Personal Financial Management (FTX2000S)

Supplementary examination
20 January 2016
Suggested solutions

SECTION A
PLEASE ANSWER ALL QUESTIONS.

QUESTION 1 (15 MARKS: 18 MINUTES)

1.1 The amount of time spent at each stage of the Personal Financial Life Cycle differs
from individual to individual, but generally most people go through 6 stages of the
Personal Financial Life Cycle. Discuss the saving and investment potential of
individuals at the Single Stage, Family Stage and Retirement Stage of the Personal
Financial Life Cycle.
(9 marks)
Solution
At the single stage of the PFLC the individual be starting to earn their own income for the first time,
but this income is low, generally lower than their expenses. [1 mark] There is therefore not much
scope for savings and investments. [1 mark] The focus is therefore on satisfying short term needs,
longer term decisions that are required for investments is not a top priority. [1 mark]

At the Family stage of the PFLC the couple’s financial priorities will be influenced by the arrival of
children. [1 mark] Whilst there is income growth, this is generally lower than growth in expenses
which now include payments for children’s clothing, nutrition, health and education. [1 mark]
Savings and investment is limited by higher expenditures and priorities also change as there is less
appetite for risk decisions. [1 mark]

At the Post-Family stage of the PFLC there is a notable reduction in expenses since the children have
now left the home. [1 mark] Growth in income will be close to its maximum and expenses will have
declined, [1 mark] which leaves a significant amount over for saving and investment in preparation
for retirement. [1 mark]

1.2 An individual’s ability and decision to take on financial risk will depend on his/her…
a. personality,
b. financial resources,
c. age,
d. number of dependents,
e. skills and abilities and
f. support and backup
What aspects of “c” “d” and “f will affect the individual’s ability to take on risk.
(6 marks)

Page 1 of 14
Solution
Age - The older a person is, the less time they have to recover from financial setbacks. Therefore,
older people tend to be less likely to take financial risk than younger people. Older people are
therefore more risk averse than younger people. [2 mark]

Number of dependents – It is far easier to take risk if you know that failure will only affect you. It is
usually more difficult to take financial risk once there are dependents such as children involved,
especially if they will suffer financially or from loss of opportunity if financial risk taking leads to a
bad outcome. [2 mark]

Support and back-up: If there is an extended or wealthy family, or a spouse with a second income to
fall back on in case things go wrong, it is naturally easier to take financial risk. [2 mark]

Page 2 of 14
QUESTION 2 (15 MARKS: 18 MINUTES)

The table below list the details of the values and dividends of 2 stocks, Yahoo and Google, and a
government bond. Answer the questions below with reference to this information.

SHARE VALUES
Purchase price End of year 1 End of year 2 End of year 3
Capitec R598.50 R610.12 R615.00 R617.2
Shoprite R114.25 R116.30 R119.00 R121.30
SASOL R443.50 R444.00 R448.10 R450.25
DIVIDENDS
Year 1 Year 2 Year 3
Capitec R35.00 R35.00 R35.00
Shoprite - R20.00 -
SASOL R50.00 R40.00

2.1 If your aim is to maximise capital growth as your main objective, which of the stocks
and bonds would you invest in? Base your answer on the share values at the end of
year 3.
(7 marks)

HPR (Capital Growth only) = P1-P0/P0

Capitec
HPR (Capital Growth only) = (617.20-598.50)/598.50
HPR (Capital Growth only) = 3.12%. [2 mark]

Shoprite
HPR (Capital Growth only) = (121.30-114.25)/114.25
HPR (Capital Growth only) = 6.17%. [2 mark]

SASOL
HPR (Capital Growth only) = (450.25-443.50)/443.50
HPR (Capital Growth only) = 1.52%. [2 mark]

Based on the capital growth the investor should choose to invest in Shoprite Checkers stock since it
generates the highest capital growth. [1 mark]

Page 3 of 14
2.2 What is Capitec’s HPR?
(3 marks)

HPR = (P3+ D1+D2 +D3- P0)/P0

HPR = (617.20+ 35.00 + 35.00 + 35.00 – 598.50)/598.50
HPR = 20.67% [3 mark]

2.3 Explain the concept of portfolio diversification.

(5 marks)

Solution
Portfolio diversification refers to the practice of including a wide variety of investments
within a portfolio. [1 mark] A portfolio of different kinds of investments will, on average,
yield higher returns and pose a lower risk than any individual investment found within the
portfolio. [2 mark]

The reduction in risk emanates from the smoothing out of unsystematic risk (company
specific risk) due to the different characteristics of companies in the portfolio. [1 mark] If
companies in the portfolio are not perfectly correlated as far as their exposure to risk is
concerned, they will on average lower portfolio risk. [1 mark]

Page 4 of 14
QUESTION 3 (15 MARKS: 18 MINUTES)

3.1 What is the difference between Comprehensive and Limited care insurance?
(2 marks)
Comprehensive car insurance typically provides cover against theft, hijacking, damage from
accidents, damage from natural disasters such as hail and floods, damage from fire and any liability
to third parties arising from an accident. [1 mark] Limited car insurance does not usually cover
damage or loss to your vehicle arising from accidents. [1 mark]

3.2 Home owners insurance consists of Contents Insurance and Building Insurance? What
is the difference? What does each cover?
(4 marks)
Content insurance is insurance that pays for damage to, or loss of, an individual’s personal
possessions while they are located within that individual’s home. [1 mark] "Possessions" refers to
anything that is not permanently attached to the structure of the home. [1 mark]

Building insurance protects against damage loss arising from damage to the structure of your home
and any associated improvements to your property. [1 mark] Most such policies cover acts of
nature, fire and water damage as a base and many then extend to specific areas of cover such as
swimming pool pumps, underground pipes and cabling, and so on. [1 mark]

3.3 What purpose does an Excess on any insurance contract serve?

(3 marks)
An excess serves two purposes. Firstly, it dissuades individuals from making large numbers of small
claims, each of which may be as demanding and time-consuming for the insurer to deal with as a
larger, more pressing claim. [1 mark]
Secondly, it reduces the costs of the insurer. [1 mark] This means insurers are able to pass on some
of this saving to clients in the form of reduced premiums. [1 mark]

3.4 Discuss three factors that are likely to affect your premium on a Motor vehicle
insurance. (Note: simply name the factor and state in one sentence why or how they
will impact the premium.)
(6 marks)
Four factors typically influence the premium you will be required to pay under your policy:
 The make and nature of the car - . The make and nature of the car are important as they
impact on the availability of spare parts for repairs, the risk of theft and the probability
of being involved in an accident. [2 mark]
 Your risk profile is determined by as determined by your age and sex. - Premiums are
highest for individuals under the age of 25 and higher for men than women, as women
are considered to be more conservative (less risky) drivers. [2 mark]
 Your home environment will also play a role in determining your premiums - High-risk
areas, often plagued by crime, will attract higher premiums than safer, low-risk areas.
Similarly, secure storage such as garages or gated complexes will lower your risk of theft
or damage and contribute to lower premiums. [2 mark]

Page 5 of 14
 The extent of the coverage in your policy will play a big role in determining your
premiums. - The greater the number of eventualities provided for, the higher your
premiums will be. It is possible to lower your premiums by increasing the excess on the
policy. [2 mark]

Note: Maximum 6 marks; mark three factors

Page 6 of 14
QUESTION 4 (15 MARKS: 18 MINUTES)

4.1 Name five risks that a CIS may be faced with. In one sentence explain what this risk entails.
(10 marks)

• Market Risk – Risk that a particular market (e.g. Bond market) may perform poorly[2 mark]
• Market Timing Risk – Risk that you may get into a market at the wrong time[2 mark]
• Currency Risk –Risk that you may lose value on your investment and/or returns when
converted back into your home currency (in the case of off-shore investments) [2 mark]
• Geographic Risk – American, UK, German, Japanese markets etc. may not move in the same
direction all the time…risk that you may be in the wrong market at the wrong time [2 mark]
• Sector Risk – Different sector of the market perform well under different circumstances and
at different times…think of risk associated with Gold Mining, Technology, Banking etc. [2
mark]
• Fund Manager Risk – refers to the skill of fund managers…the philosophy of fund managers
[2 mark]
• Organisational Risk – Risk that the CIS manager will go out of business or defraud the
investors [2 mark]
• Liquidity Risk – Liquidity of the cash component of the fund is the main concern. The
mandate will stipulate a % liquidity at any point in time. Assume a mandate stipulates 25%
liquidity…in a bear market this is fine…in a bull market this constitutes lost opportunities. [2
mark]
• Stock Picking Risk – Only relevant for funds that allow concentration of investments…if the
fund manager is not good at stock picking value could be lost…note there may be little
diversification. [2 mark]

[Note: Mark 5 risks, two marks each]

4.2 List 5 types of Collective Investment Funds that are available to investors.
 Hedge Fund [1 mark]
 Property unit trusts (PUTs) / Real Estate Investment Trusts (Reits) [1 mark]
 Money Market Fund [1 mark]
 General Equity [1 mark]
 Bond [1 mark]

Alternative Classifications also accepted

 SA Funds [1 mark]

 Global Funds [1 mark]

 Regional Fund [1 mark]

 Worldwide Funds[1 mark]

 Fund of Funds [1 mark]

 Index funds [1 mark]
 Multi-manager funds [1 mark]
 Exchange Traded Funds[1 mark]
[Note: Mark 5 types]

Page 7 of 14
QUESTION 5 (15 MARKS: 18 MINUTES)

1. This stage personal financial life cycle where retirement planning becomes the main
financial focus:

A. The paired stage

B. The family stage
C. The post-family stage
D. The retirement stage

2. You are considering two investments. Investment A is expected to generate returns

between 14% and 20%, while investment B is expected to generate returns between
16% and 28%. On this basis, you can expect…

A. Investment A to have less risk than investment B but also to have the highest potential
return
B. Investment A to have less risk than investment B but investment B to have the
highest potential return
C. Investment B to have less risk than investment A, but to also have the highest return
D. Investment B to have less risk than investment A, but investment A to have the
highest potential return

3. Which of these life insurance contracts is a form of with-profit insurance?

A. Term life insurance

B. Credit life insurance
C. Universal life policies
D. Whole life insurance

4. Which of the following trade-offs are you rewarded for when investing?

A. Uncertainty around the expected return

B. The opportunity cost of investing
C. The standard deviation of the investment
D. The cost of the investment

5. The unit trust fund that is high risk but promises high returns:

A. Money Market Fund

B. General Equity Fund
C. Bond fund
D. Hedge Fund

Page 8 of 14
 SECTION B

QUESTION 1 (41 MARKS: 49 MINUTES)

1.
PV = FV [1/(1+i)n] (1)
= R800 000 [1/(1 + 0.12)20] (1)
= R20m [0.0573]
= R82,933.41
Interest factor tables could also be used.
(2 marks)

2.
Solution using formula: PV = R?, n = 10 X 12 = 120 months, i=12%/12 = 1 %, I = R4 000?

PVAord I x PVIFA 0.6666%, 120 periods

= R4 000 x [ 1 – (1/(1+i)n )/i] (1)
= R4 000 x [ 1- (1/(1.01)120) / 0.01] (1)
= R4 000 x 69.700 (1)
= R278 802.09 (1)
Interest factor tables could also be used.
(4 marks)

3.1
FV = PV [(1+i)n] (1)
= R1 000 000 x [(1 + 0.12)12] (1)
= R1 000 000 x [3.895976]
= R3,895,976 (1)
Interest factor tables could also be used.
(3 marks)

3.2
Solution using formula: PV = R3 138 428, n = 12 X 10 = 120 months, i=12 %/12 = 1 %, I = ?

FVA I x FVA 1%, 144 periods

FVA = I x [ (1+i)n - 1)/i] (1)
R3,895,976 = I x [(1.01)144 -1 / 0.01] (1)
R3,895,976 = I x 319.06 (1)

Monthly instalment = R12 210.73 (1)

Interest factor tables could also be used.
(4 marks)

Page 9 of 14
3.3 Loan to value ratio

Loan x 100
= Market value of property (½)

= R R3,895,976 x 100 (½m)

= 7 000 000 (½)

= 55.65 % (½m)

Commentary
The loan to value ratio is used by banks to determine the amount of risk before lending money to
customers (1). A low ratio indicates low risk (1)
(4 marks)

3.4
Macro factors
The economy
Interest rates
Building costs

The property cycle

Micro factors
Location
Availability of land (Non reproductive asset)
Condition
(4 marks)
3.5
The estate agent
Attorneys
A property transaction involves a lot of legal requirements. There are specific attorneys (sometimes
called “conveyancers” or “conveyancing attorneys”) who specialise in property transactions.

The bank
Very few property transactions are cash transactions. In nearly all cases, the buyer requires a loan in
order to be able to afford the property. Often, the seller also still has a loan in place

Home loan originators

Home loan or mortgage originators serve as intermediaries. On behalf of the buyer, they approach
different banks in order to obtain the best possible mortgage conditions for the applicant (most
often meaning the lowest possible interest rate on the loan). They are usually very knowledgeable
on the various banks’ mortgage products, application requirements and loan conditions. The buyer
does not pay for home loan origination, as the originators get commissions from the banks for the
business they bring in. They usually get their leads from estate agents, in whose interest it is to help
the buyer obtain financing for the purchase as soon as possible, as the transaction (and the estate
agent’s commission) usually depends on this.

(6 marks)

Page 10 of 14
3.6
Definition of flipping
 Find a property under market value;
 Fix (upgrade) it and;
 Sell at a profit.

10 mistakes of flipping
1. Lie on loan applications 6. Bought property unseen
2. Overpaid for property 7. Bought out of province property
3. Lacked cash to upgrade 8. Bought too many properties
4. Quit his day job 9. Underestimated the upgrade costs
5. Hired unlicensed contractor 10. Poor exit strategy (partners)
(5 marks)

3.7
 Bond refinancing is the replacement of a current mortgage with a new one, usually with
improved terms or a lower interest rate.
 The purpose of refinancing is either to free up money from the home loan, or to save money
by changing to a new home loan at a lower interest rate
 It can be very costly over the long term if done without good reason.
 Remember that most of the capital is paid off towards the end of the term, and cancelling
the old loan and starting over again means that these benefits, and that the interest
payments made to date, are essentially lost.
 This can result in substantial additional costs, as there are additional costs such as
cancellation costs on the old mortgage and origination costs on the new loan.
(2 marks)

Page 11 of 14
QUESTION 2 (41 MARKS: 49 MINUTES)

This question consists of three independent parts A, B and C.

Part A (14 MARKS: 17 MINUTES)

1.
 Start early.
 A little every month.
 Automate the savings process.
 Consider every purchase carefully.
 Do not let income determine spending.
 Consider the returns.
(any 5 for 1 marks each)

2.
 Admit that there is a problem.
 Determine what the reason is.
 Reduce expenses.
 Find additional sources of income.
 Negotiate with creditors.
 Consolidate debts.
(any 5 for 1 marks each)

3. Some of the consequences of excessive borrowing and debt problems are the following:

 A bad credit record

o Once a person starts to fall behind on debt repayments, he or she starts to build up a
bad credit record, which means that future credit becomes very difficult to obtain.

 Loss of possessions
o This may ultimately result in the assets of that individual or household being
attached and sold. Because this is a forced sale, the prices obtained for the assets will
usually be low relative to their value.

 Household stress and conflict

o Financial stress as a result of excessive indebtedness

 Health problems and the cost to society

(4 marks)

Page 12 of 14
Part B (10 MARKS: 12 MINUTES)

1.
 Live longer
 Inflation
 Lifestyle
(3 marks)

2.
 Transferring your accrued benefits to the fund of your new employer.
 Transferring the funds to a retirement annuity fund.
 Having your pension or provident fund pay out its value in a lump sum.
 Having the benefits transferred to a preservation fund.
(3 marks)

3. The benefits of trusts

 Trusts allow for growing assets to be separated from the dutiable estate of an individual,
thus reducing the burden of estate duties.

 Trusts allow for the protection of assets, as it is possible to separate the ownership and
benefits of assets. The assets controlled within a trust are separate from your estate and
therefore cannot be attached by your creditors in settlement of outstanding debts.

 A trust provides for a succession of beneficiary interests in the assets of the trust. As the
assets do not vest in the beneficiaries of the trust, their rights to the use of the assets will
cease on death and may then be passed on to subsequent beneficiaries. They are a
favourable mechanism for protecting and administering assets to the benefit of successive
generations of beneficiaries.

 A trust limits the liability of the beneficiaries of the trust. While the beneficiaries of the
trust enjoy the benefits of the trust assets, they are not themselves personally liable for the
liabilities of any debts within the trust.

 A trust provides an effective mechanism for protecting the interests of beneficiaries who
are minors or improvident.

Shortcomings of trusts
 The duties of trustees are onerous and trustees are personally liable for any breach of duty
or good faith in the execution of their duties. This may lead to conflicts between trustees
and beneficiaries and can be particularly harmful where the trustees are family members.

 Trusts are potentially expensive to administer, particularly where professional trustees are
appointed. They are not typically recommended for small estates where the costs arising
from the administration of the trust may outweigh the benefits accruing to the beneficiaries.

 The transfer of property to the trust can be costly. For example, property transferred to a
trust is taxed at a rate of 8%.

(4 marks)

Page 13 of 14
Part C (17 MARKS : 20 MINUTES)
1.
R R
Gross salary 420 000 (½)
Bonus 40 000 (½)
Interest income 15 000 (1)
Dividends received 20 000 (1)
Capital Gains Tax S26A W1 83 333 (1m)
Gross income 578 333

Exempt income -35 000

Interest exemption 15 000 (1)
Dividend income 20 000 (1)
543 333
Deductions -33 500
Donations to UWC 2 000 (1)
Habitat
Pension fund: R420 000 x 7.5% 31 500 (1)
Taxable income 509 833

Tax on first R377 451 87 382 (1m)

Tax on (R509 833 – 377 451) x 35 % 46 334 (1m)
Total tax to pay 133 716
Less: Rebates
Primary -12 726 (1)
Medical aid deduction: S6A W2 5 000 (½)
S6B
115 990
Employees tax deducted (gross salary) 100 000 (1)
Final tax liability owed to by SARS / by SARS. 5 990 (½m)
(13 marks)

W1 Capital Gains Tax

Base cost Selling
price
His old car R180 000 R100 000 Exclude (1)
Unit trusts 100 000 R150 000 50 000 (1)
Land and buildings R200 000 R400 000 200 000 (1)
(for investment purposes)
250 000
250 000
Amount to be included X 33.3 %
Taxed at individual tax rates 83 333 (½m)
(4 marks)

Page 14 of 14