Malaysia Securities Exam Module 10 - Asset and Funds Management

Correct Answer: (a) Hedge funds are subject to less regulatory oversight

Explanation: Hedge funds (option a) typically face less regulatory oversight compared to traditional investment options. Mutual funds (option b) have more stringent regulations. Hedge funds are not exempt from reporting requirements (option c), and they often use leverage for investment strategies (option d).

Correct Answer: (c) Split the investment between both options to balance income and potential for capital appreciation.

Explanation: Rational asset management often involves diversification to balance different investment objectives. By splitting the investment between the high-dividend stock and the growth stock, Mr. N can achieve a balanced approach. The high-dividend stock provides a steady income stream, while the growth stock offers the potential for capital appreciation. This aligns with the principle of diversification and adapting the portfolio to various market conditions.

Correct Answer: b) The emerging market investment is riskier due to currency and political instability.

Investing in emerging markets often involves higher risks, including currency fluctuations and political instability. These markets may have less-established regulatory frameworks and face challenges that are not as prevalent in developed countries. Assessing and understanding these specific risks is crucial for making informed investment decisions. Therefore, option (b) is the correct answer.

Incorrect Answers:
a) The developed country investment is riskier due to potential economic downturns – Developed countries generally have more stable economies, making this statement less accurate.
c) Both investments carry similar risks, as economic conditions are globalized – While global economic conditions can impact investments, the risks associated with developed and emerging markets are often distinct.
d) Risk assessment is irrelevant when choosing between developed and emerging markets – Risk assessment is always relevant in investment decisions, especially when comparing different markets with unique challenges.

Correct Answer: c) Alternative investments may have illiquidity, complexity, and manager risk.

Alternative investments, including private equity and hedge funds, often come with unique risks such as illiquidity, complexity in valuation, and manager risk. Illiquidity refers to the difficulty of selling an investment quickly, complexity arises from non-traditional strategies, and manager risk pertains to the reliance on the skill of fund managers. Understanding these risks is crucial for effective risk management. Therefore, option (c) is the correct answer.

Incorrect Answers:
a) Alternative investments carry no specific risks and provide guaranteed returns – This is incorrect as all investments, including alternatives, come with specific risks, and there are no guarantees in investing.
b) The primary risk of alternative investments is market volatility – While market volatility may play a role, alternative investments have additional unique risks beyond market fluctuations.
d) Traditional asset classes are riskier than alternative investments – This oversimplifies the risk comparison between traditional and alternative investments.

Correct Answer: (d) Keep the information confidential and refrain from using it for personal gain.

Explanation: Ethical standards require analysts to maintain confidentiality and avoid using non-public information for personal gain. Options (a) and (b) involve unethical practices such as insider trading. Option (c) may not be appropriate as immediate disclosure could impact market integrity. Keeping information confidential while refraining from personal gain aligns with ethical principles in the investment industry.

Correct Answer: (b) To identify the risk associated with the investment

Explanation: Due diligence involves thoroughly assessing potential investments to identify risks and ensure that the investment aligns with the fund’s objectives and risk tolerance. It includes analyzing financial statements, management practices, legal considerations, and other factors impacting the investment’s risk profile.

Incorrect Answers:

(a) To guarantee a positive return on investment – Due diligence cannot guarantee positive returns but aims to identify and manage risks.

(c) To minimize the need for diversification – Due diligence focuses on understanding and managing risks, not necessarily on diversification.

(d) To expedite the investment decision-making process – Due diligence is a comprehensive process that may take time; its primary purpose is not to expedite decision-making but to make well-informed decisions.

The correct answer is (c) Fees and expenses, historical performance, and alignment with financial goals.

When assessing a mutual fund, investors should consider fees and expenses, historical performance, and how well the fund aligns with their financial goals. Option (a) is incomplete, as media coverage alone may not provide a comprehensive picture. Option (b) is relevant but not sufficient; the manager’s philosophy should align with the investor’s goals. Option (d) relies on popularity and recommendations, which may not guarantee suitability or alignment with the investor’s specific needs.

The correct answer is (b) Align the portfolio’s risk and return characteristics with the fund’s future liabilities.

Liability-driven investing (LDI) involves aligning the portfolio’s risk and return characteristics with the fund’s specific future liabilities. This approach helps manage the fund’s obligations effectively. Options (a), (c), and (d) are incorrect. Focusing solely on returns without considering liabilities, ignoring liabilities, or diversifying without considering specific obligations may not align with LDI principles.

he correct answer is (c) Utilize currency derivatives such as forwards or options to hedge against currency risk.

To mitigate currency risk in international investments, a manager can use currency derivatives like forwards or options for hedging. Option (a) is not a practical solution, as avoiding international investments may limit diversification benefits. Option (b) may increase rather than mitigate risk. Option (d) relies on diversification, but currency hedging provides a more targeted approach to address currency risk.

The correct answer is (a) Fund X has a higher risk-adjusted performance. The Treynor ratio measures the excess return per unit of systematic risk (beta). A higher Treynor ratio indicates better risk-adjusted performance. Therefore, if Fund X has a higher Treynor ratio, it suggests that it has achieved a higher return for the level of systematic risk taken.

Incorrect answers:

(b) Fund Y has a higher risk-adjusted performance is incorrect as the question states that Fund X has a higher Treynor ratio.
(c) Both funds have the same risk-adjusted performance is incorrect as the Treynor ratio comparison suggests a difference in risk-adjusted performance.
(d) Treynor ratio does not provide information about risk-adjusted performance is incorrect, as the Treynor ratio is specifically designed to assess risk-adjusted performance.

The correct answer is (a) The stock with a 3% dividend yield has higher income-generating potential. Dividend yield is calculated by dividing the annual dividend by the stock’s current market price. A higher dividend yield indicates a higher income relative to the stock’s price. Therefore, the stock with a 3% dividend yield is considered to have higher income-generating potential.

Incorrect answers:

(b) The stock with a 1% dividend yield has higher income-generating potential is incorrect, as the higher dividend yield of 3% implies higher income potential.
(c) Both stocks have the same income-generating potential is incorrect, as the provided dividend yield values suggest different income potential.
(d) Dividend yield does not provide information about income-generating potential is incorrect, as dividend yield is commonly used as a measure of income potential for stocks.

Correct Answer: b) Hedge funds use leverage and may have higher fees and risks

Hedge funds often use leverage to amplify returns, and they may have higher fees compared to traditional investment funds. The use of leverage can increase both potential returns and risks. Therefore, option (b) is the correct answer.

Incorrect Answers:

a) Hedge funds have lower fees and lower risk: Hedge funds typically have higher fees due to their sophisticated strategies, and risks can vary.
c) Hedge funds are limited to equity investments only: Hedge funds can employ various strategies beyond equity investments.
d) Hedge funds are primarily focused on long-term capital preservation: Hedge funds may pursue various objectives, and not all are solely focused on capital preservation.

Correct Answer: (c) Capital preservation with a focus on income-generating assets.

Explanation:
For a client near retirement, capital preservation becomes a priority. A strategy focused on income-generating assets, such as dividend-paying stocks or bonds, helps provide a reliable stream of income while aiming to protect the capital invested. This approach aligns with the goal of preserving wealth during the retirement phase.

Incorrect options:
(a) Aggressive growth investing may expose the portfolio to higher volatility, which can pose a risk to capital preservation.
(b) Value investing in high-risk stocks carries the potential for significant fluctuations, impacting capital preservation.
(d) Leveraged trading introduces additional risk and may not be suitable for capital preservation, especially for a retiree seeking stable income.

Correct Answer: (b) Exposing the portfolio to a wider range of market opportunities.

Explanation: Including global investments (option b) broadens the investment universe, providing access to diverse market opportunities and potentially enhancing returns. Eliminating currency risk entirely (option a) may not be feasible, but it can be managed through hedging. Simplifying tax reporting (option c) is not a primary consideration for international diversification. Avoiding geopolitical risks (option d) is challenging, but diversification across regions can mitigate specific risks associated with individual countries. Mr. Singh’s decision to include global assets aims to capitalize on a broader set of investment possibilities.

Correct Answer: (a) Internal Rate of Return (IRR)

Explanation: Private equity investments are often evaluated using the Internal Rate of Return (IRR) (option a), which measures the profitability and efficiency of an investment over time. Earnings Per Share (EPS) (option b) and Dividend Payout Ratio (option c) are more applicable to publicly traded stocks. Price-to-Book (P/B) ratio (option d) is a valuation metric for stocks. IRR provides insight into the overall performance of a private equity fund by considering the time value of money and the timing of cash flows, making it a key metric for assessing profitability.

Correct Answer: (c) Diversifying across multiple sectors to reduce concentration risk.

Explanation: Sector concentration risk can be mitigated by diversifying across multiple sectors (option c). Concentrating heavily in the sector with the highest recent returns (option a) may expose the portfolio to potential downturns in that sector. Ignoring sector trends (option b) overlooks opportunities for risk management and performance enhancement. Focusing on short-term sector performance (option d) may lead to impulsive decisions. Ms. Wong should prioritize a balanced and diversified approach to sector allocation to manage risks effectively.

Correct Answer: (b) Avoiding stocks of companies involved in speculative activities.

Explanation: Shariah-compliant investing prohibits involvement in speculative activities (option b). Choosing stocks with high short-term growth potential (option a) may involve speculative elements. Investing in companies with high debt levels (option c) goes against Shariah principles of avoiding excessive leverage. Ignoring environmental and social responsibility practices (option d) is contrary to ethical considerations in Islamic finance. Mr. Ahmed should prioritize stocks with stable and ethical business practices to align with Shariah-compliant principles.

Correct Answer: (d) Allocating funds across different asset classes

Explanation: Effective diversification involves spreading investments across different asset classes, such as stocks, bonds, and alternative investments. This helps reduce the impact of poor performance in any single asset class. Investing in a single industry or concentrating in one geographic region increases specific risk, and choosing assets with high correlation may not provide sufficient diversification.

Incorrect Answers:

(a) Investing in a single industry – Concentrating investments in one industry increases specific risk and lacks diversification.

(b) Concentrating investments in one geographic region – Regional concentration increases exposure to regional economic conditions and geopolitical risks.

(c) Choosing assets with high correlation – High correlation between assets diminishes the benefits of diversification as they tend to move in tandem.

The correct answer is (b) Diversify the fixed-income portfolio across various maturities.

To manage interest rate risk, diversifying the fixed-income portfolio across various maturities can help mitigate the impact of interest rate changes. Option (a) is incorrect, as solely investing in long-term bonds may expose the portfolio to higher interest rate risk. Option (c) is not a solution, as completely avoiding fixed-income securities may not align with the investor’s risk tolerance. Option (d) suggests concentrating on short-term bonds, which, while reducing interest rate risk, may limit yield potential.

The correct answer is C) Employing fund managers to make investment decisions based on research and analysis. Active management involves actively making investment decisions in an attempt to outperform the market through research, analysis, and strategic portfolio adjustments.

Incorrect options:

A) Seeking to replicate the performance of a specific market index: This is a characteristic of passive management, not active management.
B) Minimizing portfolio turnover and trading activities: Passive management typically involves less frequent trading and lower portfolio turnover.
D) Investing exclusively in government bonds: This describes a specific investment strategy but is not a key characteristic of active management.
Reference: Securities Commission Malaysia Guidelines on Unit Trust Funds and Private Retirement Schemes (Chapter 8 – Portfolio Management).

The correct answer is (a) Bond X is perceived as riskier than Bond Y. Yield to maturity (YTM) reflects the market’s expectations for the total return on a bond if held until maturity. A higher YTM is often associated with higher perceived risk, as investors demand a higher return for taking on additional risk. Therefore, Bond X with a YTM of 5% is perceived as riskier compared to Bond Y with a YTM of 3%.

Incorrect answers:

(b) Bond Y is perceived as riskier than Bond X is incorrect, as the lower YTM of 3% suggests lower perceived risk for Bond Y.
(c) Both bonds are perceived as equally risky is incorrect, as the YTM values indicate a difference in perceived risk.
(d) Yield to maturity does not provide information about perceived risk is incorrect, as YTM is often used as an indicator of the market’s perception of the risk associated with a bond.

The correct answer is (b) Regularly rebalancing their portfolio to maintain the target asset allocation. In life-cycle investing, especially as investors approach retirement, it is crucial to regularly rebalance the portfolio to ensure that the asset allocation aligns with their risk tolerance and financial goals. This helps manage risk and prevents the portfolio from becoming overly skewed towards high-risk or low-risk assets.

The other options are incorrect because:

(a) Continuously increasing exposure to high-risk assets may expose the couple to unnecessary risk, especially as they approach retirement.
(c) Shifting entirely to low-risk assets may hinder the potential for growth and income needed during retirement.
(d) Ignoring market conditions and sticking to a fixed asset allocation overlooks the dynamic nature of life-cycle investing and may lead to suboptimal outcomes.

The correct answer is (c) Reevaluate her financial goals and adjust the asset allocation accordingly. In the face of unexpected expenses, Mrs. P should reassess her financial goals and make necessary adjustments to her life-cycle investment strategy. This might involve altering the asset allocation to ensure a balance between meeting immediate needs and maintaining a long-term investment approach.

The other options are incorrect because:

(a) Increasing exposure to high-risk assets may add more volatility to the portfolio, potentially exacerbating the impact of unexpected expenses.
(b) Liquidating a portion of the portfolio without considering the overall financial plan may have long-term implications for Mrs. P’s financial well-being.
(d) Ignoring the expenses and sticking to the current asset allocation neglects the importance of adapting the investment strategy to changing circumstances.

Correct Answer: B) Include a mix of high and low-risk investments for balanced risk

Balancing the risk in a portfolio is essential to align with the client’s risk tolerance. While the client is willing to take on significant risk, a diversified portfolio that includes both high and low-risk investments can help achieve a balanced risk profile. This approach aims to provide potential for returns while managing overall portfolio volatility.

Incorrect Answers:

A) Allocate a large portion to low-risk investments for stability: This approach may not align with the client’s risk preference of taking on significant risk for high returns and could potentially limit overall portfolio growth.
C) Focus solely on high-risk investments for maximum returns: Concentrating solely on high-risk investments may lead to heightened volatility and increased exposure to potential losses.
D) Advise the client against high-risk investments due to potential losses: While risk should be managed, completely advising against high-risk investments may not align with the client’s risk appetite and goals.

The correct answer is (D) Longer maturity generally offers higher yields with increased risk. In the context of government bonds, longer maturity periods are typically associated with higher yields but also higher interest rate risk and market volatility.

Incorrect Answers:
(A) Incorrect: Longer maturity is often associated with higher interest rate risk, not lower risk.
(B) Incorrect: Shorter maturity is generally considered less risky in terms of default, as it reduces exposure to economic uncertainties over an extended period.
(C) Incorrect: Maturity plays a significant role in assessing the risk and return of government bonds, and it is not accurate to say that it has no impact.
Relevant Concept: Government Bonds, Maturity, Interest Rate Risk.

The correct answer is (C) Dividends are taxed at the individual’s progressive income tax rate, and they are not guaranteed. Dividend income is typically subject to individual income tax in Malaysia, and it is not guaranteed, unlike fixed interest payments.

Incorrect Answers:
(A) Incorrect: Dividends are not tax-free; they are subject to taxation in Malaysia. Additionally, dividends are not fixed payments.
(B) Incorrect: The tax on dividends is not at a fixed rate, and it varies based on the individual’s income tax bracket.
(D) Incorrect: Dividends are not exempt from tax, and they do not provide a fixed income stream as interest payments would.

The correct answer is (a) The asset’s returns are expected to be 50% more volatile than the market. A beta value greater than 1 indicates that the asset is expected to be more volatile than the overall market.

(b) A beta value less than 1 would imply that the asset’s returns are expected to be less volatile than the market.
(c) A beta value of 1 suggests that the asset’s returns are expected to move in line with the market.
(d) Negative correlation with the market would be indicated by a negative beta value.

Correct Answer: B) Shift the allocation to defensive stocks to mitigate downside risk.

Explanation: Dynamic Asset Allocation (DAA) involves adjusting the asset mix based on changing economic conditions. During an economic downturn, defensive stocks, which are less sensitive to economic fluctuations, are often favored to mitigate downside risk. Shifting the allocation to defensive stocks aligns with the proactive and risk-managing nature of DAA during economic cycles.

Incorrect Answers:

A) Increase the allocation to growth stocks to capitalize on potential long-term gains.

During an economic downturn, growth stocks may face challenges, and increasing their allocation may expose the portfolio to higher volatility and downside risk, conflicting with DAA principles.
C) Maintain the current asset allocation as DAA does not respond to economic cycles.

This statement is incorrect. DAA explicitly involves responding to economic cycles and adjusting the asset allocation accordingly. Maintaining the current allocation during an economic downturn would not align with the strategy’s principles.
D) Reduce exposure to cash and allocate more to speculative assets for short-term gains.

Increasing exposure to speculative assets during an economic downturn may expose the portfolio to higher risk. This approach is inconsistent with the risk-managing aspect of DAA.

The correct answer is (c) Extend the duration of fixed income securities. In a low-interest-rate environment, extending duration can capture higher yields. High-yield bonds (option a) may carry higher default risk. Inflation-protected securities (option b) may not be necessary in a low inflation environment. Shifting to short-term money market instruments (option d) may provide lower returns.

The correct answer is (a) Expense ratios of the funds. While past performance is important, the expense ratio directly impacts the overall returns for investors. High expense ratios can erode returns over time. Past performance of individual stocks (option b), dividend yields (option c), and market capitalization (option d) are important but do not provide a comprehensive picture of the fund’s overall cost-effectiveness.