Investment Management Assignment -
PARAGRAPH QUESTIONS - Answer the following questions:
Question 1 - Read the scenario below and answer the questions that follow:
Your friend just started a job at ACC Investments. On her first day she attends a seminar on retirement planning organised by her employer for all new employees. She is told by the Head of Human Resources (HR) that all employees must invest 25% of their pension contribution into one of the company funds.
The Head of HR demonstrates to the new employees how the pension fund portfolio would look after the split. He also mentions that the correlation between the two funds is -0.5.
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Table 1
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Fund Name
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Weight
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Standard deviation
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Return
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ACC commodities
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25%
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27%
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35%
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Other assets
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75%
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16%
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20%
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During the seminar, your friend wants to know what she must base her choice of fund on. The HR manger responds by saying that an adviser is available who can explain the investment process to her, but for now to choose one of the funds.
1. Calculate the portfolio return using the information in Table 1. Show all formulae, calculations and steps in answering this question. Round off the answer to two decimal places.
2. Calculate the portfolio risk using the information in Table 1. Show all formulae, calculations and steps in answering this question. Round off the answer to two decimal places.
3. Discuss what goes into the planning step of the investment management process and how this would have been helpful to your friend in choosing the funds that go into her pension portfolio.
Question 2 - Read the continuation of the scenario below and answer the questions that follow:
After the lunch break the Head of HR continues to discuss the fund options at ACC Investments. He describes them as having a return above the risk-free rate of 5%, and highlighted that the market return in 13%. He lists the funds and some of their characteristics in Table 2 below:
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Table 2
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Fund
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Beta
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Forecasted return
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ACC Property Fund
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0.8
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12%
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ACC Mining Fund
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1.87
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16%
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ACC Tracker Fund
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1
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13%
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This is the first time your friend has ever heard about a beta and she is wondering what it indicates.
1. Explain to your friend what the beta of each portfolio means.
2. Calculate the required rate of return for the ACC Property Fund, ACC Mining Fund and the ACC Tracker Fund. Show all formulae, calculations and steps in answering this question. Round the answer off to two decimal places.
3. Given the forecasted returns and the required rate of return for each portfolio calculated in the previous question, recommend the trading strategy for each portfolio. Motivate your answer.
Question 3 - Read the scenario below and answer the questions that follow:
After 30 years, your friend is going to retire from ACC Investments. During her career, she has accumulated a large number of ACC Investment shares through the share-based grant compensation. She expects to have accumulated just over one million shares, which are currently valued at R20 million at retirement. ACC Investments shares do not pay a dividend.
On retirement your friend wants to achieve the following objectives with regard to her ACC Investments:
- Reduce the risk associated with her wealth concentration
- Defer capital gains taxes
- Retain upside return potential.
She sets a meeting with her financial adviser for advice on how to accomplish these objectives. The financial adviser first notes that your friend's ACC Investments shares have a very low cost basis. Secondly, the jurisdiction in which your friend resides levies capital gains taxes only on the sale or disposal of a security. Therefore, any outright sales of shares would result in significant long-term capital gains, which would be taxed at 30%.
The first strategy that the financial adviser suggests is to buy put options on your friend's ACC Investments shares.
The financial adviser identifies put options on ACC Investments shares that have a strike price of R20.00, one year to expiration, and an option price of R1.95 per ACC Investments share.
1. Explain how each of your friend's three objectives is achieved by the financial adviser's suggested put option strategy.
2. Your friend is not sure if prices will go up or down, but believes the price will change significantly upon retirement. Which option strategy can she use to hedge her position, describe the contracts she would enter into?
Question 4 - Read the continued scenario below and answer the questions that follow:
Your friend is promoted to risk manager at ACC Investments. She is responsible for all derivative transactions. During the course of the week she makes the following transitions:
Transaction one: forward
She sold one 5 000 ounce silver forward contract at $3 per ounce.
Transaction two: SWAP
Your friend wants to reduce the exposure to the townhouse complex held in the property fund; the value of the property is R10 million. She enters into a swap to pay the total return on the property and to receive the total return on the Johannesburg Stock Exchange (JSE) All Share Index minus 10 basis points (bps). Three months later, the return on the property is calculated to have risen by 1% and the JSE All Share Index to have risen by 1.5%.
Transaction three: futures
Your friend purchases a 60 000-tons contract on wheat. The futures price on the wheat is R3 500 per ton upon initiation of the contract; she will receive a maintenance call if the value falls by 9%. Three days later the futures price falls to R3 250 after remaining unchanged for the first two days. The contract requires a 10% initial margin.
1. What would the profit (loss) for transaction one be upon maturity if the silver spot price at that time is $4.10 per ounce?
2. What would the net cash outflow/inflow for transaction two be?
3. Calculate the margin requirement for transaction three.
4. The account is marked-to-market daily, will she receive a call to maintain the margin on day three?
Question 5 - Read the scenario below and answer the questions that follow.
A portfolio manager of ACC Property Fund, has been instructed by the investment committee to consider expanding the investment universe of the fund. He is considering diversifying into alternative investments.
To prepare his report for the investment committee, he needs to highlight the conceptual characteristics of alternative investments.
Your friend also wants to diversify her current equity portfolio using alternative investments to achieve the following goals:
- Hedge inflation exposure
- Increase exposure to unlisted equity
- Increase alpha of the portfolio.
1. Explain four characteristics of alternative investments.
2. Which alternative instruments will your friend use to achieve her goals? Motivate your answer.