2019 CFA level 3 qbank reading 15 managing institutional investor portfolios questions

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Learning Management System

Lakeland Life Insurance Company is a U.S. based underwriter of life insurance policies doing
business in 23 states. In the past 5 years the company has completely revamped its product
o erings, going from a focus on whole life policies to oating rate referenced variable and
universal life policies. The average duration of the company's insurance liabilities is eight years.
Lakeland targets a 1.5% spread on investment assets over liabilities. The current expected
nominal actuarial return is 5% (based on current capital market conditions), but management
expects the rate environment to get more volatile in the coming months.
The company has segmented its investments into two portfolios: a xed-income portfolio and a
surplus portfolio. The xed-income portfolio is invested primarily in long-term corporate and

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U.S. Treasury bonds. The surplus portfolio is currently invested in the common and preferred
stock of large, well-known U.S companies. The surplus portfolio has a dividend yield of 3%.

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Management expects equity markets to earn 12% per year in the long term.

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Question #1 of 164

The appropriate return objective for the xed-income portfolio is to earn a return:

A) su cient to provide a spread of 1.5% over the promised rate on the company's variable
rate insurance products while maintaining an average duration of 8 years, in order to

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B) of 6.5% while maintaining an average duration of slightly less than 8 years due to

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projected increased interest rate volatility.
C) of 6.5% su cient to meet current liabilities and fund long-term growth in policy

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reserves through a total return approach.

Question #2 of 164
The appropriate risk tolerance for the surplus portfolio:

A) is lower than that of the xed-income portfolio, to guard against loss of principal and
maintain a constant income stream, in order to maintain public con dence in the
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B) is the same as that of the xed-income portfolio. While the portfolios are nominally
separated for regulatory purposes, they should actually be managed as a single

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C) is higher than that of the xed-income portfolio, because the funds should be used to
support long-term growth in insurance volume.

Question #3 of 164
The appropriate time horizon constraint for the surplus portfolio:

A) is longer than that of the xed-income portfolio, because the purpose of the surplus
portfolio is to support long-term growth in new lines of business.

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B) is the same as that of the xed-income portfolio. While the portfolios are nominally

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separated for regulatory purposes, they should actually be managed as a single
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C) is shorter than that of the xed-income portfolio, because policies such as universal and

Question #4 of 164

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variable life have shorter e ective maturities than traditional life insurance products.

Which of the following is NOT appropriate to include as tax or regulatory constraints in the

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company's Investment Policy Statement?

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A) The regulatory constraint should include a statement that the company is subject to the

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Prudent Expert Rule.

B) The regulatory constraint should include the recognition that, for U.S. life insurance

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companies, state law prevails over federal law.
C) The regulatory constraint should include the recognition that, by law, common stock
holdings are typically limited to a certain percentage of assets.

Question #5 of 164
A portfolio manager at an endowment fund expects in ation to increase over the intermediate
to long term. How should the return objective of the investment policy statement re ect these
expectations?
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A) A total return objective should be pursued so that spending requirements are met,
while at the same time purchasing power of fund assets is maintained.
B) An exclusive income oriented approach should be adopted so that spending
requirements can be met in the impending in ationary environment.
C) An exclusive capital gain oriented approach should be followed so that purchasing
power is preserved, while at the same time spending requirements must be reduced.

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Question #6 of 164

activities and is best described as:

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The funded status/surplus of a de ned bene t plan impacts the risk tolerance of investment

A) larger pension surpluses indicate lower risk tolerance.

B) there is no relationship between surplus in risk tolerance in a de ned bene t plan.

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Question #7 of 164

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C) larger pension surpluses indicate higher risk tolerance.

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The time horizon of a non-life insurance company di ers from that of a pension fund in that a

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nonlife insurance company's time horizon:

A) is quite long due to the uncertainty of the liability structure associated with policies

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sold, whereas a pension fund's time horizon will be much shorter due to the nite life of
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B) may be quite short and will depend upon the characteristics of policies sold, whereas a
pension fund's time horizon may be much longer, depending on workforce
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C) is dependent on the uncertainties of policies sold, whereas the time horizon of a
pension fund is a direct consequence of the business cycle.

Question #8 of 164

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The return objectives for a life insurance company can be broken into two segments, the xedincome and the surplus segments. Which return objectives are mostly associated with each
segment, respectively?

A) Spread management and maximizing yield.
B) Yield maximization and spread management.

C) Spread management and capital gains.

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Question #9 of 164

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A de ned bene t plan di ers from a de ned contribution plan in that the:

A) risk/return tradeo s of plan assets accrue to the plan sponsor.
B) risk/return tradeo s of plan assets accrue to the participant.

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Question #10 of 164

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C) bene t paid by the sponsor is de ned by contributions made to the plan.

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A life insurance company's liquidity requirement di ers from a non-life insurance company's

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requirement in that a life insurance company's liability structure is uncertain in its:

A) timing and amount, while a non-life insurance company's liability structure is also
uncertain in its amount and timing.

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B) amount, while a non-life insurance company's liability structure is uncertain in both its
amount and timing.
C) timing, while a non-life insurance company's liability structure is uncertain in both its
amount and timing.

Question #11 of 164
Which of the following underlying processes provides a natural framework from which to
establish investment criteria and objectives?
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A) Asset-liability management.
B) Community reputation risk management.
C) Credit risk management.

Lakeland Life Insurance Company is a U.S. based underwriter of life insurance policies doing
business in 23 states. In the past 5 years the company has completely revamped its product

o erings, going from a focus on whole life policies to oating rate referred variable and
universal life policies. The average duration of the company's insurance liabilities is eight years.
Lakeland targets a 1.5% spread on investment assets over liabilities. The current expected

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nominal actuarial return is 5% (based on current capital market conditions), but management

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expects the rate environment to get more volatile in the coming months.

The company has segmented its investments into two portfolios: a xed-income portfolio and a
surplus portfolio. The xed-income portfolio is invested primarily in long-term corporate and
U.S. Treasury bonds. The surplus portfolio is currently invested in the common and preferred

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stock of large, well-known U.S companies. The surplus portfolio has a dividend yield of 3%.
Management expects equity markets to earn 12% per year in the long term.
Lakeland management has decided to widen the target margin between investment returns
and liability costs from 1.5% to 2.0%. The current allocation and expected return on the two

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portfolios is outlined below.

Fixed-Income
Portfolio

Surplus Portfolio

Treasury bills

10%

10%

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Current Asset Allocations

Intermediate term
Treasury bonds

15%

0%

Intermediate term
Corporate bonds

5%

0%

Long-term Treasury
bonds

50%

0%

Long-term Corporate
bonds

20%

0%

Large company common
stock

0%

60%

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Asset Class

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Large company preferred
stock
Total

0%

30%

100%

100%

Expected Returns
Current (dividend) yield

5.0%

3.0%

Total return

7.0%

10.0%

Question #12 of 164

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Which of the following changes if any should Lakeland make given the capital market

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expectations to more closely match the rm's liabilities with the xed-income portfolio?

A) Increase the allocation to long-term treasury and corporate bonds, and reduce the
allocation to short-term treasury and corporate bonds, because the yield curve is
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B) Maintain the current asset allocation, because the total expected return is su cient to

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provide the 2% spread over required return on liabilities.

C) Increase the allocation to intermediate term corporate bonds, and reduce the allocation
to intermediate term treasury bonds and long-term treasury and corporate bonds,
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Question #13 of 164

Which of the following changes should Lakeland make to the surplus portfolio?

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A) Increase the allocation to intermediate and long-term corporate and Treasury bonds,
and reduce the allocation to equities, in order to reduce the risk exposure of the
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B) Increase the allocation to venture capital and international equities by reducing the
exposure to large company common stock, in order to increase the long-term growth
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C) Liquidate the preferred stock and substantially reduce the allocation to large company
equities. Diversify by investing in other long-term growth vehicles, such as mid-cap and
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Question #14 of 164
Which of the following statements concerning the risks in the xed-income portfolio is most
accurate?

A) Reinvestment risk is relatively less important, because the rate-sensitive nature of the
company's policies signi cantly reduces this risk.
B) Credit risk is relatively less important, because the emphasis should be on Treasury
bonds and AAA corporate bonds to be consistent with the low risk tolerance of the
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C) Interest rate risk is relatively less important, because the allocation to high-yielding

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equities in the surplus portfolio o sets the interest rate risk in the xed-income

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Question #15 of 164

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Which of the following statements least accurately describe the evolution in the investment
policies of insurance companies like Lakeland in the past 15-20 years?

A) Life insurance companies have segmented their investment portfolios along product
lines with di erent time horizons, liquidity constraints, and return objectives.

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B) The time horizon has gotten longer as the average life span of policyholders has

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increased with improvements in health care.

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C) A more volatile interest rate environment has forced companies to create new, rate-

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sensitive insurance products to prevent disintermediation.

Question #16 of 164
A nonlife insurance company is facing the end of its underwriting cycle. What should the rm
do with respect to the duration of its xed-income portfolio and the liquidity constraints in its
policy statement? The duration of the nonlife insurance company's xed-income portfolio
should be:

A) lowered in expectation of decreasing claims, and the investment policy statement
should re ect the possibility of a decreasing claims environment in its liquidity
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B) lengthened in expectation of decreasing claims, and the investment policy statement
should re ect the possibility of a decreasing claims environment in its liquidity
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C) shortened in expectation of increasing claims, and the investment policy statement
should re ect the possibility of an increasing claims environment in its liquidity
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Question #17 of 164
Connie King prepared a memo for her supervisor that listed the similarities and di erences

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between the investment objectives of a life insurance company versus the investment objective

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of a commodity pool. The memo contained the following statements:

Both life insurance companies and commodity pools are
taxable entities.

Statement
2:

Life insurance companies invest in order to meet various
funding requirements while commodity pools invest according
to objectives advertised to investors.

Statement
3:

The source of invested assets for both life insurance
companies and commodity pools are assets pooled from
investors.

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King's memo is:

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Statement
1:

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A) correct with respect to Statements 1 and 2, but incorrect with respect to Statement 3.
B) correct with respect to Statements 1, 2, and 3.

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C) correct with respect to Statement 2, but incorrect with respect to Statements 1 and 3.

Question #18 of 164
Which of the following statements regarding foundations is CORRECT?

A) An operating foundation is generally funded to support a variety of social causes over
time.
B) Independent foundations provide grants to charities, educational institutions, and social
organizations.
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C) A community foundation is dedicated solely to support a speci c organization or some
on-going research initiative.

Bob Monarch, CFA, has been managing portfolios for individuals for about 10 years. It started
out as a second job, but about 5 years ago he left his full-time position to manage the portfolios
as his sole occupation. His clients are largely retired or persons near retirement who would be
considered to be conservative investors.
In the last two years, Monarch has been sending out resumes to institutional investment rms
of various types in the hopes of becoming a full-time manager of a single fund. Recently, he has

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been invited to two interviews for the position of portfolio manager. The rst interview he

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schedules is with an investment company for a position as manager of their mid-cap growth
equity mutual fund.

Monarch's second interview will be with Starling College (Starling) for the position of
endowment manager. The endowment fund has been highly correlated with the S&P 500 in

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growth and income, but with a beta of about 0.6. The endowment follows a "socially conscious"
investment policy. The current spending rate is set at 3% annually, the minimum needed to
support Starling's operating budget. This is unlikely to change. To provide for real growth of the
principal, the fund's moderately aggressive return target is also unlikely to be altered.

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Both the mutual fund and the endowment have assets in the tens-of-millions of dollars, and

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each is o ering a roughly equivalent salary and bene ts package. Consequently, Monarch feels
he would be happy with either position. As he prepares for his interviews, he compares the

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portfolio management approach he currently employs to what would be appropriate in either
of the two prospective positions. He creates the following template and begins to summarize

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his thoughts:

Current Clients vs. Investment Co. & Endowment Fund

Return Objective

Investment Company

Endowment Fund

Higher

Higher

Risk Objective
Time Horizon
Taxes
Liquidity
Legal & Regulatory
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Unique Constraints

Focus on Single Asset
Class

Socially Conscious

After work that evening, Monarch calls Antonia Linn, a friend who is an emerging markets debt
analyst for a large investment bank. He wants her advice on the two positions he is considering,
and hopes she can give him some helpful interviewing tips. During the course of their

discussion, Linn asks Monarch to distinguish between endowments and foundations. They
disagree on the issues of taxation and the allowable functions foundations and endowments
may undertake.
Monarch states that "while both are considered tax-exempt entities, endowments are generally

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organized to provide ongoing budgetary support for the operations of a speci c entity, such as
a university or some other charity. Foundations are typically formed for grant-making purposes,

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but can also be created to provide perpetual support for a speci c charitable organization."
Linn responds: "Well, I know that's not my eld, but as I understand it, foundations are taxable
while endowments are not. In addition, I think that foundations can make grants, but can't be

interviews."

Question #19 of 164

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set up to provide permanent support. You'd better be sure to know the distinctions before your

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Compared to the risk tolerance of Monarch's current clients, the risk tolerance of the

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investment company and endowment fund would be:

A) less

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Investment Co.

more

B) more

less

C) more

more

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Endowment Fund

Question #20 of 164

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Compared to the average time horizon of his current clients, the time horizon of the investment
company and endowment fund will be:

Investment Co.

Endowment Fund

shorter

B) longer

longer

C) shorter

longer

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A) shorter

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Question #21 of 164

Which of these situations (the investment company or the endowment fund), would have the

A) There is no clear answer.
B) The investment company.

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C) The endowment fund.

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fewest tax considerations?

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Question #22 of 164

Which of these situations (the investment company or the endowment), would require the most

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attention to generating a positive alpha?

A) The endowment.
B) There is no clear answer.
C) The investment company.

Question #23 of 164
With respect to the statements made by Monarch and Linn comparing foundations and
endowments:
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A) Monarch is incorrect about taxes and incorrect about functions; Linn is correct about
taxes and correct about functions.
B) Monarch is incorrect about taxes and correct about functions; Linn is correct about
taxes and incorrect about functions.
C) Monarch is correct about taxes and correct about functions; Linn is incorrect about
taxes and incorrect about functions.

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Question #24 of 164
Monarch thinks he might be questioned about the predictive power of an investment

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manager's past performance. Which of the following factors is least likely to help when
projecting how well a manager will do in the future is:

A) what time frame was used to measure performance.

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B) whether the performance was evaluated relative to a style benchmark.

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C) the manager’s nominal return.

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Question #25 of 164

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Which of the following is the most appropriate return objective for a private foundation that
has been established to provide support in perpetuity?

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A) The long-term treasury bond return plus in ation.
B) The market return plus expected in ation.
C) 5.3% of assets plus expected in ation.

Erica Turner is a trustee of the Silas M.Turner Foundation (hereafter referred to as the
"Foundation"), which was established by her grandfather more than fty years ago. The family
foundation provides scholarships to Mississippi high school graduates that have excelled
academically and desire to attend Newsome College, Silas Turner's alma mater.

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The Foundation has eight trustees who are responsible for all administrative, investment
management, and scholarship decisions. All of the trustees are descendants of Silas Turner.
They vary from twenty-seven to eight-nine years in age and have a variety of professional
backgrounds. Once each spring, the group convenes to review the Foundation's investment
performance and award scholarships for the upcoming school year. During the interim, one of
the trustees is appointed to review quarterly performance, receive scholarship applications,
and call ad hoc meetings via teleconference should the need arise. As a whole, the trustees are
a congenial group, but their discussions can become spirited when investment strategies are
considered. Despite some widely divergent opinions, the consensus has been to maintain a
conservative a risk posture in the context of meeting the Foundation's return goals.

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The foundation has assets of $4 million. To carry on in the tradition of Silas Turner, the trustees
want to ensure that at least 10 tuition scholarships are o ered annually while maintaining the

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in ation-adjusted value of the principal. Tuition at Newsome College will be $18,000 next year,
and is anticipated to increase at an annual rate of 4% over the long-term. In ation is expected
to be 2% for the foreseeable future.

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This year the trustees have decided to update the Foundation's investment policy statement
(IPS). Because Turner is an investment professional, she has been asked by the other trustees
to comment on the following proposed risk and return alternatives.

C

D

Outperform S&P 500
by 1%.

11.0%

9.3%

7.5%

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Risk Tolerance

B

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Return
Requirement

A

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Proposed IPS

High

Moderate to
Low to
Moderate
High
Moderate

Before making a recommendation, Turner asks the trustees to consider an allocation to

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international stocks, saying that "The risk and return characteristics of international stocks, as
well as their relatively low correlation with the U.S. market, makes them attractive for

diversi cation. In addition, there is a whole new set of good companies in which to invest. Now
is an opportune time to invest internationally because transaction costs have come down so
much."
Arthur Davenport, the elder of the trustees retorts "I've been around long enough to see
international stocks go down and stay down for years. Besides, most of the big U.S. rms are
global now, so we already have international industry exposure whether we want it or not. And
all markets seem to tank at the same time these days. Furthermore, I don't trust their
accounting. I say we should stick with the asset classes we are already using."
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The group debates Turner's and Davenport's points for some time. They nally opt to continue
to use the same asset classes already in the portfolio. The current asset allocation of the Turner
Endowment is shown below:

Asset Allocation
Expected
Return

Expected Standard
Deviation

Treasury bills (Tbills)

15%

2%

0%

Intermediate
bonds

30%

4%

8%

Long-term
bonds

15%

7%

High yield bonds

5%

Large cap stocks
Small cap stocks

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Current
Allocation

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13%

17%

20%

12%

25%

15%

14%

30%

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9%

100%

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Question #26 of 164

A) IPS B.
B) IPS C.

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C) IPS D.

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the Foundation?

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Which of the proposed investment policies should Turner recommend as most appropriate for

Question #27 of 164
The trustees have decided to target a return objective of 9.5%. Given this objective, the most

appropriate allocation to Treasury bills and large cap equities is likely to be:

A) lower for T-bills; the same for large cap stocks.
B) lower for T-bills; higher for large cap stocks.
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C) the same for T-bills; higher for large cap stocks.

Question #28 of 164
Based on a 9.5% return objective, the most appropriate allocation to high yield bonds and small
cap equities is likely to be:

A) lower for high yield bonds; higher for small cap stocks.
B) initially lower for both high yield bonds and small cap stocks and then increased as the

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endowment increases in value since it will be able to take on more risk at that time.

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Question #29 of 164

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C) the same or higher for high yield bonds; the same for small cap stocks.

Based on a 9.5% return objective, the most appropriate revision to the Foundation's

intermediate and long-term bond allocation is:

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A) the same for intermediate-term bonds; higher for long-term bonds.

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B) no change for either intermediate or long-term bonds.

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C) lower for intermediate-term bonds; higher for long-term bonds.

Question #30 of 164
With regard to Turner and Davenport's comments about the value of international investing:

A) Turner is incorrect; Davenport is incorrect.
B) Turner is correct; Davenport is correct.
C) Turner is correct; Davenport is incorrect.

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Question #31 of 164
The trustees want Turner to look at suitable hedge funds. The best alternative for Turner to
consider would be a:

A) fund of funds hedge fund.
B) macro hedge fund.
C) fundamental long-short hedge fund.

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Question #32 of 164

Which of the following objectives and/or constraints would be found in an investment policy
statement (IPS) for a private foundation but NOT necessarily for an endowment?

B) Total return approach.

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A) Set spending rates.

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C) Moderate to high risk tolerance.

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Question #33 of 164

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Dr. Jack Wolfe, a nance professor with the University of Tulsa asked his students to identify
di erences between a pension fund and a growth mutual fund. Kelly Musch, a student in

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Wolfe's class, turned in a paper with two statements:

Statement
1:

The pension fund is likely to have more exibility to
signi cantly change its asset allocation.

Statement
2:

The pension fund could invest in the mutual fund, but the
mutual fund could not invest in the pension fund.

When grading Musch's paper, Dr. Wolfe should:

A) agree with Statement 1 and Statement 2.
B) disagree with Statement 1, but agree with Statement 2.
C) disagree with Statement 1 and Statement 2.

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Question #34 of 164
Which of the following de ned bene t pension plans has the greatest ability to accept risk?

Sponsor's
debt ratio

Sponsor's
pro tability

A

young

high

high

low

B

young

high

low

high

C

older

high

low

high

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A) Plan B.

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Plan

Age of
workforce

Ratio of active
to retired
participants

B) Plan A.

Question #35 of 164

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C) Plan C.

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Pension fund risk tolerance increases with:

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A) high plan asset and plan sponsor operating characteristic correlation.

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B) a low retired lives portion.

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C) provisions for early retirement or lump-sum payouts.

Question #36 of 164
Which of the following would be included in an investment policy statement (IPS) for a de ned
contribution plan?

A) Risk objectives.
B) A description of the investment alternatives available to plan participants.
C) Time horizon.

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Question #37 of 164
Asset-liability management (or surplus management) is the primary consideration in
formulating an investment policy and asset allocation for a(n):

A) de ned bene t pension plan.
B) endowment.

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C) de ned contribution pension plan.

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Question #38 of 164

The discount rate used to determine the present value of pension liabilities is the fund's:

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A) contribution return.
B) required return.

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C) desired return.

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Question #39 of 164

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Which of the following statements concerning the liability structures of life insurance
companies and nonlife insurance companies is CORRECT? For:

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A) nonlife insurance companies the amount of the liability is known, but the timing of the
liability is not known.
B) life insurance companies the amount of the liability is known, but the timing of the
liability is not known.
C) life insurance companies the amount of the liability is not known, and the timing of the
liability is not known.

Question #40 of 164
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From the perspective of the employer, which of the following statements is most accurate? A
de ned:

A) bene t plan can be underfunded; a de ned contribution plan is less risky.
B) contribution plan can be underfunded; a de ned bene t plan is more risky.
C) bene t plan can be underfunded; a de ned contribution plan is more risky.

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Question #41 of 164
Jim Findlay is the Founder and CEO of Impact Products. Findlay takes great pride in having his

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rm be on the leading edge of providing bene ts to employees. Every year, Findlay sits down
with his two senior executives, Je Beery and Tom Harbal to discuss various employee bene t
plans. This year's focus is on employee stock ownership plans (ESOPs) and cash balance plans.
With regard to ESOPs, Beery states, "In addition to the bene ts to employees, an ESOP would

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be a useful way for you as owner of the company, Mr. Findlay, to liquidate a large block of your
Impact Product holdings." After further discussion, they move on to discussing cash balance
plans. Harbal reports, "Unlike regular pension plans, cash balance plans can never be under
funded because the cash balance re ects the actual amount put away for employees." With

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regard to their statements about ESOPs and cash balance plans:

A) Beery’s statement is correct; Harbal’s statement is incorrect.

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B) Beery’s statement is incorrect; Harbal’s statement is incorrect.

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C) Beery’s statement is correct; Harbal’s statement is correct.

Ed Simon, CFA, has been assigned the arduous task of assessing the slight nuances concerning
the investment objectives and constraints for foundations and endowments. Simon's
supervisor has requested a full report on these di erences and how they a ect the investment
policy statements.

Question #42 of 164
Simon thought it best to rst look at di erences in return objectives between foundations and
endowments. Which of the following best indicates di erences between the return objectives
of foundations and of endowments?
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A) Endowment returns usually are dictated by a rule-of-thumb of "5.3% + in ation,"
whereas foundation return objectives are dictated by spending rules.
B) Foundation return objectives depend on the time horizon of the foundation, whereas
endowment return objectives are to provide a permanent base of funding.
C) Foundation return objectives are to provide a permanent base of funding whereas
endowment return objectives depend on the time horizon of the endowment.

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Question #43 of 164

Simon next turned his attention to the di erences in risk objectives between foundation and

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endowment investment policy statements. Which of the following best describes the main
di erence between foundation and endowment risk objectives?

A) Endowment risk tolerance is not dictated by the relationship between the current

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income requirement and maintenance of purchasing power, whereas this is a crucial
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B) Foundation risk tolerance is dependent on the time horizon of the foundation, whereas
endowment risk tolerance is dependent on the importance of the endowment fund in
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C) Foundation risk tolerance is dependent on the importance of foundation funds in the
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d

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h

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sponsor's overall budget picture, while endowment risk tolerance is dependent on the

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Question #44 of 164
Foundations and endowments often have di erential liquidity constraints. Simon found which
of the following to be a di erence between the liquidity constraints of a foundation and an
endowment?

A) An endowment's spending rule will have less of an e ect on liquidity requirements than
a foundation's liquidity requirement due to a minimum spending rate.
B) Endowments are required to have a minimum spending rate whereas private
foundations rarely have minimum spending rates.
C) Private foundations are required to have a minimum spending rate whereas
endowments rarely have minimum spending rates.
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Question #45 of 164
Simon discovered tax laws seem to di erentially impact foundations and endowments. Which
of the following most accurately depicts the di erential tax treatment between foundations and
endowments?

A) Endowment investment income is taxable, whereas private foundation investment
income is not.
B) Operating foundation investment income is taxable, whereas endowment investment

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income is not.

C) Private foundation investment income is taxable, whereas endowment investment

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Question #46 of 164

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income is not.

Which of the descriptions in the table below most accurately describes the liquidity
requirements for life and non-life insurance companies?

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Liquidity Requirements for Insurance Companies

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Life Insurance Companies

Fixed income
segment

Description

Fixed income
segment

Surplus
segment

Relatively high

Very low

Relatively high

Very low

II

Relatively low

Moderate

Relatively low

Very low

III

Relatively high

Very low

Relatively high

Relatively
high

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Surplus
segment

Non-life insurance
Companies

A) Description II.
B) Description III.
C) Description I.

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Question #47 of 164
Which of the following are characteristics of public foundations' and endowments' liquidity
needs, respectively?

A) Varies; low.
B) Moderate; moderate.
C) Low; varies.

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Question #48 of 164

A) The rm's declining growth rate.

C) Pension surplus.

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Question #49 of 164

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B) A declining debt/equity ratio.

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Which of the following could dictate that a pension fund take on less risk?

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Banks tend to use their investment portfolios for all of the following objectives EXCEPT:

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A) providing liquidity.

B) decreasing credit exposure.

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C) creating o balance sheet opportunities.

Question #50 of 164
Which of the following is NOT a characteristic of employee stock ownership plans (ESOP)?

A) ESOPs typically allow employees to purchase company stock at a discount from the
current market price.
B) The regulation of ESOPs can vary widely across countries.
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C) An ESOP is typically funded by a company issuing new stock speci cally to fund the
ESOP.

Helen Smith, CFA, has been assigned the portfolio management responsibilities for her rm's
rst institutional investor, Branch Industries De ned Bene t Pension Plan (hereafter referred to
as the "Plan"). To date, Smith's rm has managed money only for high net worth individuals. In
addition to her portfolio management duties, Smith has been delegated the task of formulating
the investment policy statement (IPS) for the Plan.
Branch Industries manufactures tiny transformers and circuitry used in small electrical

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appliances, and components for cars and trucks. Silver is a small, but critical, input to the

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production process, and Branch uses a reliable supplier. Branch's sales have grown steadily for
the past three years despite a rather tepid economic recovery fostered by modest tax cuts and
aggressive expansion of the money supply. It appears likely that Federal Reserve policy will
remain accommodative, with continued low interest rates. Therefore Branch's ve-year sales

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forecast is very optimistic. Branch's pro t margins are projected to be in line with its
competitors, but the rm is carrying signi cantly more debt in its capital structure than
comparable companies.

Smith has determined the following about the Plan:

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high.

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The average employee age is 45.5 years, and the active-to-retired participant ratio is

The Plan should be considered ongoing, and it has a moderate surplus.

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Employees are eligible for retirement at age 62. There are no provisions for lump-sum
distributions or early retirement.

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The discount rate for the projected bene t obligation (PBO) is 10%.
The expected return on plan assets is 10 percent.

Smith decides she needs to review the terminology, accounting, and other factors a ecting the
Plan's funding status. Below is her brief synopsis of relevant terms:
Exhibit A: Pension Terminology

De nition

PBO

Present value of future bene ts earned to
date. Assumes plan termination.

ABO

Present value of projected future bene ts.
Assumes ongoing plan.

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Net Pension Cost

Income statement expense to be recognized
for a speci c year.

Funded (Surplus) Status

Market value of plan assets less the present
value of future liabilities.

Smith recalls that the Pension Committee wishes to minimize the volatility of future
contributions. They also expressed concern that the discount rate and expected return on plan
assets might need modi cation. She decides to explore these issues further before nishing the
IPS or developing an asset allocation recommendation for the portfolio.

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Question #51 of 164

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Which of the following best explains two constraints that di er between individuals and
pension funds and the way they di er?

A) Legal and time horizon considerations: pensions must follow the Employee Retirement
Income Security Act (ERISA) whereas individuals can usually invest as they please;

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B) Liquidity and time horizon considerations: pensions always have a greater need for
liquidity than individual investors; pensions have in nite lives whereas individuals do
C) Legal and tax considerations: pensions must follow the Employee Retirement Income
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Security Act (ERISA) whereas individuals can usually invest as they please; pensions are

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Question #52 of 164
Regarding the pension terminology in Exhibit A, the de nition of:

A) ABO is correct; PBO is correct; funded status is incorrect.
B) ABO is incorrect; PBO is incorrect; funded status is correct.
C) ABO is incorrect; PBO is correct; funded status is correct.

Question #53 of 164
Future pension contributions required will be directly a ected by:
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A) the expected return on existing plan assets and pension default expectations.
B) the expected return on existing plan assets and and pension expense requirements.
C) prior expected return estimates and pension expense requirements.

Question #54 of 164
Considering the characteristics of Branch Industries and the Plan, which of the following

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statements best describes the ability of the pension plan to take risk?

B) Below average ability to take risk.

Question #55 of 164

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C) Average ability to take risk.

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A) Above-average ability to take risk.

Which of the following factors should NOT a ect a pension plan's ability and/or willingness to

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A) Plan surplus.

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take risk?

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B) Portfolio manager's investment style.

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C) Workforce characteristics.

Question #56 of 164
To maximize the sponsor's ability to make pension contributions and meet the Pension
Committee's desire to manage contribution volatility, Smith should give the most consideration
to the correlation between the sponsor's:

A) operating pro tability and Plan termination potential.
B) net income and the Plan’s ABO.
C) operating pro tability and Plan asset returns.
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