Risk

Question 1

8 points Workshop Q

Key client specific factors that would affect ATR

Answer 1

• Time scale of the investment term and objective of the investment for Tom and Sally
• Tom and Sally’s disposable income
• Tom and Sally’s current level of wealth/total assets
• Any debts that Tom and Sally may have
• Tom and Sally’s age and existing experience of investing
• Tom and Sally’s current state of health
• Any foreseeble changes in Tom and Sally’s personal circumstances
• ESG or religious views that Tom and Sally have when investing that they would to include or exclude

Question 2

Importance of reviewing ATR

Answer 2

• Change based on investment experience
• Change based what is happening in the markets and economy
• Changes in personal circumstances and health
• Changes based on future income and expected inheritances
• Changes due to getting older, changes over time and term of investment
• Fund performance/ensure investment matches ATR
• Changes in how much risk they need to take and can afford to take

Question 3

Key areas to take into account when assessing risk/risk assessment

Answer 3

• ATR - How much risk willng to take on an investment
• Capacity for loss - ability to absorb losses
• Tolerance to risk - willingness to accept a level of flutuation

Question 4

11 points Workshop Q

Describe the process of using a risk profiling tool

Answer 4

• The advisor would explain what a risk questionnaire is used for
• Tom and Sally would complete a risk questionnaire each
• Focuses on priorities, timescales and circumstances
• The answers are fed into a computer software/risk profiling system
• Which deduces a risk score for both Tom and Sally
• Score used to produce a recommended asset allocation
• Which uses the efficient frontier for investments
• The results would be discussed with Tom and Sally
• To ensure it matches their interpretation of risk
• Final ratings will be agreed with Tom and Sally
• Recommended asset model will be porduced to max return within ATR

Question 5

What are the limitations of asset allocation model

Answer 5

• Does not take account of tax wrappers or Tom and Sally’s tax position
• Does not take account of charges
• Different models produces different results
• Questions not always relevant to client’s circumstances
• Underlying assumptions are subject to change as based on historical data
• Requires regular review, relevant at a certain point in time
• Tom and Sally may not understand the questions asked and choose the wrong answer

Question 6

Briefly describe Stochastic Modelling

Answer 6

• Stochastic modelling means havings a chance or random element
• Complete profiiling questionnaire
• Forecast range of different returns for different portfolios
• Help client choose most appropriate portfolio by showing range of possible outcomes for each portfolio
• And probability of achieving them

Question 7

Briefly describe pschometric profiling

Answer 7

• Aims to assess client’s pschological risk tolerance
• They complete a series of questions
• Based on how they asess themselves for risk tolerance
• History of behaviour regarding financial decision making
• Intended financial behaviour in the future
• Look at how client migh behave in range of financial scenarios
• Looks at what their emotional responses are to various events and outcome
• Responses generate a risk score which compares against group of investors world wide
• Client chooses range of investment mix from range of portfolios

Question 8

Types of risk

Answer 8

• Inflation risk - reduces spending power of asset or income, value eroded- impact fixed income and pension benefits
• Legislation risk - changes to tax legislation -
  changes make tax treatment less advantages
• Interest rate risk -
  A fall reduces rates on savings but increase value of fixed interest -
  A rise increases rates on savings and decreases the value of fixed interest
• Liquidity risk - ability to liquidate when cash is needed -
  Property or commercial property held in investments can be difficult to liquidate
• Currency risk - exchange rates can vary and be volatile and affect value of sterling assets
• Diversification and concentration risk - risk not spread, too much in one asset class or geographical area-
  high chance on making loss on investment if it fails
• Non-systematic risk - risk specific to a company, risk of individual holding fail
• Systematic risk/market risk - risk of value in stock market can fall, equity asset classes exposed to market volatiiity
• Defualt risk - provider may not be able to return money invested
• Creditor risk - associated with corporate bonds, may not be able to pay fixed interest due

Question 9

7 points workshop Q

Comment briefly on the diversification within Tom and Sally’s current savings and investment portfolio and identify whether the portfolio meets their risk profile

Answer 9

• Tom and Sally are heavly weighted in cash which is 40% of the value of their portfolio and not in line with their medium ATR or high capacity for loss
• Lack of diversification in asset classes specifically property, fixed interest and alternative asset classes. Only exposure is via Tom’s multi asset fund that in his investment bond
• Equity asset allocation is inline with medium ATR
• The current equities holdiings are in UK only
• Lack of diversification geographically and no exposure to global funds
• They have medium to high capacity to loss so can tolerate volatility wihtin their portfoli
• Tom’s ESG preference are not met with his current asset allocation

Question 10

15 points workshop Q

Having recently completed a risk profile questionnaire, Tom and Sally are still unsure about how much investment risk tehy should take. **Identify the main factors **you should discuss with them in order to establlsh and agree their risk profiles

Answer 10

• Previous Investment experience
• Quantify medium to high capacity for loss, how much loss can they bear/absorb
• Level of emergency fund they have or require
• Term of the objective/investment time horizon
• Where the objective is in the priority scale/how important it is
• The level of return/growth they wish to achieve
• Do they want income or capital growth or both
• Level of dependency on income or capital that is to be invested
• How much capital they willing to put at risk
• Explain and assess their tolerance to risk/level of fluctuations and volatility they can stand
• Other sources of income and other assets that can be accessed
• Their age and health
• Can provide investments to match individual ATR, views may differ
• Explain risk is feature to all asset classes

Question 11

10 points workshop Q

State 5 benefits & 5 drawback of usinga a risk profilling tool to assess Tom and Sally’s attitude to risk

Answer 11

Benefits
* Different ATR can be used for different objectives and separate one Tom and Sally
* Consistent way of determining Tom and Sally’s ATR, * Same procedure carried out regularly to determine ATR
* Assist with appropriate asset allocation
* Helps client consider and understand risk
* Identifies the maximium loss tolerance/risk and reward

Drawbacks
* Dont take account of tax wrappers and tax position
* Differnt risk profiling tools have different results
* Tom and Sally may not understand the question ask in the questionnaire
* Only relevant at a point in time
* Underlying assumptions rely on historical data
* May not establish capacity for loss
* Doesnt take into account investment experience their emotions

Question 12

5 points workshop Q

Identify and explain four risks associated with Tom and Sallys current invetment portfolio

Answer 12

• Inflation risk - Cash deposit and premium bonds att risk of the value being eroded by inflation and spending power reduced over the longterm
• Interest rate risk - The cash deposit are solely dependent on interst rate for returns .
• Diversification risk- Tom and Sally’s ISA’s are only exposed to the UK market there is no geographical, property or fixed interest exposure, should the UK market experience a downturn 37% of Tom and Sallys investment would be impacted.
• Default Risk - The stocks and share ISA are only protected y the FSCS by up to £85,000 in event of default
• The joint deposit is only protected by the FSCS by up to 2 x £85,000 = £170,000in even of default

Question 13

5 points workshop Q

Outline why some of Tom and Sally’s current savings & investments are likely to be at risk from future inflation

Answer 13

• Tom and Sally have a large balance of £180,000 in fixed interest savings account.
• 4.75% interest, however, they are higher rate tax payers at 40% reducing the actual net nterest recieved, and as there is no growth this further impacts the value over time due to inflation
• Premium bonds prizes are variable, Tom and Sally have won no prizes this year and theres no guaranteed return.
• Resulting in negative net real return based on current inflation
• Bonds held in Tom’s multi asset fund within the Investment bond will be at risk in rising interest rate environment if inflation rises.

Question 14

Identify the additonal information that you would require in order to advisee Tom and Sally on the tax efficiency & suitability of their current savings and investment holdings

Answer 14

• Is there any penalties from withdrawing from the fixed term deposit account
• How far are Tom and Sally into the 2 year fixed term
• Willingness to move funds out of the fixed term diposit
• Have they won any prizes this year in relation to their Premium Bonds, how long have they held them for and what are the prizes to date
• Do they recieve any interest on their current account
• What is the asset allocation of Toms multi asset fund in the investment bond
• Is Tom willing to assign the bond to Sally and or Amelia and Noah
• Performance of the ISAS
• The number of investments and funds available on the platform and whether they match Tom and Sally’s Medium ATR
• Have Tom and Sally used any CGT allowances this tax year
• Willngness to utilize dividend allowance and CGT allowances
• Willingness to add additonal funds/investments to diversify their investment portfolio
• Do they know how much Tom’s inheritance is likely to be
• What is the value of Tom’s mother’s estate
• Willingness to use ISA allowances next year
• Reasons to why Tom and Sally are interested in commodites and precious metals, where does the interest come from?
• How much emergency fund do they need or have they earmarked any of their savings for this
• Do have any plans to use disposable income or willng to use towards their needs and objective
• Do Amelia and Noel have existing CTF or JISAs, if so have they utilised any of their allowances this tax year
• Willingness to move investment bond to the same platform as the stocks and share ISA
• Tom and Sallys tolerance to risk
• Cost and charges associated with investment and platform costs and charge
• Penalties to switch out of ISAs
• What university cost are they looking to fund and do they know how much they wish to fund
• When do Tom and Sally intend to retire
• Requirements that Tom and Sally have for ESG investments
• Purpose of £180,000 held in joint fixed rate deposit account
• What is Tom and Sallys investment experience
• Have Tom and Sally had any capital losses in the pas that they can carry forward

Question 15

State the key factors that should be taken into consideration before advising Tom and Sally on the suitability of their current savings and investment holdings

Answer 15

• Existing or required emergency fund and whether any savings earmarked for this
• Planned expenditure towards Amelia and Noels university costs
• Tom and Sally’s high rate tax status
• Current and future uses of allowances and exemptions (PSA/DA/CGT/ISA)
• Tom and Sallys salaries and nearing £100,000 and potential loss of personal allowance
• Growth expectations
• Whether their current investments match Tom and Sally’s medium ATR and thier medium to high CFL
• Tom and Sally’s disposable income is in excess of £3,000
• Term of Tom and Sallys needs and objectives
• They find reviewing their financial arrangement onerous and want to reduce burden
  Perfomance of existing investments and projected investment values
• Cost and charges of existing investment and platform
• Tom and Sally have no big expenditure planned
• State of health now and in the future
• Penalties on switches or transfer for ISA’s and fixed deposit account
• Range of funds and invesment availabe on the platform and accessible by ISA’s and investment bond to match ATR
• Whether the children have existing CTF or JISA
• Contributions from other family members
• Willingness of Tom to assign segments of Investment Bond
• Tom and Sally’s interest in commodities and precious metals
• ESG interest and what this would look like for Tom and Sally
• Whether existing fund meet ESG requirements
• Mortgage liability of £200,000 with 20 years to go, capital repayment
• Existing protection arrangements and shortfalls or gaps
• Existing pension arrangments and updated nomination forms and wills
• Where the funds are currently invested
• Term of the objective
• Asset allocations of the funds
• Inflation assumptions
• Investment bond is a PET with 7 years to go

Question 16

12 points

Identify the generic factors that would typically influence an individual ATR

Answer 16

• Inflation assumptions
• Growth assumptions
• Investment experience
• Age and health
• Term of the investment
• CFL and tolerance to loss
• Emergency fund levels or requirements
• Access to other assets
• Source of income and whether they are guaranteed or variable
• Behaviourial finance
• Their views on the economic and world markets condiitons
• Proportion of assets they are investing

Question 17

13 points

Tom and Sally have been assessed as medium risk investors, but have cacity for loss of medium to high. Explain the client-specific factors that could have influenced these ratings for Tom and Sally, why this might change in the guture

Answer 17

• Tom and Sally have about 40% of thier overall savings and investments in cash, which is low risk
• Tom has invested in a UK tracker fund which is medium risk and matches his ATR
• Sally has invested in UK ethical equity funds aligning with her ESG interest
• They have limited investment experience
• They have never benefited from financial advice before, bond was assigned by mother, they havnt gone beyond workplace pensions or stocks and shares ISA
• Their investment lack diversification asset classes such as property, fixed interest and alternatives. They have concentrated on cash and equities which broadly meets medium risk portfolio
• They have built up significant wealth, value in the property and bond from Tom’s mother gives them access to alot of savings and investments in event emergency
• They have a large amount equity of £320,000 in their porperty
• Both have high paying jobs
• They both have a high level of disposable income in excess of £3,000 a month
• They have little childcare cost but will be assisting the children with university costs, how much is unclear
• Life events such as children leaving for univesity, repayment of mortgage and moving towards retirement , will change objectives and impact ATR and CFL
• Tom and Sally are in good health and their income needs are over a very long time frame

Question 18

State analyse and evaluate

Comment on the suitability and tax efficiency of Tom and Sally’s current savings and investments

Answer 18

• They have 40% of their portfolio in cash £290,000
  The cash holding are low risk which do not meet their medium risk ATR
  The are exposed to inflation risk value eroded over time and interest rate risk and reinvestment risk if interest continue to fall, lower rate of interest earned on savings
• Of the portfolio in cash £180,000 is in a 2 year fixed term deposit account earning interest of 4.75%.
  The interest recieved uses their £500 PSA.
  However, both Tom and Sally are higher rate tax payers at 40%
  Reducing the net interest recieved
  Half the interest from the deposit account of £4050 is pushing Tom over the income threshold of £100,000 where personal allowance reduces for every £2 above income limit
  However, his net adjusted income brings his income down to £95,250, but he is not far from £100,000 threshold
  It is also subject to default risk as the value is in excess of 2 X £85,000=£170,000 and they have £180,000. £10,000 is not protected by FSCS
• Tom and Sally have a total of £100,000 in premium bonds
  It is unclear if they have recieved any prizes in the past
  They havent recieved any prizes in this tax year and prizes are variable and not gauranteed
• £10,000 in current account
  Total cash savings give them liquid funds for financial needs and objectives one of which is to assist children in university cost
• Both Tom and Sally have utilised their ISA allowance of £20,000 for this tax year
• Tom and Sally have around 37% of their portfolio in equities £265,000
  They are both in accummultion units and so income will be reinvested
  income and growth is free of income and and capital gains tax
• Tom’s ISA is in UK FTSE 100 index
  This matches his medium risk ATR
• Sally’s ISA is in UK Ethical Equity funds
  This matches her medium risk ATR and in line with views in ESG investing
  Benefits from capital growth
  Both their stocks and share ISAs are entirely exposed to the UK market
  it is not globally diversifed and so exposed to diversification risk
  The asset allocation is entirely in equities and no diversification in other assets such as property, fixed interest or alternatives
  Tom and Sally dont have any dividend producing outside their ISA and are not using their dividend allowance of £500, nor are they using their annual CGT exemptions
• Tom’s investment bond is invested in a multi asset fund and represent 23% of the couples overall portfolio
  This is diversified across assets and meets his medium ATR
  However, it is exposed only to UK market and not geographically diversified
  The bond content would be exposed to interest rate risk, inflation risk and default/creditor risk
  Equity exposed to market risk and non systematic risk
  Possibly subject to currency risk if the investment is geographically spread
  The investment bond is a PET assigned from his mother in June 2024
  The orignal base cost of £80,000 would be transferred to Tom
  Holding period and 5% withdrawals and top slicing relife would be tranferred to Tom
  Mother gifted his two sibling the same amount totalling gifts at the same time £480,000
  If Tom’s mother dies within 7 years then the inheritance would be subject to IHT as the total gifts exceeds Tom’s mother’s NRB £325,000 (not taking account that the rest of her estate could well push the gifts entirely over NRB)
  This would be payable by Tom and his 2 siblings in equal shares
  It has 100 segments, giving Tom the flexibility in how he draws money from the bond
  The investment was made in June 2020 and so there are 15 years since invstement
  No withdrawals have been made
  Tom has 5% withdrawals of £4,000 per year of orignal investment or culmulatively £60,000 that is not subject to immediate tax
  20% tax taken on any income and growth
  No income tax or capital gains tax implications whilst fund remains invested for Tom
  Encashment and realising gain are subject to income tax
  Tom has the use of topslicing
  Potential to assign to Sally or the children
  Another source of funds for assisting children

Question 19

16 points

Describe in detail the process an adviser would follow to estbalish if Tom and Sally’s current savings and investments are suitable for their needs now and in the future

State the obvious, follow step by step process in what you would do

Answer 19

• Establish ATR and CFL
• Establish current and future income needs
• Establish current and futre expenditure
• Establish future capital recieved
• Estalbish sources of income now and in the future
• Agree assumption for projected return calculations
  inflation
  growth
• Apply information to cashflow model
• Stress test to include higher expenditure needs etc
• Obtain LOA to obtain plan details
• Identify risk profile of funds
• Review past performance
• Identify suitable benchmark
• Confirm plan charges
• Highlight surpluses and shortfalls
• Recommend appropriate action
• Plan and complete ongoing review and monitoring

Question 20

Explain to Tom and Sally why their existing range of non-pension deposits and investments may be unsuitable for their objectives

Answer 20

• About 40% of Tom and Sally’s portfolio is in cash
  Not aligned with medium risk ATR
  Will form part of their estate
• Deposit Account achieves interest of 4.75%, but as Tom and Sally are higher rate tax payers at 40% this reduces the overal net interest rate
  Over time the inflation will erode the value of investment.
  Falling interest rates will reduce the interest they can reinvest after 2 years
  There is no growth
  The £4050 interest pushes Tom’s income to £100,050, forutunatley his pension contributions brought down his NAI to £95,250, or his PA would have been tapered down £1 for every £2 income above income limit
  Fixed rate accounts likely to be liquid, no access available without penalty or losing rate
  The balance of £180000 exceeds FSCS cover limits of 2 X £85,000 = £170,000. £10,000 is not protected should there be default by the provider
• The Premium Bonds have not recieved any prizes in this tax year
  The prizes are variable and not guaranteed
  the impact of inflation is greater as there is little to no interest
  eroding the value of the investment in the short term
• Though the stocks and share meet Tom and Sally’s medium ATR both fund are entirely in UK equities, there is lack of diversification amonst asset classes such as fixed interest, alternatives and property and the risk is not spread georgraphically.
  The lack of diversification will create more volatility and could impact the growth of the funds
  Not cater for their interest in commodities and precious metals
  Tom’s S&S ISA may not reflect the interest he holds for ESG investing
  Sally’s S&S ISA does reflect her interest in ESG investment, however there could be a lack of diversification due to limited number of companies that are in this areas
  Ethical investment may have higher fund manager charges due to need to montior regularly
  Both ISA’s also exceed FSCS limits of £85,000
• Though Tom’s investment bond is diversified in asset classes it is not diversified geographically
  Unclear of asset allocation
  Bond element within fund subject to interest rate and inflation risk
  Any withdrawals in excess of the 5% culmulative withdrawals will give rise to a chargebale event and topslicing could could push Tom’s income into £100,000 threshold where PA is tapered as well as make him an additonal tax payer
  Due to mum assigning the bond to Tom at the same time as gifting his two siblings the total gifts 3 X £180,000 = £480,000 they would treated as PETS, exceeding Tom’s mum’s NRB of £325,000 (this is not accounting for her estate using up the NRB which would push the entire amount over NRB and subject to IHT)
  If Tom’s mum was to die withn 7 years of making the gifts then Tom and his siblings would equally be liable for the IHT of 40%

Question 21

8 points Workshop Q

Comment on the factors that you would take into account in determining Tom and Sally’s CFL

Answer 21

• Tom and Sally’s large amount of savings and investment that they can access and large level of emergency cash
• They are both employed
• They have capacity to earn over a long period o ftime (min 14 years till min pension ageof 55)
• Tom and Sally’s income exceed expedinture and they have a high level of disposable income exceeding £3,000, their standard of living is not reliant on the investments
• They have two financially dependent children Amelia and Noah and who they are looking to assist with university cost. Their dependency if till end of univesity will be over 8 years
• They have no protection policies in place to cover them in event of serious illness or long term illness
• They have investment experience in investing in workplace pension and stocks and share ISA
• They have no planned major expenditure that they need large capital for
• They have repayment mortgage with a high loan to value and large amount of equity and 20 years till the end of term. The outstanding mortgage is £200,000 but they have no other debts. They are on a competitve interest rate with 2 and abit year left of a five year fixed rate.
• They both have a medium ATR
• So can tolerate investment volatility
• They have modest pension assts