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Description

Task:

You are asked to answer the 5 questions in the proposed case study. The weight of each question is specified in the case study.

This task assesses the following learning outcomes:

· Critically understand advanced theories and principles of Portfolio Management (from Units 1 to 6)

· Explain asset classes and financial instruments (Units 1 to 3)

· Capital Allocation across risky and risk-free portfolios (Unit 4)

· Calculate the Sharpe Ratio (Unit 5)

· Portfolio of two Risky Assets (Unit5)

· The behavioral critique (Unit 6)

Rubrics

Descriptor

9-10

The student demonstrates an excellent understanding of the concepts.

Correct answers are provided for each question.

8-8.9

The student demonstrates a good understanding of the concepts. Correct answers are provided for each question.

7-7.9

The student demonstrates a fair understanding of the concepts. Student identifies formula and correct data. However, the student fails to find the last final answer. Intermediate calculations are correct.

6-6.9

The student demonstrates some, but insufficient understanding of the concepts. Student identifies formula, correct data. Some errors are done in the calculations and the final answer is wrong. Also, for cases in which the answer is correct but not every intermediate calculation is shown.

3-5.9

The student demonstrates insufficient understanding of the concepts. They may mention some relevant ideas or concepts, although the relationship between them is not understood by the student. Student identifies correct data. Intermediate calculations and the final answer are wrong.

1-2.9

The student demonstrates insufficient understanding of the concepts and does not mention any relevant ideas or concepts.

0

The student leaves the question blank or cheats.

INVESTING YOUR OWN PORTFOLIO

You have won the jackpot of a European Lottery with a prize of €30 000. After distributing a portion of the prize to a local charity, you decide that it is a good idea to invest the rest of the prize. However, you are doubtful about which asset class or financial vehicle is more suitable given the current international context.

Bear in mind that you are in your early twenties and that your financial restrictions are negligible. While you are Not a Risk Lover, you feel comfortable with a portfolio with a high risk-reward profile. You seek professional advice and contact two recognized investment advisors.

Investment Advice Summary

You had a virtual meeting with each of advisor and then you summed-up their financial advices as follows:

Advisor 1

Advisor 2

Percentage invested in Bonds

85%

40%

Percentage invested in Equity

15%

60%

Investment Vehicle

Mutual Funds

Exchange Traded Funds (ETF)

Geographic Exposure

European Funds only

Global ETFs

Currency Exposure

Unhedged

80% FX-hedging into your local currency

Liquidity

Low to Moderate

High

Portfolio management style

Active

Passive

Rebalancing Frequency

Every six months

Every two years

1. Asset Allocation Framework:

Based on the summary, which investment advice seems more reasonable for you? Explain your answer.

(10 points)

2. Determinants of the level of interest:

Given that both advisors have recommended you allocate a portion of your portfolio into bonds, you wonder whether the ultra-low interest rates & unprecedented government policies will impact your return prospects. Analyze the effect of the following on the direction of level of interest rates and its impact on the value of bond portfolio: (5 points for each correct; total of 20 points)

a) Businesses become more pessimistic about future demand for their products and decide to reduce their capital spending.

b) Households are induced to save more (or spend less) because of increased uncertainty about their future Social Security benefits.

c) The Central Banks undertake open-market purchases of government securities in order to increase the supply of money.

d) The forward guidance signals that Central banks commit to keep the interest rates low for long (to avoid further market uncertainty and to boost economy).

3. Capital Allocation Line (CAL):

After a few of weeks of deliberation, you made-up your mind and you selected an advisor, who is not any of the advisors that you initially interviewed. In a follow-up email, you learned that most of your portfolio is invested in a risky asset (global megatrends equity ETF) with an expected rate of return of 13% and standard deviation of 19%. The relevant risk-free rate is 2%. (4 points each question; total of 20 points)

a) The strategic asset allocation of your portfolio is 70% in a global equity ETF and 30% in a risk-free money market fund. What is the expected return on your portfolio?

b) Which is the standard deviation of the rate of return on your portfolio?

c) What is the reward-to-volatility ratio (Sharpe ratio) of the global equity ETF? Which is the Sharpe ratio of your portfolio?

d) Imagine that you want to draw a Capital Allocation Line (CAL) with these data, which is the value of its intercept? Which would be its slope?

e) If the risk-free rate were to increase to 5%, what would happen to CAL that you have drawn?

4. Portfolio with Two Risky Assets:

Sometimes you ask yourself if you should have relied on the Advisor #2. You found that Fidelity Investments offers a Passive Investment fund which is invested 40% in a global Bond ETF and 60% in a global Equity ETF. The covariance of both ETF Funds is 0.0069. The table below show the expected return and risk measures for each ETF.

Calculate the expected return and variance of the Passive Investment Fund. (5 points per each correct statistic; total of 10 points)

Expected Rate of Return

Standard Deviation

Global Bond ETF

4.7%

6.1%

Global Equity ETF

15 %

23%

5. Behavioral Finance:

Since you have your own investment portfolio, you became more diligent to get financial market updates on a frequent basis. Also, you follow up the news feed of Warren Buffet, a guru of the stock market. One of his milestone strategies is called Value Investing. (2.5 points per each correct answer; total of 10 points)

a) Do you believe that Buffet is subject to Anchoring when stock picking?

b) Time ago, you read that Warren Buffet suggested to buy stock Biogen (BIIB). Immediately, you called your advisor and insisted that BIIB stock must be in your portfolio. Which behavioral bias explains your reaction?

c) Is the Markowitz portfolio selection model compatible with Behavioral Finance? Explain your answer

d) Does the performance of investors such as Warren Buffet validate a Behavioral Finance approach? Why?

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