AAMS Module 1-10 Quizzes - Questions and Answers (Complete Solutions)

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AAMS Module 1-10 Quizzes - Questions and Answers (Complete Solutions) What are the major steps in the asset management process? 1. gather data 2. establish goals 3. analyze information 4. make and i... mplement recommendations 5. monitor Stefan's business plan includes the following goal: "I will contact 50 prospective clients and document this activity in the CRM for tracking purposes." Which primary element of a good goal is missing? This goal is not time-framed. The acronym to remember for goal setting is SMART, which stands for Specific, Measurable, Achievable, Relevant, and Time-Framed. The primary flaw in this goal is that it is not time-framed. Because it is not time-framed, it is difficult to tell if this is achievable, but it is certainly measurable and very likely relevant. Which one of the following is not an invested asset? 180-day certificate of deposit A certificate of deposit is a cash equivalent and therefore should be listed under Cash and Cash Equivalents. Victoria Gregory's financial situation is as follows: Cash/cash EquivalentsL $15,000 Short Term debts: $23,000 LTDs: $140,000 Taxes: $8000 Invested Assets: $45,000 Use Assets: $192,000 What is her net worth? $89,000 Assets = Cash/cash equivalents + Invested assets + Use assets ($15,000 + $45,000 + $192,000 = $252,000). Liabilities = Short-term debts + Long-term debts ($23,000 + $140,000 = $163,000). Assets - Liabilities = Net Worth, so $252,000 - $163,000 = $89,000. Which one of the following statements best describes the income statement and its major components? The income statement indicates, for a certain period of time, an individual's cash inflows and outflows. Its components include gross income, expenses, and surplus or deficit. The income statement describes cash flow for a period of time and contains the components of gross income, from which expenses are subtracted to determine the surplus or deficit. All of the following provide a clearer picture of the client's needs 1. anticipated retirement lifestyle 2. bad experiences w/ particular investments 3. succession planning in place, if any, for a client involved in ownership of small business Which one of the following is considered a "foundation" goal? emergency fund An emergency fund is a "foundation" goal because it is an essential goal for survival in the event of a dramatic life event. Which one of the following is the better written financial goal? to accumulate $15,000 for a boat purchase in two years This goal is well written because it contains a specific dollar amount and a specific time frame. When analyzing information gathered from a client, which of the following are important factors to look for? 1. mismatches between the current investment position or resources and stated goals. This is an important factor in the analysis step. Any mismatches between the client's goals and the investment vehicles used to attain those goals should be highlighted. 2. the validity of the client's stated goals. This is an important factor in the analysis step. If the client's goals are unrealistic, this problem needs to be addressed immediately. 3. tax problems that might be ameliorated through investment planning. This is an important factor in the analysis step. Potential tax problems should be addressed as part of the investment strategy. Marcia Simpson has analyzed her client's situation and has concluded that her client will come short of attaining the amount of capital he would like to have by the time he plans to retire. The client is a low risk taker and will have limited funds for future periodic investments. Before making a recommendation, Marcia should do which one of the following? Discuss the problem and ask the client to clarify how he wishes to adjust his accumulation goal, risk level, or periodic investments. After being informed of the various constraints, implications of their decisions, and other options they have, the client can choose to make adjustments with which he is comfortable. Which of the following is a matter that needs to be clarified before making investment recommendations? 1. client's goals 2. risk parameters of the client 3. time horizons of the goals Four main attributes of a good business plan 1. written and shared with someone who has an interest in your success 2. include realistic action steps and personal goals 3. professional development goals Which of the following is the more important factor in establishing trust with a client? demonstrating professionalism and honesty Demonstrating professionalism and honesty is the most important factor in establishing trust with a client. What are the three characteristics of a well-defined goal? 1. purpose 2. specific dollar amount 3. defined time frame Which one of the following is a mismatch between a client's time horizon and stated goal? A 55-year-old client with no current retirement savings says that saving for retirement is her top priority; she plans to retire at age 62. Seven years is not enough time for this client to amass the principal needed to support a retirement period of 15 to 20 years (or longer). Managing client expectations is best achieved through which of the following? educate the client Educating your clients is the best way to help set and manage their expectations. Who ultimately makes the investment decision in the asset management process? the client Which one of the following is not included in an investment policy statement? which securities to include in the portfolio While an investment policy statement determines which types of securities may be included in a portfolio, it does NOT make recommendations as to specific securities to purchase. Which one of the following types of investors is concerned with losing what he or she has accumulated in the past? a risk-averse investor A risk-averse investor is concerned with losing what he or she has accumulated in the past. Which one of the following best describes the purpose of an investment policy statement (IPS)? to provide a foundation on which the client's portfolio is constructed, and to provide a basis for review and adaptation to changing conditions An investment policy statement's primary purpose is to provide broad guidelines with which to establish a foundation for portfolio construction, and to provide a basis for periodic review. Of the following, which one describes a key attribute of an investment policy statement? long-term perspective—to take advantage of the positive bias in the markets A key attribute of an investment policy statement is that it should be created with a long-term perspective to use the positive bias in the markets that occurs with the passage of time. Time is of critical importance in an investment policy statement because it determines the feasibility of the investment professional making recommendations that meet the client's goals. The amount of time available for a financial goal determines if the investment professional can make recommendations that will achieve that goal. Which of the following is a key element that all investment policy statements should contain? An investment policy statement should include statements regarding acceptable investment vehicles, the portfolio's asset allocation, and the client's risk tolerance level. The asset management process can be used to adjust to changes in a client's financial situation by helping the client to ignore market "noise." The asset management process is designed to help the client ignore market noise and respond only to significant events (major changes in personal situations and discontinuous changes in the markets). Sara White bought a stock that has subsequently dropped 50%. She plans to hold on to the stock in the hopes of getting back to even. What investor mistake is Sara most likely making? loss aversion Loss aversion is the reluctance to take losses and is associated with a "get-even-itis" mentality. The investment policy statement would most likely need to be changed if which of the following occurred? The investment policy statement would most likely need to be changed if a client experienced a major event in his or her life. Examples of such changes would include inheriting a large amount of money, divorcing a spouse, and taking an early retirement from his or her company. Who bears the main responsibility for decision making in an investment policy statement? the client Which behavioral mistake is defined as a misunderstanding that an investor has in relating nominal rates of return to real (inflation-adjusted) rates of return? money illusion Money illusion is a misunderstanding that an investor has in relating nominal rates of return to real (inflation-adjusted) rates of return. Which of the following is not an example of a discontinuous change? receiving a 10% raise at work Discontinuous changes represent a significant departure from a trend or pattern. Bonds fell in price on news of higher interest rates. To which one of the following risks are the bonds most likely to be subject? interest rate risk Interest rate risk centers on the inverse relationship of interest rate changes and bond prices, so, in this situation, if interest rates go up, the price of George's bonds go down. If international stocks were added to a portfolio of U.S. stocks, which one of the following risks would specifically be added to the portfolio? exchange rate risk International stocks specifically add exchange rate risk to a portfolio since their value is affected by changes in the values of foreign currencies relative to that of the U.S. dollar. Which of the following are characteristics of the Sharpe ratio? It adjusts the return for variability by using standard deviation as the measure of risk Jensen's Alpha 1. it assumes that the portfolio being evaluated is well diversified 2. both alpha and beta appear in the formula for the ratio 3. it indicates by how much the realized return differs from the return required by the capital asset pricing model (CAPM) Treynor Ratio it assumes that the portfolio being evaluated is well diversified A measure of a security's systematic risk is beta. Beta measures the degree to which a security moves with the market or systematic risk. Measurement of total risk standard deviation Assume a growth stock mutual fund has a beta of 1.3. If the stock market increases by 9%, you would expect this mutual fund to increase by 11.7%. You would expect any fund with a beta of 1.3 to increase by 11.7% (1.3 × 9%). The risk-free rate is 1.25%, the market rate of return is 8%, the standard deviation of XYZ stock is 20, and the beta of XYZ stock is 1.10. Using the capital asset pricing model in conjunction with this information, what is the expected return of XYZ stock? 8.68% CAPM is the risk-free rate plus beta times excess return, or Rs = 1.25% + (8% - 1.25%) 1.1 = 8.68%. Which one of the following lists the investments in order of least risk to most risk? Treasury securities, high-grade convertibles, REITs, collectibles Ranked from least risk to most risk in the investment pyramid are Treasury securities, high-grade convertibles, REITs, and collectibles. Which one of the following statements is correct? Jensen's alpha may be used by itself to judge an investment. Beta is the risk measure for the Jensen's alpha, but the Sharpe ratio uses standard deviation as its risk measure. Therefore, the reliability of beta is relevant for Jensen's alpha. Jensen's alpha can be used by itself to judge an investment; the Sharpe ratio must be used in comparison with another Sharpe ratio in judging an investment. A negative reading for Jensen's alpha indicates the investment did not perform as well as expected given the risk taken. For example, an alpha reading of -1 means the investment underperformed by 1% compared to what it was expected to return. Accordingly, a negative alpha does not necessarily mean the investment lost money. The Treynor ratio uses beta as its measure of risk. Negative alpha means the fund underperformed the benchmark (does NOT mean that it's a negative return, it's just LOWER than the benchmark) Assume each of the asset classes below has the following correlation to long-term government bonds: Treasury bills: 0.67 Corporate bonds: 0.81 Large stocks: 0.37 Small stocks: 0.12 Which one of the following correctly states the impact of diversification on a portfolio of long-term government bonds? Small stocks provide more diversification than large stocks. Because the correlations of small stocks to long-term government bonds are less than that of large stocks (even though both are positive), small stocks provide more diversification than large stocks. Gary Stevens would like to know the weighted beta coefficient for his portfolio. He owns 100 shares of ACE common stock with a beta of 1.1 and total current market value of $5,000; 400 shares of BDF common stock with a beta of .70 and total current market value of $8,000; and 200 shares of GIK common stock with a beta of 1.5 and total current market value of $10,000.What is the overall weighted beta coefficient for Gary's portfolio? This can be done long-hand, using the following steps:$5,000 + $8,000 + $10,000 = $23,000 total value of the portfolio([$5,000/$23,000] x 1.1) + ([$8,000/$23,000] x 0.7) + ([$10,000/$23,000] x 1.5) = 1.13478 = 1.13 The higher the standard deviation of an investment in relation to its rate of return, the greater the level of risk for a given rate of return. The greater the dispersion of returns around an average rate of return, the greater will be the standard deviation and, consequently, the higher the level of risk for a given rate of return. During the past year, the portfolio of your largest client had a return of 10% and a beta of 1.1. During the same year, the average T-bill rate was 1.25%. What is the Treynor ratio for the performance of this portfolio? .0796 The Treynor ratio divides the excess return (return - risk-free rate) by the beta—in this case, (.10 - .0125) ÷ 1.1 = .0796. The risk-adjusted ratio that can be used by itself (without comparison to something else) is the Jensen's alpha. The Jensen ("alpha") compares a portfolio's actual return with the return that could be expected based on the risk incurred in managing that portfolio, and therefore can be used by itself. Portfolio X had a Sharpe ratio of 1.10, while Portfolio Y had a Sharpe ratio of .55. Based on this information, which one of the following statements is correct? Portfolio X had better performance than Portfolio Y on a risk-adjusted basis. A higher Sharpe ratio does indicate better performance based on the risk taken, as measured by standard deviation. Which one of the following is a type of systematic risk? It is the "R" in the acronym "P.R.I.M.E." reinvestment risk Reinvestment risk is a type of systematic risk. P.R.I.M.E Systematic Risks 1. Purchasing Power Risk 2. Reinvestment Risk 3. Interest Rate Risk 4. Market Risk 5. Exchange Rate Risk Which of the following types of risk can be reduced through diversification? unsystematic risk Which one of the following betas indicate a stock that is more volatile than the market? 1.2 Beta is a relative measure of volatility, so anything greater than 1.0 indicates more volatility than the market. Several individual investments each have high standard deviations. Which of the following are true about the standard deviation for a portfolio of these same investments? I. has to be high since the standard deviations are high II. has to be low since the standard deviations are highI II. can be low if there is a low correlation of returns between the investments IV. can be high if there is a high correlation of returns between the investments III and IV only If the investments have a low correlation coefficient between them, they will reduce investment risk, which can result in a portfolio with a low standard deviation. If the investments have a high correlation of returns between them, then they will not reduce investment risk, and the portfolio will continue to have high systematic risk, hence a high standard deviation for the portfolio. Which one of the following has a direct bearing on which investments are appropriate for achieving a goal? the investor's time horizon The time horizon has a direct bearing; net worth does not, and beta and alpha are measures of volatility and performance, respectively. If an investor were looking to add another investment to his or her portfolio, which of the following correlation coefficients would provide the greatest risk reduction? a managed futures fund with a correlation of -0.25 The scale for correlation coefficients goes from -1.0 (perfectly negatively correlated) to 1.0 (perfectly positively correlated). The further to the left you go on the scale, the lower the correlation and the greater the risk reduction. With respect to the investment pyramid discussed in the module text, which one of the following would provide the greatest potential for capital appreciation? futures contracts As you move up the investment pyramid, you increase potential for capital gain, and futures contracts are at the top of the pyramid, largely due to the high degree of leverage used in trading futures contracts. Stock ABC has an average return of 9.0% with a standard deviation of 7.0%. What is the range of expected returns for ABC 68% of the time? +2.0% to 16.0% 68% of the time the returns will fall with one standard deviation of the average return. One standard deviation below the mean is 9% - 7% = 2% while one standard deviation above the mean is 9% + 7% = 16%. If an investor contributes $5,000 to her IRA at the beginning of each year for 20 years, and earns 8% annually, how much will she have accumulated? $247,114.61 Using the HP 10bII+, set the calculator to begin mode and one compounding period per year. Then 5,000 +/- PMT, 8 I/YR, 20 SHIFT N, FV = $247,114.61. Cindy Dawson just paid $9,750 for a 7%, $10,000 par value bond with 15 years to maturity. What is the yield to maturity (YTM) of this bond? Using the time value of money functions on the financial calculator, use the following assumptions on a semiannual basis: FV = 10,000 PV = -9,750 N = 15 (x2) PMT = 3507.28% 7.28% (USE ONLINE CALCULATOR) HP 10bII+: Set calculator to end mode and two compounding periods per year. Then 9,750 +/- PV, 10,000 FV, 350 PMT, 15 SHIFT N, I/YR = 7.28%. Carol Taylor has $10,000 to invest at the end of each year for five years, and she can earn a fixed rate of 8%. "How much," she asks, "will my money be worth in five years?" $58,666 This is an ordinary annuity problem with n = 5, i = 8, and PMT = 10,000, then FVOA = $58,666. Assume that the standard deviation of a stock is 30, the standard deviation of the market index is 18, and that the correlation coefficient between the stock and the market is .68. What is the beta of the stock? 1.13 Beta = (30 / 18) x 0.68 = 1.13 Which one of the following is a better measure of a mutual fund portfolio manager's performance? Time weighted returns because cash flows are not taken into consideration Time weighted returns negate the effects of contributions and withdrawals made by investors and are therefore a better measure of a manager's performance. Dollar weighted returns take cash flows into consideration but are a better measure of performance for a client. One implication of the Brinson study is that investors should concentrate on asset allocation with less attention given to securities selection and market timing. The implication from the Brinson study is to give considerable attention to asset allocation and less attention to securities selection and market timing. A U.S. dollar-denominated instrument that is a CD issued by foreign branches of major American and foreign commercial banks is a Eurodollar certificate of deposit. A Eurodollar CD is a U.S. dollar-denominated CD issued by foreign branches of major U.S. and foreign commercial banks. Yankee Certificate of Deposit A Yankee CD is a U.S. dollar-denominated CD issued by foreign banks from their U.S. branches. Banker's Acceptance A BA is a time draft that, when accepted by the bank, has the promise of payment from that bank. The relative performance of different asset classes is dependent on the holding period selected. Based on historical performance data, which class of assets would be likely to provide the greatest pretax total return over the long term? small company stocks Small company stocks have generally outperformed all other asset classes over the long term according to Ibbotson and other major tracking data. According to Ibbotson data, which one of the following had the smallest standard deviation since 1926? T-bills T-bills had a standard deviation significantly lower than that of long-term corporate bonds, government bonds, or common stocks. Investment professional Bill Winters received the latest long-term total return data for different asset classes. He sees that common stocks returned 8% compounded with a standard deviation of 19.0; T-bills had a 1.25% return with a standard deviation of 3.4. What is the expected return of a portfolio of 60% stocks and 40% T-bills? 5.3% This correct calculation is: (.6 × 8%) + (.4 × 1.25%) = 5.3% Tactical asset allocation attempts to move assets from those that appear overvalued to those that appear undervalued. Tactical asset allocation uses securities selection and market timing techniques to shift assets from those perceived to be overvalued to those that are perceived to be undervalued. Which one of the following is a unique risk associated with international bonds? currency risk Currency risk is unique to international bonds (and stock) because of the possibility of some loss in converting a foreign currency into U.S. dollars. Money market mutual funds invest in all of the following except corporate bonds Corporate bonds will generally have high marketability, but are not necessarily safe from default, and they will carry high market risk. A mutual fund sales load that is assessed on a descending scale if the fund is sold within the first five or six years of purchase is called a contingent deferred sales charge. A contingent deferred sales charge is a sales load assessed on a descending scale if the fund is sold within the first five or six years of purchase. If the market rate on coupon bonds similar to Bond A increases, Bond A's duration will decrease. There is an inverse relationship between a bond's duration and changes in market interest rates. Company XYZ has earnings this year of $1.80 per share, expects earnings next year to increase by 15%, and generally trades at a 10% premium to the S&P 500 index. Currently, the P/E of the S&P 500 index is 20. What is the expected value of XYZ next year? $45.54 The P/E is correct [20 × 1.10 = 22] and is multiplied, correctly, by next year's earnings ($1.80 × 1.15 = $2.07) to get $45.54. A U.S. investor owns a bond denominated in Mexican pesos. If the bond earned 8% while the value of the peso increased against the U.S. dollar by 4%, the investor's total return was increased by the strengthening peso. When the investor converts the Mexican bond into American dollars, the investor can buy more dollars with fewer pesos; therefore the investor's total return was increased by the strengthening peso. In general, when a foreign currency is strengthening (the U.S. dollar is weakening), that will increase the return for a U.S. investor. Which one of the following rates is most directly affected by the Federal Reserve Board? federal funds rate The Fed directly affects the federal funds rate through open market operations. [Show More]

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