CFP - Investment Planning (17% of the exam) - Section D.35

Alternative investments and liquidity risk

Hedge funds, private equity, private credit, real estate, commodities, collectibles and digital assets: fee structures, lock-ups, accredited investor requirements, valuation difficulty and the liquidity risk each adds. Items judge suitability and the portfolio share a client can prudently hold.

Accredited investorRegulation D

Practice question for this objective

Free sampleInvestment Planningmedium

Priya, 44, is single, earns 180,000 dollars a year and has a net worth of 1.2 million dollars excluding her primary residence, of which 900,000 dollars is held in investments. Her planner is weighing a Regulation D private placement and, separately, a hedge fund that relies on Section 3(c)(7) of the Investment Company Act of 1940. Assume the accredited investor tests are 1,000,000 dollars of net worth excluding the primary residence, or 200,000 dollars of individual income in each of the two most recent years, and that a natural person becomes a qualified purchaser with 5,000,000 dollars in investments. What is the correct assessment of her eligibility?

AShe is an accredited investor under the net worth test, so the Regulation D placement is open to her, but her 900,000 dollars of investments leaves her far short of qualified purchaser status. Correct
BShe fails both standards, because her 180,000 dollar income falls below the 200,000 dollar accredited investor threshold and no alternative route to eligibility is open to her.
CShe meets both standards, because net worth above 1,000,000 dollars satisfies the accredited investor test and simultaneously establishes her qualified purchaser status.
DShe is a qualified purchaser but not an accredited investor, so the 3(c)(7) hedge fund is available to her while the Regulation D placement remains closed to her.

Apply the accredited investor tests and the separate, higher qualified purchaser standard to decide which private vehicles a client may access. Accredited investor status for a natural person is met by either the net worth test, computed excluding the primary residence, or the income test, and the two are alternatives. Priya clears net worth at 1.2 million dollars, so a Regulation D offering is available to her. Qualified purchaser is a distinct and much higher bar measured on investments owned, and a fund relying on Section 3(c)(7) of the Investment Company Act of 1940 may admit only qualified purchasers, so her 900,000 dollars of investments excludes her from that fund.

Why A is correct: Net worth of 1.2 million dollars excluding the primary residence satisfies the accredited investor net worth test, while 900,000 dollars of investments is well below the 5,000,000 dollar qualified purchaser figure that a 3(c)(7) fund requires.

Why B is wrong: This treats the income test as the only accredited investor route. The tests are alternatives rather than cumulative, and Priya clears the net worth test at 1.2 million dollars excluding her home.

Why C is wrong: The first half is right and the second half collapses two separate standards. Qualified purchaser status is measured on investments owned, at a far higher figure, and accredited investor status does nothing to establish it.

Why D is wrong: This inverts both conclusions. Qualified purchaser is the higher of the two standards and she does not meet it, and a Regulation D offering is precisely the kind that is open to an accredited investor.

See more CFP practice questions, answers explained.

Exam traps in Investment Planning

Answers that look right on this material and are not. Each one is a distractor from a different question in the CFP bank for this domain.

Treynor for Rosa and Sharpe for Dev, because Rosa's undiversified holding leaves her exposed to the market factor while Dev's ten manager structure means the standard deviation of any single holding is what drives his experience.
Why it is wrong: Tempting because it names both measures correctly and applies the right logic in the wrong direction. It is wrong because the client whose specific risk is undiversified needs the total risk measure, and the client holding one sleeve of many needs the systematic risk measure.
Split the portfolio evenly between active and passive managers in every asset class, so that active risk is spread across the whole allocation rather than concentrated.
Why it is wrong: An even split feels balanced and diversified, but it places active risk in the segments the client does not believe are mispriced, which raises cost and tracking error without expressing his view.
Fund the school fees out of the interval fund, because six quarterly repurchase offers over eighteen months give ample opportunity to withdraw the 80,000 dollars in stages.
Why it is wrong: The number of windows is not the binding constraint, the size of each offer is. If requests exceed the offer the couple are prorated and receive only part of what they asked for, at the very date the fees fall due.

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