Advise Mrs Yorkie of the earliest age that she may retire at if she has a low or a medium risk tolerance and provide at least five relevant caveats (disclaimers) to your advice.

QUESTION

You are due to meet with a potential new client, Mrs Yorkie, who will shortly turn 30 years old. She has recently opened a self-invested personal pension (SIPP), is intending to contribute £6,000 per annum to it (in nominal terms and starting on her 30th birthday) and wishes to receive an annual pension of £20,000 (in real terms) from it when she retires.

You have ascertained that she pays income tax at the higher rate of 40%, that inflation is expected to be 1.5% per annum and that current annuity rates are:

Retirement age                          Annuity rate

65                                                4.2%

60                                                4.0%

55                                                3.8%

You have already decided that you will advise Mrs Yorkie to invest her SIPP portfolio in a FTSE All-Share equity index tracker fund and one of the gilts shown in the table below.

Gilt                                    Maturity Date                                 Market price per £100 nominal

4% Treasury 2047             14th July 2047                                              £144.90

1.6% Treasury 2052          14th April 2052                                             £91.40

3% Treasury 2057            14th February 2057                                       £120.70

Each gilt pays interest on a semi-annual basis, is redeemable at its nominal value of £100 and it is your intention to advise Mrs Yorkie to undertake cash matching.

The equity index tracker fund has a tracking error of 0.56% and long run historic total nominal return from UK equities is 8.1%.
You are also of the opinion that low risk investors should not hold more than 50% of their portfolios in equity but that this can be increased to 75% for medium risk investors.

Required:

Calculate the expected return of the equity index tracker fund and explain what is meant by tracking error to Mrs Yorkie.

(8 marks)

continues overleaf

Calculate the yield to maturity of each of the gilts and explain what is meant by cash matching to Mrs Yorkie.
(32 marks)

Calculate the required return of the portfolio within Mrs Yorkie’s SIPP for her to retire at 55, 60 or 65 years old.
(24 marks)

Calculate the percentage weights of the equity index tracker fund and one of the gilts in the three portfolios for Mrs Yorkie to retire at 55, 60 or 65 years old. You should state clearly which gilt will be included in each portfolio.
(12 marks)

Advise Mrs Yorkie of the earliest age that she may retire at if she has a low or a medium risk tolerance and provide at least five relevant caveats (disclaimers) to your advice.
(24 marks)

Total 100 marks

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