2019 CFA level 3 qbank r 13 14 concentrated single asset risk management answers

10/11/2018 Learning Management System Question #1 of 62 Which of the following statements regarding human capital is most accurate? A) A person’s human capital continues after retirement B) For a young investor their human capital is equivalent to a large holding of an illiquid asset C) A person’s human capital is highest when they are born and trends downward after that .in Explanation bo ok c en tre Young investors are at the peak of their human capital which is de ned as the present value of all expected future income derived from their labor Human capital is illiquid because at the beginning of their careers young investors cannot cash in their future earnings or pension accounts which they have not earned yet A person's human capital is highest when they have nished their training or education for their career and it steadily trends downward from there At retirement when a person stops working and receives income from a de ned pension plan derived from their past labor, this is considered nancial capital (Study Session 6, Module 14.1, LOS 14.a) Related Material o m SchweserNotes - Book w w Question #2 of 62 Which of the following types of risk is most likely to impact both nancial capital and human w capital? A) Liability risk B) Longevity risk C) Health risk Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 1/36 10/11/2018 Learning Management System Health risk can lead to a direct loss of nancial capital to pay illness or injury-related expenses It can also reduce human capital through diminished or inability to work Liability risk refers to being legally responsible for damages and mainly reduces nancial capital; there is no direct impact on human capital Longevity risk refers to individuals outliving their nancial capital; the assumption is that in retirement there is no human capital and so there is no impact (Study Session 6, Module 14.2, LOS 14.e) Related Material in SchweserNotes - Book en tre Question #3 of 62 Which of the following statements regarding the pricing of life insurance policies is most accurate? A) Mortality tables are built to re ect past experiences of mortality bo ok c B) Based on the assumed mortality rates, the insurance company estimates the net premiums to charge for insurance based on the assumed rate of return on i i h i C) For a level payment ve-year term policy, the level premium should be higher than m the year premium for an annual term policy Explanation w w w o Based on the assumed mortality rates, the insurance company estimates the net premiums to charge for insurance based on an assumed discount rate The discount rate is also the assumed rate of return on investing the premiums At that discount rate, the premiums must be su cient such that the present value of the premiums and payouts are equal so that the premiums are su cient to pay future bene ts The level premium will be higher than the year and lower than the year premium for annual term The premium is conceptually a weighted average of ve sequential one-year term premiums Mortality tables are built to re ect both past experiences and future projections of mortality (Study Session 6, Module 14.4, LOS 14.g) Related Material SchweserNotes - Book Question #4 of 62 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 2/36 10/11/2018 Learning Management System To structure a limited partnership that would transfer tax burdens from the current owner of a real estate investment while allowing the owner to control the property the current owner should assume the role of: A) general partner B) angel investor C) limited partner Explanation in As general partner the current owner will still make the business decisions and controls the asset An angel investor is a term that can refer to the rst non-family member investor in a new business en tre (Study Session 6, Module 13.2, LOS 13.g) Related Material Question #5 of 62 bo ok c SchweserNotes - Book B) Total wealth w w C) Human capital .o A) Financial capital m A measure of an individual's lifetime earning capacity is best de ned as which of the following? Explanation w The de nition of human capital is a measure of an individual's lifetime earning capacity It is the present value of the individual's expected income from salary, wages, bonuses, etc Employment-related retirement pension income is viewed as nancial capital Human and nancial capital added together are called total wealth (Study Session 6, Module 14.1, LOS 14.a) Related Material SchweserNotes - Book Question #6 of 62 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 3/36 10/11/2018 Learning Management System The owner of a real estate property who obtains a mortgage with recourse has done all of the following EXCEPT: A) retained control of the property B) e ectively bought a protective put on the property C) monetized the asset Explanation Only a non-recourse loan would allow the owner to default on the loan and walk away from the property without allowing the lender to pursue other means to force the borrower to pay The mortgage is a monetization strategy and leaves the owner in control of the asset .in (Study Session 6, Module 13.4, LOS 13.k) Related Material bo ok c Question #7 of 62 en tre SchweserNotes - Book Which of the following statements is least accurate regarding human capital? A) When possible, one should maximize the correlation of human and nancial m capital .o B) If an investor’s human capital is equity-like they should allocate a greater amount of w w their nancial capital to xed income investments C) The demand for life insurance will increase if human capital is bond-like w Explanation One should always o set the risk of their human capital with the risk of their nancial capital and minimize the correlation between the two If an investor's human capital is equity-like they should reduce the correlation with their nancial capital by allocating a greater amount of their nancial capital to xed income investments and visa versa The demand for life insurance will increase if human capital is bond-like and decrease if human capital is equitylike (Study Session 6, Module 14.2, LOS 14.b) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 4/36 10/11/2018 Learning Management System Question #8 of 62 Financial wealth and the demand for life insurance have: A) either a positive or a negative relationship depending upon the individual’s level of wealth B) a negative relationship C) a positive relationship Explanation in Financial wealth and the demand for life insurance have a negative relationship which means if a person has a lot of nancial wealth their need for life insurance is small and visa versa (Study Session 6, Module 14.2, LOS 14.e) en tre Related Material Question #9 of 62 bo ok c SchweserNotes - Book Factors that are positively related to the demand for life insurance include: m A) human capital volatility and risk aversion .o B) risk aversion and probability of death w w C) nancial wealth and probability of death Explanation w As either risk aversion or probability of death increase, so does the demand for life insurance Human capital volatility and nancial wealth are both negatively correlated with the demand for life insurance (Study Session 6, Module 14.5, LOS 14.k) Related Material SchweserNotes - Book Question #10 of 62 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 5/36 10/11/2018 Learning Management System Which type of life insurance imposes premiums that best re ect the pure risk of death at any particular point in time? A) Universal life insurance B) Whole life insurance C) Term insurance Explanation in The premium for a term life policy primarily re ects the mortality risk to the individual for a short, usually one year, period Generally speaking, term life premiums are lower at younger ages and rise over time in line with the increasing risk of death Pricing for the other products is more complex as the initial premiums are higher and re ect risk of death over the expected (and longer term) of the policy and not just for a single period en tre (Study Session 6, Module 14.3, LOS 14.f) Related Material Question #11 of 62 bo ok c SchweserNotes - Book business is generally to: m The purpose of a personal line of credit secured by company stock for the owner of a private w w purposes .o A) extract cash from the business so the owner can use the funds for personal B) convert the remaining ownership position to public stock w C) exit any responsibility for managing the business Explanation This is a monetization strategy that provides the owner with funds to use for other objectives The shares are still owned and the owner still has control of the company It does not convert shares to public stock, an IPO might accomplish that (Study Session 6, Module 13.4, LOS 13.j) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 6/36 10/11/2018 Learning Management System Question #12 of 62 Which of the following statements regarding annuities is least correct? A) The premium for an advanced life deferred annuity would be lower than the premium for an immediate life annuity (all else being equal) B) The payout for a joint annuity will be lower than the payout for single-life annuity (all else being equal) C) The annual payout on a life annuity would be greater for a 60 year old female than for a 60 year old male (all else being equal) .in Explanation bo ok c (Study Session 6, Module 14.4, LOS 14.h) en tre All else the same, annuity payouts for females are lower (not greater) because females have a longer life expectancy and will receive more payouts The other statements are true Advanced life deferred annuities start their payout only after a long delay Therefore the number of expected payouts is lower and the payout amount per period is higher Joint life annuities are likely to pay longer and therefore the insurance company must set a lower payout amount per period Related Material m SchweserNotes - Book o Question #13 of 62 w w By using an exchange fund it is most accurate to expect an investor can: w A) monetize the asset at a better LTV B) pay a smaller tax now to minimize future taxes C) defer and then escape future taxes Explanation Is most accurate The exchange fund simply exchanges an undiversi ed single asset holding for a share in a somewhat more diversi ed portfolio The tax basis in the new fund is the same as before the exchange with no tax due currently and the unrealized tax liability is unchanged With the increase in diversi cation the investor could seek a loan to monetize the exchange fund holding and use the funds for even further diversi cation How much a lender will loan against a relatively illiquid exchange fund is unclear but this is the best answer choice o ered (Study Session 6, Module 13.3, LOS 13.i) https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 7/36 10/11/2018 Learning Management System Related Material SchweserNotes - Book Karl and Karen Arlt are both thirty- ve years old and have two children, Noah and Jamie ages and 7, respectively Karen is a tenured professor at the local state college and Karl is an engineer working at an electrical utility company Together the Arlts have a combined income of $150,000 per year The Arlts are meeting with a nancial consultant Katherine Ryals, CFA, for the rst time who was recommended to them by Karl's brother who is also training with Ryals to become a nancial consultant himself The four of them are meeting around the Arlt's dining in room table where Ryals is gathering information to determine an investment policy statement for the Arlts who state they want to retire when they are 60 years old One of the questions en tre asks the Arlts about their general feelings of risk and Karen blurts out "the recent turmoil in the nancial markets due to the mortgage crisis makes me sick to my stomach!" Up to this point in their lives the Arlt's have not amassed a signi cant amount of nancial wealth nor have they given much thought about leaving a bequest bo ok c It is now two weeks later and the Arlt's are meeting with Ryals and Karl's brother again Ryals suggests that they purchase a million dollar variable universal life (VUL) policy whereby their premium payments will go into mutual fund type investments resulting in equity-like returns She states "because your incomes are stable your human capital is xed income-like thus to be m able to replace your steady income your demand for life insurance is high." She goes on to state "since your incomes are stable your assets should be invested in more equity-like o investments like the ones found in the VUL thus it is the perfect investment vehicle for you." w w Ryal's analysis reveals that to maintain their current $150,000 per year income when they retire in 25 years at age 60 assuming a 3% increase in income per year would require an income w stream of about $314,000 per year This represents a portfolio worth approximately $3.3 million at retirement, assumes they live another 20 years during retirement, achieve a 7% rate of return on their portfolio during retirement, and there is nothing left of the portfolio at the end of 20 years Ryals goes on to further explain that to amass the equivalent of $3.3 million 25 years from now given they have no retirement savings now and assuming a 10% yearly rate of return would require them to save roughly $2,500 per month After careful consideration of their insurance needs the Arlts decide to purchase term insurance on both of them and invest a portion of their after tax income into a deferred variable annuity Upon retirement the Arlts are expecting to choose the largest cash out ow possible from the annuity utilizing the "joint and survivor" payout option The Arlts also decide https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 8/36 10/11/2018 Learning Management System to purchase disability insurance that will pay them 80% of their salary in case either of them are unable to perform their jobs due to an illness or condition Question #14 of 62 Based on the information regarding Karl and Karen's incomes the discount rate used to determine their human capital would be: A) low representing lower risk due to their stable incomes B) high because their incomes would have a low variability over time .in C) indeterminate since the discount rate is based on factors other than the variability en tre in their incomes Explanation bo ok c Since the Arlts both have stable incomes with Karen being a tenured college professor and Karl working in the utility industry, neither of which are closely tied to the economy, the risk of their incomes is low thus the risk premium would also be low resulting in a lower overall discount rate and higher human capital (Study Session 6, Module 14.5, LOS 14.l) Related Material o m SchweserNotes - Book w w Question #15 of 62 Given the Arlt's personal information gathered from the questionnaire, which of the following w statements regarding the correct asset allocation of their portfolio is most accurate? A) Their portfolio should be allocated more towards less risky assets because they have a below average willingness to accept risk thus their overall risk level is below B) Their portfolio should be allocated more towards risky assets since their human capital is bond-like C) Since they are in the early part of the accumulation phase of their careers they can tolerate more risk in their portfolio and thus should be invested more heavily in ii Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 9/36 10/11/2018 Learning Management System Even though the Arlt's human capital is bond-like indicating they should invest their portfolio more towards equities, Karen's statement about the mortgage crisis indicates a below average willingness to take risk, thus their overall level of risk tolerance is below average Knowing the size of their portfolio is relatively small the advisor should defer to the client's willingness to take risk if willingness is below ability and the portfolio is not appreciably large (Study Session 6, Module 14.5, LOS 14.l) Related Material SchweserNotes - Book in Question #16 of 62 the asset allocation of the policy premiums are: A) correct for only one of the statements bo ok c B) incorrect for both statements en tre The statements made by the nancial consultant regarding the demand for life insurance and C) correct for both statements Explanation o m The statements made by the nancial consultant are correct for both statements Since the incomes of both Karen and Karl are stable their human capital is bond-like thus to replace this income their demand for life insurance is high and their assets should be allocated more aggressively in equity type investments w w (Study Session 6, Module 14.5, LOS 14.l) Related Material w SchweserNotes - Book Question #17 of 62 A disadvantage of the Arlt's choice of the annuity is: A) if they both die before their predicted life expectancy the remainder of their assets will go to the insurance company instead of their heirs B) the annuity is less tax e cient than utilizing a de ned contribution plan C) the annuity will lose real earning power in periods of high in ation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 10/36 10/11/2018 Learning Management System Explanation A pension is a non-marketable nancial asset because the (vested portion of the) pension belongs to the individual who earned it Inherently pensions are not traded assets (though it may be possible under some conditions to assign the future cash ows to another) In contrast the other two items are traded assets Collectables have elements of personal consumption and utility but are considered marketable in that the value of such assets is set by auction markets or specialized dealers Private equity is a business asset and although it may be relatively illiquid, it is considered a marketable asset (Study Session 6, Module 14.1, LOS 14.a) Related Material en tre in SchweserNotes - Book Question #38 of 62 The volatility of human capital and the demand for life insurance are: bo ok c A) positively correlated B) negatively correlated C) uncorrelated m Explanation w w o Human capital volatility and demand for life insurance are negatively correlated Life insurance acts as a substitute for human capital, so its face value depends on the perceived value of the human capital it replaces If the human capital has high volatility (equity-like), a higher discount rate is used to estimate its present value Thus, human capital with high volatility has a smaller present value than human capital with low volatility w (Study Session 6, Module 14.2, LOS 14.f) Related Material SchweserNotes - Book Question #39 of 62 Which risk management decision is most appropriate if a loss is not severe but occurs regularly? A) Risk reduction https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 22/36 10/11/2018 Learning Management System B) Risk retention C) Risk transfer Explanation Losses that occur regularly but are not severe require risk reduction – taking actions to reduce the amount or frequency of the loss Risk transfer (buying insurance) should be done when losses are very severe but occur infrequently Risk retention (self-insurance) should be done when losses are not severe and occur infrequently (Study Session 6, Module 14.5, LOS 14.j) Related Material en tre in SchweserNotes - Book Question #40 of 62 A) rules based system B) returns based system C) risk based system m Explanation bo ok c Margin-lending rules would most likely make economic sense in a: o Risk based systems focus on underlying economic results, not arbitrary rules w w (Study Session 6, Module 13.1, LOS 13.d) Related Material w SchweserNotes - Book Question #41 of 62 Which of the following is NOT a drawback to a xed annuity? A) The investor usually cannot void the contract B) The real value of the cash ows may decline over time C) The cash ows could be zero if the underlying asset return is negative for the investment period https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 23/36 10/11/2018 Learning Management System Explanation Cash ows received on a variable pay annuity (not xed annuity) are based on the performance of an underlying fund or set of funds selected by the investor and thus the cash ows are variable and could be zero if the performance of the underlying funds is negative for the investment period Drawbacks to xed annuities are: cash ows are xed and not increase with the rate of in ation thus the real value of the cash ows decreases over time cash ows are based on the level of interest rates at the time the annuity goes into e ect If interest rates are low when the contract goes into e ect this would lock in a low rate of return to the investor the annuity is illiquid and di cult to get out of the contract (Study Session 6, Module 14.4, LOS 14.i) in Related Material en tre SchweserNotes - Book bo ok c Question #42 of 62 Which of the following statements regarding xed and/or variable annuities is most correct? A) For xed annuities, if interest rates are expected to decrease then it is best to purchase the xed annuity now .o longer m B) Mortality credits bene t those annuitants who die earlier than annuitants who live w w C) Although the risks underlying xed and variable annuities are di erent, the fees for them tend to be similar w Explanation A decline in interest rates would lead to lower payouts on annuities purchased later Therefore, it is better to purchase the xed annuity now Fees for variable annuities tend to be higher than xed annuities The concept of mortality credits refers to the fact that some individuals will die before, and some after, their expected lifespan Annuitants who die earlier collect fewer payouts, e ectively subsidizing those who die later Therefore, mortality credits are a bene t to those annuitants who die later (Study Session 6, Module 14.4, LOS 14.i) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 24/36 10/11/2018 Learning Management System Question #43 of 62 Consider the following policy: Insurance amount = $250,000 Annual premium = $4,850 Expected annual dividend = $1,190 Time to maturity = 30 years Expected surrender value = =$70,000 in Base on a discount rate of 8%, the net surrender cost index per 1,000 of insurance is closest to: en tre A) $12.70 B) $13.10 C) $13.80 Explanation bo ok c The CFA convention is premiums are paid at the start of the year as is the annuitized cost (annuity due) and dividends are received at the end of the year (ordinary annuity) = $593,377.46 (annuity due: $4,850 annual payment, 30 years, 8%) FVdividends = $134,807.02 (ordinary annuity: $1,190 annual payment, 30 years, 8%) o = $388,570.44 (future value of premiums less dividends and surrender value) w w FVnet m FVpremiums w Annualnet NSCI = $3,176.00 (annuity due payment: $388,570.44 future value, 30 years, 8%) = $12.70 per $1,000 per year (net annual cost divided by 250 [$250,000/$1000]) (Study Session 6, Module 14.4, LOS 14.g) Related Material SchweserNotes - Book Question #44 of 62 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 25/36 10/11/2018 Learning Management System Values that are most likely on an individual's economic (holistic) balance sheet include: A) only human capital B) only bequests and de ned-contribution pensions C) bequests, human capital, and de ned-bene t pensions Explanation in Bequests, human capital and de ned-bene t pensions can all be found on an economic (holistic) balance sheet Economic (holistic) balance sheets extend the traditional balance sheet to include human capital (HC) in the calculation of assets and consumption and bequest goals in liabilities The values of de ned-contribution pensions would be included on both traditional and economic balance sheets (Study Session 6, Module 14.1, LOS 14.d) en tre Related Material Question #45 of 62 bo ok c SchweserNotes - Book For which of the following individuals would a higher exposure to equities be more appropriate as part of their overall asset allocation? m A) A 27 yr old male who runs his own, risky property development business .o B) A 50 yr old female who works part-time in a factory w w C) A 30 yr old female with a stable job as a nurse in an aged-care facility Explanation w A lower correlation between employment income and investment earnings increases the diversi cation bene ts to an individual's total wealth ( nancial and human capital) The returns from employment that is more secure and less sensitive to the business cycle (the nurse) would likely have a lower correlation with the return from equities, making equites in nancial capital more acceptable In addition younger individuals are likely to have a longer time horizon and be better able to accept a greater allocation to equity (Study Session 6, Module 14.5, LOS 14.k) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 26/36 10/11/2018 Learning Management System Question #46 of 62 What type of insurance or risk management strategy is most appropriate in protecting against loss of earnings due to long-term unemployment as a result of a job layo ? A) Disability insurance B) Self-insurance C) Annuities Explanation (Study Session 6, Module 14.2, LOS 14.e) SchweserNotes - Book m Question #47 of 62 bo ok c Related Material en tre in Disability insurance will only cover loss of income due to disability Annuities are meant to insure against longevity risk which is the risk of living too long and outliving your assets in retirement While some countries have various forms of unemployment insurance that partially compensates for job layo s or termination, that is not covered in the CFA reading and most individuals need to build up savings to protect themselves (i.e self-insure) for such risk .o Sheryl Rubenstein is a stunt double in Hollywood whose studio took out a life insurance policy w w on her What risk is her studio attempting to mitigate? A) Mortality risk w B) Longevity risk C) Earnings risk Explanation The studio is using life insurance to hedge against mortality risk, the risk of premature death That way, they will not bear the risk of lost income if she dies while performing a stunt Instead, they will receive the insurance proceeds Longevity risk is the risk of outliving your nancial assets Earnings risk is the risk that potential income is lower than expected or disrupted by losing one's job due to health, economic, or other circumstances (Study Session 6, Module 14.2, LOS 14.e) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 27/36 10/11/2018 Learning Management System Question #48 of 62 Which of the following types of annuities is most suitable for an individual who is seeking to reduce the upfront cost? A) Deferred xed annuity B) Immediate variable annuity C) Advanced life deferred annuity .in Explanation bo ok c en tre An advanced life deferred annuity is a relatively lower cost way to hedge the longevity risk of the annuitants outliving their other assets The low cost is re ected in the long delay period before the start of the payouts so a number of annuitants will die before they receive any payouts A deferred xed annuity is a more general form of an advanced life deferred annuity, but with a shorter delay period before the start of the payouts it will cost more An immediate variable annuity starts the payout immediately which would all other things being equal, require a higher upfront cost The variable component means that the future payouts are indexed to the performance of some reference asset, such as a stock index That adds complexity to the analysis but the lack of delay should increase its cost (Study Session 6, Module 14.4, LOS 14.h) Related Material o m SchweserNotes - Book w w Question #49 of 62 w In general, an individual facing retirement has a greater amount of: A) human capital than nancial capital B) both human and nancial capital than when they rst started working C) nancial capital than human capital Explanation An individual facing retirement has a decreased amount of human capital, but most likely has accumulated a signi cant amount of nancial capital On the other hand, a young individual beginning their career most likely has minimal nancial capital but a great amount of human capital (Study Session 6, Module 14.2, LOS 14.b) https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 28/36 10/11/2018 Learning Management System Related Material SchweserNotes - Book Question #50 of 62 In constructing a 'holistic balance sheet' for a young individual, which of the following is likely to be the largest liability? A) Future expenses funding .in B) Mortgage on house en tre C) Student loans Explanation bo ok c The present value of future expected out ows due to lifestyle expenses would likely be the largest liability on an economic 'holistic' balance sheet for most individuals The younger person may or may not have explicit debts such as student loans or a mortgage, but even if they the PV of other future living expenses for their remaining life would likely be larger (Study Session 6, Module 14.1, LOS 14.d) Related Material o m SchweserNotes - Book w w Question #51 of 62 With no other information to go on, the lowest speci c risk in a concentrated position would w most likely be for the owner of: A) publicly traded common shares B) investment real estate C) a privately held business Explanation With nothing else to go on the public nature and liquidity would suggest the public shares should have the lowest speci c risk (Study Session 6, Module 13.1, LOS 13.a) Related Material https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 29/36 10/11/2018 Learning Management System SchweserNotes - Book Question #52 of 62 An investor with excess assets in her primary capital can increase her holdings in the portfolio's: A) market risk bucket B) aspirational risk bucket Explanation en tre in C) personal risk bucket Primary capital is the sum of the personal and market risk bucket holdings With excess primary capital the investor can consider shifting more assets to high risk in the aspirational bucket bo ok c (Study Session 6, Module 13.2, LOS 13.f) Related Material m SchweserNotes - Book o Question #53 of 62 correct? w w Regarding the asset allocation of total wealth, which of the following statements is most w A) The aggregate human capital of a couple is less risky than their individual human capital B) Asset allocation decisions should focus on nancial capital C) Generally human capital is riskier than nancial capital Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 30/36 10/11/2018 Learning Management System For a couple, the human capital of each member is not likely to be perfectly correlated (+1) with the other, making the couple's human capital less risky in aggregate Generally human capital is less risky than many forms of nancial capital Asset allocation should consider both nancial and human capital even though the characteristics of the latter may be hard to change, so the adjustment is likely to be in the nancial capital The nature of the human capital may a ect both the overall risk taken in the nancial capital and the assets and asset classes selected (Study Session 6, Module 14.5, LOS 14.k) Related Material in SchweserNotes - Book en tre Question #54 of 62 In which nancial stage of life would an individual's investment risk tolerance most likely be increasing? bo ok c A) Preretirement B) Peak accumulation C) Career development Explanation w w o m During career development, an individual's career has been established and the job skills are likely to expand together with upward mobility As a result, investment risk tolerance is likely to increase during career development During peak accumulation (about the decade before retirement), investment risk tolerance may start decreasing in anticipation of retirement During preretirement, there is an even greater likelihood that investment risk tolerance will decrease together with increased tax planning for retirement w (Study Session 6, Module 14.3, LOS 14.c) Related Material SchweserNotes - Book Question #55 of 62 Regarding asset allocation and risk reduction, which of the following statements is most accurate? https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 31/36 10/11/2018 Learning Management System A) An a uent couple nearing retirement should focus on investing in low risk investments to provide stable retirement income B) A young couple with large debts and high expenses needs permanent life insurance C) Insurance can be used to reduce non-market risk Explanation Related Material Question #56 of 62 bo ok c SchweserNotes - Book en tre (Study Session 6, Module 14.5, LOS 14.l) in Insurance can reduce longevity and premature death risks, neither is a market risk It can also insure property to reduce risk to that speci c piece of property, reducing idiosyncratic (non-market) risk For a young couple with large debts and high expenses, lower-cost, temporary (term) insurance makes more sense An a uent and retiring couple would likely have low standard of living risk and could choose lower or higher risk based on their overall objectives A nancial asset that is speci cally designed to address the problem of outliving one's assets is o A) life insurance m called: w w B) a guaranteed investment contract C) a life annuity w Explanation Life annuities are designed to pay income to the owner as long as the owner is alive Therefore, unless the insurance company issuing the annuity fails and is unable to make the payments as promised, the annuitant cannot outlive their income (Study Session 6, Module 14.4, LOS 14.h) Related Material SchweserNotes - Book Question #57 of 62 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 32/36 10/11/2018 Learning Management System With regard to an individual's total wealth, which statement is most accurate? If an individual's human capital is xed income-like their nancial portfolio: A) should be weighted with similar non-risky xed income assets B) should be weighted in no speci c way that is related to their human capital C) may be weighted more heavily towards risky assets Explanation in An individual's nancial portfolio can be weighted more heavily towards risky assets if their human capital is xed income-like If an individual has a secure job with an annual salary, they are able to accept more risk in their nancial portfolio since their human capital has very low risk (Study Session 6, Module 14.5, LOS 14.k) en tre Related Material Question #58 of 62 bo ok c SchweserNotes - Book Life insurance is most commonly used to hedge against: m A) mortality risk w w C) longevity risk .o B) earnings risk Explanation w Life insurance is the most commonly employed hedge against mortality risk (Study Session 6, Module 14.2, LOS 14.e) Related Material SchweserNotes - Book Question #59 of 62 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 33/36 10/11/2018 Learning Management System In the following graph which of the following statements is most accurate regarding what the vertical axis represents besides dollars? the greatest while their nancial capital is the smallest .in A) The point in time when the individual is born and their potential human capital is en tre B) The point in time when the individual nishes their educational training and starts working C) The combined amount of human and nancial capital called total wealth bo ok c Explanation The vertical axis denotes the point in time when the investor nishes preparing for their career by completing their education or training and starts generating income It also shows the amounts of human and nancial capital separately Related Material w w o SchweserNotes - Book m (Study Session 6, Module 14.3, LOS 14.c) w Question #60 of 62 An advantage of a xed annuity over a variable annuity is: A) the xed annuity’s income o ers a hedge against in ation during periods of stag ation B) the xed annuity’s income stream is stable throughout the life of the annuity purchaser C) xed annuities are easier to terminate than variable annuities Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 34/36 10/11/2018 Learning Management System One advantage of a xed annuity over the variable annuity is the stable income stream o ered by the xed annuity Since the variable annuity's income is tied to the return of underlying assets, which are usually equity-like the annuity's income also uctuates as the return on the underlying assets uctuates A disadvantage of xed annuities is since their income stream is xed they lose real earning power over time due to in ation Once the xed or variable contracts are annuitized meaning the investor decides to have the payments sent to them for life, both xed and variable annuities are equally di cult to terminate (Study Session 6, Module 14.4, LOS 14.i) Related Material in SchweserNotes - Book en tre Question #61 of 62 Which of the following is NOT an example of a drawback to xed annuities? A) The investor could become locked into a low interest rate bo ok c B) The real values of the cash ows fall over time C) The payments in some periods may fail to meet the investor’s needs or may be zero if the funds lose money Explanation w w o m A xed annuity may fail to meet the investor's needs, but the payment will never be zero This is an example of a drawback for a variable annuity The real values of cash ows from a xed annuity fall over time An investor could get locked into a low lifetime return if interest rates are historically low when the xed annuity is purchased (Study Session 6, Module 14.4, LOS 14.i) Related Material w SchweserNotes - Book Question #62 of 62 John Smith owns apartment buildings He employees himself as the business manager and pays himself a market wage for this function Being recently divorced, this job has brought stability to his life Financially he does not need the "manager salary" but emotionally he needs the job Considering the behavioral nance issues Smith would be least receptive to a: https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 35/36 10/11/2018 Learning Management System A) hedge of the buildings value B) sale of the buildings C) monetization of the buildings Explanation Sale would be of least interest as it is the most likely to require giving up the properties and the resulting management job which provide a psychological bene t to Smith (Study Session 6, Module 13.1, LOS 13.e) Related Material w w w o m bo ok c en tre in SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83416043/print 36/36 ... longevity and premature death risks, neither is a market risk It can also insure property to reduce risk to that speci c piece of property, reducing idiosyncratic (non-market) risk For a young couple... a portfolio worth approximately $3. 3 million at retirement, assumes they live another 20 years during retirement, achieve a 7% rate of return on their portfolio during retirement, and there is... occur regularly but are not severe require risk reduction – taking actions to reduce the amount or frequency of the loss Risk transfer (buying insurance) should be done when losses are very severe