Risk & asset allocation

Question 1

Clients often misunderstand investment risk. What asset class often has the greatest shortfall risk, and why?

Answer 1

• cash
• because of inflation risk

Question 2

Name 3 things that might be helpful in assessing a client’s ATR?

Answer 2

• the asset allocation of their existing investments.
• their capacity for loss
• the timescale of their investment

Question 3

What do computer-based psychometric risk profiling tool make no attempt to assess?

Answer 3

The client’s capacity for loss (their ability to sustain a less favourable outcome without derailing their objectives).

Question 4

Name 2 factors that affect capacity for loss.

Answer 4

• the timescale of the investment (time to recover from a fall in the markets?)
• the client’s total wealth (are they able to ride out a market fall using other assets and thus avoid an immediate impact on their standard of living?).

Question 5

What will a client’s investment risk profile ideally be?

Answer 5

The lower of :
- their ATR as measured by the computer-based psychometric risk profiling tool
- and their capacity for loss.

Question 6

If a client’s existing assets are not sufficient to enable them to ride out a fall in the market, what might be advised?

Answer 6

To adopt a lower risk profile than might have been indicated by the risk profiling tool.

Question 7

How does stochastic modelling (aka Monte Carlo simulation) is what?

Answer 7

In essence, it uses mathematical techniques to forecast future portfolio returns and volatility.

It focuses on the probabilities of events happening by forecasting a range of possible outcomes from a range of portfolios with different asset class mixes.

Question 8

What is a major drawback of stochastic modelling?

Answer 8

The assumptions made are not transparent and are not shared with the client.

Because of this, a stochastic model may seem to imply a greater degree of certainty than is warranted.

Question 9

Computer-based psychometric risk profiling can be used to determine a client’s what?

Answer 9

ATR

Question 10

Stochastic modelling shows the impact of what on possible returns?

Answer 10

Asset allocation

Question 11

Name 4 things to be established to calculate an estimated FV of pension funds (TV of money).

Answer 11

• PV of funds
• total amount of regular cont.s
• term to retirement
• assumed rate of growth