Chapter 16: The Portfolio Management Process

Question 1

Many clients want assurance that their initial capital investment will largely remain intact. We must assess risk tolerance, and sometimes choose to have a lower return in exchange for safer assets

Answer 1

Safety of income

Question 2

Regular series of cash flows received from debt and equity securities, such as through dividends, interest, or other forms. Investors usually give up some safety in order to have a higher income from their portfolio

Answer 2

Income

Question 3

Also referred to as capital gains, which is the profit generated when securities are sold for more than they originally cost to purchase. When capital gains are the focus, the emphasis is on security selection and market timing

Answer 3

Growth

Question 4

Best safety, very steady income, very limited growth

Answer 4

Short-term bonds

Question 5

very good safety, very steady income, variable growth

Answer 5

long-term bonds

Question 6

good safety, steady income, variable growth

Answer 6

preferred shares

Question 7

least safety, variable income, often the most growth

Answer 7

common shares

Question 8

Cash/cash equivalent with lowest risk, highest quality

Answer 8

Government Issues (<1 year)

Question 9

Cash/cash equivalent with highest risk, lowest quality

Answer 9

Corporate issues (<1 year)

Question 10

Fixed income security with low risk and low price volatility

Answer 10

short term (1 - 5 years)

Question 11

fixed income security with medium risk and medium price volatility

Answer 11

medium term (5-10 years)

Question 12

fixed income security with high risk and max price volatility

Answer 12

long term (>10 years)

Question 13

Low risk; high capitalization; predictable earnings; high yield; high dividend payouts; lower price-to-earnings ratio; low price volatility

Answer 13

Conservative investments

Question 14

Medium risk; average capitalization; potential for above average growth in earnings; aggressive management; lower dividend payout; higher price-to-earnings ratio; potentially higher price volatility

Answer 14

Growth investments

Question 15

High risk; low capitalization; limited earnings record; no dividends; price-to-earnings ratio of little significance; short operating history; highly volatile

Answer 15

Venture investments

Question 16

Maximum risk; shorter term; maximum price volatility; no earnings; no dividends; price-to-earnings ratio not significant

Answer 16

Speculative investments

Question 17

The period spanning the present until the next major change in a client’s circumstances

Answer 17

Time horizon

Question 18

Refers to the amount of cash in the portfolio. The cash component could be higher or lower depending on the market cycle

Answer 18

Liquidity requirements

Question 19

The client’s marginal tax rate dictates the proportion of income the client should receive as interest income in relation to dividends. High tax rates can significantly erode the final return on the investments, such as GICs

Answer 19

Tax Requirements

Question 20

Any investment that contravenes an act, law, bylaw, regulation, or rule is considered a constraint and must be dealt with. This includes insiders and staff of certain companies.

Answer 20

legal and regulatory requirements

Question 21

Preferences for ethical investing could be constraints on the client’s portfolio, and should be considered

Answer 21

Unique Circumstances

Question 22

Agreement between a portfolio manager and a client that provides investment guidelines for the manager

Answer 22

investment policy statement

Question 23

Includes currency, money market securities, redeemable GICs, bonds with maturity of one year or less, and all other cash equivalents. Generally, 5% of a diversified portfolio, risk averse investors may hold up to 10%

Answer 23

Cash

Question 24

Bonds due in more than one year, strip bonds, mortgage-backed securities, fixed-income exchange-traded funds, bond mutual funds, and preferred shares. Primarily used to produce income, but also provide some safety of principal, or used to generate capital gains.

Answer 24

Fixed income securities

Question 25

Includes common shares, equity exchange-traded funds, equity mutual funds, convertible bonds/preferred shares. Purpose is to generate capital gains, either through trading or long-term growth in value

Answer 25

Equity Securities

Question 26

Collectibles, such as art or coins, Commodities such as gold, Derivatives, Hedge funds, Precious metals, and real estate

Answer 26

other asset classes

Question 27

Usually specified in the investment policy statement, Investors may have freedom to recommend an array of individual securities, but sometimes specific allocations are fixed.

Answer 27

Asset allocation

Question 28

We must determine the appropriate balance among the selected asset classes by investigating the client’s full circumstances to determine an appropriate asset mix.

Answer 28

Strategic Asset Allocation

Question 29

Asset classes will change in value along with fluctuations in the market, and dividends and interest income will flow into the cash component and the asset mix will change. Therefore we must always rebalance before things get too out of hand

Answer 29

Ongoing asset allocation

Question 30

Technique that adjusts the asset mix to systematically rebalance the portfolio back into it’s long-term target or strategic asset mix

Answer 30

Dynamic asset allocation

Question 31

When the investment policy statement indicates a particular long-run balance of equities to fixed income, but is not rigid. Allows to capitalize on investment opportunities in one asset class before reverting to the long-term strategic asset allocation

Answer 31

Tactical asset allocation

Question 32

Step in which specific securities such as stocks, bonds, and managed products, are chosen for inclusion in the portfolio

Answer 32

Selecting securities

Question 33

Stay informed about client’s objectives, update the profile regularly. Monitor changes in risk tolerance, need for liquidity, need for savings, and tax brackets

Answer 33

Client monitoring

Question 34

Be constantly aware of the direction of monetary policy, forecasts for GDP growth and shifts, inflation, shifts in consumer demand and capital spending, and the potential impact of these factors on the individual holdings.

Answer 34

Monitoring the market

Question 35

Include expected activity in the public and private sectors (nationally and internationally), government policies, corporate earnings, economic analysis, existing market conditions, and forecaster’s interpretations of data

Answer 35

Monitoring the economy

Question 36

Success of the portfolio is determined by comparing the total rate of return of the portfolio under evaluation with average total return of comparable portfolios, in order for the client to compare against average portfolios.

Answer 36

evaluating portfolio performance

Question 37

total return formula

Answer 37

Increase in market value / Beginning value * 100

Question 38

sharpe ratio formula

Answer 38

Return of the portfolio - risk free rate / SD of portfolio

Question 39

This is the process of reallocation assets back to their originally intended portfolio weights by selling securities that have performed will and buying others that have done poorly.

Answer 39

rebalance portfolio