Investment Planning CFP® Exam Practice Questions

Ready to test your knowledge of investment planning? We've collected some CFP^® Exam practice questions on investment planning including insights into the correct answer to help you get ready. 

Investment Strategies

This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP® Exam postponement to September 2020.

Choose the option position that has the highest risk:

1. Purchasing a call that is out of the money.
2. Selling a naked call.
3. Selling a covered call.
4. Purchasing a call that is out of the money.

Correct answer: B. Selling a naked call.

Instructor insight:

A call option where the writer does not own the stock is called a naked option. As the price increases beyond the exercise (strike) price, the writer will need to go into the market to purchase the shares to deliver. The higher the price of the stock before the buyer exercises the option, the greater the writer's loss. The high level of risk associated with naked calls is the possibility that a stock could have significant gains and the seller would be forced to purchase upon exercise.

CFP® Exam insight:

Use an options matrix to map the market outlook of the options buyer and seller:

Characteristics, Uses, and Taxation of Investment Vehicles

This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP® Exam postponement to September 2020.

Identify the transaction that would not trigger a disallowed loss per the wash sale rules:

1. Purchase of a call option that can be exercised into the same stock that was sold for a loss.
2. An investor sells a bond at a loss, then purchases back the same exact bond.
3. The purchase of a bond that is convertible to a stock that was sold for a loss.
4. A AA-rated bond issue from a blue-chip company is sold at a loss and the investor purchases another AA-rated bond from a different blue-chip company.

Correct answer: D. A AA-rated bond issue from a blue-chip company is sold at a loss and the investor purchases another AA-rated bond from a different blue-chip company.

Instructor insight:

Unless the investor purchases back the same, exact bond or bond fund, it is difficult to violate the wash sale rule with fixed income. Since the bond is issued from different companies, loss associated with the blue-chip to blue-chip transaction would not be subject to the wash sale rules.

CFP® Exam insight:

It's all about time. The entire wash sale window encompasses a 61-day period. This includes a ‘look-back’ to 30 days before the trade date, the trade date, then 30 days after the trade date.

Types of Investment Risk

This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP® Exam postponement to September 2020.

A stock has an expected return in 2020 of 8% and a standard deviation of 17%. What is the probability that the actual return will be greater than 25%?

1. 0%
2. 13.5%
3. 16%
4. 34%

Correct answer: C. 16%

Instructor insight:

Plus or minus 1 standard deviation accounts for a probability of 68%, with each (outlier) tail amounting to 16%. In this case, you were asked for the probability of a return greater than 25%, which is the expected return (8%) plus 1 standard deviation (17%). The total probability of the return being greater than 25% is 16%.

CFP® Exam insight:

Write it out! When you encounter a problem in which you are provided with a mean return and standard deviation, then asked to solve for the probability of a certain return, draw a bell curve, split it down the middle, write the mean return at the midpoint, and work outward to identify the standard deviations. From there, apply the probabilities between the appropriate standard deviations to solve.

Take the next step: Watch our video, Understanding Standard Deviation to learn more. 

Bond and Stock Valuation Concepts

This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP® Exam postponement to September 2020.

Penelope purchased 500 shares of BIF for $10,000. BIF stock is currently paying $400 of annual dividend income to Penelope. Dividends are expected to grow 4% annually. BIF stock is currently priced at $56.

Identify Penelope’s required rate of return.

Instructor insight:

Use the required rate of return formula for dividend-paying securities to solve:

r = required rate of return
D₁ = Dividend (D₀ x (1 + g))
P = Price of the stock
g = fixed, stable growth rate

Dividends are expected to grow 4% annually. The dividend/share is ($400/500 shares). BIF stock is currently priced at $56.

r = 0.0549, or 5.49%

CFP® Exam insight:

Remember to advance the dividend that is currently paid by multiplying by (1 + g) with g expressed as a decimal.

D₁ = Dividend (D₀ x (1 + g))

Tax Efficient Investing 

Your client sells common stock in The Coca-Cola Company (KO) at a loss to offset gains in other parts of his portfolio. A wash sale may be triggered if he purchases which of the following?

1. PepsiCo, Inc. common stock (PEP)
2. The Coca-Cola Company bonds maturing in 2025
3. Put options on The Coca-Cola Company common stock
4. The Coca-Cola Company convertible bonds maturing in 2025

Correct answer: D. The Coca-Cola Company convertible bonds maturing in 2025

Instructor insight:

Because convertible bonds have the option to be exchanged for Coca-Cola Co common stock they would trigger a wash sale if your client purchases them. Normal Coca-Cola Co bonds do not have the option to be exchanged for common stock and are safe to purchase without triggering a wash sale as a result.

The put options on Coca-Cola Co common stock are also safe to purchase without triggering a wash sale because the client would be buying the right to sell additional shares of Coca-Cola Co rather than buy back the shares. On the other hand, purchasing call options would trigger a wash sale as your client would then have the option to buy back the Coca-Cola Co shares.

While PepsiCo is a direct competitor with a very similar business model it's still a separate entity, so purchasing PepsiCo common stock would not trigger a wash sale. In fact, you could recommend PepsiCo common stock as an alternative to your client in order to avoid a wash sale while still achieving the same investment objective.

Listen up: Jerry Mee, CFP®, CRC®, and BIF instructor, shares everything you need to know about wash sales in this episode of the BIF Bites podcast. 

Stock Options

This question is discussed in the February 2020 Practice Question Palooza question episode of the BIF Bites podcast.

Robert (your client) has a large paper profit in his Anglewood Corporation shares, currently at $35. He is happy with the stock, but realizes that a good thing cannot go on forever. If he is willing to sell at $40, what strategy could you recommend to him?

1. Buy $40 call options.
2. Sell $40 call options.
3. Buy $40 put options.
4. Sell $40 put options.

Correct answer: B. Sell $40 call options.

Instructor insight:

The client has not expressed any worry that the price of the stock is going to drop soon, and he wants to protect the profit he currently realizes. The narrative simply states he is willing to sell at $40. Because of that, buying a put strategy to protect the gain is probably not the best choice among those offered. Selling covered calls would generate additional funds.

Investment Suitability

This question originally appeared in the June 2020 episode of the BIF Bites podcast!

Your young neighbor Suzy recently received $500 for her birthday. She is an aggressive investor and wants to get every penny invested right away. She also wants to invest the $100 she makes each month from her paper route. She is very interested in investments and knows that she should invest in a well-diversified portfolio. However, she also knows that she is still learning and could use some guidance from experts with experience. What type of investment would you recommend as the best fit for Suzy?

1. Blue Chip Stocks
2. AAA rated Bonds
3. Low cost ETF
4. Diversified Mutual Fund

Correct answer: D. Diversified Mutual Fund

Instructor insight:

With only $500, it will not be possible to purchase a well-diversified portfolio of blue chip stocks due to the cost per individual share.

As a young aggressive investor, AAA Bonds would not be appropriate choice given the client's risk tolerance.

A low cost ETF could be a good recommendation except the investor wants to invest every last penny right away as well as set up a monthly investment plan. These are features that are not possible with ETFs.

A diversified mutual fund also gives Suzy the expertise she requires in the form of the mutual fund's management team.

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