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ESG performance attribution is used to measure the impact of ESG factors on investment returns.

Why C (Brinson and risk factor attribution) is correct:

The Brinson model decomposes portfolio returns into allocation and selection effects.

Risk factor models help determine whether ESG factors explain investment performance.

Why not A or B?

A is incorrect—ESG attribution in fixed-income portfolios is complex due to limited data and different risk structures.

B is incorrect—commercial ESG tools exist, but attribution still requires custom modeling.

Both Enron and WeWork faced governance failures due to excessive control and influence by their CEOs (Jeffrey Skilling for Enron, Adam Neumann for WeWork).

Why C (CEO dominance) is correct:

Enron’s CEO misled investors through fraudulent accounting practices.

WeWork’s CEO (Adam Neumann) had unchecked authority, leading to unethical corporate decisions that ultimately resulted in a failed IPO.

Why not A or B?

A (Auditor lapses) is relevant for Enron (Arthur Andersen scandal) but not a key factor in WeWork’s collapse.

B (Related-party deals) occurred at WeWork (e.g., CEO leasing buildings to his own company) but was not a central issue in Enron’s collapse.

Conduct-related exclusions (Option C) filter out companies based on unethical or controversial business activities, such as:

Gambling, tobacco, weapons, fossil fuels, and human rights violations.

Used in ESG-focused and socially responsible investing (SRI) indices.

Option A (Faith-based exclusions) are religion-specific (e.g., Islamic finance avoiding alcohol or pork-related businesses).

Option B (Idiosyncratic exclusions) refer to custom exclusions tailored to investor preferences, not general ESG norms.

A company's water management efforts are both a credit strength and an ESG strength (Option C) because:

Credit strength: A stable water supply reduces operational risks, improving financial resilience.

ESG strength: Water sustainability aligns with environmental responsibility, reducing risks of regulatory fines or reputational damage.

Option A (Credit strength only) ignores the environmental and social benefits.

Option B (ESG strength only) overlooks the financial stability aspect.

Growing income inequality is associated with reduced social mobility (Option A), meaning that individuals from lower-income backgrounds face greater challenges in moving up the economic ladder. This happens because:

Lower-income families often have limited access to quality education, healthcare, and job opportunities, making it harder for individuals to improve their economic status.

Wealth concentration among the elite leads to a decline in broad-based economic opportunity.

More educational opportunities (Option B) is incorrect because education tends to become more expensive and less accessible as income inequality increases.

Higher purchasing power among the middle class (Option C) is incorrect because growing inequality usually means that the middle class shrinks, and wealth is concentrated among the wealthy, reducing overall purchasing power.

The ocean (Option A) is the largest carbon reservoir, storing about 39,000 gigatons of carbon—far more than forests or the atmosphere. It absorbs:

About 30% of human CO₂ emissions annually, buffering climate change.

Carbon through the biological pump, where plankton absorb CO₂.

Option B (Rainforests) are crucial carbon sinks, but they store significantly less carbon than oceans.

Option C (Atmosphere) holds about 750 gigatons of carbon, much less than the ocean reservoir.

Climate change impacts insurers in two major ways:

Asset-side risk:

Insurers invest in real estate, corporate bonds, and infrastructure, all of which face risks from climate change (e.g., property devaluation from flooding).

Liability-side risk:

Insurers must payout more claims due to extreme weather events (e.g., hurricanes, wildfires).

Increased claims raise insurance premiums, but regulatory constraints may prevent full cost recovery.

Why C (Both assets and liabilities) is correct:

Insurers must manage climate-related risks in their investment portfolios (assets) and adjust underwriting policies (liabilities).

Why not A or B?

A (Only assets) is incorrect—liability risks from increased claims are substantial.

B (Only liabilities) ignores the impact of climate risks on insurer investments.

Debt (bondholders) and equity (shareholders) investors generally have different priorities, but their interests align in times of financial distress.

Why A (Insolvency risk) is correct:

If a company faces insolvency, both debt and equity investors want stability and restructuring to avoid losses.

Both groups engage with management to push for financial recovery.

Why not B or C?

B (Capital restructuring) may benefit one group over the other.

C (High credit rating) means fewer financial concerns, reducing the need for alignment.

A lower terminal growth rate due to ESG risks (Option A) results in:

A lower valuation in a discounted cash flow (DCF) model.

Higher expected regulatory costs, operational risks, or reputational issues reducing future cash flows.

Option B (Same valuation) is incorrect because ESG risks impact long-term growth assumptions.

Option C (Higher valuation) is incorrect—ESG risks increase discount rates, lowering present value.

The Corporate Governance Committee (Option C) ensures the board:

Has diverse, skilled, and independent directors.

Follows best practices in governance, ethics, and oversight.

Option A (Audit committee) focuses on financial reporting and risk management.

Option B (Compensation committee) oversees executive pay and incentives.

Corporate bonds (Option B) have the most developed ESG integration, primarily due to:

Corporate ESG disclosures that provide granular data on sustainability risks.

Sustainability-linked bonds (SLBs) and green bonds, which have specific ESG performance targets.

ESG credit ratings from agencies like S&P, Moody’s, and MSCI ESG Ratings.

Option A (Agency bonds) (issued by government-backed institutions) have some ESG integration, but not as advanced as corporate bonds.

Option C (Government bonds) have increasing ESG focus (e.g., sovereign green bonds) but lack standardized ESG metrics.

Passive investors, unlike active investors, do not frequently trade securities but instead hold investments that track an index. Their engagement strategy is typically broad and issue-based rather than firm-specific.

Passive investors, such as large asset managers (e.g., BlackRock, Vanguard, and State Street), generally begin engagement by identifying sector-wide ESG risks or opportunities that may affect long-term value.

They then engage with companies within the sector to improve transparency and governance on these issues, often using proxy voting and public statements to drive change.

This differs from active investors, who may focus on underperformers or specific management discussions.

Social issues impact different sectors uniquely, affecting investment risks and opportunities.

Why A is correct:

Examples of sector-specific social risks:

Retail & Apparel → Supply chain labor conditions, human rights.

Tech Industry → Data privacy, employee diversity.

Healthcare → Access to medicine, ethical drug pricing.

Why not B?

B is incorrect because not all companies in a sector face the same social risks—for example, some may have stronger supply chain policies than others.

Why not C?

C is incorrect because social materiality often starts at an industry level first, then narrows down to the company level.

Independence from previous boards is critical to ensuring that new boards can bring fresh perspectives and avoid entrenchment of outdated or ineffective policies, thus improving governance practices. (ESGTextBook[PallasCatFin], Chapter 5, Page 236)

Both statements are accurate. Effective engagement with companies often requires framing the discussion around strategy and long-term performance. Active investment houses are also focusing on integrating stewardship activities with ongoing portfolio management. (ESGTextBook[PallasCatFin], Chapter 6, Page 285)