1 - Investment Management Within Retirement Plans

Question 1

INVESTMNENT RISKS:

• _________ reflects the relationship between the nominal rate of return on an investment and the increase in the rate of inflation.
• __________ involves the prospect of the corporation issuing the security suffering a decline in earnings power that would adversely affect its ability to pay interest, principal or dividends.
• _________ comprises the well-known inverse relationship between interest rates and (long-term) bond prices. That is to say, when interest rates increase, the value of long-term bonds falls.
• ________ can be thought of as an individual stock’s reaction to a change in the market. In general, most stock prices will increase if the stock market increases appreciably and decrease if the market decreases appreciably; however, the price of one stock may change half as fast as the market, on average, while another may change twice as fast. This relationship is quantified by a measure known as “beta.”
• ________ risk that is intrinsic to a particular firm.

Answer 1

• Purchasing power risk
• Business risk
• Interest rate risk
• Market risk
• speific risk

Question 2

The tax aspect of an investment is important because of the ____ status of the pension fund.

Liquidity refers to the ability to convert an investment into cash in a short time period with little, if any, loss in principal. This may be an important attribute for at least a portion of the pension plan assets in case the plan has to sustain a short period of time when the plan sponsor is unable to make ________ and, at the same time, the securities markets are depressed. If the plan did not possess an adequate degree of liquidity, the sponsor might have to sell securities at an inopportune time, perhaps resulting in the realization of ______

Answer 2

• tax-exempt
• contributions
• capital losses.

Question 3

Published in 2011, an ___-year time series analysis of the major classes of investments found, as expected, that the riskiest investments also generated the highest yields. Common stocks provided the highest annual return with small company stocks having a compound annual growth rate of ___% and large company stocks having a compound annual growth rate of ___%.

However, investors purchasing common stocks paid a price in terms of the ______ of their investment. Over the past several decades, the large company stocks experienced one- year losses as high as 26.47% (in _____). Long-term bonds issued by the government had a significantly lower return (_____%). U.S. Treasury bills were obviously the safest investment in terms of annual volatility; however, they only generated a return of ____%.

Answer 3

• 84
• 12.1%
• 9.9%
• volatilit
• 5.5%
• 3.6%.

Question 4

An investment manager’s guideline statement should cover such questions as:

1. How much _____ is the plan sponsor prepared to take to achieve a specific benchmark rate of return?
2. What is the ______ for measurement of performance relative to objectives?
3. What is the sponsor’s preference in terms of _____, especially as it relates to stocks?
4. What is the ______ outlook for the plan, and what should the fund’s investment strategy be in light of this outlook?
5. What are the sponsor’s _____ or ______ requirements?
6. How much ________ is the manager permitted regarding foreign investment, private placements, options, financial futures and the like?

Answer 4

1. risk
2. time period
3. asset mix
4. liability
5. cash flow / liquidity
6. discretion

Question 5

Effective performance measurement requires (4) steps:

Answer 5

1. Definition: Establishment of investment objectives and, to the extent practical, a clearly formulated portfolio strategy.
2. Input: Availability of reliable and timely data. Incorrect and tardy data will render the most sophisticated system ineffective.
3. Processing: Use of appropriate statistical methods to produce relevant measurements. The complex interaction of objectives, strategies and managers’ tactics cannot be understood if inappropriate statistical methods are used. A meaningful summary will make possible analysis of the investment process at the necessary depth.
4. Output: Analysis of the process and results presented in a useful format. Presentation should relate realized performance to objectives and preestablished standards. Enough material should be available to understand and analyze the process. Exhibits should be designed to highlight weaknesses in the investment process and to suggest possible improvements.

Question 6

Four important caveats must be kept in mind in choosing a performance measurement system:

1. There is a danger that a hastily chosen system, poorly related to ______, can rapidly degenerate into a mechanistic, pointless exercise.
2. The system should fit the _______—not the reverse.
3. ______ the process may alter it.
4. To save time and cost, it is important that ________ be avoided.

Answer 6

• real need
• investment objectives
• Measuring
• overmeasurement

Question 7

Before any performance is measured, agreement must exist on the correct definition for the return that is being measured. Two alternative definitions, __________ and __________, have been used in the investment community for more than 40 years.

Answer 7

• internal rate of return
• time-weighted rate of return

Question 8

The internal rate of return is valuable in that it allows the sponsor to determine whether the investment is achieving the rate of return assumed for _______ calculations; however, it is largely ineffective as a means of evaluating ________ because it is contaminated by the effects of the timing of _______ and ________—a factor over which the investment manager presumably has no control.

Answer 8

• actuarial
• investment managers
• investments
• withdrawals

Question 9

The time-weighted value is computed by dividing the time interval under study into subintervals whose boundaries are the dates of _____ into and out of the fund and by computing the internal rate of return for each _____. The time-weighted rate of return is the (_______) average for the rates for these subintervals, with each rate having a weight proportional to the _______ in its corresponding subinterval.

Answer 9

• cash flows
• subinterval
• geometric
• length of time

Question 10

uses standard statistical techniques (simple linear regression) to analyze the relationship between the periodic returns of the portfolio and those of the market (for example, the s&P 500).

Answer 10

the capital asset pricing model (CAPM)

Question 11

• The portfolio’s alpha value can be thought of as the amount of ______ produced by the portfolio, on average, independent of ______.
• The beta value is the _____ of the line measured as the change in vertical movement per unit of change in the horizontal movement. This represents the average return on the portfolio per __% return on the market. For example, if the portfolio’s beta is 1.25, then a 2% increase (decrease) in the market would be expected to be associated with a 2.5% (1.25 3 2) increase (decrease) in the portfolio, on average.

Answer 11

• return
• the return of the market
• slope
• 1%

Question 12

the ______________ can be used to measure risk-adjusted performance and to compare portfolios with different risk levels developed by actual portfolio decisions.

Answer 12

risk-adjusted rate of return

Question 13

The five major categories of this type of investment alternative are:

1. _______________. Treasury bills have maturities at issue ranging from 91 to 360 days, while Treasury notes have initial maturities ranging from one to five years. There is almost no _____ on these investments. In other words, the probability that either interest or principal payments will be skipped is nearly zero.
2. _______________. The Treasury is not the only federal agency to issue marketable obligations. Other agencies issue short-term obligations that range in maturity from one month to over ten years. These instruments typically will yield slightly more than Treasury obligations with a similar maturity.
3. _______________. These are issued by commercial banks and have a fixed maturity, generally in the range of 90 days to one year. The ability to sell prior to maturity usually depends on its ________. The default risk for these depends on the issuing bank, but it is usually quite small.
4. _______________.This is typically an unsecured short-term note of a large corporation. This investment offers maturities that range up to 270 days, but the marketability is somewhat limited if an early sale is required. The default risk depends on ________, but commensurately higher yield is available.
5. _______________. These funds invest in the instruments described above. As a result, investors achieve a yield almost as high as that paid by the direct investments themselves and, at the same time, benefit from the diversification of any default risk over a much larger pool of investments.

Answer 13

1. U.S. Treasury bills and notes / default risk
2. Federal agency issues.
3. Certificates of deposit / denomination
4. Commercial paper / the credit standing of the issuer
5. Money market mutual funds.

Question 14

The use of bonds in pension plan portfolios typically can be attributed to one of two reasons.

1. First, if the sponsor realizes that (to a large extent) the pension plan’s obligations are ______ obligations that will be paid out several years in the future, there may be a desire to purchase assets that will generate a cash flow similar to the benefit payments.
2. Second, the investment manager may be willing to purchase assets with a _______ than the money market instruments described above. This assumption of _______ is presumably compensated for by a higher yield than that available from shorter maturities.

Answer 14

• fixed dollar
• longer maturity
• interest rate risk

Question 15

Although there is no definitive manner of categorizing common stocks, it is customary to speak of them in the following terms:

1. ________ These are stocks issued by major companies with long and unbroken records of earnings and dividend payments. They should appeal primarily to pension plans seeking safety and stability.
2. _______ These are stocks issued by companies whose sales, earnings and share of the market are expanding faster than either the general economy or the industry average. They represent a higher risk, but the prospects for capital appreciation should produce a correspondingly higher total return. Because they pay relatively small dividends, they may not be attractive to pension plans with cash flow needs.
3. ________ These are stocks that pay higher-than-average dividend returns. They have been attractive to pension plans that bought stock for current income.
4. __________ These are stocks issued by companies whose earnings fluctuate with the business cycle and are accentuated by it.
5. _________ These are stocks issued by recession-resistant companies. These may be an important consideration for pension plans that cannot afford major capital losses.
6. _________ These are stocks whose prices tend to drop when interest rates rise, and vice versa.

Answer 15

1. Blue-chip stocks.
2. Growth stocks.
3. Income stocks.
4. Cyclical stocks.
5. Defensive stocks.
6. Interest-sensitive stocks.

Question 16

For plans with assets too small to be handled by an investment manager, ______ may be the only choice. Larger plans also may choose them as a relatively inexpensive way of diversifying their portfolios. Pension plans choose to invest in mutual funds for the following reasons:

1. Greater ______ through ease of entry and exit
2. Greater degree of _______
3. Easier means of portfolio ______
4. Daily update of ______ through Internet listings
5. Ease of meeting _____ or ______ goals
6. Ease of checking ________ through published studies and indexes.

Answer 16

1. mutual funds
2. liquidity
3. diversification
4. specialization
5. holdings
6. asset allocation / market timing
7. past performance

Question 17

What type of information should be elicited in a questionnaire sent to prospective investment managers?

1. Portfolio ______ and tactics
2. ______ as well as employee compensation
3. ______ procedures
4. List of ______ and specific people to contact for ______
5. Names of ______ as well as those gained in recent years
6. Historic performance of each _______ managed
7. Explanation of exactly how the firm’s ________ have been computed.

Answer 17

1. strategies
2. Ownership
3. Decision-making
4. current clients / references
5. accounts lost
6. class of assets
7. performance statistics

Question 18

Proponents of the passive strategy argue that, as the stock market becomes increasingly ________, it is more difficult for investment managers to consistently outperform the market.

If actively managed funds do indeed encounter difficulties producing a gross rate of return superior to that of the market, it will obviously be even more difficult to produce a superior return on a _______

Answer 18

• efficient
• net basis

Question 19

[use of index funds as core]

This tactic possesses the advantage of freeing the investment managers from having to deal with the core portfolio and, instead, allowing them to focus their time on their _______. Moreover, given a relative sense of security for the core investment, investment managers are able to pursue a higher risk strategy on their subset of the plan’s assets in hopes of _______

Answer 19

• specialty areas
• above-average returns.

Question 20

Another form of passive investment of pension plan assets makes use of the bond market and has been variously referred to as _______(3)___________.

This technique attempts to construct a bond portfolio such that its cash flow can be used to fund _________, such as to pay benefits to a group of retirees.

Answer 20

• dedication, immunization and contingent immunization
• specific plan liabilities

Question 21

Both employers and employees have a vital stake in the plan investment provisions of a DC plan. The employer is responsible for:

Answer 21

1. Structuring appropriate investment programs
2. Selecting suitable investment managers
3. Monitoring investment performance
4. Communicating critical investment provisions to employees.

Question 22

For the employer, the benefits of a successful investment program include (4):

Answer 22

• Low-cost fees
• Ease of administration
• Flexibility to make needed changes in investment arrangements
• Improved recognition of the company as a source of valuable benefits.

Question 23

For employees, a well-executed investment program maximizes capital accumulation through (3):

Answer 23

• Increased participation
• Improved returns
• Lower costs.

Question 24

Many factors have contributed to the creation of enhanced investment opportunities in Defined Contribution plans. Among the major factors are:

1. A growing public awareness of the role of DC plans in providing ______ and of the importance of ________
2. An increased recognition on the part of employers of the need to provide flexibility of _____ and investment _____
3. Improved and more efficient __________
4. The aggressive _______ efforts of the leading mutual funds.

Answer 24

• economic security / saving and investing wisely
• choice / education
• administrative capabilities
• marketing

Question 25

Do a variety of investment choices in a well-structured DC plan ensure maximum benefits for participants?

Answer 25

NO

Question 26

PPA has provided protection to and advanced efforts to improve investment outcomes of DC plan participants through provisions that facilitate plan sponsors’ ability to provide _________, require ________ for DC plans and permit fiduciary exemption associated with ____________.

Answer 26

• investment advice
• investment diversification
• automatic plan enrollment

Question 27

What major areas should an employer consider when evaluating the investment provisions of a DC plan (3)?

Answer 27

• Fiduciary responsibilities
• The role of employer stock
• Administrative issues.

Question 28

There are several potential disadvantages to the use of employer stock as an investment option within a DC plan. These disadvantages include the following:

1. Employer stock is a completely ________ investment option and may be inappropriate from a financial perspective.
2. Employer contributions invested in company stock at the employer’s direction are not eligible for the ______
3. Plan sponsors that permit employee contributions to be invested in company stock must comply with _______ registration and reporting requirements.
4. ________ problems may surface if the value of the employer stock declines.
5. If significant balances are built up in the company stock fund, employees have not only their livelihood but also a sizable block of their tied to _________.
6. Any investment in employer stock, while not subject to the requirement for a diversified investment alternative, must be shown to satisfy the requirement that plan assets be “______ for the exclusive benefit of employees,” and must satisfy the fiduciary requirement for ______.
7. If employer stock is offered as one of the investment options, the employer must adhere to the PPA ______ requirements. These rules do not apply to _______

Answer 28

1. undiversified
2. Section 404(c) safe harbor provisions.
3. SEC
4. Employee relations
5. the well-being of the company
6. expended / prudence
7. diversification / employee stock ownership plans (ESOPs).

Question 29

IMPORTANT

There are several administrative issues that need to be addressed in structuring the investment provisions of a DC plan. These administrative issues include (5):

Answer 29

1. Frequency of valuation
2. Frequency of change
3. Default provisions
4. Negative elections
5. Employee communications

Question 30

Describe the decisions an employer must make in the design phase of developing plan investment provisions:

The first is to consider __________. This decision will be influenced by administrative costs, risk and return characteristics, plan objectives and participant needs.

The next issue in the design phase is whether to offer asset classes as _________, from which employees will choose their own mix, or to combine them into predetermined sets of ________ reflecting different risk and return characteristics.

Answer 30

• what asset classes will be offered
• distinct investment options
• diversified portfolios

Question 31

Different employees will have different degrees of _______ depending not only on their investment horizon but also on their own ______. it is quite difficult for a professional investor to gauge the relative risk and return trade- offs of the various potential combinations of assets, even with the benefit of years of education and experience. if plan participants are to make an intelligent allocation of their investment dollars, then substantial guidance is required from the _______.

Answer 31

• risk tolerance,
• psychological preferences
• plan sponsor

Question 32

Can performance evaluation of investment managers involve a direct and straightforward comparison of their performance against certain indexes?

Answer 32

No