INV4801/101 ASSIGNMENT 01

Aim: To evaluate your knowledge of some of the fundamental aspects of learning units 1 to 3,
which deal with the portfolio management process, the Investment Policy Statement
(IPS), capital market expectations and asset allocation.
Answer the following questions and submit your assignment at https://my.unisa.ac.za
1. The Goveros Tatenda and Ruvarashe Govero, South African citizens, are reviewing their financial plan. The
Goveros, both 53 years old, have one daughter, 18 years old. With their combined after-tax
salaries totaling R100,000 a year, they are able to meet their living expenses and save R25,000
after taxes annually. They expect little change in either their incomes or expenses on an
inflation-adjusted basis other than the addition of their daughter’s college expenses. Their only
long-term financial goal is to provide for themselves and for their daughter’s education. The
Goveros both wish to retire in 10 years.
Their daughter, a talented musician, has just entered an exclusive five-year university program.
This program requires a R50,000 contribution, payable now, to the university’s endowment
fund. Thereafter, her tuition and living expenses, to be paid entirely by the Goveros, are
estimated at R40,000 annually.
The Govero’s personal investments total R600,000, and they plan to continue to manage the
portfolio themselves. They prefer “conservative growth investments with minimal volatility.” Onethird of their portfolio is in the stock of Ruvarashe’s employer, a publicly traded technology
company with a highly uncertain future. The shares have a very low cost basis for tax purposes.
The Goveros, currently taxed at 30 percent on income and 20 percent on net realized capital
gains, have accumulated losses from past unsuccessful investments that can be used to fully
offset R100,000 of future realized gains.
In 10 years, Tatenda will receive a distribution from a family trust. His portion is now R1.2 million
and is expected to grow prior to distribution. Tatenda receives no income from the trust and has
no influence over, or responsibility for its management. The Goveros know that these funds will
change their financial situation materially but have excluded the trust from their current financial
planning.
a) Formulate an Investment Policy Statement (IPS) for the Goveros. No calculations are
required for the risk and return objectives.
(15)
Use the following information to answer questions b & c
Barak Zuma and Jacob Mugabe are portfolio managers for the largest mutual fund of Liberty
Financial Advisers. Liberty Financial Advisers provides a variety of mutual funds for both
individuals and institutions. Zuma has been a portfolio manager for eight years and has seen
both bull and bear markets. Mugabe is his assistant and has been at Liberty Financial Advisers
for the two years following his graduation from a prestigious Masters in Finance program.
In their discussion over lunch, Zuma and Mugabe discuss the latest quarterly earnings
announcements for several firms in their portfolio. Despite their optimistic projections for a few firms, most announcements were quite disappointing. Mugabe though states that he is not
convinced that their prospects are as grim as the announcements suggest.
The next day, Zuma and Mugabe attend a presentation for Liberty Financial Advisers’ clients.
Their guest presenter is Naboth Machemedze, an economist at the local university who
frequently provides economic commentary for national media outlets. During his presentation,
Machemedze states that it is likely that South Africa will enter a recession next year. He
recommends that the clients shift their assets into investment grade bonds and non-cyclical
stocks. He states that he has been successful in predicting recessions over the past 20 years
and is certain of his forecasts. He states further that the only time he has been wrong in
predicting the business cycle was when the government increased spending beyond that
expected. He states that if that had not happened, his prediction of a mild recession would have
been correct, instead of the mild expansion that actually occurred.
During the afternoon session, Zuma discusses the various strategies at Liberty Financial
Advisers. In the value/neglected firm strategy, Liberty Financial Advisers seeks out firms trading
at reasonable valuations with no analyst following. Zuma states that several academic studies
have shown these firms to be good investments over a 5-year time horizon for the period from
1st of July 2008 to 30 June 2013. Zuma states that he has adopted this strategy for his portfolio.
a) Describe the psychological trap that affects Mugabe (5) b) Discuss two behavioral characteristic that Machemedze exhibit in this case. (5) 2. Gweru Innovations
U.S based Gweru international (GI) is a financially healthy, rapidly growing import/ export
company with a reasonably young workforce. Information regarding GI’s defined benefit pension
plan appears in Exhibits 1 & 2
Exhibit 1 Asset class
Large Capitalisation U.S Equities
Small Capitalisation U.S Equities
International Equities
U.S treasury bills (1-year maturity)
U.S intermediate-term bonds and
Mortgage-backed securities
U.S long term Bonds (10-year duration) Target allocation
(%)
35
10
5
10 10
12
7
4.5 17
23 1
19¹ ¹Income element 7%; price gain element 12% -2- Prior-Year
Total return
(%)
Exhibit 2
Present value of plan liabilities
Market value of plan assets
Duration of liabilities
Actuarial return assumption
GI board’s long term total return objective $298 million
$280 million
10 years
8%
10% In accordance with GI policy, the plan discounts its liabilities at the market interest rate for
bonds of the same duration. GI’s risk objectives include a limitation on volatility of surplus.
Giselle Engle, the newly appointed chief financial officer, must explain to the board of directors
why the surplus declined in a year when the actual investments return was 100 basis points
more than the long-term objective stated by the board.
a) Calculate GI’s corporate pension plan surplus. (2) b) Explain how the plan surplus could increase in a given year despite an actual return in short
of the long-term return objective.
(5)
c) Explain the importance of an appropriate investment time horizon when setting investment
policy for GI’s corporate pension plan.
(3)
d) Discus the risk tolerance of GI’s corporate pension plan. (5) Use the following information to answer question e.
YAPs Foundation
Onious Urayai is a consultant to the board of directors of the RSA-based YAPs Foundation. The
board asks Urayai to recommend an asset allocation for YAPs. Urayai reviews key objectives of
the YAPs investment policy statement shown in below:
Return objective: Real required annual rate of return on investment portfolio is 7%. Maintain the purchasing power of the portfolio.
Risk objectives: Diversify the portfolio consistent with prudent investment practices. Minimize portfolio risk while achieving the return objective. Leverage is not allowed.
For the strategic asset allocation analysis, Urayai has generated the corner portfolios shown in
Exhibit 3. Exhibit 3
Corner Portfolios
(Risk-free Rate = 3.0%; Inflation 2%)
Corner
Portfolio
Number Annual
Expected
Return
(%) 1
2
3
4
5
6 10.9
10.2
9.4
8.8
8.2
6.9 Annual
Expected
Standard
Deviation
(%)
16.3
13.7
10.1
8.6
7.3
5.3 Sharpe
Ratio RSA
Equities NonRSA
Equities Long-term
RSA
Bonds 0.48
0.53
0.63
0.67
0.71
0.74 100.0
74.1
33.7
31.4
25.0
0.0 0.0
4.0
12.0
12.0
11.8
13.7 0.0
0.0
36.7
26.7
0.0
0.0 Intermediate
term
RSA
Bonds
0.0
0.0
0.0
13.0
45.3
53.0 NonRSA
Bonds Real
Estate 0.0
0.0
0.0
0.0
3.4
27.1 0.0
21.9
17.6
16.9
14.5
6.2 e) Calculate the nominal required rate of return and determine the percentage that would be
invested in each of the asset class based on the most appropriate strategic asset allocation.
(10)