Financial Advisor Investment Planning and Portfolio Management 5 — Questions and Answers
Question 1: A client in the 37% marginal tax bracket earns 6% on a taxable bond. What after-tax yield must a municipal bond offer to be equivalent?
- 3.78% (Correct answer)
- 6.00%
- 2.22%
- 4.65%
Correct answer: 3.78%
Tax-equivalent yield = taxable yield × (1 − tax rate) = 6% × (1 − 0.37) = 3.78%.
Question 2: Which portfolio construction concept holds that adding an asset with low correlation to an existing portfolio can reduce overall portfolio risk without sacrificing expected return?
- Efficient frontier
- Diversification benefit (Correct answer)
- Jensen's alpha
- Factor investing
Correct answer: Diversification benefit
The diversification benefit arises when assets with low or negative correlations are combined, reducing total portfolio variance.
Question 3: An advisor recommends shifting a client's equity allocation from 70% to 50% because of near-term recession concerns. This is an example of:
- Strategic asset allocation
- Tactical asset allocation (Correct answer)
- Liability-driven investing
- Core-satellite investing
Correct answer: Tactical asset allocation
Tactical asset allocation involves short-term, active deviations from the long-term strategic target based on market outlook.
Question 4: What does a portfolio's R-squared (R²) statistic tell a financial advisor?
- The portfolio's expected return relative to risk
- The percentage of portfolio variance explained by movements in its benchmark (Correct answer)
- The portfolio's sensitivity to interest rate changes
- The manager's skill at stock selection
Correct answer: The percentage of portfolio variance explained by movements in its benchmark
R² measures how closely a portfolio's performance tracks its benchmark, ranging from 0 (no correlation) to 100 (perfect correlation).
Question 5: A 35-year-old client with a high risk tolerance and 30-year time horizon asks for a portfolio. Which allocation is MOST suitable?
- 20% equities / 80% bonds
- 50% equities / 50% bonds
- 80% equities / 20% bonds (Correct answer)
- 100% money market funds
Correct answer: 80% equities / 20% bonds
A long time horizon and high risk tolerance support a growth-oriented allocation heavily weighted toward equities.
Question 6: Which risk is NOT reduced through diversification within a domestic equity portfolio?
- Company-specific (idiosyncratic) risk
- Industry concentration risk
- Systematic (market) risk (Correct answer)
- Event risk from a single stock
Correct answer: Systematic (market) risk
Systematic risk affects the entire market and cannot be eliminated through diversification; only unsystematic (specific) risk can be diversified away.
Question 7: A client's Investment Policy Statement (IPS) specifies a maximum single-security concentration of 5%. This is an example of which IPS component?
- Return objective
- Risk constraint (Correct answer)
- Liquidity requirement
- Tax consideration
Correct answer: Risk constraint
Concentration limits are risk constraints that prevent excessive exposure to any single holding, protecting against idiosyncratic loss.
Financial Advisor Investment Planning and Portfolio Management 5
A client in the 37% marginal tax bracket earns 6% on a taxable bond.
What after-tax yield must a municipal bond offer to be equivalent?