CPC Financial Planning & Investment Strategies 2 — Questions and Answers
Question 1: Under the prudent investor rule, which factor is MOST critical when constructing a pension portfolio?
- Maximizing expected return regardless of risk
- Diversification to reduce unsystematic risk (Correct answer)
- Concentrating assets in highest-rated bonds
- Minimizing management fees above all else
Correct answer: Diversification to reduce unsystematic risk
The prudent investor rule requires fiduciaries to diversify investments to minimize unsystematic risk unless there is good reason not to.
Question 2: A defined benefit plan's funded status deteriorates because liability growth outpaces asset returns. Which strategy BEST addresses this asset-liability mismatch?
- Shift to an all-equity portfolio for higher returns
- Implement a liability-driven investment (LDI) strategy using long-duration bonds (Correct answer)
- Freeze plan benefits immediately
- Increase employer contributions only
Correct answer: Implement a liability-driven investment (LDI) strategy using long-duration bonds
LDI aligns asset duration with pension liability duration, reducing funded-status volatility when interest rates change.
Question 3: Which metric measures the sensitivity of a bond's price to a 1% change in interest rates?
- Convexity
- Modified duration (Correct answer)
- Current yield
- Yield to maturity
Correct answer: Modified duration
Modified duration approximates the percentage price change of a bond for a 1% (100 basis point) change in yield.
Question 4: A plan sponsor wants to reduce equity volatility while maintaining upside participation. Which overlay strategy is MOST appropriate?
- Writing covered calls on the equity portfolio
- Buying put options on a broad equity index (Correct answer)
- Selling equity futures short
- Purchasing Treasury STRIPS
Correct answer: Buying put options on a broad equity index
Buying put options provides downside protection (a floor) while preserving all upside beyond the option premium cost.
Question 5: In a glide path design for a target-date fund, equity allocation typically:
- Remains constant regardless of participant age
- Increases as the target date approaches
- Decreases as the target date approaches (Correct answer)
- Mirrors the plan's asset allocation at all times
Correct answer: Decreases as the target date approaches
Glide paths reduce equity exposure over time as participants near retirement to decrease the impact of sequence-of-returns risk.
Question 6: Which asset class is typically used in pension portfolios to hedge against unexpected inflation?
- Long-duration Treasuries
- Treasury Inflation-Protected Securities (TIPS) (Correct answer)
- High-yield corporate bonds
- Large-cap growth equities
Correct answer: Treasury Inflation-Protected Securities (TIPS)
TIPS principal adjusts with CPI, providing a direct hedge against unexpected inflation for pension liabilities indexed to wage or price growth.
Question 7: A pension plan's Investment Policy Statement (IPS) serves primarily to:
- Guarantee a specific rate of return for participants
- Document the plan's investment objectives, constraints, and governance framework (Correct answer)
- Replace the need for an investment manager
- Set maximum contribution limits under ERISA
Correct answer: Document the plan's investment objectives, constraints, and governance framework
The IPS establishes written guidelines for investment decision-making, defining objectives, risk tolerance, asset allocation ranges, and manager selection criteria.
CPC Financial Planning & Investment Strategies 2
Under the prudent investor rule, which factor is MOST critical when constructing a pension portfolio?