Case Study 1: A JOB AT EAST COAST YACHTS

You recently graduated from university and your job search led you to East Coast Yachts. Because you felt the companys business was seaworthy, you accepted a job offer. The first day on the job, while you are finishing your employment paperwork, Dan Ervin, who works in Finance, stops by to inform you about the companys 401(k) plan.

A 401(k) plan is a retirement plan offered by many companies. Such plans are tax-deferred savings vehicles, meaning that any deposits you make into the plan are deducted from your current pretax income, so no current taxes are paid on the money. For example, assume your salary will be $50,000 per year. If you contribute $3,000 to the 401(k) plan, you will pay taxes on only $47,000 in income. There are also no taxes paid on any capital gains or income while you are invested in the plan, but you do pay taxes when you withdraw money at retirement. As is fairly common, the company also has a 5 percent match. This means that the company will match your contribution up to 5 percent of your salary, but you must contribute to get the match.

The 401(k) plan has several options for investments, most of which are mutual funds. A mutual fund is a portfolio of assets.

East Coast Yachts uses Bledsoe Financial Services as its 401(k) plan administrator. Here are the investment options offered for employees:

Company Stock: One option in the 401(k) plan is stock in East Coast Yachts. The company is currently privately held. However, when you interviewed with the owner, Larissa Warren, she informed you the company was expected to go public in the next three to four years.

2

Bledsoe S&P 500 Index Fund: This mutual fund tracks the S&P 500. Stocks in the fund are weighted exactly the same as the S&P 500. This means the fund return is approximately the return on the S&P 500, minus expenses.

Bledsoe Small-Cap Fund: This fund primarily invests in small-capitalization stocks. As such, the returns of the fund are more volatile. The fund can also invest 10 percent of its assets in companies based outside the United States. This fund charges 1.70 percent in expenses.

Bledsoe Large-Company Stock Fund: This fund invests primarily in large-capitalization stocks of companies based in the United States. The fund is managed by Evan Bledsoe and has outperformed the market in six of the last eight years. The fund charges 1.50 percent in expenses.

Bledsoe Money Market Fund: This fund invests in short-term, highcredit quality debt instruments, which include Treasury bills. As such, the return on the money market fund is only slightly higher than the return on Treasury bills.

Required:

a) Critically analyse the 5 different ways of aforementioned investment (Company Stock , Bledsoe S&P 500 Index Fund, Bledsoe Small-Cap Fund, Bledsoe Large-Company Stock Fund , Bledsoe Money Market Fund ).

b) Explain the presence of each type of systematic and unsystematic risks in the mutual funds with reference to portfolio management. c)Elaborate how would each risk factor identified be managed?