Chapt er5
Per sonalFi nanci alPl anni ngandI nvest ments
Answers to Think It Over (p.132) 1
The minimum cost for a two-week US trip is: Cost of air tickets = $6,000 Accommodation expenses = $00 × !" ni#hts = $!0,00 Tota% cost = $6,000 & $!0,00 = $!6,00 As the trip re'uires at %east $!6,00, $,000 is not enou#h for the trip( An) reasona*%e answer
2
3 Income: + wou%d sae part of m) income for the trip( Savings: + wou%d inest part of m) sain#s to #enerate additiona% returns( Investment: + wou%d ea%uate different inestment choices and choose the one which can
proide m) re'uired rate r ate of return at a reasona*%e reasona* %e %ee% of risk( Consumption: + wou%d reduce m) consumption e(#( cut unnecessar) expenses. so that + can ,
sae more mone) for the trip( /r an) reasona*%e answer.
4
An) reasona*%e answer
Check Your Progress Q1
ased on the %ife c)c%e concept, the first %ife sta#e is 1)oun# sin#%e2( +n fact, as soon as a person #ets his first fu%%-time f u%%-time 3o*, some financia% p%annin# shou%d *e considered co nsidered so that proper prop er consumption *ehaiour and sain# ha*its can *e esta*%ished(
Q2
Step Step ! Unde Unders rsta tand nd )ou )ourr own own need needss
Step Step 4
5ete 5eterm rmin inee #oa% #oa%ss and and #ath #ather er data data
Step Step "
Ana% Ana%) )se )our )our fina financ ncia ia%% situ situat atio ion n
Step
5ee%o e%op a fi finan nancia cia% p% p%an
Step
+mp%ement the p% p%an
Step 6
7onitor th the p%an
NSS BAFS: Basics of Personal Financial Management © Pearson Education Asia Limited 2009 Answers to textbook exercises
32
Q3
8ithout financia% p%annin#, an indiidua% ma) make serious financia% mistakes such as oerspendin# and misuse of consumer credit(
Q4
a. +f *oth the hus*and and wife are emp%o)ed, the coup%e ma) start sain# for retirement and p%annin# their inestments( +f on%) one of them works, the) shou%d take out insurance to protect their earnin# a*i%it) a#ainst an) possi*%e financia% *urden due to death and disa*i%it)( *. +t is important to maintain their preferred %ifest)%e with a sta*%e retirement income( The) a%so need to hae enou#h mone) for medica% expenses( Another priorit) at this sta#e is estate p%annin#( The o*3ectie of estate p%annin# is effectie%) distri*utin# their wea%th with minimum taxation( c. As the *irth of chi%dren #reat%) increases a fami%)2s financia% *urden, the need for financia% protection is stron#er and insurance coer is a must( The coup%e shou%d a%so p%an for their chi%dren2s educationa% expenses( The) ma) a%so sae for ma3or purchases and retirement( d. The ma3or financia% p%annin# o*3ectie for )oun# sin#%es is to create and accumu%ate wea%th( Since the) need to support their parents and fami%ies financia%%), the) shou%d a%so take out insurance protection a#ainst the possi*%e financia% *urden that ma) resu%t due to their own death and disa*i%it)( The) ma) a%so sae for a home and retirement( (e)
The coup%e2s first priorit) is sain# for retirement( As their chi%dren hae #rown up and *ecome financia%%) independent, the need for insurance which proides financia% protection to the chi%dren and the non-workin# spouse #radua%%) decreases(
Q
This is *ecause indiidua%s usua%%) hae different needs, priorities and o*3ecties at different %ife sta#es( The characteristics of arious %ife sta#es hae a stron# effect on financia% p%annin# decisions(
Q!
8hen preparin# a *ud#et, an indiidua% has to keep track of his income and expenses( This a%%ows the indiidua% to ea%uate his financia% situation( +n addition, *ud#etin# he%ps him identif) his #oa%s and understand his financia% needs( 8ith this information, the indiidua% can dee%op a financia% p%an and know how to a%%ocate resources to achiee the #oa%s set out in the p%an(
Q"
) preparin# a *ud#et, an indiidua% can determine whether cash outf%ows wi%% exceed cash inf%ows so that an) shorta#e can *e forecast(
NSS BAFS: Basics of Personal Financial Management © Pearson Education Asia Limited 2009 Answers to textbook exercises
33
Q#
Two factors affectin# the choice of 79 funds: !
The risk-return trade-off: +n #enera%, the hi#her the %ike%ihood of %ar#e potentia% returns, the hi#her the risk, and the #reater the chance of incurrin# %osses(
4
+nestment hori;on: /ther thin#s *ein# e'ua%, the %on#er the inestment hori;on i(e(, the farther awa) from retirement., the more risk one can afford to take(
Q$
Two adanta#es of 79 funds: !
79 funds a%%ow emp%o)ees to sae for their retirement throu#h #radua% sain#s in %on#term inestment p%ans accordin# to their risk to%erance %ee%(
4
8ithin the 79 scheme chosen *) the emp%o)er, emp%o)ees can make their own inestment choices and en3o) potentia% inestment returns(
Answers to %iscussion Questions (p.144) 1
The most expensie %ife #oa%s for a married coup%e are proidin# for their chi%dren2s priate schoo%$4 mi%%ion to send one chi%d to stud) at a priate US uniersit) tuition fees p%us accommodation expenses.( 7ore costs wi%% *e ino%ed if the chi%d #oes to an internationa% hi#h schoo% in on# >on# *efore stud)in# a*road(
2
e can start inestin# now and sain# mone) for Susie2s co%%e#e education(
3
8ith persona% financia% p%annin#, ?ohn can dee%op a financia% p%an *ased on his financia% situation( This he%ps him prioritise his #oa%s and needs with his %imited financia% resources( +f the p%an is imp%emented proper%), ?ohn can steadi%) accumu%ate wea%th( This he%ps him esta*%ish financia% securit), *etter meet his financia% #oa%s and maintain his %iin# standard when his income %ee% is %ow after retirement.(
4
Considerin# his financia% situation, ?ohn shou%d ea%uate if his dau#hter@s dream is achiea*%e( As interest rates are %ow, it is not %ike%) that ?ohn can #ain enou#h mone) to pa) for his dau#hter@s oerseas education *) sain# a%one( +nstead, he shou%d inest in hi#h-return financia% products( /n the other hand, he ma) ask Susie to set a more rea%istic #oa% e(#(, stud)in# in on# >on# instead of stud)in# in US.( This is an important step in the financia%
NSS BAFS: Basics of Personal Financial Management © Pearson Education Asia Limited 2009 Answers to textbook exercises
34
p%annin# process(
Assessment
&CQ 1
2
C
3
4
A
C
!
"
5
#
5
$
A
1'
A
11
C
12
5
As the re%eant income of the emp%o)ee was %ess than $,000 in that month, he is not re'uired to contri*ute to the scheme( oweer, his emp%o)er is sti%% re'uired to make a contri*ution $",000 × = $!0.(
hort Questions 13
5ue to unexpected chan#es in persona% and externa% situations, an indiidua% ma) need to reise his financia% p%an( or examp%e, if an indiidua% suffers a sa%ar) cut, he ma) reduce consumption( +f the #oernment raises the tax rate, an indiidua% shou%d sae a %ar#er portion of his income for tax pa)ments(
14
The six financia% p%annin# needs are: consumption, taxation, insurance, inestment, retirement, and estate p%annin#(
1
1!
Step !
Understandin# )our own needs
Step 4
5eterminin# #oa%s and #atherin# data
Step "
Ana%)sin# )our financia% situation
Step
5ee%opin# a financia% p%an
Step
+mp%ementin# the p%an
Step 6
7onitorin# the p%an
Bife sta#es: oun# sin#%e, 3ust married, married with )oun# chi%dren, married with o%der
NSS BAFS: Basics of Personal Financial Management © Pearson Education Asia Limited 2009 Answers to textbook exercises
35
chi%dren, pre-retirement, and retirement(
1"
actors which shou%d *e considered: !
The choice of financia% products depends on the inestment hori;on, which in turn depends on an indiidua%2s inestment o*3ecties( +f the mone) is needed in a short period of time, short-term financia% products are more appropriate( +f the mone) wi%% not *e used for decades, %on#-term financia% products are more suita*%e(
4
+nestors shou%d a%so consider their risk to%erance %ee%( or examp%e, if an inestor is not wi%%in# to take risks, he shou%d choose %ow-risk financia% products for his portfo%io( +f he does not mind takin# risks, he ma) choose hi#h-risk financia% products which hae hi#her potentia% returns(+fheiswi%%in#toacceptanaccepta*%e%ee%ofrisk,hema) +f he is wi%%in# to accept an accepta*%e %ee% of risk, he ma) choose financia% products with different riskreturn trade-offs(
1#
+n the chi%dhood sta#e, an indiidua% norma%%) does not hae an) income or wea%th to sae or inest( Therefore the chi%dhood sta#e is norma%%) exc%uded in financia% p%annin#(
1$
+n choosin# a financia% product, we hae to consider the inestment hori;on and our risk to%erance %ee%s( The inestment hori;on depends on one2s inestment o*3ecties( +f a %ar#e amount of mone) is needed in a short period of time, we shou%d inest in short-term financia% products which hae hi#h potentia% returns e(#(, stocks.( +f we hae a %ot of time for inestin# such as sain# for retirement, we ma) choose a #oernment *ond or an e'uit) mutua% fund( +f our risk to%erance %ee%s are %ow, we shou%d choose a %ow-risk financia% product( As the return of a #oernment *ond is #uaranteed, it is suita*%e for risk aerse inestors( +f we are wi%%in# to assume an accepta*%e %ee% of risk, we ma) choose an e'uit) mutua% fund in which the risk is diersified( +f we are wi%%in# to take hi#h risks, we ma) choose a stock which has a hi#h potentia% return( oweer, we ma) suffer a sharp %oss if the stock price drops si#nificant%)(
2'
inancia% p%annin# he%ps us dea% with dai%) needs( 7ost of us not on%) rich peop%e. need financia% p%annin# in areas such as consumption and retirement( or examp%e, we ma) inest and sae mone) for our home mort#a#e pa)ments( Coup%es ma) sae mone) for their chi%dren@s education( Dmp%o)ees ma) choose proper inestment ehic%es for their retirement( To achiee our financia% #oa%s, we shou%d do financia% p%annin#(
Cse An*+sis NSS BAFS: Basics of Personal Financial Management © Pearson Education Asia Limited 2009 Answers to textbook exercises
36
21
a. ) inestin# in mutua% funds, sma%% inestors can inest in a wide ariet) of stocks which are not corre%ated( The risks of different stocks wi%% cance% each other out( This a%%ows sma%% inestors to *u) a num*er of stocks whi%e reducin# the risk of their inestment( *. u)in# a sin#%e stock is riskier( As the return tota%%) depends on the price of one stock, an inestor ma) suffer a #reat %oss if the stock price drops si#nificant%)( 8hen an inestor *u)s mutua% funds, he actua%%) inests in different kinds of stocks which are not corre%ated( The risk of the inestment is diersified( Therefore *u)in# mutua% funds is %ess risk)( c. 9eter shou%d consider his inestment hori;on and risk to%erance %ee% when he chooses financia% products( The inestment hori;on depends on 9eter@s inestment o*3ectie( 9eter@s #oa% is to sae for his $!0,000 weddin# expenses in two )ears( +f he inests in a mutua% fund: -! + 0(0!. 4$ − ! EA = $,000 × 0(0!
= $,000 ×46(FG = $!",0 +f he inests in the stock of the te%ecommunication firm: -! + 0(04. 4$ − ! EA = $,000 × 0(0!
= $,000 ×"0(4 = $!4,!00 As inestin# in the stock of the te%ecommunication firm can #enerate $!4,!00 in two )ears, which can coer 9eter2s weddin# expenses, he shou%d choose this option( oweer, 9eter shou%d a%so ea%uate his risk to%erance %ee%( As inestin# in a sin#%e stock is risk), he shou%d consider other choices( e ma) inest in other mutua% funds that proide hi#her returns( e ma) a%so consider sain# more per month( or examp%e, if he can sae $6,000 per month *) inestin# in a mutua% fund, he wi%% hae $!6!,40 $6,000 H 46(FG. in two )ears( This can coer his weddin# expenses(
22
a. 9au%: $40,000 × = $!,000 ?onathan: $!4,000 × = $600 *. 9au% shou%d choose a hi#h-risk product for his 79 funds *ecause he has a %on# inestment hori;on( e has seera% decades of workin# %eft *efore retirement( As he has
NSS BAFS: Basics of Personal Financial Management © Pearson Education Asia Limited 2009 Answers to textbook exercises
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a sta*%e income, his risk to%erance %ee% is hi#h( e can afford hi#h-risk products( c.
The return on 9%an A after three )ears: $60,000 × ! & 40.4 & $60,000 × ! & 40.! & " $60,000 or $60,000 × I -! + 0(4.
−
!
0(4
J = $4!,00
The return on 9%an after three )ears: $"0,000 × ! & .4 & $"0,000 × ! & .! & " $"0,000 or $"0,000 × I -! + 0(0.
−
!
J = $FG,"F4
0(0
As the return on 9%an A is hi#her than $400,000, 9au% shou%d choose 9%an A( d.
Since ?onathan wi%% retire soon, he shou%d choose the %ow-risk p%an( As the standard deiation of 9%an is %ower, 9%an is more suita*%e for him(
NSS BAFS: Basics of Personal Financial Management © Pearson Education Asia Limited 2009 Answers to textbook exercises
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