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Chapter 22 - Investors and the Investment Process

Chapter 22
Investors and the Investment Process

Multiple Choice Questions

1. To _____ means to mitigate a financial risk.


A. invest
B. speculate
C. hedge
D. renege

2. In a defined benefit pension plan, the _____ bears all of the fund's investment performance
risk.
A. employer
B. employee
C. fund manager
D. government

3. In a defined contribution pension plan, the _____ bears all of the fund's investment
performance risk.
A. employer
B. employee
C. fund manager
D. government

4. My pension plan will pay me a yearly retirement amount equal to 2% of my highest annual
salary for each year of service. I must have ___________.
A. a defined benefit plan
B. a defined contribution plan
C. an endowment fund
D. a variable annuity

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Chapter 22 - Investors and the Investment Process

5. A ______ insurance policy provides death benefits, with no buildup of cash value.
A. whole life
B. universal life
C. variable life
D. term life

6. If the maturity of a bank's assets is much longer than the maturity of its liabilities and it
wants to limit its interest rate risk the bank may _________.
A. prefer to invest in long term bonds in its asset portfolio
B. prefer to invest in equities in its asset portfolio
C. prefer to invest in variable rate assets
D. decide to increase its fixed rate mortgage holdings

7. You are thinking of investing in one of two assets. Asset A has higher systematic risk than
Asset B. You can be sure that Asset A's _______ return will be higher than Asset B, but you
can't be sure if Asset A's _______ return will be higher than Asset B's.
A. realized; expected
B. real; nominal
C. expected; realized
D. nominal; expected

8. A mutual fund may not hold more than ______ of the shares of any publicly traded
company.
A. 5%
B. 10%
C. 25%
D. 50%

9. Which one of the following would be considered to be a "cash equivalent" investment?


A. Treasury bills
B. Common stock
C. Corporate bonds
D. Real estate

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10. For a bank, the difference between the interest rate charged to borrowers and the interest
rate paid on liabilities is called the __________.
A. insurance premium
B. interest rate spread
C. risk premium
D. term premium

11. Price volatility is greatest on which one of the following investments?


A. Commercial paper
B. 20 year zero coupon bonds
C. Treasury notes
D. Treasury bills

12. A portfolio manager indexes part of a portfolio and actively manages the rest of the
portfolio. This is called a _________ strategy.
A. passive aggressive
B. passive core
C. passively active
D. balanced fund

13. The major asset most people have during their early working years is their ________.
A. home
B. stock portfolio
C. earning power derived from their skills
D. bond portfolio

14. At the early stage of an individual's working career their retirement portfolio should
probably consist mostly of _______.
A. annuities
B. stocks
C. bonds
D. commodities

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Chapter 22 - Investors and the Investment Process

15. If an investor wishes to invest 100% of her portfolio in safe assets but does not wish to
manage her portfolio, she should invest in __________.
A. a money market fund
B. a growth stock fund
C. several different money market instruments
D. several different stocks

16. Just two months after you put money into an investment its price falls 25 percent.
Assuming that none of the investment fundamentals have changed, which of the following
actions would evidence the greatest risk tolerance?
A. You sell to avoid further worry and buy something else.
B. You do nothing and wait for the investment to come back.
C. You buy more thinking that if it was a good investment before; now it's not only good it is
cheap too.
D. You sue your financial advisor.

17. In order to become a CFA you must do all except which one of the following?
A. Pass 3 exams designed to ensure you have sufficient knowledge of investments.
B. Obtain 3 years of work experience in money management.
C. Become a member of a local Society of the Financial Analysts Federation.
D. Divest all your own stock holdings to eliminate any potential conflicts of interest with
client recommendations.

18. Which of the following is not one of the main areas covered in the examinations that must
be taken in order to achieve the designation of Chartered Financial Analyst?
A. Investment management ethics
B. Securities analysis
C. Securities marketing techniques
D. Portfolio management

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19. As the typical investor ages the composition of their wealth usually switches from
primarily _______ to primarily _______.
A. human capital; financial capital
B. financial capital; human capital
C. intellectual capital; physical capital
D. investable capital; noninvestable capital

20. The two most important factors in describing an individual or organization's investment
objectives are ________________.
A. income level and age
B. income level and risk tolerance
C. age and risk tolerance
D. return requirement and risk tolerance

21. The term "hedge" refers to an investment that is used ________________.


A. primarily for tax loss selling purposes
B. to mitigate specific financial risks
C. to conceal one's true investment strategy from other market participants
D. primarily to defer capital losses

22. The price of your investment increases 20% one month after you buy it. You do not
believe that the stock's prospects have changed. Which one of the following actions would
indicate the lowest amount of risk aversion?
A. You hang onto the stock anticipating that it will go higher.
B. You buy more stock, anticipating that it will go higher.
C. You sell all of your stock holdings immediately.
D. You sell ½ your stock holdings and invest the proceeds in other areas of your portfolio.

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23. An individual is on the game show "Squeal or No Squeal" and she has a choice between
receiving a certain gain of $100,000 or a 50% chance of winning $200,000 or zero. Which
one of the following correctly completes the statement below? If she takes the gamble instead
of the certain $100,000 she is acting ____________________.
A. like a person who is risk neutral
B. like a person who is risk averse
C. like a person who is a risk lover
D. irrationally

24. Which one of the following typically strives to earn a return on their investments that
exceeds the actuarially determined rate of return?
A. Banks
B. Thrifts
C. Mutual funds
D. Pension funds

25. If an individual confers legal title to property to another person or institution to manage
the property on their behalf the individual has created a(n) ___________.
A. personal trust
B. charitable trust
C. endowment fund
D. mutual fund

26. Personal trusts are typically allowed to engage in which of the following investment
activities?
I. Buying and selling futures contracts
II. Short selling securities
III. Purchasing and writing options
IV. Buying stock on margin
A. I only
B. II and III only
C. II and IV only
D. None of the given activities are allowed

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27. If a defined benefit pension fund's actual rate of return is _____ than the actuarial assumed
rate then the ___________.
A. greater; employees will benefit
B. greater; firm's shareholders will benefit
C. lower; employees will benefit
D. lower; firm's shareholders will benefit

28. An employee has an average wage of $60,000 and they have worked for the firm for 25
years. The defined benefit pension plan pays retirees 2.5% of the average wage times the
years of service. The employee can expect to receive _______ per year upon retirement.
A. $18,000
B. $37,500
C. $45,325
D. $55,250

29. Life insurance companies try to hedge the risks inherent in whole-life insurance policies
by investing in __________.
A. long term bonds
B. money market mutual funds
C. savings accounts
D. short term commercial paper

30. A pension fund will owe $10 million to retirees in 6 years. An actuary assumes an 8% rate
of return on the funds invested in the pension plan. If the pension plan receives annual
contributions from the company sponsor, how much must the company pay to fully fund the
pension liability?
A. $1,212,587
B. $1,363,154
C. $1,533,333
D. $1,666,667

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31. The risk that a downturn in the market may substantially reduce your investment principal
is called _______.
A. purchasing power risk
B. interest rate risk
C. market risk
D. liquidity risk

32. The possibility that you are too conservative and your money doesn't grow fast enough to
keep pace with inflation is called ________.
A. purchasing power risk
B. liquidity risk
C. timing risk
D. market risk

33. A pension fund will owe $15 million to retirees in 20 years. An actuary assumes a 6% rate
of return on the funds invested in the pension plan but the fund actually earns 8%. The
pension plan receives annual contributions from the company sponsor. If the 8% rate of return
is expected to continue, by how much can the company reduce its pension payments per
year?
A. $65,437
B. $79,985
C. $89,462
D. $95,320

34. Many defined benefit pension plans have a target rate of return on investment
____________.
A. equal to the firm's return on equity
B. equal to the plan's assumed actuarial rate of return
C. equal to the economic inflation rate because wages often increase with inflation
D. equal to the estimated stock market return

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35. _______ is a life insurance policy that provides a death benefit and a fixed rate tax
deferred savings plan.
A. Term life
B. Whole life
C. Variable life
D. Universal life

36. Empirical evidence suggests that investors become __________ as they approach
retirement.
A. greedier
B. less interested in investments
C. more risk averse
D. more risk tolerant

37. _______ is a life insurance policy that will provide a death benefit only but has no savings
plan.
A. Term life
B. Whole life
C. Variable life
D. Universal life

38. Of the following, the investment time horizon is typically the shortest for __________.
A. banks
B. endowment funds
C. life insurance companies
D. pension funds

39. A passive asset allocation strategy involves _________.


A. investing in the stock of companies which are price takers
B. maintaining approximately the same proportions of a portfolio in each asset-class over time
C. varying the proportions of a portfolio in each asset-class in response to changing market
conditions
D. selecting individual securities in different sectors that are believed to be undervalued

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Chapter 22 - Investors and the Investment Process

40. An active asset allocation strategy involves _________.


A. investing in the stock of companies which are price takers
B. maintaining approximately the same proportions of a portfolio in each asset-class over time
C. varying the proportions of a portfolio in each asset-class in response to changing market
conditions
D. selecting individual securities in different sectors that are believed to be undervalued

41. Endowment funds are held by __________.


A. financial intermediaries
B. individuals
C. profit-oriented firms
D. nonprofit institutions

42. Which one of the following is a life insurance policy that will provide a fixed death
benefit and allows the policyholder to choose where to invest the policy's cash value?
A. Term life
B. Whole life
C. Variable life
D. Industrial life

43. Under a "passive core" portfolio management strategy, a manager would ___________.
A. index the entire portfolio
B. index part of the portfolio and actively manage the rest
C. delegate the management of core segments of the portfolio to other managers
D. actively manage the entire portfolio

44. Of the following, the most flexible type of life insurance policy from the policyholder's
perspective is probably a(n) ___________ policy.
A. term life
B. whole life
C. variable life
D. universal life

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Chapter 22 - Investors and the Investment Process

45. The amount of risk an individual should take depends on his or her
I. return requirements
II. risk tolerance
III. time horizon
A. I only
B. I and II only
C. II and III only
D. I, II and III

46. Earnings on variable life and universal life insurance policies are ___________.
A. never taxed
B. taxed only at the capital gains tax rate
C. not taxed until the money is withdrawn
D. not taxed at the federal level but are taxed at the state level

47. When a company sets up a defined contribution pension plan, the __________ bears all
the risk and the __________ receives all the return from the plan's assets.
A. employee; employee
B. employee; employer
C. employer; employee
D. employer; employer

48. Suppose that the pre-tax holding period returns on two stocks are the same. Stock A has a
high dividend payout policy and stock B has a low dividend payout policy. If you are a high
tax rate individual and do not intend to sell the stocks during the holding period,
__________.
A. stock A will have a higher after-tax holding period return than stock B
B. the after-tax holding period returns on stocks A and B will be the same
C. stock B will have a higher after-tax holding period return than stock A
D. it is impossible to determine which stock will have a higher after-tax holding period return
given the information available

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49. The objectives of personal trusts normally are __________ in scope than those of
individual investors and personal trust managers typically are __________ than individual
investors.
A. broader; more risk averse
B. broader; less risk averse
C. more limited; more risk averse
D. more limited; less risk averse

50. The prudent investor rule requires __________.


A. executives of companies to avoid investing in options of companies they work for
B. executives of companies to disclose their transactions in stocks of companies they work for
C. professional investors who manage money for others to avoid all risky investments
D. professional investors who manage money for others to constrain their investments to
those that would have been approved by a prudent investor

51. The prudent man law is an example of a regulation designed to ensure appropriate
_____________ by money managers.
A. fiduciary responsibility
B. fiscal responsibility
C. monetary responsibility
D. marketing procedures

52. An investor has a long time horizon and desires to earn the market rate of return.
However, the investor will need to withdraw funds each year from their investment portfolio.
The biggest constraint a planner would face with this client is a ___________ constraint.
A. tax
B. risk tolerance
C. liquidity
D. social

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53. When used in the context of investment decision making, the term "liquidity" refers to
_____________.
A. the ease and speed with which an asset can be sold at any value possible
B. the ease and speed with which an asset can be sold without having to discount the value
C. an aspect of monetary policy
D. the proportion of short-term to long-term investments held in an investor's portfolio

54. The term "investment horizon" refers to __________.


A. the proportion of short-term to long-term investments held in an investor's portfolio
B. the planned liquidation date of an investment
C. the average maturity date of investments held in a portfolio
D. the maturity date of the longest investment in the portfolio

55. The choice of an active portfolio management strategy rather than a passive strategy
assumes ___________.
A. the ability to continuously adjust the portfolio to provide superior returns.
B. asset allocation involving only domestic securities
C. stable economic conditions over the short term
D. the ability to minimize trading costs

56. Conservative investors are likely to want to invest in __________ mutual funds while
risk-tolerant investors are likely to want to invest in __________.
A. income, high growth
B. income, moderate growth
C. moderate income, high growth
D. moderate income, moderate growth

57. The first step any investor should take before beginning to invest is to __________.
A. establish investment objectives
B. develop a list of investment managers with superior records to interview
C. establish asset allocation guidelines
D. decide between active and passive management

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Chapter 22 - Investors and the Investment Process

58. Which of the following is the least likely to be included in the portfolio management
process?
A. Monitoring market conditions and relative values
B. Monitoring investor circumstances
C. Identifying investor constraints and preferences
D. Organizing the investment management process itself

59. A clearly understood investment policy statement is not critical for which one of the
following?
I. Mutual funds
II. Individuals
III. Defined benefit pension funds
A. II only
B. III only
C. I only
D. A policy statement is necessary for all three

60. An investor refuses to invest in any firm that produces alcohol or tobacco. This is an
example of a ___________ constraint.
A. return requirement
B. risk tolerance
C. liquidity
D. social

61. Under the provisions of a typical defined benefit pension plan, the employer is responsible
for _____________.
A. investing in conservative fixed-income assets
B. paying benefits to retired employees
C. counseling employees in the selection of asset classes
D. paying employees the market rate of return on employee contributions

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62. A life insurance firm wants to minimize its interest rate risk and it is planning on paying
out $250,000 in five years. Which one of the following investments best matches its goal?
A. High yield utility stocks
B. 5-year zero coupon bonds
C. 10-year coupon bonds
D. Money market investments rolled over as needed

63. An institutional investor will have to pay off a maturing bond issue in 3 years. The
institution has 10,000 bonds outstanding each with a $1,000 par value. The institutional
money manager is reevaluating the fund's $100 million portfolio at this time. She is bullish on
stocks and wants to put the most she can into the stock market but she cannot risk not being
able to pay off the bonds. Three year zero coupon bonds are available paying 6% interest.
What percentage of the total $100 million portfolio can she put in stocks and still ensure
meeting the bond payments?
A. 87.4%
B. 88.5%
C. 90.0%
D. 91.6%

64. An investor with high risk aversion will likely require which of the following risk return
combinations?
A. Expected return = 12%, Historical standard deviation = 17%
B. Expected return = 14%, Historical standard deviation = 19%
C. Expected return = 16%, Historical standard deviation = 21%
D. Expected return = 18%, Historical standard deviation = 23%

65. An investor with low risk aversion will likely require which of the following risk return
combinations?
A. Expected return = 11%, Historical standard deviation = 12%
B. Expected return = 12%, Historical standard deviation = 14%
C. Expected return = 14%, Historical standard deviation = 18%
D. Expected return = 17%, Historical standard deviation = 21%

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66. Medfield College's $10 million endowment fund is not allowed to spend any contributed
capital or any capital gains. The fund may only spend investment earnings. The fund is
expected to need between $500,000 and $1,000,000 to pay for new lab equipment for the
science building. Which of the following is/are true?
I. The fund should have a target rate of return of at least 10%.
II. The limitations on spending require the fund to limit its considerations to growth stocks.
III. The requirement to spend money out of the fund this year provides a liquidity constraint
that may reduce the fund's rate of return.
A. I only
B. II only
C. I and III only
D. I, II and III

67. An investor is looking at different retirement investment choices and he is willing to


accept one with upside potential even if that means sacrificing certainty. Which of the
following will he most likely select?
A. Fixed annuity
B. Defined benefit plan
C. Defined contribution plan
D. Bonds invested in an IRA

68. Both a wife and her husband work in the airline industry. They are in their 40s and they
have a high tax bracket and are concerned about their after tax rate of return. A meeting with
their financial planner reveals they are primarily focused on long term capital gains and they
will need at least a 9% to 11% average rate of return to meet their retirement goals. They
desire a diversified portfolio and liquidity is not currently a major concern. If you had to
choose from the list below which of the following asset allocations seems to best fit their
situation?
A. 10% money market; 40% long term bonds; 10% commodities; 40% high dividend paying
stocks
B. 0% money market; 60% long term bonds; 40% stocks
C. 10% money market; 30% long term bonds; 10% commodities; 50% high dividend paying
stocks
D. 5% money market; 30% long term bonds; 5% commodities; 60% stocks, most with low
dividends and high growth prospects

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69. A family will retire in a few years. They have a high tax bracket and are concerned about
their after tax rate of return. A meeting with their financial planner reveals they are primarily
focused on safety of principal and they will need a 6% to 8% average rate of return on their
portfolio. They desire a diversified portfolio and liquidity is likely to be a concern due to
health reasons. If you had to choose from the list below which of the following asset
allocations seems to best fit this family's situation?
A. 10% money market; 50% intermediate term bonds; 40% blue chip stocks, many with high
dividend yields
B. 0% money market; 60% intermediate term bonds; 40% stocks
C. 10% money market; 30% intermediate term bonds; 60% high dividend paying stocks
D. 5% money market; 35% intermediate term bonds; 60% stocks, most with low dividends

70. Your sister, an avid outdoors person, works in the airline industry and she has come to
you (the financial guru) for investment advice. She is looking at purchasing stocks she knows
something about. She is considering purchasing stock in Boeing, Lockheed Martin, United
Technologies (maker of aircraft engines) and Cabela's Sporting Goods. Based only on the
information given which stock should your recommend for her?
A. Boeing
B. Lockheed Martin
C. United Technologies
D. Cabela's

71. In 1937 the Eli Lilly family donated millions of dollars in stock to fund a not-for-profit
charitable organization. Such organizations are typically called _________________.
A. annuities
B. endowments
C. mutual funds
D. personal trusts

72. Which one of the following institutions typically has the longest investment horizon?
A. Mutual funds
B. Pension funds
C. Property and casualty insurers
D. Banks

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Chapter 22 - Investors and the Investment Process

73. At which one of the following institutions is liquidity usually the most important?
A. Mutual funds
B. Pension funds
C. Life insurers
D. Banks

74. One of the major functions of the investment committee is to ________________.


A. determine security selection of each portfolio operated by the investment company
B. translate the objectives and constraints of the investment company into an asset universe
C. determine the percentages of each security in the total investment company portfolio
D. calculate and report the overall rate of return to investment company constituents

75. For an investor concerned with maximizing liquidity, which of the following investments
should be avoided?
A. Real estate
B. Bonds
C. Domestic stocks
D. International stocks

76. The asset universe is the _____________________.


A. set of investments an investment company can legally invest in
B. existing set of assets the investment company currently owns in one or more of its
portfolios
C. list of assets approved by the investment committee that may be placed in the investment
company's portfolios
D. market portfolio of all available risky assets

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77. Go Global Investment Management has an asset allocation strategy of 60% U.S.
investments and 40% global investments. Within the U.S. Go Global has allocated 70% of its
portfolio to equities and 30% to bonds. Go Global now holds 3% of its U.S. equity portfolio
in the stock of Wally World. Internationally, Go Global has allocated 55% to equities and
45% to bonds. About what percentage of Go Global's total portfolio is invested in Wally
World?
A. 1.00%
B. 1.26%
C. 1.50%
D. 1.77%

78. Major functions of the investment committee include all but which one of the following?
A. Engage in security selection for each portfolio managed
B. Broadly determine the overall asset allocation of the investment company
C. Determine the asset class weights for each portfolio
D. Determine the asset universe

79. A portfolio is comprised of three index funds: an equity index, a bond index and an
international index. The portfolio manager changes the weights periodically according to
forecasts for each sector. This is an example of __________.
A. a passively managed core with an actively managed component
B. a totally passively managed fund
C. passive asset allocation with active security selection
D. active asset allocation with passive security selection

80. A portfolio is comprised of three index funds: an equity index comprising 40% of the total
portfolio, a bond index comprising 30% of the total portfolio and an international index
comprising 30% of the total portfolio. After each quarter the portfolio manager buys and sells
some of each sector so as to preserve the original weights for each sector. This is an example
of ____________.
A. a passively managed core with an actively managed component
B. a totally passively managed fund
C. passive asset allocation with active security selection
D. active asset allocation with passive security selection

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Chapter 22 - Investors and the Investment Process

81. One way that life insurance firms can hedge the risk created by offering whole life
insurance policies by ________________.
A. holding long term bonds
B. holding equities
C. holding short term bonds
D. exercising its right to terminate the policy

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Chapter 22 - Investors and the Investment Process

Chapter 22 Investors and the Investment Process Answer Key

Multiple Choice Questions

1. To _____ means to mitigate a financial risk.


A. invest
B. speculate
C. hedge
D. renege

Difficulty: Medium

2. In a defined benefit pension plan, the _____ bears all of the fund's investment performance
risk.
A. employer
B. employee
C. fund manager
D. government

Difficulty: Medium

3. In a defined contribution pension plan, the _____ bears all of the fund's investment
performance risk.
A. employer
B. employee
C. fund manager
D. government

Difficulty: Medium

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Chapter 22 - Investors and the Investment Process

4. My pension plan will pay me a yearly retirement amount equal to 2% of my highest annual
salary for each year of service. I must have ___________.
A. a defined benefit plan
B. a defined contribution plan
C. an endowment fund
D. a variable annuity

Difficulty: Medium

5. A ______ insurance policy provides death benefits, with no buildup of cash value.
A. whole life
B. universal life
C. variable life
D. term life

Difficulty: Easy

6. If the maturity of a bank's assets is much longer than the maturity of its liabilities and it
wants to limit its interest rate risk the bank may _________.
A. prefer to invest in long term bonds in its asset portfolio
B. prefer to invest in equities in its asset portfolio
C. prefer to invest in variable rate assets
D. decide to increase its fixed rate mortgage holdings

Difficulty: Hard

7. You are thinking of investing in one of two assets. Asset A has higher systematic risk than
Asset B. You can be sure that Asset A's _______ return will be higher than Asset B, but you
can't be sure if Asset A's _______ return will be higher than Asset B's.
A. realized; expected
B. real; nominal
C. expected; realized
D. nominal; expected

Difficulty: Medium

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8. A mutual fund may not hold more than ______ of the shares of any publicly traded
company.
A. 5%
B. 10%
C. 25%
D. 50%

Difficulty: Easy

9. Which one of the following would be considered to be a "cash equivalent" investment?


A. Treasury bills
B. Common stock
C. Corporate bonds
D. Real estate

Difficulty: Medium

10. For a bank, the difference between the interest rate charged to borrowers and the interest
rate paid on liabilities is called the __________.
A. insurance premium
B. interest rate spread
C. risk premium
D. term premium

Difficulty: Easy

11. Price volatility is greatest on which one of the following investments?


A. Commercial paper
B. 20 year zero coupon bonds
C. Treasury notes
D. Treasury bills

Difficulty: Easy

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Chapter 22 - Investors and the Investment Process

12. A portfolio manager indexes part of a portfolio and actively manages the rest of the
portfolio. This is called a _________ strategy.
A. passive aggressive
B. passive core
C. passively active
D. balanced fund

Difficulty: Easy

13. The major asset most people have during their early working years is their ________.
A. home
B. stock portfolio
C. earning power derived from their skills
D. bond portfolio

Difficulty: Medium

14. At the early stage of an individual's working career their retirement portfolio should
probably consist mostly of _______.
A. annuities
B. stocks
C. bonds
D. commodities

Difficulty: Medium

15. If an investor wishes to invest 100% of her portfolio in safe assets but does not wish to
manage her portfolio, she should invest in __________.
A. a money market fund
B. a growth stock fund
C. several different money market instruments
D. several different stocks

Difficulty: Easy

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Chapter 22 - Investors and the Investment Process

16. Just two months after you put money into an investment its price falls 25 percent.
Assuming that none of the investment fundamentals have changed, which of the following
actions would evidence the greatest risk tolerance?
A. You sell to avoid further worry and buy something else.
B. You do nothing and wait for the investment to come back.
C. You buy more thinking that if it was a good investment before; now it's not only good it is
cheap too.
D. You sue your financial advisor.

Difficulty: Easy

17. In order to become a CFA you must do all except which one of the following?
A. Pass 3 exams designed to ensure you have sufficient knowledge of investments.
B. Obtain 3 years of work experience in money management.
C. Become a member of a local Society of the Financial Analysts Federation.
D. Divest all your own stock holdings to eliminate any potential conflicts of interest with
client recommendations.

Difficulty: Easy

18. Which of the following is not one of the main areas covered in the examinations that must
be taken in order to achieve the designation of Chartered Financial Analyst?
A. Investment management ethics
B. Securities analysis
C. Securities marketing techniques
D. Portfolio management

Difficulty: Medium

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Chapter 22 - Investors and the Investment Process

19. As the typical investor ages the composition of their wealth usually switches from
primarily _______ to primarily _______.
A. human capital; financial capital
B. financial capital; human capital
C. intellectual capital; physical capital
D. investable capital; noninvestable capital

Difficulty: Medium

20. The two most important factors in describing an individual or organization's investment
objectives are ________________.
A. income level and age
B. income level and risk tolerance
C. age and risk tolerance
D. return requirement and risk tolerance

Difficulty: Medium

21. The term "hedge" refers to an investment that is used ________________.


A. primarily for tax loss selling purposes
B. to mitigate specific financial risks
C. to conceal one's true investment strategy from other market participants
D. primarily to defer capital losses

Difficulty: Easy

22. The price of your investment increases 20% one month after you buy it. You do not
believe that the stock's prospects have changed. Which one of the following actions would
indicate the lowest amount of risk aversion?
A. You hang onto the stock anticipating that it will go higher.
B. You buy more stock, anticipating that it will go higher.
C. You sell all of your stock holdings immediately.
D. You sell ½ your stock holdings and invest the proceeds in other areas of your portfolio.

Difficulty: Medium

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Chapter 22 - Investors and the Investment Process

23. An individual is on the game show "Squeal or No Squeal" and she has a choice between
receiving a certain gain of $100,000 or a 50% chance of winning $200,000 or zero. Which
one of the following correctly completes the statement below? If she takes the gamble instead
of the certain $100,000 she is acting ____________________.
A. like a person who is risk neutral
B. like a person who is risk averse
C. like a person who is a risk lover
D. irrationally

Difficulty: Medium

24. Which one of the following typically strives to earn a return on their investments that
exceeds the actuarially determined rate of return?
A. Banks
B. Thrifts
C. Mutual funds
D. Pension funds

Difficulty: Easy

25. If an individual confers legal title to property to another person or institution to manage
the property on their behalf the individual has created a(n) ___________.
A. personal trust
B. charitable trust
C. endowment fund
D. mutual fund

Difficulty: Easy

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Chapter 22 - Investors and the Investment Process

26. Personal trusts are typically allowed to engage in which of the following investment
activities?
I. Buying and selling futures contracts
II. Short selling securities
III. Purchasing and writing options
IV. Buying stock on margin
A. I only
B. II and III only
C. II and IV only
D. None of the given activities are allowed

Difficulty: Easy

27. If a defined benefit pension fund's actual rate of return is _____ than the actuarial assumed
rate then the ___________.
A. greater; employees will benefit
B. greater; firm's shareholders will benefit
C. lower; employees will benefit
D. lower; firm's shareholders will benefit

Difficulty: Medium

28. An employee has an average wage of $60,000 and they have worked for the firm for 25
years. The defined benefit pension plan pays retirees 2.5% of the average wage times the
years of service. The employee can expect to receive _______ per year upon retirement.
A. $18,000
B. $37,500
C. $45,325
D. $55,250

(0.025)($60,000)(25) = $37,500

Difficulty: Medium

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Chapter 22 - Investors and the Investment Process

29. Life insurance companies try to hedge the risks inherent in whole-life insurance policies
by investing in __________.
A. long term bonds
B. money market mutual funds
C. savings accounts
D. short term commercial paper

Difficulty: Easy

30. A pension fund will owe $10 million to retirees in 6 years. An actuary assumes an 8% rate
of return on the funds invested in the pension plan. If the pension plan receives annual
contributions from the company sponsor, how much must the company pay to fully fund the
pension liability?
A. $1,212,587
B. $1,363,154
C. $1,533,333
D. $1,666,667

Difficulty: Medium

31. The risk that a downturn in the market may substantially reduce your investment principal
is called _______.
A. purchasing power risk
B. interest rate risk
C. market risk
D. liquidity risk

Difficulty: Easy

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Chapter 22 - Investors and the Investment Process

32. The possibility that you are too conservative and your money doesn't grow fast enough to
keep pace with inflation is called ________.
A. purchasing power risk
B. liquidity risk
C. timing risk
D. market risk

Difficulty: Easy

33. A pension fund will owe $15 million to retirees in 20 years. An actuary assumes a 6% rate
of return on the funds invested in the pension plan but the fund actually earns 8%. The
pension plan receives annual contributions from the company sponsor. If the 8% rate of return
is expected to continue, by how much can the company reduce its pension payments per
year?
A. $65,437
B. $79,985
C. $89,462
D. $95,320

Difficulty: Hard

34. Many defined benefit pension plans have a target rate of return on investment
____________.
A. equal to the firm's return on equity
B. equal to the plan's assumed actuarial rate of return
C. equal to the economic inflation rate because wages often increase with inflation
D. equal to the estimated stock market return

Difficulty: Medium

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Chapter 22 - Investors and the Investment Process

35. _______ is a life insurance policy that provides a death benefit and a fixed rate tax
deferred savings plan.
A. Term life
B. Whole life
C. Variable life
D. Universal life

Difficulty: Medium

36. Empirical evidence suggests that investors become __________ as they approach
retirement.
A. greedier
B. less interested in investments
C. more risk averse
D. more risk tolerant

Difficulty: Easy

37. _______ is a life insurance policy that will provide a death benefit only but has no savings
plan.
A. Term life
B. Whole life
C. Variable life
D. Universal life

Difficulty: Easy

38. Of the following, the investment time horizon is typically the shortest for __________.
A. banks
B. endowment funds
C. life insurance companies
D. pension funds

Difficulty: Easy

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Chapter 22 - Investors and the Investment Process

39. A passive asset allocation strategy involves _________.


A. investing in the stock of companies which are price takers
B. maintaining approximately the same proportions of a portfolio in each asset-class over time
C. varying the proportions of a portfolio in each asset-class in response to changing market
conditions
D. selecting individual securities in different sectors that are believed to be undervalued

Difficulty: Easy

40. An active asset allocation strategy involves _________.


A. investing in the stock of companies which are price takers
B. maintaining approximately the same proportions of a portfolio in each asset-class over time
C. varying the proportions of a portfolio in each asset-class in response to changing market
conditions
D. selecting individual securities in different sectors that are believed to be undervalued

Difficulty: Easy

41. Endowment funds are held by __________.


A. financial intermediaries
B. individuals
C. profit-oriented firms
D. nonprofit institutions

Difficulty: Easy

42. Which one of the following is a life insurance policy that will provide a fixed death
benefit and allows the policyholder to choose where to invest the policy's cash value?
A. Term life
B. Whole life
C. Variable life
D. Industrial life

Difficulty: Medium

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Chapter 22 - Investors and the Investment Process

43. Under a "passive core" portfolio management strategy, a manager would ___________.
A. index the entire portfolio
B. index part of the portfolio and actively manage the rest
C. delegate the management of core segments of the portfolio to other managers
D. actively manage the entire portfolio

Difficulty: Easy

44. Of the following, the most flexible type of life insurance policy from the policyholder's
perspective is probably a(n) ___________ policy.
A. term life
B. whole life
C. variable life
D. universal life

Difficulty: Medium

45. The amount of risk an individual should take depends on his or her
I. return requirements
II. risk tolerance
III. time horizon
A. I only
B. I and II only
C. II and III only
D. I, II and III

Difficulty: Easy

46. Earnings on variable life and universal life insurance policies are ___________.
A. never taxed
B. taxed only at the capital gains tax rate
C. not taxed until the money is withdrawn
D. not taxed at the federal level but are taxed at the state level

Difficulty: Medium

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Chapter 22 - Investors and the Investment Process

47. When a company sets up a defined contribution pension plan, the __________ bears all
the risk and the __________ receives all the return from the plan's assets.
A. employee; employee
B. employee; employer
C. employer; employee
D. employer; employer

Difficulty: Medium

48. Suppose that the pre-tax holding period returns on two stocks are the same. Stock A has a
high dividend payout policy and stock B has a low dividend payout policy. If you are a high
tax rate individual and do not intend to sell the stocks during the holding period,
__________.
A. stock A will have a higher after-tax holding period return than stock B
B. the after-tax holding period returns on stocks A and B will be the same
C. stock B will have a higher after-tax holding period return than stock A
D. it is impossible to determine which stock will have a higher after-tax holding period return
given the information available

Difficulty: Medium

49. The objectives of personal trusts normally are __________ in scope than those of
individual investors and personal trust managers typically are __________ than individual
investors.
A. broader; more risk averse
B. broader; less risk averse
C. more limited; more risk averse
D. more limited; less risk averse

Difficulty: Medium

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Chapter 22 - Investors and the Investment Process

50. The prudent investor rule requires __________.


A. executives of companies to avoid investing in options of companies they work for
B. executives of companies to disclose their transactions in stocks of companies they work for
C. professional investors who manage money for others to avoid all risky investments
D. professional investors who manage money for others to constrain their investments to
those that would have been approved by a prudent investor

Difficulty: Medium

51. The prudent man law is an example of a regulation designed to ensure appropriate
_____________ by money managers.
A. fiduciary responsibility
B. fiscal responsibility
C. monetary responsibility
D. marketing procedures

Difficulty: Easy

52. An investor has a long time horizon and desires to earn the market rate of return.
However, the investor will need to withdraw funds each year from their investment portfolio.
The biggest constraint a planner would face with this client is a ___________ constraint.
A. tax
B. risk tolerance
C. liquidity
D. social

Difficulty: Easy

53. When used in the context of investment decision making, the term "liquidity" refers to
_____________.
A. the ease and speed with which an asset can be sold at any value possible
B. the ease and speed with which an asset can be sold without having to discount the value
C. an aspect of monetary policy
D. the proportion of short-term to long-term investments held in an investor's portfolio

Difficulty: Medium

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Chapter 22 - Investors and the Investment Process

54. The term "investment horizon" refers to __________.


A. the proportion of short-term to long-term investments held in an investor's portfolio
B. the planned liquidation date of an investment
C. the average maturity date of investments held in a portfolio
D. the maturity date of the longest investment in the portfolio

Difficulty: Easy

55. The choice of an active portfolio management strategy rather than a passive strategy
assumes ___________.
A. the ability to continuously adjust the portfolio to provide superior returns.
B. asset allocation involving only domestic securities
C. stable economic conditions over the short term
D. the ability to minimize trading costs

Difficulty: Easy

56. Conservative investors are likely to want to invest in __________ mutual funds while
risk-tolerant investors are likely to want to invest in __________.
A. income, high growth
B. income, moderate growth
C. moderate income, high growth
D. moderate income, moderate growth

Difficulty: Medium

57. The first step any investor should take before beginning to invest is to __________.
A. establish investment objectives
B. develop a list of investment managers with superior records to interview
C. establish asset allocation guidelines
D. decide between active and passive management

Difficulty: Easy

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Chapter 22 - Investors and the Investment Process

58. Which of the following is the least likely to be included in the portfolio management
process?
A. Monitoring market conditions and relative values
B. Monitoring investor circumstances
C. Identifying investor constraints and preferences
D. Organizing the investment management process itself

Difficulty: Easy

59. A clearly understood investment policy statement is not critical for which one of the
following?
I. Mutual funds
II. Individuals
III. Defined benefit pension funds
A. II only
B. III only
C. I only
D. A policy statement is necessary for all three

Difficulty: Easy

60. An investor refuses to invest in any firm that produces alcohol or tobacco. This is an
example of a ___________ constraint.
A. return requirement
B. risk tolerance
C. liquidity
D. social

Difficulty: Easy

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Chapter 22 - Investors and the Investment Process

61. Under the provisions of a typical defined benefit pension plan, the employer is responsible
for _____________.
A. investing in conservative fixed-income assets
B. paying benefits to retired employees
C. counseling employees in the selection of asset classes
D. paying employees the market rate of return on employee contributions

Difficulty: Easy

62. A life insurance firm wants to minimize its interest rate risk and it is planning on paying
out $250,000 in five years. Which one of the following investments best matches its goal?
A. High yield utility stocks
B. 5-year zero coupon bonds
C. 10-year coupon bonds
D. Money market investments rolled over as needed

Difficulty: Easy

63. An institutional investor will have to pay off a maturing bond issue in 3 years. The
institution has 10,000 bonds outstanding each with a $1,000 par value. The institutional
money manager is reevaluating the fund's $100 million portfolio at this time. She is bullish on
stocks and wants to put the most she can into the stock market but she cannot risk not being
able to pay off the bonds. Three year zero coupon bonds are available paying 6% interest.
What percentage of the total $100 million portfolio can she put in stocks and still ensure
meeting the bond payments?
A. 87.4%
B. 88.5%
C. 90.0%
D. 91.6%

(10,000)(1000) = $10,000,000 due in 3 years


$10,000,000/1.063 = $8,396,193 = present value of due amount

Max amount to put in stocks is =

Difficulty: Hard

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Chapter 22 - Investors and the Investment Process

64. An investor with high risk aversion will likely require which of the following risk return
combinations?
A. Expected return = 12%, Historical standard deviation = 17%
B. Expected return = 14%, Historical standard deviation = 19%
C. Expected return = 16%, Historical standard deviation = 21%
D. Expected return = 18%, Historical standard deviation = 23%

Difficulty: Easy

65. An investor with low risk aversion will likely require which of the following risk return
combinations?
A. Expected return = 11%, Historical standard deviation = 12%
B. Expected return = 12%, Historical standard deviation = 14%
C. Expected return = 14%, Historical standard deviation = 18%
D. Expected return = 17%, Historical standard deviation = 21%

Difficulty: Easy

66. Medfield College's $10 million endowment fund is not allowed to spend any contributed
capital or any capital gains. The fund may only spend investment earnings. The fund is
expected to need between $500,000 and $1,000,000 to pay for new lab equipment for the
science building. Which of the following is/are true?
I. The fund should have a target rate of return of at least 10%.
II. The limitations on spending require the fund to limit its considerations to growth stocks.
III. The requirement to spend money out of the fund this year provides a liquidity constraint
that may reduce the fund's rate of return.
A. I only
B. II only
C. I and III only
D. I, II and III

Difficulty: Hard

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Chapter 22 - Investors and the Investment Process

67. An investor is looking at different retirement investment choices and he is willing to


accept one with upside potential even if that means sacrificing certainty. Which of the
following will he most likely select?
A. Fixed annuity
B. Defined benefit plan
C. Defined contribution plan
D. Bonds invested in an IRA

Difficulty: Medium

68. Both a wife and her husband work in the airline industry. They are in their 40s and they
have a high tax bracket and are concerned about their after tax rate of return. A meeting with
their financial planner reveals they are primarily focused on long term capital gains and they
will need at least a 9% to 11% average rate of return to meet their retirement goals. They
desire a diversified portfolio and liquidity is not currently a major concern. If you had to
choose from the list below which of the following asset allocations seems to best fit their
situation?
A. 10% money market; 40% long term bonds; 10% commodities; 40% high dividend paying
stocks
B. 0% money market; 60% long term bonds; 40% stocks
C. 10% money market; 30% long term bonds; 10% commodities; 50% high dividend paying
stocks
D. 5% money market; 30% long term bonds; 5% commodities; 60% stocks, most with low
dividends and high growth prospects

Difficulty: Hard

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Chapter 22 - Investors and the Investment Process

69. A family will retire in a few years. They have a high tax bracket and are concerned about
their after tax rate of return. A meeting with their financial planner reveals they are primarily
focused on safety of principal and they will need a 6% to 8% average rate of return on their
portfolio. They desire a diversified portfolio and liquidity is likely to be a concern due to
health reasons. If you had to choose from the list below which of the following asset
allocations seems to best fit this family's situation?
A. 10% money market; 50% intermediate term bonds; 40% blue chip stocks, many with high
dividend yields
B. 0% money market; 60% intermediate term bonds; 40% stocks
C. 10% money market; 30% intermediate term bonds; 60% high dividend paying stocks
D. 5% money market; 35% intermediate term bonds; 60% stocks, most with low dividends

Difficulty: Hard

70. Your sister, an avid outdoors person, works in the airline industry and she has come to
you (the financial guru) for investment advice. She is looking at purchasing stocks she knows
something about. She is considering purchasing stock in Boeing, Lockheed Martin, United
Technologies (maker of aircraft engines) and Cabela's Sporting Goods. Based only on the
information given which stock should your recommend for her?
A. Boeing
B. Lockheed Martin
C. United Technologies
D. Cabela's

Difficulty: Medium

71. In 1937 the Eli Lilly family donated millions of dollars in stock to fund a not-for-profit
charitable organization. Such organizations are typically called _________________.
A. annuities
B. endowments
C. mutual funds
D. personal trusts

Difficulty: Medium

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Chapter 22 - Investors and the Investment Process

72. Which one of the following institutions typically has the longest investment horizon?
A. Mutual funds
B. Pension funds
C. Property and casualty insurers
D. Banks

Difficulty: Easy

73. At which one of the following institutions is liquidity usually the most important?
A. Mutual funds
B. Pension funds
C. Life insurers
D. Banks

Difficulty: Easy

74. One of the major functions of the investment committee is to ________________.


A. determine security selection of each portfolio operated by the investment company
B. translate the objectives and constraints of the investment company into an asset universe
C. determine the percentages of each security in the total investment company portfolio
D. calculate and report the overall rate of return to investment company constituents

Difficulty: Medium

75. For an investor concerned with maximizing liquidity, which of the following investments
should be avoided?
A. Real estate
B. Bonds
C. Domestic stocks
D. International stocks

Difficulty: Medium

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Chapter 22 - Investors and the Investment Process

76. The asset universe is the _____________________.


A. set of investments an investment company can legally invest in
B. existing set of assets the investment company currently owns in one or more of its
portfolios
C. list of assets approved by the investment committee that may be placed in the investment
company's portfolios
D. market portfolio of all available risky assets

Difficulty: Medium

77. Go Global Investment Management has an asset allocation strategy of 60% U.S.
investments and 40% global investments. Within the U.S. Go Global has allocated 70% of its
portfolio to equities and 30% to bonds. Go Global now holds 3% of its U.S. equity portfolio
in the stock of Wally World. Internationally, Go Global has allocated 55% to equities and
45% to bonds. About what percentage of Go Global's total portfolio is invested in Wally
World?
A. 1.00%
B. 1.26%
C. 1.50%
D. 1.77%

(60%)(70%)(3%) = 1.26%

Difficulty: Medium

78. Major functions of the investment committee include all but which one of the following?
A. Engage in security selection for each portfolio managed
B. Broadly determine the overall asset allocation of the investment company
C. Determine the asset class weights for each portfolio
D. Determine the asset universe

Difficulty: Medium

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Chapter 22 - Investors and the Investment Process

79. A portfolio is comprised of three index funds: an equity index, a bond index and an
international index. The portfolio manager changes the weights periodically according to
forecasts for each sector. This is an example of __________.
A. a passively managed core with an actively managed component
B. a totally passively managed fund
C. passive asset allocation with active security selection
D. active asset allocation with passive security selection

Difficulty: Medium

80. A portfolio is comprised of three index funds: an equity index comprising 40% of the total
portfolio, a bond index comprising 30% of the total portfolio and an international index
comprising 30% of the total portfolio. After each quarter the portfolio manager buys and sells
some of each sector so as to preserve the original weights for each sector. This is an example
of ____________.
A. a passively managed core with an actively managed component
B. a totally passively managed fund
C. passive asset allocation with active security selection
D. active asset allocation with passive security selection

Difficulty: Medium

81. One way that life insurance firms can hedge the risk created by offering whole life
insurance policies by ________________.
A. holding long term bonds
B. holding equities
C. holding short term bonds
D. exercising its right to terminate the policy

Difficulty: Medium

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