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标题: Portfolio Management and Wealth Planning【Reading 15】 [打印本页]
作者: andytrader    时间: 2012-3-23 13:47     标题: [2012 L3] Portfolio Management and Wealth Planning【Session 5 - Reading 15】

The funding status of an ongoing defined benefit plan is usually computed by the plan’s:
A)
accumulated benefit obligation (ABO).
B)
total future liability (TFL).
C)
projected benefit obligation (PBO).


Funding status is the relationship between present value of pension assets and present value of pension liabilities. Determining over- or under-funded status for an ongoing defined benefit plan is usually computed using the plan’s projected benefit obligation (PBO). Defined contribution plans do not have a funded status.
作者: andytrader    时间: 2012-3-23 13:47

Which of the following statements about participant-directed defined contribution plans is CORRECT?
A)
The plan must offer a sufficient number of investment vehicles for suitable portfolio construction.
B)
Defined contribution plans are not subject to ERISA.
C)
Defined contribution plans are structured similar to foundations.


For participant-directed defined contribution plans, each employee has his/her own account; hence, the structure is not similar to foundations. Defined contribution plans are subject to ERISA.
作者: andytrader    时间: 2012-3-23 13:48

From the perspective of the employer, which of the following statements is most accurate? A defined:
A)
contribution plan can be underfunded; a defined benefit plan is more risky.
B)
benefit plan can be underfunded; a defined contribution plan is less risky.
C)
benefit plan can be underfunded; a defined contribution plan is more risky.


A defined benefit plan is underfunded when the present value of the liabilities exceeds the present value of the plan’s assets. A defined contribution plan cannot become underfunded, and is, therefore, considered to be less risky from the standpoint of the employer.
作者: andytrader    时间: 2012-3-23 13:51

Which of the following statements regarding defined benefit and defined contribution pension plans is least accurate?
A)
The liability to a defined contribution plan sponsor is the current plan contribution requirement.
B)
The risk and return of defined benefit pension fund investments is borne by the plan participants.
C)
Promised benefits under a defined benefit plan are paid to plan participants at retirement and represent a liability to the plan sponsor.


As long as a pension sponsor is solvent, the performance of the fund’s investments has no impact on the benefits promised to the employees covered by the plan. The risk and return characteristics of the assets of a defined benefit pension fund are borne by the plan sponsor.
作者: andytrader    时间: 2012-3-23 13:51

A number of years ago Palmer Steel Company began offering a defined contribution pension plan only to new employees, while retaining a defined benefit plan for current employees. As a result the firm must now administer two pension plans: a defined contribution plan for its 2,500 current employees and a defined benefit plan for 1,000 older employees, almost all of whom are now retired. The firm expects to fund pension payments to retired employees out of the defined benefit plan for the next 20 years.
Recent operating problems in the volatile steel industry have resulted in several years of losses and layoffs at Palmer Steel, as well as a weak company balance sheet. The assets in the defined benefit plan have a moderate degree of correlation with the firm's operating income. The fund currently has a 10% surplus. Inflation is expected to average 3% per year for the foreseeable future.
The required real rate of return in the defined benefit plan based on actuarial assumptions is 5%. The duration of the fund's liabilities is 8 years.Because the firm is in the position of having to administer two types of pension plans, Todd Thoms, the CFO, is reviewing the relevant management issues in preparation for a presentation to the Board of Directors. Which of the following issues is framed properly from the perspective of both Palmer Steel and its employees?
A)
One shortcoming of the defined contribution plan from the employees' perspective is that the long-term rate of return is highly uncertain, and depends on investment choices made by employees.
B)
Palmer Steel should diversify the assets of BOTH plans so that the correlation between those assets and the operating cash flow of the firm itself is low, in order to improve the probability of BOTH funds meeting their respective obligations.
C)
One shortcoming of the defined contribution plan from the perspective of Palmer Steel is that it is more costly to administer.


Defined benefit pension plans tend to be more costly for the company to administer. The company bears the investment risk in a defined benefit plan, and employees bear the investment risk in a defined contribution plan. The correlation between plan assets and company cash flow is an important consideration for a defined benefit plan but not a defined contribution plan. With a defined benefit plan, the firm faces the potential risk that in slow economic conditions, the investment performance of the fund will be reduced, increasing the firm's funding obligation to keep the plan fully funded, at the same time as the firm's operating cash flow is reduced.
Choose the answer that best completes the return objective for the defined benefit plan. The return objective is to generate total returns sufficient to meet projected pension liabilities while protecting against inflation. The effective maturity of the pension liabilities and the volatility of the firm's earnings require an emphasis on:
A)
income-producing assets with a nominal return of 8% and a portfolio with a maturity of 20 years.
B)
income-producing assets with a nominal return of 8% and a portfolio with a duration of 8 years.
C)
long-term capital gains to minimize taxes and a nominal after-tax return of 8% and a portfolio with a duration of 8 years.


The return requirement is the real return required on the plan assets plus the expected inflation rate, 5% + 3% = 8%. Because of the short-term nature of the liabilities, the portfolio should be managed to match the duration of the liabilities (8 years), not the expected final maturity of the last payment (20 years). Taxes are not a consideration in a pension plan.
Which of the following factors is NOT consistent with a low risk tolerance for the defined benefit fund?
A)
Palmer Steel has a weak balance sheet.
B)
The plan has a surplus.
C)
Palmer Steel has volatile operating earnings.


Over-funded pension plans can be somewhat more risk tolerant, all else equal, because the over-funding is a cushion against short-term fluctuations in investment returns. Both of the other choices are consistent with a lower risk tolerance.
Which of the following constraints is appropriate to include in the defined benefit plan's Investment Policy Statement?
A)
The fund is constrained to operate under the regulations of ERISA, which require the fund be managed solely in the interest of the plan sponsors and beneficiaries, using the standard of the Prudent Man Rule.
B)
Taxes are not a major issue for the fund because earnings are tax-exempt.
C)
Liquidity needs are low because of the low correlation between the fund assets and the firm's operating income.


The short-term pension liabilities require significant liquidity. ERISA requires the standard of the Prudent Expert Rule, rather than the more restrictive Prudent Man Rule, and that the fund is managed in the sole interests of the plan beneficiaries, not the plan sponsors.
作者: andytrader    时间: 2012-3-23 13:52

Which of the following is a characteristic of a defined-benefit pension plan?
A)
Contributions to the plan are typically a percentage of plan participants current pay.
B)
Defined benefit plans are less expensive to administer and young employees like the portable nature of their contributions.
C)
Plan sponsors bear all investment risk. They are liable for shortages and have a claim against excess returns.


Retirement benefits from a defined benefit plan are based on a "defined benefit" formula. This is what the company owes the plan’s participants, regardless of the performance of the pension funds assets, and if the fund’s returns fall short of the pension obligations, the plan sponsor is liable for the difference. Defined benefit plans are costlier and riskier than defined contribution plans. Thus, defined contribution plans are the preferred pension plan for most employers. Also, since plan contributions are transferable to other plans, defined contribution plans are attractive to many young employees.
作者: andytrader    时间: 2012-3-23 13:52

A defined benefit plan differs from a defined contribution plan in that the:
A)
benefit paid by the sponsor is defined by contributions made to the plan.
B)
risk/return tradeoffs of plan assets accrue to the plan sponsor.
C)
risk/return tradeoffs of plan assets accrue to the participant.


All investment decisions are made by the plan sponsor, and all risk/return tradeoffs accrue to the sponsor. The benefits paid by a defined benefit plan are determined by a specified benefit formula, not by what was contributed to the plan.
作者: andytrader    时间: 2012-3-23 13:52

A defined contribution plan differs from a defined benefit plan in that the:
A)
investment decisions are made by the plan sponsor.
B)
risk/return tradeoffs of plan assets accrue to the plan sponsor.
C)
risk/return tradeoffs of plan assets accrue to the participant.


All investment decisions of defined contribution assets are made by the participant, which dictates to whom plan asset risk/return tradeoffs accrue—the participant. The benefit paid is determined by the value of the investment assets at retirement. The only requirement of the plan sponsor is the stated contribution made to the participant’s account.
作者: andytrader    时间: 2012-3-23 13:53

Which of the following is a characteristic of a defined-contribution pension plan?
A)
Investment risk of plan assets is shifted to the individual.
B)
Up to a maximum limit, the Pension Benefit Guaranty Corp (PBGC) insures plan contributions.
C)
Benefits are based on specific formulas relating to employee earnings or length of service.


For defined contribution plans, investment risk is borne by the pension beneficiary. The plan sponsor, and frequently the plan participant, make “defined contributions” to the plan. The pension benefit to the participant is based on the pension fund’s investment performance.
作者: andytrader    时间: 2012-3-23 13:53

The funded status/surplus of a defined benefit plan impacts the risk tolerance of investment activities and is best described as:
A)
larger pension surpluses indicate lower risk tolerance.
B)
there is no relationship between surplus in risk tolerance in a defined benefit plan.
C)
larger pension surpluses indicate higher risk tolerance.


A larger pension surplus indicates higher risk tolerance. Although willingness to take risk may be low, ability to take risk exists. Under-funded plans, however, may be willing to take high risk to make up pension shortfalls, but less ability to take risk exists due to an existing deficit between pension assets and liabilities.
作者: andytrader    时间: 2012-3-23 13:54

The discount rate used to determine the present value of pension liabilities is the fund’s:
A)
contribution return.
B)
required return.
C)
desired return.


The discount rate used to determine present value of pension liabilities is that rate which discounts pension benefits, and hence, dictates the rate of return on pension assets that must be met to fund pension benefits. A fund’s desired return, however, may be higher and could relate to the amount of contributions a firm makes to the plan and/or the amount of benefits a plan wishes to offer participants.
作者: andytrader    时间: 2012-3-23 13:54

The liquidity requirement of a pension plan is directly related to and increased by a:
A)
high proportion of retired lives.
B)
high proportion of active lives.
C)
low proportion of retired lives.


Pension plan liquidity requirements are increased by the proportion of participants currently receiving benefits. Hence, a high proportion of retired lives, those currently receiving benefits, indicates a larger liquidity requirement.
作者: andytrader    时间: 2012-3-23 13:54

Which of the following could dictate that a pension fund take on less risk?
A)
The firm's declining growth rate.
B)
A declining debt/equity ratio.
C)
Pension surplus.


The question obviously refers to defined benefit plans. If the firm is experiencing declining sales growth, then this speaks negatively about the financial status of the company. The sponsor’s financial status and profitability affect how much risk the plan can take. Both of the other selections are positives for the plan.
作者: andytrader    时间: 2012-3-23 14:02

Pension fund risk tolerance is increased by a young workforce and:
A)
high plan sponsor leverage.
B)
high retired-lives proportion.
C)
low retired-lives proportion.


Pension fund risk tolerance is increased by having a young workforce and a small proportion of retired lives. Both of the other combinations with a young workforce will tend to decrease risk tolerance.
作者: andytrader    时间: 2012-3-23 15:09

Pension fund risk tolerance increases according to:
A)
greater plan sponsor leverage.
B)
high flexibility in plan features.
C)
less plan sponsor leverage.


Pension fund risk tolerance increases when the plan sponsor has lower leverage. The higher the correlation between sponsor activities, as well as high flexibility in plan features (e.g., early retirement options), work to decrease the risk tolerance of a pension plan.
作者: andytrader    时间: 2012-3-23 15:11

Pension fund risk tolerance increases with:
A)
provisions for early retirement or lump-sum payouts.
B)
a low retired lives portion.
C)
high plan asset and plan sponsor operating characteristic correlation.


A low number of retired lives usually indicates an increased ability to take risk. Both of the other answers work to decrease pension fund risk tolerance. Pension fund risk tolerance decreases when plan assets and plan sponsor operating characteristics have high correlation. The ability for the plan sponsor to make contributions is decreased at the most inopportune time when plan assets and operating characteristics are highly correlated. Hence, risk tolerance decreases in a highly correlated environment. Plans that offer early retirement or lump-sum payments essentially decrease the time horizon of the retirement liability and increase the liquidity requirements of the plan, so the ability to tolerate risk is decreased.
作者: andytrader    时间: 2012-3-23 15:12

The potential effect of a pension plan policy that positively impacts a plan surplus is a:
A)
low discount rate, high retired-lives portion, and high liquidity.
B)
high discount rate, plenty of plan feature flexibility, and high liquidity requirements.
C)
high discount rate, low plan feature flexibility, and low liquidity requirements.


Pension plan surplus may be positively impacted by using a high discount rate to determine the present value of liabilities, generating a pension plan that has no flexibility (e.g., no early retirement provisions), and having a pension plan with low liquidity requirements.
作者: andytrader    时间: 2012-3-23 15:13

Which of the following scenarios will result in the lowest volatility in the surplus of a defined benefit pension plan, while at the same time keeping funding status independent of the plan sponsor’s ability to make pension contributions? A:
A)
high correlation between pension fund assets and pension fund liabilities, and a low correlation between pension fund assets and the pension sponsor's operating performance.
B)
high correlation between pension fund assets and pension fund liabilities, and a high correlation between pension fund assets and the pension sponsor's operating performance.
C)
low correlation between pension fund assets and pension fund liabilities, and a low correlation between pension fund assets and the pension sponsor's operating performance.


The likelihood of a neutral impact on a firm’s earnings is increased when changes in the value of pension assets are highly correlated with pension liabilities but uncorrelated with the firm’s operating performance. This ensures that funding the surplus is constant and independent of the pension sponsor’s ability or inability to make contributions to the plan.
作者: andytrader    时间: 2012-3-23 15:18

Ace Manufacturing’s pension plan is currently under-funded by $15,000,000. Earnings for Ace have been under pressure for the past five years, and although the downward trend seems to have been slowed, prospects for earnings growth are not promising. The average age of Ace’s current workforce is 53, and the retired-lives proportion of pension plan participants is 62%. Which of the following statements most appropriately fits in Ace’s investment policy statement for its pension plan?
A)
Due to the current under-funded status, relatively older workforce age, and high retired-lives proportion, Ace's pension plan risk tolerance profile needs to be moderate to high. The plan's return objective should be to generate high levels of return to cover the plan shortfall through aggressive growth investment vehicles.
B)
The current under-funded status of the pension plan should have no bearing on the risk tolerance or return objectives of the plan's investment policy statement. Pension plans should pursue as high a return as possible in order to minimize contributions and/or increase benefits.
C)
Due to the current under-funded status, relatively older workforce age, and high retired-lives proportion, Ace's pension plan risk tolerance profile is low to moderate. The plan's return objective should be to meet the pension benefit payment requirements of the high level of the current retired-lives proportion of participants and those soon approaching retirement. Matching plan assets with plan liabilities is a must.


Although Ace’s willingness to take risk may be high, the current under-funded status, older workforce age, and high proportion of retired lives dictates a lower than average ability to take risk. Hence, risk tolerance should be low to moderate. Assets should be chosen that deliver returns that match liability payments of current retirees and those about to enter retirement.
作者: andytrader    时间: 2012-3-23 15:18

A defined benefit plan should:
A)
construct an investment policy statement (IPS) after a manager has been chosen for the plan.
B)
invest plan assets without distinction between the tax consequences of returns generated from income and returns generated from capital gains.
C)
review investment performance on a yearly basis.


As a tax-exempt investor, there should be no preference over income or capital gains. Investment performance should be reviewed quarterly, and the IPS reviewed at least annually. The IPS should be the first step in the process.
作者: andytrader    时间: 2012-3-23 15:19

In setting a risk objective for a defined benefit plan, which of the following should NOT be considered?
A)
Investment education expertise of employees.
B)
Sponsor financial status.
C)
Workforce characteristics.


Employees are not responsible for investment performance for defined benefit plans. However, the plan must concern itself with the workforce characteristics (ages), and sponsor financial status (is it capable of funding the plan now and in the future).
作者: andytrader    时间: 2012-3-23 15:19

The Smitherson’s Family Foundation was created to fund causes dear to the family. An initial grant of $35,000,000 was established in the hopes of finding deserving projects to receive funding. The Foundation was established with a perpetual life, and one of its investment goals is to maintain the purchasing power of present assets. Which of the following represents a reasonable objective in the Foundation’s investment policy statement?
A)
The perpetual life of the plan indicates a moderate to high risk tolerance. Return objectives are to meet the required 5% private foundation spending requirement in addition to covering inflation expectations. Evaluating investments from a total return perspective is warranted.
B)
The perpetual life of the plan indicates a low to moderate risk stance. In order to preserve purchasing power, investment in the safest of all assets is critical. Investing in assets returning in excess of the required 5% spending requirement should be discouraged.
C)
All family foundations must have high risk tolerance to maintain perpetual purchasing power. Return objectives should be commensurate with the risk stance and, therefore, achieving highest growth oriented returns is prescribed.


The perpetual life of the Smitherson Family Foundation indicates a moderate to high risk tolerance. Return requirements are at least the regulatory-dictated 5% spending requirement plus inflation expectations. A total return investment objective is warranted.
作者: andytrader    时间: 2012-3-23 15:19

Which of the following return objectives is most appropriate for a defined benefit pension plan?
A)
The return on plan assets should be 50 basis points greater than the actuarial rate applied to the plan's liabilities.
B)
The return on plan assets should be equal to or greater than the plan's spending rate.
C)
To earn an inflation-adjusted return that is adequate to fund plan liabilities.


The ultimate goal of a pension plan is to have pension assets generate returns sufficient to cover pension liabilities on an inflation-adjusted basis. The specific return requirement will depend on the plan’s funding status and contributions dictated by accrued benefits.
作者: andytrader    时间: 2012-3-23 15:20

Which of the following statements would NOT be consistent with an investment policy statement (IPS) for a defined benefit plan?
A)
No objectives and constraints are needed.
B)
Tax consequences can be ignored.
C)
Adequate liquidity must be maintained to meet liabilities.


No objectives and constraints are needed for defined contribution plans in that each employee is responsible for his/her investing. They are very much needed for defined benefit plans.
作者: andytrader    时间: 2012-3-23 15:20

When formulating an investment policy statement for a defined benefit pension plan, legal and regulatory factors, in addition to unique circumstances, must be considered. In this regard, which of the following statements is least accurate?
A)
In the United States, the provisions of the Employee Retirement Income Security Act (ERISA) must be adhered to regardless of any state or local laws and regulations that govern pension investment activity.
B)
The basic tenet of the Employee Retirement Income Security Act (ERISA) is that pension plans be managed with equal regard for the interests of plan sponsors and plan beneficiaries.
C)
Due to either ethical or political objections, a pension plan may disallow investments in certain types of traditional or alternative asset classes.


The fundamental standard of care required by ERISA is that pension fund assets must be invested for the sole benefit of plan participants and not that of plan sponsors.
作者: andytrader    时间: 2012-3-23 15:21

Genentron is a small biotechnology firm that is developing new therapies and drugs for different types of cancer. Genentron has a number of benefits for its employees, including a defined benefit pension plan. The plan is overseen by Rolf Pyle and Shannon DeGroot, both senior executives with Genentron. Most of Genentron’s employees are younger, so Pyle and DeGroot have invested the pension plan’s investment portfolio aggressively. Currently, the pension portfolio allocation is 30% in the Russell 1000 Growth Index and 70% in the Commodore Health Care Fund. Pyle and DeGroot are discussing the allocation of the plan at the most recent meeting. Pyle states, “If the health care industry leads the market again this year, it is unlikely that our pension expense will have much impact on our strong earnings, and we will be able to share more of those earnings with our shareholders.” DeGroot replies, “The allocation of our pension assets should ensure that Genentron will not have to make large pension contributions even if profitability is low.”

With regard to their statements about Genetron’s pension plan:
A)
Pyle’s statement is correct; DeGroot’s statement is correct.
B)
Pyle’s statement is correct; DeGroot’s statement is incorrect.
C)
Pyle’s statement is incorrect; DeGroot’s statement is incorrect.


With 70% of Genentron’s pension assets allocated to a health care fund, the correlation between the firm’s pension assets and profits is likely to be strong. Pyle’s statement is correct – if the health care industry has strong performance, both Genetron’s profits and the performance of the pension plan are likely to be high. When a firm is generating high profits simultaneously with high returns, the probability of the firm having to make a pension contribution is low, and if a contribution is made, the amount is likely to be small.

DeGroot’s statement is incorrect. Since the correlation between Genentron’s operations and its pension portfolio is high, if the firm’s profitability is low, the firm has a higher probability of making a large pension contribution. To avoid the problem of having to make a large contribution at a time when the ability to make contributions is low, companies should seek to have a low correlation between pension assets and firm operations.
作者: andytrader    时间: 2012-3-23 15:21

The pension plan at Ferrell Manufacturing currently has a surplus. Ferrell’s management team wants to maintain the level of the surplus and keep it as stable as possible. In order to accomplish their goal, how should they position the correlation of the pension plan’s assets with the pension liabilities and the firm’s operations respectively?
Correlation of Assets with LiabilitiesCorrelation of Assets with Firm Operations
A)
LowLow
B)
HighLow
C)
HighHigh


In order to have a more stable pension plan surplus, the firm should construct plan liabilities and assets in such a way that changes in pension plan asset valuations are highly correlated with pension plan liabilities, but uncorrelated (low correlation) with the firm’s core operations. This would ensure that pension fund assets increase in value at the same time liabilities do, keeping funding status unaffected by the firm’s ability or inability to make contributions.
作者: andytrader    时间: 2012-3-23 15:22

Brown Textiles has constructed its pension plan investment policy so that its pension assets have a high correlation with pension plan liabilities and a zero correlation with the firm’s operations. Which of the following is the most likely impact of following such an investment policy?
A)
The firm will have a high probability of making pension payments when its ability to fund those payments is high.
B)
A positive long-run impact on firm valuation, and a more stable pension surplus.
C)
The firm will have a high probability of making pension payments when its ability to fund those payments is low.


If pension plan assets are highly correlated with liabilities, but have a zero correlation with firm operations, this would ensure that pension plan assets increase in value at the same time liabilities increase, while the funding status of the plan will be unaffected by the firm’s ability or inability to make contributions. In the long run, the effect on firm valuation and the firm’s constituents will be positive due to decreased volatility in fund surplus and the firm’s earnings. Note that a high correlation between the firm’s operations and its pension assets means the firm would have a low probability of making pension payments when its ability to fund those payments is high, and a high probability of making pension payments when its ability to fund those payments is low.
作者: andytrader    时间: 2012-3-23 15:22

Which of the following would be included in an investment policy statement (IPS) for a defined contribution plan?
A)
A description of the investment alternatives available to plan participants.
B)
Risk objectives.
C)
Time horizon.


In a defined contribution plan, the plan sponsor does not establish objectives and constraints but rather the plan participants set their own risk and return objectives.
作者: andytrader    时间: 2012-3-23 15:22

Which of the following statements about defined contribution investment policy statements (IPS) is least accurate?
A)
Plan sponsors should provide education about investing plan funds.
B)
Procedures are established to insure that a myriad of individual investor objectives and constraints can be handled.
C)
IPS for defined benefit and defined contribution plans are similar in nature.


Defined contribution plans call for quite a different IPS than do defined benefit plans.
作者: andytrader    时间: 2012-3-23 15:23

Which of the following statements are correct regarding a participant-directed defined contribution plan?

Statement 1: The plan should be responsible for establishing and revising the interest rate for plan loans to participants.
Statement 2: The plan should provide criteria for manager/fund selection, termination and replacement.
Statement 1Statement 2
A)
Correct Correct
B)
Incorrect Incorrect
C)
Incorrect Correct


Instead of stating objectives and constraints (as in defined benefit plans), the purpose of a participant-directed defined contribution investment policy statement is to provide a governing document that describes the investment strategies and alternatives available to plan participants. Some defined contribution plans allow plan participants to take out loans against the amount they contributed.
作者: andytrader    时间: 2012-3-23 15:23

Gina Manley, CFA, is a pension fund manager for Brooke and Associates. She manages the pension fund accounts for several small and medium-sized firms.
Company owner Herb Brooke has tasked Manley with reviewing the firm’s asset-allocation policy. In the past, Brooke and Associates included large-company international stocks and large-company domestic stocks as part of the same asset class because they have similar risk and return properties, even though they have a low (0.4) correlation with each other. Venture capital was included as part of the small-company stock asset class because it has a high correlation (above 0.7) with small-company stocks, even though the risk of venture capital investments is far greater than the risk of small company stocks.
As part of her portfolio management duties, Manley has recently taken over two pension accounts from other fund managers. The first account is the Crandall Company pension account. In reviewing the investment policy for Crandall, she finds a statement that "the fund shall not directly use equity futures, nor shall it hire any outside money manager that uses equity futures as part of its investment strategy in managing the fund’s assets."
The second new account Manley has recently acquired is the Cooper Company pension fund. The fund currently has a 70% allocation in equities, including 10% in Cooper stock, with the rest in bonds. The plan is currently underfunded. Manley believes the fund’s equity portfolio, including the Cooper stock, will provide an annualized return of 8% over the next five years. The fund’s long-term, investment-grade bonds should provide a 4% return.
Manley is also working with a new client, Chapman Inc., to set up a new pension fund. Manley’s discussions so far have been directly with the owner, David Chapman. Manley has laid out for Chapman the advantages and disadvantages of defined-benefit plans and defined-contribution plans. She tells Chapman about the following characteristics of defined-contribution plans:
Chapman is comfortable with Brooke and Associates, likes Manley’s work, and he decides to set up a defined benefit plan instead of a defined contribution plan. In the process of gathering data, Manley discovers the following information about Chapman Inc.:
David Chapman and two of his vice presidents plan to retire within the next two years.Which of the following is least likely to be an investment constraint for the Chapman pension fund?
A)
Liquidity.
B)
Taxes.
C)
Investment horizon.


Given the tax-deferred status of pension funds, taxes are usually not an important issue. Liquidity constraints depend on the age of the work force, and must be given consideration. A pension fund’s investment horizon also depends on the age of the work force and whether or not the firm is a going concern. While the work force is mostly young, the firm does have some older workers, and thus cannot ignore liquidity and time horizons. (Study Session 5, LOS 15.b)
Regarding the Cooper Company pension plan, Manley’s best course of action is to:
A)
lower the fund’s equity allocation by selling the Cooper stock.
B)
increase the allocation to equities because risk diminishes over time.
C)
lower the fund’s equity allocation, but not sell the Cooper stock, as such a large sale would drive the price down.


Manley’s fiduciary duty is to the beneficiaries of the plan, not the company. While holding the Cooper stock may benefit the shareholders, it is unlikely to benefit the employees. The company stock provides an undiversified position that is correlated with the employees’ human capital and should be sold. An equity allocation of 70% would be considered high for most pension plans (the average is around 50%), so while diversifying the bond holdings may be a good move, maintaining the equity weighting is not. Some thought could be given to the fact that the plan is underfunded, and that the plan needs growth. In this situation, the plan also needs to protect the existing assets from too much risk so that the underfunding situation is not exacerbated. In this case, reducing the equity weight to an average level and increasing contributions would be the best course of action. (Study Session 5, LOS 15.f)
Which of the following is the best justification for Crandall Company’s futures policy?
A)
Futures are used to manage short-term risks, and the fund should be concerned with long-term risks.
B)
The use of futures is inconsistent with the Prudent Expert Rule of ERISA.
C)
Futures are used mainly for speculative purposes.


Most futures transactions are used to manage short-term risks and those transactions might not impact long-term risks. Futures are often used to hedge equity holdings, and nothing in the Prudent Expert Rule would prohibit their use under the proper circumstances. The fund’s bond holdings are irrelevant, as long as there are equity holdings for which futures could be used to hedge risk. (Study Session 5, LOS 15.l)
Which of Manley's statements regarding defined-contribution plans is least accurate?
A)
The employee makes regular contributions to the fund.
B)
Benefits are based on formulas relating to employee earnings or length of service.
C)
The employer has no financial obligation beyond making contributions to the plan.


In a defined-contribution plan, the employee typically makes regular contributions to a fund that the company matches according to some formula, such as a percentage of current pay. The employee bears all of the investment risk in a defined contribution plan, and the employer has no financial obligation beyond making regular contributions on behalf of qualifying employees. (Study Session 5, LOS 15.a)
Regarding its asset classes, Brooke and Associates’ best course of action is to:
A)
separate international stocks as a unique asset class, but leave venture capital in the small-company stock class.
B)
separate venture capital as a unique asset class, but leave international stocks in the large-company stock class.
C)
separate both venture capital and international stocks as unique asset classes.


It is easier to optimize portfolios using asset classes with different risk characteristics and low correlation with other asset classes. None of the answers are wrong, but separating international stocks and venture capital into their own classes allows for the most precise optimization. (Study Session 5, LOS 15.f)
Which of the following represents the most appropriate asset allocation for Chapman’s pension fund?
A)
60% large-cap stocks, 30% small-cap stocks, 10% foreign stocks.
B)
40% investment-grade bonds, 30% small-cap stocks, 20% large-cap stocks, 10% venture capital.
C)
40% large-cap stocks, 30% high-yield bonds, 20% investment-grade bonds, 10% real estate.


No matter how young the work force, an all-equity investment mix is inappropriate for a pension fund, which is always going to have at least a slight need for liquidity (particularly when the chairman and his lieutenants retire), and must be managed in such a way as to reduce risk. However, the youth of Chapman’s work force suggests a 70% weighting in bonds is too conservative. The mix of large-cap stocks and investment-grade and high-yield bonds is attractive, but most of Chapman’s employees are both young and well-paid, suggesting they have a high risk tolerance as well as low liquidity demands. The best option is the mix of investment-grade bonds, small-cap and large-cap stocks, and venture capital, the portfolio that probably offers the highest total return. There is nothing wrong with taking some risks in a pension plan, as long as those risks are well considered and suitable given the characteristics of the work force. (Study Session 5, LOS 15.f)
作者: andytrader    时间: 2012-3-23 15:24

Jim Findlay is the Founder and CEO of Impact Products. Findlay takes great pride in having his firm be on the leading edge of providing benefits to employees. Every year, Findlay sits down with his two senior executives, Jeff Beery and Tom Harbal to discuss various employee benefit plans. This year’s focus is on employee stock ownership plans (ESOPs) and cash balance plans. With regard to ESOPs, Beery states, “In addition to the benefits to employees, an ESOP would be a useful way for you as owner of the company, Mr. Findlay, to liquidate a large block of your Impact Product holdings.” After further discussion, they move on to discussing cash balance plans. Harbal reports, “Unlike regular pension plans, cash balance plans can never be under funded because the cash balance reflects the actual amount put away for employees.” With regard to their statements about ESOPs and cash balance plans:
A)
Beery’s statement is correct; Harbal’s statement is correct.
B)
Beery’s statement is correct; Harbal’s statement is incorrect.
C)
Beery’s statement is incorrect; Harbal’s statement is incorrect.


An ESOP is a type of defined-contribution plan that allows employees to purchase company stock, sometimes at a discount to the market price. Beery’s statement is correct. Occasionally, an ESOP will purchase a large block of the firm’s stock directly from a large stockholder (such as an owner who wants to liquidate a holding). The stock is then purchased at regular intervals by plan beneficiaries. Harbal’s statement is incorrect. The account balance shown on a cash balance plan’s statement to a beneficiary is calculated on paper only based on a participant’s credits. It is possible for a company not to fund its obligation, resulting in an underfunded cash balance plan.
作者: andytrader    时间: 2012-3-23 15:24

Which of the following is NOT a characteristic of employee stock ownership plans (ESOP)?
A)
ESOPs typically allow employees to purchase company stock at a discount from the current market price.
B)
The regulation of ESOPs can vary widely across countries.
C)
An ESOP is typically funded by a company issuing new stock specifically to fund the ESOP.


ESOPs are typically funded with existing shares that are either repurchased by the company in the open market, or directly from a large shareholder. The other characteristics listed correctly describe features of ESOPs.
作者: andytrader    时间: 2012-3-23 15:25

HAL Corporation is considering shifting their current defined-benefit pension plan to a cash balance plan. In an effort to educate HAL’s board of directors about cash balance plans, Mark Davidson, HAL’s Vice President of Human Resources puts together a memo that includes two statements regarding cash balance plans.
Statement 1:The amount credited to a participant’s account in a cash balance plan is a function of salary, length of employment, and a benchmark interest rate.
Statement 2:Converting our defined-benefit pension plan to a cash balance plan would effective shift investment risk from us as the employer to the employee.

With regard to the statements in the memo, Davidson is:
A)
correct with respect to Statement 1, but incorrect with respect to Statement 2.
B)
correct with respect to Statement 1 and Statement 2.
C)
incorrect with respect to Statement 1, but correct with respect to Statement 2.


Statement 1 is correct. In a typical cash balance plan, a participant’s account is credited each year with a pay credit and interest credit. The pay credit is typically based on the beneficiary’s salary, age, and/or length of employment, while the interest credit is based up on a benchmark such as U.S. Treasuries. Statement 2 is incorrect. The sponsor of a cash balance plan (employer) bears all investment risk since increases and decreases of a plan’s investments do not affect the benefit amounts promised to participants.
作者: andytrader    时间: 2012-3-23 15:25

Which of the following statements regarding foundations is most accurate?
A)
An operating foundation is generally funded by the organization it is intended to support.
B)
Independent foundations receive their funds from an individual, family, or group.
C)
Grants from company-sponsored foundations must be made without regard to the sponsoring company’s business interest.


Company executives usually dominate the board of trustees for a company-sponsored foundation, which may use grants to further corporate interest. A fund owned and funded by the organization it is intended to support is called an endowment, not a foundation.
作者: andytrader    时间: 2012-3-23 15:26

Which of the following types of foundations do NOT have a spending requirement?
A)
Independent.
B)
Operating.
C)
Community.


Independent (or private) and company-sponsored foundations must spend five percent of their assets annually toward non-operating expenses to maintain their tax-exempt status. Operating foundations must use 85% of interest and dividend income to conduct the institution’s own program.
作者: andytrader    时间: 2012-3-23 15:26

Which of the following statements regarding foundations is CORRECT?
A)
An operating foundation is generally funded to support a variety of social causes over time.
B)
Independent foundations provide grants to charities, educational institutions, and social organizations.
C)
A community foundation is dedicated solely to support a specific organization or some on-going research initiative.


An operating foundation is funded solely to support a specific organization or some on-going research initiative. A community foundation typically funds social, educational, or religious initiatives.
作者: andytrader    时间: 2012-3-23 15:28

Manuel Insman, CFA, has just been assigned responsibilities for insurance industry clients at Frontgate, a research and portfolio management boutique. Insman’s first concern is to identify insurance industry investment characteristics. The main purpose of this activity is to formulate a turn-key investment policy statement (IPS) that will increase the efficiency of managing client assets. By doing so, Insman hopes to add value not only to his employer, but to the firm’s investment clientele. To better understand the nuances of the insurance industry, Insman attends a one-day seminar at a local university with Saul Stetson, another portfolio manager. The seminar instructor feels that it is best to separate life insurance from property and casualty (P&C) insurance companies because of their differing investment objectives and constraints. Therefore, the morning session is devoted strictly to the life insurance industry.  
The instructor begins by reviewing how the life insurance industry has changed over the years and briefly discusses a variety of new products. He points out that changes in the industry have resulted in the classification of investment activities into segments having different return objectives. He stresses that although life insurance products have a tremendous variety of features, his research indicates that return objectives are often segmented as follows:
Insman also learns that life insurance companies are often perceived to be quasi-trust funds, and hence, require attention to objectives and constraints that are not typically found in other investment policy statements. Insman makes a list of specific factors often used to determine life insurance risk objectives or liquidity requirements:
The afternoon session of the seminar is devoted to non-life—primarily P&C—companies. The instructor explains the underwriting cycle, as well as key investment policy considerations.
Insman has a hard time keeping up with all of the information the instructor is conveying, and thinks his notes on P&C liabilities might be incorrect. To check, he asks his colleague Stetson to help him clarify the differences between P&C liabilities and those of life insurance companies.
Stetson says “I believe P&C liabilities are unknown in timing and amount, whereas life insurance company liabilities are unknown in timing but known in amount.”
Insman replies “Are you sure? I thought the instructor said that P&C liabilities are unknown in timing but known in amount, whereas life insurance companies are known in amount and timing.”
Insman continues, “Well what about the underwriting cycle? It’s approximately five to seven years and tends to follow the general business cycle doesn’t it?”
Stetson declares otherwise. “I agree that the underwriting cycle is five to seven years long but it runs counter to the business cycle.”Which of the following best characterizes enhanced margin return?
A)
A net interest spread above the returns needed to fund liabilities; thus making it possible to offer competitive premiums.
B)
The excess rate of return derived from using enhanced indexing portfolio management strategies.
C)
Enhanced returns from equity-oriented investments designed to increase the surplus segment.

Enhanced margin: The rate associated with efforts to earn competitive returns on assets funding well-defined liabilities. Spread management techniques are used. If done successfully, a return in excess of a policy’s crediting rate can be earned, giving life insurance companies a competitive edge in setting policy premiums and adding new business.  
Surplus return: The difference between total assets and total liabilities is surplus. The primary objective of surplus management is to generate growth, which is key to expanding insurance volume.
Minimum return: The mandated return applied to assets earmarked to meet death benefits. The minimum rate of return is a statutory rate (normally actuarially determined) that will ensure funding so that reserves are sufficient to meet mortality predictions. (Study Session 5, LOS 15.i)

Insman wants to subdivide the list of factors impacting life insurance risk tolerance and liquidity. Which of the following set of factors best encompasses the most important risk considerations?
A)
Cash flow volatility, reinvestment risk, and credit risk.
B)
Credit risk, asset-liability mismatches, and portfolio manager style characteristics.
C)
Cash flow volatility, disintermediation effects, and asset marketability risk.


Cash flow volatility, reinvestment risk, credit risk, and asset valuation fluctuations are generally considered to be the most important risk factors to be evaluated when determining the risk objectives of a life insurance company. Liquidity is directly affected by the possibility of disintermediation, asset-liability mismatches, and asset marketability risk. The style characteristics of a portfolio manager are considered after risk objectives are determined, not during the formulation of the risk objectives. (Study Session 5, LOS 15.i)
When life insurance companies assess liquidity requirements, they do NOT typically address:
A)
the effects of disintermediation.
B)
asset-liability mismatches.
C)
risks associated with liability marketability.


Life insurance companies are required to pay an increasing amount of attention to disintermediation and asset-liability mismatches. Both of these factors impact the liquidity of asset portfolio investments. (Study Session 5, LOS 15.i)
Which of the following best describes the accuracy of Insman’s and Stetson’s statements about P&C versus life insurance liabilities?
A)
Insman is correct; Stetson is incorrect.
B)
Insman is incorrect; Stetson is incorrect.
C)
Insman is incorrect; Stetson is correct.


P&C liabilities are unknown in timing and amount. Life insurance companies know the amount of the liability (the death benefit), but not the timing. (Study Session 5, LOS 15.i)
Which of the following best describes the accuracy of Insman’s and Stetson’s statements about the P&C underwriting cycle?
A)
Insman is incorrect; Stetson is correct.
B)
Insman is correct; Stetson is incorrect.
C)
Insman is incorrect; Stetson is incorrect.


Evidence indicates the P&C underwriting cycle lasts three to five years and tends to follow general business cycles. (Study Session 5, LOS 15.i)
The unique characteristics of P&C liability structure will have the greatest effect on which of the following constraints?
A)
Time horizon and liquidity.
B)
Time horizon and taxes.
C)
The regulatory environment and unique considerations.


The uncertainty associated with P&C liability structure has the greatest impact on the liquidity and time horizon constraints. (Study Session 5, LOS 15.i)
作者: andytrader    时间: 2012-3-23 15:28

The time horizon of a non-life insurance company differs from that of a pension fund in that a nonlife insurance company’s time horizon:
A)
is dependent on the uncertainties of policies sold, whereas the time horizon of a pension fund is a direct consequence of the business cycle.
B)
is quite long due to the uncertainty of the liability structure associated with policies sold, whereas a pension fund's time horizon will be much shorter due to the finite life of employees.
C)
may be quite short and will depend upon the characteristics of policies sold, whereas a pension fund's time horizon may be much longer, depending on workforce characteristics.


Due to the uncertainty associated with the characteristics of policies sold and when claims will be paid, the time horizon of a nonlife insurance company will necessarily be short. A pension fund, however, will have a time horizon typically longer than that of a nonlife insurance company. The pension fund’s time horizon will be directly related to the plan sponsor’s workforce characteristics.
作者: andytrader    时间: 2012-3-23 15:29

The return objectives for a life insurance company can be broken into two segments, the fixed-income and the surplus segments. Which return objectives are mostly associated with each segment, respectively?
A)
Yield maximization and spread management.
B)
Spread management and maximizing yield.
C)
Spread management and capital gains.


The return objectives for a life insurance company have mainly been associated with earning a competitive return that helps increase the spread between assets and liabilities. The surplus portfolio, however, has growth in the surplus as its main return objective, which will happen via capital gains.
作者: andytrader    时间: 2012-3-23 15:29

The risk tolerance of a foundation differs from that of the fixed-income segment of a life insurance company in which of the following ways? The risk tolerance of a foundation:
A)
will typically be much greater than that of the fixed-income segment of a life insurance company.
B)
will typically be much less than that of the fixed-income segment of a life insurance company.
C)
and that of the fixed-income segment of a life insurance company will both be relatively low.


The fixed-income segment of a life insurance company’s portfolio will essentially be dedicated to providing competitive returns in meeting the liabilities attached to policies sold. Hence, the risk tolerance associated with the fixed-income segment of a life insurance company will typically be less than that of a foundation, which usually has a moderate to high risk tolerance depending on spending rates.
作者: andytrader    时间: 2012-3-23 15:29

Which of the following statements concerning foundations and endowments is CORRECT? Foundations are:
A)
grant-making institutions and may have variable time horizons; endowments are established to permanently fund some activity, and typically have infinite lives.
B)
grant-making institutions and may have variable time horizons; endowments are established to permanently fund some activity, and typically have minimum payout requirements.
C)
established to permanently fund some activity and have high degrees of risk tolerance.


Foundations are grant-making institutions and may have short or long (infinite) lives. Endowments are established to permanently fund some activity (e.g., provide scholarships) and typically have infinite lives. Endowments typically do not have minimum payout requirements. Both types of institutions typically have fairly high degrees of risk tolerance if they are long-lived.
作者: andytrader    时间: 2012-3-23 15:30

Lakeland Life Insurance Company is a U.S. based underwriter of life insurance policies doing business in 23 states. In the past 5 years the company has completely revamped its product offerings, going from a focus on whole life policies to floating rate referred variable and universal life policies. The average duration of the company's insurance liabilities is eight years. Lakeland targets a 1.5% spread on investment assets over liabilities. The current expected nominal actuarial return is 5% (based on current capital market conditions), but management expects the rate environment to get more volatile in the coming months.
The company has segmented its investments into two portfolios: a fixed-income portfolio and a surplus portfolio. The fixed-income portfolio is invested primarily in long-term corporate and U.S. Treasury bonds. The surplus portfolio is currently invested in the common and preferred stock of large, well-known U.S companies. The surplus portfolio has a dividend yield of 3%. Management expects equity markets to earn 12% per year in the long term.The appropriate return objective for the fixed-income portfolio is to earn a return:
A)
of 6.5% while maintaining an average duration of 8 years in order to fund insurance liabilities.
B)
of 18.5% sufficient to fund long-term expansion in insurance volume and fund insurance liabilities through a total return approach.
C)
sufficient to provide a spread of 1.5% over the promised rate on the company's variable rate insurance products while maintaining an average duration of 8 years, in order to fund liabilities.


The company has segmented its investment portfolio; the purpose of the fixed-income segment is to fund insurance liabilities. The return objective should focus on providing the target spread over policy costs, which float with changes in interest rates. Therefore, while the current target is 6.5% based on current economic conditions, this target rate will change as conditions change; 6.5% is not the appropriate long-term return objective. A reasonable objective for the surplus fund is to earn a return "of 12% sufficient to fund long-term expansion in insurance volume by investing in growth-oriented securities, primarily equity." A total return approach is not appropriate for the fixed-income or the surplus portfolio.
The appropriate risk tolerance for the surplus portfolio:
A)
is the same as that of the fixed-income portfolio. While the portfolios are nominally separated for regulatory purposes, they should actually be managed as a single portfolio, because funds from each can be used to meet both goals of long-term growth and current funding of liabilities.
B)
is higher than that of the fixed-income portfolio, because the funds should be used to support long-term growth in insurance volume.
C)
is lower than that of the fixed-income portfolio, to guard against loss of principal and maintain a constant income stream, in order to maintain public confidence in the company's ability, in its role as a fiduciary, to fund policyholder liabilities.


A lower risk tolerance is appropriate for the fixed-income portfolio, on the other hand, to "guard against loss of principal and maintain a constant income stream, in order to maintain public confidence in the company's ability, in its role as a fiduciary, to fund policyholder liabilities." Interest rate volatility over the short-term is not a primary concern of the surplus portfolio. The portfolios are "nominally separated," but not "for regulatory purposes;" each should have its own investment policy statement.
The appropriate time horizon constraint for the surplus portfolio:
A)
is longer than that of the fixed-income portfolio, because the purpose of the surplus portfolio is to support long-term growth in new lines of business.
B)
is shorter than that of the fixed-income portfolio, because policies such as universal and variable life have shorter effective maturities than traditional life insurance products.
C)
is the same as that of the fixed-income portfolio. While the portfolios are nominally separated for regulatory purposes, they should actually be managed as a single portfolio, because funds from each can be used to meet both goals of long-term growth and current funding of liabilities.


While it's true that "…universal and variable life have shorter effective maturities than traditional life insurance products…", this does not mean the time horizon of the surplus portfolio (which is not related to the duration of the liabilities), should be shorter than the time horizon of the fixed-income portfolio (which must be matched to the duration of the liabilities). The maturity of the securities in the portfolio depends on the appropriate time horizon, not the other way around. Finally, the portfolios are "nominally separated", but not "for regulatory purposes"; each should have its own investment policy statement.
Which of the following is NOT appropriate to include as tax or regulatory constraints in the company's Investment Policy Statement?
A)
The regulatory constraint should include the recognition that, for U.S. life insurance companies, state law prevails over federal law.
B)
The regulatory constraint should include the recognition that, by law, common stock holdings are typically limited to a certain percentage of assets.
C)
The regulatory constraint should include a statement that the company is subject to the Prudent Expert Rule.


This statement is not appropriate in the Investment Policy Statement; unlike pension funds, insurance companies are subject to the Prudent Investor Rule.
作者: clearlycanadian    时间: 2012-3-23 15:31

Endowment investment policy statements usually pay attention to the liquidity constraint determined by spending requirements. Which of the following statements most accurately represents an endowment’s relationship to spending? Endowments:
A)
use spending rules to minimize spending volatility.
B)
use spending rules to maximize spending.
C)
no longer use spending rules to estimate spending levels.


To minimize adverse impacts of spending volatility, endowments often employ spending rules that tend to minimize spending level volatility.
作者: clearlycanadian    时间: 2012-3-23 15:32

A life insurance company’s liquidity requirement differs from a non-life insurance company’s requirement in that a life insurance company’s liability structure is uncertain in its:
A)
timing and amount, while a non-life insurance company's liability structure is also uncertain in its amount and timing.
B)
amount, while a non-life insurance company's liability structure is uncertain in both its amount and timing.
C)
timing, while a non-life insurance company's liability structure is uncertain in both its amount and timing.


Life insurance companies have liability structures that are uncertain in timing but not amount. Non-life insurance companies have liability structures that are uncertain in both amount and timing.
作者: clearlycanadian    时间: 2012-3-23 15:33

Which of the following represents the most appropriate objective found in a bank’s investment portfolio?
A)
Assist with increasing after-tax income.
B)
Assist with generating capital gains-only profits.
C)
Assist with generating income-only profits.


The most appropriate objective is to increase after-tax income, not only profits associated with income or capital gains.
作者: clearlycanadian    时间: 2012-3-23 15:34

Assessing the capital risk position is relevant to the investment management process at a bank because it indicates the appropriate amount of:
A)
risk weighted assets.
B)
liquidity weighted assets.
C)
credit weighted assets.


Assessing a bank’s capital risk position indicates the level of capital that must be held by the bank to support investment activities.
作者: clearlycanadian    时间: 2012-3-23 15:35

Ed Simon, CFA, has been assigned the arduous task of assessing the slight nuances concerning the investment objectives and constraints for foundations and endowments. Simon’s supervisor has requested a full report on these differences and how they affect the investment policy statements.Simon thought it best to first look at differences in return objectives between foundations and endowments. Which of the following best indicates differences between the return objectives of foundations and of endowments?
A)
Endowment returns usually are dictated by a rule-of-thumb of "5.3% + inflation," whereas foundation return objectives are dictated by spending rules.
B)
Foundation return objectives are to provide a permanent base of funding whereas endowment return objectives depend on the time horizon of the endowment.
C)
Foundation return objectives depend on the time horizon of the foundation, whereas endowment return objectives are to provide a permanent base of funding.


Foundations may be finite-lived entities, but endowments are created to provide a permanent base of funding.
Simon next turned his attention to the differences in risk objectives between foundation and endowment investment policy statements. Which of the following best describes the main difference between foundation and endowment risk objectives?
A)
Endowment risk tolerance is not dictated by the relationship between the current income requirement and maintenance of purchasing power, whereas this is a crucial factor for foundations.
B)
Foundation risk tolerance is dependent on the importance of foundation funds in the sponsor's overall budget picture, while endowment risk tolerance is dependent on the time horizon of the endowment.
C)
Foundation risk tolerance is dependent on the time horizon of the foundation, whereas endowment risk tolerance is dependent on the importance of the endowment fund in the sponsor's overall budget picture.


Risk tolerance of foundations is critically linked to any time horizon structure while endowment risk tolerance is dependent on the importance of endowment funds in a sponsor’s overall budget picture.
Foundations and endowments often have differential liquidity constraints. Simon found which of the following to be a difference between the liquidity constraints of a foundation and an endowment?
A)
Private foundations are required to have a minimum spending rate whereas endowments rarely have minimum spending rates.
B)
An endowment's spending rule will have less of an effect on liquidity requirements than a foundation's liquidity requirement due to a minimum spending rate.
C)
Endowments are required to have a minimum spending rate whereas private foundations rarely have minimum spending rates.


Private foundations are required to pay out at least 5% of assets on an annual basis. Endowments do not have minimum spending requirements.
Simon discovered tax laws seem to differentially impact foundations and endowments. Which of the following most accurately depicts the differential tax treatment between foundations and endowments?
A)
Operating foundation investment income is taxable, whereas endowment investment income is not.
B)
Private foundation investment income is taxable, whereas endowment investment income is not.
C)
Endowment investment income is taxable, whereas private foundation investment income is not.


Private foundation investment income is taxable, whereas other foundations and endowments are not.
作者: clearlycanadian    时间: 2012-3-23 15:40

Which of the following are characteristics of public foundations’ and endowments’ liquidity needs, respectively?
A)
Moderate; moderate.
B)
Low; varies.
C)
Varies; low.


A foundation determines what its spending needs are, which thereby causes liquidity to vary for each foundation. Liquidity is low for endowments—usually only for emergencies and spending.
作者: clearlycanadian    时间: 2012-3-23 15:41

Which of the following statements best compares the legal and regulatory constraints when managing a pension plan versus managing an endowment fund?
A)
Endowment funds are managed according to the "prudent expert" rule while benefit plans are managed under the "prudent investor" rule.
B)
State pension laws generally supersede Federal pension laws regarding pension plans whereas endowment funds are primarily regulated at the Federal level.
C)
Pension plans are managed according to the Employee Retirement Income Security Act while endowment funds are governed by the Uniform Management Institutional Funds Act.

With respect to the legal and regulatory constraints, pension plans are regulated by the Employee Retirement Income Security Act (ERISA) while endowment funds are governed by the Uniform Management Institutional Funds Act (UMIFA).

Pension plans are held to a higher standard known as the “prudent expert” rule which states that ERISA fiduciaries must discharge their duties…” with care, skill, prudence, and diligence under circumstances then prevailing that a prudent person acting in like capacity and familiar with such matters would use in the conduct of an enterprise of like character and aims.”
By diversifying the investments of the plan we minimize the risk of large losses.

Endowment plans are held to a standard known as the “prudent investor” rule, which states that fiduciaries must adhere to fundamental duties of loyalty, impartiality and prudence as well as maintain overall portfolio risk at a reasonable level and provide for the reasonable diversification of investments.
Fiduciaries must also act with prudence in deciding whether and how to delegate authority to experts and in selecting and supervising agents.

作者: clearlycanadian    时间: 2012-3-23 15:41

Which of the following objectives and/or constraints would be found in an investment policy statement (IPS) for a private foundation but NOT necessarily for an endowment?
A)
Set spending rates.
B)
Total return approach.
C)
Moderate to high risk tolerance.


Both foundation and endowment IPS should include a return objective that specifies a total return approach. Additionally, both foundations and endowments have moderate to high risk tolerance levels. Only private foundations are required to set spending rates.
作者: clearlycanadian    时间: 2012-3-23 15:42

Which of the following entities could be subject to unrelated business income tax (UBIT)?
A)
Only foundations.
B)
Endowments and foundations.
C)
Only endowments.


UBIT must be paid by both endowments and foundations if income is produced that is not substantially related to a foundations’/endowments’ charitable purpose.
作者: clearlycanadian    时间: 2012-3-23 15:42

The investment policy statement (IPS) of which of the following entities may include language pertaining to net interest spread?
A)
Insurance companies.
B)
Endowments.
C)
Defined benefit plans.


Net interest spread is the difference between interest earned and interest credited to policyholders. Therefore, net interest spread may be talked about in the return objectives of an insurance company’s IPS.
作者: clearlycanadian    时间: 2012-3-23 15:43

Which of the following is the most appropriate return objective for a private foundation that has been established to provide support in perpetuity?
A)
The long-term treasury bond return plus inflation.
B)
The market return plus expected inflation.
C)
5.3% of assets plus expected inflation.


Private foundations are required to pay out 5% of assets annually. Also, foundations set up to provide perpetual support must be concerned with the preservation of capital. Hence, 5.3% plus an adjustment for inflation is a useful guideline for quantifying the return objective for a private foundation.
作者: clearlycanadian    时间: 2012-3-23 15:43

Which of the following CORRECTLY describes the primary source of invested funds to meet funding requirements for an endowment fund and an investment company?

Endowment FundInvestment Company
A)
Own assetsOwn assets[/td][tr][/tr]
B)
Assets pooled from investorsAssets pooled from investors
C)
Own assetsAssets pooled from investors


The primary difference between investment companies and other institutional investors such as an endowment fund is the source and use of their invested funds. The endowment fund will invest its own assets to meet various funding requirements while the investment company will collect funds from investors to meet the needs of the investors.
作者: clearlycanadian    时间: 2012-3-23 15:43

Dr. Jack Wolfe, a finance professor with the University of Tulsa asked his students to identify differences between a pension fund and a growth mutual fund. Kelly Musch, a student in Wolfe’s class, turned in a paper with two statements:
Statement 1: The pension fund is likely to have more flexibility to significantly change its asset allocation.

Statement 2: The pension fund could invest in the mutual fund, but the mutual fund could not invest in the pension fund.

When grading Musch’s paper, Dr. Wolfe should:
A)
agree with Statement 1 and Statement 2.
B)
disagree with Statement 1, but agree with Statement 2.
C)
disagree with Statement 1 and Statement 2.


When grading the paper, Dr. Wolfe should agree with both of Musch’s statements. Musch has indirectly hit on the two key differences between a mutual fund (investment company) and other types of institutional investors such as pension funds. The pension plan uses its own assets to meet various funding requirements while the mutual fund invests money pooled from investors based on advertised objectives and constraints. It would be relatively easy for the pension fund to have a meeting and decide to adjust its asset allocation, while the growth mutual fund, which advertises its objectives in a prospectus would likely have to change the prospectus that governed the objective of the fund and possibly hold a shareholder proxy vote. Statement 2 is also correct. The mutual fund invests funds on behalf of other investors, while the pension fund is part of a company. Since the pension is an investor itself, the pension fund could invest in the mutual fund, but the mutual fund could not invest in the pension.
作者: clearlycanadian    时间: 2012-3-23 15:44

Connie King prepared a memo for her supervisor that listed the similarities and differences between the investment objectives of a life insurance company versus the investment objective of a commodity pool. The memo contained the following statements:
Statement 1:   Both life insurance companies and commodity pools are taxable entities.
  
Statement 2:   Life insurance companies invest in order to meet various funding requirements while commodity pools invest according to objectives advertised to investors.
Statement 3:   The source of invested assets for both life insurance companies and commodity pools are assets pooled from investors.

King’s memo is:
A)
correct with respect to Statements 1 and 2, but incorrect with respect to Statement 3.
B)
correct with respect to Statements 1, 2, and 3.
C)
correct with respect to Statement 2, but incorrect with respect to Statements 1 and 3.


King is correct with respect to Statement 1. Both commodity pools and life insurance companies are taxable entities. The primary difference between commodity pools, and other institutional investors (like life insurance companies) is the source and use of their invested funds. King is correct with respect to Statement 2 in that the use of funds for the two types of investors is different. Life insurance companies invest in order to meet various funding requirements while commodity pools invest according to objectives advertised to investors. King is incorrect with respect to Statement 3, however. The source of invested funds for a life insurance company is its own assets (likely gathered from premium payments) while the source of funds for a commodity pool is assets pooled from investors.
作者: clearlycanadian    时间: 2012-3-23 15:44

The liquidity requirements of a pension fund differ from the liquidity requirements of a life insurance company in that the liquidity requirements of a pension fund:
A)
will be dictated by state statutes, whereas the liquidity requirements of a life insurance company will be dictated by federal statute.
B)
will be a direct function of the age of employees and the retired-lives portion of participants, whereas the liquidity requirements of a life insurance company will be a function of the liability requirements of products sold.
C)
and the liquidity requirements of an insurance company will be dictated by federal statute.


Pension fund liquidity is often dictated by the age of employees and the retired-lives portion of participants. Life insurance companies, on the other hand, will have liquidity requirements that are generated by the differential products sold to policy holders.
作者: clearlycanadian    时间: 2012-3-23 15:44

Which of the following statements regarding the time horizons for endowments and foundations is CORRECT? The time horizon for:
A)
an endowment is longer than that for a foundation.
B)
an endowment and the time horizon for a foundation are usually infinite and hence will differ mainly due to specific entity considerations.
C)
a foundation is longer than that for an endowment.


Most endowments and foundations are created to perpetually fund specific operating entities (hospitals, universities, museums, etc.). Hence, their time horizons are typically infinite. Their time horizons may differ, however, due to specific considerations.
作者: clearlycanadian    时间: 2012-3-23 15:45

Which of the following statements best describes the tax constraints existing for endowments and life insurance companies?
A)
Endowments are tax free entities, whereas life insurance companies are taxable.
B)
Endowments are taxable entities, whereas life insurance companies are tax free entities.
C)
Both entities are taxable.


Endowments are tax free entities but life insurance companies are taxable.
作者: clearlycanadian    时间: 2012-3-23 15:46

Which of the following statements concerning the liability structures of life insurance companies and nonlife insurance companies is CORRECT? For:
A)
life insurance companies the amount of the liability is not known, and the timing of the liability is not known.
B)
nonlife insurance companies the amount of the liability is known, but the timing of the liability is not known.
C)
life insurance companies the amount of the liability is known, but the timing of the liability is not known.


For life insurance companies the amount of the liability is known, but the timing of the liability is not known. Both are unknowns for the nonlife insurance company.
作者: clearlycanadian    时间: 2012-3-23 15:46

One difference between the asset liability management techniques between a life and nonlife insurance company is liability:
A)
payment amounts are not known for the life insurance company.
B)
payment amounts are known for the nonlife insurance company.
C)
payment amounts are known for the life insurance company.


The liability payment amounts for the life insurance company are known, whereas they are not known for the nonlife insurance company.
作者: clearlycanadian    时间: 2012-3-23 15:47

One difference between the asset liability management techniques between a life and nonlife insurance company is liability payment:
A)
amounts are known for the nonlife insurance company.
B)
amounts are unknown for the nonlife insurance company.
C)
timing is known with certainty for the nonlife insurance company.


Liability payment amounts are unknown for the nonlife insurance company.
作者: clearlycanadian    时间: 2012-3-23 15:48

Asset liability management techniques between a life and nonlife insurance company are similar in that liability payment:
A)
timing is unknown for both.
B)
amounts are known for both.
C)
amounts are unknown for both.


The payment timing for liabilities is unknown for both the life and nonlife insurance companies.
作者: clearlycanadian    时间: 2012-3-23 15:50

Asset-liability management (or surplus management) is the primary consideration in formulating an investment policy and asset allocation for a(n):
A)
defined contribution pension plan.
B)
endowment.
C)
defined benefit pension plan.


Sponsors of defined benefit pension plans are responsible for funding any shortages of a pension plan’s future liabilities. Therefore, they are typically concerned with the difference between the value of the pension plan’s assets and liabilities. Most of a sponsor’s financial obligation for a defined contribution plan is fulfilled once the plan is initially funded so asset-liability management is not a concern. Endowments must have investment policies that maintain spending rates determined by their objectives and constraints.
作者: clearlycanadian    时间: 2012-3-23 15:51

Which of the following statements most accurately describes asset-liability management for the specified institution?
A)
Managers of foundations typically attempt to match the duration of assets and liabilities.
B)
Asset allocation for pension funds is generally unaffected by regulatory constraints.
C)
Risk tolerance for an endowment is determined by the spending rate and its importance to the operating budget of the recipient.


Managers of pension funds typically attempt to match the duration of assets and liabilities. Asset allocation for foundations must accommodate a five percent spending rate so the fund may maintain its tax-exempt status. Asset allocation for pension funds is generally affected by regulatory constraints, such as restrictions on private and speculative debt.
作者: clearlycanadian    时间: 2012-3-23 15:52

Cayse Medical Foundation (CMF), a private foundation, subsidizes research into an array of medical conditions. An external donor funds its operating expenses. Manny University Endowment (MUE) is a $500 million fund that contributes $30 million per year to the university’s operating budget, or about half the university’s budget, which grows by at least the inflation rate. Which fund has a higher risk tolerance?
A)
MUE because CMF has greater liquidity constraints.
B)
CMF because CMF’s spending rate is low and the foundation does not need to grow its assets.
C)
CMF because CMF has a longer time horizon.


Because CMF operating expenses are funded externally, CMF’s spending rate is low, which increases its ability to tolerate risk. In addition, compared to endowments, which typically have to maintain the purchasing power of its assets, foundations need not grow their assets thereby increasing their risk tolerance. Both CMF and MUE have very long, perhaps infinite, time horizons. CMF must maintain a five percent spending rate to preserve its tax-exempt status, while MUE’s spending rate is six percent. MUE’s higher spending rate creates a higher liquidity constraint and lower risk tolerance. Because the university is quite dependent on the MUE, MUE has a lower risk tolerance than CMF.
作者: clearlycanadian    时间: 2012-3-23 15:52

Which of the following underlying processes provides a natural framework from which to establish investment criteria and objectives?
A)
Credit risk management.
B)
Asset-liability management.
C)
Community reputation risk management.


Asset-liability management is a natural framework from which a bank creates investment portfolio objectives.
作者: clearlycanadian    时间: 2012-3-23 15:58

A nonlife insurance company is facing the end of its underwriting cycle. What should the firm do with respect to the duration of its fixed-income portfolio and the liquidity constraints in its policy statement? The duration of the nonlife insurance company’s fixed-income portfolio should be:
A)
lowered in expectation of decreasing claims, and the investment policy statement should reflect the possibility of a decreasing claims environment in its liquidity constraint towards the end of its underwriting cycle.
B)
shortened in expectation of increasing claims, and the investment policy statement should reflect the possibility of an increasing claims environment in its liquidity constraint towards the end of its underwriting cycle.
C)
lengthened in expectation of decreasing claims, and the investment policy statement should reflect the possibility of a decreasing claims environment in its liquidity constraint towards the end of its underwriting cycle.


Nonlife insurance companies experience a noted underwriting cycle that generates low claim submissions at the beginning of the cycle and high claim submissions at the end of the cycle. The investment policy statement should reflect this changing underwriting cycle reality, which would impact a greater liquidity constraint towards the end of the cycle. Bond portfolio durations should be lowered, if they have not been already, to meet the impending increased claims submissions.
作者: clearlycanadian    时间: 2012-3-23 15:58

The ending of a general business cycle may indicate the last rounds of increased firm profitability. With the prospects of lower profits on the horizons, a pension fund plan sponsor may wish to take which of the following actions? Shift pension assets into those that have a:
A)
low correlation with pension liabilities and low correlation with the firm's operations.
B)
high correlation with pension liabilities and low correlation with the firm's operations.
C)
low correlation with pension liabilities and high correlation with the firm's operations.


Pension assets that are highly correlated with pension liabilities and have a low correlation with the firm’s operations will have a greater probability of meeting pension fund obligations and lowering contributions in the event contributions are required during the upcoming business cycle downturn.
作者: clearlycanadian    时间: 2012-3-23 15:58

A portfolio manager at an endowment fund expects inflation to increase over the intermediate to long term. How should the return objective of the investment policy statement reflect these expectations?
A)
An exclusive income oriented approach should be adopted so that spending requirements can be met in the impending inflationary environment.
B)
An exclusive capital gain oriented approach should be followed so that purchasing power is preserved, while at the same time spending requirements must be reduced.
C)
A total return objective should be pursued so that spending requirements are met, while at the same time purchasing power of fund assets is maintained.


An endowment fund should adopt a total return objective, especially in an impending inflationary environment. In this way, not only are current spending requirements met, but the ability to meet future spending requirements is also increased.
作者: clearlycanadian    时间: 2012-3-23 15:58

The following statements concern differences between the investment policy statement for an institution and that for an individual. Which of these statements is least accurate? The institutional investment policy statement:
A)
is likely to give more prominence to legal constraints.
B)
has four main steps--planning, estimation, execution, and feedback--while the individual investment policy statement has three.
C)
may have asset structure and liquidity requirements that are driven by the institution's liability structure.


Both individual and institutional policy statements should have three main steps: planning, execution, and feedback. The institutional statement is more likely to include legal and regulatory constraints, and may have the asset structure and liquidity requirements driven by the institution’s liability structure.



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