Question 2

Simon needs to select a fixed income security fund (from a selection of three funds presented below) to take advantage of the forecasted economic conditions and the yield curve changes. Current yield curve is almost a flat yield curve (short term = 2.6%, mid term= 3.0% and long term = 3.2%)

Allocation for the three sectors of the fixed income market in each fund is provided below:

Fund	Government (average duration of 4.5 years)	Investment Grade Corporate (average duration = 5.5 years)	High Yield (average duration = 2.3 years)
1	45%	40%	15
2	25	60	25
3	70	20	10

Simon expects the economic conditions to become worse, where the yield curve becomes inverted (the spread between long term and short term yield become negative)

a) Based on Simon's expectation of how the yield curve would change, explain how would government and Investment grade bonds expected to perform?

b) Based on Simon's expectation of the economy, explain how would high yield (or below Investment grade) bonds expected to perform?

c) Based on your answers to part a and part b, explain which portfolio should Simon invest in to generate the highest return. Feel free to use numerical example to demonstrate your answer.

Question 3

Monica wants to select an equity fund that will perform the best based on her market expectations. She expects that inflation will remain within the lower limit of the Reserve Bank of Australia inflation band. Monica expects interest rates to decrease in the near future. Economy is expected to slow down and consumers are pessimistic about future employment.

Allocation to industry sector allocation are as follows:

Fund	Large Cap	Small Caps
1	80%	20%
2	60%	40%
3	40%	60%

a) Explain why do small caps firms provide higher volatility than large cap firms? Your answer should focus on the firms' earnings and NOT on firms' variability of returns

b) Explain which Fund should Monica select to maximise her returns based on her forecast of the market conditions?

c) Explain what are Value investments and give an example to show how a small cap firm in the technology sector can be considered a Value investment? Your example should not be based on systematic market and industry movements.