RAA Risk Management & Asset Allocation 3 — Questions and Answers
Question 1: A client's annuity portfolio earns 6% annually but inflation averages 7%. The client is primarily experiencing:
- Liquidity risk
- Purchasing power risk (Correct answer)
- Default risk
- Market risk
Correct answer: Purchasing power risk
Purchasing power risk (inflation risk) occurs when investment returns fail to outpace inflation, eroding the real value of assets.
Question 2: Modern Portfolio Theory (MPT) suggests that the optimal portfolio for a risk-averse investor lies on the:
- Capital market line below the risk-free rate
- Efficient frontier (Correct answer)
- Security market line above the market portfolio
- Indifference curve below the efficient frontier
Correct answer: Efficient frontier
MPT identifies the efficient frontier as the set of portfolios offering the highest expected return for a given level of risk.
Question 3: A fixed indexed annuity credits interest based on which benchmark?
- A fixed declared rate set by the insurer
- The performance of an external index subject to caps and floors (Correct answer)
- The actual portfolio holdings of the insurer's general account
- The client's chosen mutual fund sub-accounts
Correct answer: The performance of an external index subject to caps and floors
Fixed indexed annuities link interest credits to an external index (e.g., S&P 500) but use caps, floors, or participation rates to limit both gains and losses.
Question 4: Which risk management technique involves spreading assets across multiple insurance carriers to reduce concentration risk?
- Hedging
- Diversification across issuers (Correct answer)
- Dollar-cost averaging
- Duration matching
Correct answer: Diversification across issuers
Holding annuities from multiple insurers limits exposure to any single carrier's credit risk, especially important near state guaranty fund limits.
Question 5: Beta measures an investment's sensitivity to:
- Interest rate changes
- Movements in the overall market (Correct answer)
- Inflation fluctuations
- Currency exchange rate shifts
Correct answer: Movements in the overall market
Beta quantifies systematic (market) risk by measuring how much an asset's return moves relative to the overall market benchmark.
Question 6: A client aged 55 wants guaranteed income starting at 70 with no access to funds during the deferral period. Which product best fits?
- Immediate income annuity
- Deferred income annuity (DIA) (Correct answer)
- Variable annuity with GMWB
- Fixed indexed annuity with income rider
Correct answer: Deferred income annuity (DIA)
A deferred income annuity (also called longevity annuity) accepts a lump sum now and begins guaranteed income at a specified future date, typically with no access during accumulation.
Question 7: Unsystematic risk in a client's annuity portfolio can best be reduced through:
- Hedging with derivatives
- Holding only government bonds
- Diversification across unrelated asset classes (Correct answer)
- Selecting annuities with higher surrender charges
Correct answer: Diversification across unrelated asset classes
Unsystematic (company-specific or sector-specific) risk is reduced through diversification, as uncorrelated assets offset each other's idiosyncratic movements.
RAA Risk Management & Asset Allocation 3
A client's annuity portfolio earns 6% annually but inflation averages 7%.
The client is primarily experiencing: