Portfolio / Fixed Income Basics: Portfolio Management Styles / Techniques

Momentum investing

A technical theory that states that stocks that have growing market momentum tend to keep on moving in the same direction. Thus, a stock that has a rapid upward price movement would be expected to continue to rise rapidly in price - so this is a stock that should be bought.

Value Line Index

a geometrically weighted index consisting of some 1,700 selected issues that are on the NYSE, NYSE American (AMEX), and NASDAQ markets. These are the securities that are followed and rated by the Value Line Investment Survey.

Dollar cost averaging

a strategy whereby a person invests the same amount of money at regular intervals in a stock or a mutual fund without regard for the price fluctuations of the security. Over time, this investment strategy usually results in an investor's average cost per share for the security being lower than the security's average price per share over the same period.

Investment policy statement

a summary of the chosen investments and asset allocation percentages that have been decided upon in order to meet the investor's financial goals, taking into account the investor's risk tolerance and investment time horizon. The policy statement outlines expected investment returns and variances and compares these to a benchmark portfolio.

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: A 2% B 4% C 6% D 10%

answer: A) 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.

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: A 5 x 20 B 10 x 10 C 15 x 20 D 30 x 55

answer: A) 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.

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 active rate of return on the portfolio is: A 5% B 10% C 15% D 20%

answer: A) 5% 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 20% rate of return; compared to the benchmark portfolio return of 15%. Thus, the active rate of return is 5%. The manager's abilities allowed him or her to do 5% better than a passive indexed portfolio of similar investments.

A portfolio invested in actively managed funds that is rebalanced monthly is considered to be: A Active/Active B Passive/Passive C Active/Passive D Passive/Active

answer: A) Active/Active

An investment adviser has its model portfolio structured to match a blend of the major U.S. based equity indexes, using index ETFs as the investment vehicle. To further diversify the portfolio against market risk, the adviser could include an ETF based on which index? A EAFE B ADRs C S&P 500 D Russell 2,000

answer: A) 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 Index fund would give 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.

What style of investing justifies paying a premium for companies that have good future potential? A Growth B Value C Strategic D Tactical

answer: A) Growth A "growth" investor looks for companies that are likely to "grow" their earnings at rapid rates, which would cause the stock price to rise. Value investors look for "out of favor" companies that have a depressed stock price. When the market realizes that these companies are "solid," their prices are expected to rise. Strategic and tactical refer to styles of asset allocation; not to investing styles.

A corporation that has a market capitalization of $40,000,000 would be an appropriate investment for a: A Micro Cap Mutual Fund B Small Cap Mutual Fund C Mid Cap Mutual Fund D Large Cap Mutual Fund

answer: A) Micro Cap Mutual Fund A "Micro Cap" stock is one with a market capitalization of up to $250 million. A "Small Cap" stock is one with a market capitalization between $250 million and $2 billion. A "Mid Cap" stock is one with a market capitalization between $2 billion and $10 billion. A "Large Cap" stock is one with a market capitalization over $10 billion.

A manager of a small cap portfolio wishes to use an index to establish a benchmark rate of return. The most appropriate index to use is the: A Russell 2000 Index B Standard and Poor's 400 Index C Dow Jones Industrial Average D NASDAQ 100 Index

answer: A) Russell 2000 Index The Russell 2000 Index consists only of small capitalization stocks, so this is the benchmark index to be used. The Standard and Poor's 400 Index is a mid-cap index. The Dow Jones Industrial Average of 30 Stocks is a large-cap index. The NASDAQ 100 Index consists of the 100 largest NASDAQ issues and also is a large-cap index.

Changing the mix of a portfolio that has been structured to meet specific financial goals is called: Changing the mix of a portfolio that has been structured to meet specific financial goals is called: A Strategic allocation B Tactical allocation C Rebalancing D Risk adjustment

answer: A) Strategic allocation 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% Changing these percentages as conditions change is part of ongoing strategic asset management. 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.

The setting of specific goals for an investment plan to be created for a customer is known as: A Strategic asset management B Tactical asset management C Dollar cost averaging D Portfolio rebalancing

answer: A) Strategic asset management Strategic asset management is the setting of the investment "strategy" under an asset allocation scheme. Tactical asset management is the permitted variation to the established strategy, to take advantage of market opportunities. Dollar cost averaging is the periodic (say monthly) investment of a fixed dollar amount into a given security. By using dollar cost averaging, the average cost per share purchased can be lower than the arithmetical average cost of the security over the same time frame - as long as the security's price has been moving up and down (as the security's price drops, the fixed periodic dollar amount buys proportionately more shares than when the security's price rises). Portfolio rebalancing is used in an asset allocation scheme when a chosen asset class outperforms the others, so that its percentage allocation increases beyond the strategic limit. The excess in that class is sold off and the proceeds reinvested in the other asset classes to rebalance the portfolio back to its strategically set percentages.

A Statement of Investment Policy prepared for distribution to a client that purchases asset allocation services covers all of the following EXCEPT: A compensation of the investment manager for providing either active or passive portfolio management B customer's investment objectives financial needs and financial goals C guidelines regarding investments that are permitted and those that are prohibited D guidelines regarding investment diversification or concentration

answer: A) compensation of the investment manager for providing either active or passive portfolio management 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 use of index funds as investment vehicles for asset classes increases: A diversification B expected rate of return C standard deviation of return D market risk

answer: A) diversification 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.

Active asset managers select investments based primarily upon: A inefficient market pricing of the investment B efficient market pricing of the investment C minimum time needed to achieve projected investment returns D minimum number of investments needed to achieve projected investment returns

answer: A) inefficient market pricing of the investment Active asset managers believe that by performing fundamental analysis, they can find undervalued companies - that is, companies that are not "efficiently priced." Passive asset managers believe that the market is basically efficient, and that one cannot consistently find "undervalued securities" - so why bother. Instead, just invest in an asset that mimics the index - that is, an index fund. This will do as well as the "market" with much lower expenses than those associated with "active" asset management.

A bond investment strategy that minimizes interest rate risk by adjusting the portfolio duration to match the client's investment time horizon is called: A portfolio immunization B portfolio diversification C portfolio rebalancing D portfolio hedging

answer: A) 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. 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.

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: A portfolio immunization B portfolio diversification C portfolio rebalancing D portfolio hedging

answer: A) 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.

Value investors: A seek to find investments that are undervalued by the market B determine the value of a security through fundamental analysis C invest in securities included in the Value Line Index D make their investment decision based upon the market performance of the security

answer: A) 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 passively managed portfolio would most likely invest in: A stocks in the S&P 500 index B European stocks C income producing stocks D limited partnership units

answer: A) stocks in the S&P 500 index A passively managed portfolio is one that is invested in index funds. Thus, the portfolio is matched to an index and is not "actively" managed. An actively managed portfolio is one that is invested in specifically chosen stocks and bonds that the investment manager believes will outperform the market.

If a passively managed fund either underperforms or overperforms the benchmark index, this is called the: A tracking error B alpha coefficient C opportunity cost D margin of error

answer: A) 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.

A customer makes the following investments in ABC stock: Date Amount Price Per Share 1/1 $6,000 $10 4/1 $6,000 $12 7/1 $6,000 $15 10/1 $6,000 $20 What is the customer's average cost per share? A $13 B $13.33 C $14.25 D $14.50

answer: B) $13.33 This is a dollar cost averaging example. Date - Amount - Price Per Share - # Shares Purchased 1/1 $6,000 $10 600 4/1 $6,000 $12 500 7/1 $6,000 $15 400 10/1 $6,000 $20 300 Total Investment = $24,000 Total Number of Shares Purchased = 1,800 Average Cost Per Share Purchased = $24,000 / 1,800 shares = $13.33 per share. Note that this is lower than the straight average price per share over this time period (which is $10 + $12 + $15 + $20 = $57 / 4 = $14.25).

A client of an investment adviser, whose long-standing investment objective was "growth," is nearing retirement. With the aid of the investment adviser, the client changes her investment objective to preservation of capital and current income. The best asset allocation mix to recommend to this client is: A 100% common stocks B 50% common stocks; 50% bonds C 10% common stocks; 90% bonds D 100% bonds

answer: B) 50% common stocks; 50% bonds As a client's financial profile changes, so does his or her investment objective. Thus, the Investment Policy Statement must shift to reflect the client's current and expected needs. The client now has an objective of both income and capital preservation would invest in a balance of common stocks and fixed income securities. The fixed income securities provide income; while the common stocks provide little current income. The common stock values will tend to increase over time, as the economy grows, preserving the customer's capital. However, if interest rates rise, forcing the value of the fixed income securities down; the common stock portion of the portfolio would be minimally affected. If economic conditions deteriorate, forcing the value of the common stocks down; then interest rates would tend to fall. This would push up the prices of the fixed income securities in the portfolio, countering the loss in value of the common stocks. Thus, a relatively even mix of common stocks and fixed income securities best meets this customer's needs.

The portfolio management technique that uses a market index as a performance benchmark that the asset manager must EXCEED is called: A Passive asset management B Active asset management C Strategic asset management D Tactical asset management

answer: B) Active asset management Active asset management is the management of a portfolio to exceed a benchmark return (say the return of a comparable index fund). The manager's "active" return is any incremental return achieved over the benchmark return. In contrast, passive asset management is simply the management of a portfolio to match the benchmark return (the "passive return"). Active managers believe that underpriced securities can be found in the market and that performance of the benchmark can be exceeded. Passive managers believe that the market is efficient at pricing securities and that one cannot do any better than the "market" return as measured by a relevant index.

A security that is quoted at $20 Buy / $21 Sell is an example of a: A Spread B Bid and Ask quote C Indication of interest D Reported trade

answer: B) Bid and Ask quote Market makers maintain a bid / ask quote in a security. Bid / Ask quotes are always from the standpoint of the dealer. The dealer is willing to sell at his "asking" price; and is willing to buy at his "bidding" price. The difference between the bid and ask is the spread - that is the market makers gross compensation for making a market in the security. Customers who wish to buy do so at the dealer's ask; customers who wish to sell do so at the dealer's bid.

Which statement is true regarding dollar cost averaging? A If market prices remain constant, the plan will produce a lower average per share cost B If market prices are fluctuating, the plan will produce a lower average per share cost C If prices rise, smaller dollar purchases must be made; while if prices fall, larger dollar purchases must be made D The plan requires that a constant dollar amount be maintained in equity securities, with any excess invested in debt

answer: B) 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.

A portfolio that is rebalanced annually is considered to be: A Active B Passive C Fixed D Strategic

answer: B) 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."

A passively managed index fund, to compensate for a negative tracking error, would: A rebalance its portfolio B actively manage a portion of its portfolio C terminate its portfolio manager and hire a more experienced individual D implement a new strategic asset allocation plan

answer: B) actively manage a portion of its portfolio 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.

A potential client is 81 years old and has asked his representative for recommendations of speculative "Dot Com" stocks. The customer has a broadly diversified bond and high dividend paying stock portfolio that provides retirement income, in addition to the customer receiving social security. The customer is concerned that his purchasing power is decreasing and wishes to allocate an increased portion of his portfolio to aggressive growth stocks. The BEST recommendation for this customer is to: A not allocate any of his portfolio to "Dot Com" stocks because they give no current income, which this customer needs B allocate a portion of the customer's portfolio to "Dot Com" stocks that will not reduce the customer's retirement income below the amount needed for comfortable living C allocate a portion of the customer's portfolio to "Dot Com" stocks as dictated by the customer, since he is making the investment decision D tell the customer that aggressive growth stocks are not suitable for a person who is at such a late stage of life

answer: B) allocate a portion of the customer's portfolio to "Dot Com" stocks that will not reduce the customer's retirement income below the amount needed for comfortable living This client is elderly, but is worried about the risk of inflation (purchasing power risk). A portion of the customer's portfolio could be reallocated to growth stocks to offset this risk, but only an amount that would not compromise the income needed by the customer to support his current living standard. This would likely result in a fairly small allocation. One could argue that such an elderly customer should not be holding any such stocks, but this customer is concerned about purchasing power risk and the only way to limit this is with investments in either growth stocks or TIPs (Treasury Inflation Protection Securities - which are not considered in this question).

One of the benefits of a global fund is that it includes: A international stocks B both domestic and international stocks C options writing strategies D a market weight of non-correlated investments

answer: B) both domestic and international stocks A "global" fund includes both domestic and international stocks. This spreads the equity investments across differing investment vehicles within the "Equities" asset class.

A portfolio manager who believes that an extremely large short interest in NYSE listed issues is bullish would be called a: A fundamentalist B contrarian C market timer D technician

answer: B) contrarian A "contrarian" is an analyst that goes against the conventional wisdom. A contrarian believes that when prices are moving up quickly, it's time to sell; and that when prices are moving down rapidly, it's time to buy. The "idea" is that these signal either an "overbought" market that is ripe for a decline, or an "oversold" market where prices have dropped too far and are ready for a rebound. A very large short interest (that is, lots of investors have sold that stock short) indicates an "oversold" market, hence prices have been pushed too low and it is time to buy.

Adding foreign stocks to a portfolio of domestic securities: A increases risk B decreases risk C has no effect on risk D is a prohibited practice

answer: B) 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 index fund manager, in order to meet its investment objective, attempts to: A match its portfolio composition exactly to the designated index and achieve the same investment return as the index B 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 C minimize reallocating the portfolio weightings as prices of securities in the index change in order to keep fund expenses at a low level D maximize portfolio return by only investing in the stocks included in the index that provide both current return and that have capital gains potential

answer: B) 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.

The advantage of buying a foreign index fund as compared to direct investing in foreign stocks is that it: A minimizes the risk of changing currency values B is easier than individually investing in foreign stocks C reduces tax liability when dividends are distributed D minimizes the business risk of the investments

answer: B) 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).

When describing a mutual fund manager, the term management tenure is the: A length of time that the individual has been in the securities industry B length of time that the individual has been managing that mutual fund C length of time that the mutual fund has been in existence D length of time that the mutual fund has been managed by a registered investment adviser

answer: B) length of time that the individual has been managing that mutual fund 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.

A fund that invests in Treasury Bills, commercial paper, and guaranteed repurchase agreements is a(n): A government securities fund B money market fund C income fund D balanced fund

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

Dollar cost averaging is used most often by: A hedge fund managers B mutual fund investors C unit investment trust purchasers D exchange traded fund managers

answer: B) mutual fund investors Dollar cost averaging (DCA) is most often used by mutual fund investors, because the periodic investment of a fixed dollar amount (say $500 per month) can buy both full and fractional shares. It is not used by hedge funds, because they time the market (they don't make fixed investments at fixed intervals) and use aggressive, leveraged strategies, such as short selling. UITs are not suitable for dollar cost averaging because they are usually fixed bond portfolios that are bought and held to maturity. ETFs are usually passively managed index funds. These could be effectively dollar cost averaged, but they can only be purchased in full shares, not fractional shares, so mutual funds are still better for DCA.

Buy and hold is an appropriate strategy when investing in: A common stocks B mutual funds C corporate bonds D preferred stocks

answer: B) mutual funds 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. Direct investments in specific assets, such as stocks or corporate bonds, require that the investor rebalance periodically to maximize returns.

A customer borrows funds at 5% and uses the proceeds to make an investment yielding 4%. This is an example of: A positive financial leverage B negative financial leverage C positive portfolio return D negative portfolio return

answer: B) 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!

If one asset class greatly underperforms another class in an asset allocation plan, the portfolio must be: A renegotiated B rebalanced C repositioned D realigned

answer: B) 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).

If a bond fund manager employs a contingent immunization strategy, then the manager will: A hedge the bond portfolio with put options to minimize market risk B switch from an active management strategy to a defensive strategy if asset values drop below a preset level C match the duration of the bonds in the portfolio to the date that anticipated obligations become due D periodically liquidate positions that have increased in value and use to proceeds to invest in positions that have decreased in value

answer: B) switch from an active management strategy to a defensive strategy if asset values drop below a preset level 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.

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? A 0 B $.25 C $.32 D $.50

answer: C) $.32 Month - Investment - Share Price - Number of Shares Purchased 1 $400 $13 30.769 2 $400 $10 40.000 3 $400 $8 50.000 4 $400 $9 44.444 Total: $1600 165.213 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 portfolio manager generates a 15% rate of return on an "aggressive growth" portfolio compared to a 13% 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: A 2% B 3% C 13% D 15%

answer: C) 13% The "passive" rate of return is that achieved by investing in an appropriate index fund. Here, the benchmark index has a 13% rate of return - this is the return that any passive investor could achieve by investing in an index fund that mimics that index.

A single 30-year old investor has no current investments and $20,000 in a savings account. The customer earns $150,000 per year and has discretionary investment funds of $25,000 per year. Which of the following is an appropriate asset allocation for this customer? A 80% Aggressive Growth Fund, 20% Emerging Markets Fund B 80% Emerging Markets Fund, 20% Aggressive Growth Fund C 30% Aggressive Growth Fund, 30% Emerging Markets Fund, 30% Growth Fund, 10% Money Market Fund D 30% Money Market Fund, 30% Treasury Securities Fund, 30% Blue Chip Stock Fund, 10% Aggressive Growth Fund

answer: C) 30% Aggressive Growth Fund, 30% Emerging Markets Fund, 30% Growth Fund, 10% Money Market Fund Since this customer is only 30 years old and is single, he has a long investment time horizon. The question does not provide any detail in terms of the customer's investment objectives and risk tolerance level. However, the concept of asset allocation is that by diversifying across asset classes, overall risk can be reduced while still achieving the customer's objective. A younger customer should be allocated more heavily into growth stocks. Choice C, with a 30% allocation to an Aggressive Growth Fund, 30% to an Emerging Markets Fund, 30% to a Growth Fund, and 10% to a Money Market Fund gives the customer a heavy concentration in growth stocks, but spread across 3 types of growth investment vehicles. Choices A and B are too concentrated in a single investment vehicle; and Choice D is better for an older investor, not a young investor.

Dealers are showing the following quotes for XYZZ stock: XYZZ Stock Bid Ask Size Dealer A 7.25 7.70 10 x 20 Dealer B 7.60 7.85 5 x 10 Dealer C 7.35 7.75 15 x 25 The "inside market" is: A 7.25 - 7.85 B 7.35 - 7.60 C 7.60 - 7.70 D 7.60 - 7.75

answer: C) 7.60 - 7.70 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 $7.70 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 $7.60 is the best price at which to sell. Quotes are shown in Bid / Ask order, so the high bid is 7.60 and the low ask is 7.70. The size of this market is 5 x 20. Dealer B is posting the best bid of $7.60 and is willing to buy 500 shares (5 round lots) at that price. Dealer A is posting the best ask of $7.70 and is willing to sell 2000 shares (20 round lots) at that price.

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 passive rate of return on the portfolio is: A 2% B 6% C 8% D 10%

answer: C) 8% The "passive" rate of return is that achieved by investing in an appropriate index fund. Here, the benchmark index has an 8% rate of return - this is the return that any passive investor could achieve by investing in an index fund that mimics that index.

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 "inside market" is: A 9.70 - 9.85 B 9.80 - 9.95 C 9.80 - 9.85 D 9.70 - 9.95

answer: C) 9.80 - 9.85 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 $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.

Which of the following is NOT a portfolio management "style?" A Active management B Passive management C Diversification D Indexing

answer: C) Diversification 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. Diversification is not a style; rather it is a technique used to reduce risk.

Which of the following is NOT a benefit of making an investment in an emerging markets fund? A Diversification B Liquidity C Higher investment yield D Reduced investment risk

answer: C) 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.

Which of the following BEST represents diversification? A Investments apportioned between large cap stocks and blue chip stocks B Investments apportioned between U.S. Government bonds and municipal bonds C Investments apportioned between domestic stocks and foreign stocks D Investments apportioned between stocks and bonds of a foreign country

answer: C) Investments apportioned between domestic stocks and foreign stocks Diversification attempts to apportion investments into asset classes that are not equally susceptible to the same negative events. Large cap stocks and blue chip stocks are the same thing. U.S. Government bonds and municipal bonds are both "safe investments" with tax benefits (interest from a U.S. Government is exempt from State income tax; interest from a municipal is exempt from Federal income tax). However, both are equally susceptible to interest rate risk. Diversification between foreign stocks and domestic stocks is true diversification. The economic events of 1 country are not directly linked to events in other countries. Investing in both the stocks and bonds of a single foreign country is also not true diversification, because it does not diversify away risk that could be unique to investing in that country such as political risk and exchange rate risk.

Which of the following is an "asset class"? A Jewelry B Furniture C Real Estate D Life Insurance

answer: C) 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.

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. If this action is taken by the manager, this is termed: A portfolio rebalancing B strategic asset management C tactical asset management D active asset management

answer: C) Tactical 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."

One of the oldest portfolio strategies that is used in a stable interest rate environment is: A swaps B options C buy and hold D momentum

answer: C) 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 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: A portfolio immunization B portfolio rebalancing C contingent portfolio immunization D contingent portfolio rebalancing

answer: C) 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): A opportunist B fundamentalist C contrarian D technician

answer: C) 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.

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: A implement the plan and let the client's tax accountant deal with any tax issues B implement the plan and recommend a tax professional to the client C develop another plan for the client D implement the plan only if the customer signs a waiver of liability

answer: C) 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.

An individual that invests a constant dollar amount at regular time intervals over a long-term investment time horizon is: A rebalancing B market timing C dollar cost averaging D reinvesting

answer: C) dollar cost averaging Dollar cost averaging is the periodic investment of fixed dollar amounts in a given security over a long time frame. This method buys more shares when prices are lower; and fewer shares when prices are higher; resulting in a lower weighted average cost per share purchased (since proportionately more shares are bought when prices are low than when prices are high).

An index fund manager is expected to generate a return that: A is lower than that of the benchmark index B matches the benchmark index C exceeds the benchmark index D at a minimum, pays for the expenses of selling the fund

answer: C) 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.

When the securities markets have reached equilibrium, transaction costs are: A subject to high volatility B subject to low volatility C minimized D maximized

answer: C) 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.

An Investment Adviser Representative takes an annual look at his client's portfolio holdings and reallocates them to match up to a previously determined strategic asset allocation percentage. This is known as: A portfolio insurance B portfolio optimization C portfolio rebalancing D portfolio tracking

answer: C) portfolio rebalancing Strategic asset allocation is the setting of percentage allocations to each asset class, based on the customer's investment objectives, investment needs, risk tolerance, financial situation, etc. Since each asset class will perform differently, the actual percentage allocations will change over time. To bring the portfolio back to the desired allocations, it must be rebalanced. This is typically done annually. Those asset classes that have outperformed and have had their percentages increase will have a portion of the holding sold to bring the percentage back to the desired allocation; and the proceeds from these sales will be used to add to positions in the underperforming asset classes.

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: A portfolio rebalancing B tactical asset allocation C rotational investing strategy D strategic asset allocation

answer: C) 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.

The purchase of an emerging markets foreign stock index fund will subject the shareholder to all of the following risks EXCEPT: A exchange rate risk B political risk C stock-specific risk D business risk

answer: C) 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.

Which asset allocation is BEST for a 35-year old single risk tolerant investor looking to achieve the highest returns? A 25% Stocks / 25% Bonds / 25% REITs / 25% Money Markets B 50% Stocks / 50% Bonds C 60% Stocks / 40% Bonds D 95% Stocks / 5% Money Markets

answer: D) 95% Stocks / 5% Money Markets The investor is 35 years old, single and risk tolerant. While an argument could be made for any one of the choices offered, the one choice that is clearly different from the others is Choice D - 95% equities and 5% money market instruments. This gives both the greatest growth potential for a relatively young investor along with the greatest risk - and this investor is risk tolerant. The other choices have a fairly large portion of the portfolio allocated to bonds, which do not have any growth potential over a long-term investment time horizon, but also have much lower risk.

A customer holds a large portfolio of corporate bonds. The customer is worried about business (capital) risk. Which diversification strategy would be LEAST effective to minimize capital risk for this customer? A Diversification among differing issuers in differing states B Diversification among differing industries C Diversification among differing maturities D Diversification among differing coupon rates

answer: D) Diversification among differing coupon rates Effective methods of diversifying away the unsystematic risk of a portfolio would be to diversify among different issuers, different states, and different industries. Thus, if one issuer, industry or economic region has problems, this would only affect a small portion of the portfolio. Diversification among differing maturities also provides a measure of risk management. If market interest rates rise, short term maturities (under 1 year) will decline in price by a minimal amount compared with longer maturities. Thus, a mix of maturities helps to minimize capital risk. Diversification among different coupon rates would be the least effective means of minimizing risk. As a generalization, the lower the coupon rate, the more volatile the bond's price movements in response to interest rate movements. However, if market interest rates rise, all of the bonds in the portfolio will drop in value (with the lower coupon rate bonds dropping faster). Thus, this type of diversification really does not protect much against market risk.

A customer is invested in a diversified portfolio of small-cap, mid-cap and large-cap stocks of companies based in the United States. Which index fund could the customer use to further diversify this portfolio? A S&P 500 B Russell 2000 C DJIA D EAFE

answer: D) 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 and further diversify his or her U.S. based portfolio against market risk, since companies in international markets would typically be affected by different events than U.S. companies. The S&P 500, DJIA, and Russell 2000 all consist of U.S. companies.

All of the following investments offer tax benefits EXCEPT: A Municipal Bonds B Variable Annuities C Real Estate D Index Funds

answer: D) 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 $40,000,000,000 would be an appropriate investment for a: A Micro Cap Mutual Fund B Small Cap Mutual Fund C Mid Cap Mutual Fund D Large Cap Mutual Fund

answer: D) Large Cap Mutual Fund A "Micro Cap" stock is one with a market capitalization of up to $250 million. A "Small Cap" stock is one with a market capitalization between $250 million and $2 billion. A "Mid Cap" stock is one with a market capitalization between $2 billion and $10 billion. A "Large Cap" stock is one with a market capitalization over $10 billion.

A portfolio invested in actively managed funds that is rebalanced annually is considered to be: A Active/Active B Passive/Passive C Active/Passive D Passive/Active

answer: D) 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."

Which of the following is NOT found in the IPS? A Investment objectives B Investment time horizon C Asset allocation percentages D Portfolio holding list

answer: D) Portfolio holding list The "IPS" is the Investment Policy Statement that an Investment adviser prepares for a new client. The purpose of the IPS is to lay out for the customer the investment objectives, risk tolerance, investment time horizon and policies that apply to the customer's investment portfolio. It details the basic investment structure including permitted asset classes, normal allocation percentages (strategic asset allocation) and permitted variations in these percentages (tactical asset allocation). It is signed by both the client and the adviser so that there is a written record that there was a "meeting of minds" between the customer and the adviser about how the adviser will manage the customer's assets. The specific investments that will be made by the adviser are not known at this point and are not part of the IPS.

A client of an investment adviser wishes to invest in an index which consists of small capitalization issues. The investment adviser would recommend the: A Dow Jones Averages B Value Line Index C Wilshire Index D Russell 2000

answer: D) 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 5,000 issues of companies headquartered in the United States that are listed on the NYSE, AMEX (NYSE American), or NASDAQ.

In the beginning of a period of economic recession, an investor who employs a sector rotation strategy would allocate investment funds to: A Technology stocks B Industrial stocks C Consumer Goods stocks D Utility stocks

answer: D) Utility 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

All of the following terms are synonymous EXCEPT: A principal B market maker C dealer D agent

answer: D) 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 Standard and Poor's 500 Index is a measure of: A price volatility of the 500 largest company stocks traded in the U.S. B market performance of 500 thinly traded speculative company stocks C price movement of a narrowly constructed portfolio of U.S. company stocks D average market performance of the largest U.S. company stocks

answer: D) average market performance of the largest U.S. company stocks The Standard and Poor's 500 Index covers the 500 largest companies in the U.S. by market capitalization. It is a valuation measure, not a volatility measure.

Rebalancing of a client portfolio based on shifting values of different asset classes is called: A passive asset allocation B strategic asset allocation C efficient asset allocation D dynamic asset allocation

answer: D) dynamic asset allocation Dynamic asset allocation is really just another name for "Tactical Asset Allocation." Once the basic asset allocation percentages are set in a portfolio composition using strategic asset allocation (this sets the basic "strategy" based on the client's investment objective, age, risk tolerance, investment time horizon, other investment holdings, etc.), the manager can "dynamically" alter the percentages, within specified limits, to take advantage of current asset valuations. Thus, "money can be taken off the table," by selling a portion of positions deemed to be overvalued; with the proceeds invested in positions that are undervalued. So know that another name for Tactical Asset Allocation is Dynamic Asset Allocation.

A money manager that employs momentum investing makes investment decisions based on the: A fundamental values B earnings growth of the company C efficient market theory D earnings trends of the company

answer: D) earnings trends of the company 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), with earnings trending higher 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), with earnings trending lower and that will lead to a stock price fall. Thus, they invest based on the earnings trends of the company. 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.

U.S. corporations account for 45% of global corporate wealth. An investor that has an objective of global investing would A only invest in corporations based in the U.S. B only invest in corporations based outside the U.S. C invest 45% of assets in U.S. companies and 55% of assets in foreign companies D spread its investments across both domestic and foreign securities, weighting investments based on performance expectations

answer: D) 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 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

answer: 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). Review

Diversification among multiple asset classes reduces the: I market risk of the portfolio II marketability risk of the portfolio III standard deviation of portfolio returns

answer: I and III Diversification of a portfolio reduces market risk; and also reduces the variability of investment returns. It does not affect marketability risk - that is, how difficult is it to liquidate given position in the portfolio.

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

answer: 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.

Broker-dealers are permitted to execute the following over-the-counter transactions? I Agency trades where the customer is charged a commission II Agency trades where the customer is charged a mark-up or mark-down III Principal trades where the customer is charged a commission IV Principal trades where the customer is charged a mark-up or mark-down

answer: I and IV 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. Furthermore, it is prohibited to charge both a commission; and a mark-up or mark-down; in any transaction.

Which statements are TRUE? I Strategic portfolio management establishes the basic portfolio structure II Tactical portfolio management establishes the basic portfolio structure III Strategic portfolio management allows market timing adjustments to portfolio structure IV Tactical portfolio management allows market timing adjustments to portfolio structure

answer: 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 under-perform 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.

Market Capitalization of a company is determined by: I Market value per share II Par value per share III Issued shares IV Outstanding shares

answer: I times IV Market capitalization of a company is the current market price per share times the number of outstanding shares (issued stock minus treasury stock). The ratings agencies categorize companies by their market capitalization - e.g., micro-cap, small cap, mid-cap, and large cap.

The Russell 2000 Index includes stocks traded in which of the following markets? I NYSE II AMEX (NYSE American) III NASDAQ

answer: I, II, III All U.S. companies listed on the NYSE, AMEX (NYSE American) or NASDAQ are considered for inclusion in the Russell 2000 Small Cap Index with a few exceptions, including the minimum price of $1.00; trading volumes; and other various factors.

"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

answer: 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.

If a firm effects trades solely on an agency basis, the firm: I carries inventory II does not carry inventory III is a market maker IV is not a market maker

answer: II and IV If a firm effects trades solely on an agency basis, it carries no inventory and is not a market maker.

An investment adviser uses various mutual funds as the asset classes that are recommended to customers. The adviser would include an emerging markets fund as a recommended class in order to: A diversify the customer's investment holdings B reduce tax liability for the customer, since foreign income is not subject to U.S. taxation C increase investment returns over the return that could be achieved by recommending another fund D lower the risk of the customer's investment portfolio

answer:: A) diversify the customer's investment holdings Emerging markets stocks are stocks of 3rd world countries that are rapidly growing (such as the BRIC countries - Brazil, Russia, India, and China). A U.S. based investor would allocate a portion of investment funds to these assets to diversify the portfolio. This would also give the portfolio the potential for increased returns, but not necessarily above the return that could be achieved by recommending another fund (making Choice C incorrect). Investing in an emerging markets fund would increase risk, not lower it. Finally, all income from investments, whether earned in the U.S. or outside the U.S., is subject to U.S. income tax for U.S. residents.

Fundamental analysis

evaluating a company's balance sheet, income statement, management, marketing strategies, and research and development as a means of predicting the future, long-term price movement of its stock. Such an analysis is based on the "fundamentals" of the company.

Tracking error

in a passively managed investment that is designed to "mirror" a designated index, the risk that the portfolio returns fall short of the index results (or exceed them).

"active" and "passive" 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." frequency/underlying investment

Technical analysis

research that seeks to predict the future price movement of a stock or the overall market by using price movement and volume indicators, and by using charts of a stock's past price and volume movements, to predict its future price movements.

Mark-up

the amount or percentage that is added to the inside ask price when a customer buys an OTC security from a FINRA member firm acting as a principal or market maker in the transaction. Except for NASDAQ stocks, the mark-up on an OTC principal transaction is not usually disclosed to the customer on a confirmation; rather it is included in a net price to the customer.

Asset class

the categorization of investments into groupings with similar risk and return characteristics. The commonly recognized asset classes are equities, fixed income securities, cash equivalents, real estate and commodities.

Strategic asset allocation

the determination of the percentage of assets to be placed in each asset class under an asset allocation scheme.

Active return

the excess return achieved by an asset manager above the specified benchmark

Tactical asset allocation

the permitted variation from the fixed percentage of assets to be placed in each asset class given to the asset manager under an asset allocation scheme.

Portfolio rebalancing

the reallocation of funds in an asset allocation model from overperforming asset classes to those that have underperformed. In this manner, the percentage allocations to each asset class are kept within the desired range.

Passive return

the return achieved by an asset manager to match the specified benchmark

Value investing

the selection of equity investments based on finding undervalued issues using fundamental analysis.

Short interest

the total level of uncovered short sales, reported twice a month by the exchanges. A very large short interest indicates that the market is "oversold" and is likely to turn upwards. A very low short interest indicates that the market is "overbought" and is likely to turn downwards. This is a contrary technical indicator.