Q#2. John Mesa, CFA is a portfolio Manager in the Trust Department of BigBand. Mesa has been asked to review the investment portfolios of Robert and Mary Smith, a retired couple and potential clients. Previously, the Smiths had been working with another financial adviser, WealthMax Total Financial Consultants (WTFC). To assist Mesa, the Smiths have provided the following background information: Family: We live alone. Our only daughter and granddaughter are financially secure and independent. Health: We are both 65 years of age and in good health. Our medical costs are covered by insurance. Expenses: Our annual after-tax living costs are expected to be $150,000 for this year and are rising with inflation, which is expected to continue at 3% annually. Housing: Our house needs major renovation. The work will be completed within the next six month, at an estimated cost of $200,000. Income: In addition to income from the Gift Fund and the Family Portfolio (both described below), we receive a fixed annual pension payment of $65,000 (after taxes), which continues for both of our lifetimes. Financial Goals: Our primary objective is to maintain our financial security and support our current lifestyle. A secondary objective is to leave $1 million to our grandchild and $1 million to our local college. We recently completed the $1 million gift to the college by creating a "Gift Fund". Preserving the remaining assets for our granddaughter is important to us. Taxes: Our investment income, including bond interest and stock dividend, is taxed at 30%. Our investment returns from price appreciation (capital Gains) are taxed at 15%, at the time of sale. We have no other tax considerations. General Comments: We needed someone like WTFC to develop a comprehensive plan for us to follow. We can follow such a plan once it is prepared for us. We invest only in companies with which we are familiar. We will not sell a security for less than what we paid for it. Given our need for income, we invest only in dividend, paying stocks. Investment: We benefit from two investment accounts: The Gift Fund (1 Million) represents our gift to the college. During our lifetimes, we will receive fixed annual payments of $40,000 (tax free) from the Gift Fund. Except for the annual payments to us, the Gift Fund is managed solely for the benefit of the college - we may not make any other withdrawals of either income or principal. Upon our deaths, all assets remaining in the Gift Fund will be transferred into the college's endowment. The Family Portfolio (1.2 million) represents the remainder of our lifetime savings. The portfolio is invested in very safe securities, consistent with the investment policy statement prepared for us by WTFC as shown below: WTFC Investment Policy for Smith: The Smith Family Portfolio's primary focus is the production of current income, with the long- term capital appreciation a secondary consideration. The need for a dependable income stream precludes investment vehicles with even modest likelihood of losses. Liquidity needs reinforce the need to emphasize minimum-risk investments. Extensive use of short-term investment grade investment is entirely justified by the expectations that a low-inflation environment will exist indefinitely into the future. For these reasons, investment will emphasize U.S. Treasury bills and notes, intermediate term investment grade corporate debt and select "blue-chip" stocks with assured dividend distributions and minimal price fluctuations. To assist in a discussion of investment policy, Mesa presents four model portfolio shown below with return for each portfolio, current yield and Sharpe Ratio: B C D ox 5 Asset Class A U.S. Large Cap U.S. Small Cap 0 Non-US Stock U.S. Bonds Venture Capital 15 15 0 80 0 10 5 4 T-Bills 7.5 After-tax Return Sharpe Ratio After-tax Yield 4.2% 0.35 4.20% 13.0 0.45 0.50 0.45 2.9 1.9 3.3 Based on the above information answer the following needs for the Smith family: A. Prepare and justify an alternative investment policy statement for the Smiths' family portfolio B. Describe how your IPS addresses three specific deficiencies in the WTFC investment policy statement. C. Recommend a portfolio from the above for the family portfolio. Justify your recommendation with specific reference to: i) three portfolio characteristics other than return or yield and ii) the Smith Family return objectives (show your calculations). Q#2. John Mesa, CFA is a portfolio Manager in the Trust Department of BigBand. Mesa has been asked to review the investment portfolios of Robert and Mary Smith, a retired couple and potential clients. Previously, the Smiths had been working with another financial adviser, WealthMax Total Financial Consultants (WTFC). To assist Mesa, the Smiths have provided the following background information: Family: We live alone. Our only daughter and granddaughter are financially secure and independent. Health: We are both 65 years of age and in good health. Our medical costs are covered by insurance. Expenses: Our annual after-tax living costs are expected to be $150,000 for this year and are rising with inflation, which is expected to continue at 3% annually. Housing: Our house needs major renovation. The work will be completed within the next six month, at an estimated cost of $200,000. Income: In addition to income from the Gift Fund and the Family Portfolio (both described below), we receive a fixed annual pension payment of $65,000 (after taxes), which continues for both of our lifetimes. Financial Goals: Our primary objective is to maintain our financial security and support our current lifestyle. A secondary objective is to leave $1 million to our grandchild and $1 million to our local college. We recently completed the $1 million gift to the college by creating a "Gift Fund". Preserving the remaining assets for our granddaughter is important to us. Taxes: Our investment income, including bond interest and stock dividend, is taxed at 30%. Our investment returns from price appreciation (capital Gains) are taxed at 15%, at the time of sale. We have no other tax considerations. General Comments: We needed someone like WTFC to develop a comprehensive plan for us to follow. We can follow such a plan once it is prepared for us. We invest only in companies with which we are familiar. We will not sell a security for less than what we paid for it. Given our need for income, we invest only in dividend, paying stocks. Investment: We benefit from two investment accounts: The Gift Fund (1 Million) represents our gift to the college. During our lifetimes, we will receive fixed annual payments of $40,000 (tax free) from the Gift Fund. Except for the annual payments to us, the Gift Fund is managed solely for the benefit of the college - we may not make any other withdrawals of either income or principal. Upon our deaths, all assets remaining in the Gift Fund will be transferred into the college's endowment. The Family Portfolio (1.2 million) represents the remainder of our lifetime savings. The portfolio is invested in very safe securities, consistent with the investment policy statement prepared for us by WTFC as shown below: WTFC Investment Policy for Smith: The Smith Family Portfolio's primary focus is the production of current income, with the long- term capital appreciation a secondary consideration. The need for a dependable income stream precludes investment vehicles with even modest likelihood of losses. Liquidity needs reinforce the need to emphasize minimum-risk investments. Extensive use of short-term investment grade investment is entirely justified by the expectations that a low-inflation environment will exist indefinitely into the future. For these reasons, investment will emphasize U.S. Treasury bills and notes, intermediate term investment grade corporate debt and select "blue-chip" stocks with assured dividend distributions and minimal price fluctuations. To assist in a discussion of investment policy, Mesa presents four model portfolio shown below with return for each portfolio, current yield and Sharpe Ratio: B C D ox 5 Asset Class A U.S. Large Cap U.S. Small Cap 0 Non-US Stock U.S. Bonds Venture Capital 15 15 0 80 0 10 5 4 T-Bills 7.5 After-tax Return Sharpe Ratio After-tax Yield 4.2% 0.35 4.20% 13.0 0.45 0.50 0.45 2.9 1.9 3.3 Based on the above information answer the following needs for the Smith family: A. Prepare and justify an alternative investment policy statement for the Smiths' family portfolio B. Describe how your IPS addresses three specific deficiencies in the WTFC investment policy statement. C. Recommend a portfolio from the above for the family portfolio. Justify your recommendation with specific reference to: i) three portfolio characteristics other than return or yield and ii) the Smith Family return objectives (show your calculations)