Personal Financial
Management
Sample Exam
2004 – 2005
Prof. Gareth Myles
g.d.myles@ex.ac.uk
Question 1
Why is financial planning worthwhile? Show
how financial planning can be used by
constructing a financial plan for the next 10
years for a graduate aged 22 who is about to
undertake a Master’s degree before entering
full-time employment. Be clear about the
assumptions you adopt.
Points
1. The discussion of the value of financial planning
should describe what financial planning is, and
then its value. Need to emphasise objectives,
constraints and attitudes.
2. Points: a. current position (debt?) b. expected
employment (degree?) c. personal situation
(marital status?) d. interests. Make assumptions,
then construct the plan. Set objectives, and be
realistic.
3. Any assumption will be allowed but a degree of
realism will be rewarded.
Degree of Detail
• The categories of expenditure do not need
to be excessively precise
• Marks will be gained by focus on the
financial aspects
- use of financial instruments
- understanding of appropriate interest rates
- comprehension of risks
Question 2
(i) What does it mean to say one asset is more risky
than another? (ii) The table gives the returns on 3
assets in the 2 potential states of the world next
year. If state 1 occurs 2/3 of the time, calculate the
expected return on each asset and the variance of
return. Which asset is the riskiest?
State 1 State 2
Asset A 7
2
Asset B 6
4
Asset C 1
7
Points
(i) An answer should talk about return and
risk in general terms, then should provide
formal definitions. More risk described,
then defined. Must say what we mean by
risk and how we measure it.
(ii) This is a very straightforward calculation.
The riskiest will have the largest variance.
Calculations
• Asset A
return = (2/3)7 + (1/3)2 = 16/3
variance = (2/3)(7 – 16/3)2
+ (1/3)(2 – 16/3)2
= (2/3)(25/9)+(1/3)(100/9)
= 150/27
Question 3
You are arrested by the police for falling
asleep at a football match. When the arresting
officer discovers you know about personal
finance, he requests your advice and you do
not feel in a position to refuse. What questions
would you ask and how would the answers
affect your advice?
Points
This is about the basic information you need to plan.
Aside from determining the current financial
position and objectives, it is also necessary to
determine attitudes to risk and potential promotion
opportunities.
For any long-term plan would also need to know
pension situation. Then relate possible answers to the
choices made in constructing a financial plan.
Answers
•
•
•
•
•
Attitude to risk determines assets choice
Pension rights affect long-term plan
Age of retirement can be significant
Plan for period after retirement
Promotion prospects can be relevant
Question 4
How do you calculate an APR? Present an
example to show how an APR can be used to
contrast two different financial flows over the
same period. Is it a worthwhile concept?
Points
This answer must define what an APR is, what it is
trying to do, and why this is worthwhile.
The formula must be stated and the interpretation of
this given.
You must present your own example and the quality
of this will matter – the APR must add something to
the comparison.
The evaluation of whether it is worthwhile should be
related to your example, and to general conclusion.
Calculating APRs
• The APR formula involves a series of cash flows
at different times
• Receive £100 at t = 0, receive £50 at t = 1.5, pay
£90 at t = 1, pay £80 at t = 2
100

0
1  r 
50
90
80


1  r 1.5 1  r 1 1  r 2
• How do you solve? By trial and error in the
examination
Question 5
You have accumulated a debt of £2000 on a
credit card. If the card charges a rate of
interest of 2% per month and allows a
minimum payment of 5% of outstanding
balance to be made each month, what would
be the debt on card after 3 years of making the
minimum payment? Is accumulating credit
card debt a good financial strategy? Can you
suggest a better alternative?
Points
The calculation is the same as in the class exercise.
This should be set out in detail for each month: balance,
interest, repayment.
Whether it is a good strategy should be related to the typical
rate of interest on the credit card compared to alternative
forms of borrowing.
This then links into the final part concerning either alternative
ways of borrowing or changes to consumption plan to avoid
borrowing.
Points
• You should not underestimate the
importance of the discussion
• Each question should take 40 minutes – use
this time
• The better alternatives should reveal
financial knowledge
Question 6
Evaluate the statement “The more informed
we become, the less we will be able to
insure.” Can insurance markets work perfectly
in practice?
Points
The evaluation of the first statement must relate back to the
theory of insurance; the basic feature of which is the sharing
of risks.
Any question of this form is an invitation to describe the
theory. Do this carefully.
The second part must define what is meant by “perfectly”.
Again this is about the theory of insurance – in this case
inviting you to describe moral hazard and adverse selection.
Examples always make for a better answer.
Good Essays
• Besides describing the theory of insurance
you must also answer the questions
• To do this requires understanding the theory
• It also requires an interpretation of the
question
• Make sure this interpretation is stated
Question 7
Should an informed person ever pay
inheritance tax? Does the same answer apply
to income tax?
Points
The answer must describe the basic features
of inheritance tax (rate of tax, what it applies
to, exemptions, spouses). Then it should
proceed to review options for reducing the tax
liability. This should then be repeated for
income tax. The answer must distinguish what
it different between income tax and
inheritance tax.
Question 8
Why are the developed countries expected to
suffer from a “pensions crisis”? What
financial decisions can you take to minimise
your exposure to this?
Points
The essay must say what the pensions crisis
is, what is causing it, provide some evidence,
and relate it to pensions and taxation. Then
you consider how to plan to avoid these
problems – the answer to this part must
distinguish between the various alternative
forms of pension (including their important
features) and then a realistic plan.
Additional Points
• Inclusion of statistical information
(dependency ratio, value of state pension
etc.) will improve essay
• The role of government policy is central
• This answer can be linked to current news
reporting