CFP CFP Investment Planning: practice questions with answers

Question 1

Florian Albright is single, with 2026 taxable income of $150,000, and his MAGI is below the net investment income tax threshold. His state has no income tax. A municipal bond yields 3.6%. 2026 single brackets: 22% on $50,400 to $105,700; 24% on $105,700 to $201,775. What taxable yield on a corporate bond of similar quality and maturity would match the municipal bond's yield?

1. A 4.74%
2. B 4.46%
3. C 2.74%
4. D 4.62%

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Answer: A. Taxable-equivalent yield = tax-exempt yield / (1 - marginal tax rate)

Taxable income of $150,000 for a single filer falls in the 24% bracket ($105,700 to $201,775).

TEY = 3.6% / (1 - 0.24) = 3.6% / 0.76 = 4.74%

A corporate bond yielding more than 4.74% would give him a higher after-tax return, before considering differences in risk and liquidity.

Question 2

Which of the following is generally classified as a leading economic indicator?

1. A Industrial production
2. B The average prime rate charged by banks
3. C Building permits for new housing
4. D The average duration of unemployment

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Answer: C. The Conference Board groups indicators by timing:

- Leading (turn before the economy): building permits, stock prices, average weekly initial unemployment claims, average weekly manufacturing hours, new orders, the interest rate spread, consumer expectations, a leading credit index.
- Coincident (move with the economy): nonfarm payroll employment, personal income less transfer payments, industrial production, manufacturing and trade sales.
- Lagging (turn after the economy): average duration of unemployment, the average prime rate, the inventory-to-sales ratio, unit labor costs, commercial and industrial loans outstanding, consumer credit to personal income, CPI for services.

Question 3

Skerrymoor Logistics stock has a beta of 1.4. The risk-free rate is 3.5% and the expected market return is 9%. An analyst forecasts a 12% return on the stock over the coming year. Based on the security market line, which conclusion is correct?

1. A Required return 11.20%; the stock plots below the SML and appears overvalued
2. B Required return 11.20%; the stock plots above the SML and appears undervalued
3. C Required return 12.60%; the stock plots below the SML and appears overvalued
4. D Required return 7.70%; the stock plots above the SML and appears undervalued

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Answer: B. Security market line (CAPM): required return = risk-free rate + beta x (market return - risk-free rate)
= 3.5% + 1.4 x (9% - 3.5%) = 3.5% + 7.7% = 11.20%

The forecast return of 12% exceeds the 11.20% required for the stock's systematic risk, so the stock plots above the SML: it appears undervalued (expected alpha of about 0.8%) and is a buy candidate. A stock whose expected return is below its required return plots below the SML and appears overvalued.

Question 4

Dmitri Volkov is considering a corporate bond priced at $1,085 with a 6% semiannual coupon and 15 years to maturity. It is callable at par in 3 years, and market rates have fallen since it was issued. Which yield measure best reflects the return he can realistically expect?

1. A Yield to maturity, as it assumes the bond is held for 15 years
2. B Yield to call, as it is the lower yield and a call is likely
3. C Current yield, as it reflects the coupon relative to price
4. D The coupon rate, as the bond pays a fixed 6% coupon

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Answer: B. A premium bond callable at par will probably be called if rates stay below its coupon. Investors should look at the yield to worst, the lower of yield to call and yield to maturity. Here: YTM = about 5.18%, yield to call (3 years, $1,000 call price) = about 3.02%, current yield = $60 / $1,085 = 5.53%. Yield to call is the realistic measure.

Question 5

Sebastian Clarke owns 1,000 shares of a stock trading at $84. He buys 3-month puts with a $76 strike for $2.60 per share and sells 3-month calls with a $95 strike for $2.15 per share. Measured from today's $84 price and including the net option cost, what are his maximum gain and maximum loss per share at expiration?

1. A Maximum gain $11.00; maximum loss $8.00
2. B Maximum gain $10.55; maximum loss $8.45
3. C Maximum gain $11.45; maximum loss $7.55
4. D Maximum gain $10.55; maximum loss $7.55

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Answer: B. Net option cost = $2.60 paid - $2.15 received = $0.45 a share (a net debit).

- Maximum gain (stock at or above $95): $95 - $84 - $0.45 = $10.55
- Maximum loss (stock at or below $76): $84 - $76 + $0.45 = $8.45

A collar brackets the outcome between the put and call strikes, adjusted for the net premium.

Question 6

Leontyne Fairbairn holds 70% of her portfolio in US stocks. For the rest she prefers a high-yield (below investment grade) corporate bond fund to an intermediate Treasury fund, because it yields about 3 percentage points more. She wants this holding to cushion her portfolio in a stock market decline. Which statement is most accurate?

1. A High-yield bonds have longer durations than Treasuries, so their main risk is that rising rates will hurt them more.
2. B Default risk in a diversified high-yield fund is unsystematic, so it is diversified away and will not weaken the cushion.
3. C High-yield bond prices tend to move opposite to stock prices, so the fund will cushion her better than Treasuries.
4. D High-yield spreads tend to widen when stocks fall, so the fund is likely to lose value in the same downturns as her stocks.

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Answer: D. High-yield bond prices depend mainly on the issuer's ability to pay, which weakens in a recession, when stocks also fall. Credit spreads widen in those periods, so high-yield funds have historically fallen alongside stocks (their correlation with equities is much higher than that of Treasuries). The extra 3% yield is compensation for this largely systematic credit risk.

High-quality Treasuries have no default risk and have tended to gain in flights to quality, so they are the better cushion against an equity decline.