Free Series 65 Practice Questions with Answers

Correct answer: D. The recommendation elevates the client's stated growth objective above her capacity to absorb loss and her need for diversification and reliable income, both of which the profile should have controlled for

A single stated objective ('aggressive growth') does not override the totality of the client's profile. Where an account is the client's sole source of living expenses with no other income, concentration risk and capital-preservation/income needs must weigh heavily; a 40% single-name position ignoring diversification and capacity is inconsistent with a holistic suitability analysis.

• A. A stated objective is not the controlling factor; it does not override the client's capacity for loss and income needs, so there is a real deficiency.
• B. The issue is a suitability and profile mismatch, not a supervisory signature or documentation defect.
• C. The problem is not that small-caps are unsuitable for all retirees; it is the mismatch between this concentrated position and this client's capacity and income needs.
• D. Concentrating 40% in one small-cap stock elevates the client's stated growth goal above her actual capacity to absorb losses, her need for diversification, and her reliance on the account for living expenses — all factors the profile should have weighed against the stated objective.

• Source: CFA Institute Standard III(C) Suitability
• Source: NASAA Model Rule 102(a)(4)-1 (Unethical Business Practices of Investment Advisers, IARs and Federal Covered Advisers)

Correct answer: C. Savings deposits and money market deposit accounts

M1 consists of the most liquid forms of money: currency, demand deposits, and traveler's checks. M2 is broader, adding near-money items such as savings deposits, money market deposit accounts, and small time deposits.

• A. Checking account (demand deposit) balances are part of M1, not something unique to M2.
• B. Currency in circulation is part of M1, not an M2-only component.
• C. Savings deposits and money market deposit accounts are 'near money' included in M2 but not in the narrower M1 measure, making this the correct answer.
• D. Traveler's checks are counted within M1, not exclusive to M2.

Correct answer: A. Trigger a two-year time-out on receiving compensation for advisory services to that government entity, because it exceeds the $350 de minimis threshold for contributions to a candidate the contributor may vote for

Pay-to-play rules (e.g., SEC Rule 206(4)-5 and parallel state provisions) impose a two-year time-out on compensated advisory business with a government entity when a covered associate makes a contribution to an official who can influence the selection of advisers for that entity, unless the contribution falls within a narrow de minimis exception: $350 per election for a candidate the contributor is entitled to vote for, or $150 per election if not entitled to vote. Here, the $500 contribution exceeds the applicable $350 threshold even though the representative can vote for the candidate, so the exception does not apply and the two-year time-out is triggered. The rule targets state and local as well as federal-adjacent offices with influence over public plan business, so option D is incorrect, and there is no 'permanent, lifetime, nationwide' bar — the time-out is two years and specific to that government entity.

• A. Correct. Because the representative is entitled to vote for the candidate, the de minimis threshold is $350; a $500 contribution exceeds it and triggers a two-year compensation time-out for that government entity.
• B. Being entitled to vote for the candidate raises the de minimis limit to $350, not an exemption for contributions of any amount; a $500 contribution still exceeds that threshold and triggers the time-out.
• C. The pay-to-play time-out is a two-year restriction tied to the specific government entity, not a permanent nationwide bar, and it does not automatically revoke the representative's registration.
• D. Pay-to-play rules apply to contributions to state and local officials who can influence government advisory business, including state office candidates; the rules are not limited to federal office.

Correct answer: A. $34,029

Present value = FV / (1 + r)^n = $50,000 / (1.08)^5 = $50,000 / 1.469328 = approximately $34,029. This is the lump sum that, growing at 8% compounded annually, reaches $50,000 in exactly 5 years.

• A. Correct. Present value = $50,000 ÷ (1.08)^5 ≈ $34,029, the amount that would grow to $50,000 in 5 years at 8% compounded annually.
• B. This doesn't match the present value calculation at 8% for 5 years; discounting $50,000 at those terms correctly yields approximately $34,029, not $37,908.
• C. This overstates the present value needed; it appears to use a lower discount rate or shorter period than specified, rather than the correct $34,029.
• D. This is a rounded guess that doesn't reflect actual discounting math; properly discounting $50,000 at 8% for 5 years gives about $34,029, not $40,000.

Correct answer: B. 5 years

Investment adviser books and records must generally be preserved for 5 years from the end of the fiscal year in which the last entry was made, with the first 2 years' records kept in an appropriate office of the adviser that is readily accessible. This is distinct from the retention periods that apply to some broker-dealer records under different rules.

• A. 3 years is not the standard adviser recordkeeping retention period.
• B. Correct — 5 years total, with the first 2 years readily accessible in an appropriate office.
• C. 6 years overstates the standard adviser recordkeeping requirement.
• D. 7 years overstates the standard adviser recordkeeping requirement.

Correct answer: A. $9.50

The sales charge percentage is defined as (POP minus NAV) divided by POP, so NAV = POP x (1 minus sales charge) = $10.00 x 0.95 = $9.50. Choice B results from incorrectly dividing POP by (1 + charge) instead of multiplying by (1 - charge), which applies the wrong base for how mutual fund sales charges are defined.

• A. NAV = POP × (1 − sales charge %) = $10.00 × 0.95 = $9.50, which is correct.
• B. This figure doesn't match applying a straightforward 5% deduction from the $10.00 POP.
• C. This would correspond to a smaller sales charge percentage than the 5% given, not the correct NAV here.
• D. This is above the POP itself, which is inconsistent with NAV being lower than POP once a sales charge is deducted.

Correct answer: D. No, the wash sale rule disallows the loss because the repurchase of a substantially identical security occurred within the 30-day window before or after the sale

The wash sale rule disallows a loss deduction if the taxpayer purchases the same or a substantially identical security within 30 days before or after the sale that generated the loss. December 15 to January 5 is only 21 days, well within the 30-day window, so the wash sale rule applies regardless of the calendar-year change. The disallowed loss is added to the cost basis of the newly acquired shares rather than being lost permanently.

• A. Incorrect. The wash sale window is a rolling 30-day period before and after the sale that ignores calendar-year boundaries.
• B. Incorrect. Losses in a taxable account are generally deductible against gains; the issue here is the wash sale timing, not a bar on deducting such losses.
• C. Incorrect. The wash sale rule is not limited to individual stocks; repurchasing the same or a substantially identical fund can trigger it, and the 30-day window is exactly what applies.
• D. Correct. Repurchasing the same fund within 30 days triggers the wash sale rule, disallowing the loss deduction (though basis is adjusted).

• Source: Internal Revenue Code Section 1091 (loss from wash sales of stock or securities)

Correct answer: B. Undisclosed compensation may mislead prospective clients and violate marketing conditions

Free services given for an endorsement are compensation. Testimonials and endorsements are permitted only with required disclosures, oversight and disqualification checks, and undisclosed compensation can mislead prospects.

• A. Free services and other non-cash benefits count as compensation and must be disclosed.
• B. Undisclosed compensation can mislead prospective clients and breaches the marketing rule's conditions.
• C. Testimonials are permitted when the rule's disclosure and oversight conditions are met.
• D. Advisers must oversee and monitor endorsements, including those from clients, when compensation is involved.

• Source: SEC Rule 206(4)-1 (investment adviser marketing)

Correct answer: B. Withdrawals are taxed as ordinary income, because neither the contributions nor the account's growth were previously taxed

A deductible traditional IRA contribution is made with pre-tax dollars, and the account grows tax-deferred. Because tax has never been paid on either the original contribution or the earnings, the entire withdrawal is taxed as ordinary income when distributed. Choice A is wrong because the contribution was never taxed. Choice C is wrong because IRA withdrawals do not receive preferential capital gains treatment regardless of what the account invested in. Choice D describes the tax treatment of a nondeductible (basis-carrying) contribution, not a fully deducted one.

• A. Because contributions were fully deductible, they were never taxed going in, so withdrawals cannot be tax-free.
• B. Since deductible contributions and all account growth have never been taxed, the entire withdrawal is taxed as ordinary income upon distribution — this is correct.
• C. Traditional IRA distributions are taxed as ordinary income, not preferential long-term capital gains rates, regardless of how gains accrued inside the account.
• D. This basis-recovery treatment would apply if contributions were nondeductible (after-tax); since these contributions were fully deductible, there is no tax-free basis to recover.

Correct answer: A. Security A has greater total risk, as measured by the dispersion of returns around the mean

Standard deviation measures total risk: the dispersion of an investment's actual returns around its average (mean) return, capturing both systematic and unsystematic risk. A higher standard deviation means returns have historically varied more widely, not that the investment is riskier in a market-correlation sense or that it earns more.

• A. Correct. Standard deviation is a total-risk measure of return dispersion around the mean.
• B. Incorrect. Systematic risk relative to the market is measured by beta, not standard deviation.
• C. Incorrect. Correlation (or R-squared) measures how closely two return series move together, not dispersion.
• D. Incorrect. Standard deviation says nothing about the level of expected return, only its variability.

Correct answer: D. Investors demand compensation for credit, liquidity and possibly other risk premiums.

A corporate spread over Treasuries compensates for default and downgrade risk, lower liquidity and other premiums. The promised yield can exceed realized return if losses occur.

• A. With identical coupons and maturities, interest-rate exposure is similar, and a fixed coupon does not lower it.
• B. Treasuries have the least credit risk, so the corporate bond's higher yield is not explained by Treasury default risk.
• C. Corporate coupons are taxable and Treasuries do not receive worse treatment, so taxes do not explain the higher yield.
• D. Correct: credit, liquidity and other risk premiums explain the higher promised yield.

Correct answer: D. Because risk tolerance (willingness to take risk) is low, the portfolio should generally be built more conservatively even though risk capacity (ability to take risk) is high

Risk capacity (financial ability to absorb loss) and risk tolerance (psychological willingness) can diverge. Best practice is generally to defer to the more conservative of the two, since a client who panics and sells during a downturn locks in losses regardless of how much capacity they theoretically had.

• A. Ignoring the questionnaire results and defaulting to an aggressive allocation disregards the client's genuine, strongly expressed unwillingness to bear volatility, which is a critical input alongside capacity.
• B. Risk capacity remains a relevant, independent consideration even after a questionnaire is completed; it doesn't become irrelevant just because tolerance has been measured.
• C. Mechanically averaging capacity and tolerance is not a principled approach; the two measures serve different purposes, and when they diverge the adviser should reason through which should predominate given the client's actual comfort and needs, not just split the difference.
• D. Correct. Even though her risk capacity is high, her low risk tolerance (emotional willingness to accept volatility) should generally lead to a more conservative portfolio than capacity alone would suggest, since taking on risk she can't emotionally tolerate risks panic selling and poor outcomes.

Correct answer: C. Stock market performance (e.g., a broad equity index)

Stock market performance is classified as a leading indicator because equity prices tend to reflect investor expectations about future corporate earnings and economic activity, moving ahead of actual changes in the broader economy. The unemployment rate and CPI are lagging indicators, they typically confirm a trend only after it has already occurred. Corporate profits are generally considered a coincident-to-lagging indicator, moving roughly with or slightly behind the business cycle.

• A. Wrong: the unemployment rate is a classic lagging indicator, employers adjust headcount only after economic conditions have already shifted.
• B. Wrong: corporate profits tend to move coincident with or slightly lag the business cycle rather than lead it, whether reported by listed companies or others.
• C. Correct: stock prices are forward-looking and are a standard component of the Conference Board's Leading Economic Index.
• D. Wrong: CPI is a lagging indicator, prices adjust after demand and cost pressures have already built up in the economy.

Correct answer: C. Disclose the capacity in which it is acting and obtain the client's consent prior to completion of each such transaction

Principal transactions create an inherent conflict of interest because the adviser is trading against the client from its own account. The adviser must disclose its capacity and obtain client consent on a transaction-by-transaction basis before completing each principal trade -- a one-time blanket consent does not satisfy this ongoing obligation.

• A. After-the-fact disclosure on a statement doesn't satisfy the fiduciary requirement, which calls for prior disclosure and consent before the trade is completed.
• B. A single blanket consent at account opening, with no further notice, does not satisfy the requirement, which applies on a transaction-by-transaction basis.
• C. The adviser must disclose it is acting as principal and obtain client consent before completing each such transaction, which is the actual legal requirement and the correct answer.
• D. Principal transactions are specifically restricted by disclosure-and-consent requirements for both state- and federally-registered advisers; they are not unrestricted.

• Source: Investment Advisers Act Section 206, 15 U.S.C. 80b-6 (prohibited transactions by investment advisers)

Correct answer: C. 1.50

Debt-to-equity ratio = Total Liabilities / Total Stockholders' Equity = $600,000 / $400,000 = 1.50, meaning the firm has $1.50 of debt for every $1.00 of equity.

• A. This inverts the ratio (equity ÷ liabilities = $400,000 ÷ $600,000 ≈ 0.67) rather than computing liabilities ÷ equity.
• B. This would only be true if liabilities equaled equity; here liabilities ($600,000) exceed equity ($400,000), so the ratio must be above 1.00.
• C. Correct. Debt-to-equity = total liabilities ÷ stockholders' equity = $600,000 ÷ $400,000 = 1.50.
• D. This overstates the ratio — it doesn't match dividing $600,000 by $400,000, which correctly yields 1.50, not 2.50.

Correct answer: C. Client-consent requirements for assignment and appropriate contract disclosures.

Advisory contracts must provide that they cannot be assigned without client consent, and a transfer of a controlling interest can be an assignment. The adviser should first address consent and disclosure.

• A. Clients must be given the opportunity to consent to an assignment, and ownership of the firm does not remove that requirement.
• B. Reporting obligations continue through a sale and cannot be suspended for integration.
• C. Correct: consent requirements and contract disclosures govern an assignment.
• D. Fiduciary duty runs to clients and continues through a change in control.

Correct answer: A. May engage in general solicitation and general advertising, but must take reasonable steps to verify that every purchaser is an accredited investor

Rule 506(c) permits general solicitation and advertising — prohibited under 506(b) — but requires the issuer to take reasonable steps to verify accredited investor status for every purchaser (rather than relying on self-certification) and does not permit any non-accredited investors. B describes a 506(b) feature; C is the opposite of the heightened verification burden; D is false — both exemptions allow unlimited offering amounts.

• A. A 506(c) offering permits general solicitation and advertising but requires the issuer to take reasonable steps to verify each purchaser is actually accredited (rather than merely self-certifying) — the correct distinguishing feature.
• B. The allowance for up to 35 non-accredited sophisticated investors applies to 506(b), not 506(c), which is limited to accredited investors regardless of any disclosure delivered before the sale.
• C. 506(c) has a heightened verification requirement; self-certification is the 506(b) approach, not 506(c).
• D. Neither 506(b) nor 506(c) caps the dollar amount raised; that isn't a distinguishing feature between them.

Correct answer: B. Passive management

Passive management seeks to match, not beat, a benchmark's return by holding substantially the same securities in the same weights, minimizing trading and cost. Active management, by contrast, involves security selection or timing decisions intended to outperform a benchmark.

• A. Active management involves security selection and trading aimed at beating a benchmark, the opposite of replicating an index with minimal turnover.
• B. Replicating an index's holdings and weights with minimal trading is the defining feature of passive (index) management.
• C. Tactical asset allocation involves deliberately shifting allocations away from a policy benchmark based on market views, not tracking an index.
• D. Market timing means actively shifting in and out of the market or asset classes based on forecasts, which contradicts the low-turnover, index-tracking approach described.

Correct answer: B. Disclosing to a client, prior to execution, that the adviser will act as principal in the transaction and obtaining the client's consent to the transaction

Principal transactions are not banned outright — they are permitted so long as the adviser discloses its capacity as principal and obtains client consent before completing the transaction, which is exactly what Choice B describes. That makes B the properly-handled, compliant practice, while unsuitable recommendations (A), unreasonable undisclosed fees (C), and unauthorized borrowing of client securities (D) are all classic examples of dishonest or unethical conduct under the Act.

• A. Recommending securities without regard to suitability is a textbook prohibited practice, so it doesn't answer this EXCEPT question.
• B. Acting as principal is permitted so long as the adviser discloses that capacity and obtains client consent before the trade completes — that's the compliant, non-prohibited way to do it, making this the correct answer.
• C. Charging an unreasonable, undisclosed fee is a prohibited practice under the Act's fee-disclosure requirements, so it isn't the exception.
• D. Borrowing securities from a client without written authorization is a classic prohibited practice, not an exception.

• Source: Investment Advisers Act Section 206, 15 U.S.C. 80b-6 (prohibited transactions by investment advisers)

Correct answer: A. The account has been open at least 5 years, and the owner is at least age 59½ (or death, disability, or first-time homebuyer exception applies)

A qualified Roth IRA distribution requires satisfying the 5-year holding period (measured from the first taxable year a contribution was made to any Roth IRA) AND a triggering event, most commonly reaching age 59½. Death, disability, and a limited first-time homebuyer exception also qualify. Missing either leg makes earnings potentially taxable (and possibly penalized).

• A. Correct. Both the 5-year rule and a triggering event (typically age 59½) must be met.
• B. Incorrect. The holding period (10 vs. 5 years) is wrong, and age 55 with separation from service is an employer-plan concept that does not make a Roth IRA distribution qualified.
• C. Incorrect. This drops the 5-year holding period requirement, which is mandatory even after age 59½.
• D. Incorrect. Age matters; without a qualifying event like reaching 59½, the distribution is not qualified even after 5 years.

Correct answer: A. Currency (exchange rate) risk

Because the bond pays interest and principal in euros, the dollar value of those cash flows depends on the euro/dollar exchange rate at the time of conversion. Even with stable credit quality and interest rates, currency fluctuations can significantly change the investor's realized return in dollar terms.

• A. Correct. Because the bond is euro-denominated, fluctuations in the euro/dollar exchange rate will affect the investor's dollar-denominated total return even if the bond's credit quality and interest rate environment are unchanged — this is currency (exchange rate) risk.
• B. Reinvestment risk concerns reinvesting coupon or principal payments at potentially lower interest rates; it's unrelated to the currency translation effect described here.
• C. Call risk relates to the issuer's ability to redeem the bond early; it's a separate risk from the currency translation effect described.
• D. Legislative risk concerns the impact of changing laws or tax treatment; it doesn't explain the currency-driven return variation described in the scenario.

Correct answer: D. All missed (arrearage) cumulative preferred dividends must be paid in full before any dividend can be paid to common stockholders

A defining feature of cumulative preferred stock is that any omitted dividends accumulate as arrearages that the company must pay in full before any dividend may be paid to common stockholders. This protects preferred holders' priority claim on distributions relative to common holders.

• A. Incorrect — common dividends cannot be paid while preferred arrearages remain outstanding, regardless of timing promises.
• B. Incorrect — the arrearage must be satisfied first; the board cannot pay common and preferred simultaneously while arrearages exist.
• C. Incorrect — cumulative preferred dividends do not expire or get forfeited; that is a feature of noncumulative preferred, where missed dividends are simply lost.
• D. Correct — cumulative preferred arrearages must be paid in full before common stockholders receive any dividend.

Correct answer: A. Liquidity need, which should be segregated into low-volatility, readily marketable assets

A known, near-term cash requirement is a liquidity constraint. The IPS should carve out sufficient liquid, low-volatility assets to meet it without forcing a sale of long-term holdings at an inopportune time, rather than altering the risk/return profile of the whole portfolio.

• A. Correct. A known cash need in six months is a liquidity need and should be segregated into low-volatility, readily marketable assets so the funds are available and stable when needed, regardless of the rest of the portfolio's risk profile.
• B. This conflates a specific short-term cash need with overall risk tolerance; the correct response is to carve out and de-risk that portion, not to lower the target return of the entire portfolio over any period.
• C. A scheduled surgery expense is a financial planning fact, not a legal constraint requiring documentation in a trust instrument.
• D. Nothing here requires tax-loss harvesting; a near-term cash need is addressed through asset allocation and liquidity planning, not a tax strategy.

Correct answer: A. Government spending on new highway construction

GDP measures the value of newly produced goods and services within a period. Government spending on new construction counts directly; resales of existing homes, secondary-market securities trades, and government transfer payments (like Social Security) do not represent new production and are excluded.

• A. Correct. Government spending on new highway construction represents current production of goods/services and is counted directly in GDP under the expenditure approach.
• B. Purchases of existing homes are transfers of existing assets, not new production, so they are excluded from GDP.
• C. Secondary market stock trades are financial transactions involving existing securities, not new production, and are excluded from GDP.
• D. Social Security payments are transfer payments, not payments for current production, so they are excluded from GDP.

Correct answer: D. Cherry-picking

Cherry-picking refers to the practice of allocating favorable trade executions to preferred or proprietary accounts after the fact, at the expense of other clients, and is a breach of fiduciary duty and an unethical business practice. Front-running involves trading ahead of a known, impending client order using knowledge of that order. Scalping involves an adviser recommending a security and then quickly selling its own position into the price movement its recommendation causes, without disclosure. Wash trading involves simultaneous buy/sell orders with no genuine change in beneficial ownership, typically to create a false appearance of activity or price. Each is a distinct violation with a distinct fact pattern.

• A. Front-running involves trading ahead of a known impending client order to profit from anticipated price movement, not steering favorable fills to a proprietary account after execution.
• B. Wash trading involves simultaneous buy and sell orders to create a false appearance of trading activity, not unfair allocation of genuine trade executions.
• C. Scalping involves an adviser trading ahead of a recommendation it is about to publish or make to profit from the resulting price move, which isn't what's described here.
• D. Correct. Selectively allocating the best-priced executions to a favored (here, proprietary) account after the fact, while giving clients the worse fills, is cherry-picking.