103-10 Asset Allocation, Portfolio Dev, Investment Strategies

Question 1

Investment Policy Statement

Answer 1

Written document that sets forth a client’s objectives, places boundaries on the portfolio’s asset allocation and investment guidelines, as well as limitations on the investment manager

Question 2

Dollar Cost Averaging (DCA)

Answer 2

The systematic process of purchasing securities over time by investing a predetermined amount of money at regular intervals
Goal of strategy: reduce the effects of market price fluctuations

Question 3

Averaging Down

Answer 3

Purchase additional shares only when the price of shares declines

Question 4

Share Averaging

Answer 4

when the investor purchases the same # of shares every time

Question 5

Bond Ladders

Answer 5

A long-term strategy for diversifying and staggering maturity dates in a client’s bond portfolio and, subsequently, for establishing a schedule for reinvesting the bond proceeds as they mature

Question 6

Bond Barbells

Answer 6

Aka the dumbbell strategy, is an active strategy for buying only short-term and long-term bonds
Requires active management by the portfolio manager because the short-term bonds mature quickly

Question 7

Bond Bullets

Answer 7

A strategy for having several bonds mature at the same time, thus minimizing IR risk

Question 8

Bond Swapping

Answer 8

The process of selling one debt security (bond) and replacing it with another
The goal of the strategy is to increase the YTM on the bond portfolio, to save on income taxes, or to reduce the overall IR risk of the portfolio

Question 9

Substitution Swap

Answer 9

Involves selling bonds w/ identical characteristics but different selling prices
The price difference is an arbitrage opportunity and will exist only shortly, until the market corrects the price inefficiency

Question 10

Intermarket Spread Swap

Answer 10

Involves the exchange of 1 type of bond (e.g. gov. bond) w/ another type of bond (e.g. corporate bond)
Occurs when investors believe 1 type of bond is currently mispriced in relation to the other
Goal is to capitalize on a YTM disparity across bond markets

Question 11

Rate Anticipation Swap

Answer 11

Attempts to take advantage of expected changes in IR
If rates are expected to increase, long-term bonds are swapped for short-term bonds
If rates are expected to decline, short-term bonds are swapped for bonds w/ long maturity dates

Question 12

Pure Yield Pickup Swap

Answer 12

A bond w/ a lower YTM is exchanged for a bond w/ a higher YTM
The new bond that replaces the old bond is either a long-term bond or a lower-quality bond sufficient to generate a higher overall YTM

Question 13

Tax Swap

Answer 13

Motivated by current tax law

One example: gain from a capital loss by selling a previously purchased bond at a loss due to rising IR

Question 14

Market Timing

Answer 14

An attempt to predict the overall direction of the securities market and to take advantage of changes in the prices of those securities, whether those prices go up (going long) or down (selling short)

Question 15

Buy-and-hold

Answer 15

The conceptual opposite of market timing – no purchases or sales of an investor’s existing portfolio will be done over a very long period of time (i.e. investment horizon)

Question 16

Sector Rotation

Answer 16

An active portfolio management strategy, means emphasizing or over allocating certain economic sectors or industries in response to the expected phase of the business cycle

Question 17

Short Selling Steps (4):

Answer 17

A) investor uses a broker to borrow stock from another investor’s account. Requires deposit equal to margin requirement (currently 50%) of the FMV.
Investor sells the borrowed stock in the open market
Investor repurchases the stock in the open market
Finally, the investor replaces, or covers, the borrowed stock

Question 18

Short Selling – Dividend Payments

Answer 18

If the company pays a dividend before the short sale is covered, the short seller is required to make a cash payment in lieu of the dividend to the investor whose stock was borrowed.

Question 19

Leverage

Answer 19

The use of borrowed money to achieve an individual’s investment objectives

Question 20

Maintenance Margin

Answer 20

Usually 35%. Is a 2nd margin requirement put in place by the BD whereby the investor must add additional funds to the account to protect the BD from losses

Question 21

Margin Call Formula

Answer 21

Margin call = debit balance / 1- maintenance margin

Question 22

Mean-Variance Optimization

Answer 22

Most financial planners who provide investment counseling use some type of mean-variance software to determine an optimum portfolio or asset allocation based on a client’s goals, risk tolerance, time horizon, tax situation, and economic forecasts

Question 23

Strategic Asset Allocation

Answer 23

Purpose is to determine an appropriate allocation based on the long-term financial goals of the client
Once the allocation is determined, it remains constant until (typically) some life-changing event occurs
Think: Hunter Advisory

Question 24

Rebalancing

Answer 24

Must take place to bring the portfolio in line w/ the strategic mix

Question 25

Tactical Asset Allocation (TAA)

Answer 25

Continuously adjusts the asset allocation and class mix in an attempt to take advantage of changing market conditions and overall investor sentiment
TAA is a market timing approach to portfolio management that is intended to take advantage of perceived market inefficiencies (and opportunities for investor profit)

Question 26

Core and Satellite Investment Strategy

Answer 26

Invests in both broad market indexes (core) and higher-risk alternatives (satellite)
Core: U.S. stocks, U.S. fixed income, developed international equities
Satellite: REITs, emerging markets, high-yield bonds

Question 27

Value Investing

Answer 27

A strategy that tends to concentrate on the numerator (or price) – of a P/E ratio
Assumes the current P/E ratio is below its natural level and that an efficient market will soon recognize this situation and drive the stock price upward
Could be considered slow and steady, while the growth approach is more aggressive

Question 28

Growth investing

Answer 28

Focuses on the denominator (or earnings) – of a P/E ratio
Assume the P/E ratio will remain constant over the near term, and the stock price in an efficient market will increase as the forecasted earnings growth of the issuing company is realized

Question 29

Charitable Remainder Trust

Answer 29

When a CRT is established and assets are transferred to the trust, a charitable income tax deduction is created for the donor and may be used to offset compensation income
The CRT can sell the securities without any income tax liability because it is a tax-exempt entity under law

Question 30

Exchange Fund

Answer 30

NOT ETF’s
Permit investors w/ concentrated portfolios of publicly traded stock to contribute the stock to the fund. In exchange, the investor receives a proportional interest in the fund.
Major benefit – an undiversified portfolio is exchanged for a diversified portfolio without incurring immediate capital gains taxes