NASAA Series 66 — All Questions

Dollar-cost averaging involves:

• a.Investing a lump sum all at once at the market peak
• b.Selling fixed amounts each month
• c.Investing a fixed dollar amount at regular intervals regardless of price✓
• d.Timing purchases to buy only at market bottoms

Dollar-cost averaging invests a constant dollar amount at regular intervals, buying more shares when prices are low and fewer when high, lowering the average cost per share over time. It reduces the risk of a poorly timed lump-sum entry. It is a systematic, discipline-based approach.

Diversification across uncorrelated asset classes primarily reduces which type of risk?

• a.Interest-rate risk on all bonds
• b.Systematic (market) risk
• c.Unsystematic (company- or sector-specific) risk✓
• d.Inflation risk entirely

Diversification lowers unsystematic risk, the portion of risk unique to a company or sector, by spreading exposure. It cannot eliminate systematic risk that affects the entire market. Combining low-correlation assets improves the risk-return tradeoff.

A client contributes to a Roth IRA. Which statement is correct?

• a.Contributions are made with after-tax dollars, and qualified distributions are tax-free✓
• b.Earnings are taxed annually
• c.Contributions are tax-deductible and withdrawals are always taxed
• d.Required minimum distributions begin at age 59.5

Roth IRA contributions are made with after-tax dollars, so qualified distributions of both contributions and earnings are tax-free. There are no lifetime required minimum distributions for the original owner. This makes Roths attractive for investors expecting higher future tax rates.

A married couple wants to pass assets to heirs while minimizing estate tax and retaining some control. An appropriate estate-planning tool to discuss is:

• a.An irrevocable trust that removes assets from the taxable estate✓
• b.A variable-rate demand note
• c.A margin account
• d.A day-trading strategy

An irrevocable trust can remove assets from the grantor's taxable estate while providing for distribution according to the grantor's wishes. It is a common estate-planning vehicle for tax efficiency and control over succession. Margin accounts and trading strategies are unrelated to estate transfer.

A client asks about the tax treatment of qualified dividends. Qualified dividends are generally:

• a.Taxed as ordinary income at the highest rate
• b.Subject to payroll taxes
• c.Completely tax-free
• d.Taxed at preferential long-term capital gains rates✓

Qualified dividends meet holding-period and other requirements and are taxed at the lower long-term capital gains rates rather than as ordinary income. This favorable treatment enhances after-tax returns on eligible equity income. Nonqualified dividends are taxed as ordinary income.

When determining suitability, the FIRST and most fundamental step is to:

• a.Gather and understand the client's financial situation, objectives, risk tolerance, and time horizon✓
• b.Recommend the highest-commission product
• c.Buy whatever is trending in the market
• d.Place the client entirely in cash

Suitability begins with a thorough understanding of the client, including financial situation, goals, risk tolerance, time horizon, and constraints. Only after building this profile can appropriate recommendations follow. Skipping this step undermines the entire advisory process.

The present value of a future sum will be lower when:

• a.The discount rate is zero
• b.The discount rate is higher✓
• c.There is no interest
• d.The time period is very short

Present value falls as the discount rate rises, because future dollars are discounted more heavily. A higher rate or a longer horizon reduces present value. This time-value-of-money concept underlies bond pricing and retirement planning.

An investor wants exposure to a broad market index at low cost with high tax efficiency and intraday liquidity. Which vehicle is MOST appropriate?

• a.A single micro-cap stock
• b.A leveraged inverse ETN held long term
• c.A broad-market exchange-traded fund (ETF)✓
• d.A non-traded REIT

A broad-market ETF offers diversified index exposure, low expense ratios, intraday trading, and generally strong tax efficiency due to its structure. Leveraged or inverse products are unsuitable for long-term index exposure, and single stocks lack diversification. The ETF best matches the stated needs.

A client in the accumulation phase of a variable annuity is concerned about outliving assets in retirement. Annuitization with a life payout option primarily addresses:

• a.Reinvestment risk
• b.Currency risk
• c.Longevity risk✓
• d.Interest-rate risk

A life-contingent annuity payout provides income for as long as the annuitant lives, directly addressing longevity risk, the danger of outliving one's assets. It transfers that risk to the insurer. It does not specifically hedge interest-rate or currency risk.

An adviser notices a client has an unusually large, concentrated position in the client's employer stock. The primary concern the adviser should raise is:

• a.Concentration risk, since both the client's job income and portfolio depend on one company✓
• b.Long-term capital gains treatment
• c.The stock's beta is exactly 1.0
• d.The stock pays qualified dividends

A concentrated position in employer stock exposes the client to significant unsystematic risk, compounded because both employment income and investment value depend on the same company. Diversification would reduce this concentration risk. Tax features are secondary to the risk concern.

The alpha of a portfolio measures:

• a.The portfolio's total risk
• b.The dividend yield
• c.The excess return relative to what its beta would predict✓
• d.The correlation to the benchmark

Alpha represents the return earned above or below what the portfolio's market risk, or beta, would predict under a model such as CAPM. Positive alpha suggests value added by the manager. It is a common measure of active management skill.

A client withdraws funds from a traditional IRA before age 59.5 without qualifying for an exception. The tax consequence is generally:

• a.Capital gains tax at 15%, with no early withdrawal penalty
• b.Ordinary income tax plus a 10% early withdrawal penalty✓
• c.Ordinary income tax plus a 20% early withdrawal penalty
• d.A 10% penalty only, with no income tax on the amount withdrawn

A distribution from a traditional IRA before age 59 and a half is generally taxed as ordinary income, and Internal Revenue Code Section 72(t) adds a 10% additional tax unless an exception applies, such as certain medical costs or a first-home purchase within the limit. Withdrawals are not taxed at capital gains rates, the additional tax is 10% rather than 20%, and income tax is still due because the contributions were generally deductible.Internal Revenue Code Sec. 72(t)

Modern portfolio theory suggests that the efficient frontier represents portfolios that:

• a.Guarantee no losses
• b.Offer the highest expected return for a given level of risk✓
• c.Contain only one asset class
• d.Have the lowest possible return

The efficient frontier plots portfolios offering the maximum expected return for each level of risk, or the minimum risk for a given return. Rational investors select portfolios on this frontier. Combining assets with low correlation shifts the frontier favorably.

An adviser recommends tax-loss harvesting near year-end. The primary benefit is to:

• a.Avoid the wash-sale rule automatically, because the losses are realized in December rather than January
• b.Convert the client's short-term capital gains into long-term capital gains taxed at lower rates
• c.Realize losses that can offset capital gains and up to a limited amount of ordinary income✓
• d.Deduct an unlimited amount of capital losses against ordinary income, with no carryover of the excess

Tax-loss harvesting realizes capital losses that offset capital gains and then a limited amount of ordinary income each year, with any excess carried forward to later years. The annual limit on losses claimed against ordinary income is $3,000, or $1,500 for a married person filing separately. Harvesting does not exempt the client from the wash-sale rule, it does not change the holding period of any gain, and the deduction against ordinary income is capped rather than unlimited.IRS Topic No. 409, Capital Gains and Losses; IRC Sec. 1211(b)

A client has a short time horizon of one year for a down payment on a home. The MOST suitable investment is:

• a.A long-dated zero-coupon bond
• b.A short-term, high-quality money market instrument✓
• c.A concentrated growth stock
• d.A leveraged equity fund

For a short horizon and a near-term spending goal, capital preservation and liquidity dominate, making short-term, high-quality instruments most suitable. Volatile equities or long-duration bonds could lose value right when the funds are needed. Time horizon strongly shapes suitability.

Duration is used to estimate a bond's:

• a.Credit rating
• b.Coupon payment date
• c.Price sensitivity to changes in interest rates✓
• d.Callability

Duration measures the sensitivity of a bond's price to interest-rate changes; longer duration implies greater price movement for a given rate shift. It helps advisers manage interest-rate risk. It is distinct from credit quality or call features.

A client wants growth but panics and sells during every market decline. This behavioral tendency is best described as:

• a.Loss aversion driving poorly timed selling✓
• b.Rational rebalancing
• c.Tax-loss harvesting
• d.Strategic asset allocation

Loss aversion causes investors to feel losses more acutely than equivalent gains, prompting panic selling at market lows that locks in losses. Recognizing this behavioral bias helps the adviser coach the client and design a suitable, resilient plan. It is not a disciplined strategy.

A 529 plan is primarily used for:

• a.Short-term trading
• b.Estate liquidity
• c.Qualified education expenses with tax-advantaged growth✓
• d.Retirement income

A 529 plan offers tax-advantaged growth and tax-free withdrawals when used for qualified education expenses. It is a common tool in education funding within a financial plan. It is not designed for retirement income or trading.

When comparing two portfolios with the same return, the one with the LOWER standard deviation is generally considered:

• a.Certain to outperform the more volatile portfolio in each future year
• b.Riskier, because a low standard deviation signals larger hidden downside risk
• c.Less volatile and thus more attractive on a risk-adjusted basis✓
• d.Equivalent to the other portfolio, since equal returns mean the two carry equal risk

Standard deviation measures total volatility. For equal returns, the portfolio with the lower standard deviation delivered those returns with less risk, so it is more attractive on a risk-adjusted basis. Past volatility does not guarantee future outperformance, a lower standard deviation does not mean greater risk, and two portfolios with the same return can still differ widely in how much they fluctuate.

An investor is subject to the alternative minimum tax and holds private-activity municipal bonds. The adviser should note that interest on certain private-activity bonds may be:

• a.Always fully tax-free under all circumstances
• b.A preference item includable for AMT purposes✓
• c.Exempt from all federal reporting
• d.Taxed as a capital gain

Interest on certain private-activity municipal bonds is a tax-preference item that can be added back for alternative minimum tax purposes, reducing its benefit for AMT-affected clients. General obligation municipal interest is typically not an AMT preference. Tax status must be evaluated per client.

A client nearing retirement wants to gradually reduce portfolio risk. A glide-path approach would:

• a.Shift the allocation progressively toward more conservative assets as the target date approaches✓
• b.Keep the allocation permanently fixed
• c.Move fully into a single stock
• d.Increase equity exposure each year

A glide path gradually reduces equity exposure and increases conservative holdings as a target date, such as retirement, nears. This aligns risk with a shortening time horizon and rising need for capital preservation. Target-date funds commonly use this method.

A high-net-worth client asks how to reduce estate taxes through lifetime giving. The adviser should mention:

• a.That gifts always trigger immediate income tax for the recipient
• b.That the annual exclusion applies only to gifts made to a spouse or a child
• c.The annual gift tax exclusion, which allows tax-free gifts up to a set amount per recipient each year✓
• d.That the annual exclusion is a single limit per donor, shared by all of the donor's recipients

The annual gift tax exclusion allows a donor to give up to an indexed amount to each recipient every year without using any of the lifetime exemption or filing a taxable gift. Systematic gifting can reduce the taxable estate over time. The exclusion is per recipient, not a single limit per donor, it is not restricted to spouses and children, and recipients generally do not owe income tax on gifts.IRC Sec. 2503(b); IRS Gift Tax FAQ

An adviser evaluates a mutual fund's performance against a benchmark index. The value that shows how closely the fund tracks the benchmark is best captured by:

• a.The fund's sales load
• b.The fund's expense ratio alone
• c.The fund's turnover ratio
• d.R-squared and tracking error relative to the benchmark✓

R-squared indicates how much of a fund's movement is explained by the benchmark, and tracking error measures deviation from it. Together they show how closely the fund follows its index. Expense ratios and loads relate to cost, not tracking fidelity.

A client holds appreciated stock and wishes to donate to charity in a tax-efficient way. Donating the appreciated shares directly, rather than selling first, generally allows the client to:

• a.Avoid capital gains tax on the appreciation and potentially deduct the fair market value✓
• b.Convert the gift into ordinary income
• c.Pay double capital gains tax
• d.Eliminate the need for any records

Donating long-term appreciated securities directly to a qualified charity generally lets the donor avoid capital gains tax on the appreciation and claim a deduction for fair market value, subject to limits. Selling first would trigger capital gains. This is a common tax-efficient giving strategy.

An adviser must recommend a suitable rollover for a client leaving an employer with a 401(k). The option that generally preserves tax deferral without immediate taxation is:

• a.A direct rollover to a traditional IRA✓
• b.Withdrawing and spending the funds
• c.Taking a full cash distribution
• d.Converting to a Roth and ignoring the tax bill

A direct rollover from a 401(k) to a traditional IRA preserves tax deferral and avoids immediate taxation and withholding. A cash distribution triggers taxes and possible penalties. A Roth conversion is taxable, so the client must plan for that liability.

Common stock represents:

• a.A guaranteed dividend obligation
• b.A short-term money market instrument
• c.A creditor claim with fixed interest
• d.An ownership equity interest with voting rights and residual claims✓

Common stock is an equity ownership interest granting voting rights and a residual claim on assets and earnings after creditors and preferred holders. Dividends are not guaranteed. Shareholders participate in growth but bear the greatest risk in liquidation.

Preferred stock differs from common stock primarily because it:

• a.Has unlimited upside like a growth stock
• b.Always carries greater voting power
• c.Is a debt instrument with a maturity date
• d.Generally pays a fixed dividend and has priority over common in dividends and liquidation✓

Preferred stock typically pays a fixed dividend and ranks ahead of common stock for dividends and in liquidation, though usually without voting rights. It behaves partly like a fixed-income security due to its fixed payment. Its price is sensitive to interest rates.

A bond's price and prevailing interest rates generally have what relationship?

• a.They are unrelated
• b.They move in opposite directions✓
• c.They are always equal
• d.They move in the same direction

Bond prices and interest rates move inversely: when rates rise, existing bond prices fall, and when rates fall, prices rise. This reflects the fixed coupon becoming relatively less or more attractive. Longer maturities amplify this sensitivity.

A zero-coupon bond:

• a.Is issued at a discount and pays no periodic interest, maturing at face value✓
• b.Is always tax-free
• c.Pays semiannual interest at a high rate
• d.Has no interest-rate risk

A zero-coupon bond is sold at a discount to face value and pays all its return at maturity, with no periodic coupons. Its long effective duration makes it highly sensitive to interest-rate changes. Holders may owe tax annually on imputed interest despite receiving no cash.

An open-end investment company (mutual fund):

• a.Continuously issues and redeems shares at net asset value✓
• b.Pays fixed interest and repays principal at maturity
• c.Trades on an exchange at a premium or discount to NAV like a closed-end fund
• d.Has a fixed number of shares that never changes

An open-end investment company continuously offers new shares and stands ready to redeem outstanding shares at net asset value. The fixed share count and the exchange trading at a premium or discount describe a closed-end fund instead. A fund holds a portfolio of securities and is not a debt instrument that pays fixed interest and returns principal at maturity.Investment Company Act of 1940 Sec. 5(a)(1), 15 USC 80a-5(a)(1)

A closed-end fund's shares:

• a.Are continuously issued and redeemed by the fund itself
• b.Are always redeemed at net asset value
• c.Are priced once a day at the next-computed NAV
• d.Trade on an exchange and may sell at a premium or discount to NAV✓

A closed-end company is any management company that is not open-end, meaning it does not offer or have outstanding redeemable securities. It sells a fixed number of shares in an offering, and those shares then trade on an exchange or in the market, where supply and demand can push the price above or below net asset value. Continuous issuance and redemption by the fund itself is the open-end structure, not this one. Redemption at net asset value is also an open-end feature, because a closed-end fund does not buy its shares back on demand. Once-a-day pricing at the next-computed NAV applies to open-end fund purchases and redemptions, whereas closed-end shares are priced throughout the day like stocks.Investment Company Act of 1940 Section 5(a) (15 U.S.C. 80a-5(a))

A call option gives the holder the right to:

• a.Obligate the writer to buy shares
• b.Receive a fixed dividend
• c.Sell the underlying at the strike price
• d.Buy the underlying at the strike price before expiration✓

A call option grants the holder the right, but not the obligation, to buy the underlying security at the strike price before expiration. The buyer profits if the underlying rises above the strike plus premium. The writer is obligated to sell if assigned.

A put option is generally used by an investor who:

• a.Seeks unlimited upside from appreciation
• b.Wants to profit from or hedge against a decline in the underlying price✓
• c.Wants to guarantee dividend income
• d.Expects the underlying price to rise sharply

A put option gives the holder the right to sell the underlying at the strike price and gains value as the underlying falls. Investors buy puts to speculate on declines or to hedge existing long positions. It is a bearish or protective strategy.

A variable annuity's separate account value during the accumulation phase:

• a.Is guaranteed by the insurer at a fixed rate
• b.Cannot lose value
• c.Fluctuates with the performance of the underlying investment subaccounts✓
• d.Is insured by the FDIC

In a variable annuity, contributions are allocated to subaccounts whose value rises and falls with market performance, so the investor bears the investment risk. Unlike a fixed annuity, there is no guaranteed accumulation rate. It is a security because of this investment risk.

A fixed annuity is characterized by:

• a.FDIC insurance
• b.Investment risk borne entirely by the contract holder
• c.A guaranteed minimum interest rate and fixed payments backed by the insurer✓
• d.Values tied to equity subaccounts

A fixed annuity provides a guaranteed minimum interest rate and fixed payments, with the insurer bearing the investment risk from its general account. Because there is no investment risk to the holder, a fixed annuity is generally an insurance product, not a security. Its guarantees depend on the insurer's claims-paying ability.

A real estate investment trust (REIT) that qualifies for favorable tax treatment must generally:

• a.Distribute a large majority of its taxable income to shareholders✓
• b.Avoid paying any dividends
• c.Invest only in government bonds
• d.Retain all of its income

A REIT must distribute a large majority of its taxable income, generally at least 90 percent, to shareholders to qualify for pass-through tax treatment. This produces relatively high dividend income for investors. REITs provide real estate exposure without direct property ownership.

An investor seeking exposure to a diversified basket of bonds with professional management and daily liquidity would MOST likely choose:

• a.A single corporate bond
• b.A bond mutual fund or bond ETF✓
• c.A private equity fund
• d.A collectible

A bond mutual fund or bond ETF offers a diversified, professionally managed portfolio of fixed-income securities with ready liquidity. A single bond lacks diversification, and private equity and collectibles are illiquid and unrelated. Pooled vehicles suit investors wanting broad bond exposure.

Treasury securities are generally considered to have virtually no:

• a.Default (credit) risk, because they are backed by the U.S. government✓
• b.Interest-rate risk
• c.Reinvestment risk
• d.Inflation risk

U.S. Treasury securities carry essentially no default risk because they are backed by the full faith and credit of the federal government. However, they remain exposed to interest-rate, reinvestment, and inflation risks. Investors accept lower yields for this credit safety.

A convertible bond gives the holder:

• a.A guaranteed equity dividend
• b.The right to force the issuer into bankruptcy
• c.The option to convert the bond into a specified number of the issuer's common shares✓
• d.Immunity from interest-rate risk

A convertible bond can be exchanged for a set number of the issuer's common shares, letting the holder participate in equity upside while receiving interest. This feature typically allows a lower coupon than a comparable straight bond. It blends debt and equity characteristics.

An investor writes a covered call. This strategy:

• a.Is purely a bearish bet
• b.Requires no ownership of the underlying
• c.Generates premium income while capping upside on the underlying shares owned✓
• d.Has unlimited downside beyond a naked position

Writing a covered call means selling a call against shares already owned, collecting premium income in exchange for capping potential upside if the stock rises above the strike. Because the position is covered by owned shares, risk is limited compared with a naked call. It suits a neutral to mildly bullish outlook.

A unit investment trust (UIT):

• a.Continuously issues and redeems shares at net asset value like an open-end fund
• b.Is run by a board of directors and an adviser that trade the portfolio actively
• c.Holds a fixed portfolio of securities and has a set termination date✓
• d.Is a corporation whose shares trade on an exchange at a premium or discount

A unit investment trust is an investment company that buys a fixed portfolio of securities and sells redeemable units against it, with a stated termination date when the trust dissolves and returns proceeds to investors. It has no board of directors and does not trade actively, it does not keep issuing units like an open-end fund, and it is not a corporation with exchange-traded shares like a closed-end fund.Investment Company Act of 1940 Sec. 4(2), 15 USC 80a-4(2)

Compared with corporate bonds, municipal bonds of similar credit quality typically offer:

• a.No credit risk at all
• b.Lower nominal yields, offset by federal tax-exempt interest✓
• c.Higher nominal yields with taxable interest
• d.Guaranteed federal insurance

Municipal bonds usually carry lower nominal yields than comparable corporates because their interest is generally exempt from federal income tax, raising the after-tax yield for taxable investors. They still carry credit and interest-rate risk. Taxable-equivalent yield comparisons are essential.

An equity-indexed (fixed-indexed) annuity typically credits interest based on:

• a.A guaranteed fixed rate with no market link
• b.Direct ownership of index shares
• c.A formula tied to an equity index, subject to caps, participation rates, or floors✓
• d.The performance of a single stock chosen by the client

A fixed-indexed annuity credits interest based on the performance of an equity index, but returns are limited by caps, participation rates, and protected by floors. The client does not directly own index securities. These features make its risk and return profile complex and require careful suitability review.

High-yield (junk) bonds are characterized by:

• a.Government backing
• b.Guaranteed principal repayment
• c.Lower credit ratings, higher yields, and greater default risk✓
• d.Investment-grade ratings and low default risk

High-yield bonds carry below-investment-grade ratings and compensate investors with higher yields to offset elevated default risk. They are more sensitive to economic downturns and issuer credit deterioration. Suitability requires a client who can tolerate this credit risk.

A money market fund seeks to:

• a.Guarantee a fixed return above inflation
• b.Preserve capital and provide liquidity by investing in short-term, high-quality debt✓
• c.Maximize capital appreciation through equities
• d.Provide leveraged exposure to commodities

A money market fund invests in short-term, high-quality debt instruments aiming to preserve principal and provide liquidity with modest income. It is not designed for capital appreciation and is not federally guaranteed. It suits cash-management needs within a portfolio.

During a period of rising inflation, the Federal Reserve is MOST likely to:

• a.Raise interest rates to slow economic activity✓
• b.Take no action at all
• c.Cut interest rates to stimulate spending
• d.Guarantee bond prices

To combat rising inflation, the Federal Reserve typically tightens monetary policy by raising interest rates, which cools borrowing and spending. Higher rates tend to pressure bond and equity prices. This is a core macroeconomic relationship advisers must understand.

Gross domestic product (GDP) declining for two consecutive quarters is a common informal indicator of:

• a.A bull market
• b.Hyperinflation
• c.An economic expansion
• d.A recession✓

Two consecutive quarters of declining real GDP is a widely used informal signal of a recession, reflecting contracting economic output. Recessions typically bring rising unemployment and weaker corporate earnings. Advisers consider the business cycle when positioning portfolios.

The real rate of return is best described as:

• a.The return guaranteed by the government
• b.The nominal return before any adjustment
• c.The dividend yield only
• d.The nominal return adjusted for inflation✓

The real rate of return is the nominal return reduced by the inflation rate, reflecting the true increase in purchasing power. It matters because inflation erodes the value of investment gains. Advisers use it to set realistic long-term expectations.

A leading economic indicator is one that:

• a.Tends to change before the overall economy changes, helping to forecast direction✓
• b.Moves at the same time as the economy
• c.Has no predictive value
• d.Confirms trends after they have occurred

Leading indicators, such as building permits or stock prices, tend to shift ahead of the broader economy, offering forecasting value. Coincident indicators move with the economy, and lagging indicators confirm trends after the fact. Analysts use leading indicators to anticipate turning points.

If the yield curve is inverted, meaning short-term rates exceed long-term rates, this is often interpreted as:

• a.A potential signal of an approaching economic slowdown or recession✓
• b.Evidence of falling inflation only
• c.A guarantee of strong future growth
• d.Proof that bond prices cannot change

An inverted yield curve, where short-term yields exceed long-term yields, has historically been viewed as a possible warning of an economic slowdown or recession. It reflects expectations of future rate cuts amid weakening growth. Advisers monitor the curve as one of several signals, not a certainty.