AAMS Asset Management Process 5 — Questions and Answers
Question 1: A client's portfolio drifts significantly from its target allocation. The manager must weigh the cost of rebalancing against which of the following?
- Custodian reputation risk
- Transaction costs and tax consequences (Correct answer)
- Regulatory filing deadlines
- Benchmark selection bias
Correct answer: Transaction costs and tax consequences
Rebalancing decisions must balance the benefit of restoring target allocation against transaction costs and potential tax liabilities from selling appreciated assets.
Question 2: Which of the following best describes the role of diversification in the asset management process?
- Eliminating all investment risk
- Reducing unsystematic risk by spreading investments across uncorrelated assets (Correct answer)
- Maximizing returns by concentrating in top performers
- Hedging against inflation using derivatives
Correct answer: Reducing unsystematic risk by spreading investments across uncorrelated assets
Diversification reduces unsystematic (company-specific) risk by combining assets whose returns are not perfectly correlated.
Question 3: A client nearing retirement shifts from 80% equities to 50% equities. This change most likely reflects a shift in:
- Benchmark selection
- Time horizon and risk tolerance (Correct answer)
- Legal constraints
- Custodial arrangements
Correct answer: Time horizon and risk tolerance
As clients near retirement, their shorter time horizon and lower risk tolerance typically prompt a shift toward more conservative allocations.
Question 4: Which of the following metrics measures the return earned per unit of total risk taken by a portfolio?
- Alpha
- Beta
- Sharpe ratio (Correct answer)
- Information ratio
Correct answer: Sharpe ratio
The Sharpe ratio divides excess return (above the risk-free rate) by the portfolio's standard deviation to measure return per unit of total risk.
Question 5: A portfolio manager uses futures contracts to temporarily reduce equity exposure without selling holdings. This technique is known as:
- Tax-loss harvesting
- Overlay management (Correct answer)
- Sector rotation
- Duration matching
Correct answer: Overlay management
Overlay management uses derivatives to adjust portfolio exposure efficiently without disturbing the underlying holdings.
Question 6: Which of the following is the correct sequence of the asset management process?
- Implement → Gather data → Set objectives → Monitor
- Gather data → Set objectives → Implement → Monitor (Correct answer)
- Set objectives → Monitor → Gather data → Implement
- Monitor → Implement → Gather data → Set objectives
Correct answer: Gather data → Set objectives → Implement → Monitor
The process flows from data gathering and goal setting, through objective formulation and implementation, to ongoing monitoring.
Question 7: A manager notices that a client's portfolio has consistently outperformed its benchmark but with significantly higher volatility. The advisor should:
- Report only the outperformance without mentioning risk
- Evaluate whether the risk taken is consistent with the client's IPS constraints (Correct answer)
- Immediately increase risk further to maximize returns
- Switch to a more aggressive benchmark
Correct answer: Evaluate whether the risk taken is consistent with the client's IPS constraints
Higher returns achieved with excess risk may violate the client's risk tolerance as documented in the IPS and must be evaluated accordingly.
AAMS Asset Management Process 5
A client's portfolio drifts significantly from its target allocation.
The manager must weigh the cost of rebalancing against which of the following?