Vignette: Kent Slow is a portfolio manager for Delta Capital. Delta provides portfolio management services for defined pension assets for a variety of companies.
Delta is considering expanding its asset management service to life insurance companies and endowments. Delta has given Kent the assignment of producing a report on issues relating to the differences between life insurance companies and endowments.
Question: Which of the following are spending rules that apply to endowments?
I. Simple spending rule
II. Arithmetic spending rule
III. Rolling 5-year average
IV. Geometric spending rule
Select an Answer: I, II, III I, III, IV I, IV II, IV
Rationale:
There are three spending rules that are used for endowments as follows:
Simple spending rule, which is the institution's specified spending rate multiplied by the beginning period market value of endowment assets.
Rolling 3-year average. This rule generates a spending amount that equals the institution's specified spending rate multiplied by the average of the three previous years' market value of endowment assets.
Geometric spending rule. The weights of prior years spending level is adjusted for inflation by a smoothing rate.
2025-05-08
Vignette: Oscar Labonski is a portfolio manager for Beta Capital. Beta provides portfolio management services for institutional clients' pension funds.
Beta has been considering expanding their business and marketing their portfolio management services to foundations. Prior to approaching any potential client, Beta has given Oscar the assignment of producing a report on issues that would be relevant to portfolio management for foundations.
Question: What is the tax status of foundations?
Select an Answer: Foundations are taxed on their investment income at regular corporate rates. Foundations are non-taxable entities. Foundations are tax exempt other than interest income but capital gains and dividends received by the foundation are tax exempt. Foundations are taxable entities, but only at a 10% rate on all investment income.
Rationale:
Other than investment income of private foundations taxed at 1%, foundations are not taxable entities. Tax considerations are not a major concern for foundations.
2025-05-07
Question: The percentage difference between the forward exchange rate and the spot exchange rate is designated:
Select an Answer: exchange rate differential. forward exchange rate discount or premium. forward discount rate or premium rate.
spot exchange rate discount or premium. interest rate parity.
Rationale:
The percentage difference between the forward exchange rate and the spot exchange rate is designated the forward exchange rate discount or premium.
2025-05-06
Vignette: Berlin Life Insurance Company is a U.S. life insurance company that has changed its product offerings to meet client demands over the past couple of years. The company has seen clients no longer as interested in whole life policies and instead purchasing floating rate policies such as variable and universal life.
The average duration of Berlin's liabilities is 10 years, and the company targets a 2% spread on its investment assets over its liabilities. The firm's actuaries have assumed a 6% nominal return based on current capital market conditions. The firm does expect the interest rate environment to get more volatile over the next year.
The company has two investment portfolios. One portfolio is invested in fixed income and relates to funds required to meet liabilities, and the other portfolio is for the company's surplus, which is invested in equities. Berlin expects the equity market to produce a 10% return in the long term. Berlin has also decided to increase the target spread between its investment returns and liabilities by an additional .5%. The current portfolios of Berlin are outlined below:
Asset Class
Fixed-Income Portfolio
Surplus Portfolio
T-bills
12%
10%
T-bonds intermediate
16%
0%
Corporate bonds
7%
0%
Treasury bonds, long term
47%
0%
Corporate bonds, long term
18%
0%
U.S. stock, large cap
0%
55%
U.S. preferred stock
0%
35%
Yield
4.8
3.2%
Total return
7.2%
10.25%
Question: Which of the following statements is not correct regarding the time horizon of Berlin over the past 10 years?
Select an Answer: Berlin would have experienced greater competition for business, which would place pressure on margins and force Berlin to invest in riskier investments. Berlin's time horizon would have gotten progressively longer as the average life span of its policyholders increased. Berlin would have had to segment its investment portfolios along product lines that have different return objectives, time horizons and liquidity concerns. Due to interest rate environments becoming more volatile, Berlin would have been forced to create rate sensitive insurance products to prevent disintermediation.
Rationale:
All the statements are correct other than the reference to the time horizon getting longer. The time horizon of insurance companies has gotten shorter as the duration of the products insurance companies are offering decreases.
2025-05-05
Vignette: Berlin Life Insurance Company is a U.S. life insurance company that has changed its product offerings to meet client demands over the past couple of years. The company has seen clients no longer as interested in whole life policies and instead purchasing floating rate policies such as variable and universal life.
The average duration of Berlin's liabilities is 10 years, and the company targets a 2% spread on its investment assets over its liabilities. The firm's actuaries have assumed a 6% nominal return based on current capital market conditions. The firm does expect the interest rate environment to get more volatile over the next year.
The company has two investment portfolios. One portfolio is invested in fixed income and relates to funds required to meet liabilities, and the other portfolio is for the company's surplus, which is invested in equities. Berlin expects the equity market to produce a 10% return in the long term. Berlin has also decided to increase the target spread between its investment returns and liabilities by an additional .5%. The current portfolios of Berlin are outlined below:
Asset Class
Fixed-Income Portfolio
Surplus Portfolio
T-bills
12%
10%
T-bonds intermediate
16%
0%
Corporate bonds
7%
0%
Treasury bonds, long term
47%
0%
Corporate bonds, long term
18%
0%
U.S. stock, large cap
0%
55%
U.S. preferred stock
0%
35%
Yield
4.8
3.2%
Total return
7.2%
10.25%
Question: Which of the following would be a recommended change to the surplus portfolio that Berlin should make?
Select an Answer: Increase large-cap allocation and reduce preferred stock allocation. Due to the increased exposure to interest rate volatility, Berlin should reduce equity exposure and increase intermediate-term corporate and treasury allocation. Berlin should reduce the equity allocation and increase the allocation to long-term corporate and treasury bonds. Eliminate the preferred stock allocation and reduce the large-cap allocation. Berlin should diversify the portfolio into other equity asset classes as well as REITs and venture capital.
Rationale:
The surplus portfolio should focus on long-term capital gains and not income. The surplus portfolio should be reasonably diversified. The current allocation is focused on large cap and preferred stocks and is not well diversified. There is no need for income from the preferred stocks in the portfolio. The allocation should include small-cap stocks, mid-cap stocks, international equities, REITs, and venture capital and a very small allocation to bonds.
