
(HP12c) 6,800
CFj 6 Nj
g CFj 6 g Nj
= $36,836.90
Page: 41
Annuity Due
Your client wants to have $90,000 in 5 years to buy a vacation condominium. If he deposits $5,000
at the beginning of each of the next 5 years, starting today, into an investment returning 8%
annually, what is the size of the additional annual payments that would be required into an
investment returning 7% annually to reach his goal?

BGN
5000 +/- PMT
5
n
8
i
FV
- 90000 =
FV
7
i
PMT
$9,478
Page: 42
Present Value
Your client's goal is to accumulate $200,000 in 5 years to build a new home.

In addition, he wants to retire in 4 years and receive $2,400 at the beginning of each month
for 1 year.
At the end of that year, he will begin receiving pension benefits and no longer will need the
$2,400 monthly payments.
Assuming a 7% rate of return, what lump sum must he deposit today to meet these goals?
Illustration of cash flows:
12 PMTs
2,400
1
4
200,000
5 n
7 i
PV
FV
= 142,597
$200,000
3
10
11
12
5
BGN
2,400 PMT
12 n
7 12 = I
PV
= 27,899
27,899
4 n
7 i
PV
FV
= 21,284
142,597 + 21,284 = $163,881

Page: 43
IRR
What is the IRR earned on a 2-year investment in a mutual fund that paid $25 at the end of each quarter for
the 1st 4 quarters; then paid $30 at the end of each quarter for the 2nd year. If the initial investment was
$7,000, and the account value at the time of final quarterly distribution was $10,500? (The quarterly
dividends were NOT reinvested)
25
0
7,000
25
1
25
2
7,000 +/- CF0

25 CFj
25 CFj
25 CFj
25 CFj
30 CFj
30 CFj
30 CFj
10,500 + 30 = CFj
IRR x 4 =
22.1088 or 22.11%
25
3
30
4
30
5
30
6
10,500
30
30
7

as follows:
(HP10B) 25
(HP12c) 25
CFj 4 Nj
g CFj 4 g Nj
(HP10B) 30
(HP12c) 30
CFj 3 Nj
g CFj 3 g Nj
Page: 44
Rate of Return
Assume your clients can invest $36,000 today to meet their goal of
$10,000 at the end of each of the next 2 years and $25,000 at the end of
the 3rd year. What average annual rate of return would they have to earn
on an investment to achieve their cash flow requirements?
36,000 +/- CF0

10,000 CFi
10,000 CFi
25,000 CFi
IRR = 10.1860 or 10.19%
The rate of return provided is on an after-tax basis. Unless otherwise noted, both principal and earnings are
used to achieve financial goals.
Page: 45
After-Tax Rate of Return
A Certificate of Deposit (CD), currently valued at $4,000 is expected to earn an interest rate of 6%
annually.
The client will pay a 28% tax on the reinvested earnings each year.
What is the After-Tax Rate for this problem?
(1 - Tax Rate) x Rate of Return

(1 - .28) x
6%
(.72) x
6
= 4.32%
What will its FV be in 31 years?
4,000 +/PV
4.32
i
31
n
FV
= $14,840.718
Page: 46
After-Tax Rate of Return
To convert a Taxable Rate to a Non-Taxable Rate (After-Tax Rate of

Return):
Non-Taxable Equivalent = (1 - Tax Rate) x Rate of Return
To convert a Non-Taxable Rate of Return to a Taxable Rate of Return?
Taxable Equivalent =
Rate of Return
(1 - Tax Rate)
Page: 47
Rate of Return of Single Sums/Annuities
6 years ago, a client invested $5,000 in a fund. He made additional investments of

$300 at the END of each year. Yesterday the client had a balance of $8,500. What
was his rate of return?
5,000
$300
$300
$300
$300
$300
$300
6
8,500
5,000 +/- PV
300 +/- PMT
8,500FV
6 n
i
4.44%
Page: 48
IRR of Unequal Cash Flows
What is the average compound rate of return earned from investing an antique chair that was
bought 6 years ago for $300, was then repaired at the end of the 2 nd year at a cost of $150, then just
sold for $850?
300 +/-
150 +/1
300 +/CF0
0
CFj
150 +/CFj
0
CFj
0
CFj
0
CFj
850
CFj
IRR
6
850

entered as follows:
(HP10B) 0 CFj 3 Nj
(HP12c) 0 g CFj 3 g Nj
12.54%
Page: 49
IRR of Unequal Cash Flows

What is the IRR earned on a 3 year fund that pays quarterly distributions. Distributions are not reinvested back into the
fund. The initial investment was $12,000 and the value of the fund at the time of the last quarterly distribution was
$16,500?
12,000
1
Q1
50
12,000 +/- CF0

50 CFj 4
57 CFj 4
60 CFj 3
16,500 +
60
IRR x 4 =
12.36%
Q2
50
Q3
50
Q4
50
2
Q1
57
Q2
57
Q3
57
Q4
57
3
Q1
60
Q2
60
Q3
60
Q4
60
16,500
Nj
Nj
Nj
Cfj
Note: Multiple Cash Flows are illustrated on the HP 10B

Page: 50
Interest Rate
Client has $1000, he wants it to be $1470 in 5 years. What annual rate will be needed.
1,000 +/- PV
1,470 FV
5 n
i
8.01%
Client has $1000, he wants it to be $1470 in 5 years. What annual rate will be needed, if it is
compounded quarterly? (More Frequent Compounding)
1,000
1,470
5 x
i
(1.94)
+/- PV
FV
4 = n
x
4 = 7.78
Page: 51
Rate of Return
An investor bought a stock for $28 and sold it for $48 after 4 years. What is the stock's Holding Period
Return?
48 - 28 = 20 28 = .7142
20
HPR=
= .7142 = 71.42%
28
Sales Price + Income - Purchase Price
HPR=
Purchase Price
What is the stock's Average Annual Compound Rate of Return?IRR = 14.43%
28 +/- CF0
0 CFj
0 CFj
0 CFj
48 CFj
IRR
14.4249%

entered as follows:
(HP10B) 0 CFj 3 Nj
(HP12c) 0 g CFj 3 g Nj
28 +/- PV
48 FV
4 n
i
14.4249%
Page: 52
Rate of Return
Assume an investor purchased a stock for $30, sold it for $45 after 6 years, and
collected an annual dividend of $1.75 during the 6-year period. What was the HPR
and IRR on this investment?
HPR=
HPR=
Sales Price + Income - Purchase Price

Purchase Price
45 + 10.50 - 30
30
25.50
30
= .85 or 85%
30 +/- CF0
1.75 CFj 5 Nj
45 + 1.75 = CFj
IRR
11.99 or
12%
Page: 53
Rate of Return
Your client invested $12,000 in the Achievement Mutual Fund 5 years ago. All dividends and
disbursements paid to the client from the fund have been reinvested directly back into the fund.
The client instructed the fund to reinvest all payments, so they were never sent to the client. If this
mutual fund investment is completely liquidated today for $19,000, What was the internal rate of
return on this investment?
12,000 +/CF0
0 CFj
0 CFj
0 CFj
0 CFj
19,000 CFj
IRR
= 9.63%
(or)
12,000 +/19,000 FV
5 n
i
= 9.63%
PV
Page: 54
Rate of Return
A bond has a market price of $875. The bond pays 12% coupon interest
semiannually. The bond will mature in 7 years and will pay a face value of $1,000.
What is the yield to maturity or internal rate of return for this bond?
875 +/- CF0

60 CFj 13 Nj
1000 + 60 = CFj
IRR
7.4698 x 2 = 14.939
or 14.94%
(or)
7 x 2 = n
875 +/- PV
1,000
FV
x .12 2 = PMT
i
x 2 = 14.94%
Page: 55
IRR
Your client has invested in a mutual fund by using a Dollar-cost Averaging Plan. Purchases of
$2,000 each have been made at the Beginning of each year for 5 years. The fund is now (at the
end of the 5th year) worth $13,000. What is the IRR for this Investment?
BGN
2,000 +/2,000 +/2,000 +/2,000 +/2,000 +/13,000
IRR
CFj
CFj
CFj
CFj
CFj
CFj
8.8768
or
8.88%
IRR is the average annual compound return.

some could have earned less.
Some years could have earned more than 8.88% &
Page: 56
IRR
Investments do not always have equal periodic payments. For example, an investor wants to know what average
annual return can be expected for a real estate investment. The cash flows that are expected for each year that the
property will be owned have been estimated. Negative cash flows, such as maintenance, insurance, & taxes, have been
subtracted from positive cash flows, such as rent, for each of 5 years to get a net amount for each year.
The
purchase price of the property is $125,000 & the client expects that the property could be sold at the end of 5 years for
$175,000. Net cash flows for each year are as follows:
End of Year 1
End of Year 2
End of Year 3
End of Year 4
End of Year 5
- 15,000
- 7,000
+ 5,000
+ 12,000
+ 15,000
Note: The last cash flow occurs at the same time that the client predicts that the property could be sold for $175,000.
Therefore, the total cash flow for the end of Year 5 is $175,000 + $15,000 = $190,000. If cash flows occur as expected,
What would the IRR be for this investment?
125,000 +/CFi
15,000 +/- CFi
7,000 +/CFi
5,000
CFi
12,000
CFi
175,000 +
15,000 =
IRR
7.5544
or
7.55%
CFi
Page: 57
IRR or Yield To Maturity
What is the IRR (or yield to maturity) earned on an investment in a bond with a $1,000 face value, a
price of $966, a 10% coupon, and 3 years to maturity?
966 +/1
50
Coupon: 1,000 x
.10 = 100
966 +/CF0
50 CFj
50 CFj
50 CFj
50 CFj
50 CFj
1,000
+ 50
= CFj
IRR x 2 =
11.369or
11.37%
2
50
3
50
4
50
5
50
6
50
1,000
2 = 50

entered as follows:
(HP10B) 50
(HP12c) 50
CFj 5 Nj
g CFj 5 g Nj
Page: 58
IRR (or Yield To Maturity)
What is the IRR (or Yield to Maturity) earned on an investment in a Zero-coupon bond with a $1,000 face
value, a price of $746 and 3 years to maturity?
Note: Zero-Coupon bonds have no coupon interest payments. However, semiannual compounding is still
used.
746 +/0 CFj

0 CFj
0 CFj
0 CFj
0 CFj
1,000 CFj
IRR
5.0051 x
CF0
746 +/1,000
3 n
i
PV
FV
= 10.01%
Page: 59
Intrinsic Value (or price) of a Zero-Coupon Bond
What is the Intrinsic Value (or price) of a Zero-Coupon Bond with a $1,000 face
value, yield to maturity of 10.01% and 3 years to maturity?
Note: Zero-Coupon bonds have no coupon interest payments. However, semiannual compounding is still
used.
CF0
0 CFj
0 CFj
0 CFj
0 CFj
0 CFj
1,000 CFj
10.01 2 = i
NPV
746.0022
or $746.00
(or)
1,000
FV
3 x 2 = n
10.01
2
PV
Page: 60
IRR
What is the IRR that has been earned from investing in a coin collection that was
purchased for $1,200 6 years ago,
was expanded at the end of the 3rd year at a cost of $400, and
has just sold for $2,500?
$2500
0
$1200
3
$400
1,200
+/CF0
0 CFj
0 CFj
400 +/CFj
0 CFj
0 CFj
2,500
CFi
IRR
8.7545 or
8.75%
Page: 61
Periodic Payments of Singles Sums/Annuities
A client wants $90,000 in 7 years. She can invest $32,000 today at 11% annually.
She plans to make additional payments at the END of each year. What periodic
payment will be needed to meet her goal?
90,000 FV
32,000 +/PV
7
n
11 i
PMT
$2,408.49
Page: 62
Serial Payment for a Future Sum
Client wants to retire in 5 years. In todays dollars he will need $100,000 in 5 years.
He assumes inflation will be 4% and he can get 7% on after-tax investments.
What series of payments will add up to $121,665.29 in 5 years, ($121,665.29 = FV of
$100,000 today)?

1.07 1.04 - 1 x 100 = i
100,000
FV
5
n
PMT
18,878.96 x 1.04 =
$19,634.11
Page: 63
Periodic Payment or Receipt
Client wants to buy a $10,000 auto, financed at 12% annually for 4 years. What
payment is required at the END of each of the 4 years?

10,000 PV
4 n
12 i
PMT
$-3292.34
Page: 64
Periodic Payment or Receipt (more frequent compounding)
Client borrows $10,000. The loan is repaid over 4 years at 12% annually
compounded monthly. What are the monthly payments?

10,000 PV
12 12 = i
4 x 12 = n
PMT
$-263.34
Page: 65
Periodic Payment/Receipt (frequent compounding)
Client wants $10,000 in 4 years. He can earn 12% annual compounded monthly. He
wants to put money away at the BEGINNING of each month to meet his goal. What
monthly payment is required?

BGN
10,000 FV
12 x 12 = i
4 x 12 = n
PMT
$-161.72
Page: 66
Mortgage Payment
John Johnson recently purchased a house for $350,000. He made a down payment
of 20% and financed the balance over 30 years at 7%. How much is Johns
monthly payment?

350,000 x .8 = PV
30 x 12 = N
7 12 = I/YR
0 FV
PMT
$-1,862.847
Page: 67
Mortgage Payment
Nathan McCoy made an offered of $370,000 to purchased a house. He made a

down payment of 5% and financed the balance over 15 years at 5.5%. How much
is Johns monthly payment?

370,000 x .95 = PV
15 x 12 = N
5.5 12 = I/YR
0 FV
PMT
$-2,872.05
Page: 68
TVM Calculation
Jennie Phillips had a goal of buying a cabin in Wisconsin when she retires. The size and type of
cabin she wants on 2 acres of land costs $85,000 today. She has graduate from a highly
esteemed college today with a 4.0 GPA, therefore she believes she can get a good job and achieve
her goal. If inflation averages 3% and she will retire in 40 years, how much will this cabin cost her
in 40 years?

85,000 PV
40 = N
3 = I/YR
FV
$-493,829
Page: 69
TVM Calculation
Blake Millers grandfather has just retired from farming the fall of 2002 after harvesting his last crop,
he gave Blake his entire farm because Blake has been such a great grandson. Blakes
grandfather paid $7,500 for the farm in 1941. Today the gift was valued at 350,000 by the IRS.
Blake wonders what his grandfathers rate of return was on his original investment of $7,500?

7,500 PV
61 = N
350,000 = FV
I/YR
6.5%
Page: 70
TVM Calculation
David Schnorr, a very intelligent young man who has just become Mr. Minnesota. Coincidentally 5
young ladies have asked him to be their husband. While he is smart enough to wait for Ms. Right
to come along later who loves him for his wonderful personality, he knows the most affluent young
lady Darci has a net worth of $700,000 and invests expecting 8% over the long term. On the other
hand, one of the others Tanya has a net worth of only $550,000 but invests more aggressively and
should receive a market return of 10%. He wonders, which of the 2 ladies will have the highest
net worth simply based on todays information, in 40 years? While he thinks about this very often,
he says it has nothing to do with agreeing to the offers. (at thats his story and hes sticking to it)

Darci
700,000 +/- PV
40 N
8 I/YR
FV
$15,207,165
Tanya
550,000 +/- PV
40 N
10 I/YR
FV
$24,892,590
David is Still Thinking!

Page: 71
Continuous Compounding FV
State Bank offers compounding daily at 6% and National Bank offers continuos
compounding at 5.9%.
You deposit $1,000 into each bank. After 2 years, you withdraw the funds. What is
the difference in the amount you get from each bank?
State Bank
1000 +/- PV
6 365 = i
2 x 365 = n
FV
= 1,127.49
National Bank
0.059 x 2 = ex x 1000
= 1,125.24
1,127.49 - 1,125.24 = 2
Page: 72
Continuous Compounding PV
In 6 years, a client will receive $100,000. If the account earns a

9% rate compounded continuously, how much is that account
worth today?
0.09 x 6 = ex = 1.7160
100,000 1.7160 =
$58,275.06
Page: 73
Mike Kibley purchased an Oriental rug for $8,000. Today, he sold the rug for $15,000. Mike determined the average
annual compound rate of return on the rug was 12%. Approximately how many years did Mike own the rug? (rounded to
the nearest .0000)
a. 6.8452
b. 5.5468
c. 4.5337
d. 5.8451
e. 6.0000
8,000 +/- PV
15,000 FV
12 i
0 PMT
n = 5.5468
Note 1: Anytime you calculate for N (term) using a HPI2C you may need to find the answer by trial and error. The HPI2C
calculator rounds to the nearest integer when calculating N, and therefore, your answer is not always precise when
calculating the term. You must then take what you have and find the exact answer by trial and error methods. The HP
Will give you 5.533.
Note 2: It you are using an HPI2C and use correct N of 5.5468 the F! will be $15,023.84, which, of course, looks
incorrect. The error is in the way the HP works. )f you are using a HPIOB, HPI7BII, Sharp EL-733A, or TIBAII Plus you
will get 5.5468 (the correct N). You can mathematically prove this answer by taking 1.12 raised to the 5.5468 power and
then multiply by $8,000 to get $15,000.04.
Page: 74
Today, Raul put all of his cash into an account earning an annual interest rate of 9% compounded monthly.
Assuming he makes no withdrawals or additions into this account, approximately how many years must Raul
wait to double his money? (rounded to the nearest .00)
a. 7.75
b. 8.25
c. 8.75
d. 7.25
e. 8.00
1
2
9
0
n
+/- PV
FV
12 =
PMT
12 =
=
0.75
7.75
7.73
HP12C
Other Calculators
Page: 75
Clarence Cushman has been investing $1,000 at the end of each year for the past 15 years. How much has
accumulated assuming he has earned 10.5% compounded annually on his investment?
a.
b.
c.
d.
e.
$20,303.72
$23,349.28
$33,060.04
$36,531.34
None of the above
0
PV
PMTOA
+/1,000
10.5 i
15 n
FVOA = $33,060.04
Page: 76
Christine Valico has been dollar-cost averaging into a mutual fund by investing $2,000 at the end of every
quarter for the past 7 years. She has been earning an average annual compound return of 11% compounded
quarterly on this investment How much is the fund worth today?
a.
b.
c.
d.
e.
0
PMTOA
11 /
7 x
FVOA
$78,266.19
$81,170.29
$82,721.95
$84,996.80
$86,875.47
PV
4
4
=
+/2,000
= i
= n
$82,721.95
Page: 77
Bill Russell has been investing $3,000 at the beginning of each year for the past 15 years. How much has
accumulated assuming he has earned 8% compounded annually on his investment?
a.
b.
c.
d.
e.
0 PV
PMTAD
8 i
15 n
FVAD =
+/-
$91,896.04
$87,972.85
$84,696.81
$81,456.34
None of the above
3,000
$87,972.85
Page: 78
Chrissy Nables has been Dollar-Cost Averaging in a mutual fund by investing $2,000 at the beginning of
every quarter for the past 7 years. She has been earning an average annual compound return of 11%
compounded quarterly on this investment. How much is the fund worth today?
a.
b.
c.
d.
e.
Begin
0 PV
PMTAD
11 4
7 x 4
FVAD =
$82,721.95
$93,902.42
$91,389.22
$84,996.80
None of the above
+/2,000
= i
= n
$84,996.80
Page: 79
Stuart Wood expects to receive $5,000 at the end of each of the next 4 years. His opportunity cost is 14%
compounded annually. What is this sum worth to Stuart today?
a.
b.
c.
d.
e.
PMTOA
14
i
4
n
FV
0
PVOA
$14,568.56
$16,608.16
$19,568.56
$17,165.41
None of the above
5,000
($14,568.56)
Page: 80
Tim, injured in an automobile accident, won a judgment that provides him $1,500 at the end of each 6-month
period over the next 6 years. If the escrow account that holds Tim's settlement award earns an average
annual rate of 11% compounded semiannually, how much was the defendant initially required to pay Tim to
compensate him for his injuries?
a.
b.
c.
d.
e.
PMTOA
11
6 x
FV =
PVOA
$6,345.81
$7,043.85
$12,927.78
$13,638.80
None of the above
1,500
12 = i
2 = n
0
= ($12,927.78)
Page: 81
Jane wants to withdraw $4,000 at the beginning of each year for the next 7 years. She expects to earn 10.5%
compounded annually on her investment. What lump sum should Jane deposit today?
a. $19,157.21
b. $18,667.20
c. $20,627.25
d. $21,168.72
PMTOA
10.5 i
7
n
FV
0
PVOA
4,000
($21,168.72)
Page: 82
Connie wants to withdraw $1,200 at the beginning of each month for the next 5 years. She expects to earn
10% compounded monthly on her investments. What lump sum should Connie deposit today?
a.
b.
c.
d.
e.
PMTAD
10
5 x
FV =
PVAD
$56,478.44
$56,949.10
$58,630.51
$59,119.10
None of the above
1,200
12 = i
12 = n
0
= ($56,949.10)
Page: 83
Gary received an inheritance of $200,000. He wants to withdraw equal periodic payments at the beginning of
each month for the next 5 years. He expects to earn 12% annual interest, compounded monthly on his
investments. How much can he receive each month?
a.
b.
c.
d.
e.
PV =
12
5 x
FV =
PMTAD
$4,404.84
$4,448.89
$49,537.45
$55,481.95
None of the above
200,000
12 = i
12 = n
0
= ($4,404.84)
Page: 84
Eugene wants to purchase a fishing camp in 5 years for $60,000. What periodic payment should he invest at
the beginning of each quarter to attain the goal if he can earn 10.5% annual interest, compounded quarterly
on investments?
a.
b.
c.
d.
e.
FV =
10.5
5 x
PV =
PMTAD
$2,319.42
$2,260.09
$8,805.91
$9,730.53
None of the above
60,000
4 = i
20 = n
0
= ($2,260.09)
Page: 85
Tina wants to purchase a home 6 years from now. She anticipates spending $150,000. To attain this goal,
how much should Tine invest at the end of each 6-month period if she expects to earn a 12% annual
compound rate of return, compounded semiannually, on her investments?
a.
b.
c.
d.
e.
FV =
15
6 x
PV =
PMTOA
$18,483.86
$16,503.44
$8,891.55
$8,388.26
None of the above
150,000
2 = i
2 = n
0
= ($8,891.55)
Page: 86
Janet purchased a car for $19,500. She is financing the auto at 11% annual interest rate, compounded
monthly for 3 years. What payment is required at the end of each month to finance Janets car?
a.
b.
c.
d.
e.
PV =
11
3 x
FV =
PMTOA
$606.71
$638.40
$632.61
$684.97
None of the above.
19,500
12 = i
12 = n
0
= ($638.40)
Page: 87
Shane estimates his opportunity cost on investments at 10.5% compounded annually. Which one of the
following is the best investment opportunity for Shane?
a.
b.
c.
d.
e.
To receive $45,000 today

To receive $120,000 at the end of 10 years
To receive $5,500 at the beginning of each year for 15 years
To receive $5,500 at the end of each year for 19 years
To receive $5,750 at the end of each year for 17 years
A
Option A
PV = $45,000
Option B
FV = 120,000
10.5
= i
10 = n
0 PMT
PV = $44,213.86
Option C
PMTAD
5,500
10.5
= i
15 = n
FV = 0
PVAD ($44,935.97)
Option D
PMTOA
5,500
10.5
= i
19 = n
FV = 0
PVOA ($44,523.35)
Option E
PMTOA
5,750
10.5
= i
17 = n
FV = 0
PVOA ($44,731.47)
Page: 88
Richard estimates his opportunity cost on investments at 9% compounded annually, which one of the
following is the best investment opportunity?
a. To receive $100,000 today
b. To receive $310,000 at the end of 15 years
c. To receive $1,200 at the end of each month for 11 years compounded monthly
d. To receive $65,000 in 5 years and $125,000 5 years later
e. To receive $65,000 in 5 years and $200,000 10 years later
C
Option A
PV = $100,000 FV
9
15
0
PV
Option B
= 310,000
= i
= n
PMT
= $85,106.79
Option C
PMT
= 1,200
9 / 12 = i
11 x 12 = n
FV = 0
PVOA ($100,327.70)
Option D
FV
65,000
9 = i
5 = n
PMT
= 0
PV ($42,245.54)
Option E
FV
65,000
9 = i
5 = n
PMT
= 0
PV ($42,245.54)
FV
125,000
15 = n
9 = i
9 = i
5 = n
FV
200,000
PMT
= 0
PMT
= 0
PV ($52,801.35)
PV ($54,907.61)
D) 42,245.54 + 52,801.35 = 95,046.54
E) 54,907.61 + 42,245.54 = 97,153.15
Page: 89
Judy Martin estimates her opportunity cost on investments to be 12% compounded annually. Which one of
the following is the best investment opportunity?
a.
b.
c.
d.
e.
To receive $50,000 today

To receive $40,000 at the end of 4 years and $120,000 8 years later at the end of the year
To receive $5,000 at the beginning of each 6-month period for 9 years compounded semiannually
D
Option A
PV = $50,000 FV
12
14
0
PV
Option B
= 250,000
= i
= n
PMT
= $51,154.95
Option C
FV
40,000
12 = i
4 = n
PMT
= 0
PV ($25,420.72)
Option D
PMT
= 5,000
12 / 2 = i
9x2 = n
FV = 0
PVAD ($57,386.30)
FV
12
3
0
PV
Option E
= 60,000
= i
= n
PMT
= $42,706.81
FV
120,000
12 = i
12 = n
PMT
= 0
PV ($30,801.01)
C) 25,420.72 + 30,801.01 = 56,221.73
Page: 90
Morris and Jo Ann Simpson are ready to retire. They want to receive the equivalent of $25,000 in today's
dollars at the beginning of each year for the next 20 years. They assume inflation will average 4% over the
long run, and they can earn an 8% compound annual after-tax return on investments.
What lump sum do Morris and Jo Ann need to invest today to attain their goal?
a.
b.
c.
d.
e.
$265,089.98
$339,758.16
$353,348.49
$357,681.56
None of the above
PMT 25,000
1.08 1.04 1 x 100 = i
20 = n
FV = 0
PVAD = ($357,681.56)
Page: 91
Stuart needs an income stream equivalent to $50,000 in today's dollars at the beginning of each year for the
next 12 years to maintain his standard of living. He assumes inflation will average 4.5% over the long run,
and he can earn a 9% compound annual after-tax return on investments. What lump sum does Stuart need
to invest today to fund his needs?
a.
b.
c.
d.
e.
$480,878.04
$455,929.00
$476,445.85
$461,025.81
None of the above
PMT 50,000
1.09 1.045 1 x 100
=
12 = n
FV = 0
PVAD = ($480,878.04)
Page: 92
Clark Roberts wants to retire in 9 years. He needs an additional $300,000 (today's $) in 9 years to have
sufficient funds to finance this objective. He assumes inflation will average 5.0% over the long run, and he
can earn a 4.0% compound annual after-tax return on investments. What serial payment should Clark
invest at the END of the first year to attain his objective?
a.
b.
c.
d.
e.
$34,623.42
$34,689.00
$36,354.60
$36,423.45
None of the above
300,000 FV
1.04 1.05 1 x 100 = (0.95238)* = i
9 = n
PV = 0
PMTOA = ($34,623.42) x 1.05 = ($36,354.60) Change Sign
*The interest rate is negative because the inflation rate exceeds the return.
Page: 93
Judy Danos wants to retire in 9 years. She needs an additional $300,000 (today's $) in 9 years to have
sufficient funds to finance this objective. She assumes inflation will average 5.0% over the long run, and she
can earn a 4.0% compound annual after-tax return on investments. What will be Judy's payment at the end
of the second year?
a.
b.
c.
d.
e.
$38,244.62
$38,172.33
$36,354.60
$34,623.42
None of the above
B
300,000 FV
1.04 1.05 1 x 100 = (0.95238)* = i
*The interest rate is negative because the inflation rate exceeds the return.
9 = n
PV = 0
PMTOA = ($34,623.42) x 1.05 = ($36,354.60) Change Sign
36,354.60* x 1.05 = $38,172.33
Page: 94
John wants to start his own business in 6 years. He needs to accumulate $200,000 (today's $) in 6 years to
sufficiently finance his business. He assumes inflation will average 4%, and he can earn a 9% compound
annual after-tax return on investments. What serial payment should John invest at the end of the first year to
attain his goal?
a.
b.
c.
d.
e.
$29,546.11
$30,727.95
$28,190.78
$29,318.41
None of the above
PMT 200,000
1.09 1.04 1 x 100 =
6 = n
FV = 0
PMTOA = $29,546.11
i
x
1.04
($30,727.95) Change Sign
Page: 95
Sarah wants to start her own business in 6 years. She needs to accumulate $200,000 (today's $) in 6 years
to sufficiently finance her business. She assumes inflation will average 4%, and she can earn a 9%
compound annual after-tax return on investments. What will be Sarah's payment at the end of the second
year?
a.
b.
c.
d.
e.
$28,190.78
$30,727.95
$30,491.00
$31,957.07
None of the above
D
200,000 FV
1.09 1.04 1 x 100 =
6 = n
PMTOA = $29,546.11
30,727.95 x 1.04 =
Change Sign
i
x 1.04 =
$31,957.07
($30,727.95)
Page: 96
Determine the future value of a periodic deposit of $6,100 made at the beginning of each year for10 years to
a mutual fund expected to earn 11.5% compounded annually during the projection period. Calculate the
future value rounded to the nearest dollar.
a.
b.
c.
d.
e.
$104,493
$116,510
$113,040
$124,344
$39,229
The question specifies that the deposits are made at the beginning of each year; therefore, the student is
required to calculate the future value of an annuity due. Answer A is the future value of deposits made at the
end of the year. Answer C is incorrect because the calculation is based on the future value of the deposits
made at the end of the year at 10% for 11.5 years, a reversal of the term and the interest rate. Answer D is
similar to C except the calculation is based on an annuity due. Answer E is the present value of an annuity
due instead of the future value of an annuity due. The keystrokes used with a financial calculator are:
PMTAD
i =
N =
PV =
FVAD
= ($6,100)
11.5
10
$0
= $116,510
Page: 97
Determine the future value of a periodic deposit of $6,100 made at the beginning of each year for 10 years to
a mutual fund expected to earn 11.5% compounded quarterly during the projection period. Calculate the
future value rounded to the nearest dollar.
a. $447,130
b. $116,510
C. $119,931
d. $107,076
e. $459,985
Step 1
($1)
PV
4 i
11 4 = n
0 PMT
FV = 1.120055
Therefore i = 12.0055
Step 2
0 PV
(6.100) PMTAD
12.0055
i
10 n
FV = 119,931
Answer A calculates the future value of a $6,100 deposit made at the end of each quarter for 40 quarters using i = 2.875
(11.5 + 4).
This is incorrect because the question specifies an annual deposit and not a quarterly deposit.
Answer E calculates the future value of an annuity due of a $6,100 deposit made at the beginning of each
quarter for 40 quarters using i = 2.875 (11.5 + 4).
Finally, answer B calculates the future value of an annuity due of a $6,100 deposit made annually for 10 years at
i = 11.5.
Page: 98
A client is to receive $650 per month for 5 years beginning one year from today at the beginning of the
month. What is the present value of all payments (rounded to the nearest dollar) assuming an annual
discount rate of 9%?
a.
b.
c.
d.
e.
$33,070
$28,943
$30,339
$31,548
$28,728
B, There are two steps in solving this question.

Step 1: calculate the present value of an annuity of $650 per month for 60 months at a discount rate of 9%.
Financial Calculations: Begin, PMT = $650, i = .75 (9 + 12), n = 60 (5*12) and solve for PV1 = $31,548
This provides the present value of an annuity one-year from now.
Step 2: This amount is further discounted to the present, one year.
Financial Calculation: Begin, FV = $31,548, i = 9, n =1 and solve for PV = $28,943
Answer A is the present value of an annuity due of $7,800 (650 * 12) received for five years at a discount rate of 9%.
Answer C is the present value of answer A discounted for one year at 9%.
Answer D is the first part of the correct calculation.
Finally, answer E is the present value of an ordinary annuity instead of an annuity due.
Page: 99
The rate which produces a Net Present Value of a series of discounted cash flows equal to zero is called
the:
a.
b.
c.
d.
e.
Return on investment (ROI)

Internal rate of return (IRR)
Average rate of return
Cost of capital
Inflation rate
B
The question presented is the definition of Internal Rate of Return.
Page: 100
If the net present value of a series of discounted cash flows is greater than zero, one could interpret that:
1. The discounted cash flows exceed the investment outlay.
2. The rate of return is higher than the cost of capital.
3. The return on investment is lower than the internal rate of return.
4. The internal rate of return was the discount rate used.
a.
b.
C.
d.
e.
1 only
1 and 4
1, 2, 3, and 4
2 and 3
2 only
A
A positive net present value of a series of discounted cash flows means that the discounted cash flows exceed the
investment outlay.
Statements 2 and 3 cannot be correct because the question does not provide appropriate information.
Statement 4 is not correct because if the internal rate of return were the rate used, the net present value amount would
be equal to zero.
Page: 101
If the net present value of a series of discounted cash flows is equal to zero, one could interpret that
1. The discounted cash flows equal the investment outlay.
2. The rate of return is lower than the cost of capital.
3. The return on investment is lower than the internal rate of return.
4. The internal rate of return was the discount rate used.
a.
b.
c.
d.
e.
1 only
1 and 4
1, 2, 3,and 4
2 and 3
2 only
B
Statements 1 and 4 are correct
A net present value of a series of discounted cash flows equal to zero means the discounted cash flows are equal to the
investment outlay.
Page: 102
If the net present value of a series of discounted cash flows is less than zero, one could interpret that:
1.
2.
3.
4.
The discounted cash flows are lower than the investment outlay.
The rate of return is lower than the cost of capital.
The return on investment is higher than the internal rate of return.
The internal rate of return was the discount rate used.
a.
b.
c.
d.
e.
1 only
1 and 4
1, 2, 3, and 4
2 and 3
2 only
A
A negative net present value of a series of discounted cash flows means the investment outlay exceeds the discounted
cash flows.
Page: 103
What is the monthly payment made at the end of each month required to accumulate a balance of $150,000
in 10 years at an assumed interest rate of 11% compounded monthly and a beginning savings balance of
$2,500?
a.
b.
c.
d.
e.
$684.97
$691.25
$656.81
$650.85
$712.14
C
There are two steps to solving this question.
The first step is to compute the future value of the beginning savings balance.
PV = $2,500, i = .92 (11 / 12), N = 120 (10 * 12) and solve for PV = $7,472.87.
This amount is subtracted from the required balance of $150,000 to arrive at the amount that needs to be funded of
$142,527.13.
Solving for this amount is as follows:
P4 = $142,527.13, i = .92 (11 + 12), N = 120 (10 * 12) and solve for PMT OA = $656.81.
Answer D has the correct inputs except the answer is the calculation of an annuity due.
Answer A calculates the annuity due assuming no beginning savings balance.
Answer B calculates the payment required assuming no beginning savings balance.
Answer E calculates the annual payment required assuming a beginning balance and divides that number by 12.
Page: 104
Joe wants to buy a business in 10 years. He estimates he will need $150,000 at that time. He currently has
a zero-coupon bond with a market value of $1,157.98 that he will use as part of the required amount. The
zero-coupon bond has a face value of $2,500 and will mature in 10 years. The bond has a semiannual
effective interest rate of 3.923%. In addition to the bond, he wants to save a monthly amount to reach his
goal. What is Joe's required monthly payment made at the beginning of each month in order to accumulate
the $150,000, including the zero-coupon bond, at an assumed interest rate of 11%?
a.
b.
c.
d.
e.
$676.10
$673.56
$669.96
$679.73
$800.91
B
The amount to be funded is $147,500, the required amount of $150,000 less the face amount of the bond of $2,500.
PV = $147,500, i =.92 (11 + 12), N = 120 (10 * 12) and solve for PMT AD = $673.56.
Answer A is incorrect because the payment is calculated as if the present value of the bond is projected at 11%, the
assumed rate of return.
It is unnecessary to project the present amount since the face value at the end is known.
Answer C is the same as A except the payment is solved as an annuity due.
Answer D calculates the future value correctly ($147,500) except as a regular payment and not an annuity due.
Answer E calculates the annuity due of $147,500 except at an interest rate of 8%, which is the implicit rate of the bond.
Page: 105
The Financial Planning Process
Benefits of Financial Planning

Integrates the Financial Mission, Financial Goals, and Financial Objectives into one
Comprehensive Cohesive Plan.
Identifies and Plans for Goals, making them more likely to be achieved.
Identifies Risk Exposures.
Gives more control over Financial Destiny.
Allows for better Strategic Choices.
Creates a framework for Feedback, Evaluation, and Control.
Establishes Measurable Goals and Expectations.
Develops an improved Awareness of Financial Choices, and of how the internal and
external environments affect those choices.
Establishes Rationality and Reality and purges the client of pie in the sky ideas and
wishful thinking.
Brings Financial Order and Discipline to clients.
Instills Confidence that goals will be achieved.
Identifies the Changes in Actions and Behaviors necessary to accomplish financial goals.
Page: 106
Provides a forum for rationalizing the need for change.
Page: 107
Financial Planning is about making Financial Choices and

Allocating Scarce Resources.
Personal Utility Curves
Economic Curves that describe the Satisfaction that an individual
receives from selecting a thing and/or additional units of that thing.
Opportunity Costs
The highest valued alternative not chosen.
That is to say what is given up in order to have another choice.
Page: 108
Lifecycle Phases & Characteristics
Page: 109
Lifecycle Phases & Characteristics

As clients move through the various phases of life, their goals and objectives will
change:
Asset Allocation Phase
Usually in the 25 to 50 age range
Young clients start out with more debt, less cash and net worth
Conservation/Protection Phase
Usually in the 35 to retirement age range
Clients have accumulated assets due to greater cash flow, now may
become slightly more risk adverse.
Distribution/Gifting Phase
Begins when they realize they have the money to do what they want.
Clients have little or no debt, and relatively high net worth.
Page: 110
6 Steps of the Financial Planning Process (EG ADIM)

1. Establishing Client Planner Relationship
Explain Issues and Concepts,

Explain Services Provided,
2. Gathering Data
Collect Qualitative (subjective) and Quantitative (measurable or factual) Information,

Establishing and Quantifying Goals (specific dollar amount & time frame),
Prioritizing or Ranking Goals in order of importance,
Determine Clients Time Horizons and Risk Tolerance
3. Analyzing and Processing Information
Identify Strengths and Weaknesses,

Consider Options and Strategies for Achievement of Goals
4. Develop and Present a Comprehensive Financial Plan
Prepare Financial Statements

Develop a Budget and a Schedule for Implementation,
Write the Plan and Explain the Plan,
Collaborate with the client to ensure they are comfortable with the plan
5. Implement the Plan
Assist client as needed with products, and working with other professionals
6. Monitoring the Plan
Periodically Review Plan for continued appropriateness, continued progress on goals.
Page: 111
Gathering Data
Whatever the sequence of interviews might be, the financial planner collects Quantitative and Qualitative Data such as
that outlined below, depending upon the clients goals.
Quantitative Data (See Practice Standard 200-2 In Appendix B.)

General Family Profile including: names, addresses, and telephone numbers of financial advisors
Assets and Liabilities, as well as Cash Inflows and Outflows (Financial Statements)
Insurance Policy Information
Employee Benefit and Pension Plan information
Tax Returns for the last three years
Details on Current Investments
Retirement Benefits Available
Information about any client-owned businesses
Copies of Wills and Trusts
Lifetime Gifting programs
Qualitative Data (subjective, not exactly measurable)
Goals and Objectives (dreams and desires)
Health Status of client and family members (heredity issues as well)
Interests and Hobbies
Expectations about Employment
Risk Tolerance Level
Anticipated Changes in current or future lifestyle
Page: 112
Steps to the Budgeting Process
1. Gather the Previous Years Bank, Credit Card and Relevant Statements,
Prepare a spread sheet, or

Use a computer program such as Quicken or MS Money,
Create Categories of expenses (such as: dinning out, utilities, insurance)
2. Identify the Various Categories of Expenses, and The Totals As a Percentage of Gross (total)
Income
3. Identify the Various Categories of Expenses As:
Fixed
Discretionary, and
Inflation Sensitive
4. Forecast Next Years Monthly Income

5. Determine Next Years Monthly Expenses
Remember to account for the non-monthly expenses
6. Project the Monthly Expenses (Budget) for the Next 12 Months

That is, reconcile steps 4 and 5
7. Compare Past Actual Monthly Expenses to the Projections

Adjust the following monthly expenses accordingly
8. Continue To Analyze the Budget Monthly,
Examples of expenses which can be controlled:

Pick out the specific discretionary expenses you can control,
Page: 113
Utilities, Long Distance telephone calls and Dining Out
Page: 114
Other Budgeting Tips

Remember to include an expense item for:
The Emergency Fund should be between 3 to 6 months of expenses.

Scheduled Expenses
Investment Savings
Families with Highly Variable Incomes or Expenses should prepare 2 budgets:

1. A Worst Case Budget based on the lowest income and highest expenses
2. A Average Case Budget based on reasonably expectations of expenses
Page: 115
Liquidity vs. Marketability
Liquidity
The ability to sell an asset quickly at a
competitive price, with no loss of principal and
little price concession.
Marketability
The ability of an investor to find a ready
market where the investor may sell their
investment.
Page: 116
Emergency Fund (All Financial Plans Need A Base)

The Emergency Fund is that base:
Should be Liquid Savings and Money that can be accessed without delay, penalty, or incurring debt.
How Much
Individuals need to retain a sufficient amount of Liquid Assets at all times to handle emergencies so they will
not have to borrow money or liquidate investments at a potentially inopportune time.
However, because investments with the greatest liquidity tend to have the lowest earnings, it is
important that the amount that is held out for an Emergency Fund is not excessive.
A good rule of thumb is that the client should have the equivalent of 3 to 6 Months of Fixed and
Variable Expenses in liquid accounts.
This would exclude the expense of Income-related Taxes and Contributions to savings and
investments.
Appropriate Assets for an Emergency Fund are Cash and/or Cash Equivalents such as:
Checking Accounts (excluding funds to be utilized for normal expenses, which from a practical
standpoint means that you should reserve an amount equal to one month's expenses, and can use
any remaining checking amounts),
Savings Accounts
Money Market Accounts or Funds, which all can be converted to cash quickly.
A Certificate of Deposit may be appropriate if it matures in the near term (<90 Days)
CDs with maturity dates of more than 90 days are not appropriate for emergency use because of the typical
Early Withdrawal Penalties
Page: 117
Emergency Fund (Flexability)
Rules of Thumb are not for everyone:

Clients with Extremely Stable Sources of Income may need less than 3 months of funds.
A client may have several sources of income (from rental real estate), both
spouses may have extremely stable employers (government jobs)
For these clients smaller Emergency Funds may be required.
Clients with Very Unstable Sources of Income, may require more than 6 months of
funds.
Some clients may have very unpredictable incomes (real estate sales people)
For these clients Larger Emergency Funds may be required.
Some financial planners also recommend that clients set up "Opportunity Funds," which
are:
Liquid or Semi-liquid Accounts available for large purchases of a non-emergency
nature that the client may wish to make, such as jewelry, furniture, or travel.
Such funds would prevent the client from having to borrow to attain these items.
Some planners use Opportunity Funds for investing purposes, ensuring that clients have
liquid funds available to take advantage of investment opportunities that may arise.
Page: 118
Financial Statements
Statement of Financial Position (Balance Sheet)

See examples in your books
1.
2.
3.
4.
5.
Assets and Liabilities should be presented at Fair Market Value (FMV)

Statement needs to be Appropriately Dated
Net Worth should be indicated
Footnotes should be utilized to describe details of both Assets and Liabilities
Property should be identified with owner (e.g., JTWROS, or H for husband, W for
wife, etc.)
6. Categories of Assets - Depends on Type and Use of Asset
Cash and Cash Equivalents

INVESTED ASSETS (INVESTMENT portfolio)
Use Assets (Residence, Furniture, and Autos)
Assets should be Listed In Order of Liquidity (the ability to convert to cash quickly)
7. Liabilities should be categorized according to Maturity Date
Current Liabilities - due within 1 - year

Long-Term Liabilities - generally Mortgages and Notes (beyond a yaer)
8. Net Worth = Assets - Liabilities

Page: 119
Financial Statements
Statement of Recurring Cash Flows (For Past Year and Pro Forma For Next Year)
See examples in your books
1. Indicate period covered

2. INFLOWS:
Gross Salaries
Interest Income
Dividend Income
Rental Income
Refunds Due (Tax)

Other Incoming Cash Flows
Alimony Received
3. OUTFLOWS:
Savings and Investment - by item

Fixed outflows (Non-Discretionary)
a. House Payments
b. Auto Payments
c. Taxes
Fixed Outflows (Discretionary)
a. Club Dues
b. Utilities (a portion may be a variable outflow)
Variable Outflows (Non-Discretionary)
a. Food
Variable Outflows (Discretionary)
b. Vacations
c. Entertainment
4. Net Discretionary Cash Flow = Inflows - Outflows

Page: 120
5. Footnotes should be used to explain details of Income and Expenses
Page: 121
Ratio Analysis
Ratio Analysis will give the planner a good idea or starting point in analyzing the client's financial situation.
Liquidity Ratio = Liquid Assets Monthly Expenses
Most planners suggest 3 to 6 months coverage of Fixed and Variable Outflows.
Housing Payment Ratio
All Monthly Non-Executory Housing Costs* + Monthly Gross Income < 28%
*Includes Principal, Interest, Taxes, Insurance, and any Condominium Fee
if a renter, then the ratio is: Rent + Insurance Monthly Gross Income < 28%
Total Payments Ratio
All Monthly Payments and Housing Costs (i.e. Housing Payment Ratio) Gross Monthly Income < 36%
The 28% and 36% are common mortgage lender standards and are healthy targets for most clients.
Solvency Ratio = Total Assets Total Debt > 1.1
Savings Ratio = Savings Per Year + Gross Income

The Savings Ratio should be 8% - 25% Depending on Age
For example, a savings ratio of 8% or more for a younger individual may be appropriate, while a person in
their late 50s 25% may be more appropriate.
Debt to Income Ratio = Annual Debt Payment Gross Income < 30%
The Cash Flow Statement should be analyzed using a Month-to-Month Comparison, calculating each
outflow as a Percent of Total Income.
The objective is to develop a Predictive Model for each expenditure (e.g. savings > 10% of gross income)
Page: 122
Typical Strengths and Weaknesses

Strengths
Weaknesses
Adequate Savings
Inadequate Savings
Appropriate Investments
Inappropriate Investments
Appropriate Risk Coverage
Uncovered Catastrophic Risks:
Appropriate Net Worth

Appropriate Emergency Fund
Valid And Appropriate Will And
Transfer Plan
Well-Articulated Goals
Excellent Cash Flow Management
Knowledge About Investments
Life,
Health,
Disability
Property
Liability
Umbrella
Inadequate Net Worth

Inadequate Emergency Fund
No Will Or Invalid Will
Inadequately Defined Financial Goals
Poor Budget - Improper Use Of Cash Flow
Lack Of Knowledge About Investments
Page: 123
Economics
Factors important to this Market System include:

Demand
Supply
Substitutes and Complements
Diminishing Marginal Utility
Price Elasticity
We need to understand Economics because:
Resources are LIMITED (Scarce, or Not Free)
Human Wants are UNLIMITED
Given these 2 constraints, we want to achieve the highest possible degree
of Efficiency.
Page: 124
Economics
Marginal Costs are the cost to produce 1 more unit of product

Variable Costs are costs that fluctuate with some Cost Driver (e.g., units produced)
Fixed Costs are costs that do not change as a result of producing additional units (i.e., rent)
Cost of Capital is an internal measure of a companys borrowing costs from stockholders or outside
creditors
Opportunity Costs: Economists refer to foregone income as a cost. The value of the next best
alternative, which you have to give up because of a decision made.
Put another way: The value of what must be given up to acquire an item.
Velocity of Money: The average number of times a dollar is used per year
Market Price, is the price at which a willing buyer and a willing seller achieve their objectives.
The Law of Demand states that as the price of a product decreases the demand for the product
increases and vice versa
The Law of Supply, states that there is a positive relationship between the price of a product and
the amount producers are willing to produce (i.e., the higher the price, the more producers will
produce)
Supply Side Economics, is a belief that offering incentives to produce can accomplish stated
objectives
Price Controls, are an attempt to adjust the balance between supply and demand
Page: 125
Economics
Demand Curve
Demanded
Page: 126
Economics
The Amount of a Commodity people buy depends on its Price

Law of Demand: The Demand for a Product Varies Inversely with its
Price
The relationship between Price and Quantity bought is illustrated by the
Demand Curve.
The Demand Curve measures Price on the Vertical Axis and

Quantities Demanded on the Horizontal Axis.
The Demand Curve is Downward Sloping - If the price of a

commodity is raised (all other things equal), buyers tend to buy
less of the commodity.
When the Price is Lowered (all other things equal), Quantity

Demanded Increases.
Page: 127
Economics
Factors Affecting Demand:

Quantity Demanded tends to Fall as Prices Rise for 2 reasons:
Substitution Effect - When the price of a good rises, consumers substitute

other similar goods for it.
Income Effect - When the price rises, consumers curb consumption.
The Average Income of Consumers is a key determinant of demand.

As incomes rise, individuals tend to buy more.
The Size of the Market clearly affects the market demand.
The Prices and Availability of Related Goods influence the demand
for a commodity.
Compliments: Cool Aid Mix and Sugar, or Peanut Butter and Bread
Special Influences affect demand, such as:

Expectations About Future economic conditions, particularly prices, may
affect demand.
Page: 128
Economics
Supply Curve
Supplied
Page: 129
Economics
Supply is the Quantity of a Good that Producers will be

Willing to Produce and Sell, at certain prices
The Supply Curve for a commodity shows the relationship
between its:
Market Price and

The amount of that commodity producers are willing to
produce and sell.
The Supply Curve measures Price on the Vertical Axis and

Quantities Supplied on the Horizontal Axis.
Page: 130
Economics
The force operating on Supply is the fact that:

Producers Supply Commodities for a Profit.
Key Elements Affecting Supply Decision Are:
The Cost of Production
The Price of Related Goods
Substitutes or Related Goods are goods that can be readily substituted
for one another in the production process.
If the price of one production substitute rises, the supply of another
substitute is likely to decrease.
Compliments: Cool Aid Mix and Sugar, or Peanut Butter and Bread
A Reduction in Tariffs and Quotas on Foreign Goods will open the market to
foreign producers and will tend to increase supply.
If a market becomes monopolized, the price at each level of output will
increase.
Page: 131
Economics
Pure Competition exists when there are a large number competitors selling a product or
service with very little difference.
An Oligopoly Occurs when you have a small number of companies that control the market for
a given type of product or service.
A Monopoly occurs when a single company owns all or nearly all of the market for a given type
of product or service.
Firms Level of Control Over the Market:
Perfect Competition Zero % control over Pricing and the Market
Monopolistic
Competition
Oligopoly
Increasing Control over Pricing and the Market
Monopoly, Sole
Producer
, 100% control over Pricing and the Market
Perfect Market
10,000 Firms
100 Firms
Imperfect
10 Firms
Markets
1 Firm
Perfect Competition (Characteristics)

1. Many Sellers and Buyers
2. Standard / Homogenous Product
3. No barriers to impede entry into or exit of the market
4. Both Buyers and Sellers have complete access to Perfect Information
Page: 132
Economics
The Market Equilibrium matches up the Price and Quantity, at the point where the Supply and
Demand Forces are In Balance.
Supply and Demand can do more than tell us about the Equilibrium Price and Quantity.
They can be used to predict the impact of changes in economic conditions on prices and
quantities.
When factors underlying Demand or Supply change, these lead to:
Shifts in Demand or Supply and to
Changes in the Market Equilibrium of Price and Quantity.
Care must be taken not to confuse:
A Change in Demand, denoted by a shift of the demand (supply) curve,

With a Change in the Quantity Demanded (supplied), denoted by movement to a
different point on the same demand curve after a price change.
Rationing by Prices - By determining the equilibrium prices and quantities of all inputs and outputs,
the market allocates (rations) the scarce goods of the society among the possible uses.
Page: 133
Economics
The Law of Diminishing Marginal Utility states that:

As the Rate of Consumption Increases,
The Marginal Utility derived from Consuming Additional Units
of a Good
Will Decline!
Marginal Utility is the additional Utility (or enjoyment) received
from the consumption of an additional unit of the same good.
Page: 134
Economics
Price Elasticity Demand

The Slope is not the same as the elasticity because:
The Demand Curves Slope depends on the actual changes in Price and
Quantity,
Whereas the Elasticity depends on the Percentage Changes in Price and
Quantity.
Elasticity and Revenue
Elasticity helps to clarify the impact of price changes on the total revenue of
producers.
Total Revenue
When demand is Price Inelastic, a price decrease reduces total revenue.
When demand is Price Elastic, a price decrease increases total revenue.
In the case of Unit-elastic Demand, a price decrease leads to no change in total
revenue.
Page: 135
Economics
Economic Factors Determine the:

Magnitude of price elasticities for individual goods;
Degree that a good is a necessity or a luxury;
Extent to which substitutes are available;
Time available for response; and
Relative importance of a commodity in the consumers budget.
The Price Elasticity of Supply measures:
The Percentage Change in quantity supplied
In response to a 1% change in the Goods Price.
A Demand Curve indicating that Consumers respond Sharply to a change in Price,
is said to be Elastic, or Highly Elastic.
A Demand Curve involving a relatively small or insignificant response by consumers to a given
Price Change,
is called Inelastic.
The Price Elasticity of Demand, is the ratio of the Percentage Change in Quantity Demanded to
the associated Percentage Change in Price:
% Quantity Demanded
% Price
Page: 136
The Economy and Business Cycles
Gross Domestic Product (GDP)

The total value of goods and services produced by a nation.
In the U.S. it is calculated by the Commerce Department, and it is the main measure of U.S.
economic output.
Gross National Product (GNP)
The dollar value of all goods and services produced in a nation's economy.
Unlike gross domestic product, it includes goods and services produced abroad.
GDP Trend Line assumes expansion at 3% annually.

Note: The Business Cycle Is Not Symmetrical as drawn.
Unpredictable.
The pattern of the business cycle is Irregular and
Page: 137
Peak Point
That point at the end of the Expansion Phase when most businesses are Operating At
Capacity and Gross Domestic Product (GDP) is increasing rapidly.
The peak is the point at which GDP is at its highest point and exceeds the long-run average
GDP.
Usually Employment Peaks here.
Contraction Phase
Leads to Trough.
Business Sales Fall, Unemployment Increases and GDP Growth Falls
Trough Point
That point at the END of the Contraction Phase where businesses are operating at their
lowest capacity levels.
Unemployment is rapidly increasing and peaks because sales fall rapidly.
GDP Growth is at its lowest or negative.
Expansion Phase
Leads to Peak.
Business Sales Rise, GDP Grows and Unemployment Declines
Page: 138
Recession
A decline in real GDP for 2 or more successive quarters characterized by:
Consumer Purchases Decline
Business Inventories Expand
GDP Falls
Capital Investment Falls
Demand For Labor Falls
Unemployment Is High
Commodity Prices Fall
Business Profits Fall
Interest Rates Fall Due To Demand For Money
Depression
Persistent Recession and a Severe Decline in Economic Activity
Page: 139
External and Internal Factors
The External Theories find the root of the business cycle in the fluctuations of
something outside the economic system such as:
Wars, Revolutions, Political Events, Rates of Growth of Population and

Migrations, Discoveries of New Lands and Resources, Scientific and
Technological Discoveries, and Innovations.
The Internal Theories look for mechanisms within the economic system itself
that give rise to self-generating business cycles.
Thus, every Expansion will breed Recession and Contraction, and
Every Contraction will in turn breed Revival and Expansion in a quasi-regular,

repeating, never-ending chain.
However, each peak and valley is higher than the last, leading to growth in the
economy over the long-term, despite the business cycle.
Page: 140
The actual business cycle has Averaged Growth of Approximately

2.9% Per Year.
The Business Cycle will exceed the average in some years
while in other years the growth will be less than the average.
Decreases in Interest Rates are often accompanied by Economic
Expansions
While Increases in Interest Rates are accompanied by Economic
Contractions.
Page: 141
The Price of Money is the Interest Rate.

The Discount Rate is the interest rate charged by the Fed on a loan that it makes to a member
bank.
The Nominal Interest Rate measures the yield in dollars per year per dollar invested.
The Return on Investments in terms of real goods and services is a real interest rate measure.
The return in terms of dollars is an absolute measure.
The real interest rate measures the quantity of goods we get tomorrow for goods forgone
today.
The Real Interest Rate is obtained by correcting nominal, or dollar, interest rates for the rate of
inflation.
GDP = The Total Amount of Goods And Services produced
WITHIN the USA
Real GDP = Adjusted For Inflation, (is more accurate)
Measured in Constant Dollars
Nominal GDP = NOT Adjusted For Inflation,
Measured in Current Dollars
Nominal GDP - Inflation = Real GDP
Page: 142
Measures of inflation
A Price Index is a Weighted Average of the prices of numerous goods
and services.
The most well known price indexes are the:
Consumer Price Index (CPI), the
Gross National Product (GNP) Deflator
Producer Price Index (PPI)
Page: 143
Consumer Price Index (CPI)
Measures the cost of a Market Basket of Consumer Goods and Services, including prices of
food, clothing, shelter, fuels, transportation, medical care, college tuition, and other
commodities purchased for day-to-day living.
A Price Index is constructed by weighting each price according to the economic importance
of the commodity in question.
Each item is assigned a fixed weight proportional to its relative importance in consumer
expenditure budgets as determined by a survey of expenditures in the 1982-1984 period.
GNP Deflator
Is the ratio of nominal GNP to real GNP and can be interpreted as the price of all components
of GNP (consumption, investment, government purchases, and net exports).
Producer Price Index (PPI)
The oldest continuous statistical series published by the Labor Department.

It measures the Level of Prices at the Wholesale or Producer Stage.
It is based on approximately 3,400 commodity prices including prices of foods, manufactured
products, and mining products.
Page: 144
Inflation Index (Number Problems)

The Cost of Living is overestimated compared to the situation where consumers
substitute relatively inexpensive for relatively expensive goods.
Although the CPI is modified from time to time, the CPI:
Is not corrected for Quality Improvements
Therefore, does not accurately capture changes in the Quality of Goods
The government tries to keep the Economy moving along at a:
Steady and Constant Pace
Not to Fast and Not to Slow!
The GDP is the Broadest Measure of the general state of the economy.
Historically the GDP Growth Rate has been Approximately 3%.
Historically, a GDP Growth Rate of LESS THAN 2% is considered low and
signals a possible Recession.
Also, a GDP Growth Rate of MORE THAN 4% signals possible Inflation.
Page: 145
Controlling The Economy

To accomplish this they can use:
Fiscal Policy, which include the tools of:
Taxation
Government Spending and Debt Management
Monetary Policy
Tight Monetary Policy and Loose (easy) Monetary Policy
Remember, Decreases in Interest Rates are generally followed
by Economic Expansion, while
Increases in Interest Rates are generally followed by Economic
Contraction
Page: 146
Components of the Money Supply

M-1 is the measure of the most liquid components of the Money Supply, and
includes:
Currency,
Checking Accounts,
NOW Accounts,
Travelers Checks and
Checking Money Market Accounts
M-2 includes all items of M-1 plus:
Savings Accounts,
Certain Money Market Mutual Funds,
Overnight Eurodollars and
Overnight Repurchase Agreements
M-3 includes all of M-2 plus:
Page: 147
Certificates of Deposit
Page: 148
The use of Taxation, Expenditures, and Debt Management of the Federal

Government is called Fiscal Policy.
The Goals pursued by changes in Fiscal Policy include:
Economic Growth,
Price Stability and
Full Employment
Page: 149
The Federal Reserve Bank (Fed) controls the Supply of Money enabling it to
significantly impact Interest Rates.
The Fed will follow a Loose or Easy Monetary Policy when it wants to INCREASE the
Money Supply to expand the level of Income and Employment.
Easy Monetary Policy - The supply of money increases resulting in the
circulation of more money.
This leads to more funds available for banks to lend and ultimately to a
decline in interest rates.
The Fed will follow a Tight Monetary Policy, in times of Inflation and when it wants to
Constrict the Supply of Money.
Tight Monetary Policy - The supply of money is restricted resulting in less
money available for banks to lend.
This leads to an increase in interest rates.
Page: 150
The Fed has several methods of Controlling the Money Supply

Reserve Requirements
The reserve requirement for a member bank of the Federal Reserve Bank is the Percent
of Deposit Liabilities that must be held in reserve.
As this requirement is increased, Less money is available to be loaned to

customers, resulting in a restriction of the money supply.
Federal Reserve Discount Rate
This is the rate at which member banks can borrow funds from the Federal Reserve to
meet reserve requirements.
When the Fed RAISES the Discount Rate, it increases the borrowing cost and
discourages member banks from borrowing funds. This results in a contraction of the
money supply.
The Fed will Lower the Discount Rate when it wants to increase the money supply.
Banks are able to borrow funds at lower rates and lend more money, which increases the
supply.
Note: The Fed Funds Rate is the overnight lending rate between member banks.
Page: 151
Open Market Operations

This is the process that the Federal Reserve follows to Purchase and Sell
Government Securities in the Open Market.
The Fed will Buy Government Securities to cause more money to circulate
Therefore, Increasing Lending and Lowering Interest Rates.
The Fed will Sell Government Securities to restrict the money supply.
As investors purchase government securities, more money leaves
circulation, which Decreases Lending and Increases Interest Rates.
Page: 152
Economic Environment - Basic Concepts
Which of the following costs best describes the cost of foregone income, which results from making an
economic decision to use funds to purchase a piece of equipment?
a.
b.
c.
d.
e.
Marginal cost
Opportunity cost
Variable cost
Fixed cost
Cost of capital.
B
Economists refer to foregone income as a cost. The decision to use resources means that other forms of
income are not realized, for example, the funds expended for a piece of machinery are not available to derive
interest income.
The foregone income costs are known as opportunity costs.
Marginal costs are the cost to produce one more unit of product Variable costs are costs that fluctuate
with some cost driver (e.g., units produced).
Fixed costs are costs that do not change as a result of producing additional units (i.e., rent).
Cost of Capital is an internal measure of a companys borrowing costs from stockholders or outside
creditors.
Page: 153
The inverse relationship between the price of a product and the number of units sold would describe which of
the following?
a.
b.
c.
d.
e.
The Law of Demand

Price Controls
Supply Side Economics
The Law of Supply
Market Price
A
The Law of demand states that as the price of a product decreases the demand for the product increases
and vice versa.
Answer B, Price Controls, is an attempt to adjust the balance between supply and demand.
Answer C, Supply Side Economics, is a belief that offering incentives to produce can accomplish stated
objectives.
Answer D, the Law of supply, states that there is a positive relationship between the price of a product
and the amount producers are willing to produce (i.e., the higher the price, the more producers will
produce).
Answer E, Market Price, is the price at which a willing buyer and a willing seller achieve their objectives.
Page: 154
If the demand for a product is inelastic, it means that:

a. An increase in the price would lead to an increase in the total amount spent on purchases of the
product.
b. An increase in the price would lead to a decrease in the total amount spent on purchases of the
product
c. An increase in the price would have no effect on the total amount spent on purchases of the
product.
d. The demand and supply are in equilibrium.
e. The price of the product cannot be increased or decreased.
A
Answer
Answer
Answer
Answer
B is the description of a product whose demand is elastic.

C describes the demand of a product that is perfectly elastic.
D is a description of the equilibrium point in supply and demand.
E is incorrect because price can be changed in a market economy.
Page: 155
If the Federal Reserve wanted to lower interest rates, it would consider which of the following?
1.
2.
3.
4.
Purchase government securities

Increase the reserve requirement of member banks
Increase the discount rate
Lower the margin requirement
a.
b.
c.
d.
e.
1 and 2
2 and 3
1 only
1 and 4
3 and 4
D
The Federal Reserve has the power to affect all of the controls listed above.
The manner in which it is done affects the objective of raising or lowering interest rates.
If the Fed purchases securities on the open market, the money supply is increased and, therefore, interest rates
are lowered.
An increase in the reserve requirement causes the money supply to decrease because banks have to reduce
their lendable reserves and this causes interest rates to rise.
An increase in the discount rate causes banks to increase their interest rates to compensate for the spread
between interest earned and interest paid.
Finally, lowering the margin requirement means that the demand for funds is not as high in order to buy stocks
and, therefore, interest rates are lowered.
Page: 156
Therefore, since #1 and #4 lower interest rates, the correct answer is D .
Page: 157
The average number of times a dollar is used per year is also known as:
a.
b.
c.
d.
e.
Inflation
Price Elasticity
Devaluation
Velocity of Money
GDP
D
The question is asking for the definition of the velocity of money and, therefore, all other answers are
incorrect
Page: 158
A common measure of Inflation is the Consumer Price Index (CPI). The index begins with a base of 100
at 1967. If the index as of December 1992 was125.6 and the index as of December 1993 was 133.5, what
was the CPI rate of inflation for 1993 rounded to the nearest one-tenth of a percent?
a.
b.
c.
d.
e.
10.6%
7.9%
5.9%
6.0%
6.3%
E
This is determined by dividing the current years index (133.5) by the prior years index (125.6).
The result is 1.063; that means the index of prices for 1993 is 1.063 times the index at the end of
1992, therefore, prices rose 6.3%.
Answers A and D are distracters.
Answer B is the difference between the two indexes and is incorrect.
Answer C calculates the percentage using the December 1993 index as the denominator and the
difference as the numerator.
Page: 159
If the U.S. Dollar equivalent of a Mexican Peso is .30656 and the U.S. Dollar equivalent of a Peruvian Inti is .
4717, what is the value of a Mexican Peso in Peruvian Inti?
a.
b.
c.
d.
e.
MN 00.6499
MN 01.5387
MN 64.9900
MN 00.0154
MN 00.1446
A
This is calculated by dividing the U.S. dollar equivalent of a Mexican Peso by the U.S. dollar
equivalent of a Peruvian Intl.
If a Mexican Peso buys less of a U.S. dollar than a Peruvian Inti, then a Mexican Peso would buy less
than one full Peruvian Inti (.30656 + .4717).
Answer B divides the U.S. dollar equivalent of the Peruvian Intl by the U.S. dollar equivalent of the
Mexican Peso.
Answer C is the same as A, except it is multiplied by 100.
Answer D is the same as B, except the answer is divided by 100.
Answer E multiplies the two U.S. dollar equivalent amounts.
Page: 160
In a random sample, the value that occurs most frequently is known as:
a.
b.
c.
d.
e.
Mean
Median
Mode
Standard deviation
Beta
C
Answer A, mean, is the mathematical average of all the values.
Answer B, median, is the value where one half of the values are above the median and one half the
values are below the median.
The standard deviation, answer D, relates to the deviation from the mean.
Answer E, Beta, is the correlation of a particular security to the market.
Page: 161
The demand for an economic product varies inversely with its price is the definition of which of the following:
a.
b.
c.
d.
e.
The Law of competition

The Law of supply and demand
The Law of demand
Laissez-faire
None of the above
C
This is the classic definition of the Law of demand.
Page: 162
Supply for a product includes which of the following:

1.
2.
3.
4.
Amount of a product available at any one time

Various amounts of a product that producers are willing to supply at all possible prices in the market
Total production in one year's time by a single firm
Amount that is supplied at equilibrium price
a.
b.
c.
d.
e.
1 only
2 only
3 and 4
1, 2, 3, and 4
None of the above
B
This is the classic definition of supply.
Page: 163
The adjustment process in a competitive market moves toward:

a.
b.
c.
d.
e.
Equilibrium
Shortage
Surplus
Capitalism
None of the above
A
The adjustment process is the price process and moves to equilibrium.
Page: 164
Which of the following describes pure competition?

1.
2.
3.
4.
Buyers and sellers deal in a variety of products.

Buyers and sellers act together.
A large number of buyers and sellers exist
Buyers and sellers have little knowledge of the items for sale.
a.
b.
c.
d.
e.
1 only
3 only
1 and 3
1 and 4
1, 2, 3, and 4
B
Pure Competition occurs with large numbers of buyers and sellers.
Page: 165
A decrease, or shift to the left, in the supply curve occurs when:

a.
b.
c.
d.
e.
Some firms leave the industry.

Government reduces regulations on production.
The cost of inputs goes down.
Taxes go down.
Competition increases.
A
Less is produced at all price levels.
Page: 166
Which of the following occurs when the price of a product decreases and consumers buy more of the
product?
a.
b.
c.
d.
e.
The product is a complementary product.

There has been an increase in supply.
A change in demand has taken place.
A change in quantity demanded has taken place.
None of the above.
D
A change in quantity demanded.
Page: 167
Consumer demand for sugar at 80 cents per pound results in $1,000 in company revenue, and a drop in
price to 50 cents per pound results in $1,250 in revenue. Which of the following may be concluded about
demand?
a.
b.
c.
d.
e.
Is Unit-Elastic
Is Inelastic
Would Overtake Supply
Is Elastic
None of the above
D
Elasticity indicates a Lower Price will Increase Overall Revenues.
Page: 168
What question can be asked to (in part) determine the elasticity of demand for an item?
a.
b.
c.
d.
e.
Should production be decreased?

Can the purchase be made by cash only?
Could something else be substituted and work just as well?
Is there enough of the product available?
All of the above.
C
If there is a Substitute Good, the product will be deemed Elastic.
Page: 169
Which of the following describes the law of Downward Sloping Demand?

a.
b.
c.
d.
e.
Consumer demand has not changed significantly

Consumer demand had dropped drastically
Consumers demand more at lower prices
Consumer demand has increased significantly
None of the above
C
The option consumers demand more at lower prices is an example of Elastic Demand.
Page: 170
An increase in the price of product A causes a decrease in the demand for product B. What are the two
products?
a.
b.
c.
d.
e.
Complement products
Substitute products
Unrelated products
Demand elastic products
None of the above
A
By definition, products are Complements if an increase in the price of Good A causes a decrease in
the demand for its complementary Good B. Therefore, the 2 products are examples of
complements.
Page: 171
Which of the following explains the principle of Diminishing Marginal Utility?

a.
b.
c.
d.
e.
The shape of the demand curve

A change in demand
The nature of inelastic demand
The substitution effect
None of the above
A
As the amount of goods consumed increases, the Marginal Utility of the good tends to decrease.
From this concept, the law of Downward Sloping Demand, the shape of the demand curve
is formed.
Therefore, answer A is correct
Page: 172
The Law of Demand states that:

a.
b.
c.
d.
e.
Consumers select alternative ways of spending income.

The relative change in price is caused by changes in demand.
The relationship between changing prices and total receipts is a direct one.
The demand for an economic product varies inversely with its price.
None of the above
D
The Law of Demand states that when the price of a good rises (at the same time all other things
are constant) that less is demanded and vice versa.
Therefore, answer D is correct.
Page: 173
Which of the following are reasons for a change in Consumer Demand?

1. Changes in consumer tastes: advertising, news reports, trends, and seasons can all affect consumer
tastes.
2. Changes in consumer demand may result from changes in consumer income: as income rises,
consumers tend to buy more; if income declines, consumers buy less.
3. Prices of related products: sometimes substitutes can be used in place of other products.
a.
b.
c.
d.
e.
1 only
2 only
3 only
1 and 2
1, 2, and 3
E
All are reasons for changes in Consumer Demand.
Page: 174
The relationship between a Demand Schedule and a Demand Curve is best described as:
a.
b.
c.
d.
e.
The two present the same information in different ways.

There is no relationship between the two.
A demand curve is part of a demand schedule.
A demand schedule is created from a demand curve.
All of the above.
A
The relationship between Price and Quantity purchased can be interpreted by a:
Numerical table (demand schedule) or a
Graph
Where Prices are measured on the Vertical Axis and Quantity demanded on the Horizontal Axis (demand curve).
Page: 175
Which of the following are determinants of Demand Elasticity?

1.
2.
3.
4.
Whether the purchase of the product can be delayed.

Whether there are adequate substitutes for the product
Whether the purchase of the product requires a large portion of income.
Whether the product has utility.
a.
b.
c.
d.
e.
1 only
2 only
2 and 3
1, 2, and 3 b
I, 2 3, and 4
D
Elasticity of Demand is an indicator of responsiveness of quantity demanded to changes in the market.
Statements 1, 2, and 3, all of which may affect the demand for a product, are determinants of Demand
Elasticity.
Page: 176
Which of the following might cause an increase in supply?

1.
2.
3.
4.
A decrease in productivity
Fewer sellers in the marketplace
More efficient technology
A decrease in government subsidies
a.
b.
c.
d.
e.
1 only
2 only
3 only
1 and 4
2 and 3
C
A key element that affects supply is the cost of production.
More Efficient Technology will decrease the cost of production.
Page: 177
Which of the following describes supply if the quantity supplied does not change significantly with a change in
price?
a.
b.
c.
d.
e.
Supply is unit elastic

Supply is elastic
Supply is inelastic
Supply is fixed
Supply is variable
C
Elasticity of Supply indicates the amount of Quantity Supplied in response to a given rise in competition.
If the amount supplied is fixed, or does not change significantly, then supply is inelastic.
Page: 178
Which of the following describes why changes in supply occur?

1.
2.
3.
4.
Changes in the cost of inputs.

Changes in productivity.
Changes in technology.
Changes in taxes.
a.
b.
c.
d.
e.
1 only
3 only
1 and 2
2 and 3
1, 2, 3, and 4
E
All affect supply classic definition of Supply.
Page: 179
Inflation causes people living on a fixed income to have:

1.
2.
3.
4.
No financial problems
No voice in the government
Declining purchasing power
Unlimited resources
a.
b.
c.
d.
e.
1 only
2 only
3 only
1 and 4
1, 2, 3, and 4
C
Inflation generally means rising prices for goods and services.
Someone on a fixed income in a time of rising prices will be forced to purchase less and, therefore, have
declining purchasing power.
Page: 180
Which of the following describes a rapid increase in the general level of prices?
a.
b.
c.
d.
e.
A market economy
A depression
Inflation
Deflation
None of the above
C
General definition of Inflation
Page: 181
Which of the following statements are true regarding Inflation?

1. The opposite of Inflation is Disinflation, which is a decline in general price level.
2. Deflation denotes a decline in the rate of inflation.
3. Deflation is often caused by a reduction in the supply of money.
a.
b.
c.
d.
e.
1 only
1 and 3
2 and 3
1, 2, and 3
3 only
The opposite of inflation is deflation, which is a decline in general price level.

Disinflation denotes a decline in the rate of Inflation.
Page: 182
Which economic goal does minimum wage support?

a.
b.
c.
d.
e.
Economic Equity
Economic Efficiency
Economic Growth
Full Employment
None of the above
Minimum Wage is one example of government intervention to promote economic equity.
Page: 183
Movement through the phases of the business cycle is initiated by shifts in aggregate demand, which create
fluctuations in Gross Domestic Product (GDP). Which combination of the following statements would be the
most significant contributor to the upward shift in aggregate demand shown in the graph?
1.
2.
3.
4.
Real National Income

Increase in demand for capital goods.
Increase in interest rates.
Increase in disposable income.
Increase in savings.
a.
b.
c.
d.
e.
1 and 3
1, 2, and 3
1, 3, and 4
2 and 4
3 and 4
A
Shifts in Aggregate Demand are stimulated by increase in demand for capital goods #1, and
increases in personal disposable income #3.
Increase in interest rates #2 and savings #4 dampen aggregate demand.
Page: 184
Under the Federal Fair Labor Standards Act, which of the following would be regulated?
1. Minimum wage
2. Overtime
3. Number of hours in the work week
a.
b.
c.
d.
e.
1 only
2 only
3 only
1, 2,and 3
None of the above
D
All are regulated by the FLSA.
Page: 185
Which of the following provisions is basic to all workers compensation systems?

a.
b.
c.
d.
The injured employee must prove the employer's negligence.

The employer may invoke the traditional defense of contributory negligence.
The employer may invoke the defense of assumption of the risk.
The employer's liability may be ameliorated by a co-employee's negligence under the fellowservant rule.
e. The injured employee is allowed to recover on a strict liability theory.
E
Strict Liability is the basis for recovery according to most workers compensation statutes.
The worker need only prove that an injury was suffered arising out of and occurring during
the course and scope of employment.
Page: 186
If you have product with inelastic demand, which of the following is true?
a.
b.
c.
d.
As the price increases, revenue decreases.

As the price increases, revenue increases.
There is no relationship between price and revenues.
None of the above.
B
If the demand is inelastic, price increases raise revenues.
Page: 187
Which best describes high unemployment with low interest rates?

a.
b.
c.
d.
Peak
Recession
Trough
Expansion
B
Recession is characterized by High Unemployment and Low Interest Rates.
Page: 188
When the economy is slowing and unemployment is increasing, what stage of the economic cycle are we in?
a.
b.
c.
d.
Trough
Recession
Peak
Recovery
B
Recession is characterized by a Slowing Economy and Increasing Unemployment
Page: 189
Which of the following statements concerning supply and/or demand is/are true?
1.
2.
3.
4.
If demand increases and supply simultaneously decreases, equilibrium price will rise.
There is an inverse relationship between price and quantity demanded.
If demand decreases and supply simultaneously increases, equilibrium price will fall.
If demand decreases and supply remains constant, equilibrium price will rise.
a.
b.
c.
d.
e.
1, 2, and 3
1 and3
2 and 4
4 only
1, 2, 3, and 4
A
Statements 1, 2, and 3 are true.
Statement 4 is false (the price would decrease).
Page: 190
Monetary and Fiscal Policy
Which of the following actions would best describe a fiscal policy economist?
1. Increase in government spending.
2. Decrease in the money supply.
3. Decrease in income taxes.
4. Increase in the inflation rate.
a.
b.
c.
d.
e.
1, 2, 3, and 4
1 and 3
2 only
2 and 4
1 only
B
Fiscal Policy Economists believe that the economy can be controlled through the use of government spending and
income tax adjustments.
Answer C is the answer to describe economists who believe that economic activity is controlled through the use
of the money supply.
A is incorrect since that answer describes all the choices that include both fiscal policy as well as monetary
policy economists.
Answer D is incorrect because inflation is determined by market factors.
Answer E partially describes a fiscal policy economist.
Page: 191
Which of the following economic activities represent(s) examples of Monetary Policy?

1.
2.
3.
4.
The federal funds rate is increased.

Congress passes a tax cut.
Bank reserve requirements are lowered by the Federal Reserve.
The Federal Open Market Committee sells securities.
a.
b.
c.
d.
e.
1 only
1 and 3
1, 3, and 4
1, 2, and 3
2, 3, and 4
C
Tax legislation is Fiscal not Monetary Policy.
Page: 192
The purposes of the Federal Reserve include:

1.
2.
3.
4.
Establishing the Prime Lending Rate (PLR).

Influencing and monitoring the flow of capital in the United States.
Establishing wage and price controls as economic circumstances dictate.
Functioning as the federal government's agency to influence or control inflation.
a.
b.
c.
d.
e.
1 only
2 only
2 and 4
2, 3, and 4
1, 2, 3, and 4
C
Commercial banks establish the Prime Rate.
The executive branch or Congress initiates any price control legislation.
Page: 193
The Federal Reserve can increase the money supply by doing which of the following?
a. Reducing the required reserve ratio and/or the discount rate
b. Increasing the required reserve ratio and/or the discount rate
c. Selling securities to US citizens
d. Buying gold from the European Central Bank
A
Reducing the required reserve ratio and or/ the discount rate.
This increases the ability of banks to make loans. These loans create new money, which increases the money
supply.
Page: 194
The Federal Reserve can decrease the money supply by doing all of the following except?
a.
b.
c.
d.
Sell U.S. Treasury securities on the open market.

Sell U.S. Treasury bonds to the general public.
Raise the required reserve ratio.
Raise the discount rate.
B
Sell U.S. Treasury bonds to the general public. U.S.
Treasury bonds are issued by the U.S. Treasury and not by the Federal Reserve.
They are issued to finance operations of the federal government.
Page: 195
The major function of the Federal Reserve System (central bank) is to:
a.
b.
c.
d.
Implement fiscal policy.

Carry out monetary policy.
Maintain the safety and soundness of banks and other savings institutions.
Serve as the countrys lender of last resort.
B
Carry out monetary policy.
The Federal Reserve controls the supply of money enabling it to significantly impact interest rates.
The Fed will follow a loose, or easy, monetary policy when it wants to increase the money supply to
expand the level of income and employment.
In times of inflation and when it wants to constrict the supply of money, the Fed will follow a tight
monetary policy.
Page: 196
If the Federal Reserve wanted to reduce the supply of money as part of an anti-inflation policy, it might:
a.
b.
c.
d.
Increase the reserve requirements.

Buy U.S. securities on the open market.
Lower the discount rate.
Buy U.S. securities directly from the Treasury.
A
Increase the reserve requirements.
The reserve requirement for a member bank of the Federal Reserve Bank is the percent of deposit
liabilities that must be held in reserve.
As this requirement is increased, less money is available to be loaned to customers, resulting in a
restriction of the money supply.
Page: 197
All of the following economic activities represent governmental fiscal policy except:
a. The government increases purchases of goods and services.
b. The government cuts taxes.
c. The government cuts the Federal Funds Rate.
d. The government uses higher taxes to dampen consumption and private investment.
C
The government cuts the Federal Funds Rate.
The Federal Reserve sets the discount rate, which the Federal Funds Rate is based on.
The Fed will lower the discount rate when it wants to increase the money supply.
Choices A and B represent expansionary fiscal policy. Choice D represents restrictive fiscal policy.
Page: 198
Which of the following monetary components would be included in the M-1 measure of the money supply?
1. NOW accounts
2. Savings accounts
3. Checking accounts
4. Currency
5. Certificates of Deposit (CD's)
a.
b.
c.
d.
e.
3 and 4
1, 2,and 5
1, 3, and 4
4 only
All of the above
C
M-1 is the measure of the most liquid components of the money supply.
M-1 specifically includes currency, checking accounts, NOW accounts, travelers checks and checking money market
accounts.
M-2 includes all items of M-1 plus savings accounts, certain money market mutual funds, Overnight Eurodollars and
Overnight Repurchase Agreements.
M-3 includes all of M-2 plus certificates of deposit Answer A is incorrect because NOW accounts are included in M-1.
Answer B is incorrect because savings accounts are M-2 and CDs are M-3.
Answer D is incorrect because checking accounts and NOW accounts are included in M-1.
Answer E is incorrect because only three of the five items are included in M-1.
Page: 199
Which of the following can the Fed do to reduce the money supply?
1. Purchase Treasury securities.
2. Decrease the reserve requirements for banks.
3. Raise the discount rate.
a.
b.
c.
d.
e.
1 only
2 only
3 only
1 and 2
2 and 3
C
Only increasing the discount rate will reduce the money supply.
Page: 200
Which of the following can be done by the Fed to increase the money supply?
1. Decrease the margin requirements for banks from 8 percent to 6 percent.
2. Increasing expenditures of the federal government, thereby circulating addition funds in the
economy.
3. Open market transactions.
a.
b.
c.
d.
e.
1 only
2 only
1 and 2
1 and 3
1, 2, and 3
All of the above have the potential to increase the money supply;
However, the Federal Reserve does not control the expenditures of the federal government
Page: 201
What actions taken by the Fed will lead to increased money supply?
a.
b.
c.
d.
Lowering the prime rate.

Lowering the discount rate.
Sell treasury securities.
Increase reserve requirements.
Lowering discount rate stimulates the money supply.
Page: 202
Which of the following is/are methods that might be used to control the supply of money?
1. Control of the Federal Reserve Discount Rate
2. Open market operations
3. Fiscal policy
a.
b.
c.
d.
e.
1 only
2 only
1 and 3
2 and 3
1, 2, and 3
E
Control of the Federal Reserve Discount Rate,
Open Market Operations, and
Fiscal Policy
Are all methods of controlling the supply of money in the U.S. economy.
Page: 203
Which of the following actions by the Federal Reserve Board would directly increase the money supply?
a.
b.
c.
d.
Lower the discount rate.

Buy securities.
Sell securities.
Increase the margin requirement
B
Buying securities on the open market causes a direct increase in the money supply.
Whereas selling securities causes a direct decrease in the money supply.
Lowering the discount rate and increasing the margin requirement affects the money supply only insofar as to
the degree that banks react to these changes.
Page: 204
The phases of a Typical Business Cycle are as follows:

a.
b.
c.
d.
e.
Trough,
Peak, Expansion,
Recession
Peak, Recession,
Expansion,
Trough
Trough,
Expansion,
Peak, Recession
Recession,
Peak, Expansion,
Trough
Recession,
Expansion,
Trough,
Peak
C
The terminology in each answer is the same, only the order is different.
A typical business cycle can be measured from trough to trough or from peak to peak with expansion and
recession in between.
A recession follows a peak, and expansion follows a trough, which means the correct answer is C.
Page: 205
In a typical business cycle, which one of the following phases would exhibit periods of increasing employment
and increasing output?
a. Intensity
b. Trough
c. Peak
d. Expansion
d. Recession
D
An expansion is where employment and output are rising.
When employment and output are no longer rising, the phase is the peak.
If employment and output begins to decrease, this indicates a recession.
Finally, when employment and output are no longer decreasing, the cycle has reached a trough.
The intensity indicates the highest and lowest points of the peak or the trough.
Page: 206
Financial Institutions
An investor wishing to invest $150,000 is concerned about the safety of his investment if he invests the funds
through a national bank. Which of the following statements is/are correct?
1. If the investor deposits the funds in a savings account, the FDIC guarantees the full amount of his
investment
2. If the FDIC guaranteed the funds in a savings account, none of the investment the investor deposits is
guaranteed if the amount exceeds $100,000.
3. If the funds were invested in a mutual fund sold by the national bank, the FDIC up to $100,000 affords the
investor protection.
4. If the investor deposits $75,000 into each of two savings accounts at the same bank in his name only, the
full amount of his investment is afforded protection by the FDIC since neither account exceeds $100,000.
a.
b.
c.
d.
e.
1 and 4
4 only
2 only
3 only
None of the statements are correct
E
Statement i is incorrect because the FDIC guarantees amounts up to $100,000. The excess over $100,000 is at risk.
Statement 2 is incorrect because deposits up to $100,000 are guaranteed.
Statement 3 is incorrect because funds invested in a mutual fund are subject to market risk and are not
guaranteed by the FDIC at all.
Statement 4 is incorrect because the FDIC guarantees amounts by depositor and not by accounts.
Page: 207
The Economy and Consumer Protection
Federal Consumer Protection Laws

Law
Purpose
Fair Packaging and Labeling Act To prohibit deceptive labeling and require disclosure
Equal Credit Opportunity Act
To prohibit discrimination in granting credit
Federal Trade Commission Act
To prohibit deceptive
Fair Credit Reporting Act
To regulate the consumer credit reporting industry
Fair Credit Billing Act
To regulate consumer credit billing practices and rights
Magnuson-Moss Warranty Act
To regulate the consumer
Truth in Lending Act
To require disclosure of terms
Fair Debt Collection Act
To prevent abusive or deceptive debt collection practices
Sherman Act
To prohibit monopolies, and promote free trade
Clayton Act
To regulate monopolization, pricing and competition
Page: 208
There are 2 fundamental areas of Worker Protection:

Job Safety
Financial Security
Laws and Programs used to this end include:
Occupational Safety and Health Act (OSHA), ensures safe and healthy working
conditions.
Workman's Compensations Acts, impose a strict form of liability on employers for
accidental injuries occurring in the work place.
Unemployment Compensation, provides temporary payments to workers who become
unemployed (through no fault of their own)
Social Security
Employee Retirement Income Security Act (ERISA), protect employees rights in
Qualified Retirement Plans
The Consolidated Omnibus Budget Reconciliation Act of 1986 (COBRA), lets
employees keep group health coverage
Page: 209
Investor Protection
Securities Acts of 1933 and 1934, which protect investors and regulate those
providing investment advice.
Security Act of 1933 was limited to new issues of securities in the primary market.
Security Act of 1934 extended the regulation to securities sold in the secondary
market. Implications were:
The overall regulation of securities markets
Disclosure Requirements
Annual Reports (must be audited) and Quarterly Reports (do not require
auditing)
Registration of organized Exchanges
Credit Regulations
Proxy Solicitation Rule
Insider Trading Rules
Rules Against Price Manipulation
Page: 210
FDIC Insurance
The basic FDIC Insured Amount of a Depositor is $100,000.

Accrued Interest is included when calculating insurance coverage.
Deposits maintained in different Categories of Legal Ownership are separately insured.
Therefore, a depositor can have more than $100,000 Insurance Coverage in a single
institution if the funds are:
Owned and
Deposited in different ownership categories.
The most common categories of ownership are:
Single (or Individual) Ownership,
Joint Ownership, and
Testamentary Accounts.
Any person or entity can have FDIC Insurance on a deposit.
A Depositor does not have to be a United States Citizen, or even a resident of the United
States.
The FDIC insures deposits in some, but not all, banks and savings associations.
Federal Deposit Insurance protects deposits that are payable in the United States.
Deposits that are only payable overseas are not insured.
Page: 211
FDIC Insurance
Securities, Mutual Funds, and similar types of Investments are not covered by FDIC Insurance.
Creditors (other than depositors) and shareholders of a failed bank or savings association are
not protected by federal deposit insurance.
Treasury Securities (bills, notes, and bonds) purchased by an insured depository institution
on a customers behalf are not FDIC insured.
All types of deposits received by a Qualifying Financial Institution in its usual course of business are
insured.
Deposits in different Qualified Institutions are insured separately.
If an institution has one or more branches, however, the main office and all branch offices are
considered to be one institution.
Thus, deposits at the main office and at branch offices of the same institution are added
together when calculating deposit insurance coverage.
Financial institutions owned by the same holding company but separately chartered are
separately insured.
The FDIC presumes that funds are owned as shown on the Deposit Account Records of the
insured depository institution.
Page: 212
FDIC Insurance
Example of Insurance for Single Ownership Accounts

Depositor
A
A
A
As Restaurant (a Sole Proprietorship)
Type of
Deposit
Savings Account
CD
NOW Account
Checking
Amount
Deposited
$25,000
$100,000
$25,000
$25,000
Total Deposited
Maximum Amount of Insurance Available
$175,000
($100,000)
Uninsured Amount
$75,000
The Uniform Gifts to Minors Act is a state law that allows an adult to make an
Irrevocable Gift to a Minor.
Funds given to a minor under the Uniform Gifts to Minors Act are held in the name
of a custodian for the minors benefit.
The funds are added to any other single ownership accounts of the minor, and the
total is insured up to a maximum of $100,000.
Page: 213
FDIC Insurance
As Ownership Interest
Account
Owners
Balance
Account #1 (A and B)
$50,000
#1
A and B
$100,000
Account #2 (B and A)
$12,500
#2
B and A
$25,000
Account #3 (A, B, and C)
$25,000
#3
A, B and C
$75,000
Account #4 (D and A)
$40,000
#4
D and A
$80,000
Total Deposited
$127,500
As ownership interest in the joint account category is limited to $100,000, so $27,500 is uninsured.
Bs Ownership Interest
Account #1 (A and B)
$50,000
Account #2 (B and A)
$12,500
$25,000
Total Deposited
$87,500
Bs ownership interest in the joint account category is $87,500. That amount is less than the $100,000
maximum, so it is fully insured.
Cs Ownership Interest
$25,000
Total Deposited
$25,000
Cs ownership interest in the joint account category is $25,000. That amount is less than the $100,000
Ds Ownership Interest
$40,000
Total Deposited
$40,000
Ds ownership interest in the joint account category is $40,000. That amount is less than the $100,000
Page: 214
Financial Instruments
Commercial Paper, is Unsecured Short-term Promissory Notes used by companies to obtain cash
They are sold through:
Dealers in the open market or
Directly to investors
Types of Commercial Paper:
Promissory Notes
Certificate of Deposits
Checks
A draft has 3 parties in which:
The Drawer (a person or entity, or writer of a check)
Orders a Drawee (a bank or other 3rd party entity)
To pay a Payee (some other 3rd party) a sum of money
A Holder in Due Course is an individual who acquires a Negotiable Instrument in Good Faith
Page: 215
Financial Instruments - Negotiable
Instruments
A Transferable, signed document that promises to pay the BEARER (or holder of the negotiable instrument)
a sum of money at a future date or on demand.
Examples include: checks, bills of exchange, and
promissory notes.
In order for an Instrument to be Negotiable, it must have all of the following requirements on the face of the
instrument:
In writing
Signed by maker or drawer
Contain an unconditional promise or order to pay
State a fixed amount in money
Payable on demand or at a definite time
Payable to order or to bearer, unless it is a check
Discrepancies Related to Negotiable Instruments
Words Control over figures

Handwritten Terms Control over typewritten and printed terms
Typewritten Terms Control over printed terms
Omission of a date does not destroy negotiability, unless the date is necessary to determine when it is payable.
Omission of the interest rate is allowed because the judicial interest rate (rate used on court judgment) is
automatically used.
Statement of consideration or where the instrument is drawn or payable is not required.
The instrument may be Postdated or Antedated and remain negotiable.
Page: 216
For example, a bank may pay a postdated check before the date on the check unless the drawer notifies the
bank to defer the payment.
Consumer Protection - Investment Advisers (Registration Requirement)
The Securities and Exchange Commission (SEC) regulates:

Investment Advisers and Their Activities under the Investment Advisers Act of 1940
Unless Exempt under specific provisions of the Act,
A Person Covered by the Act Must Register With the SEC as an Investment Adviser.
An Investment Adviser, who must register as such is a person who (regarding securities):
Provides Advice or Issues Reports or Analyses
Is in the Business of providing such services For Compensation
1.Compensation is the receipt of any economic benefit (it includes sales commissions)
2.Certain organizations and individuals are Excluded from Registration as IAs:
Banks and Bank Holding Companies (except as amended by the Gramm Leach-Bliley Act of 1999)
Lawyers, Accountants, Engineers, or Teachers, if their performance of advisory services is solely incidental to their
professions
Brokers or Dealers, if their performance of advisory services is solely incidental to the conduct of their business as
brokers or dealers, and they do not receive any special compensation for their advice
Publishers of Bona Fide Newspapers, Newsmagazines, or Business or Financial Publications of general and regular
circulation
Persons whose advice is related only to securities that are direct obligations / guaranteed by the USA
Incidental Practice Exception Is Not Available to individuals who hold themselves out to the public as providing
Financial Planning, Pension Consulting, or Other Financial Advisory Services.
Exceptions
The Act provides limited exemptions, from the registration requirement.
Page: 217
Investment advisers who,

During the course of the Preceding 12 Months, had Fewer Than 15 Clients and
Do Not Hold Themselves Out generally To the Public as Investment Advisers.
Page: 218
Consumer Protection -
Investment Advisers (Disclosure)
The Act Requires Investment Advisers entering into an Advisory Contract with a client To Deliver
a Written Disclosure Statement on their Background and Business Practices.
Form ADV Part II must be given to a client under Rule 204-3, (Brochure Rule).
According to the Brochure Rule, an Investment Adviser shall furnish Each Advisory
Client and Prospective Client with a Written Disclosure Statement.
It may be a copy of Part II of Form ADV, or Written Documents containing at least the
information required by Part II of Form ADV, or such other information as the
administrator may require.
The Disclosure should be delivered NOT LESS THAN 48 Hours prior to entering into any
investment advisory contract with such client or prospective client,
Or, at the time of entering into any contract, if the advisory client has a Right to
Terminate the contract without penalty within 5 Business Days.
If an investment adviser renders substantially different types of investment advisory
services to different advisory clients, any information required by Part II of Form ADV may
be omitted from the statement furnished to an advisory client or prospective advisory client
if such information is applicable only to a type of investment advisory service or fee which is
not rendered or charged, or proposed to be rendered or charged, to that client or
prospective client.
Page: 219
Consumer Protection
- Investment Adviser Registration Depository
The Investment Adviser Registration Depository (lARD) is:

An electronic filing system for Investment Advisers
Sponsored by the Securities and Exchange Commission (SEC) and North
American Securities Administrators Association (NASAA),
With NASD Regulation, Inc. serving as the developer and operator of the
system.
The lARD system Collects and Maintains the Registration and Disclosure Information
for Investment Advisers and their associated persons.
The new lARD system supports electronic filing of the revised Forms ADV and
ADV-W, centralized fee and form processing, regulatory review, the annual
registration renewal process, and public disclosure of Investment Adviser
information.
lARD provides regulators with the ability to monitor and process Investment
Adviser information via a single, centralized system (www.iard.com).
Page: 220
Code of Ethics
1. Integrity (3 Rules)
Rule 101 of the Code PROHIBITS the solicitation of clients through:
False or Misleading Communications or Advertisements.
Rule 103
Prohibits Commingling of Funds
Requires a Fiduciary Relationship
2. Objectivity (2 Rules)
Rule 201 states as follows:
A CFP designee shall exercise Reasonable and Prudent Professional Judgment in
providing professional services.
3. Competence (2 Rules)
Rule 301 states as follows:
A CFP designee shall keep informed of developments in the field of financial planning
and participate in continuing education throughout the CFP designees professional
career in order to improve professional competence in all areas in which the CFP
designee is engaged.
4. Fairness (16 Rules)
5. Confidentiality (3 Rules)
6. Professionalism (12 Rules)
7.
Diligence (5 Rules)
Note: You should know each of the rules at least generally!
Page: 221
Basic Investment Concepts Types of Risk
Which of the following statements about risk are true?

1. Systematic Risk can be diversified away.
2. Unsystematic Risk plus systematic risk equals total risk.
3. It is not possible for systematic risk to equal total risk.
a.
b.
c.
d.
e.
1 only
2 only
1 and 2
2 and 3
1, 2, and 3
B
Statement 1 is false. Systematic Risk is market risk and cannot be diversified away.
Statement 2 is TRUE.
Statement 3 is false. If unsystematic risk equals zero then total risk is systematic risk.
Systematic Risk is the risk that all securities are subject to and cannot be reduced or eliminated through diversification.
Unsystematic Risk is company or industry specific risk that can be reduced or eliminated though Diversification.
Page: 222
Bobby has the following securities in his portfolio:

ABC Common Stock
XYZ Common Stock
PQR Mutual Fund (small cap)
DEZ Mutual Fund (foreign small cap stocks)
30-Year Treasury Bond
5-Year Treasury Note
With which of the following risks does Bobby NOT have to be concerned?
a.
b.
c.
d.
e.
Financial risk
Default risk
Reinvestment rate risk
Systematic risk
He must be concerned with all of the above risks
B
Treasuries are considered Default Risk Free.
Financial Risk is the uncertainty (risk) introduced from the method by which a firm finances its assets (i.e., debt vs.
equity financing).
Reinvestment Rate Risk is the risk that as cash flows are received they will have to be invested at lower rates of return
than the investment that generated the cash flows.
Systematic Risk is the risk that all securities are subject to and CANNOT BE reduced or eliminated through
diversification.
Page: 223
Debt to Equity Ratios for companies are considered what type of risk?
a.
b.
c.
d.
e.
Systematic Risk
Business
Market
Financial
Both B and D
D
Financial Risk deals with the leveraging of a company's capital structure (i.e., debt vs. equity financing).
Business Risk is the uncertainty (risk) of income cash flows caused by the nature of a firm's business.
The more uncertain the income cash flows to the company, the more uncertain the cash flows to the investor.
Market Risk is a type of systematic risk (see question 2).
Page: 224
A mutual fund that invests in U.S. Companies, Foreign Companies, U.S. Corporate Bonds, and US Treasury Bonds is
NOT subject to which of the following risks?
a.
b.
c.
d.
e.
Business Risk
Default Risk
Systematic Risk
Interest Rate Risk
All of the above are risks to which the Mutual Fund would be subject
E
U.S. Companies subject the portfolio to Business Risk (A)
Corporate Bonds subject the portfolio to Default Risk (B) and Interest Rate Risk (D)
All investments are subject to Systematic Risk (C)
Page: 225
Which of the following statements about Risk is true?

1. Undiversifiable Risk is termed Unsystematic Risk
2. Systematic Risk includes business, financial, and purchasing power risk
3. Default Risk affects both equity and fixed investments
a.
b.
c.
d.
e.
1 only
2 only
1 and 2
1, 2, and 3
None of the above
E
Statement 1 is false
Systematic Risk is Undiversifiable
Business Risk and financial risk are examples of Unsystematic Risk.
Purchasing Power Risk is a Systematic Risk.
Default Risk relates only to Fixed Investments.
Page: 226
Business Risk would include which of the following?

1. Inflation
2. Fire
3. High Debt to Equity Ratio
4. Recession
a.
b.
c.
d.
e.
1 only
2 only
2 and 3
1 and 4
3 and 4
B
Fire is the only Business Risk above
Statement 1 and Statement 4 are forms of Market Risk and
Statement 3 is Financial Risk
Page: 227
Basic Investment Concepts Types of Investment Risk
Candi purchases a 30-Year Zero-Coupon Bond. The bond was issued by Du Pont, one of the Fortune 500
companies. Which of the following risks might Candi be subject to?
1. Default Risk
2. Reinvestment Rate Risk
3. Purchasing Power Risk
4. Liquidity Risk
a.
b.
c.
d.
e.
1 and 3
2 and 3
1, 2, and 3
1, 3, and 4
1, 2, 3, and 4
D
Default Risk (Yes).
Because the company may have financial difficulty in the future
Purchasing Power Risk (Yes).
Inflation may exceed the Yield to Maturity (YTM)
Liquidity Risk (Yes). Although there will always be a ready market; if she sells when interest rates have gone up, she
may have a price concession.
Reinvestment Rate Risk (No). Because the bond is a zero-coupon bond and does not have any coupon payments to
reinvest
Page: 228
To which of the following risks might a fixed-income security be subject?

2. Liquidity Risk
3. Exchange Rate Risk
5. Default Risk
a.
b.
c.
d.
e.
1 through 5
1 through 4
2 through 4
3 through 5
1, 2, 4, and 5
A
All are possible risks
Page: 229
Basic Investment Concepts Interest Rate Risk and Reinvestment Risk
Should an investor who purchased a bond five years ago yielding 8%, with a coupon of 8%, sell or hold the bond if he is
trying to maximize the Yield to Maturity for the 30-year period? Assume at the end of the first 5 years the prevailing
interest rate drops from 8% to 7% and remains at 7% for the next 25 years. Also assume that the interest rate is 8%
from purchase to the 5-year period.
a. He should sell the bond because the value of the bond with an 8% coupon will increase by over 10%
b. He should hold the bond because he will yield 8% over the life of the bond, whereas if he sells the bond he will
have to invest the proceeds at 7%
c. He should sell the bond for $1,116.54 and invest the proceeds at 7% for the remaining 25years because the
weighted average yield will be equal to 7.77%
d. Neither holding nor selling will yield a higher resulting yield to maturity
e. None of the above are true
D
Either choice will yield the same result.
Sell
Step 1: Price of bond
FV = $1,000
PMT = 80, i = 7, N =25
PV = ($1,116.54)
Step 2: Inflate PV for 25 years @ 7%
PV = ($1,116.54)
N = 25, i = 7, PMT = $0
FV = $6,059.92
Hold
Step 1: Inflate payments @ 7%
PMT = ($80)
N = 25, i = 7,
FV = $5,059.92
Step 2: Add maturity value of bond
$5,059.92
+ 1 .000.00
$6,059.92
Page: 230
Which of the following are Non-Diversifiable Risks? (CFPTM Certification Examination, released 3/95)
1. Business Risk
2. Management Risk
3. Company or Industry Risk
4. Market Risk
5. Interest Rate Risk
a.
b.
c.
d.
e.
4, 5, and 6
1, 2, and 3
5, 6, and 2
1, 3, and 4
1, 4, and 6
A
Non-Diversifiable Risks or Systematic Risks are those that affect the entire market, including Market Risk, Interest
Rate Risk and Purchasing Power Risk.
Business Risk, Management Risk, Company Risk and Industry Risk are Unsystematic Risks:
Which can be reduced or eliminated through diversification.
Page: 231
Investors seek out Tax-Advantaged Investments to accomplish which of the following?

1. Reduce risk
2. Avoid taxes
3. Build equity
4. Defer tax liability
a. 2 only
b. 1 and 3
c. 2 and 4
d. 2, 3, and 4
e. 1, 2, 3, and 4
D
Tax-Advantaged Investments do not necessarily reduce risk.
For example, Municipal Bonds, Limited Partnerships, Non-Dividend Paying Growth Stocks all have a certain amount
of risk inherent in them.
All investments should be entered into with the idea of building equity.
Page: 232
Which combination of the following statements about investment risk is correct?
(CFPTM Certification Examination, released
12/95)
1. Beta is a measure of systematic, non-diversifiable risk

2. Rational investors will form portfolios and eliminate systematic risk
3. Rational investors will form portfolios and eliminate unsystematic risk
4. Systematic risk is the relevant risk for a well-diversified portfolio
5. Beta captures all the risk inherent in an individual security
a. 1, 2, and 5
b. 1, 3, and 4
c. 2 and 5
d. 2, 3, and 4
e. 2 and 5
Note: Choices C and E are the same. These were the choices printed by the CFP Board in 12/95. No changes were made to any
of the questions released by the CFP Board.
B
Systematic Risk cannot be eliminated; thus, Statement 2 is false.
Beta only measures Systematic Risk, thus Statement 5 is false.
All other statements are true.
Page: 233
Basic Investment Concepts
Beta is a measure of:

a. Unsystematic Risk
b. Holding Period Return
c. Geometric Average Return
d. Systematic Risk
D
Unsystematic Risk is the risk associated with a particular firm, industry, or country
Holding Period Return measures the total return an investor receives over the life of the investment
The Geometric Mean is a method of calculating the internal rate of return based on periodic rates of return
Page: 234
Basic Investment Concepts
Consider the following Modern Portfolio Theory statistics for the Davis Growth Fund:
R-square
Beta
Alpha
Standard Deviation
ABC Index
0.67
0.95
1.2
19.22
TKL Index
0.56
1.0
3.25
15.65
XYZ Index
0.98
1.3
0.05
11.35
Which of the indexes is the appropriate benchmark for the Growth Fund?
a. ABC Index
b. JKL Index
c. XYZ Index
d. Either ABC Index or JKL Index because beta is close to 1.0
e. There is not enough information to determine the answer
C
R2 indicates the portion of a portfolio's returns that are attributable to an index.
R2 for XYZ equals 0.98 meaning that 98 percent of the changes in the Davis Growth Fund are attributable to XYZ index.
Page: 235
Capital Asset Pricing Model
The CAPM is a model that:

a. Models Diversifiable and Non-Diversifiable Risk
b. Explains return in terms of risk
c. Determines the geometric return of a security
d. Determines the price an investor will pay for an asset, given its level of total risk
B
The Capital Asset Pricing Model explains return assuming there is no Firm-Specific Risk
because security diversification exists
Therefore, the return is based on Non-Diversifiable (Systematic) Risk.
Page: 236
Standard Deviation
Assets A and B have the following historical returns:

Asset A
Asset B
7%
12%
-1%
4%
11%
21%
Which asset is riskier?

a. Asset A
b. Asset B
c. They are equally risky
d. Need more information
B
Average Return
6%
6%
6%
Asset A
Actual Return
Difference
Difference Squared
7%
-1%
0.00010
12%
-6%
0.00360
-1%
7%
0.00490
The sum of the differences:
0.00860
The Standard Deviation for Asset A is 6.56% [(0.00860 / (3 1)]

Average Return
12%
12%
12%
1/2
Asset b
Actual Return
Difference
Difference Squared
4%
8%
0.00640
11%
1%
0.00010
21%
-9%
0.00810
The sum of the differences:
0.01460
The Standard Deviation for Asset B is 8.54% [(0.01460 / (3 1)]
1/2
Page: 237
Yield to Maturity and Yield to Call
Cabot, Inc. bonds have the following characteristics.

10% coupon
Semiannual bond
$1,000 par value
Current price is $1,136.92
8 years to maturity
Callable in 5 years at $1,100
What is the bond's YTM and YTC?
a. YTM = 3.838%; YTC = 4.13%
b. YTM = 7.65%; YTC = 8.24%
c. YTM = 7.68%; YTC = 8.26%
d. YTM = 7.97%; YTC = 8.54%
C
Yield to Maturity
PMT = $50
FV = $1,000
PV = ($1,136.92)
N = 16
YTM = 3.838 x 2 = 7.68%
Yield to Call
PMT = $50
FV = $1,100
PV = ($1,136.92)
N = 10
YTC = 4.13 x 2 = 8.26%
Page: 238
Cabot, Inc. bonds have the following characteristics:

10% coupon
Semiannual bond
$1,000 par value
Current price is $1,136.92
8 years to maturity
Callable in 5 years at $1,100
If you sell the bond in two years for $1,200, what is the annualized Rate of Return?
a. 11.34%
b. 5.67%
c. 5.88%
d. 11.42%
A
PMT = $50
FV = $1,200
PV = $1,136.92
N=4
i = 5.67 x 2 = 11.34%
Page: 239
Your company has $200,000 to invest. The companies investment parameters are: safety of principal; moderate risk.
What should the firm invest in?
a.
b.
c.
d.
Growth Stocks.
Blue-Chip Stocks
High-Grade Preferred Stock
High-Grade Corporate Bonds
D
Because High-Grade Corporate Bonds have a high probability of payment of interest and repayment of principal,
They are a good choice given this firm's investment parameters.
Page: 240
Securities (Types & Characteristics)
Which of the following risks might a promissory note be subject to?

2. Liquidity Risk
4. Default Risk
a. 1 through 4
b. 1, 3, and 4 only
c. 1, 2, and 3 only
d. 2, 3, and 4 only
A
All are possible risks.
Since the structure of a promissory note is similar, if not equivalent, to a bond, many of the same investment
considerations that apply to bonds also apply to promissory notes.
Page: 241
It is likely that a promissory note can be subject to all of the following risks, except:
a. Liquidity Risk
b. Default Risk
c. Financial Risk
d. Reinvestment Rate Risk
C
Financial Risk refers to the capital structure of a leveraged firm and is therefore unlikely to be a risk associated with an
individual promissory note.
Page: 242
Which of the following is/are a description(s) of a call option purchased by an investor?

1. An investment that allows the owner to sell shares of stock with no time restriction
2. An investment that allows the owner to buy shares of stock with no time restriction
3. An investment that allows the owner to sell shares of stock at a specified price
4. An investment that allows the owner to buy shares of stock at a specified price
a. 1 only
b. 2 only
c. 4 only
d. 1 and 3
e. 2 and 4
C
A Call Option allows an investor to purchase securities at a specified price.
Page: 243
Which of the following is the least risky investment transaction?

a. Selling an uncovered call
b. Buying a call
c. Selling an uncovered put
d. Shorting a stock
e. Short against the box
E
The least risky transaction is Shorting Against the Box
The Short Against the Box is a Hedging Technique that is used to eliminate volatility in the value of a security
Page: 244
Which of the following is the most risky investment transaction?

a. Selling a Naked Option
b. Short Against the Box
c. Sell a Covered Call
d. Buy a Put Option
e. Buy a Call Option
A
The most risky transaction is Selling a Naked Option.
Recall that the loss when purchasing an option is limited to the premium paid.
However, selling options exposes the investor to unlimited loss for a call and loss equal to the strike price minus the
premium for a put option.
Page: 245
John sells a call option for a $3 premium. The call has an exercise price of $20. Which of the following is true?
a. John's loss is limited to $20
b. John hopes the price will go up
e. The call will most likely not be exercised while the stock is trading at $23
d. John's maximum gain is $3
e. The option will most likely not be exercised until the price is $17
D
Seller's Maximum Gain is $3, but his maximum loss is unlimited.
Since the Call Option was written as a Naked Call, the seller (John) will have to buy the stock at the Market Price
if the option is Exercised by the buyer
The buyer would exercise the option when the Stock Price Exceeds $20.00
Any price level over $20 begins to reduce the option buyer's potential loss, and at $23 the seller and buyer Break
Even
Page: 246
Dave sells a call for $3. The exercise price is $42. Which of the following is not true?
a.
b.
c.
d.
e.
The call will likely be exercised at a stock price of anything greater than $42
The buyer of the call option will not exercise at a price of $44 because he would lose $1 ($44 - $42 - $3 = -$1)
Dave can theoretically lose an infinite amount
The net profit will be zero if the call is exercised when the stock price is $45
The most Dave can make is the premium of $3
B
The buyer of the call option would have a loss of $1.00 if he exercised the option whereas the loss would equal $3.00 if
he did not exercise.
Therefore, he would exercise.
The buyer would exercise the option when the stock price exceeds $42.00.
Any price level over $42.00 begins to reduce the option buyer's potential loss, and at $45.00 the option buyer
breaks even.
Page: 247
Assume a put and call each sell for a $4 premium and each is exercisable at $54. Which of the following is true if the
stock price at expiration is $50?
1. The call would be exercised, but the net profit would equal zero
2. Purchasing both the put and call would result in a net loss of $8
3. The seller of the call should make a profit of $4
4. The seller of the put should make a profit of $4
a.
b.
c.
d.
e.
1 only
3 only
1 and 2
2 and 3
2, 3, and 4
B
Statement 1 is false. This is true for a put but not for a call.
Statement 2 is false. Call: Net loss of $4. Put: Net loss of Zero (in-money by $4.00 + $4 Premium = "0" Net).
Therefore, total loss of $4.00.
Statement 3 is true. The call option would not be exercised.
Statement 4 is false. Because the put would be exercised, both the buyer and the seller would breakeven.
Page: 248
If Dave buys a put option for $3 with an exercise price of $32 and a call option for $6, with an exercise price of $42 for
the same time and for the same stock, which of the following is/are true?
1. The largest loss Dave can sustain is $9
2. At a market price of $31 Dave will lose $2
3. At a market price of $45 Dave will lose $6
a. 1 only
b. 2 only
c. 3 only
d. 1 and 3
e. 2 and 3
D
1. The largest loss is cost of the two premiums because the call will be profitable with higher stock prices and the put
will be profitable with lower stock prices. True.
Maximum loss any option buyer can sustain is the original premium.
Out-of-money options expire with "0" premium.
2.
False
Put
32
(21)
1 - 6 = (3) +
Call
Not
Exercised
(3)
Total
=
(6)
Put
Total
Not
Exercised
3 - 6 = (3) +
(3)
=
(6)
3.
False
Call
45
(42)
Page: 249
Mary buys a put option for $3 with an exercise price of $32 and a call option for $6 with an exercise price of $42, for ABC
stock. Both options expire in December. At what stock price(s) will Mary break even?
a.
b.
c.
d.
e.
$23
$32
$42
$51
A and D
E
To break even, the price must be $9 above or below the exercise price to cover the two premiums.
Put
Call
Exercise Price
$32.00
$42.00
Premiums ($6.00 + $3.00)
- 9.00
+ 9.00
Break-even
$23.00
$51.00
Page: 250
Robin wishes to short GM. She places a market order to short sell 100 shares of GM just after it has traded previously at
46 and then at 45. GM subsequently trades at 45,44, 43Y2, 44V2, 44, 45, and 43. If Robin later buys 100 shares of GM
at $40, what will her profit be?
a.
b.
c.
d.
e.
$300
$350
$400
$450
$500
D
$44.50 Proceeds
($40.00) Cost
$4.50 x 100 = $450
The Uptick Rules only permit an investor to short a stock when the price has moved up one Tick (not on down Ticks)
Therefore, she will short the stock at $44.50 because that is the first increase in the stock price
Her gain will be the difference between $44.50 and $40.00 multiplied by the number of shares
Page: 251
Lisa short sells 100 shares of XYZ at $35. She then buys back the stock for $2,000. XYZ pays a dividend of $2.00 per
share before she buys the stock back. What is her net profit or loss?
a. $1,300 loss
b. $1,500 loss
c. $1,300 profit
d. $1,500 profit
e. $1,600 profit
C
Proceeds
Cost
Gain
Less Dividend Payment
Net Profit
$3,500
(2,000)
$1,500
(200)
$1,300
The short seller must pay any dividends due to the investor who lent the stock.
The purchaser of the short-sale stock receives the dividend from the corporation, so the short seller must pay a similar
dividend to the lender.
Page: 252
Angel short sells 100 shares of XYZ at $57 with a 50% initial margin. XYZ pays a dividend of $2.00 per share after
she sells the stock. She then buys back the stock for $54. What is the percent profit or loss?
a.
b.
c.
d.
e.
1.8%
3.5%
5.3%
7.0%
10.5%
B
Angel's investment: 100 x $57 x 0.5 = $2,850
Proceeds
Cost
Gain
Less Dividend Payment
Net Profit
$5,700
(5,400)
$300
(200)
$100
[(Net Profit) / (Investment)] = % Gain/Loss

$100 + $2,850 = 3.5%
Page: 253
Amanda buys 75 shares of BR Enterprise stock for $67 per share on margin. The initial margin is 55%, and there is a
maintenance margin of 40%. If she sells the stock for $78 per share what is her return?
a.
b.
c.
d.
e.
16%
23%
30%
36%
41%
C
Proceeds
Cost
Gain
Investment
Therefore
$78.00
(67.00)
$11.00 x 75 Shares
= $825.00
=
75 x 67.00 x 55% = $2,763.75
$825
= 29.85%
$2,763.75
= 30%
Page: 254
Amanda buys 75 shares of BR Enterprise stock for $67 per share on margin. The initial margin is 55%, and there is a
maintenance margin of 40%. At what market price will Amanda receive a margin call?
a.
b.
c.
d.
e.
$21.54
$26.80
$33.00
$50.25
$56.95
D
Margin Call
$67 x (1 0.55)
1 0.40
Loan
1 Maintenance Margin
=
$30.15
0.60
= $50.25
Page: 255
Which of the following is/are not a variable in determining the price for a call option under the BlackScholes Option
Valuation Model?
1.
2.
3.
4.
Price of the underlying security

Inflation rate
Standard deviation of returns (expected volatility)
Option exercise price
a.
b.
c.
d.
e.
2 only
3 only
4 only
1 and 2
2, 3, and 4
A
All variables except the inflation rate are elements of the Black Scholes option valuation model. The five variables in the
model are as follows:
1. Stock price
2. Exercise price
3. Risk-free rate
4. Time
5. Volatility (standard deviation)
Page: 256
What is one characteristic of a corporate zero-coupon bond?

a.
b.
c.
d.
e.
It has little price volatility

The investor receives semiannual interest payments
It is subject to interest rate risk
The investor pays taxes on interest only when the bond matures
All of the above
C
All bonds are subject to interest rate risk.
However, a Zero-Coupon Bond would not be subject to reinvestment risk.
D is incorrect because the investor pays tax on accrued interest (OID Rules).
Page: 257
Mark purchased Sandy's Porshe two years ago. Sandy provided 100% financing for the sale. Mark has a balloon
payment of $25,000 due in three years and has been making monthly payments of $662.73 at 9.75%. What was the
original price of the car?
a.
b.
c.
d.
e.
$35,275
$39,295
$45,000
$46,757
$48,224
D
N =
i
=
FV =
PMT
PV =
60
0.8125(9.75+ 12)
(25,000)
= (662.73)
$46,757
Page: 258
Which of the following is/are not a variable in determining the PRICE for a Call Option under the BlackScholes Option
Valuation Model?
1. Time to expiration
2. Risk-free interest rate
3. Exercise price of the option
a.
b.
c.
d.
e.
1 only
2 only
3 only
1 and 2
All of the above are elements of the Black-Scholes Option Valuation Model
E
All three are variables in the Black Scholes Option Model
The 5 variables in the model are as follows:
1. Stock price
2. Exercise price
3. Risk-free rate
4. Time
5. Volatility (standard deviation)
Page: 259
What is one characteristic of a high-grade general obligation municipal bond?

a.
b.
c.
d.
e.
Its main source of investment risk is business risk.

The taxing authority of the issuing government or municipality backs it.
It retains a direct claim on specific property.
Its periodic interest is paid to investors only when earned.
Its main source of investment risk is financial risk.
B
The taxing authority of the issuer backs a general obligation bond.
Page: 260
A bond with a coupon rate of 8% and a YTM of 10% is considered to be which of the following?
a.
b.
c.
d.
e.
At-The-Money
In-The-Money
By-The-Money
Out-Of-The-Money
None of the above
E
Phrases A, B, and D are used to describe the state of an option.
None are used to describe bonds.
Page: 261
All of the following are true regarding Exchange Traded Funds (ETFs) except:
a. ETFs can be bought on margin
b. Like most stocks, ETFs can only be sold short on an uptick
c. ETFs are passively managed
d. ETFs may not be equal to NAV due to supply and demand for the shares
B
Exchange Traded Funds can be sold short without an uptick and are often done with such securities as QQQ (Nasdaq100), DIA (Dow Jones Industrial) and SPY (S&P 500).
Page: 262
Which of the following methods may be used to trade exchange-traded funds (ETFs)?
1. Investors can buy or redeem shares from the fund family in 100 share blocks.
2. Investors can trade ETFs in the secondary market by using a broker.
3. ETFs can be bought on margin and can be sold short (and are not subject to the uptick rule).
a.
b.
c.
d.
e.
1 only
2 only
1 and 2 only
2 and 3 only
1, 2, and 3
D
The correct answer is D.
Statement 1 is incorrect because investors can buy or redeem shares from the fund family in 50,000 share blocks.
The other statements are correct.
Page: 263
Black-Scholes valuation model is used to determine the price of which of the following?
a.
b.
c.
d.
e.
Call Options
Put Options
Forward Contracts
Commodity Prices
A and B
A
The Black Scholes Model is used to value Call Options.
Page: 264
Baylor stock is currently selling for $63/share. A call option for this security has an exercise price of $65/ share and
can be purchased for $4/share. The option expires in 3 months. Which of the following below best describes the
option?
a. In-The-Money
b. At-The-Money
e. Out-Of-The-Money
d. By-The-Money
e. These phases do not apply to options
C
Out-of-the-money for a call option means that the exercise price is greater than the current market price for the security.
At-the-money means that the stock price is equal to the exercise price.
In-the-money for a call option means that the price of the security is higher than the exercise price of the call option.
By the-money is a nonexistent phrase.
Page: 265
Baylor stock is currently selling for $63/share. A put option for this security that has an exercise price of $65/share can
be purchased for $4/share. The option expires in 3 months. Which of the following below best describes the option?
a. In-The-Money
b. At-The-Money
e. Out-Of-The-Money
d. By-The-Money
e. These phases do not apply to options
A
A put option is in-the-money when the exercise price is greater than the current market price of the security.
A put option is out-of-the-money when the stock price is greater than the exercise price.
Page: 266
Investment Planning
Using the information in the table below, determine which call options (numbered 1 through 9) are InThe-Money, Atthe-Money, and Out-of-the-Money (assume it is January).
Market
Price
$53
$53
$53
a.
b.
c.
d.
e.
Exercise
Price
$50
$55
$60
In-the-Money
1, 2, 3
1, 4, 7
3, 6, 9
1, 4, 7
2, 3, 5, 6, 8, 9
April
1. $4.50
2. $3.00
3. $2.00
Premium for Each Call Option

July
October
4. $6.00
7. $7.00
5. $5.00
8. $6.50
6. $4.00
9. $5.25
At-the-Money
4, 5, 6
2, 5, 8
2, 5, 8
None
None
Out-of-the-Money
7, 8, 9
3, 6, 9
1, 4, 7
2, 3, 5, 6, 8, 9
1, 4, 7
D
In the money: MP> EP
At the money: MP = EP
Out of the money: MP < EP
The premium for the option is not considered in determining if a call option is in-the-money,
at-the-money, or out-of-the-money.
Page: 267
Using the table below, determine which of the call options (numbered 1 through 9) an option buyer would consider to be
the most risky (assume it is January).
Market
Price
$53
$53
$53
a.
b.
c.
d.
e.
Exercise
Price
$50
$55
$60
April
1. $4.50
2. $3.00
3. $2.00

July
October
4. $6.00
7. $7.00
5. $5.00
8. $6.50
6. $4.00
9. $5.25
1
3
5
7
9
B
Because Option #3 is Out-Of-The-Money by the greatest amount and because it has the earliest expiration date (less
time for the stock price to move into the money), it is the most risky.
(Note: The most risky will usually have the lowest premium.)
Page: 268
Using the table below, determine which of the following call options (numbered 1 through 9) an option
consider to be the least risky.
Market
Price
$53
$53
$53
a.
b.
c.
d.
e.
Exercise
Price
$50
$55
$60
April
1. $4.50
2. $3.00
3. $2.00
buyer would

July
October
4. $6.00
7. $7.00
5. $5.00
8. $6.50
6. $4.00
9. $5.25
1
3
5
7
9
D
Option #7 is the least risky because it has the most time to expiration and it is in the money by the largest amount.
Page: 269
What model was developed to determine the value of a put option?

a.
b.
c.
d.
e.
Sharp Index
Treynor Index
Black Scholes Option Valuation Model
Put-Call Parity Model
None of the above
D
The Put-Call Parity Model is used to determine the value of a put option based on the value of a similar call option.
Sharpe and Treynor are stock performance models.
Black Scholes is a call option valuation model.
Page: 270
Jim Bob Simple is a paper maker who purchases lumber from tree farmers around his state. If Jim Bob is concerned
with rising lumber prices, what type of hedge position should he enter into?
a. A short hedge; Simple should buy lumber futures contracts to protect against rising lumber prices.
b. A short hedge; Simple should sell lumber futures contracts to protect against rising lumber prices.
c. A long hedge; Simple should buy lumber futures contracts to protect against rising lumber prices.
d. A long hedge; Simple should sell lumber futures contracts to protect against rising lumber prices.
e. A long hedge; Simple should buy lumber futures contracts to protect against increasing supplies of lumber.
C
Jim Bob should buy lumber futures contracts to protect against rising prices.
This is called a Long Hedge.
Bonds and Preferred Stock
Page: 271
Which of the following statements are true concerning the characteristics of bonds and preferred stock?
1. Unlike common stock, the rights of preferred stockholders must be satisfied prior to debt creditors, such as
bondholders.
2. Like interest paid to bondholders, dividends paid to preferred stockholders are tax deductible.
3. Like bonds paying a fixed amount of interest, preferred stock pays a fixed dividend only.
4. Both bonds and preferred stock have definite maturities.
a. 1 and 2
b. 2 and 3
c. 3 and 4
d. 2, 3, and 4
E
Statement 1 is false - Creditors are satisfied before preferred stockholders
Statement 2 is false - Dividends are not deductible
Statement 3 is false - Can be participating
Statement 4 is false - Preferred stock has an indefinite life, whereas bonds have a definite maturity
Page: 272
What is the duration of a bond purchased for $948.50 which matures in 5 years and has a coupon rate of 12.5%? (Assume annual
coupon payments.)
a.
b.
c.
d.
e.
3.919 years
3.948 years
3.977 years
4.006 years
5.000 years
C - Method 1:
Period
1
2
3
4
5
Cash Flow
125
125
125
125
1,125
Product (FV)
125
250
375
500
5,625
PV @ 14%
109.65
192.37
253.11
296.04
2,921.45
$3,772.62
Yield to Maturity
PV
= $948.50
N
=5
PMT = 125
FV
= $1,000
i
= 14%
Duration = $3,772.62 $948.50 = 3.977 years

Method 2
Duration
(1 + y)
y
(1 + y) + T(c y)
C[(1 + y)T 1] + y
Duration
1.14
0.14
1.14 + 5(0.125 0.14)

0.125[(1.14)5 1] + 0.14
Duration
8.1429
Duration
8.1429
Duration
3.977
1.065
0.2557
1.1654
Page: 273
Consider the following 6 AAA-rated bonds:
Bond 1: 5-year bond with 8% coupon
Bond 3: 7 -year bond with 8% coupon
Bond 5: 10-year bond with a zero-coupon
Bond 6: 30-year bond with a 12% coupon

Which of the following statements about the above bonds are true?
1. The duration of Bond 1 is greater than Bond 2 because the cash flows for Bond 2 are higher.
2. Bond 2 has a greater potential for price fluctuation than Bond 1 because it has a larger coupon rate.
3. Bond 6 has the highest potential for price fluctuations among Bonds 2, 4, and 6 because it has the longest maturity.
4. Bond 5 has a higher potential for price fluctuations than Bond 4 because it has a lower coupon rate.
5. Bond 4 has a Duration less than that of Bond 5.
a.
b.
c.
d.
e.
1 and 2
1, 3, and 4
2, 3, and 5
1, 3, 4, and 5
1, 2, 3, and 5
D
Statement 1 is true.
Statement 2 is false.
Duration of Bond I is higher because cash flows are lower

The lower the coupon the higher potential for price fluctuation
The longer the maturity the higher potential for price fluctuation
The lower the coupon the higher potential for price fluctuation
Duration and coupon rate are inversely related
Page: 274
What is the duration of the following portfolio of bonds?
Bond A: 5-year bond with a 12.5% coupon rate, a duration of 4.0 151 years, and currently selling for $1,018.02.
Bond B: 5-year bond with a 10.0% coupon rate, a duration of 4.4676 years, and currently selling for $963.04.
Bond C: 7 -year bond with a 8.5% coupon rate, a duration of 3.9943 years, and currently selling for $926.97.
a.
b.
c.
d.
e.
3.36 years
4.35 years
4.15 years
4.73 years
6.84 years
C
Investment
Duration
Product
$1,018.02
X
4.0151
=
$
4,087.45
963.04
X
4.4676
=
4,302.48
926.97
X
3.9943
=
3,702.60
$2,908.03
=
$ 12,092.53
Portfolio duration: $12,092.53 + $2,908.03 = 4.1583 years
Page: 275
The dollar value of a T-bill quoted at 95.68 is:

a.
b.
c.
d.
e.
$9,575.00
$9,507.50
$9,568.00
$10,000.00
Cannot be determined
C
T-bills are quoted as a percent of par value thus, 95.68 is 95.68% of 10,000 or $9,568.00.
Page: 276
A $1,000 T-note maturing in eight years is selling for $93.26. The semiannual coupon payment is $35.
yield to maturity for the note?
What is the
a. 7.00%
b. 4.03%
c. 6.26%
d. 8.06%
e. 8.33%
D
The price of a Treasury note or bond is quoted in 32nds. Therefore, 26 must be divided by 32 with the result added to 93
to determine the price of the Treasury note.
N
= 16
PV
= ($938.12) = 0.938125 x $1,000]
PMT = $35
FV
= $1,000
i
= 4.03x2=8.06%
Page: 277
Which of the following statements is true regarding Serial Bonds?

a. They are secured by the taxing power of the issuer
b. They generally sell at a discount
c. They have multiple maturity dates
d. They are always long-term bonds
C
The most common type of bond is a term bond that has a single maturity date.
Serial Bonds have a series of maturity dates.
A portion of the bond issue matures each year.
Serial Bonds are typically issued by municipalities.
Page: 278
A bond that pays interest and principal from revenue generated by a particular project is called:
a. Revenue Obligation Bond
b. Project Bond
e. General Obligation Bond
d. Municipal Bond
e. A and D
E
Revenue Obligation Bonds are sold to finance specific projects, and the debt and interest are paid off with the revenue
generated from the project.
These bonds are a type of municipal bond.
Page: 279
David wishes to sell short 200 shares of ABC common stock. If the last two transactions were at 48 followed by a trade
at 49 1/8, David can sell short on the next transaction at what price?
a.
b.
e.
d.
e.
48 or above
49 1/8 or above
48 or lower
49 1/8 or lower
Any price
B
The Uptick Rule requires that short sales only occur after the stock price has increased on the previous trade.
Page: 280
In the event of a declining market, what should an investor do?

a.
b.
e.
d.
e.
Buy index futures

Sell index futures
Buy a call option
Sell a put option
None of the above
B
Selling a stock index future will hedge against declining markets.
The other options will only profit in increasing markets.
Page: 281
Which of the following strategies could be considered a protective strategy?

a.
b.
c.
d.
e.
Purchasing a call option on a stock you own

Selling a naked call
Buying a put on a stock already owned
Buying a put on a stock you sold short
Selling a call against a stock you sold short
C
Purchasing a put will be profitable if the market or stock declines.
If the market increases or the stock price increases then the investment in the security will be profitable.
The combination of a put option and a long position will limit down side risk but not limit upside potential.
Page: 282
What is the Duration of a Zero-Coupon Bond yielding 9%, maturing in 10 years, and selling for $422.41?
a.
b.
c.
d.
e.
7 years
8 years
9 years
10 years
11 years
D
Because the bond is a Zero-Coupon Bond, the Duration must be 10 years.
No calculation is necessary.
Page: 283
Which of the following issues Guaranteed Investment Contracts?

a.
b.
c.
d.
e.
Insurance companies
Stock brokers
Investment brokers
The Federal Reserve
None of the above
A
Insurance companies issue GICs.
GICs are often called stable value funds.
Page: 284
Which of the following statements are true about open-end investment companies?
1. They can sell at a premium or discount relative to NAY
2. The capitalization is not fixed
3. Shares will be redeemed based on supply and demand
4. Shares are traded on various exchanges
a.
b.
c.
d.
e.
1 only
2 only
2 and 3
3 and 4
1, 2, 3, and 4
B
Statement 2 is true; Open-End Investment Companies can sell unlimited shares and thereby increase their
capitalization.
All other statements are characteristics of Closed-End Investment Companies.
Page: 285
You buy 100 shares of XYZ stock for $60/share with an initial margin of 50% and a 30% maintenance margin.
At what price will you receive a margin call?
a.
b.
c.
d.
e.
$44.00
$43.50
$42.85
$42.00
$40.00
C
Margin Call
Loan
1 - Maintenance Margin
Margin Call
$60.00 x 50%
(1 0.30)
Margin Call
$30
0.70
Margin Call
$42.85
Page: 286
If stock drops to $40/share, how much cash will you be required to put up, assuming you bought W(
stock for $60 per share with initial margin of 50% and a 30% maintenance margin?
a.
b.
c.
d.
e.
shares ofXYZ
$100
$200
$285
$800
$2,000
B
Value
Loan
Equity
Equity needed
Cash needed
= $40 x 100
=
=
= $4,000 x 30%
=
=
=
=
=
=
$ 4,000
(3,000)
$ 1,000
$ 1,200
$200
Page: 287
Which of the statements concerning stock options is correct?

1. The writer of a put receives a premium
2. The writer of a call receives a premium
3. A writer of a call is bearish
4. A writer of a put is bullish
a.
b.
e.
d.
e.
1 only
2 only
1 and 3
1, 2, and 4
1, 2, 3, and 4
E
Statements 1 and 2 are true because the writer of any option will receive a premium.
Statement 3 is true because the purchaser of a call hopes the price will increase, whereas the seller of the option hopes
it will decline (or at least not increase).
Statement 4 is the opposite of Statement 3.
Page: 288
Which of the statements below regarding the stock market is correct?

1.
2.
3.
When stock positions are held in a margin account, a margin call generally occurs when the valli{ of the position falls to
below 75% of its original value.
OTC stocks are more likely to pay dividends than are listed stocks.
Bull (stock) markets generally last longer than do bear markets.
a. 1 only
b. 2 only
e. 1 and 3
d. 2 and 3
e. 1, 2, and 3
C
Statements 1 and 3 are true.
Statement 2 is false because most OTC stocks are more likely to reinvest earnings into the company and, therefore, not pay
dividends as high as well-established companies.
Statement 1
Assumed stock price:
Assumed initial margin:
Assumed maintenance margin:
$100
50%
35%
Margin Call
Loan
1 - Maintenance Margin
Margin Call
$50.00
(1 0.35)
Margin Call
$50
0.65
Page: 289
Margin Call = $76.92
Page: 290
A client with a large, well-diversified common stock portfolio expresses concern about a possible market decline.
However, he/she does not want to incur the cost of selling a portion of their holdings nor the risk of mistiming the market.
A possible strategy for him/her would be: (CFPTM Certification Examination, released 3/95)
a.
b.
c.
d.
e.
Buy an index call option

Sell an index call option
Buy an index put option
Sell an index put option
None of the above
C
The client will benefit if the market increases.
His/her portfolio, because it is diversified, should move with the market.
An index option also moves with the market and would therefore be a good hedge vehicle.
A put should be used because it will increase in value if the market should decline.
Page: 291
According to Fundamental Analysis, which phrase best defines the Intrinsic Value of a share of common stock?
(CFPTM Certification Examination, released 3/95)
a.
b.
c.
d.
e.
The par value of the common stock

The book value of the common stock
The liquidating value of the firm on a per-share basis
The stock's current price in an inefficient market
The discounted value of all future dividends
E
The Intrinsic Value of a share of common stock is equal to the discounted Present Value of its Cash Flows.
Page: 292
Which one of the following types of investor benefits most from the tax advantage of preferred stocks?
Certification Examination, released 3/95)
a.
b.
c.
d.
e.
(CFPTM
Government
Individual
Corporate
Mutual Funds
Non-Profit Institutional
C
Corporations receive a deduction of 70%, 80%, or 100%, depending on ownership percentage for dividends received
(IRC Section 243).
Page: 293
Municipal bonds that are backed by the income from specific projects are known as: (CFPTM
a.
b.
c.
d.
e.
Income Bonds
Revenue Bonds
General Obligation Bonds
Debenture Bonds
Project Bonds
B
General Obligation Bonds are backed by full taxing authority of the municipality
Whereas Revenue Bonds are only repaid from revenues of a particular project.
Page: 294
A call option with a strike price of $11 0 is selling for 3Yz when the market price of the underlying stock is $108.
The intrinsic value of the call is: (CFPTM Certification Examination, released 3/95)
a.
b.
c.
d.
e.
0
1
2
3
-2
A
The call option is out of the money; therefore the intrinsic value is zero.
To have an intrinsic value, the current price of the stock must exceed the strike price.
The formula is market price - strike price = intrinsic value.
Page: 295
With the same dollar investment, which of the following strategies can cause the investor to experience the greatest
loss? (CFPTM Certification Examination, released 3/95)
a.
b.
c.
d.
e.
Selling a naked put option

Selling a naked call option
Writing a covered call
Buying a call option
Buying the underlying security
B
A Call Option has unlimited upside price potential which means that writing a call without the stock as a hedge will
provide the greatest loss potential.
In selling a put option, the seller does have downside price risk, but the stock price can only drop to zero.
Writing a Covered Call only exposes the writer to lost profits.
In buying a call option, the purchaser's only risk is the premium or cost of the option.
Buying the underlying security only exposes the purchaser to downside price risk; the price of the stock can only drop to
zero.
Page: 296
Which of the following is/are characteristics of a municipal bond unit investment trust? (CFpTM
1.
2.
3.
4.
Additional securities are not added to the trust.

Shares may be sold at a premium or discount to net asset value.
Shares are normally traded on the open market (exchanges).
The portfolio is self-liquidating.
a.
b.
c.
d.
e.
1 only
1 and 4
2 and 3
2 and 4
1, 2, 3, and 4
B
Once capitalized, unit trusts do not generally accept additional funds.
Unit trusts are almost always self-liquidating.
The other characteristics apply to closed-end mutual funds.
Also, unit trusts do not have shares like a mutual fund; they are sold in units.
Page: 297
American depository receipts (ADRs) are used to: (CFpTM Certification Examination, released 3/95)
1.
2.
3.
4.
Finance Foreign Exports

Eliminate Currency Risk
Sell U.S. Securities in Overseas Markets
Trade Foreign Securities in U.S. Markets
a.
b.
c.
d.
e.
1 and 3
1 and 4
2 and 4
4 only
1, 2, and 4
D
ADRs are used to trade foreign securities in the U.S. ADRS are trust receipts issued by a U.S. bank for shares of a
foreign branch of the bank.
ADRs are legal claims against the equity interest that the bank holds.
ADRS do not eliminate currency risks.
Page: 298
Which of the following agencies issue bonds that are backed by the full faith & credit of the United States Government?
a. FHLMC
b. FNMA
c. TVA
d. GNMA
D
GNMA stands for Government National Mortgage Association.
The bonds issued by this organization are backed by the full faith and credit of the U.S. Government.
Therefore, they are considered to be default risk free.
Page: 299
Which of the following are characteristics of dosed-end investment companies?

1. Shares of dosed-end investment companies are generally redeemable by the fund.
2. Similar to stocks, shares of dosed-end investment companies are generally traded on exchanges.
3. Closed-end investment companies will often issue additional shares to raise more capital for the fund.
a.
b.
c.
d.
e.
1 only
2 only
3 only
1 and 2
1, 2, and 3
B
Statement 1 is false. Shares of closed-end funds are traded in the secondary markets, not redeemed by the company.
Statement 3 is false. Closed-end funds have a capitalization that is fixed, unlike open-end funds.
Page: 300
Which of the following statements regarding Series EE Bonds is/are correct?

1. Investors may choose to defer taxation on the interest until the bonds mature
2. Interest is not actually paid on the bonds until maturity or redemption
3. The bonds are originally sold for two-thirds of maturity (face) value
4. Series EE bonds may be traded at maturity for Series HH bonds to defer tax on accrued interest
a. 1 only
b. 2 only
c. 1 and 3
d. 1, 2, and 4
e. 1, 2, 3, and 4
D
Bonds are sold at 50% of face.
Page: 301
Mutual funds often have stated objectives indicating what type of fund the investor is choosing. Which of the following
types of funds generally focus their investment objective in narrow areas such as natural resources, technology, or
health care?
a.
b.
c.
d.
e.
Sector Funds
Growth and Income Funds
Balanced Funds
Growth Funds
Income Funds
A
Sector Funds tend to limit their investments to one sector of the economy, such as:
Natural Resources,
Technology, or
Health Care.
Page: 302
Which of the following is not considered a short-term investment vehicle?

a.
b.
c.
d.
e.
Treasury Bonds
NOW Accounts
Repurchase Agreements
Negotiable CDs
Commercial Paper
A
Treasury Bonds are long-term investment vehicles.
Page: 303
Which of the following are correct regarding the characteristic of warrants and call options?
Warrants
Call Options
1. Issued by the company
Yes
No
2. Convertible into stock
No
Yes
3. Often issued with bonds
Yes
Yes
a. 1 only
b. 2 only
c. 3 only
d. 1 and 3
e. 1, 2, and 3
A
Warrants are issued by the company.

Call options are written by other investors.
Both types of derivatives can be converted to stock.
Warrants are often issued as a sweetener for bonds, however, call options are not issued with
bonds.
Page: 304
Alex has a put option with an exercise price of $51. The stock is currently selling for $47. If the opt
$3 and 3 months until expiration, what is the intrinsic value?
a.
b.
c.
d.
e.
has a premium of
0
1
(3)
(7)
4
E
The premium is ignored when determining the intrinsic value of an option.
Therefore, the intrinsic value is $4.00 ($51 - $47).
Page: 305
With the same dollar investment, which of the following strategies can cause an investor to experience the greatest
loss?
a. Selling a Naked Call Option
b. Selling a Naked Put Option
c. Selling a Covered Call Option
d. Selling a Covered Put Option
e. Buying a Straddle
A
Selling a naked call option has the greatest potential for loss because the call writer does not own the underlying
security and the potential increase in price of the underlying security is unlimited.
Also, it only takes a few points movement to lose 100% with an option.
Page: 306
Which of the following Bonds is/are considered to be Default Risk Free?

1. Federal National Mortgage Association Bonds
2. Collateral Mortgage Obligations
3. Government National Mortgage Association Bonds
a.
b.
c.
d.
e.
1 only
2 only
3 only
1 and 2
None are considered default risk free
C
As an agency of the U.S. Government,
Guaranteed National Mortgage Association Bonds are backed by the full faith and credit of the U.S.
Government
The other two are considered to have default risk.
Page: 307
Kristen wants to invest in ABC stock, however, she must wait several months until her certificate of deposit matures.
What type of option should she invest in to protect against the market value of the stock increasing before her money
becomes available?
a.
b.
c.
d.
e.
Buy a Put Option

Write a Put Option
Buy a Call Option
Sell a call option
None of the above
C
Buying a call option will allow Kristen to purchase the stock in the future at a predetermined price if the market value
should go up.
Page: 308
Which of the following is a benefit of a STRIP Treasury?

a.
b.
c.
d.
e.
There is no taxable income

Treasury STRIPS avoid reinvestment risk
All income from STRIPS will be treated as capital gains
STRIPS are much less volatile than other bonds
None of the above is true
B
Since STRIPS do not have coupons, reinvestment risk is avoided.
Page: 309
Which of the following factors directly affects the value of a call option, and does the factor cause the value of the option
to increase or decrease?
a.
b.
c.
d.
e.
Greater Standard Deviation

Increase
Increase
Increase
Decrease
Decrease
Greater Time Till Maturity

Increase
Decrease
Increase
Decrease
Increase
Rise in Inflation
Increase
Decrease
Not directly related
Increase
Not directly related
C
Inflation will not directly affect the value of an option.
Standard deviation and increased time are directly related.
Page: 310
Which one of the following products is designed to provide both growth and income? (CFP TM Certification Examination,
released 12/96)
a.
b.
c.
d.
Fixed Premium Annuity

Nonparticipating Mortgage Real Estate Investment Trust (REIT)
Aggressive Growth Mutual Fund
Convertible Bond
D
Convertible bonds generate current income from coupon payments and allow for growth through the stock conversion
feature.
Page: 311
Which of the following terms describes funding for product development and marketing for companies who have not sold
products or services commercially?
a.
b.
c.
d.
Seed financing
Start-up financing
First-stage financing
Bridge financing
B
Seed financing is funding for the purpose of research and development of an idea.
First-stage financing is for initial manufacturing and sales.
Bridge financing is for companies that expect to go "public" within approximately one year.
Page: 312
Which of the following terms is considered early-stage business funding that does not typically exceed
$50,000 and is for the purpose of research and development of an idea?
a.
b.
c.
d.
Bridge financing
Seed financing
First-stage financing
Start-up financing
B
Bridge financing is for firms that expect to go public within approximately one year. First-stage financing is for initial
manufacturing and sales. Start-up financing is for product development and marketing for firms who have not sold
products or services commercially.
Page: 313
Which of the following publications is likely to have the historical earnings of The Blue Sky mutual fund?
a.
b.
c.
d.
Value Line investment survey

Wall Street Journal
Morningstar
Moody's
C
Morningstar publishes information regarding mutual funds.
Page: 314
Your client owns highly appreciated common stock but wants to defer any tax impact until the following tax year (12
months away). He is also concerned about the market dropping before year-end. Which of the following would best
protect his current gain while deferring taxes to the next year?
a.
b.
c.
d.
e.
Buy a Put
Sell a Put
Sell Short Against the Box
Buy a Call
Sell a Call
C
Shorting against the box will allow the client to freeze his gain until January 31 st of the year following the year the Short
against the Box transaction was entered into.
A Short against the Box is a transaction in which the owner of a stock (long position) enters into an equal and
offsetting short position.
The net result is that regardless of the movement of the stock price, no additional gains or losses will occur.
Page: 315
Mike likes a stock and expects it to significantly increase in value fairly soon. He is expecting a bond to mature in 2
months and doesn't want to miss out on any appreciation on the stock while waiting for the funds to become available.
Which of the following actions should he take?
a.
b.
c.
d.
Buy a Put
Sell a Put
Sell a Call
Buy a Call
D
Mike can lock in the price of the stock by purchasing a call option.
Page: 316
If you own a stock, what is the safest investment strategy in a market that is expected to be flat for several months?
a.
b.
c.
d.
Buy a Straddle
Buy a Call
Sell a Covered Call
Buy a Put
C
Selling a covered call will generate income from the option premium.
Since the market is expected to be flat, there is little risk that the market price of the stock will increase to the point
where the option could be exercised.
Page: 317
Which of the following strategies could be used to protect Downside Risk, with minimal cost?
1. Put Option
2. Collar
3. Short against the Box
a.
b.
c.
d.
e.
1 only
1 and 3 only
1 and 2 only
2 and 3 only
1, 2, and 3
D
A put option, collar, and shorting against the box are all viable strategies to protect against downside risk.
However, a put option would protect against downside risk at a substantial cost relative to the two other choices.
Page: 318
Mutual Funds will generally report earnings under which of the following methods?
a.
b.
c.
d.
e.
Time-Weighted Return
Dollar-Weighted Return
Average Return
Absolute Return
Annualized Return
A
The Time-Weighted Return measures the actual rate of return of a portfolio manager.
Page: 319
You own 100 shares of Abbott, Inc. In a Flat Market, what is the best thing to do?
a. Sell a call
b. Buy a put
e. Buy a straddle
d. Sell a straddle
D
A Long Straddle involves purchasing a put and call with the same exercise price and same expiration period.
A short straddle involves selling a put and call with the same exercise price and same expiration period.
The seller of a straddle will receive the premiums from the call option and the put option.
Because price volatility is not anticipated in a flat market, a short straddle can be a lucrative investment.
Page: 320
The price of Baker, Inc. stock is $53 per share. You are willing to buy 300 shares at $50.
Baker stocks are currently selling for $3 per share. What should you do?
a.
b.
c.
d.
Options on
Sell 3 puts
Buy 3 puts
Buy 3 calls
Sell 3 calls
A
The maximum gain for the writer of the put is the premium collected from the sale of the option.
With the current market price of the stock being greater than the price the investor is willing to pay, selling a put would
be more advantageous.
If the stock decreases and the option is put to the writer, then the Baker stock will be purchased at $50 ($53 exercise
price less the $3 premium).
Page: 321
Four bonds each have a 10-year maturity.

a.
b.
c.
d.
Which is the most volatile?
Municipal
Treasury
Zero
BB-Rated Corporate
C
Bonds with low coupon rates and long maturities are the most sensitive to interest rate changes.
The most volatile bond is a long-term zero-coupon bond.
Page: 322
One investment strategy is to borrow and sell shares, and then repurchase the shares at a lower price.
This strategy is called?
a. Buying on margin
b. Short against the box
c. Short sale
d. Dollar cost averaging
C
When an investor buys on margin, a portion of the purchase funds are put up by the investor and the other portion is
borrowed from the broker.
Shorting against the box occurs when an investor takes a short position with the same market value as a long position
that is held.
Dollar cost averaging is the process of purchasing securities over a period of time by investing a predetermined amount
at regular intervals.
Page: 323
In which of the following markets are large blocks of stock traded between investors without the use of
a.
b.
c.
d.
e.
brokers?
Primary
Secondary
Third
Fourth
Fifth
D
The question is the definition of the fourth market.
The Primary Market is for initial sales of securities issued to the public.
The Secondary Market consists of the large exchanges, such as the New York Stock Exchange, American Stock
Exchange, NASDAQ (over the counter (OTC) stocks), and regional exchanges.
The Third Market consists of stocks traded both on the organized exchanges and on the OTC market.
The orders on the Third Market are usually block trades of 10,000 shares or more.
Page: 324
Which markets are Initial Public Offerings (IPOs) related to?

a.
b.
c.
d.
e.
Primary
Secondary
Third
Fourth
Fifth
A
IPOs are initial public offerings, which is one of the functions of the Primary Market.
Page: 325
Which of the following statements about underwriting is NOT true?

a. All risk is shifted to the underwriter in firm-commitment underwriting agreements.
b. The investment banks will purchase the remaining securities after an initial offering in standard underwriting
agreements.
c. The investment bank incurs zero risk in "best efforts" underwriting.
d. No more than 20 non-accredited investors may participate in a private placement.
e. Private placements do not need to be registered with the SEC.
D
Up to 35 nonaccredited investors may participate in a private placement.
Page: 326
Which of the following statements is not true about the secondary market?
a.
b.
c.
d.
e.
Floor traders are the liaison between the public and the specialist.
Specialists maintain orderly markets and adjust market prices based on supply and demand.
The majority of orders are market orders.
A round lot includes 100 shares.
Stop orders turn into market orders if the stock price reaches a certain point.
A
Answer A is false because floor traders do not trade with the public.
They trade for themselves.
Page: 327
What type of order(s) will permit an investor to trade stock at a predetermined price?
a.
b.
c.
d.
e.
Market
Limit order
Stop order
Stop limit order
b and d
E
Both limit orders and stop limit orders are correct: (B and D); therefore, the correct answer is e.
Market orders trade at the market price, not a price specified by the purchaser.
A stop order, commonly referred to as a stop-loss order, is triggered at a specific stock price after a decline in the price
of a stock.
When the stop order is triggered it converts into a market order and executes at the market price.
Page: 328
Which type of underwriting would you prefer if you were concerned about minimizing cost and placing an offering
quickly?
a.
b.
c.
d.
e.
Firm commitment
Stand-by underwriting
Public placement
Private placement
Best efforts
D
Private placement does not require registration with the SEC.
Therefore, it is much quicker and less costly.
Page: 329
Which of the following individuals exclusively execute stock orders for retail clients?
a.
b.
e.
d.
e.
Commission broker
Floor broker
Registered trader
Specialist
Market maker
A
Definition of commission broker.
Page: 330
What is the most common type of order?

a.
b.
c.
d.
e.
Market order
Limit order
Stop order
Stop-limit order
Good till cancel order
A
75% to 80% of orders are market orders.
Page: 331
Which of the following is not an example of a secondary market transaction?

a.
b.
c.
d.
e.
U.S. Treasury auctions $150,000,000 in T-bills

Arkansas State issues debt to finance a toll road
A mutual fund purchases 20% of an IPO
IBM issues new shares to its stockholders
All of the above
E
All of the transactions are primary market transactions.
Page: 332
If a company is interested in issuing securities in the primary market, which of the following securities laws should it be
most concerned with?
a.
b.
c.
d.
e.
Glass-Steagall Act
Security Act of 1933
Securities Exchange Act of 1934
The Maloney Act of 1938
The Securities Investor Protection Corporation Act of 1970
B
The Securities Act of 1933 deals with securities issued in the primary market.
Page: 333
If a broker is concerned about the implication and requirements of The Securities Exchange Act of 1934, in which
market would he most likely be dealing?
a.
b.
c.
d.
e.
Fifth
Fourth
Third
Secondary
Primary
D
The Securities Exchange Act of 1934 deals with regulating the secondary market
Page: 334
Which of the following statements about industry/regulatory relationships are true?

1. The insurance industry is primarily regulated by each of the 50 states.
2. The majority of banks are subject to federal regulation by the Federal Reserve System and the Federal
Deposit Insurance Corporation.
3. Pension plan funds are primarily subject to federal regulation.
4. The organized stock exchanges, such as the New York Stock Exchange, are primarily regulated by the
individual states in which they are incorporated.
a.
b.
c.
d.
e.
1, 2, and 3
1 and 3
2 and 4
2 and 3
1, 2, 3, and 4
A
Organized exchanges are regulated by the SEC, which is a federal agency
Page: 335
Under which of the following conditions will a private placement be exempt from SEC registration?
1. The issue is sold to no more than 35 nonaccredited investors
2. The issue is sold to no more than 50 sophisticated investors
3. The issue's registration statement is filed with the SEC
a. 1 only
b. 2 only
c. 1 and 2
d. 1 and 3
e. 1, 2, and 3
A
Statement 2 is false. There is no limit for investors (accredited) investing in a private placement.
Statement 3 is false. A registration statement is not required (which is the point of a private placement).
Page: 336
Assuming you want to sell a tax shelter as a private placement, which of the following statements are true?
1. You can sell to unlimited accredited investors.
2. You must register with the SEC.
3. The tax shelter can be sold to any number of unsophisticated investors represented by know able advisors.
a.
b.
c.
d.
e.
1 only
3 only
1 and 2
1 and 3
1, 2, and 3
D
Registration with the SEC is not required with a private placement.
Page: 337
Which of the following is the body that regulates investment advisors?

a.
b.
c.
d.
e.
SEC
NASD
FDIC
Congress
Individual states
A
The SEC regulates investment advisors.
Page: 338
Using Harry Markowitz's three rules for selecting Efficient Portfolios, determine which of the portfolio sets are
preferred.
P
E(r)
Beta
1
8%
1.1
2
9%
1.25
3
11%
1.25
4
12%
1.3
5
13%
1.1
6
14%
1.25
a. 1 and 2
b. 2 and 3
c. 3 and 4
d. 4 and 5
e. 5 and 6
E
Because Portfolio 5 has the same risk with a 5% higher return than Portfolio 1, and Portfolio 6 has the same risk and a
higher return than the remaining portfolios.
Page: 339
Which of the following is a consistent strategy with the belief in the Efficient Market Hypothesis
a.
b.
c.
d.
e.
Waiting to purchase a stock until it increases above the 40-day moving average
Searching for undervalued securities
Comparing the calculated value of a security, through fundamental analysis, to tl value of the stock
Selecting a random set of stocks for a portfolio
Both a and b
D
Because the efficient market hypothesis says that on average you cannot outperform the market.
Statement A relates to technical analysis.
Statements B and C relate to fundamental analysis.
Page: 340
Based on the following information about ABC stock, which of the following is true?
Market price
$67
Current dividend
$2
Growth of dividend
8%
Required rate of return
12.5%
Risk-free rate of return
5%
Market return
11%
Beta of ABC
1.15
1. The stock is overvalued by $19 according to the dividend growth model.
2. According to the CAPM, the E(r) is 12.65%.
3. If the stock was purchased last year for $65, the holding period return would be 3%.
a. 1 only
b. 2 only
c. 3 only
d. 1 and 2
e. 2 and 3
A
Statement 1 - True
$2 (1.08)
= 48
12.5% - 8%
Statement 2 - False
E(r) = 5% + 1.15(11%- 5%)
= 11.9%
Market Price
Constant Growth Dividend Model Price
Overvalued
Statement 3 - False
($67 - $65 + $2)
= 6.155
$65
$67
(48)
$19
Page: 341
ABC stock has a Beta of 1.1 and is currently selling for $9 per share. The dividend yield is expected to be 5% for the
year. The value of the stock is forecasted at $10 per share at year-end. The risk-free rate is 7%, and the market
premium is 8%. According to the capital asset pricing model, is this a good purchase?
a. No, because the required return exceeds the expected return.
b. No, because expected return exceeds the required return.
c. Yes, because the expected risk exceeds the required return.
d. Yes, because the forecasted rate of return exceeds the required rate of return.
e. No, because the Beta of the stock is above the market Beta.
D
Gain
Note:
$10-$9
$9
=
11.11%
=
16.11%
E(r)
= Rf + (RM - Rf)
E(r)
=
7%+1.1(8%)
The market premium is defined as RM - Rf
+ 5% Dividend Yield
+ 5%
= 15.8% (CAPM)
Page: 342
Which of the following forms of the Efficient Market Hypothesis supports Technical Analysis?
a.
b.
c.
d.
e.
Weak
Semi-strong
Strong
Both a and b
None of the above
E
The Efficient Market Hypothesis is in direct contradiction to technical analysis because the Efficient Market Hypothesis
is founded on the notion that all historical data, which is what is used by technical analysts, is already accounted for in
the current stock price.
Page: 343
Which of the following forms of the Efficient Market Hypothesis does not support Technical Analysis?
a.
b.
c.
d.
e.
Weak
Semi-strong
Strong
Both band c
All of the above do not support technical analysis
E
The Efficient Market Hypothesis is in direct contradiction to technical analysis because the Efficient Market Hypothesis is
founded on the notion that all historical data, which is what is used by technical analysts, is already accounted for in the
current stock price.
Page: 344
Investment Statistics
Which of the following is NOT correct?
a.
b.
c.
d.
The variability of individual stocks is not reduced as portfolio diversification increases.

As the number of stocks within a portfolio increases, systematic risk will more closely represent total risk.
Beta is not an appropriate measure of risk unless the portfolio is sufficiently diversified.
Standard deviation is not an appropriate measure of risk unless substantially all unsystematic risk has been
eliminated through diversification.
D
Standard Deviation measures total risk (systematic and unsystematic) and is, therefore, always an appropriate
measure of risk.
Page: 345
Which of the following best describes Semivariance?
a.
b.
c.
d.
e.
The volatility that occurs between the 13-week high and low market price for an individual stock
The variability of returns below the average, or expected, returns.
The total variability of returns capturing both systematic and unsystematic risk.
Square root of the variance.
The variance of the coefficient of determination over multiple asset classes.
B
Semivariance is a statistical measure of risk.
However, it differs from variance in that semivariance only considers the downside volatility of an investment.
Specifically, semivariance measures the variability of returns below the average or expected return.
The other two choices are not correct.
Page: 346
Given the following probability distribution, determine the standard deviation of returns for the stock of ABC Company.
Probability
Expected Return
0.25
5%
0.47
13%
0.28
23%
a. 0.43%
b. 0.81%
c. 6.58%
d. 9.92%
e. 13.67%
C
Mean
= (0.25)(0.05) + (0.47)(0.13) + (0.28)(0.23) = 13.80%
Variance = (0.05 - 0.138)2 (0.25) +(0.13 - 0.138)2 (0.47) + (0.23- 0.138)2 (0.28)
= 0.001936 + 0.00003008 + 0.0023699
= 0.004336
Standard deviation = (0.004336)1/2 = 6.58%
Page: 347
Determine the Expected Return and Standard Deviation of the following distribution of returns:
Probability
Return
Expected Return
Standard Deviation
0.2
45%
a.
21.5%
18.07%
0.3
25%
b.
22.0%
13.30%
0.4
13%
c.
21.5%
13.30%
d.
20.5%
18.07%
0.1
3%
e.
22.0%
18.07%
Expected Return
(0.2) x (0.45)
= 0.090
(0.3) x (0.25)
= 0.075
(0.4) x (0.13)
= 0.052
(0.1) x (0.03)
= 0.003
0.220
Standard Deviation
= [(0.45 - 0.22)2 (0.2) + (0.25 - 0.22)2 (0.3) + (0.13 - 0.22)2(0.4) + (0.03 - 0.22)2(0.1)]1/2
= [0.01058 + 0.00027 + 0.00324 + 0.00361]1/2
= [0.01770]1/2 = 13.3%
Using the HP 12C, you get 14.02%. The 14.02% differs from the formula calculation of 13.3%. The HP 12C calculates
standard deviation of actual historical returns, while the formula in this problem determines the standard deviation of
returns with assigned probabilities. The HP 12C is generally used for historical returns while the formula in this problem
is used to predict the standard deviation of future returns.
Page: 348
Gillice Corporation stock has a mean of 14% and a standard deviation of 10%.
If the historical returns are normally distributed, what is the probability that the stock will have a return below 14%?
a. 20%
b. 25%
c. 33%
d. 40%
e. 50%
E
The mean for a normal distribution splits the distribution in half.
Because the probability of all occurrences is 100%, the probability that the stock will have a return below 14% (the
mean) is one-half (50%) of all possible occurrences.
Page: 349
Kate Corporation stock has a mean of 9% and a standard deviation of 0%. If the historical returns for Kate stock are
normally distributed, what is the probability that this stock will yield a return greater than 9%?
a.
b.
c.
d.
e.
0%
25%
33%
50%
100%
A
All returns must have been 9% for the standard deviation to be zero.
Therefore, the probability of a return of 9% is 100%.
Thus, anything else has a probability of zero.
Page: 350
Robert Corporation stock has a mean of 9% and a standard deviation of 6%. If the historical returns for Robert stock are
normally distributed, what is the probability that this stock will yield a return greater than 15%?
a.
b.
c.
d.
e.
0%
16%
32%
34%
50%
B
The probability of having a return above 9% is 50%.
The probability of having a return between 9% and 15% is 34%. [1/2 of 68% (1 Standard Deviation)]
Therefore, the probability of a return above 15% is 16% (50% - 34%).
Page: 351
Skate Corporation stock has an average return of 24% and a standard deviation of 10%. The risk-free rate of return is
currently 4%.
If the historical returns for Skate stock are normally distributed, what is the probability that this stock will have a
return in excess of the risk-free rate of return?
a.
b.
c.
d.
e.
2.5%
34.0%
95.0%
97.5%
100.0%
D
The probability of a return above 24% is 50%.
The probability of a return between 4% and 24% is 47.5% (95% divided by 2).
Therefore, the probability of a return above 4% is 97.5% (50% + 47.5%).
Page: 352
Security A has a Standard Deviation of 23%, and the market has a Standard Deviation of 18%.
The Correlation Coefficient between Security A and the market is 0.80.
What percent of the change in Security A can be explained by changes in the market?
a.
b.
c.
d.
e.
36%
50%
64%
80%
100%
0.82 = 0.64
Since the correlation coefficient is 0.80, the coefficient of determination (R2) is 0.64.
Therefore, only 64% of investment returns can be explained by changes in the market (i.e., systematic risk represents
64%).
Page: 353
Portfolio A has a standard deviation of 55%, and the market has a standard deviation of 40%. The correlation coefficient
between Portfolio A and the market is 0.50. What percent of the total risk is unsystematic risk?
a.
b.
c.
d.
e.
0%
25%
50%
75%
100%
R2 = 0.52 = 0.25
Return explained by unsystematic risk: (1 - 0.25) = 0.75
The coefficient of determination (R2), which is the correlation coefficient squared, explains the percent of change in the
dependent variable that can be explained by changes in the independent variable.
Therefore, 25% of returns are explained by changes in the market.
To determine the percentage of returns that are explained by unsystematic risk, subtract the systematic risk from 1 (1 0.25).
Page: 354
Of the five pairs of portfolios, which pair provides the highest level of diversification?
a.
b.
c.
d.
e.
Portfolio 1 & 2: with a correlation coefficient of +0.92.

Portfolio 3 & 4: with a correlation coefficient of +0.37.
Portfolio 5 & 6: with a correlation coefficient of 0.
Portfolio 7 & 8: with a correlation coefficient of -0.42.
Portfolio 9 & 10: with a correlation coefficient of -0.78.
E
The highest level of diversification will occur when the correlation coefficient is closest to -1.
Of the five pairs of portfolios, portfolios 9 and 10 offer the highest level of diversification because the correlation
coefficient of -0.78 is closest to -1.
Portfolios 9 and 10 should move in opposite directions because they are negatively correlated.
Page: 355
Capital Asset Pricing

John Wiggens has a portfolio with 23 different equities. John's portfolio increased by 20% and has a Beta of 1.50.
Utilizing the capital asset pricing model, compute by what percent did the market change (round to nearest 0.5%)
(assume the risk-free rate is 5%).
a.
b.
c.
d.
e.
14.5%
15.5%
15.0%
16.5%
17.0%
= Rf + (RM 5%)
E(r)
20%
5% + 1.5(RM - 5%)
20%
5% + 1.5RM - 7.5%
1.5RM
22.5%
RM
15%
[Capital Asset Pricing Model]
Page: 356
Page: 357
Beverly Drake has two stocks with a Correlation Coefficient of Zero.
a.
b.
c.
d.
e.
Which of the following is true?
These stocks are well diversified because as one stock appreciates in value, the other decreases in value.
These stocks are well diversified because they will move in unison.
These stocks are not well diversified because they move in unison.
These stocks will move independently of each other.
These stocks are well diversified because they move in opposite directions.
D
A correlation coefficient of zero means that the two stocks move independently.
However, since most stocks are positively correlated, a correlation coefficient of zero should provide more diversification
than most pairs of stocks.
Page: 358
Adding investments with a negative Beta to a portfolio that currently has a Beta of 1 will:
a.
b.
c.
d.
e.
Cause the portfolio to be more risky in times of a bull market

Cause the portfolio to be more risky in times of a bear market
Cause the volatility of the portfolio to increase
Cause the expected performance of the portfolio to increase in bear markets
Cause the expected performance of the portfolio to decrease in bear markets
D
A negative beta means that the investment will move in the opposite direction from the market (e.g., gold).
Therefore, if the market is declining, then the security should increase in value, thereby increasing the value of the
portfolio in a bear market.
Page: 359
Which of the following statements is/are true?

1. It is possible to eliminate almost all unsystematic risk by combining a larger number of stocks with
correlation coefficients of 0.00.
2. The market portfolio is considered the most diversified of all portfolios.
3. If two securities have a correlation coefficient of 1.0, diversification by adding these securities together in a
portfolio will not reduce unsystematic risk.
a.
b.
c.
d.
e.
1 only
2 only
1 and 3
2 and 3
1, 2, and 3
E
Statement 1 is true. Diversification is possible as long as the correlation coefficient is below one. Remember that most
stocks are positively correlated which means that combining stocks with a correlation coefficient of zero will eliminate
most, if not all, unsystematic risk.
Statement 2 is true. The market portfolio consists of all risky assets and is considered to be the most diversified portfolio.
Statement 3 is true. To reduce unsystematic risk, the correlation must be less than one.
Page: 360
Based on Markowitz's Theory of the efficient frontier, which one of the following portfolios could lie on the efficient
frontier?
Portfolio
1
2
3
4
a.
b.
c.
d.
e.
Expected
Return
8%
10%
12%
14%
Standard
Deviation
15%
14%
19%
17%
Portfolio 1
Portfolio 2
Portfolio 3
Portfolio 4
Portfolios 1 and 3
E
The Efficient Frontier consists of portfolios with the highest expected return for a given level of risk.
Because Portfolio 2 has a higher expected return and a lower standard deviation than Portfolio 1, Portfolio 1 cannot be
on the efficient frontier.
Since Portfolio 4 has a high expected return and lower risk than Portfolio 3, Portfolio 3 cannot be on the efficient frontier.
Page: 361
Which of the following statements are true about Beta and Standard Deviation?
1. Beta measures Unsystematic Risk
2. Standard Deviation measures Systematic Risk only
3. Standard Deviation measures both Systematic and Unsystematic Risks
a.
b.
e.
d.
e.
1 only
2 only
3 only
1 and 2
1 and 3
C
Beta only measures systematic risk.
Standard deviation measures total risk.
Therefore, only statement 3 is true.
Page: 362
According to the CAPM model, which of the following best explains portfolio returns?
a.
b.
e.
d.
e.
Economic factors
Systematic risk
Unsystematic risk
Interest rates
Diversification
CAPM=E(r)=Rf + (RM-Rf)
Because Beta (13) measures systematic risk, the higher the Beta, the higher the expected return.
Therefore, systematic risk best explains portfolio returns.
Page: 363
Which of the following statements is true regarding the Arbitrage Pricing Theory?
a.
b.
c.
d.
e.
Beta is not a pricing factor

Inflation is not a pricing factor
Multiple factors affect the return of a security
The risk-free rate of return does not affect the return.
None of the above
C
The APT determines returns based on multiple factors.
These factors might include inflation, growth in GDP, major political upheavals, or changes in interest rates.
Page: 364
Based on the efficient market hypothesis, which of the following statements is/are true concerning efficient market?
1. Security prices will adjust quickly to new information.
2. Security prices are rarely far from their justified price.
3. Security analysis will permit investors to consistently earn returns superior to the market.
a.
b.
e.
d.
e.
1 only
2 only
1 and 2
1 and 3
1, 2, and 3
C
Statement 3 is false because efficient markets will NOT allow investors to consistently outperform the market.
Page: 365
Use the information below to calculate the standard deviation of a portfolio with the following returns.
Year
Actual Return
1999
15%
2000
12%
2001
8%
a. 3.0
b. 3.6
c. 3.5
d. 4.0
e. 4.2
C
Actual Return
15%
12%
8%
35%
Average Return
11.67%
11.67%
11.67%
Difference
3.3333
.3333
(3.6667)
Squared Difference
11.1109
0.1111
+ 13.4447
24.6667
Average return = 35 + 3 = 11.6667

Variance = 24.6667 (3 - 1) = 24.6667 2 = 12.3334
Standard deviation = (12.3334) = 3.5119
Page: 366
The capital asset pricing model (CAPM) supports which of the following statements below?
1.
2.
3.
4.
Returns can be expected to correspond directly with the Level of Risk undertaken.
Standard deviation is the measure of market risk.
Beta is the measure of market risk.
Risk is measured by the probability of losing a portion of the initial investment.
a.
b.
c.
d.
e.
1 only
1 and 2
1 and 3
3 and 4
4 only
C
The CAPM model uses Beta as a risk measure.
It also demonstrates that as the level of risk (measured by Beta) increases, so does the expected return.
Page: 367
Using the following information below, which of the portfolios would be a reasonable selection(s) assuming a rational
investor believes in Standard Deviation as a viable measure of risk?
Expected
Standard
Portfolio Return
Deviation
Portfolio 1
15%
12%
Portfolio 2
11%
12%
Portfolio 3
11%
7%
Portfolio 4
7%
4%
a. 1 only
b. 3 only
c. 4 only
d. 2 and 4
e. 1, 3, and 4
E
Portfolio 2 should not be selected because Portfolio 1 has the same standard deviation, but with an expected return that
is 3% higher.
Portfolios 1, 3 and 4 are all reasonable choices, each representing a different risk-return tradeoff.
Page: 368
The standard deviation of the returns of a portfolio of securities will be

the weighted average of the
standard deviation of returns of the individual component securities.
a. Equal to
b. Less than
c. Greater than
d. Less than or equal to (depending upon the correlation between securities)
e. Less than, equal to, or greater than (depending upon the correlation between securities)
D
Unless the correlation coefficient between the stocks is equal to one, the standard deviation for the portfolio will always
be lower than the weighted average standard deviation for the portfolio.
Page: 369
In contrast to the Capital Asset Pricing Model, the Arbitrage Pricing Theory (APT):
a. Is usually a multi-factor model
b. Is primarily used by arbitrageurs to profit from imperfections in security markets
c. Assumes a market portfolio
d. Is a useful technical indicator
A
Arbitrage Pricing Theory uses multiple regression (many factors) to determine the specific outcome.
Page: 370
If the market risk premium were to increase, the value of common stock (everything else being equal) would:
a.
b.
c.
d.
e.
Not change because this does not affect stock values

Increase in order to compensate the investor for increased risk
Increase due to higher risk-free rates
Decrease in order to compensate the investor for increased risk
Decrease due to lower risk-free rates
D
Valuing a company is generally done by finding the present value of the cash flows generated from the company.
With everything else being equal, to value the company when the market premium increased, you would be discounting
the same stream of cash flows, but at a higher discount rate.
The higher discount rate will cause the present value of the cash flows to be lower - a decrease in the stock price.
Page: 371
Modern "asset allocation" is based upon the model developed by Harry Markowitz.
Which of the following statements is/are correctly identified with this model? (CFPTM Certification Examination, released
3/95)
1. The risk, return, and covariance of assets are important input variables in creating portfolios
2. Negatively correlated assets are necessary to reduce the risk of portfolios
3. In creating a portfolio, diversifying across asset types (e.g., stocks and bonds) is less effective than
diversifying within an asset type
4. The efficient frontier is relatively insensitive to the input variable
a.
b.
c.
d.
e.
1 and 2
1, 2, and 3
1 only
2 and 4
1, 2, and 4
C
Statement 2 is false. As long as the correlation coefficient between assets is less than 1, the risk of the portfolio will be
reduced. The word necessary makes this choice incorrect.
Statement 3 is false. Diversifying across asset types is more, not less, effective than within an asset type.
Statement 4 is false. All the input variables in Statement 1 help to create the efficient frontier.
Page: 372
Under the Efficient Market Hypothesis, which of the following terms best describes the movement of stock prices?
a. Random
b. Statistical
c. Diverse
d. Predictable
A
Random walk is the term used to describe the pattern of movement of stock prices.
Since only new information, which is unpredictable and random, will affect the price of a security the pattern of price
movement for a stock will be random.
Page: 373
If an investment has a Correlation Coefficient of 0.80 with the market, which of the following performance measures is
the best measure of risk?
a.
b.
c.
d.
e.
Sharpe
Treynor
Jensen
Sharpe and Jensen
Sharpe, Treynor, and Jensen equally
A
Since the correlation coefficient is 0.80, the coefficient of determination (R2) is 0.64.
Therefore, only 64% of the returns from the investment can be explained by the market (i.e., systematic risk represents
64%)
Beta only measures systematic risk, which means that 36% of outcomes will not be captured with Beta.
Thus, Treynor and Jensen are not appropriate because they use Beta.
Since Sharpe uses standard deviation, it is always an appropriate measure.
Page: 374
Under which of the following forms of the Efficient Market Hypothesis can an investor benefit from analyzing historical
public information?
1. Weak
2. Semistrong
3. Strong
a.
b.
c.
d.
e.
1 only
2 only
1 and 2
2 and 3
1, 2 and 3
A
Only under the weak form will an investor benefit from fundamental analysis.
Page: 375
Given the following information about Securities A and B:

Historical Returns for Securities
A
B
Year 1
10%
18%
Year 2
6%
12%
Year 3
0%
2%
Which of the following are true about Securities A and B?
1.
2.
3.
4.
5.
A is more risky because it has a higher Standard Deviation

B is more risky because it has a higher Standard Deviation
A has a higher Risk-Adjusted Return
B has a higher Risk-Adjusted Return
A and B have the same Risk-Adjusted Return
a.
b.
c.
d.
e.
1 and 3
1 and 4
2 and 3
2 and 4
1 and 5
D
Security A
Standard Deviation (SO)
5.03%
Average Return (AR)
5.33%
1.06
AR SO
Therefore, Statements 2 and 4 are true.
Security B
8.08%
10.67%
1.32
Page: 376
Under the Efficient Market Hypothesis, when would fundamental analysis be useful?
1. Weak form
2. Semistrong form
3. Strong form
a.
b.
c.
d.
e.
1 only
2 only
3 only
1 and 2
1, 2, and 3
A
Only under the weak form would fundamental analysis be useful.
Page: 377
Assume that Clay invests $7,000 of his $10,000 available assets into Portfolio A with the remainder in the S&P 500.
Changes in the S&P 500 account for or explain 25% of the returns for Portfolio A.
If Portfolio A has a standard deviation of 20% and the S&P 500 has a standard deviation of 11.5%, what if the Standard
Deviation of the combined $10,000 portfolio?
a.
b.
c.
d.
e.
15.0%
15.2%
16.0%
17.5%
18.3%
C
Since 25% of the change in Portfolio A can be explained by changes in the S&P 500, then the correlation between
Portfolio A and the S&P 500 is the square root of25% or 0.5.
The coefficient of determination (R2) is 25% and the correlation coefficient is 50%.
The correlation coefficient is then used in the formula to calculate the standard deviation of a two-asset portfolio.
2
2
2
2
=
=
=
=
W2A 2A + W2B 2B + 2WA WB [ A BrAB]

(0.7)2 (0.2)2 + (0.3)2 (0.115)2 + 2(0.7)(0.3)[(0.2)(0.115)(0.5)]
0.01960 + 0.00119 + 0.00483 = 0.02562
0.1600
Page: 378
In analyzing the position of a portfolio in terms of risk / return on the capital market line (CML), superior performance
exists if the fund's position is
the CML, inferior performance exists if the
fund's
position is the CML, and equilibrium position exists if it is
the CML?
a.
b.
e.
d.
e.
Above; on; below

Above; below; on
Below; on; above
Below; above; on
On; above; below
B
Above the line would indicate higher return for the given risk level.
On the line would indicate same return for the given risk level.
Below the line would indicate lower return for the given risk level.
Page: 379
Which of the following statements is/are true regarding the Standard Deviation of a two-asset portfolio?
1. Only if the Correlation between the two assets is negative will the Standard Deviation for the portfolio be less
than the Weighted Standard Deviation of the two assets.
2. If the Correlation between Assets A and B is 0.3 and,
80% of the Portfolio is invested in A (which has a standard deviation of 12%) and
20% is invested in B (which has a standard deviation of 15%)
Then the standard deviation of the portfolio will be less than 11%
a.
b.
e.
d.
e.
1 only
2 only
Both 1 and 2
Neither 1 or 2
Not enough information to answer Statement 1 and Statement 2
2
2
2
2
2
=
=
=
=
=
W2A 2A + W2B 2B + 2WA WB [ A BrAB]

(0.8)2 (0.12)2 + (0.2)2 (0.15)2 + 2(0.8)(0.2)[(0.12)(0.15)(0.3)]
0.00922 + 0.00090 + 0.00173
0.01185
10.89%
Page: 380
The RS Growth Company just paid a dividend of $2 last week. The dividend for RS Growth Company is expected to be
100 percent greater next year. The growth rate for the following year is expected to be 50 percent. In the third year,
and thereafter, the dividend is expected to grow annually at a rate of 6 percent.
If you had a required return of 10 percent, what is the most that you would pay for the security?
a.
b.
c.
d.
e.
$135.04
$140.00
$142.00
$159.00
$165.00
B
V2 =
0
D3
k - g
$4.00
$6.00
$159.00
165.00
Value of Security =
V2 =
$6.36
= $159.00
0.10 - 0.06
$6.36
(Price of a security at Year 2 based on future dividend stream)
$4.00
+
(1.1)1
$165.00
(1.2)2
= $140.00
Page: 381
If you believe in fundamental analysis, you would use or follow which one of the following approaches?
a.
b.
c.
d.
e.
Technical Analysis
Quantitative Analysis (searching for undervalued securities)
Efficient Market Hypothesis-weak
Efficient Market Hypothesis-strong
Passive Diversified Portfolio Approach
B
Fundamental analysis is based on comparing the intrinsic value of securities to the market value to determine which
securities are undervalued.
Page: 382
Which of the following is/are considered good complements to the PIE ratio?
1. Price to sales
2. Price to cash flow
3. Price to book
a. 1 only
b. 3 only
c. 1 and 2
d. 2 and 3
e. 1, 2, and 3
D
Both price to book and price to cash flow are considered good complements (or substitutes) to the P/E Ratio in terms of
bond and stock valuation methods.
Price to sales is an indication of how much an investor is paying for a specific revenue stream.
Page: 383
Beldar Corporation has an expected dividend payout of 35 percent, a required return of 12 percent, and an Expected
Dividend Growth Rate of 9 percent. What is the P/E Ratio for the common stock?
a.
b.
c.
d.
11.67
32.00
39.13
46.15
A
P/E =
Payout
k - g
P/E =
0.32
= 11.67
0.012 - 0.09
Page: 384
Smithe Corporation has earnings per share of $1.40 and is paying dividends of 0.56 cents per share. The required
return is 10 percent and the expected dividend growth rate is 7 percent. What is the PIE ratio for the common stock?
a.
b.
c.
d.
20.00
13.33
18.66
14.66
B
P/E =
Payout
k - g
P/E =
0.40
= 13.33
0.10 - 0.07
Page: 385
All of the following statements regarding price to Earnings/Growth (PEG) Ratio are correct except:
a.
b.
c.
d.
PEG is calculated by dividing a firm's PE ratio by the firm's expected growth rate of earnings
PEG is used to compare companies with different growth rates
Companies with a high PEG ratio have higher rates of return
All of the above are true
C
Companies with a higher PEG ratio have a lower expected rate of return.
The PEG ratio is a measure of relative valuation that can be used to compare companies with different growth rates.
Proponents of the PEG ratio believe that companies with a low PEG ratio will have higher rates of return.
Page: 386
Amber purchased a bond for $1,038.90 exactly two years ago. The bond had a maturity of 5 years and a coupon rate
of 10% (paid semiannually) when Amber first purchased it. Assuming the rates below are the prevailing rates for this
type of bond at different maturities, how much could Amber sell her bond for today?
Maturities
Interest Rates
a.
b.
c.
d.
e.
1 Year
6%
2 Years
6.5%
3 Years
7%
5 Years
8.5%
10 Years
10%
30 years
12%
$1,038.31
$1,039.00
$1,060.08
$1,078.73
$1,079.93
E
FV
i
PMT
N
PV
=
=
=
=
=
$1,000
3.5 (7% / 2)
$50 (100 / 2)
6 (3 x 2)
($1,079.93)
Page: 387
Melany inherited a bond from her grandmother 1.5 years ago.

The bond had been purchased with a 10year maturity 3.5 years before Melany received it.
The interest rate at the time Melany's grandmother purchased this bond was about 8.5%.
Melany has just determined that her bond is worth $836.00.
If the interest rates below are indications of the current prevailing market interest rates for this type of bond, how
much did Melany's grandmother purchase the bond for? (Assume coupon payments are made annually.)
Maturities
Interest Rates
1 Year
5%
Melany
PV
=
N
=
I
=
FV
=
PMT
=
2 Years
5.5%
($836)
5
7
$1,00
$30 (calculated)
3 Years
6%
5 Years
7%
Grandma
PV
=
N
=
I
=
FV
=
PMT =
10 Years
8%
30 years
10%
$1,000
10
8.5
$30 (calculated)
($639.13)
Page: 388
Which of the following statements is/are true?

1. Lower coupon bonds are more volatile than higher coupon bonds when interest rates change.
2. There is an inverse relationship between bond prices and changes in interest rates.
3. There is a direct relationship between the coupon rate of a bond and the duration of a bond.
a.
b.
e.
d.
e.
1 only
3 only
1 and 2
2 and 3
1, 2, and 3
C
As the coupon rate increases, the duration of the bond will decline, because the investor is receiving cash flows sooner.
Page: 389
Which of the following is/are assumptions of the Constant Dividend Growth Model?
1. Dividends will grow at a Constant Rate
2. Earnings of the company will grow at a Constant Rate
3. The investor's Required Rate of Return is fixed and determinable
a.
b.
c.
d.
e.
1 only
2 only
1 and 2
2 and 3
1 and 3
E
The model [P0 = D1/(k - g)] assumes dividends will grow at the same rate each year.
It also assumes that the required rate of return for the investor (k) is fixed and determinable.
Page: 390
Blonde Company's earnings increased from $5 to $7 per share. Its dividend increased from $2 to $2.20 per share, and
the share price increased from $50 to $60. Based on this information, which of the following statements about Blonde
Co. is/are true?
1. Blonde's P/E Ratio declined.
2. The Dividend Payout Ratio increased.
3. Earnings increased more than dividends.
a.
b.
e.
d.
e.
1 only
2 only
1 and 2
1 and 3
1, 2, and 3
D
P/E:
Div. Payout:
Before
50 / 5 = 10
2 / 5 = 40%
After
60 / 7 = 8.57
2.2 / 7 = 31 %
Earnings:
7 - 5
= 40%
5
Dividends:
2.20 - 2.00
= 10%
2
Result
Decline
Decline
Thus, Statements 1 and 3 are true.

Page: 391
The current annual dividend of ABC Corporation is $2.00 per share. Five years ago the dividend was $1.36 per share.
The firm expects dividends to grow in the future at the same compound annual rate as they grew during the past five
years. The required rate of return on the firm's common stock is 12%.
The expected return on the market portfolio is 14%. What is the value of a share of common stock of ABC Corporation
using the constant dividend growth model (round to the nearest dollar)?
a.
b.
c.
d.
e.
$11
$17
$25
$36
$54
PV
PV
N
i
Value of Common Stock =
d1
k - g
=
=
=
=
($1.36)
$2.00
5
8.0185
1.080185 x 2.00
= $54
0.12 - 0.08
k = Required Rate of Return

g = Growth Rate of the Dividend
Page: 392
Which combination of the following statements about bond swaps is true?

1. A Substitution Swap is designed to take advantage of a perceived yield differential between bonds that are
similar with respect to coupons, ratings, maturities, and industry.
2. Rate Anticipation Swaps are based on forecasts of general interest rate changes.
3. The Yield Pickup Swap is designed to change the cash flow of the portfolio by exchanging similar bonds
that have different coupon rates.
4. The Tax Swap is made in order to substitute capital gains for current yield.
a.
b.
c.
d.
e.
1, 2, and 3
1 and 3
2 and 4
4 only
1, 2, 3, and 4
A
Statement 1 is true. Statement 2 is true.
Statement 4 is false. Tax swaps generally take advantage of capital losses by selling bonds that have been devalued by
increasing interest rates.
Page: 393
Which of the following technical indicators measures the strength of the market by comparing the number of advancing
stocks to the number of declining stocks?
a.
b.
c.
d.
e.
Market volume
Support level
A - D ratio
Breadth of the market
Short interest
D
Breadth of the market is the technical indicator that attempts to measure the overall strength of the market by comparing
the number of advancing stocks to the number of declining stocks.
Page: 394
All of the following statements are correct concerning convexity, except:

1. Convexity is a measurement of the curvature of the Price-Yield relationship.
2. Convexity is a measure of how much a bond's Price-Yield Curve deviates from the linear approximation of
that curve.
3. Convexity is likely to be greatest with low-coupon bonds, long-maturity bonds, and low YTM bonds.
4. High-duration bonds have low Convexity.
D
The determinants of both duration's and convexity's direction of impact is the same [maturity (direct relationship),
coupon rate and yield (both inverse relationships)].
Therefore, high duration bonds have high convexity.
Page: 395
John Smith originally purchased Zerex stock for $45 per share. He purchased 3 shares, which are currently trading at
$60 per share. The stock has paid dividends of $2.00/share in year 1 and $2.30/share in year 2 (all paid at year-end).
If John has held the stock for 2 years, what is the holding period return?
a.
b.
c.
d.
e.
19.0%
22.0%
23.5%
38.0%
42.8%
E
($60 - $45) + $2 + $2.30
$45
= 42.8%
Holding Period Return is the same as Single Period Return.
Page: 396
A bond, which was purchased for par, is now selling for $1,075. The bond made semiannual coupon payments of $60
during the year. What is the single period rate of return for the owner of this bond at the end of year 1?
a.
b.
c.
d.
e.
60.0%
7.5%
13.5%
12.0%
19.5%
E
($1,075-1,000) + $60 + $60
$1,000
= 19.5%
Single Period Return is the same as Holding Period Return
Page: 397
Michael purchased 800 shares of ABC stock for $75 per share. The stock paid a $1.20 dividend per share at the end
of the year, and there was a 2 for 1 stock split during the year. If the value of his investment at the end of the year was
worth $66,000, what is the single period rate of return for the investment?
a.
b.
c.
d.
e.
8.3%
10.0%
13.2%
12.0%
14.0%
C
($66,000 - $60,000) + ($1.20)(800)(2)
$60,000
= 132%
Do not forget about the stock split.

The dividend is based on 1,600 shares.
Single Period Return is the same as Holding Period Return.
Page: 398
A portfolio had an IRR (compound return) for a 2-year period of 12.5%. During this 2-year period, $75,000 in dividends
was paid each year (at year-end) and the current FMV of this portfolio is $1.5 million.
What was the portfolio worth when it was purchased 2 years ago?
a.
b.
c.
d.
e.
$750 k
$1.00 M
$1.25 M
$1.31 M
$1.50 M
D
To clear register hit f CLX
0
g CF0
$75,000
g CFj
$1,575,000
g CFj
12.5
i
f
NPV => $1,311,111
OR
FV
PMT
N
i
PV
=
=
=
=
=
$1,500,000
$75,000
2
12.5
$1,311,111
Page: 399
A portfolio had an IRR (compound return) for a 3-year period of 8.5%.

During this 3-year period the following dividends were paid, and the current FMV of this portfolio is $58.
Dividend year 1 (end) $1.25
What was the portfolio worth when it was purchased 3 years ago (round to the nearest dollar)?
a.
b.
c.
d.
e.
$45
$47
$49
$54
$58
C
0
g CF0
1.25
g CFj
1.41
g CFj
59.58
g CFj (58 + 1.58)
8.5
i
f
NPV => $48.995
Page: 400
A portfolio had an IRR (compound return) for a 3-year period of 2.43% (including dividends).
During this 3-year period the following dividends were paid, and the current FMV of this portfolio is $58.
a.
b.
c.
d.
e.
$45
$47
$49
$54
$58
E
0
g CF0
1.25
g CFj
1.41
g CFj
59.58
g CFj
2.43
i
f
NPV => $58.004
Page: 401
A portfolio had an IRR for a 3-year period of 5.57%.

During this 3-year period the following dividends were paid and the current FMV of this portfolio is $40.
a. $30
b. $34
c. $37
d. $40
e. $50
E
0
g CF0
4.8
g CFj
5.9
g CFj
47.25
g CFj (40 + 7.25)
5.57
i
f
NPV => $49.99
Page: 402
Based on the current price, ABC stock has a holding period rate of return of 23.75% for a 5-year period ending today.
The stock was purchased 5 years ago for $20, and the stock paid a dividend at the end of Year 1 (one) of$2.00.
The dividend grew each year at 10% (for example: year 2 dividend = $2.20) and is expected to continue to grow at 10%.
What could the holder sell the stock for today if his required rate of return was 12% per year?
a.
b.
c.
d.
e.
A loss of $7.46 from the original purchase price if you use the holding period rate of return method
$161.00 if the dividend growth model is used
$24.75
Both a and b
Both band c
Answer On Following Page
Page: 403
180.D
(A)
-5
(B)
-4
($20,000)
$2.00
(A) Purchase price 5 years ago
(B) Dividends paid to date
(C) Dividend 1 period from today
Holding Period Method:
(B)
-3
Cash Flows
(B)
-2
$2.20
Holding Period Return
$2.42
(B)
-1
(B)
0
(C)
1
$5.662
$2.928
$3.221
Sales Price - Purchase Price +/- Cash Flows

Purchase Price
X = Sales Price
1. [(x - 20) + 2 + 2.2 + 2.42 + 2.662 + 2.9282] / 20 = 23.75%
2. [(x - 20) + 12.21] + 20
= 23.75%
3. (x - 20) + 12.21
= 23.75 X 20
4. (x - 20) =
4.75 - 12.21
5. x 20
=
-7.46
6. x
=
20 - 7.46
7. x
=
12.54
Sales price today

Less the original cost
Loss
Dividend Growth Model:
$12.54(based on the holding period return)

( 20.00)
($ 7.46)
The dividend today (d0) is $2.928 (from chart above).
d1
d1 is $3.22 or ($2.928 x 1.1)
k - g
$2.9282 x (1.1) = 3.22
$3.22
= $161.00
12% - 10%
The dividend growth model is: v

d1 = $3.22
OR
[(1.1)5 x $2 = $3.22]
OR
Note: The dividend is paid at the end of Year 1.

Note: $24.75 is a distracter [$20 x (1 + 0.2375)] = $24.75. This answer, however, is not correct.
Page: 404
500 shares of stock were purchased 3 years ago for $20 per share.
The following dividends have been paid at the end of each year and the holding period return is 18%.
Dividends Per
Year
Share
1
$1.25
2
$1.50
3
$2.00
How much could this investment be sold for today?
a. $8,500
b. $9,425
c. $10,000
d. $11,800
e. $12,000
B
(x - 20) + 1.25 + 1.5 + 2
= 18%
20
x = $18.85
Sales price = $18.85 x 500 = $9,425
Page: 405
The XYZ Mutual Fund has had the following performance over the last four years.
X1
X2
X3
X4
30%
3.85%
(20%)
(7.41 %)
What is the arithmetic average and Geometric Annualized Return for the four-year period?
a.
b.
c.
d.
e.
Arithmetic
1.61%
15.32%
15.32%
1.61%
None of the above
Geometric
0
14.85%
0
14.85%
A
Average
30% + 3.85% + (20%) + (7.41 %) = 6.44%
6.44% / 4 = 1.61%
Geometric
[(1 + 0.30) (1 + 0.0385) (1 - 0.20) (1 - 0.0741)] 1/4 - 1 = 0
Page: 406
The XYZ mutual fund has had the following performance over the last four years:
X1
X2
X3
X4
20%
10%
2%
16 %
What is the difference between the average and geometric annualized returns?
a.
b.
c.
d.
e.
0.
0.21%
0.42%
1.00%
44%
B
Average
20% + 10% + 2% + 16% = 48%
48% / 4 = 12%
Geometric
[(1 + 0.2) (1+ 0.1) (1 + 0.02) (1 + 0.16)] - 1 = 11.79%
(1.5618 .25) - 1
Diff: 12% - 11.79% = 0.21 %
Page: 407
Determine the geometric average of the following returns:

2000
2001
2002
2003
a. 18%
b. 20.5%
c. 21%
d. 21.5%
e. 22%
45%
25%
13%
3%
B
[(1+ 0.45) x (1 + 0.25) x (1 + 0.13) x (1 + 0.03)]1/4 - 1 = 20.5%
Page: 408
For investors to accept the possibility of outcomes that may deviate from the expected outcome
what type of return?
a.
b.
c.
d.
e.
must be provided with
Real Premium
Risk Premium
Market Premium
Expected Return
Actual Return
B
Definition of Risk Premium
Page: 409
Given the following returns for Stocks A and B, which of the following is true?
Year
1
2
3
4
A
11%
13%
14%
12%
B
10%
13%
16%
11%
1. The Geometric Annualized Rate of Return for B is greater than for A.

2. Stock B is more volatile than Stock A.
3. The average return for Stock A is higher than for Stock B.
a.
b.
c.
d.
e.
1 only
2 only
3 only
1 and 2
1, 2, and 3
B
Only Statement 2 is true.
The geometric return for A is 12.49% while it is 12.48% for B.
The average return for both A and B is 12.5%.
Page: 410
Based on the following chart, which of the following statements is/are true? (Assume all bonds make coupon payments
semiannually.)
Bond
Maturity
Coupon Rate
Current FMV
A
4 years
0
$730.69
B
5 years
10%
$1,039.56
C
10 years
5%
$688.44
D
30 years
0
$40.26
1. The order of the bonds ranked from highest to lowest YTM is: D, C, B, A.
2. The bond most sensitive to interest rate changes is Bond D.
3. The actual yield to maturity or realized return may change for all the bonds A, B, C, D (even when held to maturity) if prevailing
interest rates change.
a. 1 only
b. 3 only
c. 1 and 2
d. 2 and 3
e. 1, 2, and 3
C
Statement 1:
Bond
A
PV
($730.69)
N
8
PMT
$0
FV
$1,000
i(YTM)
4.0
ix2
8
B
($1,039.56)
10
$50
$1,000
4.5
9
C
($688.44)
20
$25
$1,000
5.0
10
D
($40.26)
60
$0
$1,000
5.5
11
Bond
A
B
C
D
YTM
8
9
10
11
Statement 2 is true because of the term and fact that it is a zero coupon.
Statement 3 is false because zero-coupon bonds held to maturity will always maintain the initial YTM and will be unaffected by
changes in prevailing interest rates.
Page: 411
Bill Smith owns treasury bonds worth $34,000, GTC stocks worth $22,500, and calls worth $15,000. If the expected return is 8%,
12.5%, and 23%, respectively, what is the overall weighted average expected return on Bill Smith's investments?
a.
b.
c.
d.
e.
8.0%
12.5%
14.3%
14.5%
23.0%
B
Method 1:
Method 2:
FMV
$34,000
22,500
15,000
$71,500
(A)
FMV
$34,000
22,500
15,000
$71,500
(A)
%
47.55%
31.47%
20.98%
100.00%
-OR-
(B)
Expected Return
8.0%
12.5%
23.0%
(B)
Expected Return
8.0%
12.5%
23.0%
Weighted Average Return =
$8,982.50
$71,500.00
(A) x (B)
Weighted Return
3.804%
3.934%
4.825%
12.563%
(A) x (B)
Weighted Return
$2,720.00
2,812.50
3.450.00
$8,982.50
= 12.56%
Note: Method 2 eliminates the need to determine the percentages for each of the portfolio assets. You should also be aware that
many of the financial calculators will calculate the weighted average (i, w) by entering only a few keystrokes.
Page: 412
Donna Catherine lives in Louisiana (assume Louisiana taxes municipal income from other states) and owns Tennessee municipal
bonds with a FMV of $12,500, U.S. Treasury Bills with a FMV of $16,000, and XYZ stock worth $18,750. The expected returns for
these investments are 9%, 7%, and 11.5%, respectively.
Assuming returns consist of ordinary income (no capital gains) and assuming Donna has a federal tax rate of 36% and a state tax
rate of 4%, what is the overall after-tax weighted average expected return for this group of investments?
a.
5.6%
b.
6.4%
C
FMV
$12,500 1
16,000 2
18,750 3
$47,250
c.
6.5%
(A)
%
26.46%
33.86%
39.68%
d.
5.5%
e.
(B)
Pretax Return
9.00%
7.00%
11. 50%
9.2%
(C)
After-Tax Yield
(1 - 0.04)
(1 - 0.36)
(1 - 0.40)
(A) x (B) x (C)

Weighted Return
2.286%
1. 517%
2.738%
6.541 %
The municipal bonds will be taxed by Louisiana, but not by the federal government.
The U.S. Treasury Bills are not taxed at the state level, but are taxed at the federal level.
3
The gains on the stock will be taxed at both the federal and state levels.
2
(A)
FMV
$12,500
16,000
18,750
$47,250
Weighted Average Return =
(B)
Pretax Expected
Return
9.00%
7.00%
11.50%
$3,090.55
$47,250.00
(C)
Tax Rate
4.00%
36.00%
40.00%
(D)
After-Tax
Expected Return
8.640%
4.480%
6.900%
(A) x (D)
After Tax
Expected Return
$1,080.00
716.80
1.293.75
$3,090.55
= 6.5 %
Page: 413
Assuming the following bonds are equivalent credit quality, which of the following bonds, when added to the portfolio independently
would cause an investment portfolio with an expected return of 12% to increase its expected return.
1.
2.
3.
A zero-coupon bond selling for $314.76 maturing in 10 years.

A bond with an 8% annual coupon (paying semiannually) selling for $739.76 and maturing in 12 years.
A bond with a 12.5% annual coupon (paying semiannually) selling for $1,014.99 and maturing in 22 years.
a.
b.
c.
d.
e.
D
PV
N
PMT
FV
YTM
1 only
2 only
1 and 2
2 and 3
1, 2, and 3
Bond 1
($314.76)
20.00
0.00
$1,000.00
11.90
(5.95 x 2) = 11.90
Bond 2
($739.76)
24.00
40.00
$1,000.00
12.18
(6.09 x 2) = 12.18
Bond 3
($1,014.99)
44.00
62.50
$1,000.00
12.30
(6.15 x 2) = 12.30
Since Bonds 2 and 3 both have a YTM greater than 12%, they will increase the investment portfolio expected return.
When valuing a zero-coupon bond, although coupon payments are not actually paid, the number of periods that are used is the same
as if the coupon payments were being paid.
This allows the valuation methodology of a zero-coupon bond to be consistent with and comparable to the valuation methodology of a
bond that makes coupon payments.
The YTM for Bond 1, therefore should also be calculated semiannually.
Page: 414
Hurley Bishop wishes to purchase a boat in 20 years when he retires so that he may sail around the world. If the boat
presently costs $450,000 and inflation is 4%, how much should he deposit at the beginning of each year to have enough
to purchase the boat at the end of 20 years?
Assume that Hurley will earn an average compounded return of 12.5% on his investments.
a.
b.
c.
d.
e.
$5,238
$8,573
$9,645
$11,478
$12,912
D
Future Cost of Boat
PV
= $450,000
N
= 20
I
= 4
PMT
= 0
FV
= ($986,005)
Remember it is an annuity due.
Yearly Deposit
PV
=
N
=
i
=
FV
=
PMTAD
=
0
20
12.5
$986,005
($11,477.75)
Page: 415
Tina Thompson purchased 100 shares of ABC preferred stock 6 years ago for $7,300. Tina received the
amounts as dividends for the last 6 years:
Year
1
2
3
4
5
6
Dividend
$250
$260
$285
$270
$285
$300
following
The dividends were all paid at the end of the year, and at the end of the 6th year Tina sold the 100 shares for
$12,250. What is the effective yield over the 6-year period for this investment (IRR)?
a.
b.
c.
d.
e.
10.40%
11.72%
12.07%
12.45%
13.02%
C
Internal Rate of Return
(7,300)
g
250
g
260
g
285
g
270
g
285
g
12,550
f
IRR =
CF0
CFj
CFj
CFj
CFj
CFj
12.07%
Page: 416
Jeff Robinson purchased a 30-year bond for $977.36 with a stated coupon of 8.5%.
What is the Yield to Maturity for this investment if Jeff receives semiannual coupon payments and expects to hold
the bond to maturity?
a.
b.
c.
d.
e.
4.36%
5.68%
8.50%
8.71%
8.93%
D
Yield to Maturity
PV
N
PMT
FV
i
=
=
=
=
=
($977.36)
60 (30 x 2)
42.5 (85/2)
$1,000
4.357
4.357% x 2 = 8.71%
PV
N
FV
PMTAD
i
=
=
=
=
=
Page: 417
Davis Company stock has an average return of 11 % and has a standard deviation of 4%.
What is the probability that the stock will earn a return over 15% (round to the nearest whole number and assume a
normal distribution)?
a.
b.
c.
d.
e.
10%
13%
16%
19%
33%
C
Standard Deviation =
15% - 11%
4%
= 1.0
Approximately 68% of occurrences will fall within one standard deviation from the mean.
Therefore, the probability of a return between 11 % and 15% is 34%.
Since there is a 50% chance of a return 11%, the probability of a return in excess of 15% must be 16% (50% - 34%).
Page: 418
Kimberly Morris is in the business of buying homes, fixing them up, and reselling them for a profit.
She is considering purchasing a home, bur knows that she will have to invest $25,000 at the end of the first month
and $5,000 at the end of 6 months to restore the house before selling it. She expects to be able to sell the house at
the end of 18 months for $176,000.
If Kimberly requires a 25% annual return on her investments and there is a 6% real estate commission for selling,
then what is the most she should pay for this house?
a.
b.
c.
d.
e.
A
$85,236
$87,285
$90,677
$92,522
$94,157
Sales Price
(1 - Commission)
Amount Realized
FV
N
i
PMT
PV
$176,000
x 0.94
$165,440
=
=
=
=
=
A
($25,000)
1
2.0833
$0
$24,490
PV of Sales Price
Less Costs:
PV of Cash Flows
B
($5,000)
6
2.0833
$0
$4,418
(C)
1st month (A)
6th month (B)
C
$165,440 (from above)
18
2.0833 (25% / 12)
$0
($114,144)
$114,144
(24,490)
(4,418)
$85,236
Page: 419
Of the four securities, which will provide the highest Risk-Adjusted Return for an investor?
Stock 1: Annual return of 15%, beta of 1.2.

Stock 4: Annual return of 8.5%, beta of 0.75.
a.
b.
c.
d.
e.
Stock 1
Stock 2
Stock 3
Stock 4
Stocks 3 and 4
A
Stock
1
2
3
4
Return
15
12
10
8.5
Beta
1.2
1.0
0.85
0.75
Return/Beta
12.50%
12.00%
11.76%
11.33%
Page: 420
If an investor, who is age 55, is saving for his retirement, is in a marginal tax bracket of 30%, and requires an after-tax
return of 8.5%, which of the following securities would you suggest?
Bond 1: A 30-year municipal bond with a coupon of 6% (payments made semiannually) selling for
$1,010.
Bond 2: An AA-rated 10-year corporate bond selling for $847.16 with a coupon payment of$50 twice a
year.
Bond 3: A BB 30-year zero-coupon bond selling for $22.86.
a. Bond 1 because its yield is greater than the after-tax yields of the other two bonds.
b. Bond 2 because its yield is greater than the after-tax yields of the other two bonds.
c. Bond 3 because its yield is greater than the after-tax yields of the other two bonds.
d. Bond 2 because it has a high yield and seems to meet his goals.
e. Bond 3 because it has the highest YTM, and all tax will be deferred because it is a zero-coupon bond.
D
Bond I
Bond II
Bond III
YTM
After-Tax YTM
5.93%
12.75%
13.00%
5.93%
8.922%
*
Bond I does not have a high enough YTM for the investor's objectives.
Bond II has a horizon of 10 years which will meet the investor's retirement needs better than the 30-ye; bonds. Also, it
has a high rating and high yield.
* Bond III will be subject to OlD (original issue date) interest each year.
Page: 421
Assume John invests in a stock for two years.

The stock earns a return of 15% the first year and a negative 10% return the second year. What was the annual
geometric return?
a. 1.5%
b. 1.7%
c. 2.5%
d. 3.0%
e. 5%
B
R
R
R
R
=
=
=
=
[(1 + k1) (1 + k2) ... (1 + kn)]1/n - 1

[(1 + 0.15) * (1 - 0.10)]1/2 - 1
1.017-1
0.017 or 1.7%
Page: 422
Assume John invests $100 in a stock for two years. The stock earns 15% the first year and loses 10% the second year.
How much is the stock worth at the end of the second year?
a.
b.
c.
d.
e.
$90.00
$100.00
$103.50
$105.00
$115.00
C
T0 = 100
T1 = 100 x 1.15 = 115
T2 = 115 x 0.9 = 103.5
Page: 423
What are the mean, medium, and mode for the series: 12, 11, 10, 10,9,8, 3?
a.
b.
c.
d.
e.
E
Mean
Median
Mode
Mean
9
8
8
10
9
Median
8
10
9
9
10
Mode
10
9
10
10
10
= Average: (12 + 11 + 10 + 10 + 9 + 8 + 3) + 7 = 63 + 7 = 9
= The number in the middle = 10
= Most frequently occurring = 10
Page: 424
Donna acquired a bond today with a coupon of 10% with 5 years remaining until maturity (interest is paid semiannually).
She acquired the bond for $1,080. Interest rates dropped overnight to 7%.
What is Donna's yield (actual or calculated) on this investment if interest rates remain at 7% and she holds to
maturity?
a.
b.
c.
d.
e.
6.7%
7.0%
7.5%
8.0%
10.0%
D
Step 1: Calculate future value of interest payments
PMT
= $50
N
= 10
i
= 3.5 (reinvestment rate)
FV
= $586.57
Step 2: Calculate realized return
FV
= $1,586.57 ($1,000 from maturity, $586.57 from Step 1)
N
= 10
PV
= ($1,080)
= 3.921 x 2 = 7.84 8.0%
i
Page: 425
Alvin purchases 200 shares of Harbor Stock for $23 per share.
Alvin makes subsequent purchases at the end of the following years:
Year 1: 50 shares at $26/ share.
Year 2: 75 shares at $29/share.
Year 3: 25 shares at $36/share.
It is now the end of the 4th year and no dividends have been paid and Harbor is trading for $41/share.
What is the annualized time-weighted return for Harbor stock over the four-year period?
a.
b.
c.
d.
e.
13.8%
14.2%
15.0%
15.5%
16.0%
D
Step 1: Calculate future value of interest payments
PV0
= ($23)
N
= 4
PMT
= $0
FV
= $41
i
= 15.5%
Time-weighted returns do not consider cash flows of the investor, only appreciation and dividends for a portfolio or stock.
The only cash flows that occurred over this time period from the investment are the initial purchase price and the sales
price.
Page: 426
Alvin purchases 200 shares of Harbor Stock for $23 per share.
Alvin makes subsequent purchases at the end of the following years:
Year 1: 50 shares at $26/ share
Year 2: 75 shares at $29/share
Year 3: 25 shares at $36/share
It is now the end of the 4th year and no dividends have been paid and Harbor is trading for $41/share.
What is Alvin's annualized return on his investment for this four-year period?
a. 16%
b. 15.5%
c.
15%
d. 14.5%
e. 14%
A
Step 1: List Cash Flows
Year
Cash Flow
0
$4,600
(200 x 23)
1
1,300
(50 x 26)
2
2,175
(75 x 29)
3
900
(25 x 36)
4
(14,350)
(350 x 41)
Step 2: Calculate IRR
f
4,600
g CF0
1,300
g CFj
2,175
g CFj
900
g CFj
(14,350)
g CFj
f
IRR
=
16.05%
Page: 427
Your client, Tiffany Woodson, owns a portfolio that earned 12% during 1999.
It had a beta of 1.3 and standard deviation of 14%. During 1999 the market (S&P 500) earned 9%.
The risk-free rate of retur was 5%. Which of the following statements is/are true?
1. The Treynor Index for the market is 0.0400
2. The Treynor Index for Tiffany's portfolio is 0.00923
3. The Treynor Index for Tiffany's portfolio is 0.0538
4. Tiffany's portfolio outperformed the market on a risk-adjusted basis
a. 1 only
b. 2 only
c. 1 and 3
d. 1, 2, and 4
e. 1, 3, and 4
E
Treynor = [Portfolio Return - Risk Free return] divided by Beta
Market: Ti = (0.09 - 0.05) / 1.0 '" 0.04000 (Statement 1 is true)
Tiffany: Ti = (0.12 - 0.05) / 1.3 '" 0.05385 (Statement 2 is false; Statement 3 is true)
The index number is higher for Tiffany's Portfolio than the market, which means that Statement 4 is
true.
Page: 428
Which of the following models of Portfolio Performance Measurement and Modern Portfolio Theories use beta as
the risk element?
1. The Jensen Index
2. The Sharpe Index
3. The Treynor Index
4. Markowitz's Capital Asset Pricing Model
a. 1 only
b. 2 only
c. 1, 3, and 4
d. 2, 3, and 4
e. 1, 2, 3, and 4
C
Sharpe uses standard deviation; all of the other models use beta as the measure of risk.
Page: 429
The Performance Fund had returns of 19% over the evaluation period and the benchmark portfolio yielded a return of
17% over the same period. Over the evaluation period, the standard deviation returns from the Fund was 23% and the
standard deviation of returns from the benchmark portfolio, 21%.
Assuming a risk-free rate of return of 8%, which one of the following is the calculation of
Sharpe Index of performance for the fund over the evaluation period?
a.
b.
c.
d.
e.
0.3913
0.4286
0.4783
0.5238
0.5870
C
Sharp Index
Sharp Index
Sharp Index
Realized Return - Risk Free return

Standard Deviation of the Portfolio
(0.19 - 0.08)
0.23
0.47826
Note:
1. All other information in the problem is for distraction purposes.
2. An easy way to remember the difference between the Sharpe Index and the Treynor Index is that Sharpe
uses standard deviation (both begin with "S") and the other index, Treynor, uses Beta.
Page: 430
In computing portfolio performance, the Sharpe Index uses

for the risk measure.
, while the Treynor Index uses
1. Standard deviation
2. Variance
3. Correlation coefficient
4. Coefficient of variation
5. Beta
a.
b.
c.
d.
5; 1
1; 3
1; 4
1; 5
D
An easy way to remember the difference between the Sharpe Index and the Treynor Index is that Sharpe uses standard
deviation (both begin with S) and the other index, Treynor, uses beta.
Page: 431
A $1,000 bond originally issued at par maturing in exactly 10 years bears a coupon rate of 8% compounded annually
and a market price of $1,147.20. The indenture agreement provides that the bond may be called after five years at
$1,050. Which of the following statement(s) is/are true? (CFPTM Certification Examination, released 3/95)
1.
2.
3.
4.
The yield to maturity is 6%

The yield to call is 5.45%
The bond is currently selling at a premium, indicating that market interest rates have fallen since the issue date
The yield to maturity is less than the yield to call
a.
b.
c.
d.
e.
1, 2, and 3
1 and 3
2 and 3
4 only
1, 3, and 4
A
PV
PMT
N
FV
i
=
=
=
=
=
YTM
($1, 147.20)
$80
10
$1,000
6%
YTC
($1,147.20)
$80
5
$1,050
5.45%
The price of bonds is inversely related to changes in interest rates.

Therefore, #1, #2, and #3 are all correct.
Page: 432
David invested $50,000 in a nonpublicly traded partnership.

This partnership generates $12,000 ofpassive income and $4,000 of interest and dividend income each year.
The partnership generates total cash flow (both passive and portfolio) of $15,000 each year. David expects to
receive $75,000 (after tax) at the end of the fifth year by selling his interest in the partnership. David also has
another entity, which generates $2,000 of passive loss each year that is not being offset by any other passive
income.
If David's after-tax rate of return is 6%, what is the net present value of the investment? (Marginal tax bracket 36%).
a. $48,000
A
Period
Pretax cash flow
Less income tax
After-tax cash flow
Plus sales proceeds
Total cash flow
b. $54,065
0
($50,000)
c.
$58,021
d. $98,000
e. $104,065
($50,000)
1
$15,000
(5,040)
$9,960
2
$15,000
(5,040)
$9,960
3
$15,000
(5,040)
$9,960
4
$15,000
(5,040)
$9,960
($50,000)
$9,960
$9,960
$9,960
$9,960
5
$15,000
(5,040)
$9,960
75,000
$84,960
Calculation of Tax
Present Value of Cash Flow
Passive Income
$12,000
FV
= $75,000
Passive Loss
(2,000)
PMT
= $9,960
Net Passive Income
10,000
i
= 6
Dividend and Interest Income
+ 4,000
N
= 5
Total Taxable Income
$14,000
PV
= ($97,999.50) = $98,000
Tax Rate
x 36%
Tax
$5,040
NPV = $98,000 - $50,000 = $48,000
Note: NPV is the difference between the PV of the cash inflows and the initial outflow.
Page: 433
Which of the following Portfolio Performance Measurements is an absolute measure of performance?

1. Jensen Index
2. Sharpe Index
3. Treynor Index
a.
b.
c.
d.
e.
1 only
2 only
3 only
1 and 3
2 and 3
A
Jensen's alpha is an absolute measure of performance.
Sharpe and Treynor are both relative measures of performance.
Page: 434
Barney Smith, resident of Louisiana, has the following two bonds:

Bond A: 10% coupon, paid annually, matures in 3 years
Bond B: 8% coupon, paid annually, maturities in 2 years
Barney will invest all cashflows from the bonds into a money market yielding 5% (after tax) per year.
Barney's marginal tax bracket is 36%. If Barney could buy those bonds today for $2,000, what would be his after-tax yield at the
end of 3 years? (round to nearest whole number)
a.
5%
b.
6%
c.
8%
d.
9%
e.
10%
Step 1: Find the future value of cash flows

Bond A coupon payments
Bond B coupon payments
Total coupon payments
Times 1 - Tax Rate
Mter-Tax Cash Flow
Plus Maturity Value
1
$100.00
80.00
$180.00
0.64
$115.20
$115.20
Cash Flow from Period 2

Cash Flow from Period 1
2
$100.00
80.00
$180.00
0.64
$115.20
1,000.00
$1,115.20
@ 5%
@ 5%
3
$100.00
0.00
$100.00
0.64
$64.00
1,000.00
$1,064.00
$1,170.96
+ 127.01
$2,361.97
(1,115.20 x 1.05)
[115.20 x (1.05)2]
Step 2: Calculate the yield for the three-year period

FV
= $2,361.97
N
= 3
PV
= ($2,000)
i
= 5.7% 6%
Page: 435
Which of the following organizations provide bond-rating services?

1. NASDAQ
2. Moody's
3. Standard and Poors
4. Duff & Phelps
a.
b.
c.
d.
e.
2 only
3 only
1, 2, and 3
2, 3, and 4
1, 2, 3, and 4
D
NASDAQ is an exchange.
The other three provide bond-rating services.
Page: 436
Immunization protects bondholders from which of the following:

1. Interest rate risk
2. Reinvestment rate risk
3. Purchasing power risk
a.
b.
c.
d.
1 only
3 only
1 and 2
1 and 3
C
Immunization protects bondholders from fluctuations in interest rates and from reinvestment rate risk. It will not protect
against purchasing power risk.
Page: 437
Bond A, which is selling for $924.18, has a coupon rate of8% and is yielding 10%.
The bond, which is a 5-year Treasury bond, has a duration of 4.7 years.
At what time horizon will an investor owning bond A be considered initially immunized against interest rate risk?
a.
b.
c.
d.
e.
2.50 years
4.70 years
4.85 years
5.00 years
The investor will always be subject to interest rate risk, regardless of his time horizon
B
When the duration of the bond matches the time horizon of the investor, the bond is considered to be initially immunized.
Page: 438
XYZ stock has a current dividend of $1.75 that has been growing at 8%.
If the stock is currently selling for $100 and your required rate of return is 10%, would you buy the stock at today's
price?
a.
b.
c.
d.
e.
Yes, because the stock is a good buy based on a risk-return relationship.

Yes, because the stock is undervalued based on the dividend growth model.
Yes, because the stock is overvalued based on the dividend growth model.
No, because the stock is not a good investment based on its risk-return relationship.
No, because the stock is overvalued based on the divided growth model.
E
v
d1
k g
(1.75)(1.08)
= $94.50
(0.10 - 0.08)
Since the value of $94.50 is less than the current market price, an investor should not purchase the stock if
he believes in the dividend growth model.
Page: 439
Betty purchased a zero-coupon bond for $500. The bond matured last week, and Betty received the face amount of
$1,000. If the bond had an average annual compound rate of 9% compounded semiannually, approximately how many
years did Betty hold the bond (round to nearest year)?
a. 8 years
b. 9 years
c. 16 years
d. 18 years
e. 32 years
A
PV
FV
i
=
=
=
($500)
$1,000
4.5 (9 / 2)
Calculate for N
N = 15.75 semiannual period divided by 2 equals approximately 8 years.
The HP 12C will give you an answer of 16 semiannual periods.
Page: 440
John Sanders owns an apartment complex with 120 units, each renting for $750 per month.
The complex has an occupancy rate of 80%. The expenses are $300,000 to maintain and run the apartment
complex. Based on the capitalized earnings approach and a capitalization rate of 12%, how much is the complex
worth?
a. $4,700,000
b. $5,600,000
c. $6,000,000
d. $6,500,000
e. $9,000,000
A
Monthly rent
Occupied units
Total monthly rent
Total yearly rent
Less yearly expense
Yearly net income
Value of the company
$750
x 96
$72,000
$864,000
(300,000)
$564,000
$4,700,000
(120 x 80%)
($564,000 / 0.12)
Page: 441
Determine the yield to maturity of a 20-year bond selling for $1,197.93 that has a coupon of 10% (paid semiannually).
a. 4%
b. 5%
c. 6%
d. 7%
e. 8%
E
PV
N
PMTOA
FV
i
=
=
=
=
=
($1,197.93)
40 (20 x 2)
$50 ($100 / 2)
$1,000
3.9999 = 4% x 2 = 8%
Page: 442
Determine the price of a bond with a 10% coupon paid semiannually, 3-year maturity, yielding 12%.
a.
b.
c.
d.
e.
A
PV
PMTOA
i
N
PV
=
=
=
=
=
$950.83
$951.96
$1,000.00
$1,049.74
$1,050.76
$1,000
$50 ($100 / 2)
6 (12% + 2)
6 (3 x 2)
($950.83)
Page: 443
John's portfolio has:
$15,000 invested in Security A,
$30,000 invested in Security B, and
$45,000 invested in Security C.

If Securities A, B, and C have betas of 1.5, 1.2, and 0.9, respectively, what is the Weighted Beta of John's portfolio?
a.
1.1
b.
1.0
c.
1.2
d.
0.9
e.
1.3
A
The weighted beta of a portfolio is determined by multiplying each security's percentage of the total portfolio times its relative beta.
The weighted beta is then the sum of the three products.
Amount
Percentage of
Security
Invested
Portfolio
Beta
Weighted Beta
A
$15,000
0.1667
1.5
0.2500
B
$30,000
0.3333
1.2
0.4000
C
$45,000
$90,000
0.5000
1.0000
0.9
0.4500
1.1000
OR
(A)
Security
A
(B)
Amount Invested
$15,000
(C)
Beta
1.5
$30,000
1.2
(B) x (C)
$22,500
$36,000
0.9
$40,500
$45,000
$90,000
Weighted Beta = $99,000 / $90,000 = 1.100
$99,000
Page: 444
Your client purchased 100 shares of FAQ stock at $60 with a 50% margin requirement and 35% maintenance margin
requirement. If the stock drops to $40, how much money does he have to put up?
a.
b.
c.
d.
e.
$0
$400
$600
$615
$800
B
Value
Loan
Equity
Equity needed
Cash needed
$40 x 100
$6,000 x 0.50
$4,000 x 35%
$4,000
(3,000)
$1,000
(1,400)
$400
Page: 445
Which one of the following statements is true regarding SEC yield?

a. It is calculated as the previous 12 months of income divided by the current market value of the underlying
assets.
b. It is conceptually the same as current yield.
c. It is a standardized method of comparing yields on different investments.
d. It is generally equivalent to yield to maturity.
C
The SEC requires mutual funds to report the SEC yield, so investors have a consistent measurement for
comparing funds. The fund's net investment income over the prior 30 days is used in the calculation.
Page: 446
Which of the following is not considered a constraint when developing an investment policy statement?
a.
b.
c.
d.
Liquidity
Taxes
Market conditions
Time
C
Liquidity, taxes, time, laws and regulation as well as any unique circumstance or reference would be considered when
developing an investment policy statement.
Page: 447
Which of the following statements is/are correct concerning the purpose of an Investment Policy Statement?
1. An Investment Policy Statement is a written document that establishes client objectives and lists limitations on
the investment manager.
2. The Investment Policy Statement can be used as the basis to measure the manager's performance against
the objectives and constraints of the policy statement.
a.
b.
e.
d.
1 only
2 only
Both 1 and 2
Neither 1 nor 2
C
In addition, the policy statement can be provided to the portfolio manager to use in establishing and
managing the characteristics of the client's portfolio.
Page: 448
Danny and Clyde Floyd are both young and are willing to take above-average risk for higher returns with their retirement
savings. Based on the following historical data, which stock should they add to their portfolio?
Stock A
Stock B
1996
21%
30%
1997
8%
5%
1998
30%
40%
1999
15%
(10%)
2000
16%
25%
a.
b.
c.
d.
e.
Either stock would be appropriate because the average return of the stocks are equal.
Stock A because its risk-adjusted rate of return is higher than Stock B.
Stock A because it has a lower standard deviation.
Stock B because it has a high return and a larger standard deviation than Stock A.
Stock B because the geometric average annual return for Stock B is greater than Stock A.
B
The average return for both Stock A and B is 18%.
The standard deviation for Stock B is greater than Stock A.
Therefore the risk adjusted return for Stock A is higher.
A
B
Mean
18%
18%
Standard Deviation
8%
20%
Geometric
17.78%
16.54%
Note: Stock A should not be added simply because it has a lower standard deviation.
Page: 449
Sam Squeaky has been investing $350 into a mutual fund at the end of each month for the last 10 years and has been
earning a compound return of 12%, consisting entirely of appreciation. Does Sam have enough money, after selling this
investment and paying taxes at 28% to purchase his dreamboat for $70,000?
a.
b.
c.
d.
e.
No, because he only has $69,729.75 after paying the tax on the capital gain.
No, because he only has $57,969.75 after paying the tax on the capital gain.
Yes, because he has $80,513.54 after the sale of the investment.
Yes, because he has $72,176.34 after paying the tax.
None of the above.
A
Note: If you chose answer b, then you forgot to subtract the basis from the proceeds when you were calculating the tax. It is a
common mistake!
Remember, the exam is integrated!
Step 1: Calculate value today
Step 2: Determine Sam's basis
PV
= $0
Amount of payments
$350
N
= 120 = 10 x 12 months
Number of payments
x 120
i
= 1 % = (12% + 12)
Basis
$42,000
PMT
= ($350)
FV
= $80,513.54
Step 3: Calculate tax
Proceeds
$80,513.54
Less Basis
(42,000.00)
Gain
$38,513.54
Tax Rate
x 28%
Tax
$10,783.79
Thus, he cannot purchase his dreamboat.
Step 4: Cash available

Proceeds
Less Tax
Ater-Tax Cash Flow
$80,51354
(10,783.79)
$69,729.75
Page: 450
Which of the following statements is/are true regarding strategic and tactical asset allocation?
1. Strategic asset allocation involves selection of the correct asset allocation based on risk tolerance of the client,
economic forecasts, and expectations of selected asset classes and rebalancing once or twice per year to keep
the portfolio within the parameters of the desired strategic mix.
2. Tactical asset allocation involves evaluating asset classes or industries as to their value and selling undervalued
classes and purchasing overvalued classes.
a.
b.
c.
d.
1 only
2 only
Both 1 and 2
Neither 1 nor 2
A
Statement 2 is incorrect because tactical asset allocation involves buying undervalued classes and selling
overvalued classes.
Page: 451
Which of the following method(s) might be considered strategies for dealing with concentrated portfolios?
1. Assuming low or moderate tax cost and a market for the security, a sale is an effective method of handling a
concentrated portfolio by investing the proceeds from the sale and creating a diversified portfolio.
2. An ESOP can assist with a concentrated portfolio problem by creating a market for an illiquid security that
cannot be otherwise sold outside a firm.
a.
b.
c.
d.
1 only
2 only
Both 1 and 2
Neither 1 nor 2
C
Both statements are correct. Other strategies for dealing with concentrated portfolios include a private
annuity and a self canceling installment note (SCIN).
These techniques are discussed in the Estate Planning section.
Page: 452
Which of the following statements is/are correct concerning the use of a charitable remainder trust (CRT) for dealing
with a concentrated portfolio?
1. The concentrated portfolio that was transferred into the CRT can be sold and the proceeds (less taxes) can be
reinvested into a diversified portfolio.
2. An advantage of transferring a concentrated portfolio into a CRT is that a charitable deduction is generally
created which can be used to offset current or future taxable income.
a.
b.
c.
d.
1 only
2 only
Both 1 and 2
Neither 1 nor 2
B
Statement 1 is incorrect because the proceeds from the sale of the concentrated portfolio in the CRT is not
taxable.
A CRT is a nontaxable entity.
CRTs are discussed in detail in the Estate Planning section.
Page: 453
All of the following are correct concerning the use of an exchange fund to assist an investor in switching
concentrated portfolio to a diversified portfolio, except:
from a
a. Exchange funds are sponsored by financial institutions.

b. Exchange funds allow investors with concentrated portfolios of publicly traded stock to con tribute stock to the
exchange fund and then receive an interest in the overall fund.
c. Because the exchange fund holds numerous publicly traded securities, the investor receives an interest in a
diversified fund.
d. The value of the investor's investment in the overall fund is somewhat diminished due to the taxable event of the
exchange.
D
A benefit of an exchange fund is that a concentrated portfolio is exchanged for an interest in a diversified
portfolio without a taxable event occurring.
Page: 454
Which of the following statements is/are correct concerning the Monte Carlo Analysis (MCA)?
1. The MCA technique is used to consider uncertainty in a probability analysis model
2. The MCA provides the most likely outcome along with other possible outcomes
a. 1 only
b. 2 only
c. Both 1 and 2
d. Neither 1 nor 2
C
Both statements are correct.
The MCA provides projections in the event variables such as rate of return and life expectancy fluctuates.
Page: 455
A person who is willing to accept a large increase in risk without a large increase in return would be classified as what?
a. Risk average
b. Risk neutral
c. Risk adverse
d. Risk seeking
e. Risk tolerant
D
Definition of risk seeking.
Page: 456
Adrean comes to you for advice. She has a large capital gain in ABC Company (approximately 100%).
She has heard rumors that may make the stock price rumble and is concerned about losing her gain. However,
because of her tax situation, she does not currently want to recognize a taxable gain.
Assuming no transaction costs, what would you advise her to do to maintain her gain without selling her stock?
a.
b.
c.
d.
e.
Sell short against the box.

Purchase a call option.
Sell a put option.
Hedge in the futures market.
Her best solution is to sell the stock and incur the tax.
A
Selling short against the box will freeze her gain without the sale of the stock.
None of the other choices will accomplish her goal.
Buying a put option would also allow her to protect her gain.
Page: 457
Joseph Gillmore, age 35, is an investor with a moderate to high risk level who is in the top tax bracket of 40% (state and
federal) and has a long-term perspective and expects to be in a lower tax bracket in 30 years.
Which of the following mutual funds would you recommend for Joseph if he is investing for his retirement?
1. Fund 1: A bond fund comprised of high quality municipal and corporate bonds, which has yielded 9.3% over the
last 10 years.
2. Fund 2: An equity growth fund, which has yielded 14.75% of income and annual appreciation of approximately
2% over the last 10 years and has a beta of 1.1.
3. Fund 3: An equity growth fund, which has yielded 2.4% of income and annual appreciation of approximately
14% over the last 10 years with a beta of 1.12.
a. Fund 1 because bond funds are less risky and this fund invests in municipal bonds, which are not
subject to federal income tax, thus reducing his tax burden.
b. Fund 2 because the total yield is higher than Fund 1 or Fund 3.
c. Fund 2 because the Beta level is lower than Fund 3.
d. Fund 3 because the capital appreciation will accumulate without tax until the shares are sold.
e. Fund 3 because with a higher beta, the returns over a long-term horizon will be higher than a fund with
a lower Beta.
D
Fund 2
Taxable Yield
14.75%
1 - Tax Rate
x 60%
After- Tax Yield
8.85%
Plus Appreciation
2.00%
Total Return (after tax)
10.85%
Beta
/ 1.10
Risk Adjusted Return
9.86%
Fund 1 is not an appropriate choice for Joseph's objectives.
Fund 3
2.4%
x 60%
1.44%
14.00%
15.44%
/ 1.12
13.79%
Page: 458
Birch and Mary Marlin are interested in adding an equity stock to their portfolio.
The Marlins require a 10% rate of return and are considering the following stocks.
Stock A: Dividends are currently $4.50 annually and are expected to grow at 5% annually; the market price is
currently $80.
Stock B: Dividends are currently $2.75 annually and are expected to grow at 9% annually; the market price is
currently $250.
Stock C: Dividends are currently $1.25 annually and are expected to grow at 7% annually; the market price is
currently $35.
Using the dividend growth model, which stock would be most appropriate for the Marlins and why?
a.
b.
c.
d.
e.
Stock A: because it has the largest dividend.

Stock A: because the market price is undervalued by the largest amount.
Stock B: because it has the largest growth rate of the three investments.
Stock B: because it is undervalued by the largest dollar amount.
Stock C: because it is undervalued the greatest amount and is the best buy for the amount of initial investment.
E
d1
Dividend Growth Model =
k-g
A
4.5 (1.05)
(0.10 - 0.05)
B
2.75 (1.09)
(0.10 - 0.09)
Value of Stock
$94.50
Less Current Market Price
(80.00)
Amount Stock is Undervalued
$14.50
Undervalued as a % of Value
15.34%
Stock C is the most undervalued (as a percent), which makes it the best buy.
$299.75
(250.00)
$49.75
16.59%
C
1.25 (1.07)
(0.10 - 0.07)
$44.58
(35.00)
$9.58
21.49%
Page: 459
Holly and Jeff Davis have recently retired and are no longer drawing an income.
They would like to change their asset allocation to provide more income in their retirement years.
Which of the following investments would help the couple in achieving their financial objectives?
1.
2.
3.
4.
Aggressive growth mutual fund shares.

AA corporate bonds
Zero-coupon bonds
Equity income mutual fund shares
a.
b.
c.
d.
e.
2 and 3
2 and 4
1 and 3
1, 2, and 4
2, 3, and 4
B
Investments 2 and 4 are the only two that will provide current income for the Davis family.
Page: 460
Buddy and Patty White own a farm in Colorado with a FMV of $300,000 (with an outstanding loan of $125,000 and a basis of $50,000). This farm is
rental property and generates $5,000 in after-tax income each year. The farm has suspended passive activity losses of $50,000, and it is expected to
appreciate at 6% per year. If the Whites can earn 10% after tax and plan to purchase a farm when they retire in 30 years, would they be better, from
a purely monetary standpoint, to sell the farm (assuming a 28% capital gains rate) and invest the proceeds or keep the farm?
a. The Whites should keep the farm because they would be better by $55,255 in today's dollars
b. The Whites should sell the farm because they would be better by $55,255 in today's dollars
c. The Whites should keep the farm because they would be better by $26,880 in today's dollars
d. The Whites should sell the farm because they would be better by $8,120 in today's dollars
e. There is no difference monetarily between keeping the farm and selling the farm
C
Alternative 1: Sell the Farm
Sale of the Farm
Sales Price
Less Outstanding Loan
Cash
Less Tax
Net Cash
$300,000
(125,000)
$175,000
(56,000)
$119,000
Alternative 2: Keep the Farm

Appreciation (FV) of the Farm
PV
=
($300,000)
N
=
30
i
=
6%
PMT
=
$0
FV
=
$1,723,047
Tax on the Sale of the Farm

Sales Price
Less Basis
Gain
Less Passive Activity Loss
Realized Gain
Tax Rate
Tax
FV of the Rent
$0
30
10%
($5,000)
$822,470
$300,000
(50,000)
$250,000
(50,000)
$200,000
x 28%
$56,000
PV of Both
FV
= $2,545,517 (1,723,047 + 822,470)
N
= 30
i
= 10%
PMT
= $0
PV
= ($145,880)
Keep Farm (PV)

$145,880
Sell the Farm (net cash)
(119,000)
Difference
$ 26,880
Another way to think of this comparison is to determine how much the Whites would have assuming thl invested the $119,000 for 30 years at 10%.
They would have $2,076,479, which is less than the value c the farm plus the value of the rental payments of $2,545,517.
Page: 461
Buddy and Patty White own a farm in Colorado with a FMV of $300,000 (with an outstanding loan of
$125,000 and a basis of $50,000). This farm is rental property and generates $5,000 in after-tax income each year. The
farm has suspended passive activity losses of $50,000 and it is expected to appreciate at 6% per year. If the Whites can
earn 10% after tax and plan to purchase a farm when they retire in 30 years, would they be better, from a purely
monetary standpoint, to sell the farm (assuming a 28% capital gains rate) and invest the proceeds or keep the farm?
How much after tax income must the property generate to be at break-even regarding the sale vs. keeping the farm?
a.
b.
c.
d.
e.
C
FV of Sale
PV
N
i
PMT
FV
$2,851
($2,851)
$2,149
$5,861
($2,149)
=
=
=
=
=
($119,000)
30
10
$0
$2,076,479
FV of Keeping Farm
Difference
FV = $2,545,517
$469,038
Difference in Payments to Break Even

PV
= $0
Current Rent
FV
= $469,038
Less
i
= 10
Rent to Break Even
N
= 30
PMT
= ($2,851)
$5,000
(2,851)
$2,149
Page: 462
Allison Michaels comes to you to and asks you which of the following payout methods she should accept from her
qualified plan (assume all Michaels live at least until they are 90 and that they can earn 8% after tax):
Option 1: Lump-sum payment of $204,000.
Option 2: An annuity paid for a term certain of 15 years of $24,000 per year.
Option 3: An annuity, second to die payment, paid over the joint-life expectancy of Allison and her son: 27.5 years, in
the amount of $18,450.
a.
b.
c.
d.
e.
Option 1 because it has the highest future value.

Option 1 because it has the highest present value.
Option 2 because it has the highest guaranteed present value.
Option 3 because it has the highest present value.
Option 3 because it has the highest future value.
C
FV
N
i
PMT
PV
=
=
=
=
=
Option 2
$0
15
8%
$24,000
($205,427)
Option 3
$0
27.5
8%
$18,450
($202,844)
Note: HP 12C shows ($193,994)
Page: 463
What is the present value of an annuity if it pays $2,500 per year at year-end for 20 years and the annuity does not
begin for 3 years? (Assume a discount rate of 15%.)
a.
b.
c.
d.
e.
A
Step 1:
N
i
PMT
FV
PV3
=
=
=
=
=
$10,289
$13,627
$16,438
$23,721
$50,000
20
15%
$2,500
$0
($15,648.33)
Step 2:
FV3
=
N
=
i
=
PMT =
PV0
=
$15,648.33
3
15%
$0
($10,289)
Page: 464
Todd and Diana Martin are establishing a college fund for their 14-year-old son, Mike. The Martins do not wish to invest
aggressively, but are willing to take a reasonable and normal investment risk.
Which of the following investments makes the most sense for the college fund and why?
a. A series of taxable zero-coupon bonds owned by Mike because they can provide appropriate funds at the
correct times and are taxed at the child's rate.
b. A variable life insurance policy owned by Mike because it saves taxes and it contains life insurance.
c. A money market index checking account owned by Todd and Diana because this account is very safe.
d. A small-cap stock mutual fund owned by Mike because it provides the best return at a modest level of risk
consistent with the time horizon.
e. Treasury notes with a 7 -year maturity owned by Todd and Diana because the 7 -year maturity Treasury notes
have little interest rate risk.
A
Funds for education must meet the appropriate time horizon; therefore, E, which relates to investments that have
maturities beyond the time horizon is wrong.
Because small cap stocks are too risky of an investment for such a short period of time, D is incorrect. B does not match
the investment vehicle to the time horizon of the investment.
The zero-coupon bond allows the Martins to match the time horizon of the investments to the duration of the bonds and
avoid reinvestment risk.
In addition, the income will be taxed at the child's rate.
Page: 465
Your client, a conservative investor, is saving to build a new home in five years. Which of the following types of
investment is the most appropriate for your client's goal?
a.
b.
c.
d.
e.
Science and technology mutual fund

S&P 500 Index fund
7 -year Treasury notes
International stock mutual fund
Zero-coupon municipal bond
E
Because your client's goal is only five years away, equities would not be appropriate (A, B, D).
The seven year Treasury (C) does not match the client's five-year goal.
The best choice would be the zero-coupon municipal bond.
Page: 466

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The following memorization cards are a compilation of

Using the Formulas

Assume a client wants to know the Future Value of an investment of $500

1.06  yx 4 =, you will see the factors is: 1.2625

Using TVM Tables

Future Value Table

Setting Up Your HP-10BII Calculator

Setting the number of Decimals (to 4 places)

SHIFT CLEAR ALL

Using Your Financial Calculator

1. Identify what you are

You only need to take a small number of different factors into

For both problems you will need the:

Things to REMBER!!! When Using Your Financial Calculator

Always Clear Your Calculator before and after doing each

Remember to correctly use the +/- key

Clear Your Calculator

Future Value of a Single Sum

$1,000 is invested at 8% compounded annually for 3 years. What will its

Present Value of a Single Sum

Client will receive $1,000 in 3 years.

What will it be worth today if the

Clear Your Calculator

His opportunity cost is 10% compounded monthly.

Present Value of a Single Sum

Table (1.46410) x 12,000

Table (1.46410) x 12,000

Using a Financial Calculator

Clear Your Calculator

Future Value of Annuities

FV of Single Sums and Annuities

Future Value of an Annuity

PV of Single Sums and Annuities

Clear Your Calculator

Present Value of an Annuity

Clear Your Calculator

Future Value of an Ordinary Annuity

Future Value of an Annuity

Compounding Periods of Single Sums/Annuities

Number of Compounding Periods

Number of Compounding Periods (More Frequent Compounding)

Number of Compounding Periods

Number of Compounding Periods

Number of Compounding Periods

Present Value of a Serial Payment

Client wants to receive an equivalent of $10,000 in todays dollars at the

Note: Multiple repetitious cash flows can be

(HP10B) 10,000 CFj 2 Nj

NPV of Unequal Cash Flows

Clear Your Calculator

Uneven Cash Flows

Note: Multiple repetitious cash flows can be entered

Price (Or Intrinsic Value) Of A Bond

Note: Multiple repetitious cash flows can be entered

Lump Sum with a Annuity Due

Clear Your Calculator

Your client's goal is to accumulate $200,000 in 5 years to build a new home.

142,597 + 21,284 = $163,881

7,000 +/- CF0

Note: Multiple repetitious cash flows can be entered

36,000 +/- CF0

After-Tax Rate of Return

(1 - Tax Rate) x Rate of Return

1.06 yx 4 =, you will see the factors is: 1.2625