Question

1. Robert Taylor, 50 years old and a U.S. resident, recently retired and received a

$500,000 cash payment from his employer as an early retirement incentive. He also

obtained $700,000 by exercising his company stock options. Both amounts are net of

tax. Taylor is not entitled to a pension; however, his medical expenses are covered by

insurance paid for by his former employer. Taylor is in excellent health and has a normal

life expectancy. Taylor’s wife died last year after a long illness, which resulted in devastating medical expenses. All their investments, including a home, were liquidated to fully satisfy these

medical expenses. Taylor has no assets other than the $1.2 million cash referenced above, and he has no debts. He plans to acquire a $300,000 home in three months and insists on paying

cash given his recent adverse experience with creditors. When presented with investment

options, Taylor consistently selects the most conservative alternative.

After settling into his new home, Taylor’s living expenses will be $2,000 per month

and will rise with inflation. He does not plan to work again. Taylor’s father and his wife’s parents died years ago. His mother, Renee, is 72 years old and in excellent physical health. Her mental health, however, is deteriorating and she has relocated to a long-term-care facility. Renee’s expenses total $3,500 per month. Her monthly income is $1,500 from pensions. Her income and expenses will rise with inflation. She has no investments or assets of value. Taylor, who has no siblings, must cover Renee’s income shortfall.

EXHIBIT 2-3 Robert Taylor Investment Policy Statement

Return objective                         • Income requirement is $2,000 monthly.

• Total return requirement is 2.7% annually ($24,000/$900,000).

Risk tolerance                           • Substantial asset base and low return requirement provide ample

   resources to support an aggressive, growth-oriented portfolio.

Time horizon                             • Client is 50 years old, recently retired, and in excellent health.

• Time horizon exceeds 20 years.

Liquidity needs                          • $300,000 is needed in three months for purchase of home.

• Modest additional cash is needed for normal relocation costs.

   $100,000 may be needed for possible investment in son’s business.

• A normal, ongoing cash reserve level should be established.

Tax concerns                                              • There is little need to defer income.

• Mother’s expenses may have an effect.

Legal and regulatory factors               • No special considerations exist.

Unique circumstances                           • Client desires to support mother.

• Client insists that any investment in son’s business be excluded from     long-term planning.

• Client has strong aversion to debt.

Taylor has one child, Troy. Troy and a friend need funds immediately for a start-up

business with first-year costs estimated at $200,000. The partners have no assets and

have been unable to obtain outside financing. The friend’s family has offered to invest

$100,000 in the business in exchange for a minority equity stake if Taylor agrees to invest

the same amount.

Taylor would like to assist Troy; however, he is concerned about the partners’ ability

to succeed, the potential loss of his funds, and whether his assets are sufficient to support

his needs and to support Renee. He plans to make a decision on this investment very

soon. If he invests $100,000 in Troy’s business, he insists that this investment be excluded

from any investment strategy developed for his remaining funds.

With the above information, portfolio manager Sarah Wheeler prepared the investment

policy statement for Taylor shown in Exhibit 2-3.

A. Evaluate the appropriateness of Taylor’s investment policy statement with regard to

the following objectives: Reference your answer.

i. Return requirement

ii. Risk tolerance

iii. Time horizon

iv. Liquidity requirements

Answer 1