BOTH HAVE HIGH NEEDS FOR CASH EQUIVALENTS TO FUND LARGE PAYOUTS. ..

Question

4.  Both have high needs for cash equivalents to fund large payouts. Determine whether you agree or disagree with each statement made by Edwards. Support your decision. Note: supporting your opinion by simply reversing an incorrect statement will receive no credit. Grading GuideAnswer for Question 4 Disagree-Statement 1. DB plan time horizons are primarily determined by the duration of the liabilities and are not perpetual. (They may be legally perpetual, but that is irrelevant to the IPS.) Disagree-Statement 2. For DB plans, future inflation may only apply to some liabilities, not all. Or, inflation is already incorporated in the actuary's determination of future and PV of liabilities of DB plans. Inflation is not a component of return for the DB manager to consider in the way it is done for foundations. Agree-Statement 3. The correlations are relevant to both. If the receiving foundation is highly dependent on portfolio distributions, it reduces risk tolerance. So, if low returns correlated with increased needs, portfolio risk tolerance would need to be lower. For DB plans, the high correlation described reduces risk tolerance to avoid contribution requirements increasing when business results are poor. Disagree-Statement 4. The need to hold cash equivalents and fund payouts varies for both. Candidate discussion: 1 point for each correct determination and 1 point for the explanation if the decision is correct. (Study Session 6, LOS 13. b, c, i) QUESTION 5 HAS SEVEN (A, B, C, D, E, F, G) PARTS FOR A TOTAL OF 25 MINUTES Vincent Scavuzzo is a CFA charterholder and was recently hired as a director of high net worth clients for an investment firm. One of his goals is to move the firm into alternative investments. In preparation for this move, the firm's board has raised several issues he must address. ... A. Explain why the firm will need legal and tax advisors to invest in private equity and other partnerships when this is not needed for existing stock and bond portfolios. Answer for Question 5-A These investments use a limited partnership (or similar) structure. Each partnership can differ, so it is essential to review the document for legal or tax implications. One common stock is legally like another common stock, but one partnership may not be the same as another in legal or tax details. Candidate discussion: 3 points for discussing the unique structure details of each partnership contract. (Study Session 13, LOS 26.b, d, g, i, k, l, m, n) B. State whether direct real estate or REITs will be more expensive to invest in. Support your decision with one reason it will be more expensive for the firm and one reason it will be more expensive for clients. Answer for Question 5-B Direct RE will be more expensive:   For the firm: each property is unique and information is generally not publically available, so the property must be thoroughly researched prior to any recommendation. (Or property must be physically managed and maintained, which will involve time and expense).   For the client: investment management fees are generally higher (or commission and other transaction costs are generally higher). Candidate discussion: 1 point for direct, 2 points each for the two reasons. One must relate to the firm and one the client. C. State whether direct real estate or REITs should provide the largest diversification benefit and explain why. Do not base your answer on return data for any specific historical time period. Answer for Question 5-C Direct RE: It should provide lower correlation to other portfolio assets and more diversification benefit. (Or REITs provide less diversification benefit because they behave partially like stock. They are in fact stock in publically traded shares of companies that invest in real estate.) Candidate discussion: 1 point for direct RE and 2 points for one reason. D. Explain decision risk and whether it is a more serious problem for private equity (PE) or for commodity futures contracts. Answer for Question 5-D Decision risk refers to investors investing in securities they do not really understand and then exiting the strategy at an inopportune time and at high cost. It is higher for PE. Or PE is generally illiquid and has a multiyear time horizon. The investor may be unable to exit and then assert they never understood the risks. In contrast, commodity futures are both liquid, have low transaction costs, and have short expiration dates. Being able to exit lowers the decision risk. Candidate discussion: 1 point each for explaining what decision risk is and that it is a bigger issue for PE. 1 point for an explanation of why it will be lower for futures contracts or higher for PE. E. Discuss how venture capital (VC) and buyout funds (BO) differ in regard to using leverage, riskiness of the underlying securities, consistency of returns, and cash flow pattern to the investors over the life of the fund. E.   BO funds often use leverage and VC do not.   Underlying VC investments are more risky.   BO fund returns are typically more consistent.   BO funds generally begin to return cash to investors sooner and complete their liquidation in a shorter period. Candidate discussion: 1 point each, for the four issues. F. Explain what vintage year means and the implication for selecting private equity benchmarks. Answer for Question 5-F Vintage year is the year in which initial investments are made. The initial economic conditions generally have a significant effect on subsequent returns and, therefore, the benchmark should have the same vintage year as the investment. Candidate discussion: 1 point for explaining vintage year and 2 points for the discussion. For a

Answer

4.  Both have high needs for cash equivalents to fund large payouts. Determine whether you agree or disagree with each statement made by Edwards. Support your decision. Note: supporting your opinion by simply reversing an incorrect statement will receive no credit. Grading GuideAnswer for Question 4 Disagree-Statement 1. DB plan time horizons are primarily determined by the duration of the liabilities and are not perpetual. (They may be legally perpetual, but that is irrelevant to the IPS.) Disagree-Statement 2. For DB plans, future inflation may only apply to some liabilities, not all. Or, inflation is already incorporated in the actuary's determination of future and PV of liabilities of DB plans. Inflation is not a component of return for the DB manager to consider in the way it is done for foundations. Agree-Statement 3. The correlations are relevant to both. If the receiving foundation is highly dependent on portfolio distributions, it reduces risk tolerance. So, if low returns correlated with increased needs, portfolio risk tolerance would need to be lower. For DB plans, the high correlation described reduces risk tolerance to avoid contribution requirements increasing when business results are poor. Disagree-Statement 4. The need to hold cash equivalents and fund payouts varies for both. Candidate discussion: 1 point for each correct determination and 1 point for the explanation if the decision is correct. (Study Session 6, LOS 13. b, c, i) QUESTION 5 HAS SEVEN (A, B, C, D, E, F, G) PARTS FOR A TOTAL OF 25 MINUTES Vincent Scavuzzo is a CFA charterholder and was recently hired as a director of high net worth clients for an investment firm. One of his goals is to move the firm into alternative investments. In preparation for this move, the firm's board has raised several issues he must address. ... A. Explain why the firm will need legal and tax advisors to invest in private equity and other partnerships when this is not needed for existing stock and bond portfolios. Answer for Question 5-A These investments use a limited partnership (or similar) structure. Each partnership can differ, so it is essential to review the document for legal or tax implications. One common stock is legally like another common stock, but one partnership may not be the same as another in legal or tax details. Candidate discussion: 3 points for discussing the unique structure details of each partnership contract. (Study Session 13, LOS 26.b, d, g, i, k, l, m, n) B. State whether direct real estate or REITs will be more expensive to invest in. Support your decision with one reason it will be more expensive for the firm and one reason it will be more expensive for clients. Answer for Question 5-B Direct RE will be more expensive:   For the firm: each property is unique and information is generally not publically available, so the property must be thoroughly researched prior to any recommendation. (Or property must be physically managed and maintained, which will involve time and expense).   For the client: investment management fees are generally higher (or commission and other transaction costs are generally higher). Candidate discussion: 1 point for direct, 2 points each for the two reasons. One must relate to the firm and one the client. C. State whether direct real estate or REITs should provide the largest diversification benefit and explain why. Do not base your answer on return data for any specific historical time period. Answer for Question 5-C Direct RE: It should provide lower correlation to other portfolio assets and more diversification benefit. (Or REITs provide less diversification benefit because they behave partially like stock. They are in fact stock in publically traded shares of companies that invest in real estate.) Candidate discussion: 1 point for direct RE and 2 points for one reason. D. Explain decision risk and whether it is a more serious problem for private equity (PE) or for commodity futures contracts. Answer for Question 5-D Decision risk refers to investors investing in securities they do not really understand and then exiting the strategy at an inopportune time and at high cost. It is higher for PE. Or PE is generally illiquid and has a multiyear time horizon. The investor may be unable to exit and then assert they never understood the risks. In contrast, commodity futures are both liquid, have low transaction costs, and have short expiration dates. Being able to exit lowers the decision risk. Candidate discussion: 1 point each for explaining what decision risk is and that it is a bigger issue for PE. 1 point for an explanation of why it will be lower for futures contracts or higher for PE. E. Discuss how venture capital (VC) and buyout funds (BO) differ in regard to using leverage, riskiness of the underlying securities, consistency of returns, and cash flow pattern to the investors over the life of the fund. E.   BO funds often use leverage and VC do not.   Underlying VC investments are more risky.   BO fund returns are typically more consistent.   BO funds generally begin to return cash to investors sooner and complete their liquidation in a shorter period. Candidate discussion: 1 point each, for the four issues. F. Explain what vintage year means and the implication for selecting private equity benchmarks. Answer for Question 5-F Vintage year is the year in which initial investments are made. The initial economic conditions generally have a significant effect on subsequent returns and, therefore, the benchmark should have the same vintage year as the investment. Candidate discussion: 1 point for explaining vintage year and 2 points for the discussion. For a