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Portfolio Management and Wealth Planning【Session16 - Reading 40】

Heidi Burke was recently hired by Beekley Capital Advisors as a portfolio manager. On her first day on the job, Cynthia Beekley, owner and founder of the firm, asks Burke to write down the fiduciary responsibilities of a portfolio manager as they pertain to monitoring a client’s portfolio. Burke writes down the following items and hands the paper to Beekley.

Item 1: Watch for changes in client objectives that may necessitate changes to the portfolio.
Item 2: Construct the investor’s portfolio to meet the needs of the client as specified in the IPS.
Item 3: Identify changes in capital market conditions and asset class risks.
Item 4: Look for changes in client constraints that could cause changes in the client’s allocation.
Item 5: Avoid trying to make tactical timing changes to a client portfolio because evidence shows that market timing increases risk without increasing return.

Which of the following most accurately describes Burke’s statements?
A)
Only Items 1 and 4 address Beekley’s question, while Items 2 and 5 are a fiduciary duties not related to monitoring.
B)
Only Items 1, 3, and 4 address Beekley’s question, while Item 2 is a fiduciary duty not related to monitoring.
C)
Only Item 3 addresses Beekley’s question, while Items 1 and 4 would be part of a client’s investment policy statement.



Since the portfolio manager is in a position of trust, he has the fiduciary duty to construct the needs of the client as specified in the IPS and the duty to monitor the portfolio to be sure it continues to meet the client needs. The monitoring process includes monitoring a client’s objectives and constraints as well as changes in market conditions. Therefore, Item 2 is a fiduciary duty not related to monitoring, while Items 1, 3, and 4 address fiduciary duties related to monitoring. Item 5 is not necessarily true since a skilled manager could use tactical asset allocation to reduce risk and/or increase returns.

Darrell Woolaver is the founding principal for Woolaver Capital Management. In his marketing materials, Woolaver makes it a point to tell clients the two primary responsibilities he has as a fiduciary when it comes to portfolio management.

Responsibility 1:    Construct each client’s portfolio so that it offers the maximum return per unit of risk.

Responsibility 2:    Regularly monitor the investor’s portfolio to make sure it continues to meet the client’s needs.

With respect to his statements about the responsibilities Woolaver has as a fiduciary when it comes to portfolio management, Woolaver is:
A)
incorrect with respect to Responsibility 1, and incorrect with respect to Responsibility 2.
B)
incorrect with respect to Responsibility 1, but correct with respect to Responsibility 2.
C)
correct with respect to Responsibility 1, and correct with respect to Responsibility 2.



Woolaver is incorrect with respect to Responsibility 1. The portfolio manager has a fiduciary duty to construct the portfolio to meet the needs of the client as specified in the investment policy statement. Although seeking the maximum return per unit of risk is as admirable goal, the client’s goals with respect to risk tolerance, liquidity, legal considerations, or other factors may not be fully considered under Woolaver’s first statement. Responsibility 2 is correct. The portfolio manager has a fiduciary duty to monitor the portfolio to be sure it continues to meet the client’s needs. This means monitoring the client’s circumstances and capital market conditions, and making changes to the portfolio as necessary.

TOP

Which of the following choices best describes the reason(s) why a fiduciary must monitor a portfolio?
  • The risk tolerance of the investor may change over time.
  • Economic conditions are likely to change over time.
  • The investor’s liquidity requirements may change over time.
  • The client portfolio may need to respond to legal or regulatory changes.
A)
I, II, III and IV.
B)
I only.
C)
II only.



The initial construction of an investor’s portfolio is based upon the client’s circumstances and long-term capital market expectations at the time of construction. The reason why a fiduciary must monitor the portfolio is because both of these broad categories are subject to change. Changes in the investor’s circumstances (risk tolerance, liquidity, establishment of a trust, or other factors) or changes in economic conditions or capital market expectations may necessitate changes to the client’s portfolio which should be carried out by the portfolio manager.

TOP

The cost of not rebalancing the portfolio includes all of the following EXCEPT:
A)
holding assets that no longer fit the needs of the client.
B)
the costs of desirable trades that never happen.
C)
holding an overpriced asset.



This is a cost of trading due to rebalancing.

TOP

Which of the following would NOT be a condition for rebalancing a portfolio?
A)
Changing time horizons.
B)
Impact of trades on security prices.
C)
Availability of new asset classes.



Impact of trades on security prices represents a cost of rebalancing.
Changing time horizon may necessitate changes in asset mix. New securities may allow asset allocation shifts with lower transaction costs or create more efficient portfolios.

TOP

Which of the following statements regarding rebalancing strategies is least accurate?
A)
Using futures contracts can significantly enhance the benefits of tactical asset allocation.
B)
Market timing strategies will tend to outperform constant mix strategies.
C)
Drifting mix strategies tend to perform poorly compared to disciplined rebalancing strategies.



Market timing strategies have been shown to perform poorly relative to constant mix strategies. The other statements are true.

TOP

Jim Cantore is a 45 year old client with a $1.5 million portfolio that is heavily weighted toward equities. Cantore will continue working for the next 20 years and has a substantial retirement portfolio through his current employer. Cantore's three children are now nearing college age and will all attend premiere universities in the U.S. which each cost $50,000 per year to attend. All college expense will be paid out of Cantore's portfolio. Cantore should:
A)
Not rebalance his portfolio because his children should all pay their own way through school.
B)
Rebalance his portfolio toward high quality, intermediate-term debt instruments to service the expected liquidity needs of his portfolio.
C)
Rebalance his portfolio toward large-cap common stocks and international securities because education costs are highly correlated with the returns to these securities.



The liquidity needs of sending his children to school should take precedence over his retirement needs, which are already well funded.

TOP

Which of the following statements regarding disciplined rebalancing is CORRECT? Disciplined rebalancing (e.g., maintaining an asset mix at 60% stocks and 40% bonds):
A)
allows for the possibility of a drifting mix.
B)
prevents substantial gains from market timing.
C)
eliminates periodic departures from the policy mix.



Disciplined rebalancing prevents drifting of the asset mix with market variability. Evidence suggests that market timing fails to add value.

TOP

Which of the following represents the most effective way to reduce the costs of using a tactical asset allocation strategy?
A)
Rebalance using futures contracts.
B)
Use package trading.
C)
Increase the size of cash balances.



Because futures are so inexpensive, using them significantly reduces transaction costs and can increase the benefits of a tactical strategy. Excessive cash balances have been shown to decrease overall portfolio returns, and using package trades may reduce costs, but may not be viable alternatives for some investment strategies.

TOP

Mimi Smith, a client of Osborne Capital, Inc., believes that her portfolio should be rebalanced. She supports her claim by stating that she just won the lottery and wants to retire 10 years earlier than before. Does she have a valid claim?
A)
No. Not enough information is given to determine.
B)
Yes. Her wealth and time horizon have changed.
C)
Yes. Her time horizon has changed.



Changes in wealth, time horizon, and liquidity requirements all dictate the need to rebalance. Taxes, laws, and regulations, as well as unique circumstances, also play into this decision.font>

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