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Investment Planning and Risk Management Principles
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Investment Planning and Risk Management Principles
Investment Planning and Risk Management Principles
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1
Question
Why should investment discussions start with "why" according to the chapter?
Page 1
Answer
The discussion must begin with the purpose of investment – why one is investing – rather than focusing on specific investments without considering the investor's needs.
2
Question
What is the first step in goal setting for investment planning?
Page 2
Answer
The first step is to identify life events that require funding, both desirable and undesirable, and then assign priorities to determine which goals are most important.
3
Question
How should financial goals be quantified for effective planning?
Page 2
Answer
Financial goals should be converted from broad objectives into specific amounts and timelines, such as the estimated cost of a goal and the target year when funds will be needed.
4
Question
What distinguishes a responsibility goal from a good-to-have goal in investment planning?
Page 2
Answer
Responsibility goals, such as retirement funding or children's education, are considered essential obligations, while good-to-have goals, like a grand vacation, are desirable but not mandatory. Priorities are determined by the individual and family.
5
Question
How does Stephen Covey's urgent versus important matrix apply to financial goal planning?
Page 3
Answer
Important but not urgent financial goals are often postponed until they become urgent, causing financial stress. Proactive planning for these goals is essential to avoid them turning into crises.
6
Question
Why is inflation adjustment critical when planning for long-term financial goals?
Page 4
Answer
Inflation erodes purchasing power over time, so the future cost of a goal will be much higher than today's price. Without accounting for inflation, the accumulated corpus may be grossly insufficient.
7
Question
What is the pool approach to meeting financial goals, and what is its main drawback?
Page 4
Answer
The pool approach involves having a single pool of savings or investments from which all financial requirements are met. The main drawback is that the investment horizon remains uncertain, which is critical for making appropriate investment decisions.
8
Question
How does inflation impact a family's monthly expenses over 20 years at 6% annual inflation?
Page 5
Answer
If current monthly expenses are Rs. 30,000, at 6% inflation they will rise to approximately Rs. 53,725 after 10 years and Rs. 96,214 after 20 years.
9
Question
What is the relationship between saving and investing?
Page 5
Answer
Saving and investing are two steps of the same process: saving involves reducing consumption to set money aside, and that saved money is then invested. Saving precedes investing, and saving emphasizes safety, while investing aims to earn returns with an associated risk-return trade-off.
10
Question
What are the three most important factors to evaluate any investment?
Page 6
Answer
Safety (capital protection and certainty of income), liquidity (ease of converting to cash), and returns (current income and capital appreciation).
11
Question
In addition to safety, liquidity, and returns, what other factors should be considered when evaluating an investment?
Page 6
Answer
Other factors include convenience (ease of investing, checking value, withdrawing), ticket size (minimum investment required), taxability of income, and tax deductions available.
12
Question
What is the difference between current income and capital gains as forms of investment returns?
Page 6
Answer
Current income is receivable periodically without selling the investment, such as interest or dividends. Capital gains are realized only when the investment is sold, representing the appreciation in value.
13
Question
Why should self-occupied residential property not be considered an investment?
Page 7
Answer
Selling a self-occupied property would negatively impact one's lifestyle, so it cannot be treated as a liquid investible asset. The text emphasizes that for most individuals, buying a home for self-use is an expense rather than an investment.
14
Question
What is the difference between owning a house for self-occupation and owning a residential property as an investment?
Page 7
Answer
A self-occupied house is an expense because selling it would disrupt lifestyle; an investment property is held for rental income or capital appreciation and can be sold without affecting one's primary residence.
15
Question
List at least three characteristics of real estate as an asset class.
Page 7
Answer
Real estate is illiquid (takes weeks or months to sell), not divisible (cannot sell part), has high transaction costs (brokerage, registration), can generate current income through rents, and its performance is heavily dependent on location.
16
Question
Why are gold and silver considered safe haven assets?
Page 8
Answer
They are globally accepted stores of value. In times of economic or currency failure, gold is viewed as the final shelter, and many central banks still hold gold in their reserves.
17
Question
What is a key drawback of investing in physical gold or silver?
Page 8
Answer
The investor must rely solely on capital appreciation since these commodities do not generate any current income. Additionally, purity verification is difficult without a certificate, and certification adds cost.
18
Question
What are the three subcategories of bonds based on maturity?
Page 9
Answer
Short-term bonds (ideal for liquidity needs), medium-term bonds, and long-term bonds (for income generation needs). Bonds can also be classified by issuer type: government or corporate.
19
Question
What is the main difference between ownership assets and lending assets in terms of future cash flows?
Page 10
Answer
For lending assets (e.g., bonds, fixed deposits), future cash flows are agreed at issuance. For ownership assets (e.g., equity, real estate, commodities), future returns are unknown and highly uncertain.
20
Question
According to the text, what has been the historical compounded annual return of the BSE Sensex from 1979 to January 2026 before dividends?
Page 9
Answer
The Sensex grew from 100 to 82,269, representing a compounded annual appreciation of approximately 15.4% per annum before adding dividends.
21
Question
How does investing in international equities provide exposure beyond company performance?
Page 10
Answer
Investing in foreign stocks exposes the investor to both the company's fortunes and changes in the exchange rate between the foreign currency and the domestic currency.
22
Question
Under which asset category are Real Estate Mutual Funds, Real Estate Investment Trusts, and Infrastructure Investment Trusts classified?
Page 11
Answer
They are classified under real estate or infrastructure as financial assets, as shown in the table of investment avenues.
23
Question
Under which asset category do Hybrid Mutual Funds or Multi-Asset Funds belong?
Page 11
Answer
They belong to hybrid asset classes, which are separate from the four broad categories of equity, fixed income, real estate, and commodities.
24
Question
What is inflation risk and why is it particularly damaging over long investment horizons?
Page 11
Answer
Inflation risk is the erosion of purchasing power due to rising prices. Over long periods, even moderate inflation significantly reduces what money can buy; for example, at 8% inflation, Rs. 10,000 today would need Rs. 46,610 in 20 years to buy the same goods.
25
Question
What is the nominal rate of return and how is the real rate of return calculated?
Page 12
Answer
The nominal rate is the return earned without adjusting for inflation. The real rate of return is adjusted for inflation: if the nominal return exceeds inflation, the real rate is positive, and vice versa.
26
Question
What is liquidity risk and which asset classes typically exhibit high liquidity risk?
Page 13
Answer
Liquidity risk is the risk that an investment cannot be sold quickly without a significant price concession or penalty. Real estate and certain fixed-income products with lock-in periods typically have high liquidity risk.
27
Question
What is credit risk in the context of fixed-income investments?
Page 13
Answer
Credit risk is the possibility that the issuer will delay or default on interest payments or principal repayment. It can arise from the issuer's inability to pay (business stability) or unwillingness to pay.
28
Question
What is the difference between market risk and specific (company) risk?
Page 14
Answer
Market risk (systematic) affects all stocks broadly due to economy-wide factors and cannot be diversified away. Specific risk (unsystematic) is unique to a company and can be reduced through diversification.
29
Question
What are the three categories of risk factors that can affect a company's stock price, from broadest to most specific?
Page 14
Answer
Market-wide factors (e.g., economic downturn, geopolitical events), industry-specific factors (e.g., government policy change, technological disruption), and company-specific factors (e.g., decline in sales due to poor management).
30
Question
How does interest rate risk affect bond prices?
Page 15
Answer
There is an inverse relationship: when interest rates increase, existing bond prices decrease because they offer lower fixed rates compared to new bonds; when rates decrease, bond prices increase.