5QQMN532
Asset Management
Tutorial 2
Practical applications of structuring portfolios for different clients
Question 1:
Case studies of investor types and their preferences
You are an investment advisor with three new private clients. You can use the template included below. You are provided with the information shown below and need to:
a) Formulate the investment objectives and constraints for each client.
b) Recommend which asset classes and investment strategy are most appropriate to each client
c) Outline further questions you would need answered before you could arrive at a final strategy for each client
Client 1
Has £300,000 to place under management. He has no other significant assets except for the house he lives in (he has already repaid the mortgage). The client is two years away from retirement and does not have a pension.
Client 2
Has US$3 million to invest and lives in Grand Cayman. He has homes in the US, UK and Switzerland and a sizeable income from a laundry business. He wishes to take advantage of investing in alternative instruments and gain exposure to international markets.
Client 3
Is an equity trader in a major financial center with US$10,000 a month to invest. Has no job security and is unlikely to be in one job long enough to accumulate a significant company pension. Has strong views on investment but is constrained by the compliance department of his employer on his choice of investments.
Suggested framework for organising the answer in Question 1 for each client:
RETURN
|
RISK
|
|
TIME HORIZON
|
|
LIQUIDITY
|
|
LEGAL
|
|
TAX
|
|
UNIQUE NEEDS
|
|
INVESTMENT STRATEGY
|
QUESTIONS
Question 2
If the returns from two assets are:
|
|
Year 1
|
Year 2
|
Year 3
|
|
Asset A
|
+5%
|
+12%
|
-8%
|
|
Asset B
|
+6%
|
+5%
|
+1%
|
Calculate the
a) the covariance between the two assets’ returns and
b) the correlation between the two assets’ returns
Assume the data shown are the population data.
Question 3
A portfolio is 70% invested in an index fund and 30% in a risk-free asset. The index fund has a standard deviation of returns of 15%. Calculate the standard deviation for the total portfolio returns.
Question 4
You are a wealth manager. One of your clients has $10 million invested in long-term corporate bonds. This bond portfolio’s expected annual rate of return is 9%, and the annual standard deviation is 10%.
You try to persuade your client to invest in an index fund that closely tracks the Standard & Poor’s 500 Index. The index has an expected return of 14%, and its standard deviation is 16%.
a) Suppose your client invests all her funds in a combination of the index fund and Treasury bills. Can the client improve her expected rate of return without changing the risk of his portfolio? The Treasury bill yield is 6%.
b) Could you do even better by investing equal amounts in the corporate bond portfolio and the index fund? The correlation between the bond portfolio and the index fund is +0.1.
Question 5
A portfolio is entirely invested in two assets, with standard deviations of 10% and 15%, respectively. The correlation between the assets is –1.
What percentage of the portfolio should be invested in each asset to completely eliminate portfolio risk?
Hint: to solve this, you will need to remember the binomial formula (a-b)2 = a2 + b2 – 2ab