CIC Investment Policy & Planning 5 — Questions and Answers
Question 1: Which of the following scenarios would trigger a mandatory review and potential revision of an existing IPS?
- The S&P 500 rises 15% in a calendar year
- The client inherits a significant estate, substantially increasing net worth (Correct answer)
- The portfolio's benchmark is reconstituted annually
- Interest rates decline by 25 basis points
Correct answer: The client inherits a significant estate, substantially increasing net worth
A material change in the client's financial circumstances, such as a large inheritance, fundamentally alters risk capacity and objectives, requiring IPS revision.
Question 2: The 'investment philosophy' section of an IPS most likely describes:
- A list of approved securities for purchase
- The manager's beliefs about market efficiency and how alpha is generated (Correct answer)
- The client's net worth and income statement
- Quarterly performance targets
Correct answer: The manager's beliefs about market efficiency and how alpha is generated
The investment philosophy articulates beliefs about market behavior and the approach the manager will use to construct and manage the portfolio.
Question 3: For a client with both taxable and tax-advantaged accounts, the IPS concept of 'asset location' refers to:
- The geographic diversification of international holdings
- Placing asset classes in the account type where their tax treatment is most favorable (Correct answer)
- Selecting the custodian for safekeeping of securities
- Identifying undervalued sectors in different countries
Correct answer: Placing asset classes in the account type where their tax treatment is most favorable
Asset location is the strategy of holding tax-inefficient assets (e.g., bonds, REITs) in tax-deferred accounts and tax-efficient assets (e.g., index funds) in taxable accounts.
Question 4: A client's IPS specifies a nominal return objective of 7% but inflation averages 3%. What is the real return objective?
- 3.88% (Correct answer)
- 4.00%
- 7.00%
- 10.00%
Correct answer: 3.88%
Real return = (1 + nominal) / (1 + inflation) - 1 = (1.07 / 1.03) - 1 ≈ 3.88%.
Question 5: Which of the following IPS elements is unique to endowments and foundations compared to individual investor policies?
- A specified risk tolerance level
- A perpetual time horizon with an intergenerational equity mandate (Correct answer)
- A requirement for diversification across asset classes
- A benchmark for performance measurement
Correct answer: A perpetual time horizon with an intergenerational equity mandate
Endowments and foundations operate in perpetuity, balancing current spending needs with preserving real purchasing power for future generations—a concept absent in finite individual portfolios.
Question 6: An IPS that permits 'tactical asset allocation' allows the portfolio manager to:
- Permanently change the strategic asset allocation targets
- Make short-term deviations from strategic targets to exploit perceived market opportunities (Correct answer)
- Select individual stocks without any constraints
- Ignore the client's risk tolerance during volatile markets
Correct answer: Make short-term deviations from strategic targets to exploit perceived market opportunities
Tactical asset allocation involves temporary, deliberate deviations from strategic targets within defined bands to capture short-term return opportunities.
Question 7: Which of the following best illustrates the difference between an investor's 'stated' and 'revealed' risk tolerance?
- An investor claims to be aggressive but panics and sells equities during a 20% market downturn (Correct answer)
- An investor holds both stocks and bonds in their portfolio
- An investor earns a higher return than their benchmark in a bull market
- An investor requests monthly performance reports from their advisor
Correct answer: An investor claims to be aggressive but panics and sells equities during a 20% market downturn
Stated tolerance is self-reported preference; revealed tolerance is actual behavior under stress—panic selling reveals lower true risk tolerance than stated.
CIC Investment Policy & Planning 5
Which of the following scenarios would trigger a mandatory review and potential revision of an existing IPS?