CAIA - 03 - The Endowment Model

Question 1

An ___ is a donated pool of capital that is intended to be invested to maintain the real value of its assets in perpetuity and to provide an annual income to support a purpose specified by the donor of the capital.

Answer 1

An endowment is a donated pool of capital that is intended to be invested to maintain the real value of its assets in perpetuity and to provide an annual income to support a purpose specified by the donor of the capital.

Question 2

The nominal value of an initial donation that is to be maintained is referred to as the ___.

Answer 2

The nominal value of an initial donation that is to be maintained is referred to as the corpus.

Question 3

A ___ is a non-profit organization that either funds its own charitable causes or donates funds to other organizations.

Answer 3

A foundation is a non-profit organization that either funds its own charitable causes or donates funds to other organizations.

Question 4

Foundations differ from endowments in the following ways:

1. They are ___-making institutions, whereas endowment funds are established to provide funds for a specific purpose.
2. They tend to have ___lives
3. They are subject to ______requirements
4. They are (more/less) likely to receive funding from ongoing donations

Answer 4

Foundations differ from endowments in the following ways:

1. They are grant-making institutions, whereas endowment funds are established to provide funds for a specific purpose.
2. They tend to have finite lives
3. They are subject to minimum spending requirements
4. They are less likely to receive funding from ongoing donations

Question 5

There are several types of foundations:

1. O___
2. C___
3. C___
4. I___

Answer 5

There are several types of foundations:

1. Operating

2. Community

3. Corporate

4. Independent

Question 6

___ foundations are most like endowments, in that the income generated is used to fund the foundation’s operations.

Answer 6

Operating foundations are most like endowments, in that the income generated is used to fund the foundation’s operations.

Question 7

___ foundations are located in a specific geographic region and distribute gifts and investment returns to other local charities.

Answer 7

Community foundations are located in a specific geographic region and distribute gifts and investment returns to other local charities.

Question 8

___ foundations tend to donate to local charities in the region in which the company has the most employees or customers.

Answer 8

Corporate foundations tend to donate to local charities in the region in which the company has the most employees or customers.

Question 9

___ foundations are funded by an individual or a family often with a single gift in the form of stock, and typically no subsequent gifts.

Answer 9

Independent foundations are funded by an individual or a family often with a single gift in the form of stock, and typically no subsequent gifts.

Question 10

Independent foundations present two challenges:

1. Wealth is often concentrated in a ___ ___
2. They do not typically receive ___ ___ .

Answer 10

Independent foundations present two challenges:

1. Wealth is often concentrated in a single stock
2. They do not typically receive additional donations.

Question 11

The goal of an endowment manager should be to maintain ___ equity.

Answer 11

The goal of an endowment manager should be to maintain intergenerational equity.

Question 12

Intergenerational equity may be expressed as a ___% chance of maintaining the real value of the endowment in perpetuity.

Answer 12

Intergenerational equity may be expressed as a 50% chance of maintaining the real value of the endowment in perpetuity.

Question 13

If the chance of the endowment surviving in perpetuity is low, it means that the endowment’s spending rate is (high/low).

Answer 13

If the chance of the endowment surviving in perpetuity is low, it means that the endowment’s spending rate is high.

Question 14

Endowments (do/do not) have flexibility in their spending rates. This contrasts with U.S. foundations that are required to spend at least ___% per year on operating expenses and charitable activities.

Answer 14

Endowments do have flexibility in their spending rates. This contrasts with U.S. foundations that are required to spend at least 5% per year on operating expenses and charitable activities.

Question 15

To be able to operate in perpetuity and meet payout ratios, endowments and foundations need to reach a ___ ___.

Answer 15

To be able to operate in perpetuity and meet payout ratios, endowments and foundations need to reach a return target.

Question 16

Foundations that want to preserve the real value of their assets will have an ___ target return: ___ plus a minimum of ___ %

Answer 16

Foundations that want to preserve the real value of their assets will have an aggressive target return: inflation plus a minimum of 5%

Question 17

The higher education price index (HEPI) is typically ___ than CPI

Answer 17

The higher education price index (HEPI) is typically higher than CPI

Question 18

The ___ model is an investment approach that aims to generate high returns through aggressive asset allocations, particularly to alternative investments.

Answer 18

The endowment model is an investment approach that aims to generate high returns through aggressive asset allocations, particularly to alternative investments.

Question 19

David Swensen does not invest in investment-grade or high-yield bonds due to the ___-___ conflict of corporate managers working for stockholders and possibly making decisions that would be detrimental to bondholders.

Answer 19

David Swensen does not invest in investment-grade or high-yield bonds due to the principal-agent conflict of corporate managers working for stockholders and possibly making decisions that would be detrimental to bondholders.

Question 20

The investment outperformance of large endowments may be due to six advantages that large endowments possess.

1. Aggressive ___ ___
2. Effective investment ___ ___
3. ___ -___ advantage
4. Access to network of ___ ___
5. Acceptance of ___ risk
6. Sophisticated ___ ___ and ___ oversight

Answer 20

The investment outperformance of large endowments may be due to six advantages that large endowments possess.

1. Aggressive asset allocation
2. Effective investment manager selection
3. First-mover advantage
4. Access to network of talented alumni
5. Acceptance of liquidity risk
6. Sophisticated investment staff and board oversight

Question 21

Typically, (more/less) returns come from security selection and market timing (TAA) in an endowment vs. a pension.

Answer 21

Typically, more returns come from security selection and market timing (TAA) in an endowment vs. a pension

Question 22

Top endowment funds’ manager-selection and first-mover advantage can be attributed to their superior ___ ___. (i.e., good relationships with successful people)

Answer 22

Top endowment funds’ manager-selection and first-mover advantage can be attributed to their superior network effect. (i.e., good relationships with successful people)

Question 23

___-___investment consultants advise on issues such as asset allocation and manager selection, and advice/decisions are taken to the investment committee for a vote.

Answer 23

Non-discretionary investment consultants advise on issues such as asset allocation and manager selection, and advice/decisions are taken to the investment committee for a vote.

Question 24

___ ___ are external consultants with discretionary authority to make and implement specific decisions without the investment committee’s vote.

Answer 24

Outsourced CIOs are external consultants with discretionary authority to make and implement specific decisions without the investment committee’s vote.

Question 25

The benefits of OCIOs is as follows: 1. Improved \_\_\_ 2. \_\_\_of \_\_\_in manager research 3. More ___ \_\_\_ 4. More efficient \_\_\_-\_\_\_

Answer 25

The benefits of OCIOs is as follows: 1. Improved **resources** 2. **Economies** of **scale** in manager research 3. More **cost effective** 4. More efficient **decision**-**making**

Question 26

Large endowments need to address specific risks: 1. Interaction between ___ \_\_\_ , ___ , and the endowmen't s long-term ___ \_\_\_ 2. ___ risk and challenges with \_\_\_ 3. Protecting against ___ risk

Answer 26

Large endowments need to address specific risks: 1. Interaction between **spending rates**, **inflation**, and the endowmen't s long-term **asset value** 2. **Liquidity** risk and challenges with **rebalancing** 3. Protecting against **tail** risk

Question 27

Studies show that, all else equal, funds with long lock-up periods tend to generate (higher/lower) returns.

Answer 27

Studies show that, all else equal, funds with long lock-up periods tend to generate **higher** returns.

Question 28

\_\_\_ ___ investing uses a 3 tiered a approach to match liquidity to investors' time horizons in asset allocation decisions. 1. Tier 1 assets are ___ -\_\_\_ , ___ assets 2. Tier 2 assets are ___ , ___ assets 3. Tier 3 assets are ___ , ___ assets.

Answer 28

**Liquidity driven** investing uses a 3 tiered a approach to match liquidity to investors' time horizons in asset allocation decisions. 1. Tier 1 assets are **low**-**risk**, **liquid** assets 2. Tier 2 assets are **risky**, **liquid** assets 3. Tier 3 assets are **risky**, **illiquid** assets.

Question 29

What are the 4 methods for hedging tail risk? 1. Increase allocations to ___ and ___ -\_\_\_ debt 2. Use equity ___ \_\_\_ 3. Construct a portfolio of ___ options on currencies, commodities, and credit products and ___ options on volatility indices and high-quality bonds. 4. Structure allocations within ___ \_\_\_ to reduce exposure to extreme events

Answer 29

What are the 4 methods for hedging tail risk? 1. Increase allocations to **cash** and **risk**-**free** debt 2. Use equity **option hedges** 3. Construct a portfolio of **put** options on currencies, commodities, and credit products and **call** options on volatility indices and high-quality bonds. 4. Structure allocations within **asset classes** to reduce exposure to extreme events

Question 30

The basket hedging approach is considerably (more/less) costly than equity option hedges.

Answer 30

The basket hedging approach is considerably **less** costly than equity option hedges.

Question 31

In contrast to exchange-traded hedges, hedges purchased in the over-the-counter market are exposed to ___ risk, which is generally extremely high during crises.

Answer 31

In contrast to exchange-traded hedges, hedges purchased in the over-the-counter market are exposed to **counterparty** risk, which is generally extremely high during crises.