CTFA Investment Management for Trust Accounts 1 — Questions and Answers
Question 1: Which asset allocation concept involves periodically restoring a portfolio to its target allocation after market movements have caused drift?
- Rebalancing (Correct answer)
- Dollar-cost averaging
- Tax-loss harvesting
- Asset location
Correct answer: Rebalancing
Rebalancing restores a portfolio to its intended asset allocation by selling overweighted assets and buying underweighted ones after market changes cause drift.
Question 2: What does the Sharpe ratio measure in portfolio analysis?
- Risk-adjusted return expressed as excess return per unit of total risk (standard deviation) (Correct answer)
- Total return relative to a benchmark index
- The portfolio's sensitivity to market movements (beta)
- The percentage of return attributable to the manager's skill
Correct answer: Risk-adjusted return expressed as excess return per unit of total risk (standard deviation)
The Sharpe ratio measures how much excess return (above the risk-free rate) an investor earns per unit of total portfolio risk, expressed as standard deviation.
Question 3: Under modern portfolio theory, which concept describes the set of optimal portfolios offering the highest expected return for each level of risk?
- The efficient frontier (Correct answer)
- The capital market line
- The security market line
- The minimum variance portfolio
Correct answer: The efficient frontier
The efficient frontier represents all portfolios that maximize expected return for a given level of risk or minimize risk for a given expected return.
Question 4: What is the primary purpose of including alternative investments such as real estate or commodities in a trust portfolio?
- To reduce overall portfolio volatility through diversification and low correlation with stocks and bonds (Correct answer)
- To maximize current income distributed to income beneficiaries
- To satisfy state legal list requirements for trust investments
- To eliminate exposure to equity market risk entirely
Correct answer: To reduce overall portfolio volatility through diversification and low correlation with stocks and bonds
Alternatives often have low or negative correlations with traditional assets, reducing overall portfolio volatility through diversification benefits.
Question 5: Which fixed-income measure describes the sensitivity of a bond's price to changes in interest rates?
- Duration (Correct answer)
- Convexity
- Yield to maturity
- Current yield
Correct answer: Duration
Duration measures the approximate percentage change in a bond's price for a 1% change in interest rates—longer duration means greater interest rate sensitivity.
Question 6: What is asset location in the context of trust and tax-efficient investing?
- Placing assets in accounts where their tax characteristics provide the greatest after-tax benefit (Correct answer)
- Selecting the geographic regions where trust assets should be invested
- Determining the legal situs of the trust for state income tax purposes
- Identifying the physical location of trust-held real property
Correct answer: Placing assets in accounts where their tax characteristics provide the greatest after-tax benefit
Asset location strategically places investments in accounts based on their tax treatment—tax-inefficient assets in tax-advantaged accounts and tax-efficient assets in taxable accounts.
CTFA Investment Management for Trust Accounts 1
Which asset allocation concept involves periodically restoring a portfolio to its target allocation after market movements have caused drift?