Question 2 Part A 4 of 9 ou work for AA Pensions Trust, a private pensions organisation - under the National Pensions Regulatory Authority, Ghana. You are preparing to meet a group of individuals who are interested in investing in your personal pension products, As part of the agenda for the meeting, your potential clients have asked for some education on the issues listed below. Write a report that briefly addresses each of the issues below; i. What is the primary goal of portfolio diversification? Briefly discuss the determinants of portfolio risk. ii. As illustrated below, Elton and Gruber (1977) shows that about 80% of the diversifiable risk in a single stock can be eliminated with about 10 securities in the portfolio. 49.2 - Diversifiable risk 23.9- Average annual standard deviation ( 19.2 Nondiversifiable risk 10 20 30 40 1.000 Number of stocks in portfolio a. Distinguish between diversifiable and non-diversifiable risk of a security b. Given the findings of Elton and Gruber, as illustrated above, would you expect individual investors and institutional investors - mutual funds, pension funds, etc. - to hold similar number of securities to achieve optimal diversification? If yes, why? If no, why not? Please clearly justify your answer. iii. What advice would you give to a client who is confused about the concept that in a well-functioning market all assets will have the same reward to risk ratio? Your answer should cover the following issues: a. How would we expect that all assets have the same reward to risk ratio? b. How can an investor increase his/her returns if this holds true? (70 marks) Professor White, having reached the statutory retirement age, has retired and has been paid been paid his lump sum benefit of C200.000. The professor has no immediate need for the amount received and he is considering investing the amount in KK Motors Lid, one of the top-performing stocks on the Ghana Stock Exchange. The stock under consideration has an expected return of 20% and a volatility of 12%. Suppose the risk-free rate is 15%, and the market portfolio has an expected return of 25% and a volatility of 18%. Illustrate numerically that given the market portfolio and the risk-free rate, an investment in the shares of KK Motors is not an efficient investment because: a. A combination of the risk free rate and the market portfolio will yield the same return as the investment in the stock of KK Motors Lid, but with a lower risk. b. At combination of the risk free rate and the market portfolio offers the same level risk as the investment in the stock of KK. Motors Lid, but with a higher expected return. (30 marks) Total: [100 marks]6 of 9 "3 The following table provides information relating to two recently issued corporate bonds by Eden Properties ple and Mozay Finance Lid. Both bonds were issued at par. Characteristic Eden Properties Mozay Finance Maturity 2030 2040 Issue size 6500 million C100 million Coupon 15% 18% Call provisions Noncallable Callable after 5 years Optional early Put provisions None retirement by bondholder Collateral Mortgaged on Assets None Bonds will be listed Bonds will not be Trading for trading listed for trading Bond rating A From the information in the table above, identify and discuss features of the two bonds that might explain the lower coupon on the bond issued by Eden Properties, (40marks) Part B Your client is considering one of the two corporate bonds given below, Both bonds pay semi-annual coupons and are currently trading at the same price of C102 35. Characteristic Bond A Bond B Market price C102.35 $102.35 Maturity 2025 2025 Coupon 15% 18% Yield to maturity 10% 3% Macaulay Duration 4.1 years 3.9 years Callable after 18 Call Features Noncallable months at $105,00 i. Using the information in the table above, estimate the percentage price change and the new price for both bonds if the yield falls by 50 basis points. Him: % Change in Bond Price & - Dun XAr ii. Briefly discuss why the actual price changes in the two bonds might differ from your estimates calculated in (i) above if the yields actually fall by 50 basis points. In each case indicate whether the actual price will be higher or lower than the estimated price and why, (Credit will be given for graphical illustration of concepts) (40marks)7 Part C As the Chief Investment Officer of a major Investment Company with a large active bond portfolio, you are considering the sale of one of the two corporate bonds in each of the two sets below in order to rebalance the bond portfolio. You anticipate that yields on corporate bonds would increase, given the possible recent default of Edendale. Which bond would you recommend for sale in each of the two sets? Provide appropriate justification for the recommended bond. Coupon Yield to Set Bond Maturity Rate Maturity CB Al 8.0% 10 years 10.0% Set A CB A2 8.0% 10 years 6.5% CB BI 4.0% 15 years 10.0% Set B CB B2 8.0% 10 years 10.0% (20 marks) Total: [100 marks] 88 QUESTION 4 PART A Following is the portfolio weights, w, expected return, R, vectors and the variance-covariance matrix, VC, for a three-asset portfolio: 0.5 15 100 45 10 W = 0.3 R = 12 VC = 45 64 10 0.2 10 10 36 Calculate: i. the expected return, and ii. standard deviation of the portfolio. (40 marks) PART B i. Briefly discuss the three forms of market efficiency and their implications for technical and fundamental analysis as a basis for security selection. ii. Research on mutual fund performance suggests that mutual funds generally underperform their benchmarks, and that any superior returns is largely due to luck rather than skill. Briefly discuss the implications of the research why an investor might want to buy shares of a mutual fund, in spite of the evidence of poor performance. (60 marks) Total: [100 marks]