CFA CFA level 3 CFA level 3 CFA level 3 CFA level 3 CFA level 3 CFA level 3 finquiz item set questions, study session 7, reading 18

Reading 18 Asset Allocation with Real-world Constraints FinQuiz.com   FinQuiz.com CFA Level III Item-set - Question Study Session June 2018 Copyright © 2010-2018 FinQuiz.com All rights reserved Copying, reproduction or redistribution of this material is strictly prohibited info@finquiz.com FinQuiz.com © 2017 - All rights reserved Reading 18 Asset Allocation with Real-world Constraints FinQuiz.com   FinQuiz Item-set ID: 134472 Questions 1(134473) through 6(134478) relate to Reading 18 Mark Reid Case Scenario Mark Reid is an asset advisor at SouthWest Asset Management (SWAM) Reid is designing an asset allocation for two defined benefit pension plan’s respectively operated by his clients, Joyce Manufacturing (JM) and Regale Corporation (RC) He begins by collecting details on both pension plans in Exhibit below: Exhibit 1: Defined Benefit Pension Plans JM Funding ratio 0.75 Equity allocation (%) 50 Fixed-income allocation (%): Corporate bonds 20 Alternative investments allocation (%) 30 Time horizon of plan liabilities 20 years Average duration of bond assets 15 years Total value of financial assets $500 million RC 1.00 80 20 15 years 16 years $25 million As part of his analysis, Reid also summarizes the investment objectives of the pension funds as follows: JM: To reduce surplus risk RC: To minimize long-term future contributions, convert to an annuity plan, and maintain portfolio volatility Reid sits down with the RC’s chief financial officer to discuss the plan’s asset allocation His agenda is to focus on the following two items: Item 1: Propose an allocation to alternative investments identical to JM This will be achieved by liquidating a portion of the equity allocation and re-investing the proceeds in alternative investments Item 2: Consider the impact of taxes on the asset allocation (Exhibit 1) by analyzing a breakdown of pre-tax returns and standard deviations (Exhibit 2) and correlations (Exhibit 3) Exhibit 2: Pre-tax Returns and Standard Deviations of RC’s Asset Allocation Pre-tax Pre-tax Asset Class Expected Standard Tax Rate Return (%) Deviation (%) (%) Investment grade (IG) corporate bonds 10 18 50 High yield (HY) corporate bonds 13 19 50 Equities 20 25 30 FinQuiz.com © 2017 - All rights reserved Reading 18 Asset Allocation with Real-world Constraints FinQuiz.com   Exhibit 3: Correlation Matrix for RC’s Asset Allocation Asset Class IG Bonds HY Bonds Equities IG bonds 1.0 0.7 0.1 HY bonds 0.7 1.0 - 0.5 Equities 0.1 - 0.5 1.0 Based on his taxes and correlations analysis, Reid decides to place equities in a taxable account and makes the following two conclusions: Conclusion 1: Although IG and HY bonds are less tax-efficient, the addition of these two bonds will bring risk reduction benefits to a taxable account Conclusion 2: While taxes serve to reduce the distribution of returns, the correlations between any two asset classes are unaffected Next, Reid proceeds to set rebalancing ranges for a modified version of JM’s current asset allocation which are presented in Exhibit These ranges consider a proposed strategic asset allocation (SAA) for the policy portfolio The relevant data are presented in Exhibit Exhibit 4: Rebalancing Ranges for a Modified Version of JM’s Policy Portfolio Modified Pre-tax Asset Class SAA Current Rebalancing (%) Allocation (%) Range Equities 50 43 ±5% Bonds 40 32 ±10% Alternative 10 25 ±5% investments During Reid’s meeting with JM, the asset advisor discusses the results of his findings and the rebalancing ranges for the three asset classes Reid makes the following comments concerning the rebalancing range for alternative investments: Statement: “In response to a recent above average performance of alternative investments securities, the rebalancing range has been widened to facilitate an overweighting of the asset class to a higher policy limit.” Lewis Strong, Reid’s subordinate, reviews the asset allocation pointing out that the advisor has failed to consider the asset class’ past record of extreme volatility FinQuiz.com © 2017 - All rights reserved Reading 18 Asset Allocation with Real-world Constraints FinQuiz.com   FinQuiz Question ID: 134473   Considering the asset allocation presented in Exhibit and each client’s objectives, which of the following statements is most likely correct? The asset allocation for: A   JM carries a higher liquidity risk B   RC carries a higher contribution risk C   RC will result in a lower pension cost FinQuiz Question ID: 134474   In context of the meeting between Reid and the chief investment officer, which of the following asset allocation constraints has Item failed to consider? A   Liquidity B   Asset size C   Time horizon FinQuiz Question ID: 134475   With respect to his analysis of the impact of taxes on the asset allocation, Reid is most likely correct regarding: A   Conclusion only B   Conclusion only C   both of the conclusions FinQuiz Question ID: 134476   Using the data in Exhibit 2, the impact of taxes is lowest on the volatility of: A   equities B   IG bonds C   HY bonds FinQuiz Question ID: 134477   Using the tax rates in Exhibits and a 25% tax rate for alternative investments, which asset class presented in Exhibit requires rebalancing? A   Bonds B   Equities C   Alternative investments FinQuiz Question ID: 134478   In light of Lewis’ observation and Reid’s statements concerning the rebalancing range for alternative investments, which of the following behavioral biases is the advisor subject to? A   Availability B   Illusion of control C   Representativeness FinQuiz.com © 2017 - All rights reserved  .. .Reading 18 Asset Allocation with Real-world Constraints FinQuiz. com   FinQuiz Item- set ID: 134 472 Questions 1( 134 4 73) through 6( 134 478) relate to Reading 18 Mark Reid Case... Equities 20 25 30 FinQuiz. com © 2017 - All rights reserved Reading 18 Asset Allocation with Real-world Constraints FinQuiz. com   Exhibit 3: Correlation Matrix for RC’s Asset Allocation Asset Class... extreme volatility FinQuiz. com © 2017 - All rights reserved Reading 18 Asset Allocation with Real-world Constraints FinQuiz. com   FinQuiz Question ID: 134 4 73   Considering the asset allocation