HW 5 Solutions - S OLUTIONS 1 N eed for cash Ongoing...

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140 SOLUTIONS 1. Need for cash: Ongoing expenses Emergency reserve Anticipated income €82,500/yeat expected total return on portfolio (subject to risk) €1,020,OOO after taxes from sale ofIngerMatine €132,500/yeat €132,500 €50,OOO/year art sales The after-tax proceeds from the imminent sale of IngerMatine well exceed her anticipated needs for cash for the coming yeat (2 x €132,500 = €265,OOO). Thus, Christa's liquidity needs ate currently met. Because portfolio returns are risky and her anticipated annual income of €132,500 just covers her annual cash needs, however, Christa may face a challenge in the form of liquidity requirements at some point in the future. 2. After the sale of IngerMatine, Christa's portfolio will have a matket value of roughly €1,120,OOO, taking account of the after-tax proceeds from the sale of IngerMatine ( €1,020,OOO), her balanced mutual funds ( €75,OOO), and her money market fund ( €25,OOO). Her expected portfolio return is €82,500, equal to a 7.4 percent rate of return. Her required real return, if she reduces her spending by combining her apartment and studio, is €50,OOO (an sales of €50,OOO less €lOO,OOO expenses), or 4.5 percent as a rate of return on her portfolio. Because the portfolio's expected return of 7.4 percent translates to a real return of approximately 4.4 percent (7.4 percent less 3 percent inflation), the portfolio is not expected to meet the return requirement of 4.5 percent. 3. Portfolio guidelines and investment policy should be reviewed whenever a significant change occurs in the underlying assumptions of the policy statement. At Christa's portfolio performance reviews, the need for an interim reevaluation of the policy statement should always be considered. Possible triggers for a policy statement review might include the following: • A change in personal circumstances affecting risk-return objectives or portfolio constraints. Examples could include an increase in expected income from nonportfolio sources, uninsured health problems, or marriage.
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n. cnange In market conditions affecting long-term risk-return relationships among asset classes. Examples could include a shift in outlook for inflation and global political changes. • New investment markets or vehicles. Examples could include markets made accessible through commingled investment fUnds and retirement saving accounts. • A change in tax laws. An example could be elimination of the capital gains tax. • A severe performance shon&ll, sufficient to jeopardize the ponfolio's ability to meet expense needs in excess of income from other sources. 4. Hans's reckless actions will significantly reduce his portfolio. Hopefully, this incident will make him aware of his financial vulnerability and the long-term consequences of his actions. The potential costs of the accident have created an immediate need for liquidity. Currently, Hans has a diversified equity portfolio valued at €200,OOO and cash of €lOO,OOO. Ifhe has not already done so, he should immediately use the cash to retain an anorney for his upcoming legal challenges. He
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  • Winter '10
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  • return objective, • Stephenson

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