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(Answered) Prepare the constraints portion of a new investment policy statement for Pierce. Indicate how each...


Claire Pierce, a vice president for Spencer Design, is a 42-year-old widow who is a resident of the United States. She has two children: a daughter aged 21, and a son, aged 7. She has a $2,200,000 portfolio;half of the portfolio is invested in Spencer Design, a publicly traded common stock, which has a cost basis of $350,000. Despite a substantial drop in the value of her portfolio over the last 2 years, her long term annual total returns have averaged 7% before tax. The recent drop in value has caused her great anxiety, and she believes that she could no longer tolerate an annual decline greater than 10%. Pierce intends to retire in 20 years, and her goals, in order of priority, over the next 20 years are:? Funding the cost of her daughter?s upcoming final year of college, which has a present value of $18,000, and her son?s future college costs, which have a present value of $91,000.? Increasing the portfolio to a level that will fund her retirement living expenses, which she estimates to be $180,000 after tax for the first year of her retirement.? Building her?dream house? in 5 years, the cost of which (including land) has a present value of $375,000.? Giving, if possible, each of her children $1,000,000 when they reach age 40. After subtracting the present value (before tax) of her children?s education costs and her homebuilding costs, the present value of her portfolio is $1,509,000. With continued annual growth of 7% before tax, the portfolio?s value will be approximately $3,928,000 at the end of 20 years. Pierce?s annual salary is $145,000, her annual living expenses are currently $100,000, and both are expected to increase at an inflation rate of 3% annually. Taxes on income and short-term capital gains (holding period 1 year or less) are substantially higher than taxes on long-term capital gains (holding period greater than 1 year). For planning purposes Pierce wants to assume that all returns are fully taxable and that her average tax rate on all income and gains is 30%. The inflation and tax rates are expected to remain constant. Currently, Pierce rents a townhouse, has no debt, and adamantly intends to remain debt-free. Spencer Design has no pension plan, but provides company-paid medical insurance for executives for life and for their children to age 25. After tax, Pierce?s salary just covers her living expenses and therefore does not allow her to make further meaningful capital contributions to her portfolio. Pierce has prepared the following investment policy statement: Claire Pierce?s Investment Policy Statement The portfolio should be invested conservatively, as I want to protect its principal value. My salary covers my current living expenses, but the portfolio will need a moderate level of liquidity to cover the college expenses. My desire to give each of my children one million dollars when they reach age 40 requires the portfolio to have a long-term focus but allows for a low return objective in keeping with my low risk tolerance. Because of my tax circumstances, the portfolio should focus on securities that generate little or no taxable income. a. Prepare the objectives portion of a new investment policy statement for Pierce. Indicate how each of your two objectives addresses a different weakness in Pierce?s current investment policy statement. b. Prepare the constraints portion of a new investment policy statement for Pierce. Indicate how each of your four constraints addresses a different weakness in Pierce?s current investment policy statement. Note: The legal and regulatory constraint is not applicable and should not be included among the constraints addressed in your response. c. Pierce indicates that Spencer Design has a leading and growing market share, as the industry is quite fragmented. The company has shown steady fundamental growth trends, and Pierce intends to hold her Spencer Design stock, which is expected to return at least 9% annually before tax with a standard deviation of returns of 20%. Pierce has decided to invest the balance of her assets in one of the three alternative portfolios described in Table 26I. Recommend which one of the three alternative portfolios in Table 26I is most appropriate for the balance of Pierce?s assets. d. Pierce is considering three alternative portfolio managers for that portion of her equity portfolio that is not in Spencer Design stock. The average market return and standard deviation characteristics and fees for each of the managers are expected to be very similar. The three managers are further described in Table 26J. Recommend which one of the three portfolio managers in Table 26J is most appropriate for Pierce?s equity portfolio. Portfolio A Portfolio B Portfolio C Expected Annual Return (before tax) Standard Deviation of Returns Money market Money market $ 51,000 $ 51,000 $ 550,000 4.2% 2.5% Bonds Bonds 491,000 792,000 330,000 6.4 7.8 Equities Equities 558,000 257,000 220,000 10.8 17.8 TOTAL TOTAL $1,100,000 $1,100,000 $1,100,000 $1,100,000 Manager Description Description Description Description Description Description Description F Manager of a portfolio that is equally weighted among the stocks in the S&P 500 Index. Portfolio holdings are adjusted quarterly. Manager of a portfolio that is equally weighted among the stocks in the S&P 500 Index. Portfolio holdings are adjusted quarterly. Manager of a portfolio that is equally weighted among the stocks in the S&P 500 Index. Portfolio holdings are adjusted quarterly. Manager of a portfolio that is equally weighted among the stocks in the S&P 500 Index. Portfolio holdings are adjusted quarterly. Manager of a portfolio that is equally weighted among the stocks in the S&P 500 Index. Portfolio holdings are adjusted quarterly. Manager of a portfolio that is equally weighted among the stocks in the S&P 500 Index. Portfolio holdings are adjusted quarterly. Manager of a portfolio that is equally weighted among the stocks in the S&P 500 Index. Portfolio holdings are adjusted quarterly. G Manager of a market-weighted value index portfolio that consists of the half of the S&P 500 Index with the lowest price-to-book value ratios. Portfolio holdings are adjusted quarterly. Manager of a market-weighted value index portfolio that consists of the half of the S&P 500 Index with the lowest price-to-book value ratios. Portfolio holdings are adjusted quarterly. Manager of a market-weighted value index portfolio that consists of the half of the S&P 500 Index with the lowest price-to-book value ratios. Portfolio holdings are adjusted quarterly. Manager of a market-weighted value index portfolio that consists of the half of the S&P 500 Index with the lowest price-to-book value ratios. Portfolio holdings are adjusted quarterly. Manager of a market-weighted value index portfolio that consists of the half of the S&P 500 Index with the lowest price-to-book value ratios. Portfolio holdings are adjusted quarterly. Manager of a market-weighted value index portfolio that consists of the half of the S&P 500 Index with the lowest price-to-book value ratios. Portfolio holdings are adjusted quarterly. Manager of a market-weighted value index portfolio that consists of the half of the S&P 500 Index with the lowest price-to-book value ratios. Portfolio holdings are adjusted quarterly. H Manager of an actively managed large-capitalization portfolio with an average holding period of 7 years. Manager of an actively managed large-capitalization portfolio with an average holding period of 7 years. Manager of an actively managed large-capitalization portfolio with an average holding period of 7 years. Manager of an actively managed large-capitalization portfolio with an average holding period of 7 years. Manager of an actively managed large-capitalization portfolio with an average holding period of 7 years. Manager of an actively managed large-capitalization portfolio with an average holding period of 7 years. Manager of an actively managed large-capitalization portfolio with an average holding period of 7 years.
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