Deck 22: Investors and the Investment Process

Question 1

To ________ means to mitigate a financial risk.

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

Answer 1

C

Question 2

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

Answer 2

A

Question 3

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

Answer 3

B

Question 4

To become a CFA, you must do all of the following except which one?

A) Pass three exams designed to ensure that 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 5

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 6

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 7

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

A) Treasury bills
B) common stock
C) corporate bonds
D) real estate

Question 8

The two most important factors in describing an individual's 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 9

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 10

Just 2 months after you put money into an investment, its price falls 25%. 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 but cheap too.
D) You sue your financial adviser.

Question 11

At the early stage of an individual's working career, his or her retirement portfolio should probably consist mostly of ________.

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

Question 12

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

Question 13

As the typical investor ages, the composition of his 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 wants to invest 100% of her portfolio in safe assets but does not want 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

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

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

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 18

SoHo International Investment Management has an asset allocation strategy of 57% U.S. investments and 43% global investments. Within the United States, Go Global has allocated 55% of its portfolio to equities and 45% to bonds. SoHo International now holds 4.4% of its U.S. equity portfolio in the stock of Bright Force. Internationally, SoHo International has allocated 72% to equities and 28% to bonds. About what percentage of SoHo International's total portfolio is invested in Bright Force?

A) 1%
B) 1.26%
C) 1.5%
D) 1.81%

Question 19

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 20

You are thinking of investing in one of two assets. Asset A has higher systematic risk than asset B. You can be sure that asset A's ________ return will be higher than asset B's, but you can't be sure if asset A's ________ return will be higher than asset B's.

A) realized; expected
B) real; nominal
C) expected; realized
D) nominal; expected

Question 21

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

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

Question 22

Which 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 23

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 24

A passive asset allocation strategy involves ________.

A) investing in the stock of companies that 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 25

An active asset allocation strategy involves ________.

A) investing in the stock of companies that 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 26

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

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

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 individual is on the game show Squeal or No Squeal, and she has a choice between receiving a certain gain of $100,000 and receiving a 50% chance of winning $200,000 or zero. 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 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

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 31

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 32

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 33

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 34

A pension fund will owe $15 million to retirees in 8 years. An actuary assumes an 7% 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 each year to fully fund the pension liability?

A) $1,212,587
B) $1,462,016
C) $1,533,333
D) $1,666,667

Question 35

A pension fund will owe $ 20 million to retirees in 25 years. An actuary assumes a 5.6% rate of return on the funds invested in the pension plan, but the fund actually earns 7.1%. The pension plan receives annual contributions from the company sponsor. If the 7.1% rate of return is expected to continue, by how much can the company reduce its pension payments per year?

A) $65,437
B) $73,871
C) $89,462
D) $95,320

Question 36

Empirical evidence confirms that investors become ________ as they approach retirement.

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

Question 37

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 38

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) a personal trust
B) a charitable trust
C) an endowment fund
D) a mutual fund

Question 39

An employee has an average wage of $60,000 and has worked for the firm for 28 years. The defined benefit pension plan pays retirees 2.3% of the average wage times the years of service. The employee can expect to receive ________ per year upon retirement.

A) $18,000
B) $38,640
C) $45,325
D) $55,250

Question 40

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 on to 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 half of your stock holdings and invest the proceeds in other areas of your portfolio.

Question 41

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 42

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 43

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 44

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 45

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 46

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 be approved by a prudent investor

Question 47

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 her 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 48

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

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

Question 49

The prudent investor rule 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 50

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 51

Suppose that the pretax 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) The answer cannot be determined from the information given.

Question 52

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 53

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 54

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 55

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 56

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 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) none of these options (A policy statement is necessary for all three.)

Question 58

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 management and passive management

Question 59

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-growth; high growth
D) high-growth; moderate growth

Question 60

Endowment funds are held by ________.

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

Question 61

Medfield College's $10 million endowment fund is not allowed to spend any contributed capital or any capital gains. The fund may spend only 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 that the fund 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 62

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 63

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 that they are primarily focused on long-term capital gains and 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. 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 64

A life insurance firm wants to minimize its interest rate risk, and it is planning on paying out $250,000 in 5 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 65

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 a retirement plan

Question 66

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 67

An investor with high risk aversion will likely prefer which of the following risk and 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 68

A portfolio consists 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 69

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 70

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 71

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 that they are primarily focused on safety of principal and 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. 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 72

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 73

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 into 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 you recommend for her?

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

Question 74

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 total portfolio of $100 million at this time. She is bullish on stocks and wants to put the most she can into the stock market, but she cannot risk being unable 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%
D) 91.6%

Question 75

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

A) mutual funds
B) pension funds
C) life insurers
D) banks

Question 76

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 77

A portfolio consists of three index funds: an equity index accounting for 40% of the total portfolio, a bond index accounting for 30% of the total portfolio, and an international index accounting for 30% of the total portfolio. After each quarter the portfolio manager buys and sells some of each sector 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

Question 78

The asset universe is the ________.

A) set of investments in which an investment company can legally invest
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 into the investment company's portfolio
D) market portfolio of all available risky assets

Question 79

An investor with low risk aversion will likely prefer which of the following risk and 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 80

Go Global Investment Management has an asset allocation strategy of 70% U.S. investments and 30% global investments. Within the United States, Go Global has allocated 65% of its portfolio to equities and 35% to bonds. Go Global now holds 4% of its U.S. equity portfolio in the stock of Wally World. Internationally, Go Global has allocated 62% to equities and 38% to bonds. About what percentage of Go Global's total portfolio is invested in Wally World?

A) 1%
B) 1.26%
C) 1.5%
D) 1.82%