Ethics in Financial Planning

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Questions and Answers

What is a primary purpose of a Statement of Advice (SoA)?

To outline the costs associated with investments

To present a detailed risk assessment of products

To set out the advice and the context of that advice (correct)

To serve as a contract between the adviser and the client

Under what condition can advice be given without a Statement of Advice?

If the investment products are worth more than $50,000

If the adviser has over five years of experience

If the client is an existing customer of the adviser

If the client explicitly states they will not act on the advice (correct)

What essential information must a SoA include regarding the adviser?

The adviser's qualifications and contact details (correct)

The adviser's personal investment portfolio

The adviser's hobbies and interests

The adviser's performance history with clients

Which of the following is NOT a requirement for a Statement of Advice?

The adviser's personal commission rates Signup and view all the answers

What additional details must be included in a SoA when recommending a product replacement?

Charges for disposal of the original product Signup and view all the answers

When must a Statement of Advice be provided to a client?

Before any action is taken to implement the recommended advice Signup and view all the answers

What is typically included in a SoA regarding the advice's influence?

Information about any associations that may affect the advice Signup and view all the answers

What aspect is NOT necessary to disclose in a SoA when replacing a product?

The client’s financial history Signup and view all the answers

What is the primary purpose of a Product Disclosure Statement (PDS)?

To inform clients about the risks, tax implications, and other relevant information about a financial product Signup and view all the answers

When must a Financial Services Guide (FSG) be offered to clients?

Before formal negotiations begin Signup and view all the answers

Which one of the following is NOT a required component of an FSG?

A summary of all investment options Signup and view all the answers

What is the typical equity risk premium in Australia?

4-6% Signup and view all the answers

What is the correct relationship between risk and expected return in investments?

Expected return is generally a function of risk Signup and view all the answers

What aspect does asset allocation primarily address in investment portfolio construction?

The division of funds across different asset classes Signup and view all the answers

Which of the following statements about inflation-adjusted rates of return is true?

They have remained relatively constant over time. Signup and view all the answers

In the context of investment decisions, security selection refers to which of the following?

Selecting individual securities within chosen asset classes Signup and view all the answers

What is the primary objective of active management in portfolio investing?

To capitalize on short-term price movements by frequently buying and selling securities. Signup and view all the answers

Which type of bond is specifically designed to offer a regular fixed payment of interest?

Coupon paying bond Signup and view all the answers

Which of the following risks is NOT typically associated with bonds?

Enterprise risk Signup and view all the answers

What distinguishes investment-grade bonds from other types of bonds?

They have a lower likelihood of default and are considered safer investments. Signup and view all the answers

In the context of bond trading, what does a 'hold to maturity' strategy imply?

It guarantees a return based solely on interest payments. Signup and view all the answers

Which of the following bond types typically does NOT pay interest regularly?

Zero coupon bond Signup and view all the answers

What is the main reason for an investor to choose investment-grade bonds?

They provide improved access to capital and lower borrowing costs for issuers. Signup and view all the answers

Which of the following bond risks pertains to changes in interest rates affecting bond pricing?

Interest rate risk Signup and view all the answers

What distinguishes equity from debt in terms of payment obligations?

Equity holds less obligation for payment than debt. Signup and view all the answers

What are the benefits of Bond ETFs compared to traditional bonds?

Greater flexibility and diversified exposure. Signup and view all the answers

Which of the following statements about long-term vs. short-term returns on equities is true?

Historically, equities tend to outperform other asset classes over the long term. Signup and view all the answers

What is a primary risk associated with investing directly in shares?

Volatility leading to potential significant short-term losses. Signup and view all the answers

In which of the following scenarios might an investor prefer equity over debt?

When looking for participation in a company's growth through capital gains. Signup and view all the answers

What is a key consideration when choosing which shares to buy?

Understanding company fundamentals and market trends. Signup and view all the answers

What effect did the COVID-19 pandemic have on the stock market?

It led to substantial declines in stock prices. Signup and view all the answers

Which of the following is NOT true regarding the nature of equity?

Equity can only be generated from external sources. Signup and view all the answers

What is typically required as proof of capability to handle interest rate rises when applying for a mortgage?

A stress test using a higher interest rate than the current one Signup and view all the answers

What percentage of the purchase price do most mortgage loans typically cover?

60-80% Signup and view all the answers

Which of the following is NOT a characteristic of mortgage insurance?

It is always optional for loans above 80% LVR Signup and view all the answers

How can the amount of stamp duty payable be reduced when purchasing a property?

By buying land and then constructing a house on it Signup and view all the answers

What is the effect of an offset account related to a mortgage?

Offsets the amount owing on the home loan Signup and view all the answers

What is a key advantage of buying a property compared to renting?

The potential to eventually own the property Signup and view all the answers

What typically influences the acceptance of a mortgage application?

The amount of deposit paid Signup and view all the answers

What happens if the Loan to Valuation Ratio exceeds 80%?

Mortgage insurance is usually compulsory Signup and view all the answers

Which type of loan structure combines both fixed and variable rates?

Cocktail loan Signup and view all the answers

Which of the following is a factor that might affect the cost of property insurance?

The size and type of structure Signup and view all the answers

Study Notes

Conflict of Interest

A conflict of interest exists when a financial planner (FP) has the opportunity to prioritize their own interests over those of the client.
An example is advising a client to purchase a particular product solely because the FP earns commission, rather than providing objective recommendations.
To avoid conflicts of interest, FPs should disclose any commissions and ensure that recommendations are based on the client's personal circumstances and objectives, regardless of any personal benefits.

Statement of Advice (SoA)

A Statement of Advice (SoA) is a document that details the advice provided and its context.
It is required when personal financial advice is given, before any action is taken to implement the advice.
The SoA must include:
- Product details, explaining the recommended product's advantages over alternatives.
- Information about the advisor, including their name, qualifications, contact details, and the name of the authorized principal they represent.
- Details about remuneration and benefits received by anyone involved (fees, charges, and distribution methods).
- Disclosure of any associations that could potentially influence the advice provided.
- A warning if the advice is based on inaccurate or insufficient information.
- Reasons for replacing one product with another.
Advice can be provided without a SoA in specific circumstances:
- When investments, basic deposit products, or super amounts are less than $15,000.
- When the advice solely consists of an offer to sell a product, and the client makes it clear that they do not intend to buy, no sale results, and the advice is given over the phone for traded products, subject to client approval and the advisor providing an FSG.
When the SoA recommends replacing one product with another, additional details must be provided:
- Benefits of switching to the alternative product.
- Potential losses resulting from disposing of the original product.
- Charges associated with disposing of the original product.
- Charges for switching to the alternative product.
- Any other significant consequences of the action.

Product Disclosure Statement (PDS)

A PDS is a document that provides information about a financial product, including risks, tax implications, fees, expenses, charges, and any other relevant details that would influence the client's decision.
It is required before a client becomes legally obligated to acquire the product or invest in it.
The PDS can be provided electronically, such as through email.

Financial Services Guide (FSG)

An FSG discloses the services offered to a client.
It is required to be presented at the beginning of negotiations.
An FSG must include:
- The title "Adviser Financial Services Guide" or "FSG".
- Name and contact details of the advisor.
- Information about the authorized principals, including their names and contact details.
- Disclosure of who the advisor represents when providing services.
- Information about any business relationships or associations between the principal and issuers of products.
- Details of internal and external complaints resolution mechanisms.
- A statement affirming the FSG's authorization by the principals.

Asset Allocation

Different investments exhibit varying performance levels according to their associated risks, with equities typically offering higher potential returns but also carrying greater risk compared to real property and bonds.
Expected return is directly related to risk.
In Australia, the long-term returns on equities have averaged between 10% and 11.5% p.a. However, equities experience substantial short-term volatility.
Historically, the equity (risk) premium has hovered around 4-6%.
Inflation-adjusted ("real") rates of return have remained relatively consistent over time.

Investment Portfolio Construction

Investment portfolio construction involves two key stages:
- Asset allocation (macro decision): Determines the percentage of funds allocated to different asset classes based on risk tolerance, financial goals, and investment horizon.
- Security Selection (micro decision): Involves choosing and investing in specific securities within each asset class. This decision depends on the fund's risk profile, regulatory constraints, ethical guidelines, sector preferences, and economic forecasts.

Active vs Passive Management

Active management involves frequent buying and selling of securities to capitalize on short-term price fluctuations. Its objective is to "buy low, sell high" and maximize gains.
Passive management embraces a buy-and-hold strategy, based on the belief that markets are generally efficient and achieving consistent outperformance through active trading is difficult. Its objective is to achieve long-term growth by holding investments without frequent trading.

Bonds

A bond is a contract between the issuer and the investor, outlining the issuer's obligation to make specific cash payments to the investor on predetermined dates.
This obligation includes the principal plus interest (compensation for using the funds).
Types of bonds include coupon paying bonds, zero-coupon bonds, convertible bonds, callable bonds, annuity bonds, asset-backed bonds, indexed bonds, and junk (non-investment grade) bonds.
Bonds offer a lower risk compared to equities but present lower potential returns.
Key risks associated with bonds: interest rate risk, reinvestment risk, inflation risk, credit/default risk, liquidity risk, and rating downgrade risk.

Investment-Grade Bonds

Investment-grade bonds are considered safer investments with lower default risk, making them attractive to a wide range of investors.
They offer issuers lower borrowing costs and improve access to capital.
Investors benefit from better liquidity, stability, and potentially lower volatility in their investment portfolios.
Being classified as investment-grade is vital for maintaining investor confidence and accessing broader capital markets on favorable terms.

Coupon-Paying Bonds

Coupon-paying bonds offer regular fixed payments of interest (C) plus repayment of the principal at maturity (F).
Interest payments (C) are typically made biannually and determined by the bond's face value and interest rates.
Investors can withdraw their funds at any time, making them suitable for those requiring quick access to their money.

ETF vs CMT

Bond ETFs (Exchange Traded Funds) have gained popularity due to their greater flexibility, lower costs, ability to trade throughout the day, diversified exposure to a broad range of bonds, and lower management fees.

Debt

Debt imposes a contractual obligation on a firm to make regular payments of interest and principal to lenders.

Equity

Equity, the counterpart to debt, represents a residual claim on the cash flows generated by a firm's assets.
Equity holders have a lower claim on the firm's cash flows compared to debt holders.
Dividends are paid after interest payments.
Capital is returned after borrowings are repaid.
An equity risk premium exists, reflecting the higher risk associated with equity investments.
Equity can be generated from internal sources (retained earnings) or external sources (new issues).

Long-Term vs. Short-Term Returns on Equities

Long-term equity investments have historically demonstrated stable and higher returns compared to other asset classes, such as bonds or cash.
However, in the short term, equity investments carry significant risk due to market volatility.
Stock prices can fluctuate drastically, potentially resulting in substantial losses.

How Risky Are Shares?

Investing in shares involves practical considerations and risks:
- How and Where to Buy Shares: Shares of publicly listed companies are traded on stock exchanges, such as the Australian Stock Exchange (ASX). Investors need to contact a broker and establish a trading account.
- Which Shares to Buy: Choosing which shares to buy requires thorough research into companies, understanding market trends, and considering diversification strategies to mitigate risk.

Property Investments

Property investments involve taking out a mortgage or loan to fund the purchase.
Lenders typically require:
- Evidence of sufficient salary/wages to service the loan (including interest and principal payments) and proof that employment is ongoing.
- A stress test using a higher interest rate than the current one to assess the borrower's capability to handle interest rate rises.
- Evidence of a savings discipline history (statements).
- Proof of having the required deposit for the loan.
- A credit check to confirm the absence of default loans.
- A valuation or other evidence that the purchase price reflects the property's value.
A deposit is typically required, typically at least 20% of the purchase price for most mortgage loans.
Mortgage insurance may be required, particularly for loans with a Loan to Valuation Ratio (LVR) exceeding 80%, to protect the lender against loan default.
The borrower pays the mortgage insurance premium, which increases with higher LVRs.
Typically, lenders require property insurance and potentially contents insurance on the mortgaged property.

Stamp Duty

State governments levy land duty, also known as stamp duty, which is roughly proportional to the purchase price. Higher-priced properties incur higher stamp duty.
Duty can be reduced by purchasing land and then building on it, as only the land incurs duty.
Specific duty reductions apply to first-home buyers and properties purchased "off the plan" (before construction is complete).

Alternative Home Loans

Several alternative home loan options are available, including:
- Fixed rate mortgages: Offer a fixed interest rate for a specified period, providing interest rate certainty.
- Interest only mortgages: Only require interest payments on the loan, leaving the principal untouched.
- Mortgage offset accounts: Everyday bank accounts linked to a home loan, where savings and salary deposits offset the outstanding loan amount, reducing interest charges and generating potential tax savings.
- Low-start loans: Offer lower initial interest rates, which gradually increase over time.
- Capital indexed loans: Interest rates increase as inflation rises, potentially offering lower initial interest rates.
- Cocktail loans: Combine fixed and variable interest rates, offering flexibility and potential cost savings.

Rent vs. Buy

Purchasing a property means paying a mortgage and eventually owning the property.
Renting allows the difference between rent payments and a potential mortgage payment to be invested in an investment portfolio or superannuation.
The required deposit size for a property purchase significantly impacts the outcome.
The decision to buy often requires a savings discipline, whereas renting does not.

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Description

This quiz covers the concepts of conflict of interest and the Statement of Advice (SoA) in financial planning. It highlights the importance of prioritizing client interests and the need for transparency in financial advisory roles. Test your knowledge on ethical practices and documentation in financial advice.