Mr. Smith is a foreign investor who has an account with a small Luxembourg bank. He does not pay taxes on his account. He gave a complete management mandate to the bank and wants to judge the performance of the manager. He is using the U.S. dollar as his base currency.

a. He is looking at the two most recent valuation monthly reports, which are given in Exhibit A, and wonders how to compute the performance. He reads in the financial press that the MSCI World index has risen by 2 percent this month (in U.S. dollars). Basically, he would like to answer the following questions:

i. What is the total return on his portfolio?

ii. What are the sources of this return; that is, how much is due to capital appreciation, yield, and currency movements?

iii. How good is the manager in selecting securities on the various markets?

You must give him precise, quantified information that will help him to answer these questions. (First, compute the return for each segment of the portfolio and its components, that is, price, yield, and currency; then combine these returns to answer the last two queries.)

b. Mr. Smith is aware that cash flows, as well as movements among the various segments of his portfolio, may obscure his analysis. He tries to compute the performance during the next month where the manager has been more active.

He wants to make sure he understands how a valuation report is constructed before doing his analysis. He gets the following information to prepare his own version of the valuation report:

Cash flow: Mr. Smith added $10,000 to his account.

Transactions: The manager sold the 500 Exxon. The total proceeds of the sale, net of commissions, were $20,000. He bought 400 Pernod-Ricard on the Paris Bourse for a total cost of $30,860.

Income received: A semiannual coupon was paid on the EIB bond for a total receipt of $575. AMAX dividends were $357.

EXHIBIT A 

Account Valuation Reports (explanation)

The valuation report is set up following a standard method:

–  Column 1 describes the security and its quotation currency.

–  Column 2 gives either the number of securities for common stocks or the nominal invested for fixed income.

–  Column 3 gives the market price in local currency. For bonds, this is given in percentage of the nominal (par) value.

–  Column 4 gives the accrued interest as the percentage of the nominal (par) value. Usually, a yen bond with a coupon of, say, 8% will bear an interest of 8/365% per day. This is cumulated in the accrued interest column until the coupon is paid (semiannual, here).

–  Column 5 gives the capital amount in base currency (here, U.S. dollars). It is the market price (column 3), multiplied by the column 2 value, multiplied by the exchange rate.

–  Column 6 gives the amount of accrued interest in base currency. It is the accrued interest in percentage (column 4), multiplied by the column 2 value, multiplied by the exchange rate.

Mr. Smith has no indication of the e< i day of the transactions, and it would be too complicated to break down the month into sub periods, anyway. He therefore decides to make the assumption that even transaction or cash flow occurred just before the end of the month and at the month-end exchange rate. To help him, you should

i. Establish a new valuation report (see Exhibit A),

ii. Discuss the methodology for adjusting for cash movements, and

iii. Analyze the manager's performance.

Transcribed Image Text:

Market Prices on February 28 AMAX 24 Dollar/yen Dollar/euro 0.0047 Hitachi 880 1.05 U.S. stock index Japan stock index TDK 6,000 103 Club Méditerranée 85 97 Pernod-Ricard 72 France stock index 110 Government 6% 92 (accrued interest, 1.55%) EIB 8.5% 93 92 Yen bond index 101 World index 104 98 (accrued interest, 0.62%)