John's Inheritance: Part 2

Markus, CFA, preparing to answer a list of queries concerning share valuation. These queries and answers were to serve as the outline for a presentation before a committee of officials from the city of Ipoh. The committee needed guidance on how best to follow the instructions in the will of James John, who had left the city 2,000 shares of CIMB stock, currently valued at approximately RM1,250,000. John's will instructed the city to sell the CIMB shares and set up a diversified stock portfolio that would fund annual grants for youth groups in the city. During the course of Markus's first presentation, Ipoh officials voiced out a great deal of concern about the risks of the stock market, yet John's instructions were quite clear. The city was to invest the money in stocks, not bonds or certificates of deposit (CD), and it could retain only limited amounts of cash for grant-making purposes. Markus has set up a second meeting to discuss risk. He really wants this account, so he will try to strike the right tone and behave reassuringly, but still be realistic. He has been in the business since 1982, so he knows very well that the market has its ups and downs. Assume once again that you are Markus preparing to answer a set of return- and risk-oriented queries that have surfaced as a result of the first presentation.

Question 1

Assess your answer on how do we measure the returns on our portfolio? Markus will answer this question by assuming that an RM1,000,000 portfolio in a given year earns RM30,000 in dividends and either gain or loses RM100,000 in market value. Show his computations. Be prepared to answer a follow-up question about the value of the portfolio after a 5% grant distribution. Markus will also compute John's EAR on his investment in CIMB to illustrate a multiyear perspective. John purchased the CIMB stock for RM 200,000 and held it for three years before he died.

Question 2

CIMB seems to be a great company. Justify your answer why did John require the city to sell the CIMB stocks and reinvest the money in a diversified portfolio?