Balanced Fund Portfolio Construction



Assessing the Stalchecks' Portfolio Performance

This case gives the student an opportunity to compute the holding period return (HPR) for several investment vehicles. The student must recognize that the risk of a particular investment will affect the assessment of its actual performance. To this end, the student is required to use Jensen's measure (alpha), which uses portfolio beta to measure risk and the CAPM to adjust for market return, and then draw conclusions.

Before-tax HPRs

HPR for common stock: HPRt ?

HPR ?

? 13.91% for a 1-year holding period

HPR for industrial bonds: HPR ?

HPR ?

HPR for mutual fund:

HPR ? ? 8.59% for a 1-year holding period

HPR for options:

HPR: ? 11.54% for a 1-year holding period

After-tax HPRs:

Stock (400 shares): (Reduced rate on dividends)

[400($0.90) (0.85) ? 400(18.75 - 17.25)(1 - 0.38)]/($17.25 ( 400) ??($306 ? $372)/$6,900 ? $678/$6,900 ? 9.83%

Industrial bonds (8 bonds)

After-tax HPR ? 8.89% ? (1 - 0.38) ? 5.51% for 1-year holding period

Mutual fund (500 shares):

(Reduced rate on dividend and capital gain distributions)

[500($0.60 ? $0.50) ( 0.85) ? 500(20.02 - 19.45)(1 - 0.38)]/($19.45 ( 500) ?

($467.50 ? $285)/$9,725 ? $752.50/$9,725 ? 9.67%

Options:

After-tax HPR ? 11.54% ? (1 - 0.38) ? 7.15% for 1-year holding period

Total investment? ($17.25 ? 400) ? ($970 ? 8) ? ($19.45 ? 500) ? $26,000

? $6,900 ? $7,760 ? 9725 ? 26,000 ? $50,385

? $50,385

Total current income? ($0.90 ? 400) ? ($92.50 ? 8) ? ($1.10 ? 500) ? $0

? 360 ? 740 ? 550

? $1,650

Total capital gain? ($1.50 ? 400) ? (-$6.25 ? 8) ? ($0.57 ? 500) ? $3,000

? $3,835

HPR (portfolio)?

JM? (rp - RF) - [bp ? (rm - RF)]

? (10.89 - 7.20) - [1.2 ? (10.10 - 7.20)]

? 3.69 - (1.20 ? 2.90) ? 3.69 - 3.48 ? 0.21

Using Jensen's measure, the actual portfolio return is better than the required return because it is positive. It is reasonable to use this measure, which uses the portfolio's beta, to evaluate a four-vehicle portfolio.

This question should lead to discussion—it has no “pat” answer. In general, the portfolio is balanced between current income and growth. The ratio of current income to capital gain is 43 ($1,650/$3,835); one might wish to discuss whether or not this is satisfactory. The returns on each of the investment vehicles appear acceptable; the ones that might require investigation are the bonds and the mutual fund. They have lower before-tax returns than the S&P 500 Stock Composite Index, but they may be somewhat less risky. Probably, the most obvious recommendation is to monitor the portfolio rather than change it at this time.

Evaluating Formula Plans: Charles Spruge's Approach

This case allows students to use a simplified portfolio to evaluate the four formula plans presented in the text. For ease in computation and discussion, we have assumed that fractional shares can be purchased. Instructors may wish to revise the numbers to eliminate fractional shares.

Price Per Share

End of Period

Period

ConCam

Fleck

1

22 1/8

22 1/82

2

22 7/8

24 1/2

3

22 7/8

25 3/8

4

22

28 1/2

5

22 1/4

21 7/8

6

22 1/8

19 1/4

7

22

21 1/2

8

22 1/4

23 5/8

Number of Shares ...