Investment Managed Future Case study



Investment Managed Future Case study

Return and Risk Assumptions

Every portfolio involves some risks as well as returns associated with its included assets, in this case some of the assumed risks and returns from the major asset class index data are given below:

Market Risk

Market risk is also called systematic risk, which involves the risk of probability that the security's value will move in tnadem with the overall market (AXA, 2012). So, in this case, if the price of shares included in Henry's portfolio will experience a decline, then the portfolio return will also decline. Similarly, in case the prices of bonds included in Henry's portfolio rise, then the value of overall portfolio (bonds) would likely to incarese.

Interest Rate Risk

Interest rtae risk is associated mainly with the fixed income investments; therefore in this case if the interest rates increase in the future, then the price of bonds will decline, hence reducing the return of portfolio.

Inflation Risk

Inflation risk involves the risk that the value of the portfolio will be eroded due to the reduction in the purchasing power of savings, which is the result of inflation (AXA, 2012). So, this risk is associated with conservative investments and need to consider while evaluating such investments, including bonds, money market investments, and bond funds as long term investments. Therefore, the bonds in Henry's portfolio may represent gains over time, they may actually be losing value if they do not keep pace with rate of inflation. Thus, in case the inflation increases and the value of bond would not increases in line with inflation rate, then the real return will decline.

Credit Risk

Credit risk is associated with bonds and bond funds; refer to an ability of a bond issuer to repay its debt as promised when the bond matures. Agencies like Standard and Poor's or Moody's give credit ratings to the bonds and bond funds (AXA, 2012). Generally, when the rating is higher, the credit risk is lower. Therefore, in case the ratings of bonds included in Henry's portfolio declines then the overall portfolio's return will also reduce, however, all types of bonds are not risky. Similarly, in case the company whose shares are included in Henry's portfolio observe decline in its rating, then the share price of that company's stock will decline, thus resulting in less return.

Arithmetic Average Annual Return

Year

Shares

Bonds

Cash

1994

7119

1942

2888

1995

8621

2304

3120

1996

9859

2578

3357

1997

11108

2893

3547

1998

12197

3169

3729

1999

14483

3130

3916

2000

15404

3507

4160

2001

17000

3700

4379

2002

15508

4026

4588

2003

17774

4148

4813

2004

22750

4437

5083

2005

27943

4694

5374

2006

34711

4840

5697

2007

40291

5010

6083

2008

24801

5759

6545

2009

33978

5857

6774

2010

34521

6208

7092

2011

30897

6916

7447

2012

37135

7452

7738

Arithmetic Average

21900

4345.789

5070

Standard Deviation of Annual Returns & Correlation of Returns

Standard Deviation

Year

Shares

Bonds

Cash

1994

7119

1942

2888

1995

8621

2304

3120

1996

9859

2578

3357

1997

11108

2893

3547

1998

12197

3169

3729

1999

14483

3130

3916

2000

15404

3507

4160

2001

17000

3700

4379

2002

15508

4026

4588

2003

17774

4148

4813

2004

22750

4437

5083

2005

27943

4694

5374

2006

34711

4840

5697

2007

40291

5010

6083

2008

24801

5759

6545

2009

33978

5857

6774

2010

34521

6208

7092

2011

30897

6916

7447

2012

37135

7452

7738

Standard Deviation

10790.27

1565.709

1527.515

Correlation Returns

Shares & Bonds

Shares

Bonds

7119

1942

8621

2304

9859

2578

11108

2893

12197

3169

14483

3130

15404

3507

17000

3700

15508

4026

17774

4148

22750

4437

27943

4694

34711

4840

40291

5010

24801

5759

33978

5857

34521

6208

30897

6916

37135

7452

Correlation Coefficient

0.883092

Bonds & Cash

Bonds

Cash

1942

2888

2304

3120

2578

3357

2893

3547

3169

3729

3130

3916

3507

4160

3700

4379

4026

4588

4148

4813

4437

5083

4694

5374

4840

5697

5010

6083

5759

6545

5857

6774

6208

7092

6916

7447

7452

7738

Correlation Coefficient

0.993609

Shares & Cash

Shares

Cash

7119

2888

8621

3120

9859

3357

11108

3547

12197

3729

14483

3916

15404

4160

17000

4379

15508

4588

17774

4813

22750

5083

27943

5374

34711

5697

40291

6083

24801

6545

33978

6774

34521

7092

30897

7447

37135

7738

Correlation Coefficient

0.913914

Rationalization of Risk & Return

The results of question 1 clearly indicates that all the three assets included in Henry's portfolio associate risk due to which returns can be altered. For example, the standard deviation of shares included in portfolio is 10790.26, which indiactes that stocks included in this portfolio can deviate this much in accordance with the chnages in market. Similarly, bonds standard deviation is 1565.709, indicating that the bonds can deviate highly across the risks associated with ...