Question 1

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

Accepted Answer

Life insurance companies typically invest in long term bonds to match the longer term liabilities associated with whole-life insurance policies. This helps to hedge against interest rate risk and ensure they have adequate funds to meet future claims. Money market mutual funds and savings accounts generally offer lower returns and are not suitable for matching long term liabilities. Short term commercial paper is typically used for short term financing needs and does not match the long term nature of whole-life insurance policies.

Question 2

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?

Accepted Answer

To calculate the reduction in pension payments, we need to find the present value of the $15 million owed in 20 years at a rate of return of 8%. Using the PV function in Excel, we get a present value of $3,620,352.35.

Next, we need to calculate the annual payment necessary to fully fund this amount over 20 years at a 6% rate of return. Again, using Excel, we get an annual payment of $204,016.09.

However, the fund is actually earning 8%, so the annual payment needed to fully fund the $15 million in 20 years is lower. Using Excel, we get an annual payment of $181,030.26.

Therefore, the company can reduce its pension payments by the difference between the two annual payments: $204,016.09 - $181,030.26 = $22,985.83. Rounding this to the nearest thousand gives us the answer of $79,985.

Therefore, the correct answer is B.

Question 3

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...

Question 4

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

Accepted Answer

Whole life insurance provides a death benefit and builds cash value over time at a fixed rate, while also allowing for the potential of earning dividends. The cash value grows tax-deferred and can be borrowed against or used as collateral for a loan.

Question 5

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

Accepted Answer

Term life insurance policies provide a death benefit only and do not have a savings or cash value component, making them the best option for those who want affordable and straightforward life insurance coverage.

Question 6

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

Accepted Answer

The possibility that your conservative investment strategy doesn't keep pace with inflation is known as purchasing power risk. This is because your money may not be growing at a rate high enough to maintain its purchasing power over time.

Question 7

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

Accepted Answer

The answer of Personal trusts are typically allowed to engage...

Question 8

An active asset allocation strategy involves _________.

Accepted Answer

An active asset allocation strategy involves varying the proportions of a portfolio in each asset-class in response to changing market conditions. This approach seeks to take advantage of market opportunities and manage risk by adjusting the portfolio's exposure to different asset classes. Options A, B, and D do not describe an active asset allocation strategy.

Question 9

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 pension is calculated as 2.5% of $60,000 times 25 years, which equals $37,500 per year.

Question 10

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

Accepted Answer

Empirical evidence suggests that investors become more risk averse as they approach retirement. This is because they have a shorter time horizon to recover from any losses and need to protect their accumulated wealth.

Question 11

A passive asset allocation strategy involves _________.

Accepted Answer

A passive asset allocation strategy involves maintaining approximately the same proportions of a portfolio in each asset-class over time, without making any modifications based on market conditions or individual securities. This strategy is based on the belief that over the long term, the overall mix of assets in the portfolio will provide reasonable returns while minimizing risk.

Question 12

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 ____________________.

Accepted Answer

A person who chooses a gamble with a 50% chance of winning $200,000 over a certain $100,000 is acting like a risk lover, as they prefer the gamble with higher potential payoff despite the risk of winning nothing.

Question 13

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?

Accepted Answer

Buying more stock after a price increase indicates a lower level of risk aversion, as it involves taking on more risk with the expectation of further gains.

Question 14

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)___________.

Accepted Answer

By confering legal title to property to another person or institution to manage the property on their behalf, the individual has created a personal trust. A charitable trust is set up for charitable purposes, an endowment fund is a fund containing property donated to a nonprofit organization, and a mutual fund is a professionally managed investment fund.

Question 15

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

Accepted Answer

Defined benefit pension plans typically have an assumed actuarial rate of return that is used to calculate the plan's funding status and required contributions. This rate is usually based on the long-term expected returns of the plan's investments, such as stocks and bonds. Setting a target rate of return that is too high can cause the plan to be underfunded, while setting a rate that is too low can result in excess contributions and potentially hurt the sponsor's bottom line. Therefore, the assumed actuarial rate of return is a commonly used benchmark for target returns on investment for defined benefit pension plans.

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 ensure they have enough funds to meet their future obligations to retirees. Banks, thrifts, and mutual funds may also aim to exceed certain performance benchmarks, but may not have the same degree of pressure to do so as pension funds.

Question 17

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 potential losses from an adverse market movement. It is not necessarily used for tax loss selling purposes, to conceal one's investment strategy or to defer capital losses.

Question 18

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

Accepted Answer

Banks typically have a short investment time horizon as they need to have liquidity to meet their customers' demands for withdrawals and other transactions.

Question 19

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

Accepted Answer

Market risk refers to the potential loss of principal due to changes in the market, such as a downturn. Purchasing power risk refers to the risk that inflation will erode the value of your investment over time. Interest rate risk refers to the potential for changes in interest rates to affect the value of your investment. Liquidity risk refers to the potential for a lack of buyers or sellers to affect the ease with which you can buy or sell an investment. Out of the options given, market risk is the most appropriate to describe the potential loss due to a market downturn.

Question 20

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.

Quiz 22: Investors and the Investment Process