Behavioural finance emerged as a field of study primarily because of which development?
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Read the guarantee details →Written case practice · 50 marks
Business risk, protection and behavioural choices
Mr Lee, 45, owns a private-business stake valued at HK$20m, a home worth HK$7m subject to a HK$3m mortgage, and HK$8m of liquid investments. Of the liquid portfolio, HK$3m is cash and HK$5m is listed equities; HK$4m of those equities is in a separate listed company in the same industry. He has personally guaranteed a separate HK$5m business loan. Annual family spending and mortgage payments total HK$800,000. He has existing life cover of HK$2m. His spouse depends on his income and they have an eight-year-old child. Assume a full immediate guarantee call for the liquidity stress, no asset-price changes or tax, and no income after the business fails. For a separate simplified insurance calculation, use ten years of family spending of HK$600,000 a year plus the HK$5m guarantee, less existing life cover, without discounting or using investment assets. He refuses to sell his concentrated equity until it recovers to his purchase price.
Write your answers before opening the marking guide. Self-assess this case separately from the MCQ score.
1. Calculate net assets before the contingent guarantee is called. Then calculate liquid assets remaining after a full guarantee call and one year of HK$800,000 outgoings. Explain the limits of the net-asset figure. (10 marks)
Model answer and marking guide
Net assets=20+7+8−3=HK$32m before any guarantee loss. The guarantee is a contingent exposure, not an additional called liability in that first balance-sheet calculation. Liquid assets after the stress=8−5−0.8=HK$2.2m. Much of the apparent wealth is illiquid or correlated with the business; shares could fall during failure, making the stated stress optimistic. Award4 marks for net assets,4 for stressed liquidity and2 for limitations.
2. Explain the concentration and behavioural risks and how the adviser should respond to the purchase-price condition. (15 marks)
Model answer and marking guide
Business equity, salary and the loan guarantee link multiple risks to one source; the same-industry shares further concentrate the liquid portfolio. Refusing to sell solely until the purchase price returns suggests reference dependence, loss aversion or a disposition effect, but holding a loser alone does not prove irrationality. Review forward-looking prospects, liquidity needs and alternatives; explain diversification and a staged risk-reduction plan consistent with the mandate. Do not promise recovery or ignore informed client preferences. Award5 marks for concentration,5 for behavioural analysis and5 for response.
3. Calculate the simplified additional life-cover gap using the specified convention, then explain what must be checked before recommending a policy. (15 marks)
Model answer and marking guide
Required cover=5m+(10×0.6m)=HK$11m; less existing 2m gives an illustrative HK$9m additional gap. Verify policy term, underwriting, exclusions, affordability, beneficiaries and ownership, loan-guarantee terms, inflation/discounting and available assets or other cover. Term protection may address temporary dependency, but the case calculation is not a universal recommendation and an insurance policy does not automatically discharge a business guarantee. Award5 marks for calculation and10 for implementation checks.
4. Outline the spouse/child protection and succession arrangements and the review triggers. (10 marks)
Model answer and marking guide
Review wills, executors, guardianship wishes and appropriate arrangements for a minor, using qualified legal advisers. Align beneficiary and ownership arrangements with family needs and business governance. Consider a trust only after assessing its terms, trustee powers, costs and legal/tax consequences. Review after loan, business, family, income or health changes and as the child approaches independence. Award6 marks for arrangements and4 for review triggers.
