CFA 41: Portfolio Management Overview

With respect to the formation of portfolios, which of the following statements is most accurate? Portfolios affect risk less than returns. Portfolios affect risk more than returns. Portfolios affect risk and returns equally.

B is correct. As illustrated in the reading, portfolios reduce risk more than they increase returns.

Investors should use a portfolio approach to: reduce risk. monitor risk. eliminate risk.

A is correct. Combining assets into a portfolio should reduce the portfolio's volatility. Specifically, "individuals and institutions should hold portfolios to reduce risk." As illustrated in the reading, however, risk reduction may not be as great during a period of dramatic economic change.

Which of the following is the best reason for an investor to be concerned with the composition of a portfolio? Risk reduction. Downside risk protection. Avoidance of investment disasters.

A is correct. Combining assets into a portfolio should reduce the portfolio's volatility. The portfolio approach does not necessarily provide downside protection or guarantee that the portfolio always will avoid losses.

Which of the following financial products is least likely to have a capital gain distribution? Exchange traded funds. Open-end mutual funds. Closed-end mutual funds.

A is correct. Exchange traded funds do not have capital gain distributions. If an investor sells shares of an ETF (or open-end mutual fund or closed-end mutual fund), the investor may have a capital gain or loss on the shares sold; however, the gain (or loss) from the sale is not a distribution.

Which of the following forms of pooled investments is subject to the least amount of regulation? Hedge funds. Exchange traded funds. Closed-end mutual funds.

A is correct. Hedge funds are currently exempt from the reporting requirements of a typical public investment company.

A defined benefit plan with a large number of retirees is likely to have a high need for income. liquidity. insurance.

A is correct. Income is necessary to meet the cash flow obligation to retirees. Although defined benefit plans have a need for income, the need for liquidity typically is quite low. A retiree may need life insurance; however, a defined benefit plan does not need insurance.

The planning step of the portfolio management process is least likely to include an assessment of the client's securities. constraints. risk tolerance.

A is correct. Securities are analyzed in the execution step. In the planning step, a client's objectives and constraints are used to develop the investment policy statement.

Which of the following institutions will on average have the greatest need for liquidity? Banks. Investment companies. Non-life insurance companies.

A is correct. The excess reserves invested by banks need to be relatively liquid. Although investment companies and non-life insurance companies have high liquidity needs, the liquidity need for banks is on average the greatest.

Which of the following pooled investments is most likely characterized by a few large investments? Hedge funds. Buyout funds. Venture capital funds.

B is correct. Buyout funds or private equity firms make only a few large investments in private companies with the intent of selling the restructured companies in three to five years. Venture capital funds also have a short time horizon; however, these funds consist of many small investments in companies with the expectation that only a few will have a large payoff (and that most will fail).

Which of the following institutional investors is most likely to manage investments in mutual funds? Insurance companies. Investment companies. University endowments.

B is correct. Investment companies manage investments in mutual funds. Although endowments and insurance companies may own mutual funds, they do not issue or redeem shares of mutual funds.

Which of the following institutional investors will most likely have the longest time horizon? Defined benefit plan. University endowment. Life insurance company.

B is correct. Most foundations and endowments are established with the intent of having perpetual lives. Although defined benefit plans and life insurance companies have portfolios with a long time horizon, they are not perpetual.

Which of the following investment products is most likely to trade at their net asset value per share? Exchange traded funds. Open-end mutual funds. Closed-end mutual funds.

B is correct. Open-end funds trade at their net asset value per share, whereas closed-end funds and exchange traded funds can trade at a premium or a discount.

With respect to the portfolio management process, the rebalancing of a portfolio's composition is most likely to occur in the: planning step. feedback step. execution step.

B is correct. Portfolio monitoring and rebalancing occurs in the feedback step of the portfolio management process.

An analyst gathers the following information for the asset allocations of three portfolios: Portfolio Fixed Income (%) Equity (%) Alternative Assets (%) 1 25 60 15 2 60 25 15 3 15 60 25 Which of the portfolios is most likely appropriate for a client who has a high degree of risk tolerance? Portfolio 1. Portfolio 2. Portfolio 3.

C is correct. Portfolio 3 has the same equity exposure as Portfolio 1 and has a higher exposure to alternative assets, which have greater volatility (as discussed in the section of the reading comparing the endowments from Yale University and the University of Virginia).

With respect to the portfolio management process, the asset allocation is determined in the: planning step. feedback step. execution step.

C is correct. The client's objectives and constraints are established in the investment policy statement and are used to determine the client's target asset allocation, which occurs in the execution step of the portfolio management process.