PSC-TDA Flashcards
How does purchasing insurance help smooth consumption?
A contingent claim provides a payout to preserve lifetime wealth when an unexpected loss occurs.
Which one of the following is a good benchmark to estimate the expected rate of return of a safe asset?
The yields on TIPS
Financial theory usually assumes people are _______________ and expect a reward for taking risk.
Risk averse
Is volatile compensation important to consider as part of investment planning?
Yes, volatility in income constitutes a risk in investment planning.
The two factors associated with higher-than-expected future stock performance are
low volatility and less trading frequency.
Which approach would a pension plan use if it is interested in eliminating the interest rate risk associated with its investment portfolio?
Immunization
Investment A has a return of 6 percent and a standard deviation of 10 percent. The risk-free rate is 3 percent. The Sharpe Ratio for Investment A is ___________.
The Sharpe Ratio is .06 – .03, divided by the standard deviation of 0.10. The final calculation is 0.03/0.10 = 0.3.
The event study is an example of a research technique used to test whether
Markets respond quickly to new information.
By law, the primary goals of monetary and fiscal policy are
Full employment and price stability.
In an efficient market, the investment portfolio that provides the highest expected Sharpe Ratio is
The market portfolio.
After the price of her company’s stock falls, a CEO attributes the drop to a decline in the overall stock market. If the CEO is correct that the stock price is strongly related to changes in the market, she is implying that
The R-squared of the stock with respect to the market is high.
As an asset class, the performance of human capital is most similar to that of a
Bond.
If an investor’s nominal return is 5 percent and the inflation rate is 2 percent, the investor’s real rate of return is
The correct calculation is ((1+.05)/(1+.02))–1 = 0.0294, or 2.94 percent.
Client A has $700,000 saved in a traditional IRA and $300,000 in a Roth IRA. Client B has $500,000 saved in a traditional IRA and $500,000 in a Roth IRA. Which retiree can meet a higher spending goal with their current savings assuming they own the same investments?
Since Client B has the same retirement savings balance as Client A but has a larger share of that balance in Roth savings, Client B will be able to spend more after-tax dollars in retirement.
Each of the following municipal bonds provides a yield of 3.5 percent for 10 years. Which will have the highest price?
A New York general obligation bond
The sale of a life insurance policy in a life settlement
Could provide the advantage of some of the gain on the policy being taxed at long-term capital gains rates.
An investment advisor increases the duration of a bond portfolio. One implication of this decision is that
The bond portfolio will be more sensitive to changes in interest rates.
During periods of rapidly rising interest rates, such as the early 1960s to the mid-1980s, which of the following has historically experienced the worst performance?
Long-term bond funds
Which of the following defines the term “mortality credits”?
The risk pooling aspect of an income annuity in which those who live long have part of their income subsidized by those who died earlier
Which of the following items related to real estate can serve as a leading economic indicator?
Commercial vacancy rates
The selection of a benchmark index should be based on the index being
As similar as possible to the portfolio being evaluated.
A trend analysis can best be used to
Calculate growth in revenue over time.
An appropriate characterization of business tax treatment would be
Corporations are taxed on corporate income, and shareholders are taxed on dividends received.
A wealth management client is considering a charitable donation. She wishes to retain some cash flow after making the contribution of property. The client is reluctant to deal with significant fees or complexities. An appropriate charitable donation for this client would be a
Charitable gift annuity.
Rick is very wealthy but lives a low-profile life. He gives generously but always anonymously. He has highly appreciated publicly traded stock. He wants to establish a giving tradition that goes on for generations. Which fact as stated above would lead you to rule out a private foundation for Rick?
He wants to be private about his giving.
A wealth management professional can assist in the implementation and administration of a private foundation by
Assisting the trustee in forming an investment policy statement for the investment of the private foundation’s assets.
An appropriate first step to providing a client with a beneficiary designation audit is to
Perform a fact finding to identify the client’s assets and how they are currently transferred.
A typical revocable living trust
Is required to tax the grantor on income earned by the trust even if distributions are made to third-party beneficiaries.
Which one of the following statements correctly describes marginal utility?
The satisfaction received from an additional unit of consumption
What pooling technique can reduce the risk of dying early in the life cycle and not meeting a bequest goal?
Life insurance
News of an unexpected inheritance will most likely result in which of the following?
An increase in permanent income and a reduction in the savings needed before retirement
A typical utility curve is
Concave based on a decreasing marginal utility of consumption.
Which of the following is a market risk to the value of human capital?
Working in an occupation whose profits are closely tied to interest rates
The primary purpose of a contingent claim is to
Protect total wealth against a random loss.
A year of tuition costs $10,000 today. We save $10,000 today to fund tuition in 5 years. After 5 years, our investment has grown to $15,000. A year of tuition now costs $17,000.
The tuition investment has experienced a negative real return.
When a client has less flexibility to adjust spending, the client’s portfolio should be
Less in risky assets and more in safe assets
An investor’s preference for certainty implies that
The investor needs a reward for taking risk.
How much would a client pay for a risky investment with a 50 percent probability of it being worth $3,000 and 50 percent probability of it being worth $8,000 in one year assuming a natural log utility function?
This means the value of the risky investment is based on its expected utility, not its expected value. [0.5 x (3,000)] + [0.5 x (8,000)] ≈ 8.4967822. Then calculate 8.4967822, which gives you $4,898.9
A risk-tolerant investor
Is willing to consider a more uncertain investment payout, all other things being equal.
The three elements of a financial goal are
Goal amount, time horizon, and goal flexibility.
Life-cycle planning is best described as providing
A model to smooth spending over time by addressing spending and income risks.
An investor hopes to reach a specific goal of $200,000 by saving $2,000 per month. How does investment risk affect this goal?
The amount of risk taken could either shorten or lengthen the time needed to meet this goal.
How does purchasing insurance help smooth consumption?
A contingent claim provides a payout to preserve lifetime wealth when an unexpected loss occurs.
An investor purchases an asset for $100. If the investor sells the asset for $200 and also receives a $2 dividend prior to the sale, the holding period return for this asset is
(sale price – purchase price + dividend)/(purchase price). 102 Percent
Assets A and B have a covariance of 2 percent. The standard deviation of Asset A is 15 percent, and the standard deviation of Asset B is 20 percent. What is the correlation coefficient of A and B?
.2*.15 = .03. 0.02/0.03 = 0.667.
An investor holds two assets, Asset X and Asset Y. In most years, when the return on Asset X is below its mean return, the return on Asset Y is also below its mean return. It is likely that assets X and Y have a
If Asset X and Asset Y both tend to have a return above or below (as in this case) their mean returns during the same year, they have a positive covariance.
Expected return is best described as
The average, or central tendency, return.
A stock researcher can predict an increase in the price of a stock by obtaining a nonpublic earnings report, but not by obtaining publicly available information. The researcher is taking advantage of a market that is only
Semi-strong form efficient.
Risk-free Asset A has a payout of $105 in one year. Asset B has an expected stochastic payout in one year of $105. The price of Asset B will be
Since the return on Asset B is stochastic, or uncertain, the price an investor is willing to pay is lower than the price of a risk-free asset whose payout is the same as the expected payout of the risky asset. “Lower than Asset A”
Two assets have a correlation coefficient of zero. The expected rate of return of Asset A is 9 percent, and the expected rate of return of Asset B is 5 percent. The standard deviation of Asset A is 20 percent, and the standard deviation of Asset B is 8 percent. The investor holds half of his or her portfolio in Asset A and half in Asset B. Which one of the following is true?
A portfolio’s efficiency is always improved by combining financial assets that are not perfectly correlated. The return on the portfolio of two assets is equal to the weight of each asset, in this case 50 percent, multiplied by the return. 0.59 percent + 0.55 percent = 7 percent.
The “Markowitz bullet,” or efficient frontier, illustrates which of the following?
The combinations of assets that provide the highest return for each level of risk
Bill has invested 25 percent of his portfolio in his employer’s stock. This subjects Bill to a significant amount of what type of risk?
Idiosyncratic risk
The market return is 8.2 percent, and the risk-free rate is 3.5 percent. An asset with a beta of 1.2 achieves a return of 9.7 percent. What part of the return is alpha?
The expected return according to CAPM was 3.5 percent + 1.2*(8.2 percent – 3.5 percent) = 9.14 percent. The alpha is the difference between the asset return of 9.7 percent – 9.14 percent = 0.56 percent.
What is the appropriate relationship between Social Security benefits and a person’s overall portfolio?
A financial planner should include the estimated present value of Social Security benefits as part of a client’s overall portfolio.
The Fama-French 3-factor model includes which of the following investment factors?
Size, value, and beta
The broadest measure of inflation is the
Consumer Price Index for All Urban Consumers, or CPI-U
Liability-driven investing (LDI) differs from other forms of investment management because it incorporates strategies that
Account for future payouts in determining portfolio allocation.
Re balancing is a technique primarily concerned with
Risk management.
The risk associated with the unexpected loss of human capital is
Mortality risk
The clients who receive the largest benefit from tax sheltering are
Investors with a higher marginal tax rate receive larger benefits from tax sheltering.
Asset location can best be described as
Positioning assets among accounts in order to maximize net return
The U.S. stock and bond markets currently make up approximately what percentage of their respective total global market capitalizations?
40 percent
Historical returns for cash, bonds, and stocks indicate that
Returns are consistent with modern portfolio theory.
An investment advisor tells a client to be patient after the value of her stocks has fallen in the middle of a recession because the market will eventually recover. The advisor is likely basing this recommendation on the phenomenon of
Equity mean reversion.
If the index of leading indicators is rising, the index of coincident indicators is flat, and the index of lagging indicators is falling, then the business cycle is most likely in which phase?
Trough
You are asked to consider lending to a company that is willing to pay 10 percent on new loans. In doing due diligence, you ask why the company instead did not seek capital from a financial institution that specializes in obtaining financing for companies. This type of lender is known as a(n)
An investment bank specializes in helping companies find private lenders and is likely more skilled than individual investors at evaluating a firm’s ability to repay the investment.
If interest rates rise after a bond is issued at par, the bond will most likely
Sell at a discount.
A 10-year maturity, $1,000 par value bond is issued in the primary market at the par of $1,000. The bond has a 3 percent coupon paid semiannually. How much will the price change if interest rates immediately rise to 6 percent?
The coupon payment is paid twice a year, so there are 20 payments of $15 each. Since the bondholder receives two $15 coupons per year (0.03*1,000)/2, the payment is $15. There are 20 periods; the new interest rate is 6 percent/2, or 3 percent, per period; and the future value remains $1,000. The present value is $776.84, making the difference –$223.16.
A corporation has its credit rating changed from B to Ba. What impact will this change likely have on the current yield of the bond?
The current yield is the annual bond coupon payment, which does not change, divided by the price of the bond. Since a move from B to Ba suggests that the likelihood of default has decreased, the price of the bond will increase and the current yield will fall
A ranking of Treasury securities in order of initial maturity from shortest to longest would be
Bills, bonds, notes
An advantage of owning individual bonds rather than bond funds is the
Control over the timing of coupon payments
Cash is most useful for which type of financial goal?
Short term and inflexible
A corporation issues a $1 dividend, has 20 million shares outstanding, and a stock price of $25 per share. The company earned $100 million in profits. The dividend payout ratio is
The dividend payout ratio is the percentage of profits distributed to investors as dividends. The company paid $1 * 20 million in dividends, or $20 million. It earned $100 million in profits. The dividend payout ratio is $20 million/$100 million, or 0.20.
An investor holding a large position in an emerging market stock finds that it will be difficult to sell this position at the current price because there are not enough buyers to absorb the large number of shares. This is an example of _______ risk.
Liquidity risk
One of the most common reasons for a firm going public is
A common reason for going public is so the founder can trade equity for cash that can be invested in a more diversified portfolio.
Most individual investors purchase financial securities through the
Secondary market
An investor who is a member of a dividend clientele is most likely applying which one of the following behavioral phenomena to the concept of income from stocks?
Framing
For which of the following stocks is it most appropriate to use a dividend discount model to assess a fair price today?
A company with stable earnings and a sticky dividend, but modest prospects for growth
The super sector that tends to have the lowest beta is
Defensive stocks tend not to drop as much in value during a recession, resulting in a lower beta.
Which of the following is a characteristic of a real estate investment trust?
At least 75 percent of income must come from rents, interest from mortgages, or other real estate investments.
An investor sells 1,000 shares of a mutual fund at 10 a.m. on Tuesday. Her proceeds from the sale are calculated based on the net asset value of the 1,000 shares at the
Close of the market on Tuesday.
Socially responsible funds might be considered for a portfolio because they provide
A warm-glow effect.
The primary difference between indices that are value weighted and those that are equal weighted is
The market portfolio is, in theory, a value-weighted portfolio. Value weighting gives greater exposure to large cap securities, and equal weighting gives greater exposure to small cap securities.
Which of the following types of investments may be more appropriate when held within a unit investment trust (UIT) rather than a mutual fund?
Illiquid investments
A measure that suggests there are many investors who believe that a stock is overpriced is
The short sale interest.
A wealthy client couple is considering the purchase of a real estate investment using 5% of their portfolio. The investment property will be overseen by a management company. Which of the following risks related to investment real estate is most important to consider for this client?
While investment property represents an idiosyncratic risk to a portfolio, for wealthy clients with adequate liquidity who are investing only 5% of their portfolio in an investment property, the primary risk is the liability risk associated with a potential lawsuit.
Owning property that represents a significant percentage of a client’s wealth is an example of a(n) _______ risk exposure.
Idiosyncratic risk
The credited interest rate on a fixed indexed annuity is determined based on the change in a stock index
Without the impact of dividends and with a floor of 0 percent
Permanent life insurance has a larger premium than term life insurance because
Permanent life insurance builds up funds to help offset the cost of insurance in the later years of the policy.
Which of the following statements concerning the use of the cash surrender value of a life insurance contract is correct?
Policy loans from cash value can generally be taken without federal income tax consequences.
A benefit of purchasing an annuity compared with putting money into a retirement plan like a 401(k) or 403(b) is that
There are no limits to deposits into an annuity but there are deposit limits in the other plans.
Client A is completing medical school and is self-employed as a medical technician making $80,000 per year. Client B is an older doctor with an income well above the taxable wage base. How much higher are Client A’s marginal self-employment contributions for each dollar of earned income than Client B’s?
Since Client A is self-employed, he pays 15.3 percent of his income as a Social Security contribution.
Sarah claimed her Social Security benefits in 2017 at age 62, when the earnings test limit was $16,920. She was entitled to receive $1,000 a month. However, Sarah was still working and had earnings of $22,920 in 2017. Due to the earnings test, her benefits will be reduced by
Because she claimed benefits while still working and before her full retirement age, Sarah is subject to the earnings test. For each $2 she earns over the threshold, she is subject to a $1 reduction in her Social Security benefits. The earnings test threshold for 2017 was $16,920. Since she is $6,000 over the threshold, she is subject to a $3,000 reduction in benefits.
The alternative minimum tax (AMT) is best described as
A separate tax system parallel to the regular income tax system.
An important distinction between the federal gift tax and federal estate tax is
Tuition payments made directly to an educational institution on behalf of another individual are not subject to gift tax but are subject to estate tax.
An advisor is transitioning a $1 million taxable account with a $750,000 cost basis to a new target asset allocation. The client is single and 60 years old. She has adjusted gross income (AGI) of $250,000. Which of the following tax thresholds would be the most likely to apply to her situation?
The estimated taxable gain is $250,000. Along with the projected $250,000 in AGI, the client’s personal exemption could be fully phased out at some point.
A traditional IRA contribution is most appropriate for
The traditional IRA contribution is most appropriate for the 68-year-old investor who meets the age requirement (younger than 70 ½), the taxable compensation requirement, and the modest income eligibility requirements, which are designed to limit IRAs for middle-income investors.
A reason for an investor to contribute to a Roth IRA over a traditional IRA is if
If a client doesn’t have any Roth balances, a Roth IRA contribution would make sense because it would give the investor tax diversification
An investor is considering a Roth conversion and paying the taxes from a taxable account. Her combined marginal tax rate is 30 percent. She projects out that in 10 years she will likely pay the same tax rate on distribution that she would on the conversion. Which of the following actions should she take?
She should do the conversion; the Roth will outperform
529 college savings plans are ideal for education funding because
Monies contributed to the account grow tax free and are distributed tax free as long as the funds are used for qualified educational purposes.
Which of the following statements accurately describes the difference between qualified and nonqualified deferred compensation plans?
An unlimited amount of compensation may be deferred under a nonqualified deferred compensation plan.
A heuristic is
A simple rule or shortcut that allows for quick decision making.
