Module 2 Flashcards
Purpose of Investment Policy
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.
A Good Investment Policy is…
1.) Realistic
2.) Long-Term Perspective
3.) Clearly Defined
Policy Investment “GRASP”
Goals
Risk
Asset Allocation
Strategies/Suitable Investments
Periodic Review
Bond Price Change Formula (Duration)
% Change in Price = -Duration x Change in Interest Rate
Bond Yields
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).
Systematic Risk “PRIME”
Purchasing Power Risk
Reinvestment Risk
Interest Rate Risk
Market Risk
Exchange Rate Risk
Unsystematic Risk
Business Risk
Financial Risk
Credit Risk
Default Risk
Liquidity Risk
Marketability Risk
Event Risk
Coefficient of Variation (CV) Formula
CV = Standard Deviation / Mean Return
3 Risk-Adjusted Return Ratios
Sharpe Ratio
Treynor Ratio
Jensen’s Alpha
Longevity Risk
Retirees outliving their financial resources
Low Return Risk
1.) Money will run out too soon
2.) Inflation outpaces return
Risk Tolerance
The extent to which an investor is willing to accept more risk in exchange for the possibility of a higher return.
Primary Forms of Asset Allocation
Strategic
Tactical
Core-Satellite
Strategic Asset Allocation
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.
Tactical Asset Allocation
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.
Core-Satellite Asset Allocation
A combination of strategic and tactical asset allocation that divides a portfolio into two components.
Qualified Default Investment Alternative (QDIA) Rules
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.
Factors to Consider for Asset Allocations
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
Asset Allocation Process
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
Three Key Elements of Stock Investment Strategy
1.) An identifiable goal
2.) A method to attain that goal
3.) The competencies and resources to sustain the strategy
Two Strategies of Bond Investing
1.) Ladder Strategy
2.) Barbell Strategy
Ladder Strategy
The ladder strategy, also called the staggered maturity strategy, spreads equal amounts of the bond holdings along different maturities.
Barbell Strategy
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.
The Sharpe ratio measures…
Total risk as measured by standard deviation.
