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.

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.

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

the following objectives:

i. Return requirement

ii. Risk tolerance

iii. Time horizon

iv. Liquidity requirements

After revising the investment policy statement and confirming it with Taylor, Wheeler

is now developing a long-term strategic asset allocation for Taylor. Wheeler will use

the following revised information to recommend one of the allocations in Exhibit 2-4.

• Taylor has decided to invest $100,000 in his son’s business but still insists that this

investment be disregarded in making his allocation decision.

• Taylor’s total cash flow needs have changed to $4,200 a month.

• The available asset base is $800,000.

• Wheeler estimates that the inflation rate will be 1 percent next year.

• Taylor is determined to maintain the real value of his assets because he plans to set

up a charitable foundation in the future.

• Taylor insists on taking no more risk than absolutely necessary to achieve his return

goals.

Portfolio	A	B	C	D
Stocks	20%	40%	60%	80%
Bonds	75%	55%	35%	15%
Cash	5%	5%	5%	5%
Total	100%	100%	100%	100%
Expected Return	6.70%	7.50%	8.20%	9.10%
Standard Deviation	9.00%	11.50%	15.30%	19.00%

2. Select the strategic asset allocation that is most appropriate for Taylor and justify your

selection with two supporting reasons related to the revised information shown above.

Answer rating: 100% (QA)

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