optiix

While assessing an investor’s risk tolerance, a financial adviser is least likely to ask which of the following questions?

A) “How much insurance coverage do you have?”

B) “Is your home life stable?”

C) “What rate of investment return do you expect?”

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While the degree of risk tolerance will have an affect on expected returns, assessing the risk tolerance comes first, and the resulting set of feasible returns follows. The other questions address risk tolerance.

optiix

All of the following affect an investor’s risk tolerance EXCEPT:

A) tax bracket.

B) family situation.

C) years of experience with investing in the markets.

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Tax concerns play an important role in investment planning. However, these constitute an investment constraint, not an investment objective (i.e. risk tolerance).

optiix

Which of the following statements about investment constraints is least accurate?

A) Diversification efforts can increase tax liability.

B) Unwillingness to invest in gambling stocks is a constraint.

C) Investors concerned about time horizon are not likely to worry about liquidity.

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Investors with a time horizon constraint may have little time for capital appreciation before they need the money. Need for money in the near term is a liquidity constraint. Time horizon and liquidity constraints often go hand in hand. Diversification often requires the sale of an investment and the purchase of another. Investment sales often trigger tax liability. Younger investors should take advantage of tax deferrals while they have time for the savings to compound, and while they are in their peak earning years. Many retirees have little income and face less tax liability on investment returns.

optiix

Which of the following should least likely be included as a constraint in an investment policy statement (IPS)?

A) Constraints put on investment activities by regulatory agencies.

B) Any unique needs or preferences an investor may have.

C) How funds are spent after being withdrawn from the portfolio.

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How funds are spent after withdrawal would not be a constraint of an IPS.

optiix

All of the following are investment constraints EXCEPT:

A) pension plan contributions of the employer.

B) tax concerns.

C) liquidity needs.

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Investment constraints include: liquidity needs, time horizon, tax concerns, legal and regulatory factors and unique needs and preferences. While employer contributions may be of interest, and an issue in some instances, it is not classified as a specific investment constraint.

optiix

Which of the following is least likely to be considered a constraint when preparing an investment policy statement?

A) Liquidity needs.

B) Risk tolerance.

C) Tax concerns.

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The constraints are: liquidity needs, time horizon, taxes, legal and regulatory factors, and unique needs and preferences. Risk tolerance is included in the investment objectives of the policy statement, not in the constraints.

optiix

When preparing a strategic asset allocation, how should asset classes be defined with respect to the correlations of returns among the securities in each asset class?

A) Low correlation within asset classes and high correlation between asset classes.

B) Low correlation within asset classes and low correlation between asset classes.

C) High correlation within asset classes and low correlation between asset classes.

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The portfolio diversification benefits from strategic asset allocation result from low correlations of returns between asset classes. Asset classes should consist of assets with similar characteristics and investment performance, which means correlations within an asset class are relatively high.

optiix

An investment manager has constructed an efficient frontier based on a client’s investable asset classes. The manager should choose one of these portfolios for the client based on:

A) relative valuation of the asset classes.

B) the investment policy statement (IPS).

C) a risk budgeting process.

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After defining the investable asset classes and constructing an efficient frontier of possible portfolios of these asset classes, the manager should choose the efficient portfolio that best suits the investor’s objectives as defined in the IPS. The investor’s strategic asset allocation can then be defined as the asset allocation of the chosen portfolio. Tactical asset allocation based on relative valuation of asset classes would require the manager to deviate from the strategic asset allocation. Risk budgeting refers to the practice of determining an overall risk limit for a portfolio and allocating the risk among strategic asset allocation, tactical asset allocation, and security selection.