Chapter 18

Question 1

Asset Allocation Process

Answer 1

1. Determine the SAA
2. Rebalance the portfolio
3. formulate a tactical asset allocation strategy (optional)

Question 2

Performance attribution

Answer 2

returns are explained in terms of the relative contributions of asset allocation and security selection

Question 3

Debt securities characteristics

Answer 3

• Term to maturity
• credit quality
• structure (i.e. convertible, preferred, etc.)
• geography

Question 4

Equity Securities Classifications

Answer 4

• capitalization
• geography
• style (value or growth)

Question 5

Asset Location

Answer 5

refers to the placement of assets in taxable, tax-deferred, and tax-exempt accounts to achieve the greatest after-tax return for a given risk tolerance

Question 6

Where should debt securities that generate interest income be held?

Answer 6

In a tax deferred or exempt account

Question 7

Where should equity securities that generate dividends or capital gains be held?

Answer 7

In a taxable account

Question 8

Two factors for an appropriate SAA

Answer 8

• the clients investment objectives

- capital market expectations

Question 9

Two factors affecting capital market expectations

Answer 9

• past performance

- professional judgement

Question 10

Mean variance optimization

Answer 10

Procedure devised by the American economic Harry Markowitz to identify the efficient frontier from a set of asset class returns, standard deviations, and correlations

Question 11

Three Methods to Design an SAA

Answer 11

• mean variance optimization
• rule of thumb
• ad hoc

Question 12

Rule of Thumb

Answer 12

Based on time diversification, under this principle, above average returns tend to offset below average returns over time, so that the annualized standard deviation of an investment diminishes (life cycle approach or age approach)

Question 13

Life Cycle Approach

Answer 13

categorizes investors by different life cycles based on their age and characteristics (early earning years, mid-earning years, peak earning years, retirement)

Question 14

Age Approach

Answer 14

more specific than life cycle approach because it is based on the client’s specific age: allocation to equities = 100 - client’s age

Question 15

Ad Hoc Approach

Answer 15

SAA is based simply on the advisor’s opinion or instinct (not recommended)

Question 16

Two approaches to rebalancing

Answer 16

Calendar rebalancing

Weight based rebalancing

Question 17

Corridor Width

Answer 17

the trading band within which the market value of each asset class can fluctuate without having to be rebalanced

Question 18

Two opposing Strategies of Tactical Asset Allocation

Answer 18

Counter-trend strategy

Momentum strategy

Question 19

Counter-trend strategy

Answer 19

Directs investments toward asset classes that have recently underperformed and away from those that have outperformed, with the expectation that the trend will change

Question 20

Momentum Strategy

Answer 20

Tilts the portfolio toward asset classes that have recently outperformed with the expectation that they will continue to do so

Question 21

Valuation Based Approach

Answer 21

Entails identifying an inexpensive or expensive asset class by comparing the current and prospective value of an asset class relative to other asset classes (look at risk premium)

Question 22

Cyclical Based Approaches

Answer 22

Involves monitoring economic and business cycles and looking for patterns that have historically led to rises and fall in the stock and bond markets

Question 23

Factors that influence economic and business cycles

Answer 23

• shape of yield curve
• monetary and fiscal policy
• taxation policy and levels
• inflation
• corporate profits
• market valuations