CES Portfolio Management & Strategy 2 — Questions and Answers
Question 1: A trustee holds a concentrated position (60% of portfolio) in a single stock inherited by the trust. What is the trustee's primary fiduciary obligation?
- Sell immediately regardless of tax consequences
- Diversify within a reasonable time unless the trust instrument permits retention (Correct answer)
- Retain the position indefinitely to honor the grantor's intent
- Obtain beneficiary consent before taking any action
Correct answer: Diversify within a reasonable time unless the trust instrument permits retention
Under the Uniform Prudent Investor Act, trustees must diversify trust assets within a reasonable time unless circumstances justify retention, balancing tax costs against concentration risk.
Question 2: Which portfolio construction concept measures the sensitivity of a bond's price to changes in interest rates?
- Convexity
- Duration (Correct answer)
- Yield spread
- Credit quality
Correct answer: Duration
Duration measures the weighted average time to receive a bond's cash flows and approximates the percentage price change for a 1% change in interest rates.
Question 3: An estate plan uses a Grantor Retained Annuity Trust (GRAT). How should the trustee invest GRAT assets to maximize wealth transfer?
- Invest in tax-exempt municipal bonds to minimize income tax
- Target returns exceeding the IRS Section 7520 hurdle rate (Correct answer)
- Hold only cash equivalents to preserve principal
- Focus on dividend-paying stocks to fund annuity payments
Correct answer: Target returns exceeding the IRS Section 7520 hurdle rate
A GRAT transfers wealth when the portfolio return exceeds the Section 7520 rate; any excess passes to remainder beneficiaries gift-tax free.
Question 4: What does the 'total return' approach to trust investing allow that the traditional income/principal distinction does not?
- Trustees to charge higher fees for performance
- Allocation of portfolio gains to income for distribution purposes (Correct answer)
- Elimination of the duty of loyalty to beneficiaries
- Unrestricted speculation in derivatives
Correct answer: Allocation of portfolio gains to income for distribution purposes
The total return approach allows trustees to treat a portion of capital gains as distributable income, enabling growth-oriented portfolios that serve both income and remainder beneficiaries.
Question 5: A trust has both a current income beneficiary and a remainder beneficiary. Which investment strategy best balances their competing interests?
- All fixed income to maximize current distributions
- A balanced portfolio targeting total return with an appropriate payout rate (Correct answer)
- All equities to maximize long-term growth for remaindermen
- Cash equivalents to avoid any investment risk
Correct answer: A balanced portfolio targeting total return with an appropriate payout rate
A balanced total-return portfolio with a defined payout rate equitably serves income beneficiaries' current needs and remainder beneficiaries' long-term growth interests.
Question 6: Under the Uniform Prudent Investor Act, which factor is NOT relevant to the investment standard of care?
- General economic conditions
- The trustee's personal investment performance record (Correct answer)
- Tax consequences of investment decisions
- The role each investment plays within the overall portfolio
Correct answer: The trustee's personal investment performance record
UPIA requires trustees to consider circumstances of the trust and beneficiaries, not the trustee's own investment track record, which is irrelevant to the fiduciary standard.
Question 7: A CES specialist advises that systematic rebalancing of a trust portfolio serves which primary purpose?
- Minimizing trustee liability by documenting activity
- Maintaining the target asset allocation and risk profile over time (Correct answer)
- Generating taxable events to establish cost basis
- Maximizing short-term trading profits for the trust
Correct answer: Maintaining the target asset allocation and risk profile over time
Rebalancing returns a portfolio to its target allocation after market drift, ensuring the risk/return profile continues to match the trust's investment policy statement.
CES Portfolio Management & Strategy 2
A trustee holds a concentrated position (60% of portfolio) in a single stock inherited by the trust.
What is the trustee's primary fiduciary obligation?