kim226

The ability to take risk is best judged by:

A) the time horizon of only short term objectives.

B) the time horizon of both short- and long-term objectives.

C) the time horizon of long term objectives.

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The time horizon of both short- and long-term objectives will have direct consequences on an investor’s ability to take risk.

kim226

Although legal and regulatory constraints do not usually impact an individual investor’s policy statement, attention must often be paid between two parties of personal trusts. Which parties exhibit the greatest tension in setting investment policy for a personal trust?

A) Grantor and remaindermen.

B) Income beneficiary and remaindermen.

C) Income beneficiary and the trust officer.

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A creative tension exists between the income beneficiary and remaindermen listed in a personal trust. Income beneficiaries would like to have as much current income from the trust as possible. Remaindermen wish to have as large of a portfolio passed to them after the income beneficiary dies. The conflict between current income and longer-term portfolio growth is a situation that must be addressed in formulating investment policy for a personal trust.

kim226

Which class of liquidity constraints is usually NOT considered a factor when formulating an individual’s investment policy statement?

A) Negative liquidity events.

B) Cash carried on the person.

C) Ongoing expenses.

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The amount of cash an investor carries with them should not impact the investment policy statement. The primary liquidity constraints impacting the long-term policy statement are those cash outflows required in meeting ongoing expenses and negative liquidity events.

kim226

Vivian Collins is a client of ESP Financial Advisors. She presents her situation as follows: Collins is currently a divorced mother to a 5-year-old daughter, Daija. She is 35 years old. She has worked at her current job with the government for the last 13 years, and assumes that she will remain there until retirement and collect her pension. Collins wants to be able to send Daija to the college of her choice. Collins expects her daughter to eventually marry and have children. She would love to be able to leave something to these future grandchildren. How many time horizons does Collins have?

A) 3.

B) 4.

C) 5.

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Collins has 4 distinct time horizons. The first is now until the time that Daija enrolls in college. The second is supporting Daija's college education. The third is her remaining years before retirement and after supporting Daija through college. The fourth is retirement. In retirement if a goal is to leave some assets to her grandchildren then the portfolio would need to be managed with that in mind.

kim226

With respect to the constraints portion of an investor’s investment policy statement, issues relating to on-going expenses, emergency reserves, alterations in on-going expenses, and transactions costs are all examples of:

A) time horizon issues.

B) unique circumstances.

C) liquidity issues.

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The issues listed in the stem of the question are concerned with the investor’s liquidity requirement.

kim226

Which two constraints greatly impact an individual’s investment policy statement?

A) Legal/regulatory and unique circumstances.

B) Time horizon and tax considerations.

C) Legal/regulatory and liquidity concerns.

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Individual investors have finite lives and are taxable entities. Legal/regulatory factors may have an impact, but for the most part, individual investors can invest in almost any manner they please.

kim226

An analyst is developing an investment policy statement for Sally Edgewood, a 48-year old orthodontist with an annual income in excess of $400,000. Edgewood has accumulated an investment portfolio with a current value of $4 million. Her portfolio is concentrated in small capitalization stocks with a bias toward high-tech companies. She has expressed a desire to earn a return equal to the return of 12 percent above the return of the Russell 2000 small capitalization stock index. Edgewood lives well on 50 percent of her annual income. She has always been a ski enthusiast and this year she plans to purchase a second home in the mountains in western Wyoming. This purchase will be mortgaged and require her to make an $80,000 down payment. Edgewood plans to retire at the age of 63 and is currently paying taxes at a rate of 30 percent on both income and capital gains.Which of the following most accurately portrays Edgewood’s overall risk tolerance? Edgewood’s willingness:

A) to accept risk is average and her ability to accept risk is above average. Thus, her overall risk tolerance is average.

B) and ability to accept risk is above average. Thus, her overall risk tolerance is above average.

C) to accept risk is above average and her ability to accept risk is average. Thus, her overall risk tolerance is average.

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Edgewood’s ability to assume risk is above average as indicated by the fact that her income is relatively large and exceeds her annual living expenses by a substantial amount. Also, being invested in small, high tech firms is an indication of Edgewood’s above average willingness to accept risk.

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Which of the following most accurately describes Edgewood’s tax, liquidity, and time horizon constraints? Edgewood’s overall time horizon is:

A) long, her tax constraints are significant, and her liquidity needs are high.

B) long, her tax constraints are significant, and her liquidity needs are low.

C) short, her tax constraints are significant, and her liquidity needs are low.

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Edgewood’s overall time horizon is long—25 years or more—and it consists of two states: pre-retirement and post-retirement. A 30 percent income and capital gains tax is significant. Her liquidity needs are low and can easily be paid out of income.

kim226

When developing an investment policy statement (IPS), which of the following items should be one of the first considerations?

A) Unique circumstances.

B) Liquidity.

C) Return objectives.

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When constructing an IPS, the first two considerations deal with objectives: return objectives and risk tolerance. The constraints are dealt with after the objectives have been stated.

kim226

Which of the following parts of an investment policy statement (IPS) is NOT considered a constraint?

A) Taxes.

B) Time horizon.

C) Risk tolerance.

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Risk tolerance levels are part of the objectives part of the IPS, not a constraint.

kim226

When constructing an investment policy statement (IPS), which of the following statements would be considered least accurate?

A) If there are liquidity requirements, the applicable after-tax return will need to be calculated.

B) One of the distinguishing factors between individual and institutional investors is time horizon.

C) The use of total return analysis is almost always the wrong way to approach an IPS.

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Use of a total return statement is almost never incorrect. Institutional investors may have infinite life but individuals do not. The other statements are true statements with respect to liquidity and time horizon.