1、LEVEL III Question: 1 Topic: Portfolio Management Individual Minutes: 26 2009 Level III Guideline Answers Morning Session - Page 1 of 68 Questions 1 and 2 relate to Patricia and Alexander Tracy. A total of 35 minutes is allocated to these questions. Candidates should answer these questions in the or
2、der presented. QUESTION 1 HAS FOUR PARTS (A, B, C, D) FOR A TOTAL OF 26 MINUTES. Patricia and Alexander Tracy, both age 59, are residents of Canada. They have twin sons who will enter a four-year university program in one year. Patricia is a long-time employee of a telecommunications company. Alexan
3、der is a self-employed sales consultant. Alexanders annual income is now steady after years of extreme highs and lows. The Tracys have built an investment portfolio through saving in Alexanders high income years. The Tracys current annual income is equal to their total expenses; as a result, they ca
4、nnot add to savings currently. They expect that both their expenses and income will grow at the inflation rate. All medical costs, now and in the future, are fully covered through government programs. The Tracys worry about whether they have saved enough for retirement, and whether they will be able
5、 to maintain the real value of their portfolio. Inflation is expected to average 4% for the foreseeable future. The Tracys have approached Darren Briscoe to help them analyze their investment strategy and retirement choices. The Tracys disagree about the appropriate investment strategy. Patricia pre
6、fers not losing money over making a high return. This is partly a result of continuing regret for a loss experienced in an equity mutual fund several years ago. Alexanders history of making frequent changes in their portfolio greatly annoyed Patricia. She thinks Alexander focused only on potential r
7、eturn and paid little attention to risk. The Tracys currently have all their assets in inflation-indexed, short-term bonds that are expected to continue to earn a return that would match the inflation rate after taxes. After retirement, they are willing to consider changing their investment strategy
8、 if necessary to maintain their lifestyle. The Tracys are eligible to retire next year at age 60. If they do, Patricia will receive annual payments from her companys defined-benefit pension plan and both Patricia and Alexander will receive payments from the Canadian government pension plan. Alexande
9、r does not participate in any company or individual retirement plan. Briscoe has compiled financial data and market expectations for the Tracys retirement, shown in Exhibit 1. Currently, Briscoe estimates that the Tracys investment portfolio will grow to 1,100,000 Canadian dollars (CAD) by their ret
10、irement date next year. LEVEL III Question: 1 Topic: Portfolio Management Individual Minutes: 26 2009 Level III Guideline Answers Morning Session - Page 2 of 68 Exhibit 1 Financial Data and Market Expectations Patricia and Alexander Tracy Retirement at Age 60 (2010) Expected annual expenses CAD 125,
11、000 Annual pension income (after-tax) Patricias company plan CAD 40,000 Combined government pension CAD 40,000 Total annual pension income CAD 80,000 Expected annual inflation 4.0% Expected annual after-tax portfolio return 4.0% Pension income from both Patricias company plan and the government pens
12、ion plan is fully indexed for inflation. Briscoe expects a tax rate of 20% to apply to the Tracys withdrawals from the investment account. The Tracys expect to earn no employment income after retirement. The Tracys residence is not considered part of their investable assets. The Tracys have the opti
13、on to delay retirement until age 65. The Tracys intend to retire together, whether it is in 2010 at age 60 or in 2015 at age 65. Briscoe determines that if the Tracys retire at age 60, their risk tolerance is below average. If they retire at age 60, they plan to pay off their mortgage and associated
14、 taxes by withdrawing CAD 100,000 from their portfolio upon retirement. Another consideration for the Tracys relates to funding university expenses for their sons. If the Tracys retire at age 60, each son will receive a scholarship available to retiree families from Patricias company that will cover
15、 all university costs. If the Tracys retire at age 65, all pension income would increase and would almost meet their annual spending needs. If they retire at age 65, the Tracys would pay all university expenses from their investment portfolio through an arrangement with the university. The arrangeme
16、nt, covering both sons, would require the Tracys to make a single payment of CAD 200,000 at age 60. LEVEL III Question: 1 Topic: Portfolio Management Individual Minutes: 26 2009 Level III Guideline Answers Morning Session - Page 3 of 68 A. i. Prepare the return objectives portion of the Tracys inves
17、tment policy statement (IPS) that will apply if they retire at age 60. ii. Calculate the pre-tax nominal rate of return that is required for the Tracys first year of retirement if they retire at age 60. Show your calculations. (12 minutes) B. Indicate specific factors for the Tracys, for each of the
18、 following, which support Briscoes conclusion that the Tracys risk tolerance is below average: i. Ability to take risk. Indicate two factors. ii. Willingness to take risk. Indicate one factor. (6 minutes) C. Prepare the current (2009) liquidity constraint for the Tracys IPS: i. if they retire at age
19、 60. ii. if they retire at age 65. (4 minutes) D. Prepare the current (2009) time horizon constraint for the Tracys IPS: i. if they retire at age 60. ii. if they retire at age 65. (4 minutes) LEVEL III Question: 1 Topic: Portfolio Management Individual Minutes: 26 2009 Level III Guideline Answers Mo
20、rning Session - Page 4 of 68 Reading References: 8. “Frame Dependence: The Second Theme,” Ch. 3, Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing, Hersh Shefrin (Oxford University School Press, 2002) 14. “Managing Individual Investor Portfolios,” Managing Inves
21、tment Portfolios: A Dynamic Process, 3rdedition, James W. Bronson, Matthew H. Scanlan, and Jan R. Squires (CFA Institute, 2007) Purpose: To test the candidates: (1) understanding of the investment policy statement for an individual investor, (2) ability to assess pertinent factors for an investors a
22、bility to assume risk, (3) ability to calculate an investors required return, and (4) understanding of an investors other constraint factors. LOS 2009 III-3-8 -a, “Frame Dependence: The Second Theme” The candidate should be able to: a) explain how loss aversion can result in investors willingness to
23、 hold on to deteriorating investment positions; LOS 2009 III-4-14-a,f,j,k,l, “Managing Individual Investor Portfolios” The candidate should be able to: a) discuss how source of wealth, measure of wealth, and stage of life affect individual investors risk tolerance; f) compare and contrast risk attit
24、udes and decision-making styles across distinct investor personality types, including cautious, methodical, spontaneous, and individualistic investors; j) explain how to set risk and return objectives for individual investors and discuss the impact that ability and willingness to take risk have on t
25、olerance; k) identify and explain each of the major constraint categories included in an individual investors investment policy statement; l) formulate and justify an investment policy statement for an individual investor; LEVEL III Question: 1 Topic: Portfolio Management Individual Minutes: 26 2009
26、 Level III Guideline Answers Morning Session - Page 5 of 68 Guideline Answer: PART A i. Return Objective Statement The Tracys return objective is to provide sufficient after-tax cash flow in retirement to meet annual living expenses in excess of pension and other retirement income. Given the Tracys
27、concern about inflation eroding their purchasing power, the portfolio should also realize a return high enough to maintain the real (inflation adjusted) value of their asset base. ii. Return Calculations are: Retire Next Year at Age 60 Cash Flows Inflows Patricias company pension CAD 40,000 Combined
28、 government pension 40,000 Total Inflows 80,000 Outflows Estimated expenses 125,000 After-tax net income needed (45,000) Pretax net income needed (using 20% tax rate) (56,250) Investable Assets Estimated investment portfolio in one year 1,100,000 Mortgage payoff (100,000) Investment portfolio upon r
29、etirement 1,000,000 Required Return Calculation Pretax income need divided by investable assets 5.625% Plus expected inflation 4.000% Required Pretax Nominal Return (arithmetic) 9.625% Required Pretax Nominal Return (geometric) 9.850% (1.05625 1.04) 1 = .0985 = 9.850% OR (1.0563 1.04) 1 = 9.86% LEVE
30、L III Question: 1 Topic: Portfolio Management Individual Minutes: 26 2009 Level III Guideline Answers Morning Session - Page 6 of 68 PART B These circumstances indicate a below average overall risk tolerance for the Tracys: Ability to take risk Small amount of investable assets to support them in re
31、tirement relative to their spending levels, particularly if they choose to retire at age 60 Because there will be no post-retirement employment income, there will be no further funds added to their portfolio (no human capital during retirement). With one year to retirement, there will be no further
32、funds added to investable assets since current annual income equals expense. Alexander does not participate in any company or individual retirement plan. Willingness to take risk Their desire for preservation of the real value of their portfolio Patricias preference to avoid losses due to previous e
33、xperience Conservative nature of current investments PART C Liquidity Needs In 2009, the year before retirement, the Tracys have no liquidity constraints. If they retire at age 60: The Tracys will need significant annual distributions (CAD 56,250 pretax or CAD 45,000 after-tax) from their investment
34、 portfolio to support their living expenses. They will also need CAD 100,000 to pay off their mortgage and income taxes associated with the withdrawal upon retirement. They expect no other significant inflows or outflows. If they retire at age 65: The Traceys need CAD 250,000 CAD 200,000 / (1 0.2) t
35、o fund their sons prepaid tuition plan in one year and pay taxes on the withdrawal. There will be no other liquidity needs because the Tracys expect to continue meeting their living expenses with their salary income until retirement. PART D Time Horizon If they retire at age 60: LEVEL III Question:
36、1 Topic: Portfolio Management Individual Minutes: 26 2009 Level III Guideline Answers Morning Session - Page 7 of 68 The one year to retirement could be considered the first of a two-stage horizon. Otherwise, the Tracys have a long, single stage time horizon of 25 years or more in retirement based u
37、pon their current ages. If they retire at age 65: The Tracys have a two stage horizon. 1) The first covers the six-year period until retirement. 2) The second covers an estimated 20 years or more in retirement. Alternatively, the Tracys could be said to have a multi-stage horizon consisting of 1) on
38、e year during which the University payment is due, 2) five additional years of work, and 3) an estimated 20 years or more in retirement. LEVEL III Question: 2 Topic: Portfolio Management Individual Minutes: 9 2009 Level III Guideline Answers Morning Session - Page 8 of 68 Questions 1 and 2 relate to
39、 Patricia and Alexander Tracy. A total of 35 minutes is allocated to these questions. Candidates should answer these questions in the order presented. QUESTION 2 HAS ONE PART FOR A TOTAL OF 9 MINUTES. Patricia and Alexander Tracy both retired five years ago at age 65 and their sons now support thems
40、elves. As a result of better than expected investment returns over the past five years, the Tracys investment portfolio has significantly increased in value. They now think that their future after-tax investment returns will exceed their expenses for their remaining joint life expectancy. Their new
41、investment objective is to maximize the assets their sons will inherit, subject to a review of the Tracys risk tolerance by their financial advisor. During retirement, the Tracys medical costs are fully covered by the government. The Tracys have no earned income during retirement. They have previous
42、ly paid off all debt and expect to remain debt-free. Determine whether each of the following measures has increased, decreased, or remained unchanged for the Tracys since just prior to retirement: i. implied assets ii. implied liabilities iii. risk tolerance Justify each response with one reason. An
43、swer Question 2 in the Template provided on page 9. (9 minutes) LEVEL III Question: 2 Topic: Portfolio Management Individual Minutes: 9 2009 Level III Guideline Answers Morning Session - Page 9 of 68 Template for Question 2 Measure Determine whether each of the following measures has increased, decr
44、eased, or remained unchanged for the Tracys since just prior to retirement. (circle one) Justify each response with one reason. i. implied assets Increased Decreased Remained unchanged ii. implied liabilities Increased Decreased Remained unchanged iii. risk tolerance Increased Decreased Remained unc
45、hanged LEVEL III Question: 2 Topic: Portfolio Management Individual Minutes: 9 2009 Level III Guideline Answers Morning Session - Page 10 of 68 Reading References: 15. Excerpts from “Lifestyle, Wealth Transfer and Asset Classes,” Ch. 4, and “Techniques for Improving After-Tax Investment Performance,
46、” Ch. 6, Investment Management for Taxable Private Investors, Jarrod Wilcox, Jeffrey E. Horvitz, and Dan diBartolomeo (The Research Foundation of CFA Institute, 2006) 19. “Life-Cycle Investing,” Ch. 3, Investment Management for Taxable Private Investors, Jarrod Wilcox, Jeffrey E. Horvitz, and Dan di
47、Bartolomeo (The Research Foundation of CFA Institute, 2006) 20. “Lifetime Financial Advice: Human Capital, Asset Allocation, and Insurance,” Roger G. Ibbotson, Moshe A. Milevsky, Peng Chen, Financial Analyst Journal (CFA Institute, January/February 2006) 46. “Monitoring and Rebalancing,” Ch. 11, Man
48、aging Investment Portfolios: A Dynamic Process, 3rdedition, Robert D. Arnott, Terence E. Burns, Lisa Plaxco, and Philip Moore (CFA Institute, 2007) Purpose: To test the candidates: (1) understanding of the investment policy statement for an individual investor, (2) ability to assess pertinent factor
49、s for an investors ability to assume risk, (3) ability to calculate an investors required return, and (4) understanding of an investors other constraint factors. LOS 2009-III-4-15-b, Excerpts from Investment Management for Taxable Private Investors The candidate should be able to: b) explain the expected effects of shrinking time horizons, as investors grow older, on (1) the risk tolerance for average investors and that
