CIC Investment Policy & Planning 3 — Questions and Answers
Question 1: The capital market expectations component of an IPS is used primarily to:
- Document the client's tax situation
- Set forward-looking estimates of risk and return for asset classes (Correct answer)
- Determine the client's liquidity needs
- Establish rebalancing thresholds
Correct answer: Set forward-looking estimates of risk and return for asset classes
Capital market expectations are forecasts of asset class returns, risks, and correlations used as inputs for portfolio construction and strategic asset allocation.
Question 2: A university endowment's IPS typically includes a 'spending rule' because:
- Universities must pay dividends to shareholders
- Distributions must be balanced against portfolio growth to preserve purchasing power in perpetuity (Correct answer)
- Government regulations require endowments to spend at least 50% annually
- The spending rule determines the manager's fee
Correct answer: Distributions must be balanced against portfolio growth to preserve purchasing power in perpetuity
Endowments have an infinite time horizon and must balance current spending needs against preserving real capital for future generations.
Question 3: Which of the following best describes 'strategic asset allocation' as defined in an IPS?
- Short-term tactical shifts to exploit market mispricings
- Long-term target weights for asset classes aligned with the client's risk/return objectives (Correct answer)
- The selection of individual securities within each asset class
- A quarterly rebalancing schedule
Correct answer: Long-term target weights for asset classes aligned with the client's risk/return objectives
Strategic asset allocation establishes the long-term policy portfolio weights for each asset class based on the client's objectives and constraints.
Question 4: An investor with a 30-year retirement savings horizon and stable employment would most appropriately have which IPS characteristic?
- High liquidity requirement and low risk tolerance
- Low return objective and conservative asset allocation
- Higher equity allocation and moderate-to-high risk tolerance (Correct answer)
- Emphasis on capital preservation over growth
Correct answer: Higher equity allocation and moderate-to-high risk tolerance
Long time horizons and stable income allow investors to tolerate volatility and pursue growth-oriented strategies with higher equity exposure.
Question 5: Which of the following is NOT typically included as a major section of an Investment Policy Statement?
- Duties and responsibilities of involved parties
- Return and risk objectives
- Specific buy and sell recommendations for securities (Correct answer)
- Permissible asset classes and constraints
Correct answer: Specific buy and sell recommendations for securities
An IPS sets policy and guidelines but does not specify individual security buy/sell recommendations, which are left to portfolio management discretion.
Question 6: A client's 'after-tax return objective' of 5% annually assumes their marginal tax rate is 25%. What pre-tax return must the portfolio generate?
- 5.00%
- 5.25%
- 6.25%
- 6.67% (Correct answer)
Correct answer: 6.67%
Pre-tax return = after-tax return / (1 - tax rate) = 5% / (1 - 0.25) = 6.67%.
Question 7: When an IPS is being prepared for a client with conflicting risk and return objectives, the investment counselor should:
- Prioritize the return objective and ignore the risk constraint
- Default to the most conservative interpretation
- Reconcile conflicts through client education and explicit written agreement (Correct answer)
- Refuse to create an IPS until conflicts are resolved on their own
Correct answer: Reconcile conflicts through client education and explicit written agreement
The counselor must educate the client on trade-offs and document agreed-upon resolutions in the IPS to align expectations and responsibilities.
CIC Investment Policy & Planning 3
The capital market expectations component of an IPS is used primarily to: