CRPC MODULES (1-3) QUESTIONS
WITH CORRECT SOLUTIONS
What are two purposes of investment policy? - ANSWER-1. To provide a foundation of
goals, time horizons, and constraints on which the client portfolio is constructed
2. To provide a basis for review, performance evaluation, and adaptation to changing
conditions.
Why is a long term perspective essential as an element of investment policy? -
ANSWER-The returns work better in the investors favor if they are patient. There are
ups and downs in the market but over time the investor is playing a winning game.
Why is it important that investment policy be clearly defined? - ANSWER-They must
understand the critical importance of their investment policy, it also makes decision
based on how risky the client may be. It must be accurate and clear to them.
At a minimum, what five elements should every investment policy contain? - ANSWER-
Goals, Risk, Asset Allocation, Strategies, Periodic Review
How do you find the percentage change in bond price? - ANSWER-Negative duration
multiplied by the change in interest rate
What are the advantages and disadvantages of common stocks, and why should stocks
be an important element in most retirement portfolios? - ANSWER-Over time, common
stocks have almost always outperformed other financial instruments. They also offer
rising dividends. Disadvantage is their volatility, which is also higher than most asset
classes. Two major risks are business risk and market risk.
What are the advantages and disadvantages of fixed-income securities, and to what two
sources of return do their owners look? - ANSWER-Advantage to fixed income
securities is their cash flow stream and return of principal if held to maturity, high
certainty of return. Their disadvantages are a lower return due to guarantee as well as
exposure to inflation and interest rate risk.
What are the advantages and disadvantages of cash equivalent investments for the
retirement investor? - ANSWER-Advantages include a short-term maturity, they are
highly liquid, and have a high safety of principal. The disadvantages are that they offer
generally lower rates of return and are thereby subject to purchasing power risk.
What are the advantages and disadvantages of real estate for the retirement investor? -
ANSWER-Advantages include an average rate of return and diversification.
Disadvantages include poor liquidity, high transaction costs, and tax-reporting
responsibilities. They also can easily become overvalued.
, Explain Standard Deviation - ANSWER-A statistical measure of total risk that considers
the dispersion of all data points around the average. With investments, higher standard
deviation means higher risk.
Explain Beta - ANSWER-Bet is the term referring to a security's volatility measured to
the market. The entire markets beta is 1. If security's bet is > 1 it is more volatile than
the market. If < 1 the security is less volatile than the market.
Explain Duration - ANSWER-Duration is a term used to describe the price sensitivity of
a bond or bond portfolio to changes in interest rates. Higher duration = higher price
volatility
XYZ Stock has SD of 14% and a mean of 10%. What is coefficient variation? -
ANSWER-0..10 = 1.4
Which coefficient variation has a better risk/return relationship? 0.88 or 1.5? -
ANSWER-0.88 offers less risk per unit of return and therefor is the better investment
How do you find the percentage change in the value of a bond? - ANSWER-Multiply the
duration by the interest rate change
Sharpe Ratio - ANSWER-Reward-to-volatility ratio; ratio of portfolio excess return to
standard deviation.
Treynor Ratio - ANSWER-measures investment performance as the ratio of portfolio
risk premium over portfolio beta
Jensen's Alpha - ANSWER-measures investment performance as the raw portfolio
returns less the return predicted by the capital asset pricing model
What is meant by the concept of Strategic Asset Allocation? - ANSWER-Identify the
asset mix that will provide the optimal balance between expected risk and return for a
long investment horizon. Portfolio manager tries to maintain this balance
Tactical Asset Allocation - ANSWER-When a manager varies from the strategic
allocation weights when attractive opportunities are present. May be seen as the
opposite of momentum investing where one would move money away from the asset
category that has been the most successful
Core Satellite asset allocation - ANSWER-70-80% invested in broad index fund or etfs
- remaining satellite consists of actively managed MFs in niches such as sector funds or
alt investments like hedge funds
Target Retirement Funds - ANSWER-Mutual funds that are usually a fund of funds that
allocate assets among stock, bond, and money market funds within the same fund
WITH CORRECT SOLUTIONS
What are two purposes of investment policy? - ANSWER-1. To provide a foundation of
goals, time horizons, and constraints on which the client portfolio is constructed
2. To provide a basis for review, performance evaluation, and adaptation to changing
conditions.
Why is a long term perspective essential as an element of investment policy? -
ANSWER-The returns work better in the investors favor if they are patient. There are
ups and downs in the market but over time the investor is playing a winning game.
Why is it important that investment policy be clearly defined? - ANSWER-They must
understand the critical importance of their investment policy, it also makes decision
based on how risky the client may be. It must be accurate and clear to them.
At a minimum, what five elements should every investment policy contain? - ANSWER-
Goals, Risk, Asset Allocation, Strategies, Periodic Review
How do you find the percentage change in bond price? - ANSWER-Negative duration
multiplied by the change in interest rate
What are the advantages and disadvantages of common stocks, and why should stocks
be an important element in most retirement portfolios? - ANSWER-Over time, common
stocks have almost always outperformed other financial instruments. They also offer
rising dividends. Disadvantage is their volatility, which is also higher than most asset
classes. Two major risks are business risk and market risk.
What are the advantages and disadvantages of fixed-income securities, and to what two
sources of return do their owners look? - ANSWER-Advantage to fixed income
securities is their cash flow stream and return of principal if held to maturity, high
certainty of return. Their disadvantages are a lower return due to guarantee as well as
exposure to inflation and interest rate risk.
What are the advantages and disadvantages of cash equivalent investments for the
retirement investor? - ANSWER-Advantages include a short-term maturity, they are
highly liquid, and have a high safety of principal. The disadvantages are that they offer
generally lower rates of return and are thereby subject to purchasing power risk.
What are the advantages and disadvantages of real estate for the retirement investor? -
ANSWER-Advantages include an average rate of return and diversification.
Disadvantages include poor liquidity, high transaction costs, and tax-reporting
responsibilities. They also can easily become overvalued.
, Explain Standard Deviation - ANSWER-A statistical measure of total risk that considers
the dispersion of all data points around the average. With investments, higher standard
deviation means higher risk.
Explain Beta - ANSWER-Bet is the term referring to a security's volatility measured to
the market. The entire markets beta is 1. If security's bet is > 1 it is more volatile than
the market. If < 1 the security is less volatile than the market.
Explain Duration - ANSWER-Duration is a term used to describe the price sensitivity of
a bond or bond portfolio to changes in interest rates. Higher duration = higher price
volatility
XYZ Stock has SD of 14% and a mean of 10%. What is coefficient variation? -
ANSWER-0..10 = 1.4
Which coefficient variation has a better risk/return relationship? 0.88 or 1.5? -
ANSWER-0.88 offers less risk per unit of return and therefor is the better investment
How do you find the percentage change in the value of a bond? - ANSWER-Multiply the
duration by the interest rate change
Sharpe Ratio - ANSWER-Reward-to-volatility ratio; ratio of portfolio excess return to
standard deviation.
Treynor Ratio - ANSWER-measures investment performance as the ratio of portfolio
risk premium over portfolio beta
Jensen's Alpha - ANSWER-measures investment performance as the raw portfolio
returns less the return predicted by the capital asset pricing model
What is meant by the concept of Strategic Asset Allocation? - ANSWER-Identify the
asset mix that will provide the optimal balance between expected risk and return for a
long investment horizon. Portfolio manager tries to maintain this balance
Tactical Asset Allocation - ANSWER-When a manager varies from the strategic
allocation weights when attractive opportunities are present. May be seen as the
opposite of momentum investing where one would move money away from the asset
category that has been the most successful
Core Satellite asset allocation - ANSWER-70-80% invested in broad index fund or etfs
- remaining satellite consists of actively managed MFs in niches such as sector funds or
alt investments like hedge funds
Target Retirement Funds - ANSWER-Mutual funds that are usually a fund of funds that
allocate assets among stock, bond, and money market funds within the same fund
