Determining Risk Tolerances, Return Objectives and Liquidity Objectives

Client Analysis
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Client Analysis
Risk tolerance is a term used to define the amount of loss an investor speculates to encounter while making an investment decision. A number of factors assist an investor to determine the level of risk they can afford to take (Bodie et al., 2021). Becoming aware pf the risk tolerance level enables them to develop a plan for the entire portfolio hence providing a direction for investment objectives. For Instance if a client’s risk tolerance is low, investment decisions will be conservative. In essence, the investment portfolio will mostly include more low-risk investments and less high-risk investments.
Return objectives for an investment could be either absolute or relative. An absolute return means the return a portfolio should achieve over a certain period. For instance if an individual wants to achieve a return of 9%, or an inflation-adjusted return of 2%, it is paramount that a positive return is delivered over time. This is expected with no regard of whether the market performance is good or bad. For an absolute return, no index or benchmark is used to measure the performance (Bodie et al., 2021). Varieties of strategies, which depend on the skills of the manager, are used to generate an absolute return. On the other hand, a relative return objective is stated relative to a designated benchmark.
In this scenario, it is important to consider the age of the client. This is because individuals at different ages have different strategies for investment. Ezra is 26 years old and therefore relatively young. This makes his tolerance to risk high because the investment is not his primary source of income. Moreover, his willingness to lose up to 30-40% of his invested capital if he stands to gain higher returns shows that his risk tolerance is moderate to high. This also goes to indicate that he expects high returns from the potential investment. In addition, Ezra does not expect his risk tolerance to change after marriage.
Liquidity defines the ability to convert assets into cash without suffering substantial price erosion. According to Lal and Rao (2016), it is essential to consider the cash requirements of clients in order to assess whether their needs require them to invest in liquid investments. At the moment, Ezra’s liquidity is relatively low as most of his savings are invested in the stock market. In addition, he has many investments totaling up to $4800 a month. With this information, it would be accurate to conclude that Ezra is classified in the growth and capital preservation category. Moreover, he also fits into the asset preservation category, as he prefers to have some savings in the bank in case an unexpected disruption occurs with his work. In addition, Ezra fits into the characteristics of risk takers who invest in stock and equities heavily.
However, for client 2, the portfolio describes Jacob and Rachel aged 53 and 52 respectively whom are nearing retirement. Their main aim is to protect their assets while drawing income from them in a tax-efficient manner. In addition to this, Jacob and Rachel have the responsibility of paying college fees for two of their children. While the couple collectively earns $190,000, they still have to live below their means with their children’s college expenses having to come out of their pockets for the next 6-8 years.
The factors above would classify the clients as having moderate risk tolerance taking into account that they have to pay the fees from their pockets. This also means that they cannot afford riskier investments. In addition, putting the client’s expenses into consideration, one can perceive that liquid investments might be a priority. This makes less liquid investment options less viable for the clients. Additionally, from an analysis of the client’s portfolio, an investment manager can perceive that the clients would prefer an investment that is a source of income rather than one with high returns (Tarlie, 2016). Therefore, a moderately aggressive portfolio would be more appropriate for Rachel and Jacob, as it would satisfy their average risk tolerance while attaining a balance of earning income and capital growth. These clients can therefore be classified into income and growth categories, as they need the investment as a source of income while also expecting capital growth into their retirement.
Stock Analysis
IBM value using the Free Cash Flow valuation model
= free cash flows per share/Current market price per share
= 13.36/153.83 = 8.68%
The firm has an outstanding performance as measured by the free cash flows per share.
The expected return is 0.75% + (0.86*9%) = 8.49%
ORCL value using the dividend valuation model = Dividends/ 1+g
0.6/1.211 = $49.55
This formula was used because the firm has a high 5-year dividend growth. In addition, it is suited for stock with a low payout ratio. Therefore, it makes sense to value the firm using divide...