GAC Investment Strategies 3 — Questions and Answers
Question 1: A government finance officer is evaluating two bonds with identical credit ratings and maturities. Bond A is callable and Bond B is non-callable. Bond A should offer:
- A lower yield because of added flexibility for the issuer
- A higher yield to compensate investors for reinvestment risk (Correct answer)
- The same yield since credit ratings are equal
- A lower yield due to greater market liquidity
Correct answer: A higher yield to compensate investors for reinvestment risk
Callable bonds must offer higher yields to compensate investors for call risk and reinvestment risk if the bond is redeemed early when rates fall.
Question 2: Which provision in a state investment law most directly limits a government's ability to pursue higher-yielding but riskier investments?
- Legal list statutes (Correct answer)
- Prudent investor rule
- Yield maximization mandate
- Portfolio diversification requirement
Correct answer: Legal list statutes
Legal list statutes explicitly enumerate the types of securities a government is permitted to purchase, restricting investment choices regardless of risk-return analysis.
Question 3: Under the GFOA's best practices, the PRIMARY objective hierarchy for governmental investment management is:
- Yield, Safety, Liquidity
- Safety, Liquidity, Yield (Correct answer)
- Liquidity, Safety, Yield
- Safety, Yield, Liquidity
Correct answer: Safety, Liquidity, Yield
GFOA and most state statutes establish Safety first (preservation of principal), Liquidity second (meeting cash flow needs), and Yield third (return on investment).
Question 4: A government holds a repurchase agreement (repo) in which it transfers securities to the dealer. Under GASB guidance, the government should report:
- A reduction in investment assets and recognition of a loan payable
- The transferred securities as still owned and a cash asset received (Correct answer)
- The repo as an off-balance-sheet contingency
- A gain equal to the difference between sale price and repurchase price
Correct answer: The transferred securities as still owned and a cash asset received
In a repo entered by the government as lender, the government receives cash collateralized by securities and reports both the cash and the obligation to return it.
Question 5: Which factor most directly increases the concentration risk of a governmental investment portfolio?
- Holding 80% of the portfolio in securities of a single issuer (Correct answer)
- Investing in securities with varying maturities
- Using multiple custodial banks
- Diversifying across money market funds and Treasuries
Correct answer: Holding 80% of the portfolio in securities of a single issuer
Concentration risk arises when a large portion of the portfolio is exposed to a single issuer, sector, or counterparty, creating significant loss potential if that issuer defaults.
Question 6: A government's investment policy requires all securities to be rated at least 'A' by a nationally recognized rating agency. This policy primarily addresses:
- Interest rate risk
- Liquidity risk
- Credit risk (Correct answer)
- Foreign currency risk
Correct answer: Credit risk
Minimum credit rating requirements are designed to limit credit (default) risk by restricting the portfolio to issuers deemed financially sound by major rating agencies.
Question 7: Which of the following best describes the 'laddering' investment strategy used by government treasurers?
- Concentrating maturities at the short end of the yield curve
- Staggering maturities evenly across multiple time horizons (Correct answer)
- Investing entirely in long-term securities for maximum yield
- Purchasing only floating-rate notes to minimize rate risk
Correct answer: Staggering maturities evenly across multiple time horizons
Laddering staggers investment maturities evenly across the yield curve so that a portion of the portfolio matures regularly, providing both liquidity and reinvestment opportunities.
GAC Investment Strategies 3
A government finance officer is evaluating two bonds with identical credit ratings and maturities.
Bond A is callable and Bond B is non-callable.
Bond A should offer: