Small-Cap Stock

B is correct. Jennifer's profile is well-suited for small-cap exposure: 30-year time horizon provides ample time to weather volatility, stable income allows her to hold through downturns, no debt means strong financial stability, and her stated comfort with volatility aligns with small-cap characteristics. A moderate allocation to small-cap stocks can enhance long-term growth potential while maintaining diversification.

A is incorrect because small-cap stocks are appropriate for investors with Jennifer's characteristics (long time horizon, high risk tolerance, stable financial situation). They are not universally too risky. C is incorrect because concentrating entirely in small-caps would eliminate diversification benefits and expose her to unnecessary concentration risk. A balanced portfolio typically includes multiple asset classes and market capitalizations. D is incorrect because age and experience alone don't determine suitability. her long time horizon and risk tolerance make small-cap stocks appropriate now, not later when her time horizon would actually be shorter.

B is correct. Small-cap stocks are defined as companies with market capitalizations between $300 million and $2 billion. This is the industry standard classification used by most financial institutions, index providers, and investment research firms.

A describes micro-cap stocks, which fall below the small-cap threshold and represent the smallest publicly traded companies with even lower liquidity and higher risk than small-caps. C describes mid-cap stocks, which are larger than small-caps but smaller than large-caps, typically offering a balance between growth potential and stability. D describes large-cap stocks, which are the largest publicly traded companies with greater stability, higher liquidity, and typically lower growth rates than smaller companies.

B is correct. New market cap: 25 million shares × $90 = $2.25 billion, which exceeds the $2 billion small-cap threshold and places the company in mid-cap territory ($2B-$10B range). Liquidity typically improves when companies move into higher market cap categories because they attract more institutional investors, gain index inclusion in mid-cap indices, receive more analyst coverage, and experience higher daily trading volumes.

A is incorrect because $2.25 billion exceeds the $2 billion small-cap upper limit. While the share count remained constant, the market capitalization increased due to share price appreciation. C is incorrect because $2.25 billion is mid-cap, not large-cap (which starts around $10 billion). Also, liquidity typically improves, not decreases, as companies grow, despite higher nominal share prices. Higher share prices don't reduce liquidity when accompanied by increased institutional interest and trading volume. D is incorrect because market capitalization is calculated using current market prices, not IPO prices. Market cap fluctuates daily based on current share prices.

C is correct (the EXCEPT answer). Small-cap stocks are NOT always inappropriate for investors approaching retirement. Suitability depends on the individual client's complete financial picture, including risk tolerance, time horizon, other assets, income needs, and overall portfolio allocation. A retiree with substantial assets, pension income, and high risk tolerance might appropriately hold some small-cap exposure for growth potential. The blanket statement "always inappropriate" ignores individual circumstances.

A is accurate: Small-cap stocks typically experience higher volatility than large-caps due to less stable earnings, greater sensitivity to economic changes, lower institutional ownership providing less price stability, and higher susceptibility to company-specific events. B is accurate: Lower trading volumes mean fewer buyers and sellers at any given time, resulting in wider bid-ask spreads and potentially higher transaction costs. Small-caps average daily trading volumes of tens of thousands to low millions of shares, compared to tens of millions for large-caps. D is accurate: Small-cap companies are often in earlier growth stages with more room for business expansion, market share gains, and earnings growth. They can potentially grow into mid-cap or large-cap companies, offering substantial appreciation. Large-caps are typically mature businesses with slower growth rates.

B is correct. Statements 1, 2, and 3 support adding small-cap exposure to this client's portfolio.

Statement 1 is TRUE: Historical data shows small-cap stocks have outperformed large-cap stocks over long time periods (20+ years), though with higher volatility along the way. This long-term outperformance potential supports inclusion for growth-oriented investors with appropriate time horizons.

Statement 2 is TRUE: A 20-year time horizon provides sufficient time to weather the higher short-term volatility of small-cap stocks and benefit from their long-term growth potential. The client is 45 years old and likely has at least 20 years before needing portfolio assets, making small-cap volatility more acceptable.

Statement 3 is TRUE: The current portfolio shows no small-cap exposure (60% large-cap stocks, 30% bonds, 10% cash), representing a gap in market capitalization diversification. Adding small-cap exposure would provide exposure to a different segment of the equity market with different risk/return characteristics, enhancing overall portfolio diversification.

Statement 4 is FALSE: Small-cap stocks are MORE volatile than large-cap stocks, not less. They experience larger price swings due to less stable earnings, lower liquidity, higher sensitivity to economic changes, and greater company-specific risk. This is a fundamental characteristic that makes them less suitable for conservative investors but potentially more rewarding for those who can tolerate volatility.