3. Investment Planning. 11. Asset Allocation & Portf. Diversification

Question 1

A chef would tell you that it is very important to have the right balance of ingredients while preparing a meal. An incorrect proportion or combination of spices can result in a disastrous attack on the taste buds. Creating an investment portfolio is like preparing an entrée. Each investment vehicle placed in the portfolio is like an ingredient for an entrée. The proportions of securities used to build the portfolio will define its expected risk and return. Asset allocation and portfolio diversification are both techniques used to identify the right combination of securities to put into a portfolio. Asset allocation identifies the asset class proportions while portfolio diversification suggests the correct mix of securities within the asset classes. However, just like an entrée should be created considering the taste preferences of the person eating it, a portfolio’s diversification and asset allocation methods should be suitable to the investor’s needs.

Answer 1

The Asset Allocation and Portfolio Diversification module, which should take approximately two and a half hours to complete, will explain the various asset allocation and portfolio diversification topics and techniques.

Upon completion of this module you should be able to:
* Describe the asset allocation process, and
* Specify techniques and methods to build portfolios.

Question 2

Maintaining a well-diversified portfolio is an important step in maximizing returns and reducing risks in the long term. This calls for an appropriate investment mix that will explore the investment objectives and tolerance for risk. Based on these objectives, a specific portfolio combination, including money market funds, bonds and equities should be planned. Asset allocation accounts for a large part of the variability in the return on a typical investor’s portfolio.

With growth in the economy, individuals have more disposable income. Along with disposable income, every individual wants their money to work for them while maintaining low risk. The best way to do so is by investing the money to maximize returns and minimize risks. But the knowledge and understanding of different methods and techniques for investing in stocks and bonds is minimal among most investors.

Answer 2

To ensure that you have a solid understanding of asset allocation and portfolio diversification, the following lessons will be covered in this module:
* Life Cycle Asset Allocation
* Asset Allocation Process
* Security Analysis and Portfolio Construction

Question 3

Section 1 – Asset Allocation Process

Asset allocation focuses on determining the mixture of asset classes that will provide a combination of risk and return that is optimal given an investor’s financial situation and investment objectives. An asset class is a grouping of securities with similar characteristics, such as stocks, bonds, and money market instruments.

The asset allocation process should begin with the development of a strategic asset allocation (SAA). SAA identifies asset classes and the proportions for those asset classes that would comprise the normal portfolio mix. Tactical asset allocation (TAA) comes after SAA, as it involves planning for deviations from normal asset allocation. TAA establishes policies to govern dynamic reallocations of a temporary nature. After the SAA and TAA plans are complete, market timing or security selection may be integrated into the plans. However, investors cannot begin working on the SAA and TAA plans until a policy statement, listing the objectives of the investor, is created.

Answer 3

To ensure that you have a solid understanding of the asset allocation process, the following topics will be covered in this lesson:
* Phase 1: Written Policy
* Phase 2: Managing the Money

Upon completion of this lesson, you will be able to:
* Identify the steps involved in creating the written policy, and
* Identify the steps involved in managing the money.

Question 4

Describe Step 1: Gain Understanding

Answer 4

In the first step of the financial planning process, a relationship is established between you and the client. During this step, the client must disclose sensitive personal information about his or her finances. It is important for you to establish a rapport that will make your client comfortable and confident in sharing this information with you. If your clients withhold information from you, it will be difficult for you to help create a financial plan that has the correct asset allocation to help them reach their goals. Individual investors must be willing to reveal intimate facts to their money manager about their age, education, work experience, health, and details about their family and personal life.

There is a wide array of goals and constraints that are appropriate for the investments of different types of investors. An important part of the money management processes is to continue discussions with the client to stay abreast of any changes that might occur. In the initial discussions it is important that you and your client discuss:
* The client’s financial situation,
* The length of the client’s investment horizon,
* The client’s tax situation,
* Any legal constraints that might be binding on the client’s investing activities,
* Anticipated cash withdrawals or deposits, and
* The client’s liquidity needs.

CASE-IN-POINT:
The information exchange is not a one-way street. In order for clients to gain confidence in you and share their personal financial situation with you, you must prove to them that you are a competent financial planner who has had success helping other clients to reach their investment objectives. You may find yourself listing your credentials in order to gain some of their confidence. It would also be helpful to recite examples of success. At the same time, it would not be helpful to come across as someone who applies the same asset allocation for every client, or who does not pay attention to the uniqueness of his or her client’s financial situations.

PRACTITIONER ADVICE:
Interviewing clients is a learned skill. How you ask for information and handle the conversation is crucial to getting an accurate portrayal of the client’s situation. Experience will allow planners to recognize when to take a client’s response at face value and when to probe further.

Question 5

Can a client have more than one time horizon?
* Yes
* No

Answer 5

Yes
* Yes. A client could have multiple investment goals, each with its own time horizon.
* For example, in creating a financial plan, you may discover that your client wants to retire in 35 years, pay for her son’s college education in 18 years, and buy a new home in 5 years. Each of these is a different goal carrying a different time horizon.

Question 6

Describe Goals in Asset Allocation

Answer 6

Different clients have different goals. Some clients might wish to maximize their average annual rate of return. In contrast, an inflation-conscious client or a retirement planner might have a goal of earning a real (inflation-adjusted) rate of return that averages 2% per year. The goal of another client might be to accumulate a certain dollar amount by a specific date. Institutional investors typically have a wider range of goals than individual investors.

PRACTITIONER ADVICE
Goal setting is done during the entire interview process. The planner will need to probe the client to find out what is important to the client, temper expectations, and prioritize them. It is helpful to keep goals realistic and sort them by importance and urgency.

Goals need to be realistic and specific. For example, an unrealistic goal would be, “I want to be rich in a few years.” A more realistic goal maybe, “I would like to have sufficient savings to provide a retirement income in 25 years.”

CASE-IN-POINT
Different people will have different goals. Just because someone is more advanced in age does not necessarily mean they cannot have any long-term goals. They could very well be saving for someone else who will survive them, such as creating an investment portfolio to be held in a Supplementary Income Trust that holds money for the use of a dependent with special needs.

Question 7

Describe Tax Situations in Asset Allocation

Answer 7

The United States has progressive income tax structures for both corporations and individuals. Progressive income taxes place taxpayers with large incomes in higher tax brackets. As a result, some investment behavior is tax-motivated. For example, progressive income taxes make people with large incomes become interested in municipal bond investments because the coupon interest is tax-exempt in the United States.

Estate taxes and Unified Gift and Inheritance taxes are typically of concern for investors who are trying to accumulate wealth and eventually disperse some to their heirs. Estate planning strategies will need to be considered for a client’s long-term goals.

For 2022, marginal tax rates are 10%, 12%, 22%, 24%, 32%, 35% and 37%. A person who is in the higher tax brackets may want investments that are tax-exempt for income such as municipal bonds and municipal money market instruments. However, for the wealthiest investors, there is an Alternative Minimum Tax, which ensures they cannot shelter all of their money in tax-exempt investment vehicles and not pay any taxes.

PRACTITIONER ADVICE
Everyone enjoys the sound of “tax-free,” but the investment that will produce the highest after-tax return will have the highest tax equivalent yield.

Tax equivalent yield = Tax free rate/(1 – Tax bracket).

The long-term capital gains tax is levied for investments held for over one year if the proceeds exceed the purchase price. The maximum tax rate for long-term investments is 20%. Short-term capital gains taxes are for investments held for one year or less than one year and are taxed as part of an investor’s income. If there was a net loss, then it can be deducted, up to $3,000 per year. If the amount of the loss is greater than $3,000, then the investor can carry that amount to future tax years, and continue to deduct up to $3,000 per year.

Understanding the client’s tax situation is important to designing a portfolio that will produce a desired net tax return.

Question 8

Which of the following investments would you recommend for your client’s liquidity needs?
* High Yield Bonds
* Foreign Stock
* Shares of a Partnership
* Money Market Fund
* Land

Answer 8

Money Market Fund
* Liquidity needs such as emergency funding or a temporary place to hold some money must be met by liquid asset.
* Money market mutual funds are the most liquid investments in the list.
* The low eating of the high yield bond makes it tough to sell.
* Foreign stocks may be harder to sell than domestic ones, especially from emerging markets.
* Land and shares to a partnership are typically classified as illiquid investments as well.

Question 9

Describe Step 2: Expectations

Answer 9

The expectations of investors can vary and most often they may not get everything they want from their investments. For example, some investors are unaware of the corrosive effects inflation can have; some hope to select only assets that appreciate in price rapidly; and some want their portfolio to be liquidated before every market collapse. It is normal for investors to ignore inflation and to desire eye-popping investments. In such situations, planners must explain what is possible and what is impossible. Some additional topics that you can discuss with your clients to set expectations are:
* What is realistic and achievable,
* The scope of what the portfolio will attempt to accomplish,
* The positive relationship between risk and return,
* Market volatility, and
* The extreme difficulty and low success rate of market timing.

Investors should also be made wary of charts and tables of financial data used in promotional literature. For example, a mutual fund might advertise a high average return earned over a period selected to include unusually good times. Salespeople sometimes will push a product that has done well recently rather than what it might be expected to do in the near term. Wise planners will use scientifically prepared investment indexes and market statistics to educate their clients and help them develop realistic investment expectations.

PRACTITIONER ADVICE
The planner must help the client understand what is realistic to expect. Every client wants a tax-free investment that yields 20% with check writing privileges and no downside risk. However, in most investment environments, that type of vehicle simply does not exist.

Question 10

How is a benchmark portfolio used in an investment policy? Click all that apply.
* Reference point for risk objectives
* Security selection
* Measure performance against
* Reference point for return objectives
* Diversification

Answer 10

Reference point for risk objectives
Measure performance against
Reference point for return objectives
* Funds are professionally managed based on a previously determined strategy. Investors do not get to choose which securities should be purchased or sold.

Question 11

Match the corresponding level of potential risk and return with the portfolios.
Highest potential risk and reward
Higher potential risk and reward
Conservative potential risk and reward
Most conservative potential risk and
reward
* 10% money market instruments, 20% bonds, 70% stocks
* 20% money market instruments, 30% bonds, 50% stocks
* 25% money market instruments, 60% bonds, 15% stock
* 10% money market instruments, 10% bonds, 80% stocks

Answer 11

• Highest potential risk and reward - 10% money market instruments, 10% bonds, 80% stocks
• Higher potential risk and reward - 10% money market instruments, 20% bonds, 70% stocks
• Conservative potential risk and reward - 20% money market instruments, 30% bonds, 50% stocks
• Most conservative potential risk and reward - 25% money market instruments, 60% bonds, 15% stock

Question 12

Strategic asset allocation (SAA) is the portion of the portfolio that has asset class mix for the normal mix for the long-run portfolio. Tactical asset allocation (TAA) is the portion of the portfolio designed to profit from temporaty market disequilibria. State False or True.
* False
* True

Answer 12

True
* SAA is the asset mix that is intended to accomplish investment objectives over the long run.
* TAA is designed to deviate from SAA when temporary market conditions make it profitable to do so.

Question 13

Exam Tip & Audio

Exam Tip: Common testable applications of the efficient frontier are covered in this recording.
AUDIO:
* Exactly how it’ll be tested on exam. There will be plots on, above and below the line.
* The plots right on the line – that’s the Efficient Frontier – those portfolios are all considered equally efficient. The highest return for a given amount of risk.

Answer 13

• The plots on the line are the most efficient.
• Plot below the line – achievable, but not efficient.
• Plot above the line – not achievable at all.

Question 14

Simply Stated: The Markowitz Efficient Frontier AUDIO:

What does the Markowitz efficient frontier plots out?

Answer 14

Plotting out Mean variance optimization – investor is getting an optimal amount of return given a unit of risk they’re willing to take
* T bills 6% and Stocks 14% (higher return, higher risk)
* Risk averse will plot on left and lower end of curve
* Risk tolerant will plot on right and upper end of curve

Question 15

Match the corresponding types of asset allocations with the correct descriptions.
Strategic Asset Allocation
Tactic Asset Allocation
Dynamic Asset Allocation
Integrated Asset Allocation
* Optimize based on investment goals and market conditions
* Change in weights to meet temporary market conditions
* Change in weights to meet a change in investor’s circumstances
* Derive long-term asset allocation weights

Answer 15

• Strategic Asset Allocation - Derive long-term asset allocation weights
• Tactic Asset Allocation - Change in weights to meet temporary market conditions
• Dynamic Asset Allocation - Change in weights to meet a change in investor’s circumstances
• Integrated Asset Allocation - Optimize based on investment goals and market conditions

Question 16

Describe Rebalancing to ensure asset allocation

Answer 16

One way to ensure asset allocation is continuously updated in accordance to the client’s risk tolerance and time horizon is to periodically rebalance the portfolio. There are two typical situations that require rebalancing:
* Time: As time goes by, the investor’s time horizon will shorten. The closer to the time horizon the more conservative the portfolio should be. It is similar to driving on the highway: As a driver approaches an exit, he or she will move from the faster lanes to the slower lanes before ultimately taking the off-ramp.
* Performance: As the performance of the securities changes, the asset allocation may change accordingly. For example, in the late 1990s, stocks, especially tech stocks, did exceptionally well. Their increased value will skew the stock portion of the portfolio above the original asset allocation proportions. To rebalance the portfolio, an investor may sell off the excess proportion of the stock portfolio and purchase the other asset classes until the asset allocation is back to the original proportions.

PRACTITIONER ADVICE
Rebalancing for performance change is a hard sell to a client. You are, in essence, telling the client to sell things that are doing well and buy things that are not doing as well. Although this falls right into the investment strategy of buying low and selling high, most people have trouble letting go of winners until it is too late. In hindsight, if investors did sell some tech stocks in the late 1990s and buy into some bonds, they may have saved themselves from much of the negative returns of the early 2000s.

Question 17

Section 1 - Asset Allocation Process Summary

The asset allocation process focuses on allocating the funds to be invested among different asset classes to achieve a combination of risk and expected return that fulfills the investor’s preferences. The right mix of money market instruments, bonds, and stocks can help clients meet their long-term goals. Built-in flexibility can help adjust the allocation if market conditions or personal circumstances change.

In this lesson, we have covered the following:
* Phase 1: Written Policy: Requires the planner and the client to work together to create a written policy statement. The policy statement guides the remainder of the asset allocation process, and it furnishes a standard against which the performance of the investment manager can be evaluated.

Answer 17

• Phase 2: Managing the Money: Requires the investment manager to manage the client’s money. This phase begins with the preparation of needed forecasts. Then the investment funds are allocated to asset classes and the appropriate investment orders are executed. This phase ends with a periodic performance report. The investment manager and the client discuss the performance report and, if necessary, update the written policy statement.

PRACTITIONER ADVICE
Each investment manager or asset management company will have its own philosophy and software for determining the right asset allocation mix for clients. Although the methods may be different, most questionnaires will center on the investor’s goals, liquidity requirements, risk tolerances, and time horizons. Some may ask several questions about the same thing in order to force the client to think of the topic from different perspectives. There are many Internet resources to help investors determine for themselves what asset allocation is right for them.

Question 18

Analysts who study historical market data in hopes of finding patterns that will repeat themselves in the future are known as:
* Risk-return analysts
* Technical analysts
* Graphic analysts
* Fundamental analysts
* Pattern analysts

Answer 18

Technical analysts
* Technical analysts study historical market data. They prepare graphs of stock prices and study statistics in hopes of discerning patterns that will repeat themselves in the future. Technical analysts typically analyze dozens of different assets and market indexes, but they typically prepare their forecasts for one asset or one market index at a time.

Question 19

An asset allocation strategy that gives simultaneous consideration to the investor’s goals and policies and capital market conditions and uses these data as inputs to an optimizer is known as:
* Insured asset allocation
* Dynamic asset allocation
* Integrated asset allocation
* Strategic asset allocation
* Tactical asset allocation

Answer 19

Integrated asset allocation
* Integrated asset allocation considers the investor’s goals and policies and capital market conditions, and then uses these data as inputs to some kind of optimizer.
* The optimizer’s solution becomes the new inputs that are reconsidered along with the investor’s latest goals and policies and most recent market conditions when revising the asset allocation.

Question 20

The asset allocation decision:
* Involves selecting the classes of assets in which funds will be invested.
* Should focus on selecting assets that are expected to offer the highest return over the investment horizon.
* Refers to the decision on what specific securities the funds should be used to purchase.
* Should be strictly adhered to throughout the investment horizon in order to maintain a well-diversified portfolio.

Answer 20

Involves selecting the classes of assets in which funds will be invested.
* The asset allocation decision involves selecting the classes of assets, rather than the specific securities, in which to invest. It needs to be based on the objectives and constraints of the investor, which may not be investing to offer the highest expected return. It must be revisited regularly to ensure that the objectives and constraints are still being met and to make any necessary changes if the objectives and constraints are modified due to changes in the investor’s circumstances.

Question 21

Put the following in the correct order:
* Create and agree upon an investment policy, then forecast expected risk and return.
* Review performance and make changes as necessary.
* Allocate funds.
* Gain understanding of the client’s goals, circumstances and risk tolerance.

Answer 21

• First - Gain understanding of the client’s goals, circumstances and risk tolerance.
• Second - Create and agree upon an investment policy, then forecast expected risk and return.
• Third - Allocate funds.
• Fourth - Review performance and make changes as necessary.

Question 22

Section 2 – Portfolio Diversification

Portfolio diversification is achieved by attempting to eliminate unsystematic (firm-specific or diversifiable) risk. In order to do this, the portfolio manager must go beyond asset class allocation and ensure that the portfolio that is constructed contains securities whose extremely good and bad returns can cancel each other out without affecting expected return. In search of such diversification, the portfolio manager must identify each security’s unsystematic risk and how it would relate to the unsystematic risks of the other securities within the portfolio.

In building a diversified portfolio, the portfolio manager will first find a portfolio that has the expected return and risk that matches the client’s needs. Then the manager will diversify the portfolio between asset classes. Once the manager decides on the right mix of asset classes, he or she must determine how to select the securities to build a diversified portfolio. The securities can be chosen based on a passive management approach, or a number of active management strategies, or a blend of different strategies.

Answer 22

To ensure that you have a solid understanding of security analysis and portfolio construction, the following topics will be covered in this lesson:
* Portfolio Selection
* Asset Class Definition and Correlation
* Passive vs. Active
* Sector Selection
* Concentrated Portfolios

Upon completion of this lesson, you will be able to:
* Define the methods used to determine the appropriate diversified portfolio,
* Compare and contrast various asset classes,
* Compare and contrast the diversification of a passively managed portfolio and an actively managed one,
* Identify the diversification techniques to select sectors,
* Identify the diversification techniques to select individual stocks, and
* Describe diversification as it relates to concentrated portfolios.

Question 23

Section 2 – Portfolio Diversification Summary

Investment managers are concerned about their client’s investment objectives to be able to generate an efficient set to build well-diversified portfolios. They need to study the market environment and market movement, and the projected economic environment is communicated by means of briefings and written reports. Once they have decided the appropriate optimal portfolio for the investor and create a suitable asset allocation, then they will decide on a method for stock selection.

In this lesson, we have covered the following:
* Portfolio Selection: The manager will need to identify the portfolio that best meets the expected return and risk stated in the investment policy.
* Asset Class Definition and Correlation: Each asset class can meet specific investment objectives, and can also be combined to increase diversification for the portfolio.

Answer 23

• Passive vs. Active: Passive management is as diversified as the benchmark index that it is mimicking. Active management will control the portfolio’s diversification through actively selecting securities based on the correlation of their diversifiable risks.
• Sector Selection: Is a top-down approach where the manager creates an optimal portfolio based on a subset or subsets of securities.
• Individual Stock Selection: There are a variety of approaches to active management and individual stock selection. The selection could be preceded by a screening process to narrow down the universe of stocks to pick from.
• Concentrated Portfolios: Typically have fewer than 20 different stocks held in them. They are less diversified and depend solely on the ability of the portfolio manager.

Question 24

This analysis attempts to predict short-term price movements and makes recommendations concerning the timing of purchases and sales of stocks.
* Fundamental
* Technical
* Bottom-up
* Top-down

Answer 24

Technical
* Technical analysis is involved with short-term predictions of security price movements based on past patterns of prices and trading volumes, and then makes recommendations concerning the timing of purchases and sales of stocks.

Question 25

Along with identifying certain characteristics of securities, financial analysis also attempts to identify which of the following?
* Economic fundamentals of the market
* Forecast of securities values
* Mis-priced securities
* Under-priced securities

Answer 25

Mis-priced securities
* Financial analysts are active mangers who focus their research efforts on analyzing company financial statements. Such research permits an analyst to better understand a company’s business operations, as well as the characteristics of securities, group of securities, and which securities might be mis-priced.

Question 26

Which one of the following is a component of the investment process that involves identifying which securities to invest in and determining the proportion of funds to invest in each of the securities?
* Investment policy
* Security selection
* Portfolio revision
* Portfolio evaluation

Answer 26

Security selection
* Security selection is a component of the investment process where assets are identified for investment and the proportion of funds to invest in each of the assets is determined. The investment manager makes a forecast of expected returns, standard deviations, and co-variances for all available securities. This results in the identification of the optimal portfolio.

Question 27

Module Summary

Every investor looks for an investment mix comprising a well-diversified portfolio. This helps to reap maximum returns at a low risk level. To achieve this combination, investors should discuss their investment objectives with a planner. Depending on the client’s time horizon and investment objectives, the planner can decide which stocks, bonds, Treasury bills, or other assets to invest in. The selection techniques can also be applied to arrive at the right proportion of assets to invest.

The key concepts to remember are:

Answer 27

• The Asset Allocation Process is comprised of two phases: the written policy phase and the money management phase. The investment manager is required to meet the client and discuss issues regarding investment objectives, risk-return preferences, goals, time horizon, and asset allocation.
• Portfolio Diversification: The portfolio manager will first find a portfolio that has the expected return and risk that matches the client’s needs. Asset allocation is then applied to diversify between asset classes. The security selection process can be a passive management approach, one of a number of active management strategies, or a blend of different strategies.

Question 28

Exam 11. Asset Allocation & Portf. Diversification

Exam 11. Asset Allocation & Portf. Diversification

Question 29

If the sale of stock results in a net loss, what is the maximum amount an investor may claim as a tax deduction in that year?
* $5,000
* 100% of the net amount without limit
* 20% of the net loss amount
* $3,000

Answer 29

$3,000
* If the sale of stock results in a net loss, then it can be deducted up to $3,000 per year. If the amount of the loss is greater than $3,000, the investor can carry that amount to future tax years and continue to deduct up to $3,000 per year.

Question 30

Iris is in a 37% marginal federal income tax bracket. If Iris can earn 3% by investing in a tax-exempt municipal bond, what is her taxable equivalent yield?
* 4.76%
* 2.19%
* 2.01%
* 8.11%

Answer 30

4.76%

Tax equivalent yield = Tax-exempt rate ÷ (1 – Tax bracket).
0.03 ÷ (1 - 0.37)
0.03 ÷ 0.63 = 0.0476, or 4.76%

Question 31

According to the Markowitz efficient market hypothesis, the most efficient portfolios lie __ ____??____ __.
* above the efficient frontier
* either above or below the efficient frontier
* below the efficient frontier
* on the efficient frontier

Answer 31

on the efficient frontier
* The most efficient portfolios lie directly on the efficient frontier.

Question 32

Preparing forecasts for asset allocation typically includes each of the following EXCEPT:
* Statistics for foreign and domestic stock indexes.
* Statistics for individual foreign and domestic stocks.
* Statistics for foreign and domestic bond indexes.
* Statistics for foreign and domestic real estate indexes.

Answer 32

Statistics for individual foreign and domestic stocks.
* In preparing forecasts for asset allocation Investment managers typically overlook individual stocks, individual bonds, and individual pieces of real estate, and focus instead on the categories of homogeneous assets.

Question 33

In Step 1 of the asset allocation process, “Gain Understanding,” each of the following is considered EXCEPT:
* The length of the client’s investment horizon.
* Reallocation of existing assets.
* The client’s tax situation.
* The client’s liquidity needs.

Answer 33

Reallocation of existing assets.
* Reallocation of existing assets would occur at a later step and is not considered in Step 1.

Question 34

Which method of asset allocation attempts to address the client’s portfolio asset allocation based on the typical needs of a person at a particular point in their lifetime?
* Risk tolerance allocation
* Passive asset allocation
* Active asset allocation
* Lifecycle asset allocation

Answer 34

Lifecycle asset allocation
* Lifecycle asset allocation attempts to address the client’s portfolio asset allocation based on the typical needs of a person in a similar lifecycle stage.

Question 35

A Markowitz efficient portfolio has
I. The maximum expected return available at its level of risk.
II. The maximum risk at its level of expected return.
* II only
* I only
* Neither I nor II
* Both I and II

Answer 35

I only
* Every Markowitz efficient portfolio:
* has the maximum expected return available at its level of risk, and
* the minimum risk at its level of expected return.

Question 36

A written investment policy statement includes each of the following EXCEPT:
* Any constraining policies
* Adviser fee structure disclosures
* Asset Allocation policies
* A benchmark

Answer 36

Adviser fee structure disclosures
* The purpose of a written investment policy statement carefully sets forth the client’s investment goals and policies. Adviser compensation is discussed at the commencement of the engagement and is not part of the written investment policy statement.

Question 37

Consider the following investors and their respective marginal federal income tax brackets. Which investor has the highest taxable equivalent yield holding a municipal bond yielding 3%?
* Marlene: 0% marginal federal income tax bracket
* Iris: 24% marginal federal income tax bracket
* Sue: 12% marginal federal income tax bracket
* Rose: 37% marginal federal income tax bracket

Answer 37

Rose: 37% marginal federal income tax bracket
* The investor in the highest federal income tax bracket has the highest taxable equivalent yield because they experience the highest tax savings by holding the municipal bond.

Question 38

Which of the following would be expected to have the greatest market volatility?
* Small company stock funds
* Money market funds
* Large company stock funds
* Bond funds

Answer 38

Small company stock funds
* Small company stick funds would be expected to have the greatest volatility.