FASEA Data Analysis and Interpretation 3 — Questions and Answers
Question 1: An adviser compares two managed funds: Fund A has an annualised return of 11% with a standard deviation of 18%, and Fund B returns 9% with a standard deviation of 10%. The risk-free rate is 3%. Which fund has the superior Sharpe ratio?
- Fund A, with a Sharpe ratio of approximately 0.44
- Fund B, with a Sharpe ratio of 0.60 (Correct answer)
- Both funds have identical Sharpe ratios
- Fund A, because it has the higher absolute return
Correct answer: Fund B, with a Sharpe ratio of 0.60
Fund A's Sharpe ratio = (11-3)/18 ≈ 0.44; Fund B's = (9-3)/10 = 0.60, so Fund B delivers more return per unit of risk.
Question 2: A client aged 58 has a 20-year retirement projection showing a 90% probability of not running out of funds. The adviser revises assumptions to use actual historical sequence-of-returns data instead of average returns. The probability falls to 74%. What does this reveal?
- The original model was fraudulent
- Sequence-of-returns risk is not captured by average return assumptions (Correct answer)
- The client should immediately retire later
- A 74% probability is always unacceptable under FASEA standards
Correct answer: Sequence-of-returns risk is not captured by average return assumptions
Sequence-of-returns risk—the danger of poor early returns depleting the portfolio—is systematically underestimated by models that use average rather than sequential historical returns.
Question 3: In reviewing a client's insurance needs data, an adviser calculates the human life value (HLV) method yields $1.8M coverage need, while the income replacement method yields $1.2M. Which approach best satisfies FASEA's appropriate advice standard?
- Always use the higher figure to avoid underinsurance
- Always use the lower figure to keep premiums affordable
- Explain both methodologies and recommend coverage appropriate to the client's specific circumstances (Correct answer)
- Use whichever method the client prefers without further analysis
Correct answer: Explain both methodologies and recommend coverage appropriate to the client's specific circumstances
FASEA's appropriate advice obligation requires the adviser to explain the basis for recommendations; using both methods as inputs and tailoring to client circumstances demonstrates this duty.
Question 4: A regression analysis of a client's investment portfolio shows an R-squared of 0.85 against the ASX 200 benchmark. What does this most accurately tell the adviser?
- The portfolio has outperformed the benchmark by 85%
- 85% of the portfolio's return variance is explained by movements in the ASX 200 (Correct answer)
- The portfolio has a beta of 0.85
- The manager has added 85% alpha over the period
Correct answer: 85% of the portfolio's return variance is explained by movements in the ASX 200
R-squared measures the proportion of a portfolio's variance explained by the benchmark index, indicating how closely the portfolio tracks the index.
Question 5: When reviewing five years of a client's annual income data ($62k, $68k, $71k, $74k, $210k), which measure of central tendency should an adviser use to best represent the client's typical annual income for budgeting purposes?
- Mean ($97k), as it reflects all data equally
- Median ($71k), as it is resistant to the outlier year (Correct answer)
- Mode, because it is the most frequently occurring value
- Range, because it shows the full variability
Correct answer: Median ($71k), as it is resistant to the outlier year
The median is more representative of typical income when data contains outliers, as the $210k year (possibly from a one-off event) disproportionately inflates the mean.
Question 6: A client's Statement of Advice includes projected retirement savings of $950,000 based on a 7% nominal growth assumption. If the adviser fails to disclose that this assumes no contribution breaks, no market downturns, and ignores fees, this most directly breaches which FASEA obligation?
- The obligation to maintain professional competence
- The obligation to act with honesty and provide complete and accurate information (Correct answer)
- The obligation to prioritise the licensee's interests
- The obligation to refer clients to specialists
Correct answer: The obligation to act with honesty and provide complete and accurate information
FASEA's Code of Ethics Standard 3 requires advisers to be honest and not create false impressions; presenting projections without material assumptions disclosed would violate this standard.
Question 7: An adviser is comparing two annuity products for a retiree client. Product X pays $2,500/month for life; Product Y pays $3,100/month for 15 years guaranteed only. The client's life expectancy is 18 years. Based purely on expected value, which product is superior?
- Product Y, because it has a higher monthly payment
- Product X, because the expected total payout over 18 years ($540,000) exceeds Product Y's guaranteed total ($558,000)
- Product Y, because $3,100 x 180 months = $558,000 vs Product X's $2,500 x 216 months = $540,000 (Correct answer)
- Both products have identical expected value
Correct answer: Product Y, because $3,100 x 180 months = $558,000 vs Product X's $2,500 x 216 months = $540,000
Over 18 years, Product Y pays $558,000 vs Product X's $540,000, but Product X continues if the client outlives 18 years, making longevity risk a critical additional factor.
FASEA Data Analysis and Interpretation 3
An adviser compares two managed funds: Fund A has an annualised return of 11% with a standard deviation of 18%, and Fund B returns 9% with a standard deviation of 10%.
The risk-free rate is 3%.
Which fund has the superior Sharpe ratio?