Deck 22: Investors and the Investment Process

Question 1

Price volatility is greatest on which one of the following investments?

A) Commercial paper
B) 20 year zero coupon bonds
C) Treasury notes
D) Treasury bills

Answer 1

B

Question 2

For a bank,the difference between the interest rate charged to borrowers and the interest rate paid on liabilities is called the __________.

A) insurance premium
B) interest rate spread
C) risk premium
D) term premium

Answer 2

B

Question 3

Which one of the following would be considered to be a "cash equivalent" investment?

A) Treasury bills
B) Common stock
C) Corporate bonds
D) Real estate

Answer 3

A

Question 4

You are thinking of investing in one of two assets.Asset A has higher systematic risk than Asset

A) realized; expected
B) You can be sure that Asset A's _______ return will be higher than Asset B, but you can't be sure if Asset A's _______ return will be higher than Asset B's.
B) real; nominal
C) expected; realized
D) nominal; expected

Question 5

Just two months after you put money into an investment its price falls 25 percent.Assuming that none of the investment fundamentals have changed,which of the following actions would evidence the greatest risk tolerance?

A) You sell to avoid further worry and buy something else.
B) You do nothing and wait for the investment to come back.
C) You buy more thinking that if it was a good investment before; now it's not only good it is cheap too.
D) You sue your financial advisor.

Question 6

To _____ means to mitigate a financial risk.

A) invest
B) speculate
C) hedge
D) renege

Question 7

In a defined benefit pension plan,the _____ bears all of the fund's investment performance risk.

A) employer
B) employee
C) fund manager
D) government

Question 8

If the maturity of a bank's assets is much longer than the maturity of its liabilities and it wants to limit its interest rate risk the bank may _________.

A) prefer to invest in long term bonds in its asset portfolio
B) prefer to invest in equities in its asset portfolio
C) prefer to invest in variable rate assets
D) decide to increase its fixed rate mortgage holdings

Question 9

At the early stage of an individual's working career their retirement portfolio should probably consist mostly of _______.

A) annuities
B) stocks
C) bonds
D) commodities

Question 10

A mutual fund may not hold more than ______ of the shares of any publicly traded company.

A) 5%
B) 10%
C) 25%
D) 50%

Question 11

A ______ insurance policy provides death benefits,with no buildup of cash value.

A) whole life
B) universal life
C) variable life
D) term life

Question 12

In a defined contribution pension plan,the _____ bears all of the fund's investment performance risk.

A) employer
B) employee
C) fund manager
D) government

Question 13

As the typical investor ages the composition of their wealth usually switches from primarily _______ to primarily _______.

A) human capital; financial capital
B) financial capital; human capital
C) intellectual capital; physical capital
D) investable capital; noninvestable capital

Question 14

If an investor wishes to invest 100% of her portfolio in safe assets but does not wish to manage her portfolio,she should invest in __________.

A) a money market fund
B) a growth stock fund
C) several different money market instruments
D) several different stocks

Question 15

A portfolio manager indexes part of a portfolio and actively manages the rest of the portfolio.This is called a _________ strategy.

A) passive aggressive
B) passive core
C) passively active
D) balanced fund

Question 16

Which of the following is not one of the main areas covered in the examinations that must be taken in order to achieve the designation of Chartered Financial Analyst?

A) Investment management ethics
B) Securities analysis
C) Securities marketing techniques
D) Portfolio management

Question 17

The two most important factors in describing an individual or organization's investment objectives are ________________.

A) income level and age
B) income level and risk tolerance
C) age and risk tolerance
D) return requirement and risk tolerance

Question 18

My pension plan will pay me a yearly retirement amount equal to 2% of my highest annual salary for each year of service.I must have ___________.

A) a defined benefit plan
B) a defined contribution plan
C) an endowment fund
D) a variable annuity

Question 19

In order to become a CFA you must do all except which one of the following?

A) Pass 3 exams designed to ensure you have sufficient knowledge of investments.
B) Obtain 3 years of work experience in money management.
C) Become a member of a local Society of the Financial Analysts Federation.
D) Divest all your own stock holdings to eliminate any potential conflicts of interest with client recommendations.

Question 20

The major asset most people have during their early working years is their ________.

A) home
B) stock portfolio
C) earning power derived from their skills
D) bond portfolio

Question 21

Life insurance companies try to hedge the risks inherent in whole-life insurance policies by investing in __________.

A) long term bonds
B) money market mutual funds
C) savings accounts
D) short term commercial paper

Question 22

A pension fund will owe $15 million to retirees in 20 years.An actuary assumes a 6% rate of return on the funds invested in the pension plan but the fund actually earns 8%.The pension plan receives annual contributions from the company sponsor.If the 8% rate of return is expected to continue,by how much can the company reduce its pension payments per year?

A) $65,437
B) $79,985
C) $89,462
D) $95,320

Question 23

A pension fund will owe $10 million to retirees in 6 years.An actuary assumes an 8% rate of return on the funds invested in the pension plan.If the pension plan receives annual contributions from the company sponsor,how much must the company pay to fully fund the pension liability?

A) $1,212,587
B) $1,363,154
C) $1,533,333
D) $1,666,667

Question 24

_______ is a life insurance policy that provides a death benefit and a fixed rate tax deferred savings plan.

A) Term life
B) Whole life
C) Variable life
D) Universal life

Question 25

_______ is a life insurance policy that will provide a death benefit only but has no savings plan.

A) Term life
B) Whole life
C) Variable life
D) Universal life

Question 26

The possibility that you are too conservative and your money doesn't grow fast enough to keep pace with inflation is called ________.

A) purchasing power risk
B) liquidity risk
C) timing risk
D) market risk

Question 27

Personal trusts are typically allowed to engage in which of the following investment activities?
I)Buying and selling futures contracts
II)Short selling securities
III)Purchasing and writing options
IV)Buying stock on margin

A) I only
B) II and III only
C) II and IV only
D) None of the given activities are allowed

Question 28

An active asset allocation strategy involves _________.

A) investing in the stock of companies which are price takers
B) maintaining approximately the same proportions of a portfolio in each asset-class over time
C) varying the proportions of a portfolio in each asset-class in response to changing market conditions
D) selecting individual securities in different sectors that are believed to be undervalued

Question 29

An employee has an average wage of $60,000 and they have worked for the firm for 25 years.The defined benefit pension plan pays retirees 2.5% of the average wage times the years of service.The employee can expect to receive _______ per year upon retirement.

A) $18,000
B) $37,500
C) $45,325
D) $55,250

Question 30

Empirical evidence suggests that investors become __________ as they approach retirement.

A) greedier
B) less interested in investments
C) more risk averse
D) more risk tolerant

Question 31

A passive asset allocation strategy involves _________.

A) investing in the stock of companies which are price takers
B) maintaining approximately the same proportions of a portfolio in each asset-class over time
C) varying the proportions of a portfolio in each asset-class in response to changing market conditions
D) selecting individual securities in different sectors that are believed to be undervalued

Question 32

An individual is on the game show "Squeal or No Squeal" and she has a choice between receiving a certain gain of $100,000 or a 50% chance of winning $200,000 or zero.Which one of the following correctly completes the statement below? If she takes the gamble instead of the certain $100,000 she is acting ____________________.

A) like a person who is risk neutral
B) like a person who is risk averse
C) like a person who is a risk lover
D) irrationally

Question 33

The price of your investment increases 20% one month after you buy it.You do not believe that the stock's prospects have changed.Which one of the following actions would indicate the lowest amount of risk aversion?

A) You hang onto the stock anticipating that it will go higher.
B) You buy more stock, anticipating that it will go higher.
C) You sell all of your stock holdings immediately.
D) You sell ½ your stock holdings and invest the proceeds in other areas of your portfolio.

Question 34

If an individual confers legal title to property to another person or institution to manage the property on their behalf the individual has created a(n)___________.

A) personal trust
B) charitable trust
C) endowment fund
D) mutual fund

Question 35

Many defined benefit pension plans have a target rate of return on investment ____________.

A) equal to the firm's return on equity
B) equal to the plan's assumed actuarial rate of return
C) equal to the economic inflation rate because wages often increase with inflation
D) equal to the estimated stock market return

Question 36

Which one of the following typically strives to earn a return on their investments that exceeds the actuarially determined rate of return?

A) Banks
B) Thrifts
C) Mutual funds
D) Pension funds

Question 37

The term "hedge" refers to an investment that is used ________________.

A) primarily for tax loss selling purposes
B) to mitigate specific financial risks
C) to conceal one's true investment strategy from other market participants
D) primarily to defer capital losses

Question 38

Of the following,the investment time horizon is typically the shortest for __________.

A) banks
B) endowment funds
C) life insurance companies
D) pension funds

Question 39

The risk that a downturn in the market may substantially reduce your investment principal is called _______.

A) purchasing power risk
B) interest rate risk
C) market risk
D) liquidity risk

Question 40

If a defined benefit pension fund's actual rate of return is _____ than the actuarial assumed rate then the ___________.

A) greater; employees will benefit
B) greater; firm's shareholders will benefit
C) lower; employees will benefit
D) lower; firm's shareholders will benefit

Question 41

Conservative investors are likely to want to invest in __________ mutual funds while risk-tolerant investors are likely to want to invest in __________.

A) income, high growth
B) income, moderate growth
C) moderate income, high growth
D) moderate income, moderate growth

Question 42

An investor has a long time horizon and desires to earn the market rate of return.However,the investor will need to withdraw funds each year from their investment portfolio.The biggest constraint a planner would face with this client is a ___________ constraint.

A) tax
B) risk tolerance
C) liquidity
D) social

Question 43

Which of the following is the least likely to be included in the portfolio management process?

A) Monitoring market conditions and relative values
B) Monitoring investor circumstances
C) Identifying investor constraints and preferences
D) Organizing the investment management process itself

Question 44

Suppose that the pre-tax holding period returns on two stocks are the same.Stock A has a high dividend payout policy and stock B has a low dividend payout policy.If you are a high tax rate individual and do not intend to sell the stocks during the holding period,__________.

A) stock A will have a higher after-tax holding period return than stock B
B) the after-tax holding period returns on stocks A and B will be the same
C) stock B will have a higher after-tax holding period return than stock A
D) it is impossible to determine which stock will have a higher after-tax holding period return given the information available

Question 45

When used in the context of investment decision making,the term "liquidity" refers to _____________.

A) the ease and speed with which an asset can be sold at any value possible
B) the ease and speed with which an asset can be sold without having to discount the value
C) an aspect of monetary policy
D) the proportion of short-term to long-term investments held in an investor's portfolio

Question 46

The term "investment horizon" refers to __________.

A) the proportion of short-term to long-term investments held in an investor's portfolio
B) the planned liquidation date of an investment
C) the average maturity date of investments held in a portfolio
D) the maturity date of the longest investment in the portfolio

Question 47

Which one of the following is a life insurance policy that will provide a fixed death benefit and allows the policyholder to choose where to invest the policy's cash value?

A) Term life
B) Whole life
C) Variable life
D) Industrial life

Question 48

The objectives of personal trusts normally are __________ in scope than those of individual investors and personal trust managers typically are __________ than individual investors.

A) broader; more risk averse
B) broader; less risk averse
C) more limited; more risk averse
D) more limited; less risk averse

Question 49

The prudent investor rule requires __________.

A) executives of companies to avoid investing in options of companies they work for
B) executives of companies to disclose their transactions in stocks of companies they work for
C) professional investors who manage money for others to avoid all risky investments
D) professional investors who manage money for others to constrain their investments to those that would have been approved by a prudent investor

Question 50

Of the following,the most flexible type of life insurance policy from the policyholder's perspective is probably a(n)___________ policy.

A) term life
B) whole life
C) variable life
D) universal life

Question 51

Under a "passive core" portfolio management strategy,a manager would ___________.

A) index the entire portfolio
B) index part of the portfolio and actively manage the rest
C) delegate the management of core segments of the portfolio to other managers
D) actively manage the entire portfolio

Question 52

The first step any investor should take before beginning to invest is to __________.

A) establish investment objectives
B) develop a list of investment managers with superior records to interview
C) establish asset allocation guidelines
D) decide between active and passive management

Question 53

An investor refuses to invest in any firm that produces alcohol or tobacco.This is an example of a ___________ constraint.

A) return requirement
B) risk tolerance
C) liquidity
D) social

Question 54

The amount of risk an individual should take depends on his or her
I)return requirements
II)risk tolerance
III)time horizon

A) I only
B) I and II only
C) II and III only
D) I, II and III

Question 55

The choice of an active portfolio management strategy rather than a passive strategy assumes ___________.

A) the ability to continuously adjust the portfolio to provide superior returns.
B) asset allocation involving only domestic securities
C) stable economic conditions over the short term
D) the ability to minimize trading costs

Question 56

Earnings on variable life and universal life insurance policies are ___________.

A) never taxed
B) taxed only at the capital gains tax rate
C) not taxed until the money is withdrawn
D) not taxed at the federal level but are taxed at the state level

Question 57

A clearly understood investment policy statement is not critical for which one of the following?
I)Mutual funds
II)Individuals
III)Defined benefit pension funds

A) II only
B) III only
C) I only
D) A policy statement is necessary for all three

Question 58

The prudent man law is an example of a regulation designed to ensure appropriate _____________ by money managers.

A) fiduciary responsibility
B) fiscal responsibility
C) monetary responsibility
D) marketing procedures

Question 59

When a company sets up a defined contribution pension plan,the __________ bears all the risk and the __________ receives all the return from the plan's assets.

A) employee; employee
B) employee; employer
C) employer; employee
D) employer; employer

Question 60

Endowment funds are held by __________.

A) financial intermediaries
B) individuals
C) profit-oriented firms
D) nonprofit institutions

Question 61

At which one of the following institutions is liquidity usually the most important?

A) Mutual funds
B) Pension funds
C) Life insurers
D) Banks

Question 62

Your sister,an avid outdoors person,works in the airline industry and she has come to you (the financial guru)for investment advice.She is looking at purchasing stocks she knows something about.She is considering purchasing stock in Boeing,Lockheed Martin,United Technologies (maker of aircraft engines)and Cabela's Sporting Goods.Based only on the information given which stock should your recommend for her?

A) Boeing
B) Lockheed Martin
C) United Technologies
D) Cabela's

Question 63

Major functions of the investment committee include all but which one of the following?

A) Engage in security selection for each portfolio managed
B) Broadly determine the overall asset allocation of the investment company
C) Determine the asset class weights for each portfolio
D) Determine the asset universe

Question 64

One of the major functions of the investment committee is to ________________.

A) determine security selection of each portfolio operated by the investment company
B) translate the objectives and constraints of the investment company into an asset universe
C) determine the percentages of each security in the total investment company portfolio
D) calculate and report the overall rate of return to investment company constituents

Question 65

Go Global Investment Management has an asset allocation strategy of 60% U.S.investments and 40% global investments.Within the U.S.Go Global has allocated 70% of its portfolio to equities and 30% to bonds.Go Global now holds 3% of its U.S.equity portfolio in the stock of Wally World.Internationally,Go Global has allocated 55% to equities and 45% to bonds.About what percentage of Go Global's total portfolio is invested in Wally World?

A) 1.00%
B) 1.26%
C) 1.50%
D) 1.77%

Question 66

Under the provisions of a typical defined benefit pension plan,the employer is responsible for _____________.

A) investing in conservative fixed-income assets
B) paying benefits to retired employees
C) counseling employees in the selection of asset classes
D) paying employees the market rate of return on employee contributions

Question 67

For an investor concerned with maximizing liquidity,which of the following investments should be avoided?

A) Real estate
B) Bonds
C) Domestic stocks
D) International stocks

Question 68

An investor with low risk aversion will likely require which of the following risk return combinations?

A) Expected return = 11%, Historical standard deviation = 12%
B) Expected return = 12%, Historical standard deviation = 14%
C) Expected return = 14%, Historical standard deviation = 18%
D) Expected return = 17%, Historical standard deviation = 21%

Question 69

An institutional investor will have to pay off a maturing bond issue in 3 years.The institution has 10,000 bonds outstanding each with a $1,000 par value.The institutional money manager is reevaluating the fund's $100 million portfolio at this time.She is bullish on stocks and wants to put the most she can into the stock market but she cannot risk not being able to pay off the bonds.Three year zero coupon bonds are available paying 6% interest.What percentage of the total $100 million portfolio can she put in stocks and still ensure meeting the bond payments?

A) 87.4%
B) 88.5%
C) 90.0%
D) 91.6%

Question 70

Both a wife and her husband work in the airline industry.They are in their 40s and they have a high tax bracket and are concerned about their after tax rate of return.A meeting with their financial planner reveals they are primarily focused on long term capital gains and they will need at least a 9% to 11% average rate of return to meet their retirement goals.They desire a diversified portfolio and liquidity is not currently a major concern.If you had to choose from the list below which of the following asset allocations seems to best fit their situation?

A) 10% money market; 40% long term bonds; 10% commodities; 40% high dividend paying stocks
B) 0% money market; 60% long term bonds; 40% stocks
C) 10% money market; 30% long term bonds; 10% commodities; 50% high dividend paying stocks
D) 5% money market; 30% long term bonds; 5% commodities; 60% stocks, most with low dividends and high growth prospects

Question 71

Which one of the following institutions typically has the longest investment horizon?

A) Mutual funds
B) Pension funds
C) Property and casualty insurers
D) Banks

Question 72

An investor with high risk aversion will likely require which of the following risk return combinations?

A) Expected return = 12%, Historical standard deviation = 17%
B) Expected return = 14%, Historical standard deviation = 19%
C) Expected return = 16%, Historical standard deviation = 21%
D) Expected return = 18%, Historical standard deviation = 23%

Question 73

A life insurance firm wants to minimize its interest rate risk and it is planning on paying out $250,000 in five years.Which one of the following investments best matches its goal?

A) High yield utility stocks
B) 5-year zero coupon bonds
C) 10-year coupon bonds
D) Money market investments rolled over as needed

Question 74

An investor is looking at different retirement investment choices and he is willing to accept one with upside potential even if that means sacrificing certainty.Which of the following will he most likely select?

A) Fixed annuity
B) Defined benefit plan
C) Defined contribution plan
D) Bonds invested in an IRA

Question 75

In 1937 the Eli Lilly family donated millions of dollars in stock to fund a not-for-profit charitable organization.Such organizations are typically called _________________.

A) annuities
B) endowments
C) mutual funds
D) personal trusts

Question 76

A family will retire in a few years.They have a high tax bracket and are concerned about their after tax rate of return.A meeting with their financial planner reveals they are primarily focused on safety of principal and they will need a 6% to 8% average rate of return on their portfolio.They desire a diversified portfolio and liquidity is likely to be a concern due to health reasons.If you had to choose from the list below which of the following asset allocations seems to best fit this family's situation?

A) 10% money market; 50% intermediate term bonds; 40% blue chip stocks, many with high dividend yields
B) 0% money market; 60% intermediate term bonds; 40% stocks
C) 10% money market; 30% intermediate term bonds; 60% high dividend paying stocks
D) 5% money market; 35% intermediate term bonds; 60% stocks, most with low dividends

Question 77

Medfield College's $10 million endowment fund is not allowed to spend any contributed capital or any capital gains.The fund may only spend investment earnings.The fund is expected to need between $500,000 and $1,000,000 to pay for new lab equipment for the science building.Which of the following is/are true?
I)The fund should have a target rate of return of at least 10%.
II)The limitations on spending require the fund to limit its considerations to growth stocks.
III)The requirement to spend money out of the fund this year provides a liquidity constraint that may reduce the fund's rate of return.

A) I only
B) II only
C) I and III only
D) I, II and III

Question 78

The asset universe is the _____________________.

A) set of investments an investment company can legally invest in
B) existing set of assets the investment company currently owns in one or more of its portfolios
C) list of assets approved by the investment committee that may be placed in the investment company's portfolios
D) market portfolio of all available risky assets

Question 79

A portfolio is comprised of three index funds: an equity index,a bond index and an international index.The portfolio manager changes the weights periodically according to forecasts for each sector.This is an example of __________.

A) a passively managed core with an actively managed component
B) a totally passively managed fund
C) passive asset allocation with active security selection
D) active asset allocation with passive security selection

Question 80

A portfolio is comprised of three index funds: an equity index comprising 40% of the total portfolio,a bond index comprising 30% of the total portfolio and an international index comprising 30% of the total portfolio.After each quarter the portfolio manager buys and sells some of each sector so as to preserve the original weights for each sector.This is an example of ____________.

A) a passively managed core with an actively managed component
B) a totally passively managed fund
C) passive asset allocation with active security selection
D) active asset allocation with passive security selection