Deck 2: Asset Allocation and Security Selection

Question 1

The third step of the portfolio management process is to construct the portfolio.

Answer 1

True

Question 2

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

Answer 2

False

Question 3

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

Answer 3

True

Question 4

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

Question 5

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

Question 6

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

Question 7

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

Question 8

The spending phase occurs when investors are relatively young.

Question 9

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

Question 10

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

Question 11

Return is the only important consideration when establishing investment objectives.

Question 12

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

Question 13

Investment planning is complicated by tax concerns.

Question 14

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

Question 15

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

Question 16

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

Question 17

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

Question 18

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

Question 19

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

Question 20

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

Question 21

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

Question 22

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

Question 23

The ____ phase is the stage when investors in their early-to-middle earning years attempt to accumulate assets to satisfy near-term needs,e.g., children's education or down payment on a home.

A) accumulation
B) spending
C) gifting
D) consolidation
E) divestiture

Question 24

____ 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 25

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 26

____ 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 27

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 28

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 29

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 30

John is 55 years old and 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 31

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

Question 32

Arts and antiques are inferior inflation hedges compared to long-term bonds and common stocks.

Question 33

Individual real estate assets had much lower standard deviations and either low positive or negative correlations with other asset classes in a portfolio context.

Question 34

____ 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 35

Once the portfolio is constructed, it must be continuously

A) rebalanced.
B) recycled
C) reinvested
D) monitored.
E) manipulated.

Question 36

One of the reasons for constructing a policy statement is it

A) creates a standard by which to judge the performance of the investor.
B) helps the investor decide on realistic investment goals.
C) is open-ended in order to provide guidance for specific investments and time frames.
D) guarantees success.
E) helps the portfolio manager to become familiar with financial markets and investing risks.

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

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

Question 39

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) nominal preservation

Question 40

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 41

The future value of $50,000 invested today, at the end of 10 years assuming an interest rate of 7.5 percent 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 42

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 43

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 five years (assuming annual compounding)?

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

Question 44

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 percent. 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 45

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 percent. 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 46

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 47

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 percent.

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

Question 48

USE THE TAX TABLE PROVIDED BELOW FOR THE FOLLOWING PROBLEM(S)

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 49

An individual in the 36 percent tax bracket has $20,000 invested in a tax-exempt account. If the individual earns 10 percent annually before taxes and inflation is 3.0 percent 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 50

An individual in the 36 percent 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 51

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 percent, 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 52

An individual in the 15 percent tax bracket has $10,000 invested in a tax-exempt IRA account. If the individual earns 8 percent annually before taxes and inflation is 2.5 percent 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 53

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 five years (assuming annual compounding)?

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

Question 54

____ 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 55

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 percent.

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

Question 56

USE THE TAX TABLE PROVIDED BELOW FOR THE FOLLOWING PROBLEM(S)

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 57

USE THE TAX TABLE PROVIDED BELOW FOR THE FOLLOWING PROBLEM(S)

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

Question 58

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 59

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 these are correct.

Question 60

USE THE TAX TABLE PROVIDED BELOW FOR THE FOLLOWING PROBLEM(S)

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 61

Adding Japanese, Australian, and Italian stocks to a U.S. stock portfolio _____ the portfolio risk because the global portfolio reflects only worldwide _____.

A) reduces; systematic factors
B) increases; systematic factors
C) does not change; correlation
D) reduces; risk
E) increases; risk

Question 62

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 these are correct.

Question 63

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; 100
B) 100; 40
C) 90; 40
D) 40; 100
E) 40; 90

Question 64

Most art and antiques are _____, and the transaction costs are ____ compared to those of financial assets.

A) illiquid; low
B) illiquid; high
C) liquid; low
D) liquid; high
E) correlated to bonds; high

Question 65

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

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

Question 66

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

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

Question 67

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 these are correct.

Question 68

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

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

Question 69

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) cash allocation.

Question 70

A study examining the performance of numerous assets from the United States and around the world confirms that

A) riskier assets with higher standard deviations experienced lower returns.
B) riskier assets with lower standard deviations experienced higher returns.
C) standard deviation did a better job of explaining the returns than beta.
D) U.S. equities have zero correlation with world government bonds and with the commodities index.
E) most assets (including common stocks) have positive correlations with inflation.

Question 71

A study examining the performance of numerous assets from the United States and around the world confirms that

A) riskier assets with higher standard deviations experienced lower returns.
B) riskier assets with lower standard deviations experienced higher returns.
C) beta did a better job of explaining the returns than standard deviation.
D) U.S. equities are highly correlated with world government bonds and with the commodities index.
E) most assets (including common stocks) have positive correlations with inflation.

Question 72

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

Question 73

A study examining the performance of numerous assets from the United States and around the world confirms that

A) riskier assets with higher standard deviations experienced lower returns.
B) riskier assets with lower standard deviations experienced higher returns.
C) standard deviation did a better job of explaining the returns than beta.
D) U.S. equities are highly correlated with world government bonds and with the commodities index.
E) most assets (including common stocks) have negative correlations with inflation.

Question 74

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

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

Question 75

A study examining the performance of numerous assets from the United States and around the world confirms that

A) riskier assets with higher standard deviations experienced lower returns.
B) riskier assets with higher standard deviations experienced higher returns.
C) standard deviation did a better job of explaining the returns than beta.
D) U.S. equities are highly correlated with world government bonds and with the commodities index.
E) most assets (including common stocks) have positive correlations with inflation.

Question 76

Adding foreign stocks and bonds to a U.S. portfolio will almost certainly _____the risk of the portfolio and can possibly _____ its average return.

A) reduce; increase
B) increase; reduce
C) increase; increase
D) decrease; decrease
E) not change; decrease

Question 77

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

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