NASAA Series 66 — All Questions

An adviser tells clients it is 'registered with and approved by the SEC,' implying the SEC has endorsed the quality of its services. This representation is:

• a.Accurate, because SEC registration means the Commission has reviewed and approved the adviser's qualifications and the quality of its services
• b.Permitted for SEC-registered advisers, because the Commission itself examines them, though not for advisers registered only with a state
• c.A prohibited misrepresentation — stating or implying that registration means the regulator approved or endorsed the adviser's abilities is misleading and unlawful✓
• d.Permitted, because Section 208(b) allows an adviser to say it is registered, and 'approved by' is another way of saying so

Section 208(a) makes it unlawful for a registered adviser to represent or imply that it has been sponsored, recommended or approved, or that its abilities or qualifications have been passed upon, by the United States or any agency or officer. Section 208(b) permits a true statement that the adviser is registered only if the effect of registration is not misrepresented, so 'approved by' goes beyond what it allows. Registration is not approval, for SEC registrants or anyone else, and the SEC's examinations do not amount to an endorsement.Investment Advisers Act of 1940 §208(a)-(b)

An adviser accepts a gift of significant value from a client and does not disclose it, later favoring that client's interests over others in allocation decisions. The failure here most directly implicates:

• a.The registration-by-coordination timing requirements that govern exactly when a federal securities offering may become effective at the state level
• b.The fiduciary duty to treat clients fairly and to disclose conflicts, since undisclosed benefits can bias allocation and breach loyalty✓
• c.The statutory exemption for isolated non-issuer transactions effected through a broker-dealer
• d.The recordkeeping rule's five-year document retention period for advisory books and records

Accepting undisclosed benefits that bias how the adviser allocates opportunities or trades among clients breaches the fiduciary duties of loyalty and fair dealing under IAA §206. Advisers must allocate fairly among clients and disclose conflicts that could influence their impartiality.

An agent, to boost year-end production numbers, recommends that several clients switch mutual-fund families, incurring new sales charges without a meaningful benefit. This practice is:

• a.Encouraged as sound practice, because moving assets among different fund families usefully diversifies the client's overall fund-family exposure and manager risk across the portfolio
• b.Permitted without concern, as long as the client signs a written switch-acknowledgment letter beforehand
• c.Improper switching (a form of churning) — recommending fund switches that generate charges without a legitimate benefit to the client is a prohibited practice✓
• d.Acceptable, because each newly recommended replacement fund is individually suitable for the client

Recommending mutual-fund switches that impose new sales charges without a genuine benefit to the client ('switching' or fund churning) is a prohibited practice under NASAA model rules. It exists to generate charges/commissions and breaches suitability and best-interest obligations.

Under the Uniform Securities Act and NASAA rules, an agent who effects transactions in an account based on inside information provided by a client who is a corporate director has:

• a.Has a valid and complete legal defense, because the agent did not personally originate the material nonpublic information but merely acted on a tip from a corporate insider
• b.Committed only a suitability violation and not any kind of fraud or insider-trading violation
• c.Violated insider-trading prohibitions — trading on material nonpublic information is unlawful regardless of its source✓
• d.Acted lawfully, because the information came directly from the client rather than from the firm itself

Trading on material nonpublic information is prohibited no matter how the information was obtained; the client-source does not create a defense. This violates the antifraud provisions (USA §101) and insider-trading law, and firms must maintain §204A controls to prevent it.

An adviser provides a client with a hypothetical performance illustration that omits the effect of fees and cherry-picks the best historical period. Under the marketing rule and antifraud provisions, this presentation is:

• a.Allowed for accredited investors and qualified purchasers without any further conditions, disclosures, or netting of fees, since sophisticated clients can evaluate the figures themselves
• b.Acceptable, provided the client is simply told that the figures shown are 'for illustration only'
• c.Permitted, because hypothetical performance illustrations are inherently understood to be disclaimed
• d.Misleading and prohibited — performance advertising must be fair and balanced, present net-of-fee results, and not cherry-pick favorable periods✓

IAA Rule 206(4)-1 (marketing rule) and the antifraud provisions require performance advertising to be fair and balanced, to show net-of-fee results, and to avoid misleading cherry-picking of favorable periods. Omitting fees and selecting only the best period is a prohibited, misleading presentation.

An investment adviser wants to keep a client's securities in the adviser's own name 'for convenience.' Holding client securities registered in the adviser's name is:

• a.Acceptable, so long as the adviser sends the client a detailed annual summary listing all of the securities being held registered in the adviser's own name for the client's convenience
• b.A custody arrangement raising misappropriation risk — client securities must be held by a qualified custodian, generally in the client's name, not the adviser's✓
• c.Permitted for any adviser that has filed a current Form ADV Part 2 with its regulator
• d.Encouraged, because registering the securities in the adviser's name streamlines trade settlement

Registering client securities in the adviser's own name is a dangerous form of custody that exposes clients to misappropriation and the adviser's creditors. IAA Rule 206(4)-2 and NASAA custody rules require a qualified custodian and generally that assets be held in the client's name with account statements sent to the client.

A client instructs an agent to buy a security, but the agent, believing a different security is better, buys the different security instead. Regardless of outcome, this is:

• a.Proper and defensible, because the agent used sound professional judgment to buy what it sincerely believed was the better security for the client's benefit and long-term returns
• b.An unauthorized transaction — substituting a different security than the client ordered is a prohibited practice absent discretionary authority✓
• c.Permitted, so long as the substitute security was actually suitable and happened to perform well afterward
• d.A merely ministerial substitution that falls entirely outside the reach of the securities laws

Buying a security other than the one the client specified, without discretionary authority, is an unauthorized transaction and a prohibited practice under NASAA model rules. The agent must follow the client's instructions; good intentions or favorable results do not cure the lack of authorization.

Under the Investment Advisers Act, an adviser that exercises discretion and directs client brokerage owes clients a duty of best execution, which means the adviser must:

• a.Seek the most favorable terms reasonably available under the circumstances, considering price, execution quality, and total cost — not merely the lowest commission✓
• b.Direct every single client trade to whichever broker-dealer happens to pay the adviser the most in soft-dollar credits and other back-end rebates, without regard to price
• c.Ignore execution quality entirely, because commissions are ultimately the client's own responsibility
• d.Always route the order to the broker offering the very lowest commission, regardless of all other factors

Best execution under IAA §206 requires the adviser to seek the most favorable overall terms reasonably available, weighing execution quality, price, speed, and total transaction cost — not simply the lowest headline commission. Directing trades for the adviser's own soft-dollar benefit outside the safe harbor breaches this duty.

An adviser's employee overhears material nonpublic information in an elevator and the firm has no written policies to prevent its misuse. The firm's failure violates:

• a.The exempt-transaction provisions covering isolated non-issuer trades effected through a broker
• b.The registration-by-qualification disclosure requirements applicable to new securities offerings
• c.The civil-liability and rescission provisions found in the Uniform Securities Act, which let a buyer recover the purchase price whenever a security was sold in violation of the Act
• d.Section 204A of the Investment Advisers Act, requiring written policies reasonably designed to prevent the misuse of material nonpublic information✓

IAA §204A requires advisers to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material nonpublic information (information barriers, restricted lists, training). A firm lacking such controls violates §204A even before any trade occurs.

An investment adviser that is registered in a state moves its principal office and place of business permanently to a different state. Under NASAA rules the adviser generally must:

• a.Register in the new state and comply with that state's requirements, since a place of business there triggers registration (subject to the federal/state division)✓
• b.Do nothing at all until its next scheduled annual registration renewal date comes around on the calendar, at which point it may simply file an address change with the old state
• c.Automatically become a federal covered adviser the moment it relocates across the state line
• d.Cancel all of its existing advisory contracts and start the client relationships over in the new state

Under USA §201 and NASAA rules, maintaining a place of business in a state generally triggers state registration for a state-covered adviser. Relocating the principal office requires registering in the new state and meeting its requirements; relocation alone does not convert a state adviser into a federal covered adviser.

A client asks an agent a question the agent cannot answer accurately. Under NASAA principles, the agent should:

• a.Answer from memory using what a colleague mentioned in passing, without verifying it, so the client gets a prompt reply
• b.Guess based on general market experience so as not to appear uninformed, since clients expect an agent to know the answer to any question about a product the agent sells
• c.Decline to answer beyond the agent's knowledge and obtain accurate information or escalate, rather than make an unsupported or misleading statement✓
• d.Give a confident-sounding answer on the spot to preserve the client's trust, and correct it later only if the client asks again

An agent must not make statements that cannot be supported, because an inaccurate or unsupported answer can be a misrepresentation or an omission of a material fact. The proper course is to say what is not known, then obtain accurate information or escalate to a supervisor or compliance. Repeating an unverified remark, guessing from experience, and sounding confident and fixing it only if asked again all risk giving the client a false impression.

An adviser wishes to use social media testimonials from happy clients in its advertising. Under the current SEC marketing rule this is:

• a.Permitted subject to conditions — disclosure of client status and any compensation, adviser oversight and adoption/entanglement responsibility, and a written agreement for compensated promoters✓
• b.Outside the marketing rule entirely, because posts on social-media platforms are third-party content that the rule never reaches
• c.Flatly and absolutely prohibited under all circumstances, exactly as testimonials once were before the rule changed
• d.Permitted only where the testimonials are completely unpaid and were posted spontaneously by total strangers

The amended marketing rule, Rule 206(4)-1, permits testimonials and endorsements, including on social media, if the adviser makes the required disclosures about client status and compensation, oversees the content, and has a written agreement with any compensated promoter; de minimis compensation of $1,000 or less in 12 months is excepted from some of those conditions. Content an adviser chooses to use in its advertising is covered by the rule, so it is not outside it. The former ban on testimonials no longer applies, and the rule does not limit endorsements to unpaid posts by strangers.17 CFR 275.206(4)-1(b)

An agent's broker-dealer is not registered in a state, but the agent solicits several retail residents there. Under the Uniform Securities Act, the agent's solicitation is:

• a.Lawful if the agent is registered in the state, because the agent's own registration is enough even when the employing firm is not registered there
• b.Lawful if the agent is registered with FINRA, since FINRA registration substitutes for state registration of the agent
• c.Permitted, because only the broker-dealer firm, and not the individual agent, must register in the state
• d.Unlawful — both the broker-dealer and the agent generally must be registered in the state to solicit its retail residents (absent an exemption)✓

Under Section 201 of the Uniform Securities Act, it is unlawful to transact business in the state as a broker-dealer or agent unless registered, and it is unlawful for a broker-dealer to employ an agent who is not registered. So both the firm and the agent generally must be registered there, absent an exemption. The agent's own registration cannot stand in for the firm's, FINRA registration does not replace state registration, and the individual agent has its own registration duty.Uniform Securities Act (1956) §201(a)-(b)

An investment adviser representative leaves a state-registered adviser. Under NASAA rules, the obligation to notify the Administrator of the IAR's termination falls on:

• a.The state securities Administrator itself, which is expected to track all such IAR terminations automatically without any filing from the firm or the representative
• b.Only the departing investment adviser representative, acting entirely on their own initiative
• c.The investment adviser (the employing firm), which must notify the Administrator when an IAR's employment ends✓
• d.No one at all, because an IAR's state registration simply lapses silently upon termination

Under USA §201 and NASAA rules, for state-registered advisers the FIRM (the investment adviser) is responsible for notifying the Administrator when an IAR begins or ends employment. This differs from the broker-dealer/agent context, where the agent and both firms notify. Registrations do not simply lapse without notice.

A broker-dealer wants to combine (net) a customer's purchase and sale in the same security to reduce the customer's commissions on a legitimate transaction. Compared with 'painting the tape,' this legitimate netting is:

• a.Identical in every meaningful respect to unlawful market manipulation such as painting the tape, and therefore flatly prohibited by the antifraud provisions of the Act
• b.Prohibited in all cases unless the state Administrator affirmatively approves the netting in advance
• c.Permissible when it reflects genuine transactions executed for a bona fide purpose, unlike manipulative matched orders designed to create false activity✓
• d.Allowed only for large institutional customers and never for ordinary retail customers of the firm

Genuine transactions executed for a bona fide economic purpose are lawful, even when they net a customer's activity. What the antifraud provisions (USA §101) prohibit is SHAM activity — matched or wash trades designed to create a false appearance of trading. Intent and economic reality distinguish the two.

An adviser discovers it made a trading error that harmed a client account. Consistent with fiduciary duty, the adviser should:

• a.Correct the error and absorb the loss, but disclose it to the client only if the client asks, since an error that has been corrected causes no continuing harm to the account
• b.Promptly correct the error and make the client whole, and disclose the error consistent with the duty of loyalty and care, rather than shifting the loss to the client✓
• c.Wait to see whether the market recovers, and correct the error only if the loss has not disappeared by the next quarterly statement
• d.Charge the full cost of correcting the error back to the client as an ordinary account expense item

An adviser's fiduciary duties of loyalty and care require it to correct a trading error promptly, to bear the resulting loss itself so the client is made whole, and to disclose the error. Correcting the error but staying silent unless asked fails the duty to disclose. Waiting for the market to recover leaves the client exposed to the loss and lets the adviser gamble with the client's account. Passing the correction cost to the client moves the loss to the party who did not cause it.

An agent recommends a security that is suitable for the client but fails to disclose a substantial, known risk specific to that issuer. The failure to disclose the material issuer-specific risk is:

• a.Permissible, provided the specific issuer risk is described somewhere within the many pages of the security's official statutory prospectus, whether or not the client ever reads it
• b.A material omission — suitability does not excuse omitting a material fact needed to keep statements from being misleading✓
• c.Fully excused, because the recommendation itself was determined to be suitable for the client overall
• d.Acceptable, because issuer-specific risk is assumed and understood by all investors as a matter of course

Even a suitable recommendation must be accompanied by disclosure of material facts; omitting a known, material issuer-specific risk violates the antifraud provisions (USA §101). Suitability and full disclosure are separate obligations — satisfying one does not excuse breaching the other.

An IAR tells a prospective client that the IAR 'personally guarantees' the advisory firm's recommendations will beat the market every year. This representation is:

• a.Valid, because the IAR's documented record of beating the market over many prior years supports the claim and makes it a fair statement of expectation
• b.Acceptable puffery, since regulators do not scrutinize general statements of confidence about performance that no reasonable client takes literally
• c.Permitted if the prospective client is an accredited investor who acknowledges the claim in writing
• d.A prohibited guarantee and misrepresentation — no adviser or IAR may guarantee performance or that recommendations will outperform✓

NASAA Model Rule 102(a)(4)-1(l) makes it an unethical practice to guarantee a client that a specific result will be achieved. Personally guaranteeing that recommendations will beat the market every year is such a guarantee and a material misrepresentation. A strong past record does not make a promise about the future true. A specific, personal guarantee is not puffery. Accredited-investor status and a written acknowledgment do not make a performance guarantee permissible.NASAA Model Rule 102(a)(4)-1(l)

Under the Uniform Securities Act, when an adviser deducts fees, exercises discretion, or otherwise touches client assets, the single most important protection for the client's assets against misappropriation is:

• a.Using a qualified custodian and delivering independent account statements to the client, so client assets are segregated and independently verifiable✓
• b.Requiring the client to sign a detailed written waiver that expressly gives up the standard qualified-custodian and independent-statement protections in exchange for lower fees
• c.Allowing the adviser to hold the client's assets in the adviser's own personal account for efficiency
• d.Relying solely and exclusively on the disclosures the adviser makes within its Form ADV filing

The custody framework (IAA Rule 206(4)-2 and NASAA custody rules) protects clients by requiring a qualified custodian and independent account statements, so client assets are segregated from the adviser and independently verifiable. Disclosure alone or client waivers do not substitute for these structural safeguards.

An adviser fails to update its Form ADV after a material change (for example, a new disciplinary event or a change in fee structure). Under the Investment Advisers Act, the adviser has:

• a.Complete discretion to decide entirely for itself whether any particular material change is even worth reporting to regulators, and may defer the amendment until it becomes convenient to file
• b.Violated its updating obligations — Form ADV must be amended promptly for material changes and updated at least annually, and clients must receive updated brochure information✓
• c.A duty to update the Form ADV only if and when a specific client actually requests the current information
• d.No obligation to update the Form ADV at all until the next scheduled five-year renewal cycle arrives

Under IAA Rule 204-1 and the brochure rule, an adviser must amend Form ADV promptly for material changes (such as disciplinary events or fee changes) and at least annually, and must deliver updated brochure information/material-change summaries to clients. Failing to update material information also implicates the antifraud provisions.

In building a client profile, which of the following is a NONFINANCIAL consideration?

• a.The client's overall net worth, computed as the sum of all assets minus all outstanding liabilities
• b.The client's total annual gross income from wages, self-employment, bonuses, and other recurring sources
• c.The client's prior investment experience and personal attitude toward taking risk✓
• d.The client's current federal marginal income-tax bracket and any applicable state income taxes

Nonfinancial factors such as age, investment experience, and attitude toward risk shape the profile alongside financial factors (income, net worth, tax bracket). Experience and risk attitude are nonfinancial. A complete suitability profile weighs both categories.

A client's time horizon is best defined as:

• a.The length of time until the client expects to need the invested funds✓
• b.The proportion of the portfolio that can be converted to cash quickly
• c.The total dollar amount of income the client earns each year before taxes
• d.The client's willingness to tolerate short-term declines in the market value of the portfolio

Time horizon is the period until the money is needed, distinct from risk tolerance (willingness to bear volatility) and liquidity (ease of converting to cash). A longer horizon generally supports more volatility and equity exposure.

A client has a high emotional willingness to take risk but only a small, fixed income and little savings. The adviser should recognize that the client's risk CAPACITY is:

• a.Low, because limited financial resources reduce the ability to absorb losses✓
• b.Irrelevant, because only the client's stated willingness to take risk should ever determine suitability
• c.Equal to the client's willingness, so an aggressive all-equity portfolio is clearly appropriate for this person
• d.Best measured solely by the client's self-reported comfort with market volatility on a questionnaire

Risk capacity (the financial ability to absorb losses) differs from risk tolerance (the emotional willingness). Suitability generally uses the lower of the two. Limited resources mean low capacity despite high willingness.

A client may face a large, unexpected medical bill within 60 days. In the investment policy, this is primarily a:

• a.Time-horizon consideration favoring long-dated government bonds
• b.Liquidity constraint favoring readily accessible, stable-value holdings✓
• c.Legal constraint requiring the account to be retitled into an irrevocable trust
• d.Tax consideration that makes municipal bonds the most appropriate holding for this client

A near-term cash obligation creates a liquidity constraint: the need to convert assets to cash without loss. It calls for stable, accessible holdings rather than volatile or illiquid ones.

An existing client retires and their income drops sharply. Under suitability obligations, the adviser should:

• a.Wait until the client submits a written request to change the strategy
• b.Keep the aggressive growth strategy unchanged, because the account was suitable when it was first opened
• c.Update the client profile and reassess whether the current allocation still fits✓
• d.Move the whole portfolio into the highest-yielding bonds at once, since retirees need income

A material change in circumstances such as retirement and sharply lower income calls for updating the client profile and reassessing whether the allocation still fits. Waiting for a written request leaves the adviser relying on an outdated profile. Suitability is not judged only at account opening, so keeping the growth strategy is wrong. Moving everything into the highest-yielding bonds swaps one unexamined strategy for another and ignores the client's risk capacity.

Compared with a retail customer, a large institutional investor such as a pension plan is generally presumed to:

• a.Have the same suitability protections as an unsophisticated first-time investor
• b.Have greater capacity to evaluate investment risk independently✓
• c.Require more detailed explanations of basic product features
• d.Be prohibited from investing in derivatives or privately placed securities

Institutional investors are presumed more sophisticated, which changes the nature of the suitability analysis. They are generally capable of independently assessing risk, unlike a typical retail customer.

A client states three goals: maximum current income, maximum growth, and complete safety of principal. The adviser should explain that:

• a.These objectives conflict and must be prioritized and traded off against one another✓
• b.Complete safety of principal is guaranteed by any diversified stock portfolio
• c.Maximum growth and maximum income are the same objective and can be treated as one goal
• d.All three objectives can be achieved at once by purchasing a single high-yield junk bond fund

Objectives such as safety, income, and growth involve trade-offs; no single portfolio maximizes all at once. The adviser must help the client prioritize among competing goals.

The primary purpose of documenting a client's financial profile before making recommendations is to:

• a.Establish a reasonable basis that recommendations fit the client's needs✓
• b.Enable the firm to charge the highest permitted performance-based fee
• c.Satisfy a marketing requirement so client testimonials can be used in advertising
• d.Shift responsibility for investment losses onto the client regardless of what was recommended

Profiling creates the reasonable-basis foundation for suitability, documenting that advice fits the client's objectives, risk tolerance, and constraints. It supports suitable recommendations, not fee maximization.

Why can a longer time horizon justify a higher allocation to equities?

• a.More time allows short-term volatility to be smoothed by long-run compounding✓
• b.A longer horizon converts capital gains into tax-free income
• c.Equities are legally required to be the majority holding in any account with a ten-year horizon
• d.A longer horizon eliminates market risk and guarantees equities will not lose value

Time diversification: a longer horizon lets compounding work and gives short-term volatility time to average out. It does not eliminate market risk, but it improves the case for equities.

For a 35-year-old saving for retirement in 30 years, an all-cash portfolio is risky primarily because:

• a.Money market funds may not be held longer than five years
• b.Cash instruments carry high default risk and are likely to lose their entire principal
• c.Cash produces large taxable capital gains each year
• d.Inflation erodes purchasing power over long horizons (purchasing-power risk)✓

Over a long horizon, purchasing-power (inflation) risk is the key danger of an all-cash portfolio: real returns can be negative. Growth assets are needed to outpace inflation.

Which objective is BEST served by a portfolio of dividend-paying stocks, high-quality bonds, and REITs?

• a.Elimination of interest-rate risk
• b.Current income✓
• c.Aggressive long-term capital appreciation
• d.Speculation

Dividend-paying stocks, high-quality bonds, and REITs all generate cash flow, making them well suited to a current-income objective. They are not primarily growth or speculative vehicles.

A risk-tolerance questionnaire labels a client 'aggressive,' but the client became distressed and sold during the last downturn. The adviser should:

• a.Assume the client's earlier panic was irrational and can be ignored
• b.Weigh the client's actual behavior, which suggests lower true risk tolerance✓
• c.Rely on the questionnaire score and raise the equity allocation to its maximum permitted level
• d.Disregard the client's behavior because a signed questionnaire overrides experience

Demonstrated behavior can reveal true risk tolerance better than a questionnaire. The adviser should reconcile stated and revealed tolerance, leaning toward the more conservative real-world evidence.

A client has a 2-year goal (a home down payment) and a 25-year goal (retirement). The MOST appropriate approach is to:

• a.Fund only the nearer goal now and postpone any retirement investing entirely until the down payment has been spent
• b.Match each goal to its own horizon: conservative assets for the near goal and growth assets for the far one✓
• c.Hold the down-payment money in growth stocks and the retirement money in cash, so the nearer goal earns the higher return
• d.Blend both goals into one 60% stock and 40% bond portfolio, since the two horizons average out to about 13 years

Goal-based planning matches each objective's assets to its own time horizon and liquidity needs: conservative assets for the 2-year down payment and growth-oriented assets for the 25-year retirement goal. Postponing retirement saving forfeits decades of compounding. Reversing the mix exposes the short-term money to market losses and starves the long-term goal of growth. Blending both goals into one portfolio on an averaged horizon fits neither goal.

Before implementing a long-term investment plan, a general financial-planning principle is that a client should first:

• a.Concentrate the portfolio in a single high-conviction stock
• b.Borrow on margin to invest more
• c.Establish an adequate emergency cash reserve✓
• d.Purchase the maximum permissible amount of variable annuities to shelter income

The financial-planning pyramid puts an emergency reserve (commonly three to six months of expenses) and debt management before long-term investing. A cushion prevents forced liquidation of investments.

A passive (indexing) investment approach is BEST described as:

• a.Frequently trading to exploit short-term mispricings
• b.Selecting undervalued stocks through fundamental analysis
• c.Rotating among sectors each quarter based on macroeconomic forecasts
• d.Seeking to match a benchmark index's return at low cost✓

Passive management replicates a benchmark index to match its return with low turnover and low cost. It contrasts with active security selection and market timing.

A critic of active management relying on the efficient market hypothesis would argue that:

• a.Markets are so inefficient that any manager can reliably earn large excess returns
• b.After fees, most active managers struggle to consistently beat their benchmark✓
• c.Active managers are guaranteed by regulation to outperform index funds
• d.Index funds may not be sold to retail investors because they underperform active strategies

The efficient market hypothesis holds that prices reflect available information, so after costs active managers rarely beat the index consistently. This argument supports low-cost indexing.

A value investing style focuses on:

• a.Companies with rapidly rising earnings trading at high price-to-earnings multiples
• b.A fixed replica of a broad market index
• c.Stocks trading below their intrinsic worth, often with low P/E or P/B ratios✓
• d.Securities chosen by their recent price momentum

Value investing seeks securities priced below intrinsic value, typically with low price-to-earnings or price-to-book ratios. It contrasts with growth investing, which pays up for expansion.

A growth investing style is characterized by:

• a.Buying stocks that trade at low price-to-earnings and price-to-book ratios compared with intrinsic value
• b.Buying the stocks that have fallen most in the past year, expecting them to revert to prior prices
• c.Emphasis on companies with above-average earnings growth, often reinvesting profits rather than paying dividends✓
• d.Emphasis on mature companies that pay high, stable dividends and offer modest earnings growth

Growth investing targets companies with above-average earnings growth, which often reinvest profits instead of paying dividends and trade at higher valuations. Buying on low price-to-earnings and price-to-book ratios is value investing. Buying recent losers expecting a rebound is contrarian investing. Favoring mature, high-dividend companies is an income approach.

Tactical asset allocation differs from strategic asset allocation because it:

• a.Sets long-term target weights from the client's risk tolerance and rebalances to them periodically
• b.Matches asset maturities to the dates of the client's known future liabilities
• c.Chooses individual securities within each asset class rather than choosing the asset-class weights themselves
• d.Makes shorter-term shifts away from target weights to exploit perceived opportunities✓

Tactical allocation makes shorter-term shifts away from the strategic target weights to exploit perceived opportunities, then typically returns to the targets. Setting long-term weights from risk tolerance and rebalancing to them describes strategic allocation. Matching maturities to known liabilities is a dedication or liability-driven approach. Choosing individual securities within asset classes is security selection, not asset allocation.

A buy-and-hold strategy's main advantages include:

• a.Generating large short-term gains taxed at favorable long-term rates
• b.Lower transaction costs and deferral of taxable capital gains✓
• c.Eliminating market and interest-rate risk because securities are never sold
• d.Guaranteeing outperformance of an actively traded portfolio

Buy-and-hold minimizes trading costs and defers capital-gains taxation while reducing timing errors. It does not eliminate market risk or guarantee outperformance.

A 'core-satellite' portfolio construction typically combines:

• a.A low-cost index 'core' with smaller active 'satellite' positions✓
• b.A large actively managed 'core' with smaller index funds added as the 'satellite' positions
• c.A 'core' of the investor's taxable holdings and 'satellite' accounts held in tax-deferred retirement plans
• d.Equal-weighted holdings in a few index funds and a few active funds, with no designated core position

Core-satellite pairs a low-cost, passive index core that supplies broad market exposure with smaller active satellite positions that aim to add return. Reversing the roles, with an active core and index satellites, gets the structure backward. Core and satellite are portfolio roles, not account types, so splitting taxable and tax-deferred accounts is asset location. Equal weights with no designated core is just a mixed portfolio.

A contrarian investor tends to:

• a.Always follow the prevailing market consensus and crowd sentiment
• b.Trade only in the direction of the strongest recent twelve-month price momentum
• c.Buy assets that are out of favor and sell those that are widely popular✓
• d.Hold a static index fund and never deviate from the benchmark's exact composition

Contrarian investing goes against prevailing sentiment, buying unpopular assets and selling popular ones, betting on mean reversion. It is the opposite of momentum following.

Studies of portfolio returns commonly conclude that the largest driver of a diversified portfolio's variability over time is:

• a.The security-selection decisions made within each asset class
• b.The brokerage firm selected to custody the assets
• c.The precise day and time at which each order is entered into the market
• d.The overall asset allocation among stocks, bonds, and cash✓

Research generally finds that asset-allocation policy, the mix of stocks, bonds, and cash, explains most of the variability of portfolio returns over time, more than security selection or market timing.

Combining two assets with a correlation coefficient of -1.0 would:

• a.Give no diversification benefit, because risk is just the weighted average of the two assets' risks
• b.Raise portfolio volatility above the weighted average of the two assets' standard deviations
• c.Allow risk to be reduced to zero in the right proportion, since the two assets move perfectly oppositely✓
• d.Cut risk by exactly half, since each asset's movements partly cancel the other's

A correlation of -1.0 means the assets move in exactly opposite directions, so some combination of weights can reduce portfolio standard deviation to zero. A weighted-average risk with no benefit describes a correlation of +1.0. No correlation can push portfolio volatility above the weighted average. The reduction is not fixed at half; it depends on the weights and can reach the full amount.

Two assets have a correlation coefficient of +1.0. Combining them in a portfolio will:

• a.Eliminate the unsystematic risk of the two individual securities
• b.Create a portfolio whose expected return far exceeds that of either asset on its own
• c.Reduce the portfolio's standard deviation below the weighted average of the two assets' deviations
• d.Provide no diversification benefit, since the assets move in perfect lockstep✓

Perfectly positively correlated (+1.0) assets move together, so combining them yields portfolio risk equal to the weighted average, producing no diversification benefit.

As more securities are added to a diversified stock portfolio, unsystematic risk:

• a.Declines with diminishing benefit, approaching the market's systematic risk✓
• b.Is unchanged, because diversification reduces only systematic risk and leaves company-specific risk alone
• c.Falls steadily until it reaches zero at about 30 securities
• d.Rises with each new security, since each adds its own business risk

Adding securities reduces unsystematic (diversifiable) risk with diminishing benefit, approaching the floor of systematic market risk, which cannot be diversified away. Diversification works on company-specific risk, not the reverse. Unsystematic risk does not hit zero at any fixed number of securities. It also does not rise as securities are added, because individual risks offset one another.

Adding international equities to a U.S.-only portfolio is primarily intended to:

• a.Convert the portfolio's dividends into completely tax-free income under current U.S. federal income-tax rules
• b.Improve diversification through exposure to markets that may not move in step with the U.S.✓
• c.Guarantee higher returns every single year because foreign markets always outperform the U.S. market over time
• d.Eliminate currency risk entirely and remove all exposure to foreign political and economic developments

International diversification adds assets with imperfect correlation to domestic markets, potentially improving the risk-return tradeoff. It also introduces currency and political risk.

Systematic rebalancing back to target weights tends to:

• a.Shift the entire portfolio into whichever asset class rose most last year
• b.Enforce selling relatively high and buying relatively low✓
• c.Guarantee no loss in any calendar quarter
• d.Increase portfolio risk by letting the best-performing asset class grow without limit

Rebalancing trims outperforming asset classes and adds to underperformers, imposing a buy-low/sell-high discipline and controlling the drift of portfolio risk away from targets.

Holding 15 different large-cap U.S. equity mutual funds that own broadly similar stocks is an example of:

• a.True diversification, since each fund has a different management company
• b.A hedge, because large-cap funds offset one another when the market falls
• c.Redundant overlap that adds cost without meaningfully improving diversification✓
• d.A core-satellite structure, with some funds serving as active satellites

Owning many funds that hold broadly similar large-cap stocks is redundant overlap: it adds cost and complexity without meaningfully improving diversification, because the holdings are highly correlated. Different managers do not make the holdings different. Large-cap funds fall together, so they do not hedge one another. A core-satellite structure needs a distinct index core and a small number of differentiated satellites, not 15 look-alike funds.

Portfolio X returns 8% with a standard deviation of 12%. Portfolio Y returns 8% with a standard deviation of 16%. A rational, risk-averse investor would say portfolio X:

• a.Is inferior to Y, because more standard deviation means better long-run outcomes
• b.Cannot be compared without their expense ratios
• c.Is identical to Y in every respect that matters to a risk-averse investor
• d.Dominates Y, since it offers the same return with less risk✓

With equal expected return, the lower-standard-deviation portfolio (X) dominates and lies closer to the efficient frontier. Risk-averse investors prefer less risk per unit of return.