Deck 10: Investment Planning Strategies

Question 1

How do you determine the risk tolerance level of an investor? (pp. 464-466)

Answer 1

Determining risk tolerance level is not a precise technique, because generally it is a subjective measure. Also, it may rise with an increase in the net worth, income, investment knowledge, and sophistication; it could also decline as the client approaches retirement.
For simplicity, investors can be classified as high, medium, low, and zero risk takers. The most effective way of making this determination is to ask the investor to take a well-designed test.

Question 2

Are there certain investment vehicles which should be specifically considered as a client approaches retirement? (pp. 464-470)

Answer 2

Some of the products that merit closer examination are: (a) Fixed annuity, (b) Split annuity, (c) Bond funds, and (d) Jumbo CD. Others can be easily added to this list.

Question 3

What are the three basic investment objectives of a typical investor?

Answer 3

The three basic investment objectives relate to an investor's need for liquidity, current income, and investment growth.
Liquidity
An essential component of a well-designed investment portfolio is the percentage allocated for cash reserves. The investor's liquidity needs can be classified into three categories: Operating funds, emergency funds, and funds earmarked for capitalizing on future investment opportunities. The cash reserves portion of an investment portfolio satisfies all three liquidity needs of an investor.
Current Income
The types and amounts of fixed income securities and annuities included in an investment portfolio are influenced by the investor's current income needs. There are two major considerations in determining these income needs. First, the total of all the income sources-salary, pension, current investment income, bonuses, and so on-should be compared with the current income needs which, in turn, are determined by the desired standard of living of the investor. The excess of income needs over total income sources, if any, is the amount of additional income which must be generated by new investments. Second, the investor must recognize the trade-off involved in this process; the higher the amount invested in securities generating current income, the lower the amount available for investing in growth securities, and the smaller the potential for future growth of the principal.
Investment Growth
One of the major objectives in investment planning is to maximize the growth of the total investment portfolio. Several major considerations determine the amount of investable funds to be allocated to growth investments and the types of investment products selected to achieve this objective. These considerations include the returns desired, the investor's risk tolerance level, and the investor's future income needs and time horizon.

Question 4

What are the three stages of financial life cycle through which an investor passes?

Question 5

What is meant by the term, investor preference?

Question 6

Question 2. The concept of investment planning involves:

A) time horizon
B) life cycle
C) tax planning
D) all of the above

Question 7

How can a financial planner determine the risk tolerance level of an investor? (pp. 449-453)

Question 8

You have just presented Figure 10.2 entitled "Life Cycle Stages and Distribution of Investment" to a prospective client named Karl Gore. Karl is 60 years old and totally disagrees with your allocation between safe and risky investments. How do you respond to his criticism?

Question 9

Karen Shultz has checked the item "I cannot afford any loss of principal regardless of potential return" on the Measuring Attitude Toward Risk (p. 458 in the text) questionnaire. However, 90 percent of her portfolio, which is approaching $1 million, is in equity securities. Karen seeks your advice.

Question 10

Question 5. Which of the following is not part of the investment life cycle:

A) preparation
B) accumulation
C) acceleration
D) preservation

Question 11

Comment on the following statement: The investment planning process is initiated with goal setting. (pp. 442-443)

Question 12

Question 1. Investment planning process involves:

A) analysis of the current investment portfolio
B) determination of the client's risk tolerance level
C) analysis of the client's investment preferences
D) all of the above

Question 13

When a client comes to a financial planner, he usually
I. knows his objectives
II. knows general investment and tax saving strategies
III. doesn't know his current income needs
IV. knows the desired rate of growth of his funds

A) I, II, and III
B) III
C) III and IV
D) II and IV

Question 14

Explain the various components of a Target Investment Portfolio (TIP).

Question 15

Comment on the following statement: Risk and return are positively related.

Question 16

What are the basic steps involved in reorganizing an investment portfolio?

Question 17

Bob Barrett wants to invest $50,000 in stocks. His objective is to use this fund for financing his son's college education. His son is a senior in high school. What is your recommendation?

Question 18

Jeff Esard has asked you to develop an investment plan for his family. Jeff has over $100,000 to invest and he believes that by investing in equities, he should be able to double his money in three and a half years. Would you be willing to accept Jeff as your client?

Question 19

You have explained to Paul Heleski the advantages of dollar cost averaging. Paul asks why a financial planner should not be able to invest the entire sum when the market hits the bottom. How do you respond to Paul's question?

Question 20

Question 3. Which of the following statements is true:

A) clients usually appreciate the power of diversification
B) clients know their needs for liquidity and current income
C) investment planning objectives are usually easy to formulate
D) investment goals change with time

Question 21

Question 12. With respect to a target investment portfolio, which of the following statements is true?

A) Once the target investment portfolio is constructed it is relatively easy to implement
B) Once the target investment portfolio is constructed it may not be achievable due to unfavorable tax considerations
C) Once the target investment portfolio is constructed it may not be achievable due to the presence of illiquid investments in the portfolio
D) B and C
E) None of the above is true

Question 22

Investors can use Asset Allocation Model for the following purposes:
I. maximizing portfolio returns
II. balancing risk and return
III. finding the perfect mix of funds
IV. increasing safety of the portfolio

A) I and II
B) I, II, and III
C) II, III, and IV
D) I, II, III, and IV

Question 23

Question 6. Which of the following is not true for the accumulation stage:

A) necessity to build cash reserves and emergency funds
B) high level of security
C) buying basic assets like home
D) necessity to create funds for children's education

Question 24

Question 8. Which stage of the financial life cycle an investor is in after entering the peak earning years and taking care of family responsibilities?

A) Acceleration
B) Accumulation
C) Preservation
D) Deceleration
E) Post acceleration

Question 25

Question 13. Which of the following is not an investment planning principle?

A) Determination of client's risk tolerance
B) Tax evasion planning
C) Reducing the estate tax on wealth
D) Growth of investment over time
E) All are relevant factors

Question 26

Question 14. Which of the following investments offers the potential for appreciation in value?

A) Income
B) Growth
C) Cash reserves
D) Tax sheltered investments
E) A and B

Question 27

Question 11. Which of the following statements regarding a client's risk tolerance level is true?

A) The determination of a client's risk tolerance level is precisely done
B) It is easy to express as a specific number or level
C) Over time a risk tolerance level typically increases, then decreases as the client gets older
D) It is generally an objective measurement
E) C and D

Question 28

During the acceleration stage the following is true:
I. investor can take more risks
II. investor has more resources
III. portfolio should be more growth oriented
IV. portfolio should exclude all income oriented investments

A) I and II
B) II, III, and IV
C) I, II, and III
D) IV

Question 29

Common measures of value are:
I. low P/E ratio
II. low price-to-book ratio
III. high dividend yield
IV. high EPS rate growth

A) I, II and III
B) I, III, and IV
C) II and III
D) I, II, III, and IV

Question 30

Rebalancing your portfolio from time to time will help you achieve the following goal:
I. maintain a consistent strategy of investment
II. sell high
III. invest at lower prices
IV. reduce your capital gain taxes

A) I, II, and III
B) I, III, and IV
C) II, III, and IV
D) III and IV