Competency 18 Section 2

Question 1

1. With asset dedication, fixed income needs can be met with constant-maturity bond mutual funds.

Answer 1

False. Asset dedication suggests using specific bonds held to their maturity date to target upcoming spending needs. (LO 18-2-1)

Question 2

2. Portfolio volatility should be of little concern when a client is firmly entrenched in the safety zone above the critical path.

Answer 2

True. (LO 18-2-1)

Question 3

3. Asset dedication differs from a buffer zone approach because asset dedication extends beyond cash to consider a wider set of assets for meeting upcoming spending needs.

Answer 3

True. (LO 18-2-1)

Question 4

4. As each year passes, it is advisable to roll the income portfolio forward by another year when the client is in the danger zone below the critical path.

Answer 4

False. Such action will further lock a client into a trajectory of wealth depletion and an inability to meet their lifetime spending objectives. (LO 18-2-1)

Question 5

5. In a Financial Planning Association survey described by Steven Huxley and J. Brent Burns, individual investors identified market volatility as their top investment risk.

Answer 5

False. The top investment risk was outliving savings (64% identified it), followed by not saving enough and then market volatility. (LO 18-2-1)

Question 6

6. A portfolio of dividend stocks is generally more concentrated (largest issues make up a higher percentage of the total portfolio) than a total market portfolio of stocks.

Answer 6

True. (LO 18-2-2)

Question 7

7. Those seeking yield by focusing on bonds with more distant maturity dates face a risk of capital losses when interest rates decline

Answer 7

False. A reduction in interest rates increases the present value of bonds. Longer-term bonds will enjoy a larger gain in value. (LO 18-2-2)

Question 8

8. Two ways to seek higher income from a fixed income portfolio are to shift from corporate bonds to U.S. government bonds, and to shift from short-term bonds to long-term bonds

Answer 8

False. Corporate bonds tend to offer higher yields than same-maturity date U.S. government bonds. (LO 18-2-2)

Question 9

9. Income portfolios are generally less tax efficient than portfolios built from a total returns perspective.

Answer 9

True. (LO 18-2-2)

Question 10

10.Strategies which increase stock allocations when markets are overvalued and which decrease stock allocations when markets are undervalued have historically had a tendency to support higher sustainable withdrawal rates than strategies with fixed stock allocations.

Answer 10

False. Stock allocations should decrease when valuations are high and vice versa to have this effect. (LO 18-2-3)

Question 11

11.A client whose assets greatly exceed the present value of their liabilities has the capacity to use a more aggressive asset allocation

Answer 11

True. (LO 18-2-3)

Question 12

12.Lifecycle strategies which reduce stock allocations in response to age during retirement distribution have a tendency to reduce sustainable withdrawal rates

Answer 12

True. (LO 18-2-3)

Question 13

13.If assets fall below liabilities, the safety-first approach would suggest to reduce spending plans rather than increase the aggressiveness of one’s stock allocation.

Answer 13

True. (LO 18-2-3)

Question 14

14.The equity yield curve shows the worst-case cumulative losses over different time horizons.

Answer 14

False. The losses shown in the equity yield curve are annualized, not cumulative. (LO 18-2-4)

Question 15

15.Buying a put option on a portfolio is a strategy to reduce downside risk.

Answer 15

True. (LO 18-2-4)

Question 16

16.A collar strategy combines an investment portfolio with purchases of both a put option and a call option on the portfolio.

Answer 16

False. With a collar strategy, one writes or sells a call option, rather than purchasing it, in order to generate revenues to buy a put option. (LO 18-2-4)

Question 17

17.The minimax principle suggests that asset allocation be guided by what portfolio is expected to provide the best risk-adjusted returns.

Answer 17

False. With the minimax principle, the portfolio is chosen to minimize the maximum amount of losses in the worst-case scenario, not in the average case. (LO 18-2-4)

Question 18

18.Using financial derivatives for portfolio protection is usually a more valid idea for early in the retirement period, rather than late in the retirement period.

Answer 18

True. (LO 18-2-4)

Question 19

19.Though the present value of annuitized assets does not show up as part of a client’s financial portfolio, it is still an important component of a client’s asset holdings.

Answer 19

True. (LO 18-2-5)

Question 20

20.If the annuity payout rate is higher than a client’s desired withdrawal rate from their financial portfolio, then partial annuitization will result in lower sustainability for the remaining financial assets.

Answer 20

False. A higher payout rate means that a lower withdrawal rate may be used from the remaining financial assets to meet the spending objectives of the client. (LO 18-2-5)

Question 21

21.The present value of guaranteed annuity payments declines as a client ages and their time horizon shortens.

Answer 21

True. (LO 18-2-5)

Question 22

22.An argument against replacing bonds with SPIAs in a retirement portfolio is that regulators may object to the increased stock allocation observed for remaining financial assets.

Answer 22

True. (LO 18-2-5)

Question 23

39. Which of the following statements about the impact of shifting from lower yield bond into higher yield bond investments is least likely to be correct? (LO 18-2-2)

A. It can increase the credit risk of the portfolio.

B. It can extend the duration of the income portfolio.

C. It can decrease the tax efficiency of the portfolio.

D. It can reduce the volatility of the portfolio.

Question 24

64. Which of the following statements concerning the income portion of the portfolio with the asset dedication approach is (are) correct? (LO 18-2-1)

I. Term certain annuities could be used to meet the client’s income needs using the asset dedication approach.

II. Bond funds are commonly used to meet the client’s income needs using the asset dedication approach.

A. I only

B. II only

C. Both I and II

D. Neither I nor II

Answer 24

64. The answer is A. Statement II is incorrect. Bond funds cannot be used to lock in specific income needs with the same specificity of individual bonds.

Question 25

65. Which of the following statements about research results of the valuation based asset allocation approach is (are) correct? (LO 18-2-3) I. A Kitces study showed that increasing equity exposure by 20 percent whenever market valuations rise sufficiently will increase the SAFEMAX (safe withdrawal rate). II. Robert Shiller demonstrated that the price divided by average real earnings over the previous 120 months (PE10) can provide reasonable predictive power for long-term real stock market returns. A. I only B. II only C. Both I and II D. Neither I nor II

Answer 25

65. The answer is B. Statement I is incorrect. Kitces found that decreasing equity exposure when market values rise will increase the safe withdrawal rate

Question 26

67. Which of the following statements about using derivatives with a retirement portfolio is (are) correct? (LO 18-2-4) I. Put options create downside protection but can be expensive. II. The best, most cost effective time to use a derivative strategy in a retirement portfolio is early in retirement. A. I only B. II only C. Both I and II D. Neither I nor II

Answer 26

67. The answer is C. Both statements are correct

Question 27

68. Which of the following statements about partial annuitization and the portfolio failure rate is (are) correct? (LO 18-2-5) I. If the annuity payout rate is higher than the desired withdrawal rate, then annuitization can clearly increase sustainability. II. If the equity allocation is increased after purchasing an annuity, the impact on sustainability depends on assumptions about asset returns. A. I only 　 B. II only C. Both I and II D. Neither I nor II

Answer 27

68. The answer is C. Both statements are correct

Question 28

94. All of the following statements concerning the critical path and the asset dedication strategy are correct EXCEPT (LO 18-2-1) A. The critical path is based on the client’s current financial situation, goals, and anticipated financial needs. B. Comparing the client’s current situation to the critical path identifies when changes are required to the portfolio. C. Portfolio volatility should be of little concern when a client is firmly entrenched in the safety zone above the critical path. D. The critical path investment goals are tied to benchmark indexes such as the S&P 500 index

Answer 28

94. The answer is D. The critical path investment goals are tied to meeting the client’s own specific income needs

Question 29

95. All of the following are common approaches to dynamic asset allocation decision making in retirement EXCEPT (LO 18-2-3) A. Lifecycle asset allocation theory 　 B. The "minimax" theory C. Valuation based asset allocation D. Adaptive asset allocation in which stock allocation relates to funding status

Answer 29

95. The answer is B. The minimax theory is not an approach to dynamic reallocation; it is a philosophy for selecting investments that tries to minimize the worst case scenario

Question 31

66. Which of the following statements concerning approaches for providing downside portfolio protection is (are) correct? (LO 18-2-4) I. Including more asset classes can allow for different portfolio characteristics and potentially a portfolio with better return/volatility characteristics. II. The "MINIMAX" philosophy focuses on trying to improve average investment returns. A. I only B. II only C. Both I and II D. Neither I nor II

Answer 31

66. The answer is A. B is incorrect since the MINIMAX philosophy focuses on improving the worst case scenario