CIMA Investment Policy and Process 3 — Questions and Answers
Question 1: In the CIMA investment process, 'capital market expectations' are used primarily to:
- Audit past portfolio performance against benchmarks
- Provide forward-looking estimates of returns, risks, and correlations for asset classes (Correct answer)
- Set legal investment restrictions for institutional clients
- Determine the client's personal risk tolerance score
Correct answer: Provide forward-looking estimates of returns, risks, and correlations for asset classes
Capital market expectations are forward-looking forecasts of asset class returns, volatilities, and correlations used as inputs to the strategic asset allocation process.
Question 2: A 'tactical asset allocation' (TAA) overlay differs from strategic asset allocation (SAA) in that TAA:
- Establishes permanent, long-term target weights for the portfolio
- Makes short-term deviations from SAA targets to exploit market opportunities (Correct answer)
- Is solely determined by client risk tolerance
- Never permits deviation from the benchmark
Correct answer: Makes short-term deviations from SAA targets to exploit market opportunities
TAA involves temporarily shifting portfolio weights away from SAA targets to capitalize on perceived short-term market mispricings or changing conditions.
Question 3: Which of the following best describes 'rebalancing' in the context of investment policy?
- Changing the client's risk tolerance annually
- Restoring portfolio weights to target allocations after market movements cause drift (Correct answer)
- Moving all assets into cash at year-end
- Replacing underperforming managers with new ones
Correct answer: Restoring portfolio weights to target allocations after market movements cause drift
Rebalancing is the process of buying and selling assets to return the portfolio to its target strategic asset allocation after market movements cause the actual weights to drift.
Question 4: A defined benefit pension plan's investment policy is unique because the portfolio must be managed relative to:
- The S&P 500 benchmark only
- The plan's liabilities (future pension obligations) (Correct answer)
- The personal financial goals of the pension trustees
- Absolute return targets set by the government
Correct answer: The plan's liabilities (future pension obligations)
Defined benefit plans use liability-relative investing, where the portfolio is managed to fund and hedge future pension payment obligations rather than against a market benchmark alone.
Question 5: The concept of 'risk budgeting' in portfolio management refers to:
- Setting a fixed dollar limit on allowable investment losses
- Allocating an acceptable level of risk across asset classes, strategies, or managers (Correct answer)
- Budgeting the cost of risk management software
- Limiting portfolio turnover to control transaction costs
Correct answer: Allocating an acceptable level of risk across asset classes, strategies, or managers
Risk budgeting allocates a total portfolio risk budget (e.g., tracking error or volatility) across various sources of return to ensure efficient use of risk capacity.
Question 6: An IPS specifying that no single security can exceed 5% of the portfolio value is an example of a:
- Return objective
- Risk tolerance statement
- Concentration constraint (Correct answer)
- Tax consideration
Correct answer: Concentration constraint
A concentration constraint limits exposure to any single security, sector, or issuer to reduce idiosyncratic risk and ensure diversification.
Question 7: Which of the following is considered an 'endogenous' constraint in an investment policy statement?
- Government regulations on permissible investments
- Tax laws affecting capital gains treatment
- Client's personal ethical objection to tobacco stocks (Correct answer)
- ERISA rules for pension fund management
Correct answer: Client's personal ethical objection to tobacco stocks
Endogenous (internal/client-specific) constraints arise from the client's own circumstances, preferences, or values, such as ESG screens or restrictions on specific industries.
CIMA Investment Policy and Process 3
In the CIMA investment process, 'capital market expectations' are used primarily to: