Schweser QBank 2017portfolio management and wealth planning 08 asset allocation and rela portfolio management (1)

Explanation Tactical asset allocation deviates from Strategic asset allocation to take advantage of short-term capital market expectations.. The answers given are as follows:Prickett: "D

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Asset Allocation and Related Decisions in Portfolio Management (1)

Tactical asset allocation is a deviation from the strategic asset allocation for the purpose of:

aligning with investor's risk preferences

exceeding investor's return objectives

taking advantage of short-term capital market expectations

Explanation

Tactical asset allocation deviates from Strategic asset allocation to take advantage of short-term capital market expectations

Dynamic asset allocation is considered an advantage over static asset allocation because of all of the following factors exceptit:

expresses unanticipated changes in macroeconomic factors

is more cost efficient when implementing

allows for changes over time

Explanation

Dynamic asset allocation is costly and difficult to implement However, many investors feel that these costs are acceptable inorder to reap the benefits of dynamic asset allocation These benefits include the allowance for changes in parameters overtime and the expression of unanticipated changes in macroeconomic factors

Reid Williams is responsible for training new analysts and portfolio managers for Grames Investment Advisors Since Gramesspecializes in institutional clients, Williams wants to make sure that his new trainees know the needs of various institutionalinvestors Reid gives an assignment to all of his trainees to identify general differences in asset allocations for different types

of institutional investors One of Williams' trainees, Phil Nagy, turns in his assignment with the following statements

Statement 1: A bank is likely to hold more bonds than an insurance company's surplus portfolio

Statement 2: An endowment is likely to hold more equities than the portfolio that funds an insurance company's fixed

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Professor Erik Rickel, an instructor for Babcock College asked his Investments 340 class to identify reasons that support theconclusion that strategic asset allocation is the most important factor for defining portfolio performance Three of Rickel'sstudents raised their hands and gave answers to his question The answers given are as follows:

Prickett: "Defining an investor's strategic asset allocation helps the portfolio

manager focus on the investor's goals with respect to risk and return."

Rorrer: "Results of academic studies show that the overall returns to market

timing and security selecting are minimal at best and in many cases do

not cover a portfolio's operating expenses and trading costs."

Cloe: "Since the assets within asset classes tend to have a similar response to

macroeconomic changes, the target weights of the portfolio's chosen

asset classes will tend to drive the variability of portfolio returns."

Which of the students' statements accurately support the conclusion that strategic asset allocation is the most important factorfor defining portfolio performance?

Prickett's and Cloe's only

Prickett's, Rorrer's, and Cloe's

Rorrer's and Cloe's only

Explanation

All three of the students' statements are accurate and all three support the conclusion that strategic asset allocation is themost important factor for defining portfolio performance A clearly defined asset allocation provides discipline and focus on aninvestor's goals by ensuring that the investor's portfolio accurately reflects the investor's desires with respect to risk and return.Also, empirical studies support the conclusion that strategic asset allocation (not timing or security selection) defines the vastmajority of a portfolio's long term performance, and the variability of portfolio returns

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Question #5 of 83 Question ID: 465431

Strategic asset allocation is based upon:

long-term capital market expectations and the investment policy statement

short-term capital market expectations and the investment policy statement

long-term capital market expectations and risk/return preferences of the investor

Explanation

Strategic asset allocation is based on long-term capital market expectations (which forms the basis for the generation of theefficient frontier) and the investment policy statement (IPS) of the investor The IPS includes not only the risk/return objectives

of the investor but also the investor's constraints

Which of the following statements regarding the characteristics of asset classes is most correct? Asset classes should:

not be highly correlated

Asset Class Allocation (%)

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Jones' human capital makes up the bulk of her portfolio.

Jones has a large amount of financial capital

Jones has a low risk tolerance

Explanation

With only 10% in fixed assets and the rest in equities, Jones has a very aggressive portfolio At a young age, an aggressiveportfolio like this makes sense as the individual will have a high allocation to human capital (future stream of income fromworking) At this stage, the allocation to human capital will be much larger than the allocation to financial capital (investmentportfolio), therefore, the investment portfolio should be invested in riskier, high return assets Note that Jones likely has a highrisk tolerance given the aggressive portfolio

Any mean-variance efficient portfolio has the:

highest return among all other portfolios

lowest standard deviation for a given level of expected return

lowest standard deviation and the highest expected return

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Portfolio B has the highest utility

Constrained optimization usually involves an additional constraint that:

the weights of all asset classes add up to 1

each asset class weight should be positive

short sales are not allowed

Explanation

The weight of all asset classes adding up to one is part of un-constrained optimization Constrained optimization has anadditional constraint that the weights of all the asset classes should be non-negative or that there be no short sales Theweight of asset classes can be zero or positive

Based on the following information, which asset class is the most significant in an efficient portfolio with an expected return of12.50%?

The following are the long-term capital market expectations:

Asset Class Expected

Return Exp Std Dev.

Asset Class Weights

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International equity with a weight of 45.51%.

International equity with a weight of 48.70%

Alternative investments with a weight of 20.17%

In other words, the efficient portfolio with an expected return of 12.50% has 87% weight of corner portfolio 4 and 13% weight

of corner portfolio 5 With respect to asset classes, the weights are then derived as follows:

Hence, International equity is the most significant asset class with the highest weight of 48.70%

Darlene Szuch is constructing an asset allocation for a client and just completed the step of formulating her expectations forthe capital markets and making projections for the risk and return of various asset classes Which of the following is her nextstep in the asset allocation process?

Determine the client's risk objective and return requirement

Determine the mix of asset classes that best meets the objectives defined in the

Investment Policy Statement

Monitor the various asset classes and make adjustments to market and asset class

expectations as necessary

Explanation

The asset allocation process starts with determining the investor's risk tolerance and return objectives Step 2 is to formulatecapital market expectations and the potential effects on various asset classes Step 3 is to determine the mix of assets thatbest meet the objectives defined in the IPS Once the strategic asset allocation has been implemented it should be monitoredregularly and adjustments should be made to the strategic allocation as needed Also, if identified market changes are short-term only, the manager should determine if implementing tactical asset allocation measures is appropriate

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Asset Class Weights

The following portfolios are under consideration by an investor:

Portfolio Expected Return

For an investor with a risk-aversion of 6, which portfolio would have the highest utility?

Portfolio B with a utility of 0.115

Portfolio A with a utility of 0.092

Portfolio A with a utility of 0.085

Explanation

For portfolios A and B we first need the approximate standard deviation

Portfolio A with an expected return of 11% lies between corner portfolios 4 and 5 Let w denote the weight of corner portfolio 5,

we solve for w in the following equation:

11 = (10.54)(w) + (12.79)(1-w)

w = 0.80

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ᅞ A)

ᅚ B)

ᅞ C)

Questions #16-21 of 83

Approximate standard deviation of portfolio A = (0.80)(8.14)+(0.20)(13) = 9.11

Similarly, Portfolio B with an expected return of 13.50% lies between corner portfolios 2 and 3 Let w denote the weight ofcorner portfolio 2, we solve for w in the following equation:

Monitor and control

Identify and minimize

Explanation

Strategic asset allocation reflects the investor's desired systematic risk exposure and allows the manager to monitor andcontrol risk - not to reduce or minimize it

Sam and Ellen Smithson have recently retired after numerous years of working as a heart surgeon and pediatrician,

respectively The Smithsons were unable to have children, so they devoted their lives to helping others through their

professional and charitable activities Sam is involved in the local "Pantry Pass," an organization that gathers food items fordistribution to the needy Ellen is involved in her local "Housing for the Homeless," chapter Over the years they have servedthe two organizations as active volunteers and as board members

The Smithson's professional activities generated high incomes, well in excess of expenses Prior to retirement, their lifestylecould be described as comfortably frugal Over the years, a retirement savings account in the amount of $4,000,000 wasaccumulated

Marcus Medley, CFA is an investment consultant who serves high net worth individuals During his discussions with theSmithsons, Sam and Ellen mentioned the following:

We consider our retirement portfolio to be large both in absolute terms and relative to our lifestyle needs

Our living expenses are estimated to be no greater than $150,000 per year, but we do want to maintain our purchasingpower without eroding the principal of our account

We are both in good health and have at least another 20 to 25 years of life expectancy We do not expect any majormedical expenses, either chronic or acute, over the foreseeable future

Z

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We have no debts and are not interested in anything that would require us to borrow

After we die, we would like to leave the remainder of our portfolio equally to the charities with which we have been involvedall these years One of our objectives is to maximize the funds transferred

Although we hope to leave a substantial estate to the charities, we wish to ensure that at least a floor value amount will betransferred

Neither one of us has a high tolerance for risk For the most part, our retirement savings have been in low-risk investmentvehicles Our investment portfolio decisions have been made in congruence with our desire to leave a legacy for futuregenerations and to help our fellow man

We know we could establish a charitable remainder trust but we're not ready to do that yet; we want to stay in control of allour assets as long as we're able Besides, our estate probably isn't large enough right now to be subject to death taxes

We agree with your firm's capital market expectations and the projection that inflation will average 3.25% over the term

long-We do not want to use any type of derivative security like options or futures - and we would never consider short selling.During the course of their meeting, Medley asks the Smithsons whether their approach to investing has been passive oractive Ellen Smithson says "Oh, I'm definitely the passive type - I don't believe in getting too involved, so I let Sam make most

of the decisions on our portfolio He's done a wonderful job up to now, but I guess it's time we had someone else take anactive role in helping us."

Sam comments, saying "Yes, it's pretty much been up to me My investment philosophy has been to invest 70% of our assets

in a total return bond fund and 30% in an S&P 500 index fund, thus ensuring that we track their performance fairly closelywhile holding down costs Then I've tried to get a little more juice by investing selectively in individual companies that producesurgical instruments or products for the cardiovascular field That way I can leverage my expertise and judiciously use mylimited time for investing."

Later, Medley reviews the Smithsons' personal statements and the latest economic activity forecasts He then begins toformulate an Investment Policy Statement (IPS) and some general asset allocation recommendations

Which of the choices below most closely matches the investment strategies of Ellen and Sam?

Ellen has no investment approach; Sam has a semi-active approach

Ellen has no investment approach; Sam has a passive approach

Ellen has a passive approach; Sam has a semi-active approach

Explanation

Ellen is describing a passive personality type, rather than a passive approach to investing Sam's investment methodology isclosest to that of semi-active (risk-controlled, enhanced index) managers He seeks to track an underlying index while trying toprovide extra value by more heavily weighting the medical technology and services sector (Study Session 9, LOS 20.b)

While writing the risk objective statement, Medley ponders the Smithson's ability and willingness to accept risk The Smithson'sappear to have the ability:

to take below-average risk; willingness to take above-average risk

to take above-average risk; willingness to take below-average risk

and willingness to take below-average risk

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One of the first concepts Medley wants to explain to the Smithson's at their next meeting is the idea of holding an "optimal"portfolio Which of the following will dictate the selection of an investor's optimal portfolio?

Any portfolio lying above the efficient frontier

The tangential intersection between an investor's risk and return and the efficient

of the risk free asset with the global market portfolio resulting in the highest Sharpe ratio (highest return for a given level ofrisk) (Study Session 8, LOS 18.r)

According to the Smithson's risk profile, a general asset allocation that would fit well with their objectives is:

an asset allocation heavily-weighted toward fixed-income to meet their current

income needs and provide for modest growth

an asset allocation heavily-weighted toward risk-free securities to meet their current

income needs and minimize the possibility of losing any of the original $4 million

a conservative, total return asset allocation to meet their current income and wealth

transfer goals

Explanation

An asset allocation that focuses on total return would appear to best meet the Smithson's objectives given the apparentdisconnect between ability and willingness to take risk The Smithson's need to earn a 3.75% return ($150,000/$4,000,000) tomeet their current income needs in today's dollars To protect their purchasing power, they must also generate an additional3.25% A conservative total return approach provides an appropriate balance between meeting their retirement needs andtheir goal of maximizing the amount of their charitable estate The risk-free and modest growth portfolios would not meet alltheir objectives (Study Session 8, LOS 18.g)

Which of the following dynamic asset allocation strategies would be most appropriate for meeting the Smithson's charitableobjectives?

Buy and hold

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Constant proportion portfolio insurance strategy.

Constant mix strategy

Explanation

A constant mix strategy would have a zero floor value, hence would not be an appropriate strategy for meeting Smithson'sobjectives A buy and hold strategy is not a dynamic asset allocation strategy but is the "do nothing" strategy where once yourinitial asset allocation is chosen you do not reallocate but instead just let the allocation fluctuate according to any changes inthe market (Study Session 16, LOS 31.j)

A constant mix asset allocation strategy assumes that an investor's risk tolerance:

increases as the portfolio value rises and falls as the portfolio value falls

falls as the portfolio value approaches the floor value

is constant, regardless of wealth levels

Explanation

With a constant mix strategy, an investor's risk tolerance is constant, regardless of wealth levels CPPI assumes that risktolerance increases as stocks rise and falls as stocks fall (Study Session 16, LOS 31.j)

Which of the following statements regarding asset allocation strategies is least accurate?

In order to effectively implement a strategic asset allocation strategy, the investor's risk

tolerance must remain constant

Tactical allocation is a contrarian investment strategy

Strategic asset allocation is a drifting mix strategy

Explanation

Strategic asset allocation is a constant-mix strategy It requires that a portfolio is rebalanced in order to maintain a prescribed allocation

Dynamic asset allocation is most suitable for investors who:

have insignificant liabilities

undertake the asset-liability approach to strategic asset allocation

have a long time horizon

Explanation

Dynamic asset allocation is most suitable for investors who have significant liabilities and utilize the asset-liability approach tostrategic asset allocation

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An investor has a spending rate of 8% If inflation is expected to be 3.50% annually and the cost of earning investment returns

is 0.5%, which of the following represents the correct weight of one of the asset classes that will at a minimum satisfy theinvestor's goals of capital preservation in real terms to an investor with a risk aversion value of 4?

Asset class 2 with weight of 50.00%

Asset class 1 with a weight of 42.90%

Asset class 3 with weight of 39.00%

With respect to the asset classes, the weights are then derived as follows:

Weight of asset class 1 = (0.22)(0%) + (0.78)(55%) = 42.90%

Carl Allen and Cliff Hanes are analysts for Tacticon Advisory (Tacticon) Allen and Hanes have been assigned the task ofdocumenting some of Tacticon's asset allocation techniques After receiving accolades in a recent trade magazine articlefeaturing investment firms with innovative trading strategies, their supervisor, Amos Ridley, decides it is time the firm beganformally documenting the firm's proprietary asset allocation process

Ridley wants Allen and Hanes to record the specifics of Tacticon's investment process for internal use He also wants them tocompile a document explaining a variety of allocation techniques to be used by the marketing staff and portfolio managers

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when working with prospects and clients

At their first meeting after receiving the assignment, a discussion of strategic and tactical allocation commences Allen andHanes feel confident about the distinction between the two, but are less certain about the differences between asset-liabilitymanagement (ALM) versus asset-only approaches to asset allocation

Hanes states "ALM and asset-only approaches are used for strategic asset allocation With ALM an investor's optimal assetallocation is directly related to explicit liability modeling On the other hand, with asset-only strategies, liabilities only indirectlyimpact the return objective."

Allen replies, "I'm not so sure I thought that tactical, asset-only approaches like immunization and cash flow matching aremore precise than ALM for controlling risk."

Strategic asset allocation:

involves short-term variations from an investor's normal asset mix

establishes a portfolio's long-term asset class exposures by integrating each element

of investment policy with capital market expectations

sets a portfolio's asset class exposures to unsystematic risk

Explanation

Strategic asset allocation establishes a portfolio's long-term asset class exposures by integrating each element of investmentpolicy with capital market expectations It affords an investor the ability to control systematic risk exposures by aligning theirrisk and return objectives with the actual portfolio of investments Tactical asset allocation involves adjustments away from thestrategic mix to take advantage of short-term projections of relative asset class performance

Concerning the discussion between Hanes and Allen about ALM versus asset-only allocation approaches:

both are correct

only one is correct

both are incorrect

Explanation

Hanes is correct: ALM and asset-only approaches are used for strategic not tactical asset allocation With ALM an investor'soptimal asset allocation is directly related to explicit liability modeling Allen is incorrect: with asset-only strategies, liabilitiesonly indirectly impact the return objective Asset-only approaches are less precise than ALM for controlling risk Immunizationand cash management are ALM approaches

Daniel Roe and Loretta Morgan are both potential new clients of Grachek Investment Advisors A summary of Ellen Grachek'snotes concerning the potential clients are as follows:

Roe stated that he wants to have a positive return on his $500,000 portfolio at all times, and that his required before-tax

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ᅞ A)

ᅚ B)

ᅞ C)

return is 7% On a risk aversion questionnaire, Roe scored an 8, with 10 indicating the highest risk aversion

Morgan indicated that her $1,000,000 portfolio must generate a 2% return each year in order to meet her living expenseswithout making any withdrawals from the portfolio's principal On a risk aversion questionnaire, Morgan scored a 3, with 10indicating the highest risk aversion

Grachek Investment Advisors has four model portfolios that they use for each client Characteristics for each portfolio areidentified below:

Portfolio Expected Return Standard Deviation

Statement 2: Using Roy's Safety-First Measure, Portfolio D generates a score of

0.40, and would be the worst choice of the four for Morgan's

portfolio

Regarding Gracket's statements:

Statement 1 is incorrect; Statement 2 is incorrect

Statement 1 is incorrect; Statement 2 is correct

Statement 1 is correct; Statement 2 is correct

Explanation

Grachek's statement regarding Roe is based on utility-adjusted return

Utility adjusted return = U = R - 0.005(A)(σ )

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Based on the calculations, Portfolio D would be the worst choice for Morgan's portfolio Statement 2 is correct

Which of the following would indicate that an asset class is useful for describing the returns of a portfolio?

The intercept term is significantly different from zero

The R-squared of the model is high

The error term is high

Explanation

A high R-squared would indicate that the model explains a good proportion of portfolio returns

Suzanne Melby, a newly hired analyst for Taylor Capital Advisors, is making a presentation to Taylor's investment committeeabout the practical concerns when adding new asset classes to an investment portfolio In her presentation, Melby makes twostatements:

Statement 1:We have seen from the previous charts that adding international

securities can increase the returns of a portfolio; however, from the

investor's standpoint, risk may be perceived as higher due to the

inclusion of currency, political, and legal risk

Statement 2:The investment committee has decided that some type of alternative

investment such as hedge funds should be included in all client

portfolios, but the large amounts of capital required and the difficulty

of finding information may prevent us from investing in alternative

investments in some client portfolios

With regard to Melby's statements, the Taylor Capital Advisors investment committee should:

agree with Statement 1, but disagree with Statement 2

disagree with Statement 1, but agree with Statement 2

agree with both Statement 1 and Statement 2

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practical concerns when investing in global securities and alternative investments such as hedge funds The practical

considerations of including global securities in a portfolio relate to risks that an investor does not face with a domestic-onlyportfolio such as currency, political, and legal risks Even if there are diversification benefits from including global securities, aportfolio manager needs to consider that the investor would be exposed to risks that they would not otherwise be exposed to.Melby's second statement is also correct as a lack of information, large amount of required capital, and the need to carefullyselect out-performers are all drawbacks to alternative investments that potentially could prevent the investment manager fromusing them in client portfolios

The phrase "conditional return correlations" can best be defined as:

correlation that depends upon market volatility

returns that are conditional upon the correlation used

correlation that increases during times of financial crises due to measurement bias

Explanation

The observation that correlations increase during financial crises is inconsistent with the assumption that correlation andstandard deviation remain stable over time One solution to this problem is run mean variance analysis and optimize theportfolio over two sets of data: one set assuming normal conditions of higher returns with lower correlations and volatilities plusanother set assuming lower returns with higher correlations and volatilities In other words return and correlation are

conditional on volatility The other two answers are less accurate One of the answers says return is conditional on correlation,that answer is less accurate Another answer says correlations increase during crisis, while this is a true statement it is not adefinition of conditional return correlations

What is the major difference between dynamic asset allocation and static asset allocation? Dynamic asset allocation:

considers asset and liability management simultaneously while static asset

allocation does not

considers more than one asset class while static asset allocation only considers one

asset class at a time

takes a multi-period view of the investment horizon while static asset allocation does

not

Explanation

Dynamic asset allocation takes a multi-period view of the investment horizon while static asset allocation does not Dynamicasset allocation and static asset allocation both can be used for asset only or asset-liability approaches to strategic assetallocation Both dynamic and static asset allocation approaches consider more than one asset class

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Return Exp Std Dev.

Asset Class Weights

Alternatively:

We solve for w in the following equation:

13.50 = w(13.66) + (1-w)(13.02)

w = 0.75

of corner portfolio 3 With respect to the US bonds asset class, the weight is then derived as follows:

Weight of US bonds = (0.75)(0%) + (0.25)(0%) = 0%

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ᅞ A)

ᅚ B)

ᅞ C)

The first step in the portfolio construction process is called:

tactical asset allocation

strategic asset allocation

capital market expectation

Explanation

The steps in the asset allocation process are:

1 Determine the investor's risk, return, and constraints

2 Formulate long-term capital market expectations

3 Determine the mix of assets (allocation) that best meets the objectives of the IPS

4 Monitor the portfolio

5 Adjust the portfolio as necessary for strategic or tactical asset allocation

Strategic asset allocation is the first step in the portfolio construction process which is step 3 above Tactical asset allocation isthe subsequent deviation from the strategic asset allocation based on short-term capital market expectations Capital marketexpectations are used for the generation of the efficient frontier used in step 2 above which occurs before the portfolio

construction takes place

James Mason is the Chief Operating Officer of the Homeless Mission Foundation (HMF), a foundation with the purpose ofproviding food, clothing, and shelter for homeless individuals Mason is currently in the process of preparing a report to HMF'sboard recommending an asset allocation for the foundation This year, Mason estimates that HMF's operating budget will be

$2.75 million In order to assist with preparation of his report, Mason has compiled the following data

The market value of the foundation is currently $50,000,000

The cost for providing services to homeless individuals is expected to rise at a rate of 3.0% per year

The board would like to maintain a cash cushion equal to half of the estimated operating budget in order to meet anyunexpected expenses

Management fees for the foundation are estimated to be 0.40%

The board is willing to accept market risk in order to meet its long-term objectives, but the board wants to accept shortfallrisk (defined as expected return minus two standard deviations) of no more than 15%

Mason must recommend one of three different portfolios to the board Mason's choice of portfolios is shown below:

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In his report, Mason is going to recommend a portfolio based on 3 criteria: liquidity needs, return requirements, and shortfallrisk Which of the portfolios should Mason recommend?

Portfolio B

Portfolio C

Portfolio A

Explanation

Liquidity requirements - Mason's notes stated that the portfolio needs to maintain cash equal to 50% of the estimated

operating budget This means that cash in the portfolio needs to be equal or greater than [(2.75)(0.5)]/50 = 2.75% All of theportfolios meet the liquidity requirement

Return Requirements - Spending is equal to (2.75/50) = 5.5% With inflation of 3.0% and management fees of 0.40%, thereturn requirement is (1.055)(1.004)(1.03) -1 = 9.10% Only Portfolios B meets the return requirement

Shortfall risk - The shortfall risk for each portfolio is as follows:

Portfolio A: 7.85% - (2 × 11.15%) = -14.45%

Portfolio B: 9.20% - (2 × 12.10%) = -15.00%

Portfolio C: 8.80% - (2 × 12.20%) = - 15.60%

Therefore, only Portfolios A and B meet the shortfall risk requirement

Since Portfolio B is the only one to meet all three requirements, Portfolio B is the best choice

Strategic asset allocation reflects what systematic risk exposure?

Long-term systematic risk exposure

Asset class systematic risk

Investor's desired systematic risk exposure

Explanation

Strategic asset allocation reflects the investor's desired systematic risk exposure

Which of the following does NOT accurately reflect a statement describing the resampled efficient frontier?

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At each level of return the most efficient of the simulated efficient portfolios is

at the center of a distribution

A single portfolio with specific asset class weights at each level of return

A portfolio may be considered statistically equivalent if the manager's portfolio is within

a 90% confidence interval of the most efficient portfolio

Explanation

A single portfolio with specific asset class weights at each level of return describes traditional mean variance optimization Theother answer choices describe the resampled efficient frontier where Monte Carlo simulation is used to create an efficientfrontier at each return level and run thousands of times resulting in an efficient frontier that is the result of an averagingprocess The efficient frontier becomes a blur rather than a single sharp curve At each level of return, the most efficient of thesimulated efficient portfolios is at the center of the distribution

Which of the following characteristics of asset classes is most desirable? Asset classes should:

Return Exp Std Dev.

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Asset Class Weights

of corner portfolio 5 With respect to asset classes, the weight is then derived as follows:

Intl bonds = (0.87)(5.24%) + (0.13)(0) = 4.56%

Intl equity = (0.87)(52.01%) + (0.13)(26.55) = 48.70%

Shad Reed is on the Board of Trustees for the Wesley Ridge World Hunger Organization The primary role of the organization

is to oversee a large endowment fund that was originally established in 1995 as the Wesley Ridge U.S Hunger Fund toprovide food to low income children in the United States Recently, the original donor for the endowment has died and

provided the fund another $200 million in his will and broadened the scope of the fund to provide food for hungry children allover the world With the new addition, the endowment's assets are currently valued at $600 million When the fund wasoriginally established, the spending rate was 5%; however, with the broader scope, the payout has increased to 6% Also,since funds are going to be distributed to other countries, the board has determined that approximately 25% of the

foundation's annual payout will be in the foreign currencies of other countries The fund's investment policy statement whichhas been revised by the board is shown below:

Return Objective Accounting for inflation of 2.5% and the new spending rate of 6%, the return requirement for the plan is

8.5% A total return approach is appropriate

Risk Tolerance Above average, although risk tolerance has declined due to higher spending needs

Liquidity The endowment has minimal operating expenditures - liquidity requirements are low.

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Which of the following sets of recommendations would be most appropriate for the endowment fund?

Decrease the allocation to U.S Equities, decrease the allocation to

international equities, increase the allocation to foreign government bonds,

and increase the allocation to intermediate-term U.S Treasury bonds

Increase the allocation to foreign government bonds, increase the allocation to

international equities, keep the allocation to cash the same, and keep the allocation to

venture capital the same

Increase the allocation to cash, decrease the allocation to U.S equities, decrease the

allocation to international equities, and increase the allocation to venture capital

Explanation

Since liquidity needs are low, the allocation to cash is appropriate Since payments are going to be made in foreign currencies,

it makes sense to increase the allocation to both foreign bonds and international equities Especially if these asset classeshave low correlation with other assets in the portfolio, increasing their weight in the portfolio could reduce risk, although theirhigher standard deviations suggest only moderate increases Since the fund has a long time horizon and above average risktolerance, the allocation to venture capital is fine given its above average returns and likely low correlation with other assets inthe portfolio

Which of the following is least accurate regarding an emerging market stock and country where the country has recently beenintegrated into the world markets?

The market microstructure becomes more efficient as transaction costs fall,

liquidity increases, and information flows more freely

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ᅞ B)

ᅚ C)

Capital costs will fall with higher stock prices and lower risk fueling economic growth

Portfolio diversification benefits increase as the stand-alone risk of the stock

investments that have minimal volatility Their current investment portfolio is valued at $1.2 million

The investment policy statement for the Herbsters is shown below:

Return Objective The Herbster's income requirement is $6,000 monthly Total return requirement is $72,000 /

$1,200,000 = 6%

Risk Tolerance Ability to take on risk: average Willingness to take risk: below average

Liquidity Need cash each year for the next four years to fund college education

Considerations Desire to fund daughter's college education.

The Herbster's current portfolio is shown below:

Asset/Fund

Allocation (%)

Expected Return

Expected Yield

Expected Standard Deviation Tucker Technology Common

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Undeveloped commercial

After reviewing the notes on the Herbster's, Morgan reviews recommendations complied by Todd Irons, a fellow portfoliomanager with IIM Irons' recommendations include the following:

Recommendation 1: Reduce the weighting in Tucker Technology common stock - the large position exposes the

portfolio to unnecessary security specific risk

Recommendation 2: Increase the allocation to the Diversified Bond Fund in order to increase income and

decrease volatility

Recommendation 3: Increase the allocation to Large Capitalization Equities to provide growth

Recommendation 4: Maintain the allocation to emerging market equities due to their high returns

Recommendation 5: Maintain the allocation the undeveloped commercial land due to its low correlation with

other assets in the portfolio

After reviewing Irons' recommendations, Morgan should agree with:

Recommendations 1, 2 and 4 only

Explanation

Morgan should agree with Recommendations 1, 2, and 3 The allocation to emerging market equities is probably too highgiven the Herbster's preference for low volatility investments Also, the allocation to undeveloped commercial land would be acash drain on the Herbster's portfolio due to payments for taxes, etc The Herbsters need income and liquidity to meet

ongoing portfolio disbursement requirements and the undeveloped commercial land provides neither

Kimbo Slice has several different places where he has assets in which he manages as separate accounts such as his checkingaccount which he uses for short term cash and emergency needs, his 401(k) account for retirement, and his children's collegefund In his 401(k) he owns a small cap stock in a company which makes catheters to be used in experimental cancer

treatment in which the catheter is used to deliver cancer killing drugs to hard to reach tumors in the body The stock hasrecently taken a downturn in price due to the FDA not approving their most recent catheter As a result of the downturn inprice, Slice purchases more of the stock in hopes of recouping his losses at some future time Slice's management of hisportfolio is indicative of:

money illusion and fear of regret

mental accounting and loss aversion

asset allocation and pyramiding

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