Chapter 3 Practice Question Answers
1. Answer: A. You are expected to know the customer’s financial status, tax status, and investment objectives. You are not expected to know information the customer refuses to disclose.
2. Answer: D. Often, bond issuers will choose to redeem their higher paying bonds in a declining interest rate environment. This tendency of higher paying bonds to get called before their maturity date is referred to as “call risk.”
3. Answer: A. Systematic risk refers to the tendency of a downward trend in the overall investment market to depress individual securities.
4. Answer: C. Using Moody’s combination of letters and numbers to rate bonds, Baa3 is the lowest quality investment-grade bond available. S&P would rate the same bond BBB-.
5. Answer: D. Interest rate risk refers to the risk of fluctuation in the market value of fixed-income investment products due to interest rate movements. Typically, interest rate risk is higher for fixed-income investment products with longer maturities and higher durations.
6. Answer: D. To qualify for long-term capital gains tax treatment, an asset needs to be held for more than a year.
7. Answer: B. Diversification is grounded in the idea that it is unwise to put all your eggs in one basket. Specifically, diversification is the process of choosing a variety of assets to spread out the risk from any one asset. One strategy for achieving diversification is the buying of uncorrelated assets, or assets that do not have a history of moving the same direction at the same time. Diversification lowers nonsystematic risk, but it does not lower systematic (market-wide) risk. Diversification can be used to lower risk in a portfolio within asset classes or across asset classes.
8. Answer: