Round 2 questions to memorize
The Brinson, Hood, and Beehower Study "Determinants of Portfolio Performance" (1986) states: (a)94% of the variability of a portfolio's performance over time is due to asset allocation. (b)94% of the return of a portfolio's performance over time is due to asset allocation. (c)94% of overall value added can be explained by asset allocation.
(a)94% of the variability of a portfolio's performance over time is due to asset allocation. The finding is that 94% of the movements of one's portfolio is due to the market movement of the asset class in which the portfolio is invested.
Which of the following best defines a scattergram? (a)The frequency distribution of historical returns of a financial asset(b)The mapping of excess returns of a fund to the excess returns of an index(c)The vertical mapping of percentiles of a distribution of an investment(d)The graphical representation of historical returns vs standard deviation of investments
(b)The mapping of excess returns of a fund to the excess returns of an index
Which legal statute first delineated that standard of prudence is to be applied at the portfolio level, and not the individual investment level?
(b)UPIA. UPIA extends ERISA's prudent man to prudent investor.
Q96. Your client's municipal bond portfolio is now worth $540,000. He originally invested $430,000 7 years ago (equals his cost basis). His marginal federal ordinary income tax rate is 40% and his state rate is 6%. Your client's state exempts muni-bond interest but not realized gains from sales. The tax rate on long-term capital gains is currently 25%. He asks you to sell the entire portfolio to fund the purchase of a second home. What are the tax consequences for doing so? a. $0 b. $27,500 c. $34,100 d.$50,600
Answer: $34,100 Solution: Municipal bond funds may generate some tax-free income but gains from the sale of the fund itself are taxable. In this case the gains are considered "long-term" capital gains as the fund shares have been held more than one year. The entire gain of $110,000 is taxed at 31% since the fact pattern specifically states that this state does not exempt realized gains from the sale of muni-bonds from its state income tax.
Q88. According to studies by Brinson, Beebower & Hood, ___________ (___________) was much more influential than ___________ (___________) in determining the variation in total plan returns when studying some of the largest pension plans in the U.S. a. investment policy (asset allocation); investment strategy (security selection and market timing) b. investment policy (security selection and asset allocation); investment strategy (market timing) c. investment strategy (market timing and security selection); investment policy (asset allocation) d. investment strategy (security selection); investment policy (market timing and asset allocation)
Answer: a. Solution: Brinson, Beebower and Hood studied 91 large U.S. pension funds over 1974-1983 and found that the majority of the variation in portfolio returns could be attributed to investment policy as it related to each fund's chosen asset allocation model, while only approximately 10% of that variation in returns had to do with a combination of market timing and security selection
Q69. All of the following are arguments for using hedge funds as a complement or replacement to bond allocations in a well-diversified portfolio with the exception of which below? a. hedge fund returns are highly correlated with bond returns b. hedge funds can be used to displace bonds in an efficient frontier analysis c. hedge fund returns tend to have lower risk than most types of stocks d. hedge fund returns tend to have relatively low correlations with equities
Answer: a. Solution: Hedge funds are not typically highly correlated with bonds.
Q110: INCORRECT Q110. Lara Smythe has just realized a large capital gain from selling a concentrated position of her individual equity portfolio (a taxable account). Capital gains are currently taxed at 20% and her marginal federal and state income tax rates combine for a total of 45%. Lara expects us to remain in a low interest rate environment with possible deflation continuing in some sectors. Her outlook on the stock market is uncertain but not overly pessimistic. Lara expects to need the proceeds from the sale of these assets in roughly 5 years. Which of the investment options below would be most appropriate for Lara based on these facts and circumstances? a. invest in municipal bonds with staggered or matching intermediate term duration b. build a portfolio of laddered certificates of deposit and short-term Treasury bonds c. reinvest in equities but with diversification this time due to a short time horizon d. keep the proceeds in cash or tax-free money market account
Answer: a. Solution: Investing in municipal bonds with maturities that match her short time horizon and with acceptable durations are likely the best investment option of those listed. Lara expects inflation to remain low and possibly fall which makes longer term maturity fixed income investments look attractive but she only has 5 years until she needs the money and taking on unnecessary interest rate risk does not seem prudent. Furthermore, she'll want to avoid highly taxable investments (like certificates of deposit and Treasury bonds) if she can due to her high tax bracket. Investing in equities, even with diversification, does not appear reasonable with such a short time horizon. Keeping the money in cash or money market is probably too conservative and the opportunity cost over five years is significant
Q67. Which of the following statements about the taxation of Real Estate Investment Trusts (REITs) is/are not accurate? I. REITs must generally follow the same rules as Unit Investment Trusts (UITs) but must follow the same method of self-assessment as partnerships II. REITs are taxed first at the trust level and then to beneficiaries III. rental income and expenses are treated as business income and expenses IV. income is essentially tax exempt to REITs at the trust level if they distribute at least 90% of income to unitholder a. I b. II c. III d. IV
Answer: a. Solution: REITs must generally follow the same rules as Unit Investment Trusts (UITs) but must follow the same method of self-assessment as corporations.
Consider the following probability distribution for stocks A and B: The coefficient of correlation between A and B is State Probability Return on Stock A Return on Stock B 1 0.10 10% 8% 2 0.20 13% 7% 3 0.20 12% 6% 4 0.30 14% 9% 5 0.20 15% 8% The coefficient of correlation between A and B is a. 0.46. b. 0.60. c. 0.58. d. 1.20.
Answer: a. Solution: covA,B = 0.1(10% - 13.2%)(8% - 7.7%) + 0.2(13% - 13.2%)(7% - 7.7%) + 0.2(12% - 13.2%)(6% - 7.7%) + 0.3(14% - 13.2%)(9% - 7.7%) + 0.2(15% - 13.2%)(8% - 7.7%) = 0.76; rA,B = 0.76/[(1.1)(1.5)] = 0.46.
Q109. _____________________ support(s) the possibility that funds that invest in companies that are heavily weighted in an index will underperform their peers, and funds that invest in more companies not well represented in the index will outperform their peers. a. Core and satellite strategies b. Active-share research c. Risk-parity investing d. Dynamic asset allocation
Answer: b. Solution: Active-share research supports the possibility that funds that invest in companies that are heavily weighted in an index will underperform their peers, and funds that invest in more companies not well represented in the index will outperform their peers. See Key Concepts slides for Section 20: Manager Search and Selection.
Q32: The correlation coefficient of two stocks is .84. Stock A (bio-tech stock) has an expected return of 15%, a standard deviation of 22% and a beta of 1.3. Stock B (energy stock) has an expected return of 9%, a standard deviation of 18% and a beta of 1.1. What is the covariance between stocks A and B? a. .0113 b. .0333 c. 1.2012 d. 21.2121
Answer: b. Solution: Covariance of ab = correlation coefficient of ab (.84) x SDEVa x SDEVb .84 x .22 x .18 = .0333
Which of the following statements is/are accurate regarding hedge fund performance? I. hedge fund performance for the industry (i.e., as a whole) appears better than it actually is due to survivorship bias II. hedge fund performance for the industry (i.e., as a whole) appears worse than it actually is due to survivorship bias III. individual hedge fund manager performance appears better than it actually is in relation to the existing hedge fund universe due to survivorship bias IV. individual hedge fund manager performance appears worse than it actually is in relation to the existing hedge fund universe due to survivorship bias a. I and III b. I and IV c. II and III d. II and IV
Answer: b. Solution: Hedge fund performance for the industry (i.e., as a whole) appears better than it actually is due to survivorship bias given that only the surviving funds are accounted for. Thus, the funds with worse performance dropped out of the listing which raises the aggregate performance of the surviving universe. Individual hedge fund managers' performance however appears worse than it actually is in relation to the existing hedge fund universe due to survivorship bias. Example: a fund manager ranks 10 out of 100 funds in the universe; 5 years later he is still ranked 10 but there are only 50 funds left in the universe. Consequently he falls from the top 10% in performance to the top 20% in performance.
Which of the following is not one of the statements found in IMCA's Code of Professional Responsibility? a. Disclose the existence of actual, potential, and/or perceived conflicts of interest and relevant financial relationships, direct and/or indirect. Take appropriate action to resolve or manage any such conflicts. b. Provide competent service by truthful representation of competency, maintenance and/or development of professional certifications, and, when appropriate, the recommendation of other professionals or colleagues. c. Maintain a high level of ethical conduct. d. Act in the best interest of the client.
Answer: b. Solution: Should read: "Provide competent service by truthful representation of competency, maintenance and/or development of professional capabilities, and, when appropriate, the recommendation of other professionals."
Q72: Speculators may use futures markets rather than spot markets because I. transactions costs are lower in futures markets. II. futures markets provide leverage. III. spot markets are less efficient. IV. futures markets are less efficient a. I and III b. I and II c. II and III d. IV and I
Answer: b. Futures markets allow speculators to benefit from leverage and minimize transactions costs. Both markets should be equally price-efficient.
Q4. Which of the following activities is not specifically included in IMCA's Disciplinary Rules and Procedures document as potential "grounds for discipline"? a. Violation of the criminal statutes of any state or the United States for commission of a serious crime. Conviction of a crime shall not be a prerequisite for the filing of a disciplinary petition b. Violation of the License Agreement between IMCA and the Licensee c. Violation of an employer agreement or client agreement including policies and procedures outlined in an Investment Policy Statement d. Violation of the rules of FINRA or other financial services self-regulatory organization
Answer: c. Solution: Reference - IMCA's Disciplinary Rules and Procedures (page 3)
Q98. Alicia Parker is an investment consultant who has been retained by We Care, LLC (a local non-profit) to help them manage their $10 million retirement account. The members of the organization's investment committee do not have significant experience managing investment funds but did perform due diligence before hiring Ms. Parker. Despite their best effort to hire the best talent available, Ms. Parker makes several strategic investment mistakes which lead to large losses in the portfolio. According to several complaints made against Ms. Parker on file with state and national regulators, she may be guilty of gross negligence in performing her duties as consultant to the We Care, LLC and other clients. Which of the following statements is accurate according to UPMIFA? a. the investment committee's decision to delegate authority of investment management would likely be found imprudent under these circumstances b. the investment consultant was not acting in a principal-agent relationship c. the board of directors will not likely be held personally responsible for actions of the investment consultant d. We Care, LLC is allowed to recoup their losses in court because of the gross negligence cited
Answer: c. Solution: The investment committee will not likely be held personally responsible for actions of the investment consultant as they performed the necessary due diligence in selecting her (see Thayer's lecture on investment policy statements). We Care, LLC may be able to recoup losses in a court based on fraud or gross negligence but there is no guarantee of such recovery.
Q105. Given only the following information below, which of the following investments would likely be best to add to a portfolio if the primary goal in adding another asset is to reduce risk? a. investment "A" with correlation of -0.25 and standard deviation of 17% b. investment "B" with correlation of +0.35 and standard deviation of 15% c. investment "C" with correlation of -0.50 and standard deviation of 19% d. investment "D" with correlation of +0.75 and standard deviation of 13%
Answer: c. Solution: While standard deviation is, by definition, a measure of total (or overall) risk, we're actually looking for low correlations to lower the overall "portfolio risk" when considering adding any new asset or investment to such a portfolio.
Q21. Both you and your client expect inflation and interest rates to rise over the next decade or more. Your client is 5 years from retirement and has demonstrated a moderate disposition toward risk over the 10 years that you have known him and managed his accounts. Given that you employ a tactical asset allocation approach to portfolio management, which of the following portfolio recommendations below would be most appropriate for your client based on those details? a. sell corporate bonds and sovereign debt in order to buy equities and commodities b. raise the duration of fixed income assets and lower bond exposure c. raise allocations to equities and real assets while buying put coverage on these assets to manage risk d. lower bond durations and increase exposure to real assets within the equity portfolio
Answer: d Solution: Given a tactical asset allocation approach, changes to the proportion of equities to fixed-income should be allowed. That being said, shifts increasing risk (such as adding equities) are not likely appropriate given the client is nearing retirement. If you expect higher inflation and rates to rise, you would want to reduce bond exposure or you may want to reduce duration. Furthermore, you may want to raise exposure to real assets which historically (but not always) appreciate more than stocks in periods of rising inflation. You answered: sell corporate bonds and sovereign debt in order to buy equities and commodities
Q3. Which of the following is NOT acceptable for CIMA® designees based on IMCA's Guidelines for Consultants Regarding the Acceptance of Benefits from Third Parties? I. John Smith, a CIMA® designee, and his wife were treated to a very nice dinner and show costing more than a thousand dollars by a salesperson of an asset manager hoping to win new business. John has his employer's written approval before the event. II. As a result of doing new business, Mary Jones, a CIMA® designee, is rewarded with a weekend vacation to Hawaii for which travel is being paid for by the asset manager. Mary must report the event to her employer and disclose to her clients. III. Brian Johnson, a CIMA® designee, has been invited to attend an educational event held by an investment management company. Brian seeks written approval from his employer and will submit expenses for Time Left on this Section: 0:23:25 reimbursement upon approval. IV. Jackie Taylor, a CIMA® designee, attends a private event, by invitation only, held by a vendor at a national conference for investment advisors. Jackie does not disclose her activity to her employer or clients because the estimated market value of her attendance at the event is probably only worth a couple of hundred dollars. a. I and III b. I and IV c. II and III d. II and IV Solution: Scenario "I" is acceptable as this event qualifies as a third-party benefit but is allowed under the circumstances described with the approval of his employer. Scenario "II" is specifically prohibited by Item #3 in the IMCA (third-party benefits) document. Scenario "III" is acceptable given approval is sought prior to the event per Item #9 in the IMCA document. Scenario "IV" would have been acceptable if the event at the conference had been open to all attendees (Item #10) but since it is a private event, it qualifies as a third-party benefit, and since the value is over $100 it must be approved by the designee's employer (Item #4). Reference: IMCA Guidelines for Consultants Regarding the A
Answer: d.
Q5. Which of the following are specifically included or addressed in IMCA's Guidance for the Code of Professional Responsibility? I. The requisite information that the IMCA professional must provide to any client is "information needed to make informed decisions". The nature and format of the information needed for informed decision-making depends on several factors, including, without limitation, the nature of the client relationship, the client's goals or objectives, the complexity of the request and analysis, the decision to be made by the client, and applicable legal, regulatory, and firm requirements concerning the provision of information to clients. II. If an IMCA professional is required to meet a suitability standard with regard to a client, then acting in that particular client's best interest means compliance with the suitability standard. If on the other hand, the IMCA professional has a fiduciary obligation to a particular client, acting in that client's best interest requires compliance with the IMCA professional's fiduciary obligations. III. "To maintain confidentiality," means to keep the client information private and ensure that it is not disclosed to any unauthorized persons. IMCA professionals may release client information under certain circumstances if they have prior, written consent from the client and approval from their firm. IMCA professionals may be required to release client information to certain government agencies and regulatory bodies including self-regulatory organizations without a client's consent. IV. Disclosure contemplates either oral or written provision of information. Although not required, oral disclosure should, under best practices, be confirmed in a timely manner in writing to demonstrate compliance. a. I, II, and III b. II, III, and IV c. III, IV, and I d. IV, I, and II
Answer: d.
You are presented with the investment options below. Calculate the value of each using a discount rate of 5% and choose the most attractive option. a. invest $1,000 today and receive $2,500 after 10 years b. invest $1,200 today and receive $3,300 after 14 years c. invest $800 today and receive $1,900 after 12 years d. invest $1,500 today and receive $3,600 after 8 years
Answer: d. Solution: Calculate the return using PV = 1,000, FV = 2,500, n = 10, thus I = 9.60%. Discount back 10 years using 5%: PV = 1.00, I = 9.60%, n = 10, thus FV = 2.50. FV = 2.50, n = 10, I = 5, thus PV = 1.54. Calculate the return using PV = 1,200, FV = 3,300, n = 14, thus I = 7.49%. Discount back 14 years using 5%: PV = 1.00, I = 7.49%, n = 14, thus FV = 2.75. FV = 2.75, n = 14, I = 5, thus PV = 1.39. Calculate the return using PV = 800, FV = 1,900, n = 12, thus I = 7.48%. Discount back 12 years using 5%: PV = 1.00, I = 7.48%, n = 12, thus FV = 2.38. FV = 2.38, n = 12, I = 5, thus PV = 1.33. Calculate the return using PV = 1,500, FV = 3,600, n = 8, thus I = 11.57%.
Q55. Which of the following statements about mutual funds is/are incorrect? I. mutual funds may be considered pass-through entities for tax purposes II. income plus capital gains distributions plus appreciation divided by the fund's initial net asset value (NAV) equals the rate of return on a mutual fund III. open-ended funds are priced at a premium or discount to NAV IV. closed-end funds issue new shares when investors buy in and redeem shares when investors cash out a. I and III b. II, III and IV c. IV only d. III and IV
Answer: d. Solution: Mutual funds may be considered pass-through entities for tax purposes. Income plus capital gains distributions plus appreciation divided by the fund's initial net asset value (NAV) equals the rate of return on a mutual fund. Closed-end funds are priced at a premium or discount to NAV. Open-ended funds issue new shares when investors buy in and redeem shares when investors cash out.
Q23. Which of the following statements below are not accurate as they relate to stock and bond returns and risk for the U.S. and developed European countries over the last 100 years? I. nominal annual stock returns averaged between 9%-12% II. real annual stock returns averaged between 6%-8% III. standard deviations for stocks averaged between 20%-24% IV. standard deviations for bonds averaged between 8%-11% a. I, III b. I, IV c. II, III d. II, IV
Answer: d. Solution: Nominal annual returns for US and European stocks averaged somewhere around 9% and 12% from 1900-2000. Real annual returns for US and European stocks averaged somewhere around 4% and 7% from 1900-2000. Standard deviations for US and European stocks averaged somewhere around 20% and 24% from 1900-2000. Standard deviations for US and European bonds averaged somewhere around 10% and 14% from 1900-2000.
Q35. Which of the following statements about the variance of a portfolio of risky securities is accurate? a. is a weighted sum of the securities' variances b. is the sum of the securities' variances c. is the sum of the securities' covariances d. is the weighted sum of the securities' variances and covariances
Answer: d. Solution: The variance of a portfolio of risky securities is a weighted sum taking into account both the variance of the individual securities and the covariances beTetween securities
Q33: When two risky securities that are positively correlated but not perfectly correlated are held in a portfolio... P P 1/2 Time Left on this Section: 0:23:25 a. the portfolio standard deviation will be equal to the weighted average of the individual security standard deviations. b. the portfolio standard deviation will be greater than the weighted average of the individual security standard deviations. c. the portfolio standard deviation will be greater than the weighted average of the individual security standard deviations and it will always be equal to the securities' covariance . d. the portfolio standard deviation will be less than the weighted average of the individual security standard deviations.
Answer: d. Solution: Whenever two securities are less than perfectly positively correlated, the standard deviation of the portfolio of the two assets will be less than the weighted average of the two securities' standard deviations. There is some benefit to diversification in this case.
Q22. Calculate the equity premium from the following data: Stock market index return = 10.2% Corporate bond index return = 7.1% Short-term treasury bills = 3.7% Inflation = 2.2% a. 6.50% b. 8.00% c. 7.83% d. 6.27%
The equity premium equals the excess of the stock market index return and the risk-free rate (i.e., return of the short-term Treasury bill). [(1+.102)/(1+.037)]-1 = 6.27% See CIMA text, page 239.
A) A historgram
The frequency distribution of historical returns of a financial asset
C) A floating Bar chart
The vertical mapping of percentiles of a distribution of an investment
Q58. A preferred stock will pay a dividend of $3.00 in the upcoming year, and every year thereafter, i.e., dividends are not expected to grow. You require a return of 9% on this stock. Use the constant growth dividend discount model (DDM) to calculate the intrinsic value of this preferred stock. a. $33.33 b. $0.27 c. $31.82 d. $56.25
a. $33.33 Solution: 3.00/.09 = 33.33
Q24. Rank the following investments from most attractive to least attractive as measured by Sharpe ratio using the modern period data from 1989-2009. a. MSCI emerging markets, S&P 500, EAFE b. S&P 500, MSCI emerging markets, EAFE c. MSCI emerging markets, EAFE, S&P 500 d. S&P 500, EAFE, MSCI emerging markets
a. MSCI emerging markets, S&P 500, EAFE
Q12: Which of the following statement(s) regarding correlation coefficients is/are accurate? I. When two stocks have a correlation coefficient that is greater than zero but less than 1.00, it means that they have a positive correlation and there may be some benefit through diversification. II. Mutual fund A and mutual fund B have a correlation coefficient of -0.89. This indicates beneficial diversification given the low level of positive correlation or association between these funds. III. Two investments that have a perfectly negative correlation coefficient of -1.00, would have an expected return of zero in a perfectly balanced portfolio allocation. IV. A portfolio of investments that exhibits a vast range of correlation coefficients from 0.20 to 0.60 would be considered highly diversified and ensure a very low risk level as measured by standard deviation. a. I and II b. I and III c. II and III d. II and IV
b
Which of the statements below is a proposition that a strong proponent of supply-side economics would most likely stress? a. Higher marginal tax rates will lead to a reduction in the size of the budget deficit and lower interest rates as they depend on government revenues. b. Higher marginal tax rates promote economic inefficiency and thereby retard aggregate output as they encourage investors to undertake low productivity projects with substantial tax shelter benefits. c. Income redistribution payments will exert little impact on real aggregate supply as they do not consume resources directly. d. A tax reduction will increase the disposable income of households, and thus, the primary impact of a tax reduction on aggregate supply will stem from the influence of the tax change on the size of the budget deficit or surplus
b. Higher marginal tax rates promote economic inefficiency and thereby retard aggregate output as they encourage investors to undertake low productivity projects with substantial tax shelter benefits. Supply-side economists focus on incentives and marginal tax rates. Remember that supply-siders believe that incentives should be focused on the producers (suppliers) of goods and services. So any fiscal or monetary policy that will encourage more production should (all else held equal) improve efficiencies and ultimately bring prices down and that will encourage more consumption. So supplysiders want barriers (taxes, restrictive regulation, tariffs, etc.) to be lowered or removed to encourage more output.
Q90. Kahneman and Tversky (1973) report that __________ and __________. a. people give too little weight to recent experience compared to prior beliefs; tend to make forecasts that are too extreme given the uncertainty of their information b. people give too much weight to recent experience compared to prior beliefs; tend to make forecasts that are too extreme given the uncertainty of their information c. people give too little weight to recent experience compared to prior beliefs; tend to make forecasts that are not extreme enough given the uncertainty of their information d. people give too much weight to recent experience compared to prior beliefs; tend to make forecasts that are not extreme enough given the uncertainty of their information
b. people give too much weight to recent experience compared to prior beliefs; tend to make forecasts that are too extreme given the uncertainty of their information
Q65. If the yield on mortgage-backed securities was abnormally high compared to Treasury bonds, a hedge fund pursuing a relative value strategy would _______. a. short sell the Treasury bonds and short sell the mortgage-backed securities b. short sell the Treasury bonds and buy the mortgage-backed securities c. buy the Treasury bonds and buy the mortgage-backed securities d. buy the Treasury bonds and short sell the mortgage-backed securities
b. short sell the Treasury bonds and buy the mortgage-backed securities. If the yield on mortgage-backed securities was abnormally high compared to Treasury bonds, a hedge fund pursuing a nondirectional strategy would short sell the Treasury bonds and buy the mortgage-backed securities.
Q57. All of the following are disadvantages of which type of equity index? No distinction is made between relative or absolute valuations. Difficult to keep stocks in this index due to constant fluctuations. Difficult for funds to manage substantial amounts of money in this type of index. a. Capitalization-weighted index b. Fundamentally-weighted index c. Equal-weighted index d. Price-weighted index
c. Equal-weighted index
Q19. Which of the following is not an appropriate interpretation of an upward sloping yield curve? a. may be an indication that interest rates are expected to increase. b. may incorporate a liquidity premium. c. may reflect the confounding of the liquidity premium with interest rate expectations. d. yields may be indicating a slow-down in the economy and potential for recession.
d. yields may be indicating a slow-down in the economy and potential for recession.
