Portfolio Management【Reading 46】Sample investing, following, understand, 2012

optiix

Which of the following is NOT a rationale for the importance of the policy statement in investing? It:

A) helps investors understand the risks and costs of investing.

B) identifies specific stocks the investor may wish to purchase.

C) forces investors to understand their needs and constraints.

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The policy statement outlines broad objectives and constraints but does not get into the details of specific stocks for investment

optiix

Which of the following is NOT a rationale for the importance of the policy statement in investing? It:

A) allows the investor to judge performance by objective standards.

B) specifies a benchmark against which to judge performance.

C) forces investors to take risks.

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By no means should the policy statement force the investor to take risks. The statement forces investors to understand the risks of investing.

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Which of the following best describes the importance of the policy statement? It:

A) outlines the best investments.

B) limits the risks taken by the investor.

C) states the standards by which the portfolio's performance will be judged.

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The policy statement should state the performance standards by which the portfolio's performance will be judged and specify the benchmark that represents the investors risk preferences.

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Brian Nebrik, CFA, meets with a new investment management client. They compose a statement that defines each of their responsibilities concerning this account and choose a benchmark index with which to evaluate the account’s performance. Which of these items should be included in the client’s Investment Policy Statement (IPS)?

A) Neither of these items.

B) Both of these items.

C) Only one of these items.

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Two of the major components of an IPS should be a statement of the responsibilities of the investment manager and the client, and a performance evaluation benchmark.

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Which of the following statements about the importance of risk and return in the investment objective is least accurate?

A) The return objective may be stated in dollar amounts even if the risk objective is stated in percentages.

B) Expressing investment goals in terms of risk is more appropriate than expressing goals in terms of return.

C) The investor’s risk tolerance is likely to determine what level of return will be feasible.

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Expressing investment goals in terms of risk is not more appropriate than expressing goals in terms of return. The investment objectives should be stated in terms of both risk and return. Risk tolerance will likely help determine what level of expected return is feasible.

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Which of the following statements about risk and return is NOT correct?

A) Return-only objectives provide a more concise and efficient way to measure performance for investment managers.

B) Return objectives should be considered in conjunction with risk preferences.

C) Return objectives may be stated in dollar amounts.

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Return-only objectives may actually lead to unacceptable behavior on the part of investment managers, such as excessive trading (churning) to generate excessive commissions.

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Which of the following statements about risk and return is NOT correct?

A) Specifying investment objectives only in terms of return may expose an investor to inappropriately high levels of risk.

B) Return objectives may be stated in absolute terms.

C) Risk and return may be considered on a mutually exclusive basis.

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Risk and return must always be considered together when expressing investment objectives. Return objectives may be expressed either in absolute terms (dollar amounts) or in percentages.

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Which of the following factors is least likely to affect an investor’s risk tolerance?

A) Number of dependent family members.

B) Level of insurance coverage.

C) Level of inflation in the economy.

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The level of inflation in the economy should be considered in determining the return objective. Risk tolerance is a function of the investor's psychological makeup and the investor's personal factors such as age, family situation, existing wealth, insurence coverage, current cash reserves and income.

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Which of the following statements about risk is NOT correct? Generally, greater:

A) insurance coverage allows for greater risk.

B) spending needs allows for greater risk.

C) existing wealth allows for greater risk.

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Greater spending needs usually allow for lower risk because there is a definite need to ensure that the return may adequately fund the spending needs (a “fixed” cost).

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Which of the following statements is NOT consistent with the assumption that individuals are risk averse with their investment portfolios?

A) Higher betas are associated with higher expected returns.

B) Many individuals purchase lottery tickets.

C) There is a positive relationship between expected returns and expected risk.

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Investors are risk averse. Given a choice between two assets with equal rates of return, the investor will always select the asset with the lowest level of risk. This means that there is a positive relationship between expected returns (ER) and expected risk and the risk return line (capital market line [CML] and security market line [SML]) is upward sweeping. However, investors can be risk averse in one area and not others, as evidenced by their purchase of lottery tickets.