CFA Practice Question
Tony Picelli has several clients in different stages of life. One of his clients, Jake, is about to retire and his wife requires long-term medical care. Tony suggests that Jake should move some of his investments into medium-term highest-quality corporate bonds, for current income as well as preservation of principal. Tony explains the limited price appreciation potential of bonds if they are sold before maturity as well as the risk of loss in such an event. Tony also points out that if the bonds are held until maturity, Jake is guaranteed their yield to maturity.
A. Tony has violated Standard III (C) - Suitability by recommending an inappropriate security to Jake.
B. Tony has not violated any standards since he has explained the risks and opportunities related to corporate bonds.
C. Tony has violated Standard I (C) - Misrepresentation.
Explanation: Tony has violated Standard I (C) - Misrepresentation by assuring the client that the return on corporate bonds is guaranteed to equal their market yield if they are held until maturity. He has failed to mention the default risk if the issuer goes bankrupt and has not mentioned that market yield can only be earned if coupons are reinvested at the same yield. Guaranteeing returns is prohibited under the Standards.
User Contributed Comments 8
| User | Comment |
|---|---|
| awellman | I think the fact that guaranteeing returns is prohibited is the point to take away. Anytime you see a guarantee, consider it a violation. |
| IBBY84 | i've seen many examples with "guarneeting" and they were all violate |
| jackwez | good point.. thanks for the tip |
| pstebelp | By definition, there is no default risk if you hold to maturity, because after maturity, it wouldn't matter if the company goes bankrupt. However, the coupons need to be reinvested at the same yield... |
| jerasmus | There is definitely still default risk, even if the bond is held to maturity, since the company might still not have the funds to pay back the principle. |
| chandsingh | Probably the main thing here is the reinvestment risk on the coupons. I missed that |
| ninad123 | If US Treasuries are Guaranteed, there is no violation |
| bantoo | But it woould have been appropriate to tell guaranteed return from corporate bond |