Chapter 22 – Investors and The Investment Process
CHAPTER 22
INVESTORS AND THE INVESTMENT PROCESS
1. The investment objectives of the Masons should be expressed in terms of return and
risk. These return and risk preferences should be portrayed in terms of the Mason’s
preferences, their current financial status, and the stage in their life cycle.
Investment Objectives
Return Requirement: Dr. Mason is nearing retirement. Therefore, the overriding
taxes), the Masons will have a large enough financial base to pursue their other
objectives, specifically, for the grandchildren and for scholarships to the Essex
Institute. These latter two objectives suggest a portfolio seeking long-term capital
appreciation. Therefore, the substantial size of the assets permits a growth-oriented
posture with a secondary emphasis on current income. Common stocks and equity real
greater risk in the pursuit of higher long-term capital appreciation. A significant
portion of the Masons’ assets can be invested in growth assets, such as common stocks
and real estate, with secondary emphasis on investments with a high current income
yield. The greater the amount of royalties received, the greater the risk-tolerance for
the portfolio.
Time Horizon: Because the Masons are in the later part of their life cycle, one would
ordinarily expect them to have a relatively short time horizon. The size of the Masons’
assets, however, and the objectives of providing for the education of their
grandchildren and for scholarships, dictate that a substantial portion of the portfolio be
invested for the longer term. Common stocks and real estate would be appropriate.
Chapter 22 – Investors and The Investment Process
Tax Considerations: The income from royalties and investments will require that the
portfolio be structured for favorable tax treatment. Long-term growth assets, which enjoy
deferral of gains until the sale of the assets, are suitable. Real estate, in the form of rental
property, provides tax deductions that might also be desirable, and rental income would
income. This policy will provide the opportunity to achieve the objectives of educating
the grandchildren and funding the scholarships to the Essex Institute, while providing
enough retirement income. Growth assets should also be a better inflation hedge. Real
estate, tax-exempt bonds, and low-risk money market investments would provide the
necessary diversification.
2.
a. Mature pension fund:
I nvestment Objectives
Return requirement: Return must exceed the fund’s actuarially assumed rate of
return based in part on the anticipated 5% rate for wage cost increases.
b. Conservative endowment fund:
Investment Objectives
Return requirement: Return must meet or exceed 5% spending rate with 3%
inflation rate. Return can be from income or capital gains but budget
requirements would place the emphasis on income. Inflation considerations
require some consideration of long-term growth.
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Chapter 22 – Investors and The Investment Process
Risk tolerance: With a 8.15% (1.05 1.03 – 1 = .0815) return objective,
moderate level of risk tolerance may be required but the certainty of return will
c. Life insurance company specializing in annuities:
Investment Objectives
Return requirement: Return should exceed new money rate by sufficient
margin to meet expenses and profit objectives. Lower minimum accumulation
rate tempers return objective.
Risk tolerance: With a 7% new money return objective, moderate level of risk
tolerance may be required, but certainty of return and avoidance of
reinvestment rate risk virtually mandates the use of an immunized fixed
Tax considerations: A minor factor because competition will require a high
rate of return, most of which will accumulate for the policyholder and thus not
be subject to tax.
Regulatory and legal: Significant state regulation will affect asset mix and
quality.
CFA 1
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Chapter 22 – Investors and The Investment Process
Answer:
b. Purchasing power risk.
CFA 2
Answer:
b. Organizing the management process itself.
CFA 3
Answer:
CFA 4
Answer:
CFA 5
Answer:
CFA 6
Answer:
CFA 7
Answer:
Investment Objectives
Return Requirement: Often, the return is stated in terms of minimum levels required to
fund a specific liability or budget requirements, as indicated by the Wood Museum
position and the trustees’ fears of a financial crisis indicate a low tolerance for risk.
Investment Constraints
Liquidity Requirements: The client’s need for cash or cash availability from securities
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Chapter 22 – Investors and The Investment Process
Wood Museum, the immediacy of the budget requirements (1 to 3 years) suggests a
very short time horizon for at least a major portion of the portfolio.
Tax Considerations: Wood Museum is tax exempt.
CFA 8
Answer:
The most important area of change concerns taxes. Mrs. Atkins pays income tax, but
the endowment fund will be free of taxes.
Atkins Fund has an above average ability to assume risk.
Investment Constraints
Liquidity: Liquidity needs are low. Except for investment reasons and periodic
fund.
Legal: Most endowment funds are governed by state regulations, and since most states
have moved to a “prudent man” standard, regulatory and legal constraints should not
be significant investment factors (certainly no more so than during the time that Mrs.
Atkins is alive).
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Chapter 22 – Investors and The Investment Process
Unique Needs: Although the details provided concerning Good Samaritan are
somewhat sketchy, and additional information might be appropriately requested, it
would appear that this hospital is experiencing financial difficulties which have been
characteristic of this industry for several years. The existence of an operating deficit,
and the possibility that this deficit may grow, suggest that a slightly more conservative
posture relative to other endowment funds might be appropriate.
CFA 9
Answer:
a. An appropriate investment policy statement for the endowment fund will be
A proposed IPS might be:
“The endowment fund’s investment assets shall be managed in a Prudent Man
b. The account circumstances will affect the initial asset allocation in the
following major ways:
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whole or part.
Chapter 22 – Investors and The Investment Process
iii. The equity portfolio will emphasize a growth orientation. Income in
excess of the current income requirement will be added to equity. Not
payout requirement dictates a zero risk posture on a large part of the total
while the prudent man environment will act to prevent overzealous risk
taking in the “remainder” portion.
v. The fund’s tax-exempt status maximizes allocation flexibility, both as to
income aspects and as to planning for future capital growth.
CFA 10
Answer:
a. Investment objectives are goals; investment constraints are the limits within
which the responsible party must operate in order to achieve the objectives;
period.”
An investment constraint is a limitation on the investment decision-making
constraints imposed.
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Chapter 22 – Investors and The Investment Process
b. Investment Objectives
Return: Total return equal to or greater than the foundation’s annual spending
plus the rate of inflation.
Taxes: None.
c. Investment Policies
A portfolio balance, to be averaged over time, of a maximum position of 67%
in equity-type investments and a minimum position of 33% in fixed income
In the case of convertible securities, corporate obligations and preferred stocks
carrying a credit rating, qualifying for purchase are securities rated no less than
BBB (“regarded as having an adequate capacity to pay interest / dividends and
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whole or part.