STEP Portfolio Management & Strategy 2 — Questions and Answers
Question 1: Under the Uniform Prudent Investor Act (UPIA), which factor is NOT explicitly listed as relevant to a trustee's investment decisions?
- General economic conditions
- The beneficiary's personal tax bracket (Correct answer)
- Expected tax consequences of investment decisions
- The role each investment plays within the overall portfolio
Correct answer: The beneficiary's personal tax bracket
The UPIA lists general economic conditions, expected tax consequences, and portfolio role as relevant factors, but does not single out a beneficiary's personal tax bracket as a listed consideration.
Question 2: A trustee holds a highly concentrated position in a single stock inherited by the trust. The Prudent Investor Rule generally requires the trustee to:
- Retain the stock indefinitely to avoid triggering capital gains
- Diversify the holding within a reasonable time unless special circumstances justify retention (Correct answer)
- Seek court approval before selling any portion of the concentrated position
- Hold the position until the primary beneficiary requests diversification
Correct answer: Diversify the holding within a reasonable time unless special circumstances justify retention
The UPIA requires trustees to diversify trust assets within a reasonable time after acceptance unless the trustee reasonably determines that retention is in the beneficiaries' best interests.
Question 3: Which portfolio strategy is most appropriate when a trust has income beneficiaries who require regular distributions and remainder beneficiaries focused on long-term capital growth?
- All-equity growth portfolio
- Total return approach with a distribution policy (Correct answer)
- Short-duration bond ladder only
- Money market fund with quarterly rebalancing
Correct answer: Total return approach with a distribution policy
A total return approach balances current income needs with long-term growth by distributing a set percentage of total portfolio value, serving both income and remainder beneficiaries.
Question 4: Which of the following best describes 'systematic risk' in portfolio management?
- Risk that can be eliminated through diversification across asset classes
- Risk inherent to the entire market that cannot be diversified away (Correct answer)
- Risk arising from poor security selection by the portfolio manager
- Risk specific to a single company's operations or management
Correct answer: Risk inherent to the entire market that cannot be diversified away
Systematic (or market) risk affects all investments and cannot be eliminated through diversification; it includes factors like interest rate changes, recessions, and geopolitical events.
Question 5: A trust's Investment Policy Statement (IPS) specifies a 60/40 equity-to-bond allocation. After a strong equity market rally, the portfolio drifts to 72/28. The trustee should:
- Allow drift indefinitely as equities are outperforming
- Rebalance to restore the 60/40 target allocation (Correct answer)
- Revise the IPS to reflect the new allocation
- Wait for bonds to recover before rebalancing
Correct answer: Rebalance to restore the 60/40 target allocation
Rebalancing restores the portfolio to its policy target allocation, maintaining the intended risk profile and adhering to the IPS as required by fiduciary duty.
Question 6: Which measure assesses the risk-adjusted return of a portfolio by comparing excess return per unit of total risk (standard deviation)?
- Treynor Ratio
- Jensen's Alpha
- Sharpe Ratio (Correct answer)
- Information Ratio
Correct answer: Sharpe Ratio
The Sharpe Ratio divides a portfolio's excess return (above the risk-free rate) by its standard deviation, measuring return per unit of total risk.
Question 7: When constructing a trust portfolio for a beneficiary with a 30-year time horizon and moderate risk tolerance, which strategic asset allocation is generally most appropriate?
- 100% short-term Treasury bills to preserve capital
- Predominantly cash and money market instruments
- Diversified mix weighted toward equities with fixed income buffer (Correct answer)
- Equal split between commodities and real estate only
Correct answer: Diversified mix weighted toward equities with fixed income buffer
A long time horizon supports a higher equity weighting for growth potential, while a fixed income buffer provides stability appropriate for moderate risk tolerance.
STEP Portfolio Management & Strategy 2
Under the Uniform Prudent Investor Act (UPIA), which factor is NOT explicitly listed as relevant to a trustee's investment decisions?