CFA Level 1 - Portfolio Management Session 18 - Reading 64

CFA Level 1 – Portfolio Management, Session 18 – Reading 64

(Notes, Practice Questions, Sample Questions)

1. Which one of the following alternatives correctly outlines the importance of the portfolio perspective?

A)Market participants should attempt to eliminate the unsystematic risk associated with each security by forming portfolios that will diversify away this risk.

B)Market participants should focus on the systematic risk of the components of a portfolio not the unsystematic risk of the components of a portfolio.

C)Market participants should analyze the risk-return trade-off of a portfolio as a whole, not the risk-return trade-off of the individual investments in a portfolio.

[Explanation: The key underlying principle of the portfolio perspective is that market participants should analyze the risk-return trade-off of the portfolio as a whole, not the risk-return trade-off of the individual investments in the portfolio]

2. Diversification can reduce:

A)systematic risk.

B)macroeconomic risks.

C)unsystematic risk. [Explanation: Systematic risk reflects factors that have a general effect on the security markets as a whole, and cannot be diversified away.

Macroeconomic risk comes in many forms, and it is usually considered systematic risk. Unsystematic risk can be reduced through diversification]

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

A)Developing an IPS. [Explanation: Developing an IPS is a subset of the planning process]

B)Feedback.

C)Execution.

4. In which step of the portfolio management process developing an IPS occur?

A)Strategic asset allocation.

B)Feedback

C)Planning. [Explanation: Developing an IPS occurs in the planning steps of the process.

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The purpose of developing an IPS is to govern decision making]

5. Which of the following most accurately identifies the three main steps in the portfolio management process?

A)Objectives, constraints, risk tolerance.

B)Planning, asset allocation, security selection.

C)Planning, execution, feedback. [Explanation: The three main steps in the portfolio management process are planning, execution, and feedback. The other items listed are subcomponents of these steps]

6. Which of the following most accurately identifies the three main steps in the portfolio management process?

A)Objectives, constraints, risk tolerance.

B)Planning, asset allocation, security selection.

C)Planning, execution, feedback. [Explanation: The three main steps in the portfolio management process are planning, execution, and feedback. The other items listed are subcomponents of these steps]

7. Which of the following is not considered an investment constraint?

A)Unique considerations.

B)High-risk securities. [Explanation: Although there may be reasons why high-risk securities are not included in an overall portfolio, they are only a consequence of constraining factors. Liquidity requirements and unique considerations are both constraining factors]

C)Liquidity requirements.

8. The guidelines in the investment policy statement are important because they:

A)dictate how subsequent managers should change portfolio implementation.

B)determine how to make portfolio shifts after dramatic short-term value declines.

C)allow continuity in implementation by current and subsequent managers. [Explanation: The investment policy statement creates implementation guidelines so that any competent manager can implement portfolio decisions]

9. Which of the following is least likely to be an advantage of a valid investment policy statement?

A)Provides for short-term strategy shifts in response to short-term dramatic value declines. [Explanation: The investment policy statement does not provide for shifts in strategy due to value declines]

B)Promotes long-term discipline in investment decisions.

C)Allows for a continual dynamic process in meeting investor objectives.

10. The investment policy statement is important because it helps:

A)direct long-term investment portfolio decisions that deter adjustments due to panic and overconfidence. [Explanation: The investment policy statement helps insure against short-term strategy changes due to panic or overconfidence]

B)direct long-term investment portfolio decisions and promotes adjustments in response to panic and overreaction.

C)direct short-term investment portfolio decisions as a result of short-term responses to overreacting markets.

11. The investment policy statement does not contain which of the following?

A)Portfolio position listing. [Explanation: The investment policy statement does not contain a listing of portfolio positions, only guidelines as to what positions are allowed]

B)Evaluation of investor risk preferences.

C)Asset allocation guidelines.

12. The investment policy statement does not contain:

A)industry specifics for potential investment. [Explanation: The investment policy statement may provide guidelines for which industry may or may not be included in the portfolio but will not provide specifics about industry characteristics]

B)guidelines for adjusting portfolio composition.

C)a client description.

13. A money manager who crafts portfolios using all of Standard & Poor’s sector index exchange traded funds (ETFs), aggressively overweighting and underweighting sectors, follows what investment strategy?

A)Semi-active. [Explanation: Semi-active strategies involve using indexes as the underlying investments, but trying to add value through some active management. In this case, the manager starts with index ETFs, but actively adjusts the allocation. He is a semi-active manager]

B)Active.

C)Passive.

14. Which of the following statements regarding the effect of investors’ time horizon on portfolio choice is least accurate?

A)Endowments and foundations typically invest with an average or below average tolerance for risk. [Explanation: Endowments and foundations typically invest with an average or above average tolerance for risk, in part due to their relatively longer investment time horizons]

B)Longer time horizons may indicate an investor’s greater ability to take risk, even if willingness is not apparent.

C)Legal and regulatory factors usually do not affect the investment policies of individual investors.

15. Which of the following factors are least likely to affect the formulation of an investment policy statement for a university’s endowment fund?

A)Multi-stage time horizons.

B)Tax considerations. [Explanation: An endowment would receive tax-exempt status, and therefore would not have to include tax considerations when formulating an investment policy statement]

C)Social considerations.

16. Max and Anna Klushefski have both turned 30 in the last year. The couple decides 30 is the right age to start thinking more about their future, so they meet with a financial planner, Thelma Black. Both Max and Anna work. Their 401k plans have a combined value of $135,000 and represent their only investment assets. Anna, a schoolteacher, is pregnant with their first child and plans to quit her job when the child is born. The couple hopes to have at least two more children. Max makes $65,000 per year as a junior executive at a clothing firm. The couple has been banking Anna’s salary for the last two years and can live on what Max makes.

Max and Anna had not thought much about their future, but in response to Black’s questions, they come up with two goals:

Anna wants to stay out of the work force until all of her children are out of the house.

Max wants to retire at 65 with at least $2 million in his portfolio.

Neither Max nor Anna knows much about investing, but Max’s friends tell him that stocks are the best option because they earn the best returns. Max and Anna want to invest most of their money in stocks.Based only on the information presented above, the Klushefskis’:

A)investment objectives are too aggressive.

B)plans need to consider time horizons. [Explanation:Given that a 30-year-old man is making $65,000 in an executive position, he can be excused for aiming fairly high. A $2 million portfolio is aggressive, but not necessarily out of reach, with 35 years to work on it. The Klushefskis are young enough so they can afford to take risks and can live on their work income. That meshes with their willingness to focus on stocks. However, their plans do not include payments for college or any other major expenses between now and retirement. They should consider other possible needs for their money and plan their finances according to those time horizons, as well as their retirement goals]

C)ability to take risk conflicts with their willingness to take risk.

17. Which of the following statements regarding the ethical conduct necessary for managing portfolios is least accurate?

A)The standard of conduct is embodied by the CFA Institute Code and Standards.

B)The portfolio manager should not presume that they have more knowledge than the client.[Explanation: Because the portfolio manager is an expert in the field, he or she has presumably more knowledge than the client. The manager is thus in a position of trust and should adhere to the highest standards of ethical conduct]

C)The portfolio manager should meet standards of competence.

18. Jack Weatherford is a portfolio manager and is providing advice for Maria Conn, an accountant. From his brief conversation with Conn, Weatherford has learned that Conn is 43 years old and her goal is to save for retirement. Weatherford has been extremely busy lately but would like to get Conn started with an asset allocation as soon as possible. He tells her that he might temporarily put her assets in domestic equities and then reallocate her assets when he has time. Which of the following statements is most accurate? Weatherford should:

A)not allocate her assets until he has developed an investment policy statement for her. [Explanation: Weatherford should not allocate her assets until he has determined her risk and return objectives as well as investment constraints. An entire allocation to equities may be unsuitable for her if, for example, she has high liquidity needs. Because the portfolio manager is an expert in the field, he or she has presumably more knowledge than the client. The manager should not rely on the client to make the investment decision. The manager should also not rely solely on the client’s profile to make the investment decision. The manager is in a position of trust and should meet both standards of competence and conduct]

B)invest Conn’s funds in the domestic equities immediately so Conn does not miss out on potential bull markets.

C)let Conn make investment decisions so that he avoids liability for potential investment losses.

19. Kelsey Opelt is a portfolio manager and is providing advice for Jay Steele, a retiree. Opelt has been working with Steele for many years. They have a good relationship and Opelt has taught Steele the basic of investments. Steele has fairly steady liquidity requirements. His house is paid for, he has good health insurance, and he has a steady pension. He only requires $1,000 a month in spending money that allows him to enjoy retirement. His children are grown and financially independent. His wife Harriet passed away five years ago. Because of Steele’s steady lifestyle, low liquidity requirements, and investment knowledge, Opelt has not adjusted Steele’s portfolio for capital market expectations in many years. The portfolio has performed quite well recently, due to an average return in the stock market of 25% over the past three years. Opelt should:

A)not perform any actions because Steele’s circumstances have not changed, and are not expected to change, for many years.

B)monitor the portfolio and capital market expectations more closely. [Explanation: Opelt should monitor the portfolio and capital market expectations more closely. Although it appears that Steele’s circumstances have not changed, capital market conditions can change, which could call for a change in asset allocation. This may well be the case here because of the recent high stock market returns. Monitoring the portfolio and capital market expectations is an important part of portfolio management]

C)not interfere with the portfolio because it is performing so well.