Book - Chapter 10 ST Questions

Question 1

1. Why is three-monthly volatility a relatively unimportant measure of risk for investment strategies with a 20-year time horizon?

Answer 1

The longer an investor can hold on to volatile investments, such as shares or property, the greater the likelihood that they can ride out cyclical or other short-term downturns. Investment planning is an important component of the overall financial planning process and comprises six main stages:

Question 2

2. What are the six main stages of the financial planning process?

Answer 2

1. Establishing and defining the relationship between the client and the personal financial planner.
2. Gathering client data and determining goals and expectations.
3. Analysing and evaluating the clients financial status.
4. Developing and presenting the financial plan.
5. Implementing the financial planning recommendations.
6. Monitoring the financial plan and the financial planning relationship.

EGADIM

Question 3

3. Why is it a good idea for investors to keep some of their investment portfolio in a liquid, easily accessible form?

Answer 3

There are two reasons why liquidity within a portfolio can be advantageous:

a. The client may have unexpected needs for cash, which could result in serious capital loss if market prices are low.
b. It enables clients to take opportunities for adding to holdings at times of distress or panic selling.

Question 4

4. If a client is saving for retirement in 15 years’ time, explain why they are more likely to have a higher proportion of their portfolio in equities than in short-dated gilts.

Answer 4

This is a relatively long time horizon and there is no mention of liquidity requirements, so it is likely that the client is willing to tolerate a medium or high level of risk in the portfolio. In this case equities are a more appropriate investment than short-term gilts.

Question 5

5. Explain the difference between risk tolerance, risk perception and capacity for loss.

Answer 5

Risk tolerance is best described as a client’s willingness to accept a certain level of fluctuation in the value of their investments without feeling an immediate desire to sell.

Attitude to risk perception represents the client’s personal opinion on the risks associated with making an investment, based on their prior knowledge and experience.

Capacity for loss is the client’s actual ability to absorb any financial losses that might arise from making a particular investment.

Question 6

6. How would you expect the asset allocation for a medium to high-risk investor to look?

Answer 6

Cash allocation is kept to the minimum. They will be prepared to invest outside the UK and in high-risk funds and will take a long-term view and may choose to sacrifice some diversification for a more focL1sed and volatile portfolio.

Question 7

7. What is the role of synthesis in analysing a client’s; financial position?

Answer 7

Synthesis is simply the bringing together of the information in a clear summary of the main aspects of the client’s financia1I position. The main facts about the client should be concisely expressed for rapid understandings of the overall situation. A clear set of summaries makes analysis much easier.

Question 8

8. What are lifetime cash flow projections?

Answer 8

Lifetime cash flow projections are being used increasingly by financial planners to forecast clients’ income and expenditure profiles over the long term.

Question 9

What is an investment policy statement and what should it contain?

Answer 9

An investment policy statement summarises the client’s investment objectives and the strategy to be used and should set out:

• The purpose of the investments ..
• The income or growth objectives.
• The timescale.
• A statement about the client’s risk profile - in detail or an outline.
• A statement about asset allocation, again in detail or an outline.
• Other issues, such as ethical or socially responsible investment.