Patricia and Alexander Tracy, both age 59, are residents of Canada. They have twin sons who
will enter a four-year university program in one year. Patricia is a long-time employee of a
telecommunications company. Alexander is a self-employed sales consultant.

Alexander’s annual income is now steady after years of extreme highs and lows. The Tracys
have built an investment portfolio through saving in Alexander’s high income years. The
Tracys’ current annual income is equal to their total expenses; as a result, they cannot add to
savings currently. They expect that both their expenses and income will grow at the inflation
rate. All medical costs, now and in the future, are fully covered through government programs.

The Tracys worry about whether they have saved enough for retirement, and whether they will
be able to maintain the real value of their portfolio. Inflation is expected to average 4% for the
foreseeable future.

The Tracys have approached Darren Briscoe to help them analyze their investment strategy and
retirement choices. The Tracys disagree about the appropriate investment strategy. Patricia
prefers not losing money over making a high return. This is partly a result of continuing regret
for a loss experienced in an equity mutual fund several years ago. Alexander’s history of making
frequent changes in their portfolio greatly annoyed Patricia. She thinks Alexander focused only
on potential return and paid little attention to risk.

A. i. Prepare the return objectives portion of the Tracys’ investment policy statement
(IPS) that will apply if they retire at age 60.

ii. Calculate the pre-tax nominal rate of return that is required for the Tracys’ first
year of retirement if they retire at age 60. Show your calculations.

(12 minutes)

B. Indicate specific factors for the Tracys, for each of the following, which support
Briscoe’s conclusion that the Tracys’ risk tolerance is below average:

i. Ability to take risk. Indicate two factors.
ii. Willingness to take risk. Indicate one factor.

(6 minutes)

C. Prepare the current (2009) liquidity constraint for the Tracys’ IPS:

i. if they retire at age 60.
ii. if they retire at age 65.

(4 minutes)

D. Prepare the current (2009) time horizon constraint for the Tracys’ IPS:

i. if they retire at age 60.
ii. if they retire at age 65.
Reading References:
8. “Frame Dependence: The Second Theme,” Ch. 3, Beyond Greed and Fear:
Understanding Behavioral Finance and the Psychology of Investing, Hersh Shefrin
(Oxford University School Press, 2002)
14. “Managing Individual Investor Portfolios,” Managing Investment Portfolios: A Dynamic
Process, 3rd
edition, James W. Bronson, Matthew H. Scanlan, and Jan R. Squires (CFA
Institute, 2007)

To test the candidate’s: (1) understanding of the investment policy statement for an individual
investor, (2) ability to assess pertinent factors for an investor’s ability to assume risk, (3) ability
to calculate an investor’s required return, and (4) understanding of an investor’s other constraint

LOS 2009 -III-3-8 -a, “Frame Dependence: The Second Theme”
The candidate should be able to:
a) explain how loss aversion can result in investors’ willingness to hold on to
deteriorating investment positions;

LOS 2009 -III-4-14-a,f,j,k,l, “Managing Individual Investor Portfolios”
The candidate should be able to:
a) discuss how source of wealth, measure of wealth, and stage of life affect individual
a) discuss how source of wealth, measure of wealth, and stage of life affect individual
investors’ risk tolerance;
f) compare and contrast risk attitudes and decision-making styles across distinct
investor personality types, including cautious, methodical, spontaneous, and
individualistic investors;
j) explain how to set risk and return objectives for individual investors and discuss the
impact that ability and willingness to take risk have on tolerance;
k) identify and explain each of the major constraint categories included in an
individual investor’s investment policy statement;
l) formulate and justify an investment policy statement for an individual investor;