Laws and regulations fairfax should be aware of and

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Laws and Regulations . Fairfax should be aware of, and abide by, any securities (or other) laws or regulations relating to her “insider” status at Reston and her holding of Reston stock. Although there is no trust instrument in place, if Fairfax’s future investing is handled by an investment advisor, the responsibilities associated with the Prudent Person Rule will come into play, including the responsibility for investing in a diversified portfolio. Also, she has a need to seek estate planning legal assistance, even though there are no apparent gift or bequest recipients. Unique Circumstances and/or Preferences . The value of the Reston stock dominates the value of Fairfax’s portfolio. A well-defined exit strategy needs to be developed for the stock as soon as is practical and appropriate. If the value of the stock increases, or at least does not decline before it is liquidated, Fairfax’s present lifestyle can be maintained after retirement with the combined portfolio. A significant and prolonged setback for Reston Industries, however, could have disastrous consequences. Such circumstances would require a dramatic downscaling of Fairfax’s lifestyle or generation of alternate sources of income in order to maintain her current lifestyle. A worst-case scenario might be characterized by a 50% drop in the market value of Reston’s stock and sale of that stock to diversify the portfolio, where the sale proceeds would be subject to a 35% tax rate. In this scenario, the net proceeds of the Reston part of the portfolio would be: $10,000,000 × 0.5 × (1 - 0.35) = $3,250,000 When added to the Savings Portfolio, total portfolio value would be $5,250,000. For this portfolio to generate $658,000 in income, a 12.5% return would be required. Synopsis. The policy governing investment in Fairfax’s Savings Portfolio will put emphasis on realizing a 3% real, after-tax return from a mix of high-quality assets with less than average risk. Ongoing attention will be given to Fairfax’s tax planning and legal needs, her progress toward retirement, and the value of her Reston stock. The Reston stock holding is a unique circumstance of decisive significance in this situation. Developments should be monitored closely, and protection against the effects of a worst- case scenario should be implemented as soon as possible. 28-10
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Chapter 28 - Investment Policy and the Framework of the CFA Institute b. Critique . The Coastal proposal produces a real, after-tax expected return of approximately 5.18%, which exceeds the 3% level sought by Fairfax. The expected return for this proposal can be calculated by first subtracting the tax-exempt yield from the total current yield: 4.9% - 0.55% = 4.35% Next, convert this to an after-tax yield: 4.35% × (1 - 0.35) = 2.83% The tax exempt income is then added back to the total: 2.83% + 0.55% = 3.38% The appreciation portion of the return (5.8%) is then added to the after-tax yield to get the nominal portfolio return: 3.38% + 5.80% = 9.18% Finally, the 4% inflation rate is subtracted to produce the expected real after-tax return: 9.18% – 4.0% = 5.18%
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