Questions #1-6 of 47
The Portfolio Management Process and the Investment Policy
Statement
Test ID: 7442187
Yoo Jin, CFA, isthe ChiefInvestment OfficerofPark, Kim & LeeInvestmentManagement (PKL), whichspecializesin private wealthmanagementforaffluentfamilies. Yoohasrecentlymet witha potentialnew client, the Ahnfamily. PKL washighly recommended bya businessassociateofeldestmemberofthefamily, Ahn Kwan, andthreegenerationsofthefamilyare consideringinvesting withthefirmtoestablishanew investment portfolio. The portfolioisintendedsolelyto providecapitalfor thefourthandyoungestgenerationofthefamilyandtheirdescendents, sothefamilycanmaintainits positioninfuture generations. Portfolioincomeisnotcurrentlyneededtosupportthethreeeldestgenerationsofthe Ahnfamily becausethe businessventures provideanincomesufficienttomaintainaluxuriouslifestyle.
Sincetheelderly Ahn Kwanisnotinsufficientlygoodhealthtoattendthemeetingin person, thefamilyrepresentedatthis initialconference by Ahn Kwan'seldestson, Ahn Yong. Heexplainsto Yoothatthefamily wantstotakeacautiousapproachto itsinvestments. Thefamilytakessubstantialrisk inits businessventuresanddoesnot wanttorisk itscapital.
Asthediscussion proceeds, heinforms Yoothatthefamilyisalsointerestedinexploringnew investmentopportunitiesfortheir existing portfoliosas well. Thethreeadultgenerationsofthe Ahnfamilyhavesofar kepttheirmoneyinvarious bank accounts becauseofconcernabout possiblelossesinthesecuritiesmarket. Theaccountsgenerally payaninterestrate between4% and 5%. Ahn Kwan, however, has been persuaded byhis businessassociatethatthefamilyislosinganimportantopportunity toincreaseitsreturns bynotinvestinginthestock market. The Koreanequitymarketsoaredmorethan40% inthe previous year, and Ahn Kwanrealizesthat keepingmoneyininterest-bearingaccountsiscostingthefamilysubstantiallyinmissed opportunities. Hehasagreedtoconsidermovingasubstantial portionofthefamily'sassetsovertoPKL sincehehas been assuredthatPKL isaresponsible, cautiousfirm.
Indiscussingthemoveintoequities, Ahn Yongexplainshisfather's position. "Myfatherhasdevotedhisentirelifeto establishingthesuccessofhisfamily. Thefinancial positionofhischildren, hisgrandchildren, andtheirdescendantsisof primaryimportancetohim. Hedoesnot wanttorisk losingmoneythathehas workeddecadesfor."
Ahn Yongelaboratesonhisfather'sconcerns bysaying, "Myfatherhasseen whathappenedin Japan. The peak inthe Nikkei index camein1989, andthemarkethasneverrecovered. Anyone whoinvested back thenlostnearlytwo-thirdsofhismoney. Myfatherdoesnot wantthattohappentoourfamily."
Yoo Jinasks, "We wouldofcourseonlyinvestyourfamily'smoneyinmarketsthatyou wantto participatein. Wouldyourfather wantthefamily'smoneyinvestedinthe Japanesemarket?" Ahn Yongassertsemphatically, "Myfatherisonlyinterestedin participatinginthe Koreanmarkets. Hedoesnot wantourmoneyinvestedoverseas."
The portfoliomanager who would beresponsibleforthe Ahnfamily portfoliosisShinSun, CFA. Inreviewingthemeeting with Shin, Yooexplainsthatinherview, thefamily'sgoalsareinconsistentandeducationisrequiredtoresolvetheinconsistency. Yoonotesthatthefamilyisonlyinterestedininvestinginthe Koreanequitymarket, butthe Koreanequitymarketishighly volatile. It wouldnot be possibletocreatea portfolioconsistingsolelyof Koreanequitiesthat would beconsistent with Ahn Kwan'sinvestmentrisk tolerance.
Shinmakesthecasethatthefamilyhasaveryhighrisk tolerance. Shinargues, "Thetimehorizonofthe Ahnfamilyisvirtually infinite, sincethemoneyisintendedforfuturegenerations. Inaddition, the portfoliohasnocurrentincomerequirements. In thiscase, theycanhaveaveryhighrisk tolerance. Certainlythe Ahnfamilyisinanexcellent positiontoinvestinthe Korean equitymarket."
Question #1 of 47
QuestionID:464632ᅞ A) ᅚ B) ᅞ C)
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QuestionID:464633ᅞ A) ᅞ B) ᅚ C)
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Question #4 of 47
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instructionsandinvestthefamily'smoneyina portfolioof Koreanequities. Ifthatis whathesays, thenitisourdutytofollow his wishes." ShinconcludesthatPKL shouldconstructa portfolioconsistent withthe Ahnfamily'ssubstantialabilitytoassume risk.
Thebestdescriptionoftheimportanceof portfolio perspectiveisthatinvestors, analystsand portfoliomanagersshould analyzethe:
unsystematic risk of the individual investments in the portfolio. risk-returntradeoffofthe portfolioasa whole.
risk-returntradeoffoftheindividualinvestmentsinthe portfolio.
Explanation
Investors, analystsand portfoliomanagersshouldanalyzetherisk-returntradeoffofthe portfolioasa whole, nottheindividual investmentsinthe portfolio. (StudySession18, LOS60.a)
Whichofthefollowingis least likely to determinean individualinvestor'sabilityto accept risk?
Long-term wealth target.
Liabilities.
Marketexpectations.
Explanation
Liabilitiesand long-term wealth targetareeach direct determinants of an individualinvestor'sabilityto accept risk. Market expectations willaffect return achieved butis nota direct determinant of an investor'sabilityto accept risk. (Study Session 18, LOS 60.e)
Thetwo principal risk objective measurementsare best described as:
tracking risk and absolute risk. absolute risk and relative risk. absolute risk and qualitative risk.
Explanation
Thetwo risk objective measurementsareabsoluteand relative risk. Tracking risk isan example of a relative risk objective. Qualitative risk isa form in which an absolute risk objective may bestated. (Study Session 18, LOS 60.e)
Regarding Shin'sand Yoo'sassertionsaboutthe family's risk toleranceand theimplications for the management of their portfolios:
ᅚ B) ᅞ C)
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QuestionID:464636ᅚ A) ᅞ B) ᅞ C)
Question #6 of 47
QuestionID:464637ᅞ A) ᅚ B) ᅞ C)
Question #7 of 47
QuestionID:464613ᅞ A)
ᅞ B)
Yoo'sstatementis correct; Shin'sstatementisincorrect. Yoo'sstatementis correct; Shin'sstatementis correct.
Explanation
Shin'sstatementthatthe family hasa verysubstantialabilityto assume risk is correct, but heisincorrectto claim thatthe portfolio should be constructed in accordance with their abilityto assume risk without resolving the conflict with their low willingnessto assume risk). When theinvestor'sabilityand willingnessto assume risk arein conflict, the curriculum always recommends designing portfolios consistent with the willingness, notability, to assume risk. Yoo is correctthatthereisan inconsistencyin thestated risk tolerance - notincreasing the risk of the portfolio abovethat of interest-bearing bank accounts -and the goal of investing in thestock market, and thateducating the clientis required. Sincethe willingnessto assume risk is inherentlyin conflict with thestated objective of investing in equities (which cannot duplicatethelow risk of interest-bearing bank accounts), thereis no wayaround having to educatethe familyto resolvethe conflict. (Study Session 18, LOS 60.e)
A return objectiveshould best be considered from the perspective of:
total return.
return from income relativeto return from capital gains. required return.
Explanation
The return objectiveshould be considered from atotal return perspective, even if thereisaspecific income or capital gains target. Desired or required return may be unrealistic given available market conditions or risk tolerance. (Study Session 18, LOS 60.e)
Which is least likely to be considered one of thethreeintegrativestepsin the portfolio management process?
Planning.
Developing an investment policystatement. Feedback.
Explanation
Thethreeintegrativestepsin the portfolio management processare planning, execution and feedback. Developing an IPS is part of the planning phase. (Study Session 18, LOS 60.b)
The investment policy statement is important because it helps:
direct short-term investment portfolio decisions as a result of short-term responses to overreacting markets.
ᅚ C)
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direct long-term investment portfoliodecisions that deter adjustments due to panic and overconfidence.
Explanation
The investment policy statement helps insure against short-term strategy changes due to panicoroverconfidence.
Whichof the following is not typically included in an investment policy statement?
Identification of duties.
Names of specificmanagers ormutual funds that should be used.
A client description.
Explanation
General statements about how funds should be invested are included in the investment policy statements. It wouldnot be wise to include specificmanager/mutual funds, as the people involved inmanagingmoney change over time. Instead, asset allocationobjectives should be used.
Whichof the following is not considered to be an investment constraint?
Time horizon.
Risk tolerance.
Tax concerns.
Explanation
An investor's risk tolerance is includedunderobjectives. Constraints include liquidity needs, time horizon, tax concerns, legal and regulatory factors, andunique circumstances.
Which of the following is least likely to bean advantage of a valid investment policystatement?
Allows for a continual dynamic process in meeting investor objectives.
Provides for short-term strategy shifts inresponse to short-termdramaticvalue declines.
Promotes long-termdiscipline in investment decisions.
Explanation
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Question #13 of 47
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The objective of achieving a 10% annual rate ofreturn is an example of a(n):
relative return objective.
absolute risk objective.
requiredreturnobjective.
Explanation
The objective of earning a 10% return isa required return objective becauseit representssomelevel of return that must be acheived bythe portfolio.
Investorobjectives relate to whichof the following? Evaluating:
asset allocation and security factors.
risk andreturnfactors.
capital market and security factors.
Explanation
Investorobjectives relate directly to the risk andreturnfactors acceptable to the investor. Risk factors are associated withhow muchrisk the investorcan tolerate. Returnfactors relate torequired anddesiredreturns.
Max and Anna Klushefski have both turned 30 in thelastyear. The couple decidesthat 30 isthe rightageto startthinking moreabouttheir future, so they meet with a financial planner, Thelma Black. Both Max and Anna work. Their 401k plans have a combined value of $135,000 and this representstheir onlyinvestmentassets. Anna, aschoolteacher, is pregnant with their first child and plansto quit her job when the child is born. The couple hopesto haveatleasttwo more children. Max makes $95,000 per year asa junior executiveata clothing firm. The couple has been banking Anna'ssalary for thelasttwo years, as they can live on what Max makes.
Max and Anna had notthought much abouttheir future, butin responseto Black's questions, they come up with two goals: Anna wantsto stay out of the work force untilall of their children are out of the house.
Max wantsto retireat 65 with atleast $2 million in their portfolio.
Neither Max nor Anna knows much aboutinvesting, but Max's friendstell him thatstocksarethe best option becauseequities earn the best returns. Max and Anna wantto invest most of their moneyin stocks.
Based only on theinformation presented above, the Klushefskis': investment objectives are unrealistic.
time horizon should be multistage.
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QuestionID:464606ᅚ A) ᅞ B) ᅞ C) Explanation
A multistage horizon isa combination of shorter term and longer term horizons, such as when a couple must fund both their children'seducation in the near term and their retirement much later. A 30-year-old man is making $95,000 in an executive position can beexcused for aiming fairly high: a $2 million portfolio isaggressive, but not necessarily out of reach, with 35 yearsto work on it. The Klushefskisareyoung enough thatthey can afford to take risksthat meshes with their willingnessto focus on stocks.
Which of the following statements regarding theeffect of investors' time horizon on portfolio choiceis least accurate?
Legal and regulatory factors usually do not affect the investment policies of
individual investors.
Endowmentsand foundationstypicallyinvest with an average or below average tolerance for risk.
Longer time horizons mayindicatean investor's greater abilityto take risk, even if willingnessis notapparent.
Explanation
Endowmentsand foundationstypicallyinvest with an average or aboveaveragetolerance for risk, in part dueto their relatively longer investmenttime horizons.
Which of the following factorsare least likely to affectthe formulation of an investment policystatement for a university's endowment fund?
Social considerations. Tax considerations. Multi-stagetime horizons.
Explanation
An endowment would receivetax-exemptstatus, and therefore would not haveto includetax considerations when formulating an investment policystatement.
Whichof the following is not a step in the portfoliomanagement process?
Developing an IPS. Execution.
Question #17 of 47
QuestionID:464629ᅞ A)
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QuestionID:464601ᅞ A) ᅞ B) ᅚ C)
Question #19 of 47
QuestionID:464604ᅞ A) ᅚ B) ᅞ C) Explanation
Developing an IPS isasubset of the planning process.
Whichof the following statements about investment policy statements (IPS) is least accurate? The IPS:
helps insure against short-term shifts in strategy when either market environments or portfolio performance cause panic or overconfidence.
can be readily implemented by current orfuture investment advisors.
isan informalstatement of objectivesand constraints.
Explanation
Investment policy statements should always be formally written documents that take into account objectives and constraints and governs investment decision-making.
Equity pricing modelsassume which risk is priced?
Unsystematic.
Bothsystematicandunsystematic. Systematic.
Explanation
Unsystematic risk can bediversifiedaway. Thus, equity-pricing modelsaredesignedto reflect onlysystematic risk. Itis assumedthatthe portfolio manager willtakestepsto diversifyand reduce risk.
Which of the following is not part of the general steps of the portfoliomanagement process?
Feedback.
Performance evaluation.
Planning.
Explanation
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Which of the following most accuratelyidentifies the three mainstepsin the portfoliomanagement process?
Objectives, constraints, risk tolerance.
Planning, execution, feedback.
Planning, asset allocation, security selection.
Explanation
The three mainstepsin the portfoliomanagement process are planning, execution, andfeedback. The otheritems listed are subcomponentsof these steps.
Investment constraints are best defined asfactors:
restricting investment choices.
encouraginginvestment choices.
determininginvestment choices.
Explanation
Investment constraints are those factors limitingorrestrictinginvestment choices.
Whichofthefollowingstatements regardingtheethicalconductnecessaryfor managing portfoliosisleastaccurate?
The portfolio manager should not presume that they have more knowledge than the client.
Thestandardofconductisembodied bythe CFA Institute CodeandStandards.
The portfoliomanager shouldmeetstandardsofcompetence.
Explanation
Becausethe portfoliomanager isanexpertinthefield, heor shehas presumablymore knowledgethantheclient. The
manager isthusina positionoftrustandshouldadheretothehigheststandardsofethicalconduct.
The investment policy statement doesnot contain whichof the following?
Portfolio position listing.
Asset allocationguidelines.
Question #24 of 47
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QuestionID:464630ᅚ A)
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Explanation
The investment policy statement doesnot contain a listingof portfolio positions, only guidelines as to what positions are allowed.
Whichof the followingdoesnot relate toreturnobjectives? Specifying:
security-specific returns.
portfolioreal after-tax returns.
returnrequirements.
Explanation
Required anddesiredreturns, specifiedinreal after-tax levels, relate directly to the formulationof the investor'sreturnobjective. Security
-specific returns are important in analyzing potential additions to the portfolio, but donot come into play whenspecifying the overall portfolioreturnobjective.
Individual investors andinstitutional investors can be impacteddifferently by different constraints. Which constraintshave a large impact onindividual investors and a large impact on pensionfunds, respectively?
Legal and regulatory issues for individual investors and tax considerations for
pensions.
Tax considerationsforindividual investors and legal andregulatory issuesfor pensions.
Liquidity concernsforindividual investors and tax considerationsfor pensions.
Explanation
Individual investors are taxable entities, whereas pensions are tax exempt. Institutional investorsmust operate under ERISA regulations, whereasindividuals caninvest as they see fit. Liquidity concerns and unique considerationsdo affect bothindividual investors and pensions.
Whichof the followingisnot considered aninvestment constraint?
High-risk securities.
Liquidity requirements.
Unique considerations.
Explanation
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constrainingfactors. Liquidity requirements and unique considerations are both constrainingfactors.
Horace Cline buyslarge-cap stocksandshortsS&P 500 Index futures. Whatinvestmentstrategydoes Cline practice?
Active. Semi-active. Growth.
Explanation
Clineusesindex futures, butthatdoesnotmakehimanindexer. By purchasingstocksandshortingtheindex, Clineistryingto
taketheindex'smovementsoutoftheequation, leveragingthealphafromhisstock picks. Heisanactivemanager. Wedonot
haveenoughinformationtodetermine whether Clineisagrowthor valueinvestor.
A defined benefit pension plan wouldmostlikelyhave whichofthefollowingsetof returnobjectivesand risk tolerance? Return Requirements Risk Tolerance
Fund pension liablility + inflation
Plan features, funding status of plan,& age of workforce
Lifecyclestageof beneficiariesRisk toleranceof beneficiaries Pensionliablility+inflation Risk toleranceof beneficiaries
Explanation
For adefined benefit pension plan, return requirementsare basedupontheminimumneededtofundthe pensionliability whileaccountingfor inflation. The risk toleranceisdependentuponthe plan'sfeatures, theageofthe workforce, andthe
fundingstatusofthe plan.
Jack Weatherfordisa portfoliomanager andis providingadvicefor Maria Conn, anaccountant. Fromhis briefconversation
with Conn, Weatherfordhaslearnedthat Connis43 yearsoldandher goalistosavefor retirement. Weatherfordhas been
extremely busylately but wouldliketoget Connstarted withanassetallocationassoonas possible. Hetellsher thathemight temporarily puther assetsindomesticequitiesandthen reallocateher assets whenhehastime. Whichofthefollowing statementsismostaccurate? Weatherfordshould:
ᅞ B)
ᅞ C)
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QuestionID:464602invest Conn'sfundsinthedomesticequitiesimmediatelyso Conndoesnotmissout
on potential bullmarkets.
let Connmakeinvestmentdecisionssothatheavoidsliabilityfor potentialinvestment losses.
Explanation
Weatherfordshouldnotallocateher assetsuntilhehasdeterminedher risk and returnobjectivesas wellasinvestment constraints. Anentireallocationtoequitiesmay beunsuitablefor her if, for example, shehashighliquidityneeds. Becausethe portfoliomanager isanexpertinthefield, heor shehas presumablymore knowledgethantheclient. Themanager shouldnot relyontheclienttomaketheinvestmentdecision. Themanager shouldalsonot relysolelyontheclient's profiletomakethe
investmentdecision. Themanager isina positionoftrustandshouldmeet bothstandardsofcompetenceandconduct.
Diversificationcan reduce:
unsystematic risk. systematic risk.
macroeconomic risks.
Explanation
Systematic risk reflectsfactorsthathaveageneraleffectonthesecuritymarketsasa whole, andcannot bediversifiedaway.
Macroeconomic risk comesinmanyforms, anditisusuallyconsideredsystematic risk. Unsystematic risk can be reduced
throughdiversification.
Whichof the followingbestrepresents the general stepsof the planning phase of the portfoliomanagement process? Determining:
the investor's tax situation and unique circumstances.
investorobjectives and constraints.
the investor's time horizon.
Explanation
ᅞ A)
ᅞ B)
ᅚ C)
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Whichoneofthefollowingalternativescorrectlyoutlinestheimportanceofthe portfolio perspective?
Market participants should attempt to eliminate the unsystematic risk
associated with each security by forming portfolios that will diversify away this risk.
Market participantsshouldfocusonthesystematic risk ofthecomponentsofa portfolionottheunsystematic risk ofthecomponentsofa portfolio.
Market participantsshouldanalyzethe risk-returntrade-offofa portfolioasa whole,
notthe risk-returntrade-offoftheindividualinvestmentsina portfolio.
Explanation
The keyunderlying principleofthe portfolio perspectiveisthatmarket participantsshouldanalyzethe risk-returntrade-offof
the portfolioasa whole, notthe risk-returntrade-offoftheindividualinvestmentsinthe portfolio.
The guidelinesin the investment policy statement are important because they:
dictate how subsequent managers should change portfolio implementation.
allow continuity inimplementation by current andsubsequent managers.
determine how tomake portfolioshifts afterdramatic short-termvalue declines.
Explanation
The investment policy statement createsimplementationguidelinesso that any competent manager canimplement portfoliodecisions.
WilliamParthley, age69, hashad badluck withhisinvestmentsin recentyearsanddecidestoconsultMoira Wembley, CFA,
for advice.
Parthley's portfolioiscomposedof 90% stocksand10% bonds, withatotalvalueof $2.6million. Classifyinghimselfas
conservative, Parthley blamedtheaggressiveallocationona previousmoneymanager, andsayshe wantstosubstantially
increasethefixed-income weightingofhis portfolio.
Fromhis portfolio, Parthleyhopestofundhis retirementata rateof $7,000 per month, adjustedfor inflation. Hehasalso
promisedhisalmamater atleast $2millionuponhisdeath. Parthleyisingoodhealth, andmostofthemeninhisfamilyhave livedintotheir late80s.
Basedsolelyontheinformation presentedabove, Wembleycanconcludethatthereismostlikelyaconflict between Parthley's:
return requirements and asset allocation.
return requirementsandassetallocationas wellashis willingnesstotake risk and
abilitytotake risk.
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QuestionID:464651ᅞ A)
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QuestionID:464618ᅞ A)
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Explanation
Parthley's portfolioislargeenoughtomeethisneeds, withsome roomtospare. Hisannualspendingaccountsfor just 3.23% ($7,000/month × 12months / $2.6million) ofthe portfolio. Evenaccountingfor inflationandtaxes, a7% return would probably beenoughtosupportParthley withoutdippingintothe principal. Furthermore, witha $600,000 cushionabovethe $2million neededfor the bequest, Parthleycanaffordtodip intothe principalifnecessary. Assuch, hisdesiretomovetoamore conservativeallocationisnotinconflict withhis return requirements.
Parthley's wealthandmodest return requirementsuggesthehasasubstantialabilitytotake risk. YetParthleyconsiders himselfconservative. Thereappearsto beaconflicthere.
Kelsey Opeltisa portfoliomanager andis providingadvicefor JaySteele, a retiree. Opelthas been working withSteelefor
manyyears. Theyhaveagood relationship and OpelthastaughtSteelethe basicofinvestments. Steelehasfairlysteady liquidity requirements. Hishouseis paidfor, hehasgoodhealthinsurance, andhehasasteady pension. Heonly requires
$1,000 amonthinspendingmoneythatallowshimtoenjoy retirement. Hischildrenaregrownandfinanciallyindependent. His
wife Harriet passedawayfiveyearsago. BecauseofSteele'ssteadylifestyle, low liquidity requirements, andinvestment knowledge, OpelthasnotadjustedSteele's portfoliofor capitalmarketexpectationsinmanyyears. The portfoliohas
performed quite well recently, duetoanaverage returninthestock marketof25% over the pastthreeyears. Opeltshould:
not interfere with the portfolio because it is performing so well.
not performanyactions becauseSteele'scircumstanceshavenotchanged, andare
notexpectedtochange, for manyyears.
monitor the portfolioandcapitalmarketexpectationsmoreclosely.
Explanation
Opeltshouldmonitor the portfolioandcapitalmarketexpectationsmoreclosely. AlthoughitappearsthatSteele's
circumstanceshavenotchanged, capitalmarketconditionscanchange, whichcouldcallfor achangeinassetallocation. This may well bethecasehere becauseofthe recenthighstock market returns. Monitoringthe portfolioandcapitalmarket expectationsisanimportant partof portfoliomanagement.
A moneymanager whocrafts portfoliosusingallofStandard & Poor'ssector index exchangetradedfunds (ETFs), aggressivelyoverweightingandunderweightingsectors, follows whatinvestmentstrategy?
Active. Semi-active.
Passive.
Explanation
Semi-activestrategiesinvolveusingindexesastheunderlyinginvestments, buttryingtoaddvaluethroughsomeactive
management. Inthiscase, themanager starts withindex ETFs, butactivelyadjuststheallocation. Heisasemi-active
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QuestionID:464607ᅞ A)
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The investment policy statement isleastlikely to contain whichof the following?
Investor contact phone numbers and addresses.
Portfolio adjustment guidelines.
Identificationofresponsibilitiesof partiesinvolved.
Explanation
The investment policy statement doesnot contain contact information, only informationregardingresponsible parties.
Ophelia McGillicutty, a retired airline executive, has been buying andsellingstocksformore than 50 years. At 74, she controls a modest investment portfolioof $280,000. Over the last three decades, McGillicutty hasgiven away millionsofdollars to charities. She lives comfortably onher pension andherdeceasedhusband'sSocial Security benefits. McGillicutty keeps the bulk ofherinvestmentsin stocks, althoughher children andgrandchildrensay she is takingon toomuchrisk at her age.
McGillicutty should be most concerned about:
tax considerations.
liquidity.
diversification.
Explanation
GivenMcGillicutty's ability and willingness to live onher existingmonthly income, liquidity isnot a concern. We have noreason to believe that income will not support herfor the rest ofher life, and we know ofno pressingneedsforherinvestment funds. Assuch, while a high stock weightingmay look oddon paper consideringher age, it isnot necessarily inappropriate, particularly ifshe isinvestingforgrowth to fund charitable donationsorher children'sinheritance. Taxes, however, concernmost investors. GivenMcGillicutty'srelative insensitivity to the other twooptions, tax considerationsseem to be the biggest potential problem area.
In whichstep of the portfoliomanagement processdeveloping anIPSoccur?
Strategic asset allocation.
Feedback
Planning.
Explanation
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QuestionID:464619ᅞ A)
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Question #41 of 47
QuestionID:464616ᅚ A)
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Questions #42-47 of 47
KarenMogdansis a money manager workingon an account for Jim Howell. Inorder to channel Mogdans' knowledge of the risk andreturn characteristicsofdifferent asset classesinto a strategic asset allocationfor Howell, she needs:
a return target.
aninvestment policy statement (IPS).
a rebalancingstrategy.
Explanation
Mogdanshas expertise ondifferent asset classes, suggestingshe is also knowledgeable about the market'srisk characteristics. The rebalancingstrategy will be developed at the same time as the asset allocation, or perhaps afterward. It won't help create the allocation. And while Howell'sreturn target isimportant, it must be consideredin the context ofhisrisk tolerance, portfolio constraints, etc. The IPS containsdata neededfor a knowledgeable manager tostructure a portfoliosuitable for anindividual investor.
The investment policy statement doesnot contain:
industry specifics for potential investment.
a client description.
guidelinesfor adjusting portfolio composition.
Explanation
The investment policy statement may provide guidelinesfor whichindustry may ormay not be includedin the portfolio but will not provide specifics about industry characteristics.
Herbert vonSoltanini, CFA, manages a variety of balanced portfoliosfor Great Performance Asset Management (GPAM). GPAMhas a broad base of clients covering the entire spectrumofinstitutional investors. The firmmanagesmoney globally, but the bulk ofits clients are locatedin Europe and the Americas.
Soltaniniisscheduled to travel to the USin a few weeksfor annual meetings with key clientsin New York, Boston, and Chicago. Great Performance requires portfoliomanagers toreview the investment policy statements (IPS) of each client before the annual meeting to ensure that the IPSstill meets the current requirementsof the client, and that the IPSis up todate before any revisions are made toit as a result of the annual meeting.
In preparationfor the trip, Soltanini askedhis assistant, DomenicoBachandel, toreview the relevant UnitedStates-based clients and the statusof theirinvestment policy statements. Bachandel immediately finds a potential discrepancy in the IPS among the firm's pension fund clients, and asksSoltaninifor a meeting todiscuss the problem.
Question #42 of 47
QuestionID:464639ᅞ A)
ᅚ B)
ᅞ C)
In addition, the range of beneficiariesvaries widely as well. Some ofSoltanini'soldest client relationships are with the defined benefit planssponsored by long-establishedfirms. These firms' employee basesoften consist mostly ofskilledmanufacturing workers withhigh salaries andgenerous pension benefits. They generally have a very large proportionofretirees and extremely highrequirementsfor current income to pay the benefitsof the plan'sretirees. Often, their plans are severely underfunded. A clear example is Riverbank Manufacturing, which covers all employees with a defined benefit plan. The planis extremely generous anddrastically underfunded because more plan participants are retired than are currently employed.
In contrast, Soltaninihasmore recently developedrelationships withmany firmsin the service sector, especially financial services, communications, and technology. Most of these firmshave defined contribution plans, but Soltanini alsomanagesseveral defined benefit planssponsored by service sectorfirms as well.
The defined benefit plansfor the newer clients tend to be fully-funded. Infact, many of them are significantly overfunded because the firmsmake large pension contributionsingood years togive themselves the flexibility toreduce required contributionsin bad years. These plans tend tohave a very small percentage ofretirees-inmany cases, less than 5% - andvery high turnover among workers, so that only a small percentage become vestedin the plan.
In addition, these plans tend tooffer lessgenerous pension benefits than the plans established earlier by the manufacturingfirms. Consequently, many ofSoltanini'sservice sector clientsfind that funding theirdefined benefit plansisrelatively inexpensive for the plan sponsor. Sunrise Telecomis a perfect example of this. Only 3% of the plan participants at Sunrise are retired, andit experiences a very high turnover among workers. Previous contributions to the pension planhave providedsufficient portfolio assets tomake the plan substantially overfunded.
Bachandel is concerned because hisreview showed a great divergence ofinvestment objectivesin the IPSfor the various pension clients andseveral of the IPSfor the plans appear to conflict. The IPSfor the plan at Riverbank Manufacturingindicates a very low tolerance for risk, while that forSunside Telecomindicates a very highrisk tolerance. Given that these are bothdefined benefit plans, Bachandel wonders why the IPSs are sodifferent.
At the meeting withSoltanini, Bachandel suggestsone possible explanationfor the discrepancies by saying, "The returnrequirementsfor defined benefit pension plansdon't have to be similarsince they are determined by the life cycle stage of the beneficiaries." Soltanini pointsout, "The risk tolerance of the plan will dependon the risk tolerance of the beneficiaries."
Bachandel alsoraises concern about the IPSstatementsingeneral, since the problems extend beyond the pensionfund clients. He sees a strikingdifference in the IPSof the variousinsurance companiesfor which Great Performance manages portfolios, as well.
Bachandel clarifiesforSoltanini, "The returnrequirementsfor life insurance companiesdepend primarily on policy pricing andfinancial strength." He hypothesizes toSoltanini that thisfact could explain the discrepanciesin theirstatedreturnrequirements. Soltanini adds that all theirinsurance company clients will most likely have similarrisk tolerances. "The risk tolerance at both life and casualty insurance companiesis likely to be below average because ofregulatory constraints."
Bachandel andSoltaninidecide that there isnoobvious problem with the client investment policy statements. They agree to wait and review the IPS with the clients at the upcoming annual meetings.
The mostlikely event to be successfully diversified away in a portfolio would be:
business cycle risk.
unanticipated corporate loss.
unanticipatedinflation.
Explanation
Question #4
3
of 47
QuestionID:464640ᅞ A)
ᅚ B)
ᅞ C)
Question #44 of 47
QuestionID:464641ᅚ A)
ᅞ B)
ᅞ C)
Question #4
5
of 47
QuestionID:464642ᅞ A)
ᅞ B)
ᅚ C)
Question #46 of 47
QuestionID:464643portfolio and thus can be diversified away. Inflation, consumer confidence and the business cycle are all sourcesofsystematic risk. (Study Session18, LOS60.a)
RegardingBachandel's andSoltanini's assertions about the risk tolerance ofdefined benefit pension plans:
Soltanini's statement is incorrect; Bachandel's statement is correct.
Soltanini'sstatement isincorrect;Bachandel'sstatement isincorrect.
Soltanini'sstatement is correct;Bachandel'sstatement is correct.
Explanation
Bothstatements are incorrect. Bachandel'sstatement isincorrect because returnrequirementsdependon the life cycle stage of beneficiaries at defined contribution, not defined benefit, plans. Soltanini'sstatement is alsoincorrect because the risk tolerance of a defined contribution, not defined benefit, planisdetermined by the risk tolerance of the beneficiaries. (Study Session18, LOS60.f)
Whichof the followingisleastlikely to be considered part of the planning phase of the portfoliomanagement process?
Selecting appropriate individual investments.
Determining the appropriate investment strategy.
Developing aninvestment policy statement.
Explanation
The planning phase of the portfoliomanagement process consistsof analyzingobjectives and constraints, developing anIPS, determining the appropriate investment strategy, andselecting an appropriate asset allocation. Selecting appropriate individual investmentsis part of the execution phase, not the planning phase. (Study Session18, LOS60.b)
RegardingBachandel's andSoltanini's assertions about the returnrequirements andrisk tolerancesforinsurance companies:
Soltanini's statement is incorrect; Bachandel's statement is correct.
Soltanini'sstatement is correct;Bachandel'sstatement is correct.
Soltanini'sstatement is correct;Bachandel'sstatement isincorrect.
Explanation
Soltanini'sstatement is correct since both life andnon-life insurance companies tend tohave below average risk tolerance because of significant regulatory constraints. Bachandel'sstatement isincorrect because the returnrequirementsofnon-lifeinsurancecompanies depend primarilyon policy pricingandfinancialstrength. Thereturnrequirementsoflifeinsurancecompaniesdepend primarilyon policy
holderreserverates. (StudySession18, LOS60.f)
ᅞ A)
ᅞ B)
ᅚ C)
Question #47 of 47
QuestionID:464644ᅞ A) ᅚ B) ᅞ C)
active investment strategies should be used instead of strategic asset allocation when
the portfolio manager believes he can exceed market returns.
marketexpectationsdeterminetheobjectivesandconstraintsoftheinvestor, whichtranslate
intostrategicassetallocation.
forecastsofrisk-returncharacteristicsofassetclassesincludedinthe portfolioconnect
marketexpectationstotheobjectivesandconstraintsoftheinvestor.
Explanation
Activeand passiveinvestmentstrategiesareinvestmentapproaches, notreplacementsforstrategicassetallocation. Passive
approachesareless, notmore, responsivetochangesinexpectations. Marketexpectationsdonotdeterminetheobjectivesor
constraintsoftheinvestor. (StudySession18, LOS64.c)
Whichofthefollowingisleastlikelyto beconsideredoneofthefivemainclassesofinvestmentconstraints?
Time horizon.
Willingnesstoassumerisk.
Tax considerations.
Explanation
Thefivemainclassesofinvestmentconstraintsareliquidity, timehorizon, legalandregulatoryconcerns, tax considerations, andunique
circumstances. Willingnesstoassumerisk isanaspectofrisk tolerance, whichisconsideredaninvestmentobjective, notaninvestment
