CPC Financial Planning & Investment Strategies 3 — Questions and Answers
Question 1: A pension consultant recommends rebalancing a portfolio from 65/35 equity/bond back to target weights after a strong equity rally. This practice primarily manages:
- Liquidity risk
- Drift risk and unintended asset allocation exposure (Correct answer)
- Manager selection risk
- Interest rate duration risk
Correct answer: Drift risk and unintended asset allocation exposure
Rebalancing corrects drift from target allocations caused by differential asset class returns, preventing unintended concentration risk.
Question 2: The Sharpe ratio measures a portfolio's excess return per unit of:
- Systematic risk (beta)
- Total risk (standard deviation) (Correct answer)
- Tracking error
- Duration
Correct answer: Total risk (standard deviation)
The Sharpe ratio equals (portfolio return − risk-free rate) ÷ portfolio standard deviation, rewarding returns per unit of total volatility.
Question 3: Which type of investment manager benchmark is MOST appropriate for evaluating a passive index fund?
- A peer group universe median
- The exact index the fund replicates (Correct answer)
- A blended 60/40 stock-bond benchmark
- The consumer price index plus 3%
Correct answer: The exact index the fund replicates
Passive index funds should be evaluated against the specific index they track, as their goal is to replicate — not beat — that index.
Question 4: Under ERISA Section 404(c), plan fiduciaries are relieved of liability for participant investment losses when:
- The plan offers at least three diversified investment options and participants exercise independent control (Correct answer)
- The plan achieves a minimum 5% annual return
- All investments are in stable value funds
- The plan is fully insured by the PBGC
Correct answer: The plan offers at least three diversified investment options and participants exercise independent control
ERISA 404(c) relief applies when the plan offers a broad range of investment alternatives (at least three diversified options) and participants exercise control over their accounts.
Question 5: A pension plan holds alternative investments including private equity and hedge funds primarily to achieve:
- Daily liquidity for benefit payments
- Enhanced returns and diversification through low correlation with public markets (Correct answer)
- Guaranteed principal protection
- Reduced PBGC premiums
Correct answer: Enhanced returns and diversification through low correlation with public markets
Alternatives offer return premiums (illiquidity premium) and low correlations to public equity and bonds, improving portfolio efficiency.
Question 6: When evaluating an active equity manager, which statistic BEST isolates skill from luck over a short time period?
- Total return ranking in peer group
- Information ratio (IR) (Correct answer)
- Expense ratio
- Beta to the benchmark
Correct answer: Information ratio (IR)
The information ratio (active return ÷ tracking error) measures consistency of outperformance, making it a better indicator of manager skill than raw returns.
Question 7: A cash balance plan credits participant accounts with a fixed pay credit and an interest credit. The interest rate risk in a cash balance plan is borne by:
- The participant, since accounts fluctuate with markets
- The plan sponsor, since they must fund the guaranteed interest credit (Correct answer)
- The PBGC exclusively
- The investment manager
Correct answer: The plan sponsor, since they must fund the guaranteed interest credit
In a cash balance plan, the employer (plan sponsor) guarantees both pay credits and interest credits, assuming investment and interest rate risk.
CPC Financial Planning & Investment Strategies 3
A pension consultant recommends rebalancing a portfolio from 65/35 equity/bond back to target weights after a strong equity rally.
This practice primarily manages: