Try 10 focused Series 65 questions on Client Recommendations, with explanations, then continue with the full Securities Prep practice test.
Series 65 Client Recommendations questions help you isolate one part of the NASAA outline before returning to a mixed practice test. The questions below are original Securities Prep practice items aligned to this topic and are not copied from any exam sponsor.
| Item | Detail |
|---|---|
| Exam | NASAA Series 65 |
| Official topic | Topic III - Client Investment Recommendations and Strategies |
| Blueprint weighting | 30% |
| Questions on this page | 10 |
An investment adviser is asked to manage a nonprofit charity’s portfolio that includes donor-restricted endowment funds earmarked only for scholarships. Which action best matches the adviser’s responsibility when providing advice to this type of client?
Best answer: C
Explanation: Charities are governed by authorized fiduciaries (e.g., a board), and restricted-purpose assets must be managed consistent with those restrictions.
A charity is an institutional client that acts through authorized decision-makers (such as its board or investment committee). When assets are donor-restricted, the adviser must treat the restriction as a binding constraint and reflect it in the client’s objectives and investment policy so recommendations are consistent with the restricted purpose.
For a foundation or charity, the adviser’s “client” is the organization, which can only act through its authorized fiduciaries (typically a board of directors or an investment committee). A key governance step is confirming who has authority to hire the adviser, set objectives, and approve guidelines. In addition, donor-restricted or otherwise restricted-purpose funds impose real constraints (e.g., scholarships only), so the adviser should document and manage to those constraints in the IPS/mandate (including permitted investments, risk limits, liquidity needs, and time horizon). Recommending strategies that conflict with restrictions is inconsistent with acting in the client’s best interest and can create compliance and fiduciary issues. The closest trap is treating a charity like an individual retail client rather than an institution with formal governance and purpose limits.
A client names two primary beneficiaries on her traditional IRA: her son Alex (50%) and her daughter Brooke (50%). On the custodian’s form, she elects “per stirpes.” Alex dies before the client, leaving two children. The client later dies and Brooke is still living.
Which distribution description is correct?
Best answer: A
Explanation: With a per stirpes election, a deceased beneficiary’s share generally passes to that beneficiary’s descendants by family branch.
“Per stirpes” means distributions follow family branches if a named beneficiary has predeceased the account owner. Here, Alex’s 50% does not disappear; it is redirected to Alex’s descendants. Brooke’s 50% remains unchanged because she is living at the owner’s death.
Beneficiary designations control who receives assets in accounts like IRAs, and the “per stirpes” election is used to address what happens if a named beneficiary dies before the account owner. Per stirpes generally keeps the intended split by branch: each named beneficiary’s share stays allocated to that beneficiary’s family line.
Applied here:
A common pitfall is assuming that simply listing heirs automatically covers a predeceased beneficiary; without a per stirpes election (or clearly drafted contingent beneficiaries), the result can shift to surviving named beneficiaries or to the default terms of the account agreement.
An IAR tells a client she can fill the client’s bond purchase two ways: (1) route the order to an unaffiliated broker as an agency trade for a stated commission, or (2) have the firm’s affiliated broker-dealer sell a similar bond out of its own inventory immediately as a principal trade, with the broker-dealer “building in” its compensation to the price.
When evaluating the principal-trade approach, what is the primary tradeoff the client should understand?
Best answer: A
Explanation: In a principal trade, the dealer’s compensation is embedded in the price, creating a conflict and potential for an inferior execution price versus an agency commission.
A principal trade means the dealer is the counterparty and is compensated through a markup/markdown embedded in the execution price. That compensation structure creates a conflict of interest and makes the key tradeoff whether the client is receiving a fair price and best execution compared with an agency trade with an explicit commission.
The core distinction is who is on the other side of the trade and how compensation is earned. In an agency trade, the broker acts as an intermediary and typically earns an explicit commission while seeking best execution in the market. In a principal trade, the broker-dealer sells from (or buys into) its own inventory and earns compensation through the spread/markup/markdown embedded in the price.
For the client, the primary tradeoff in the principal approach is potential pricing disadvantage driven by the dealer’s economic incentive (a conflict): the dealer benefits from selling at a higher price (or buying at a lower price). The key question becomes whether the client receives a fair price and best execution, with appropriate disclosure and consent when required.
Other considerations may exist, but they are generally secondary to the pricing/conflict issue in this scenario.
An investor buys a mutual fund at an NAV of $100 per share. Over the next 6 months, the fund pays $2 per share in distributions (taken in cash), and the investor then sells at an NAV of $104. Which statement is most accurate about the investor’s holding period return (HPR) and annualized (effective) return?
Best answer: C
Explanation: Total return is \((104-100+2)/100=6\%\) for 6 months, and annualizing effectively gives \((1.06)^2-1\approx12.36\%\).
Holding period return includes both price change and cash distributions, divided by the beginning value. Here, the investor earned $4 of price appreciation plus $2 of distributions on a $100 starting value for a 6% HPR. The annualized effective return compounds the 6-month total return over two 6-month periods.
Holding period return (HPR) measures the total percentage gain over the actual holding period, including both income (distributions/interest/dividends) and price change:
\[ \begin{aligned} \text{HPR} &= \frac{\text{Ending value} - \text{Beginning value} + \text{Income}}{\text{Beginning value}} \\ &= \frac{104 - 100 + 2}{100} = 0.06 = 6\% \end{aligned} \]To annualize an effective (compounded) return, scale the holding-period growth factor to a one-year period. Since 6 months is 0.5 years:
\[ \text{Annualized effective} = (1+0.06)^{1/0.5}-1 = (1.06)^2-1 \approx 12.36\% \]A common mistake is to annualize by simply multiplying the 6-month return by 2, which produces a simple (non-compounded) rate.
A client in a high federal income-tax bracket needs approximately $60,000 in cash within the next two weeks for a home down payment. In the client’s taxable brokerage account, the adviser can sell either (1) shares of Stock A with a $18,000 unrealized gain held for 8 months or (2) shares of Stock B with a $18,000 unrealized gain held for 2 years; the client views the positions as equally attractive going forward. The client wants to minimize the tax impact of raising the cash and prefers to make only one sale. Which recommendation best satisfies the client’s constraints?
Best answer: A
Explanation: Selling the 2-year holding produces long-term capital gain treatment, while selling the 8-month holding would generally be taxed as short-term (ordinary income) gain.
The key distinction is that short-term capital gains (generally positions held 1 year or less) are taxed like ordinary income, while long-term capital gains receive preferential tax rates. Because the client must raise cash now and wants to minimize taxes, selling the position held for 2 years best meets the constraints.
When an investor sells a security at a profit in a taxable account, the gain is a capital gain, but the holding period determines how it is taxed. Short-term capital gains (typically for positions held 1 year or less) are taxed at ordinary income rates, which is especially costly for a high-bracket client. Long-term capital gains (typically for positions held more than 1 year) are taxed at lower, preferential rates. Here, both sale choices raise the needed cash and realize the same dollar gain, so the tax-efficient decision is to sell the security with the long-term holding period. A common takeaway is to prioritize realizing long-term gains (or harvesting losses) when a client is trying to reduce current tax drag.
A client asks about liability differences between investing in a general partnership (GP) and a limited partnership (LP). A partnership has one general partner and one limited partner (who does not participate in management). The partnership is sued and loses a judgment for $900,000. Partnership assets available to satisfy the judgment total $650,000.
Which statement is most accurate about who can bind the partnership and the potential additional personal liability?
Best answer: B
Explanation: The general partner has binding authority and unlimited liability, including the $900,000 − $650,000 = $250,000 shortfall.
In a limited partnership, the general partner manages the business and can bind the partnership, while limited partners are typically passive and cannot. General partners have unlimited personal liability for partnership obligations, so they can be pursued for any unpaid amount after partnership assets are applied. Here, the unpaid shortfall is $250,000.
The key distinction is management (and binding authority) and liability exposure. A general partner in either a GP or an LP can act for the business and bind the partnership (e.g., entering contracts). Limited partners are generally passive investors; if they do not participate in management, they typically cannot bind the partnership and their loss is generally limited to their investment.
When a partnership debt exceeds partnership assets, the remaining amount can be collected from the general partner(s). Here the shortfall is:
\[ \begin{aligned} \text{Judgment} - \text{Partnership assets} &= 900{,}000 - 650{,}000 \\ &= 250{,}000 \end{aligned} \]That $250,000 is the additional amount for which the general partner may be personally liable; the limited partner is not personally liable for it under the stated facts.
A client bought 100 shares of a stock at $100 per share and sold all shares 6 months later at $108 per share. During the holding period, the client received $2 per share in cash dividends (assume dividends are part of total return).
If the adviser wants to compare this performance to a 1-year return, what annualized return is most likely appropriate to report (geometric annualization)?
Best answer: D
Explanation: The 6-month holding period return is 10%, so the annualized (compounded) return is \((1.10)^2-1\approx 21%\).
The holding period return includes both price change and dividends: \((108+2-100)/100=10%\) over 6 months. To express that return on a 1-year basis using geometric annualization, compound it for two 6-month periods: \((1.10)^2-1\approx 21%\).
Holding period return (HPR) measures total return over the actual time held, including income. Here, total gain per share is $8 (price) + $2 (dividend) = $10 on a $100 beginning value, so the 6-month HPR is 10%.
To compare to a 1-year return, use geometric (compounded) annualization:
\[ \begin{aligned} \text{HPR} &= \frac{108+2-100}{100}=0.10\\ \text{Annualized} &= (1+\text{HPR})^{12/6}-1\\ &= 1.10^2-1\\ &= 0.21\;\text{or }21\% \end{aligned} \]A common mistake is using simple scaling (multiplying by 2), which ignores compounding.
An IAR at a state-registered RIA is onboarding a new retail client at an independent custodian. The client’s account is currently set up as a cash account. During the intake call, the client asks the adviser to “short 1,000 shares” of a volatile stock as soon as the account is funded.
What is the adviser’s best next step?
Best answer: B
Explanation: A short sale requires a margin arrangement and risk disclosures at the custodian before any trade is placed.
Short sales generally require a margin account because the shares must be borrowed and the position can generate margin calls. Since the client is in a cash account, the adviser should first ensure the account is properly approved and documented for margin/short selling at the custodian, with appropriate risk disclosures delivered before trading.
Short selling is typically done in a margin account because the broker-custodian must be able to borrow and deliver the shares, hold required collateral, and issue margin calls if the position moves against the client. In an advisory workflow, the adviser should not proceed from a cash account straight to placing a short sale. The appropriate next step is to have the client establish margin/short-sale capability with the custodian (where the credit and borrowing mechanics occur) and receive/acknowledge the required margin and short-sale risk disclosures before any order is entered. Key suitability points the adviser should cover include potentially unlimited losses, forced buy-ins, and margin calls/liquidation risk. The trade itself comes only after the account type and documentation support the requested strategy.
An investment adviser representative is meeting with an ERISA plan’s investment committee. The committee shares the following excerpt from its Investment Policy Statement (IPS).
Exhibit: IPS excerpt (partial)
Based on the exhibit, which statement best describes the purpose of the IPS for the committee?
Best answer: B
Explanation: The excerpt sets objectives, constraints, benchmarks, and review/rebalancing rules that fiduciaries can use to govern and evaluate ongoing management.
An IPS is a governance document that translates a client’s objectives and constraints into practical guidelines for portfolio construction, rebalancing, and performance evaluation. The exhibit shows an objective, target allocation, constraints, a benchmark, and a scheduled review process—elements used to monitor whether management remains consistent with the agreed policy.
The core purpose of an IPS is to provide a written framework for disciplined decision-making and oversight. For an ERISA plan’s investment committee, that framework supports fiduciary governance by documenting how the portfolio should be managed (objectives, risk posture, constraints, and target allocation) and how it will be monitored (benchmarks, rebalancing triggers, and periodic reviews). The exhibit’s rebalancing band and quarterly review schedule are classic monitoring tools, while the benchmark enables performance and “style drift” assessment relative to the stated policy. The key takeaway is that an IPS guides and measures process and consistency; it does not promise outcomes.
Which statement best describes a practical limitation of mean-variance optimization (Modern Portfolio Theory) when building an “optimal” portfolio?
Best answer: D
Explanation: Mean-variance optimization can be extremely sensitive to estimated expected returns, variances, and correlations, so minor estimation errors may meaningfully change the “optimal” mix.
Mean-variance optimization depends on forward-looking inputs—expected returns, variances, and correlations—that must be estimated. Because those estimates are uncertain and can shift over time, the calculated “optimal” portfolio can change a lot even when the true opportunity set has not meaningfully changed. This sensitivity is a core real-world limitation of the model.
Mean-variance optimization (the classic MPT framework) finds portfolio weights that maximize expected return for a given level of variance (or minimize variance for a given expected return). In practice, the model’s output is only as good as its inputs—especially expected returns, but also variances and correlations/covariances.
Because these inputs are estimated from historical data or forecasts, they are noisy and unstable. A small change in an assumed return or correlation can materially move the efficient frontier and produce very different “optimal” weights, sometimes leading to unintuitive or highly concentrated allocations. The key takeaway is that MPT is a powerful framework, but its recommendations can be fragile when inputs are uncertain.
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