CIMA Investment Policy & Portfolio Construction 3 — Questions and Answers
Question 1: Which of the following is an example of a 'liquidity constraint' that would be documented in an IPS?
- A client's preference for dividend-paying stocks
- A need to withdraw $50,000 annually for living expenses (Correct answer)
- A restriction on investing in emerging markets
- A requirement to match a specific benchmark index
Correct answer: A need to withdraw $50,000 annually for living expenses
Liquidity constraints specify expected cash outflow needs, which require the portfolio to maintain sufficient liquid assets to meet withdrawals without forced asset sales.
Question 2: A 'goals-based' portfolio construction approach differs from a mean-variance approach primarily because it:
- Maximizes the Sharpe ratio for the entire portfolio
- Segments assets into mental accounts tied to specific life goals (Correct answer)
- Focuses exclusively on minimizing downside risk
- Requires the use of index funds in every allocation
Correct answer: Segments assets into mental accounts tied to specific life goals
Goals-based investing builds separate sub-portfolios (mental accounts) aligned to distinct goals such as retirement, education, or a legacy, rather than optimizing one aggregate portfolio.
Question 3: Strategic asset allocation (SAA) is BEST described as:
- Short-term deviations from a benchmark based on market forecasts
- A long-term target mix of asset classes aligned with the investor's IPS objectives (Correct answer)
- A passive index strategy with no active management
- Monthly rebalancing to capture momentum across asset classes
Correct answer: A long-term target mix of asset classes aligned with the investor's IPS objectives
SAA establishes a long-term policy portfolio that reflects the investor's return objectives, risk tolerance, and constraints as stated in the IPS.
Question 4: Which statement about tactical asset allocation (TAA) is MOST accurate?
- TAA permanently changes the strategic asset allocation targets
- TAA involves temporary, deliberate deviations from SAA to exploit market opportunities (Correct answer)
- TAA is used exclusively by passive managers
- TAA eliminates the need for an Investment Policy Statement
Correct answer: TAA involves temporary, deliberate deviations from SAA to exploit market opportunities
TAA makes short-term shifts away from the strategic benchmark weights based on market views, intending to add alpha before reverting to the policy mix.
Question 5: When evaluating a client's 'ability to bear risk,' which factor is MOST relevant?
- The client's emotional reaction to market downturns
- The client's financial capacity to sustain losses without jeopardizing goals (Correct answer)
- The client's preference for growth versus income investments
- The client's age relative to industry averages
Correct answer: The client's financial capacity to sustain losses without jeopardizing goals
Ability to bear risk is an objective, financial measure based on wealth, income stability, and time horizon, distinct from the subjective willingness to take risk.
Question 6: A foundation with a perpetual time horizon and 5% annual spending requirement should set its long-term portfolio return objective at a MINIMUM of:
- 5% nominal
- 5% plus inflation plus investment expenses (Correct answer)
- The risk-free rate plus an equity risk premium
- The prior year's CPI reading
Correct answer: 5% plus inflation plus investment expenses
To preserve real purchasing power indefinitely, the foundation must earn at least enough to cover its spending rate, inflation, and management costs.
Question 7: Which portfolio construction technique explicitly accounts for the non-normality of asset return distributions?
- Mean-variance optimization (MVO)
- Black-Litterman model
- Mean-CVaR optimization (Correct answer)
- Equally weighted diversification
Correct answer: Mean-CVaR optimization
Mean-CVaR (Conditional Value-at-Risk) optimization uses downside tail risk as its measure, directly addressing skewness and fat tails that MVO ignores.
CIMA Investment Policy & Portfolio Construction 3
Which of the following is an example of a 'liquidity constraint' that would be documented in an IPS?