Deck 16: Investors and the Investment Process

Question 1

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 1

B

Question 2

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

Answer 2

B

Question 3

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

Answer 3

A

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.

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

Question 5

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

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

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?

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

Question 7

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

Question 8

To ________ means to mitigate a financial risk.

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

Question 9

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

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

Question 10

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

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

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 ________.

A)a money market fund
B)a growth share fund
C)several different money market instruments
D)several different shares

Question 12

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 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

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

Question 14

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 15

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 16

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 17

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; non-investable capital

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 ________.

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 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 ________.

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

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?

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

Question 21

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 22

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 23

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 24

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 25

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 26

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 shares 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 27

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

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

Question 28

An active asset allocation strategy involves ________.

A)investing in the shares 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

________ 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 30

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 31

A passive asset allocation strategy involves ________.

A)investing in the shares 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

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 33

Endowment funds are held by ________.

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

Question 34

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 35

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 36

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 37

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 38

________ 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 39

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 40

Many defined benefit pension plans have a target rate of return on investment equal to ________.

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

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

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

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

Question 43

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 44

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 45

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

Question 46

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

Question 47

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 shares.
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 48

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)counselling employees in the selection of asset classes
D)paying employees the market rate of return on employee contributions

Question 49

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 re-evaluating the fund's $100 million portfolio at this time. She is bullish on shares and wants to put the most she can into the share 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 shares and still ensure meeting the bond payments?

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

Question 50

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 51

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 52

A life insurance firm wants to minimise 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 shares
B)5-year zero coupon bonds
C)10-year coupon bonds
D)Money market investments rolled over as needed

Question 53

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 54

Go Global Investment Management has an asset allocation strategy of 60% US investments and 40% global investments. Within the US Go Global has allocated 70% of its portfolio to equities and 30% to bonds. Go Global now holds 3% of its US 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 55

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 56

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 shares 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 you recommend for her?

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

Question 57

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)Organising the investment management process itself

Question 58

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 minimise trading costs

Question 59

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 60

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