Question 1

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

Accepted Answer

The interest rate spread is the difference between the interest rate earned on loans and the interest rate paid on liabilities, such as deposits. Banks make money by charging borrowers a higher interest rate than the rate they pay on deposits, and this net interest margin is often referred to as the interest rate spread. Choice A is incorrect, as insurance premium refers to the payments made for insurance coverage. Choice C, risk premium, is the additional return required to compensate for the risk of an investment, and choice D, term premium, refers to the additional return that investors demand for holding long-term bonds instead of short-term ones.

Question 2

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

Accepted Answer

A passive core strategy involves indexing a portion of a portfolio to achieve broad market exposure while actively managing the rest to seek higher returns or manage risk. This approach combines the benefits of both passive and active management.

Question 3

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

Accepted Answer

In a defined benefit pension plan, the employer guarantees a specific retirement benefit to their employees, which means they are responsible for contributing enough money to the plan to cover the promised benefits. Additionally, the employer also bears the investment risk as they are the ones who invest the plan's assets. This means that if the plan's investments perform poorly, it is the employer's responsibility to make up the difference to ensure that the promised retirement benefits can still be paid out. Therefore, the correct answer is A) employer.

Question 4

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.

Accepted Answer

The answer of An employee has an average wage of...

Question 5

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

Accepted Answer

At the early stage of an individual's working career, they have a longer investment horizon and should aim for higher returns in the long run. Shares or equities provide these higher returns compared to bonds or annuities. Commodity investments are generally more volatile, and suitable for investors with a higher risk tolerance.

Question 6

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

Accepted Answer

Buying more shares after a price increase, despite no change in the share's prospects, indicates a lower level of risk aversion as it involves increasing exposure to the same asset.

Question 7

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

Accepted Answer

Cash equivalents are short-term investments that are quickly convertible into cash and have low risk levels. Treasury bills are considered to be the most common cash equivalent investment as they are issued by the government and have a maturity of less than one year. They are easily tradable and have minimal credit risk. Common stock, corporate bonds, and real estate are not considered cash equivalents as they have different liquidity and risk profiles.

Question 8

To ________ means to mitigate a financial risk.

Accepted Answer

To hedge means to take steps to reduce or mitigate a financial risk. This typically involves making an investment or taking a position that will counteract potential losses from another position or investment. By hedging, investors aim to minimize their overall risk and protect themselves from unexpected market movements.

Question 9

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

Accepted Answer

During the early working years, most people have not had the opportunity to accumulate significant assets such as a home or extensive share/bond portfolios. Therefore, their main asset is their earning power, which is derived from their skills and ability to generate income through employment.

Question 10

The two most important factors in describing the investment objectives of an individual or organisation are ________.

Accepted Answer

The two most important factors in describing the investment objectives of an individual or organization are the return requirement and risk tolerance. Income level and age can be secondary factors that influence these two primary factors. However, return requirement and risk tolerance directly impact investment decisions and portfolio strategies. Therefore, D is the most suitable answer.

Question 11

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 ________.

Accepted Answer

A money market fund invests in short-term, low-risk instruments such as Treasury bills and commercial paper. It provides a relatively safe investment option for investors who do not wish to actively manage their portfolio but want their investments to be in safe assets. Investing in several different money market instruments, as suggested in choice C, can be time-consuming and may require a higher level of expertise, which may not be suitable for investors who are not interested in managing their portfolio. Growth share funds, as suggested in choice B, seek capital appreciation through investments in growth-oriented stocks and are riskier in nature, making them less suitable for investors seeking safe assets. Similarly, investing in several different shares, as suggested in choice D, can expose an investor to higher risks and require active management, making it unsuitable for investors who do not wish to manage their portfolio.

Question 12

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

Accepted Answer

Life insurance companies invest in long term bonds in order to hedge the risks inherent in whole-life insurance policies. Long term bonds provide a relatively stable and predictable return on investment, which helps the insurance company to manage risk and ensure that it can meet its long-term financial obligations to policyholders. Money market mutual funds, savings accounts, and short term commercial paper are not typically used by life insurance companies for this purpose.

Question 13

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 shares on margin

Accepted Answer

Personal trusts are generally restricted from engaging in high-risk investment activities such as buying and selling futures contracts, short selling, purchasing and writing options, and buying shares on margin, as these can jeopardize the trust's assets and are often not aligned with the fiduciary duty to preserve and protect the trust's assets.

Question 14

The term 'hedge' refers to an investment that is used ________.

Accepted Answer

A hedge is an investment that is used to mitigate specific financial risks, such as market volatility, interest rate changes, or currency fluctuations.

Question 15

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

Accepted Answer

When the actual rate of return on a defined benefit pension fund's investments is greater than the actuarial assumed rate, the excess returns can reduce the amount the firm needs to contribute to the fund to meet its future obligations. This can lead to increased profits or reduced costs for the firm, benefiting the shareholders.

Question 16

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

Accepted Answer

Pension funds typically strive to earn a return on their investments that exceeds the actuarially determined rate of return in order to be able to meet their future pension obligations to their beneficiaries.

Question 17

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

Accepted Answer

The answer of As the typical investor ages the composition...

Question 18

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 ________.

Accepted Answer

If a bank's assets have a much longer maturity than its liabilities, it will be susceptible to interest rate risk. Variable rate assets can help manage this risk as they will adjust in response to changes in interest rates. Preference for long term bonds (A) or fixed rate mortgages (D) will only exacerbate the interest rate risk. Equities (B) are not typically used as a way to manage interest rate risk.

Question 19

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 ________.

Accepted Answer

The statement describes a defined benefit plan, where the retirement income is calculated based on a formula that takes into account the employee's salary and years of service. The other options listed (defined contribution plan, endowment fund, variable annuity) do not fit this description.

Question 20

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?

Accepted Answer

The answer of A pension fund will owe $10 million...

Quiz 16: Investors and the Investment Process