Personal Financial Management

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Personal Financial Management

• Sample Exam
• 2004 2005
• Prof. Gareth Myles
• g.d.myles_at_ex.ac.uk

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Question 1

• Why is financial planning worthwhile? Show how
  financial planning can be used by constructing a
  financial plan for the next 10 years for a
  graduate aged 22 who is about to undertake a
  Masters degree before entering full-time
  employment. Be clear about the assumptions you
  adopt.

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Points

• The discussion of the value of financial planning
  should describe what financial planning is, and
  then its value. Need to emphasise objectives,
  constraints and attitudes.
• Points a. current position (debt?) b. expected
  employment (degree?) c. personal situation
  (marital status?) d. interests. Make assumptions,
  then construct the plan. Set objectives, and be
  realistic.
• Any assumption will be allowed but a degree of
  realism will be rewarded.

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Degree of Detail

• The categories of expenditure do not need to be
  excessively precise
• Marks will be gained by focus on the financial
  aspects
• - use of financial instruments
• - understanding of appropriate interest rates
• - comprehension of risks

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Question 2

• (i) What does it mean to say one asset is more
  risky than another? (ii) The table gives the
  returns on 3 assets in the 2 potential states of
  the world next year. If state 1 occurs 2/3 of the
  time, calculate the expected return on each asset
  and the variance of return. Which asset is the
  riskiest?
•  
•  

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Points

• An answer should talk about return and risk in
  general terms, then should provide formal
  definitions. More risk described, then defined.
  Must say what we mean by risk and how we measure
  it.
• This is a very straightforward calculation. The
  riskiest will have the largest variance.

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Calculations

• Asset A
• return (2/3)7 (1/3)2 16/3
• variance (2/3)(7 16/3)2
• (1/3)(2 16/3)2
• (2/3)(25/9)(1/3)(100/9)
• 150/27

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Question 3

• You are arrested by the police for falling asleep
  at a football match. When the arresting officer
  discovers you know about personal finance, he
  requests your advice and you do not feel in a
  position to refuse. What questions would you ask
  and how would the answers affect your advice?

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Points

• This is about the basic information you need to
  plan.
• Aside from determining the current financial
  position and objectives, it is also necessary to
  determine attitudes to risk and potential
  promotion opportunities.
• For any long-term plan would also need to know
  pension situation. Then relate possible answers
  to the choices made in constructing a financial
  plan.

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Answers

• Attitude to risk determines assets choice
• Pension rights affect long-term plan
• Age of retirement can be significant
• Plan for period after retirement
• Promotion prospects can be relevant

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Question 4

• How do you calculate an APR? Present an example
  to show how an APR can be used to contrast two
  different financial flows over the same period.
  Is it a worthwhile concept?

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Points

• This answer must define what an APR is, what it
  is trying to do, and why this is worthwhile.
• The formula must be stated and the interpretation
  of this given.
• You must present your own example and the quality
  of this will matter the APR must add something
  to the comparison.
• The evaluation of whether it is worthwhile should
  be related to your example, and to general
  conclusion.

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Calculating APRs

• The APR formula involves a series of cash flows
  at different times
• Receive 100 at t 0, receive 50 at t 1.5,
  pay 90 at t 1, pay 80 at t 2
• How do you solve? By trial and error in the
  examination

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Question 5

• You have accumulated a debt of 2000 on a credit
  card. If the card charges a rate of interest of
  2 per month and allows a minimum payment of 5
  of outstanding balance to be made each month,
  what would be the debt on card after 3 years of
  making the minimum payment? Is accumulating
  credit card debt a good financial strategy? Can
  you suggest a better alternative?

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Points

• The calculation is the same as in the class
  exercise.
• This should be set out in detail for each month
  balance, interest, repayment.
• Whether it is a good strategy should be related
  to the typical rate of interest on the credit
  card compared to alternative forms of borrowing.
• This then links into the final part concerning
  either alternative ways of borrowing or changes
  to consumption plan to avoid borrowing.

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Points

• You should not underestimate the importance of
  the discussion
• Each question should take 40 minutes use this
  time
• The better alternatives should reveal financial
  knowledge

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Question 6

• Evaluate the statement The more informed we
  become, the less we will be able to insure. Can
  insurance markets work perfectly in practice?

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Points

• The evaluation of the first statement must relate
  back to the theory of insurance the basic
  feature of which is the sharing of risks.
• Any question of this form is an invitation to
  describe the theory. Do this carefully.
• The second part must define what is meant by
  perfectly. Again this is about the theory of
  insurance in this case inviting you to describe
  moral hazard and adverse selection.
• Examples always make for a better answer.

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Good Essays

• Besides describing the theory of insurance you
  must also answer the questions
• To do this requires understanding the theory
• It also requires an interpretation of the
  question
• Make sure this interpretation is stated

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Question 7

• Should an informed person ever pay inheritance
  tax? Does the same answer apply to income tax?

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Points

• The answer must describe the basic features of
  inheritance tax (rate of tax, what it applies to,
  exemptions, spouses). Then it should proceed to
  review options for reducing the tax liability.
  This should then be repeated for income tax. The
  answer must distinguish what it different between
  income tax and inheritance tax.

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Question 8

• Why are the developed countries expected to
  suffer from a pensions crisis? What financial
  decisions can you take to minimise your exposure
  to this?

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Points

• The essay must say what the pensions crisis is,
  what is causing it, provide some evidence, and
  relate it to pensions and taxation. Then you
  consider how to plan to avoid these problems
  the answer to this part must distinguish between
  the various alternative forms of pension
  (including their important features) and then a
  realistic plan.

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Additional Points

• Inclusion of statistical information (dependency
  ratio, value of state pension etc.) will improve
  essay
• The role of government policy is central
• This answer can be linked to current news
  reporting