Advanced Investment Strategies (AIS) Free Practice Questions Set 2

Correct Answer: b) Domestic economic indicators

Explanation: When considering international investing, Mr. X should primarily focus on domestic economic indicators. These indicators provide insights into the health of a country’s economy, including factors such as GDP growth, inflation rates, unemployment rates, and industrial production. Understanding these indicators helps investors assess the overall economic climate of a country and make informed decisions about investment opportunities. Exchange rate fluctuations (option a) are indeed a risk associated with international investing, but they are not the primary factor to consider. Political stability (option c) and interest rate differentials (option d) are also important, but they are secondary to the economic indicators as they can directly impact the economic stability of a country. For instance, political instability may lead to economic uncertainty, affecting investment returns. However, domestic economic indicators provide a more direct assessment of the economic health of a country, making option b the correct answer.

Correct Answer: d) Liquidity risk may be higher due to less developed financial markets

Explanation: Investing in emerging markets carries various risks, one of which is liquidity risk. Unlike developed markets, emerging markets may have less developed financial infrastructures, resulting in lower trading volumes and liquidity. This can make it challenging for investors to buy or sell assets at desired prices, especially during volatile market conditions. Option d correctly identifies this risk, making it the correct answer.

Options a, b, and c are incorrect:
a) Emerging markets often have higher growth potential compared to developed markets due to factors such as rapid industrialization, urbanization, and favorable demographics.
b) Currency risk is typically higher in emerging markets due to volatile exchange rates, not minimal. Fluctuations in currency values can significantly impact investment returns.
c) Political instability is relatively common in emerging markets and can adversely affect investment performance. Therefore, it is not uncommon as stated in option c.

Correct Answer: c) Bottom-up stock picking

Explanation: Bottom-up stock picking involves analyzing individual companies based on their fundamental attributes, such as financial performance, competitive advantages, and brand strength. By focusing on companies with strong global brands, Mr. X is employing a bottom-up approach, selecting stocks based on their specific merits rather than broader market trends or macroeconomic factors. Therefore, option c is the correct answer.

Options a, b, and d are incorrect:
a) Tactical asset allocation involves adjusting the allocation of assets within a portfolio in response to changing market conditions or economic outlook. It does not specifically focus on selecting stocks based on their fundamental attributes.
b) Currency hedging is a risk management strategy used to mitigate the impact of currency fluctuations on investment returns. It is not directly related to selecting stocks based on brand strength.
d) Momentum investing involves buying stocks that have exhibited strong past performance, expecting that the upward trend will continue in the short term. This strategy does not necessarily prioritize companies with strong global brands.

Correct Answer: B) Diversification across international markets reduces the correlation between asset returns, thus lowering portfolio risk.

Explanation: The correct answer is B. Diversification across international markets reduces the correlation between asset returns, thus lowering portfolio risk. This principle is based on Modern Portfolio Theory (MPT), which states that by spreading investments across different asset classes and geographical regions, an investor can reduce the overall risk of their portfolio. It’s essential to note that international investing doesn’t guarantee higher returns, as mentioned in option C, due to currency exchange rate fluctuations. Geopolitical risks can still exist in international markets, and diversification alone cannot eliminate them entirely. Option A is incorrect because focusing solely on emerging markets doesn’t ensure maximum returns and could expose the investor to higher risks associated with those markets.

Correct Answer: B) International investing allows investors to access industries and sectors that may not be well-represented in their domestic market.

Explanation: The correct answer is B. International investing allows investors to access industries and sectors that may not be well-represented in their domestic market. This is a significant advantage as it provides investors with opportunities for further diversification and potential higher returns. Option A is incorrect because liquidity varies across different international markets and may not necessarily be higher than domestic markets. Option C is inaccurate; international investing is subject to various regulations and may even involve additional regulatory complexities compared to domestic investing. Option D is also incorrect as tax implications can vary significantly depending on the investor’s country of residence and the specific tax treaties in place.

Correct Answer: A) Currency hedging

Explanation: The correct answer is A. Currency hedging. Currency hedging involves using financial instruments such as forward contracts or options to mitigate the impact of currency exchange rate movements on investments denominated in foreign currencies. In Mr. Rodriguez’s case, if he had implemented currency hedging, he could have protected his investments from the adverse effects of currency depreciation. Options B, C, and D are related to concepts in international finance, but they do not directly address Mr. Rodriguez’s situation of protecting his investments from currency risk.

Correct Answer: B) Implementing rigorous due diligence to assess the political and economic stability of the countries where she intends to invest.

Explanation: The correct answer is B. Implementing rigorous due diligence to assess the political and economic stability of the countries where she intends to invest. Emerging markets can present higher risks due to factors such as political instability, currency fluctuations, and less mature regulatory environments. Conducting thorough due diligence helps investors like Ms. Chen to identify and mitigate these risks. Option A is incorrect because investing exclusively in small-cap companies within emerging markets may increase risk exposure without necessarily maximizing growth potential. Option C is incorrect because leveraging margin trading can amplify losses in volatile markets, increasing risk rather than managing it. Option D is incorrect because concentrating risk in a single emerging market goes against the principle of diversification, which aims to spread risk across different assets or markets.

Correct Answer: B) The impact of changes in the Canadian dollar’s exchange rate relative to the US dollar.

Explanation: The correct answer is B. The impact of changes in the Canadian dollar’s exchange rate relative to the US dollar. As an investor based in the United States, Mr. Thompson should consider the currency risk associated with investing in Canadian equities. Fluctuations in the exchange rate between the Canadian dollar (CAD) and the US dollar (USD) can affect the value of his investments. Option A is incorrect because while tax considerations are important, they do not directly affect potential returns from investments in Canadian equities. Option C is incorrect because historical performance alone does not guarantee future returns, and comparing performance over a decade may not reflect current market conditions. Option D is incorrect because while regulatory requirements may impact investment decisions, they are not directly related to evaluating potential returns.

Correct Answer: C) Currency exchange rate fluctuations between the investor’s home currency and the currencies of the countries where the mutual fund invests.

Explanation: The correct answer is C. Currency exchange rate fluctuations between the investor’s home currency and the currencies of the countries where the mutual fund invests. Since the mutual fund holds assets denominated in various currencies, changes in exchange rates can impact the fund’s returns when translated back into the investor’s home currency. Option A is incorrect because domestic interest rates may influence other aspects of the investor’s portfolio but are less likely to directly affect the performance of an international mutual fund. Option B is incorrect because while political stability is important for investment decisions, it is just one of many factors influencing the performance of the mutual fund. Option D is incorrect because while expense ratio and management fees can impact the fund’s returns, they are not as directly related to currency exchange rate fluctuations.

Correct Answer: C) The index covers large and mid-cap equities from 27 emerging market countries.

Explanation: The correct answer is C. The MSCI Emerging Markets Index covers large and mid-cap equities from 27 emerging market countries. This index provides investors with exposure to companies in developing economies, offering diversification beyond developed markets. Option A is incorrect because the MSCI Emerging Markets Index specifically focuses on emerging markets, not developed countries. Option B is incorrect because it describes the MSCI World Index, which covers developed markets, not emerging markets. Option D is incorrect because the MSCI Emerging Markets Index primarily includes large and mid-cap stocks, not small-cap stocks.

Correct Answer: B) MSCI EAFE Index

Explanation: The correct answer is B. The MSCI EAFE Index (Europe, Australasia, and Far East) is a suitable benchmark for gaining exposure to developed markets outside of North America. This index represents large and mid-cap equities from developed countries in Europe, Australasia, and the Far East, providing diversification across various regions. Option A is incorrect because the FTSE Emerging Markets Index focuses on emerging markets, not developed markets. Options C and D are incorrect because the S&P 500 Index and Dow Jones Industrial Average (DJIA) are both U.S.-focused indices, providing exposure to the U.S. equity market, rather than developed markets outside of North America.

Correct Answer: C) MSCI EAFE Index and MSCI Emerging Markets Index

Explanation: The correct answer is C. Including the MSCI EAFE Index (for developed markets outside of North America) and the MSCI Emerging Markets Index (for emerging markets) in the portfolio would best achieve Mr. Lee’s objective of exposure to both developed and emerging markets. This combination provides diversification across a broad range of countries and regions. Option A is incorrect because the FTSE Developed Asia Pacific Index focuses only on developed markets in the Asia Pacific region, excluding emerging markets. Option B is incorrect because the S&P Global 100 Index includes large-cap companies from both developed and emerging markets but does not specifically provide exposure to emerging markets. Option D is incorrect because it includes two indices focusing on developed markets, neglecting exposure to emerging markets.

Correct Answer: A) The total market capitalization of all publicly traded companies worldwide.

Explanation: The correct answer is A. The total market capitalization of all publicly traded companies worldwide. Market capitalization represents the total value of a company’s outstanding shares and is a key determinant of the size of the equity market. Option B is incorrect because the number of stock exchanges does not directly determine the size of the global equity market. Option C is incorrect because the total number of shares outstanding may vary widely across companies and does not accurately reflect the overall size of the market. Option D is incorrect because the average daily trading volume, while important for liquidity, does not represent the total size of the equity market.

Correct Answer: B) The fixed income market is generally larger than the global equity market because it includes government and corporate bonds.

Explanation: The correct answer is B. The fixed income market is generally larger than the global equity market because it includes government and corporate bonds. Fixed income securities, such as bonds, often have larger outstanding issuance compared to equities, contributing to the overall size of the fixed income market. Option A is incorrect because while equities may have higher liquidity in some cases, it does not necessarily make the global equity market larger than the fixed income market. Option C is incorrect because the size of the two markets can vary significantly, and they are not necessarily equal. Option D is incorrect because while interest rates and economic conditions may influence market sizes, they are not the primary determinants of the size comparison between equities and fixed income.

Correct Answer: A) Increasing privatization of state-owned enterprises in emerging markets.

Explanation: The correct answer is A. Increasing privatization of state-owned enterprises in emerging markets. Privatization initiatives, especially in emerging markets, can lead to the listing of formerly state-owned companies on stock exchanges, thereby increasing the number of publicly traded companies and contributing to the growth of the global equity market. Option B is incorrect because a decrease in IPOs would likely hinder the growth of the equity market by reducing the number of new listings. Option C is incorrect because a shift towards fixed income securities would not directly contribute to the growth of the equity market. Option D is incorrect because decreased investor participation would likely shrink the equity market rather than stimulate growth.

Correct Answer: D) The fund tracks a global equity index that includes companies from both developed and emerging markets.

Explanation: The correct answer is D. The fund tracks a global equity index that includes companies from both developed and emerging markets. Investing in a fund that tracks a global equity index provides broad exposure to companies from both developed and emerging markets, helping Mr. Patel achieve diversification across different regions. Option A is incorrect because a benchmark including only large-cap companies from developed markets would not provide exposure to emerging markets. Option B is incorrect because investing in a region-specific fund may limit diversification and exposure to other regions. Option C is incorrect because a bottom-up approach to stock selection may overlook opportunities in emerging markets if the fund focuses solely on individual company fundamentals without considering geographical location.

Correct Answer: A) Geographical bias

Explanation: The correct answer is A. Geographical bias. Geographical bias refers to the tendency of investors or markets to favor certain regions over others, leading to outperformance in those regions over a specific period. This bias can be influenced by factors such as economic growth rates, political stability, technological advancements, or demographic trends. Option B, regional volatility, refers to the degree of variation in returns within a particular region, not the consistent outperformance of one region over another. Option C, sector rotation, refers to shifts in investment preferences among different sectors of the economy, rather than geographical regions. Option D, investment style drift, refers to changes in an investment manager’s approach or strategy, which may deviate from the stated investment style but does not relate directly to regional outperformance.

Correct Answer: B) These indices cover a broad range of companies from both developed and emerging markets, representing a significant portion of the global equity market.

Explanation: The correct answer is B. These indices cover a broad range of companies from both developed and emerging markets, representing a significant portion of the global equity market. Indices like the MSCI World Index or the FTSE All-World Index are designed to provide diversified exposure to global equity markets, including companies from various regions and market capitalizations. Option A is incorrect because these indices typically include companies from both developed and emerging markets, not just large-cap companies from developed countries. Option C is incorrect because while emerging markets may be included, these indices are not solely focused on small-cap companies. Option D is incorrect because these indices aim to provide broad global diversification rather than maintaining geographical concentration.

Correct Answer: A) To reduce exposure to country-specific risks and achieve greater diversification.

Explanation: The correct answer is A. To reduce exposure to country-specific risks and achieve greater diversification. Investing in global equities allows investors to diversify their portfolios across different countries and regions, reducing the impact of country-specific risks such as political instability, economic downturns, or regulatory changes. Option B is incorrect because while tax considerations are important, they are not the primary reason for investing in global equities. Option C is incorrect because currency exchange rate fluctuations are a risk factor that investors need to consider when investing internationally, rather than a reason for investing in global equities. Option D is incorrect because exploiting regulatory arbitrage opportunities may not align with ethical investment principles and may expose investors to additional risks associated with less regulated jurisdictions.

Correct Answer: B) Several mid-cap companies conduct initial public offerings (IPOs) and become publicly traded entities.

Explanation: The correct answer is B. Several mid-cap companies conduct initial public offerings (IPOs) and become publicly traded entities. When mid-cap companies conduct IPOs and become publicly traded, they contribute to the overall market capitalization of the global equity market, thus increasing its size. Option A is incorrect because a decline in a large-cap company’s stock price would decrease its market capitalization but would not necessarily impact the overall size of the global equity market. Option C is incorrect because a multinational corporation repurchasing its shares would reduce its market capitalization but would not affect the overall market size. Option D is incorrect because a decrease in the total number of publicly traded companies due to mergers and acquisitions would likely reduce the overall market capitalization, thus decreasing the market size.

Correct Answer: A) Currency hedging using forward contracts or options.

Explanation: The correct answer is A. Currency hedging using forward contracts or options. Currency hedging involves using financial instruments such as forward contracts or options to mitigate the impact of currency fluctuations on international investments. By hedging the currency risk, investors like Mr. Johnson can reduce the volatility in their portfolio returns. Option B is incorrect because focusing exclusively on emerging market equities does not necessarily mitigate currency risk, as emerging market currencies can also be volatile. Option C is incorrect because while rebalancing may help maintain the desired asset allocation, it does not directly address currency risk. Option D is incorrect because avoiding international investments altogether limits diversification opportunities and does not eliminate currency risk if the investor’s domestic currency fluctuates.

Correct Answer: C) Concentration risk

Explanation: The correct answer is C. Concentration risk. Concentration risk refers to the risk of having a large portion of investments concentrated in a particular country, region, sector, or asset class. In the context of global equity markets, concentration risk arises when a significant portion of the market capitalization is concentrated in a few countries, making the market vulnerable to adverse events specific to those countries. Option A is incorrect because market segmentation refers to the division of markets based on factors such as geography, industry, or asset class, rather than concentration risk. Option B is incorrect because equity market inefficiency refers to situations where stock prices do not accurately reflect all available information, leading to potential opportunities for investors. Option D is incorrect because regulatory arbitrage refers to the practice of taking advantage of differences in regulatory requirements across jurisdictions to gain a competitive advantage, which is not directly related to concentration risk.

Correct Answer: C) Currency translation gain

Explanation: The correct answer is C. Currency translation gain. Currency translation gain refers to the increase in the value of international investments denominated in foreign currencies when converted back into the investor’s domestic currency due to a weakening of the domestic currency. This phenomenon enhances returns for investors holding international equities when their domestic currency depreciates relative to the foreign currencies in which the investments are held. Option A, currency appreciation effect, would refer to the strengthening of the domestic currency, which would decrease returns for investors holding international equities. Option B, exchange rate arbitrage, involves exploiting differences in exchange rates between currencies to profit from currency trading, rather than the impact on investment returns. Option D, currency diversification benefit, refers to the risk-reducing effect of holding investments denominated in multiple currencies, rather than the impact of currency fluctuations on returns.

Correct Answer: A) Invest in tax-efficient exchange-traded funds (ETFs) that minimize foreign tax liabilities.

Explanation: The correct answer is A. Invest in tax-efficient exchange-traded funds (ETFs) that minimize foreign tax liabilities. Some ETFs are structured to minimize foreign tax liabilities by employing strategies such as holding securities that generate qualified dividends or engaging in securities lending to offset foreign withholding taxes. This can help mitigate the impact of foreign taxes on investment returns for investors like Mr. Chang. Option B is incorrect because avoiding countries with high tax rates may limit investment opportunities and diversification. Option C is incorrect because tax loss harvesting primarily applies to domestic investments and may not be applicable to foreign tax liabilities. Option D is incorrect because converting international investments into tax-deferred accounts may not be feasible for all investors and may not eliminate foreign tax obligations indefinitely.

Correct Answer: A) The MSCI World Index includes only developed market equities, while the FTSE All-World Index includes both developed and emerging market equities.

Explanation: The correct answer is A. The MSCI World Index includes only developed market equities, while the FTSE All-World Index includes both developed and emerging market equities. The MSCI World Index tracks large and mid-cap stocks across 23 developed markets, representing approximately 85% of the global equity market. In contrast, the FTSE All-World Index covers stocks from developed and emerging markets, offering broader exposure to global equity markets. Option B is incorrect because both indices cover equities of various market capitalizations, not exclusively large-cap equities. Option C is incorrect because both indices cover equities from various regions, not limited to specific geographic areas. Option D is incorrect because both indices typically use market capitalization-weighted methodologies to determine constituent weights.

Correct Answer: A) Tracking error

Explanation: The correct answer is A. Tracking error. Tracking error measures the divergence in performance between a portfolio and its benchmark index. A positive tracking error indicates that the portfolio has outperformed the benchmark, while a negative tracking error suggests underperformance, as observed in Ms. Patel’s situation. Tracking error is an important metric used by portfolio managers to assess the effectiveness of their investment strategy relative to the benchmark. Option B, benchmark mismatch, does not accurately describe the situation and is not a standard term in investment terminology. Option C, portfolio dispersion, refers to the variability of returns within a portfolio, rather than the comparison of portfolio returns to a benchmark. Option D, alpha generation, refers to the excess return generated by a portfolio manager above the return of the benchmark index, which is not applicable in this context where the fund underperforms the benchmark.

Correct Answer: A) The S&P Global 100 Index includes the top 100 companies by market capitalization from developed markets worldwide.

Explanation: The correct answer is A. The S&P Global 100 Index includes the top 100 companies by market capitalization from developed markets worldwide. This index represents some of the largest and most established companies across various sectors, providing investors with exposure to global blue-chip stocks. Option B is incorrect because the S&P Global 100 Index typically consists of companies from developed markets, rather than emerging markets. Option C is incorrect because index constituents are typically selected based on market capitalization or other criteria, rather than revenue growth. Option D is incorrect because the S&P Global 100 Index is usually weighted by market capitalization, not an equal-weighting methodology.

Correct Answer: B) The MSCI ACWI represents a market-cap-weighted index that covers both developed and emerging market equities.

Explanation: The correct answer is B. The MSCI ACWI represents a market-cap-weighted index that covers both developed and emerging market equities. The MSCI ACWI is designed to provide investors with a broad representation of the global equity market, including companies from both developed and emerging markets, weighted by their market capitalization. Option A is incorrect because the MSCI ACWI includes both developed and emerging markets, rather than solely developed markets. Option C is incorrect because the MSCI ACWI is not exclusively focused on small-cap companies. Option D is incorrect because the MSCI ACWI is not region-specific; it covers companies from all regions worldwide.

Correct Answer: B) Higher economic growth rates and corporate earnings potential in emerging markets.

Explanation: The correct answer is B. Higher economic growth rates and corporate earnings potential in emerging markets. Emerging markets often exhibit higher economic growth rates and offer greater potential for corporate earnings growth compared to developed markets. This economic strength and growth potential can contribute to outperformance of the FTSE Emerging Markets Index relative to the MSCI World Index. Option A is incorrect because increasing regulatory restrictions in developed markets would likely hinder performance rather than contribute to outperformance of emerging markets. Option C is incorrect because currency appreciation of developed market currencies would typically benefit developed market investors rather than emerging market investments. Option D is incorrect because declining liquidity and trading volumes in developed markets would suggest weakness in those markets rather than strength in emerging markets.

Correct Answer: B) The S&P Global 1200 Index covers 1200 companies from around the world, representing a significant portion of the global equity market.

Explanation: The correct answer is B. The S&P Global 1200 Index covers 1200 companies from around the world, representing a significant portion of the global equity market. The S&P Global 1200 Index is a broad-based index that includes large-cap and mid-cap companies from both developed and emerging markets, providing comprehensive coverage of the global equity market. Option A is incorrect because the S&P Global 1200 Index is not limited to large-cap companies from developed markets. Option C is incorrect because the S&P Global 1200 Index includes companies from both developed and emerging markets, rather than focusing exclusively on emerging markets. Option D is incorrect because the S&P Global 1200 Index covers companies from all regions worldwide, not just the Asia-Pacific region.