Chapter 5Personal Financial Planning and Investments
Short Questions
B3C05T2Q001eng
What factors should investors consider when choosing financial products?(4 marks)
Answer:
Investors should consider their investment horizon which is the length of time that an investment is held to achieve an investment objective. For example, if they save for retirement, long-term financial products are more suitable. (2 marks)
Investors should also consider their risk tolerance level. They should think about what risk level they can bear and choose financial products with appropriate risk levels. (2 marks)
B3C05T2Q002eng
How should the following persons plan for their finances?
(a)David is 35 years old. He is a pilot. He supports his retired parents financially.
(b)Keith is a 60-year-old taxi driver. He plans to retire in two years. His children are studying at universities and will graduate next year. (4 marks)
Answer:
(a)David should take out insurance protection against any possible financial burden due to death or disability. He should also accumulate wealth and save for retirement. (2 marks)
(b)Saving for retirement should be Keith’s first priority. As Keith’s children will start working, the need for insurance which gives financial protection to them will decrease. (2 marks)
B3C05T2Q003eng
Martin is a university student. He works as a part-time tutor and earns about $2,000 per month. However, he likes buying things with credit cards. He usually spends several thousand per month. Explain how a personal budget can help him solve thisproblem. (3 marks)
Answer:
A budget can help Martin avoid the problem of overspending. As Martin can foresee the potential cash shortage from a budget, he will realise that he will not have enough money for repayment. Then he will reduce his credit card purchases. (3 marks)
B3C05T2Q004eng
How can an employee benefit from the MPF system?(2 marks)
Answer:
The system allows employees to save for their retirement through gradual savings in long-term investment plans at the right risk level. They can also make their own investment choices and enjoy potential capital gains. (2 marks)
B3C05T2Q005eng
Some critics contend that the actual returns from MPF funds are not attractive. Suggest two reasons for this.(4 marks)
Answer:
MPF service providers charge their clients considerable fees and expenses. These charges lower the returns earned on the funds and thus reduce the benefits that employees will receive on their investment. (2 marks)
Unless an employee chooses a guaranteed fund, any loss suffered from an MPF scheme is entirely borne by him.(2 marks)
B3C05T2Q006eng
Derick runs a Chinese restaurant. As some customers have complained about poor hygiene conditions, Derick has decided to redecorate the restaurant. He plans to borrow $500,000 from Bank A.
(a)Complete the following table which illustrates the six steps of personal financial planning.(6 marks)
(b)Suggest two macroeconomic data which Derick should collect. Explain your answer.(4 marks)
(c)Suppose Derick is required to repay the loan in five years by annual instalments. The annual interest rate is 8%. How much should Derrick pay per year? Given that the PVIFA8%, 5 is 3.993. (1 mark)
(d)Suppose Bank B provides a loan to Derick. Its annual interest rate is 5% and the repayment period is eight years. Should Derick choose this loan instead of Bank A’s loan? Given that the PVIFA5%, 8 is 6.463. (4 marks)
(Calculations to the nearest dollar)
Answer:
(a)
(1 mark each)
(b)Interest rate: Derick should compare the interest rates of different lending institutions and choose the lowest one. Then he can obtain funds at the lowest cost. (2 marks)
Inflation rate: Derick should estimate the change in operating costs such as increases in the price of imported food and salary adjustments for his staff. Then he will know if he is able to make repayments in future. (2 marks)
(c)Annual payment = (1 mark)
(d)Annual payment of Bank B’s loan (1 mark)
Total interest of Bank A’s loan = $125,219 5 – $500,000 = $126,095(1 mark)
Total interest of Bank B’s loan = $77,363 8 – $500,000 = $118,904(1 mark)
As the total interest payment of Bank B’s loan is less than Bank A’s loan, Derick should choose Bank B’s loan. (1 mark)
B3C05T2Q007eng
Stephen is 30 years old. He is the marketing manager at a listed company, earning a monthly salary of $65,000. He plans to marry in five years. His father, Dick, is a 55-year-old bus driver. He will retire next year. They are now choosing their MPF funds.
(a)Which life stages are Stephen and Dick in?(2 marks)
(b)What financial products do Stephen and Dick need, respectively?(4 marks)
(c)Should Stephen choose low-risk or high-risk MPF funds? Explain your answer.(3 marks)
(d)The following table shows two financial products:
Product A / Product BExpected return / 5% / 12%
Standard deviation / 8% / 15%
Which product should Stephen and Dick choose, respectively? Explain your answer.(4 marks)
Answer:
(a)Stephen is in the young single stage and Dick is in the pre-retirement stage.(2 marks)
(b)Stephen: As his father will retire soon and Stephen will support the family financially, he should take out insurance protection against any possible financial burden due to death or disability. He should also invest so that he can accumulate wealth for his future marriage. (2 marks)
Dick: As he will retire soon, the first priority is saving for retirement.(2 marks)
(c)Stephen should choose high-risk MPF funds because of his long investment horizon. He has a few decades to work before his retirement. As his income level is comparatively high, his risk tolerance level is high and he can afford high-risk investments. He should choose high-risk MPF funds to earn high returns. (3 marks)
(d)Stephen should choose Product B because he can afford greater risks. The expected return and the risk of Product B are higher (shown by the higher standard deviation). (2 marks)
Dick should choose Product A. His risk tolerance level is low because he will retire soon and his income level will be low. As Product A is safer, Dick should choose this. (2 marks)
B3C05T2Q008eng
Nick is 35 years old. He has two children, one is five years old and the other is three years old. He is a chef and his wife is a primary school teacher.
(a)Which life stage is Nick in?(1 mark)
(b)Based on the answer in (a), suggest how Nick should plan his finances.(2 marks)
(c)Suppose Nick is considering making an investment, using his savings of $150,000, for five years. He will choose one of the following two plans:
Product A / Product BAnnual rate of return / 10% / 8%
Compounding frequencies / Annually / Semi-annually
Which one should Nick choose?(3 marks)
(d)Refer to (c). Suppose Nick can only afford a maximum loss of $30,000. The potential maximum losses of Product A and Product B are 18% and 15%, respectively. Which product should Nick choose now? (3 marks)
(Calculations to one decimal place)
Answer:
(a)Nick is at the married with young children stage.(1 mark)
(b)Nick should take out insurance to protect his family against any possible financial burden due to his death or disability. He should also save money for his children’s educational expenses. (2 marks)
(c)The total amount of Product A after five years: $150,000 (1 + 10%)5 = $241,576.5(1 mark)
The total amount of Product B after five years: $150,000 (1 + 4%)10 = $222,036.6(1 mark)
As the return on Product A is higher, Nick should choose Product A.(1 mark)
(d)The maximum loss of Product A = $150,000 18% = $27,000(1 mark)
The maximum loss of Product B = $150,000 15% = $22,500(1 mark)
As both the maximum losses of Products A and B are less than $30,000, Nick should choose Product A because of its higher return. (1 mark)
B3C05T2Q009eng
The following table shows Angela’s personal budget for the month of January 2009:
Item / Past actual(December) / Budgeted / Actual
(January) / Variance
$ / $ / $ / $
Cash inflows:
Salary / 20,000 / 20,000 / 20,000 /
Bonus / 0 / 20,000 / 25,000 / 5,000
Interest / 500 / 500 / 500 /
Cash outflows:
Rent / 5,500 / 5,500 / 5,500 /
Electricity and water / 1,000 / 1,000 / 1,200 / (200)
Telephone / 300 / 300 / 300 /
Travelling / 1,500 / 1,500 / 1,500 /
Food / 4,500 / 5,000 / ? / (500)
Entertainment / 2,000 / 2,500 / ? / (2,000)
Shopping / 2,000 / 2,000 / ? / (3,000)
(a)How much did Angela spend on food, entertainment and shopping, respectively, in January?(3 marks)
(b)What are the actual net cash flows in December 2008 and January 2009, respectively?(3 marks)
(c)Suppose Angela plans to rent an apartment, which is close to her workplace. The rent is $6,500 per month; however, it is estimated that her travelling expenses will decrease significantly to $400 per month. Should Angela rent this apartment? Explain your answer. (4 marks)
(d)‘The actual cash inflow is greater than the actual cash outflow. Therefore, Angela has planned well financially in January,’ Angela’s mother said. Is Angela’s mother correct? Explain your answer. (3 marks)
Answer:
(a)Food = $5,000 – ($500) = $5,500(1 mark)
Entertainment = $2,500 – ($2,000) = $4,500(1 mark)
Shopping = $2,000 – ($3,000) = $5,000(1 mark)
(b)Net cash flow of December 2008 = ($20,000 + $500) – ($5,500 + $1,000 + $300 + $1,500 + $4,500 + $2,000 + $2,000) = $3,700. (1.5 marks)
Net cash flow of January 2009 = ($20,000 + $25,000 + $500) – ($5,500 + $1,200 + $300 + $1,500 + $5,500 + $4,500 + $5,000) = $22,000 (1.5 marks)
(c)Increase in cash outflow of rent = $6,500 – $5,500 = $1,000(1 mark)
Decrease in travelling expenses = $1,500 – $400 = $1,100(1 mark)
As the decrease in travelling expenses can cover the increase in rent, Angela should rent the apartment.(2 marks)
(d)No, although the actual cash inflow is greater than the actual cash outflow, the variances of cash outflow for entertainment and shopping are high. Angela spent much more than she had planned on these two items. The increase in actual net cash flow is only due to her bonus. (3 marks)
B3C05T2Q010eng
Victor is 28 years old. He is an accountant and plans to marry in three years. As he is the only child in his family, he has to support his retired parents financially.
(a)Fill in the life stages in the life cycle below.(2 marks)
(b)How should Victor plan for his finances now?(2 marks)
(c)After five years, Victor has married and has a child. His wife, Jenny, has quit her job and stays at home to take care of their baby. How should Victor plan for his finances at this stage? (2 marks)
(d)Fifteen years later, Victor’s child has grown older. Victor has been promoted to a senior position while Jenny is working again. Victor has decided to let his child study overseas when he finishes his secondary school. How should Victor plan his finances at this stage? (2 marks)
Answer:
(a)
(0.5 mark each)
(b)Victor should take out insurance protection against any possible financial burden due to his death or disability. He should also save for marriage expenses and invest to accumulate wealth. (2 marks)
(c)As his financial burden increases, Victor should take out insurance protection. He should also plan for his child’s educational expenses. If there is any money left, he should save for major purchases and retirement. (2 marks)
(d)As Victor earns a higher income and has more surplus funds, he should repay his loans and save for his child’s university education. He should also save for retirement. (2 marks)