8.5 Asset Allocation

Question 1

During a period of increasing inflation, which one of the following investments might be appropriate

Answer 1

The answer is common stock of energy firms. Rising inflation causes interest rates to rise, which causes financial firms’ cost of sales to rise, thereby restricting these firms’ profits and depressing their stock prices. Rising inflation helps companies that hold and/or sell real assets, such as commodities and real estate, thereby causing these companies’ stock prices to rise. Long-term bond prices fall as interest rates rise, which they generally do during periods of rising inflation

Question 2

describes a lifecycle fund

Answer 2

A fund that bases and adjusts its asset allocation on a specific target date at which the investor will retire

Question 3

Jana believes that the allocation to emerging market equities in her portfolio has become overvalued, so she trims the holdings in that asset class and reinvests the proceeds in other asset classes that she believes are undervalued. Jana’s approach to asset allocation can best be described as

Answer 3

Tactical asset allocation continuously adjusts the asset allocation and class mix in an attempt to take advantage of changing market conditions and overall investor sentiment

Question 4

As investors’ required rates of return decrease due to a decrease in interest rates caused by expectations of lower inflation rates, the stock market and investors can be expected to react in which way?

Answer 4

As an investor’s required rate of return decreases, the present value of future benefits of the stock increases, and therefore the value of the stock increases. Investors will probably buy stocks because they perceive that interest rates are stabilizing.

Question 5

Portfolio selection -

Answer 5

An alternative way to use the Markowitz model as a selection technique is to think in terms of asset classes, such as domestic stocks, foreign stocks of industrialized countries, stocks of emerging markets, and bonds.
The asset allocation decision refers to the allocation of portfolio assets to broad asset classes, such as cash equivalents, bonds, and equities.

Question 6

Assume that the economic forecast for the coming year is expected to be one of increasing inflation and interest rates. The GDP is expected to be strong. Which of the following types of investments would be advisable for the coming year and why?

Answer 6

Liquid investments, such as money market funds and short-term securities, to allow the investor flexibility to reinvest as rates increase

Tangible assets, such as real estate and gold, to keep pace with the rate of inflation