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CFA Level III > R13 - Managing Institutional Investor Portfolios > Flashcards

R13 - Managing Institutional Investor Portfolios Flashcards

1
Q

Defined contribution plan?

A

employer: makes specified contribution and provides set of investment choices
employee: selects the investment. Investment policy is part of IPS. Employee assets are portable

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2
Q

Defined benefit plan?

A

employer:
- responsible for future benefit payments.
- bears investment risk

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3
Q

DB plan terminology: Surplus?

A

Plan assets - PV of liabilities

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4
Q

DB plan terminology: Active-lives?

A

plan liabilities for participants working and accruing benefits

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5
Q

DB plan terminology: Retired-lives?

A

plan liabilities for participants drawing benefits

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6
Q

DB plan terminology: Deferred-lives?

A

plan liabilities for participants no longer working but not yet drawing benefits

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7
Q

DB plan terminology: Frozen plan?

A

No new entrants allowed or no new benefits accrued

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8
Q

DB plan typical return objectives?

A
  • generate sufficient return to cover liabilities
  • Minimum return equal to actuarial discount rate
  • absolute return objective
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9
Q

DB plan return objective for active vs retired lives?

A

active - future benefits less certain

retired - future benefits more certain

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10
Q

Factors that affect DB plan ability to bear risk: Funded status?

A

negative surplus = underfunded and decreased ability

positive surplus = overfunded and increased ability

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11
Q

Factors that affect DB plan ability to bear risk: Financial status/profitability of plan sponsor?

A
  • weak status/profitability decreases ability

- strong status increases

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12
Q

Factors that affect DB plan ability to bear risk: correlation between plan returns and sponsor business returns?

A

+ correlation decreases ability

- correlation increases ability

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13
Q

Factors that affect DB plan ability to bear risk: plan features affecting liquidity needs?

A
  • higher liquidity needs decrease ability

- lower liquidity needs increase ability

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14
Q

Factors that affect DB plan ability to bear risk: workforce characteristics affecting liquidity demands or time horizon?

A
  • higher liquidity needs and shorter time horizon decreases ability
  • lower liquidity needs and longer time horizon increases ability
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15
Q

DB plan typical risk objectives?

A
  • manage std dev of surplus (or assets)

- achieve 100% funded status

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16
Q

DB plan time horizon?

A

-functionally determined by plan and current participant characteristics

  • duration of plan liabilities
  • assets used to fund current participants
  • may be split between retired lives and active lives
  • may be long term

-for a terminating plan, horizon is termination datae

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17
Q

DB plan taxes?

A

-generally tax exempt, except for special situations

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18
Q

DB plans legal?

A

-obligation to manage assets with benefit to participants

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19
Q

DB plan liquidity?

A

-as required to meet plan payouts

  • higher needs indicated by:
  • –higher ratio of retired/active lives
  • –older workforce
  • –higher ratio of plan disbursements/sponsor contributions
  • –plan features like early retirement and lump-sum distribution
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20
Q

DB plan unique?

A

-often none

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21
Q

Hybrid plans: ESOP?

A
  • set up to buy company stock

- may be able to contribute with pre or after-tax funds

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22
Q

Independent foundation: description, purpose, source of funds, spending requirements?

A

desc - single donor, private or family
purpose - makes grants with aim of contributing to society
source - corporate sponsor
requirements - 5% of avg markt value of assets during preceding year (ex inv management fees)

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23
Q

Operating foundation: desc, purpose, source of funds, spending requirements?

A

purpose - funding an org
source - can by group, individual, or family
requirements - 85% of dividends plus interest income (maybe also 3.33% of assets)

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24
Q

Community foundation: desc, purpose, source of funds, spending reqs?

A

desc - publicly sponsored grant-awarding org
purpose - fund social, educational, religious, other
source - general public/large donors
spending reqs - none

25
Return objective of foundations?
typical obj - preserve real value and meet spending targets also - maintain intergenerational neutrality so real value maintained
26
Spending rules of foundations?
simple - x% of beginning market value; but this makes distributions volatile smoothing rules - purpose of reducing volatility of distributions example - x% of avg 3yr market value
27
Risk tolerance of foundations?
ability - perpetual time horizon; flexibility of spending reqs; need to maintain purchasing power; if deemed appropriate by foundation board reduces ability - recipients depend on distributions; lack of smoothing rules
28
Liquidity constraints of foundations?
- needs for cash in excess of contributions received - smoothing helps - cash equivalent needs usually low
29
Legal and regulatory constraints of foundation?
- generally less regulated | - varies by country and type
30
Unique constraints of foundations?
varies and case specific, for example: - concentrated holdings; restrictions on sale; prohibited investments - socially responsible investing - board biases/opinions - inadequate resources for due diligence on comples investments
31
Return objectives of endowments?
- maintain principal - maintain perpetual purchasing power - distributions sustainable and reliable - total return should cover spending, inflation, and fees
32
Endowment spending rules?
simple - x% of beginning market value rolling avg - x% of last 3yrs geometric - y% of spending is x% of avg last 3yrs mrkt value, while (1-y%) is past distribution of amount adj for inflation
33
Endowment risk tolerance?
- normally high due to perpetual time horizon - reductions of risk tolerance: - --lack of smoothing rules - --receivers are heavily dependent on distributions - --directors focused on short term
34
liquidity and legal/regulatory constraints on endowments?
liquidity - needs generally limited | legal/reg - varied; normally less regulated
35
life insurance return objective?
- earn crediting (accumulation rate) necessary to meet promised benefits - earn net interest spread above crediting rate
36
life insurance risk tolerance?
-invest using fiduciary principles for quasi-trust funds - match asset to liability characteristics - --duration mismatch of A/L exposes surplus to interest rate risk and capital adequacy problems - --reinvestment risk - reinvesting coupon at rate lower than original purchase yield - cash flow volatility - anything hindering timely collection of income reduces reinvestment earnings/return - credit risk - can reduce returns
37
life insurance liquidity concerns?
- typically predictable | - special considerations - disintermediation/asset marketability
38
life insurance liquidity issues: disintermediation?
disintermediation increases when int rates increase and asset sold at depressed value
39
life insurance liquidity issues: asset marketability?
product mix has moved to shorter duration
40
life insurance time horizon?
- traditionally long duration | - match asset duration to liability
41
life insurance taxes?
- policyholder share not taxed generally | - corporate share taxed
42
life insurance legal and regulatory concerns?
heavily regulated: - eligible investments - % of types allowed (lists) - valuation methods
43
casualty insurance compared to life insurance?
- casualty has shorter liability duration - longer processing period of payout (long tail on claims) - uncertain payouts/amounts (life is uncertain in timing, but amount is certain)
44
issues with casualty insurance?
- business risk can be concentrated geographically | - face an underwriting/profitability cycle
45
describe underwriting/profitability cycle.
- often tied to economic cycle - after period of underwriting losses and low profits insurers increase standards and raise premiums - profits attract capital which increases underwriting capacity - increased capital/competition in lowers premiums and underwriting standards - losses come and standards tightened again
46
casualty insurance company return objective key considerations?
1. support competitive pricing 2. increase profitability 3. grow the surplus 4. tax considerations - emphasize taxable bonds when tax rate is zero and profits are negative; tax exempt when opposite is true 5. total return focus - regulatory/accounting rules favor active management; realized gains increase surplus In summary: want to earn positive spread
47
casualty insurance company return objective differences from life insurance companies?
objectives and results more varied for casualty: - regulations more relaxed - product mix and liability durations differ - companies focus on asset appreciation strategies - capital adequacy and surplus vary
48
casualty insurance company risk objective key considerations?
1. cash flow needs are large/erratic 2. common stock to surplus ratio: equity investing mostly limited to surplus account; risk appetite lower during inflation and bear markets 3. few specific regulatory limits vs life insurance companies
49
casualty insurance company liquidity concerns?
- high liquidity needs - typically: - emphasize highly liquid securities - match assets to known specific needs - hold high quality government bond portfolio - if there is surplus, can invest that more aggresively
50
casualty insurance company time horizon concerns?
- horizon relatively short to match liability duration - generally accept more interest rate risk than in life companies - allows for larger mismatch of asset/L duration - mismatch related to underwriting cycle Duration swings in US with underwriting cycle: - when profitable and t>0 - --focus on tax exempt bonds and extend asset duration as tax exempt yield curve tends to be steep - when unprofitable and t = 0 - --emphasize taxable bonds and reduce asset duration
51
casualty insurance companies: legal/regulatory/unique concerns?
regulation: - -permissive vs life companies - -no asset valuation reserve unique: --specific to company or case
52
For banks, the securities portfolio is a residual after what?
after meeting reserves and loan demand.
53
Bank security portfolio objectives?
- manage interest rate risk: shorter duration to offset longer loan portfolio duration. - manage liquidity: high liquid short term gov securities to offset illiquied riskier loans - generate income for bank - diversify credit risk
54
Bank security portfolio return objective?
contribute to earning positive spread over cost of funds (interest paid on deposits)
55
Bank security portfolio risk objective?
- focus on asset/liability management and protecting surplus | - risk tolerance is below average
56
Bank security portfolio legal/regulatory concerns?
- extensive - limits on holding common stock and below investment grade securities - capital requirements - some regulations are minimum liquidity levels and max leverage - leverage adjusted duration gap (LADG) measures interest rate risk
57
Bank security portfolio liquidity/time horizon concerns?
liquidity: driven by deposits/withdrawals | time horizon: driven by maturity of liabilities
58
Bank security portfolio taxes and unique concerns?
taxable - incentive to hold losers and sell winners | unique - case specific
59
For what kinds of companies to use ALM vs Asset Only?
ALM where definable, measurable liabilities: - DB pension plans - Insurance companies - Banks Asset only where not: - Foundations - Endowments

CFA Level III (17 decks)

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