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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 high.

D) and that of the fixed-income segment of a life insurance company will both be relatively low.

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Answer and Explanation

The fixed-income segment of a life insurance companys 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.

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Which of the following are characteristics of public foundations and endowments liquidity needs, respectively?

A) Low; high.

B) Low; varies.

C) Varies; low.

D) Moderate; moderate.

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Answer and Explanation

A foundation determines what its spending needs are, which thereby causes liquidity to vary for each foundation. Liquidity is low for endowmentsusually only for emergencies and spending.

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Ed Simon, CFA, has been assigned the arduous task of assessing the slight nuances concerning the investment objectives and constraints for foundations and endowments. Simons 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) Foundation return objectives are to provide a permanent base of funding whereas endowment return objectives depend on the time horizon of the endowment.

B) Foundation return objectives depend on the time horizon of the foundation, whereas endowment return objectives are to provide a permanent base of funding.

C) Endowment returns usually are dictated by a rule-of-thumb of "5.3% + inflation," whereas foundation return objectives are dictated by spending rules.

D) Neither foundation nor endowment return objectives focus much on purchasing power preservation.

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Answer and Explanation

Foundations may be finite-lived entities, but endowments are created to provide a permanent base of funding.

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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) 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.

B) 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.

C) 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.

D) Inflation rarely impacts the risk tolerance of either foundation or endowment.

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Answer and Explanation

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 sponsors overall budget picture.

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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) Endowments are required to have a minimum spending rate whereas private foundations rarely have minimum spending rates.

C) 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.

D) A foundation's spending rule will have less of an effect on liquidity requirements than an endowment's liquidity requirement due from a minimum spending rate.

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Answer and Explanation

Private foundations are required to pay out at least 5 percent of assets on an annual basis. Endowments do not have minimum spending requirements.

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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) Private foundation investment income is taxable, whereas endowment investment income is not.

B) Endowment investment income is taxable, whereas private foundation investment income is not.

C) Community foundation investment income is taxable, whereas endowment investment income is not.

D) Operating foundation investment income is taxable, whereas endowment investment income is not.

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Answer and Explanation

Private foundation investment income is taxable, whereas other foundations and endowments are not.

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Which of the following statements best compares the legal and regulatory constraints when managing a pension plan versus managing an endowment fund?

A) Pension plans are managed by the Employee Retirement Income Security Act while endowment funds are governed by the Uniform Management Institutional Funds Act.

B) Endowment funds are managed according to the "prudent expert" rule while benefit plans are managed under the "prudent investor" rule.

C) Both endowment and pension plans are highly regulated by Federal governmental agencies.

D) State pension laws generally supersede Federal pension laws regarding pension plans whereas endowment funds are primarily regulated at the Federal level.

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Answer and Explanation

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.

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.

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Banks tend to use their investment portfolios for all of the following objectives EXCEPT:

A) providing liquidity.

B) creating off balance sheet opportunities.

C) decreasing credit exposure.

D) mitigating interest rate risk.

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Answer and Explanation

This is not an objective of a banks investment portfolio. All others are.

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Which of the following is a potential shortcoming of a banks propensity to invest in low risk securities? Not enough funds invested in:

A) municipal bonds.

B) loans.

C) commercial paper.

D) agency securities.

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Answer and Explanation

Low risk securities carry low (or no) risk weightings, which require no capital to support the investment. Loans are a core function of banking, but, as they are considered high risk, they require capital to support the investment. Unbalanced investments in low risk securities and not in loans are problematic because of the potential mismatch between cash inflows on assets and outflows on liabilities.

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Assessing the capital risk position is relevant to the investment management process at a bank because it indicates the appropriate amount of:

A) credit weighted assets.

B) risk weighted assets.

C) marketability weighted assets.

D) liquidity weighted assets.

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Answer and Explanation

Assessing a banks capital risk position indicates the level of capital that must be held by the bank to support investment activities.

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Which of the following represents the most appropriate objective found in a banks investment portfolio?

A) Assist with generating income-only profits.

B) Assist with increasing after-tax income.

C) Assist with generating capital gains-only profits.

D) Assist with generating municipal securities only profits.

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Answer and Explanation

The most appropriate objective is to increase after-tax income, not only profits associated with income, capital gains, or municipal securities.