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South African Financial Planning

Notes on South African Financial Planning#

1. Principles and Practice of FInancial Planning#

  • FAIS (Financial Advisory and Intermediary Services) Act implemented for more financial stability and market conduct - protecting and treating clients fairly.
  • Better protection from clients from unethical and incompetent operators

Nature of Financial Products and Services#

Intangible - cannot be seen, felt or touched - making it harder to make a decision.

Issues faced in the industry:

  • Financial literacy
  • Lack of confidence in finance industry
  • Information difficult to understand and not highly accessible
  • Lack of transparency
  • Errors of omission, misleading client
  • Difficult for clients to detect misrepresentation
  • Difficult to know the full cost of the product
  • Cannot be tested prior to purchase
  • Client’s future depends on performance, you can’t just return a faulty product
  • No guarantees

Definition Financial Planning#

Guidance to acheive financial and lifestyle goals

FPI (Financial Planning Institute) definition:

Financial planning is the process of developing strategoes to assist clients in managing their financial affairs to meet life and financial goals. The process of financial planning involves reviewing all the relevant aspects of the client’s current situation and comparing them with the client’s desired situation and designing a plan to assist the client on the journey of financial independence

Things ot take into account in creating a plan:

  • Personal factors: age, lifestyle, current portfolio, attitude to risk, financial responsibilities
  • Lifestyle and lifestyle goals
  • Financial objectives - how to achieve those goals
  • Time-frames: short, medium, long

Benefits of Financial Planning#

Clients more likely to achieve desired financial and lifestyle goals. Enchance the growth of assets and give more control over financial affairs. Does not mean guaranteed great wealth.

  • Maintaining a balance of capital and income
  • Protecting against financial risk
  • Maintaining the value and purchasing power of capital
  • Legitamately minimising taxation
  • Acceptable level of investment return
  • Financial independence at retirement
  • Appropriate structure of liabilities and debt reduction
  • security for the family
  • balancing timing of cash outflow and inflow
  • balancing current lifestyle with future lifestyle
  • regular reviews of the financial plan

The industry used to be very sales focussed - the ultimate aim of the meeting was to sell a product. It is important to note that long term the interests of the client must be paramount.

Resistance to Financial Planning#

  • Financial planning is not just purchasing or investing in financial products
  • Clients fail to see importance of monitoring and annual review
  • Clients have mounting debt
  • It is a low priority in their busy and challenging lives
  • Previous negative experiences with financial planners and product suppliers
  • Perception of an industry being sales-driven and not solutions and service-driven

Competencies and skills#

Be professional - continually develop and master competencies and skills

Knowing when you don’t have the skills to advise the client. Do not give advice in an area where you do not have the required experise.

Building Relationships of Trust#

Trust - Firm belief in the reliability or truth of a person

High trust relationships are characterised by character and competence. Character - integrity, motive Competence - capabilities, skills, results

Personal values, ethics and honesty. Good interpersonal skills.

Key principles:

  • Go first - Make the first investment in the relationship
  • Show, don’t tell - demonstrate value
  • Listen for what’s different, not familiar
  • Earn the right to offer advice - listen to the client’s situation
  • Keep asking - Ask a lot of questions, keep silent and listen
  • Say what you mean - Client should hear both good and bad news
  • When you need help, ask for it - ask the client for help in solving a problem
  • Show an interest in the person
  • Use compliments, not flattery
  • Show appreciation

If trust is broken, it can be almost impossible to re-establish

Communication Skills#

Listen effectively, be empathetic and sensitive to client’s position. Communicate in a manner that is easy to understand - use plain language. Clients must feel that their needs and interests are being put first

  • Listen closely to what client is saying
  • Focus on what your client is telling you
  • Do not offer solutions, products or recommendations prematurely
  • Show Interest

Presentation skills#

Speak clearly, be well prepared by confident

Research Skills#

Be up-to-date with regulatory, legal economic and political environment

Use official websites: SARS, FSCA, Prudential Authority, SARB, National treasury or financial intelligence centre.

Report Writing#

  • Consider level of literacy, education and experience of your audience
  • Don’t be too long winded - short and sweet
  • Reason for report in introduction, conclustion based on the query and findings

Relationship with other Professionals#

  • Work with professionals who offer services that you are unable to offer
  • Indentify busineses and indiviudals with the same ethical and service standards

Professional Membership#

To use the CFP mark:

  • Education - Approved courses
  • Examination
  • Experience - 3 Years minimum
  • Ethics - COde of Conduct

Financial Planning Process#

  1. Establish / Define relationship
    • Financial planning process and competencies
    • Determine if FP can meet needs
    • Define scope of engagement
  2. Collection clients Info
    • Personal, financial needs and objectives
    • Collect quantitive information and documents
    • Collect qualitive info
  3. Analyse current financial status
    • Analyse client’s info
    • Assess the client’s objectives needs and priorities
  4. Develop recommendations and present
  5. Implement financial planning recommendations
    • Agree on implementation responsibilities
    • Identify and present products for implementation
  6. Review the client’s situation
    • Agree on responsibilities
    • Review and re-evaluate situation

Step 2: Collecting client information

Identify personal and financial objectives

  • Ask open-ended questions with follow-up.
  • Observe body language
  • Encourage to state specifics ie. to retire financially secure, what does that mean so it can be measured.

Collect quantitivate information

  • Personal details (+ spouse)
  • Contact details
  • Dependent details
  • Business details - earnings and details
  • Bank details
  • assets and liabilities
  • Income and expenses
  • Monthly budget
  • cash available for investment
  • Risk management
  • Health planning
  • Tax planning
  • Retirement planning
  • Estate planning
  • Loan contracts and debt papers


  • id / passport
  • authorisation to allow fp to gather info
  • policy schedules of existing policies
  • investment schedules
  • copy of utility bill
  • copy of salary slip
  • client’s marriage details
  • copy of trust deeds
  • power of attorney (if required)
  • copy of previous wills
  • tax information
  • Relevant agreemnts of contracts
  • Any other financial info

Collect quantitative info

  • Propensity to save
  • Method of arriving at spending decisions
  • Attitude to debt
  • financial experience
  • risk-return of investments
  • tolerance for risk
  • assumptions and rates of return in investments
  • time horizon
  • lifestyle issues
  • health
  • attitude to tacation

Include a statement in the financial plan that the recommendations are based on information provided by the client

Step 3: Analyse and assess the client’s financial status

Agreed assumptions: expected retirement age, life expectancy, income needs, risk factors, time horizons, inflation rates, tax rates and investment returns.

Identify the gap between their current situation and their future goals. If current course is unlikely to result in their stated goals being achieved, recommendations made in the financial plan musdt state why and how the proposed recommendations may assist in meeting their goals.

  • Personal Financial management
    • Current positions: living within means, budget
    • Existing debt and repayment terms
    • Establish whether client has emergency fund - amount
    • Recommend cash management strategies
  • Investment Planning
    • Required rate of return
    • tax effectiveness, risk, conditions, liquidity, impact of inflation, maturity dates, diversification, costs
    • Assets to retain and dispose of
    • Welath creation, income generation and wealth protection
  • Risk Management
    • Capital and income needs in event of death, disability or dread disease
    • Short term insurance (car, house, household contents) needs - may need a short term insurance expert
    • health benefits - refer to specialised healthcare advisor
  • Tax Planning
    • thorough understanding of tax law
  • Retirement planning
    • Educate about importance of retirement planning
    • Pre-retirement, at retirement and post retirement
  • Estate planning
    • Calculate estate duty and taxes
    • Calculation of liquidity - estate duty, executor’s fees, liabilities, bequests, income needs of spouse and dependants
    • Estate planning - estate duty minimisation, investment strategies, spouse transfer strategies, estate pegging strategies
    • Testamentary planning - valid, up-to-date will; distributions of asssets to heirs, fiancial stabilty of spouse and dependants, guardianship and maintenance of children
  • Business Financial planning - if client owns business

Step 4: Develop Recommendations and Present

  • Identify available strategies
  • Develop fiancial planning recommendations
  • Present recommendations to the client

Contents of a Financial Plan * Client details * Executive summary * Client objects, needs and priorities * Client planning assumptions * Financial planning goals * Assets and liabilities * Cash flow management * Risk management * Short term insurance recommendations * Healthcare recommendations * retirement planning recommendations * investment planning recommednations * estate planning recommendations * implementation strategy * Monitoring of financial plan * Future Review Dates

Step 5: Implementing the financial planning recommendations

  • Agree on implemenation responsibilities
  • Identify and present products and services for implementation

Step 6: Review the CLient’s situation

  • Agree on responsibilities and terms of review of cleint’s situation
  • Review and re-evaluate the client’s situation

Circumstances to review a financial plan:

  • Change in marital status
  • New child
  • Loss or change in job
  • an inheritance
  • death
  • a change in responsibilities
  • change in goals or financial objectives
  • changes in legislation
  • Changes in economic/business cycle
  • CHanges in global macro-economic factors
  • political changes
  • introduction of new products and services

Successfully managing a financial service busness#

  • It must be win-win for financial planner and client
  • Provide skills and knowledge
  • REsearch target market
  • Income generation model
  • Compliance
  • Employ the right staff
  • Use technology to advantage
  • Advertise and brand the business

2. Ethics and Professional Standards#

Members of the public lose confidence and trust as well as their hard-earned money, their life-savings. Only strong ethical principles of an individual and industry level will limit unethical behaviour. Ethics - character and personal disposition for choosing right from wrong Morals - societal values held collectively

Simply obeying the laws does not mean you are being ethical. You need to do right by the client.

The importance of ethical behaviour#

Global financial crisis and scandals like Enron, Worldcom, Steinhoff, HSBC money laundering and Valeant Pharmaceuticals have decreased confidence.

Important to follow the FAIS General Code of Conduct (GCC) and the King IV report on corporate governance.

Levels of Ethics#

Personal Ethics#

Right or wrong based on your own principles using approprate self-interest.


Integrity, Responsibility, justice, fairness, forgiveness, generosity, compassion, self-discipline, wisdom, courage, care for all living things and environment


Achievement, power, creativity, wealth, comfort, status, health, service, open-mindedness, meaningful work and challenge

Professional Ethics#

According to the FPSB (Financial planning standards board) these are 4 major trends:

  • Consumer demand
  • Focusing on relationship rather than transactions
  • Regulatory changes
  • Globalisation

Business Ethics

  • Through ethical eadership
  • Creating and maintaining an ethical culture
  • Zero tolerance for unethical behaviour

Ethical Transgressions#

Has alot to do with upbringing, socialisation, culture and society

  • Deception
  • Stealing
  • Harming

Once a lie has been figured out by the client, it is hard for the client to trust you ever again.

Factors Contributing to unethical behaviour#

  • Self-interest - commision, salaries and profit
  • Some do not prioritise ethical behaviour
  • Hard for cleints to assess products and services before making the purchase
  • Inherent power imbalance between client, financial planner and product supplier - complex and difficult to understand increasing reliance on planner

Ethical Traps * Obedience to authority * Conformity Bias * Incrementalism - lowering standards * Groupthink - pressure - making bad decisions * Over-optimism * Over-confidence * Self-serving bias * Framing * Sunk costs - instead of abondoning a deteriorating situation * Intanigible far removed affect

Perception of Unethical behaviour in financial service industry#

Service industry is large: banks, insurance companies, asset management and pension funds.

Ethical Issues in the Financial Services Industry#

Self-serving bias can make it difficult for financial planners to be objective when giving advice as monetary incentives can impact on the judgement of even the most well-intentioned person.

A strong ehtical culture is required.

Tests of Ethical behaviour#

  • Utilitarian principle - greatest good for greatest number of people
  • Kant’s categorical imperitive - acting in a way that is universal law
  • The professinoal ethic - a disinterested panel of professionals would view as proper
  • The platinum rule - treat other people the way they would like to be treated
  • Television / newspaper test - comfotable explaining their actions in a newspaper or on tv
  • Family test - explaining to family members

Code of Ethics and Professional Conduct#

FAIS Act for all Financial Service Providers (FSP)

Act honestly and fairly, and with due skill, care and diligence, in the interest of clients and integrity of the financial servies industry

  • Honesty, fairness, due skill, care, diligence, interests of clients, integrity

Ethical obligations:

  • Trust
  • Confidentiality
  • Adequate disclosure
  • Respect of client
  • Right of client to accessible information
  • Right of client to appropriate knowledge and skills

FPI Code of Ethics and Practice Standards

Eight principles:

  • Client First - Did I act in the ebst interest of the client?
  • Integrity - Am I prepared to read about my actions in tomorrow’s newspaper?
  • Objectivity - Did I not allow emotins to cloud my judgement?
  • Fairness - Have I done what a reasonable person would ahve done? Would I do the same in the future.
  • Competence - Do I have the sufficently updated knowledge to render the best advice?
  • Confidentiality - Did I protect confidential information?
  • Diligence - Have I applied all effort to protect confidential information of the client?
  • Professionalism - Have I inspired trust as a professional and in the industry?

Fiduciary Institute of South Africa

Drafting of wills, administration of trusts and estates, beneficiary funds and estates, tax and financial advice.

Integrity, diligence and public image of the fiduciary profession

CFA Institute

Standards of Professional Conduct * Professionalism * Integrity of capital markets * Duties to clients * Duties to employers * Investment analysis, recommendations and actions * Conflict of Interest * Responsibilities as a CFA member or candidate


Ethical dilemmas may arise and it is important to become aware of small transgressions day to day. For example, you sell a client a financial product that offers a higher rate of commission when you know it carries a high degree of risk and is not appropriate for the client at all or you churn a policy because you need to reach a sales target.

Regulatory Environment#

2008 financial crisis highlighted the cost of poorly regulated and inadequately monitored financial markets. Regulations ro be financially sound: prescribed capital asset requirements, adequate solvency margins and sufficient liquid assets.

Regulatory Background#

Regulation to prevent dangers than arise from financial institutions that are unfair to customers and undermines confidence in the financial system.

Need for Regulation#

  • South African low financial literacy
  • Intangible products
  • Planners have far more knowledge than clients
  • High and opaque fees
  • insufficient access to appropriate and reasonable priced savings
  • sale of products motivated by commissions

Objectives of regulation#

  • Ensure public informed and edcucated
  • Best business practice
  • Stable financial services industry
  • Ensuring economic stability

Twin Peaks Model of Regulation#

National treasury policy to address:

  • A stronger regulatory framework
  • Effective supervision
  • Crisis resolution and systemic institutions
  • International assessment and peer review

4 Priorities:

  • Financial stability
  • Consumer protection and market conduct
  • Expanding access through financial inclusion
  • Combatting financial crime

FSR Act#

The FSR Act has to date not been proclaimed, even though government decided in 2011 to shift to a twin peaks model


  • Financial stability
  • Safety, soundness of financial instituitions
  • Fair treatment and protection of financial customers
  • Efficiency and integrity of financial system
  • preventino of financial crime
  • financial inclusion
  • transformation
  • confidence in finance sector

Financial Stability - South African Reserve Bank

  • Protect the value fo the currency in the interest of balanced and sustainable economic growth
  • Bank regulationa and supervision
  • Issuing banking licencses to banking instituitions and monitoring activities
  • Monetary policy
  • Macro-economic policy
  • Provides liquidity to banks
  • Custodian of cash reserves
  • Issuing of notes and minting coins
  • National payment system
  • Official gold and foreign exchange reserves
  • Administering exchange controls

Financial Stability Oversight Committee

Prudential Authority

Enhance safety and soundness in financial instituitions, market infrastructures and financial stability

FCSA - Financial sector conduct authority

Regulate and supervise the conduct of financial istituitions


No consistent / cohesive legislatin governing them

  • OBS - Ombudsman for Banking Services -
  • Ombudsman for long-term insurance -
  • Ombudsman for short term insurance -

Treating Customers Fairly#

Check the book

Retail Distribution Review#

Check the book

POPI (Protection of Person Information)#

Check the book

Foreign Tax Compliance Act#

Check the book

Financial Advisory and Intermediary Services Act#

FAIS Act with FAIS Ombud. FSP’s must apply for licence Monitoring and enforcement is done by the FCSA (Financial Sector Condict Authority)


  • Financial Service - furnishing of advice and/or rendering an intermediary service
  • Advice - Any recommendation, guidance or proposal in respect of purchase, investment in, transaction, variation, replacement or termination of a financial product.
    • Does not include factual advice about procedure of transaction, description of a financial product, answering administrative questions, objective info or promotional info
    • Exempt: executor, curator, liquidator, trustee (of property), parent / guardian / tutor
  • Intermediary Service - Any act leading to a transaction
    • Achieving a result between a client and a product supplier
    • Must be related to a financial product

Financial product:

  • Shares
  • Debentures and securitised debt
  • Money-market instruments
  • Collective Investment schemes
  • Long / Short term insurance policies
  • Benefit by retirement fund
  • Foreign currency investments
  • Deposits at a bank
  • A Medical Scheme
  • Alternative Investment Fund

Authorisation of FSP’s#

Financial Service Provider (FSP) - any person who furnishes advice and/or renders an intermediary service

No one can act as an FSP unless licensed by the Authority (Financial Sectore Conduct Authority)


  • I - FSP
  • II - Discretinary - Investment decisions on behalf of client
  • IIA - Hedge Fund FSP
  • III - Administrative FSP - Renders on instruction of client
  • IV - Assistance Business FSP

Licence must be displayed

Record Keeping#

Records to be kept for minimum 5 years:

  • cancellationfs of transactions
  • complaints received
  • cases of non-compliance
  • record of all verbal and written communication relating to the financial service

Check the book: a lot more brain numbing content there

5. Anti-money Laundering and Counter terrorist Financing#

FICA - Financial Intelligence Centre Act

Money Laundering#

Anything having the effect of concealing or disguising the nature, source, location, disposition or movement of proceeds of unlawful activities or the interests of anyone in such proceeds

The money laundering process#


Money enters the formal financial system. Eg. properties bought, cash deposited. Large amounts are split into smaller accounts across many bank accounts.


Seperating the funds from the origianl criminal source

  • Drawing money, splitting and sending to other bank accounts
  • Purchasing property and selling it shortly afterwards
  • Depositing money into business and requesting it to be paid into a personal account
  • Moving money Internationally


Integrating the money into the full formal financial system as clean money

Indicators of Money Laundering#

Transaction indicators#
  • Large once off transactions
  • Overseas businesses from higher-risk juristictions
  • Clients lack of concern of expensive charges
  • Stated purpose inconsistent with transaction
  • Payments made by other parties than client
  • Multiple sources of funds
  • overpayment for refund
  • Unexplained transactional patterns
  • Over-invoicing / Under-invoicing
  • mulitple Invoicing
Client Indicators#
  • False personal informations
  • Complex corporate structure
  • Known criminal / associate
  • Large geographic distance between client and provider
  • Refusal / reluctance to say source of funds
  • Concern for secrecy
  • Attempts to avoid regulat record-keeping
  • Use of bearer shares (ownership need not be registered)
  • Use of nominees and trustees

A lot more on this topic in the book

6. Law of Contract and Delict#

Contracts form the agreement, obligations and rights between 2 parties.

Elements of the Contract#

  • Agreement to performance and non-performance
  • Intention of the parties
  • Capacity of contract
  • Legality of the contract - within public policy
  • Formalities

Low of Delict#

Primary source of obligations: the wrongdoer has a personal duty to compensate the victim for the harm done and the person harmed has the right to reparations.

A lot more words in this chapter

7. Personal Financial Management#

An important aspect, often overlooked in favour of risk, investment or retirement planning

Answers whether client is living within their means, whether emergency fund is adequate and what different demands on cash flow are.

Gathering Information#

  • Assets and Liabilities
  • Income and Expenditure

Statement of Assets and Liabilities#


  • Liquid Assets - readily available
    • Cash
    • Money in savings/current account
    • Money market funds
  • Fundamental assets - functional assets
    • houses
    • motor vehicles
    • personal property: furniture, clothing, jewellery
  • Investment assets - acquired to earn a return
    • securities - shares / fixed interest bearing investments
    • cash value of insurance policies
    • fixed deposits
    • unit trusts
    • investment property
    • offshore investments
    • hard assets - art, gold, etc

Important to know who owns the asset Whether the asset is ceded as security Property has a mortgage bond on it Assets are valued at the fair market value


ie. Debt

  • Short Term Liabilities
    • Overdraft
    • Credit Card
    • Loans
  • Long-tem liabilities
    • Mortgage bond on property

At this point recommendations can be made to pay off debt or keep invested

If the interest payable on debt is greater than after-tax investment return then it is advisable to pay off debt

Net Worth = Total Assets - Total Liabilities

Cash Flow Statement#

Income and expenditure - source of income, amount of income and how the income is being used.

Sources of income: salary, rental income, dividends, royalties, interest Expenses: household and personal needs, funding of lifestyle and repayment of debt

A client who is single with no dependants is likely to have a better cash flow and will be able to invest more surplus cash than a family with young dependants

Cash flow is actual, budget is an estimate.


Gives a sense of control, identfies areas of overspending and gives a sense of control

Importance of Budgeting#

  • Encourages involvement
  • responsibility
  • Identified problems and where money is spent
  • Idnetifies priorities
  • Encourages financial responsibility
  • Gives realistic expectations
  • Allows to set time frames for goals

Drawing budget#

Income Expenses Profit/Loss

When there is a cumulative loss you either have to earn more money or reduce expenses Reducing expenses is usually the easiest thing to do

Emergency Fund Planning#

Funds immediately available in the event of an emergency Eliminating the need for certain short term insurance The funds should be invested in a low-risk investment such as a bank or money-market fund. Credit cards, personal loans, overdraft facility should be avoided if possible

Reasons for an Emergency Fund#

  • Loss of Employment
  • Illness / accidence
  • Disability
  • Loss of business
  • loss of income
  • divorce, speration or death of spouse
  • market not conducive to sale of asset

Basic Financial Ratios#

On there own may be less useful but are good in seeing trends

Solvency Ratio#

Net worth to total assets as a percentage. Low solvency for higher levels of debt, high solvency for couples nearing retirement and have paid off debt.

solvency_ratio = net_worth / total_assets * 100

Liquidity Ratio#

Compares liquid assets with current debt. Cash and 12 month cash equivalents vs amount of debt to be repaid within 12 months. Shows how many months of debt can be funded if income increases, a higher liquidity ratio is important to conservative clients:

liquidity_ratio = liquid_assets / current_dent * 100

Savings Ratio#

Level of savings as a percentage of total income. Savings is the amount left over after deducting expenditure from income (use after tax income) and any amounts paid into investments.

savings_ratio = savings / total_income * 100

Debt Service Ratio#

Monthly debt commitments as a percentage of gross monthly income:

monthly_debt_service_ratio = ((annual_debt_commitments / 12) / (annual_gross_income / 12)) * 100

Impacts decisions to increase debt with a big purchase or to stop full time work

Debt Management#

  • Credit - power to buy and borow on trust
  • Debt - something that is owed

Debt can be useful if used sparingly. When buying an item where the price is guarenteed to rise in the future fast than interest on the debt.

Over-indebtedness - Unable to pay credit obligations on time

Important to know if client has unexpected short term debt or it is chronic long-term debt

Reasons for getting into debt:

  • mismanagement of finances
  • undisciplined buying habits
  • poor advice
  • loss of income
  • excessive lifestyle
  • unexpected costs
  • retrenchment
  • unexpected medical expenses

Recommendations and strategies:

  • reduce spending on unnecessary items
  • pay off debt with highest interest rate first
  • transfer expensive debt to lower interest rate
  • debt consolidation - consolidate smaller loans into one large one
  • liquidate investments to pay off debt
  • pay additional amounts into mortgage bond
  • destroy credit cards and use a debit card

Refer a client that is unable to manage debt to a debt counsellor

  • A debt counsellor restructures debt so client still has enough for basic needs and credit gets paid.
  • Creditors must approve repayment plan
  • Avoids cost of going to court and declaring client insolvent
  • During debt counselling creditors cannot take legal action, cannot repossess and client cannot take loans.
  • If none of the methods are effective, the client is declared insolvent and assets will be converted to cash to repay debtors.

Types of Credit#

Maximum Interest Rates

  • Mortgage Agreements - repo_rate * 2.2 + 5% per year
  • Credit facilities / other credit - repo_rate * 2.2 + 10% per year
  • Unsecured credit / developmental credit agreements - repo_rate * 2.2 + 20% per year
  • short term credit transactions - 5% per month
  • incidental credit agreements - 2% per month

The credit provider cannot charge a higher rate (penalty) on overdue payments

Supplier Accounts#

This is telephone, water and electricity accounts where a service/priduct is received and payment is due sme time after that. After 20 days it becomes incidenetal credit at a max of 2% per month

In-store Credit#

  • Read the agreement on credit limit, repayment period, interest rates, changes, fees, terminatino etc
  • Interest free for a few months - the prices in the store have been marked up to cover the delay in receiving the money. Cash paying customer pay the same price, subsidising the credit account customers
  • Best advice is to not buy items on account, rather save and pay cash

Store loans#

  • For fridges and furniture
  • R1000 - R10000
  • Rate: 2 - 7% more than prime rate (very expensive)

Credit cards#


  • Reduce amount of cash required
  • Credit limit
  • No interest for 45 days
  • Medium term budget facility for larger purchases - set of tyres, camera, new fridge or tv
  • Max monthly fee is R50


  • Allows current account to be overdrawn
  • Interst is very high
  • Should be avoided except by small business owner needing to buy supplies for future sales

Personal Loan#

  • Similar to overdraft
  • High interest rates
  • Not linked to bank account
  • Any bank
  • Fixed amount, fixed period, fixed interest rate
  • Up to 3 times gross monthly income
  • Can be used to consolidate debt (pay off higher interest debt)

Revolving Credit#

  • Similar to overdraft
  • High interest rate
  • Up to 5 times gross monthly salary
  • Can draw up to limit again when repayments put balance owing less than 75%

Insurance Policies#

Certain policies like endowments allow clients to borrow against them. This should only be a last resort.

Medium term financing#

  • To buy an expensive item, it is unlikely the client has the savings.
  • Company can repossess the item if monthly payments are not made
  • Interest rates charged can be above prime and chcange when prime changes
  • Fixed interest rates are usally offered at times when interest rates are high and expected to drop. Usually a fixed interest rate should be avoided.
  • In certain circumstances the interest calculated on the capital amount and for the full period of the agreement. The reducing balance method is much cheaper and therefore advisable to use the budget facility on your credit card instead of using hire purchase.

Financing a motor vehicle

  • Usually the second largest purchase a client will unlikely have the money
  • Maximum of 60 months

For client deriving income from vehicle:

  • Not required to pay deposit
  • Asset regarded as belonging to the client, tax dedcuations are based on actual costs (if you use the vehicle for business)
  • Can choose to structure with a residual (balloon) amount of 0 to 40%.
  • Higher residual or more steeply structured the repayments - higher the interestd charges
  • Can reduce repayments in the first year and increase along with car allowance, salart or income
  • Client can request finance on residual amount
  • Another option is financial rental: finance company agrees to buy vehicle back at certain time and price. Benefit is that VAT is charge on repayment not on total value of vehicle.

For client that is not self employed and does not derive income from the vehicle:

  • Required to pay a deposit (Usually 10%)
  • Monthly installments can’t differ by more than 10% one month to next

Settling a finance agreement

  • May be in clients best interest to sell or settle the finance agreement
  • Request a settlement figure from the finance company - informs company of intention to settle
  • Paying the balance owing on the statement is bad because that includes interest for the full period. The settlemtn figure would be less.
  • Don’t just pay the settlement amount as company may treat it as payment advance and reduces your saving

Long-term financing#

The largest purchases usually


Property transfer costs:

  • Transfer duty - transfer of title depends on value of property
  • Conveyancer’s fees
  • Deeds office registry fee
  • Sundries

Bond registration costs:

  • Conveyancer’s fees - get cond registered
  • Deeds office registry fee - registration of mortgage bond
  • Sundries

Mortgage bond costs:

  • Mortgage bond initiation fee
  • Admin fee
  • Homeowners insurance
  • Additional life insurance - a life policy to cover the bond amount

Other costs:

  • Municipal rates and taxes
  • Sectional title levies - levy instead of rates. Cover rates, maintenance costs and upkeep of common areas
  • Service connections - Charge for new connections
  • Service deposits - 3 month depsots for water, electricity and telephones
  • Agents commission - 5 - 7.5%
  • Certificates - electricity and pest control paid by seller
  • VAT - 15%
  • Occupational rent or interest - if you stay early in the house

Mortgage bond finance

  • Granted over a long period of time 20 - 30 years.
  • Limited by gross income, it usually can;t exceed 30% the gross.
  • Varaible rates of interest - when prime changes
  • Fixed interest or capped - usually a slighly higher rate


What info is needed:

  • Size of the bond qualified for
  • Amount of deposit required
  • Best interest rates must be established
  • Establish what costs can be included in bond - bond registration or transfer fees
  • Estimate of repayments

Cost of credit

  • Important to establish how frequent the interest is calculated - annually, half-yearly or quarterly.
  • Establish the effective (or actual rate) interest

Repayment of Debt vs Investing Surplus Funds#

  • Minimum Investment - Any surplus funds should be used to pay off debt
  • Return - If you can get a higher return than the rate on the debt. By paying off a debt incurring interest of 14% the client is effectively earning 14%
  • Tax considerations - Use the after tax comparison
  • Risk - Limited risk of paying off debt
  • Liquidity - Reducing liquid funds at cleint’s disposal
  • Managment - No management or admin costs

The Time Value of Money#

Future Value of a Single Lump Sum#

  • PV - Present Value
  • FV - Future Value
  • PMT - recurring payment
  • Compund Interest factor: (1 + i)^n

The formula for a single capital investment:

FV = PV(1 + i)^n

The direction of Cash Flow#

  • Money that leaves your pocket is negative
  • Money that you receive is positive

A R1000 (PV) investment is a negative amount as it leaves his pocket. The amount he receives on maturity R1331 (FV) is positive

From the point of view of the bank, the R1000 (PV) received is positive and the R1331 (FV) is negative.

Calculating FV where interest is compounded more than once per annum#

  • Divide the nominal rate by the number of times a year the interest is compounded
  • Multiple the term by the number of times interst is compounded

Recurring Payments (Annuities)#

A recurring payment is shortened to PMT

The present value of an annuity. The purchasing power of your money decreases in the future.

The present value applies a formula for measuring the current value of a stream of equal payments at the end of future payments. This is called discounting.

When is the present value of an annuity used? When a court settlement entitles the recipient to R2000 for 30 years. The receiving party opts to receive a single cash payment instead of over time. The present value will be calculated which will be less than the total of future payments because of discounting.

Future Value of an Annuity#

If the payments are made in arrears:

FV = PMT * ((1 + r)^n -1)/r)

if the payments are made in advance:

FV = (1 + r) * PMT * ((1 + r)^n -1)/r)

When we talk about the present value we are talking about the equivalent present day monetary value to a given period stream of payments. So today putting R8919.56 in the bank is equivalent of investing R1500 each year for 10 years. Therefore compounding the present day value will give you the future value.

So this shows 2 ways of calculating the Future value. * Calculate it directly * First calculate the PV and then compound it over the period to get the future value

Present Value of an annuity#

If the payments are made in arrears:

PV = PMT * (1 - (1 + r)^-n / r)

If payments are made in advance:

PV = PMT + PMT * (1 - (1 + r)^(-n-1) / r)

Amortisation and Calculation of Loan installments#

  • Use the reducing balance method.
  • When a loan is repayed it consists of capital repayment and interest charged.
  • The first installment will have a high interest content and low capital repayment amount. This trend to the last installment which has a low interest amount and high capital amount repayment.

You can use numpy functions np.pmt, np.ppmt and np.ipmt to work out the period payments, principal amount and interest amount each.

If the interest rate changes or something else changes during the process

  1. determine the outstanding balance of the loan at that point
  2. treat the outstanding balance as the new loan repayable over the outstanding period and then calcualte the new monthly installments

The Present value of an Escalating Annuity#

  • Annuity increases by a fixed percentage every year
  • This is called the escalation rate

Formula to calculate rate at which pmt is discounted:

(((1 + i/ (1 + e)) - 1) * 100
  • i is the rate
  • e is the escalation rate

resultant rate - rate inclusive of principal amount eg: 12% => 1.12

Use this resultant rate in the calculation of the present value to get the amount

The Future value of an escalting annuity#

  1. Calculate the resultant rate
  2. Calculate the present value
  3. Use compound interest to calculate the future value

Example: Required Escalation rate#

What is the required escalation rate for requirements:

Future value wanted: R33391.75 Years = 10 Payments per year = 1 Rate = 15% per annum First payment = R1000

Step 1

Calculate the present value of R33391.75

In [19]: np.pv(0.15, 10, pmt=0, fv=33391.75)
Out[19]: -8253.929910644814


Step 2

Calculate the resultant rate:

In [21]: np.rate(10, -1000, 8253.93, 0, when=1)
Out[21]: 0.04545455285667707

Step 3

The interest is 15% so we can derive the escalation rate using the formula:

resultant_rate = (((1 + i/ (1 + e)) - 1) * 100


4.5454 = (((1 + 0.15/ (1 + e)) - 1) * 100

0.045454 = (1.15 / 1 + e) - 1

1.045454 = 1.15 / 1 + e

1.045454 + 1.045454e = 1.15

1.045454e = 0.104546

e ~= 0.1000

Therefore each year the amount should increase by 10%

Source: The South African Financial Planning Handbook (2018)

Example: Required amount to invest for given escalation rate#

John needs R50000 in 10 years time. He earns 15% interest. He is willing to escalate his investment by 10% per annum. What is the amount he must invest on the beginning of year 1.

Step 1: Calculate the PV with FV as the base

In [22]: np.pv(0.15, 10, pmt=0, fv=50000)
Out[22]: -12359.235306093293

Step 2: Calculate the resultant rate

resultant_rate = (((1 + i/ (1 + e)) - 1) * 100
resultant_rate = (((1 + 0.15/ (1 + 0.10)) - 1) * 100
resultant_rate = (1.15/1.10 - 1) * 100
resultant_rate = 4.54545454.

Step 3: Determine the first payment

In [25]: np.pmt(0.045454545454, 10, 12359.23, when=1)
Out[25]: -1497.375145921585

Therefore the first annual installment must be R1497.37

Effective Rate of Return#

Compound interest can be referred to as interest on interest

Bank A lets you invest at 15%, interest accumulates once a year. Investing R100 gives you R115 at the end of the year.

The nominal and effective interest rates are the same: 15%

Bank B lets you invest at 15%, interest accumulates monthly. Investing R100 gives you R116.08.

The effective rate is 16.08%, the nominal rate is 15%.

Internal Rate of Return#

Is the discount rate that makes the net present value of all cash flows from a particular project equal to 0. A higher Internal rate of return is more desirable. It can be used to rank and compare several investment prospects.

Step 1: Calculate the cash flow for each period

Remember paying into an investment is negative, getting paid out is positive.

For example:

A client makes an investment of R100000 into QWERTY. He expects the following cash flows over the next 5 years:

year 1: 20000 year 2: 25000 year 3: 24000 year 4: 35000 year 5: 39000

In [3]: np.irr([-100000, 20000, 25000, 24000, 35000, 39000])
Out[3]: 0.11726662568720658

The internal rate of return is 0.1172711.72% which is higher than the 10% desired rate of return.

Net present value#

The present value of future cash flows.

Robert invested different amounts each year and received R700 after 6 years. If the interest rate is 8% what is the net present value of the investment:

year 1: 100 year 2: 150 year 3: 90 year 4: 105 year 5: 20 year 6: 30

In [9]: np.npv(0.08, [-100, -150, -90, -105, -20, -30, 700])
Out[9]: 6.598877828064417


Payments towards capital and interest#

My Viljoen buys a flat and gets a R50000 bond. The bond repayments are R573.35 at the end of each month. The interest rate is 13.35% and the term is 25 years.

Calculate the interest and capital repayments during the first year of repayment:

In [23]: sum(np.ipmt(0.1325/12, range(12), 25 * 12, 50000, when=0))
Out[23]: -6611.8796465517225

In [24]: sum(np.ppmt(0.1325/12, range(12), 25 * 12, 50000, when=0))
Out[24]: -268.3229232057447

Interest paid is R6611.88 Balance paid is R268.32

The total is 573.35 * 12 = 6880.2 == 6611.88 + 268.32 = 6880.2

Remaining balance is: 50000 - 268.32 = R49731.68

Effective after tax rate#

Jansen wins R250000. She purchases a voluntary annuity for 30 years, providing an income of R2350 per month in advance. What is the effective after tax interest rate if the marginal ta rate is 43% and capital portion of the annuity is 40%.

Only 60% is taxable, therefore: 0.6 * 0.43 * 2350 = R606.3

The after tax annuity is: 2350 - 606.3 = 1743.7

Now plug it in to get the rate for a period (in this case a month)

In [45]: rate = np.rate(360, -1743.7, 250000, 0, when=1)
In [48]: rate
Out[48]: 0.006282192846926178

This is the amount of interest for each month. Multiply by 12 to get the annual effective figure:

In [49]: rate * 12
Out[49]: 0.07538631416311414
Calculate rate required#

At what rate should an investor invest R12000 to receive R18000 in 2.5 years if compounded monthly:

In [53]: np.rate(2.5 * 12, 0, -12000, 18000)
Out[53]: 0.013607250893419872

This gives you the monthly rate of interest, we need the interest for the 12 months:

In [54]: np.rate(2.5 * 12, 0, -12000, 18000) * 12
Out[54]: 0.16328701072103846

Therefore the interest needed is 16.32%

Calculate present value (original value)#

Driver bought a second-hand vehicle, after 5 years his total payment to the bank amounted to R104996 including interest at 22% per annum, compounded monthly. What was the original price of the car?

In [56]: np.pv(0.22 / 12, 5 * 12, 1749.94, when=0)
Out[56]: -63360.207591073646
Important when using ppmt and ipmt#

The per variable needs to start at 1 and end at 1 + end period.

So for 24 months == range(1, 25)

Also make sure you be explicit about when=1

9. Risk Management#

Risk - A conidtion where a possibility of adverse deviation from a desired outcome that is expected or hoped for

Important to adress all risks appropriately by minimising and mitigating in a financially viable way


  • Family risk - loss of income, assets through illness, injury, premature death, loss or damage to property
  • Loss of income - most common finnancial risk
  • Business risks - death of key employee
  • Property risk - fire, theft and mischief
  • liability risk - held legally responsible for injury or damage to another
  • investment risk - risk of underlying investment devaluing
  1. Gather info and objectives of client - future goals, families, working conditions, responsibilties, agreements, businesses, liabilities, health and finances
  2. Identify risk management objectives - Write down a risk inventory or all possible risks. Recommednations must be consistent with the overall financial plan.
  3. Analyse and evaluate the risks - class them critical, important and unimportant
  4. Develop a risk management plan

Developing a Risk Management Plan#


  • Risk avoidance - do not participate in the activity (avoid rugby injury by not playing rugby)
  • Risk reduction - decrease chance of risk. Regular exercise and not smoking for health risks. Installation of an alarm and burgalar bars to reduce theft.
  • Risk transfer - Death or loss of an asset can ruin a client or their family financially. Entering into an insurance contract is risk transfer.
  • Risk retention - Choice to carry the risk - accept it and be responsible for it. “Self-insurance” and usually applies to smaller risks.

Types of insurance contracts:

  • Life insurance (long term)
  • disability insurance
  • medical aid / scheme (insurance)
  • motor car insurance (shrot term)
  • short-term housing etc…

Implementing the plan#

Implement and regularly review

10. Principles of Insurance#

Important for financial planners to understand insurance law and llaws governing insurance products and contracts

Insurance - means of transferring financial risk

  • spreading amongst many people
  • shifting from an individual to a group
  • insurer agrees to take over the risk for a premium

Insurance law#

  • public insurance law - statutory (related to loaws and statutes) regulations, insurance tax law, statutory insurance schemes and consumer protection
  • private insurance law - law of insurance intermediaries


  • Common law - Roman-dutch. Development in insurance law by the courts
  • Legislation - Long-term insurance act 52 of 1998, short term insurance act 53 of 1998, FAIS ACt
  • Constitutional bill of rights - Supreme law of South Africa

Insurance Contract#

Elements of the contract * Undertaking of insured to pay a premium * obligation of the insurer to compensate for a loss * the risk being insured against * insurable interest



  • In South Africa it is not legal for the same company to do both types of insurance
  • Must be registered with the FSB


  • Policy holder - person entitled to the policy benefits under the long-term policy
  • Life insured - person whose life, ability or health the policy relates

The policyholder is responsible for the life insured lack of disclosure

Third party

  • cession
  • noting of interest
  • beneficiary of policy
  • insolvency of insurer

Indemnify - secure against Patrimonial - inherited from mother / father

Something is non-patrimonial if it cannot be inherited - ie. death, illness and loss of a limb

Indemnity Insurance#

  • Object must be of a patrimonial nature (can be inherited) - property, liability to third party and loss of occupation
  • Compensation for actual cost of loss - restore to same position ( no profit and no loss)
  • Limited interest (a maximum value)
  • Must be insured at time of loss

Capital insurance#

  • Object must be non-partimonial (cannot be inherited) - loss of limb, death of family member
  • Monetary compensation regardless of financial loss
  • unlimited interest in own or spuses’s life. Limited interest for other family members and debtors.
  • Must exist at time of taking out the contract


  • The amount to be paid is ascertained.
  • a deducation can be made on the “deducation new for old” method
  • Insurance based on replacement (new) value has no deducation
  • Some include an excess clause - the insured bears a proportion of a certain amount of every loss


An insured will not be able to recover more than the indemnity value. IE. if you insure to a max of R1000000, something only worth R800000 you only get R800000.

Double Insurance#

  • Insuring the same interest and same risk with two or more insurers. Not allowed in medical schemes.
  • No advantage to this


A house worth R600000 is insured for R400000.

(value_insured / value_at_risk) * loss_incurred

(160000/200000) * 25000 = 20000

Replacement and repair#

  • Can choose to repair an item
  • insurer cannot change mind


Example: You part your outside your house and a bus collides with it. The bus takes responsibility. On your comprehensive policy, the insurer paid R7500 to you. The right to claim the R7500 from the bus company has been subroged (transferred) to the insurer. The right of subrogation exists between the insurer and insured (not between the insurer and third party)

Insurable interest#

Insurable interest is the object of insurance: whether a physical objet or the financial loss arising from death In capital insurance, the insurable interest msudt be present at the time of start of contract. Example: business partners take out life insurance. If they break up in the future it does not invalidate the the cover held.

In indemnity insurance if an object has been damaged, stolen or sold at the time of the loss it will not be covered.

Beneficiary Nominations#

Beneficiary - person nominated by policy or policyholder to claim the proceeds of the policy. A nominal of proceeds.

Cessation, beneficiaries, revocation of nomination is all in the book

Long-Term Insurance#

Types of policies:

  • Assistance policy - life policy where benefit / amount of premum in return for an annuity does not exceed R10000 (or R30000)
  • Disability policy - contract where benefits are paid on a disability event
  • Fund Policy - contract for the purpose of funding (a medical scheme, provident fund or retirement annuity)
  • Health policy - benefits on a health event
  • Life policy - benefits or annuity in teh case of a life event (life begins, continues, ends)
  • Sinking fund policy - one or more sums of money at a fixed or determinable future date

alot more policy related stuff in the book

Tax rate#
  • taxable income derived from a long-term insurance business is subject to 30%.
  • Company / corporate policyholders are taxed at the corporate rate of 28%.
  • Income from an untaxed policyholder is exempt.

Short-Term Insurance#

Typres of policies:

  • Engineering policy - relating to vehicles, erection of buildings and installation of machinery
  • Gaurantee policy - failure of person to discharge an obligation
  • Liability policy
  • Miscellaneous policy
  • Motor policy
  • Accident and health policy
  • Property policy
  • Transportation policy

Motor Insurance#

  • Road accident fund - legal liability for death or injury caused by the insured motor vehicle
  • Balance of third party - damage to other person’s property
  • Balance of third party, fire and theft - third-party plus damage by fire and theft
  • Comprehensive - Third-party, fire and theft plus accidental loss or damage to insured vehicle

More in the book

11. Healthcare#

  • The first medical scheme was set up by De Beers Consolidated Mines in 1889.
  • As costs increased, medical schemes were only entitle to vary the member’s contributins based on their income and number of dependents.
  • In 1989 the ability to differentiate contribution rates and risk rate was introduced
  • Allowed schemes to cherry-pick
  • In 1993, deregulation went further where minimum benefits were removed, enabling schemes to limit and exclude cover for procedures
  • Medical scheme contributions rose steeply, and growth of members slowed.
  • In 1999, no open medical scheme admitted anyone over 55 years old and all schemes had life-time exclusions for pre-existing conditions
  • In 1999 (Medical Schemes Act 131 of 1998) ended the period of risk rating.
  • NHI (National Helath Insurance) - universal healthcare cover providing the same quality of healthcare regardless of income, social status or residency.


  • National Health Insurance (NHI) - Universal healthcare to both contributors and those who cannot afford to
  • Social Health Insurance (SHI) - Healthcare only to those who can afford to contribute. Private sector provides for contributors, public sector for those that cannot.
  • National Health Service (NHS) - Certain standard of healthcare funded by tax payers at the point of service. State is both purchaser and provider.

Medical Scheme Act 131 of 1998#

Open access or open enrollment

  • Medical schemes have to admit anyone who applies for membership
  • Only protection to poor risks is waiting periods and late joiner penalties

Community Rating

  • All members pay the same contributions
  • Members cannot be made to pay more based on age, sex, state of health or other grounds
  • Only income and number of dependants can be used
  • Younger members subsidise medical expenses of older beneficiaries
  • Late joiner penalties is only protection for late joiners
  • Discounted contributions to certain providers for using certain healthcare providers (eg. Discovery Delta)
  • Scheme can charge different rates for child dependents
  • Claims costs are lower for children hence a lower contribution is requried to provide them with cover

Minimum Benefits * PMB - Prescribed minimum benefits * 300 PMB’s for emergency medical conditions and 27 common chronic conditions * PMB’s should follow the predominant hospital practice * Schemes formulary - Chronic medicine benefits can insist that the members are treated with medicines approved by the scheme * The scheme’s formulary must be made available on request

Demarcation between medical scheme and insurance products#

  • CMS (Council for medical schemes) and the Department of Health do not want insurance products to undermine medical schemes. Ie. Younger, healthier individuals paying cheaper premiums.
  • Medical schemes need the young and healthy to subsidise the old and unhealthy
  • Insurance providers are poorly regulated
  • Discriminate against the elderly (rightly so)
  • Insurance policies make more money available to healthcare suppliers and therefore can sustain higher charges having a negative impact on medical schemes.

Guidelines on key differences:

  • Medical scheme pays a member’s actual medical expenses, Insurance policy pays a benefit that can be unrelated to medical cost
  • Benefit pay out must be inline with sum for policyholder is insured

Policy Benefit provided by medical insurance:

  • premiums according to fiancial risk
  • Discriminate (good discrimination) based on age, sex, health, medical history and smoking status
  • Refuse cover to those they consider too high risk
  • Not bound by minimum benefits
  • Limits on premium increases
  • Can pay a broker up to 20% of premiums. Cannot exceed 22.5% plus vat.
  • Usually sold by listed companies aiming to make a prfit (much like medical schemes)

Still many ongoing cases and acts in parliament

Key Differences between medical scheme and health insurance#
  • Benefits paid - Medical scheeme can pay memeber’s actual medical expenses. Health insurance offers a pre-determined amount of cover for certain health events - must be paid to insured not healthcare provider
  • Period of cover - medical schemes cover is in force as long as member pays contributions. Health care policies offer cover for the term of the poliy
  • Increase in premiums and cover - both increase each health. Health insurance have 12 month policies.
  • Acceptance of cover - medical schemes must admit everyone, life assurers and short-term insurers can refuse cover.
  • Risk rating - Medical schemes cannot risk rate members, health insurers can risk rate individuals.
  • Commission and fees - Medical sceheme may pay a broker only 3% of contributins up to a maximum of R90 + VAT a month
  • A broker can earn up to 20% of premiums on a short-term insurance policy, Fees may not exceed 22.5% plus VAT.
  • Profit and governance - Medical schemes cannot make a profit that can be distributed to external parties. Insurers are listed companies looking to make a profit: spending 60 - 65% on claims, 12 - 18% on admin and 15 - 20% on commission.

Regulators, Scheme Rules, Membership Requirements, Benefit Options, Miscellaneous Scheme Issues, Current and Future Developments, Choosing a Medical Scheme#

alot of content in the book

Choosing a Medical Scheme#

Step 1: Compile a list of medical schemes**#

  • Membership scheme size - bigger is often better, economies of scale, bargaining power
  • Membership growth - schemes need to attract younger members. Reduction in members shows unhappiness.
  • Solvency ratio - 25% of gross contributions
  • Operating profit/loss
  • Increases - a scheme with a higher than average increase may be in financial difficulty
  • Claims ratio - amount of contributions spent on healthcare expenses. No healthcare expenses should be limited to 10% of contributions.
  • Credit Rating
  • Service levels - ask how quickly claims are paid, ask others of experience and ask healthcare providers

Step 2: Establish client’s needs#

See what a member has spent on in the last 5 years A member is more likely to need expensive benefits as they get older and increase number of dependants

  • hospitalisation - back operation or childbirth
  • specific conditions - diabetes or heart conditions
  • specialised dentistry
  • optical benefits

Step 3: Matching needs to benefits offered#

  1. Medical benefits offered - savings account - how much and whether enough to cover. In network? where are they located
  2. Annual limits and sub-limits - unlimited, or limited to a rand value or number of visits. Watch out for combinations: consultations with gp and specialists, basic and advanced dentistry and pariology and pathology. Check transplant and chemotherapy. Limits and exclusions.
  3. Rate at which benefits are covered - Reference Price List (RPL)
  4. Co-payments or levies - Co payments for specialists or certain procedures not in the PMB.
  5. Restirctions on access - certaino doctors, particular hospital groups, certain pharmacies, list of medical formularies.

Step 4: Check Cost and review choices#

Check for late joiner peanlty: over the age of 35, has not been a memvber of another medical scheme or has lapsed payment for 3 months.

If employer pays subsidy - remember to deduct that subsidy from the overall contribution and establish if any portion of the subsidy is taxed.

Is the member prepared to pay the contributions for the benefits offered? If not prepared, the levle of cover will need to be cut back.

12. Introduction to Investment Planning#

Important to evaluate investment decisions, investment performance and investment managers. Know how clients behave under certain circumsdtances especially in a dramatic decline in market prices.

Investment - current commitment of money for a period of time to derive future benefits.

Compensate fot:

  • postponed consumption - time value of money
  • rate of inflation - maintain purchasing power
  • Unvertainty - risk (higher risk should be given a higher reward)

Real vs Financial Assets#

Financial Assets - Equities, bonds, cash, derivatives and certain types of property Real assets - tangible such as physical property, commodities and collectibles.

Asset Classes#

Group of securities that exhibit similar characteristics

  • cash - liquid, low-risk investment can easily be converted to cash (money market)
  • bonds - debt in an entity
  • shares - ownership in a company
  • property - physical property, real estate and real estate invest trusts (REIT)

Investment Process#

  • Porfolio is a collectoin of investment assets
  • asset allocation - choice among asset classes
  • Over the long term - asset allocation is the most important decision an investor makes
  • saving - income not spent that can be added to your portfolio
  • Top down portfolio construction - starts with asset allocation

Since 1900:

  • South African equity has returned better than 12% per year
  • South African bonds 6.8%
  • Cash has returned 6%

This gives a real return of

  • Equity: 7.3% - R1 invested is worth R3671.7
  • Bonds: 1.8% - R1 invested is worth R7.78
  • Cash: 1% - R1 is worth R3.14

Stocks are far riskier with annual returns as low as -30% and as high as 104%. In contract government issued treasury bills are risk-free (essentially) as you know the interest rate you will earn when you buy them.

Important to look at how fees would have affected these returns.

Security analysis is the valuation on particular securities in a portfolio

  • Valuation is far more difficult for shares - depends on situation of individual firm
  • Bottom up construction
  • May cause hevy represenation on a certain industry

It is often the case that it is not the plan that fails to client but the client that fails the plan

Monitoring, adjusting and knowing you client’s attitude to risk is an essential part of the financial planner’s task

  • There are so many investment products it is difficult for clients to choose.
  • Financial planner is focused on the client
  • Asset managers are focused on security analysis and funds

It is now called wealth management where both tasks are undertaken together.

Beware of conflict of interest, especially if the owner of the asset management company is given you financial planning advice. They will usually put you in funds and positions that make them the most profit.

Wealth management process:

  • client goals
  • risk tolerance
  • behavioural biases
  • client constraints
  • life balance sheet
  • tax profile
  • market expectations
  1. Advisor Review
  2. Client Review
  3. Portolfio monitoring - rebalance, market review, performance evaluationa nd measurement
  4. Portfolio management
  5. Comprehensive investment policy
  6. Data gathering and analysis
  7. Client relationship and education

13. Investment Return and Risk#

Actual investment returns can rarely be predicted, let alone gauranteed

  • Investors want the highest expected returns with the lowest possible risk
  • Time value of money, inflation and risk play a role in determining the required rate of return.
  • Important to know the willingness and capacity for investors to take risk (take a big loss)

Measuring investment returns#

The headline return is misleading. It does not reflect the risk taken, impact of inflation, taxes or fees for the investor. A study showed that a 11.24% reported nominal return actually equated to a 5.21% real return.

Performance attribution analysis must be done to determine where the return came from, hwo much risk was taken, how much of the return was through the market versus skill of the portfolio manager.

Risk Free Rate of Return#

Government borrows money by issuing treasury bills and bonds. Treasury bills have the shortest time to maturity, Government can raise taxes or print money (not in South Africa’s case) to pay them.

It is virtually free of any default risk and is a benchmark. A greater return is know an excess return arrising from more risk - the rsk premium

Nominal Rate of Return#

Gross return one earns on an investment without considering the effects of the risk taken, time value of money, inflation or taxes.

Real rate of Return#

Reflects the impact of inflation in purchasing power terms. The RRFR - Real Risk Free Rate accounts for the time value of money assuming no inflation and no investment risk.

real_rate = [(1 + nominal_rate) / (1 + inflation_rate)] - 1

Required Rate of Return#

Most fundemental and relevant rate - important yet diificult to accurately determine.

required_return_rate = real_risk_free_rate + expected_inflation + default_risk_premium + liquidity_premium + maturity_risk_premium

Does not account for risk capacity and risk tolerance

Another way of looking at required rate is the Capital Asset Pricing Model (CAPM) - what is that?

Holding Period Return#

  • Total return for a specified period over which an investment is held
  • Investors prefer this as a percentage on an annualised basis

    HPR = (end_value - begin_value + dividends_received) / begin_value

To caluclate annulised, first calculate HPR then use:

Annual_HPR = [(1 + HPR)^1/n - 1] * 100

Expected Rate of Return#

An estimate

  1. Analyse various expected returns
  2. Analyse the likelihood of various scenarios playing out

    Expected_return = propability_of_return * possible_return

  • Boom - Probability of return: 40% - Possible return: 30%
  • Normal - Probability of return: 20% - Possible return: 15%
  • Recession - Probability of return: 40% - Possible return: -10%

    return = (0.4 * 0.3) + (0.2 * 0.15) + (0.4 * -0.1) return = 0.1188 == 11.88%

Real Return after Tax#

Money market account giving 8.5%, fully taxable at your 45% marginal rate.

real_return = return * (1 - tax_rate)
real_return = 8.5% * (1 - 0.45)
real_return = 4.675%

What before tax rate is needed to get 8.5% return:

8.5% = required_return * (1 - 0.45)
required_return = 8.5% / 0.55
required_return = 15.45%

With 10% on a 5-year fixed deposit and a marginal tax rate of 45% and interest exemption of R23500. The before tax return is R100000.

tax_free_return_percentage = exemption_amount / before_tax_return 
tax_free_return_percentage = 23800 / 100000 =  0.238

# portion of the 10% yield that is taxable
taxable_yield = rate_given - (rate_given * tax_free_percentage)
taxable_yield = 0.1 - (0.1 * 0.238)
taxable_yield = 0.0762
tax_free_yield = 1 - 0.0762 = 0.0238

after_tax_yield = (tax_free_return_percentage * (1 - tax_rate)) + tax_free_return_percentage
after_tax_yield = 0.0762 * (1 - 0.45) + 0.0238
after_tax_yield = 0.06571 == 6.571%

Remember to use the NPV (Net present value) and IRR (Internal rate of return)

Investment Risk#

Risk is uncertainty that an investment will earn its expected rate of return

One way to reduce risk is to diversify across asset classes. This does not eliminate risk but does reduce the risk of losing everything at once

Inflation Risk#

  • Purchasing power risk - risk of an investment losing purchasing power over time.
  • Important when looking at interest rate sensitive securities like bonds
  • A shortcut to calculate the time it takes for purchasing power to half is: 72 / (rate * 100)
  • At 12% inflation: 72/12 = 6 years for purchasing power of capital to half
  • At 6% inflation: 72/6 = 12 years for purchasing power of capital to half
  • Investors with a long-term view: inflation poses as great a threat as stock market volatility. Therefore the portfolio should be more heavily weighted towards equities - even for a more conservative risk profile.
  • Investors with a short-term view: share price volatility poses a greater threat than inflation, therefore a portfolio should be more heavily weighted towards cash and short-term deposits.

  • Interest rate risk - financial and real assets are affected by unexpected or expected changes in interest rate

  • Market risk - Day-to-day fluctuations in an asset’s price also referred to as volatility
  • Business risk - Uncertainty of cash flows caused by the nature of a company
  • Financial risk - uncertainty with how a business finances as investment
  • Liquidity risk - The ability to convert the value of an asset into cash at a value close to its market value. Shares of small cap companies have high liquidity risk as they are thinly traded. As opposed to treasury bills that are very liquid.
  • reinvestment risk - If interest rates rise, investors in short term instruments can profitable reinvest at higher rates and avoid capital value losses associated with longer term investments.However if interest rates fall, short term instrument owners will have to reinvest at lower rates.
  • country risk - political risk
  • currency risk - exchange-rate risk, uncertainty of returns for a foreign currency.
  • Systematic risk - large range of assets - also called market risk or non-diversifiable risk
  • Unsystematic risk - Asset specific - single or small grou pof asset - risk. It is eliminated by diversification.

Measuring Risk#

Standard Deviation#

How far from the expected return the realised return falls under normal circumstances

  • Volatility - amount of uncertainty about the size of changes in a securities value. The price of a securtity with high volatility can change in a relatively short period in either direction.

A standard deviation of 20% around a mean return of 12% essentially means:

  • out of a number of years - About 68% of years, the return will fall within 12% + 1 standard deviation and 12% - 1 standard deviation

The formula is the sum of the difference between the expected return and actual squared, multipled by the probability of that occuring. All of that square rooted.

  • variance is the standard deviation squared.
  • standard deviation is the variance square rooted.

caluclating the standard deviation of returns:

  1. Calculate the mean
  2. determine the square deviations from the mean - giving the variance
  3. square root the variance

Coefficient of Variance#

The ratio of the standard deviation to the means. Useful for comparing the degree of variation from one data series to another even if the means are dramatically different.

coefficient_of_variation = standard_deviation / expected_return

Lower the standard deviation to the means return, the better your risk-return trade-off. The higher the coefficient of variation, the higher the risk.

Beta (Beta Coefficient)#

  • The measure of volatility of a security or portfolio in comparison to the market as a whole.
  • The tendency of a security’s return to respond to swings in the market. A beta of 1 indicates that the security’s price will move with the market.
  • Greater than 1 means the moves are more volatile than the market.
  • Less than 1, means less volatile than the market.
  • For example utility stocks have beta’s of less than 1, but Nasdaq high-text stocks have greater than 1 meaning they give a higher rate of return compared to the market but greater risk on downturns.
  • Portfolios also have Betas and can be used to compare the volatility of a portfolio in comparison to the market - more aggressive or defensive

Sharpe Ratio#

Performance earned in excess of the risk-free return compared to the risk taken. What is the risk free rate? Usually obtained from treasury bills with no default risk

sharpe_ratio = (portfolio_return - risk_free_rate) / std_deviation
  • Clearly, if an investor is taking risk they should anticipate a higher return than they could get in an investment that has no risk
  • Does the additional return earned justify the additional risk taken

Treynor ratio#

Similar to the sharpse ratio but uses the Beta to determine the risk instead of standard deviation

treynor_ratio = (portfolio_return - risk_free_rate) / portfolio_beta
  • Good for comparing the performance of a portfolio against the asset class that the portfolio is drawn from
  • Treynor consider’s only market risk, Sharpe considers all risk

Jenen’s Alpha#

  • The measurement of portfolio manager skill
  • Measured returns and risk
  • The difference in performance that would have been expected from a comparable portfolio
  • A positive value indicates that the fund manager has “beat the market”

A risk-adjusted performance measure that represents the average return on a portfolio over and above that predicted by the capital asset pricing mdoel (CAPM) given the portfolio’s beta and average market return.

jensens_alpha = rate_of_return - [risk_free_rate + beta_of_portfolio(rate_of_return_market - risk_free_rate)]

Risk and the individual investor#

Investor constraints are very important and impact the risk or return objectives.

Investment Constraints#

Time Horizon#
  • When will the client need to draw on his capital.
  • Research shows that while equities are very volatile over short periods, volatility declines with the passage of time.
  • Impacts on the ability and willingness of an investor to tolerate risk
  • Reseach suggest’s that as holding period increases, the risk is reduced.
  • A person who retires at 65 is likely to live for another 15 to 25 years

In Seigel’s research on efficient portfolios (most returns) What is thought-provoking about this is that it suggests that even conservative investors who take a five-year view should be holding 38.7% of their portfolio in shares and a moderate investor 61.6%

Liquidity Requirements#
  • Ability to convert the investment into cash
  • Price or cost at which it can be liquidated
  • It is advisable for a client to have a sum of money available as an emergency fund
  • Specific capital requirements, such as a overseas trip, needs a specific budget and appropriate investment
Tax Considerations#
  • income tax, cpaital gains tax, dividends tax, interest income tax
  • use of tax concessions available
Unique circumstances#
  • religious - avoid tabacco and gambling

Investment Objectives#

Risk Objectives#
  • Risk measurment - Standard deviation or Beta

Risk tolerance is not quantifiable but risk objective’s are:

  • A “Lower than average risk tolernce” may mean a loss of total value not to exceed x% or annual volatility to not exceed y%
  • absolute risk objectives - relating to total returns - at least a real return of 1% over inflation
  • relative risk objectives - not be less than the JSE All Share Index over a 12 month period

Risk tolerance and risk capacity

  • risk tolerance - willingness to take risk, emotional tolerance for volatility, uncertainty and taking a loss
  • risk capacity - abiltiy to take risk, the financial capacity to withstand market losses

If risk tolerance exceeds risk capacity, the lower of the 2 should prevail. * If a client is willing to take more risk but due to the financial circumstances, shouldn’t. * A client can take lots of risk but does not like taking a loss, things should be more conservative.

Return Objectives#
  • How are returns measured? percentage, benchmar, nominal, real, pre-tax, post-tax
  • How much return does an investor want?
  • How much return does the investor need? required return
  • Specific return objectives - 5% after-tax

An investor’s return objective should be consistent with the investor’s risk objective

  • Mandate - set of instructions detailing the investment manager’s task and how his performance will be evaluated
Risk profiling#

There are risk profiling services available * conservative, moderate and aggressive

A financial planner could recommend a multi-manager product such as a wrap fund or structured fund tailored towards a specific risk profile

Conservative Investor#
  • Long term capital preservation
  • Cash: 30%, Bonds: 50%, Equities: 20%
Moderate Investor#
  • Looking for income and growth
  • Less volatile than the market as a whole
  • Cash: 10%, Bonds: 35%, Equities: 55%
Aggressive Investor#
  • High level of growth
  • Willing to endure a measure of uncertainty to achieve the goal
  • cash: 5%, Bonds: 10%, Equities: 85%

It is important to know that a clien’s tolerance for risk is actually lower than the client thinks

13. Investment Theory#

Efficient Market Hypothesis#

  • Thousands searching for price anomalies in the market.
  • Any mispricings are arbitraged out of the market.
  • The price is the reflation of collective wisdom
  • New information is quickly and efficiently taken up in the price
  • Eugene Fama argued that it was impossible to beat the market

Versions of EMH (Efficient Market Hypothesis)#

  • Weak form - share prices already reflect all the information dervied from trading data, prices, volume or short interest
  • Semi-strong form - All info regarding prospects of the firm are already in the price
  • Strong form - All information even internal info is reflected in the price

The result was the birth of index funds

Implications of the EMH for investors#

If you believe in the Efficient market hypothesis:

  • Investor whould split between risk free and market.
  • Instead of worrying about buying the right investment, worry about getting the risk profile right.
  • It is futile to try and beat the market as all info is already known
  • Getting a higher return than market is most probably because of greater risk taking
  • Stuying public information will not allow investors to gain abnormal returns
  • New information would change intrinsic value and be absorbed almost immediately my the market
  • rely on a passive management strategy and pay as little as possible for it - such as an index fund
  • Research suggests that most investment managers do not beat the averages and those who do, tend to do so on an inconsistent basis.

If you don’t belive it:

  • Active managers believe their ability to recognise mispricings give them an advantage
  • Make various kinds of bets
  • Claim better sources of information

Portfolio Selection and Markowitz Diversification#

  • Way to create efficient portfolios
  • The average risk of a portfolio is made up of the covariance of one security to another
  • The important thing is how the investments relate to each other
  • Combining investments that are not perfectly correlated can reduce risk without sacrificing return
  • A practical example: determines the number of shares an investor should hold in a portfolio to ensure that the portfolio is no more risky than the market as a whole
  • You can plot a client indifference curve which represent the investor’s preference for risk and return
  • Then test them against portfolios risk return scatter plot

Allows investor to identify optimal portfolio from an almost infinite number of possible portfolios

  1. Investor specifies a set of securities
  2. The securities are analysed and the expected returns, variances and covariances are found.
  3. The efficient set is determined using the securities selected and assumptions made. The portfolios forming tje efficient set are then calculated.

CAPM - Capital Asset Pricing Model#

  • Developed in 1963 by William Sharpe
  • A practical way to select share portfolios
  • Instead of Markowitz’s co-variance, only the relationship between each security and the dominant factor is used
  • Sharpe argued that the dominant factor was how the market performed as a whole
  • what the hell is the dominant factor?

Capital market line#

Instead of buying a tailor-made portfolio, the investor buys the market in different amounts depending on his appetite for risk.

Sharpe ratio - Reward per unit of risk taken is the difference between market return less risk-free rate of interest divided by the unit of risk taken (standard deviation of the capital market line)

In Capital Asset Pricing Model, all investors hold the same portfolio, with differing amounts of money invested

The idea of creating a portfolio of less risky shares does not find favour with this theory. In direct contrast to the thoughts of Benjamin Graham, the father of value investing and role model of Warren Buffett, who felt that risk could be reduced by the careful analysis and selection of a portfolio of shares.

Securities market line#

  • If market as a whole moves in a particular direction, most shares will move in the same direction but at difference rates.
  • The Beta (B) co-efficient indicates the security’s return changes systematically with changes in the market’s return
  • A beta greater than one indicates that the security has above average risk
  • Expected return:
    • earn at least risk-free rate
    • equities are more risky than risk free investments and should earn an equity premium
    • affected by specific risk of equity
  • If a security earns more than expected from the beta, the excess is called the Alpha (a)
  • The Capital Asset Pricing Model belives risk can be reduced by diversification
  • A stage is reached where risk cannot be reduced anymore within an asset class.
  • Risk left is non-diversifiable or systematic risk
  • The investor receives no reward for taking on diversifiable or non-systematic risk

    return = risk_free_rate + beta * (average_return_equities - risk_free_rate)


  • CAPM is difficult to prove and disprove
  • It assumes an efficient portfolio, the market portfolio
  • Interesting how few portfolio managers are actually able to beat the market
  • Research shows no association between beta and returns
  • Modern portfolio maangement accepts that investors act rationally. In reality most investors get lower returns than the markets they invest in because they react irrationally to political and economic noise
  • Markets are not stable or self-regulating
  • Markets do not follow the normal (gaussian) distribution curve, that is why we have fat tails.
  • It is a theoretical starting point (not a hard and fast model)

Arbitrage Pricing Theory#

  • Main factor affecting return is risk. It is also difficult to prove or disprove empirically.
  • Capital asset pricing model assumes investors are risk averse
  • Assumes:
    • Portfolio should earn risk-free rates of return
    • Depends on how senstive it is to certain factod and the amounts
    • Each share has its own idiosyncratic risk
  • Need a big database and complex statistic analysis

    return = risk_free_return + B1(factor_1) + B2(factor_2) + B3(factor_3)

Random Walk#

  • French Mathematician - Louis Bachelier
  • Probability of prices going up is the same as down
  • Expectation of the speculation is therefore 0

15. Economics#

A study of mankind in the ordinary business of life - Alfred Marshall

  • Price of Food, effects of changes
  • Spending patterns of a nation
  • Money and how it is created
  • Interest rates and the affects on households, business, government and markets
  • Inflation, cause and inflation targets
  • Unemployment, causes and ways to reduce
  • Exchange rate, depreciation against the dollar
  • Some countries and people richer than others


  • Concerned with the economy as a whole
  • Economics growth, price stability, full employment, balance of payments
  • total production, total income, total expenditure, total stock of money, general price level
  • rate of economic growth, inflation rates and unemployment


  • Focuses on individual decision units and their interactions
  • Individuals, households and businesses
  • Transactions
  • Supply and demand
  • Firms trying to maximise profits within boundaries of constraints

Economy and National Accounts#

Basic model of the Economy#

  • It is the flow of goods and services between producers and consumers.
  • Producers sell goods to consumers
  • Consumers pay for goods by selling their labour
  • Producers pay consumers for their labour

Four main sectors in an economy: 1. Households 2. Firms 3. Government 4. Foreign Sector

National Accounts#

Measurements about the state and performance of the economy - done by StatsSA and SARB

Gross Domestic Product (GDP)#
  • Measure of economic activity - all goods and services produced - within that economy in a specific period.
  • Annually or quarterly
  • Nominal GDP - Measured in terms of current prices
  • Real GDP - Takes into account the impact of price variations by measuring GDP at constant prices
  • Most important indicator of the economy
  • Output of foerign owned firms is included, income of locally owned foreign firms (Naspers) are excluded
  • GDP = C (Household spending) + I (Company spending on capital goods) + G (Gov spending) + [X ( Spending by foreigners on SA goods) - M (Spending by South Africans on Imported goods)]
Gross Domestic Expenditure (GDE)#
  • Total value of spending on goods and services within a country
  • Private expenditure + Governement expenditure
  • GDE = GDP - X (Exports) + M (Imports)
  • GDE > GDP = More exports than imoprts
  • GDE < GDP = More imports than exports
  • Balance of payments
Gross National Income#
  • A political term - instead of geographic term of GDP
  • All income by citizens and permanent residents - irrespective of where production occurs
  • GNI = GDP - primary income payments + primary income receipts
  • GNI = GDP - Net primary income

Balance of Payments#

  • Record of transactions between residents of the reporting country and the rest of the world
  • Any period of sustained economic growth leads to an increased demand for imports - causing the balance of accounts going into deficit
  • If inflow of foreign money does not come, interest rates have to rise to attract foreign money to balance the account.
  • Which could increase foreign portfolio inflows causing the rand to appreciate - higher demand for curreny
  • In turn, lowering the level of economic activity in the domestic economy
  • In the 1990’s South Africa was banned from imports from certain countries and therefore ran at a trade surplus. Which hampered the economy. Rapidly growing economies have a negative trade balance - which increases demand for capital goods and imports
  • Insufficient inflow of foreign currency to meet demand for imports accompanies a decline in the value of the currency of the importing country.
  • Foreign direct investment (into plant and machinery) is low compared to foreign financial market investment - which can be moved out on the short term.
  • Withdrawal of short term capital -> leads to a run on a country’s currency -> defending the rand with higher interest rates as opposed to stingent exchange controls making it harder to repatriate money.
  • 5 accounts:
    • current account: exports - imports
    • capital transfer account:
    • financial account: Internation transfers in assets and liabilities
    • unrecorded transactions
    • official reserves account

Supply and Demand#

  • Supply - how much the market can offer. Quantity supplied is what producers will supply at a certain price.
  • Demand - how much is desired by buyers. Quantity desired by buyers at a particular price.
  • Higher price of a good, the more supply by producers.
  • Leads to more revenue and profit.
  • We are talking about intention and means to buy items, people must be willing and able to buy.
  • Higher the price of a good, the lower the demand by buyers.
  • Supply and demand are equal
  • Allocation of goods is at its most efficient
  • Amount of goods supplied is the same as the amount of goods being demanded
  • Real market equilibrium can only ever be reached in theory

excess supply - price is set too high, demanded quantity is much lower so excess supply. excess demand - price is set too low (below equilibrium), too many consumers want the good but producers are not producing the amount demanded. So there is excess demand.

The Business Cycle#

Expansion phase#

  1. economic activity low - current account surplus - demand for imports low
  2. domestic companies export more
  3. domestic money supply increases
  4. increased money supply - interest rates decline
  5. more consumer spending
  6. demand increases producers expand production
  7. higher wages and salaries
  8. increased imports
  9. Increase in prices (inflation) due to increased demand

Contractionary phase#

  1. price of goods less competitive, less demand from abroad
  2. imports rise, exports decrease
  3. balance of payments deficit
  4. money leave the country - supply of money declines
  5. value of rand weakens - imports become more expensive
  6. interest rates rise to attract more foreign money
  7. consumers demand less - prices (inlfation) decreases

Revival phase#

  1. Prices are declining or stable
  2. Weak rand makes S exports attractive
  3. Declining imports and rising exports - trade balance moves to surplus
  4. Increase in supply of money
  5. Reduces interest rates
  6. demand for goods increase
  7. More people employed - wages increase
  8. Inflation begins

Investing in the Business Cycle#

  1. Producers experience strong demand - investors unaware of the potential invest in cash and interest bearing investments which offer attractive yields instead of shares
  2. Strong expansion is taking place - investors react enthusiastically
  3. New entries and expansion causes overcapcity, prices and profits decline - investors become disenchanted - investor’s portfolios are biased to shares and underweight in bonds
  4. No new entries, demand catches up with supply - shares are completely out of favour, investors are underweight shares and overwight bonds and fixed
  5. demand exceeds supply, profits increase - some investors go back into shares others continue to hold cash
  6. Prices rise, increases in profits are reported - invesotrs once again get enthusiastic, unit trust sales boom and interest bearing investments fall out of favour.

Investors that can predit the turning points in business cycle can increase their returns. Predicting such turning points is not easy.

Leading Indicators of Business Cycle#
  • Volume of orders in manufacturing (opinion survey)
  • stocks in relation to demand (opinion survey)
  • Business confidence (opinion survey)
  • leading business cycle indicators of trade partners over 12 months
  • commodity prices in USD for a basket of SA commodities
  • Real M1 money supply (deflated with CPI)
  • Prices of all classes of shares (6 month smoother rate)
  • Residential building plans passed
  • interest rate spread
  • gross operating surplus as percentage of GDP
  • labour productivity
  • job advertisements
  • average hours worked for factory workers (opinion survey)
Coincident indicators#
  • Gross value added at constant prices
  • Vehicle sales at constant prices
  • Production capacity
  • formal non-agricultural employment
  • industrial production index
Lagging Indicators#
  • Unemplyment
  • value of non-residential buildings completed
  • nominal labour cost per unit or production in manufacturing sector
  • cement sales in tons
  • ratio of households use of instalment sales credit
  • prime rate

Fiscal and Monetary Policy#

Fiscal Policy#

  • Government policy on spending and taxation
  • Main instrument is the budget - spending plans and how this spending will be funded

Monetary policy#

  • Measures taken to adjust money supply and the rate of interest in an economy to maintain stable prices, full employment and economic growth

Some economists think: 1. money supply increases -> interest rates will fall 2. lower interest rates -> more investment projects become profitable 3. investment increases 4. increase in GDP

Why observers say a decrease in interest rates is an attempt to increase GDP. Some say that this increases inflation though.

Instruments of monetary policy: repo rate and open market policy - sale or purchase of domestic financial assets (treasury bills and government securities). When it wants to increase money supply it buys government securities on the open market, to persuade market to sell securities the price of bonds have to be raised. To reduce money supply it sells bonds at a cheaper rate than the ruling price - therebuy raising effecive interest rates? How?

Inflation targetting#

Between 3% AND 6%, arguments for:

  • keeping public informed
  • provide an anchor for inflation expectations
  • increased transparency
  • increased accountability
  • increased stability in nominal rates
  • reducing inflation expectatoins
  • reducing degree of money illusion
  • stability in the value of money
Interest Rates#
  • The amount a borrower pays to a lender for the use of the funds borrowed
  • A real interest rate = Nominal interest rate - inflation rate
  • Eg. 15% mortgage rate - 8% annual inflation rate = 7% real interest rate for sake of comparing

Prospects for lower interest rates depend on:

  • maintenance or tightening of discipline in public sector finances
  • slower growth in bank credit extension
  • a stronger national savings effort
  • improvement in current account balance of payments and level of foreign reserves
  • relative strength of the currency compared to other currencies
  • decline in inflation
  • level of inflation and interest rates in other parts of the world
Interest Rate Patterns#
  • Vary based on the riskiness of the investment
  • If demand exceeds supply, interest rates will rise. If supply exceeds demand, interest rates will decline.
  • If government expenditure exceeds revenue, it has to borrow from the private sector to make up the shortfall. The higher the deficit, the greater the borrowings, the greater the interest rate.
  • More investment in equipment and plant will increase demand for long term capital, increasing its interest rate.
  • If interest rates overseas are high, interest rates locally need to be high to attract foreign money.

South African investors may be prepared to hold money overseas at low interest rates if they believe that the value of the rand will decline against that currency.

Investors need to be rewarded for holding investments with different maturity dates. This is the liquidity preference theory


Too much money chasing too few goods

  • Continuous increase in prices

deflation - reduction in supply of credit and decrease in government, personal and investment spending - regarded as negative state of economy.

disinflation - slowing of the rate at which prices increase

Effects of inflation#

  • Distributions effect - redistribute income and wealth from creditors (lenders) to debtors (borrowers), if the real interest rate is negative (inflation > interest rate)
  • Economic effects - encourages speculative activity, discourage saving. Balance of payment problems - SA inflation greater than trading partners
  • Social and political effects - price rises make people unhappy, causes tension and conflict.

Causes of Inflation#

  • Cost-push - A cost of production increase without a corresponding increase in output
  • Demand-pull - Increase in demand for goods and services accomadated by an increased supply of money to buy. Self-perpetuating (increased prices -> increase demand for wages -> increased demand for goods and services -> increased prices)

Consumer price inflation - a basket of consumer goods and services Producer price inflation - measures cost of production. Includes capital and intermediate goods, excludes VAT (included in CPI) and excludes services (45% of CPI)

Why is Inflation Bad?#

  • Losses to savers (interest not enough to compensate for inflation)
  • Losses to people with fixed incomes - purchasing power diminishes over time
  • Losses to tax payers - if slary increases inline with inflation, the higher tax rate means a larger share is taken of your slary.
  • Confusing price signals
  • Reduced attention to productivity - wage negotiations are more focused on compensation for inflation instead of increased productivity and employment.
  • Wastage of time and resources - Prices change very often then people have to focus on changing prices and watching news etc than doing their actual job
  • Heightened tension and docial disruptions

Ill-informed people claim that inflation is not bad. They argue that higher inflation will stimulate economic growth. These claims are false. It is easy and inexpensive to print more money, thereby boosting inflation; even the poorest countries do that. If this were a way to achieve economic prosperity no poor countries would remain on earth.

How to Stop Inflation?#

Freeze all prices - controls symptoms not cause

If inflation too high: 1. SARB raises repo rate 2. Banks raise lending and deposit rates 3. People buy fewer goods on credit 4. less money with shopkeepers 5. less money harder to increase wages 6. Inflation is reduced

Lending rates must be significantly higher than the inflation rate if excessive credit growth is to be prevented

SARB can also use open market operations - buying and selling financial assets on the open market

Exchange Rates#

Exchange rate - price of one currency in terms of another currency

Direct method - amount of local currency to buy a foreign currency Indirect method - amount of foreign currency to but 1 unit of a local currency

There is a selling rate (rate dealer will sell to you) and a buying rate (rate a dealer will buy from you) The difference between these rates is the spread

  • Determined by market forces - supply and demand
  • SARB can intervene in the forex market by supplying dollars when large demand for foreign exchange threatens to disrupt the market
  • The balnce-of-payments is the biggest determinant
  • Non economic factors: political developments and rumours also affect the exchange rate
Spot and Future exchange rates#
  • Spot rate - rate for immediate delivery
  • Forward rate - rate for delivery at a future date
  • The forward price is usually higher or lower than spot
  • Lets importers and exporters cover themselves against the risk of future changes in the spot exchange rate

The effective exchange rate is the weighted average


  • A person is unemployed if he or she desires employment but cannot find a job.
  • Unemployed persons as a percentage of a total number of people willing and able to work
  • Expanded definition includes everyone who desires employment irrespective of whether they are trying or not.


  • Frictional - Workers moving from one job to another
  • Structural - A mismatch between offered jobs and potential worker’s education, skills, expertise and geographic location.
  • Seasonal - farming and tourism may change with the seasons
  • Cyclical - Not enough aggregate demand from the business cycle

Role of Gold#

  • Gold was internationally accepted as the preferred metal to back various currencies
  • On 15 August 1971, Nixon announced the end of the gold standard.

The great recession financial crisis (2008-2009)#

  1. Extension of credit to homeowners that could not affort the credit
  2. Packaged debt sold to other investors
  3. Combining poor investments into a single vehicle made it less risky
  4. Individual defaulted to instituiotions, insittions defaulted to one another

Instituitions no longer trusted individuals and each othe. leading to a liquidity crisis.

Governments and central banks became major shareholders in the big financial instituitions.

Usually the injection of liquidity into the world economies would have caused inflation. Not in this case.

Warning signs of crisis:

  • Asset price inflation
  • Rising leverage and indebtedness
  • Sustained current account deficits
  • Slowing down in the rate of economic growth


This is not in the book but it is an important term…yield

  • Yield is the earnings (or cash flow) generated from an investment over time
  • It is expressed in terms of a percentage of the invested amount / market value of the security

The Money Market#

  • Short-term funds to borrowers from the government and the corporate sector. (short term == not eceeding 12 months)
  • High liquidity, low risk


  • SARB - South African Reserve Bank
  • Corporation for public deposits
  • PIC - Public Investment Corporation
  • IDC - Industrial Development Corporation
  • Land and Agricultural Bank

Money Market Instruments#

  • Treasury Bills - Short term debt issued by government, benchmark indicator of market conditions, used as liquid assets
  • Call deposits - Called back on demand, Interest calculated on a daily balance and paid monthly
  • Notice deposits - Period of notice must be given prior to withdrawal of funds
  • Banker’s acceptance
  • Promissory notes
  • Negotiable certificate of Deposit

Money Market yields#

  • Money market for debt instruments is up to one year
  • Discount instrument - sell at a discount to their face value, make a single payment on maturity and make no interest payments before maturity. The yield percentage is always higher than the discount because yield is a percentage of the purchase value (which is lower than the redemption value)
  • Interest bearing instruments - quoted in nominal terms. In comparing the yield of money market instruments, always convert the yield into an effective annual rate (EAR)

Discount Instruments#

  1. Calculate the yield:

    amount discounted = ( face_value * days_to_maturity * discount_rate ) / 365

  2. Determine the nominal annual yield:

    NAY = ( discounted_amount / purchase_price ) * (365 / days_to_maturity )

  3. Use a financial calcualtor to get the EAR. Assume the investment is continously rolled over for 1 year, the rate stays unchanged.


Treasury bill has a face value of R1000000 with 91 days until maturity at a discount rate of 6%. What is teh Effective Annual Rate.

amount_discounted = (1000000 * 91 * 0.06) / 365
amount_discounted = 14958.90410958904

This is R60000 annual interest apportioned to 91 of 365 days.

The purchase price of the treasury bill is:

purchase_price = 1000000 - amount_discounted
purchase_price = 985041.095890411

The nominal annual yield:

nay = (amount_discounted / purchase_price ) * (365 / 91)
nay = 0.06091116426545029
nay = 6.0911%

The effective annual rate would be compounding over 1 year:

rate = 6.2316%

Interest Bearing Intrument#

Use a financial calculator: nominal to effective

  • Low risk, lower returns
  • Unlikely place for individual participation due to minimum investment criteria
  • Through money market funds investors can invest in codt-effective and convenient way

The Bond Market#

  • Issued by governments, public corporations and companies
  • From 2 to 20 years
  • Offer investor a series of fixed interest payments during its life along with repayment of principal

Capital Market#

The bond market (or capital market) can be issued by the borrower directly to the lender but there is also a secondary market.

Issuers in the Capital Markets#

  • Private sector - companies need funds for long-term investments (issuing shares, corporate bonds, debentures and rights issues)
  • Central Government - Issue long term bonds, considered the safest investment as government can pay off loan with tax it takes from evryone else.
  • Municipalites and public corporations - (Eksdom, public utilities - Rand Water) Finance for long term expansion projects

Role Players#

  • Banks - deposit takers who offer mortgage finance for housing
  • Insurance companies - personal savings as insurance premiums can be used to source funds from the public sector
  • stock exchange - lists new bonds

Types of Bonds#

Coupon Bonds#

  • Issuer to pay the bondholder a fixed sum of money on the maturity of the bond along with constant periodic interest payments
  • Convertible bonds - can convert bonds into shares of teh issuing company
  • Callable bond - Grants issuer the right to repurchase the bond if interest rates decreae
  • Bond with put option grants bondholders the right to sell their bonds back to the issuer at a special put price

Zero-coupon Bonds#

Discount bonds that do not pay periodic interest. Initially sold at a price below par value.

Inflation linked bonds#

  • Pay interest rate that adjusts to keep track with inflation
  • Contracted to vanilla bonds which pay a fixed rate for the lifetime of the bond
  • Yields usually lower compared to vanilla bonds
Tax on inflation linked bonds#
  • Changes in the rate are taxable
  • Coupon payments and the difference between the acquisition cost and the nominal value of a bond is defined as intrest and is taxable for income tax purposes

Risk of Bonds#

  • Interest rate risk - changes in interest rates (interest rates rise, bond values fall)
  • Yield curve risk - yield change by different amounts for bonds with different maturities
  • Call risk - callable bond’s investors may need to reinvest at lower rates (reinvestment risk)
  • Credit risk - creditworthiness of a bon’s issuer will deteriorate, increasing the required return and decreasing the bond’s value
  • Liquidity risk - sell bond lower than market value because of lack of liquidity
  • Inflation risk - increases more than expected
  • Volatility risk - interest rate volatility
  • Sovereign risk - Changes in government attitudes and policies towards payment and serviving of debt

Attributes of a Bond#

  • Principal value (face value, future value, redemption value, nominal value or par value) - Paid to the holder on the maturity date
  • Market value (present value) - present value of all future cash flows of the bond, discounted at the current market rate
  • Coupon rate (coupon yield, nominal yield) - fixed rate of interest the holder will receive each year
  • Term to maturity - period of time until the maturity of bond

Bond Pricing and Yields#

Calcualting the present value of a bond#

  • Determined by current interest rate in country at the time
  • Interest rates may vary above and below the fixed rate of the bond’s lifetime
  • A bond giving 15% coupon rate and current rates decrease to 13% will increase the value of the bond
  • The price of a bond rises as the current market interest rate falls

An investor invests in an Eksdom bond. Par value: R1000000. Coupon rate of 8.5% with a maturity of 5 years. Coupon payments take place at the end of every 6 month period.

  1. Work out the monthly payments:

    1000000 * 8.5% = 85000 85000 / 2 = 42500 (biannual payments)

  2. The rate (discount rate) is 8% / periods: 0.08/2 = 0.04

The future value is 1000000

In [2]: np.pv(0.08/2, 10, 42500, 1000000, 0)                                    
Out[2]: -1020277.2394483876

The investor will therefore pay R1020277 today for an investment with the above amounts

If interest rates went to 9% the value of the bond would be:

In [3]: np.pv(0.09/2, 10, 42500, 1000000, 0)                                    
Out[3]: -980218.2045572248

Bond Yields#

  • price of a bond = expected cash flow and required yield
  • yield of a bond = coupon payments, income from reinvestment of coupons received, capital gains/losses on the market value of the bond

  • Nominal yield - coupon rate

Current yield#
current_yield = annual_yield / market_price

The current yield for a 15 year, 7% coupon bond with a par value of R1000 selling for R769.4:

annual_yield = R1000 * 0.07 = 70

current_yield = 70 / 769.4
current_yield = 9.1%

Only the coupon interest rate is taken into account. Capital gain, loss and time value of money is ignored

Yield to Maturity#

Interest rate that will make the present value of a bond’s remaining cash flows equal to the price

Eg. A 15 year bond with a 7% coupon bond with a maturity value of R1000 and a current value of R769.4

Future value = R1000 Periods = 15 * 2 = 30 Present value = - R769.4 Payment = 7% * R1000 = R70 / 2 = R35

yield to maturity (rate) = ?

In [10]: np.rate(30, 35, -769.4, 1000, 0)
Out[10]: 0.05000103851314496
  • A bond selling at par has a current yield == yield to maturity
  • A bond selling at discount has current yield < yield to maturity
  • A bond selling at a premium has current yield > yield to maturity

Yield Curves#

A plot of yields to maturity

Pure Expectations Theory#
  • Average of short term rates that are expected in the future
  • If short term rates are expected to rise, interest rate yields on longer maturities will be higher than those on short maturities. Yield curve is upward sloping.
  • If short term rates are expected to fall, the longer maturity bonds will offer lower yields. Downward sloping.
Liquidity Preference Theory#
  • Investors require a risk premium for holding longer-term bonds
  • Interest rate risk is greater for longer maturity bonds
Market Segmentation Theory#
  • Investors and borrowers have different preferences for maturity ranges.
  • Supply and demand for different maturity ages affect yield
  • Age of Investor
  • Regulations and policy restrictions

Yield Curve Shapes#

  • Rising yield curve - longer maturities flatten out
  • Declining yield curve - longer maturities flatten out
  • Flat yield curve - equal
  • Humped yield curve - yield on intermediate-term issues are above short-term


  • Term to maturity is the number of years until redmeption
  • Longer the maturity of the bond, the more sensitive it is tochanges in interest rate
  • Duration of a bond compares bonds by measuring their cash flows over a weighted period of time
  • Duration and volatility of a bond increases as teh term to maturity increases
  • A longer term bond will be affected more by an increase in interest rate as the loss of potential income on the ten-year bond will be greater than on the fice year bond.


  • Amount of a bonds price change when interest rates change
  • Sensitivity to change in interest rate

    bond_volatility = percentage_change_price / change_current_interest_rates

Say interest rates go from 10% to 12%. The bond price goes down 20%. Bond volatility = 10.

Bond Price Quotations#

  • The R186 bond was issued at an initial yield of 10.5%.
  • If interest rates are lower than 10.5% in 2026, the government is likely to redeem the bonds and issue stock at a lower rate.
  • Bonds are not quoted in rands and cents, but in terms of intrest rates.
  • The current spot price is 8.74 or 8.74%
  • If yield goes up, price or value of the bond will decline
  • If yield comes down, price or value of the bond will increase.
  • The are not user friendly
  • You need to calculate:
    • yield to maturity
    • clean price - excluding accrued interest
    • interest accrued
    • total price
    • running yield - interest paid on the bonds dividend by the clean price
    • duration of the bond


  • Converting illiquid financial assets (mortages and debtor’s accounts) into negotiable transfer instruments
  • Cash flow is redirected into a negotiable debt instrument
  • Corporate liquidity is usually enhanced and the assets remain on the balance sheet
  • Lending risks: investment, interest rate, liquidity and credit risk are allocated to parties best able to absorb them

Always take tax into account when calculating income from bonds

The Property Market#

  • Property is valuable because it can be used and is relatively scarce
  • They are heterogeneous - differ from each other
  • Not easy to convert into use as a different purpose
  • Illiquid investment

Factord affecting value#

  • Political, social and economic
  • Interest rates - buyers need to raise a mortgage to buy a house
  • Costs involved - transfer duty, conveyancing costs, bond registration costs, estate agent’s commissions

Returns from property#

  • Rental income
  • Increase in capital

If interest rates rise, the property owner can find themselves in a situation where the cost of borrowing rises faster than the rental income received.

A change in yield can have a considerable impact on the value of a property

capitalisation_rate = 100 / rate_of_return

property_value = rental_return_per_annum * capitalisation_rate

Eg. Income from a property per annum is R120000, the rate of return is 10%.

property_value = 120000 * (100/10)

If the rate of return goes to 12%

property_value = 120000 * (100/12)

Therefore capital growth is achieved when current market yield decreases or if the rental income increases.

  • The interest rates affect the market yield
  • If interest rates decline, the value of the property is likely to increase

    capitalisation_rate = (first_year_net_operating_income / purchase_price) * 100

  • The first year’s net operating income is the initial yield

  • If a building is rented below market rentals, the initial yield will be below the capitalisation rate
  • The capitalisation rate is a good tool in comparing properties

Direct Property Investment#

Factors affecting property value:

  • Price relative to similar properties
  • Reputable area - stability
  • developments near property
  • condition - hints at future maintenance costs
  • crime rate
Mortgaging a property#
  • High interest rates dictate that the best investment an individual can make would be to repay the mortgage if they cannot claim mortgage interest as a deduction.
  • Tex deductible is for commercial and industrial buildings
  • Investor may want to maximise borrowing if it is tax deductible but must ensure the outstanding value of the loan does not exceed the value of the property

Individuals who own their own homes should pay off their mortgage over a shorter time

  • Paying off the mortgage is a low risk investment strategy
  • Contrasting that to a bond rate of 10.5% and a marginal tax rate of 35%, paying off a bond is a much better investment.
  • There are no additional fees and VAT on the payments

  • If the increase in housing prices lag behind inflation then it makes a house (and mortgage for it) a bad investment

  • Sometimes the return from rented property may not cover the cost of owning the property
  • Then it is whether rentals will rise or capital gains will compensate for the loss on rentals
Costs of Purchasing Property#
  • Transfer duty is payable unless the property is bought directly from the developer or builder. In that case VAT is charged.
  • Conveyancing fees - 1 to 2% to the price

Getting a bond for R1600000 on a R2000000 house would have the following costs: * Bond registration costs including VAT: R22686 * Bank initiation fee including VAT: R5985 * Post, Petties and FICA: R1200 * Property Transfer Costs: R25650 * Transfer Duty: R60500

You can expect to pay: R117221 in costs

Then to rent the property out there are a few costs: * Estate agent to find tenant: 5% * Management: 10% * Money spent on repairs, rates, levies and insurance

The investment return is calculated by subtracting expenses from total income.


  • Loan Repayment
  • Sectional Title Levy
  • Freehold property Rates
  • Insurance Premiums
  • Allowances for repairs and maintenance (12.5% of monthly rental)


  • Rental of lease agreement
  • Less agent’s colelction fee

Eg. The rental of a R400000 property would need:

Bond repayment: R4128 Levy: R600 Rates: R400 Insurance: R55 Maintenance: R400

Total: R5583

The rent needs to be more than that

Sectional Title#
  • Part owner of the land and common property
  • Complex is controlled by a body corporate
  • Owner of any section of the building is a member of the body corporate
Time Share#
  • Holdiay accomdation
  • Ownership of sectional title units for 1 week of the 52 in a year
  • Demand for particular weeks differ, making some hard to sell.
  • Levies must be adequate to cover costs and major repairs
  • More of a saving on future costs than an investment
Share Block Schemes#
  • Right of occupancy in a specific section of a building in which the invetor owns shares
  • As shares are being purchased the investor would be required to take out a personal loan which may result in higher interest rates
Retirement Villages#
  • Only sell if 75% of holders agree.
  • Income tax exemption for the company involved in residential accomadation
Property Syndications#

TL;DR Stay away

  • Group of investors who pool funds in order to purchase commercial or industrial property
  • Units are sold for R10000
  • A single investor cannot control more than 25%
  • Income is received quarterly
  • Paid out as percentage of rental income based on shareholding
  • Not very liquid investments
  • Large instituitional investors are usually the first to take up desired projects
  • South Africa has been plagued with distrous property syndication schemes
  • Experience has shown that one cannot rely on the opinions of the promoters when assessing the investment of a particular proposal.

Keep in mind:

  • Track record of people
  • who are tenants when are the leases in place
  • actual rentals compared to market
  • location; is it desirable?
  • cash reserves to cover major refurbishment
  • design of building
  • access services and building services are adequate
  • company’s constitution
  • restrictions on transferability
  • who will manage the company
  • Will income cover the cost of borrowing