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York University COURSE ADMS 3541 Summer 2014

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Question 1: Definitions (8 marks);Define briefly each of the following terms;Income splitting;Adverse selection;Speculative Risk;Comprehensive auto coverage;3;Question 2: Short Answer (6 marks, 3 each);What does the law of large numbers say and what is its significance in financial planning?;Briefly describe three income tax deferral techniques.;4;Question 3: After-tax return (6 marks);Nosheen Aziz bought a bond for $990. It paid a semi-annual coupon of 4% on the face value of $1,000. In one year it matured at face value. Her marginal tax rate is 42%.;a) What was her EAR before-tax? (2 marks);b) What was her EAR after-tax? (4 marks).;5;Question 4: Alternative Lenders (12 marks);Ayan Roy has trouble with his budget. His $400 car payment is due tomorrow, but he only has $100 in cash on hand which he needs for groceries until he gets paid again in two weeks. He knows he has put himself in a bad situation and is exploring the unsavory options available to him. He has the following choices for the $400 car payment;1. ?Gracious? Grady, the local payday lender, charges a flat $12 fee plus interest at 55% EAR plus 10%*(principal + interest) for a 14 day loan. Gracious Grady promises: ?What happens here stays here: no-one ever knows who borrows from me or how much because I don?t report to anyone. All I need from you is your cheque.?;2. Pawnstar, the local pawnshop, has offered Ayan $400 for his Tag Heuer watch. The loan is structured so that Ayan gets his watch back if he pays 2% interest plus 18% in fees in 30 days (he gets no discount if he pays it off sooner). His watch is valued at over $2000.;3. Ayan?s friend?s friend?s friend knows of someone who will charge him $100 for the loan ? meaning that he gets $400 now, but then owes him $500 in two weeks. This ?friend? is known around town as Fingerless Freddie, which concerns Ayan just a bit.;a) Calculate the EAR for each of the three options. (7 marks);6;a) Identify specifically one relevant factor or consideration about each one of these options that was not captured in the EAR calculation. (3 marks);?Gracious? Grady;Pawnstar;Freddie;b) Give Ayan two marks worth of financial planning advice. (2 marks);7;Question 5: Risk Management and Insurance (28 marks);Melissa Fernandez and Daniel Gaglia are 55. They have 3 children who are all out of the house and off on their own and one disabled child who still lives at home with them (and will always live at home). Their house in Toronto is currently valued at $1 million and it is almost paid off. They own a ski condo in Collingwood that also has a mortgage, 3 cars, a truck, a large stamp collection, and a sizeable investment account that Daniel inherited from his late mother. Daniel works as an independent contractor repairing roofs. His income is unsteady ? he can make between $35,000 and $85,000 in any given year, after all business expenses. Melissa is an attorney at a local law firm with a healthy pension and benefits package. Melissa has recently been experiencing some health issues related to a heart condition. Daniel has about $250,000 in his RRSP and no pension. They want to talk to an insurance professional about adequate insurance coverage. They plan to retire no later than age 65, but perhaps earlier if they can.;a) List five risks faced by this family, classify the severity and frequency, and clearly explain how they can manage each of these risks. (20 marks);There are many potential answers to this question.;8;b) Estimate the amount of life insurance that Daniel requires. Use an interest rate of 3% before-tax. There is a range of reasonable answers to this question. Justify your answer, do not give calculations only. (8 marks);9

 

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