Module 2

Question 1

Purpose of Investment Policy

Answer 1

1.) To provide a foundation of goals, time horizons, and constraints on which the client portfolio is constructed; and
2.) To provide a basis for review, performance evaluation, and adaptation to changing conditions.

Question 2

A Good Investment Policy is…

Answer 2

1.) Realistic
2.) Long-Term Perspective
3.) Clearly Defined

Question 3

Policy Investment “GRASP”

Answer 3

Goals
Risk
Asset Allocation
Strategies/Suitable Investments
Periodic Review

Question 4

Bond Price Change Formula (Duration)

Answer 4

% Change in Price = -Duration x Change in Interest Rate

Question 5

Bond Yields

Answer 5

1.) Current yield is the bond’s annual interest divided by its current price.
2.) Yield to maturity (YTM) factors in the yearly interest along with the difference between the bond’s current price and its value at maturity. This is the standard yield normally quoted for bonds.
3.) Yield to call (YTC) factors in the yearly interest until the bond is expected to be called along with the difference between the bond’s current price and its call price (the price the issuer will pay to the bondholder if it calls the bond prior to maturity).

Question 6

Systematic Risk “PRIME”

Answer 6

Purchasing Power Risk
Reinvestment Risk
Interest Rate Risk
Market Risk
Exchange Rate Risk

Question 7

Unsystematic Risk

Answer 7

Business Risk
Financial Risk
Credit Risk
Default Risk
Liquidity Risk
Marketability Risk
Event Risk

Question 8

Coefficient of Variation (CV) Formula

Answer 8

CV = Standard Deviation / Mean Return

Question 9

3 Risk-Adjusted Return Ratios

Answer 9

Sharpe Ratio
Treynor Ratio
Jensen’s Alpha

Question 10

Longevity Risk

Answer 10

Retirees outliving their financial resources

Question 11

Low Return Risk

Answer 11

1.) Money will run out too soon
2.) Inflation outpaces return

Question 12

Risk Tolerance

Answer 12

The extent to which an investor is willing to accept more risk in exchange for the possibility of a higher return.

Question 13

Primary Forms of Asset Allocation

Answer 13

Strategic
Tactical
Core-Satellite

Question 14

Strategic Asset Allocation

Answer 14

It seeks to identify the asset mix that will provide the optimal balance between expected risk and return for a long investment horizon. Strategic asset allocation aims to create efficient portfolios from different asset classes that provide that optimal balance.

Question 15

Tactical Asset Allocation

Answer 15

Tactical asset allocation is an active approach that tries to position a portfolio into those assets, sectors, and individual securities showing the most promise for above average gains. Changes are then made as the prospects for these assets, sectors, and securities change.

Question 16

Core-Satellite Asset Allocation

Answer 16

A combination of strategic and tactical asset allocation that divides a portfolio into two components.

Question 17

Qualified Default Investment Alternative (QDIA) Rules

Answer 17

Rules that are designed to make it easier for fiduciaries of defined contribution plans with participant-directed investment accounts, such as 401(k) plans, to automatically enroll participants.

Question 18

Factors to Consider for Asset Allocations

Answer 18

The goals and constraints stated in the investment policy
The risks, returns, and correlations associated with and between different asset classes
Client sensitivity to risk
Client needs for current income
The client’s investment time horizon

Question 19

Asset Allocation Process

Answer 19

1.) Determine which asset classes should be represented in the portfolio
2.) Determine the percentage that each asset class should represent in the total portfolio
3.) Select the securities
4.) Review the performance and investment climate

Question 20

Three Key Elements of Stock Investment Strategy

Answer 20

1.) An identifiable goal
2.) A method to attain that goal
3.) The competencies and resources to sustain the strategy

Question 21

Two Strategies of Bond Investing

Answer 21

1.) Ladder Strategy
2.) Barbell Strategy

Question 22

Ladder Strategy

Answer 22

The ladder strategy, also called the staggered maturity strategy, spreads equal amounts of the bond holdings along different maturities.

Question 23

Barbell Strategy

Answer 23

The barbell strategy splits the bond portion of the portfolio between short-term and long-term bonds. Both ends then stagger maturities similar to the ladder approach.

Question 24

The Sharpe ratio measures…

Answer 24

Total risk as measured by standard deviation.

Question 25

Graham recommended that nonprofessional investors apply which one of the following rules of thumb?

Answer 25

Buy stocks for two-thirds or less of their net current assets

Question 26

Strategic asset allocation is…

Answer 26

A “target allocation” approach to investing.

Question 27

Measure of a mutual fund’s risk-adjusted return as measured by total risk?

Answer 27

The fund’s standard deviation

Question 28

A measurement of total risk is…

Answer 28

Standard Deviation