MANAGEMENT

Security Analysis and Portfolio Management

Security Analysis and Portfolio Management

Case Study

Critically assessing the theoretical and empirical evidence for the belief that 'it's almost inconceivable that real returns on equities will average less than 1.09% over the next 40 years'

The analysis of given case indicates that 1.09% interest, at which Clare College has borrowed the money in order to invest in rock-bottom stocks and shares, is the lower rate of interest that can just be happens occasionally. It clearly points out that this interest is lower than usual, where it is obvious that the real return on equities will of course average more than this least rate of interest over the next 40 years. Where, it is also indicated that stock market have hit the rock-bottom, which indicates that now the market have to make money provided by the rise in share prices and dividends over the next 40 years. Thus, it is clearly evident that the average return from the shares Clare have invested in, will be of course more than the interest rate it have to pay over the next 40 years.

The selection of optimal portfolio by a particular investor is always effected by many factors, among which degree of risk aversion is one of the main factors. Those investors who are risk averted chose that portfolio which is less risky as compared to others (Bucciol & Miniaci, 2007, p.2-3). So in this case, Clare College does not show risk aversion as they have borrowed money at lower rate but investing it in stocks market, however it is predictable that equity market will make money in future, yet they have incorporated risk in their portfolio decision. Here, we can also witness that the investment decision taken by the college is based on the excess return that they are anticipated to gain on their equity investment over a risk free rate. This indicates the equity risk premium, which is the additional return a particular security or securities provide over a risk-free rate (Damodaran, 2012, n.d). Thus, the belief incorporates aspects of risk aversion and equity risk premium i.e. Clare College has taken risk by borrowing money at lower rate and investing it in stock market that is expected to make money in future, and this action is taken due to the excess return securities will provide over the risk free rate of return (market interest rate).

Critically assess the theoretical and empirical evidence for the belief that the strategy outlined in the case is less risky over the long run than it would be over a short period of time

The strategy that Clare College has implied is that they have borrowed money at lower interest rate (due to crash financial market) and have invested it in stock market which is at rock bottom. This strategy is less risky over the long run than it would be over a short period of time because the institutions of UK are forced to match their long-term liability very closely, due to which ...