CTFA Investment Management for Trust Accounts 2 — Questions and Answers
Question 1: Which investment strategy attempts to replicate the performance of a market index at low cost?
- Passive (index) investing (Correct answer)
- Active management
- Tactical asset allocation
- Absolute return investing
Correct answer: Passive (index) investing
Passive investing uses index funds or ETFs to replicate benchmark indices at minimal cost, based on the premise that markets are largely efficient.
Question 2: What is the primary fiduciary concern when a trustee uses affiliated investment products in a trust portfolio?
- A potential conflict of interest because the trustee may benefit from higher fees on affiliated products (Correct answer)
- Diversification risk from concentrating assets in one fund family
- Violation of the trust's asset allocation policy
- Failure to meet the minimum investment minimums required by trust law
Correct answer: A potential conflict of interest because the trustee may benefit from higher fees on affiliated products
Using affiliated products creates a conflict of interest because the corporate trustee may earn additional revenue from fund management fees, potentially at the beneficiary's expense.
Question 3: In trust portfolio management, what is the significance of a trust's time horizon?
- Longer time horizons allow for greater equity exposure because short-term volatility can be weathered over time (Correct answer)
- Longer time horizons require more conservative allocations to preserve principal
- Time horizon is irrelevant because trust distributions must be paid regardless of market conditions
- Shorter time horizons allow the trustee to take more risk because recovery is expected soon
Correct answer: Longer time horizons allow for greater equity exposure because short-term volatility can be weathered over time
A longer investment horizon allows the trust to bear more short-term volatility and invest more heavily in equities with higher expected long-term returns.
Question 4: What is beta in the context of investment management?
- A measure of a security's or portfolio's volatility relative to the overall market (Correct answer)
- The excess return earned above the risk-free rate
- The standard deviation of a portfolio's monthly returns
- The correlation coefficient between two asset classes
Correct answer: A measure of a security's or portfolio's volatility relative to the overall market
Beta measures how much a security or portfolio moves relative to the market; a beta of 1.5 means the asset is expected to move 1.5 times as much as the market.
Question 5: Which risk is specific to an individual company or security and can be eliminated through diversification?
- Unsystematic (idiosyncratic) risk (Correct answer)
- Systematic (market) risk
- Interest rate risk
- Inflation risk
Correct answer: Unsystematic (idiosyncratic) risk
Unsystematic risk is company-specific risk (e.g., a product recall or management scandal) that can be diversified away by holding a broad portfolio of securities.
Question 6: What is dollar-cost averaging and what is its primary behavioral benefit for long-term investors?
- Investing fixed dollar amounts at regular intervals, which reduces the average cost per share and removes emotional market-timing decisions (Correct answer)
- Investing a lump sum immediately to maximize exposure to market gains
- Shifting to cash equivalents during volatile markets to preserve principal
- Buying only when the market drops by a set percentage to time the market
Correct answer: Investing fixed dollar amounts at regular intervals, which reduces the average cost per share and removes emotional market-timing decisions
Dollar-cost averaging invests fixed amounts on a schedule regardless of price, automatically buying more shares when prices fall and fewer when prices rise.
CTFA Investment Management for Trust Accounts 2
Which investment strategy attempts to replicate the performance of a market index at low cost?