*When accounting for inflation in this unit, you may use the simple additive method.
1. Your client Vicky has just received an inheritance of $300,000 after tax. She wishes to use this money to fund a $6,000 vacation each year for the rest of her life, without drawing down the original $300,000. Vicky faces a marginal tax rate of 25% on investment income. You expect that inflation will average 3% per year.a. Without adjusting for taxes or inflation for the moment, find the required return needed to fund the vacations from the $300,000.b. Accounting for inflation*, find the required return.c. Now accounting for taxes, find the required pre-tax, inflation-adjusted return. Express your answer as a percentage rounded to two decimal places.
2. An investor is going to save $1,500 per month, and wants to end up with $1 million in 27 years.a. Find the required return (interest rate) needed for $1,500 monthly deposits to become $1 million in 27 years. Show the Excel formula or calculator steps you used. Express your answer as a percentage rounded to two decimal places.b. Adjust this required return for 2% inflation* and 20% taxes. Check figure for this problem: 8.56%. You must show work.
The rest of the questions in this assignment use the following scenario:Paul and Heidi Ellis are a married couple who are seeking your advice as a portfolio manager. Paul and Heidi are both 38 years old. They have established careers, earn $140,000 a year, and have modest expenses. The $140,000 is probably close to the peak income they will have over their lifetimes. The couple currently faces a marginal tax rate of 30%; however, with proper planning you believe that any investment income will be taxed at just 20%.Paul and Heidi have stated that they wish to retire by the age of 65 with $1,000,000 inflation-adjusted dollars, to be raised by saving $1,500 monthly from their wages. You expect that inflation will average 2% per year. The couple is currently able to pay all living expenses out of wages, and in a side fund, they are saving for an elaborate vacation ($12,000) in three years.Your discussions with the couple lead you to believe that Paul is a cautious investor, while Heidi is an spontaneous investor. Paul has stated that he would not want losses of more than 5% in any year, while Heidi is willing to accept losses of up to 20% in a year in order to try for a higher expected return. You believe you can get the couple to comprise on a possible 15% loss. Paul is a strict vegetarian and does not want any investments in companies related to the production of animals for food.3. Using the facts given in the scenario above, write the Return Objectives section of an investment policy statement for Paul and Heidi Ellis. Note that you already found the required return in Question 2 of this assignment. Use the relevant parts of Exhibit 2-8 (starting on page 48) and Example 2-1 (starting on page 51) as examples. Explain all conclusions within the statement and demonstrate that you understand the material in the text.Return Objectives
4. Using the facts given in the scenario above, write the Risk Tolerance section of an investment policy statement for Paul and Heidi Ellis. Follow the specific information given in Chapters 1 and 2; for example there are questions that determine the ability to take risk on pages 12 and 37-38. Clearly divide your statement into three sections: ability, willingness, and overall tolerance. Use the relevant parts of Exhibit 2-8 (starting on page 48) and Example 2-1 (starting on page 51) as examples. Explain all conclusions within the statement and demonstrate that you understand the material in the text.Risk Tolerance
5. Using the facts given in the scenario above, write the Constraints section of an investment policy statement for Paul and Heidi Ellis. Use the relevant parts of Exhibit 2-8 (starting on page 48) and Example 2-1 (starting on page 51) as examples. Explain all conclusions within the statement and demonstrate that you understand the material in the text.Constraints
6. Below are some proposed asset allocation alternatives for the couple’s retirement portfolio. Answer the questions below the table.Allocation Alternatives ? A B C D EExpected Total Return 8.2% 9.1% 9.6% 10.0% 11.5%Expected Standard Deviation 7.5% 9.6% 10.2% 11.8% 13.5%Sharpe Ratio 0.560 0.531 0.549 0.508 0.556
Using the required return of 8.56% and the acceptable one year loss of 15%:a. Which portfolios meet the return requirement?b. Which portfolios meet the risk tolerance level using the two standard deviation rule? Show work.c. Which portfolio would you recommend? Explain.d. What else would you need to check about this portfolio before recommending it? Explain.
