Investment Planning

Question 1

investment

Answer 1

the current commitment of money for a period of time in order to derive future benefits that will compensate the investor for:
1. The time the funds are committed
2. The expected rate of inflation
3. The uncertainty of the future payments

Question 2

The time the funds are committed

Answer 2

this refers to the time value of money. An investor who postpones the consumption of money expects to be compensated for the opportunity cost by interest earned.

Question 3

The expected rate of inflation

Answer 3

this refers to the investors need to earn a real return in excess of the rate of inflation in order for capital to maintain its purchasing power.

Question 4

The uncertainty of the future payments

Answer 4

This refers to the risk an investor is prepared to take.
The higher the risk, the greater the return required.

Question 5

Return objectives of the Investment Policy Statement

Answer 5

1. Distinguish between return requirement and return desire
2. Total return approach – annual after-tax return necessary to meet investment goals

Question 6

Risk Objectives Investment Policy Statement

Answer 6

1. Ability to take risk
2. Willingness to take risk

Question 7

Ability to take risk

Answer 7

1. Suited to quantitative assessment – planner should define terms of analysis
2. Determined by financial goals relative to resources & time within which to meet goals

Question 8

Willingness to take risk

Answer 8

1. More subjective assessment
2. Psychological profiling provides estimates of individual’s willingness to take risk – but imprecise science

Question 9

Constraints of the Investment Policy Statement

Answer 9

1. Time Horizon
2. Liquidity
3. Taxation
4. Legal and Regulatory Requirements
5. Unique Circumstances

Question 10

Time Horizon

Answer 10

1. Can be single stage or multi-stage time horizon
2. Stage of life investments assume that time horizon shortens gradually as life stages change
3. If client has grandchildren – circumstances may determine investment goals & time horizon
4. If a person needs an income during their working lives (e.g. 10 years) and assumes that they will live another 15 years after retirement, their investment time horizon is multi-staged (10 and 15 years)

Question 11

Types of time horizons

Answer 11

No universal definition of long-term or short-term – however, generally
10 – 20 years = long-term
3 – 10 years = intermediate-term
0 – 3 years = short-term

Question 12

Liquidity

Answer 12

Ability to efficiently meet anticipated & unanticipated demands for cash
1. Transaction costs – e.g. brokerage fees – early disinvestment penalty
2. Price volatility – lowers certainty with which cash can be realised efficiently

Question 13

Liquidity requirements

Answer 13

1. Ongoing expenses – use high degree of liquidity in investment portfolio
2. Emergency reserves – can range from 3 – 6 months
3. Negative liquidity events – e.g. unplanned birth of a child
4. Positive liquidity events should be noted in the IPS – e.g. anticipated inheritance

Question 14

Taxation

Answer 14

1. Use tax concessions such as interest and dividend exemptions
2. Consider income tax and capital gains tax implications on investment vehicles
3. Defer tax to avoid impact of diminishing benefit of compounding returns
4. Tax avoidance
5. Wealth transfer

Question 15

Tax avoidance

Answer 15

1. Consider tax-exempt securities - although typically offer lower returns
2. Some tax-sheltered savings have a minimum holding period – e.g. Endowments

Question 16

Wealth transfer

Answer 16

Transfer at death – Estate Duty implications

Question 17

Legal and Regulatory Requirements

Answer 17

Often involve taxation and transfer of personal property ownership through:
1. Trusts
2. Family foundations

Question 18

Unique Circumstances

Answer 18

1. Does the client have dependants
2. Does the client want their dependants to benefit from capital - e.g. disabled child
3. Do they want the capital to be extinguished at death
4. Religious, ethical and social responsibility considerations

Question 19

Measuring Investment Return

Answer 19

1. Nominal rate of return = gross return before tax and inflation
2. Real rate of return = [(1 + nominal) / (1 + inflation)] – 1
3. Real return after tax = Return x (1 – tax rate)
4. Before tax return = Return / (1 – tax rate)

Question 20

Measuring Investment Risk

Answer 20

1. Standard deviation = possible range of outcomes around the expected return
2. Beta = measure of volatility of a security/portfolio in comparison to the market as a whole
3. Alpha = return that is unique to particular asset or portfolio and which cannot be explained by market or systematic risk

Question 21

RISK PROFILING - The Conservative Investor

Answer 21

1. The conservative investor is looking for long-term capital preservation, protected from
   extreme fluctuations in volatility
2. They are heavily invested in bonds and cash
3. Capital is maintained and there is little potential for growth

Bond (50%), Cash (30%), Equity (20%)

Question 22

RISK PROFILING - The Moderate Investor

Answer 22

1. The moderate investor is looking for both income and growth
2. The equity content dominates the bond and cash content
3. The portfolio is less volatile than the market as a whole

Bond (35%), Cash (10%), Equity (55%)

Question 23

RISK PROFILING - The Aggressive Investor

Answer 23

1. The aggressive investor is looking for a high level of aggressive growth
2. They invest in shares of companies showing a high growth potential
3. Portfolio is highly volatile resulting in the investor requiring a long-term approach to the investment.

Bond (10%), Cash (5%), Equity (85%)

Question 24

A collective investment scheme (characteristics 1)

Answer 24

1. POOLS THE MONEY of a number of investors who want to invest in bonds, shares and money market instruments
2. The total fund is divided into individual units containing the same portion of assets as the fund
3. Offers full time management by professionals
4. Investors require a unique portfolio based on their investment objectives
5. Whilst many asset classes exist in this regard, direct investments in shares, bonds, property may be very costly to an individual
6. Collective investment schemes exist to bridge that gap

Question 25

What can be purchased in the collective investment scheme (characteristics 2)

Answer 25

1. Investors may purchase participatory interests which leads to them participating proportionately in the income and profits of that managed portfolio 2. Allows for power of compounding (where income can be automatically reinvested) 3. Allows for monthly or once off investments

Question 26

Collective Investment Schemes are governed by who

Answer 26

the Collective Investment Schemes Control Act (CISCA) which replaced the unit trust control act

Question 27

Types of Collective Investment Schemes

Answer 27

1. Unit trusts 2. Hedge funds 3. Open ended investment schemes 4. Participatory bonds 5. Collective investment schemes in property 6. Offshore investment schemes

Question 28

Tax Free Savings Account

Answer 28

1. If the client wants to build up capital in a tax effective manner, a tax free savings account should be used. 2. A maximum of R33 000 can be invested per annum in approved savings instruments, subject to a lifetime limit of R500 000. 3. All returns, including interest, dividends and capital gains on the disposal of these investments is tax free. 4. If more than R33 000 per annum is paid in, the excess contribution is taxed at 40%.

Question 29

Business Cycle

Answer 29

recurrent but non-periodic fluctuations in the general business activity of an economy Phases: A lower turning point (or trough), An expansion, An upper turning point (or peak), And a contraction

Question 30

Shares performance during business cycle

Answer 30

1. Tend to perform best during both the RECOVERY and EXPANSION phases when economic conditions are improving and company revenues are increasing 2. Volatile at the upper turning point (PEAK) of the cycle as investors become less certain about the future 3. Prices decline during the CONTRACTION phase of the cycle when economic conditions are less desirable and corporate profits are falling

Question 31

Bonds performance during business cycle

Answer 31

1. Likely to perform well during the CONTRACTION phase and lower turning point (TROUGH) when interest rates generally decline 2. Tend to perform less well during the late EXPANSION phase and upper turning point (PEAK) when interest rates are rising

Question 32

Property performance during business cycle

Answer 32

1. Tends to perform well during RECOVERY and EXPANSION when and employment and economic conditions are improving 2. Tend to perform less well during the CONTRACTION phase when economic conditions are deteriorating and employment is declining

Question 33

Cash performance during business cycle

Answer 33

generally more attractive during the CONTRACTION phase when economic conditions are worsening and there is widespread pessimism, particularly in the business sector

Question 34

Commodities performance during business cycle

Answer 34

1. Likely to perform well during the EXPANSION phase of the business cycle when production is increasing rapidly; production capacity is at or near full utilization and demand for commodities is high 2. Perform less well during CONTRACTION when manufacturers are reducing production and demand for commodities is low

Question 35

Commodity precious metals performance during business cycle

Answer 35

1. Tend to perform best during the upper turning point (PEAK) when the demand for precious metals like gold, platinum and silver rises for industrial purposes and as a hedge against inflation 2. Tend to perform less well during the CONTRACTION phase, when industrial demand is low and inflation is declining

Question 36

Fund fact sheet

Answer 36

The minimum disclosure document is where you will find a lot of information that will help you make decisions about your unit trust investment decisions

Question 37

Fund fact sheet includes

Answer 37

1. The investment objectives and key characteristics of the fund. 2. What is the fund’s investment risk – or risk of losing value. 3. The fund’s benchmark. 4. The fund’s fees. 5. The income and dividends paid out over the past 12 months. 6. The fund’s recent performance. 7. Key allocations to asset classes or market sectors. 8. Funds are obliged to tell your quarterly how your fund has performed and how many units you hold