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.

kim226

Joanne Sparta is a 48-year old, successful physician who earns in excess of $500,000 per year. She has also been successful speculating on small business startups, which has added an average of $200,000 to her annual income over the last 10 years. Sparta travels extensively. She likes to consider herself someone who lives in the fast lane and possesses refined tastes in both the arts and entertainment. Sparta’s annual expenses, including travel and entertainment, average $375,000. Sparta has no foreseeable liquidity needs, legal, regulatory, or tax concerns, and has no unique circumstances. Which of the following most appropriately describes Sparta’s ability and willingness to bear risk? Sparta is:

A) willing, but unable to accept risk.

B) neither able or willing to accept risk.

C) both willing and able to accept risk.

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Based on the information provided, Sparta’s fast life style, speculative activities, and relatively large income in excess of expenses, indicates both a willingness and ability to accept risk.

kim226

The process of elimination can be used to arrive at an individual’s asset allocation. Which step is often considered the first hurdle in the elimination process?

A) Risk objective.

B) Return objective.

C) Liquidity constraint.

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The first step in the elimination process is to select those allocations that at least meet the real after-tax total return objective of the investor. Once that step is completed, then other considerations are addressed.

kim226

After selecting allocations based on a return objective criterion, the process of elimination for selecting the appropriate individual investor allocation can next use which of the following factors?

A) Risk objective.

B) Unique considerations.

C) Liquidity constraint.

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Once the return objective has been met, eliminating allocations via the risk objective can be accomplished.

kim226

If more than one allocation exists after elimination via return and risk criteria, the advisor then can eliminate those that do NOT meet an individual’s:

A) familial heritage.

B) unique considerations.

C) acquaintance recommendations.

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Unique preferences and other considerations should be used to eliminate those allocations that are inappropriate beyond risk and return objectives. These unique preferences may be related to statements made about what type of securities an individual does not desire holding or some desired liquidity level not already considered explicitly in the liquidity constraint. Any indication as to inappropriateness can be used to eliminate all but the most appropriate allocation.

kim226

Which of the following inputs is NOT used in both deterministic and probabilistic analyses in individual retirement planning?

A) Current income.

B) Assets owned.

C) Input variable probabilities.

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In both approaches, the individual supplies a similar set of personal information, including the above as well as age, savings, etc. The difference between deterministic and probabilistic analyses is that deterministic planning techniques use single values for economic and financial variables. Monte Carlo (MC) simulations generate a probabilistic forecast of multiple retirement period values. Only Monte Carlo simulation would require the input of variable probabilities.