kasinkei

William Parthley, age 69, has had bad luck with his investments in recent years and decides to consult Moira Wembley, CFA, for advice.
Parthley’s portfolio is composed of 90% stocks and 10% bonds, with a total value of $2.6 million. Classifying himself as conservative, Parthley blamed the aggressive allocation on a previous money manager, and says he wants to substantially increase the fixed-income weighting of his portfolio.
From his portfolio, Parthley hopes to fund his retirement at a rate of $7,000 per month, adjusted for inflation. He has also promised his alma mater at least $2 million upon his death. Parthley is in good health, and most of the men in his family have lived into their late 80s.Based solely on the information presented above, Wembley can conclude that there is most likely a conflict between Parthley’s:

A) willingness to take risk and ability to take risk.

B) return requirements and asset allocation.

C) return requirements and asset allocation as well as his willingness to take risk and ability to take risk.

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Parthley’s portfolio is large enough to meet his needs, with some room to spare. His annual spending accounts for just 3.23% ($7,000/month × 12 months / $2.6 million) of the portfolio. Even accounting for inflation and taxes, a 7% return would probably be enough to support Parthley without dipping into the principal. Furthermore, with a $600,000 cushion above the $2 million needed for the bequest, Parthley can afford to dip into the principal if necessary. As such, his desire to move to a more conservative allocation is not in conflict with his return requirements.
Parthley’s wealth and modest return requirement suggest he has a substantial ability to take risk. Yet Parthley considers himself conservative. There appears to be a conflict here.

kasinkei

Yoo Jin, CFA, is the Chief Investment Officer of Park, Kim & Lee Investment Management (PKL), which specializes in private wealth management for affluent families. Yoo has recently met with a potential new client, the Ahn family. PKL was highly recommended by a business associate of eldest member of the family, Ahn Kwan, and three generations of the family are considering investing with the firm to establish a new investment portfolio. The portfolio is intended solely to provide capital for the fourth and youngest generation of the family and their descendents, so the family can maintain its position in future generations. Portfolio income is not currently needed to support the three eldest generations of the Ahn family because the business ventures provide an income sufficient to maintain a luxurious lifestyle.
Since the elderly Ahn Kwan is not in sufficiently good health to attend the meeting in person, the family represented at this initial conference by Ahn Kwan’s eldest son, Ahn Yong. He explains to Yoo that the family wants to take a cautious approach to its investments. The family takes substantial risk in its business ventures and does not want to risk its capital.
As the discussion proceeds, he informs Yoo that the family is also interested in exploring new investment opportunities for their existing portfolios as well. The three adult generations of the Ahn family have so far kept their money in various bank accounts because of concern about possible losses in the securities market. The accounts generally pay an interest rate between 4% and 5%. Ahn Kwan, however, has been persuaded by his business associate that the family is losing an important opportunity to increase its returns by not investing in the stock market. The Korean equity market soared more than 40% in the previous year, and Ahn Kwan realizes that keeping money in interest-bearing accounts is costing the family substantially in missed opportunities. He has agreed to consider moving a substantial portion of the family’s assets over to PKL since he has been assured that PKL is a responsible, cautious firm.
In discussing the move into equities, Ahn Yong explains his father’s position. “My father has devoted his entire life to establishing the success of his family. The financial position of his children, his grandchildren, and their descendants is of primary importance to him. He does not want to risk losing money that he has worked decades for.”
Ahn Yong elaborates on his father’s concerns by saying, “My father has seen what happened in Japan. The peak in the Nikkei index came in 1989, and the market has never recovered. Anyone who invested back then lost nearly two-thirds of his money. My father does not want that to happen to our family.”
Yoo Jin asks, “We would of course only invest your family’s money in markets that you want to participate in. Would your father want the family’s money invested in the Japanese market?” Ahn Yong asserts emphatically, “My father is only interested in participating in the Korean markets. He does not want our money invested overseas.”
The portfolio manager who would be responsible for the Ahn family portfolios is Shin Sun, CFA. In reviewing the meeting with Shin, Yoo explains that in her view, the family’s goals are inconsistent and education is required to resolve the inconsistency. Yoo notes that the family is only interested in investing in the Korean equity market, but the Korean equity market is highly volatile. It would not be possible to create a portfolio consisting solely of Korean equities that would be consistent with Ahn Kwan’s investment risk tolerance.
Shin makes the case that the family has a very high risk tolerance. Shin argues, “The time horizon of the Ahn family is virtually infinite, since the money is intended for future generations. In addition, the portfolio has no current income requirements. In this case, they can have a very high risk tolerance. Certainly the Ahn family is in an excellent position to invest in the Korean equity market.”
Shin suggests, “Educating a new client can be a very delicate issue. That is especially true when the client is the elderly head of a very successful family. I would not want to tell Ahn Kwan that we cannot do what he wants. We should follow his instructions and invest the family’s money in a portfolio of Korean equities. If that is what he says, then it is our duty to follow his wishes.” Shin concludes that PKL should construct a portfolio consistent with the Ahn family’s substantial ability to assume risk. The best description of the importance of portfolio perspective is that investors, analysts and portfolio managers should analyze the:

A) risk-return tradeoff of the portfolio as a whole.

B) unsystematic risk of the individual investments in the portfolio.

C) risk-return tradeoff of the individual investments in the portfolio.

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Investors, analysts and portfolio managers should analyze the risk-return tradeoff of the portfolio as a whole, not the individual investments in the portfolio. (Study Session 18, LOS 64.a)

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Which of the following is least likely to determine an individual investor’s ability to accept risk?

A) Long-term wealth target.

B) Liabilities.

C) Market expectations.

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Liabilities and long-term wealth target are each direct determinants of an individual investor’s ability to accept risk. Market expectations will affect return achieved but is not a direct determinant of an investor’s ability to accept risk. (Study Session 18, LOS 64.c)

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The two principal risk objective measurements are best described as:

A) tracking risk and absolute risk.

B) absolute risk and relative risk.

C) absolute risk and qualitative risk.

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The two risk objective measurements are absolute and relative risk. Tracking risk is an example of a relative risk objective. Qualitative risk is a form in which an absolute risk objective may be stated. (Study Session 18, LOS 64.c)

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Regarding Shin’s and Yoo’s assertions about the family’s risk tolerance and the implications for the management of their portfolios:

A) Yoo’s statement is correct; Shin’s statement is correct.

B) Yoo’s statement is correct; Shin’s statement is incorrect.

C) Yoo’s statement is incorrect; Shin’s statement is correct.

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Shin’s statement that the family has a very substantial ability to assume risk is correct, but he is incorrect to claim that the portfolio should be constructed in accordance with their ability to assume risk without resolving the conflict with their low willingness to assume risk). When the investor’s ability and willingness to assume risk are in conflict, the curriculum always recommends designing portfolios consistent with the willingness, not ability, to assume risk. Yoo is correct that there is an inconsistency in the stated risk tolerance – not increasing the risk of the portfolio above that of interest-bearing bank accounts – and the goal of investing in the stock market, and that educating the client is required. Since the willingness to assume risk is inherently in conflict with the stated objective of investing in equities (which cannot duplicate the low risk of interest-bearing bank accounts), there is no way around having to educate the family to resolve the conflict. (Study Session 18, LOS 64.c)

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A return objective should best be considered from the perspective of:

A) return from income relative to return from capital gains.

B) required return.

C) total return.

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The return objective should be considered from a total return perspective, even if there is a specific income or capital gains target. Desired or required return may be unrealistic given available market conditions or risk tolerance. (Study Session 18, LOS 64.c)

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Which is least likely to be considered one of the three integrative steps in the portfolio management process?

A) Feedback.

B) Developing an investment policy statement.

C) Planning.

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The three integrative steps in the portfolio management process are planning, execution and feedback. Developing an IPS is part of the planning phase. (Study Session 18, LOS 64.b)

kasinkei

Which of the following best represents the general steps of the planning phase of the portfolio management process? Determining:

A) the investor's time horizon.

B) investor objectives and constraints.

C) the investor's tax situation and unique circumstances.

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The two major steps in the planning phase are determining investor objectives and constraints. The other choices are subsets of this choice. Objectives are concerned with what an investor wishes or requires to happen with the investment portfolio as well as being mainly concerned with risk and return considerations. Constraints pertain to limitations placed on how portfolio objectives are achieved. Primary constraints associated with liquidity include (1) time horizon, (2) legal and regulatory issues, (3) taxes, and (4) unique circumstance considerations.

kasinkei

Which of the following is not typically included in an investment policy statement?

A) Names of specific managers or mutual funds that should be used.

B) Identification of duties.

C) A client description.

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General statements about how funds should be invested are included in the investment policy statements. It would not be wise to include specific manager/mutual funds, as the people involved in managing money change over time. Instead, asset allocation objectives should be used.

kasinkei

The objective of achieving a 10% annual rate of return is an example of a(n):

A) absolute risk objective.

B) required return objective.

C) relative return objective.

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The objective of earning a 10% return is a required return objective because it represents some level of return that must be acheived by the portfolio.

kasinkei

Which of the following does not relate to return objectives? Specifying:

A) security-specific returns.

B) return requirements.

C) portfolio real after-tax returns.

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Required and desired returns, specified in real after-tax levels, relate directly to the formulation of the investor’s return objective. Security-specific returns are important in analyzing potential additions to the portfolio, but do not come into play when specifying the overall portfolio return objective.

kasinkei

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

A) Risk tolerance.

B) Tax concerns.

C) Time horizon.

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An investor’s risk tolerance is included under objectives. Constraints include liquidity needs, time horizon, tax concerns, legal and regulatory factors, and unique circumstances

kasinkei

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

A) Objectives, constraints, risk tolerance.

B) Planning, asset allocation, security selection.

C) Planning, execution, feedback.

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The three main steps in the portfolio management process are planning, execution, and feedback. The other items listed are subcomponents of these steps.

kasinkei

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

A) Objectives, constraints, risk tolerance.

B) Planning, asset allocation, security selection.

C) Planning, execution, feedback.

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Click for Answer and Explanation
The three main steps in the portfolio management process are planning, execution, and feedback. The other items listed are subcomponents of these steps.

kasinkei

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

A) Strategic asset allocation.

B) Feedback

C) Planning.

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Developing an IPS occurs in the planning steps of the process. The purpose of developing an IPS is to govern decision making.