Maestría en Finanzas

Gestión de Portafolios y Planificación de Inversiones

PRACTICA DIRIGIDA N° 1
Jefe de Prácticas: Luis Paz Delgado.
Correo: LRM.PazD@up.edu.pe
Fecha: 19-06-2019

I. THE PORTFOLIO MANAGEMENT PROCESS AND THE INVESTMENT POLICY

STATEMENT
1. Which of the following most accurately identifies the three main steps in the portfolio management
process?

A) Objectives, constraints, risk tolerance.

B) Planning, execution, feedback.

C) Planning, asset allocation, security selection.

2. Which of the following is not considered to be an investment constraint?

A) Tax concerns.

B) Time horizon.

C) Risk tolerance.

3. Individual investors and institutional investors can be impacted differently by different constraints.
Which constraints have a large impact on individual investors and a large impact on pension funds,
respectively?

A) Legal and regulatory issues for individual investors and tax considerations for pensions.

B) Liquidity concerns for individual investors and tax considerations for pensions.

C) Tax considerations for individual investors and legal and regulatory issues for pensions.

4. Which of the following statements about investment policy statements (IPS) is least accurate? The IPS:

A) Helps insure against short-term shifts in strategy when either market environments or portfolio performance
cause panic or overconfidence. Direct long-term investment portfolio decisions.

B) Is an informal statement of objectives and constraints.

C) Can be readily implemented by current or future investment advisors.

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5. The objective of achieving a 10% annual rate of return is an example of a(n):

A) Absolute risk objective.

B) Required return objective.

C) Relative return objective.

6. William Parthley, age 69, has had bad luck with his investments in recent years and decides to consult
Moira Wembley, CFA, for advice. Parthley’s portfolio is composed of 90% stocks and 10% bonds, with a
total value of $2.6 million. Classifying himself as conservative, Parthley blamed the aggressive
allocation on a previous money manager, and says he wants to substantially increase the fixed-income
weighting of his portfolio.
From his portfolio, Parthley hopes to fund his retirement at a rate of $7,000 per month, adjusted for
inflation. He has also promised his alma mater at least $2 million upon his death. Parthley is in good
health, and most of the men in his family have lived into their late 80s.

Based solely on the information presented above, Wembley can conclude that there is most likely a
conflict between Parthley’s:

A) Return requirements and asset allocation.

B) Willingness to take risk and ability to take risk.

C) Return requirements and asset allocation as well as his willingness to take risk and ability to take risk.

7. A money manager who crafts portfolios using all of Standard & Poor’s sector index exchange traded
funds (ETFs), aggressively overweighting and underweighting sectors, follows what investment
strategy?

A) Active.

B) Semi-active.

C) Passive.

8. A defined benefit pension plan would most likely have which of the following set of return objectives
and risk tolerance?

Return Requirements Risk Tolerance

A) Life cycle stage of beneficiaries Risk tolerance of beneficiaries

B) Fund pension liability + inflation Plan features, funding status of plan, & age of workforce

C) Pension liability + inflation Risk tolerance of beneficiaries

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9. James Stephenson, age 55 and single, is a surgeon who has accumulated a substantial investment
portfolio without a clear long-term strategy in mind. Two of his patients who work in financial
markets comment as follows:

• James Hrdina: ‘‘My investment firm, based on its experience with investors, has standard investment
policy statements in five categories. You would be better served to adopt one of these standard policy
statements instead of spending time developing a policy based on your individual circumstances.’’

• Charles Gionta: ‘‘Developing a long-term policy can be unwise given the fluctuations of the market. You
want your investment adviser to react continuously to changing conditions and not be limited by a set
policy.’’

Stephenson hires a financial adviser, Caroline Coppa. At their initial meeting, Coppa compiles the
following notes:

“Stephenson currently has a $2.0 million portfolio that has a large concentration in small-capitalization U.S.
equities. Over the past five years, the portfolio has averaged 20 percent annual total return on investment.
Stephenson hopes that, over the long term, his portfolio will continue to earn 20 percent annually. When
asked about his risk tolerance, he described it as ‘‘average.’’ He was surprised when informed that U.S.
small-cap portfolios have experienced extremely high volatility.

He does not expect to retire before age 70. His current income is more than sufficient to meet his
expenses. Upon retirement, he plans to sell his surgical practice and use the proceeds to purchase an
annuity to cover his postretirement cash flow needs.

Both his income and realized capital gains are taxed at a 30 percent rate. No pertinent legal or regulatory
issues apply. He has no pension or retirement plan but does have sufficient health insurance for
postretirement needs.”

A. The comments about investment policy statements made by Stephenson’s patients are best
characterized as:

Hrdina Gionta
A Correct Correct
B Correct Incorrect
C Incorrect Correct
D Incorrect Incorrect

B. In formulating the return objective for Stephenson’s investment policy statement, the most
appropriate determining factor for Coppa to focus on:

A. Return desires

B. Ability to take risk

C. Return requirement

D. Stephenson’s returns over past five years

C. Stephenson’s willingness and ability to accept risk can be best characterized as:

Willingness to Accept Risk Ability to Accept Risk

A Below average Below average
B Below average Above average
C Above average Below average
D Above average Above average

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II. MANAGING INDIVIDUAL INVESTOR PORTFOLIOS

10. Jennifer Moore has worked in a governmental position (administrative assistant) since graduating from
high school. She loves her job because she is very good at following her bosses’ orders. At office
functions, many of her colleagues ranted and raved about the quality of her baked goods. Some even
suggested that they tasted so good that she should quit her job and sell baked goods. Moore is 50
years old and never paid attention to the suggestions of her colleagues. She plans on retiring from the
government in three years.

Based on her personality type, what type of investor is Moore?

A) Cautious.

B) Methodical.

C) Individualist.

11. Which of the following is a reason why psychological profiling is important for understanding
individual investor behavior? Investors:

A) Are assumed to only select portfolios that maximize a return for a given level of risk.

B) Are loss averse.

C) Focus on individual asset risk/return characteristics as well as how the individual asset interacts with other
assets in the portfolio.

12. Tony Mitchell, a college professor, is considering investing in a mutual fund. His number one priority is
long-term capital appreciation. He will take above-average risk in exchange for the possibility of
outperforming the market. Tony is 30 years old and expects to be at the university until age 70. Which
fund is more appropriate for Mitchell given a risk free rate of 3%?

Mutual Fund A Mutual Fund B

Balanced Growth and Income
Five year return 14% Five year return 12%
Standard deviation = 12 Standard Deviation = 7
Consists of 40% growth stocks, 60% preferred stocks Consists of 60% growth stocks and 40% high dividend stocks

A) A, because it has a better risk/return relationship.

B) A, because of its higher five year return.

C) B, because it has a better risk/return relationship.

13. Kent Andling is 55 years old and recently sold his high tech manufacturing company, which was
started in his father’s basement 35 years ago. Andling’s two children are grown and have been featured
in recent entrepreneur magazine articles as up and coming entrepreneurs. How would Andling be
classified given this brief profile?

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A) Not enough information to tell.

B) Moderate-to-high risk tolerant.

C) Low-to-moderate risk tolerant.

14. Dan Newsmith is 35 and was recently promoted to regional sales manager of a national trading
company. Newsmith has no credit card debt, he does not have an automobile loan, and his home is
mortgage free. Newsmith’s salary and bonus more than adequately cover living expenses. Given this
brief profile, classify Newsmith’s ability to tolerate risk when investing excess funds.

A) Moderate-to-high risk tolerance.

B) Low-to-moderate risk tolerance.

C) Not enough information to tell.

15. Dan Kreuz, age 35, is a supervisor with BHS Consumer Finance and earns an annual salary of $95,000
per year before taxes. His spouse, Szeren Kreuz, age 36, is a marketing manager for a firm specializing
in rental property, and earns $55,000 per year. Dan and Szeren recently inherited $800,000 from
Szaren’s father’s estate. In addition to their income and their inheritance, the Kreuz’s have accumulated
the following assets:

 $10,000 in cash
 $150,000 in stock and bond mutual funds
 $240,000 in BHS common stock.

The Kreuz’s annual living expenses are $90,000 per year and their tax rate is 40 percent. After-tax
salary increases will offset any future increases in living expenses.

In a discussion with their financial advisor, Joel Douglas, the Kreuz’s express concern about having
enough assets for a comfortable retirement. The Kreuz’s make the following comments to Douglas:

 We want to retire in 20 years.

 We were very uncomfortable with the decline in the stock market from 2000-2002, and cannot tolerate a
drop in our investments of more than 10% in any given year.
 We do not plan to have children.

After the discussion with Douglas, he goes back to his office to prepare an investment policy statement
for the Kreuz’s. He determines that to meet their goals, they will need $2,500,000 in 20 years. Which of
the following is the most appropriate description of the risk objective for the Kreuz’s?

Willingness to Take Risk Ability to Take Risk Overall Conclusion

A) Below Average Below Average Below Average

B) Below Average Above Average Below Average

C) Below Average Above Average Above Average

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16. Jack and Ruth Ingram, each 50 years old, live in Canada and have recently retired. Jack worked for
much of his career at Pitt Manufacturing, a publicly traded, small-capitalization (small-cap) Canadian
firm. Jack has agreed to join Pitt’s board of directors without compensation. The Ingrams are in good
health and have adequate medical insurance coverage.

Jack has accumulated Pitt common stock currently valued at C$1,000,000 through the company’s
employee stock ownership program. Since the Pitt stock has appreciated significantly in recent years,
Jack’s holdings have a low average cost basis. Pitt stock and options on the Pitt stock are traded in
active and liquid markets on a national exchange.

The Ingrams have recently inherited C$2,400,000 net of taxes consisting mostly of small-cap Canadian
equities. The inheritance, the Pitt stock Jack has accumulated, and C$800,000 in bonds and cash
equivalents represent their total financial assets. The Ingrams live in a house with a market value of
C$1,250,000. They have decided to donate the house to a provincial park upon their death.

Their only child, Paul (22 years old), has a well-paying job and is economically independent.

The Ingrams are meeting with Caleb Swann, CFA, their long-time advisor, to discuss financial planning
issues. The Ingrams agree that their current annual pre-tax income need is C$200,000. The Ingrams
expect that their inflation-adjusted expenses will remain constant during retirement. They plan to fund
their living expenses by taking annual distributions from their portfolio with the first distribution to
occur immediately. Swann believes an appropriate long-term inflation rate is 2.5 percent and an
appropriate planning horizon is 35 years. Upon their death, the Ingrams wish to leave gifts to Paul and
to a local charity. They wish to maintain the purchasing power of these gifts to be equivalent to
C$2,000,000 and C$1,000,000, respectively, in today’s dollars.

Swann believes he has gathered enough information about the Ingrams to determine their personality
types. A summary of this information is presented in the following chart.

• Jack often reads about investing and realizes that achieving higher returns is
accompanied by taking higher risk.
• Jack and Ruth both agree they will accept a lower return if it means they can take less
risk.
• Jack likes to be presented with facts rather than generalities, and he is always
interested in discussing articles about investing.
• When Ruth was a child, her parents experienced significant financial difficulty as a
result of poor performance of their equity investments.
• Ruth is concerned whenever the Ingrams’ portfolio experiences moderate fluctuations in
value.

a) Classify Jack and Ruth within of following investors types. Justify your classification:

i. Cautious investor (Ruth)

ii. Methodical investor (Jack)

iii. Spontaneous investor

iv. Individualistic investor

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b) In the following template, formulate the objectives and constrains for the Ingrams. Calculations are
required in the case of return (nominal pre-tax):

Investment Objectives and Constrains

Objectives Return
Risk

Constrains Time Horizon

Taxes

Liquidity

Legal and regulatory

Unique circumstances

17. Barbara Analee, a retired registered nurse and business woman, recently retired at age 50 to pursue a
life as a blues singer. She had been running a successful cosmetics and aesthetics business using
state-of-the-art lasers to treat wrinkles and skin blemishes. She is married to Tom, a retired scientist
(age 55). They have saved $3 million in their portfolio (Barbara contributed $2.5 million to this portfolio)
and now they want to travel the world. Their three children are all grown and out of college and have
begun to have their own families. Barbara now has two grandchildren. Barbara and Tom feel that they
have achieved a comfortable portfolio level to support their family’s needs for the foreseeable future.

In order to meet their basic living expenses, Tom and Barbara feel that they need $75,000 per year in
today's dollars before taxes to live comfortably. As a trained professional, Barbara likes to be
intensively involved in researching investment opportunities. Barbara and Tom want to be able to
provide $10,000 per year (pretax) indexed for inflation to each of their grandchildren over the next ten
years for their college education. She believes that she can accomplish this through her portfolio. She
also wants to set aside $15,000 each year (pretax) indexed for inflation for traveling for her musical
performances at various dinner clubs around the U.S. They have no debt and they own their home
without a mortgage. Most of their portfolio is currently in large cap U.S. stocks and U.S. Treasury notes
and bills.

They have approached Pamela Jaycoo, CFA, for guidance on how they could best achieve their
financial goals while also providing for their grandchildren’s college needs. Inflation is expected to stay
at 3 percent annually for the foreseeable future.

A. Barbara Analee can be classified into which of the following personality types?

A) Individualist investor.

B) Methodical investor.

C) Cautious investor.

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B. What is the Analees return objective for this year?

A) 6.17%.

B) 6.67%.

C) 3.83%.

C. What is their tolerance for risk?

A) Below average.

B) Average.

C) Above average.

D. What is Barbara’s willingness and ability to assume risk?

Willingness Ability

A) Above average Average

B) Below average Average

C) Above average Above average

E. Based on the information presented in the case above, which one of the following portfolios should
the Analees choose:

Expected Return Portfolio A Portfolio B Portfolio C

U.S Stocks - S&P 500 9% 20% 5% 10%
U.S Stocks - Small Cap 10% 20% 15% 10%
Intl Stocks - Developing 12% 15% 15% 10%
U.S Corporate Bonds 5% 15% 0% 35%
U.S Treasury Bonds 3% 10% 0% 25%
Venture Capital 11% 5% 30% 0%
Real Estate 15% 10% 30% 0%
Cash 1% 5% 5% 10%
Total Return (before taxes) 8.8% 11.6% 5.7%
Total Return (after taxes) 5.6% 7.4% 3.6%
Yield (after taxes) 1.9% 1.9% 2.8%

A) Portfolio B.

B) Portfolio C.

C) Portfolio A.

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III. CAPITAL MARKET EXPECTATIONS

18. Which of the following is NOT a characteristic of a good forecast using capital market expectations?
The forecasts:

A) Have a minimum amount of forecast error.

B) Are consistent with the forecasts used for other assets.

C) Are subjectively formed.

19. Frank Bowden is formulating the expected returns, standard deviations, and correlations for bonds and
equities given global economic forecasts. Tom Weatherford is examining the returns to a U.S. small-
cap stock based on analyst's forecasted returns versus the capital asset pricing model and the security
market line. Which of the following about Bowden and Weatherford is most accurate?

A) Bowden is performing beta research and Weatherford is performing alpha research.

B) Bowden is performing alpha research and Weatherford is performing beta research.

C) Bowden is performing beta research and Weatherford is performing beta research.

20. Seth Bildownes is an analyst who has prepared forecasts regarding the current capital market
environment. He recently gave his presentation to the managing directors of his firm. Excerpts of his
presentation follow:
‘‘Noting that year-end holiday sales have been weak over the past several years, I believe that current
expectations should be likewise muted. In fact, just last week, I had an occasion to visit Harrods and
noticed that the number of shoppers seemed quite low.
The last time I saw a retail establishment with so little pedestrian traffic at the beginning of December
was in 1990, and that coincided with one of the worst holiday sales periods in the past 50 years. Thus,
there will be no overall year-over-year retail sales growth this holiday season.’’

A. Identify any psychological traps that may be interfering with the creation of Bildownes’s forecasts.

B. Recommend a way to mitigate the bias caused by any trap identified in Part A.

21. An investor is considering adding three new securities to his internationally focused fixed-income
portfolio. The securities under consideration are as follows:

• 1-year U.S. Treasury note (noncallable)

• 10-year BBB/Baa rated corporate bond (callable)
• 10-year mortgage-backed security (MBS) (callable; government-backed collateral)

The investor will invest equally in all three securities being analyzed or will invest in none of them at
this time. He will make the added investment provided that the expected spread/premium of the equally
weighted investment is at least 0.5 percent (50 bps) over the similar-term Treasury bond. The investor
has gathered the following information:

• Real risk-free interest rate: 1.2%

• Current inflation rate: 2.2%

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• Spread of 10-year over 1-year Treasury note: 1.0%

• Long-term inflation expectation: 2.6%
• 10-yr MBS prepayment risk spread (over 10-year Treasuries): 95 bps **
• 10-yr call risk spread: 80 bps
• 10-yr BBB credit risk spread (over 10-year Treasuries): 90 bps

**This spread implicitly includes a maturity premium in relation to the 1-year T-note as well as
compensation for prepayment risk.

Using only the information given, address the following problems using the risk premium
approach:

A.- Calculate the expected return that an equal-weighted investment in the three securities could
provide.

B.- Calculate the expected total risk premium of the three securities, and determine the investor’s
probable course of action.

22. Calculate the short-term interest rate target given the following information.

Neutral rate 4.00%

Inflation target 2.00%
Expected Inflation 5.00%
GDP long-term trend 3.00%
Expected GDP 1.00%

A) 4.5%.

B) 6.5%.

C) 5.0%.

23. Which of the following is consistent with a steeply upwardly sloping yield curve?

A) Monetary policy is expansive while fiscal policy is restrictive.

B) Monetary policy is expansive and fiscal policy is expansive.

C) Monetary policy is restrictive and fiscal policy is restrictive.

Answer:

When both fiscal and monetary policies are expansive, the yield curve is sharply, upwardly sloping (i.e., short-term
rates are lower than long-term rates), and the economy is likely to expand in the future.

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24. Which of the following statements regarding interest rates and yields is most accurate?

A) An increase in short-term rates increases the yields on long-term bonds.

B) An increase in short-term rates may increase or decrease the yields on long-term bonds.

C) Short-term rates are independent of the yields on long-term bonds.

IV. ASSET ALLOCATION

25. Tactical asset allocation is a deviation from the strategic asset allocation for the purpose of:

A) Taking advantage of short-term capital market expectations.

B) Aligning with investor’s risk preferences.

C) Exceeding investor’s return objectives.

26. Bruce Calloway is interested in utilizing an appropriate asset allocation strategy for his portfolio. His
long-term view of the capital market conditions is that there will always be change and opportunities to
capture excess returns in the market. As a risk neutral investor, he is a consistent risk taker and his
risk tolerance on his portfolio can be expected to be constant based on such market expectations.
Which asset allocation strategy is the most appropriate strategy for his portfolio?

A) The tactical asset allocation strategy is most appropriate since this strategy assumes the investor’s risk
tolerance is constant and his capital market expectations are subject to frequent change.

B) The dynamic strategic asset allocation strategy is most appropriate since this allows the capability to quickly
move in and out of different assets as market conditions change.

C) The strategic asset allocation strategy is most appropriate since this strategy allows the portfolio to be
periodically rebalanced according to market conditions.

27. What is the major difference between dynamic asset allocation and static asset allocation? Dynamic
asset allocation:

A) Considers more than one asset class while static asset allocation only considers one asset class at a time.

B) Considers asset and liability management simultaneously while static asset allocation does not.

C) Takes a multi-period view of the investment horizon while static asset allocation does not.

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28. Jeff Graefe has a risk-aversion value of 6. He is evaluating three competing investments with the
following characteristics. Which investment would have the least utility for Graefe?

Portfolio Return Std. Dev.

A 18.0% 24.0%
B 13.5% 10.0%
C 9.5% 6.0%

A) A.

B) B.

C) C.

29. Frances Bonner, a retired nurse, is a potential new client for Fullen Capital Management. Bonner has
told Fullen that in order to pay the living expenses not covered by her pension and social security, she
must generate $10,000 annually on her $500,000 investment portfolio. She does not want to use
principal to meet her living expenses. Fullen has four model portfolios that Bonner could use for her
portfolio.

Portfolio Expected Return Standard Deviation

A 4.5% 6%
B 5.5% 8%
C 6.5% 10%

Based on Roy’s Safety-First Measure, Bonner should select:

A) Portfolio B.

B) Portfolio A.

C) Portfolio C.

30. James Mason is the Chief Operating Officer of the Homeless Mission Foundation (HMF), a foundation
with the purpose of providing food, clothing, and shelter for homeless individuals. Mason is currently
in the process of preparing a report to HMF’s board recommending an asset allocation for the
foundation. This year, Mason estimates that HMF’s operating budget will be $2.75 million. In order to
assist with preparation of his report, Mason has compiled the following data.

 The market value of the foundation is currently $50,000,000.

 The cost for providing services to homeless individuals is expected to rise at a rate of 3.0% per year.
 The board would like to maintain a cash cushion equal to half of the estimated operating budget in order
to meet any unexpected expenses.
 Management fees for the foundation are estimated to be 0.40%.
 The board is willing to accept market risk in order to meet its long-term objectives, but the board wants to
accept shortfall risk (defined as expected return minus two standard deviations) of no more than 15%.

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Mason must recommend one of three different portfolios to the board. Mason’s choice of portfolios is
shown below:

Asset Class Portfolio A Portfolio B Portfolio C

Large cap U.S. stocks 24% 30% 20%
Small cap U.S. stocks 10% 5% 13%
International – Developed market equities 5% 13% 5%
International – Emerging market equities 5% 5% 10%
U.S. Corporate bonds 25% 20% 17%
U.S. Treasury bonds 20% 16% 21%
Real estate 5% 10% 10%
Cash 6% 3% 4%
TOTAL 100% 100% 100%
Expected Annual Total Return (%) 7.85% 9.20% 8.80%
Expected Standard Deviation (%) 11.15% 12.10% 12.20%

In his report, Mason is going to recommend a portfolio based on 3 criteria: liquidity needs, return
requirements, and shortfall risk. Which of the portfolios should Mason recommend?

A) Portfolio B.

B) Portfolio A.

C) Portfolio C.

31. Paul Kelley and Marie Dascenzo are portfolio managers for Myers and Schmolenberger Investment
Advisors. Kelley and Dascenzo are discussing the asset allocation process that their firm should follow
for its clients. Kelley states, “The asset allocation process should always start with determining the
risk tolerance and return objective for each client.” Dascenzo replies, “While about half of the steps of
the asset allocation process is the responsibility of the portfolio manager, the other half of the asset
allocation process is the responsibility of the client.”

With regard to their statements about the asset allocation process:

A) Kelley is correct; Dascenzo is incorrect.

B) Kelley is incorrect; Dascenzo is incorrect.

C) Kelley is correct; Dascenzo is correct.

32. The first step in the portfolio construction process is called:

A) Tactical asset allocation.

B) Strategic asset allocation.

C) Capital market expectation.

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33. Any mean-variance efficient portfolio has the:

A) Lowest standard deviation and the highest expected return.

B) Lowest standard deviation for a given level of expected return.

C) Highest return among all other portfolios.

34. Shad Reed is on the Board of Trustees for the Wesley Ridge World Hunger Organization. The primary
role of the organization is to oversee a large endowment fund that was originally established in 1995 as
the Wesley Ridge U.S. Hunger Fund to provide food to low income children in the United States.
Recently, the original donor for the endowment has died and provided the fund another $200 million in
his will and broadened the scope of the fund to provide food for hungry children all over the world.
With the new addition, the endowment’s assets are currently valued at $600 million. When the fund was
originally established, the spending rate was 5%; however, with the broader scope, the payout has
increased to 6%. Also, since funds are going to be distributed to other countries, the board has
determined that approximately 25% of the foundation’s annual payout will be in the foreign currencies
of other countries. The fund’s investment policy statement which has been revised by the board is
shown below:

Accounting for inflation of 2.5% and the new spending rate of 6%, the return
Return Objective
requirement for the plan is 8.5%. A total return approach is appropriate.
Above average, although risk tolerance has declined due to higher spending
Risk Tolerance
needs.
The endowment has minimal operating expenditures – liquidity requirements are
Liquidity
low.
Time Horizon Long-term
Legal/Regulatory N/A
Taxes N/A
Unique Considerations N/A

The board has consulted with an investment advisor to discuss changes to the endowment’s current
asset allocation which is shown below:

Expected Expected Standard

Asset Class Allocation (%)
Return Deviation
Cash 2% 3.0% 2%
Intermediate-term U.S. Treasury bonds 28% 5.5% 7%
Foreign Government Bonds 8% 6.5% 10%
U.S. equities 50% 9.5% 18%
International equities 7% 11.0% 23%
Venture Capital 5% 19.0% 38%

Which of the following sets of recommendations would be most appropriate for the endowment fund?

A) Increase the allocation to cash, decrease the allocation to U.S. equities, decrease the allocation to international
equities, and increase the allocation to venture capital.

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B) Increase the allocation to foreign government bonds, increase the allocation to international equities, keep the
allocation to cash the same, and keep the allocation to venture capital the same.

C) Decrease the allocation to U.S. Equities, decrease the allocation to international equities, increase the
allocation to foreign government bonds, and increase the allocation to intermediate-term U.S. Treasury bonds.

35. Stokes Day Nursery is a nonprofit organization to provide day care for children from low-income
homes. The endowment that funds the nursery has a value of $8 million, and it is estimated that the
nursery will need $360,000 in the current year to fund its operations. The nursery’s expenses are
expected to grow by 3% annually, in line with inflation. William Rose has been hired as a consultant to
review Stokes Day Nursery’s portfolio. The asset allocation for the current portfolio is shown below.

Asset Class Allocation (%) Expected Return

Cash 2% 3%
Intermediate-term Treasury bonds 35% 4.5%
High quality corporate bonds 33% 5.0%
U.S. equities 25% 8.5%
Int’l equities (developed markets) 5% 10.0%
Int’l equities (emerging markets) 0% 12.0%

Rose makes four suggestions regarding the current portfolio:

Suggestion 1: The allocation to cash should be higher.

Suggestion 2: The allocation to intermediate-term Treasury bonds should be lower.
Suggestion 3: The allocation to U.S. equities should be lower.
Suggestion 4: The allocation to emerging market international equities is appropriate.

Which of the suggestions should the board of directors for Stokes Day Nursery agree with?

A) Suggestions 2 and 4 only.

B) Suggestions 1 and 2 only.

C) Suggestions 1 and 3 only.

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