Module 54.1: Portfolio Planning and Construction

Question 1

What is an investment policy statement?

Answer 1

typically begin with investor’s goals in terms of risk and return.

Question 2

What are the major components of an investment policy statement?

Answer 2

1) description of client objectives
2) statement of the purpose
3) statement of duties and responsibilities
4) procedures to update IPS
5) investment objectives
6) investment constraints
7) investment guidelines
8) evaluation of performance
9) appendices

Question 3

What is an absolute objective vs. relative risk objective?

Answer 3

absolute - stated in terms of probability or specific portfolio results

relative - relate to a specific benchmark and can also be strict.

Question 4

What does an investors ability to bear risk depend on?

Answer 4

depends on financial circumstances such as investment horizons, greater assets vs. liabilities, more insurance against unexpected outcomes, secure job.

Question 5

What does an investors willingness to bear risk based on?

Answer 5

belief of investments, objective and sometime achieved through a questionnaire

Question 6

What happens when an investors willingness to take risk is high, but ability is low? what should prevail?

Answer 6

ability to take risk should prevail.

Question 7

What are the 7 constraints of building an investment portfolio?

Hint: R-R-T-T-L-L-U

Answer 7

1) Risk
2) Return
3) Time horizon
4) tax
5) liquidity
6) legal restrictions
7) unique contstraints

Question 8

What does a longer time horizon mean in terms of risk and liquidity?

Answer 8

more risk and less liquidity

Question 9

In the process of asset allocation, what should the correlation of returns be between an asset class and within an asset class?

Answer 9

between asset classes correlation should be low, and within they should be high.

Question 10

What is tactical asset allocation?

Answer 10

taking advantage of short term opportunities within an asset class

Question 11

What are two issues with active management to consider?

Answer 11

1) many managers may not correctly use the risk budget

2) tax consequences of frequent trading

Question 12

What is the core-satellite approach?

Answer 12

invests the majority, or core, portfolion of the portfolio in passively managed indexes, and invests a smaller portion in active strategies.