Mary and Nick Stalcheck have an investment portfolio containing 4 vehicles. It was developed to provide them with a balance between current income and capital appreciation. Rather than acquire mutual funds shares or diversify within a given class of investment vehicle, they developed their portfolio with the idea of diversifying across various types of vehicles. The portfolio currently contains common stock, industrial bonds, mutual fund shares, and options. They acquired each of these vehicles during the past 3 years, and they plan to invest in other vehicles sometime in the future.
Currently, the Stalchecks are interested in measuring the return on their investment and assessing how well they have done relative to the market. They hope that the return earned over the past calendar year in excess of what they would have earned by investing in a portfolio consisting of the S & P 500 Stock Composite Index. Their research has indicated the the risk-free rate was 7.2 % and that the (before-tax) return on the S & P 500 was 10.1% during the past year. With the aid of a friend, they have been able to estimate the beta of their portfolio, which was 1.20. in their analysis, they have planned to ignore taxes, because they feel their earnings have been adequately sheltered. Because they did not make any portfolio transactions during the past year, all the Stalchecks investments have been held more than 12 months and they would have to consider only unrealized capital gains, if any. To make the necessary calculations, the Stalchecks have gathered the following information on each of the 4 vehicles in the portfolio.
Common Stock. They own 400 share KJ Enterprises common stock. KJ is a diversified manufacturer of metal pipe and is known for its unbroken stream of dividends. Over the past years, it has entered new markets and, as a result, has offered moderated capital appreciation potential. Share price has risen from $17.25 at the start of the last calendar year to $ 18.75 at the end of the year, quarterly cash dividends of $0.20, $0.20, $0.25, and $0.25 were paid.
Industrial bonds. The own 8 Cal Industries bonds. The bonds have $1000 par value, have a 9.250% coupon, and are due in 2027. They are A-rated by Moody’s. The bond is quoted at 97.000 at the beginning of the year and ended the calendar year at 96.375%.
Mutual funds. They hold 500 shares in the Holt fund, a balanced, no-load mutual fund. The dividend distributions on the fund during the year consisted of & 0.60 in investment income and $0.50 in capital gains. The fund’s NAV at the beginning of the calendar year was $19.45 and at the end of the at $20.02.
Options. They own 100 options contracts on the stock of a company they follow. The value of these contracts totaled $26,000 at the beginning of the calendar year. At year-end the total value of the options contract was $29,000.
a) Calculate the holding period return on a before-tax basis for each of these four investments.
b) Assuming that the Stalchecks’s ordinary income is currently being taxed at a combined (federal and state) tax rate of 38% and that they would pay a 15% capital gains tax on dividends and capital gains for holding periods longer than 121 months, determine the after-tax HPR for each of their four investments.
c) Recognizing that all on the Stalchecks investments were unrealized, calculate the before-tax portfolio HPR for their vehicle portfolio during the past calendar year. Evaluate this return relative to its current income and capital gain components.
d) Use the HPR calculated in question c to compute Jensen’s measure (Jensen’s alpha). Use that measure to analyze the performance of the Stalchecks portfolio on a risk- adjusted, market adjusted basis. Comment on your findings. Is it reasonable to use Jensen’s measure to evaluate a four- investment portfolio? Why or why not?
e) on the basis of your analysis in questions a,c, and d, what, if any, recommendtions might you offer the Stalchecks relative to the revision of their portfolio? Explain your recommendations.