Chap028 - Chapter 28 - Investment Policy and the Framework...

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Chapter 28 - Investment Policy and the Framework of the CFA Institute CHAPTER 28: INVESTMENT POLICY AND THE FRAMEWORK OF THE CFA INSTITUTE PROBLEM SETS 1. You would advise them to exploit all available retirement tax shelters, such as 403b, 401k, Keogh plans and IRAs. Since they will not be taxed on the income earned from these accounts until they withdraw the funds, they should avoid investing in tax-preferred instruments like municipal bonds. If they are very risk-averse, they should consider investing a large proportion of their funds in inflation-indexed CDs, which offer a riskless real rate of return. 2. a.The least risky asset for a person investing for her child’s college tuition is an account denominated in units of college tuition. Such an account is the College Sure CD offered by the College Savings Bank of Princeton, New Jersey. A unit of this CD pays, at maturity, an amount guaranteed to equal or exceed the average cost of a year of undergraduate tuition, as measured by an index prepared by the College Board. b. The least risky asset for a defined benefit pension fund with benefit obligations that have an average duration of ten years is a bond portfolio with a duration of ten years and a present value equal to the present value of the pension obligation. This is an immunization strategy that provides a future value equal to (or greater than) the pension obligation, regardless of the direction of change in interest rates. Note that immunization requires periodic rebalancing of the bond portfolio. c. The least risky asset for a defined benefit pension fund that pays inflation-protected benefits is a portfolio of immunized Treasury Inflation-Indexed Securities with a duration equal to the duration of the pension obligation (i.e., in this scenario, a duration of ten years). (Note: These securities are also referred to as Treasury Inflation-Protected Securities, or TIPS.) 3. a.George More’s expected accumulation at age 65: n i PV PMT FV Fixed income 25 3% $100,000 $1,500 FV = $264,067 Common stocks 25 6% $100,000 $1,500 FV = $511,484 b. Expected retirement annuity: n i PV FV PMT Fixed income 15 3% $264,067 0 PMT = $22,120 Common stocks 15 6% $511,484 0 PMT = $52,664 28-1
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Chapter 28 - Investment Policy and the Framework of the CFA Institute c.In order to get a fixed-income annuity of $30,000 per year, his accumulation at age 65 would have to be: n i PMT FV PV Fixed income 15 3% $30,000 0 PV = $358,138 His annual contribution would have to be: n i PV FV PMT Fixed income 25 3% $100,000 -$358,138 PMT = $4,080 This is an increase of $2,580 per year over his current contribution of $1,500 per year. 4. a.The answer to this question depends on the assumptions made about the investor’s effective income tax rates for the period of accumulation and for the period of withdrawals. First, we assume that (i) tax rates remain constant throughout the entire time horizon; and, (ii) the investor’s taxable income remains relatively constant throughout. Consequently, the
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Chap028 - Chapter 28 - Investment Policy and the Framework...

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