Mary and Nick Stalcheck have an investment portfolio containing four vehicles. I
ID: 2762446 • Letter: M
Question
Mary and Nick Stalcheck have an investment portfolio containing four vehicles. It was developed to provide them with a balance between current income and capital appreciation. Rather than acquire mutual fund shares or diversify within a given class of investment vehicle, they developed their portfolio with the idea of diversifying across various types of vehicles. The portfolio currently contains common stock, industrial bonds, mutual fund shares, and options. They acquired each of these vehicles during the past three years, and they plan to invest in other vehicles sometime in the future.
Currently, the Stalchecks are interested in measuring the return on their investment and assessing how well they have done relative to the market. They hope that the return earned over the past calendar year in in excess of what they would have earned by investing in a portfolio consisting of the S&P 500 Stock Composite Index. Their research has indicated that the risk-free rate was 7.2% and that the (before-tax) return on the S&P 500 portfolio was 10.1% during the past year. With the aid of a friend, they have been able to estimate the beta of their portfolio, which was 1.20. In their analysis, they have planned to ignore taxes, because they feel their earnings have been adequately sheltered. Because a they did not make any portfolio transactions during the past year, all of the Stalchechk's investments have been held more than 12 months, and they would have to consider only unrealized capital gains, if any. To make the necessary calculations, the Stalchecks have gathered the following information on each of the four vehicles I their portfolio.
Common stock: They own 400 shares of KJ Enterprises common stock. KJ is a diversified manufacturer of metal pipe and is know for its unbroken stream of dividends. Over the past few years, it has entered now markets and, as a result, has offered moderate capital appreciation potential. Its share price has risen from $17.25 at the start of the last calendar year to $18.75 at the end of the year. During the year, quarterly cash dividends of $.20, $.20, $.25, and $.25 were paid.
Industrial bonds: The Stalchecks own eight Cal Industries bonds. The bonds have a $1,000 par value, have a 9.250% coupon, and are due in 2021. They are A-rated by Moody's. The bond was quoted at 97.000 at the beginning of the year and ended the calendar year at 96.375%.
Mutual funds: The Stalcheks hold 500 shares of Holt Fund, a balanced, no-load mutual fund. The dividend distributions on the fund during the year consisted of $.60 in investment income and $.50 in capital gains. The fund's NAV at the beginning of the calendar year was $19.45, and it ended the year at $20.02.
Options: The Stalchecks own 100 options contracts on the stock of a company they follow. The value of these contracts totaled $26,000 at the beginning of the calendar year. At year-end the total value of theoptions contracts was $29,000.
a. Calculate the holding period return on a before-tax basis for each of these four investment vehicles.
b) Assuming their ordinary income is currently being taxed at a combined tax rate of 38%. And that they would pay a 15% capital gains tax on dividends and capital gains for holding periods longer than 12 months, determine the after tax HPR for each of their 4 investment vehicles.
c) Recognizing that all gains on their investments were unrealized, calculate the before tax portfolio HPR for their 4 vehicle portfolio during the past calendar year. Evaluate this return relative to its current income and capital gain components.
d) Use the HPR calculated in question c to compute the Jensen's measure (Jensen alpha). Use that measure to analyze the performance of their portfolio on a risk adjusted, market adjusted basis. Comment on your finding. Is it reasonable to use Jensen's measure to evaluate a 4 vehicle portfolio? Why or why not?
Explanation / Answer
Answer:a) NOTE: I assumed that the 97,000 quote in industrial bonds really means 97%.
Common stock = [(18.75-17.25)+.20+.20+.25+.25]/17.25 = 13.91%
Industrial bonds = [(1000*96.375%-970)+1,000*9.25%]/970=8.89%
Mutual fund = [(20.02-19.45)+0.60+0.50]/19.45 = 8.59%
Options=(29000-26000)/26000=11.54%
Answer:b)
Common stock = [(18.75-17.25)*(1-15%)+(.20+.20+.25+.25)*(1-15%)]/17.25 = 11.83%
Industrial bonds = [(1000*96.375%-970)*(1-15%)+(1,000*9.25%)*(1-35%)]/970=5.65%
Mutual fund = [(20.02-19.45)*(1-15%)+0.60*(1-35%)+0.50*(1-15%)]/19.45 = 6.68%
Options=(29000-26000)*(1-15%)/26000=9.81%
Answer:c) Weight of security at the beginning of the year relative to total portfolio
Portfolio value, beginning = 6,900+7,760+9,725+26,000 = 50,385
Common stock = 400*17.25 = 6,900 => 6,900/50,385 = 13.69%
Industrial bonds = 97%*1000*8 = 7.760 => 7,760/50,385 = 15.40%
Mutual funds = 500*19.45 = 9,725 => 9,725/50,385 = 19.30%
Options = 26,000 => 26,000/50,385 = 51.60%
HPR = 13.91%*13.69%+8.89%*15.40%+8.59%*19.30%+11.54%*51.60% = 12.79%
Current income return = 360+740+300 = 1400/50,385 = 2.78%
Common stock = (0.20+0.20+0.25+0.25)*400 = 360
Industrial bonds = 1000*9.25%*8 = 740
Mutual fund = 0.60*500 = 300
Options = 0
Capital gains return = (600-50+285+3,000)/50,385 = 3,835/50,385 = 7.61%
Common stock = (18.75-17.25)*400 = 600
Industrial bonds = [(1000*96.375%-970)*8 = -50
Mutual fund = [(20.02-19.45)*500=285
Options = 3,000
The capital gains form a higher portion of the total holding period returns of the portfolio.
Answer:d) Jensen's measure = 12.79% - 7.2% - [1.20x(10.1%-7.2%)] = 9.07%
From the above alpha, the Stalcheck portfolio has been over performing the market. However, I believe that it is reasonable to use this measure to evaluate the portfolio as it is the investment vehicles comprising the portfolio were chosen with the goal of getting a better return than the market.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.