What should you do with her money?
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Jennifer Jones wants to accumulate wealth, but she has told you, her new financial planner, that she is risk averse. What should you do with her money?
a. Invest in products that bring the highest return regardless of risk.
b. Invest in products that produce high income because fixed income products are generally low risk.
c. Put Jennifer’s assets in 100% cash equivalents because she is risk averse.
d. Determine Jennifer's true risk tolerance
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- You've heard the expression "no pain, no gain"? In the investment world, the comparable phrase would be "no risk, no reward." How you feel about risking your money will drive many of your investment decisions. The risk-comfort scale extends from very conservative (you don't want to risk losing a penny regardless of how little your money ears) to very aggressive (you're willing to risk much of your money for the possibility that it will grow tremendously). As you might guess, most investors' tolerance for risk falls somewhere in between. If you're unsure of what your level of risk tolerance is, this quiz should. 10. Your attitude toward money is best described as: (a) a dollar saved is a dollar earned, (b) you've got to spend money to make money, (c) cash and carry only, (d) whenever possible, use other people's money.Ross wants to invest some money that he just inherited. He found that his bank offers a savings account paying a guaranteed 3% rate of return. However, he would like to earn a higher return. Ross should keep in mind that to earn a higher return on his money he: A)will have to invest overseas. B) should invest in a business that has a very stable and predictable rate of return. C)will probably have to accept a higher level of risk. D) will probably have to engage in illegal activitiesSuppose that there are two possible investors with entirely different preferences. Think of A as an ant, who wishes to save for the future, and of G as a grasshopper, who would prefer to spend all his wealth on some ephemeral frolic, taking no heed of tomorrow. Suppose that each has a nest egg of exactly $100,000 in cash. G chooses to spend all of it today, while A prefers to invest it in the financial market. Both have access to a well-functioning, competitive financial market, in which they can borrow and lend at 5% interest rate. Suppose that A and G are offered the opportunity to invest their $100,000 in a new business that a friend is founding. This will produce a one-off surefire payment of $111,000 next year. What would the ant (A) and grasshopper (G) do ? Would they borrow or lend? How much and when would each consume? Multiple Choice A would lend, consume 0 today and $120,000 next year A would lend, consume 0 today and $105,000 next year G would borrow,…
- Viden, a financial advisor for high-net-worth individuals, is examining the portfolio of a client who has requested to reduce the risk of his portfolio which is currently populated only with stocks. The client needs an investment with regular cash flows to finance his daughter’s 4-year university education, as well as a short term fund to meet unexpected requirements in cash. (a) Determine what are the best asset classes to meet his needs, and discuss the reasons for your choice. (b) What will happen to the systematic risk of the client’s portfolio after the change?Maria Juarez is a professional tennis player, and your firm managesher money. She has asked you to give her information about what determines the level of various interestrates. Your boss has prepared some questions for you to consider.a. What are the four most fundamental factors that affect the cost of money, or the general level of interestrates, in the economy?b. What is the real risk-free rate of interest (r*) and the nominal risk-free rate (rRF)? How are these tworates measured?c. Define the terms inflation premium (IP), default risk premium (DRP), liquidity premium (LP), and maturityrisk premium (MRP). Which of these premiums is included in determining the interest rate on (1)short-term U.S. Treasury securities, (2) long-term U.S. Treasury securities, (3) short-term corporatesecurities, and (4) long-term corporate securities? Explain how the premiums would vary over timeand among the different securities listed.d. What is the term structure of interest rates? What is a yield…Investing is a risky business, so investors must be ready to accept that future investment cash flows may be uncertain and unpredictable. This being case, what is the best way to evaluate the value of such an investment? A. Determine the future value of the individual anticipated cash flows at a minimum acceptable rate of return B. Convert the individual future cash flows in a perpetuity and determine the present value of the perpetuity C. Convert the individual future cash flows into an annuity and determine the present value of the annuity D. Determine the present value of the individual anticipated cash flows at a minimum acceptable rate of return
- Your friend took a finance class and learned about risk/return tradeoff. Wanting a high return, he invested in a risky, start- up Technology Company. A year later, the company went bankrupt and he lost his entire investment. He became furious with his finance lecturer for misleading him, claiming he wastaught that higher return goes with higher risk. Explain how your friend misinterpreted the risk/return tradeoff concept?Joan McKay is a portfolio manager for a bank trust department. McKay meets with two clients, Kevin Murray and Lisa York, to review their investment objectives. Each client expresses an interest in changing his or her individual investment objectives. Both clients currently hold well-diversified portfolios of risky assets.a. Murray wants to increase the expected return of his portfolio. State what action McKay should take to achieve Murray’s objective. Justify your response in the context of the CML.b. York wants to reduce the risk exposure of her portfolio but does not want to engage in borrowing or lending activities to do so. State what action McKay should take to achieve York’s objective. Justify your response in the context of the SML.We have probably all heard about the Bernard Madoff Scandal. As investors we need to have adequate financial literacy to avoid these types of events. What steps can you take to help ensure your financial advisor is creating a portfolio that benefits you and your investment objectives? What types of questions should you be asking? What can you do to help ensure your returns are where they should be? (How would you check to verify that your returns are realistic and acceptable?)
- In the context of the different categories of investors, match each sentence to the correct category of investor. * Conservative Moderate conservative Moderate Moderate aggressive Aggressive This investor is looking to invest for the long-term with a specific goal in mind (for example, college savings, retirement, etc.). Investor who does not want to lose any capital and counts on the investment revenues to pay for day to day living expenses. This investor is willing to take on more risk to realize higher returns, being able to accept higher downside risk than the market, but expects to be substantially compensated when markets go up. Similar to Conservative, but this investor wants to participate a little more in market changes although wants maximum protection. This investor is willing to accept large fluctuations in portfolio returns to produce returns substantially above the market in the long-term, usually having an extremely long-term horizon so that she/he can…You must make one of two decisions, each withpossible gains and possible losses. One of thesedecisions is much riskier than the other, having muchlarger possible gains but also much larger possiblelosses, and it has a larger EMV than the safer decision.Because you are risk averse and the monetary valuesare large relative to your wealth, you base yourdecision on expected utility, and it indicates thatyou should make the safer decision. It also indicatesthat the certainty equivalent for the risky decision is$210,000, whereas its EMV is $540,000. What dothese two numbers mean? What do you know aboutthe certainty equivalent of the safer decision?Sharon Smith, the financial manager for Barnett Corporation, wishes to select one of three prospective investments: X, Y, and Z. Assume that the measure of risk Sharon cares about is an asset's standard deviation. The expected returns and standard deviations of the investments are as follows: Investment Expected return Standard deviation X 17% 7% Y 17% 8% Z 17% 9% a. If Sharon were risk neutral, which investment would she select? Explain why. b. If she were risk averse, which investment would she select? Why? c. If she were risk seeking, which investments would she select? Why? d. Suppose a fourth investment, W, is available. It offers an expected return of 18%,and it has a standard deviation of 9%. If Sharon is risk averse, can you say which investment she will choose? Why or why not? Are there any investments that you are certain she will not choose?