Customer Name: Charlie Customer
Age: 69
Marital Status: Single - Widowed
Dependents: None
Occupation: Retired
Household Income: $31,000 (Social Security and Pension)
Net Worth: $130,000 (excluding residence)
Own Home: Yes $220,000 Value, No Mortgage
Investment Objective: Current Income
Risk Tolerance: Low
Investment Time Horizon: 20 years
Investment Experience: 0 years
Current Portfolio Composition: Cash in Bank: $130,000
After reviewing this customer's profile sheet, which recommendation would be most appropriate?
A. The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20-year TIPS to meet the customer's desire for current income and his low risk tolerance requirements
B. The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20-year STRIPS to meet the customer's desire for current income and his low risk tolerance requirements
C. The customer should mortgage his house for $100,000 at current market interest rates and use the proceeds to buy 20 year income bonds to provide current income
D. The customer should take at least $100,000 of cash from the bank and invest the proceeds in 20-year Treasury Bonds to meet the customer's desire for current income and his low risk tolerance requirements
The best answer is D.
This customer is age 69, with no current investments or investment experience. The customer has a fairly low retirement income and needs additional current income to live comfortably. This customer really only has 2 assets to tap for potential current income. He owns a fully paid house worth $220,000; and has $130,000 of cash in the bank.
One way to supplement income is for the customer to get a reverse mortgage on the house, but this is not a banking exam, so we will not go near that possibility! The other way to supplement income is to invest the cash in the bank in an investment that is safe and that gives current income. Treasury Bonds pay interest semi-annually at a higher rate than that earned on bank deposits, and are really safe, so these would be the best recommendation. STRIPS do not provide current income since they are a zero-coupon Treasury obligation so these will not work. TIPS give a lower current interest rate than regular Treasury bonds, in return for protecting the investor against inflation - however the inflation protection is not "paid" until maturity, so again, these will not give the greatest additional current income.