Chapter 5 Practice Question Answers
1. Answer: B. A C-corp, or subchapter C-corp, does not pass through its earnings without taxation. A C-corp’s net profits are actually subject to a corporate tax rate before they are distributed to its owners, who are then taxed again on that income.
2. Answer: A. A JTWROS account is automatically divided equally among the remaining joint account holders in the event of the death of one of the others. An individual’s percentage ownership interest in a joint tenancy in common account, a general partnership, or LLC is passed to their heirs according to their estate plan or state law.
3. Answer: A. An inability to tolerate even temporary drops in a portfolio’s value would best be described as a conservative risk tolerance. A moderate risk tolerance would be able to sustain temporary drops in value with the expectation of a rebound. Just because someone is conservative in their risk tolerance doesn’t mean that they identify current income as their primary goal; even that may be too risky for some conservative clients.
4. Answer: A. Tax-free municipal bonds would be the least suitable for John because he is not in a high income tax bracket and, therefore, would not be able to take advantage of the tax benefits of municipal bonds. In addition, municipal bonds would not offer the liquidity necessary to buy his house.
5. Answer: B. Municipal bonds would be the most suitable investment for Alex, because as an executive for a Fortune 500 company, he would be earning a high income, and therefore in a high tax-bracket. The interest on the municipal bonds would supplement his current income. While blue chip stocks pay dividends, the dividends would not be high enough to help him if he gets into a cash crunch. REITs pay high dividends, but they also are subject to taxation at Alex’s ordinary income rate. Finally, while high-yield bonds offer higher coupon rates, their risk is probably too high for Alex to take a chance