Series 66: Portfolio / Fixed Income Basics (Portfolio Management Styles)

A customer who wishes to sell securities in the market will receive the:

bid price Bid and ask are always from the standpoint of the dealer. The dealer will buy from a customer at the dealer's bid (buying price); the dealer will sell to the customer at the dealer's ask (offering price). If a customer wishes to sell, he or she will be selling to the dealer at the dealer's bid price.

An agent places an order to sell 10,000 shares of ABC stock at the market close. This is known as:

block trading A trade of 10,000 shares or more is a block trade. Such a trade can be large enough to strongly influence the market price of a stock, so these are often handled outside of computerized execution systems to avoid a market price distortion. There is no information given in the question to show that the trade is manipulative or a prohibited practice.

Adding foreign stocks to a portfolio of domestic securities:

decreases risk Diversifying across countries is another way for an investor to reduce risk of a portfolio. Domestic stock prices and foreign stock prices are not directly linked. Each country's economy is different and is responding to different events (usually).

An order ticket to sell 100 shares of ABC short means that the seller will:

deliver shares that are borrowed on settlement date A short sale is a sale of borrowed shares. The customer is speculating that the price of the security will drop, and borrows the shares from a broker to sell. These borrowed shares are delivered to the buyer on settlement date. The short seller intends to buy back the stock at a later date (hopefully at a lower price) and replace the borrowed (short) position.

An institutional customer places a very large order to buy a thinly-traded security. The trader who receives the order believes that it will push the market price of the stock up and, prior to entering the order, places an order to buy that stock for the firm's trading account. This is an example of:

front running When a trader gets a large institutional order that will have a "market impact," the temptation is to place an order to benefit from the expected market move prior to entering the large institutional order. This is called "front running" and is explicitly prohibited. In contrast, "trading ahead" is a specific NYSE violation where a Specialist (DMM), rather than matching a customer who wants to sell at the market to another customer who wants to buy at the market, "trades ahead" and instead, buys the security from the seller into the Specialist's inventory account and then sells it to the buyer out of that inventory account at a penny higher price (another name for this is "pennying"). Review

An investment strategy where a higher price is paid for a stock based upon expected returns is:

growth investing A growth investor buys a stock based upon demonstrated growth in earnings or sales over time. The theory is that such companies can continue to grow rapidly, and therefore should command a higher market price.

A company that is listed on the NYSE has been in business for 3 years. It has a high P/E ratio, has rapidly growing earnings, but has never paid a dividend. This would be categorized as a:

growth stock A growth stock has a high Price/Earnings ratio, growing earnings and a low or non-existent dividend payout ratio. The return to investors comes from a growing share price. A value stock gives investors "value" for their money. They are stable companies that are consistently profitable, but are currently out-of-favor with investors (as evidenced by a low Price/Earnings ratio). The view is that they will come back into favor as investors realize that the company is undervalued and will appreciate in price more rapidly than the overall market.

An order ticket to sell may be marked "long" in all of the following circumstances EXCEPT the customer:

holds fully paid warrants to buy the underlying stock in custody of the broker-dealer A customer is "long" if the customer owns an option, right or warrant on that stock and has exercised (so we know that the stock is actually coming in). Similarly, if a customer is short a put and it has been exercised, we know that the customer will be receiving the stock - so the customer is "long." A customer is "long" if the customer owns a convertible security (into that stock) and has given irrevocable instructions to convert. If a customer simply owns a right, call, or warrant; is short a put; or owns a convertible; this is not considered to be "long" the underlying stock until the action is taken to turn that instrument into that stock.

The Specialist (Designated Market Maker) can handle all of the following orders on the NYSE floor EXCEPT a:

not held order A Specialist (Designated Market Maker) cannot exercise discretion over price or time of execution, and therefore cannot accept a not held order. Specialists accept market, marketable limit and limit orders for execution.

All of the following customers are considered to be long 100 shares of ABC stock EXCEPT a customer who:

owns 1 ABC call contract A customer is considered to be long stock once the stock has been purchased. The transaction does not have to settle for the customer to be considered to be long. A customer is considered to be long if he owns options or warrants and has exercised. Choice B is not considered a long stock position since the call has not been exercised, while Choice D is a long position because the warrants have been exercised. A customer is considered to be long stock if the customer owns a convertible security and gives irrevocable instructions to convert (Choice C), because he or she will then receive the shares from the conversion.

A customer is dollar cost averaging by investing $400 per month into a mutual fund. Over 4 months, the customer has made purchases at $13 per share, $10 per share, $8 per share, and $9 per share. By using this method, the customer has an average cost per share that is how much lower than the average price per share?

$.32 Month Investment Share Price Number of Shares Purchased 1$400$13 30.7692$400$10 40.0003$400$8 50.0004$400$9 44.444$1600165.213 shares The average cost per share is: $1600/165.213 shares = $9.68 per share. The average price per share is: $13 + $10 + $8 + $9 = $40 / 4 = $10 per share. Thus, the average cost is $.32 lower than the average price per share. Finally, note that mutual funds can issue fractional shares.

A stock is quoted as follows: Bid Ask 18.95 19.00 10 x 10 The spread for a round turn trade is:

$50 The size of the quote is "10 x 10" = 10 round lots of 100 shares = 1,000 shares both bid and offered. If the dealer sells 1,000 shares at $19.00 and buys 1,000 shares at $18.95 (a round turn trade), the dealer makes a spread of $.05 on 1,000 shares = $50.

A portfolio manager generates a 20% rate of return on a "small cap" portfolio, compared to a 15% rate of return on the benchmark portfolio and a 10% rate of return on the Standard and Poor's 500 index over the same period. The passive rate of return on the portfolio is:

15% The "passive" rate of return is that achieved by investing in an appropriate index fund. Here, the benchmark index has a 15% rate of return - this is the return that any passive investor could achieve by investing in an index fund that mimics that index.

A portfolio manager generates a 10% rate of return on a "small cap" portfolio, compared to an 8% rate of return on the benchmark portfolio and a 6% rate of return on the Standard and Poor's 500 index over the same period. The active rate of return on the portfolio is:

2% The "active rate of return" measures a manager's performance against the appropriate benchmark portfolio (typically an index of securities with similar characteristics to the portfolio being actively managed). The manager achieved a 10% rate of return; compared to the benchmark portfolio return of 8%. Thus, the active rate of return is 2%. The manager's abilities allowed him or her to do 2% better than a passive indexed portfolio of similar investments.

A 25-year old man receives $50,000 and wants to retire at age 65 with an income of $1,500 per month from his investment portfolio. The adviser should invest:

25% in bonds and 75% in stocks As a "rule of thumb," when balancing investments between stocks and bonds, the portion of the portfolio that should be invested in equities is "100% minus that person's age." Since this individual is age 25, 75% should be invested in equities for growth; with the other 25% invested in safe bonds.

Dealers are showing the following quotes for ABCD stock: ABCD Stock Bid Ask Size Dealer A 9.75 9.85 10 x 20 Dealer B 9.80 9.90 5 x 10 Dealer C 9.70 9.95 15 x 25 The "size" of the market is:

5 x 20 The "inside market" is the high bid and low ask. These are the best prices at which to trade.Stocks are purchased from a dealer at the dealer's ask price - and paying less to buy is better - so the low ask of $9.85 is the best price at which to buy. Stocks are sold to a dealer at the dealer's bid price - and receiving more to sell is better so the high bid of $9.80 is the best price at which to sell. Quotes are shown in Bid / Ask order, so the high bid is 9.80 and the low ask is 9.85. The size of this market is 5 x 20. Dealer B is posting the best bid of $9.80 and is willing to buy 500 shares (5 round lots) at that price. Dealer A is posting the best ask of $9.85 and is willing to sell 2,000 shares (20 round lots) at that price.

Dealers are showing the following quotes for DEFF stock: DEFF Stock Bid Ask Size Dealer A 6.75 6.95 10 x 20 Dealer B 6.60 6.85 5 x 10 Dealer C 6.65 7.00 15 x 25 The "inside market" is:

6.75 - 6.85 The "inside market" is the high bid and low ask. These are the best prices at which to trade. Stocks are purchased from a dealer at the dealer's ask price - and paying less to buy is better - so the low ask of $6.85 is the best price at which to buy. Stocks are sold to a dealer at the dealer's bid price - and receiving more to sell is better so the high bid of $6.75 is the best price at which to sell.Quotes are shown in Bid / Ask order, so the high bid is 6.75 and the low ask is 6.85. The size of this market is 10 x 10. Dealer A is posting the best bid of $6.75 and is willing to buy 1,000 shares (10 round lots) at that price. Dealer B is posting the best ask of $6.85 and is willing to sell 1,000 shares (10 round lots) at that price.

Portfolio management "styles" are:

Active and Passive The management "styles" are basically active asset management (the manager selects the specific investments) or "passive" asset management, where the manager uses index funds as the investment vehicle. Growth stocks and income investments are 2 asset classes than can be used in setting an investment strategy. Systematic and non-systematic refer to risk that can be diversified away (non-systematic risk) and risk that cannot be diversified away (systematic risk, which is the same as market risk). Top-down and bottom-up refers to different methods of analyzing particular investments. Top-down starts at the sector level to find industry sectors that are likely to outperform and drills down to specific companies that are good investments. Bottom-up starts at the company level to identify better investment opportunities, regardless of industry sector.

Broker-dealers are permitted to execute all of the following over-the-counter transactions EXCEPT:

Agency trades where the customer is charged a fair and reasonable mark-up or mark-down In over-the-counter transactions, for effecting an agency trade, only a commission can be charged; while in a principal transaction, only a mark-up or mark-down can be charged. It is prohibited to charge a commission in a principal transaction. Similarly, it is prohibited to charge a mark-up in an agency transaction.

An Investment Adviser has clients who have positions in ACME Company. If the company has an earnings beat at its next quarterly earnings announcement, she believes the stock will rise rapidly. She wants to place orders for her customers that have ACME positions to sell the stock, capturing the gain, if the price rises sufficiently. She has other customers who do not have a position in ACME stock, and believes that if the price starts to rise, the upward momentum will propel the stock much higher. For these customers, she wishes to place orders to buy if the price starts to rise. What two orders should she use?

Buy Stop and Sell Limit Buy limit orders are placed below the current market and are filled if the market price falls. In contrast, buy stop orders are placed above the current market and are filled if the market price rises. Sell limit orders are placed above the current market and are filled if the market price rises. Sell stop orders are placed below the current market and are filled if the market price falls. For those customers with positions in ACME stock, the IA wants to sell if the price rises, so sell limit orders must be placed. For those customers for whom the IA wants to buy if the market price starts to rise, buy stop orders must be placed.

All of the following statements concerning dollar cost averaging (DCA) are correct EXCEPT:

DCA reduces the cost of purchasing shares below current market price Dollar-cost averaging is a way to reduce the investor's average cost of shares below the average price per share over the same period. The average cost will not be below the market price, and may actually be above the current market price in a steadily decreasing market. DCA requires an investor to make fixed dollar investments at regular intervals without regard to market trends. The result will be that the investor will buy more shares when the price falls and fewer shares when the price for shares is high.

The index that is composed of companies in developed countries outside of the United States is the:

EAFE The EAFE Index stands for Europe, Australasia, and the Far East. It consists of companies of developed countries in these areas - so these are all companies outside of North America. Investing in an EAFE ETF would give the customer international exposure. The S&P 500 and Russell 2000 consist of U.S. companies. ADRs are American Depositary Receipts - the way in which foreign companies list their shares in the U.S. They are not Index Exchange Traded Funds.

Which investment is LEAST likely to offer tax advantages?

Growth stock Real estate offers the tax advantages of depreciation deductions, deduction of mortgage interest and potential capital gains when the property is sold. Municipal bonds offer the tax benefit of no Federal tax on the interest income received. A Standard and Poor's 500 index fund is said to be "tax-efficient" because the fund manager does not routinely buy and sell positions in the fund. The fund composition is changed only when the index composition is changed (which occurs, at most, 1 time per year). Thus, such a fund generally does not have capital gains to distribute to shareholders annually, whereas an actively managed fund would. A growth stock is the best choice offered. Its only tax advantage is that growth in share price is taxed at capital gains rates when sold if the position is held for over 1 year. Also note that arguments could be made comparing the tax benefits of a growth stock vs. a Standard and Poor's 500 index fund, but we feel that a growth stock is the best choice offered.

Which of the following is NOT a benefit of making an investment in an emerging markets fund?

Higher investment yield An emerging markets fund is a type of growth fund (growth investing) that invests in companies in rapidly growing countries (e.g., a "BRIC" Fund - Brazil-Russia-India-China). Investing via a mutual fund structure provides diversification (which reduces investment risk) and provides liquidity, since the fund shares can be redeemed daily at NAV, or if the fund is closed-end, the shares can be sold in the market. What is not a benefit is a higher investment yield - the yield may be higher than making direct investments in these foreign stocks or it may be lower. Furthermore, the expenses of running the fund (which include a high management fee for these types of funds) can be a real drag on returns. So, while the investment return may be better than direct investing, it might also be worse. This is the best of the choices offered.

The spread is: I earned by a market maker when it effects a round turn principal transaction II earned by an order entry firm when it effects a riskless agency transaction III the difference between the bid and ask quote IV represents the commission charged for effecting the trade

I and III A market maker maintains a bid-ask quote in each security in which a market is made. The ask price is always higher than the bid price. Assume that the bid-ask is 34-35. For each round-turn trade done by the market maker, $1 is earned (sell at the ask of $35; buy back at the bid of $34). This is the "spread" and is the compensation earned by the market maker. Most of the larger market making firms do not deal with the public. As an example, Knight Trading is the biggest NASDAQ market maker and it does not take public orders. A retail firm will route a buy order to Knight and buy at the ask price and then add a commission to the price as agent on the customer confirmation; or it will route a sell order to Knight and sell at the bid price and then subtract a commission from the sale proceeds on the customer confirmation as agent. A member firm can have both a market making operation and a retail operation under the same holding company. For example, UBS is the 2nd largest NASDAQ market maker, and it also has a retail brokerage unit. If a customer of the retail brokerage unit places an order to buy, it can be filled by UBS's market making desk at the ask price and then UBS adds a mark-up to the price on the customer confirmation (because it is a dealer in that security so it is acting as a principal in the transaction). If a customer of the retail brokerage unit places an order to sell, it can be filled by UBS's market making desk at the bid price and then UBS subtracts a mark-down from the price on the customer confirmation (because it is a dealer in that security so it is acting as a principal in the transaction).

A stock is quoted as follows: Bid Ask 18.95 19.00 10 x 10 The spread for a round turn trade is: I $.05 II $5 III $50 IV $500

I and III The size of the quote is "10 x 10" = 10 round lots of 100 shares = 1,000 shares both bid and offered. If the dealer sells 1,000 shares at $19.00 and buys 1,000 shares at $18.95 (a round turn trade), the dealer makes a spread of $.05 on 1,000 shares = $50.

Which 2 of the following investments are passively managed? I Index funds II Sector funds III Growth funds IV Unit investment trusts

I and IV Growth funds are actively managed - the manager chooses the stocks to buy and sell in the fund in an attempt to outperform. The same is true for Sector funds. Index funds match the portfolio composition to a benchmark index, so they are passively managed. UITs (Unit Investment Trusts) have a fixed portfolio that is established when the trust is created and that portfolio does not change. So a UIT is really not managed at all - which, in a sense, is the ultimate form of passive management!

Which statements are TRUE? I Strategic portfolio management is the determination of the asset allocation percentages among differing asset classes in the portfolio II Strategic portfolio management is the determination of the permitted variance within each asset allocation percentage assigned to a specific asset class III Tactical portfolio management is the determination of the asset allocation percentages among differing asset classes in the portfolio IV Tactical portfolio management is the determination of the permitted variance within each asset allocation percentage assigned to a specific asset class

I and IV Strategic portfolio management is the determination of the percentage allocation to be given to each investment vehicle within an asset class - for example a portfolio might be strategically allocated as follows: Money Market Instruments10% Corporate Bonds30% Large Cap Equities50% Small Cap Equities10% Tactical asset management is the permitted variance within each allocation percentage. For example, Large Cap equities are allocated 50%, but the manager may be tactically allowed to lower this percentage to, say, 40% or raise it to 60%. Thus, if the manager believes that Large Cap equities will underperform the market, he or she can lower the allocation to 40%; and if the manager believes that they will outperform the market, he or she can raise the allocation to 60%. This gives the manager some ability to "time the market" when conditions are overbought or oversold.

An investment policy statement prepared for a client would include which of the following? I Expected returns of the recommended strategy and the variance of these returns II Recommended allocations among differing asset classes III Strategies used for selecting specific stocks in the equity portion of the portfolio

I, II, III The investment policy statement prepared for a client for whom a portfolio is to be constructed details the allocation percentages for each chosen asset class; and the expected returns from each class along with the possible variance of these returns. In addition, it can detail any strategies used for "tactically" timing the market when choosing specific investments within each class. Thus, the customer has a written statement detailing the major aspects of how the portfolio will be constructed and managed. Review

Which of the following transactions can be effected in a cash account? I The purchase of marginable securities II The purchase of non-marginable securities III The short sale of marginable securities IV The long sale of marginable securities

I, II, IV Any security, whether marginable or not, can be purchased in a cash account as long as 100% of the purchase amount is deposited. In a margin account, marginable securities can be purchased by putting up the 50% Reg. T. margin percentage (or more than this, if the customer so wishes). Only "long" sales are permitted in cash accounts - in a long sale the customer is delivering the shares that he or she owns to settle the transaction. Short sales (sales of borrowed shares) can only be effected in margin accounts (and these require that a 50% margin deposit be made).

Which of the following information is on an order ticket? I Order size II Duration of order III Price of the transaction if it is a market order IV Name of security

I, II, IV The order ticket will have the order size, duration of order (Day, GTC, etc...), and the name of the security. If the order is a market order, no price is specified - the order is marked "MKT." The order is filled at the prevailing market price.

"DRIPs": I are offered by broker-dealers II are offered by issuers III allow for investment in an issuer's securities with no commission charges IV allow for investment in an issuer's securities with regular commission charges

II and III "DRIP" stands for "Dividend Re-Investment Plan." These are plans offered by corporate issuers that give shareholders the ability to reinvest cash dividends paid by the company in additional shares of that company. This is a feature similar to automatic reinvestment of dividends at NAV in a mutual fund. There are no commission charges on reinvested dividends and fractional shares can be purchased. The issuer's DRIP allows the shareholder to build an increasing position in that issuer's stock over time in a passive fashion. Because additional shares are purchased periodically with the reinvested dividends, this is a form of dollar cost averaging. The disadvantage of a DRIP is that the investor cannot determine the timing of these incremental purchases.

An IAR has constructed a buy and hold bond portfolio. The major factors to consider are: I selecting bonds that will give superior performance II making sure all of the bonds have a high credit rating III choosing bonds that are not callable IV choosing bonds from differing issuers

II and III A buy and hold bond portfolio is completely passively managed. Bonds are purchased and simply held to maturity. There is no periodic rebalancing. To do this correctly, only non-callable bonds of the highest credit quality should be purchased. Otherwise, bonds can be called, forcing the investor to make new bond purchases over the investment time horizon. Since the investments will be held for a long time without change, deteriorating credit quality is an issue and only the highest quality issues should be purchased.

Buy and hold is an appropriate strategy when investing in: I stocks II stock mutual funds III stock exchange traded funds IV stock options

II and III Because funds are managed by an investment adviser, they are designed to be a "buy and hold" investment. The fund manager is constantly deciding which securities positions to add to, or subtract from, the portfolio to maximize returns. Therefore, the investment is continually rebalanced. Direct investments in specific assets, such as stocks or corporate bonds, require that the investor rebalance periodically to maximize returns.

Bid and ask quotes in a dark pools are: I publicly displayed II not publicly displayed III for 100 share round lots IV for 10,000 share or greater block trades

II and IV Dark pools are operated by the larger broker-dealers (e.g., Goldman Sachs) and there are some that are independent companies (e.g., Liquidnet). They allow institutions to buy or sell very large blocks without displaying their orders in a display system such as NASDAQ. They are called dark pools because the size of the trade and the identity of the institution are not displayed. This avoids the problem that could occur where the display of a very large order in such a system, by itself, could move the market. If there is a match in a dark pool and a trade results, it still must be reported to the appropriate tape. The hours of operation of a dark pool are the same as those for the public exchanges since their pricing is usually tied to the market price on the exchange at that moment.

In the beginning of a period of economic recovery, an investor who employs a sector rotation strategy would allocate investment funds to:

Technology stocks A sector rotation strategy allocates funds to differing economic sectors that tend to "outperform" based on the phase of economic cycle. The sectors that do this are: Early Phase Recovery: Technology Late Phase Recovery: Industrials Peak: Consumer Goods Early Phase Recession: Utilities / Telecoms Late Phase Recession: Financials

Which of the following statements are TRUE regarding the use of index funds as investment vehicles for asset classes? I The use of index funds increases market risk II The use of index funds reduces market risk III Index funds are narrowly diversified IV Index funds are broadly diversified

II and IV Index funds are broadly diversified, since they hold all of the securities in the designated index. This reduces market risk or the standard deviation of return. The impact of diversification on the portfolio's rate of return should be one of lowering the rate of return closer to the market average, along with lowering the risk associated with that rate of return.

Which statement is true regarding dollar cost averaging?

If market prices are fluctuating, the plan will produce a lower average per share cost Dollar cost averaging requires that an investor make periodic payments (say monthly) of a fixed dollar amount (say $100 per month) to buy a given security. If the price of the security is fluctuating, the average purchase cost per share will be lower for the investor than the simple mathematical average price of the shares over the same period. Dollar cost averaging does not work if the price of the stock remains fixed, nor does it protect against loss in a falling market.

Which statement is TRUE about agency transactions?

In an agency transaction, a commission is charged In an agency transaction, a commission is charged. In a principal transaction, a mark-up or mark-down is charged. It is prohibited to charge both a commission; and a mark-up or mark-down; in the same transaction.

The S&P 500 is a(n):

Index The Standard and Poor's 500 is an index, consisting of the 500 largest companies headquartered in the United States, by market capitalization. The SPY is the Standard and Poor's 500 Index "Depository Receipt" - it is an Exchange Traded Fund (ETF). Note that the S&P 500 Index itself is not an asset class - asset classes used for investment are broadly defined as stocks, bonds, cash, real estate, and commodities. Thus, the S&P 500 Index would be a subset of the "stocks" asset class.

All of the following investments offer tax benefits EXCEPT:

Index Funds Municipal bonds offer interest income that is free of federal income tax and free of state and local income taxes when purchased by a resident of that state. Thus, they offer a tax benefit. Direct investment in real estate permits the owner to deduct depreciation and mortgage interest cost, so this is a tax benefit. Variable annuities offer the tax benefit of tax-deferred build up in the separate investment account. Mutual funds do not allow for "flow-through" of loss deductions; they do not offer an exemption from federal income taxation on either interest or dividend income that is distributed to shareholders; and if a shareholder reinvests distributions, they are still taxable (there is no tax-deferred build-up).

A corporation that has a market capitalization of $40,000,000 would be an appropriate investment for a:

Micro Cap Mutual Fund A "Micro Cap" stock is one with a market capitalization of up to $300 million. A "Small Cap" stock is one with a market capitalization between $300 million and $1 billion. A "Mid Cap" stock is one with a market capitalization between $1 billion and $5 billion. A "Large Cap" stock is one with a market capitalization over $5 billion.

A corporation that has a market capitalization of $4,000,000,000 would be an appropriate investment for a:

Mid Cap Mutual Fund A "Micro Cap" stock is one with a market capitalization of up to $300 million. A "Small Cap" stock is one with a market capitalization between $300 million and $1 billion. A "Mid Cap" stock is one with a market capitalization between $1 billion and $5 billion. A "Large Cap" stock is one with a market capitalization over $5 billion.

Which investment offers tax benefits?

Municipal bond funds Municipal bonds funds offer interest income that is free of federal income tax and free of state and local income taxes when purchased by a resident of that state. Thus, they offer a tax benefit. REITs, International Funds, and Index Funds do not offer an exemption from federal income taxation on either interest or dividend income that is distributed to shareholders.

A portfolio characterized by high growth and low dividend paying stocks would be invested in the stocks in the:

NASDAQ Composite Index The S&P 500 and NYSE Composite Index are generally composed of large capitalization mature companies. Mature companies are characterized by low growth rates and high dividend payout ratios. The NASDAQ Index is heavily weighted in younger high tech growth companies, with smaller market capitalizations (aside from some notable large cap issues like Microsoft, Intel and Apple). Growth companies are characterized by high growth rates and low dividend payout ratios. Finally, the Wilshire Index consists of all NYSE, AMEX (NYSE American) and NASDAQ issues, so it is a blend of small, mid and large cap issues.

A portfolio invested in actively managed funds that is rebalanced annually is considered to be:

Passive/Active The terms "active" and "passive" are most often used when looking at the management of a stock portfolio. An actively managed portfolio has its investments selected by a professional manager; whereas a passive portfolio has a composition that is matched to a market index. However, "active" and "passive" can also be used to refer to the frequency of portfolio rebalancing. A portfolio that is rebalanced once annually is said to be "passive;" a portfolio that is rebalanced more frequently or as market conditions move is said to be "active." These terms can be combined to describe both the frequency of rebalancing (active or passive) and the underlying investment style (active or passive). Therefore, a portfolio that is: rebalanced monthly and actively managed is called: "Active/Active;" rebalanced annually and actively managed is called: "Passive/Active;" rebalanced monthly and invested in index funds is called: "Active/Passive;" and rebalanced annually and invested in index funds is called: "Passive/Passive."

A portfolio invested in index funds that is rebalanced annually is considered to be:

Passive/Passive The terms "active" and "passive" are most often used when looking at the management of a stock portfolio. An actively managed portfolio has its investments selected by a professional manager; whereas a passive portfolio has a composition that is matched to a market index. However, "active" and "passive" can also be used to refer to the frequency of portfolio rebalancing. A portfolio that is rebalanced once annually is said to be "passive;" a portfolio that is rebalanced more frequently or as market conditions move is said to be "active." These terms can be combined to describe both the frequency of rebalancing (active or passive) and the underlying investment style (active or passive). Therefore, a portfolio that is: rebalanced monthly and actively managed is called: "Active/Active;" rebalanced annually and actively managed is called: "Passive/Active;" rebalanced monthly and invested in index funds is called: "Active/Passive;" and rebalanced annually and invested in index funds is called: "Passive/Passive."

Which of the following is an "asset class"?

Real Estate Asset allocation theory says that allocating assets among a selection of asset classes based on investment objectives and risk tolerance provides needed diversification. These allocations are rebalanced periodically (typically at least annually) based on changing needs over time as well as relative performance of each asset class. The typical asset classes are: Cash/Money Market Instruments Fixed Income Securities Equities Commodities Real Estate Note that jewelry, furniture and life insurance are not asset classes.

Credit on securities extended by brokers to customers is controlled by:

Regulation T Credit on securities from broker to customer is controlled by Regulation T of the Federal Reserve Board.

A client of an investment adviser wishes to invest in an index which consists of small capitalization issues. The investment adviser would recommend the:

Russell 2000 The Russell 2000 index consists of 2,000 small capitalization issues. The Value Line Index consists of some 1,700 stocks followed by the Value Line Investment Survey, spread among NYSE, AMEX (NYSE American) and NASDAQ issues. The Dow Jones Averages consists of 30 industrials, 20 transportation and 15 utilities. The Wilshire Index consists of about 6,000 issues of companies headquartered in the United States that are listed on the NYSE, AMEX (NYSE American), or NASDAQ.

Which of the following indexes is the most widely quoted measure of the overall performance of small to mid cap company shares?

Russell 2000 Index The NASDAQ 100 Index tracks the 100 largest stocks included on NASDAQ. The Standard and Poor's 500 Index consists of large capitalization issues. The Value Line Index of about 1700 stocks consists mainly of NYSE, AMEX (NYSE American) and large NASDAQ issues, so these are primarily large capitalization issues as well. The Russell 2000 index consists of 2,000 small capitalization issues. Though the Russell is "small," it is not a "micro cap" index. The average Russell 2000 company's market capitalization is over $500 million. The market cap of the largest company in the index is about $1.4 billion - comparing that to an S&P 500 top holding like Apple with a market cap of $900 billion.

Which transaction can ONLY be done in a margin account?

Short sale of stock Both stock and options can be purchased in cash accounts or margin accounts. A long sale is the sale of a position that is owned. Such a sale can occur in either a cash or margin account. The short sale of stock is the sale of borrowed shares. Short sales can only be done in a margin account, since they require a substantial margin deposit due to the risk of unlimited loss.

Which transaction is NOT permitted in a cash account?

Short sale of stock Both stock and options can be purchased in cash accounts or margin accounts. A long sale is the sale of a position that is owned. Such a sale can occur in either a cash or margin account. The short sale of stock is the sale of borrowed shares. Short sales can only be done in a margin account, since they require a substantial margin deposit due to the risk of unlimited loss.

A corporation that has a market capitalization of $400,000,000 would be an appropriate investment for a:

Small Cap Mutual Fund A "Micro Cap" stock is one with a market capitalization of up to $300 million. A "Small Cap" stock is one with a market capitalization between $300 million and $1 billion. A "Mid Cap" stock is one with a market capitalization between $1 billion and $5 billion. A "Large Cap" stock is one with a market capitalization over $5 billion.

A customer places an order on the NYSE to buy bonds. The order reads "Buy 5M ABC 9s M '42 @ 90 GTC". Which statement is true about this order?

The order must be executed at a price of 90 or better Since this order was entered "GTC" - "good til canceled" - the order stays on the books of the Specialist/DMM until execution is possible. The customer is attempting to establish a long position with this order and wants to buy for 90% of par or less if possible. If executed, the customer is buying $5,000 par value (5M = $5,000) of bonds at 90% = $4,500 or less.

What is the trading characteristic of a Fixed UIT?

The sponsor makes an OTC market in trust units Fixed Unit Investment Trusts are investment company securities that are initially sold with a prospectus at the POP. Thereafter, the sponsor makes a market in trust units, and will buy back trust units from investors that wish to get out of them. The sponsor will then resell these "used" trust units for their remaining value to other investors. Also note that in the prospectus, the wording covering this typically goes "the sponsor currently makes a market in trust units and intends to continue making a market in trust units, but is under no obligation to make a market in trust units." Open-End investment companies are mutual funds. These are issued by the fund sponsor and are redeemable at any time with the sponsor. They do not trade. Closed-end funds are investment companies that have an IPO and then are "closed" to new investment. They are listed on an exchange and trade like any other stock.

What is the trading characteristic of an Open-End fund?

They are securities which are redeemable with the sponsor at any time Closed-end funds are investment companies that have an IPO and then are "closed" to new investment. They are listed on an exchange and trade like any other stock. Open-End Investment companies are mutual funds. These are issued by the fund sponsor and are redeemable at any time with the sponsor. They do not trade. Unit Investment Trusts are investment company securities that are initially sold with a prospectus at the POP. Thereafter, the sponsor makes a market in trust units, and will buy back trust units from investors that wish to get out of them. The sponsor will then resell these "used" trust units for their remaining value to other investors.

What is the trading characteristic of a Closed-End fund?

They trade on exchanges like any other stock Closed-end funds are investment companies that have an IPO and then are "closed" to new investment. They are listed on an exchange and trade like any other stock. Open-End Investment companies are mutual funds. These are issued by the fund sponsor and are redeemable at any time with the sponsor. They do not trade. Unit Investment Trusts are investment company securities that are initially sold with a prospectus at the POP. Thereafter, the sponsor makes a market in trust units, and will buy back trust units from investors that wish to get out of them. The sponsor will then resell these "used" trust units for their remaining value to other investors.

Two bonds are issued at the same time, by the same company, with the same coupon and maturity. One year after issuance, the bonds are traded at the same time in the market at two different prices. Which statement is TRUE about this?

This could occur because the bonds are traded OTC Because the bonds are exactly the same, in theory, they would trade at the same price. However, bonds trade in the OTC market and not on an exchange. The OTC market is a network of independent dealers who trade. In the OTC market, each bond dealer prices the bonds as the dealer sees fit. Each dealer will not have the exact same price. (For example, different car dealers offer the same exact car at different prices).

All of the following terms are synonymous EXCEPT:

agent A dealer is a market maker, who is a principal in a transaction, earning a mark-up or mark-down. An agent is a broker who is middleman in a transaction, earning a commission.

The simplest way of investing in a mutual fund is:

buy and hold Because mutual funds are managed by an investment adviser, they are designed to be a "buy and hold" investment. The fund manager is constantly deciding which securities positions to add to, or subtract from, the portfolio to maximize returns. Therefore, the investment is continually rebalanced. Dollar cost averaging is a more disciplined method of making mutual fund investments - but it required the investor to make periodic purchases of constant dollar amounts over a long time frame, so it is not as "simple" as just "buy and hold."

One of the oldest portfolio strategies that is used in a stable interest rate environment is:

buy and hold Buy and hold is the oldest and simplest portfolio strategy. If interest rates are stable, then interest rate risk for a bond portfolio is minimized, and the risk of rising interest rates hurting stock valuations minimizes market risk for stock portfolios. Momentum investing is a technical strategy that says that stocks that have momentum behind them are likely to continue in that direction. Swaps and options are not strategies - they are derivatives.

An example of a passive long term bond investment strategy is:

buy and hold Since long term bonds are more volatile than short term bonds as market interest rates move, a long term bond investor should be a "buy and hold" investor. As long as the bond is held to maturity, the bondholder will not experience a market value loss due to an interest rate rise. This is a "passive" strategy because it does not require a manager to decide when to change the portfolio composition. When constructing a bond portfolio, "laddering" the portfolio means that the portfolio is structured with short-term; intermediate term; and long-term investments. As the short-term bonds mature, the proceeds are reinvested either in new short-term, intermediate-term or long-term bonds, depending on anticipated movements in interest rates (if rates are expected to rise, then the proceeds are invested in short-term bonds, which will fall the least from a market interest rate rise; if rates are expected to fall, then the proceeds are invested in long term bonds, which will rise the most from a market interest rate fall; if rates are expected to be stable, then the proceeds are invested in intermediate term bonds). Thus, there is active portfolio rebalancing going on as interest rates move - so this is an example of an interest rate anticipation strategy. A barbell strategy is a similar strategy, using only short term and long term bonds (the 2 ends of the barbell). Thus, a barbell, a ladder, and interest rate anticipation, are all "active" strategies.

All of the following information must be on an order ticket before it can be entered EXCEPT:

commission The commission is calculated after the trade is executed - it is not on the order ticket that is used to enter the order. The ticket must include the size of the trade, desired execution price, and customer identification

An investment approach where an active bond fund manager will switch to a defensive strategy if the portfolio falls below a predetermined point is known as:

contingent portfolio immunization Do not confuse bond portfolio immunization with "contingent" bond portfolio immunization. Portfolio immunization protects a bond portfolio against interest rate risk. It is the strategy of managing a portfolio to make it worth a specific amount at a stated date in the future. This strategy is typically used to fund a known future liability, and often uses a top-credit rated zero coupon bond that matures at the obligation due date as the funding vehicle. Contingent bond portfolio immunization is an "active management" strategy where the manager attempts to select bonds that will outperform a benchmark index; but if the portfolio drops below a predetermined value, the manager shifts to a defensive strategy, buying top-credit rated bonds with a lower rate of return, but this assures, at least, a minimum return rate. Also note that while there is contingent portfolio immunization, there is no such thing as contingent portfolio rebalancing.

The stock market has reacted negatively to the release of strongly negative economic indicators and has fallen by 15% over a 2 week time window. An investor that believes that this is a buying opportunity would be called a(n):

contrarian A "contrarian" is a person that goes against the conventional wisdom. Thus, when the market is rising rapidly, the contrarian believes that it is ready for a fall and will sell; and when the market has declined precipitously, the contrarian believes that the market will rise, and will buy.

Which of the diversification factors below will NOT reduce the non-systematic risk of a portfolio?

coupon rate The coupon rate has no bearing on diversification. In the trading market, the price of a bond is determined by the market yield for that type of security - not the coupon rate. To reduce non-systematic risk (meaning the risk that any one security may be a "bad" investment), diversification of a bond portfolio by choosing different issuers, different industries, different geographic issuer locations, and different maturities (since long term prices are more volatile than short-term debt prices) are all valid.

The Investment Policy Statement would include the:

customer investment objectives and goals The Statement of Investment Policy documents the asset allocation plan that has been created for the client. It details the portfolio goals such as expected returns and investment strategies. It typically specifies the asset allocation plan, identifies acceptable levels of risk, and acceptable investment types. The investment manager's compensation has nothing to do with this document. The investment adviser's mission statement and the adviser's specific portfolio review procedures also have nothing to do with the document.

An Investment Adviser Representative (IAR) prepares a sophisticated investment strategy for a client. The IAR subsequently learns that the strategy will have severe tax consequences for the client. The IAR should:

develop another plan for the client Given the choices, the best one is to develop another plan for the client. The IAR does not have tax expertise, and should only implement the plan if a tax professional reviews it and determines that the adverse tax consequences can be overcome. This is not offered as a choice, so the best action is to scrap this plan and start over.

A market maker's compensation can be best described as the:

difference between the bid and ask quote A market maker maintains a bid-ask quote in each security in which a market is made. The ask price is always higher than the bid price. Assume that the bid-ask is 34-35. For each round-turn trade done by the market maker, $1 is earned (sell at the ask of $35; buy back at the bid of $34). This is the "spread" and is the compensation earned by the market maker. Most of the larger market making firms do not deal with the public. As an example, Knight Trading is the biggest NASDAQ market maker and it does not take public orders. A retail firm will route a buy order to Knight and buy at the ask price and then add a commission to the price as agent on the customer confirmation; or it will route a sell order to Knight and sell at the bid price and then subtract a commission from the sale proceeds on the customer confirmation as agent. A member firm can have both a market making operation and a retail operation under the same holding company. For example, UBS is the 2nd largest NASDAQ market maker, and it also has a retail brokerage unit. If a customer of the retail brokerage unit places an order to buy, it can be filled by UBS's market making desk at the ask price and then UBS adds a mark-up to the price on the customer confirmation (because it is a dealer in that security so it is acting as a principal in the transaction). If a customer of the retail brokerage unit places an order to sell, it can be filled by UBS's market making desk at the bid price and then UBS subtracts a mark-down from the price on the customer confirmation (because it is a dealer in that security so it is acting as a principal in the transaction).

An investment policy statement would NOT include:

disclosure of the fees that the adviser will earn for implementing the recommended strategy The investment policy statement prepared for a client for whom a portfolio is to be constructed details the allocation percentages for each chosen asset class; and the expected returns from each class along with the possible variance of these returns. In addition, it can detail any strategies used for "tactically" timing the market when choosing specific investments within each class. Thus, the customer has a written statement detailing the major aspects of how the portfolio will be constructed and managed. The statement does not include the fees that the adviser will earn. These would be disclosed separately to the customer.

An example of diversification is the purchase of:

domestic mutual funds and international mutual funds Diversification means that a given event will not affect all securities held in the portfolio in the same manner. Domestic stock prices and foreign stock prices are not directly linked. Each country's economy is different and is responding to different events (usually). Both Treasury bonds and municipal bonds are subject to interest rate risk - if market interest rates go up, their prices decline. Both blue chip stocks and mid-cap stocks are subject to a "bad" stock market brought on by a deteriorating U.S. economy. Investing in money market instruments and T-Bills is the same thing. While, safe, it is not "diversification" and exposes the customer to the opportunity cost of not making other investments that give better returns.

An index fund manager, in order to meet its investment objective, attempts to:

exceed the underlying index's return by slightly overweighting securities that he or she expects to outperform the market to cover the fund's expenses Because there are expenses associated with running a mutual fund, such as management fees, brokerage fees, administrative fees, etc., an index fund manager that is attempting to match the performance of a designated index must actually do "better" than the index return to cover these expenses. To do so, the manager will tactically vary asset allocations from the index percentage by small amounts to "time" the market to achieve a better rate of return.

An index fund manager is expected to generate a return that:

exceeds the benchmark index This is an interesting question. While investors expect an index fund to generate a yield that matches the chosen index, in reality, the fund manager must exceed this return because of the expenses associated with managing the fund. Assume that the Standard and Poor's 500 index rises by 10% in a year and that an S&P 500 index fund has an expense ratio of .25% (primarily management fees). Thus, the manager of the fund must have a gain of 10.25% in the fund to yield 10% to investors after expenses are deducted. The way that the manager can do this is to sell covered calls to generate extra income against positions held in the portfolio; and the manager can slightly alter the weighting of stocks in the portfolio to those that he or she believes will outperform the overall index over the coming time period.

Bond portfolio immunization protects the portfolio against:

interest rate risk Portfolio immunization is the strategy of managing a portfolio to make it worth a specific amount at a stated date in the future. This strategy is typically used to fund a known future liability. Assume that a customer needs $50,000 in 10 years. If the customer buys a safe 10-year zero-coupon obligation with a $50,000 face amount such as Treasury STRIPS, then the customer will have the needed principal amount 10 years from now. (Note that the duration of the 10 year zero coupon bond is 10 (years) - exactly the same amount of time until the debt must be paid.) The intent of bond portfolio immunization is to eliminate interest rate risk. If the customer were to buy, say, a conventional 30-year Treasury bond to pay off this liability in 10 years, and interest rates rose substantially in the meantime, those bonds would drop in value, and the needed funds would not be there in 10 years. The bottom line is that to immunize a portfolio, the duration of the bonds used to fund the future liability must match the length of time until the liability must be paid.

The advantage of buying a foreign index fund as compared to direct investing in foreign stocks is that it:

is easier than individually investing in foreign stocks Buying a foreign stock index fund is much simpler than trying to buy foreign stocks directly. The holder is still subject to the risk that the companies invested in do poorly - this is business risk. The holder of a foreign stock index fund is still subject to exchange rate risk (the risk that the value of the foreign currency in which the stocks are denominated falls versus the U.S. dollar, so that when the currency value is converted into U.S. dollars, it buys fewer U.S. dollars). Finally, all dividend distributions from mutual funds are taxable (with the exception of distributions from municipal bond funds).

A trader who places an order to sell 100 shares of ABC at $68 when the market price of ABC stock is at $64 has placed a(n):

limit order The trader wants to sell the stock at $68 when the market is at $64. This trader does not want to sell for less than $68 per share, so he has placed a limit on the price. The order cannot be filled unless the market rises to $68 or higher. This order will remain "open" until it is filled, but limit order is the better answer to the question.

A value investor seeks stocks that have:

low P/E ratios value investor is looking for "out-of-favor" stocks that typically have low Price/Earnings ratios; high dividend yields; low price to book value per share ratios; and low market capitalization because the share price is depressed. The theory is the market will recognize that this really is a good company, and the share price will rise -so at the current price, the stock is a "value."

When the market price of a security has reached equilibrium, transaction costs will be:

lower When a stock has found its equilibrium price in the market, this means that there is active trading occurring and that the number of buyers and sellers is balanced. In such a market, the spread is minimized, and this is a cost of trading (aside from commission costs). Note that when markets are rapidly rising, which happens when buyers outnumber sellers, market makers are continually revising their quotes, and their spreads tend to be wider as they are doing this. The same is true when markets are rapidly falling. So transaction costs in "fast moving" markets tend to be higher (because spreads are wider); while transaction costs in stable markets tend to be lower.

The length of time that the current fund manager has been the portfolio manager of a fund is called:

manager tenure When looking at the performance of a mutual fund over many years, a key factor is the length of time that the investment adviser has been managing that fund. Typically, a long-tenured adviser who has produced good investment returns can be expected to do so in the future. Investment advisers with a short tenure do not have a proven track record; and if there is a change of investment adviser, this can be a red flag to potential investors, because the new adviser does not yet have a track record.

When the market price of a share of stock is multiplied by the number of shares that the company has outstanding, this is known as:

market capitalization When the market price of a share of stock is multiplied by the number of shares that the company has outstanding, this is known as market capitalization. This is the aggregate valuation that the market is placing on the company's business. Most stock indexes (with the notable exception of the Dow Jones Averages) are weighted by market capitalization. Thus, if a company in the Standard and Poor's 500 Index that has a very large number of shares outstanding increases in price by $1; this will make the index increase in value more than if a company with a smaller number of shares outstanding increased by the same $1 (since the S&P 500 index is weighted by market capitalization).In contrast, in the Dow Jones Industrial Average, which is not weighted by market capitalization, any single stock increasing by $1 in price will have the same impact of the price movement of the index.

When the securities markets have reached equilibrium, transaction costs are:

minimized When a stock has found its equilibrium price in the market, this means that there is active trading occurring and that the number of buyers and sellers is balanced. In such a market, the spread is minimized, and this is a cost of trading (aside from commission costs). Note that when markets are rapidly rising, which happens when buyers outnumber sellers, market makers are continually revising their quotes, and their spreads tend to be wider as they are doing this. The same is true when markets are rapidly falling. So transaction costs in "fast moving" markets tend to be higher (because spreads are wider); while transaction costs in stable markets tend to be lower.

A money manager that believes that a company that reports higher than expected earnings will continue to generate superior returns and stock price appreciation is a follower of:

momentum investing Momentum investors believe that stocks that show positive earnings momentum (e.g., higher than expected earnings) are more likely to continue to surprise investors (in a good way) and that will lead to a stock price rise. Conversely, they believe that stocks that show negative earnings momentum (e.g., lower than expected earnings) are more likely to continue to surprise investors (in a bad way) and that will lead to a stock price fall. This is really a "following the herd" theory, since investors tend to buy stocks on good earnings news and sell stocks on bad earnings news.

A fund that invests in Treasury Bills, commercial paper, and guaranteed repurchase agreements is a(n):

money market fund Since all of the investments listed are money market instruments, this is a money market fund.

A customer borrows funds at 5% and uses the proceeds to make an investment yielding 4%. This is an example of:

negative financial leverage Leverage is the use of debt to "lever" investment returns. If a customer can borrow funds at 5% and use the proceeds to make an investment yielding 4%, the customer has 1% negative financial leverage. Negative financial leverage occurs when the customer borrows money at a higher interest rate to make an investment generating a lower rate of return - which should not be done!

An investor knows that he must pay back the principal of a $50,000 loan that he got from a close relative to buy a house. The loan matures in 10 years. To make sure that the client has the funds to pay back the loan in 10 years, you recommend that the customer buy 50M of 10-year Treasury STRIPS. This is an example of:

portfolio immunization Portfolio immunization is the strategy of managing a portfolio to make it worth a specific amount at a stated date in the future. This strategy is typically used to fund a known future liability. Since this customer needs $50,000 in 10 years, buying a zero-coupon obligation (a STRIPS in this example) will give the customer the needed principal amount 10 years from now. The intent of bond portfolio immunization is to eliminate interest rate risk. If the customer were to buy, say, a conventional 30-year Treasury bond to pay off this liability in 10 years, and interest rates rose substantially in the meantime, those bonds would drop in value, and the needed funds would not be there in 10 years. The bottom line is that to immunize a portfolio, the duration of the bonds used to fund the future liability must match the length of time until the liability must be paid.

If one asset class greatly underperforms another class in an asset allocation plan, the portfolio must be:

rebalanced When investment performance varies over time from one asset class to another, the target percentage allocations will shift from their optimal setting. To bring the portfolio back to these targets, it must be rebalanced - that is, a portion of the overperforming class(es) must be sold off and the proceeds reinvested in the underperforming class(es).

Diversification of a portfolio among asset classes:

reduces the variability of the rate of return over the investment time horizon Diversification reduces the variability of investment returns over the investment time horizon. In a diversified portfolio, some investments will be under-performing and some will be over-performing, tending to average out the rate of return. Thus, variability of the rate of return is reduced.

A trader uses a predetermined strategy where investment funds are moved from one sector to another based on a calendar schedule, using the following sectors as the asset classes: utilities, retailers, consumer staples, technology, and transportation stocks. This is an example of:

rotational investing strategy "Sector rotating" is an active investment strategy that seeks to use the economic cycle as the basis for making investment decisions. For example, when the economy is entering a recession, funds are allocated to defensive utility and consumer staples stocks that are less affected by a contracting economy. When the economy starts to grow again, these positions are liquidated and investments are made in technology and transportation stocks that perform well in a rapidly growing economy, etc.

An investment adviser places trades in different asset classes based on the phases of the business cycle. This is an example of:

sector rotation Sector rotation is an investment strategy that attempts to take advantage of the business cycle. Remember that the business cycles has 4 phases - expansion, prosperity (peak), recession and recovery (trough). The industries that have done best in each phase of the cycle are: Recovery: Technology, Transportation Expansion: Basic Materials, Capital Goods Peak: Consumer Staples, Energy Recession: Utilities, Financials An investor using sector rotation would invest in each of the above asset classes only when the economy entered the appropriate phase of the business cycle, rotating out of the investments made in the previous phase of the business cycle - hence, this is called "sector rotation."

Value investors:

seek to find investments that are undervalued by the market Value investors believe that the market is not completely efficient at pricing securities and that undervalued securities can be found in the marketplace. Once the market realizes the true worth of these undervalued companies, their prices should rise at a greater rate than the general market.

A portfolio with an objective of global investing would:

spread its investments across both domestic and foreign securities, overweighting countries that are likely to experience faster rates of growth Global investing is the spreading of investments in countries across the world - with the emphasis on making investments in countries that are likely to experience faster rates of growth.

U.S. corporations account for 45% of global corporate wealth. An investor that has an objective of global investing would

spread its investments across both domestic and foreign securities, weighting investments based on performance expectations Global investing is the spreading of investments in countries across the world - with the emphasis on making investments in countries that are likely to experience faster rates of growth.

The purchase of an emerging markets foreign stock index fund will subject the shareholder to all of the following risks EXCEPT:

stock-specific risk Buying a foreign stock index fund is much simpler than trying to buy foreign stocks directly. The holder is still subject to the risk that the companies invested in do poorly - this is business risk. The holder of a foreign stock index fund is still subject to exchange rate risk (the risk that the value of the foreign currency in which the stocks are denominated falls versus the U.S. dollar, so that when the currency value is converted into U.S. dollars, it buys fewer U.S. dollars). Political risk is the risk of investing in third world countries that have weak political systems. For example, a country with a dictator could simply nationalize the companies that are the investments in the fund, giving the shareholders nothing! An emerging markets fund is subject to this risk. By investing in a mutual fund, stock specific risk is minimized. Stock specific risk is the risk that a large investment is made in a single stock that then turns bad. By diversifying the portfolio, this risk is reduced.

The target allocation for a specific asset class has been set at 20% of total assets under an asset allocation scheme. The manager is permitted to reduce this percentage to 15%; and can increase it to 25%; as he or she sees fit. The setting of the 20% target allocation is called:

strategic asset management The selection of the percentage of total assets to be allocated to a given asset class is called "strategic asset management" - that is, setting the investment strategy. The permitted variation from this percentage that is given to the asset manager, so that the manager can take advantage of market opportunities, is called "tactical asset management".

Strategic portfolio management is the selection of the:

target asset allocation for each asset class selected for investment Strategic asset allocation is the determination of the target percentage to be allocated to each asset class (e.g., 50% Debt; 50% Equities) and then to the investment vehicles within that asset class (e.g., the 50% Debt allocation might be invested 25% in Treasury Bonds and 25% in Corporate Bonds). Tactical asset allocation is the permitted variation around each of the chosen percentages - for example, even though Equities are targeted at 50%, this might be allowed to be dropped to as low as 40% or as high as 60%, depending on market conditions.

All of the following are advantages of "DRIPs" EXCEPT:

the investor gets to decide the timing of additional stock purchases in that issuer "DRIP" stands for "Dividend Re-Investment Plan." These are plans offered by corporate issuers that give shareholders the ability to reinvest cash dividends paid by the company in additional shares of that company. This is a feature similar to automatic reinvestment of dividends at NAV in a mutual fund. There are no commission charges on reinvested dividends and fractional shares can be purchased. The issuer's DRIP allows the shareholder to build an increasing position in that issuer's stock over time in a passive fashion. Because additional shares are purchased periodically with the reinvested dividends, this is a form of dollar cost averaging. The disadvantage of a DRIP is that the investor cannot determine the timing of these incremental purchases.

A customer places an order to "Sell 100 ABC @ $90 Stop." The customer wishes to sell the stock at:

the market price, if the market falls to $90 per share or lower This order is a Sell Stop order, which is placed below the current market value. If the market price falls to $90, the order is elected and becomes a market order to sell. Once elected, the order is executed at the next available price as a market order. The order is executed, but the specific execution price is unknown.

A customer places an order to "Buy 100 ABC @ $90 Stop". The customer wishes to buy the stock at:

the market price, if the market rises to $90 per share or higher This order is a Buy Stop order, which is placed above the current market value. If the market price rises to $90, the order is elected and becomes a market order to buy. Once elected, the order is executed at the next available price as a market order. The order is executed, but the specific execution price is unknown.

If a passively managed fund either underperforms or overperforms the benchmark index, this is called the:

tracking error The deviation between a portfolio's return and the benchmark return is known as the "tracking error" (this can be either positive or negative). Here is an example of how tracking error occurs and can be managed. Index fund managers, who seek to match the performance of a benchmark index, must, in reality, do better than the benchmark index results to cover the costs of operating the fund (e.g., brokerage costs, administrative costs, etc.). They cannot be completely passive in their approach because then they will always underperform the index (the "tracking error"). Therefore, in order to boost their yield up to cover these expenses, they must employ a bit of active asset management - in essence, making disproportionately large bets on stocks in the index that they think will outperform the index - in order to juice up their returns enough to cover fund expenses. The idea is that the positive tracking error from the actively managed positions will more than offset the negative tracking error built into the passively managed positions.

Tactical portfolio management is the selection of the:

variation permitted in target asset allocation for each asset class selected for investment Strategic asset allocation is the determination of the target percentage to be allocated to each investment vehicle within an asset class (e.g., 25% Treasuries; 25% Corporate Debt; 50% Equities). Tactical asset allocation is the permitted variation around each of the chosen percentages - for example, even though Equities are targeted at 50%, this might be allowed to be dropped to as low as 40% or as high as 60%, depending on market conditions.