Patricia Young is an individual investment advisor who uses a computer model to place her clients into an appropriate portfolio. The model takes the clients goals and a range of simulated returns and presents the probability of achieving their goals. The investor then chooses the portfolio that provides a satisfactory probability of achieving their goals. By using this process, Young is: A) violating the Standard on suitability. B) violating the Standard on misrepresenting the expected investment performance. C) violating the Standard on reasonable basis and representations. D) not violating the Standards. I understand the answer but thought some others might like to see the question since it tripped me up.
I would say A since there is no mention of risk. Those portfolios may achieve the returns the investor wants, but the portfolio still may not be suitable. Just a guess.
Your answer: D was incorrect. The correct answer was A) violating the Standard on suitability. The Standard on suitability calls for Young to assess risk tolerance, which is ignored by her process. Damn the risk, I had forgotten about that when I answered the question. Another +1 for Niblita75.
I was going to say A as well for the same reason Niblita75 mentioned…Risk and Return go hand in hand…Suitability deals with both…not just one.
I would think “probability of achieving those goals” is a way of mentioning risk. Another stupid ethics question where you have to try to quess what is implied and what is purposely left out.
I second thepinkman’s opinion. Risk is measurable statistically and if you have done that, then you have the “probability of achieving those goals” . People like Taleb believe that risk is not measurable but thats another debate. Dont hang poor Patricia Young for a sin she hasnt committed.
Those portfolios can all have a large std. deviation of returns used as in input to calculate an expected value. Just because you ran a simulation doesn’t reduce risk.
After a re-read the explanation given seems reasonable in that the model takes the “range of simulated returns” with no mention of risk… However, initially I selected A for a different reason. The computer model can’t quantify infinite client needs. Or simply that suitability should be judged on a case by case basis not simply by results of a questionnaire. Maybe client A wants a low turnover portfolio due to taxes or client B wants to be socially responsible… A cookie cutter q&a model may not produce results suitable for all possible variations. Anyway, I thought I read somewhere that only using a questionnaire process violates the suitability standard. I vaguely remember saying something like “wow, all those 401k plans with the 5 question risk/return quizzes, plugging people into the growth model, or the target date model, aren’t going to like this!”
I got tripped up for the same reason - risk is not expected returns but a measure of variation from achieving those returns. Once I remembered that it’s easy to see why A’s the right answer. For example, portfolio A with 1% 3% 5% returns and portfolio B with 2% 3% 4% will have the same probability of achieving a 3% return, but portfolio A is a lot more risky! thepinkman Wrote: ------------------------------------------------------- > I would think “probability of achieving those > goals” is a way of mentioning risk. Another > stupid ethics question where you have to try to > quess what is implied and what is purposely left > out.