FM102 Personal Financial Planning

SCHOOL OF ACCOUNTING AND FINANCE

Final Examination
Semester 2 2016

FACE TO FACE Mode

Duration of Exam: 3 hours + 10 minutes

Reading Time: 10 minutes

Writing Time: 3 hours

Instructions:

1. This paper has 3 sections. All questions are compulsory.

2. Answer all your questions in the answer booklet provided.
3. This exam covers 50 % of overall mark
4. Total no. of pages: 14
5. This exam is closed book.
6. Materials allowed: Only a calculator.
SECTION A MULTIPLE CHOICE QUESTIONS 50 Marks
You should spend no more than 60 minutes on this section.

Choose one best answer for each question. All answers in this section to be answered on the
multiple choice answer sheet provided. Each question is worth 2 marks.

_____________________________________________________________________________________

1. Which statement about Fiji Superannuation Fund

is false?

a. The minimum contribution towards the fund is 18% of employees’ gross wages
and salaries.
b. Retirement pension is payable at the age of 55.
c. Two-thirds of members’ funds is available for pre-retirement purposes.
d. The Fund has predominantly been a passive investor in the past.

2. Which of the following is the best advice for a student with university loans?

a. After graduation, have a budget that includes money for paying more on the loan
than is required monthly.
b. Get a full time job with a large company that has a tuition reimbursement policy for
its employees.
c. Refinance the loan by transferring the amount of money owed to a credit card with a
low-interest rate.
d. After five years of working, if the loan is not fully repaid apply for personal
bankruptcy.

3. An investor who is interested in diversifying his share portfolio should buy

a. speculative shares, such as new companies without a history of profits.
b. shares in different sectors, such as health care, finance and technology.
c. shares offering a fixed rate of return..
d. shares with high dividends.

2
 4. If the rate of inflation declines rapidly, what is the effect on the market price of a bond?

a. It will decrease.
b. It will increase.
c. It will cause substantial fluctuations in the price.
d. It will have no effect.

5. A will may be successfully contested on which of the following grounds?

a. Lack of testamentary capacity.

b. Undue duress.
c. Incorrect execution.
d. All of the above.

6. Money market securities generally have a term:

a. less than that of the capital market.

b. greater than that of the capital market.
c. equal to that of the capital market.
d. of at least 5 years.

7. The management expense ratio (MER) is a ratio of fees charged to the:

a. book value of assets under management.
b. market value of assets under management.
c. unit price of the fund.
d. none of the above.

8. The goal of risk management is to:

a. Minimize insurance expenditures.

b. Make certain that uninsured losses do not occur.
c. Minimize the adverse consequences of losses and uncertainty connected with pure
risks.
d. Eliminate financial loss.

3
9. The principle of utmost good faith:

a. Holds only the insurer to a high standard of honesty in executing insurance policies.
b. Generally does not apply to health insurance.
c. Holds both the insured and insurer to a high standard of honesty throughout the
duration of the insurance policy.
d. Is a tool used to defraud policyholders.

10. If the frequency of loss is low and the severity is high, generally the most appropriate risk
management tool to use is:

a. risk transfer or insurance

b. risk reduction
c. risk assumption
d. risk avoidance

11. A 45 year old male purchases $500,000 worth of whole life insurance naming his wife
beneficiary. During the course of the application process he misstates his medical health
claiming he never was a smoker and did not have high cholesterol readings, both of which
were false statements. Three years later he dies of a heart attack while attending a local
football game. Under these circumstances:

a. the insurer will pay $500,000 to his wife as beneficiary.

b. the insurer will deny the claim saying it was null and void due to false statements
made by the insured.
c. the insurer will deny the claim saying the policy is voidable based on material
misrepresentation.
d. the insurer will pay past premiums with interest.

4
12. Plain Co. Ltd’s ordinary share has a beta of 0.90, while Dynamite Co. Ltd’s ordinary share
has a beta of 1.80. The expected return on the market is 10 percent, and the risk-free rate is 6
percent. According to the capital-asset pricing model (CAPM) and making use of the
information above, the required return on Plain Co. Ltd's ordinary share should be , and
the required return on Dynamite's ordinary share should be .

a. 3.6 percent; 7.2 percent

b. 9.6 percent; 13.2 percent
c. 9.0 percent; 18.0 percent
d. 14.0 percent; 23.0 percent

13. AccPac Industries has a debt-to-equity ratio of 1.6 compared with the industry average of
1.4. This means that the company
a. will not experience any difficulty with its creditors.
b. has less liquidity than other firms in the industry.
c. will be viewed as having high creditworthiness.
d. has greater than average financial risk when compared to other firms in its industry.

14. Which would be an appropriate investment for temporarily idle corporate cash that will
be used to pay quarterly dividends three months from now?

a. A long-term AAA-rated corporate bond with a current annual yield of 9.4 percent.
b. A 5-year Treasury bond with a current annual yield of 8.7 percent.
c. Ninety-day commercial bond with a current annual yield of 6.2 percent.
d. Share that has been appreciating in price 8 percent annually, on average, and
paying a quarterly dividend that is the equivalent of a 5 percent annual yield.

15. A margin loan exposes the borrower to which source(s) of risk for interest repayments?

a. timing issues arising from the receipt of investment income and the repayment of
loan interest
b. the ability of the borrower to replace or add to security provided in the event of a
margin call
c. the loan servicing ability of the borrower to meet repayments from existing
income
d. both a and c

5
16. Mr West has recently purchased $12,000 worth of shares in Pearls Ltd. Given the relative
risk exposure of Pearls Ltd., Mr West expects an annual rate of return on the investment of
9% p.a. compounded at regular intervals of 4 months. Approximately how much would Mr
West expect to realise from the sale of his investment in 5 years from now?
a. $13,911
b. $18,463
c. $18,696
d. $43,710

17. The latest rate of return credited as interest to the members of the Fiji National Provident
Fund (FNPF) in 2015 was:

a. 6%
b. 6.25%
c. 5.5%
d. 6.9%

18. Which of the following statements about the superannuation fund in Fiji (i.e. FNPF) is
correct:
a. FNPF has been a passive investor, but wants to adopt a more active investment
approach.
b.. 90% of FNPF’s investment portfolio are invested locally, and 10% are invested off-
shore.
c. FNPF offers commercial loans to state-owned enterprises.
d. All of the above are correct.

19. The strike price of an option is:

a. the price paid for the option premium.

b. the trading price of the option at the inception of the option contract.
c. the price at which an option contract will be transacted if the option is exercised.
d. none of the above

6
20. Investment products or instruments that derive their value from underlying assets include:

a. contracts for difference (CFDs).

b. options.
c. warrants
d. all of the above

21. The market price of a share is determined by:

a. the board of directors of the firm.

b. the stock exchange on which the share is listed.
c. the CEO of the company.
d. individuals buying and selling the stock.

22. Assume that the interest rate is greater than zero. Which of the following cash-inflow
streams should you prefer?

Year1 Year2 Year3 Year4

a. $400 $300 $200 $100

b. $100 $200 $300 $400

c. $250 $250 $250 $250

d. Any of the above, since they each sum to $1,000.

23. Which of the following statement is true about investing?

a. It doesn't really matter when you invest, as long as you invest at least 10% of your
income.

b. The earlier you start saving, the more time your money will grow dramatically.

c. Waiting to invest is okay, since you'll have more income and less debt later in life.

d. Investing is an important financial skill anyone that makes more than $50,000 per
year should have.

7
24. Which of the following is generally true about the calculation of an individual’s equity or
net worth ratio?

a. For a young person or couple, it is expected that their equity ratio would be
relatively low as they are likely to have a relatively high level of debt.

b. For a young person or couple, it is expected that their equity ratio would be
relatively high as they are likely to have a relatively low level of debt.

c. The ratio shows the percentage of net worth to total assets.

d. Both a and c.

25. In finance, risk may be defined as:

a. the chance of a loss of capital.

b. the chance of loss of purchasing power.

c. the variability of returns.

d. all of the above.

8
SECTION B SHORT ANSWER QUESTIONS 25 Marks
You should spend no more than 30 minutes on this section.
_____________________________________________________________________________________

1. Tom was having coffee with two of his old school friends, Willie and Simon, and the
conversation turned to the share market. Both Willie and Simon said that they had bought
into Slick Oil Company when the price per share was 25 cents and now the shares were
worth $30 each.

‘Wow,’ said Tom. ‘That’s for me. I’ll buy some!’

Willie said that the shares were still on the rise even though the company had not paid a
dividend yet, and that the company was sure to declare a distribution soon. Simon said
the price–earnings ratio was about 120 to one but that was not really anything to worry
about as it was a growth stock and did not need to worry about earnings in the short term.

Required:

a) What sort of investor behaviour do you think Tom is showing? (2 marks)

b) What sort of investor behaviour do you think Willie and Simon are showing?
(2 marks)

c) What advice would you offer to the three friends?

(4 marks)

2. Briefly outline three (3) ways one can withdraw their superannuation fund (with FNPF),
upon retirement in Fiji.
(6 marks)

3. Tama is aged 42. He recently inherited $180 000 from his uncle’s estate and is looking to
invest the funds. He wants to invest the funds outside of his superannuation account in
order to provide access to liquidity if required. With the additional funds that he now has,
he is prepared to take on more risk in order to try to generate a higher rate of return. He
would like to use $60 000 to build a swimming pool in around 4 years.
Tama earns a salary of $120 000 p.a. and his spouse Tamsy earns a salary of $52 000 p.a.
They normally have a disposable income of around $10 000 p.a. after all expenses. The
couple has 2 children aged under 16. They have minimal debt and their investments other
than superannuation consist of $40 000 held in their bank account and $55 000 held in a
term deposit. Tama has $320 000 held in his industry superannuation fund and invested
in a conservative investment option. Tama wants to ensure that these funds are secured

9
for his retirement and therefore wishes to minimise the risk associated with his
superannuation monies.
(a) What would be the benefits of Tama investing the inheritance into managed
funds? Identify two (2) of the benefits.
(4 marks)
(b) Given his risk profile and financial situation, how would you construct an
appropriate asset allocation for Tama? Provide recommended proportions across
the various asset classes.
(3 marks)
(c) Briefly outline two issues Tama would need to consider in determining which
particular managed funds would be appropriate to invest into?
(4 marks)

10
SECTION C PROBLEM SOLVING QUESTIONS 25 Marks
You should spend no more than 80 minutes on this section.
____________________________________________________________________________________

1. Mario and Danielle have been married for 10 years, are childless and have no desire to
have children. Mario's annual net income is $120,000, and he has group life insurance for
the same amount. Danielle's net income is $45,000 and she has no group insurance. Their
home is valued at $320,000, and they currently have 20 years left on their $250,000
mortgage.

Mario would like to donate an amount of $100,000 to the aged care home that cared for his
parents. Danielle inherited $250,000 recently upon the death of her father, which they are
using to maximize their registered retirement savings plan (RRSP) contributions. In the
event of his own death, Mario would like to leave the house to Danielle mortgage-free.

Required:

To meet Mario’s needs, what is the minimum amount of life insurance coverage he should buy?
Show your working.
(4 marks)

2. a) When the December gold futures contract was trading at US$408 per 10 gram, expecting a
fall in the price, Mr Joey Tuwai sells ten December gold futures contracts of 1 kg each in
September. As expected, the gold prices fall with the December futures contracts trading at
US$406 by October. Joey decides to close out the contract, and lock in his gain.

Required:

What is the amount of profit that Joey makes? Show your working.
(4 marks)

2. b) You manage a risky portfolio with an expected rate of return of 17% and a standard
deviation of 27%. The Treasury-bill rate is 7%. One of your clients chooses to invest
70% of a portfolio in your fund and 30% in a T-bill money market fund.

Required:

What is the expected value and standard deviation of the rate of return on your client’s portfolio?
(4 marks)

11
3. Stan Dover is a coffee exporter who is concerned about recent news reports of a record
coffee harvest in the current year from South America and its potential effects on future
coffee prices. After seeking your advice, Stan has decided to undertake the following
strategy to protect his current coffee holdings against an expected decrease in prices:

1. Sell 4 coffee futures contracts today (3 October 2014).

2. Buy back 4 coffee futures contracts on 30 December 2014 just prior to the expiry of
the contract.

The relevant price information for coffee futures contracts are as follows:

Date Details Amount ($)

3 October 2014 1 Coffee futures contract $40 000
(5 % deposit required)
30 December 2014 1 Coffee futures contact $38 500

Required:

Determine whether Stan was successful in protecting against an expected decrease in the coffee
price as evidenced by his approximate realised return calculated on:

a) a 3 monthly basis, and

b) an annual basis. (8 marks)

Use the table below, which is reproduced in your answer booklet, to write part of your answer to
this question:

Date Particulars Total

3 October, 2014 Cash Flow from selling 4 $
Coffee Futures Contracts
Less: Deposit Required $
(5%) per contract
Net Cash Flow $
30 December, 2014 Less: Buy back 4 Coffee $
Future Contracts
3 January, 2015 Add: Deposit Returned $
NET GAIN $

12
4. For each independent scenario below, discuss which security should sell at a greater
price?

(a) A 6- month European call option with a strike price of $60 or a 6-month European
call on the same stock with an exercise price of $55?
(3 marks)

(b) A 20-year Treasury bond with a 6.5% coupon rate or a 20-year Treasury bond
with a 7.5% coupon rate?
(2 marks)

The End

13
CAPM Formula: Ri = Rf + βi (Rm – Rf)

14