Ch 18: Investment Policy Statement

Shane expects to incur the following cash outflows during the following year: Down payment on a condo next year $30,000 Travel $3,000 Purchase car for nephew $12,000 Rent $14,000 The liquidity constraint for Shane is closest to:

$45,000. Liquidity events are expected one-time lump sum cash outflows that occur in the short term. They constrain the investment management process because those funds are not available for investment in financial securities. The ongoing rent is part of the income needs used in the return objective.

A defined benefit plan has 300 employees with a majority of them under age 50. The pension fund manager has collected the following data: Risk-free rate 2.15% S&P 500 return (5-year average) 10.42% Expected inflation rate 1.80% Discount rate used to compute pension obligation 6.85% Yield to maturity on the company 20-year bonds 5.75% The return objective for the pension fund is closest to:

6.85%

The Frick Endowment (FE) fund provides scholarships each year to women who deferred college to raise children and are now starting or returning to school. FE's average spending rate over the past 4 years has been 6.2%, while inflation has averaged 1.4%. The endowment's portfolio generated a 15% return last year, and the risk-free rate is 2.1%. For the upcoming year, FE's return objective is closest to:

7.6% Endowment funds should use the spending rate plus a measure of inflation as its return objective. Spending rates are typically smoothed over a reasonable time period, and the four-year average seems fair. The return objective should be 6.2% + 1.4% = 7.6%.

Mary George retires early and will have no income other than her portfolio income. Mary believes she will need $500,000 in before-tax income per year to cover her living expenses. Mary has $7 million in investable assets and inflation is expected to be 0.5%. Mary plans on donating $100,000 to the Atlas Foundation, $125,000 to the local hospital, and $33,000 her alma mater's endowment fund. Mary's return objective is closest to:

7.9% Mary George retires early and will have no income other than her portfolio income. Mary believes she will need $500,000 in before-tax income per year to cover her living expenses. Mary has $7 million in investable assets and inflation is expected to be 0.5%. Mary plans on donating $100,000 to the Atlas Foundation, $125,000 to the local hospital, and $33,000 her alma mater's endowment fund. Mary's return objective is closest to:

Which of the following statements regarding the investment horizon (time) constraint is(are) correct?

A long-term time horizon may be divided into several stages.

The execution stage of the investment management process least likely includes:

Analysis of capital market expectations.

Mrs. Meadows has a history of insisting that her risk tolerance level is high during periods of economic prosperity, and asking that the portfolio be invested in risky stocks, and then changing her mind during economic recessions and asking that the stocks be sold. This should be noted in which of the following constraints?

Behavioral constraint.

A financial adviser is crafting the policy statement for a client and investigates several key factors that will influence his allocation decision. The factors include commodity prices, rate of inflation, and exchange rates. The financial adviser is most likely performing:

Economic analysis.

Emma-Jean is 30 years old and has a low tolerance for risk; however, the return objective for her retirement portfolio is 9.5%. Which of the following is the most appropriate action for the portfolio manager to take?

Educate the client regarding the need to accept additional risk to meet her objectives, and risk characteristics over long time horizons.

The least likely goal of both the CFA® and the CFP® codes of conduct is:

Guarantee of superior performance by portfolio managers.

John Ball is a first-time homeowner who purchases a home for $200,000 using a down payment of $20,000. The monthly mortgage payment is $1,079.19. The annual property tax bill of $6,321.82 is most likely a:

Liquidity constraint.

Andrea grew up in a family where money and investing conversations were commonplace. Her father bought her 18 shares of Brick, Co. stock for her 18th birthday and she has enjoyed watching the price fluctuate up and down over the past 5 years. She does not have any savings other than the Brick stock, and she has $70,000 in student loans that she must begin paying on this year. She knows that her budget will be tight, but feels that she can make it work as long as she can find a full-time job with benefits upon graduation from college. Andrea's ability to take risk is most likely:

Low

Lavar Boots is a financial adviser and interviews a new client. Lavar recommends an investment in longer-term bonds because of an expectation that interest rates will fall over the next five-year period. The recommendation is most likely a part of the:

Planning stage.

All of the following statements regarding a pension fund's ability to take risk are correct EXCEPT:

Plans that are fully funded have a reduced ability to take risk.

Which of the following is not a correct description of the section of the investment policy statement (IPS)?

Purpose: States the expectation that the portfolio will outperform the market.

A correlation coefficient between pension assets and annual operating cash flows of the plan's sponsor is 0.85. Details of the correlation coefficient will most likely:

Result in a low ability to take risk in the policy statement.

All of the following should be included in the tax constraint for an individual investor EXCEPT:

Social Security taxes withheld from the investor's paycheck.

Which of the following is most likely to be a component of an investor's ability to take risk?

The client has a net worth of $1.5 million.

The return objective for a pension fund is most likely a function of:

The discount rate used to compute the present value of the pension obligation.

The board of trustees of an endowment fund has agreed with its financial adviser to permit the use of derivative securities to add value to the portfolio. This decision is most likely to appear as part of the:

Unique circumstance constraint.