Certification Exam Length Practice

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Calculate the net present value (rounded to the nearest dollar) of the initial investment needed today that would grow to become $1,000,000 in 25 years based on a 10-percent annual return, compounded quarterly, net of inflation and fees. Assume the following: one-half of the investment gains each year are tax deferred, one-quarter of the annual gains are taxed at the 15-percent capital gains rate, and one-quarter of the annual total gains are taxed at a 40-percent income tax rate. a) $ 84,647 b) $ 118,442 c) $ 92,296 d) $ 126,402

$ 118,442 Calculate the After Tax Interest Rate 5% Tax Deferred 2.5% x (1- .15) = 2.125% 2.5% x (1-.4)= 1.5% After Tax Interest= 5 + 2.125 + 1.5 = 8.625 Calculate the Present Value needed Today, Compounded Quarterly FV= $1,000,000 N= 25 x 4 = 100 I= 8.625/4= 2.1563 PV= $118, 442

What is the tax penalty owed on an early IRA distribution of $17,000 if the initial contribution in the IRA was $5,000? Assume a 25-percent effective tax rate and a 15-percent capital gains rate. a) $5,950 b) $1,700 c) $6,800 d) $4,250

$1,700 Calculate the penalty $17,000 x .10 = $1,700

What is the simple interest on a $50,000 purchase over five years if the annual interest rate is 6% and inflation is 3%? a) $1,500 b) $7,500 c) $3,000 d) $15,000

$15,000 Isolate variables needed for a simple interest calculation. • P • N • I Apply the simple interest formula P X N X I$50,000 x 5 x 6%= $15,000

What is the tax paid on $10,000 of U.S. Treasury bond income assuming a 33-percent federal tax rate, 8-percent state tax rate, and 2-percent city tax rate? a) $4,100 b) $0 c) $4,300 d) $3,300

$3,300 Treasuries are taxed at the Federal Rate Only. $10,000 x .33 = $3,300

What is the total tax owed on an early IRA distribution of $10,000? Assume a 30-percent effective tax rate and a 15-percent capital gains rate. a) $4,500 b) $4,000 c) $1,000 d) $5,500

$4,000 Calculate the tax owed $10,000 x .30 = $3,000 Calculate the penalty $10,000 x .10 = $1,000 Add the tax and penalty $3,000 + $1,000 = $4,000

Calculate the tax liability for a 45-year-old investor who takes a nonqualified withdrawal of $10,000 from his IRA. Assume a 35-percent federal tax bracket, an 8-percent state tax bracket, and a 15-percent capital gains rate. a) $5,300 b) $3,500 c) $4,300 d) $6,800

$5,300 Calculate the tax owed $10,000 x (.35 + .08) = $4,300 Calculate the penalty $10,000 x .10 = $1,000 Add the tax and penalty $4,300 + $1,000 = $5,300

An investor places $100,000 into a diversified portfolio of equities. If the portfolio returns 10 percent and CPI is 3.5 percent, what is the long-term purchasing power reduction due to inflation, in dollars, of the portfolio after 25 years? a) $0 b) $625,003 c) $87,500 d) $458,467

$625,003 Calculate the Future Value on a Inflation and non-inflation adjusted basis. • Without Inflation i. PV= 100,000, N= 25, I=10, Calculate FV ii. FV= $1,083,450 • With Inflation i. Inflation Adjusted Return= [(1.1/1.035) -1 ]x 100 ii. =6.28% iii. PV= 100,000, N= 25. I=6.28, Calculate FV iv. FV= $458,447 Calculate the difference $1,083,470 - $458,447 = $625,003

If the current inflation rate is 3 percent and the risk-free rate is 2 percent, what is the amount an investor needs 20 years from now to equal the purchasing power of $50,000 (round to the nearest $1,000)? a) $90,000 b) $65,000 c) $100,000 d) $70,000

$90,000 Inflate $50,000 using Time Value of Money PV= 50,000, I= 3, N=20Calculate FV FV= $90,000

A US investor purchases 250 shares of LMN company for 90 euro when the exchange rate between the dollar and euro was $0.95/€. If the investor sells the stock a year later at 95 euro, what is the return of the investment to the US Investor if the exchange rate is now $1.05/€? a) 5.26% b) 15.79% c) 5.53% d) 16.67%

16.67% 1. Calculate the investment in dollars (per share) 90 x .95 = $85.5 2. Calculate the sale in dollars 95 x .1.05 = $99.75 3. Calculate Holding Period Return (99.75-85.5) /85.5 = 16.67%

What is the standard deviation of Security A? Consider the following sample data set for Security A: Year Return 2004 12% 2005 15% 2006 10% 2007 7% a) 2.92% b) 3% c) 3.36% d) 2.5%

3.36% 1. Calculate the mean of the data set a. 12 + 15 + 10 + 7 = 44 b. 44/4= 11% 2. Compute the difference of each data point, and square the result. a. 12-11 = 1, 1x1 = 1 b. 15-11 = 4, 4x4= 16 c. 10-11= -1, -1x-1= 1 d. 7-11= -4, -4x-4= 16 3. Compute the sum of these values a. 1 + 16 + 1 + 16 = 34 4. Take the sum, and divide by n-1, or 3 a. 34/3= 11.33 5. Take the square root of 11.33 a. 3.36%

If an investor purchases one share of stock on January 1, 2009, for $100, and sells it on January 2, 2010, for $150, what is the investor's after-tax return? Assume 3-percent inflation rate , a 15-percent long-term capital gains rate, and a 30-percent federal income tax rate. a) 35% b) 27.5% c) 42.5% d) 38%

42.5% Calculate the Holding Period Return HPR= (150 -100) / 100 = 50% Apply the Long Term Capital Gains Rate and After Tax return formula After Tax Return= 50% x (1-,15) = 50% x .85 42.5%

If the capital markets returns 7.5 percent, what is the equity premium if the risk-free rate is 2 percent and inflation is 3 percent? a) 2.5% b) 5.5% c) 9.5% d) 4.5%

5.5% Equity Risk Premium = RM - RF = 7.5% - 2% = 5.5%

What is the current yield of a nine-year bond with a fair market value of $1,075 and an annual coupon rate of 7%? a) 7.58% b) 9.80% c) 5.90% d) 6.51%

6.51% Calculate the current yield. Current Yield = Coupon Payment/Current Price Coupon = 7% or $70 coupon payment Current Price = $1075 60/950 = 6.51%

Which combination of bonds would immunize a portfolio if the underlying liability being funded has a duration of 5 years? Maturity Duration Bond A 5 2 Bond B 13 10 a) 25% Bond A, 25% Bond B b) 37.5% Bond A, 62.5% Bond B c) 62.5% Bond A, 37.5% Bond B d) 50% Bond A, 50% Bond B

62.5% Bond A, 37.5% Bond B 1. Use the Criss-Cross Method a. Find the difference in duration between the bonds b. 10- 2 c. 8 2. Calculate the percentage of Bond A a. Bond A = [(Duration B - Immunization)]/Difference in Duration of Bonds b. (10-5)/8 c. 5/8 = .625 or 62.5% 3. Calculate the percentage of Bond B a. Bond B = [(Duration A - Immunization)]/Difference in Duration of Bonds b. (2-5)/8 (use absolute value) c. 3/8 = .375 or 37.5%

What is the convexity of this portfolio of bonds? Use the data below for the following question. Bond Type Allocation Convexity Duration Municipal 30% 75 7.5years Agency 25% 90 9 years Corporate 45% 55 6 years Bond Type Allocation Convexity Durarion Municipal 30% 75 7.5 years Agency 25% 90 9 years Corporate 45% 55 6 years a) 69.75 b) 73.3 c) 29.16 d) 55.87

69.75 Calculate the Weighted Average Convexity a. .30 x 75 = 22.5 b. .25 x 90 = 22.5 c. .45 x 55 = 24.75 d. 22.5 + 22.5 + 24.75 = 69.75

Calculate the yield to maturity for a bond that has a six-year maturity, a current value of $925, and pays a $40 semiannually. a) 4.83% b) 5.50% c) 9.68% d) 8.88%

9.68% Calculate the Yield to Maturity using Time Value of Money adjusting for a semi-annual coupon. PV= -925 FV= 1000 PMT= 40 N= 6 x 2 = 12 Calculate I or Yield to Maturity I = 4.838% YTM= 4.838 x 2 = 9.68%

An investor is seeking private, highly illiquid, and speculative investments that require a large minimum investment. The investor, most likely, needs to be a/an: a) Charity with over $500,000 in assets b) A business with at least one owner who is accredited c) Trust with over $1,000,000 in assets d) A bank

A bank The federal securities laws define the term "accredited investor" in Rule 501 of Regulation D as: 1. a bank, insurance company, registered investment company, business development company, or small business investment company; 2. an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million; 3. a charitable organization, corporation, or partnership with assets exceeding $5 million; 4. a director, executive officer, or general partner of the company selling the securities; 5. a business in which all the equity owners are accredited investors; 6. a natural person who has individual net worth, or joint net worth with the person's spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person; 7. a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or 8. a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

Greater exposure and transparency in international markets have allowed consultants to allow portfolios: a) Reduced exposure to currency volatility b) A better opportunity to direct target beta c) Less inherent risk in individual global equities d) Increased government regulation

A better opportunity to direct target beta The basis of transparency is enforced by regulators, but demanded by investors in light of recent market changes and from the sheer number of strategies that have failed over the past 10-20 years. The influence on target beta is direct. With greater exposure, consultants and quantitative analysts may have a better opportunity to monitor and direct target beta, which will lead to more-directed portfolio allocation decisions on a fund-by-fund basis. Transparency allows investors to make more-strategic decisions about their overall holdings.

A point of review for most firm's active management techniques is: a) A custom benchmark b) Usually measured by the relative beta of the normal portfolio c) To create a benchmark that reflects positive alpha at all times d) CPI

A custom benchmark The custom benchmark proves to be point of review for most relationships and an established mark for a consultant to compare their firm's active management techniques versus a passive benchmark.

The time value of money is best described as: a) An accounting principle that allows for money deflation based on income tax rates b) A finance principle that calculates the future value of money figuring in a given amount of interest for a given amount of time c) A finance principle that averages the future value of money based only on market returns d) An accounting principle that discounts capital gains rates based on a set period of time

A finance principle that calculates the future value of money figuring in a given amount of interest for a given amount of time Time value of money is the concept that allows investors and advisors to accurately compare future values of money and present values of money based on interest, coupon, and time assumptions. Typically, an investment that returns capital sooner to an investor is more preferred to one that does not. The financial concept allows for calculation of future value, present value, periods, interest, and payments. The values of the variable will be based on 3-4 of the other variables not being calculated that are mentioned above. This concept is not strictly based on market returns or tax rates.

A consultant is analyzing different managers for his client portfolios. He has a client coming this afternoon and must research one asset class in particular. His best source of information, given his time constraint, would be: a) A manager database b) Each manager him/herself c) Each company's website d) IMCA

A manager database Databases allow consultants to research managers quickly, and add this research to their due diligence process in an efficient manner. With technology applications today, the updating is often daily, with pricing updates available on a live-feed basis in some cases. This provides up to date data that may be used to make manager decision promptly when needed on behalf of the investor.

A client would like to invest in government securities and is considering bills, notes, and bonds. With respect to U.S. government discount securities, which of the following is true? a) Payments are made quarterly b) A single payment is made at maturity c) Payments are made annually d) Payments are made semi-annually

A single payment is made at maturity Treasury bills are issued as a discount security because they have maturities of one year or less. The investment's return will be the difference between the issue price and the face amount paid upon maturity. Coupon securities will have maturities of two years or longer, which include Treasury notes and Treasury bonds. Treasury notes are issued with maturities of two, three, five, seven, and 10 years, and Treasury bonds have original maturities of more than 10 years. Unlike discount securities, coupon securities will pay interest every six months along with a principal payment upon maturity.

An investor believes that the domestic markets are poised to fall and would like to explore different ways to reduce his risk. His portfolio exhibits a significant degree of home bias. His consultant should suggest: a) Adding multinationals b) Adding a global fund to reduce correlation and setting an upside constraint level for his domestic funds c) Selling his entire portfolio d) Adding an international fund to diversify risk and setting a downside constraint level for his domestic funds

Adding an international fund to diversify risk and setting a downside constraint level for his domestic funds Adding international investments and setting downside limits to domestic funds could accomplish th investors goals. Diversification is a key advantage to global funds. Risk is not only diversified by company and industry, but geographically as well. Investors in global funds will have low home bias and wish to broaden their investment options. International investors relative to global investors, will usually want an increase in international or country specific risk. If a portfolio exhibits a large degree of home bias, adding international investments could decrease their overall risk. If they do not have large home bias risk, adding international investing may be used as a speculative tool to add exposure in higher risk markets.

A rolling period return can best be classified as: a) A basic calculation of an investment's increase in value over a 12-month period expressed as a percentage for the year b) A random sample of returns over a set period c) An average annualized return for a period beginning with the year in review d) An average annualized return for a period ending with the year in review

An average annualized return for a period ending with the year in review A rolling-period return is an average annualized return for a period ending with the year in review. Rolling-period returns are useful for examining returns for holding periods similar to those of the investor. Each rolling-period return can be viewed as the experience of an investor who began in the first month of the rolling period.

Business cycles: a) Are well defined as they occur, but have no standard length of time for the cycle b) Are coincident indicators and have no standard length of time for the cycle c) Are not usually well defined until after the fact and there is no standard length of time for the cycle d) Considered to be a leading indicator and have a standard length of time for the cycle

Are not usually well defined until after the fact and there is no standard length of time for the cycle Business cycles are not usually well defined until after we have experienced them and there is no standard length of time we should expect a cycle to last. However, there are widely recognized indicators that can help predict where an economy currently exists along the path of the business cycle. Leading indicators tend to tell us where the cycle may be headed, coincident indicators where we are right now and lagging indicators where we have been.

According to the 1990s study by Brinson and Beebower, which of the following has the largest influence with regard to investor return? a) Asset selection b) Asset allocation c) Manager experience d) Market timing

Asset allocation The Brinson Beebower studies ranged from the 1970's to the 1990's. The conclusion of the study was that over 90% of the risk return characteristics were achieved through asset allocation and not asset selection, manager talent, or market timing. The study analyzed portfolio variance and analyzed historical manager data. Many studies have been published to contradict the findings, but this study has been well followed and accepted since the 90's.

A basic investment policy statement can include which of the following? a) Fund management biographies b) Asset selection c) Fund performance data d) Asset allocation

Asset allocation The IPS sets forth a formal platform for determining the appropriate asset allocation. This platform is the basis for managing risk while offering an acceptable likelihood of achieving objectives. It will cover the general asset allocation among stocks, bonds, and other investments Asset selection is not a component of the IPS. The IPS is a transportable document and will not contain the specific underlying investments that may be ultimately recommended by the consultant. The fund performance data and management bios would be a component of the investment process, but not the IPS. This data is used to pick specific investments and would not be part of the IPS.

A consultant begins to follow economic indicators. Which of the following will give him the best insight in where the economy is headed? a) Unemployment b) GDP c) Building Permits d) Inflation

Building Permits Tracking the trends of leading indicators such as the money supply, building permits, the Index of Consumer Expectations and initial unemployment claims can give us clues as to whether the economy will be growing or heading towards a trough. When these indicators are positive and all else is equal, the market will tend to rise with the expectation that the economy will be growing in the near future. That should lead to coincident indicators rising while the business cycle is in expansion. As the expansion continues, we should then see evidence in lagging indicators, such as the duration of unemployment and inflation, which should show we were, in fact, expanding.

Over longer periods of time, equities generally have outperformed most major asset classes. Which asset allocation strategy is focused strictly on the long-term performance of the equity markets? a) Buy and hold b) Constant proportion portfolio insurance c) Tactical d) Strategic

Buy and hold In asset allocation, several subsets of strategies are used in portfolio management. The strategies dictate the manager's overall investment policy and can be passive or active. The most basic strategy is the buy-and-hold strategy. The buy-and-hold strategy is considered to be a long-term investment strategy and holds its foundations in the long-term performance of the markets.

The least active investment strategy is a) Strategic asset allocation b) Constant proportion portfolio insurance c) Buy-and-hold strategy d) Tactical asset allocation

Buy-and-hold strategy In asset allocation, several subsets of strategies are used in portfolio management. The strategies dictate the manager's overall investment policy and can be passive or active. The most basic strategy is the buy-and-hold strategy. The buy-and-hold strategy is considered to be a long-term investment strategy and holds its foundations in the long-term performance of the markets.

Bonds are debt instruments issued: a) Typically as a last resort option for companies b) In perpetuity c) By a company that may need to raise capital d) Only during the initial public offering of the company

By a company that may need to raise capital A bond is a negotiable debt instrument that is issued by a company or government that may need to raise capital to support its operations. The issuer sets specific terms including the amount of interest (or coupon) they will pay for borrowing the money, how long they will pay the interest, and when they will return the principal amount borrowed. The debt is considered an obligation and bond rights differ from equity or stock ownership rights. Characteristics of most bonds include bond interest, a maturity date, and the return of the bond principal. The exception is the zero-coupon bond that does not pay interest.

A consultant is formulating his hypothesis for portfolio return in the coming year and for the next 10 years. He determines that clients should have a higher equity exposure than in years past. This analysis starts with: a) Portfolio beta b) Domestic unemployment data c) Capital market expectations d) The Investment Policy Statement

Capital market expectations Capital market expectations are the conclusions that investment analysts reach about risk and return for specific asset classes. Capital market expectations help determine specific portfolio expectations given expected returns of asset classes or individual securities, standard deviations and correlations among the portfolio's assets. This type of analysis is also considered Beta research since it is used to derive a forecast of expected returns based on market expectations.

Because of investment barriers, CAPM may be the wrong model to use in: a) The United States b) Japan c) Germany d) China

China The ability to capture growth in emerging markets like China and others with barriers make it difficult to truly diversify. This, once again, can interfere with the CAPM assumption of diversified assets. The lower the barriers, the more investors can attempt to diversify. CAPM becomes an attractive model in well diversified and established markets.

A company is considering issuing debt to raise capital for a project. Which type of option should the company wish to consider if it wants to pay a low rate of interest and wants holders to benefit in the company's long-term profitability if the project pans out? a) Extendible option b) Conversion option c) Call option d) Put option

Conversion option A conversion option allows the bondholder to trade in the debt instrument for an equity position with the company, at some specified date and preset price. This option usually will result in a lower coupon rate. This feature also can be issued on an at-will basis.

A consultant is analyzing non-linear price movement of bonds. If a bond decreases 4.5% on a increase in interest rates of .75%, and the duration of the bond is 6.5 years, what is the impact of convexity? a) Convexity has a positive impact on the price of the bond by .5625% b) Convexity has a negative impact on the price of the bond by .75% c) Convexity does not impact the price of this bond d) Convexity has a positive impact on the price of the bond by .375%

Convexity has a positive impact on the price of the bond by .375% The correct answer is: Convexity has a positive impact on the price of the bond by .375%. 1. Using Duration, calculate the change in price a. Price change = - (change in yield) x MD b. = - (.75% x 6.5) c. = -4.875% 2. Calculate the difference between the linear and actual price change: a. 4.875 - 4.5 = .375%

A client would like to add international investments and inquires about the risk involved with a potential investment. The risk specifically involved in international investing is: a) Inflation risk b) Currency risk c) Interest-rate risk d) Market risk

Currency risk When considering foreign investments, currency risk also must be analyzed. The impact of exchange rates as well as foreign inflation rates can add to the overall risk and return in the region. The additional risks listed are not unique to domestic or international investments and are considered universal.

The risk specifically involved in international investing is: a) Market risk b) Currency risk c) Interest-rate risk d) Inflation risk

Currency risk When considering foreign investments, currency risk also must be analyzed. The impact of exchange rates as well as foreign inflation rates can add to the overall risk and return in the region. The additional risks listed are not unique to domestic or international investments and are considered universal.

A portfolio duration of 5.25 means that for a 100 basis point rise in all bond yields, the market value of the portfolio will: a) Increase by approximately 4.25% b) Decrease by approximately 5.25% c) Increase by approximately 5.25% d) Decrease by approximately 4.25%

Decrease by approximately 5.25% The correct answer is decrease by approximately 5.25%. The first rule applied is an increase in bond yields or interest rates will mean a decrease in the portfolio value. The 100 basis point decrease in yield in a portfolio with a duration of 5.25 will experience a -5.25% decline in the portfolio value.

Which of the following must meet ERISA guidelines? a) Individual retirement arrangement b) Foundation c) Simplified employee pension d) Defined contribution plan

Defined contribution plan ERISA is a federal law that regulates all kinds of employee benefits plans in the private sector. This includes pension plans, profit sharing plans, 401(k) plans and so-called "welfare" plans such as group health benefit plans, long and short term disability plans and other non-pension arrangements. Defined contribution and defined benefit plans are subject to ERISA guidelines. IRA's, SEP plans, and foundations are not governed by ERISA laws.

A plan sponsor would like to begin analysis on a brand new plan for her company and engages a consultant. What is the first step that the sponsor should consider? a) Determine asset mix b) Pick a manager c) Determine plan needs d) Select asset classes

Determine plan needs Step one in the IPS process is to determine client and plan needs. This is the most critical for both client and consultant. Here, the consultant gathers information not only about the client's financial goals and objectives, but also about the client's attitude toward wealth, his or her expectations about investing the assets, time horizon, and other personal information that might have a bearing on how the assets are deployed. Carefully worded questions must be asked about the client's definition of risk and how much of that risk, defined in the client's own terms, he or she can tolerate. The IPS also serves as the guide for deciding the most-appropriate allocation for the client's assets. This is not an easy task. Well-known studies document the theory that more than 90 percent of the variability of returns is due to asset allocation. The importance of discovering sufficient information from the client--especially regarding risk tolerance¬¬--to make the critical asset allocation determination cannot be overstressed. After the determination is made according to the unique attributes and objectives of the client, the IPS becomes an important reminder to the client to maintain a disciplined approach to investing. Determining asset mix and classes are part of the process, but only after needs are determined. Picking managers is not part of the IPS process.

A consultant reviews his client portfolio and comes up with the following observations: • Portfolio exhibits home bias. • High correlation between funds exists. • Portfolio rebalancing has not occurred. Based on these observations, the consultant may want to recommend implementing which of the following adjustments? a) Adding a CPPI strategy b) Adding higher correlation assets c) Developing a multiple-asset-class portfolio d) Purchasing domestic only funds

Developing a multiple-asset-class portfolio Developing a multiple asset class portfolio would be the best solution for the given challenges. A multiple asset class portfolio can allow the investor to stay invested in markets relative to an individual asset class holding by having asset classes that do well shoring up other asset classes that might be flat or falling during the same time. Multiple asset class portfolios can also force discipline with regards to portfolio rebalancing. With multiple asset classes, the investor can determine which asset classes have done well in their portfolio and which ones have fallen over a given time period. If we assume that all asset classes will trend up, the act of rebalancing at the end of a preferred time frame creates an easy to execute strategy.

A globally diversified portfolio may experience higher returns with lower risk because: a) Interest rates in foreign countries typically are higher than those in the domestic country b) Developing countries should experience higher rates of economic growth c) Emerging economies typically have more-stable government policy than developed economies d) Global markets move in unison

Developing countries should experience higher rates of economic growth The case for international diversification is important to understand. Studies in Europe long have substantiated the benefits of diversifying investments internationally. The results of various studies have substantiated that investing internationally in similar industries reduced volatility compared to investing in the same country and different industries. In addition, developing economies should experience larger growth rates. While this adds additional volatility, correlation will generally add to lower portfolio risk in the overall portfolio when added to domestic equities. Global markets generally will not move in unison. If they did, the benefit of diversification may not exist. Emerging economies governments would not generally be considered to be stable relative to developed countries. Additionally, interest rates in foreign countries may or may not be higher than the domestic country.

For consultants, the efficient frontier assists in: a) Finding the lowest risk possible, regardless of the client's needs b) Removing risk from equity portfolios c) Discovering the optimal portfolio for the client's needs d) Optimizing the ideal risk-free portfolio

Discovering the optimal portfolio for the client's needs The efficient frontier represents all portfolios offering the highest return for any given level of risk. Portfolios that sit on the frontier would considered be optimal for a given level of risk or a target portfolio return. The efficient frontier line can be used to identify "low risk" portfolios, but that should be taken together in the context of client risk. The goal of the efficient frontier line is not to remove equities or simply look for the ideal risk free portfolio. The line will identify the highest return for a given level or risk.

An investor would like to model a portfolio and review the potential for loss only. His consultant should review the portfolio's: a) Downside deviation b) Maximum acceptable return c) Variance d) Standard deviation

Downside deviation Downside deviation, like standard deviation, measures the price volatility of financial instruments. The key difference is that downside deviation, or downside risk, focuses only on the price movement to the downside of a Minimally Accepted Return (MAR). By focusing on downside risk only, the goal is to model the potential for losses in a security due to adverse market conditions. This modeling gives investors an opportunity to model worst-case scenarios and disaster scenarios, and the impact any negative scenario may have on the portfolio.

A client see the Wilshire 5000 as an index used in his performance reports for his well-diversified portfolio of equities. As a predictor of future returns, the client should be aware that the use of this benchmark: a) Exhibit backward looking bias b) Is always appropriate c) Should be the best predictor of future performance d) May resulting higher returns to his portfolio

Exhibit backward looking bias The biggest disadvantage to using this index is that a backward looking bias exists. The index reflects past performance and cannot necessarily be used to predict future performance of the asset class. Reviewing a portfolio to lead or lag an index may not be the best predictor of future returns.

If an investor is concerned about bond yield volatility, what is the core bond topic his consultant may wish to review at the next client meeting? a) Maturity b) Immunization c) Credit Ratings d) Fluctuation

Fluctuation Duration helps to measure the possible fluctuations of a bond's price over time. Duration is a time value measurement and, as such, includes all principal and interest payments in its calculation. Duration, while only a theoretical value, provides a more accurate way to compare potential risks. In a well-immunized portfolio, the fluctuations in the portfolio value occur in tandem with fluctuations in the value of the liabilities. In other words, the duration of the asset and the liability are equal.

An investor seeking to gain exposure in the currency markets may choose to add which of the following to her portfolio? a) Venture capital funds b) Hedge funds c) Future funds d) International funds

Future funds Future funds are a type of alternative investments that uses futures contracts to manage portfolios. Fund managers may engage in contracts that may be long or short. The contract classes are broad, but examples include metals, energy commodities, currencies, equity indexes, US bond futures, and "soft" commodities. Soft commodities can include food supplies and other raw materials, such as sugar, cocoa, and cotton.

Speculative risk is the chance of: a) Gain b) Asset decline to zero c) Loss d) Gain or loss

Gain or loss Speculative risk is the risk of loss or gain. Investors that seek this risk, or speculators, will generally place investments based on their analysis of which direction the market may move. If they believe the market or security is set to increase, they may choose to establish a long position. If they believe the opposite, a short position may be the recommended strategy. Investors engaged in speculation are often exposed to general market risk and their fates are determined on whether they are on the right or wrong side of a trade. Pure speculation can be extremely risky.

A 56-year old investor is considering withdrawing funds from his retirement account. His consultant should advise that he may avoid the 10-percent penalty associated with early withdrawal of funds if: a) He takes substantially equal periodic payments b) He is employed and would like to use the funds for medical expenses c) He owes the IRS his estimated tax payments d) The funds are being used for a first-time home improvement project

He takes substantially equal periodic payments A 10-percent federal penalty is assessed when there is a withdrawal from a retirement plan prior to age 59½. The penalty is calculated by taking 10 percent of the taxable withdrawal amount. Separate penalties may exist at the state level as well. The IRS allows for this penalty to be waived in the following situations, yet the distribution is still taxable: • Termination of employment • Disability • Higher-education expenses • Unreimbursed medical expenses • Medical insurance for the unemployed • First-time home purchase • IRS levy • Inherited IRA • Substantially equal periodic payments-72T • Distribution for qualified reservist called to active duty

Which of the following would be considered a form of current income? I Coupon payments II Capital gains III Bond interest IV Equity split a) I and II b) II and IV c) III and IV d) I and III

I and III Coupon payments and Bond Interest would be considered forms of current income. Current income is defined as a series of regular cash flows received from various investment sources. Capital gains would not be considered a type of cash flow and is a profit generally associated with the disposition of an asset. An equity split may result in an increase number of shares in the equity, however typically there is not a cash flow that results on a recurring basis during or after a split.

Combining domestic and foreign equity generally: I Reduces risk II Increases risk III Increases volatility IV Reduces volatility a) I and IV b) II and III c) I and II d) I and III

I and IV International diversification will result in risk reduction and volatility reduction for a given return as long as the correlation coefficient between the domestic and the foreign market is lower than 1.0. Lower correlations can provide profound risk reduction over time.

Which of the following statements are correct regarding the importance for consultants to develop an IPS for their clients? I. The policy will facilitate internal communication of the policy II. The policy will facilitate external communication of the policy III. It ensures a change of policy during periods of organizational turnover a) I b) I, II c) I, III d) II, III

I, II The IPS is designed to communicate the policy both internally and externally. Internally, the policy is communicated to all decision makers and externally the policy is communicated to consultants, investment managers, actuaries, and other professionals involved in managing assets. It is not responsible for change during organizational turnover.

Which of the following are benefits associated with separately managed accounts? I. Proxy Voting II. Daily Transaction Transparency III. Pooled Securities IV. Initial investment can be existing securities a) I, IV b) I, II, IV c) III, II d) I, II, III, IV

I, II, IV Separately managed accounts will conduct proxy voting, have transaction transparency, and can implement a client's current securities at inception. Pooled securities are generally not a characteristic of SMA's.

What are the three topics an investment policy statement should include? I. Emphasis on importance of diversification II. Risk tolerance of the investor III. Statement of investor objectives IV. Distinctions among components of investment return a) I, II, and IV b) I, III, and IV c) II, III, and IV d) I, II, and III

I, II, and III The three key items in the IPS are 1. Emphasis on importance of diversification 2. Risk tolerance of the investor 3. Statement of investor objectives The components of the investment return involves the diagnosis of investments placed in the portfolio. The IPS is designed to convey general asset allocation strategies, but is not utilized for choosing, analyzing, or reviewing current investments.

Identify the basic task(s) of the investment policy statement: I. An overview of a plan's delegation of authority and responsibility II. A selection of specific investment funds III. A description of the sponsor's strategy with respect to each investment policy component IV. An explanation of the sponsor's rationale underlying the choice of investment strategies a) I and II b) I, III, and IV c) II and III d) II and IV

I, III, and IV The role of the IPS is to facilitate internal and external communication of the investment policy, to ensure continuity of policy during periods of turnover within a sponsor's organization, and to provide a clear baseline against which to review proposed policy changes. It should accomplish four basic tasks: An overview of a plan's delegation of authority and responsibility among the various decision-making groups, including trustees, staff, actuary, administrator, consultant, and money managers. The roles of each of these groups also must be clearly identified.A delineation of the sponsor's definition of the primary investment policy components, i.e., cash-flow requirements, asset allocation, and diversification.A description of the sponsor's strategy with respect to each investment policy component, i.e., percent of equities, percent of bonds, the investment objectives, and the guidelines to the managers.An explanation of the sponsor's rationale underlying the choice of investment strategies. Selecting specific investments is not the role of an IPS.

A client has engaged a consultant to allocate investment assets for her portfolio. At which step in the asset allocation process would securities be purchased? a) Asset class selection b) Manager due diligence analysis c) Determine investment objectives d) Implementation

Implementation Implementation is the step that puts the IPS in action. The consultant needs to have a good understanding of investment alternatives, but also needs to be knowledgeable regarding market capitalization and different styles of management. A review of existing allocations should be conducted to determine if any changes are needed in the asset mix or the investment managers. An analysis also should be performed to determine the preferred number and types of managers. Reviewing the manager structure is a dynamic process that continues throughout the account's lifetime.

A consultant is assisting her client in the negotiation of fees with a manager and ensuring that qualified legal counsel be included in the negotiation of the contract terms. She is most likely: a) Selecting b) Implementing c) Establishing criteria d) Screening

Implementing During implementation, the selected managers should be informed of their status and those not selected also should be advised and thanked. The implementation process then continues with the consultant involved in activities such as: • Assisting the client in the negotiation of fees and ensuring that qualified legal counsel be included in the negotiation of the contract terms. • Assisting with establishing fees and related items such as directed brokerage. • Developing a transition plan. Careful planning of the transition can save time and money. If a manager is being replaced, it usually is a good practice, and less expensive, to let the new manager take over the old portfolio rather than converting it to cash. • Establishing reporting and review procedures for ongoing monitoring.

Placing international investments in a portfolio generally will: a) Improve the Sharpe ratio b) Increase the risk of the portfolio c) Have no effect on the Sharpe ratio d) Reduce the Sharpe ratio

Improve the Sharpe ratio In order to increase Sharpe ratios, the standard deviation of the portfolio needs to reduce. By adding assets that have low correlation and high Sharpe ratios, the result should be higher overall returns and reduced standard deviations. This combination would improve portfolio Sharpe ratios.

If a multinational corporation does a large amount of business in a foreign country, investments in the company can: a) Avoid currency risk due to the home-bias principle b) Reduce political risk based on country of incorporation c) Only lead to higher returns in most circumstances d) Increase diversification similar to an international investment

Increase diversification similar to an international investment Multinational corporations can increase diversification based on similar principles of foreign investments. Multinational corporations manage, develop, and deliver goods in more than one country. Multinational corporations can have a direct impact on the economic and political policies in the countries in which they do business. As such, multinationals can correlate positively in the countries in which they conduct business.

Which of the following is considered a "BRIC" country? a) Belgium b) India c) Romania d) Colombia

India BRIC refers to the largest 4 emerging market economies in the world. In current finance, the acronym BRIC refers to: B- Brazil R- Russia I- India C- China

Which of the following is true regarding fixed-income valuation and risk? a) Inerest rates and bond prices have an inverse relationship b) Rising interest rates have a positive impact on real rates of return c) Credit risk and bond prices have a direct relationship d) Longer maturities result in lower volatility for bonds

Inerest rates and bond prices have an inverse relationship Bond prices have an inverse relationship to prevailing interest rates. As interest rates increase, bond prices fall and vice versa for decreasing rates and bond prices. This is a nonspecific risk, affects most bonds in the fixed-income universe, and is a major source of volatility in the bond markets.

A fixed income manager is faced with a prolonged low interest rate environment. In order to generate income, what swap might he consider? a) Junk for preferred b) Investment grade for lower quality bonds c) Corporate bonds for municipals d) Junk for investment grade

Investment grade for lower quality bonds The manager may consider a swap from high quality bonds to low quality bonds. The lower the rating, the higher the yield to maturity. High-yielding bond below investment grade (B) are often referred to as "junk bonds." Bond ratings can be divided between investment grade and below investment grade.

An investor is considering investment options and notices the high compensation of the hedge fund manager that his consultant recommends after a record year at the fund. The consultant may wish to advise the client that: a) It may be time to seek a lower cost manager b) It is preferable to work with a manager that is ties to client success c) This is a red flag d) Hedge fund managers can only attract more assets if they make more money

It is preferable to work with a manager that is ties to client success Alternative investments generally require more skill on the part of the manager than other investment vehicles. Many alternative investments such as hedge funds charge a fee and also allow the portfolio manager to take a percentage of the profits. Therefore, the manager must produce enough returns to compensate for the fees and his or her share of the profits, and to compensate the investor for the added risk taken. The alignment of fees may be a preferable arrangement for the investor. This allows return goals to be aligned.

Based on life stages, the most appropriate investment to place in an account for a 70-year old investor would be: a) Large-cap stock b) Leveraged ETF's c) Emerging market stock d) Small-cap stock

Large-cap stock Large-cap stocks currently are defined as those with market capitalizations greater than $10 billion. Of the choices listed, large-cap stocks may be considered to be safer than small-cap, emerging, and leveraged ETF's. This would make it the most appropriate for a 70-year old investor based on life stages.

An example of a special restriction in an investment policy statement would be: a) Liquidity requirements b) A benchmark c) Return requirements d) Risk tolerance

Liquidity requirements Liquidity needs are considered restrictions or constraints to the IPS. Most assets generally are highly liquid (readily marketable), therefore liquidity is not always a major concern in financial management. Alternative investments, however, may be highly illiquid in which case the IPS should contain an estimate of net cash flows. If the manager may be required to liquidate assets in the future to meet cash outflows, the manager needs to know this in advance. Risk and return are objectives in an IPS. The Benchmark is a component, but not necessarily a special restriction.

A consultant is engaged in manager selection due diligence and is reviewing quantitative methods of managers. She reviews the correlation of her fund to the benchmark and measures R2 to be 98. She concludes that the: a) Manager is more than likely tracking the benchmark for his performance b) Risk profile of the client does not allow use of this benchmark c) Benchmark index has higher performance than this manager d) Benchmark is inappropriate to use

Manager is more than likely tracking the benchmark for his performance R-squared is the square of the correlation coefficient between a benchmark or index and a specific investment. Typically this is a tool used to determine whether a particular benchmark is appropriate. This may also indicate if a manager is tracking a specific benchmark.

The largest sector of the U.S. investment-grade market is: a) Municipal bond market b) U.S. Treasuries c) I-bond market d) Mortgage-backed securities market

Mortgage-backed securities market In terms of U.S. debt, the mortgage-backed market is the largest, followed by Treasuries and corporate bonds. U.S. mortgage-backed securities account for about 25 percent of all bonds outstanding in the United States

Comparing a small capitalization mutual fund to the Dow Jones Industrial Average allows a consultant: a) No meaningful comparison b) A relevant baseline to execute portfolio changes c) An approximate measure of international portfolio performance d) To decide whether a manager has significant alpha

No meaningful comparison A benchmark is a hypothetical portfolio consisting of one or more indexes that are combined in the same proportions as the asset classes in an actual portfolio to replicate a manager's style or discipline. The Dow Jones Industrial Average is a benchmark that my be used to track Large Capitalization US Stock and would draw no meaningful comparison when compared against a small capitalization mutual fund.

With respect to U.S. government coupon securities, which of the following is true? a) A payment is made at maturity b) Payments are made annually c) Payments are made semi-annually d) Payments are made quarterly

Payments are made semi-annually Government securities are split into two main categories: discount securities and coupon securities. The issue price and maturity of the securities is the main difference between these two categories. Discount securities are sold at a value below the actual face amount, while coupon securities are sold at the face value and also pay interest every six months.

An investor is looking for a simple basis to conduct analysis on a fund he owns. Which of the following might he use and why? a) A Value-at-Risk measure would be best based on a review of downside risk b) Peer Group Analysis because it is a simple analysis of a fund versus its competitors c) Jensen's alpha relative to the S&P 500 because it is an absolute measure of return d) A scattergram based on the availability of mathematical data input

Peer Group Analysis because it is a simple analysis of a fund versus its competitors Peer group comparisons are perhaps the simplest way to analyze performance. This is the relative performance of a fund or manager to other funds and managers that have similar portfolio attributes. This is comparing peers to their competitors and ranking performance for a period of time.

Which of the following is the final step in the investment process utilizing investment policy statements? a) Define risk for the specific client b) Pick a manager c) Determine asset mix d) Determine plan needs and acceptable risk level

Pick a manager The IPS sets forth a formal platform for determining the appropriate asset allocation. This platform is the basis for managing risk while offering an acceptable likelihood of achieving objectives. Generally, the steps are: 1. The consultant gathers information not only about the client's financial goals and objectives, but also about the client's attitude toward wealth, his or her expectations about investing the assets, time horizon, and other personal information that might have a bearing on how the assets are deployed. 2. This step involves the evaluation of portfolio managers and the selection of those managers that meet the IPS criteria. Once the appropriate managers have been chosen for the selected investment vehicles, the consultant implements the investment plan. 3. This step is an ongoing process in which the consultant carefully monitors the progress of the account, holds portfolio review meetings, and recommends adjustments or reallocations when circumstances warrant.

Which of the following investments would considered to be the least tax efficient? a) Preferred stocks b) Convertible bonds c) Growth stocks d) Income stocks

Preferred stocks Preferred stocks will carry the highest dividend rate and would be considered to be the least tax efficient. Growth stocks do not pay dividends by definition, so would be considered to be tax efficient. Income stocks and convertible bonds will generally have low or lower dividend and interest rates, respectively, than preferred stocks.

A client wishes to exclude certain stocks from his investment strategy. Which of the following investment vehicles allows for this to be implemented without the use of an advisor? a) Separately managed accounts b) Private accounts c) Mutual funds d) Exchange-traded funds

Private accounts Private accounts are similar to separately managed accounts; the only difference is that private accounts are opened directly with the money management firm with no intermediary. These accounts provide for an open structure that allows flexibility and the ability to cater a portfolio to the investor's individual needs. Separate accounts may accomplish the goal of individual management, but the accounts are opened through an intermediary such as an adviser or RIA. Mutual funds and exchange-traded funds do not offer the ability to customize solutions for individuals.

Which of the following investment vehicles allows for client-specific tax solutions implemented directly with the management company? a) Separately managed accounts b) Mutual funds c) Private accounts d) Exchange-traded funds

Private accounts Private accounts are similar to separately managed accounts; the only difference is that private accounts are opened directly with the money management firm with no intermediary. These accounts provide for an open structure that allows flexibility and the ability to cater a portfolio to the investor's individual needs. Separate accounts may accomplish the goal of individual management, but the accounts are opened through an intermediary such as an adviser or RIA. Mutual funds and exchange-traded funds do not offer the ability to customize solutions for individuals.

A client is considering different investment vehicles for his asset management. Which of the following statements is true regarding professionally managed funds? a) Private accounts are held directly with money management firms b) Mutual funds are highly customizable to the investor c) Mutual funds are extremely tax efficient compared to private accounts d) Separately managed accounts allow for little flexibility

Private accounts are held directly with money management firms Private accounts are accounts held directly with money management firms. These accounts o not utilize the assistance of any intermediaries. Mutual funds are pooled asset funds that generally are not customizable at the client level. Separate accounts are similar to Private accounts and do allow for flexibility in asset selection, tax management, and a number of other options. Compared to private accounts, mutual fund would be considered to be less tax efficient with inherited gains and pooled tax management.

Which of the following is not included in "The Nine P's" utilized in manager search and selection? a) Professional b) Place c) Plans d) Price

Professional Professional is not a criteria included in "The Nine P's" utilized in manager search and selection.

If an investment policy statement requires the manager to review and shift the current asset allocation to the original allocation on a quarterly basis, this is known as the: a) Rebalancing protocol b) Return requirement c) Fund objective d) Risk tolerance

Rebalancing protocol The rebalancing protocol defines the method of rebalances and the timing as well. Investors who hold multi-asset portfolios with a target asset allocation will need to consider a strategy to rebalance the allocation if the target range of assets changes over time. These changes can have a profound impact on the risk and return characteristics of the portfolio and ultimately the outcome to the investor. The objective, risk tolerance, and return requirement are all critical to the IPS, but are not the components that address rebalancing.

Investment barriers include all of the following except: a) Restricting capital gain recognition b) Limiting dividends from being cashed in c) Limiting foreign ownership to 10 percent of capitalization d) Reducing tax owed by foreign investors

Reducing tax owed by foreign investors Barriers can make it difficult to invest in foreign countries. The ability to capture growth in markets with barriers makes it difficult to truly diversify. The lower the barriers, the more investors can attempt to diversify. Reducing tax owed by foreign investors would not be considered a barrier. It would be the opposite, allowing for investments to be more attractive in those countries.

If inflation is expected to increase, a consultant may choose to do all of the following except: a) Buy I-bonds b) Purchase precious metals c) Sell commodities d) Sell Treasuries

Sell commodities With rising inflation, the price of goods tends to increase and this increase is usually followed by an increase in interest rates. Holding commodities and metals would be a correct investment strategy. A rise in interest rates would be potential cause to sell fixed income. I-bonds, however, hedge against inflation and would see increased yields in this environment.

An investor is considering pooled funds as a vehicle to manage his funds. In reviewing financial publications, he decided that he wants to exclude stocks that invest in gambling, tobacco, and alcohol. He also would like to maintain the objectivity that a professional advisor can offer him. He would like tax management if possible, but it is not a major concern. Based on this criteria, he would be best served investing in a: a) Exchange-traded fund b) Hedge fund c) Private account d) Separate account

Separate account Separately managed accounts are investment account platforms offered by brokerage firms set up through investment advisors. These accounts provide for an open structure that allows flexibility and the ability to cater a portfolio to the investor's individual needs. Private accounts allow for similar management, but these accounts are held directly at the companies and would not utilize an intermediary. Mutual funds and exchange-traded funds do not offer the ability to customize solutions for individuals. These investments would, however, allow for the use of a professional advisor.

Strategic allocation can best be described as an asset allocation method that: a) Sets a base policy mix and rebalances to that allocation b) Allows for short-term deviations to take advantage of economic conditions c) Sets a floor level and utilizes a multiplier to adjust the portfolio d) Allows for short-term deviations to take advantage of market conditions

Sets a base policy mix and rebalances to that allocation Strategic asset allocation usually is considered a form of the buy-and-hold strategy because allocations are rebalanced once every few years. Simulations, such as Monte Carlo, are used to determine the likely range of outcomes associated with each mix of asset classes. The mix of asset classes used is based on the expected returns for each asset class. The investor considers the range of outcomes for each mix and chooses the preferred approach, in turn establishing a long-term allocation strategy.

Which of the following is a metric utilized by a consultant seeking to make rebalancing decisions? a) Strategic portfolio allocating b) Tracking Error c) Single-index optimization d) Multiple-index optimization

Single-index optimization Single-index regression allows the consultant to review statistical deviation and make decisions, such as rebalancing, based on findings. Deviation from the mean allows for consultants to make long-term, statistical decisions on a particular asset.

An accredited investor as opposed to a non-accredited investor may have access to: a) A small number of speculative ADR's b) Specialized international mutual funds c) Speculative limited partnerships d) A larger number of ETF's

Speculative limited partnerships Most investors have access to publicly traded instruments at various economic levels. A millionaire can purchase shares in a public stock as can a college student. For private, more-speculative investments, investors may have to be accredited.

A consultant's firm introduces a new hedge fund strategy that was presented at a dinner last night. The consultant should: a) Advise clients immediately that are accredited to consider the fund b) Adjust the IPS to include that class of hedge fund for all high net worth clients c) Attend the hedge fund sponsored cruise d) Start his due diligence

Start his due diligence Conducting careful due diligence on the management of the alternative investment source is critical. Each alternative investment choice has different characteristics, which is one reason alternatives must be so carefully chosen. In many cases, alternative strategies will be new to your clients. Because of this unfamiliarity, the relationship between portfolio manager and advisor takes on new dimensions. The portfolio manager and the advisor's firm take on the responsibility of educating advisors. Advisors are, in turn, expected to adequately educate clients.

Changes in asset mixes are driven by predictions concerning the asset's potential returns when utilizing: a) Market timing b) Constant proportion portfolio insurance c) Strategic asset allocation d) Tactical asset allocation

Tactical asset allocation Tactical allocation is based on a constant mix of asset classes and is performed routinely as part of the ongoing process of asset management. Changes in asset mixes are driven by predictions concerning the asset's potential returns.

Which of the following is an advantage to an investor who utilizes a 401(k) plan versus an investor who does not? a) The choice of investments available b) Reduced investment expense c) Professional management d) Tax Deferral

Tax Deferral 401K's allow for tax deferral. The tax on 401K deposits defers income to a point in the future at which time income tax will be owed. This would not be available to an investor investing in a normal investment account. Investment choice and professional management are available to both investors. The investment expense is not necessarily reduced and can be carry larger expenses in some cases.

Taking a deduction for real estate taxes, mortgage interest, or charitable contributions are all examples of: a) Tax evasion b) Tax credits c) Tax avoidance d) Tax deferral

Tax avoidance Tax avoidance is a legal practice and taking tax deductions or and investing in tax-free instruments would be considered forms of avoidance. Deferral strategies are usually affiliated with retirement arrangements and annuities. Tax reduction is the act of utilizing strategies within current guidelines and law that will allow for tax to be reduced. The act of tax evasion is illegal.

A client is in the highest tax bracket and contributes to a retirement plan on a pre- and post-tax basis. Withdrawals on post-tax contributions to retirement plans are: a) Taxed on the contribution only b) Taxed on the contribution minus losses c) Fully taxable d) Taxed on the gains

Taxed on the gains Post tax IRA contributions and retirement contributions in general will be taxed to the extent there are gains. The initial deposits made on a post tax basis will not be subject to tax. Losses in retirement accounts will not reduce the tax directly. Unlike Traditional IRA's and retirement plans, these are not fully taxable.

Which of the following is true when discussing debt markets? a) The Treasury debt market is the largest in the world and is highly illiquid b) The corporate debt market is the largest in the world and is highly illiquid c) The Treasury debt market is the largest in the world and is highly liquid d) The corporate debt market is the largest in the world and is highly liquid

The Treasury debt market is the largest in the world and is highly liquid As a debt issuer, the United States is the largest issuer of debt in the world and the Department of the Treasury is responsible for issuing all Treasury bonds, notes, and bills. As such, the treasury debt market is the largest in the world and is considered to be highly liquid. Treasury Bills are considered to be the equivalent of a risk free asset.

A major advantage to using the S&P500 index as a benchmark is that: I) Portfolio volatility is reduced based on 500 securities II) It is the only relevant measure for US equity III) The index is predetermined IV) The index composition is reset daily

The index is predetermined A major advantage to using the S&P 500 index as a benchmark is that the index is pre-determined. Since many independent companies establish these indexes S&P for the S&P 500), they are widely accepted as benchmarks and used by managers readily. The size and credit ratings for the indexes are often pre-determined as well, making the indexes more efficient and potentially more correlated to managed portfolios

Which of the following is true regarding international investments and Sharpe ratios? a) The higher the correlation with the U.S. market, the lower the Sharpe ratio of the foreign market needs to be for it to become an investment that increases your Sharpe ratio b) The lower the correlation with the U.S. market, the lower the Sharpe ratio of the foreign market needs to be for it to become an investment that decreases your Sharpe ratio c) The lower the correlation with the U.S. market, the lower the Sharpe ratio of the foreign market needs to be for it to become an investment that increases your Sharpe ratio d) The lower the correlation with the U.S. market, the higher the Sharpe ratio of the foreign market needs to be for it to become an investment that increases your Sharpe ratio

The lower the correlation with the U.S. market, the lower the Sharpe ratio of the foreign market needs to be for it to become an investment that increases your Sharpe ratio In order to improve Sharpe ratios, the standard deviation of the portfolio needs to reduce. By adding assets that have low correlation, the result should be reduced standard deviations. By having lower correlations, a foreign investment can have lower Sharpe ratios. This combination would improve the overall portfolio Sharpe ratios.

Which of the following is correct regarding long-duration portfolios? a) The portfolio contains less risk than a short-duration portfolio b) The portfolio should have relatively low fluctuation compared to a short-duration portfolio c) Volatility does not change with long- or short-duration portfolios d) The portfolio contains more risk than a short-duration portfolio

The portfolio contains more risk than a short-duration portfolio The duration of a bond is a function its relationship to coupon rate, yield, and time to maturity. The duration/risk of a bond will be higher when: 1. the coupon is lower 2. the yield is lower 3. there is a long time left to maturity.

Systematic risk can be described as: a) The remainder of total risk after removing unsystematic risk b) A measure of risk that encompasses diversifiable and nondiversifiable risk c) The risk attributed to a company's balance sheet d) Beta multiplied by standard deviation

The remainder of total risk after removing unsystematic risk Total risk combines the systematic and unsystematic risks associated with an investment. It considers the relationship between both market risk and the risk inherent in the investment and the combined effect on an investment. Systematic risk is the remainder of total risk after removing unsystematic risk.

A consultant is discussing short t erm volatility in the stock market. She should advise her client that: a) These are poor leading indicators b) Short term moves are a great leading indicator c) These could be a result of the market being a lagging indicator d) The stock market is a coincident indicator and there is immediate action needed in the portfolio

These are poor leading indicators The stock market is a leading indicator. They are typically considered a good indicator of the long-term profitability of a company, and eventually translate to a more robust economy. As an indicator, however, it makes utilizing the market difficult for investment policies. If the market is indicating a good economy, the market move may have already occurred. On the other hand, the short-term volatility in the market may not accurately reflect economic expectations as well.

A domestic mid-cap fund returns 12% for the year and the index with the highest r-squared to the fund returns 10% and the index with the lowest r-squared to the fund returns 14%. Given these statistics, the: a) Down-capture ratio is 116 b) Down-capture ratio is 85.7 c) Up-capture ratio is 120 d) Up-capture ratio is 20

Up-capture ratio is 120 1. Identify the appropriate benchmark. In this case, the benchmark would be the one with the highest r-squared ratio. 2. The up capture ration is the fund return divided by the index return. 12/10= 1.2 or 120%

If XYZ is a U.S. Small Cap fund, then the: Assume the following: XYZ Mutal Fund 9.5% Russell 2000 Index 11.4% S&P 500 Index 8% MSCI EFA Index 7% Wilshire 5000 Index 7.5% NASDAQ 100 12% a) Appraisal ratio is 16.7 b) Down-capture ratio is 20 c) Up-capture ratio is 120 d) Up-capture ratio is 83.3

Up-capture ratio is 83.3 The answer is the up capture ration is 83.3. 1. Identify the appropriate benchmark. In this case, the benchmark would be the Russell 2000 for the Small Cap Mutual Fund. 2. The up capture ration is the fund return divided by the index return. 9.5/11.4 = .833 or 83.3%

An investor believes markets are set to fall and would like to transfer risk in his portfolio. He should: a) Use derivatives b) Transfer funds to a hedge fund c) Purchase correlating bonds d) Use a managed futures fund

Use derivatives Derivatives also allow investors to transfer and hedge risk. Derivatives include options, futures, warrants, swaps, and forwards.

What technique may a portfolio manager employ when managing a global portfolio? a) Invest in large-capitalization stocks only for greater return b) Avoid foreign government bonds to hedge currency risk c) Increase home bias for safety d) Utilize derivatives to guard against currency risk

Utilize derivatives to guard against currency risk Derivatives can provide a significant hedge against currency volatility. This technique can be used by global portfolio managers to manage currency risk. The impact of exchange rates as well as foreign inflation rates can add to the overall risk and return in the region.

To reduce risk in a portfolio, managers tend to seek assets: a) In similar classes b) With high correlation c) With low correlation d) That have no correlation

With low correlation To reduce risk in portfolios, managers would add assets that have low correlation. The result of adding assets with low correlation is that a reduction in the volatility of the overall portfolio occurs and that concurrently reduces the portfolio's standard deviation of return. Adding high correlation assets would generally keep the risk the same. Assets with no correlation would have no predictability, therefore it is unknown whether risk is reduced. Similar asset class additions would be highly correlated and therefore would generally keep the risk profile the same.

A key deficiency in Macaulay duration is the assumption that: a) Yield to maturity stays constant b) Yield to maturity fluctuates c) Current yield is volatile d) Duration is measured in weeks

Yield to maturity stays constant The deficiency in Macaulay duration is the assumption that YTM remains constant for a given bond, even as actual interest-reinvestment rates change in the market place. The deficiency stems from the fixed-reinvestment-rate assumption used in calculating the bond's yield to maturity. It assumes that a bond's YTM will remain constant over its maturity period and ignores reinvestment risk.


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