S4 1 Answers

Schweser Printable Answers - S4-1

Test ID#: 14

Question 1 - #103974

If the tax rate is positive and there is periodic payment of investment income taxes, then which of the following relationships is most accurate?

Your answer: A was correct!

Under the given conditions: tax drag > tax rate. This is because the tax rate is being applied periodically to a value (the taxable gain or investment income) that is increasing at a compound rate.

This question tested from Session 4, Reading 11, LOS d.


Which of the following is NOT an example of a cause of savings risk?

Your answer: C was correct!

A drop in a person抯 financial wealth due to a drop in the equity markets is an example of financial market risk and not savings risk. Savings risk is when a person doesn抰 save enough for retirement and spends more than they should during the accumulation phase. Savings risk usually arises from a lack of long-term planning and is the result of consuming too much current income rather than saving it. Relying too much on growth in a 401k to make up for a lack of saving is an example of savings risk.

This question tested from Session 4, Reading 14, LOS e.

Question 3 - #92077

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

Your answer: A was incorrect. The correct answer was C) Cash carried on the person.

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.

This question tested from Session 4, Reading 10, LOS k.

Question 4 - #93095

Which of the following is a reason why psychological profiling is important for understanding individual investor behavior? Investors:

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A) Tax drag > tax rate.

B) Tax drag = tax rate.

C) Tax drag < tax rate.

A) A person expects to average a 12% rate of return in their 401k retirement account.

B) A person fails to determine how much they need to save given an assumed rate of return and time frame.

C) The financial markets drop significantly wiping out a significant portion of a person抯 wealth.

A) Negative liquidity events.

B) Ongoing expenses.

C) Cash carried on the person.

of 26Printable Exams

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Your answer: B was correct!

Psychological profiling is important because investors tend to exhibit certain psychological characteristics which are not rational and are not consistent with modern portfolio theory. One of these psychological characteristics is loss aversion, which means that investors would prefer larger uncertain losses to smaller certain losses (risk seeking behavior). The concept of loss aversion conflicts with the assumption of risk aversion under modern portfolio theory, which says that investors minimize risk for a given level of return. Note that the other answer choices are all assumptions under modern portfolio theory (MPT).

This question tested from Session 4, Reading 10, LOS b.

Question 5 - #91852

Which of the following is NOT determined using situational profiling? Investor:

Your answer: C was incorrect. The correct answer was B) behavior.

Situational profiling does not determine investor behavior, but represents an analysis of behavior in determining preferences and biases, as well as philosophy.

This question tested from Session 4, Reading 10, LOS a.


With respect to the effectiveness of life insurance for individual investors, it is:

Your answer: B was incorrect. The correct answer was C) tax efficient, and accessibility of assets held inside the policy can be either good or poor, depending upon the terms of the policy.

With respect to the effectiveness of life insurance for individual investors, it is tax efficient, accessibility of assets held inside the policy can be either good or poor depending upon the terms of the policy, and the degree of control over the management of the assets is limited. Depending upon the type of policy some of the value of the policy may be withdrawn as a tax free loan. Death benefits paid to beneficiaries are generally tax free with no reporting required.

This question tested from Session 4, Reading 12, LOS h.


When an investor makes a charitable gift of appreciated securities:


A) are assumed to only select portfolios that maximize a return for a given level of risk.

B) are loss averse.

C)focus on individual asset risk/return characteristics as well as how the individual asset interacts with other assets in the portfolio.

A) biases.

B) behavior.

C) philosophy.

A) tax inefficient, and the degree of control over the management of the assets is limited.

B) tax efficient, and the degree of control over the management of the assets is unlimited.

C)tax efficient, and accessibility of assets held inside the policy can be either good or poor, depending upon the terms of the policy.

A) the recipient must pay the capital gains taxes.

B) the tax rate is based upon the gifting rate.

C) usually no gift transfer taxes are assessed.



When an investor makes a gift of appreciated securities usually no gift transfer taxes are due, the investor donating the securities is allowed to take an income tax deduction in the amount of the fair market value of the securities, and no capital gains taxes are assessed so the investment continues to grow tax free at the charitable organization.

This question tested from Session 4, Reading 12, LOS f.


An advantage of a fixed annuity over a variable annuity is:


One advantage of a fixed annuity over the variable annuity is the stable income stream offered by the fixed annuity. Since the variable annuity抯 income is tied to the return of underlying assets, which are usually equity-like the annuity抯 income also fluctuates as the return on the underlying assets fluctuates. A disadvantage of fixed annuities is since their income stream is fixed they lose real earning power over time due to inflation. Once the fixed or variable contracts are annuitized meaning the investor decides to have the payments sent to them for life, both fixed and variable annuities are equally difficult to terminate.



The legal process that takes place at death in which a court is involved is known as:


Probate is a legal process that takes place at death, during which a court determines the validity of the decedent抯 will, inventories the decedent抯 property, resolves any claims against the decedent, and distributes remaining property according to the will. The most common tool used to transfer assets is a will (also known as a testament). A will is the legal document that states the rights others will have to your assets at your death. If a person dies without a will or their will is determined to be invalid, then they are said to have died intestate.



Amy Tillman and Josh Northrup are portfolio managers for Parquet Asset Management. Tillman and Northrup are discussing the process their firm uses to identify an individual investor抯 objectives and constraints, and ultimately construct an investment policy statement. Tillman makes the following statements to Northrup during the course of their conversation:

With regard to Tillman抯 statements:

A) the fixed annuity抯 income stream is stable throughout the life of the annuity purchaser.

B) the fixed annuity抯 income offers a hedge against inflation during periods of stagflation.

C) fixed annuities are easier to terminate than variable annuities.

A) the testamentary process in which the decedent抯 assets are transferred according to their will.

B)probate in which among other things the validity of the decedent's will is determined, and their remaining property is distributed.

C)the intestate process in which the decedent抯 property is inventoried and claims against the decedent are resolved.

Statement 1: Since investors tend to exhibit irrational, psychological characteristics, the investor should be educated so that these characteristics are put aside and rational expectations can be the sole determinant of the investor抯 risk and return objectives.

Statement 2: Investors that exhibit the characteristic of asset segregation may tend to take on more risk than necessary in their portfolios.

Statement 1 Statement 2



Your answer: A was incorrect. The correct answer was C)

Psychological/behavioral patterns can have a significant influence on an investor抯 decision making process. Statement 1 is incorrect � the role of a portfolio manager is not to eliminate the effect of these psychological patterns on decision making, but to know and understand the investor抯 situation, and use these psychological characteristics when discussing risk and return objectives with the client. The client may need education, but the psychological characteristics a client has should be a key consideration when setting risk and return objectives. Statement 2 is correct. Asset segregation refers to focusing on individual assets instead of evaluating the asset抯 impact on the portfolio. Asset segregation tends to lead to the investor taking on more risk than is necessary in their portfolio � the investor may dismiss a particular asset because 搃t is too risky� however, in a portfolio context, the asset would actually reduce the risk of the portfolio as a whole.



A financial asset that is specifically designed to address the problem of outliving one抯 assets is called:


Life annuities are designed to pay income to the owner as long as the owner is alive. Therefore, unless the insurance company issuing the annuity fails and is unable to make the payments as promised, the annuitant cannot outlive their income.



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


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.

This question tested from Session 4, Reading 10, LOS l.

Question 13 - #103953

On a graph where the risk is on the horizontal axis and the returns are on the vertical axis, the existence of taxes on investment returns would probably shift the mean-variance optimization portfolio:

A) Correct Incorrect

B) Correct Correct

C) Incorrect Correct

Incorrect Correct

A) a guaranteed investment contract.

B) life insurance.

C) a life annuity.

A) Unique circumstances.

B) Liquidity.

C) Return objectives.

A) down and to the right.

B) down only, and there would not be a shift left or right.

C) down and to the left.



Your answer: B was incorrect. The correct answer was C) down and to the left.

Taxes lower returns, but they also shift some of the investment risk to the government.

This question tested from Session 4, Reading 11, LOS i.

Question 14 - #119634

Which of the following equations represents the relative value of a gift when it is subject to taxes?

Your answer: A was incorrect. The correct answer was C)

Equation #1 below shows the relative value of a taxable gift (numerator) when the gift is subject to gift taxes compared to if it is gifted as part of an estate (denominator).

1.

Equation #2 below shows the relative value of a tax free gift if it is gifted today (numerator) compared to if it is gifted as part of an estate (denominator).

2.

Equation #3 below shows the relative value of a taxable gift when the donor pays the gift taxes (numerator) compared to if it is gifted as part of an estate (denominator).

3.



Larry Smith, CFA, is the new equity portfolio manager for a socially responsible mutual fund. The investment policy statement stipulates which stocks do not meet the fund抯 definition of socially responsible. Because Smith was new to the fund, he did not personally agree to the stocks that were forbidden. Subsequently, he included a stock into the portfolio that was on the restricted list. Which of the following statements is least accurate?

A)

B)

C)

A) Smith was responsible for reading and understanding the investment policy statement prior to stock selection.

B) Smith did not violate the investment policy statement.

C) Smith is to be held responsible for the investment policy statement even though it was written before he was employed at the fund.



Your answer: A was incorrect. The correct answer was B) Smith did not violate the investment policy statement.

Smith is in clear violation of the fund抯 investment policy statement. Just because he is new to the fund, does not exempt him from following the statement. Most investment policy statements contain a stated review process that provides direction for dispute resolution.

This question tested from Session 4, Reading 10, LOS g.

Question 16 - #100912

Which of the following statements regarding human capital volatility is most accurate? When human-capital is bond-like, an investor抯 financial assets should be:

Your answer: B was incorrect. The correct answer was C) more aggressively allocated and their demand for life insurance will increase.

When human-capital is bond-like, an investor抯 financial assets can be more aggressively allocated and the demand for life insurance will increase. On the other hand, when human-capital is equity-like, an investor抯 financial assets should be allocated towards low risk assets and their demand for life insurance will decrease.



The ability to take risk is best judged by:


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

This question tested from Session 4, Reading 10, LOS j.


Kent Andling is 55 years old and recently sold his high tech manufacturing company, which was started in his father抯 basement 35 years ago. Andling抯 two children are grown and have been featured in recent entrepreneur magazine articles as up and coming entrepreneurs. How would Andling be classified given this brief profile?


Although Andling is approaching the latter stage of life, his participation as an entrepreneur of a high-tech manufacturing firm indicates knowledge of risk-taking activities. Apparently, he has brought up his children to understand risk-taking activities, too. These factors indicate a moderate-to-high risk tolerant profile.



A) allocated towards low risk assets and their demand for life insurance will increase.

B) more aggressively allocated and their demand for life insurance will decrease.

C) more aggressively allocated and their demand for life insurance will increase.

A) the time horizon of only short term objectives.

B) the time horizon of long term objectives.

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

A) Moderate-to-high risk tolerant.

B) Not enough information to tell.

C) Low-to-moderate risk tolerant.



An entrepreneur started a company many years ago. The company went public a few years ago, and the entrepreneur continued to increase both the value of the company and its stock. The entrepreneur openly feels a sense of pride in his accomplishments with the company. Based upon this scenario it is likely that a financial advisor suggesting that the entrepreneur sell some of the position in the company with the goal of diversification would:


Entrepreneurs who start and build a company often have an emotional attachment to the company and its stock, and they are reluctant to sell for that reason.



Investor psychology indicates investors will form portfolios via which method?

Your answer: B was incorrect. The correct answer was C) Pyramiding.

Pyramiding is the concept applied to investor portfolio formation in which portfolios are created by matching layers of assets to specific goals. Each layer of assets is not particularly evaluated within an overall portfolio context.


Question 21 - #103975

The tax drag from both longer investment horizons and higher investment returns:


They are multiplicative in the formula. Thus, when both are increased, the tax drag rapidly increases.


Question 22 - #103973

Given an accrual equivalent after-tax return equal 6% and a pre-tax return equal to 7.2%, what is the accrual equivalent tax rate?


The accrual equivalent after-tax rate is:

A)meet a great deal of resistance from the entrepreneur because entrepreneurs are not interested in selling stock for a profit.

B) find the entrepreneur very receptive to the idea and eager to earn a profit on the stock.

C) meet a great deal of resistance from the entrepreneur because of the emotional attachment to the stock.

A) Triangulating.

B) Integrating.

C) Pyramiding.

A) are unrelated, and each has a linear relationship with cash drag that is independent of the other.

B) have a multiplicative effect, so that the tax drag increases rapidly as the investment horizon and the returns increase.

C) have an offsetting effect, so the tax drag can be zero in some cases where the investment horizon and returns are greater than zero.

A) 16.67%.

B) 12.93%.

C) 20.00%.



0.1667 = 16.67% = 1 − (6% / 7.2%).

This question tested from Session 4, Reading 11, LOS c.


Which of the following statements about appropriate investment planning is CORRECT?


Consultation with tax counsel could be recommended for complicated tax situations and an estate counsel for estate issues. A 23-year-old investor should be more concerned about capital appreciation, not preservation. Investment policy statements are more useful the more specific they are.


Question 24 - #100917

Which of the following has a positive relationship with the demand for life insurance?


An investor抯 aversion to risk and the demand for life insurance have a positive relationship � the greater their level of risk aversion the more life insurance they demand. The level of financial wealth and demand for life insurance have a negative relationship as does the volatility of the investor抯 human capital and demand for life insurance.


Question 25 - #100887

A stock is expected to increase in value from $500 to $1,000 over a five-year period. The applicable capital gains tax rate is 28%. What is the expected after-tax value in five years?


The pre-tax investment return is 14.87% =($1,000/$500)(1/5) � 1.

The formula for the future-value interest rate factor is FVIFCGT = [(1 + R)N(1 � TCG) + TCG] 1.72 = [(1.1487)5 (1 � 0.28) + 0.28]. Thus, the after-tax value in five years is expected to be $860 = $500 × 1.72.


Question 26 - #104074

In the following graph which of the following statements is most accurate regarding what the vertical axis represents besides dollars?

A)An appropriate investment objective for a typical 23-year-old investor is a low-risk strategy, such as capital preservation.

B) Individual investment planning could include the consultation of counsel.

C) It is not a good idea to get too specific when constructing an investment policy statement.

A) The level of financial wealth.

B) The volatility of the investor抯 human capital.

C) An investor抯 aversion to risk.

A) $860.

B) $781.

C) $552.



Your answer: B was incorrect. The correct answer was C) The point in time when the individual finishes their educational training and starts working.

The vertical axis denotes the point in time when the investor finishes preparing for their career by completing their education or training and starts generating income. It also shows the amounts of human and financial capital separately.



With respect to the risk from a concentrated holding, the investment advisor抯 overall objective is to diversify the portfolio until all:


With respect to the risk from a concentrated holding, the investment advisor抯 overall objective is to diversify the portfolio until all non-systematic risk is eliminated. Systematic risk will still be present if any long position in equity securities is held.


Question 28 - #103977

If an investment is held in an account that is taxed annually, the government bears:


If the investment returns are taxed solely as income at the tax rate t and the pre-tax standard deviation of returns is S, then the investor抯 after-tax risk is S × (1 − t), and the government bears a portion of the risk.



James Corby and Paul Neiberlein are investment advisors for the money management firm of Gael Investment Advisors. Gael Investment Advisors is a firm with 28 investment advisors started by Corby in 1982. The firm has €730 million under

A)The point in time when the individual is born and their potential human capital is the greatest while their financial capital is the smallest.

B) The combined amount of human and financial capital called total wealth.

C) The point in time when the individual finishes their educational training and starts working.

A) systematic risk is eliminated.

B) non-systematic risk is eliminated.

C) liquidity risk is eliminated.

A) some of the investment risk.

B) none of the investment risk.

C) all of the investment risk.



management. Neiberlein became partner of the firm in 1993. Gael specializes in providing advice to executives with high net worth. Although the executives demand customized services, Gael has found this market niche to be very profitable.

Corby and Neiberlein are providing investment advice to Dave Cegelski, who is 39 years old and the CEO of a technology firm, Reston Technologies. Cegelski started the firm in 1991 and took it public in 1999 so that he could liquidate some of equity and diversify his portfolio. Cegelski抯 liquid assets are minimal. Due to the high risk of the technology industry, he would like to decrease the risk of his financial assets.

Cegelski still holds the majority of his wealth in Reston Technologies stock as it accounts for roughly 60 percent of his portfolio. However, Cegelski does not want to send a negative signal to the financial markets. Reston Technologies is now a mid cap stock that is closely watched by analysts. Furthermore, Cegelski does not want to relinquish control of Reston Technologies stock because he is concerned that a hostile investor may attempt to gain control of the firm. However, he would like to achieve the diversification of his portfolio quickly, because he is concerned about a downturn in the technology sector. He also wants to be able to have the funds necessary for his children抯 college education, which begins in three years.

Tom Cecil is another client of Gael Investment Advisors. He is 45 years old and the primary owner of Irvington Beverage Distributors. Irvington Beverage Distributors holds the exclusive rights to distribute several brand name alcoholic beverages in a three state area. Cecil bought his ownership stake from his uncle eleven years ago. Besides Cecil, the only other owners are friends, family, and private investors. The Irvington ownership position constitutes about three quarters of Cecil抯 portfolio. Cecil would like to diversify his assets in a tax efficient manner because he is in the top tax bracket. He is single with no children and no immediate liquidity needs.

Over lunch on the following day, Corby and Neiberlein discuss the attractiveness of alternative investments for their clients, including real estate, private equity, commodities, managed futures, and distressed securities. Corby notes that the standard deviation of managed futures is generally less than that of equities but greater than that of bonds. Corby also states that the correlation between managed futures and equities is low and often negative.

Neiberlein states that the Sharpe ratio is inappropriate for hedge fund evaluation because the returns for hedge funds are often serially correlated, which artificially increases the standard deviation.

Part 1) Which of the following best represents Cegelski抯 risk exposures?

Your answer: B was incorrect. The correct answer was A) Cegelski抯 main exposures are to systematic risk and unsystematic risk.

Cegelski抯 main exposures are to systematic risk and unsystematic risk. He has unsystematic risk because his portfolio is poorly diversified. The Reston Technologies stock is publicly traded so, although he does not want to, he could liquidate his shares publicly. (Study Session 4, LOS 13.b)


James Corby and Paul Neiberlein are investment advisors for the money management firm of Gael Investment Advisors. Gael Investment Advisors is a firm with 28 investment advisors started by Corby in 1982. The firm has €730 million under management. Neiberlein became partner of the firm in 1993. Gael specializes in providing advice to executives with high net worth. Although the executives demand customized services, Gael has found this market niche to be very profitable.



Tom Cecil is another client of Gael Investment Advisors. He is 45 years old and the primary owner of Irvington Beverage Distributors. Irvington Beverage Distributors holds the exclusive rights to distribute several brand name alcoholic

A) Cegelski抯 main exposures are to systematic risk and unsystematic risk.

B) Cegelski抯 main exposures are to systematic risk, unsystematic risk, and liquidity risk.

C) Cegelski抯 main exposures are to systematic risk.



beverages in a three state area. Cecil bought his ownership stake from his uncle eleven years ago. Besides Cecil, the only other owners are friends, family, and private investors. The Irvington ownership position constitutes about three quarters of Cecil抯 portfolio. Cecil would like to diversify his assets in a tax efficient manner because he is in the top tax bracket. He is single with no children and no immediate liquidity needs.



Part 2) Which of the following represents the best mitigation of Cegelski抯 risk exposures? Corby and Neiberlein should recommend that:


Cegelski should enter into an equity swap where he would exchange the return on Reston Technologies stock for the return on some other asset in a private, over-the-counter contract. He does not want to send a negative signal by selling the stock outright. An exchange fund would not allow him to sell his shares in three years. In an exchange fund, the investor contributes their shares to a common diversified pool of stock that similar investors have contributed to. The investor makes a commitment to keep their shares in the fund for a period of time (usually seven years) after which they can withdraw a proportionate share of the fund. He does not currently have the liquidity necessary to enter into a completion fund. He also does not want to increase his risk so he should not borrow against his Reston shares to enter the completion fund. To raise the funds to invest in a completion fund, the individual borrows funds against his or her stock or uses the dividends from his or her current stock. In the former case, the increased leverage increases the investor抯 risk. In the latter case, obtaining the funds necessary to invest in the completeness fund may take substantial time. Cegelski has stated that he wants to diversify in a timely manner. (Study Session 4, LOS 13.d)







A) Cegelski enter into an exchange fund agreement.

B) Cegelski enter into an equity swap.

C) Cegelski construct a completion portfolio.




Part 3) Which of the following best represents Cecil抯 risk exposures?

Your answer: C was incorrect. The correct answer was B) Cecil抯 main exposures are to systematic risk, unsystematic risk, and liquidity risk.

Cecil has exposure to systematic risk, unsystematic risk, and liquidity risk. Irvington Beverage Distributors is a private firm so he cannot liquidate his ownership position quickly. He also has unsystematic risk because his portfolio is poorly diversified. (Study Session 4, LOS 13.b)








Part 4) Which of the following would be the least appropriate method of mitigating Cecil抯 risk exposures?

Your answer: B was incorrect. The correct answer was A) An outright sale of Irvington Beverage Distributors stock.

Cecil cannot easily sell his ownership position because Irvington Beverage Distributors is a private firm. Furthermore, he has stated that he would like to minimize his taxes and an outright sale is usually the most tax inefficient method of diversifying a portfolio. (Study Session 4, LOS 13.d)


A) Cecil抯 main exposures are to systematic risk.

B) Cecil抯 main exposures are to systematic risk, unsystematic risk, and liquidity risk.

C) Cecil抯 main exposures are to systematic risk and unsystematic risk.

A) An outright sale of Irvington Beverage Distributors stock.

B) Constructing a completion portfolio.

C) Entering into an exchange fund agreement.









Part 5) Regarding Corby抯 statement concerning managed futures:

Your answer: C was incorrect. The correct answer was B) Corby is correct.

Corby is correct. The standard deviation of managed futures is generally less than that of equities but greater than that of bonds. The correlation between managed futures and equities is low and often negative. (Study Session 13, LOS 31.d)





Tom Cecil is another client of Gael Investment Advisors. He is 45 years old and the primary owner of Irvington Beverage Distributors. Irvington Beverage Distributors holds the exclusive rights to distribute several brand name alcoholic beverages in a three state area. Cecil bought his ownership stake from his uncle eleven years ago. Besides Cecil, the only

A) Corby is incorrect because the risk of managed futures is higher than that of equities.

B) Corby is correct.

C) Corby is incorrect because the correlation of managed futures with equities is quite high.



other owners are friends, family, and private investors. The Irvington ownership position constitutes about three quarters of Cecil抯 portfolio. Cecil would like to diversify his assets in a tax efficient manner because he is in the top tax bracket. He is single with no children and no immediate liquidity needs.



Part 6) Regarding Neiberlein抯 statement concerning the use of the Sharpe ratio for hedge fund evaluation:


Neiberlein is incorrect because, although the returns for hedge funds are often serially correlated, the resulting standard deviation of returns will be artificially low. For example, if returns are trending for a period of time, the measured standard deviation will be lower than what may occur in the future. Serially correlated returns also result when the asset is illiquid and previous period prices are used (because current prices are not available). (Study Session 13, LOS 31.s)


Question 30 - #103976

In a tax-exempt account, contributions to the account are made with:

Your answer: C was incorrect. The correct answer was A) after-tax funds and do not reduce the investor抯 current tax bill.

The tax benefit for a tax-exempt account occurs when the funds are withdrawn.


Question 31 - #100911

Financial wealth and the demand for life insurance have:


Financial wealth and the demand for life insurance have a negative relationship which means if a person has a lot of financial wealth their need for life insurance is small and visa versa.



The results of a personality typing questionnaire can be used to classify investors according to risk tolerance and how

A) Neiberlein is incorrect because hedge fund returns are not serially correlated and the standard deviation of returns will be artificially low.

B) Neiberlein is incorrect because hedge fund returns are not serially correlated.

C) Neiberlein is incorrect because the standard deviation of returns will be artificially low.

A) after-tax funds and do not reduce the investor抯 current tax bill.

B) after-tax funds and reduce the investor抯 current tax bill.

C) pre-tax funds and reduce the investor抯 current tax bill.

A) a positive relationship.

B) either a positive or a negative relationship depending upon the individual抯 level of wealth.

C) a negative relationship.



decisions are made. The classification that represents the most risk averse investor would be a(an):


Cautious investors are those investors most averse to portfolio losses. These investors are the most risk averse investor classification and prefer assets with low probability of loss.


Question 33 - #100888

An investor deposited $33,000 in a zero coupon bond position 20 years ago. It consisted of 100 zero coupon bonds each with a face value of $1,000 and 20 years to maturity. The investor抯 current marginal tax rate is 30%. At maturity, and after all taxes have been paid, the value of the position is $84,500. Compute the accrual equivalent after-tax return.


The accrual equivalent after-tax return = 4.81% = ($84,500 / $33,000)(1/20) − 1. The current marginal tax rate is not relevant to solving the problem.


Question 34 - #118252

The primary motivation for estate planning is to:

Your answer: C was incorrect. The correct answer was B) minimize taxes.

The primary motivation for estate planning is to minimize taxes.


Question 35 - #103971

The tax rate is 34%. An investment of $5,000 earns a pre-tax return equal to 8%, which is taxable each year. What will the investment be worth in ten years after taxes?


After-tax value = $5,000 × [1 + 0.08 × (1 − 0.34)](10) = $8,364.28


A) methodical investor.

B) cautious investor.

C) spontaneous investor.

A) 4.81%.

B) 4.33%.

C) 3.99%.

A) match investment horizon objectives.

B) minimize taxes.

C) maximize returns.

A) $8,056.

B) $8,364.

C) $7,124.



Question 36 - #119636

The main purpose of a trust is to:


A trust is when assets from a grantor or settlor are transferred outside of the probate process to beneficiaries by an appointed person called a trustee. The trustee manages the assets in the best interests of the beneficiaries according to the trust documents.



Behavioral finance models of asset pricing take into account economic considerations and add:


In a world that accounts for behavioral factors, personal preferences are added to asset pricing models. Not only do basic economic relationships impact security prices but so do personal preferences. Investors� likes and dislikes enter the pricing function.



An investment policy statement does NOT provide which of the following?


An investment policy statement does not provide guaranteed investment results.


Question 39 - #118251

Once an individual reaches the retirement age a main concern is:


When an individual reaches retirement age the primary issue is to establish a spending rate (i.e., an income distribution plan) that will not result in their outliving their assets.


A) avoid the probate process.

B) designate how assets are to be transferred to beneficiaries.

C) protect the assets from creditors and others making claims against the trust assets.

A) personal preferences.

B) individual selections.

C) security specific characteristics.

A) Long-term investment decision making guidelines.

B) Guaranteed investment returns.

C) Weighting ranges for asset allocation.

A) establishing a spending rate that will not result in their outliving their assets.

B) safety of principal, with investment income being secondary.

C) reallocating financial assets to adopt a more conservative profile.




The concept of behavioral finance has begun to be employed in investment management. Which of the following statements is CORRECT regarding behavioral finance and its potential affect on a client抯 risk objectives? Behavioral finance implies that investors are:


Behavioral finance suggests that investors may view risk of loss differently from risk of gain (i.e., that they are more risk seeking in the domain of losses). This is known as being loss averse. The investor抯 psychological profile can affect their willingness to take risk. However, the ability to take risk is a more objective measure of what is appropriate given the client抯 situation.


Question 41 - #100922

With regard to an individual抯 total wealth, which statement is most accurate? If an individual抯 human capital is fixed income-like their financial portfolio:


An individual抯 financial portfolio can be weighted more heavily towards risky assets if their human capital is fixed income-like. If an individual has a secure job with an annual salary, they are able to accept more risk in their financial portfolio since their human capital has very low risk.


Question 42 - #103982

In applying efficient frontier analysis for an investor who uses both taxable and tax-advantaged accounts, the mean-variance optimization:

Your answer: B was incorrect. The correct answer was A) would simultaneously determine both the weights in the available assets and their location in the various accounts.

The mean-variance optimization should optimally allocate assets and determine the optimal asset location for each asset. Substitution of adjusted returns would allow the process to be done in one step.

This question tested from Session 4, Reading 11, LOS i.


A) loss averse, rather than risk averse, and this may have an impact upon the investors' willingness to take risk.

B) risk averse, rather than loss averse, and this may have an impact upon the investors' willingness to take risk.

C) loss averse, rather than risk averse, and this may have an impact upon the investors' ability to take risk.

A) may be weighted more heavily towards risky assets.

B) should be weighted with similar non-risky fixed income assets.

C) should be weighted in no specific way that is related to their human capital.

A)would simultaneously determine both the weights in the available assets and their location in the various accounts.

B)cannot simultaneously determine both the weights in the available assets and their location in the various accounts, but it can be done in a step-wise fashion. Usually the weights are determined first and then the locations.

C)cannot simultaneously determine both the weights in the available assets and their location in the various accounts, but it can be done in a step-wise fashion. Usually the locations are determined first and then the weights.



Which of the following statements about personality typing for individual investors is CORRECT?


As opposed to precise categories, broad classifications are easy to derive. The more subjective the assessment, the more difficult to standardize. An ad hoc approach would be a less formal approach based on the investment professional抯 interview with investors.


Question 44 - #100915

Which of the following is NOT a drawback to a fixed annuity?


Cash flows received on a variable pay annuity (not fixed annuity) are based on the performance of an underlying fund or set of funds selected by the investor and thus the cash flows are variable and could be zero if the performance of the underlying funds is negative for the investment period. Drawbacks to fixed annuities are:

cash flows are fixed and do not increase with the rate of inflation thus the real value of the cash flows decreases over time.

cash flows are based on the level of interest rates at the time the annuity goes into effect. If interest rates are low when the contract goes into effect this would lock in a low rate of return to the investor.

the annuity is illiquid and difficult to get out of the contract.


Question 45 - #100863

The nation of Pensacola is best described as having a flat and heavy tax regime. Which of the following assets would be most appropriate for Pensacola investors using a TDA?

Your answer: C was incorrect. The correct answer was A) High dividend yielding stocks.

In a Flat and Heavy Tax Regime, interest income receives favorable tax treatment but dividends do not. The high dividend yielding stocks are therefore most appropriate for a TDA. Tax-exempt bonds don抰 require the tax protection provided by a TDA.



Jim Thamen, CFA, recently received an assignment from his supervisor Andy Stone, CFA, to prepare a proposal for managing Ellen and Joe Swathman抯 investment portfolio. Ellen, 62, and Joe, 65, recently inherited $2,500,000 from Ellen抯 eccentric uncle, Daniel, and wish to invest their money wisely. The Swathmans have two grown children, Marcus, 30, and Sue, 27, who are financially independent from their parents. Although both Marcus and Sue are married, the Swathmans do not have any grandchildren.

A) An ad hoc approach to personality typing is to administer a short questionnaire.

B) It is difficult to render precise categorizations of broad groups of investors.

C) Subjective assessments of investors are easy to standardize.

A) The cash flows could be zero if the underlying asset return is negative for the investment period.

B) The investor usually cannot void the contract.

C) The real value of the cash flows may decline over time.

A) High dividend yielding stocks.

B) Tax-exempt bonds.

C) Interest bearing, taxable bonds.



For the past 20 years, Ellen has worked as a legal secretary for a regional law practice that specializes in professional malpractice, product liability, and worker抯 compensation litigation. Joe is nearing retirement age at the local rock quarry he co-founded with a high school classmate almost 40 years ago. Although the rock quarry has not provided the Swathmans with a large amount of excess discretionary income, they have been able to provide themselves and their children a comfortable living. Joe and his partner Ed Small have executed a buy-sell agreement and maintain life insurance to fund a buy-out in the event of the untimely death of either. Although Ellen is planning to retire within 9 to 12 months, Ed wants to continue working at the quarry for a few more years.

The Swathmans are in relatively good health, have adequate health insurance, property and casualty, disability, liability, and life insurance. All consumer debts have been paid. They plan to spend approximately $200,000 over the next year renovating their home in preparation for retirement.

Thamen recorded the following statements made by Joe Swathman in a recent meeting:

1. 揈llen and I do not consider ourselves wealthy by any measure. Although the inheritance doubles our net worth, I know plenty of others with substantially greater retirement accounts. Besides, we have a quite a bit tied up in the business. On top of that, we will probably live another 25 years. So I think we are average risk-takers.�

2. 揈llen抯 work has made her sensitive to potential property and casualty or liability losses. She leaves the investment decisions up to me, but says that we should be careful.�

3. 揑 had a great return with Netshopper stock and sold it too early. I bought it at $1.25. Last year when they announced a distribution deal with Nike the stock jumped to $8.75 so I sold. It抯 still going strong, as both their sales model and management team are winners. Yesterday, I checked and it closed at $26.00.�

4. 揑've been following a stock called Computrol which was projected to hit $42.50. New information came out from the company with predictions it should hit $85.00 but analysts predicted it will only hit $65.�

A week later, Thamen is trying to determine the appropriate dynamic asset allocation strategy for the Swathman portfolio given the economic outlook, capital market conditions, and the Swathman抯 risk and return objectives. He consults his supervisor, Andy Stone, to discuss it.

Thamen begins by stating that 揳 buy and hold strategy outperforms a constant mix strategy in a trending market and underperforms the constant proportion portfolio insurance strategy (CPPI) in a flat, but oscillating market."

Stone replies: 揑 agree that a buy and hold strategy outperforms a constant mix strategy in a trending market but it also outperforms the CPPI strategy in a flat, but oscillating market."

Part 1) In formulating an investment policy statement for the Swathmans, Thamen decides to develop a brief situational profile for his clients. Which of the following best represents the situational risk profile for the Swathmans?

Your answer: C was incorrect. The correct answer was A) With respect to source of wealth, measure of wealth, and age, Joe Swathman's statements and the additional supporting information indicate an overall average risk tolerance.

The size of their assets in the context of their age (time horizon), suggests the Swathman抯 are unlikely to exhaust their savings during retirement. Thus, their financial situation indicates an above-average ability to incur risk. In contrast, Joe's entrepreneurial background (increased risk tolerance), statement about them being of average risk tolerance, his statement about Ellen saying they should be careful (below average risk tolerance), adequate insurance, and no debt indicates they manage their finances in a responsible manner. Hence their statements and background reflect an average to some what below-average willingness to take risk leaning more towards average. Overall their risk tolerance would be average based on their average willingness to take risk. On the exam you would not want to give a range of risk tolerances but instead state a single level of risk tolerance. For example state something like:

Ability to tolerate risk is above average Willingness is average Overall risk tolerance is average

A)With respect to source of wealth, measure of wealth, and age, Joe Swathman's statements and the additional supporting information indicate an overall average risk tolerance.

B)With respect to source of wealth, measure of wealth, and age, Joe Swathman's statements and the additional supporting information indicate below-average to average risk tolerance.

C)The Swathman抯 substantial net worth, the financial independence of their children, and the fact that the Swathman抯 have no grandchildren to provide for in the future indicate an above-average to aggressive risk tolerance.



In this particular case of the Swathman's their asset base is not large enough to average the two risk tolerances of ability and willingness together and recommend counseling to reconcile the two. You would instead defer to the lower level of risk tolerance which is their willingness. (Study Session 4, LOS 10.a)













Part 2) Thamen understands that behavioral finance topics are becoming more important when attempting to better understand the relationship between portfolio manager and client. Which of the following behavioral investor traits were exhibited in Swathman's statements 1-4?


Only statements 3 and 4 describe behavior investor traits. Statement 3 is describing regret where the feeling in hindsight is associated with making a bad decision. Statement 4 is describing anchoring which is the inability to fully incorporate the impact of new information on projections. (Study Session 3, LOS 8.b)


A) Frame dependence and familiarity.

B) Representativeness and loss aversion.

C) Regret and anchoring.














Part 3) Thamen starts formulating the risk tolerance portion of the investment policy statement. He knows it is important to consider both the willingness and ability to take risk. Which of the following generally has the most impact on an individual抯 ability to take risk?

Your answer: C was incorrect. The correct answer was A) Portfolio size and time horizon.

The ability to incur risk is determined by the size of an investor抯 portfolio relative to his goals, the time horizon, the importance of the investment goals and the amount of volatility the portfolio can sustain without jeopardizing the goals. Other constraints (taxes, liquidity needs, etc.) may impact both the ability and willingness of and individual to take risk but are not generally considered to be as important as time horizon and portfolio size. (Study Session 4, LOS 10.j)


Jim Thamen, CFA, recently received an assignment from his supervisor Andy Stone, CFA, to prepare a proposal for managing Ellen and Joe Swathman抯 investment portfolio. Ellen, 62, and Joe, 65, recently inherited $2,500,000 from Ellen抯 eccentric uncle, Daniel, and wish to invest their money wisely. The Swathmans have two grown children, Marcus, 30, and Sue, 27, who are financially independent from their parents. Although both Marcus and Sue are married, the

A) Portfolio size and time horizon.

B) Liquidity requirements and tax considerations.

C) Liquidity requirements and portfolio size.



Swathmans do not have any grandchildren.











Part 4) Regarding the comments by Thamen and Stone about the different dynamic asset allocation strategies:


Stone's statement is correct. The Buy and Hold strategy outperforms a Constant Mix strategy in a trending market and outperforms the CPPI strategy in a flat but oscillating market. Thamen was right about Buy and Hold but wrong on CPPI.

The Constant Mix strategy outperforms a comparable Buy and Hold strategy, which, in turn, outperforms a CPPI strategy in a flat but oscillating market.

The CPPI strategy outperforms a comparable Buy and Hold strategy, which, in turn, outperforms a Constant Mix strategy in trending markets. (Study Session 16, LOS 40.h)



A) Stone is correct on Buy and Hold, but incorrect on CPPI; Thamen is correct on both Buy and Hold and CPPI.

B) Stone is correct on both Buy and Hold and CPPI; Thamen is correct on Buy and Hold and incorrect on CPPI.

C) Stone is incorrect on both Buy and Hold and CPPI; Thamen is incorrect on Buy and Hold and correct on CPPI.













Part 5) Thamen wants to incorporate the information ratio in the portfolio management process. Which of the following statements best describes the information ratio?


The information ratio is used to determine if a manager's alpha is a result of mere chance, or the manager's skill. It shows the relationship between the manager's alpha and the standard deviation of alpha (tracking error): information ratio = alpha / tracking error. (Study Session 17, LOS 41.p)



For the past 20 years, Ellen has worked as a legal secretary for a regional law practice that specializes in professional malpractice, product liability, and worker抯 compensation litigation. Joe is nearing retirement age at the local rock quarry he co-founded with a high school classmate almost 40 years ago. Although the rock quarry has not provided the Swathmans with a large amount of excess discretionary income, they have been able to provide themselves and their

A) The information ratio shows the relationship between the manager's alpha and the standard deviation of alpha.

B) The information ratio uses tracking error in the numerator of the equation which represents the standard deviation of monthly alphas.

C)The lower the information ratio, the more likely it is that a manager's performance is the result of skill rather than luck.



children a comfortable living. Joe and his partner Ed Small have executed a buy-sell agreement and maintain life insurance to fund a buy-out in the event of the untimely death of either. Although Ellen is planning to retire within 9 to 12 months, Ed wants to continue working at the quarry for a few more years.










Part 6) Thamen has been reading about the benefits of using Monte Carlo approaches in retirement planning. Which of the following is NOT a correct statement with regard to the benefits of using a Monte Carlo approach?


The results of Monte Carlo techniques are only as good as the inputs used. A weakness of Monte Carlo simulations is the need to pre-specify the distribution of the variables used or rely on historical distributions. (Study Session 4, LOS 10.n)



Bill Kelley, age 55, just retired and accepted an early retirement package from his employer, FertileGro Lawncare. The early retirement package has an estimated value of $1.2 million after taxes. After taking the retirement package, Kelley took a job in customer service at a local hospital and currently has a salary of $50,000 per year. Sharon Kelley, age 54, works part-time as the Treasurer for their church and has a salary of $15,000 per year. They have two children, Shannon, age 31, and Sarah, age 18. Shannon is married and does not require financial assistance, while Sarah is in her first year of college. The Kelleys consider the early-retirement package a wonderful addition to their existing $2 million in savings. They have no debt and pay their expenses on monthly basis. Total family expenses last year including tuition amounted to approximately $93,750.

Bill and Sharon Kelley recently approached Modern Portfolio Management, Inc. for help in managing their portfolio. At a recent fact-finding meeting, the Kelleys made the following statements:

Our primary goal is to pay for the college education of our youngest daughter, Sarah. Tuition, room, and board last

A) Monte Carlo forecasting techniques result in greater reliability than deterministic techniques.

B) Monte Carlo techniques often better represent trade-offs between short term risks and long-term goals.

C) Probabilistic forecasts are often better than point estimates in financial markets.



year was $30,000 and is expected to grow at 5% per year. We want to retire at age 65 and live comfortably. We are taxed at a 25% rate on dividends, capital gains, and income. Inflation is expected to grow at 2.5% per year indefinitely. People get too excited about the stock market - they talk about making all of this money, but they could turn around

and lose it tomorrow. We don抰 want to be in any individual investment or security that is considered too risky. We do not foresee any unusual expenses, but like to keep some cash on hand, just in case of emergencies.

Modern Portfolio Management presents the Kelleys with three model portfolios. Which of the portfolios would be best suited for the Kelley抯 to meet their living expenses this year?

Your answer: C was incorrect. The correct answer was B) Portfolio 2.

Portfolio 2 is the optimal portfolio. The Kelley抯 time horizon would be characterized as being long term with 3 stages:

1. Time until Sarah is out of college 2. Time until retirement 3. Retirement

The inflows are $50,000 + $15,000 = $65,000 before tax = $65,000 (1-.25) = $48,750 after tax.

The outflows have to be adjusted for inflation since they were last year's costs thus we have:

$93,750 total costs last year = $30,000 tuition + $63,750 living expenses Tuition expenses adjusted for inflation are $30,000 � 1.05 = $31,500 Living expenses adjusted for inflation are $63,750 � 1.025 = $65,344 Total outflows this year = $31,500 + $65,344 = $96,844

Inflows - outflows = $48,750 - $96,844 = -$48,094

Required return = 48,094 / 3,200,000 = 1.5% after tax real required return

1.5 / (1-.25) = 2% before tax real required return

Adjusting for inflation = 2.0 + 2.5 = 4.5% before tax nominal required return

Portfolio 2 meets the return requirement and also is in line with their low risk tolerance as indicated by not wanting to be in a security that is too risky. Portfolio 3 is also not acceptable because it is not well diversified and has 20% allocated to cash. Portfolio 1 looks like a good choice, especially with its slightly higher return than Portfolio 2 and broad diversification, however the portfolio has a much higher than necessary cash allocation, and the lack of return from cash seems to be made up for by a 10% stake in venture capital. Portfolio 2 appears to be a better match with the Kelley抯 risk tolerance.

This question tested from Session 4, Reading 10, LOS m.

Asset Class Portfolio 1 Portfolio 2 Portfolio 3

Large cap U.S. stocks 20% 35% 15%

Small cap U.S. stocks 10% 15% 0%

International developed market equities 5% 10% 0%

International emerging market equities 5% 5% 0%

U.S. corporate bonds 20% 30% 45%

U.S. Treasury bonds 10% 0% 20%

Real estate 5% 0% 0%

Venture capital 10% 0% 0%

Cash 15% 5% 20%

Total expected return 6.8% 6.3% 5.1%

Current yield 3.8% 3.5% 4.6%

A) Portfolio 1.

B) Portfolio 2.

C) Portfolio 3.



Question 48 - #118256

Investors use estate planning tools for all of the following reasons EXCEPT to:


Investors often use estate planning tools such as trusts, foundations, and life insurance, to minimize taxes and increase the efficiency of the transfer of assets to others. In so doing, they will maximize the value of wealth given to heirs or others but has little or no impact upon investment returns.


Question 49 - #100916

Which of the following statements is least accurate regarding human capital?


One should always offset the risk of their human capital with the risk of their financial capital and minimize the correlation between the two. If an investor抯 human capital is equity-like they should reduce the correlation with their financial capital by allocating a greater amount of their financial capital to fixed income investments and visa versa. The demand for life insurance will increase if human capital is bond-like and decrease if human capital is equity-like.


Question 50 - #103955

Which of the following moves by a government would most likely lead to the government taking on more investment risk?

Your answer: C was incorrect. The correct answer was A) Moving from a common progressive tax regime to a heavy dividend tax regime.

Moving from a common progressive tax regime to a heavy dividend tax regime would increase the tax on dividends, which are taxed annually, and this would shift some of the investment risk to the government.


©2011 Kaplan Schweser. All Rights Reserved.

A) increase the efficiency of the transfer of assets to others.

B) maximize wealth for heirs or others.

C) maximize investment returns.

A)If an investor抯 human capital is equity-like they should allocate a greater amount of their financial capital to fixed income investments.

B) The demand for life insurance will increase if human capital is bond-like.

C) When possible, one should maximize the correlation of human and financial capital.

A) Moving from a common progressive tax regime to a heavy dividend tax regime.

B) Moving from a heavy dividend tax regime to a common progressive tax regime.

C) Tax regimes cannot shift investment risk.

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