Deck 2: The Asset Allocation Decision

Question 1

Banks face regulatory constraints at both the state and federal level.

Answer 1

True

Question 2

____ are investment specialists that are responsible for managing the investments of others. There are often legal standards against which they must abide in the performance of their duties.

A)Underwriters
B)Investments bankers
C)Fiduciaries
D)Account executives
E)Trust officers

Answer 2

C

Question 3

The gifting phase is similar to, and may be concurrent with, the spending phase.

Answer 3

True

Question 4

Experts suggest life insurance coverage should be seven to ten times an individual's annual salary.

Question 5

Banks typically

A)Have low liquidity needs.
B)Face very few federal and state regulatory constraints.
C)Don't have to compete for funds.
D)Have high liquidity needs and a short time horizons constraint.
E)Low investment risk.

Question 6

Non-life insurance companies have somewhat unpredictable cash outflows and are therefore faced with different investment constraints than life insurance companies.

Question 7

Cash flows for nonlife insurance companies, such as property and casualty, are similar to cash flows of life insurance companies.

Question 8

The retirement plan that promises to pay a specific benefit to its beneficiaries is

A)A defined contribution plan.
B)A defined benefit pension plan.
C)A non-contribution pension plan.
D)An actuarial pension plan.
E)Supplemental Retirement Account (SRA).

Question 9

Banks must compete for funds (savings deposits, CD's, etc.) in order to make loans and other types of investments.

Question 10

Most experts recommend a cash reserve of at least one year's worth of living expenses.

Question 11

Long-term, high-priority goals include some form of financial independence.

Question 12

Endowment funds

A)Are formed from the contributions to charitable and educational institutions.
B)Are attractive investments for individuals with low liquidity needs.
C)Usually have very short investment horizons.
D)Provide retirement benefits for public employees.
E)Provide death benefits for its contributor's survivors.

Question 13

In a defined contribution pension plan,

A)The plan does not promise to pay the retiree a specific income stream after retirement.
B)The plan does promise to pay the retiree a specific income stream after retirement.
C)The employee's retirement income is not an obligation of the firm.
D)The company carries the risk of paying future pension benefits to retirees.
E)Choices a and c

Question 14

Defined contribution pension plans promise to pay retirees a specific income stream after retirement.

Question 15

Many endowments are tax-exempt.

Question 16

Term life insurance provides both a death benefit and a savings plan.

Question 17

Banks have high liquidity needs and therefore, have a short time horizon.

Question 18

The spending phase occurs when investors are relatively young.

Question 19

Which of the following is not true regarding defined contribution pension plans?

A)Employees make regular contributions to the plan.
B)Employers make regular contributions to the plan.
C)The employer bears all of the investment risk.
D)Benefits are directly related to the earnings of the funds investments.
E)The number of defined contribution plans is increasing.

Question 20

Which of the following statements concerning defined benefit plans is false?

A)The company bears the risk of investments
B)Employees are entitled to either a lump-sum payment or income stream at retirement
C)Risk tolerance depends on funding status and its actuarial rate
D)Defined benefit plans for young workers are typically more conservatively invested than defined contribution plans
E)All of the above are true statements

Question 21

The ability to retire at a certain age is a typical example of a long-term, lower-priority goal.

Question 22

Which of the following is not a life cycle phase?

A)Discovery phase
B)Accumulation phase
C)Consolidation phase
D)Spending phase
E)Gifting phase

Question 23

Equity allocations of pension funds in Japan and Germany are similar to those in the United States.

Question 24

Individual security selection is far more important than the asset allocation decision.

Question 25

Average tax rate is defined as total tax payment divided by total income.

Question 26

Risk tolerance is exclusively a function of an individual's psychological makeup.

Question 27

An appropriate investment objective for a typical 25-year-old investor is a low-risk strategy, such as capital preservation or current income.

Question 28

The majority of a pension fund's return is explained by asset allocation.

Question 29

Investment planning is complicated by the tax code.

Question 30

The portfolio mixes of institutional investors around the world are approximately the same.

Question 31

It is not a good idea to get too specific when constructing your policy statement.

Question 32

It is essential that both the client and the portfolio manager agree on an appropriate benchmark portfolio.

Question 33

Asset allocation is the process of dividing funds into different classes of assets.

Question 34

An example of a unique need in an investment policy statement is related to the legal responsibilities of a fiduciary or trustee.

Question 35

The typical investor's goals rarely change during his/her lifetime.

Question 36

Investing 30 to 40 percent of your retirement funds in the company you work for is reasonable when they match funds.

Question 37

In an investment policy statement the objectives of an investor are expressed in terms of

A)risk and return
B)risk
C)return
D)time horizon
E)liquidity needs

Question 38

Return is the only important consideration when establishing investment objectives.

Question 39

In constructing the portfolio, the manager should maximize the investor's risk level.

Question 40

The current outlay of money to guard against a potentially large future loss is commonly known as

A)Asset management.
B)Portfolio management.
C)Minimizing risk.
D)Loss control.
E)Insurance.

Question 41

Asset allocation is

A)The process of dividing funds into asset classes.
B)Concerned with returns variability.
C)Concerned with the risk associated with different assets.
D)Concerned with the relationship among investments' returns.
E)All of the above.

Question 42

Which of the following statements is true?

A)Except for tax-exempt investors and tax-deferred accounts, annual tax payments increase investment returns.
B)The only way to maintain purchasing power over time is to invest in bonds.
C)After adjusting for taxes, long-term bonds consistently outperform stocks.
D)An asset allocation decision for a taxable portfolio that does not include a substantial commitment to common stocks may make it difficult for the portfolio to maintain real value over time.
E)None of the above

Question 43

For an investor with a time horizon of 4 years and higher risk tolerance, an appropriate asset allocation strategy would be

A)100% cash
B)30% cash, 50% bonds, and 20% stocks
C)20% cash, 40% bonds, and 40% stocks
D)10% cash, 40% bonds, and 50% stocks
E)100% bonds

Question 44

Which of the following statements is false?

A)Unrealized capital gains are taxable.
B)Realized capital gains are taxable.
C)Tax-exempt investments are attractive to individuals with high tax liabilities.
D)Returns comparisons should be made on an equivalent tax basis.
E)Tax exempt investors prefer tax exempt investments.

Question 45

Important reasons for constructing a policy statement include:

A)Helps investors decide on realistic investment goals
B)Create a standard by which to judge the performance of the portfolio manager
C)Develop an instrument to judge risk
D)Choices a and b
E)All of the above

Question 46

Which of the following is not considered to be an investment objective?

A)Capital preservation
B)Capital appreciation
C)Current income
D)Total return
E)None of the above (that is, all are considered investment objectives)

Question 47

The first step in the investment process is the development of a(n)

A)Objective statement.
B)Policy statement.
C)Financial statement.
D)Statement of cash needs.
E)Statement of cash flows.

Question 48

For an investor with a time horizon of 12 years and higher risk tolerance, an appropriate asset allocation strategy would be

A)100% stocks
B)30% cash, 50% bonds, and 20% stocks
C)10% cash, 30% bonds, and 60% stocks
D)50% bonds and 50% stocks
E)100% bonds

Question 49

For an investor with a time horizon of 6 to 10 years and lower risk tolerance, an appropriate asset allocation strategy would be

A)100% stocks
B)100% cash
C)30% cash, 50% bonds, and 20% stocks
D)10% cash, 30% bonds, and 60% stocks
E)100% bonds

Question 50

____ is an appropriate objective for investors who want their portfolio to grow in real terms, i.e., exceed the rate of inflation.

A)Capital preservation
B)Capital appreciation
C)Portfolio growth
D)Value additivity
E)Nominal preservation

Question 51

____ gains are taxable and occur when an asset is sold for more than its basis (the value of the asset when it was purchased by the original owner, or inherited by the heirs of the original owner).

A)Realized capital
B)Income
C)Portfolio
D)Nominal
E)Real

Question 52

For an investor with a time horizon of 8 years and higher risk tolerance, an appropriate asset allocation strategy would be

A)100% stocks
B)100% cash
C)30% cash, 50% bonds, and 20% stocks
D)10% cash, 30% bonds, and 60% stocks
E)100% bonds

Question 53

Research has shown that the asset allocation decision explains ____% of the variation in fund returns across all funds, and ____% of the variation in returns for a particular fund over time.

A)90 and 100.
B)100 and 40.
C)90 and 40.
D)40 and 100.
E)40 and 90.

Question 54

The asset allocation decision must involve a consideration of

A)Cultural differences.
B)The objectives stated in the investor's policy statement.
C)The types of assets that are appropriate for the investor.
D)The risk associated with different investments.
E)All of the above.

Question 55

____ must be stated in terms of expected returns and risk. An investor's tolerance for risk must be established before returns objectives can be stated.

A)Investment requirements
B)Investment constraints
C)Investment rewards
D)Investment objectives
E)Investment policy

Question 56

The policy statement may include a ____ against which a portfolio's or portfolio manager's performance can be measured.

A)Milestone
B)Benchmark
C)Landmark
D)Reference point
E)Market pair

Question 57

For an investor with a time horizon of 15 years and moderate risk tolerance, an appropriate asset allocation strategy would be

A)100% stocks
B)40% cash and 60% stocks
C)30% cash, 50% bonds, and 20% stocks
D)50% bonds, and 50% stocks
E)20% bonds, and 80% stocks

Question 58

____ refer(s) to the ability to convert assets to cash quickly and at a fair market price and often increase(s) as one approaches the later stages of the investment life cycle.

A)Liquidity needs
B)Time horizons
C)Liquidation values
D)Liquidation essentials
E)Capital liquidations

Question 59

Which of the following is not a step in the portfolio management process?

A)Develop a policy statement.
B)Study current financial and economic conditions.
C)Construct the portfolio.
D)Monitor investor's needs and market conditions.
E)Sell all assets and reinvestment proceeds at least once a year.

Question 60

Once the portfolio is constructed, it must be continuously

A)Rebalanced.
B)Recycled
C)Reinvested
D)Monitored.
E)Manipulated.

Question 61

Assume that you invest $750 at the end of each quarter for the next 20 years in a mutual fund. The annual rate of interest that you expect to earn in this account is 5.25%. The amount in the account at the end of 20 years is

A)$60,000.00
B)$105,039.84
C)$37,009.35
D)$123,510.52
E)$115,637.37

Question 62

The future value of $50,000 invested today, at the end of 10 years assuming an interest rate of 7.5% per year, with semiannual compounding, is

A)$104,407.60
B)$103,051.58
C)$123,510.52
D)$210,673.43
E)$105,117.46

Question 63

Exhibit 2.1
USE THE TAX TABLE PROVIDED BELOW FOR THE FOLLOWING PROBLEM(S) $\begin{array} { l }&\text { If Taxable Income }&\text { Then }&\text { The Tax is }\\\text { Single }&\begin{array}{|r|r|}\hline {\text { Is Over }} & \text { But Not Over } \\\hline \$ 0 & \$ 7,150 \\\hline \$ 7,150 & \$ 29,050 \\\hline \$ 29,050 & \$ 70,350 \\\hline \$ 70,350 & \$ 146,750 \\\hline \$ 146,750 & \$ 319,100 \\\hline \$ 319,100 & - \\\hline\end{array}&&\begin{array}{|r|r|r|}\hline \text { This Amount } & \text { Plus This } \% & \text { Of The Excess Over } \\\hline 0 & 10 \% & 0 \\\hline 715 & 15 \% & \$ 7,150 \\\hline \$ 4,000 & 25 \% & \$ 29,050 \\\hline \$ 14,325 & 28 \% & \$ 70,350 \\\hline \$ 35,717 & 33 \% & \$ 146,750 \\\hline \$ 92,592.50 & 35 \% & \$ 319,100 \\\hline\end{array}\\\\\begin{array} { l } \text {Married }\\ \text {Filing }\\ \text {Jointly }\\\end{array}&\begin{array}{|r|r|}\hline \$ 0 & \$ 14,300 \\\hline \$ 14,300 & \$ 58,100 \\\hline \$ 58,100 & \$ 117,250 \\\hline \$ 117,250 & \$ 178,650 \\\hline \$ 178,650 & \$ 319,100 \\\hline \$ 319,100 & - \\\hline\end{array}&&\begin{array}{|r|r|r|}\hline 0 & 10 \% & 0 \\\hline 1430 & 15 \% & \$ 14,300 \\\hline \$ 8,000 & 25 \% & \$ 58,100 \\\hline \$ 22,787.50 & 28 \% & \$ 117,250 \\\hline \$ 39,979,50 & 33 \% & \$ 178,650 \\\hline \$ 86,328 & 35 \% & \$ 319,100 \\\hline\end{array}\\\end{array}$


-Refer to Exhibit 2.1. What is the average tax for a single individual with taxable income of $85,000?

A)13.57%
B)15.68%
C)21.68%
D)25.74%
E)29.55%

Question 64

Someone in the 15 percent tax bracket can earn 8 percent annually on his investments in a tax-exempt IRA account. What will be the value of a $10,000 investment after 5 years (assuming annual compounding)?

A)$ 6,805
B)$14,693
C)$15,528
D)$20,114
E)$50,000

Question 65

Which of the following is not a typical portfolio constraint?

A)Liquidity needs
B)Risk tolerance
C)Time horizon
D)Tax concerns
E)Legal factors

Question 66

Assume that you invest $1250 at the end of each of the next 15 years in a mutual fund. You currently have $10,000 in the mutual fund. The annual rate of interest that you expect to earn in this account is 4.35%. The amount in the account at the end of 15 years is

A)$58,940.30
B)$28,750.00
C)$37,009.35
D)$44,630.81
E)$25,690.50

Question 67

Exhibit 2.1
USE THE TAX TABLE PROVIDED BELOW FOR THE FOLLOWING PROBLEM(S) $\begin{array} { l }&\text { If Taxable Income }&\text { Then }&\text { The Tax is }\\\text { Single }&\begin{array}{|r|r|}\hline {\text { Is Over }} & \text { But Not Over } \\\hline \$ 0 & \$ 7,150 \\\hline \$ 7,150 & \$ 29,050 \\\hline \$ 29,050 & \$ 70,350 \\\hline \$ 70,350 & \$ 146,750 \\\hline \$ 146,750 & \$ 319,100 \\\hline \$ 319,100 & - \\\hline\end{array}&&\begin{array}{|r|r|r|}\hline \text { This Amount } & \text { Plus This } \% & \text { Of The Excess Over } \\\hline 0 & 10 \% & 0 \\\hline 715 & 15 \% & \$ 7,150 \\\hline \$ 4,000 & 25 \% & \$ 29,050 \\\hline \$ 14,325 & 28 \% & \$ 70,350 \\\hline \$ 35,717 & 33 \% & \$ 146,750 \\\hline \$ 92,592.50 & 35 \% & \$ 319,100 \\\hline\end{array}\\\\\begin{array} { l } \text {Married }\\ \text {Filing }\\ \text {Jointly }\\\end{array}&\begin{array}{|r|r|}\hline \$ 0 & \$ 14,300 \\\hline \$ 14,300 & \$ 58,100 \\\hline \$ 58,100 & \$ 117,250 \\\hline \$ 117,250 & \$ 178,650 \\\hline \$ 178,650 & \$ 319,100 \\\hline \$ 319,100 & - \\\hline\end{array}&&\begin{array}{|r|r|r|}\hline 0 & 10 \% & 0 \\\hline 1430 & 15 \% & \$ 14,300 \\\hline \$ 8,000 & 25 \% & \$ 58,100 \\\hline \$ 22,787.50 & 28 \% & \$ 117,250 \\\hline \$ 39,979,50 & 33 \% & \$ 178,650 \\\hline \$ 86,328 & 35 \% & \$ 319,100 \\\hline\end{array}\\\end{array}$


-Refer to Exhibit 2.1. What is the tax liability for a married couple filing jointly with taxable income of $125,000?

A)$23,800
B)$18,427
C)$24,958
D)$16,867
E)$19,650

Question 68

Research from the 1970s to the 1990s found that over 90 percent of a fund's returns over time is explained by:

A)Market timing
B)Stock selection
C)Manager selection
D)Asset allocation
E)All of the above

Question 69

An individual in the 15% tax bracket has $10,000 invested in a tax-exempt IRA account. If the individual earns 8% annually before taxes and inflation is 2.5% per year, what is the real value of the investment in 20 years?

A)$23,211
B)$28,467
C)$29,178
D)$37,276
E)$46,610

Question 70

What would the after-tax yield be on an investment that offers a 6 percent fully taxable yield? Assume a marginal tax rate of 31%.

A)2.79%
B)6.48%
C)4.14%
D)7.20%
E)12.50%

Question 71

For an investor with a time horizon of 5 years and moderate risk tolerance, an appropriate asset allocation strategy would be

A)100% cash
B)30% cash, 50% bonds, and 20% stocks
C)20% cash, 40% bonds, and 40% stocks
D)10% cash, 30% bonds, and 60% stocks
E)100% bonds

Question 72

Which of the following strategies seeks to increase the portfolio value by reinvesting current income in addition to capital gains?

A)Capital appreciation
B)Capital preservation
C)Return preservation
D)Current income
E)Total return

Question 73

You currently have $150,000 in an IRA designated for retirement. If you save an additional $100 at the end of every month and expect to earn an annual return of 12%, how much do you expect to have in the IRA in 10 years?

A)$467,632
B)$518,062
C)$732,546
D)$949,328
E)$1,215,234

Question 74

What would the equivalent taxable yield be on an investment that offers a 6 percent tax exempt yield? Assume a marginal tax rate of 28%.

A)0.125%
B)7.20%
C)6.48%
D)8.33%
E)32.14%

Question 75

Suppose the 8 percent investment of the previous problem is taxable rather than tax-deferred. What will be the after-tax value of his $10,000 investment after 5 years (assuming annual compounding)?

A)$10,680
B)$11,765
C)$13,895
D)$14,693
E)$15,528

Question 76

Exhibit 2.1
USE THE TAX TABLE PROVIDED BELOW FOR THE FOLLOWING PROBLEM(S) $\begin{array} { l }&\text { If Taxable Income }&\text { Then }&\text { The Tax is }\\\text { Single }&\begin{array}{|r|r|}\hline {\text { Is Over }} & \text { But Not Over } \\\hline \$ 0 & \$ 7,150 \\\hline \$ 7,150 & \$ 29,050 \\\hline \$ 29,050 & \$ 70,350 \\\hline \$ 70,350 & \$ 146,750 \\\hline \$ 146,750 & \$ 319,100 \\\hline \$ 319,100 & - \\\hline\end{array}&&\begin{array}{|r|r|r|}\hline \text { This Amount } & \text { Plus This } \% & \text { Of The Excess Over } \\\hline 0 & 10 \% & 0 \\\hline 715 & 15 \% & \$ 7,150 \\\hline \$ 4,000 & 25 \% & \$ 29,050 \\\hline \$ 14,325 & 28 \% & \$ 70,350 \\\hline \$ 35,717 & 33 \% & \$ 146,750 \\\hline \$ 92,592.50 & 35 \% & \$ 319,100 \\\hline\end{array}\\\\\begin{array} { l } \text {Married }\\ \text {Filing }\\ \text {Jointly }\\\end{array}&\begin{array}{|r|r|}\hline \$ 0 & \$ 14,300 \\\hline \$ 14,300 & \$ 58,100 \\\hline \$ 58,100 & \$ 117,250 \\\hline \$ 117,250 & \$ 178,650 \\\hline \$ 178,650 & \$ 319,100 \\\hline \$ 319,100 & - \\\hline\end{array}&&\begin{array}{|r|r|r|}\hline 0 & 10 \% & 0 \\\hline 1430 & 15 \% & \$ 14,300 \\\hline \$ 8,000 & 25 \% & \$ 58,100 \\\hline \$ 22,787.50 & 28 \% & \$ 117,250 \\\hline \$ 39,979,50 & 33 \% & \$ 178,650 \\\hline \$ 86,328 & 35 \% & \$ 319,100 \\\hline\end{array}\\\end{array}$


-Refer to Exhibit 2.1. What is the marginal tax rate for a single individual with taxable income of $85,000?

A)15%
B)25%
C)28%
D)33%
E)35%

Question 77

An individual in the 36% tax bracket has $20,000 invested in a tax-exempt account. If the individual earns 10% annually before taxes and inflation is 3.0% per year, what is the real value of the investment in 10 years?

A)$31,000
B)$33,200
C)$38,614
D)$39,343
E)$47,823

Question 78

John is 55 years old has $55,000 outstanding on a mortgage and no other debt. John typically saves $5,000 in an IRA account and another $10,000 in a company pension. John is most likely in the:

A)Discovery phase
B)Accumulation phase
C)Consolidation phase
D)Spending phase
E)Gifting phase

Question 79

An individual in the 36% tax bracket invests $5,000 in a tax-exempt IRA. If the investment earns 10% annually, what will be the value of the IRA after five years?

A)$6,600
B)$6,818
C)$7,500
D)$8,053
E)$10,879

Question 80

Exhibit 2.1
USE THE TAX TABLE PROVIDED BELOW FOR THE FOLLOWING PROBLEM(S) $\begin{array} { l }&\text { If Taxable Income }&\text { Then }&\text { The Tax is }\\\text { Single }&\begin{array}{|r|r|}\hline {\text { Is Over }} & \text { But Not Over } \\\hline \$ 0 & \$ 7,150 \\\hline \$ 7,150 & \$ 29,050 \\\hline \$ 29,050 & \$ 70,350 \\\hline \$ 70,350 & \$ 146,750 \\\hline \$ 146,750 & \$ 319,100 \\\hline \$ 319,100 & - \\\hline\end{array}&&\begin{array}{|r|r|r|}\hline \text { This Amount } & \text { Plus This } \% & \text { Of The Excess Over } \\\hline 0 & 10 \% & 0 \\\hline 715 & 15 \% & \$ 7,150 \\\hline \$ 4,000 & 25 \% & \$ 29,050 \\\hline \$ 14,325 & 28 \% & \$ 70,350 \\\hline \$ 35,717 & 33 \% & \$ 146,750 \\\hline \$ 92,592.50 & 35 \% & \$ 319,100 \\\hline\end{array}\\\\\begin{array} { l } \text {Married }\\ \text {Filing }\\ \text {Jointly }\\\end{array}&\begin{array}{|r|r|}\hline \$ 0 & \$ 14,300 \\\hline \$ 14,300 & \$ 58,100 \\\hline \$ 58,100 & \$ 117,250 \\\hline \$ 117,250 & \$ 178,650 \\\hline \$ 178,650 & \$ 319,100 \\\hline \$ 319,100 & - \\\hline\end{array}&&\begin{array}{|r|r|r|}\hline 0 & 10 \% & 0 \\\hline 1430 & 15 \% & \$ 14,300 \\\hline \$ 8,000 & 25 \% & \$ 58,100 \\\hline \$ 22,787.50 & 28 \% & \$ 117,250 \\\hline \$ 39,979,50 & 33 \% & \$ 178,650 \\\hline \$ 86,328 & 35 \% & \$ 319,100 \\\hline\end{array}\\\end{array}$


-Refer to Exhibit 2.1. What is the tax liability for a single individual with taxable income of $85,000?

A)$23,800
B)$18,427
C)$24,958
D)$16,867
E)$19,650