NASAA Series 65 — All Questions

A mother bought stock for $20 per share. It was worth $50 per share when she died, and her son sells it for $55. What is the son's taxable gain per share?

• a.$35
• b.$5✓
• c.$50
• d.$30

Inherited property receives a basis stepped up to fair market value at death, so the son's basis is $50 and his gain is $5. A $50 figure is the value at death, not the gain. A $30 figure is the mother's gain at death, which the step-up eliminates. A $35 figure uses her original $20 basis, which applies to gifts rather than inheritances.Basis of inherited property

A parent gives a child stock bought for $20 per share when it was worth $50 per share. The child later sells it for $55. What is the child's taxable gain per share?

• a.$30
• b.$35✓
• c.$0
• d.$5

A gift carries over the donor's basis, so the child's basis is $20 and the gain is $55 - $20 = $35. A $5 gain applies a stepped-up basis, which is available only for inherited assets. A $30 figure is the donor's gain at the time of the gift. A $0 figure would require selling at the donor's cost.Basis of gifted property

A client plans a charitable gift and holds long-term appreciated stock with a low cost basis. Which approach gives the most tax benefit?

• a.Give the shares to a relative who then donates them
• b.Donate the shares directly and deduct only the cost basis
• c.Sell the shares and donate the cash, deducting the cash amount
• d.Donate the shares directly and deduct their fair market value✓

Donating long-term appreciated stock directly lets the donor deduct fair market value (for itemizers) and avoids capital gains tax on the appreciation. Selling first triggers the gain, leaving less to donate and deduct. The deduction is not limited to basis for long-term holdings given to a public charity. A pass-through gift to a relative would carry over the donor's basis and add a gift tax reporting step for no benefit.Charitable giving

A client was born in 1962. At what age must the client begin taking required minimum distributions from a traditional IRA?

• a.73
• b.75✓
• c.72
• d.70 1/2

Under SECURE 2.0, required distributions begin at age 75 for people born in 1960 or later. Age 70 1/2 was the rule before 2020, age 72 applied to people born in 1949 or 1950, and age 73 applies to people born from 1951 through 1958.Required minimum distributions

A retiree misses a required minimum distribution and corrects the shortfall within the allowed correction window. What excise tax applies to the amount not withdrawn?

• a.6%
• b.10%✓
• c.25%
• d.50%

The excise tax on a missed distribution is 25% of the shortfall, reduced to 10% when corrected within the correction window, generally two years. The 25% rate applies if the shortfall is not corrected in time. The 50% rate was the rule before 2023. The 6% figure is the excise tax on excess IRA contributions, a different penalty.Required minimum distributions

Which Roth IRA owner can take a distribution of earnings that is completely free of income tax and penalty?

• a.A 62-year-old whose first Roth contribution was six years ago✓
• b.A 62-year-old whose first Roth contribution was three years ago
• c.A 50-year-old whose first Roth contribution was ten years ago
• d.A 45-year-old using the earnings to pay college tuition

A qualified distribution needs a five-year holding period and a qualifying event such as age 59 1/2, death, disability or a first-home purchase up to $10,000. The 62-year-old with three years of history has not met the five-year test. The 50-year-old meets the five-year test but not the age or event requirement. Tuition is an exception to the 10% penalty but earnings are still taxable.Roth IRA distributions

A client converts a $50,000 pre-tax traditional IRA balance to a Roth IRA in 2026. How is the conversion taxed?

• a.The conversion is not taxed because it stays within the IRA system
• b.The $50,000 is taxed at capital gains rates with no penalty
• c.The $50,000 is added to ordinary income for 2026, with no 10% penalty✓
• d.The $50,000 is added to ordinary income and also incurs a 10% penalty

A conversion of pre-tax money is taxed as ordinary income in the year of conversion. The 10% penalty applies to early distributions, not to a conversion. Capital gains rates do not apply to IRA money. Only after-tax basis is converted tax-free.Roth conversions

Beginning in 2026, what is the annual limit on 529 plan withdrawals that can be used for elementary and secondary school tuition per beneficiary?

• a.$20,000✓
• b.$10,000
• c.$2,000
• d.$5,000

The 2025 tax legislation raised the K-12 tuition limit to $20,000 per beneficiary per year starting in 2026. The $10,000 figure was the earlier limit. The $2,000 figure is the Coverdell annual contribution limit, and $5,000 is not a 529 limit.Education savings

A grandparent makes a five-year election for a 529 plan contribution in 2026 for one grandchild. What is the largest amount that can be contributed without a taxable gift, assuming no other gifts?

• a.$190,000
• b.$95,000✓
• c.$19,000
• d.$76,000

The five-year election allows five years of annual exclusions at once: 5 x $19,000 = $95,000 for a single donor. A $19,000 amount is a single year. A $76,000 figure counts four years. A $190,000 figure is the amount for a married couple splitting gifts.Education savings

What is the lifetime limit on rollovers from a 529 plan to a Roth IRA for the same beneficiary?

• a.$35,000✓
• b.$10,000
• c.$25,000
• d.$50,000

The 529-to-Roth rollover is capped at $35,000 per beneficiary for life, the account must have been open at least 15 years, and each year's rollover cannot exceed the annual IRA contribution limit. The other amounts are not statutory limits.Education savings

What is the maximum annual contribution per beneficiary to a Coverdell education savings account?

• a.$5,000
• b.$500
• c.$10,000
• d.$2,000✓

Coverdell contributions are limited to $2,000 per beneficiary per year across all contributors, and they phase out for higher-income contributors. The $500 figure was the pre-2002 limit. Five thousand and ten thousand dollars are not Coverdell limits.Education savings

A client born in 1962 starts Social Security retirement benefits at age 62. What percentage of the full retirement age benefit will the client receive?

• a.80%
• b.60%
• c.70%✓
• d.75%

For people born in 1960 or later, full retirement age is 67, and claiming at 62 reduces the benefit by 30%, leaving 70%. The other percentages do not match the reduction formula of 5/9 of 1% per month for the first 36 months and 5/12 of 1% beyond that.Social Security

A client with a full retirement age of 67 delays claiming Social Security until age 70. The monthly benefit will be what percentage of the full retirement age benefit?

• a.124%✓
• b.132%
• c.116%
• d.108%

Delayed retirement credits add 8% per year for each year past full retirement age, up to age 70: three years x 8% = 24%, so the benefit is 124%. A 108% figure counts one year, a 116% figure counts two, and 132% would imply four years.Social Security

What is the maximum portion of Social Security benefits that can be subject to federal income tax?

• a.100%
• b.50%
• c.75%
• d.85%✓

Up to 85% of benefits may be taxable when combined income is above the upper threshold. The 50% figure is the maximum at the first threshold. Seventy-five percent is not a statutory tier. One hundred percent of benefits is never taxable.Social Security

A client needs $60,000 in two years for a home down payment and has a low tolerance for loss. Which recommendation is most suitable?

• a.A ladder of CDs and Treasury bills maturing within two years✓
• b.A 10-year investment-grade corporate bond fund
• c.A high-yield bond fund with a five-year duration
• d.A diversified fund of large-capitalization growth stocks

A short time horizon and low risk tolerance call for principal stability and maturities that line up with the date of need, which a ladder of CDs and Treasury bills provides. Growth stocks can lose value within two years. A 10-year bond fund carries substantial interest-rate risk over the period. High-yield bonds add credit risk and rate risk, which conflicts with the client's goal.Suitability

Which holding is best placed in a tax-deferred IRA instead of a taxable account?

• a.A broad-market stock index ETF with qualified dividends
• b.A growth stock the client plans to hold for decades
• c.A taxable bond fund paying ordinary-income interest✓
• d.A municipal bond fund paying tax-exempt interest

Interest from taxable bonds is taxed at ordinary rates each year, so sheltering it in an IRA saves the most. Index ETFs with qualified dividends and long-held growth stocks are already tax-efficient in a taxable account. A municipal bond fund placed in an IRA wastes its tax exemption, since IRA withdrawals are taxed as ordinary income.Asset location

An investor puts $500 into a fund each month. The prices on the three purchase dates are $10, $5 and $10. What is the investor's average cost per share?

• a.$5.00
• b.$10.00
• c.$7.50✓
• d.$8.33

The investor buys 50 + 100 + 50 = 200 shares for $1,500, an average cost of $7.50. The $8.33 figure is the simple average of the three prices, which is higher because it ignores that more shares were bought at the low price. A $5.00 figure is the lowest price. A $10.00 figure is the highest price.Dollar-cost averaging

A $500,000 portfolio has a 60% stock and 40% bond target. Stocks have grown to $350,000. How much stock should be sold to return to the target?

• a.$20,000
• b.$50,000✓
• c.$150,000
• d.$100,000

The target stock value is 60% of $500,000 = $300,000, so $350,000 - $300,000 = $50,000 must be sold and moved to bonds. A $20,000 figure is not tied to the target. A $100,000 figure would move the stock allocation to 50%. A $150,000 figure would leave stock at 40%.Portfolio rebalancing

A private non-operating foundation holds $40 million of investment assets, none used directly in its charitable programs, and has no acquisition debt. Using the statutory minimum investment return, about how much must it distribute for the year?

• a.About $1.6 million, which is 4% of the assets
• b.About $2.8 million, which is 7% of the assets
• c.About $2.0 million, which is 5% of the assets✓
• d.About $1.2 million, which is 3% of the assets

IRC 4942(e)(1) sets the minimum investment return at 5% of the foundation's non-exempt-use assets less acquisition debt, so 5% of $40 million is $2.0 million. Four percent is a common endowment spending rule, not the foundation payout rate. Seven percent is the optional UPMIFA presumption-of-imprudence threshold for endowments. Three percent has no basis in the foundation rules. A shortfall draws a 30% excise tax on undistributed income.IRC s.4942(e)(1)

A university endowment has fallen below the total of the original gifts. The board asks the adviser what UPMIFA allows. Which statement is correct?

• a.The board may still appropriate funds after weighing prudence factors such as inflation, expected total return and the fund's purposes✓
• b.Spending must stop until the fund recovers to the historic dollar value of the original gifts, and only then may appropriations resume
• c.Spending is limited to the interest and dividends the fund actually received that year, with no use of capital gains at all
• d.Spending may not exceed 5% of the fund's value in any year, as the payout rule for a private foundation requires

UPMIFA dropped the historic-dollar-value floor of the older UMIFA, so a fund below its gift value can still support appropriations if the board acts prudently under the listed factors. The floor-based rule describes the old act. An income-only limit is also not in UPMIFA, which uses a total-return approach. The 5% figure belongs to private foundations under IRC 4942, and UPMIFA's only percentage is an optional 7% presumption of imprudence.UPMIFA s.4

A trust pays all net income to the settlor's widow for life, and the principal passes to the settlor's children at her death. The trustee's adviser proposes putting 100% of the trust in high-yield bonds. Which statement best captures the trustee's duty?

• a.The trustee must favor the children, because they hold the ultimate interest and the principal should be preserved for them above all
• b.The trustee must act impartially, weighing the widow's need for income against the children's interest in preserving and growing principal✓
• c.The trustee must favor whichever beneficiary the trustee judges to have the greater financial need, since need sets the order of priority in a trust
• d.The trustee must favor the widow, because she is the only current beneficiary and the trust exists mainly to support her during her lifetime

UPIA s.6 requires a trustee of a trust with two or more beneficiaries to act impartially and take account of their differing interests, so an all-income portfolio shortchanges the remainder beneficiaries. Favoring the current beneficiary, favoring the remaindermen, or favoring the needier party each breaks that duty by ranking one group above the other.Uniform Prudent Investor Act s.6

A corporation's treasurer asks the adviser to invest $5 million that will be needed for a plant purchase in four months. Which ordering of priorities is most appropriate?

• a.Liquidity first, then yield, then safety of principal
• b.Safety of principal first, then liquidity, then yield✓
• c.Yield first, then liquidity, then safety of principal
• d.Safety of principal first, then yield, then liquidity

Cash earmarked for a known near-term outlay must be there in full when needed, so safety comes first, then the ability to convert it to cash, and only then yield. Putting yield ahead of safety invites principal loss. Putting yield ahead of liquidity, as the other two orderings do, risks holding assets that cannot be sold promptly at the payment date.Prudent investor standard; institutional cash management

An adviser holds a client's valid durable power of attorney naming the client's daughter as agent. The client dies on Friday. On Monday the daughter calls to sell stock in the client's account. What should the adviser do?

• a.Decline, because the agent's authority ended at the client's death and the personal representative must now give instructions✓
• b.Accept, because a durable power of attorney keeps its effect until the account is formally retitled in the name of the estate or the heirs
• c.Accept instructions from the daughter for up to 30 days while the estate is being opened and a personal representative is appointed
• d.Accept the order, but only if the sale is made to protect the value of the account for the heirs and the daughter documents the reason

Every power of attorney, durable or not, terminates when the principal dies; durability only keeps it alive through incapacity. After death the court-appointed personal representative holds authority over the account. There is no grace period, and no protective-sale exception lets an agent keep acting after the principal's death.Uniform Power of Attorney Act s.110

A 45-year-old beneficiary of an irrevocable trust phones the adviser and demands that the trust's stock be sold to pay for a boat. The trustee is the adviser's client and has given no such instruction. What should the adviser do?

• a.Execute the sale once the beneficiary signs a written indemnity that holds the adviser harmless for any resulting loss to the trust
• b.Decline to act on the beneficiary's demand and take direction only from the trustee, within the terms of the trust document✓
• c.Execute the sale if the beneficiary is the only living beneficiary and the other remainder interests are contingent or unborn
• d.Execute the sale, because the beneficiary owns the economic interest in the assets and is entitled to direct how they are used day to day

Legal title and investment authority sit with the trustee, who must follow the trust instrument; a beneficiary has no right to direct trades. An economic interest, a signed indemnity, or being the only current beneficiary does not transfer the trustee's authority to the beneficiary.Uniform Trust Code s.801; trust instrument

A custodian of a UTMA account for her nephew asks the adviser to sell shares and wire $15,000 to her own bank account to pay off a credit card. Why must the adviser refuse?

• a.A custodian who is a relative of the minor may not withdraw funds under any circumstances
• b.Withdrawals above the annual gift tax exclusion need court approval before any use
• c.UTMA property belongs irrevocably to the minor, and the custodian may use it only for the minor's benefit✓
• d.UTMA property may not be used for anything until the minor reaches the age of majority

A UTMA gift is irrevocable and the assets are the child's; the custodian is a fiduciary who may spend only for the minor's benefit, so paying the custodian's own debt is improper. The custodian may in fact use funds for the minor before majority, so a total freeze is wrong. Court approval is not triggered by the gift tax exclusion, and a relative may serve as custodian and make proper expenditures.Uniform Transfers to Minors Act

An adviser opens an advisory account for a closely held corporation. The president says she alone will give instructions. What should the adviser obtain to confirm who is authorized to act?

• a.A corporate resolution or incumbency certificate from the board naming the authorized persons and the scope of their authority✓
• b.The corporation's most recent audited financial statements together with a certificate of good standing from the secretary of state
• c.A personal financial statement and the latest tax return from the president, showing that she holds the controlling share of the company
• d.A signed power of attorney from each shareholder naming the president as agent for all decisions in the corporation's securities account

An entity acts through officers whose authority comes from its governing documents, so the adviser needs a board resolution or certificate of incumbency identifying who may open the account and instruct. The president's personal financials do not prove corporate authority. Shareholders do not grant trading authority by power of attorney, and audited statements show finances, not who may act.Corporate account documentation; KYC

In planning a joint account, the husband's questionnaire scores as aggressive and the wife's as conservative. Neither will give ground. What is the adviser's best course?

• a.Discuss the difference with both spouses, agree on a joint allocation or separate sub-portfolios, and document the resolution✓
• b.Follow the spouse who earns the larger share of household income, because that spouse bears the greater share of the financial risk
• c.Use the more aggressive profile because the household's horizon is long and the account is meant for growth
• d.Average the two risk scores and invest at the midpoint without any further discussion, since the result is mathematically neutral for both

The adviser's role is to surface the conflict, explain trade-offs, and reach and record a mutually accepted structure, which may include separate sleeves. Silently averaging the scores hides the disagreement. Deferring to the larger earner treats income as authority over risk preferences. Choosing the aggressive profile overrides one client's stated comfort level.Fiduciary duty; suitability of recommendations

A client's questionnaire rated her as having a high risk tolerance. In the last market selloff she sold all of her equity funds at the bottom. At the next meeting, what should the adviser do?

• a.Move the whole account to cash permanently, since the sale shows that she cannot bear any investment risk and will always sell at the bottom
• b.Rely on the signed questionnaire, because it is the client's own written statement of tolerance and one selloff proves little about it
• c.Make no change until the next annual questionnaire is completed, so that the profile stays consistent from year to year with her signed answers
• d.Treat the behavior as evidence of lower real tolerance, discuss it with her, and revise the risk profile and IPS if she agrees✓

Observed behavior under stress is often a better gauge of tolerance than a questionnaire, so the adviser should discuss the gap and update the documented profile. A signed form does not outrank what the client actually did. Permanent cash ignores her growth needs and capacity. Waiting a year leaves a recommendation based on a profile the adviser has reason to doubt.Fiduciary duty; know-your-client updating

A 58-year-old client has $4 million, a pension that covers all her living costs, and a 25-year horizon, but says a 10% decline would make her ill. How should the adviser set the allocation?

• a.Ask her to sign a waiver acknowledging the risk and then invest to her capacity regardless of what she says about her tolerance
• b.Base the allocation on capacity alone, since only capacity is measurable and feelings should not drive it
• c.Treat her low willingness as a binding limit, explain the long-term cost of lower growth, and document the choice✓
• d.Split the difference by averaging her capacity and her tolerance and setting the allocation midway between them

Capacity is what she can afford to lose; tolerance is what she is willing to endure. When tolerance is the lower of the two, it constrains the recommendation, and the adviser's job is to educate and record the trade-off. A waiver does not make an unsuitable fit suitable, and capacity alone ignores the client who will abandon a plan she cannot stomach. Averaging the two measures produces a portfolio that fits neither the client's circumstances nor her temperament.Risk capacity vs risk tolerance

A client has three goals: a house down payment in 3 years, a child's college in 12 years, and retirement in 27 years. How should the adviser set the investment approach?

• a.Give each goal its own horizon and risk level, with the 3-year money invested conservatively✓
• b.Use the 3-year horizon for all of the assets so that none of the money is ever exposed to a loss
• c.Use the 27-year retirement horizon for the whole portfolio, since the longest horizon gives the most growth potential
• d.Use the roughly 14-year average of the three horizons for one portfolio

Each goal has a different deadline and loss tolerance, so goals-based planning matches assets to each. Applying the longest horizon exposes the down-payment money to equity risk it cannot absorb. Applying the shortest starves the retirement goal of growth. Blending the horizons to a 14-year average fits none of the three goals.Goals-based planning; fiduciary duty

A client's assets are a $420,000 home, $310,000 in retirement accounts, $85,000 in a taxable account, $30,000 in vehicles and $25,000 in cash. Liabilities are a $290,000 mortgage, an $18,000 auto loan and $7,000 of credit card debt. What is the client's net worth?

• a.$870,000
• b.$555,000✓
• c.$580,000
• d.$135,000

Total assets are 420,000 + 310,000 + 85,000 + 30,000 + 25,000 = $870,000. Total liabilities are 290,000 + 18,000 + 7,000 = $315,000. Net worth is 870,000 - 315,000 = $555,000. The $580,000 figure subtracts only the mortgage, the $135,000 figure leaves out the home while still subtracting the mortgage, and $870,000 is total assets with no liabilities deducted.

A client earns $9,000 a month before tax and $7,000 after tax. Monthly obligations are a $1,980 mortgage payment including taxes and insurance, a $450 car loan, a $320 student loan and $150 in minimum credit card payments. What is the back-end debt-to-income ratio?

• a.32.2%✓
• b.10.2%
• c.41.4%
• d.22.0%

Total monthly debt payments are 1,980 + 450 + 320 + 150 = $2,900, and 2,900 / 9,000 gross income = 32.2%. The 22.0% figure is the front-end ratio using the housing payment alone. The 41.4% figure divides by take-home pay, which is not the convention. The 10.2% figure leaves out the housing payment.

A client with no current savings wants $300,000 in 15 years. She expects a 6% annual return and will deposit the same amount at the end of each year. About how much must she deposit annually?

• a.$12,159, which assumes deposits at the start of each year
• b.$20,000, which divides the goal by 15 and ignores growth
• c.$18,000, which is 6% of the goal
• d.$12,889, using the future value of an annuity factor✓

The future-value-of-annuity factor at 6% for 15 years is (1.06^15 - 1) / 0.06 = 23.276, so the deposit is 300,000 / 23.276 = about $12,889. Dividing $300,000 by 15 gives $20,000 and ignores growth. About $12,159 is the answer for deposits made at the start of each year. Multiplying $300,000 by 6% gives $18,000, a single year's interest, which is not a deposit schedule.

A retiree needs $72,000 a year in today's dollars. Social Security will cover $30,000 of that. Using a 4% initial withdrawal rate, what portfolio is needed, in today's dollars?

• a.$1,050,000✓
• b.$840,000
• c.$1,800,000
• d.$750,000

The portfolio must fund only the $42,000 gap (72,000 - 30,000), and 42,000 / 0.04 = $1,050,000. The $1,800,000 figure capitalizes the full $72,000 and ignores Social Security. The $840,000 figure divides the gap by 5% rather than 4%. The $750,000 figure capitalizes the Social Security income instead of the shortfall.

A child will start college in 10 years. The first year costs $50,000 in today's dollars, and college costs are expected to rise 5% a year. What will the first year cost then?

• a.About $77,566
• b.About $75,000
• c.About $52,500
• d.About $81,445✓

Compounding gives 50,000 x 1.05^10 = about $81,445. The $75,000 figure adds 5% simple interest for ten years. The $77,566 figure compounds for only nine years. The $52,500 figure applies a single year of inflation.

A client's essential living costs are $4,200 a month and her gross income is $5,600 a month. She wants an emergency fund equal to six months of essential costs and holds $15,000 in liquid savings. What is the shortfall?

• a.$10,200, the six-month target of $25,200 less savings✓
• b.$18,600, a target sized on gross income
• c.$12,600, a three-month cushion
• d.$25,200, the target with no credit for savings

The target is 6 x 4,200 = $25,200, and 25,200 - 15,000 = $10,200 is the shortfall. The $18,600 figure sizes the fund from gross income (6 x 5,600 = 33,600) rather than essential costs. The $25,200 figure ignores existing savings. The $12,600 figure is a three-month cushion.

A surgeon is shopping for disability income insurance. Which definition of total disability is most favorable to her?

• a.She is disabled when her earnings fall, with benefits paid in proportion to the lost income
• b.She is disabled only if she cannot work in any job suited to her education, training and experience
• c.She is disabled only when a covered injury causes a specific listed loss, such as the loss of sight in both eyes or of two limbs
• d.She is disabled if she cannot perform the duties of her own specialty, even if she could work in another job✓

An own-occupation definition pays when the insured cannot do her specialty, which suits a highly specialized professional. An any-occupation test is the narrowest because it denies benefits if any suitable job exists. A named-loss (presumptive) definition covers only listed losses, and a residual benefit pays for partial income loss rather than defining total disability.Disability income insurance contract terms

A client's family needs are $600,000 to replace income, $250,000 to retire the mortgage and $100,000 for education. She has $300,000 of existing life insurance and $150,000 of liquid assets earmarked for these needs. Under the needs approach, how much additional coverage is indicated?

• a.$950,000, which subtracts neither resource
• b.$500,000, which subtracts both resources✓
• c.$800,000, which subtracts only the liquid assets
• d.$650,000, which subtracts only the existing life insurance

Total needs are 600,000 + 250,000 + 100,000 = $950,000. Existing insurance and earmarked liquid assets together total $450,000, leaving $500,000. The $650,000 figure ignores the liquid assets, $800,000 ignores the existing policy, and $950,000 ignores both.Needs analysis approach to life insurance

A client carries $300,000 of auto liability, $500,000 of homeowners liability and a $2 million personal umbrella policy. She is held liable for $1.2 million after an auto accident. How is the loss most likely paid?

• a.The auto policy pays $300,000 and the umbrella policy pays the remaining $900,000✓
• b.The auto policy pays $300,000, the homeowners policy pays $500,000 and the umbrella pays $400,000
• c.The auto policy pays $300,000 and the client pays the remaining $900,000 personally
• d.The umbrella policy pays the full $1.2 million, and the auto policy pays nothing

An umbrella policy sits above the underlying liability limits, so the auto policy responds first and the umbrella covers the excess up to its limit. The umbrella does not displace the underlying policy. The homeowners liability coverage does not apply to an auto accident. The client is not left to pay the excess, since that is precisely the gap the umbrella is bought to fill.Personal liability coverage

A client quickly sold a stock that was up 12% to lock in the gain, but she keeps a stock that is down 30% because she will not sell until it gets back to even. Which behavior does this pattern best illustrate?

• a.The disposition effect, driven by loss aversion✓
• b.Overconfidence, the overrating of one's own skill
• c.Herd behavior, the imitation of other investors
• d.Recency bias, the overweighting of the latest results

Selling winners early and holding losers to avoid realizing a loss is the disposition effect, rooted in loss aversion. Herd behavior is following other investors, recency bias is overweighting the latest results, and overconfidence is overrating one's own skill or information, none of which is the point of this fact pattern. The adviser should refocus the client on each holding's future prospects, not its purchase price.

A client trades about 150 times a year, is certain she can pick winners, and has trailed a comparable index fund for five years after costs. Which bias is most evident, and what is the adviser's best response?

• a.Loss aversion; tell her to hold her losing positions longer
• b.Overconfidence; show her net-of-cost results against a benchmark and document a trading policy in the IPS✓
• c.Anchoring; ask her to base decisions on her original purchase prices
• d.Herd behavior; move her into whatever fund most clients hold

Frequent trading with a belief in superior skill despite poor net results is classic overconfidence, and a benchmark comparison plus a written trading policy is a constructive response. Loss aversion would show up as reluctance to sell losers, anchoring as fixation on a reference price, and herd behavior as imitation of others. Neither of the suggested responses addresses her actual problem.

Several of a client's coworkers recently made large gains in a single theme fund. The client now wants to move his entire retirement portfolio into it, saying he does not want to miss out. Which bias is driving the request?

• a.Loss aversion
• b.Herd behavior✓
• c.Mental accounting
• d.Anchoring

Following what peers are doing, and fearing exclusion from their gains, is herd behavior. Mental accounting is treating money differently by label, loss aversion is the stronger pain of losses than pleasure of gains, and anchoring is fixation on a reference number. The adviser should revisit his IPS, diversification and the risk of buying after a run-up.

A client keeps $80,000 in a savings account earning 1% that she calls her house fund, while carrying $20,000 of credit card debt at 22%. She refuses to touch the savings. Which concept explains her reluctance?

• a.Representativeness, which judges likelihood by resemblance to a typical case
• b.Availability bias, which overweights information that is easy to recall
• c.Mental accounting, which treats money as non-interchangeable because of its label✓
• d.Hindsight bias, which makes past outcomes seem to have been predictable

Treating the house fund as separate from the debt, although the money is fungible and the debt costs far more than the savings earn, is mental accounting. The other three biases are real but concern probability judgments and memory, not the labeling of money. The adviser should show the net cost of holding both.

Which of these IPS entries is a constraint rather than an objective?

• a.A goal of earning a 6% net annual return
• b.A $60,000 need for cash in two years to buy a home✓
• c.A limit on any one-year loss of 15%
• d.A goal of growing the portfolio to $1 million

Constraints are limits on how the portfolio may be run, such as liquidity needs, time horizon, taxes, legal factors and unique circumstances; the dated $60,000 cash need restricts the portfolio's liquidity. A return target and a dollar growth goal are return objectives, and a maximum acceptable loss expresses the risk objective.Investment policy statement; CFA Institute IPS framework

Which event most clearly calls for the adviser to revisit the client's IPS before the next scheduled annual review?

• a.The portfolio drifts 2 points from a target weight that has a 5-point rebalancing band
• b.The client receives a $900,000 inheritance that raises her net worth by about 60%✓
• c.A lower-cost share class of one of her funds becomes available
• d.The broad stock market falls 8% over a quarter, within the loss the IPS already allows

A large inheritance changes the client's capacity, objectives and liquidity, which are the premises of the IPS. A decline that stays within the stated risk limits, a cheaper share class, and drift inside the rebalancing band are all handled by the policy as written and do not change the client's circumstances.Investment policy statement review

A client calls to say a health problem means she will retire five years earlier than planned. What should the adviser do?

• a.Update the profile and IPS, reassess the allocation against the shorter horizon, and document the change and the reasoning✓
• b.Move the portfolio to cash immediately to protect the early retirement date, and revisit the plan only after she has stopped work
• c.Note the call and hold off on changes until the annual review, since the current allocation was already reviewed and approved by her
• d.Wait for the client to submit a formal written change request and a letter from her physician before touching the IPS

A change in horizon alters the premises of the recommendation, so the adviser should promptly update and document the profile and revisit the allocation. Waiting for the annual review or a formal written request leaves an unsuitable portfolio in place. Going entirely to cash on the adviser's own initiative ignores the client's growth needs and her say in the matter.Fiduciary duty; know-your-client updating

Two stocks each have a standard deviation of 20%. A portfolio is invested 50% in each, and the correlation between them is 0.0. The portfolio's standard deviation is closest to:

• a.10.0%
• b.28.3%
• c.14.1%✓
• d.20.0%

With zero correlation, variance = (0.5 x 20)^2 + (0.5 x 20)^2 = 100 + 100 = 200, so the standard deviation is the square root of 200, about 14.1%. The 20.0% figure would result only at a correlation of +1.0. The 10.0% figure halves the risk as if the stocks were perfectly offsetting. The 28.3% figure adds the variances without the weights.Modern portfolio theory

A portfolio of large-company stocks has a standard deviation of 15%. The adviser considers adding 10% in a commodity fund with a standard deviation of 25% and a correlation of 0.1 with the portfolio. Which statement is most accurate?

• a.Portfolio risk can fall only if the new fund's correlation is negative
• b.Portfolio risk can fall below 15%, because the correlation is far below +1.0✓
• c.Portfolio risk can fall only if the new fund's expected return is higher
• d.Portfolio risk must rise, because the new fund is riskier on its own

What matters is how an asset moves relative to the portfolio, not its stand-alone risk. With a 90/10 mix, variance = 0.81(225) + 0.01(625) + 2(0.9)(0.1)(0.1)(15)(25) = about 195.3, a standard deviation near 14.0%. A negative correlation is not required, and the effect on risk does not depend on expected return.Modern portfolio theory

The risk-free rate is 3%, and the market portfolio has an expected return of 10% and a standard deviation of 16%. An investor holds 50% in the risk-free asset and 50% in the market portfolio. What are the expected return and standard deviation of the combination?

• a.6.5% and 16.0%
• b.10.0% and 8.0%
• c.6.5% and 9.5%
• d.6.5% and 8.0%✓

Return = 0.5(3%) + 0.5(10%) = 6.5%. The risk-free asset has zero standard deviation and no correlation with the market, so risk = 0.5 x 16% = 8.0%. Leaving risk at 16% ignores the risk-free half, and 9.5% treats the 3% rate as if it were a standard deviation. Using the market's 10% return ignores the weighting.Capital market line; separation theorem

Four portfolios are listed as (expected return, standard deviation): A (8%, 10%), B (8%, 12%), C (10%, 12%), D (6%, 7%). Which portfolio is NOT efficient?

• a.Portfolio D
• b.Portfolio C
• c.Portfolio B✓
• d.Portfolio A

An efficient portfolio offers the highest return for its risk and the lowest risk for its return. B is dominated: A earns the same 8% with less risk, and C earns more at the same 12% risk. A has the lowest risk among the 8%-return choices, C has the highest return, and D has the lowest risk of all, so none of them can be beaten on both measures.Efficient frontier