Asset Allocation Flashcards

Which asset allocation model explicitly accounts for the investor's tolerance for shortfall risk by maximizing expected return subject to a minimum acceptable return constraint?

Answer: Safety-first (Roy's criterion)

Roy's safety-first criterion selects the portfolio that minimizes the probability of falling below a threshold return level, prioritizing downside protection over maximum expected return.

In factor-based (smart beta) asset allocation, exposures are typically structured around factors such as:

Answer: Value, size, momentum, quality, and low volatility

Factor-based allocation targets systematic return premia such as value, size, momentum, quality, and low volatility, which have historically been associated with excess returns over time.

Which statement best describes the concept of 'home bias' in asset allocation?

Answer: Investors' tendency to over-allocate to domestic securities relative to their global market weight

Home bias is the well-documented tendency for investors to hold a disproportionately large share of their portfolios in domestic securities, reducing the diversification benefits of global investing.

A defined benefit pension plan with a long investment horizon and stable contribution base would MOST likely be able to tolerate:

Answer: Higher allocations to illiquid asset classes such as private equity

A long-horizon, well-funded defined benefit plan can afford to accept illiquidity risk in exchange for the potential liquidity premium embedded in private equity and similar asset classes.

Which of the following best describes the role of capital market assumptions (CMAs) in the asset allocation process?

Answer: They provide forward-looking estimates of returns, risks, and correlations used as inputs for portfolio optimization

Capital market assumptions are forward-looking estimates of expected returns, standard deviations, and correlations for asset classes, serving as the key inputs to the optimization models used in strategic asset allocation.

An investor implementing a 'constant proportion portfolio insurance' (CPPI) strategy will:

Answer: Increase equity exposure when markets rise and reduce it when markets fall

CPPI is a dynamic strategy that increases risky asset exposure as portfolio value rises above a floor and reduces it as portfolio value approaches the floor, providing downside protection while participating in upside.

According to the CIMA body of knowledge, which of the following is the most appropriate first step when constructing a strategic asset allocation for a new client?

Answer: Completing a thorough risk assessment and defining the client's investment objectives and constraints

The foundation of any sound asset allocation is a comprehensive assessment of the client's risk tolerance, return objectives, time horizon, liquidity needs, and other constraints as documented in the Investment Policy Statement.