Topic 1 - Personal Financial Planning Flashcards
1
Q
What was the worldwide impact of the global financial crisis?
A
- some financial institutions were forced to close
- some, such as the Lehman Brothers, were bailed out by the government at a very high cost
- several financial institutions became wary of dealing with other institutions because of heightened credit risk
- countries were forced to guarantee bank liabilities and to stimulate their economies to avoid recession
2
Q
Name the three different perspectives finance can be studied from.
A
- From an individual or personal perspective.
- From the corporate perspective.
- From the government or public perspective.
3
Q
Differentiate between short-term, medium-term and long-term financial planning goals.
A
Short-term
- those that must be achieved within a year or within 12 months from the start of planning
- includes buying a car or paying for a holiday
Medium-term
- between 2 and 5 years
- includes paying to attend an educational program that will increase income in the long-term
Long-term
- extend from 6 to 40 (or more) years
- includes planning the purchase, or even the sale of a house
4
Q
The Superannuation Guarantee is one reason why personal financial planning has increased in importance in recent years.
(b) Will you make your decision about setting an investment portfolio choice in an accumulation fund or will you leave it to a default choice where the fund manager nominates one portfolio selection such as ‘conservative’ for all members who do not nominate their own selection?
Write your opinion about making a choice of investments for your own superannuation fund.
A
Most people need a level of education and knowledge to understand portfolio differences and related risks and rewards.
People need an understanding of the long-term volatility and return to assist them in their own selection choice.
5
Q
Indirect property investment occurs when the owner
Select one:
a. owns a company that manages the property portfolio
b. owns a trust that can invest in property
c. is a company or trust through which the investor participates in the cash flows from the property
d. rents the property before owning it
A
c. is a company or trust through which the investor participates in the cash flows from the property
6
Q
The global financial crisis:
Select one:
a. was brought about by US investment banks disguising the true risk characteristics of the collateralised debt obligations they were selling
b. was made worse by the uncertainty within global markets as to the level of credit risk posed by financial institutions leading to governments having to guarantee bank deposits
c. resulted in Governments offering stimulus packages to attempt to prevent economies from slipping into recession
d. all of the above
A
d. all of the above
All of the issues raised above were relevant to the recent global financial crisis.
(Learning objective 1.7 ~ outline the origin of the global financial crisis and describe its impact on Australia)
7
Q
In recent years, what changes have the government made to the pension age and why?
What incentives are the government providing?
A
- to reduce the pressure of taking care of a large number of retirees, the government has increased the pension age from about 60 years to 65 years for women, to match that of men
- an increase in the retirement age above 65 years has also been proposed for men
- the government is also providing incentives, such as the work bonus scheme, to encourage people to stay at work longer and to defer taking the pension
8
Q
A close reading of chapter 1 provides which of the following lessons for investors:
Select one:
a. be aware of market cycles
b. do not diversify unless there are no other options available
c. both a and b
d. none of the above
A
a. be aware of market cycles
Being aware of market cycles is one of the lessons in chapter 1. The chapter also advocates the benefits arising from diversification as a sound investment principle.
(Learning objective 1.1 ~ describe the concept of personal financial planning)
9
Q
The term personal financial planning generally implies:
Select one:
a. the achievement of a financial outcome within a specified time period
b. successfully gaining a job promotion
c. winning the lottery within a specified time period
d. both a and b
A
a. the achievement of a financial outcome within a specified time period
Personal financial planning generally implies the achievement of a financial outcome within a specified time period. The other factors listed, although personal in nature, would not be expected to form part of the personal financial planning process.
(Learning objective 1.1 ~ describe the concept of personal financial planning)
10
Q
What is finance?
A
Finance deals with how we manage our money.
It includes activities such as:
- investing,
- borrowing,
- lending
- and planning.
11
Q
Suppose you had a friend who lost their job and was unable to pay the electricity account when it was due and the electricity was disconnected.
How could a financial counsellor assist your friend?
A
A financial counsellor could assist your friend by:
- Negotiating on your friend’s behalf with the electricity supply company. This could enable immediate re-connection of the electricity supply as well as establishing an on-going payment plan to cover the arrears.
- In addition, the counsellor may also be able to identify and assist your friend in avoiding other potential crises relating to their acute unemployment and a current cash shortfall.
- The counsellor may also be able to assist in drawing up a new personal budget for your friend to help them manage their current situation as well as to optimise the benefits of saving once they gain new employment
12
Q
Why do you need a budget of expenses when planning for retirement?
A
- a budget of expenses is needed to help you work out how much money you require for retirement
- it is estimated that a single person will need about $43,000 to live a comfortable lifestyle in retirement
- a couple will need close to $60,000 for a similar lifestyle
- if you want to spend money on holidays, as well as eating out during retirement, you will need to increase your allowance for leisure
13
Q
Given an understanding of interest-rate risk, an existing fixed-interest investor in bonds would be affected in which of the following way(s) if the market interest rates on bonds were to rise from 8% to 10%?
Select one:
a. interest receipts from the bonds would fall and the market price of the bond would also fall
b. interest receipts from the bonds would rise and the market price of the bond would also rise
c. interest receipts from the bonds would be unaffected and the market price of the bond would fall
d. interest receipts from the bonds would be unaffected and the market price of the bond would rise
A
c. interest receipts from the bonds would be unaffected and the market price of the bond would fall
14
Q
A market which processes news instantaneously and correctly is
Select one:
a. perfect
b. efficient
c. risk free
d. inconceivable
A
b. efficient
15
Q
List the various types of risk and explain why they are worth knowing about.
A
- there are various types of risk worth knowing about because they affect the returns and capital values of investments
- knowing about the risk factors will help in choosing appropriate assets for risk profiles:
16
Q
The currency risk effects from holding an investment valued in an overseas currency will result in:
Select one:
a. a rise in the Australian dollar value of the investment if the Australian dollar falls relative to the overseas currency
b. a rise in the Australian dollar value of the investment if the Australian dollar rises relative to the overseas currency
c. a fall in the Australian dollar value of the investment if the Australian dollar rises relative to the overseas currency
d. both a and c
A
d. both a and c
A rise/fall in the Australian dollar value of the investment will result if the Australian dollar falls/rises relative to the overseas currency – this is the basis of currency risk
(Learning objective 1.5 ~ define various types of risk)
17
Q
Market volatility as a component of interest-rate risk:
Select one:
a. affects the amount of interest payments received on a fixed-interest investment
b. affects the value of a fixed-interest investment at its maturity date
c. affects the value of a fixed-interest investment sold before its maturity date
d. both a and b
A
c. affects the value of a fixed-interest investment sold before its maturity date
Market volatility affects the value of a fixed-interest investment sold before its maturity date. Any increase in market interest rates will have an inverse relationship on the value of the fixed-interest investment resulting in a decrease in its relative value.
(Learning objective 1.5 ~ define various types of risk)
18
Q
What are the main objectives of the Financial Services Reform Act?
A
- to reduce systematic risk and provide fair and effective clearing and settling facilities!!
- to encourage confidence and informed decision-making about financial products and services among customers
- to provide the guidelines for fair, honest and professional dealings between customers and their financial planners
- has led to a number of licencing regimes, including the Australian Financial Services Licence (AFSL)
19
Q
Explain why the defined benefit scheme was replaced by the defined accumulation fund.
A
- due to the combined effect of increased longevity and increased numbers nearing retirement (including their surviving spouses), employers were worried about their future exposure to paying pensions for longer than initially calculated
- moving to the defined accumulation fund means employees receive a superannuation benefit which is the accumulation of the fund after the employer has made the compulsory contributions
20
Q
These crises are interspersed with periods of economic boom, resulting in four stages of the business cycle:
A
1) Boom or expansion
- characterised by high employment, high economic growth and an increase in inflationary pressure
2) Contraction
- marked by slow economic growth, decline in sales and a rise in the unemployment rate, extending into a recession
3) Recession
- unemployment becomes high and economic growth declines to very low levels
4) Recovery
- unemployment begins to fall and economic growth starts to rise
21
Q
Define the time value of money.
A
- money owned today is worth more than money to be acquired in the future
- anything can happen to future money: due to inflation, it can diminish in value and buy fewer goods than it could today
- money available today can be invested to earn future interest, but there is a risk in receiving money in the future, rather than today
- however, there is enough information about the risk factors to allow us to value and account for dealings in the future through:
discount and interest rates
22
Q
Generally accepted finance principles would support which of the following statements?
Select one:
a. ‘high return generally equals high risk’
b. ‘high return generally equals low risk’
c. ‘high risk is generally inversely related to high return’
d. none of the above
A
a. ‘high return generally equals high risk’
The risk-return trade-off is positive with a higher investment return generally only being possible when the investor is (financially) exposed to relatively higher risk levels.
(Learning objective 1.1 ~ describe the concept of personal financial planning)
23
Q
Describe the role of the financial planner.
A
- the financial planner, on the other hand, provides services for fees, including advice on investing and superannuation issues
- work with people who have savings and are looking to maximise income from their investments
24
Q
Define assets, liabilities and equity.
A
Assets
- refers to something valuable that we own
- includes our car, computer, books, clothing and debts owed to us from debtors
Liabilities
- what we owe to others
- although both can be used to make payments, banknotes and coins are assets, while credit cards are liabilities
- include bank loans and overdrafts
- amounts owed to others and are yet to be paid
- to be recognised as liabilities they must be legally enforceable
- a purchased house is an asset, but the mortgage on the house is a liability
- when the mortgage owed on the house is taken out of the value on the house, the difference is equity
Equity
- the value left of the asset after subtracting the outstanding liability
25
Why is it so important to have a *dedicated* **savings plan** to meet retirement **needs**?
- during retirement, our **consumption** is *reduced* because we have fewer expenses
- for example, we may finally own our home and therefore do _not_ have *further* **mortgage payments**
- in reality, however, people are very *unlikely* to have *sufficient* **money** to cover their retirement
- few people have a *dedicated* **savings plan** to meet their retirement needs
- in contrast, most people tend to *accumulate* **debt** or use **credit cards**, rather than to **save** during their working lives
- most retirees do _not_ have enough money to *cover* the **lifestyle** they want during retirement
26
The main measure of a share’s value on a stock exchange is the
Select one:
a. dividend yield
b. Sharpe ratio
c. the net present value of expected future earnings
d. price-earnings ratio
**d.** price-earnings ratio
27
What does it mean to say that the **goals** you set must be *realistic*?
- this means that they must be **specific**:
- they must have **value** (must be *quantifiable*)
- the **time period** over which goals are to occur must be stated
- e.g. a short-term goal is to:
* buy a car in 6 months-time (statement of time-frame)
* for not more than $50,000 (statement of value)
28
A client aged 50 years says to you, a junior financial planner, 'I would like to retire with a comfortable level of income. Can you help me do that?'
How would you restate the client's request in more definite terms?
A more definite goal would be: ‘I would like to retire in 15 years time with an after-tax income of $60 000 in today’s dollars’.
That is an objective that contains a defined time frame and a specific dollar amount.
29
Tanya is 19 years old and has been working as a retail assistant for 2 years. She earns $33 800 per year in salary after tax. Because her family lives in a country town, Tanya had to leave home to find employment and learn to look after herself and her finances.
She shares a flat with two friends. Her weekly payments on average are rent $150; public transport fares $50; food $140; utility bills $50; mobile/internet phone $30; clothing $50; and entertainment $60. She also makes sure that she is saving some of her income and for the past 2 years has arranged for automatic debit of $400 per month from her bank account into a managed fund. The amount accumulated in the fund comprises the original $2 000 she was given for her seventeenth birthday to start the fund when she left home and contributions and earnings of $8 000, making a total sum of about $10 000. The managed fund is a balanced fund. Any money left over after expenses and investment is kept in her bank account, which totals $1 000.
Tanya’s main goal is to buy a car in the next 6 months if she can afford it. She will use some money in her managed fund if she has to, but hopes to buy a car valued at about $13 000 plus insurance of $750 p.a.
5. What are the main three investment risks that Tanya faces given her short-term goal?
The three investment risks that Tanya faces given her short-term goal are:
1. Mismatch risk – the fact that Tanya will have to liquidate a long-term investment asset (managed fund) to pay for a short-term, depreciating asset (new car)
2. Market risk – the price of the car and/or the cost of insurance may increase over the next six months
3. Interest rate risk – the rate of return on Tanya’s investment fund increases which means that she pays a higher opportunity cost on the money she withdraws from the fund to pay for her new car and insurance
30
Define **money**.
- a *medium* of **exchange** (**payment**) and an *indication* of the **value** of an asset
- everyone accepts money in exchange for *other* **assets** or things they are selling
- includes:
**coins**, **notes**, amounts held in **chequing** and **savings accounts**, and **credit cards**
31
What does **personal financial planning** mean?
How does it *differ* from **business planning**?
How are **goals** set regarding *time-frames*?
- it means the **steps** taken to plan your finances for the future
- it is different from planning for a business because the business accounts are **separate** from your personal finances
- personal financial planning starts with setting goals for the **short** term, **medium**-term and **long** term
32
What major **economic events** does the textbook cover?
- the major global and national economic events since the **1987 share market crash** to the **dot.com crash** at the beginning of the current century
- the **World Trade Centre attack** to the **Global Financial Crisis** and the more recent **European Debt Crisis**
33
*Sketch* the four stages of the business cycle.
34
Why is it now so *important* that **employees** have a good ***understanding*** of **defined accumulation funds**?
- moving from a **defined benefit fund** to a **defined accumulation fund** means that the *risk* of **investment** has now been *transferred* from the **employer** to the **employee**
- the **employee** now bears the *risk* of the **investment choice** and the resulting *performance* of the **fund**
- employees, therefore, need a good understanding of the *complexity* of the **legislation**, **products** and **decisions** associated with *managing* their **super investments**
35
Stimulating or contracting the economy via changes in interest rates is an example of the government’s use of:
Select one:
a. fiscal policy
b. industrial relations policy
c. monetary policy
d. welfare policy
**c.** monetary policy
Government intervention using interest rates is an example of monetary policy.
(Learning objective 1.6 ~ describe the general features of the economic environment)
36
Why is the **Financial Services Reform Act** of 2001 *central* to the profession of financial planning?
- forms the **basis** of several *changes* to the business of financial planning
- it is the *main* **regulatory framework** covering:
* financial **products** and **services**
* financial **markets**
* the **clearing** and **settling** of facilities
- *administered* by the Australian Security and Investment Commission (**ASIC**)
37
Describe the earlier **defined benefit fund**.
- before, employees would receive a retirement benefit based on a **formula** comprising the *length* of **service** and final *average* **salary** (last 2-3 years of service)
- the **employee** was _not_ involved in the investment **decisions** of the superannuation fund
- it was the *employer's* **responsibility** to place *sufficient* contributions into the fund to *meet* the **expected** retirement payments
- the benefit was mostly in the form of a **pension** which was *payable* for **life**
38
In Australia, it is expected that by about 2050 there will be approximately:
Select one:
a. 4 males in working age groups and 2.5 females in working age groups for each retired person
b. 5.0 people in working-age groups for each retired person
c. 3.5 people in working-age groups for each retired person
d. 2.7 people in working-age groups for each retired person
**d.** 2.7 people in working-age groups for each retired person
Statistical research in Australia provides evidence that by about 2050 there will be approximately 2.7 people in working-age groups for each retired person.
(Learning objective 1.2 ~ explain why personal financial planning has gained in importance over the past few years)
39
A managed fund investing in subprime mortgages will be holding assets of:
Select one:
a. low quality with a low possibility of default by borrowers
b. low quality with a high possibility of default by borrowers
c. high quality with a low possibility of default by borrowers
d. high quality with a high possibility of default by borrowers
**b.** low quality with a high possibility of default by borrowers
Assets held by the fund will be of low quality with a high possibility of default by borrowers reflecting the risk-return trade-off.
(Learning objective 1.6 ~ describe the general features of the economic environment)
40
The Superannuation Guarantee is one reason why personal financial planning has increased in importance in recent years.
(a) Why do you think that many people show a low level of interest in their superannuation fund?
Because of the length of time before they can access their money.
For a 30-year-old it is between 25 and 35 years before they have access.
The payments of the regular amounts may seem relatively minor and other more immediate priorities may exist (such as a family).
Hence, the long-term benefit is far removed from most people’s reality.
41
Section 961B(1) and RG 175 both require a financial advice provider to act in the best interests of the client in relation to the advice they provide to the client.
Describe 'best advice' in one or two sentences, using an example to illustrate your answer.
An example of an adviser giving “best advice” may come from the following situation: the adviser may be employed by a parent company which also specialises in selling hedge-fund investments.
On the one hand, the adviser’s employer may offer incentives to favour such products, but if their client is a mature-age, and inexperienced retail investor the “best advice” would be to avoid such a high-risk investment.
42
How have recent regulatory changes helped shape the personal financial planning profession *between* **2006 and 2010**?
- **'Simpler Super'** was introduced in **2006-2007**, which involved significant changes to superannuation rules
- changes to the age pension **assets and income test** came into force in **2007**
- **2008-2010:** the government commissioned a number of enquiries into the **superannuation industry**
- the **financial planning industry** also went through a major *review*
43
Why has the government introduced the **compulsory superannuation scheme**?
What are the current and future contribution **rates**?
- since the pension is _not_ **enough** to allow for a decent lifestyle during retirement, the government has introduced the **compulsory superannuation scheme**
- the scheme *currently* requires **employees** to contribute **9.5%** of employee's wages to their superannuation savings
- it is expected that this contribution will *increase* to **12%** in **2025**
44
What is the **risk of poor diversification**?
- it is necessary to *diversify* **investment** in order to *spread* the **risk** we have by investing in assets whose returns move in *opposite* **directions**
- this helps to reduce the *overall* risk of your **investment portfolio**
45
The highest credit rating from those indicated below would be:
Select one:
a. CCC
b. AAA
c. A
d. BBB
**b.** AAA
The highest credit rating indicated would be AAA. Rating agencies consider funds rated from AAA to BBB to be ‘investment grade’.
(Learning objective 1.5 ~ define various types of risk)
46
The lowest level of business activity occurs during which of the following phases in the business cycle?
Select one:
a. boom or expansion phase
b. recession phase
c. recovery phase
d. contraction phase
**b.** recession phase
The lowest level of business activity occurs during the recession phase and economic growth may even be negative during this time.
(Learning objective 1.6 ~ describe the general features of the economic environment)
47
Why is it important to *plan* for **retirement**?
- few people plan for retirement when they start working, but planning for retirement early in life is important to ensure that you have a **decent** **life** when you retire
- planning enables you to *match* the **sources of money** with the purchases you intend to make and to consider the **time-frame** associated with set goals
- e.g. a car loan, and not a mortgage or a credit card, should be used to finance the purchase of a car
48
The role of ASIC is to:
Select one:
a. ensure compliance by practitioners with legal requirements governing the financial planning industry
b. draft legislation governing the financial planning industry
c. establish and monitor compliance of the prudential regulations that govern the operations of financial institutions within Australia
d. monitor competition policy within the financial services sector
**a.** ensure compliance by practitioners with legal requirements governing the financial planning industry
49
A friend of yours wants to know how the global financial crisis started.
Using a diagram and in your own words, provide an answer to your friend.
Points to include:
1. the offer to prospective home buyers at no deposit
2. the low-interest rate (for a honeymoon period)
3. no principal repayments for the honeymoon period
4. the impact of the raised interest rates and requirement to repay a portion of the principal
5. the mortgages were packaged according to the risk and sold to investors
6. when homeowners decided they couldn’t pay the mortgage any more, they stopped paying
7. the value of houses and the packaged mortgages (CDOs) fell when repayments stopped
8. banks stopped lending because the value of their assets fell.
50
Items which are regarded as financial products include:
Select one:
a. a security (e.g. a share in a body corporate or a debenture of a body corporate)
b. health insurance, funeral bonds and reinsurance
c. exempt public sector superannuation schemes within the meaning of the Superannuation Industry (Supervision) Act 1993
d. all of the above
**a.** a security (e.g. a share in a body corporate or a debenture of a body corporate)
51
A number of lessons can be drawn from the issues covered in the topic.
Discuss why we need to **plan** *early*.
- it is necessary to plan very early in order to obtain *sufficient* income for **retirement**
- this means understanding the *sources* of income and the various **assets** in which income can be invested to grow
52
What does **liquidity risk** refer to?
- it is important to have *access* to **cash** at short notice for emergency purposes
- _not_ having access means risking **insolvency**, not being able to pay debts in time, if and when they fall due
53
Why is personal financial planning *gaining* **importance**?
What does it require the **estimation** of and **why**?
- because it allows people to *set* **personal goals** and arrange the financial means to *achieve* them
- these goals include planning for **retirement**
- eventually, we all have to retire, but people are now retiring at a much older age and _without_ *sufficient* **superannuation** to maintain the lifestyle they want
- personal financial planning, therefore, requires estimating *how long* we expect to **live** in order to:
* *calculate* how much it will **cost** to maintain the lifestyle that we want during retirement
* and how much we need to *save* **now** in order to reach our retirement **target**
54
Tanya is 19 years old and has been working as a retail assistant for 2 years. She earns $33 800 per year in salary after tax. Because her family lives in a country town, Tanya had to leave home to find employment and learn to look after herself and her finances.
She shares a flat with two friends. Her weekly payments on average are rent $150; public transport fares $50; food $140; utility bills $50; mobile/internet phone $30; clothing $50; and entertainment $60. She also makes sure that she is saving some of her income and for the past 2 years has arranged for automatic debit of $400 per month from her bank account into a managed fund. The amount accumulated in the fund comprises the original $2 000 she was given for her seventeenth birthday to start the fund when she left home and contributions and earnings of $8 000, making a total sum of about $10 000. The managed fund is a balanced fund. Any money left over after expenses and investment is kept in her bank account, which totals $1 000.
Tanya’s main goal is to buy a car in the next 6 months if she can afford it. She will use some money in her managed fund if she has to, but hopes to buy a car valued at about $13 000 plus insurance of $750 p.a.
4. What advice might a financial counsellor give to Tanya in such circumstances? Is there any other advice you may offer to help her achieve her goal?
The financial counsellor is likely to reinforce the golden rule of budgeting to Tanya - to live within her means. This highlights the fact that there is always a trade-off with financial resources and wants and needs. If a person has less money coming in then will also have less money going out. Tanya has a choice about supplementing her income through extra casual work or reducing her discretionary spending. The amount of decrease in her income can be reasonably accommodated through a reduction in current spending. Therefore, her short-term goal of saving for the car and insurance is still eminently achievable.
55
Tanya is 19 years old and has been working as a retail assistant for 2 years. She earns $33 800 per year in salary after tax. Because her family lives in a country town, Tanya had to leave home to find employment and learn to look after herself and her finances.
She shares a flat with two friends. Her weekly payments on average are rent $150; public transport fares $50; food $140; utility bills $50; mobile/internet phone $30; clothing $50; and entertainment $60. She also makes sure that she is saving some of her income and for the past 2 years has arranged for automatic debit of $400 per month from her bank account into a managed fund. The amount accumulated in the fund comprises the original $2 000 she was given for her seventeenth birthday to start the fund when she left home and contributions and earnings of $8 000, making a total sum of about $10 000. The managed fund is a balanced fund. Any money left over after expenses and investment is kept in her bank account, which totals $1 000.
Tanya’s main goal is to buy a car in the next 6 months if she can afford it. She will use some money in her managed fund if she has to, but hopes to buy a car valued at about $13 000 plus insurance of $750 p.a.
2. How would a financial counsellor help Tanya to determine whether she may be on target to meet her goal?
A financial counsellor could help Tanya determine whether she is on track to meet her goal by:
* Forecasting the future value of her savings plan after six months and incorporating a scenario analysis (best, worst and normal case scenario) in terms of her cash inflows and outflows.
* Helping her to establish a fair price for the car – which will become the main part of her savings goal.
* Suggesting ways for Tanya to obtain competitive quotes on her car insurance - which will become the second part of her savings goal.
* Helping her to devise a budget so as to maximise her current savings and to minimise the need for her to liquidate her long-term, managed-fund investment.
56
What was the initial *impact* of the Collateralised Debt Obligations (**CDOs**) being **sold**?
- the CDOs were sold **worldwide**, although luckily, they were _not_ *extensively* offered within Australia compared to within other countries
- the **rating agencies** helped the process by rating securities *higher* than they were worth, even though the *performance* of the securities appeared **suspicious**
- the economic **contraction** saw house prices *fall* so that the value of houses was *less* than the loans
- led to a severe and unexpected **shock** in the US real estate market, *spreading* to a number of large **financial institutions** in various countries
57
A number of lessons can be drawn from the issues covered in the topic.
Discuss the **risk of investment**.
- the **income** from assets are subject to *various* levels of risk depending on the **assets** and the **cycles** within the economy
- *reducing* risk requires *diversifying* the investment **portfolio** so that assets within the portfolio have *different* levels of risk and comprise assets with risk levels moving in *opposite* **directions**
- the portfolio of investments will need to be *reviewed* from time to time to make changes that *maximise* **returns** from investment
- we also need to be aware of **scams** that promise high returns at low risk
- in general, *high* **returns** are accompanied by *high* **risk**
58
What is **credit risk**?
- the *opposite* to **liquidity risk**
- the risk that a business or a person to whom you have lent money to will become **insolvent** and unable to pay amounts owed to you
- assessing the *prospective* borrower's **credit history** and **performance** before lending will help minimise this risk
59
What does **planning** involve?
Planning involves *developing* **budgets** and **forecasting**.
60
How have recent **regulatory changes** helped *shape* the personal financial planning **profession** between the **1980s** and the year **2001**?
- events in the **1980s** and **1990s** led to the **Financial Services Reform Act**, which was put into place in **2001** and has changed the way financial services are *provided*
61
Define **cash** and **liquidity**.
- cash includes **banknotes**, **coins** and **debit cards**
- cash is **liquid**: for **money** to be liquid it must be readily *convertible* into **cash**
- this means the money in a **savings account** is NOT liquid because it takes *time* to be accessed in the form of **cash**
62
Capital gains tax on the profit made by an owner-occupier at the point of sale in Australia is normallly
Select one:
a. 50%
b. nil
c. assessable on only half the profit on sale
d. only 5%
**b.** nil
63
What types of **assets** and **liabilities** do finance deal with?
**Assets**
* bonds
* shares
* property
* superannuation
**Liabilities**
* mortgages
* loans
64
What is **inflation risk**?
- the risk that the **purchasing power** of a person's money will be *eroded* by increases in the **cost of living**
65
What is the role of **financial counsellor**?
- *different* from that of the **financial planner**
- provide *free*, *independent* and *confidential* **services** to people facing financial **hardship**
- play a role in *educating* the **public** on various financial matters
- help **individuals** to *prepare* **budgets**, *restructure* their **debts** and *advocate* financial issues on behalf of their clients, especially regarding issues relating to **debt**
- can help their clients to work out *repayments* with their **creditors** and *improve* their expenditure through **budgeting**
66
The Corporations Act requires financial planners to disclose three documents to their clients.
What are these documents?
Describe the purpose of each.
The FSRA requires licensees and their representatives to disclose a financial services guide (FSG) and to provide both a Statement of Advice (SOA) and a Product Disclosure Statement (PDS).
The FSG must be given to a client at the earliest practicable opportunity before a financial service is provided, and as soon as it becomes apparent that a financial service will be, or is likely to be, provided. In such a document, many statutory and professional disclosures are provided by the licensees and their representatives. The FSG helps compliance and transparencies and reduces potential disputes between contracting parties.
The SOA is mandatory each time advice is given to a client. It must set out the client’s personal circumstances, objectives, risk profile, financial needs, likes and dislikes and so on. The SOA must also disclose any benefits (such as fees, commissions and soft dollar arrangements) obtained that might reasonably be expected to influence the entity providing the advice.
The PDS is the document supplied by the product supplier. It sets out details about: who the fund manager is; the risks of the investment; past performance; the fees and other costs of management; and application forms.
67
How did the **global financial crisis** *begin*?
- began with *poor* **lending standards** by US banking and financial institutions
- they lent money to people with *very* poor **credit ratings** in the hope that if they **defaulted**, the financial institutions could *recover* their money by **selling** the mortgage properties
- various **credit ratings** were *parcelled* into what became known as **Collateralised Debt Obligations (CDOs)** in the hope that by *diversifying* these obligations, the bad loans would be **hidden** among the good ones
68
What is **currency risk**?
- applies to investments made **overseas**
- associated with the **exchange rate** of the Australian dollar *against* the **currency** of the overseas country of investment
69
Tanya is 19 years old and has been working as a retail assistant for 2 years. She earns $33 800 per year in salary after tax. Because her family lives in a country town, Tanya had to leave home to find employment and learn to look after herself and her finances.
She shares a flat with two friends. Her weekly payments on average are rent $150; public transport fares $50; food $140; utility bills $50; mobile/internet phone $30; clothing $50; and entertainment $60. She also makes sure that she is saving some of her income and for the past 2 years has arranged for automatic debit of $400 per month from her bank account into a managed fund. The amount accumulated in the fund comprises the original $2 000 she was given for her seventeenth birthday to start the fund when she left home and contributions and earnings of $8 000, making a total sum of about $10 000. The managed fund is a balanced fund. Any money left over after expenses and investment is kept in her bank account, which totals $1 000.
Tanya’s main goal is to buy a car in the next 6 months if she can afford it. She will use some money in her managed fund if she has to, but hopes to buy a car valued at about $13 000 plus insurance of $750 p.a.
1. Clearly state Tanya’s short-term goal.
Tanya’s short-term goal is to buy a car costing $13,000 plus $750 insurance in the next 6 months.
70
What are the *challenges* and *incentives* of retirement funds for the **self-employed**?
- people who are self-employed are allowed a **tax deduction** for *contributions* that they make to their **superannuation funds**
- this is to *encourage* the self-employed to **save** for retirement
- however, it is NOT **compulsory** for the self-employed to contribute to superannuation and some may _not_ have *any* **retirement savings**
71
Tanya is 19 years old and has been working as a retail assistant for 2 years. She earns $33 800 per year in salary after tax. Because her family lives in a country town, Tanya had to leave home to find employment and learn to look after herself and her finances.
She shares a flat with two friends. Her weekly payments on average are rent $150; public transport fares $50; food $140; utility bills $50; mobile/internet phone $30; clothing $50; and entertainment $60. She also makes sure that she is saving some of her income and for the past 2 years has arranged for automatic debit of $400 per month from her bank account into a managed fund. The amount accumulated in the fund comprises the original $2 000 she was given for her seventeenth birthday to start the fund when she left home and contributions and earnings of $8 000, making a total sum of about $10 000. The managed fund is a balanced fund. Any money left over after expenses and investment is kept in her bank account, which totals $1 000.
Tanya’s main goal is to buy a car in the next 6 months if she can afford it. She will use some money in her managed fund if she has to, but hopes to buy a car valued at about $13 000 plus insurance of $750 p.a.
3. Suppose the retail store proposes to reduce Tanya’s hours and her annual pay will decrease to $31 000 per annum. How will this affect her living costs and savings target?
If Tanya’s annual pay decreased to $31 000 from $33 800, this represents an 8.28% reduction. It is possible for Tanya to decrease her discretionary living costs in order to accommodate this earnings decrease. For instance, Tanya spends $50 and $60 per week on clothing and entertainment respectively, which represent the third and fourth highest expenditure items. On a weekly basis, the pay decrease means that she receives approximately $34 less per week. So, if she can reduce her weekly clothing and entertainment expenditure by this amount then she can maintain the status quo in terms of her savings target.
Alternatively, Tanya could seek some additional casual work to make-up for the pay shortfall, which would mean she could maintain her current clothing and entertainment expenditure in addition to meeting her savings target.
72
How did the global financial crisis *impact* on **Australia**?
- Australia fared better than most other countries because of the *limited* **exposure** to the Collateralised Debt Obligations
- extensive measures were also made to *stimulate* the **economy**
73
How does the Australian **government** ensure that we are *saving* towards our retirement?
- In Australia, _everyone_ is *entitled* to the **pension** when they retire, _but_ the pension is far from **enough** to maintain a decent living standard
- **compulsory superannuation** has become a means by which the government ensures that we are *saving* towards our retirement
74
Define the **risk-return relationship**.
- the *more* **risk** you expect to take, the *more* **return** you should expect to receive
- a **linear relationship** between risk and return
75
How have recent regulatory changes helped shape the personal financial planning profession *since* **2011**?
- in **2011**, the **Future of Financial Advice (FoFA)**, proposed changes to the financial planning industry about how financial planners were to be **remunerated**
- these were implemented in **2011** through the **regulatory guide RG 175**
- **reforms** to the financial planning industry have *continued* since **2012**
76
What is the *role* of **ASIC** regarding the Australian Financial Services Reform Act of 2001?
- the Act is **administered** by the Australian Securities and Investment Commission (ASIC)
- ASIC provides a **legal framework** that protects *customers* and *corporate markets* that deal with financial products and services
- it ensures Australian financial markets are *fair* and *transparent* so that investors and customers can confidently make informed **decisions**
- ASIC monitors **disclosures** of the *remuneration* of **licensees** or those who represent them
- ASIC can *revoke* or *suspend* a **licence** or even *ban* a person from providing financial services
77
The ‘know your client rule’:
Select one:
a. is contained within the Financial Services Guide
b. provides that a licensee must monitor and supervise the activities of representatives to ensure they are complying with the law
c. applies to both wholesale and retail clients
d. provides that before a financial planner is able to give specific advice on an investment, the Corporations Act requires the planner to make every effort to understand the client’s investment objectives, financial situation and particular needs
**d.** provides that before a financial planner is able to give specific advice on an investment, the Corporations Act requires the planner to make every effort to understand the client’s investment objectives, financial situation and particular needs
Before a financial planner is able to give specific advice on an investment, the Corporations Act requires the planner to make every effort to understand the client’s investment objectives, financial situation and particular needs.
(Learning objective 1.9 ~ outline the regulatory framework that applies to financial planning in Australia)
78
A number of lessons can be drawn from the issues covered in the topic.
Why do we need to *abide* by established **rules** of conduct and **regulations**?
- a number of **reforms** to superannuation now place the *responsibility* of saving for retirement in the employee's hands
- this has occurred concurrently with **education programs** and **counselling** to help employees make effective financial decisions
- for the rules to work, they must be *complied* with when making financial decisions and when saving for **superannuation**
79
What is the *long-term* **aim** of personal financial planning?
- to *build* sufficient **income** over our **working lives** to meet our *current* **consumption** and to *provide* for our **retirement** during which period we earn *little* or _no_ income
80
What are the **challenges** involved with an *aging* **population**?
- like many developed countries, Australia's **population** is *aging*
- more **women** are working \> *reduced* the **birthrate**
- people are living longer because of:
* *improvements* in the **health system**/**lifestyles**
* better **diet**
* good **exercise regime**
- there is now **pressure** on the healthcare system to *care* for older people
- a *larger* **working population** is *required* to meet the **needs** of those _not_ in the labour force, including retirees
- although **immigration** may be the way to address this **imbalance**, it is _not_ without *problems*
- the expectation is that, by **2050**, there will only be about **2.7 workers** for *each* **retiree**
- this **ratio** is _not_ enough to *maintain* the population that is not in the labour force
81
Define **solvency** and **insolvency**.
- means being able to *pay* an amount **owed** to another *on time*
- **insolvency** means _not_ having the money to pay debts as and when they fall due:
\> cause **creditors** to *pursue* payment owed to them in court
- if you are *unable* to pay your creditors, they can declare you **bankrupt**
82
What is the *relationship* between **personal financial planning** and the **life cycle theory**?
- there is a *close* association between your personal financial planning and the life cycle theory of **consumption** and **saving**
- the theory deals with how *much* **income** a person *earns* over their lifetime and how they *spend* the income
- **consumption** patterns tend to be relatively *stable*, while a person's **income** tends to *fluctuate* wildly over their lifetime
- this is because a person might _not always_ have a job or they may *leave* **work** to raise children, leaving significant gaps in their earnings capacity
83
What can we learn from the *major* **historical events** of **investment markets**?
- **trends** in the economic environment affect the *values* of **assets** and the **incomes** generated from them and the risks they pose
- recognising **cycles** in the economic environment can help us to effectively *manage* our personal finances
84
Monetary policy, administered by the RBA, is concerned with control over interest rates and the amount of money in circulation and is used to:
Select one:
a. stimulate the economy by increasing interest rates
b. stimulate the economy by decreasing interest rates
c. slow the economy by increasing interest rates
d. both b and c
**d.** both b and c
A reduction in interest rates tends to encourage spending and borrowing by consumers to increase activity throughout the economy. Also, an increase in interest rates tends to restrict borrowing and spending and is designed to slow down the growth in the economy.
(Learning objective 1.6 ~ describe the general features of the economic environment)
