2019 CFA level 3 qbank reading 10 managing individual investor portfolios answers

10/11/2018 Learning Management System Question #1 of 95 In creating an investment policy statement, a portfolio manager needs to be aware that an investor's psychological pro le may impact: A) neither the investor’s risk tolerance nor their return objective B) the investor’s risk tolerance and return objective C) the investor’s risk tolerance only .in Explanation bo ok c (Study Session 5, Module 10.1, LOS 10.b) en tre Psychological pro ling is important for understanding individual investor behavior because defense mechanisms of the brain often cause investors to violate standard nance assumptions (MPT), resulting in irrational decisions These psychological tendencies can impact client preferences, goals and constraints When constructing an investment policy statement, these psychological preferences can have a direct impact on a client's willingness to take risk as well as their desired return Related Material m SchweserNotes - Book o Question #2 of 95 w w Which of the following statements about risk and decision-making styles would least likely appear in a personality typing questionnaire? w A) My favorite subject in school was mathematics B) I not like contact sports, like football C) I typically lose sleep when the market is down Explanation Most investor questionnaires focus on self-evaluative statements and comments on di erent non-investment scenarios Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 1/66 10/11/2018 Learning Management System Question #3 of 95 Most of the short questionnaires used by investment professionals to determine client risk tolerance levels consist of: A) comments about non-investment scenarios B) comments about investment scenarios C) questions that focus on how the individual would deal with the professional if he/she lost their money Explanation Related Material bo ok c SchweserNotes - Book en tre (Study Session 5, Module 10.2, LOS 10.c) in The questions tend to focus on self-evaluative statements and comments on di erent noninvestment scenarios An analyst is developing an investment policy statement for Sally Edgewood, a 48-year old orthodontist with an annual income in excess of $400,000 Edgewood has accumulated an investment portfolio with a current value of $4 million Her portfolio is concentrated in small m capitalization stocks with a bias toward high-tech companies She has expressed a desire to earn a return equal to the return of 12 percent above the return of the Russell 2000 small o capitalization stock index Edgewood lives well on 50 percent of her annual income She has w w always been a ski enthusiast and this year she plans to purchase a second home in the mountains in western Wyoming This purchase will be mortgaged and require her to make an $80,000 down payment Edgewood plans to retire at the age of 63 and is currently paying taxes w at a rate of 30 percent on both income and capital gains Question #4 of 95 Which of the following most accurately portrays Edgewood's overall risk tolerance? Edgewood's willingness: A) and ability to accept risk is above average Thus, her overall risk tolerance is above average B) to accept risk is above average and her ability to accept risk is average Thus, her overall risk tolerance is average https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 2/66 10/11/2018 Learning Management System C) to accept risk is average and her ability to accept risk is above average Thus, her overall risk tolerance is average Explanation Edgewood's ability to assume risk is above average as indicated by the fact that her income is relatively large and exceeds her annual living expenses by a substantial amount Also, being invested in small, high tech rms is an indication of Edgewood's above average willingness to accept risk (Study Session 5, Module 10.9, LOS 10.j) Related Material Question #5 of 95 en tre in SchweserNotes - Book Which of the following most accurately describes Edgewood's tax, liquidity, and time horizon bo ok c constraints? Edgewood's overall time horizon is: A) long, her tax constraints are signi cant, and her liquidity needs are high B) short, her tax constraints are signi cant, and her liquidity needs are low m C) long, her tax constraints are signi cant, and her liquidity needs are low Explanation w w o Edgewood's overall time horizon is long—25 years or more—and it consists of two states: pre-retirement and post-retirement A 30 percent income and capital gains tax is signi cant Her liquidity needs are low and can easily be paid out of income (Study Session 5, Module 10.9, LOS 10.j) w Related Material SchweserNotes - Book Question #6 of 95 Which of the following sets of assumptions is most relevant to the behavioral nance investment framework? Investors are: A) loss averse, investors exhibit biased expectations, investors construct portfolios via asset segregation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 3/66 10/11/2018 Learning Management System B) risk averse, investors demonstrate rational expectations with respect to investment choices, investors construct portfolios consistent with asset integration C) risk averse, investors exhibit biased expectations, investors construct portfolios via asset segregation Explanation Behavioral nance assumes that: Related Material Question #7 of 95 bo ok c SchweserNotes - Book en tre (Study Session 5, Module 10.1, LOS 10.b) in investors are loss averse, which means they prefer uncertain losses to certain losses investors exhibit biased expectations, due to overcon dence in their ability to forecast the future investors construct portfolios via asset segregation, meaning that they tend to focus on an asset's individual investment features versus its impact on the overall portfolio position Which of the following personality types applies to investors who make investment decisions m based on facts as opposed to their feelings or intuitions? o A) Methodical and individualist w w B) Spontaneous and methodical C) Methodical and cautious w Explanation Methodical investors research markets, industries, and rms for potential investments and are constantly on a mission to improve their analytical decision-making skills Individualists also research their investment opportunities and exhibit independent thought when making investment decisions Individualists are very dent, and this makes them capable of questioning inconsistencies in either recommendations or conclusions made by others Individualist investor types tend to be less risk averse than methodical investors (Study Session 5, Module 10.2, LOS 10.c) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 4/66 10/11/2018 Learning Management System Question #8 of 95 Which of the following is NOT determined using situational pro ling? Investor: A) philosophy B) biases C) behavior Explanation Situational pro ling does not determine investor behavior, but represents an analysis of behavior in determining preferences and biases, as well as philosophy .in (Study Session 5, Module 10.1, LOS 10.a) Related Material bo ok c Question #9 of 95 en tre SchweserNotes - Book Joanne Sparta is a 48-year old, successful physician who earns in excess of $500,000 per year She has also been successful speculating on small business startups, which has added an average of $200,000 to her annual income over the last 10 years Sparta travels extensively She m likes to consider herself someone who lives in the fast lane and possesses re ned tastes in o both the arts and entertainment Sparta's annual expenses, including travel and entertainment, w w average $375,000 Sparta has no foreseeable liquidity needs, legal, regulatory, or tax concerns, and has no unique circumstances Which of the following most appropriately describes Sparta's w ability and willingness to bear risk? Sparta is: A) neither able or willing to accept risk B) willing, but unable to accept risk C) both willing and able to accept risk Explanation Based on the information provided, Sparta's fast life style, speculative activities, and relatively large income in excess of expenses, indicates both a willingness and ability to accept risk (Study Session 5, Module 10.9, LOS 10.j) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 5/66 10/11/2018 Learning Management System Question #10 of 95 Although legal and regulatory constraints not usually impact an individual investor's policy statement, attention must often be paid between two parties of personal trusts Which parties exhibit the greatest tension in setting investment policy for a personal trust? A) Grantor and remaindermen B) Income bene ciary and remaindermen C) Income bene ciary and the trust o cer .in Explanation bo ok c en tre A creative tension exists between the income bene ciary and remaindermen listed in a personal trust Income bene ciaries would like to have as much current income from the trust as possible Remaindermen wish to have as large of a portfolio passed to them after the income bene ciary dies The ict between current income and longer-term portfolio growth is a situation that must be addressed in formulating investment policy for a personal trust (Study Session 5, Module 10.3, LOS 10.i) Related Material o m SchweserNotes - Book w w Question #11 of 95 Desired return objectives are those return levels associated with: w A) major goals B) secondary goals C) vacation home goals Explanation Desired return objectives are associated with secondary goals Desired returns may be lowered if there is a disconnect between risk tolerance and return objectives (Study Session 5, Module 10.6, LOS 10.f) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 6/66 10/11/2018 Learning Management System Question #12 of 95 Tony Mitchell, a college professor, is considering investing in a mutual fund His number one priority is long-term capital appreciation He will take above-average risk in exchange for the possibility of outperforming the market Tony is 30 years old and expects to be at the university until age 70 Which fund is more appropriate for Mitchell given a risk free rate of 3%? Mutual Fund A Mutual Fund B Growth and Income Five year return 14% Five year return 12% Standard deviation = 12 Standard Deviation = Consists of 40% growth stocks, 60% preferred stocks Consists of 60% growth stocks and 40% high dividend stocks bo ok c A) A, because of its higher ve year return en tre in Balanced B) A, because it has a better risk/return relationship C) B, because it has a better risk/return relationship Explanation w w o m Fund B is more appropriate because it has a higher mix of growth verses income and its Sharpe ratio is higher at 1.29 versus Fund A at 0.92 Sharpe ratio A = (14 - 3) / 12 = 0.92, Sharpe ratio B = (12 - 3) / = 1.29 thus Fund B has a higher return for a given level of risk.  It should be noted that Mitchell should be able to nd another fund to better meet his objectives (i.e., a growth fund) (Study Session 5, Module 10.1, LOS 10.b) w Related Material SchweserNotes - Book Question #13 of 95 Gary Daly is a retired schoolteacher who invests most of his money in U.S Treasury bonds and notes He has often stated that in times of crisis, he feels that it is better to be safe than sorry In terms of behavioral nance, Daly is exhibiting which personality type? A) Methodical https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 7/66 10/11/2018 Learning Management System B) Cautious C) Spontaneous Explanation Daly's personality type is a "cautious" investor who has a strong desire for nancial security Daly is both risk and loss averse and would prefer very safe investments As such, investors prefer to rely on their feelings to make important investment decisions (Study Session 5, Module 10.2, LOS 10.c) Related Material en tre in SchweserNotes - Book w w w o m bo ok c Question #14 of 95 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 8/66 10/11/2018 Learning Management System Given the following investment policy statement, which portfolio allocation would be most appropriate for Martin and Sheila Torch? Ability to take risk: Martin is a pediatrician and has a high level of income The high level of income, and modest size of living expenses compared to overall assets give the Torch's a high ability to tolerate risk Willingness to take risk: Objectives in Torch states that he wants to emphasize protecting the asset base he has built and does not want the value of his investments to decline more than 10% in a given year Torch's statement implies a low willingness to take risk bo ok c Overall: en tre Risk Tolerance m The low willingness to take risk overshadows the Torch's high ability to take risk w w o Return Objectives w Constraints Time Horizon Liquidity Requirements Income requirement in retirement is 2.1% Growth requirement including in ation and meeting gifting goals is 3.8% Total after tax return requirement = 5.9% Multistage, consisting of time horizons Torch will retire in years Retirement - at least 20 years Post retirement - desire to gift assets at death to children and charities Minimal liquidity requirements other than funding annual living expenses Seek legal counsel to create documents to Legal/Regulatory express the Torch's wishes after their death Taxes The Torch's are taxable investors in the 35% https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 9/66 10/11/2018 Learning Management System tax bracket Tax aspects of investments should be considered Unique Considerations Desire to leave two children and charities a large estate after the death of Martin and Sheila Expected Yield Allocation Allocation Allocation Cash (T-bills) 3.0% 3.0% 5% 5% 10% Domestic Bonds 5.5% 5.5% 15% 20% 35% International Bonds 6.5% 5.0% 5% 10% 10% Domestic Equities 8.0% 2.0% 40% 30% International Equities (Developed) 11.0% 2.5% 10% 20% 10% Venture Capital 20.0% 0.0% 20% 0% 0% Real Estate (REITs) 8.0% 5.0% 5% 5% 5% 10.00% 7.70% 6.78% 2.53% 3.30% 3.83% 0.42 0.52 0.62 w w Expected after-tax return Expected yield en tre w Sharpe ratio 40% bo ok c o m Asset Class in Expected After-tax Return A) Allocation B) Allocation C) Allocation Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 10/66 10/11/2018 Learning Management System in ation for traveling for her musical performances at various dinner clubs around the U.S They have no debt and they own their home without a mortgage Most of their portfolio is currently in large cap U.S stocks and U.S Treasury notes and bills They have approached Pamela Jaycoo, CFA, for guidance on how they could best achieve their nancial goals while also providing for their grandchildren's college needs In ation is expected to stay at percent annually for the foreseeable future Question #77 of 95 in Barbara Analee can be classi ed into which of the following personality types? A) Individualist investor en tre B) Methodical investor C) Cautious investor Explanation m bo ok c Barbara can be clearly classi ed as an Individualist Investor whereby decisions are based on thinking, rather than feeling Having been trained as a nurse where the methodical study of the human anatomy is required, she would not be afraid to her own research work on her investments and would even question recommendations and conclusions made by her investment advisors She is also less risk averse because she understands the results of her decisions, particularly when she is involved in treating hospital patients and customers using a laser w w o Cautious investors base their investment decisions on feeling and are more risk averse Methodical investors base their investment decisions on thinking and are also more risk averse (Study Session 5, Module 10.6, LOS 10.g) w Related Material SchweserNotes - Book Question #78 of 95 What is the Analees return objective for this year? A) 6.67% B) 3.83% C) 6.17% https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 52/66 10/11/2018 Learning Management System Explanation The Analees' pre-tax return objective is computed as follows: $75,000 Travel expenses $15,000 College Fund $20,000 Total $110,000 Portfolio Principal Value $3,000,000 Income Objective: (110,000 / 3,000,000) 3.67% Plus In ation: +3.00% Total Return Objective: 6.67% Related Material Question #79 of 95 w w B) Above average .o A) Below average m What is their tolerance for risk? bo ok c SchweserNotes - Book en tre (Study Session 5, Module 10.6, LOS 10.g) in Ongoing living expenses C) Average w Explanation Their tolerance for risk is average Their liquidity needs are high because of their living expenses and other needs yet they have a large portfolio so overall their risk tolerance is average Since they are in their retirement years, they will be living o their portfolio and not adding to it other than the growth in the portfolio to meet their living expenses and stay even with in ation Always view the portfolio from a total return basis in which the amount used for living expenses is taken from a combination of income and capital gains generated from the portfolio A general rule is that there should always be some cash component in the portfolio but not too much, usually around ±5% or to months worth of living expenses (Study Session 5, Module 10.6, LOS 10.g) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 53/66 10/11/2018 Learning Management System Question #80 of 95 What is Barbara's willingness and ability to assume risk? Willingness Ability Above average B) Above average Average C) Below average Average in A) Above average Explanation bo ok c (Study Session 5, Module 10.6, LOS 10.g) en tre Although Barbara's willingness to assume risk may be high (above average) given her past entrepreneurial pursuits and the Analees' time horizon is quite long, her ability to assume risk is average given her current income needs Thus, the need to protect her current assets is important so her risk tolerance is lowered to average because of her high liquidity needs Related Material m SchweserNotes - Book w w w o Question #81 of 95 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 54/66 10/11/2018 Learning Management System Based on the information presented in the case above, which one of the following portfolios Portfolio A Portfolio B Portfolio C U.S Stocks - S&P 500 9% 20% 5% 10% U.S Stocks - Small Cap 10% 20% 15% 10% Intl Stocks Developing 12% 15% 15% 10% U.S Corporate Bonds 5% 15% 0% 35% U.S Treasury Bonds 3% 10% 0% 25% Venture Capital 11% 5% 30% 0% Real Estate 15% 10% 30% 0% Cash 1% 5% 5% 10% 8.8% 11.6% 5.7% 5.6% 7.4% 3.6% 1.9% 1.9% 2.8% bo ok c Total Return (before taxes) o w w A) Portfolio B m Total Return (after taxes) Yield (after taxes) en tre Expected Return in should the Analees choose: B) Portfolio C w C) Portfolio A Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 55/66 10/11/2018 Learning Management System The most appropriate portfolio for the Analees is Portfolio A The justi cation and rationale for Portfolio A is that this portfolio provides a good balance in terms of their return objectives, risk tolerance and constraints However, the portfolio provides an adequate return of 8.8% versus their return requirement of 6.8% Portfolio A also provides a su cient amount of income to meet current income needs while minimizing the e ects of in ation It is a well diversi ed portfolio that balances the risks evenly among most asset classes: 55% stocks, 25% bonds, 10% real estate, and 5% each in venture capital and cash Although this portfolio can meet the needs of the family, tax planning is advised to minimize their level of total tax liability Such planning must be done in tandem with the investment advisor, Pamela Jaycoo, so as to coordinate construction of the appropriate asset classes .in Portfolio B is inappropriate because it concentrates a higher proportion of assets into venture capital and real estate (combined 60%), traditionally lower liquidity classes and higher levels of volatility Furthermore, there is a higher concentration of assets allocated to small and international stocks, also asset classes that exhibit higher volatility levels Related Material SchweserNotes - Book o m Question #82 of 95 bo ok c (Study Session 5, Module 10.6, LOS 10.g) en tre Portfolio C is inappropriate because it does not meet their return objectives, and is designed for conservative investors with low risk tolerances There is a high concentration in bonds (60%), too much concentrated in cash (10%), and the rest evenly distributed among the remaining asset classes For this question only, assume that Barbara has accepted an o er to work part-time as a w w lounge singer in Las Vegas for the next ve years but still continue with her traveling as a blues singer This position will pay her a gross income of $45,000 annually However, the Analees w annual living expenses will increase to $85,000 After ve years, Barbara plans on returning to retirement at which point, the Analees living expenses will return to 75,000 per year in today's dollars Also assume they will live for 30 more years at which time the portfolio will be completely spent down Based on this new information, what is the Analees return objective? A) 2.39% B) 6.97% C) 6.48% Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 56/66 10/11/2018 Learning Management System The Analees' pre-tax return objective is computed as follows: Next Five Years: Ongoing living expenses $85,000 Travel expenses $15,000 Barbara's Income -45,000 College Fund $20,000 Total $75,000 $75,000 Travel expenses $15,000 College Fund $20,000 Total $110,000 Ongoing living expenses Travel expenses bo ok c After contributing to grandchildren's education: en tre Ongoing living expenses in Return to Retirement: $75,000 $15,000 $90,000 Total Return Objective: m Total $3,000,000 w w w o Portfolio Principal Value Income Objective: CF0 = -3,000,000 C01 = 75,000 F01 = C02 = 110,000 F02 = C03 = 90,000 F03 = 20 CPT IRR = -0.61% Plus In ation: +3.00% Total Return Objective: 2.39% (Study Session 5, Module 10.6, LOS 10.g) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 57/66 10/11/2018 Learning Management System Question #83 of 95 Which of the following statements regarding situational pro ling is least accurate? A) When properly used, situational pro ling will provide a great degree of insight into an investor's preferences, economic situation, goals, and desires B) Situational pro ling considers an individual's preferences, economic resources, goals, and desires C) With situational pro ling, the source of an investor's wealth is considered an in indicator of the investor's risk tolerance en tre Explanation Due to the extensive number of possible individual situations, situational pro ling must be applied cautiously It should be applied as only an initial step in developing an understanding of an individual's preferences, economic situation, goals, and desires bo ok c (Study Session 5, Module 10.1, LOS 10.a) Related Material m SchweserNotes - Book o Question #84 of 95 w w The concept of behavioral nance has begun to be employed in investment management Which of the following statements is CORRECT regarding behavioral nance and its potential w a ect on a client's risk objectives? Behavioral nance implies that investors are: A) loss averse, rather than risk averse, and this may have an impact upon the investors' ability to take risk B) risk averse, rather than loss averse, and this may have an impact upon the investors' willingness to take risk C) loss averse, rather than risk averse, and this may have an impact upon the investors' willingness to take risk Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 58/66 10/11/2018 Learning Management System Behavioral nance suggests that investors may view risk of loss di erently from risk of gain (i.e., that they are more risk seeking in the domain of losses) This is known as being loss averse The investor's psychological pro le can a ect their willingness to take risk However, the ability to take risk is a more objective measure of what is appropriate given the client's situation (Study Session 5, Module 10.1, LOS 10.b) Related Material SchweserNotes - Book in Question #85 of 95 en tre Which of the following inputs is NOT used in both deterministic and probabilistic analyses in individual retirement planning? A) Assets owned C) Input variable probabilities Explanation bo ok c B) Current income w w o m In both approaches, the individual supplies a similar set of personal information, including the above as well as age, savings, etc The di erence between deterministic and probabilistic analyses is that deterministic planning techniques use single values for economic and nancial variables Monte Carlo (MC) simulations generate a probabilistic forecast of multiple retirement period values Only Monte Carlo simulation would require the input of variable probabilities (Study Session 5, Module 10.8, LOS 10.l) Related Material w SchweserNotes - Book Question #86 of 95 The ability to take risk is best judged by: A) the time horizon of long term needs and goals B) the time horizon of only short term needs and goals C) the time horizon of both short- and long-term needs and goals https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 59/66 10/11/2018 Learning Management System Explanation The time horizon of both short- and long-term nancial needs and goals will have direct consequences on an investor's ability to take risk (Study Session 5, Module 10.6, LOS 10.g) Related Material SchweserNotes - Book w w w o m bo ok c en tre in Question #87 of 95 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 60/66 10/11/2018 Learning Management System Bill Kelley, age 55, just retired and accepted an early retirement package from his employer, FertileGro Lawncare The early retirement package has an estimated value of $1.2 million after taxes After taking the retirement package, Kelley took a job in customer service at a local hospital and currently has a salary of $50,000 per year Sharon Kelley, age 54, works part-time as the Treasurer for their church and has a salary of $15,000 per year They have two children, Shannon, age 31, and Sarah, age 18 Shannon is married and does not require nancial assistance, while Sarah is in her rst year of college The Kelleys consider the early-retirement package a wonderful addition to their existing $2 million in savings They have no debt and pay their expenses on monthly basis Total family expenses last year including tuition amounted to approximately $93,750 .in Bill and Sharon Kelley recently approached Modern Portfolio Management, Inc for help in managing their portfolio At a recent fact- nding meeting, the Kelleys made the following en tre statements: Our primary goal is to pay for the college education of our youngest daughter, Sarah Tuition, room, and board last year was $30,000 and is expected to grow at 5% per year bo ok c We want to retire at age 65 and live comfortably We are taxed at a 25% rate on dividends, capital gains, and income In ation is expected to grow at 2.5% per year inde nitely People get too excited about the stock market - they talk about making all of this money, but they could turn around and lose it tomorrow We don't want to be in any individual m investment or security that is considered too risky .o We not foresee any unusual expenses, but like to keep some cash on hand, just in w w case of emergencies Modern Portfolio Management presents the Kelleys with three model portfolios Which of the w portfolios would be best suited for the Kelley's to meet their living expenses this year? Asset Class Portfolio Portfolio Portfolio Large cap U.S stocks 20% 35% 15% Small cap U.S stocks 10% 15% 0% International developed market equities 5% 10% 0% International emerging market equities 5% 5% 0% U.S corporate bonds 20% 30% 45% U.S Treasury bonds 10% 0% 20% https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 61/66 10/11/2018 Learning Management System Real estate 5% 0% 0% Venture capital 10% 0% 0% Cash 15% 5% 20% Total expected return 6.8% 6.3% 5.1% Current yield 3.8% 3.5% 4.6% A) Portfolio B) Portfolio C) Portfolio .in Explanation Time until Sarah is out of college Time until retirement bo ok c Retirement en tre Portfolio is the optimal portfolio The Kelley's time horizon would be characterized as being long term with stages: The in ows are $50,000 + $15,000 = $65,000 before tax = $65,000 (1-.25) = $48,750 after tax The out ows have to be adjusted for in ation since they were last year's costs thus we have: o m $93,750 total costs last year = $30,000 tuition + $63,750 living expenses Tuition expenses adjusted for in ation are $30,000 × 1.05 = $31,500 Living expenses adjusted for in ation are $63,750 × 1.025 = $65,344 Total out ows this year = $31,500 + $65,344 = $96,844 w w In ows - out ows = $48,750 - $96,844 = -$48,094 Required return = 48,094 / 3,200,000 = 1.5% after tax real required return w Adjusting for in ation = 1.5 + 2.5 = 4.0% after tax nominal required return 4.0 / (1-.25) = 5.3% before tax nominal required return Portfolio meets the return requirement and also is in line with their low risk tolerance as indicated by not wanting to be in a security that is too risky Portfolio is not acceptable because its return is too low, it is not well diversi ed, and has 20% allocated to cash Portfolio looks like a good choice, especially with its slightly higher return than Portfolio and broad diversi cation, however the portfolio has a much higher than necessary cash allocation, and the lack of return from cash seems to be made up for by a 10% stake in venture capital Portfolio appears to be a better match with the Kelley's risk tolerance (Study Session 5, Module 10.8, LOS 10.k) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 62/66 10/11/2018 Learning Management System Question #88 of 95 An investment policy statement bene ts investment advisors because it provides: A) guidelines for capital market expectation formations B) guaranteed legal protection against errors in omission lawsuits C) an understanding of the advisory relationship between manager and client Explanation (Study Session 5, Module 10.2, LOS 10.d) Related Material Question #89 of 95 bo ok c SchweserNotes - Book en tre in The investment policy statement provides an understanding of the relationship between manager and client The investment policy statement does not provide guaranteed legal protection or how to form capital market expectations m Deterministic approaches di er from Monte Carlo approaches in that deterministic o approaches: A) generate ranges of outcomes whereas Monte Carlo approaches generate single w w numbers B) generate single numbers whereas Monte Carlo approaches generate a range of w outcomes C) use probability forecasts whereas Monte Carlo approaches use best estimates Explanation Monte Carlo approaches rely on probabilistic inputs to generate a range of outcomes that may provide better information than any method that generates a single number, like deterministic approaches (Study Session 5, Module 10.8, LOS 10.l) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 63/66 10/11/2018 Learning Management System Question #90 of 95 An investment policy statement does NOT provide which of the following? A) Guaranteed investment returns B) Long-term investment decision making guidelines C) Weighting ranges for asset allocation Explanation An investment policy statement does not provide guaranteed investment results .in (Study Session 5, Module 10.2, LOS 10.d) Related Material bo ok c Question #91 of 95 en tre SchweserNotes - Book When planning for retirement, an individual investor may wish to use a Monte Carlo approach over a deterministic approach because: A) deterministic approaches use inappropriate inputs m B) Monte Carlo approaches provide a better analysis of outcome ranges than the o single wealth gure estimate generated by deterministic approaches w w C) Monte Carlo approaches are simpler and quicker to implement Explanation w Monte Carlo approaches generate ranges of outcomes that can be associated with probabilities of their occurrences Although slightly more involved in implementation, and sometimes taking longer to generate, Monte Carlo generated ranges and or probabilities may better indicate to the client realistic retirement opportunities (Study Session 5, Module 10.8, LOS 10.l) Related Material SchweserNotes - Book Question #92 of 95 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 64/66 10/11/2018 Learning Management System Steve Smith is 55 years old He has just been promoted to VP of manufacturing of a well established manufacturing conglomerate Recently, Smith received a substantial inheritance from a wealthy relative Given this information, how would Smith be classi ed along a risk tolerance spectrum? A) Moderate-to-high B) Not enough information to tell C) Low-to-moderate Explanation (Study Session 5, Module 10.1, LOS 10.b) SchweserNotes - Book m Question #93 of 95 bo ok c Related Material en tre in Steve Smith could be classi ed on the low-to-moderate range of a risk tolerance spectrum His age classi es him as getting closer to retirement His sources of wealth have been attained through relatively passive means (inheritance and well-established conglomerate) His perception of wealth, however, may be high given the recent inheritance and may indicate a moderating risk stance .o Situational pro ling often uses measures of wealth in determining investor risk preferences Which of the following is the best de nition for measure of wealth within a situational pro ling w w context? The: A) perceived amount of wealth held w B) absolute amount of wealth held C) amount of wealth held in the stock market Explanation The amount of wealth important to an investor in a situational pro le is the amount of wealth perceived as large or small by the investor If the investor perceives his amount of wealth to be large, he may be more tolerant of risk taking activities If the amount of wealth is perceived to be small, the investor may be less tolerant of risk taking activities (Study Session 5, Module 10.1, LOS 10.a) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 65/66 10/11/2018 Learning Management System Question #94 of 95 Which of the following statements about Monte Carlo simulation is CORRECT? Monte Carlo simulation: A) is best when it uses only historical data B) typically produces approximately 100 trials C) forecasts a more accurate risk/return tradeo than a deterministic approach .in Explanation (Study Session 5, Module 10.8, LOS 10.l) SchweserNotes - Book m Question #95 of 95 bo ok c Related Material en tre History provides a view of only one possible path among the many that might occur in the future It is di cult to estimate expected returns using historical gures because of the volatility factor Monte Carlo analysis produces probability distribution by tabulating the outcomes of a large number (often 10,000) of simulated trials .o The willingness to take risk is best judged by the: w w A) psychological pro le of the investor B) nancial pro le of the investor w C) subjective nature of the prospective investments Explanation The willingness to take risk is related to the psychological characteristics of investors and is best measured in subjective terms (Study Session 5, Module 10.6, LOS 10.g) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83415874/print 66/66 ... (T-bills) 3. 0% 3. 0% 5% 5% 10% Domestic Bonds 5.5% 5.5% 15% 20% 35 % International Bonds 6.5% 5.0% 5% 10% 10% Domestic Equities 8.0% 2.0% 40% 30 % International Equities (Developed) 11.0% 2.5% 10% 20% 10% ... https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice /qbank/ 24 038 518/quiz/ 834 15874/print 3/ 66 10/ 11/2018 Learning Management System B) risk averse, investors demonstrate rational expectations with respect to investment choices, investors... U.S Treasury bonds Venture capital Cash (T-bills) 0% 5% 20% 35 % 35 % 4% 22% 0% 30 % 20% 10% 0% 0% 3% 3% 4% 5% 8.62% 7.80% 6 .10% 12.80% 10. 20% 7.40% w w o Standard deviation 5% m Total expected return