a) Identify and explain briefly THREE factors that affect the Hans ability to take risk. b) Identify

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Question:

a) Identify and explain briefly THREE factors that affect the Hans’ ability to take risk.

b) Identify and explain briefly THREE problems in the current asset allocation. (6 marks)

Jacky and Ruby Hans, both 50 years old, live in the U.S. and have recently retired. Jacky was the CEO of Picasso Retail, small-cap American firm, before retirement and had worked in the company for 25 years. Jacky has accumulated Picasso common stock, publicly traded with high liquidity, with current market value of US$1,200,000 through the company’s employee stock compensation scheme.

They own and live in an apartment with a market value of US$1,000,000 and have decided to donate the apartment to a non-governmental organization (NGO) upon their death. Their only child, Peter (25 years old), has a well-paid job and does not need any financial support from the Hans.

The existing current portfolio for Hans is shown as below:

Asset Class	Current Allocation (%)	Expected Annual Return (%)	Expected Annual Standard Deviation (%)
Cash Equivalent	15.0	3.1	3.2
US Corporate Bond	2.0	4.5	6.0
US Government Bond	10.0	4.0	4.5
US Equities (large-cap)	7.0	8.0	12.5
US Equities (small-cap)	41.0	9.5	17.2
Picasso Retail stock	25.0	6.5	34.1
Total portfolio	100.0	7.1	12.1

The Hans are meeting with Victor Water, their financial consultant, to discuss financial planning issues. They agree that they need US$200,000 pre-tax income annually for their expenses, which will remain constant during retirement after adjusting for inflation. They plan to fund their living expenses by taking annual distributions from their portfolio. Upon their death, the Hans wish to leave gifts to Peter and to a local charity. They wish to maintain the purchasing power of these gifts to be equal to US$2,000,000 and US$1,000,000 respectively in today’s value. After considering the expected long-term inflation rate (2.5%) and intended investment horizon (35 years), Victor set the targeted pre-tax return of their portfolio at 8%.

Besides, Victor concludes that a shortfall risk (defined as the expected return minus two standard deviations) that Hans can tolerate in any one year is -14%.