1. You are P. J. Walter, CFA, a managing partner of a prestigious investment counseling firm that specializes in individual rather than institutional accounts. The firm has developed a national reputation for its ability to blend modern portfolio theory and traditional portfolio methods. You have written a number of articles on portfolio management. You are an authority on the subject of establishing investment policies and programs for individual clients, tailored to their particular circumstances and needs.
Dr. and Mrs. A. J. Mason have been referred to your firm and to you in particular. At your first meeting on June 2, 2012, Dr. Mason explained that he is an electrical engineer and long-time professor at the Essex Institute. He is also an inventor, and, after 30 years of teaching, the rights to one of his patented inventions, the "inverse thermothrocle valve," have just been acquired by a new electronics company, ACS, Inc.
In anticipation of the potential value of his invention, Dr. Mason had followed his accountant's advice and established a private corporation, wholly owned by the Masons, to hold the title to the inverse thermothrocle valve patent. It was this corporation that ACS acquired from the Masons for $1 million in cash, payable at the closing on June 7, 2012. In addition, ACS has agreed to pay royalties to Dr. Mason or his heirs based on its sales of systems that utilize the inverse thermothrocle valve.
Since ACS has no operating record, it is difficult for either the company or Dr. Mason to forecast future sales and royalties. While all parties are optimistic about prospects for success, they are also mindful of the risks associated with any new firm, especially those exposed to the technological obsolescence of the electronics industry. The management of ACS has indicated to Dr. Mason that he might expect royalties of as much as $100,000 in the first year of production and maximum royalties of as much as $500,000 annually thereafter.
During your counseling meeting, Mrs. Mason expressed concern for the proper investment of the $1,000,000 initial payment. She pointed out that Dr. Mason has invested all of their savings in his inventions. Thus, they will have only their Social Security retirement benefits and a small pension from the Essex Institute to provide for their retirement. Dr. Mason will be 65 in 2016. His salary from the Essex Institute is $55,000 per year. Additionally, he expects to continue earning $10,000 to $25,000 annually from consulting and speaking engagements.
The Masons have two daughters and a son, all of whom are married and have families of their own. Dr. and Mrs. Mason are interested in helping with the education of their grandchildren and have provided in their wills for their estate to be divided among their children and grandchildren.
In the event that the royalty payments from ACS meet the projections cited above, Mrs. Mason is interested in providing a scholarship fund in the name of Dr. Mason for the benefit of enterprising young engineers attending the Essex Institute. The scholarship fund ranks third behind the provision for the Masons' retirement and for the education of their grandchildren.
In your discussions with Dr. and Mrs. Mason, you have stressed the importance of identifying investment objectives and constraints and having an appropriate investment policy. Identify and describe an appropriate set of investment objectives and investment constraints for Dr. and Mrs. Mason, and prepare a comprehensive investment policy statement based on these investment objectives and constraints.