ChFC Investment Planning Practice Questions
Question 1
A client's target allocation is 60% equities/40% bonds. After a strong equity market run, the portfolio has drifted to 75% equities/25% bonds, all held in a taxable brokerage account. The client wants to rebalance back to target. Which consideration is most important for the planner to address before executing the trades?
- A. Selling appreciated equity positions to rebalance will likely trigger realized capital gains, so the planner should evaluate tax-lot selection, use of new cash contributions, or available losses to offset the gains
- B. Rebalancing in a taxable account has no tax consequences since it merely restores the original allocation, so the planner can sell positions in any order without regard to cost basis or holding period, and no gain or loss would be reported to the IRS
- C. Rebalancing should be deferred until the market direction is clear, because adjusting the allocation after an equity run-up constitutes market timing that a fiduciary planner must avoid
- D. The client should first sell a portion of the bond position before making any equity trades, to raise cash for the rebalance
Show answer and explanation
Correct answer: A. Selling appreciated equity positions to rebalance will likely trigger realized capital gains, so the planner should evaluate tax-lot selection, use of new cash contributions, or available losses to offset the gains
In a taxable account, selling appreciated securities to rebalance realizes capital gains and creates a current tax liability — rebalancing is not a tax-free event just because the destination allocation matches the original policy. A prudent planner evaluates strategies to minimize the tax drag: selecting specific tax lots (e.g., higher-basis shares), directing new contributions or dividends toward the underweighted asset class instead of selling, or harvesting available losses elsewhere to offset the gains. This is a core distinction between rebalancing in taxable versus tax-deferred/qualified accounts, where such trades have no immediate tax impact.
- A. Correct. Trimming the overweighted equities will likely realize capital gains, so the planner should consider tax-lot selection (e.g., highest-cost lots), directing new contributions to underweight bonds, and harvesting available losses to offset the gain before trading.
- B. Selling appreciated shares in a taxable account to rebalance does have tax consequences — it realizes capital gains that must be reported, which weren't triggered simply by the market drifting the allocation.
- C. Periodic rebalancing to a stated target allocation is a routine, disciplined risk-management practice, not market timing; waiting for market direction to become clear would be the timing decision.
- D. Bonds are underweight, not overweight, so selling bonds moves the portfolio further from target and creates unnecessary transactions and tax consequences of its own.
Question 2
Using the Capital Asset Pricing Model (CAPM), a stock has a beta of 1.4, the risk-free rate is 4%, and the expected return on the market portfolio is 10%. What is the stock's required rate of return under CAPM?
- A. 8.4%
- B. 10.0%
- C. 12.4%
- D. 14.0%
Show answer and explanation
Correct answer: C. 12.4%
Under CAPM, required return = risk-free rate + beta × (expected market return − risk-free rate) = 4% + 1.4 × (10% − 4%) = 4% + 1.4 × 6% = 4% + 8.4% = 12.4%.
- A. This is beta times the market risk premium alone (1.4 × 6%), omitting the risk-free rate — a common calculation error.
- B. Equals the market return itself; ignores the stock's higher-than-market beta entirely.
- C. Correct — the full CAPM formula, including the risk-free rate addback, yields 12.4%.
- D. Overstates the result; does not correspond to any correct or partial application of the CAPM formula with these inputs.
Question 3
Using the Capital Asset Pricing Model (CAPM), if the risk-free rate is 3%, the expected market return is 9%, and a stock has a beta of 1.5, the stock's required rate of return is:
- A. 9%
- B. 12%
- C. 13.5%
- D. 15%
Show answer and explanation
Correct answer: B. 12%
CAPM: required return = risk-free rate + beta × (market return - risk-free rate) = 3% + 1.5 × (9% - 3%) = 3% + 1.5 × 6% = 3% + 9% = 12%.
- A. Incorrect — this is simply the market return, ignoring the stock's beta entirely.
- B. Correct — 3% + 1.5(9% - 3%) = 12%.
- C. Incorrect — this results from multiplying beta by the market return directly (1.5 × 9%) instead of by the risk premium.
- D. Incorrect — this does not correspond to a standard CAPM calculation error path using the given inputs; it overstates the required return.
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A client begins investing a fixed dollar amount into an equity mutual fund every month regardless of the share price. Which statement about this dollar-cost averaging strategy is most accurate?
- A. It guarantees a profit regardless of market direction
- B. It guarantees the investor will outperform a lump-sum investment
- C. It results in purchasing more shares when prices are low and fewer shares when prices are high, without guaranteeing a profit
- D. It eliminates market risk entirely
Show answer and explanation
Correct answer: C. It results in purchasing more shares when prices are low and fewer shares when prices are high, without guaranteeing a profit
Dollar-cost averaging (DCA) involves investing a fixed dollar amount at regular intervals, which mathematically results in buying more shares when prices are lower and fewer shares when prices are higher — potentially lowering the average cost per share over time. However, DCA does not guarantee a profit or protect against loss in a declining market, and it does not guarantee outperformance versus lump-sum investing (in fact, lump-sum investing historically outperforms DCA more often in rising markets, since more money is exposed to growth sooner).
- A. Dollar-cost averaging doesn't guarantee a profit; if the fund's price trends consistently downward, the investor can still lose money.
- B. DCA doesn't guarantee outperformance versus a lump sum; in a steadily rising market, lump-sum investing often outperforms DCA.
- C. Because the fixed dollar amount buys more shares when prices are low and fewer when prices are high, DCA can lower the average cost per share over time, but it never guarantees a profit or eliminates loss potential.
- D. DCA doesn't eliminate market risk; the investor remains fully exposed to the security's price fluctuations.