Module 2 Chapter Reviews Flashcards
What is the investment policy and what is its purpose?
The investment policy is a set of guidelines for managing the financial assets of a financial plan.
The investment policy has 2 purposes:
1) to provide a foundation of goals, time horizon, and constraints on which the portfolio is constructed.
2) to provide a basis for review, performance evaluation, and adaptation to changing conditions.
Why is a long-term perspective essential as an element of investment policy?
The US financial markets have a positive bias over the long term, but is much more unpredictable in the short term.
Why is it important that investment policy be clearly defined?
Having a clearly defined investment policy will help the planner avoid errors and reduces the chances of disputes between them and the client.
What are the five essential elements of an investment policy?
G.R.A.S.P
G - Goals
R - Risk
A - Asset Allocation
S - Strategic/ Suitable Investments
P - Periodic Review
What are the three attributes of a sound investment policy?
- Policy must be realistic
- Policy should have a long-term perspective
- Policy must be clearly defined
What are the advantages and disadvantages to stocks?
Stocks offer higher returns than most other asset classes and can even offer an increasing dividends. But, stocks are also one of the most volatile asset classes, therefore they are very risky.
Why should stocks be an important element in most retirement portfolios?
Many retirees do not have enough capital to afford retiring without being able to make greater returns to outpace inflation and expenses.
What are the advantages and disadvantages of fixed-income securities?
Fixed-Income securities are very safe and have low volatility. but they offer a lower rate of return and have inflation risk and interest rate risk
What are the two sources of returns of fixed-income securities?
Return can be made by collecting coupons or capital gains.
What are the advantages and disadvantages to cash equivalent investments for retirees?
Cash equivalents are highly liquid and have a high safety of principle, but they offer low returns and have purchasing power risk
What are the advantages and disadvantages of real estate for retirees?
Real estate offers good rates of return, but have low liquidity, high transaction costs, and tax reporting responsibilities
What are the five types of systematic risk?
P.R.I.M.E.
P - Purchasing power risk
R - Reinvestment risk
I - Interest rate risk
M - Market risk
E - Exchange rate risk
Explain standard deviation in terms of investing
Standard deviation is a measure of the risk (volatility) of a holding based on the variations around the mean.
Explain beta in terms of investing
Beta is a measure of a securities volatility compare to its benchmark. Beta is a multiplier of the index it is benchmarked
Explain duration in terms of investing
Duration measures the sensitivity of a bond’s price to changes in interest rates. High duration means higher volatility and interest rate risk.
Price change (%) = -(rate change) * duration
What is the coefficient of variation for a stock?
The coefficient of variation is a relative measure of risk (risk per unit of return) and allows risk comparison among different investments.
What is the Sharpe Ratio?
The Sharpe Ratio is a measure of risk-adjusted return. The Sharpe ratio measures the performance of an investment relative to the total risk taken.
Higher sharpe ratio means greater return for each unit of risk
What is the Treynor ratio?
The Treynor Ratio measures the degree of systematic risk of an investment/portfolio as measured by beta.
What is Jensen’s alpha?
The Jensen’s Alpha compares the expected return (as measured by beta) with the actual return.
Describe the purpose of asset allocation.
Asset allocation allows you to meet the clients goals while dampening the volatility of market fluctuations.
Explain the two factors that can alleviate concerns for price volatility.
Time and asset allocation.
Longer time horizons reduce the short term volatility risk.
Asset allocation reduces volatility of the overall portfolio.
What is longevity risk?
Longevity risk is the risk that retirees will outlive their financial resources.
What is a Strategic Allocation?
A strategic allocation is an allocation that is chosen for the long term and rebalanced periodically to allocated funds to underperforming securities (cheap) and reducing exposure to securities with large gains (overpriced)
What is a Tactical Allocation?
Tactical asset allocation is an active approach to investing by changing the allocations of a portfolio depending on the market conditions and expectations.
