Chapter 28 Test Bank - Static

Student: ___________________________________________________________________________

Multiple Choice Questions

1. The CFA Institute divides the process of portfolio management into three main elements, which are ______, ______, and ______.

A. planning; execution; results

B. security selection; asset allocation; action
C. planning; asset allocation; feedback
D. planning; execution; feedback
E. risk tolerance; feedback; action

2. The planning phase of the CFA Institute's investment management process

A. uses data about the client and capital market.

B. uses details of optimal asset allocation and security selection.
C. uses changes in expectations and objectives.
D. All of the options are correct.
E. None of the options are correct.

3. The execution phase of the CFA Institute's investment management process

A. uses data about the client and capital market.

B. uses details of optimal asset allocation and security selection.
C. uses changes in expectations and objectives.
D. All of the options are correct.
E. None of the options are correct.

4. The feedback phase of the CFA Institute's investment management process

A. uses data about the client and capital market.

B. uses details of optimal asset allocation and security selection.
C. uses changes in expectations and objectives.
D. All of the options are correct.
E. None of the options are correct.

5. __________ refer to strategies aimed at attaining the established rate of return requirements while meeting expressed risk tolerance
and applicable constraints.

A. Investment constraints
B. Investment objectives
C. Investment policies
D. All of the options are correct.
E. None of the options are correct.

6. One incorrect belief that is often cited as a reason for fully funded pension funds to invest in equities is

A. stocks have higher risk.

B. bonds have lower returns.
C. stocks provide a hedge against inflation.
D. stocks have higher returns.
E. All of the options are incorrect beliefs that are often cited.

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7. __________ in the process of asset allocation.

A. Deriving the efficient portfolio frontier is a step

B. Specifying asset classes to be included in the portfolio is a step
C. Specifying the capital market expectations is a step
D. All of the options are steps.
E. None of the options are steps.

8. Questionnaires and attitude surveys suggest that risk tolerance

A. increases with age.

B. decreases with age.
C. stays constant over the life cycle for most investors.
D. cannot be assessed.
E. None of the options are correct.

9. __________ can be used to create a perfect inflation hedge.

A. Gold
B. Real estate
C. TIPS
D. The S&P 500 Index
E. None of the options are correct.

10. A fully funded pension plan can invest surplus assets in equities provided it reduces the proportion in equities when the value of
the fund drops near the accumulated benefit obligation. This strategy is referred to as

A. immunization.
B. hedging.
C. diversification.
D. contingent immunization.
E. overfunding.

11. Workers who change jobs may wind up with lower pension benefits at retirement than otherwise identical workers who stay with
the same employer, even if the employers have defined benefit plans with the same final pay benefit formula. This is referred to as

A. an accumulated benefit obligation.

B. an unfunded liability.
C. immunization.
D. indexation.
E. the portability problem.

12. The __________ the proportion of total return that is in the form of price appreciation, the __________ will be the value of the tax
deferral option for taxable investors.

A. greater; greater
B. greater; lower
C. lower; greater
D. The answer cannot be determined from the information provided.
E. None of the options are correct.

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13. An important benefit of Keogh plans is that

A. they are not taxable until funds are withdrawn as benefits.

B. they are protected against inflation.
C. they are automatically insured by the Federal government.
D. they are not taxable until funds are withdrawn as benefits, and they are protected against inflation.
E. they are not taxable until funds are withdrawn as benefits, and they are automatically insured by the Federal government.

14. Variable life insurance

A. combines life insurance with a tax deferred annuity.

B. provides a minimum death benefit that increases subject to investment performance.
C. can be converted to a stream of income.
D. All of the options are correct.
E. None of the options are correct.

15. Endowment funds are held by

A. charitable organizations.
B. educational institutions.
C. for profit firms.
D. charitable organizations and educational institutions.
E. educational institutions and for profit firms.

16. __________ center on the trade off between the return the investor wants and how much risk the investor is willing to assume.

A. Investment constraints
B. Investment objectives
C. Investment policies
D. All of the options are correct.
E. None of the options are correct.

17. The stage an individual is in his/her life cycle will affect his/her

A. return requirements.
B. risk tolerance.
C. asset allocation.
D. return requirements and risk tolerance.
E. All of the options are correct.

18. A remainderman is

A. a stockbroker who remained working on Wall Street after the 1987 crash.
B. an employee of a trustee.
C. one who receives interest and dividend income from a trust during their lifetime.
D. one who receives the principal of a trust when it is dissolved.

19. __________ are boundaries that investors place on their choice of investment assets.

A. Investment constraints
B. Investment objectives
C. Investment policies
D. All of the options are correct
E. None of the options are correct.

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20. The investment horizon is

A. the investor's expected age at death.

B. the starting date for establishing investment constraints.
C. based on the investor's risk tolerance.
D. the date at which the portfolio is expected to be fully or partially liquidated.

21. Liquidity is

A. the ease with which an asset can be sold.

B. the ability to sell an asset for a fair price.
C. the degree of inflation protection an asset provides.
D. the ease with which an asset can be sold and the ability to sell an asset for a fair price.
E. All of the options are correct.

22. 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

23. 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
E. Cannot determine; depends on the economic environment.

24. 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 an individual in a high marginal tax bracket 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.

25. The prudent investor rule requires

A. executives of companies to avoid investing in options of companies by which they are employed.
B. executives of companies to disclose their transactions in stocks of companies by which they are employed.
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 the
prudent investor.

26. The longest time horizons are likely to be set by

A. banks.
B. property and casualty insurance companies.
C. pension funds.
D. banks and pension funds.
E. property and casualty insurance companies and pension funds.

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27. The longest time horizons are likely to be set by

A. banks.
B. property and casualty insurance companies.
C. endowment funds.
D. banks and endowment funds.
E. property and casualty insurance companies and endowment funds.

28. The shortest time horizons are likely to be set by

A. banks.
B. property and casualty insurance companies.
C. pension funds.
D. banks and property and casualty insurance companies.
E. property and casualty insurance companies and pension funds.

29. Institutional investors will rarely invest in which of these asset classes?

A. Bonds
B. Stocks
C. Cash
D. Real estate
E. Precious metals

30. For an individual investor, the value of home ownership is likely to be viewed

A. as a hedge against increases in rental rates.

B. as a guarantee of availability of a particular residence.
C. as a hedge against inflation.
D. as a hedge against increases in rental rates and as a guarantee of availability of a particular residence.
E. All of the options are correct.

31. Assume that at retirement you have accumulated $500,000 in a variable annuity contract. The assumed investment return is 6%,
and your life expectancy is 15 years. What is the hypothetical constant benefit payment?

A. $30,000.00
B. $33,333.33
C. $51,481.38
D. $52,452.73
E. The answer cannot be determined from the information provided.

32. Assume that at retirement you have accumulated $500,000 in a variable annuity contract. The assumed investment return is 6%,
and your life expectancy is 15 years. If the first year's actual investment return is 8%, what is the starting benefit payment?

A. $30,000.00
B. $33,333.33
C. $51,481.38
D. $52,452.73
E. The answer cannot be determined from the information provided.

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33. The first step a pension fund 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.

34. General pension funds typically invest __________ of their funds in equity securities.

A. none
B. 5 10%
C. 15 35%
D. 40 60%
E. more than 60%

35. The optimal portfolio on the efficient frontier for a given investor depends on

A. the investor's degree of risk tolerance.

B. the coefficient, A, which is a measure of risk aversion.
C. the investor's required rate of return.
D. the investor's degree of risk tolerance and the investor's required rate of return.
E. the investor's degree of risk tolerance and the coefficient, A, which is a measure of risk aversion.

36. The optimal portfolio on the efficient frontier for a given investor does not depend on

A. the investor's degree of risk tolerance.

B. the coefficient, A, which is a measure of risk aversion.
C. the investor's required rate of return.
D. the investor's degree of risk tolerance and the investor's required rate of return.
E. the investor's degree of risk tolerance and the coefficient, A, which is a measure of risk aversion.

37. Target date retirement funds are not

A. funds of funds diversified across stocks and bonds.

B. designed to change their asset allocation as time passes.
C. a simple, but useful, strategy.
D. designed to function much like hedge funds.

38. A ___________ is established when an individual confers legal title to property to another person or institution to manage the
property for one or more beneficiaries.

A. tax shelter
B. defined contribution plan
C. personal trust
D. fixed annuity
E. Keogh plan

39. Professional financial planners should

A. assess their client's risk and return requirements on a one time basis.
B. explain the investment plan to the client.
C. inform the client about the outcome of the plan.
D. assess their client's risk and return requirements on a one time basis, explain the investment plan to the client, and inform the client
about the outcome of the plan.
E. explain the investment plan to the client and inform the client about the outcome of the plan.

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40. Deferral of capital gains tax

I) means that the investor doesn't need to pay taxes until the investment is sold.
II) allows the investment to grow at a faster rate.
III) means that you might escape the capital gains tax if you live long enough.
IV) provides a tax shelter for investors.

A. II and III
B. I, II, IV
C. I, III, and V
D. II, III, and IV

41. Deferral of capital gains tax does not

I) mean that the investor doesn't need to pay taxes until the investment is sold.
II) allow the investment to grow at a faster rate.
III) mean that you might escape the capital gains tax if you live long enough.
IV) provide a tax shelter for investors.

A. III
B. II
C. I, II, and V
D. II, III, and IV

42. Which of the following investments does not allow the investor to choose how to allocate assets?

A. Variable Life insurance policies

B. Keogh plans
C. Personal funds
D. Tax qualified defined contribution plans
E. Universal Life policies

43. Which of the following investments allows the investor to choose how to allocate assets?

A. Variable Life insurance policies

B. Keogh plans
C. Personal funds
D. Tax qualified defined contribution plans
E. All of the options are correct.

44. Pension funds

I) accept contributions from employers, which are tax deductible.

II) pay distributions that are taxed as ordinary income.
III) pay benefits only from the income component of the fund.
IV) accept contributions from employees, which are not tax deductible.

A. I and IV
B. II and III
C. I and II
D. I, II, and IV
E. I, II, III, and IV

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45. Pension funds do not

I) accept contributions from employers, which are tax deductible.

II) pay distributions that are taxed as ordinary income.
III) pay benefits only from the income component of the fund.
IV) accept contributions from employees, which are not tax deductible.

A. III and IV
B. II and III
C. I and II
D. I, II, and IV
E. I, II, III, and IV

46. Stephanie Watson is 23 years old and has accumulated $4,000 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Stephanie thinks she will retire at age 67 and figures
she will live to age 81. The plan allows for two types of investments. One offers a 3.5% risk free real rate of return. The other offers
an expected return of 10% and has a standard deviation of 23%. Stephanie now has 5% of her money in the risk free investment and
95% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the
investments. Her salary will grow at the same rate as inflation. How much does Stephanie currently have in the safe account; how
much in the risky account?

A. $3,800; $200
B. $2,000; $2,000
C. $200; $3,800
D. $2,500; $1,500
E. $1,500; $2,500

47. Stephanie Watson is 23 years old and has accumulated $4,000 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Stephanie thinks she will retire at age 67 and figures
she will live to age 81. The plan allows for two types of investments. One offers a 3.5% risk free real rate of return. The other offers
an expected return of 10% and has a standard deviation of 23%. Stephanie now has 5% of her money in the risk free investment and
95% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the
investments. Her salary will grow at the same rate as inflation. Of the total amount of new funds that will be invested by Stephanie and
by her employer on her behalf, how much will she put into the safe account each year; how much into the risky account?

A. $3,800; $200
B. $2,000; $2,000
C. $200; $3,800
D. $2,500; $1,500
E. $1,500; $2,500

48. Stephanie Watson is 23 years old and has accumulated $4,000 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Stephanie thinks she will retire at age 67 and figures
she will live to age 81. The plan allows for two types of investments. One offers a 3.5% risk free real rate of return. The other offers
an expected return of 10% and has a standard deviation of 23%. Stephanie now has 5% of her money in the risk free investment and
95% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the
investments. Her salary will grow at the same rate as inflation. How much can Stephanie be sure of having in the safe account at
retirement?

A. $37,221
B. $16,423
C. $11,856
D. $21,156.
E. $49,219

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49. Stephanie Watson is 23 years old and has accumulated $4,000 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Stephanie thinks she will retire at age 67 and figures
she will live to age 81. The plan allows for two types of investments. One offers a 3.5% risk free real rate of return. The other offers
an expected return of 10% and has a standard deviation of 23%. Stephanie now has 5% of her money in the risk free investment and
95% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the
investments. Her salary will grow at the same rate as inflation. How much can Stephanie expect to have in her risky account at
retirement?

A. $2,731,838
B. $2,915,415
C. $1,425,316
D. $224,651
E. $3,545,886

50. Genny Webb is 27 years old and has accumulated $7,500 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Genny thinks she will retire at age 63 and figures she
will live to age 90. The plan allows for two types of investments. One offers a 3% risk free real rate of return. The other offers an
expected return of 12% and has a standard deviation of 39%. Genny now has 20% of her money in the risk free investment and 80% in
the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments.
Her salary will grow at the same rate as inflation. How much does Genny currently have in the safe account; how much in the risky
account?

A. $1,500; $6,000
B. $3,000; $4,500
C. $2,000; $5,500
D. $4,800; $2,700
E. $3,500; $3,500

51. Genny Webb is 27 years old and has accumulated $7,500 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Genny thinks she will retire at age 63 and figures she
will live to age 90. The plan allows for two types of investments. One offers a 3% risk free real rate of return. The other offers an
expected return of 12% and has a standard deviation of 39%. Genny now has 20% of her money in the risk free investment and 80% in
the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments.
Her salary will grow at the same rate as inflation. Of the total amount of new funds that will be invested by Genny and by her
employer on her behalf, how much will Genny put into the safe account each year; how much into the risky account?

A. $1,500; $2,500
B. $1,200; $1,800
C. $800; $3,200
D. $1,250; $2,750
E. $1,400; $1,600

52. Genny Webb is 27 years old and has accumulated $7,500 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Genny thinks she will retire at age 63 and figures she
will live to age 90. The plan allows for two types of investments. One offers a 3% risk free real rate of return. The other offers an
expected return of 12% and has a standard deviation of 39%. Genny now has 20% of her money in the risk free investment and 80% in
the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments.
Her salary will grow at the same rate as inflation. How much can Genny be sure of having in the safe account at retirement?

A. $45,473
B. $62,557
C. $78,943
D. $54,968
E. $74,643

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53. Genny Webb is 27 years old and has accumulated $7,500 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Genny thinks she will retire at age 63 and figures she
will live to age 90. The plan allows for two types of investments. One offers a 3% risk free real rate of return. The other offers an
expected return of 12% and has a standard deviation of 39%. Genny now has 20% of her money in the risk free investment and 80% in
the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments.
Her salary will grow at the same rate as inflation. How much can Genny expect to have in her risky account at retirement?

A. $1,800,326
B. $1,905,095
C. $1,743,781
D. $1,224,651
E. $345,886

54. Alex Goh is 39 years old and has accumulated $128,000 in his self directed defined contribution pension plan. Each year he
contributes $2,500 to the plan, and his employer contributes an equal amount. Alex thinks he will retire at age 62 and figures he will
live to age 86. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 11% and has a standard deviation of 37%. Alex now has 25% of his money in the risk free investment and 75% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. How much does Alex currently have in the safe account; how much in the risky account?

A. $31,200; $46,800
B. $39,000; $39,000
C. $32,000; $96,000
D. $45,300; $32,700
E. $64,000; $14,000

55. Alex Goh is 39 years old and has accumulated $128,000 in his self directed defined contribution pension plan. Each year he
contributes $2,500 to the plan, and his employer contributes an equal amount. Alex thinks he will retire at age 62 and figures he will
live to age 86. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 11% and has a standard deviation of 37%. Alex now has 25% of his money in the risk free investment and 75% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. Of the total amount of new funds that will be invested by Alex and by his employer on his
behalf, how much will Alex put into the safe account each year; how much into the risky account?

A. $2,500; $2,500
B. $3,200; $1,800
C. $3,000; $2,000
D. $1,250; $3,750
E. $2,400; $2,600

56. Alex Goh is 39 years old and has accumulated $128,000 in his self directed defined contribution pension plan. Each year he
contributes $2,500 to the plan, and his employer contributes an equal amount. Alex thinks he will retire at age 62 and figures he will
live to age 86. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 11% and has a standard deviation of 37%. Alex now has 25% of his money in the risk free investment and 75% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. How much can Alex be sure of having in the safe account at retirement?

A. $132,473
B. $162,557
C. $178,943
D. $189,211
E. $124,643

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57. Alex Goh is 39 years old and has accumulated $128,000 in his self directed defined contribution pension plan. Each year he
contributes $2,500 to the plan, and his employer contributes an equal amount. Alex thinks he will retire at age 62 and figures he will
live to age 86. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 11% and has a standard deviation of 37%. Alex now has 25% of his money in the risk free investment and 75% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. How much can Alex expect to have in his risky account at retirement?

A. $1,400,326
B. $1,309,529
C. $1,543,781
D. $1,224,651
E. $1,345,886

58. Alan Barnett is 43 years old and has accumulated $78,000 in his self directed defined contribution pension plan. Each year he
contributes $1,500 to the plan, and his employer contributes an equal amount. Alan thinks he will retire at age 60 and figures he will
live to age 83. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 10% and has a standard deviation of 34%. Alan now has 40% of his money in the risk free investment and 60% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. How much does Alan currently have in the safe account; how much in the risky account?

A. $31,200; $46,800
B. $39,000; $39,000
C. $15,900; $62,100
D. $45,300; $32,700
E. $64,000; $14,000

59. Alan Barnett is 43 years old and has accumulated $78,000 in his self directed defined contribution pension plan. Each year he
contributes $1,500 to the plan, and his employer contributes an equal amount. Alan thinks he will retire at age 60 and figures he will
live to age 83. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 10% and has a standard deviation of 34%. Alan now has 40% of his money in the risk free investment and 60% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. Of the total amount of new funds that will be invested by Alan and by his employer on his
behalf, how much will he put into the safe account each year; how much into the risky account?

A. $1,500; $1,500
B. $1,200; $1,800
C. $2,000; $1,000
D. $2,500; $500
E. $1,400; $1,600

60. Alan Barnett is 43 years old and has accumulated $78,000 in his self directed defined contribution pension plan. Each year he
contributes $1,500 to the plan, and his employer contributes an equal amount. Alan thinks he will retire at age 60 and figures he will
live to age 83. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 10% and has a standard deviation of 34%. Alan now has 40% of his money in the risk free investment and 60% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. How much can Alan be sure of having in the safe account at retirement?

A. $59,473
B. $62,557
C. $78,943
D. $89,211
E. $104,632

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61. Alan Barnett is 43 years old and has accumulated $78,000 in his self directed defined contribution pension plan. Each year he
contributes $1,500 to the plan, and his employer contributes an equal amount. Alan thinks he will retire at age 60 and figures he will
live to age 83. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 10% and has a standard deviation of 34%. Alan now has 40% of his money in the risk free investment and 60% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. How much can Alan expect to have in his risky account at retirement?

A. $158,982
B. $309,529
C. $543,781
D. $224,651
E. $345,886

62. An income beneficiary is

A. a stockbroker who remained working on Wall Street after the 1987 crash.
B. an employee of a trustee.
C. one who receives interest and dividend income from a trust during their lifetime.
D. one who receives the principal of a trust when it is dissolved.
E. None of the options are correct.

63. Assume that at retirement you have accumulated $750,000 in a variable annuity contract. The assumed investment return is 9%,
and your life expectancy is 25 years. What is the hypothetical constant benefit payment?

A. $30,000.00
B. $33,333.33
C. $51,481.38
D. $76,354.69
E. The answer cannot be determined from the information provided.

64. Assume that at retirement you have accumulated $750,000 in a variable annuity contract. The assumed investment return is 9%,
and your life expectancy is 25 years. If the first year's actual investment return is 9%, what is the starting benefit payment?

A. $30,000.00
B. $33,333.33
C. $76,354.69
D. $52,452.73
E. The answer cannot be determined from the information provided.

65. Assume that at retirement you have accumulated $825,000 in a variable annuity contract. The assumed investment return is 5.5%,
and your life expectancy is 18 years. What is the hypothetical constant benefit payment?

A. $73,358.93
B. $33,333.33
C. $51,481.38
D. $52,452.73
E. The answer cannot be determined from the information provided.

66. Assume that at retirement you have accumulated $825,000 in a variable annuity contract. The assumed investment return is 5.5%,
and your life expectancy is 18 years. If the first year's actual investment return is 7%, what is the starting benefit payment?

A. $30,000.00
B. $74,401.95
C. $51,481.38
D. $52,452.73
E. The answer cannot be determined from the information provided.

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67. Which of the following are commonly thought to be good general investment guidelines?

I) Don't try to outguess the market, buying and holding generally pays off.
II) Diversify investments to spread risk.
III) Investments should be highly concentrated in your company's stock.
IV) 401K money is best placed in money market accounts because risk is very low.
V) Investments should be allocated to stocks, bonds, and money market funds.

A. I, III, and IV
B. I, II, and V
C. II, IV, and V
D. III, IV, and V
E. I, II, IV, and V

68. Which of the following are commonly thought to be bad general investment guidelines?

I) Don't try to outguess the market, buying and holding generally pays off.
II) Diversify investments to spread risk.
III) Investments should be highly concentrated in your company's stock.
IV) 401K money is best placed in money market accounts because risk is very low.
V) Investments should be allocated to stocks, bonds, and money market funds.

A. I, III, and IV
B. I, II, and IV
C. II, IV, and V
D. III and IV
E. I, II, IV, and V

69. The principle of duration matching is

A. used only in bond portfolio management.

B. a useful concept for investments with target dates.
C. matching one's assets to one's objectives.
D. a useful concept for investments with target dates and means matching one's assets to one's objectives.
E. None of the options are correct.

70. The principle of duration matching is not

A. used only in bond portfolio management.

B. a useful concept for investments with target dates.
C. matching one's assets to one's objectives.
D. a useful concept for investments with target dates or matching one's assets to one's objectives.
E. None of the options are correct.

71. Target date retirement funds

A. are funds of funds diversified across stocks and bonds.

B. are inappropriate for most investors.
C. have very high fees.
D. function much like hedge funds.

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72. Target date retirement funds are not

A. inappropriate for most investors.

B. very high in fees.
C. designed to function much like hedge funds.
D. inappropriate for most investors or very high in fees.
E. All of the options are correct.

73. Target date retirement funds

A. change their asset allocation as time passes.

B. are a simple, but useful, strategy.
C. function much like hedge funds.
D. change their asset allocation as time passes and are a simple, but useful, strategy.
E. All of the options are correct.

74. The desirable components of an Investment Policy Statement for individual investors can be divided into

A. three main elements consisting of scope and purpose, governance, and risk management.
B. three main elements consisting of scope and purpose, governance, and investment, return and risk objectives.
C. four main elements consisting of scope and purpose, governance, risk management, and feedback.
D. four main elements consisting of scope and purpose, governance, risk management, and investment, return and risk objectives.
E. five main elements consisting of scope and purpose, governance, risk management, investment, return and risk objectives, and
evaluation.

75. The scope and purpose section of an Investment Policy Statement for individual investors typically consists of defining the

A. return, distribution, and risk requirements.

B. process for review of the IPS.
C. appropriate metrics for risk measurement.
D. relevant constraints.
E. context, investor, and structure.

76. The governance section of an Investment Policy Statement for individual investors typically contains

A. assigning the responsibility for determining investment policy.

B. the review process for the IPS.
C. assigning the responsibility for risk management.
D. the review process for the IPS and assigning the responsibility for risk management.
E. All of the options are correct.

77. The risk management section of an Investment Policy Statement for individual investors typically contains

A. relevant constraints.
B. other relevant considerations.
C. performance measurement accountabilities, metrics for risk measurement, and the rebalancing process.
D. relevant constraints and other relevant considerations.
E. All of the options are correct.

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 Chapter 28 Test Bank - Static Key

Multiple Choice Questions

1. The CFA Institute divides the process of portfolio management into three main elements, which are ______, ______, and ______.

A. planning; execution; results

B. security selection; asset allocation; action
C. planning; asset allocation; feedback
D. planning; execution; feedback
E. risk tolerance; feedback; action

The three main elements are planning, execution, and feedback.

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Difficulty: 1 Basic
Topic: Investment management process

2. The planning phase of the CFA Institute's investment management process

A. uses data about the client and capital market.

B. uses details of optimal asset allocation and security selection.
C. uses changes in expectations and objectives.
D. All of the options are correct.
E. None of the options are correct.

The planning phase of the CFA Institute's investment management process uses data about the client and capital market.

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Topic: Investment management process

3. The execution phase of the CFA Institute's investment management process

A. uses data about the client and capital market.

B. uses details of optimal asset allocation and security selection.
C. uses changes in expectations and objectives.
D. All of the options are correct.
E. None of the options are correct.

The execution phase of the CFA Institute's investment management process uses details of optimal asset allocation and security
selection.

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Topic: Investment management process

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4. The feedback phase of the CFA Institute's investment management process

A. uses data about the client and capital market.

B. uses details of optimal asset allocation and security selection.
C. uses changes in expectations and objectives.
D. All of the options are correct.
E. None of the options are correct.

The feedback phase of the CFA Institute's investment management process uses changes in expectations and objectives.

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Topic: Investment management process

5. __________ refer to strategies aimed at attaining the established rate of return requirements while meeting expressed risk tolerance
and applicable constraints.

A. Investment constraints
B. Investment objectives
C. Investment policies
D. All of the options are correct.
E. None of the options are correct.

Objectives are goals, constraints refer to actions the investor is unwilling to take; both objectives and constraints determine policies.

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Topic: Investment policy statements

6. One incorrect belief that is often cited as a reason for fully funded pension funds to invest in equities is

A. stocks have higher risk.

B. bonds have lower returns.
C. stocks provide a hedge against inflation.
D. stocks have higher returns.
E. All of the options are incorrect beliefs that are often cited.

Nominal returns on stocks are highly correlated with inflation, yet many pension managers cite inflation protection as a reason for
investing in equities.

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Topic: Pension and insurance funds

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7. __________ in the process of asset allocation.

A. Deriving the efficient portfolio frontier is a step

B. Specifying asset classes to be included in the portfolio is a step
C. Specifying the capital market expectations is a step
D. All of the options are steps.
E. None of the options are steps.

All of the options determine asset allocation.

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Topic: Asset allocation and security selection

8. Questionnaires and attitude surveys suggest that risk tolerance

A. increases with age.

B. decreases with age.
C. stays constant over the life cycle for most investors.
D. cannot be assessed.
E. None of the options are correct.

The life cycle view of investment behavior suggests that investors are more risk tolerant when they are younger, and surveys support
this view.

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Topic: Individual investor considerations and objectives

9. __________ can be used to create a perfect inflation hedge.

A. Gold
B. Real estate
C. TIPS
D. The S&P 500 Index
E. None of the options are correct.

The CPI is the rate of inflation, thus CPI linked bonds can be used to create a perfect inflation hedge.

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Topic: Bond types and features

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10. A fully funded pension plan can invest surplus assets in equities provided it reduces the proportion in equities when the value of
the fund drops near the accumulated benefit obligation. This strategy is referred to as
A. immunization.
B. hedging.
C. diversification.
D. contingent immunization.
E. overfunding.

Contingent immunization allows the fund to participate in the higher returns of the equity market while protecting the benefits of plan
participants.

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Topic: Pension and insurance funds

11. Workers who change jobs may wind up with lower pension benefits at retirement than otherwise identical workers who stay with
the same employer, even if the employers have defined benefit plans with the same final pay benefit formula. This is referred to as

A. an accumulated benefit obligation.

B. an unfunded liability.
C. immunization.
D. indexation.
E. the portability problem.

The portability problem results in reduced benefits for workers who change jobs but cannot take accumulated benefits from defined
benefit plans when they move.

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Topic: Retirement savings and Social Security

12. The __________ the proportion of total return that is in the form of price appreciation, the __________ will be the value of the tax
deferral option for taxable investors.

A. greater; greater
B. greater; lower
C. lower; greater
D. The answer cannot be determined from the information provided.
E. None of the options are correct.

Deferral of the capital gain tax allows the investment to grow at a faster rate until the tax is actually paid.

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Topic: Tax shelters

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13. An important benefit of Keogh plans is that

A. they are not taxable until funds are withdrawn as benefits.

B. they are protected against inflation.
C. they are automatically insured by the Federal government.
D. they are not taxable until funds are withdrawn as benefits, and they are protected against inflation.
E. they are not taxable until funds are withdrawn as benefits, and they are automatically insured by the Federal government.

Keogh plans, like other tax deferred retirement plans, are not subject to taxes until funds are withdrawn as benefits.

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Topic: Tax shelters

14. Variable life insurance

A. combines life insurance with a tax deferred annuity.

B. provides a minimum death benefit that increases subject to investment performance.
C. can be converted to a stream of income.
D. All of the options are correct.
E. None of the options are correct.

Variable life insurance includes all of the listed features.

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Topic: Pension and insurance funds

15. Endowment funds are held by

A. charitable organizations.
B. educational institutions.
C. for profit firms.
D. charitable organizations and educational institutions.
E. educational institutions and for profit firms.

Endowments are funds established for not for profit organizations, such as colleges, universities, charities, hospitals, etc.

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Topic: Professional investor considerations and objectives

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16. __________ center on the trade off between the return the investor wants and how much risk the investor is willing to assume.

A. Investment constraints
B. Investment objectives
C. Investment policies
D. All of the options are correct.
E. None of the options are correct.

The objective is to earn the maximum return, given the amount of risk the investor is willing to assume.

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Topic: Individual investor considerations and objectives

17. The stage an individual is in his/her life cycle will affect his/her

A. return requirements.
B. risk tolerance.
C. asset allocation.
D. return requirements and risk tolerance.
E. All of the options are correct.

The stage in the life cycle affects risk tolerance and therefore affects return requirements and asset allocation.

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Difficulty: 2 Intermediate
Topic: Individual investor considerations and objectives

18. A remainderman is

A. a stockbroker who remained working on Wall Street after the 1987 crash.
B. an employee of a trustee.
C. one who receives interest and dividend income from a trust during their lifetime.
D. one who receives the principal of a trust when it is dissolved.

When the trust is dissolved, the remainderman receives the remaining principal.

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Topic: Individual investor considerations and objectives

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19. __________ are boundaries that investors place on their choice of investment assets.

A. Investment constraints
B. Investment objectives
C. Investment policies
D. All of the options are correct
E. None of the options are correct.

Investment constraints consist of actions the investor is unwilling to take.

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Topic: Investment constraints

20. The investment horizon is

A. the investor's expected age at death.

B. the starting date for establishing investment constraints.
C. based on the investor's risk tolerance.
D. the date at which the portfolio is expected to be fully or partially liquidated.

The investment horizon is the planned liquidation date.

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Topic: Investment constraints

21. Liquidity is

A. the ease with which an asset can be sold.

B. the ability to sell an asset for a fair price.
C. the degree of inflation protection an asset provides.
D. the ease with which an asset can be sold and the ability to sell an asset for a fair price.
E. All of the options are correct.

Liquidity refers to the speed at which an asset can be sold for a fair price.

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Topic: Investment constraints

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22. 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

The objectives of personal trusts normally are more limited in scope than those of individual investors and personal trust managers
typically are more risk averse than individual investors.

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Topic: Professional investor considerations and objectives

23. 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
E. Cannot determine; depends on the economic environment.

With a defined contribution plan, the employee bears the risk of the portfolio returns and thus risk of benefit levels. However, the
employee also receives all of the returns generated by the defined contribution plan.

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Difficulty: 2 Intermediate
Topic: Retirement savings and Social Security

24. 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 an individual in a high marginal tax bracket 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.

Taxes are not paid on capital gains until the stock is sold. If the pre tax holding period returns on the two stocks are the same, more
taxes will be paid on the stock with the high dividend payout policy (stock A) and thus the after tax returns of A will lower than the
after tax returns of B.

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Difficulty: 2 Intermediate
Topic: Tax shelters

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25. The prudent investor rule requires

A. executives of companies to avoid investing in options of companies by which they are employed.
B. executives of companies to disclose their transactions in stocks of companies by which they are employed.
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 the
prudent investor.

The prudent investor rule allows one to diversify, which means that some risky investments are allowed in a portfolio. However, the
riskiness of the portfolio should be such that a prudent investor would be willing to assume.

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Topic: Professional standards, practices, and conduct

26. The longest time horizons are likely to be set by

A. banks.
B. property and casualty insurance companies.
C. pension funds.
D. banks and pension funds.
E. property and casualty insurance companies and pension funds.

Banks and non life insurance companies typically have short time horizons.

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Difficulty: 2 Intermediate
Topic: Pension and insurance funds

27. The longest time horizons are likely to be set by

A. banks.
B. property and casualty insurance companies.
C. endowment funds.
D. banks and endowment funds.
E. property and casualty insurance companies and endowment funds.

Endowment funds, pension funds, and life insurance companies typically have long time horizons.

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Topic: Pension and insurance funds

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28. The shortest time horizons are likely to be set by

A. banks.
B. property and casualty insurance companies.
C. pension funds.
D. banks and property and casualty insurance companies.
E. property and casualty insurance companies and pension funds.

Banks and non life insurance companies typically have short time horizons.

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Difficulty: 2 Intermediate
Topic: Pension and insurance funds

29. Institutional investors will rarely invest in which of these asset classes?

A. Bonds
B. Stocks
C. Cash
D. Real estate
E. Precious metals

Institutional investors typically limit their holdings to the first four of these asset classes.

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Topic: Professional investor considerations and objectives

30. For an individual investor, the value of home ownership is likely to be viewed

A. as a hedge against increases in rental rates.

B. as a guarantee of availability of a particular residence.
C. as a hedge against inflation.
D. as a hedge against increases in rental rates and as a guarantee of availability of a particular residence.
E. All of the options are correct.

Real estate has not been shown to be an effective hedge against inflation.

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Topic: Individual investor considerations and objectives

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31. Assume that at retirement you have accumulated $500,000 in a variable annuity contract. The assumed investment return is 6%,
and your life expectancy is 15 years. What is the hypothetical constant benefit payment?

A. $30,000.00
B. $33,333.33
C. $51,481.38
D. $52,452.73
E. The answer cannot be determined from the information provided.

PV = −500,000, i = 6, n = 15, PMT = 51,481.38.

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Topic: Time value of money

32. Assume that at retirement you have accumulated $500,000 in a variable annuity contract. The assumed investment return is 6%,
and your life expectancy is 15 years. If the first year's actual investment return is 8%, what is the starting benefit payment?

A. $30,000.00
B. $33,333.33
C. $51,481.38
D. $52,452.73
E. The answer cannot be determined from the information provided.

B = 51,481.38 (1.08/1.06) = 52,452.73.

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Topic: Time value of money

33. The first step a pension fund 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.

The first step for any investor is to determine the goals and objectives of the portfolio. All subsequent steps in the investment process
follow.

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Topic: Pension and insurance funds

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34. General pension funds typically invest __________ of their funds in equity securities.

A. none
B. 5-10%
C. 15-35%
D. 40-60%
E. more than 60%

Pension funds can theoretically maximize tax benefits and minimize administrative costs by investing in fixed income securities, yet
they remain highly invested in equities.

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Topic: Pension and insurance funds

35. The optimal portfolio on the efficient frontier for a given investor depends on

A. the investor's degree of risk tolerance.

B. the coefficient, A, which is a measure of risk aversion.
C. the investor's required rate of return.
D. the investor's degree of risk tolerance and the investor's required rate of return.
E. the investor's degree of risk tolerance and the coefficient, A, which is a measure of risk aversion.

The investor's position on the efficient frontier is determined by the investor's degree of risk tolerance and the coefficient, A, which is
a measure of risk aversion. The investor will opt for the portfolio with the maximum returns at the acceptable level of risk tolerance,
which will be on the efficient frontier.

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Topic: Risk aversion

36. The optimal portfolio on the efficient frontier for a given investor does not depend on

A. the investor's degree of risk tolerance.

B. the coefficient, A, which is a measure of risk aversion.
C. the investor's required rate of return.
D. the investor's degree of risk tolerance and the investor's required rate of return.
E. the investor's degree of risk tolerance and the coefficient, A, which is a measure of risk aversion.

The investor's position on the efficient frontier is determined by the investor's degree of risk tolerance and the coefficient, A, which is
a measure of risk aversion. The investor will opt for the portfolio with the maximum returns at the acceptable level of risk tolerance,
which will be on the efficient frontier.

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Topic: Risk aversion

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37. Target date retirement funds are not

A. funds of funds diversified across stocks and bonds.

B. designed to change their asset allocation as time passes.
C. a simple, but useful, strategy.
D. designed to function much like hedge funds.

Target date retirement funds are funds of funds diversified across stocks and bonds, change their asset allocation as time passes, and
are a simple but useful strategy.

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Topic: Retirement savings and Social Security

38. A ___________ is established when an individual confers legal title to property to another person or institution to manage the
property for one or more beneficiaries.

A. tax shelter
B. defined contribution plan
C. personal trust
D. fixed annuity
E. Keogh plan

Personal trusts are to be managed for the benefit of the beneficiary. Managers of these trusts are often more risk averse than the
individual investors.

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Topic: Individual investor considerations and objectives

39. Professional financial planners should

A. assess their client's risk and return requirements on a one time basis.
B. explain the investment plan to the client.
C. inform the client about the outcome of the plan.
D. assess their client's risk and return requirements on a one time basis, explain the investment plan to the client, and inform the client
about the outcome of the plan.
E. explain the investment plan to the client and inform the client about the outcome of the plan.

They should assess risk and return requirements on an ongoing basis as their clients advance through the life cycle and their needs
change.

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Topic: Professional standards, practices, and conduct

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40. Deferral of capital gains tax

I) means that the investor doesn't need to pay taxes until the investment is sold.
II) allows the investment to grow at a faster rate.
III) means that you might escape the capital gains tax if you live long enough.
IV) provides a tax shelter for investors.

A. II and III
B. I, II, IV
C. I, III, and V
D. II, III, and IV

The only incorrect response is III. Capital gains tax will have to be paid eventually when the assets are sold.

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Topic: Tax shelters

41. Deferral of capital gains tax does not

I) mean that the investor doesn't need to pay taxes until the investment is sold.
II) allow the investment to grow at a faster rate.
III) mean that you might escape the capital gains tax if you live long enough.
IV) provide a tax shelter for investors.

A. III
B. II
C. I, II, and V
D. II, III, and IV

Capital gains tax will have to be paid eventually when the assets are sold.

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Topic: Tax shelters

42. Which of the following investments does not allow the investor to choose how to allocate assets?

A. Variable Life insurance policies

B. Keogh plans
C. Personal funds
D. Tax qualified defined contribution plans
E. Universal Life policies

Universal Life policies are managed by the insurance company, whose portfolio managers make the decisions about asset allocation.

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Topic: Individual investor considerations and objectives

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43. Which of the following investments allows the investor to choose how to allocate assets?

A. Variable Life insurance policies

B. Keogh plans
C. Personal funds
D. Tax qualified defined contribution plans
E. All of the options are correct.

Keogh plans, personal funds, variable life insurance policies, and tax qualified defined contribution plans allow investors to choose
how assets are allocated.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Individual investor considerations and objectives

44. Pension funds

I) accept contributions from employers, which are tax deductible.

II) pay distributions that are taxed as ordinary income.
III) pay benefits only from the income component of the fund.
IV) accept contributions from employees, which are not tax deductible.

A. I and IV
B. II and III
C. I and II
D. I, II, and IV
E. I, II, III, and IV

The funds aren't limited to using only the income component for payouts and employees' contributions are tax deductible.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Pension and insurance funds

45. Pension funds do not

I) accept contributions from employers, which are tax deductible.

II) pay distributions that are taxed as ordinary income.
III) pay benefits only from the income component of the fund.
IV) accept contributions from employees, which are not tax deductible.

A. III and IV
B. II and III
C. I and II
D. I, II, and IV
E. I, II, III, and IV

The funds aren't limited to using only the income component for payouts and employees' contributions are tax deductible.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Pension and insurance funds

28-29
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46. Stephanie Watson is 23 years old and has accumulated $4,000 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Stephanie thinks she will retire at age 67 and figures
she will live to age 81. The plan allows for two types of investments. One offers a 3.5% risk free real rate of return. The other offers
an expected return of 10% and has a standard deviation of 23%. Stephanie now has 5% of her money in the risk free investment and
95% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the
investments. Her salary will grow at the same rate as inflation. How much does Stephanie currently have in the safe account; how
much in the risky account?

A. $3,800; $200
B. $2,000; $2,000
C. $200; $3,800
D. $2,500; $1,500
E. $1,500; $2,500

The safe account has .05 × $4,000 = $200 and the risky account has .95 × $4,000 = $3,800.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Retirement savings and Social Security

47. Stephanie Watson is 23 years old and has accumulated $4,000 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Stephanie thinks she will retire at age 67 and figures
she will live to age 81. The plan allows for two types of investments. One offers a 3.5% risk free real rate of return. The other offers
an expected return of 10% and has a standard deviation of 23%. Stephanie now has 5% of her money in the risk free investment and
95% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the
investments. Her salary will grow at the same rate as inflation. Of the total amount of new funds that will be invested by Stephanie and
by her employer on her behalf, how much will she put into the safe account each year; how much into the risky account?

A. $3,800; $200
B. $2,000; $2,000
C. $200; $3,800
D. $2,500; $1,500
E. $1,500; $2,500

The safe account gets .05 × ($2,000 + 2,000) = $200 and the risky account gets .95 × ($2,000 + 2,000) = $3,800.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Retirement savings and Social Security

28-30
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48. Stephanie Watson is 23 years old and has accumulated $4,000 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Stephanie thinks she will retire at age 67 and figures
she will live to age 81. The plan allows for two types of investments. One offers a 3.5% risk free real rate of return. The other offers
an expected return of 10% and has a standard deviation of 23%. Stephanie now has 5% of her money in the risk free investment and
95% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the
investments. Her salary will grow at the same rate as inflation. How much can Stephanie be sure of having in the safe account at
retirement?

A. $37,221
B. $16,423
C. $11,856
D. $21,156.
E. $49,219

The value in the safe account in 44 years will be $200 × (1.035)44 + $200 × FVIFA3.5%,44 = $21,156.33.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Retirement savings and Social Security

49. Stephanie Watson is 23 years old and has accumulated $4,000 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Stephanie thinks she will retire at age 67 and figures
she will live to age 81. The plan allows for two types of investments. One offers a 3.5% risk free real rate of return. The other offers
an expected return of 10% and has a standard deviation of 23%. Stephanie now has 5% of her money in the risk free investment and
95% in the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the
investments. Her salary will grow at the same rate as inflation. How much can Stephanie expect to have in her risky account at
retirement?

A. $2,731,838
B. $2,915,415
C. $1,425,316
D. $224,651
E. $3,545,886

The value in the risky account in 44 years will be $3,800 × (1.10)44 + $3,800 × FVIFA10%,44 = $2,731,838.38.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Retirement savings and Social Security

28-31
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50. Genny Webb is 27 years old and has accumulated $7,500 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Genny thinks she will retire at age 63 and figures she
will live to age 90. The plan allows for two types of investments. One offers a 3% risk free real rate of return. The other offers an
expected return of 12% and has a standard deviation of 39%. Genny now has 20% of her money in the risk free investment and 80% in
the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments.
Her salary will grow at the same rate as inflation. How much does Genny currently have in the safe account; how much in the risky
account?

A. $1,500; $6,000
B. $3,000; $4,500
C. $2,000; $5,500
D. $4,800; $2,700
E. $3,500; $3,500

The safe account has .20 × $7,500 = $1,500 and the risky account has .8 × $7,500 = $6,000.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Retirement savings and Social Security

51. Genny Webb is 27 years old and has accumulated $7,500 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Genny thinks she will retire at age 63 and figures she
will live to age 90. The plan allows for two types of investments. One offers a 3% risk free real rate of return. The other offers an
expected return of 12% and has a standard deviation of 39%. Genny now has 20% of her money in the risk free investment and 80% in
the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments.
Her salary will grow at the same rate as inflation. Of the total amount of new funds that will be invested by Genny and by her
employer on her behalf, how much will Genny put into the safe account each year; how much into the risky account?

A. $1,500; $2,500
B. $1,200; $1,800
C. $800; $3,200
D. $1,250; $2,750
E. $1,400; $1,600

The safe account gets .2 × ($2,000 + 2,000) = $800 and the risky account gets 8 × ($2,000 + 2,000) = $3,200.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Retirement savings and Social Security

28-32
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52. Genny Webb is 27 years old and has accumulated $7,500 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Genny thinks she will retire at age 63 and figures she
will live to age 90. The plan allows for two types of investments. One offers a 3% risk free real rate of return. The other offers an
expected return of 12% and has a standard deviation of 39%. Genny now has 20% of her money in the risk free investment and 80% in
the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments.
Her salary will grow at the same rate as inflation. How much can Genny be sure of having in the safe account at retirement?

A. $45,473
B. $62,557
C. $78,943
D. $54,968
E. $74,643

The value in the safe account in 36 years will be $1,500 × (1.03)36 + $800 × FVIFA3%,36 = $54,968.17.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Retirement savings and Social Security

53. Genny Webb is 27 years old and has accumulated $7,500 in her self directed defined contribution pension plan. Each year she
contributes $2,000 to the plan, and her employer contributes an equal amount. Genny thinks she will retire at age 63 and figures she
will live to age 90. The plan allows for two types of investments. One offers a 3% risk free real rate of return. The other offers an
expected return of 12% and has a standard deviation of 39%. Genny now has 20% of her money in the risk free investment and 80% in
the risky investment. She plans to continue saving at the same rate and keep the same proportions invested in each of the investments.
Her salary will grow at the same rate as inflation. How much can Genny expect to have in her risky account at retirement?

A. $1,800,326
B. $1,905,095
C. $1,743,781
D. $1,224,651
E. $345,886

The value in the risky account in 36 years will be $6,000 × (1.12)36 + $3,200 × FVIFA12%,36 = $1,905,095.42.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Retirement savings and Social Security

28-33
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54. Alex Goh is 39 years old and has accumulated $128,000 in his self directed defined contribution pension plan. Each year he
contributes $2,500 to the plan, and his employer contributes an equal amount. Alex thinks he will retire at age 62 and figures he will
live to age 86. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 11% and has a standard deviation of 37%. Alex now has 25% of his money in the risk free investment and 75% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. How much does Alex currently have in the safe account; how much in the risky account?

A. $31,200; $46,800
B. $39,000; $39,000
C. $32,000; $96,000
D. $45,300; $32,700
E. $64,000; $14,000

The safe account has .25 × $128,000 = $32,000 and the risky account has 75 × $128,000 = $96,000.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Retirement savings and Social Security

55. Alex Goh is 39 years old and has accumulated $128,000 in his self directed defined contribution pension plan. Each year he
contributes $2,500 to the plan, and his employer contributes an equal amount. Alex thinks he will retire at age 62 and figures he will
live to age 86. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 11% and has a standard deviation of 37%. Alex now has 25% of his money in the risk free investment and 75% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. Of the total amount of new funds that will be invested by Alex and by his employer on his
behalf, how much will Alex put into the safe account each year; how much into the risky account?

A. $2,500; $2,500
B. $3,200; $1,800
C. $3,000; $2,000
D. $1,250; $3,750
E. $2,400; $2,600

The safe account gets .25 × ($2,500 + 2,500) = $1,250 and the risky account gets 75 × ($2,500 + 2,500) = $3,750.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Retirement savings and Social Security

28-34
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56. Alex Goh is 39 years old and has accumulated $128,000 in his self directed defined contribution pension plan. Each year he
contributes $2,500 to the plan, and his employer contributes an equal amount. Alex thinks he will retire at age 62 and figures he will
live to age 86. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 11% and has a standard deviation of 37%. Alex now has 25% of his money in the risk free investment and 75% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. How much can Alex be sure of having in the safe account at retirement?

A. $132,473
B. $162,557
C. $178,943
D. $189,211
E. $124,643

The value in the safe account in 23 years will be $32,000 × (1.04)23 + $1,250 × FVIFA4%,23 = $124,643.26.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Retirement savings and Social Security

57. Alex Goh is 39 years old and has accumulated $128,000 in his self directed defined contribution pension plan. Each year he
contributes $2,500 to the plan, and his employer contributes an equal amount. Alex thinks he will retire at age 62 and figures he will
live to age 86. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 11% and has a standard deviation of 37%. Alex now has 25% of his money in the risk free investment and 75% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. How much can Alex expect to have in his risky account at retirement?

A. $1,400,326
B. $1,309,529
C. $1,543,781
D. $1,224,651
E. $1,345,886

The value in the risky account in 23 years will be $96,000 × (1.11)23 + $3,750 × FVIFA11%,23 = $1,400,326.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Retirement savings and Social Security

28-35
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58. Alan Barnett is 43 years old and has accumulated $78,000 in his self directed defined contribution pension plan. Each year he
contributes $1,500 to the plan, and his employer contributes an equal amount. Alan thinks he will retire at age 60 and figures he will
live to age 83. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 10% and has a standard deviation of 34%. Alan now has 40% of his money in the risk free investment and 60% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. How much does Alan currently have in the safe account; how much in the risky account?

A. $31,200; $46,800
B. $39,000; $39,000
C. $15,900; $62,100
D. $45,300; $32,700
E. $64,000; $14,000

The safe account has .4 × $78,000 = $31,200 and the risky account has .6 × $78,000 = $46,800.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Retirement savings and Social Security

59. Alan Barnett is 43 years old and has accumulated $78,000 in his self directed defined contribution pension plan. Each year he
contributes $1,500 to the plan, and his employer contributes an equal amount. Alan thinks he will retire at age 60 and figures he will
live to age 83. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 10% and has a standard deviation of 34%. Alan now has 40% of his money in the risk free investment and 60% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. Of the total amount of new funds that will be invested by Alan and by his employer on his
behalf, how much will he put into the safe account each year; how much into the risky account?

A. $1,500; $1,500
B. $1,200; $1,800
C. $2,000; $1,000
D. $2,500; $500
E. $1,400; $1,600

The safe account gets .4 × ($1,500 + 1,500) = $1,200 and the risky account gets .6 × ($1,500 + 1,500) = $1,800.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 1 Basic
Topic: Retirement savings and Social Security

28-36
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60. Alan Barnett is 43 years old and has accumulated $78,000 in his self directed defined contribution pension plan. Each year he
contributes $1,500 to the plan, and his employer contributes an equal amount. Alan thinks he will retire at age 60 and figures he will
live to age 83. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 10% and has a standard deviation of 34%. Alan now has 40% of his money in the risk free investment and 60% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. How much can Alan be sure of having in the safe account at retirement?

A. $59,473
B. $62,557
C. $78,943
D. $89,211
E. $104,632

The value in the safe account in 17 years will be $31,200 × (1.04)17 + $1,200 × FVIFA4%,17 = $89,211.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Retirement savings and Social Security

61. Alan Barnett is 43 years old and has accumulated $78,000 in his self directed defined contribution pension plan. Each year he
contributes $1,500 to the plan, and his employer contributes an equal amount. Alan thinks he will retire at age 60 and figures he will
live to age 83. The plan allows for two types of investments. One offers a 4% risk free real rate of return. The other offers an expected
return of 10% and has a standard deviation of 34%. Alan now has 40% of his money in the risk free investment and 60% in the risky
investment. He plans to continue saving at the same rate and keep the same proportions invested in each of the investments. His salary
will grow at the same rate as inflation. How much can Alan expect to have in his risky account at retirement?

A. $158,982
B. $309,529
C. $543,781
D. $224,651
E. $345,886

The value in the risky account in 17 years will be $46,800 × (1.10)17 + $1,800 × FVIFA10%,17 = $309,529.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Retirement savings and Social Security

62. An income beneficiary is

A. a stockbroker who remained working on Wall Street after the 1987 crash.
B. an employee of a trustee.
C. one who receives interest and dividend income from a trust during their lifetime.
D. one who receives the principal of a trust when it is dissolved.
E. None of the options are correct.

An income beneficiary is one who receives interest and dividend income from a trust during their lifetime.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 1 Basic
Topic: Individual investor considerations and objectives

28-37
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63. Assume that at retirement you have accumulated $750,000 in a variable annuity contract. The assumed investment return is 9%,
and your life expectancy is 25 years. What is the hypothetical constant benefit payment?

A. $30,000.00
B. $33,333.33
C. $51,481.38
D. $76,354.69
E. The answer cannot be determined from the information provided.

PV = 750,000, i = 9, n = 25, PMT = 76,354.69.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Time value of money

64. Assume that at retirement you have accumulated $750,000 in a variable annuity contract. The assumed investment return is 9%,
and your life expectancy is 25 years. If the first year's actual investment return is 9%, what is the starting benefit payment?

A. $30,000.00
B. $33,333.33
C. $76,354.69
D. $52,452.73
E. The answer cannot be determined from the information provided.

B = 76,354.69 (1.09/1.09) = 76,354.69.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Time value of money

65. Assume that at retirement you have accumulated $825,000 in a variable annuity contract. The assumed investment return is 5.5%,
and your life expectancy is 18 years. What is the hypothetical constant benefit payment?

A. $73,358.93
B. $33,333.33
C. $51,481.38
D. $52,452.73
E. The answer cannot be determined from the information provided.

PV = 825,000, i = 5.5, n = 18, PMT = 73,358.93.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Intermediate
Topic: Time value of money

28-38
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66. Assume that at retirement you have accumulated $825,000 in a variable annuity contract. The assumed investment return is 5.5%,
and your life expectancy is 18 years. If the first year's actual investment return is 7%, what is the starting benefit payment?

A. $30,000.00
B. $74,401.95
C. $51,481.38
D. $52,452.73
E. The answer cannot be determined from the information provided.

PV = 825,000, i = 5.5, n = 18, PMT = 73,358.93; 73,358.93 (1.07/1.055) = 74,401.95.

AACSB: Knowledge Application

Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Challenge
Topic: Time value of money

67. Which of the following are commonly thought to be good general investment guidelines?

I) Don't try to outguess the market, buying and holding generally pays off.
II) Diversify investments to spread risk.
III) Investments should be highly concentrated in your company's stock.
IV) 401K money is best placed in money market accounts because risk is very low.
V) Investments should be allocated to stocks, bonds, and money market funds.

A. I, III, and IV
B. I, II, and V
C. II, IV, and V
D. III, IV, and V
E. I, II, IV, and V

Don't try to outguess the market, buying and holding generally pays off, diversify investments to spread risk, investments should be
allocated to stocks, bonds, and money market funds.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Investment policy statements

28-39
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68. Which of the following are commonly thought to be bad general investment guidelines?

I) Don't try to outguess the market, buying and holding generally pays off.
II) Diversify investments to spread risk.
III) Investments should be highly concentrated in your company's stock.
IV) 401K money is best placed in money market accounts because risk is very low.
V) Investments should be allocated to stocks, bonds, and money market funds.

A. I, III, and IV
B. I, II, and IV
C. II, IV, and V
D. III and IV
E. I, II, IV, and V

Good advice would be that investors should not try to outguess the market, buying and holding generally pays off, to diversify
investments to spread risk, and that investments should be allocated to stocks, bonds, and money market funds.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Investment policy statements

69. The principle of duration matching is

A. used only in bond portfolio management.

B. a useful concept for investments with target dates.
C. matching one's assets to one's objectives.
D. a useful concept for investments with target dates and means matching one's assets to one's objectives.
E. None of the options are correct.

The principle of duration matching is a useful concept for investments with target dates and means matching one's assets to one's
objectives.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Investment policy statements

70. The principle of duration matching is not

A. used only in bond portfolio management.

B. a useful concept for investments with target dates.
C. matching one's assets to one's objectives.
D. a useful concept for investments with target dates or matching one's assets to one's objectives.
E. None of the options are correct.

The principle of duration matching is a useful concept for investments with target dates and means matching one's assets to one's
objectives.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Investment policy statements

28-40
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71. Target date retirement funds

A. are funds of funds diversified across stocks and bonds.

B. are inappropriate for most investors.
C. have very high fees.
D. function much like hedge funds.

Target date retirement funds are funds of funds diversified across stocks and bonds.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Investment policy statements

72. Target date retirement funds are not

A. inappropriate for most investors.

B. very high in fees.
C. designed to function much like hedge funds.
D. inappropriate for most investors or very high in fees.
E. All of the options are correct.

Target date retirement funds are funds of funds diversified across stocks and bonds.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Investment policy statements

73. Target date retirement funds

A. change their asset allocation as time passes.

B. are a simple, but useful, strategy.
C. function much like hedge funds.
D. change their asset allocation as time passes and are a simple, but useful, strategy.
E. All of the options are correct.

Target date retirement funds are funds of funds diversified across stocks and bonds, change their asset allocation as time passes, and
are a simple but useful strategy.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 2 Intermediate
Topic: Investment policy statements

28-41
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74. The desirable components of an Investment Policy Statement for individual investors can be divided into

A. three main elements consisting of scope and purpose, governance, and risk management.
B. three main elements consisting of scope and purpose, governance, and investment, return and risk objectives.
C. four main elements consisting of scope and purpose, governance, risk management, and feedback.
D. four main elements consisting of scope and purpose, governance, risk management, and investment, return and risk objectives.
E. five main elements consisting of scope and purpose, governance, risk management, investment, return and risk objectives, and
evaluation.

The desirable components of an Investment Policy Statement for individual investors can be divided into four main elements
consisting of scope and purpose, governance, risk management, and investment return and risk objectives.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Investment policy statements

75. The scope and purpose section of an Investment Policy Statement for individual investors typically consists of defining the

A. return, distribution, and risk requirements.

B. process for review of the IPS.
C. appropriate metrics for risk measurement.
D. relevant constraints.
E. context, investor, and structure.

The scope and purpose section of an Investment Policy Statement for individual investors typically consists of defining the context,
investor, and structure.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Investment policy statements

76. The governance section of an Investment Policy Statement for individual investors typically contains

A. assigning the responsibility for determining investment policy.

B. the review process for the IPS.
C. assigning the responsibility for risk management.
D. the review process for the IPS and assigning the responsibility for risk management.
E. All of the options are correct.

The governance section of an Investment Policy Statement for individual investors typically contains assigning the responsibility for
determining investment policy, the review process for the IPS, and assigning the responsibility for risk management.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Investment policy statements

28-42
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
77. The risk management section of an Investment Policy Statement for individual investors typically contains

A. relevant constraints.
B. other relevant considerations.
C. performance measurement accountabilities, metrics for risk measurement, and the rebalancing process.
D. relevant constraints and other relevant considerations.
E. All of the options are correct.

The risk management section of an Investment Policy Statement for individual investors typically contains performance measurement
accountabilities, metrics for risk measurement, and the rebalancing process.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Intermediate
Topic: Investment policy statements

28-43
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education
 Chapter 28 Test Bank - Static Summary

Category # of Questions
AACSB: Knowledge Application 22
AACSB: Reflective Thinking 55
Accessibility: Keyboard Navigation 77
Blooms: Apply 22
Blooms: Remember 39
Blooms: Understand 16
Difficulty: 1 Basic 31
Difficulty: 2 Intermediate 43
Difficulty: 3 Challenge 3
Topic: Asset allocation and security selection 1
Topic: Bond types and features 1
Topic: Individual investor considerations and objectives 9
Topic: Investment constraints 3
Topic: Investment management process 4
Topic: Investment policy statements 12
Topic: Pension and insurance funds 10
Topic: Professional investor considerations and objectives 3
Topic: Professional standards, practices, and conduct 2
Topic: Retirement savings and Social Security 19
Topic: Risk aversion 2
Topic: Tax shelters 5
Topic: Time value of money 6

28-44
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education