Advanced Financial Planning Case Studies for CFP

Posted by Prashant Shah on April 4, 2012 Following are the case studies which are reasonably tough but good to solve. Please note that FPSB ndia is the sole owner o! the case studies. "very paper has two cases# $lic% to &ownload 1. 010'A( )i*ay $ase 2. 011F"B+0, S-P-. $AS" /. 0120A.+0, A.1A .-2 $AS" 4. 01/AP.+0, A(A0 1A 3. 0140A2+0, SA402A
6. 013 '4("+0, .A546

Solution# 1. 010'A( )i*ay Ans 2. 011F"B+0, S-P-. A(S /. 0120A.+0, A.1A .-2 A(S 4. 01/AP.+0, A(A0 1A 3. 0140A2+0, SA402A 7. 013 '4("+0, .A546

Estate Planning for CFP 2

Posted by Prashant Shah on -ctober 22, 2012 Intestate Succession:

A person who dies without 8a%ing a 9ill is %nown as intestate A heir is a person entitled to inherit property a!ter death o! the intestate

Succession Acts:

For 5indus, Buddhists, 'ains and Si%hs the laws o! inheritance have been codi!ied in the 5indu Succession Act, 1,37 For $hristians the ndian Succession Act, 1,23 will be applicable Parsis and 0usli8s have a di!!erent law o! inheritance t e:tends to the whole o! ndia e:cept the State o! 'a88u and 1ash8ir ;he law o! intestate succession is concerned with 8atters as to who are the heirs, what are the rules o! pre!erence a8ong the various relations, in what 8anner is the property distributed in case where there is 8ore than one heir and so on.

Heirs of a Hindu Male: 1. $lass heirs 2. $lass heirs /. Agnates 4. $ognates, and 3. <overn8ent General rules of succession in the case of males

=a> !irstly, upon the heirs, being the relatives speci!ied in class o! the Schedule? =b> secondly, i! there is no heir o! class , then upon the heirs, being the relatives speci!ied in class o! the Schedule? =c> thirdly, i! there is no heir o! any o! the two classes, then upon the agnates o! the deceased? and =d> lastly, i! there is no agnate, then upon the cognates o! the deceased.

istri!ution of "ro"ert# among heirs in class I of the Schedule

.ule 1+;he intestate@s widow, or i! there are 8ore widows than one, all the $ido$s together% shall ta&e one share. .ule 2+;he surviving sons and daughters and the 8other o! the intestate shall each ta&e one share. .ule /+;he heirs in the branch o! each pre+deceased son or each pre+deceased daughter o! the intestate shall ta%e !et$een them one share. .ule 4+;he distribution o! the share re!erred to in .ule /#

=i> a8ong the heirs in the branch o! the pre+deceased son shall be so 8ade that his widow =or widows together> and the surviving sons and daughters get eAual portions? and the branch o! his predeceased sons gets the sa8e portion? =ii> a8ong the heirs in the branch o! the pre+deceased daughter shall be so 8ade that the surviving sons and daughters get eAual portions.

istri!ution of "ro"ert# among heirs in class II of the Schedule ;he property o! an intestate shall be divided between the heirs speci!ied in any one entry in class o! the Schedule so that they share eAually. Agnates and Cognates: (e:t heir o! 5indu 8ale is BAgnates and $ognates@. n it !irst pre!erence is given to BAgnates@ C then B$ognates@. ;he rules !or deter8ining who are agnates C cognates are the sa8e? so are the rules relating to distribution o! property a8ong the8. Agnates 8ean when a person traces his relationship with another through 8ales. $ognates 8eans whenever in the relationship o! a person with another, a !e8ale =or 8ore than one !e8ale>. 'ist of Class I Heirs

i. 0other ii. 9idow iii. &aughter iv. Son v. 9idow o! a predeceased son vi. Son o! a predeceased son vii. &aughter o! a predeceased son viii. 9idow o! a predeceased son o! a predeceased son i:. &aughter o! a predeceased son o! a predeceased son :. Son o! a predeceased son o! a predeceased son :i. &aughter o! a predeceased daughter, :ii. Son o! a predeceased daughter.

(ew heirs are added by 5indu Succession =A8end8ent> Act, 2003.

i. Son o! a predeceased daughter o! a predeceased daughter ii. &aughter o! a predeceased daughter o! a predeceased daughter iii. &aughter o! a predeceased son o! a predeceased daughter iv. &aughter o! a predeceased daughter o! a predeceased son

Class II Heirs $ategory D

Father

$ategory D

=1>Son@s daughter@s son, =2>Son@s daughter@s daughter, =/> brother, =4> sister.

$ategory D

=1> &aughter@s son@s son, =2> daughter@s son@s daughter, =/> daughter@s daughter@s son, =4> daughter@s daughter@s daughter.

$ategory + )

=1> Brother@s son, =2> sister@s son, =/> brother@s daughter, =4> sister@s daughter.

$ategory +)

Father@s !ather? !ather@s 8other.

$ategory +)

Father@s widow? brother@s widow.

$ategory +)

Father@s brother? !ather@s sister.

$ategory +)

0other@s !ather? 8other@s 8other

$ategory + E

0other@s brother? 8other@s sister.

Posted in $FP, "state Planning F 6eave a $o88ent G

Estate Planning for CFP (

Posted by Prashant Shah on -ctober 13, 2012 )hat is Estate Planning* "state Planning is a process o! arranging and planning a person@s succession and !inancial a!!airs. ;he pri8ary goal o! estate planning is ensuring that the estate o! the individual passes to the estate owner@s intended bene!iciaries. Im"ortance of Estate Planning: 1. 5ar8onious and planned succession and disposition o! the estate which helps ensure that your 8oney and other assets go to the people you choose 2. "!!icient 8anage8ent and accu8ulation during and a!ter li!e /. ;o ta%e care o! un!oreseen eventualities by providing !or who will care !or your 8inor children i! you beco8e unable to 4. &e!using potential con!licts over the distribution o! your assets n the real world you 8ay seldo8 !ind the !a8ilies those who have no issues related to the estate. "state planning is indeed a need o! the day. t is the core responsibility o! the planner to 8a%e the client aware about the i8portance and ease o! process !or estate planning. 2ou 8ay also observe that people tal% a lot about estate, thin% even 8ore !or the ways o! disposing it but do nothing to avoid probable con!licts a8ong the loved !a8ily 8e8bers. Means of Estate Planning )ill A will is a legal docu8ent that states how your assets will be distributed a!ter your death as per your wishes. ;here -!ten arises proble8s and co8plications when a person dies without a 9ill. A 9ill is de!ined as Hthe legal declaration o! the intention o! the testator, with respect to his property, which he desires to be carried into e!!ect a!ter his death.I Characteristics of )ill:

1. 'egal eclaration: ;he docu8ents intending to be a 9ill or a testa8ent 8ust be legal, i.e. in con!or8ity with the law and 8ust be e:ecuted by a person legally co8petent to 8a%e it 2. is"osition of Pro"ert#: ;he declaration should relate to disposition o! the property o! the person 8a%ing the 9ill /. eath of the +estator: ;he declaration as regards the disposal o! the property 8ust be intended to ta%e e!!ect a!ter his death

4. ,evoca!ilit#:;he essence o! every 9ill is that it is revocable during the li!eti8e o! the testator. People capable o! 8a%ing 9ills are, "very person who is# 1. not a 8inor 2. o! sound 8ind /. !ree !ro8 !raud, coercion or undue in!luence +#"es of )ill

Im"ortant terms: +estator: A person who 8a%es the will

+estament: A legal docu8ent declaring a person@s wishes regarding the disposal o! their property when they die Codicil: According to ndian Succession Act, Section 2=b> $odicil is an instru8ent 8ade in relation to a 9ill and e:plaining, altering or adding to its dispositions and shall be dee8ed to !or8 part o! the will Pro!ate: A probate 8eans a copy o! the will, given to the e:ecutor, certi!ied under the seal o! the co8petent court and signed by one o! the registrar, certi!ying that the 9ill has been proved

'ife Insurence Polic# Selection

Posted by Prashant Shah on Septe8ber 23, 2010 Be!ore choosing any li!e insurance product one 8ust consider the !ollowing# 1. AdeAuacy o! coverage 2. $ash out!lowJ a8ount o! pre8iu8 /. &uration o! need 4. ":penses o! the policy 3. Surrender charges 5owever there are several 8ethods to evaluate the various li!e insurance policies. -elth Method ;he Belth yearly price o! protection 8ethod enables to deter8ine whether a given li!e insurance policy is co8petitively priced based on the annual cost per .s. 1,000 o! protection. Si8ply put, it weighs costs against coverage. ;he Belth yearly rate o! return 8ethod allows to deter8ine whether the rate o! return on the invest8ent co8ponent o! a given policy is good, !air, or poor.

;ry to solve above eAuation with !ollowing# Post ;a: nterest .ate K 12L Annual Pre8iu8 K .s. 10000 Bonus K .s. 13000 &eath Bene!it K .s. 10 lacs $S) K .s. 3,00,000 $)P K .s. 4,70,000 Internal ,ate of ,eturn $o88only used !or policy evaluation purposes in business purchases o! li!e insurance Surrender.-ased I,, Solves !or the ..Jinterest rateJyield that causes accu8ulated pre8iu8s =less any bonus paid>to eAual the policy $) at one or 8ore pre+selected policy durations ;ypically, highly negative =with a li8it o! a negative 100 percent> in early years =short durations> and beco8es less negative, and increasingly positive, with longer durations eath.-ased I,,

Solves !or the ..Jinterest rateJyield that causes accu8ulated HnetI pre8iu8s to eAual the Face A8ount at one or 8ore selected policy durations n early years =short durations>, this .. will be very large but declines with longer durations =i.e., the longer the insured lives>. Posted in Products F 6eave a $o88ent G

'in&ed 'ife Insurance

Posted by Prashant Shah on Septe8ber 2/, 2010 ;hese plans have been o! great success in recent years. t is a hybrid plan which gives an option o! choosing the invest8ent portion to the insured. t co8bines the bene!it o! li!e insurance as well as giving various options o! participating in the growth o! the capital 8ar%et. ;he traditional plan o! insurance co8panies never disclose to insured where his 8oney is invested. ;his non transparency part is eli8inated by the lin%ed plans. ;he SA or death cover, payable in the event o! death during the ter8, is related to the pre8iu8 usually as 8ultiple li%e 3 ti8es the annual pre8iu8. .&A guideline# SA has to be 1.23 ti8es !or single pre8iu8 or 3 ti8es in case o! annual pre8iu8. 9hen we tal% about transparency and !acilities we should also consider the charges o! lin%ed plans. ;hey are as !ollows# 1. Pre8iu8 Allocation $harge 2. 0ortality $harges /. Fund 0anage8ent Fees 4. PolicyJ Ad8inistration $harges 3. Surrender $harges Service ;a: &eductions nvestors 8ay note, that the portion o! the pre8iu8 a!ter deducting !or all charges and pre8iu8 !or ris% cover is utiliMed !or purchasing units. 6ets also understand the di!!erence between the traditional plans and the lin%ed plans

Financial Planning Practice Standards

Posted by Prashant Shah on Septe8ber N, 2012

FPSB@S F (A($ A6 P6A(( (< P.A$; $" S;A(&A.&S FPSB has de!ined standards o! per!or8ance that# 1. "stablish the level o! practice e:pected o! a !inancial planning pro!essional engaged in the delivery o! !inancial planning to a client? 2. "stablish nor8s o! pro!essional practice and allow !or consistent delivery o! !inancial planning by !inancial planning pro!essionals? /. $lari!y the respective roles and responsibilities o! !inancial planning pro!essionals and their clients in !inancial planning engage8ents? and 4. "nhance the value o! the !inancial planning process. A !inancial planning pro!essional should always consider all aspects o! the client@s !inancial situation in !or8ulating strategies and 8a%ing reco88endations, and should !ollow these Practice Standards to the e:tent that they apply to any given situation. At least so8e o! these Practice Standards apply both to co8prehensive !inancial planning and to the provision o! services that only represent one o! the co8ponents o! !inancial planning =i.e., Financial 0anage8ent, Asset 0anage8ent, .is% 0anage8ent, ;a: Planning, .etire8ent Planning and "state Planning>. As these standards are e:tre8ely i8portant !or FPP, sa8e has been re!lected in the $FP e:a8s, especially in ":a8 3. 2ou can e:pect at least one Auestion !ro8 the practice standards.

+ime /alue of Mone#% Part.0

Posted by Prashant Shah on Septe8ber 7, 2010 ! 0r. A is earning 12L rate o! return and in!lation !or the sa8e period happened to be NL. ;he real rate o! return earned by hi8 is.. 6et@s !irst o! all understand the concept o! real rate. .eal rate is the ad*usted rate. ;his ad*ust8ent can done with any rate say !or e:a8ple an auto8obile co8pany@s sales has grown by 10L and the price rise during the year is 3L. ;he real growth in the sales o! the co8pany is .eal growth is O=1P0.10>J=1P0.03>Q+1 K 4.R7L ;he eAuation above which we have used is Fisher1s eAuation.

n the case o! 0r. A the answer is O=1.12>J=1.0N>Q D 1 K /.R0L. 5ence we can say that 0r. A has earned /.R0L in ter8s o! purchasing power even though the total rate o! 12L. ;he concept o! real rate is use!ul !or !inancial planning while doing the retire8ent planning especially at the withdrawal stage. (ow let@s ta%e up so8e o! the 8iscellaneous approaches !or ti8e value First is rule of 22 ! 0r. earns 12L rate o! return, within how 8any years his 8oney will get doubles "Auation# R2Jr 9here rK rate o! interest Answer# R2J0.12 K 7 years Second is rule of 30 "Auation# 0./3 P =7,Jr> ! we !ind the doubling period using previous Auestion, the sa8e will be Answer# 0./3 P =7,J.12> K 7.1 years. .ule o! R2 and 7, both are the appro:i8ation 8ethods however rule o! 7, gives better appro:i8ation. Im"ortant: Both the 8ethods assu8e co8pound interest. Posted in ;)0 F 2 $o88ents G

+ime /alue of Mone#% Part.4

Posted by Prashant Shah on Septe8ber 4, 2010 6et say 0r. A wants to arrange 8oney !or his children !orever. 9ill ti8e value o! 8oney be use!ul to understand such arrange8entS 2es de!initely. ;he concept which we are tal%ing about is 5Per"etuit#1. 6et@s understand with an e:a8ple.

0r. A has .s.10 la%h with hi8 and wants to give so8e 8oney to his children every year at the end o! year. ! rate o! return which he can earn is 10L, what a8ount o! 8oney he can give to his childrenS 1000000 T 0.10 K .s.1,00,000 !orever, i! rate o! return is constant at 10L. 0r. A wants .s.1 la%h !orever. .ate o! return is 12L, what a8ount o! 8oney he is reAuired to invest nowS ;his is the Auestion o! present value o! perpetuity. P) K 100000J0.12 Ans$er: .s.N,//,/// 0r. A wants .s.1 la%h !orever !ro8 today. .ate o! return is 12L, what a8ount o! 8oney he is reAuired to invest nowS ;his is the Auestion o! present value o! perpetuity due. P) K =100000J0.12> T 1.12 Ans$er: .s.,,//,/// Alternatively you can !ind the P) o! perpetuity in nor8al way and can add up the reAuired 8oney today. Say N,//,///P1,00,000 K .s.,,//,///. 0r. A wants .s.1 la%h !orever at an interval o! every two years. .ate o! return is 12L, what a8ount o! 8oney he is reAuired to invest nowS 9e reAuire the co8pound rate !or two years. i.e. =1.12>2 D 1 K 23.44L P) K 100000J0.2344 Ans$er: .s./,,/,0N2 (ow let@s ta%e up a challenge Auestion 0r. A reAuires .s.2 la%h !orever at an interval o! every three years. First withdrawal is a!ter 1 year !ro8 today. .ate o! return is ,L per annu8. ;he a8ount o! 8oney to be invested today !or the sa8e isU.. Ans$er: 1eep tryingU All the bestV

W Previous "ntries

,is& and ,eturn for CFP.3

Posted by Prashant Shah on 0arch 23, 201/ ,is& Ad6usted Performance Measurement 7Im"ortant for E8amination9 +he Shar"e measure Sharpe =1,77> de!ined this ratio as the reward+to+variability ratio, but it was soon called the Sharpe ratio in articles that 8entioned it. t is de!ined by

;his ratio 8easures the e:cess return, or ris% pre8iu8, o! a port!olio co8pared with the ris%+!ree rate, co8pared, this ti8e, with the total ris% o! the port!olio, 8easured by its standard deviation. ! the port!olio is well diversi!ied, then its Sharpe ratio will be close to that o! the 8ar%et. 9ith this ratio the 8anager can chec% whether the e:pected return on the port!olio is su!!icient to co8pensate !or the additional share o! total ris% that he is ta%ing. Since this 8easure is based on the total ris%, it enables the relative per!or8ance o! port!olios that are not very diversi!ied to be evaluated, because the unsyste8atic ris% ta%en by the 8anager is included in this 8easure. +he +re#nor measure ;he ;reynor =1,73> ratio is de!ined by

;he ter8 on the le!t is the ;reynor ratio !or the port!olio, and the ter8 on the right can be seen as the ;reynor ratio !or the 8ar%et port!olio, since the beta o! the 8ar%et port!olio is 1 by de!inition. $o8paring the ;reynor ratio !or the port!olio with the ;reynor ratio !or the 8ar%et port!olio enables us to chec% whether the port!olio ris% is su!!iciently rewarded. ;he ;reynor ratio is particularly appropriate !or appreciating the per!or8ance o! a well diversi!ied port!olio, since it only ta%es the syste8atic ris% o! the port!olio into account. +he :ensen measure 'ensen@s alpha ='ensen, 1,7N> is de!ined as the di!!erential between the return on the port!olio in e:cess o! the ris%+!ree rate and the return e:plained by the 8ar%et 8odel, or Illustration: 2ou are evaluating the ran%ings based on Sharpe and ;reynor .atio o! three !unds A, B and $ . ;he average returns obtained !ro8 !unds A, B and $ have been 17L, 1,L and 14L, respectively against the 8ar%et return o! 1/L. ;he standard deviations o! !und returns have been 1R, 22 and 17, respectively versus the 8ar%et return standard deviation o! 13. ! the beta reported o! these !unds is 1.2, 1.4 and 1.1, respectively and the ris%+!ree rate o! return is 3.3L, what are your ran%ings in the order o! best to worstS Posted in $FP, nvest8ent Planning, .is% And .eturn F 6eave a $o88ent G

,is& and ,eturn for CFP.;

Posted by Prashant Shah on 0arch 1,, 201/ Modern Portfolio +heor# and Asset Pricing ;he relation between port!olio returns and port!olio ris% was recogniMed by two (obel 6aureates in "cono8ics, 5arry 0ar%owitM and 9illia8 Sharpe. 5arry 0ar%owitM tuned us into the idea that investors hold port!olios o! assets and there!ore their concern is !ocused upon the port!olio return and the port!olio ris%, not on the return and ris% o! individual assets. ;he relevant risk to an investor is the port!olio@s ris%, not the ris% o! an individual asset. ! an investor considers buying an additional asset or selling an asset !ro8 the port!olio, what 8ust be considered is how this change will a!!ect the risk o! the port!olio. Possi!le Portfolio

+he Efficient Frontier: the best co8binations o! e:pected return and standard deviation.

All the assets in each port!olio, even on the !rontier, have so8e ris%. (ow let@s see what happens when we add an asset with no ris%Xre!erred to as the ris%+!ree asset. ! we loo% at all possible co8binations o! port!olios along the e!!icient !rontier and the ris%+!ree asset, we see that the best port!olios are no longer those along the entire length o! the e!!icient !rontier? rather, the best port!olios are now the co8binations o! the ris%+!ree asset and one and only one port!olio o! ris%y assets on the !rontier.

Sharpe de8onstrates that this one and only one port!olio o! ris%y assets is the market portfolioX a port!olio that consists o! all assets, with the weights o! these assets being the ratio o! their 8ar%et value to the total 8ar%et value o! all assets. ! investors are all ris% averseXthey only ta%e on ris% i! there is adeAuate co8pensationXand i! they are !ree to invest in the ris%y assets as well as the ris%+!ree asset, the best deals lie along the line that is tangent to the e!!icient !rontier. ;his line is re!erred to as the capital market line =$06>. ! the port!olios along the capital 8ar%et line are the best deals and are available to all investors, it !ollows that the returns o! these ris%y assets will be priced to co8pensate investors !or the ris% they bear relative to that o! the 8ar%et port!olio. ;he $06 speci!ies the returns an investor can e:pect !or a given level o! ris%. ;he $AP0 uses this relationship between e:pected return and ris% to describe how assets are priced. ;he $AP0 speci!ies that the return on any asset is a !unction o! the return on a ris%+!ree asset plus a ris% pre8iu8. ;he return on the ris%!ree asset is co8pensation !or the ti8e value o! 8oney. ;he risk premium is the co8pensation !or bearing ris%. Putting these co8ponents o! return together, the $AP0 says# E8"ected return on an asset < E8"ected return on a ris&.free asset = ,is& "remium 5ence, .eAuired rate or return K .! P =.8 D .!> Y

9here, =.8 D .!> is 0ar%et .is% Pre8iu8 For each asset there is a beta. ! we represent the e:pected return on each asset and its beta as a point on a graph and connect all the points, the result is the security market line (SML) Securit# Mar&et 'ine:

Illustrations: Find Beta o! security E i! e:pected 8ar%et pre8iu8 is 13L, ris% !ree return is RL and e:pected return o! security E is 20LS

=a> 0.N/4 =b> 0.,00 =c> 9 0.R00 >?432

.is% !ree rate o! return is NL, e:pected 8ar%et pre8iu8 is 13L and Beta o! security is 0.N0. 9hat is the e:pected rate o! return o! the securityS

=a> 1/.7L =b> 13.00L =c> 12.00L

7d9 2>?>>@

Assu8e .! is RL, 18 is 17L !or a security E and has a beta !actor o! 1.4, the reAuired return o! the security isZZZZZZZ.

21.7L 20.0L

1R.4L 1,.7L 2/.2L

Source# Financial 0anage8ent and Analysis by F,AAB :? FA-CDDI?