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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 taxpreferred
instruments like municipal bonds. If they are very riskaverse, they should consider
investing a large proportion of their funds in inflationindexed 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 inflationprotected
benefits is a portfolio of immunized Treasury InflationIndexed 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 InflationProtected
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
281
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View Full DocumentChapter 28  Investment Policy and the Framework of the CFA Institute
c.In order to get a fixedincome 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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 Spring '10
 SMITH

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