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CISI - Portfolio Construction Theory in Wealth Management > Summer 2021 Exam > Flashcards

Summer 2021 Exam Flashcards

1
Q

If a rating agency increases the probability of default on a bond by one grade, this can be expected to result in a promised yield to maturity:

a. equal to zero.
b. equal to the expected yield.
c. greater than the expected yield.
d. less than the expected yield.

A

c. greater than the expected yield.

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2
Q

What are the aims of the UN Sustainable Development Goals (UN SDGs)?

A

To make economies more productive, socially inclusive, and environmentally conscious

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3
Q

In company law, a derivative action is:

A

where a shareholder, in place of the company, brings a claim against a director of the company for negligence, default or breach of duty or breach of trust.

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4
Q

For an employed UK tax payer with a portfolio of directly held FTSE 100 shares:

A

two different CGT rates may apply to realised gains in the same year.

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5
Q

Hilary makes a direct purchase of single listed AIM regular trading company shares for cash, sells some FTSE 100 shares, and buys some convertible bonds. Which stamp duty was she liable, if any?

A

Stamp Duty Reserve Tax.

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6
Q

A real estate investment trust (REIT) has property rental income of £5,000,000. To gain full tax benefits, what is the minimum that must be distributed?

A

£4,500,000.

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7
Q

The main purpose of the January 2020 revision to the UK Stewardship Code is to

A

strengthen governance, transparency, and reporting.

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8
Q

A company has earnings per share of 16p, dividend per share of 4p, used one quarter of earnings to buyback shares, and has a share price of 200p. The company has a:

A

total yield of 4%.

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9
Q

A company has earnings per share of 2p, dividend per share of 1p, and a share price of 10p. The company has a:

A

dividend cover of 2.

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10
Q

In order to remain a FTSE 350 company director, the UK Corporate Governance Code requires existing directors to stand for re-election:

A

annually.

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11
Q

The January 2020 revision to the UK Stewardship Code did not integrate:

a. the UN Principles for Responsible Investment.
b. the EU Shareholder Rights Directive.
c. the Paris Agreement on climate change.
d. extensive investor and stakeholder feedback.

A

c. the Paris Agreement on climate change

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12
Q

An investment portfolio not within a tax wrapper and with an acquisition value of £400,000 was disposed of for £450,000 without incurring any CGT liability. There were no offsetting losses. The portfolio consisted entirely of:

A

gilts and venture capital trust (VCT) shares purchased at issue.

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13
Q

A common concern about green bonds is:

A

the definition of green has not yet been properly defined.

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14
Q

A decrease in investors’ risk aversion is represented on the security market line (SML) by:

A

a change in slope of the line.

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15
Q

Which is not a test of the semi-strong form of the efficient market hypothesis?

A

Serial correlation in stock returns.

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16
Q

A company has a current price of USD25 a share, an expected growth rate in perpetuity of 4% and expected dividend per share next year (D1) of USD1. You have a required rate of return of 5%. The expected return minus the required return is equal to:

A

3%.

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17
Q

According to the Green Bond Principles, which is not an eligible capital project for capital raising?

A

Automotive.

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18
Q

A factor portfolio has:

A

a factor sensitivity of one to a particular factor and zero to all other factors.

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19
Q

A corporate bond with a par value of £100,000 has a default probability of 5% and a predicted recovery rate of 60%. The bond’s expected loss is:

A

£2,000

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20
Q

Which is not a UN Sustainable Development Goal?

a. Life on land.
b. Zero hunger.
c. Gender equality.
d. Zero inequality.

A

d. Zero inequality.

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21
Q

Expected asset class investment returns are a key input into multi-asset portfolio construction. Give three key techniques used to derive expected asset class returns.

A
  • Averaging simulations
  • Sampling technique and adjust
  • Use models
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22
Q

How do you use averaging simulations to get the expected return of an asset class?

A
  • Use historic returns
  • Simulate possible returns by jumbling the sequence
  • Average out the outcomes from simulations
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23
Q

How do you use sampling to get the expected return of an asset class? (2)

A
  • get sample of returns using historic data
  • adjust the mean and standard deviation based on factors for the future
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24
Q

How do you use models to get the expected return of an asset class?

A
  • Use models like CAPM
  • Get data for factors
  • Risk free rate, beta, return of market
25
Q

How are the best and worst days of market returns distributed and how does this affect market timing? (2)

A
  • The worst and best return days are clustered
  • Makes timing challenging
26
Q

What expertise is needed to understand potential market downturns (4)

A
  • Financial
  • Economic
  • Unprecedented (i.e. Covid)
  • Political
27
Q

Why is it hard to have the expertise needed to predict the market

A

Need to know a lot about different things

28
Q

What are the steps needed in timing the market (active management)?

A
  • Identify signal
  • Develop conviction to act
  • Sizing how much to invest
  • Monitor and reverse if needed
29
Q

What does the performance of hedge funds suggest about active management performance?

A

Suggests marketing timing (active management) is difficult.

30
Q

The scientist first invites Bob to put £1 on the result of a heads or tails coin flip, offering £3 if Bob chooses correctly. Bob declines the bet.

What behavioural bias might have led Bob to act the way he had? (3)

A
  • loss aversion
  • fear of loss is greater than happiness from gain
  • Even with positive expected value
31
Q

Bill is willing to pay £1 for the chance to win £1.50 (£0.50 profit) on correctly calling heads or tails because he recently lost £5 in the casino and it is important that he breaks even on his gambling for the day.

What behavioural bias might have led Bill to act the way he had?

A
  • Mental accounting
  • Gambling account is down for the day
  • Negative expected value (0.5 x 1.50 = 0.75)
32
Q

A scientist does not ask Jane to wager money but instead offers her a choice of taking £0.50 or winning £1.00 if the next coin flip comes up heads. Jane takes the £0.50.

What behavioural bias might have led Jane to act the way she had?

A
  • Acted rationally
  • Should be indifferent between both outcomes
33
Q

What are the main benefits of holding adding commodities into portfolio? (3)

A
  • diversification
  • Inflation link
  • Safety of precious metal
34
Q

What are the disadvantages of holding commodities in portfolio?

A
  • Commodity returns are speculative
  • Does not generate value
35
Q

How can you invest in commodities?

A
  • Direct equity (invest in companies)
  • Collective vehicles
  • Derivatives
36
Q

What are the three further investment risks taken over and above Treasury Bills should the client instead select a money market fund as the risk-free rate for the portfolio.

A
  • Foreign currencies
  • Overseas governments may default
  • May pay interest (reinvestment risk)
37
Q

Concisely explain the real-world constraints and interactions that mean the theoretically efficient portfolio may not be held (3)

A
  • Rebalancing decisions
  • Liquidity / availability
  • Ethics / RI
38
Q

How are index-linked gilts taxed when sold? (2)

A
  • Tax free in line with gilt taxation
  • There is capital gains tax
39
Q

How are index-linked bonds taxed when sold?

A
  • Profit made is taxed as income not capital gains
40
Q

Why are modern markets hard to beat? (3)

A
  • A lot of investors and professionals
  • They are driven by making profit
  • Mispricing doesn’t stay big for long
41
Q

What is the speed of information incorporated into security prices in EMH

A

Information is rapidly analysed and incorporated into security price

42
Q

How do real prices compare to theoretical prices? (3)

A
  • Can be slightly different
  • Due to factors such as transaction costs, differences in information, etc
  • Overall unlikely to be wildly different
43
Q

Why is it hard to beat the market even for a smart investor?

A
  • Market reflects the wisdom of all market participants
  • Investor would need an advantage to beat them consistently
  • Hard to get this advantage unless have insider info (illegal)
44
Q

Give three behavioural finance concepts that might give a fund comparative advantage in active asset allocation

A
  • Myopia (Present Bias)
  • Herding
  • Loss aversion
45
Q

What is myopia (present bias)?

A

This is short-termism / lack of long-term thinking

46
Q

How can you use myopia (present bias) to get an advantage and beat the market? (4)

A
  • Market participants may be forced to think short-term
  • This could be due to economics of their businesses
  • Take a long term approach
  • Allocate investments based on data that looks further into the future
47
Q

What is herding/conformity?

A

When investors/market participants follow each other

48
Q

Why is herding bad in investments?

A
  • Markets reacts slower
  • Decision based on following the crowd
  • Important fundamentals might be ignored
49
Q

How can you use herding to your advantage in active management?

A
  • Take opposing view if signal from analysis and conviction is strong
  • Use speed, when see that herding/momentum is forming
  • Get in at the start of momentum
50
Q

What is loss bias?

A

Irrational fear of loss even with positive expected outcome

51
Q

Why is loss aversion bad?

A
  • ignores positive expected outcome
  • essentially loss because of fear
52
Q

How to use loss bias to your advantage in active management? (3)

A
  • happens when market drops
  • take position when market participants are in “fear”
  • Use as signal of undervaluation
53
Q

Explain the purpose of the subjective scaling sometimes used within the risk tolerance calculation. (2)

A
  • used as penalty taken off expected return
  • reduces significance of penalty
54
Q

Give 3 merits of using risk aversion scores in portfolio selection

A
  • easy to calculate and explain
  • Helps to start conversation with client
  • Combines objective investment risk with subjective psychological risk
55
Q

Give 3 drawbacks of using risk aversion scores in portfolio selection

A
  • Does not include risk need or risk capacity
  • Scaling (if added) is subjective
  • Relies on client’s response
56
Q

What is the meaning of ‘certainty equivalent’

A

if portfolio’s certainty equivalent return > risk-free alternative

then portfolio is desirable

57
Q

How does certainty equivalent help clients?

A
  • helps understand riskiness between portfolios
  • helps understand riskiness between portfolio and risk free asset
58
Q

How can risk aversion scores help DC pension funds? (3)

A
  • Know how much risk to take
  • Help members pick suitable default structure
  • Helps achieve right risk at different time/age

CISI - Portfolio Construction Theory in Wealth Management (15 decks)

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