LOS n: Compare and contrast the investment objectives and constraints of institutional investors given relevant data such as descriptions of their financial circumstances and attitudes toward risk.

Q1. 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)   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.

C)   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.

Q2. 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)   low correlation with pension liabilities and high correlation with the firm's operations.

C)   high correlation with pension liabilities and low correlation with the firm's operations.

Q3. 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)   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.

B)   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.

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.

Q4. The following statements concern differences between the investment policy statement for an institution and that for an individual. Which of these statements is FALSE? The institutional investment policy statement:

A)   is likely to give more prominence to legal constraints.

B)   may have asset structure and liquidity requirements that are driven by the institution's liability structure.

C)   has four main steps--planning, estimation, execution, and feedback--while the individual investment policy statement has three.

LOS n: Compare and contrast the investment objectives and constraints of institutional investors given relevant data such as descriptions of their financial circumstances and attitudes toward risk. fficeffice" />

Q1. 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)   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.

C)   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.

Correct answer is B)

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.

Q2. 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)   low correlation with pension liabilities and high correlation with the firm's operations.

C)   high correlation with pension liabilities and low correlation with the firm's operations.

Correct answer is

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.

Q3. 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)   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.

B)   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.

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.

Correct answer is A)

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.

Q4. The following statements concern differences between the investment policy statement for an institution and that for an individual. Which of these statements is FALSE? The institutional investment policy statement:

A)   is likely to give more prominence to legal constraints.

B)   may have asset structure and liquidity requirements that are driven by the institution's liability structure.

C)   has four main steps--planning, estimation, execution, and feedback--while the individual investment policy statement has three.

Correct answer is C)         

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.