Concentrated Fund - No One Affects Security Prices and the Security Prices and Quantities Are Fixed - Example

Name Instructor Course Date Report on the Concentrated Fund Introduction The purpose of this report is to inform the government whether concentrated fund acted appropriately or not. This will help the government to choose whether or not to continue investing in the portfolio of concentrated fund. The information from the government is obtained through risk profiling of the portfolios. This will bring about categorization of projects into risk and non risk projects in investment decision. In this scenario, we will focus on the concentrated fund analyze their outcome through cross examination of the covariance and variance, expected return based on the data collected for the 15 years. The calculations to ascertain our argument will be based on the weighted average of the bond yield for the entered 15years period. This is indicated below. 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 5.81 5.21 5.7 6.27 5.23 5.54 5.1 5.44 5.32 5.64 6.2. 5.71 4.67 5.11 4.52 3.09 6.21 5.49 6.0 6.32 5.62 5.85 5.37 5.59 5.35 5.59 6.oo 7.25 5.04 5.11 4.86 3.55 The results have been calculated on average to suitably allow us to make calculations on the entire report simple to handle. Estimation of the expected return Assumptions of CAPM Investors evaluate the portfolios by mean and variance over one period horizon Preferences satisfy non-satiation Investors are risk averse. Trading conditions; Assets are infinitely divisible Borrowing and lending can be undertaken at a risk free rate No taxes or transaction cost. The risk free is same for all The Capital Asset Pricing Model (CAPM) is one of the investment and financial analysis tools. Its formula is as shown below r = rF + β*(rM – rF) where r = required rate of return of a financial asset β = the financial asset beta rF = risk free rate rM = required rate of return of a market portfolio In this case, the calculation is done using the CAPM- capital asset pricing model. Where: is the expected return on the capital asset is the risk-free rate of interest such as interest arising from government bonds (the beta) is the sensitivity of the expected excess asset returns to the expected excess market returns [(6.0-5.7)+(6.32-6.27)+(5.62-5.23)+(5.85-5.54)+(5.37-5.1)+(5.59-5.54)]/5=0.274 0.06+0.01+0.078+0.062+0.054+0.01=0.274 or 27.4% Analysis: The expected return for the period from 1999 to 2004 is 27.4% . this expected return is much higher than the set objective of 10% over the entire period. Problems associated with CAPM: CAPM is not viable in ideal situation due to its assumptions that do not match real conditions. CAPM always clash with investment appraisal coz it focuses on single period horizon. To estimate the variance and the covariance matrix Beta is the ratio between the covariance and the variance The formulae for covariance are very similar to the formulae for variance. Furthermore we assume that E [F] = 0 Var [F] = E [FF0] = I E [F] = 0 Var [F] = E [0] = 2 where ª is a diagonal matrix containing the residual variances and Cov[F; "] = 0. The covariance structure for r implied by our assumptions then becomes Var[r] = E[(r ¡m)(r ¡m)T ] = E[(LF + ")(LF + ")T ] = LE[FFT ]LT + E["FT ]LT + LE[F"T ] + E[""T ] = LLT Form our sample X1; :: : ;Xn into a n _ p random matrix A With independent rows: The aim of estimation of covariant matrix is to ascertain the specific factor loading based on spectral decomposition of covariant matrix. The table below shows the estimated covariance for the years 1999 to 2004. The covariance matrix essentially helps to determine the variability of various outcomes. (34.04-33.28)(34.75-34.04)=0.54 The estimated covariance is 0.54 Variance therefore=0.73. The matrix will therefore be 5.85 5.7 6 6.3 6.27 6.32 5.7 5.54 5.85 To provide the weighing of your portfolio. Including risk, to calculate the actual portfolio return over 2006 to 2008.the return portfolio can be calculated as follows: Return of portfolio = (W1 x R1) + (W2 x R2) + (W3 x R3) + …..(Wn x Rn) Where W1, W2, W3 and Wn stand for the weightings in % of assets, for asset 1 to n, in the portfolio. Whereas, R1, R2, R3 and Rn are returns for the respective assets, 1 to n, in the portfolio YEAR MARKET VALUE WEIGHT RETURN WEIGHTED RETURN 2006 5.62 30.9 10 3.09 2007 6.1 33.5 10 3.35 2008 6.48 35.6 10 3.56 Total returns= 10. Calculations 2006 5.62/18.2 x100=30.9, 6.1/18.2x100=33.5 and 6.48/18.2x100=35.6. The weighted return against this becomes 30.09, 3.35 and 3.56 respectively. This is calculated based on the 10% expected return that has been set by the government. From the above returns calculated, is clear that the preset target for the concentrated fund has been achieved since is exactly 10%. The government should therefore consider to have acted appropriately. The variations in the portfolio return in this solution in comparison to the one indicated in part one and two is as result of the difference in weighing of the assets against their returns. The asset portfolios also have different lifespan and this shows that they may not have uniform returns. Following the analysis of the securities throughout the 15years span, we can conclude that the government should accept the consolidated fund because it has shown a steady outcome. The estimated expected return was found to be 27% which is much more than the expected return of 10%. This indicates that the concentrated fund is a viable project that the government should be able to fund. The advantages of this concentrated fund out ways the disadvantages and costs that are equally associated with it. From this research we have concluded that concentrated fund is most suitable to meet the needs of this time. The following factors form basis for our recommendation. Financial security- the investment guarantees financial security to the individuals who invest in it. Investment choice- concentrated fund has been able to meet the investment demands of the people through advice and collective investment accounts. In conclusion, from the analysis, concentrated fund is the appropriated investment security. This has been verified through theoretical calculation based on 15 year record of the portfolio returns. It has the ability to monitor your funds more regularly. Based on the requirements, it is fit to conclude that the concentrated fund offers the best investment of charges. Problems associated with CAPM Problems The model assumes economic agents optimise over a short-term horizon, and in fact investors with longer-term outlooks would optimally choose long-term inflation-linked bonds instead of short-term rates as this would be more risk-free asset to such an agent. In this case, the term for concentrated fund is fifteen years. The assumption of short lifespan does not hold in this case since its more than one year. This is evident in this case because the duration of this investment is 15 years. The CAPM assumption over a short horizon is totally conflicting in this case. The model assumes that given a certain expected return, active and potential shareholders will prefer lower risk (lower variance) to higher risk and conversely given a certain level of risk will prefer higher returns to lower ones. It does not allow for active and potential shareholders who will accept lower returns for higher risk. Casino gamblers pay to take on more risk, and it is possible that some stock traders will pay for risk as well The model assumes that there are no taxes or transaction costs, although this assumption may be relaxed with more complicated versions of the model. The government imposes taxes on the economic agents. In this case, consolidated fund is not an exceptional since it cannot evade it. This makes this assumption not applicable in this scenario because it is an entity unless specifications on tax incentives are given. The government has the right to impose tax to every firm in order to collect revenue. This totally conflicts with CAPM expectation on its assumption. CAPM is not viable in ideal situation due to its assumptions that do not match real conditions. Most of the assumptions labeled against CAPM only apply in theory but not in practice. The assumptions are meant to be explanatory and help us understand the importance of CAPM. CAPM always clash with investment appraisal coz it focuses on single period horizon. Investment appraisal requires that the project to be appraised should undergo stages. CAPM in this case only focus on single period horizon which goes against this assumption. In conclusion, from the analysis, concentrated fund is the appropriated investment security. This has been verified through theoretical calculation based on 15 year record of the portfolio returns. It has the ability to monitor your funds more regularly. Based on the requirements, it is fit to conclude that the concentrated fund offers the best investment of charges. The calculated weighted return of 10% supports this argument since the government expectation of return was estimated to be 10%.( Sanwal 45) The expected return also supports this argument because it is more than the expected return by the government. The covariant and the variance are also close indicating that the real results are not much varied from the expected results. The slight difference in the expected results calculated may have resulted from the argument based on the slight variability in the results. CAPM also assumes homogeneity in the investors’ expectations which does not apply to this scenario. From our calculation, we noted that expected return is 27.2% which is not equivalent to the government’s expectation of 10%. CAPM also assumes that the asset return follow a normal distribution, It also assumes that no one affects the security prices and that the security prices and quantities are fixed. While the CAPM emerges as the most commonly used approach for both institutional and private investors, somebody has to prove that this simple model really holds true in the market (Sanwal 76) References Maginn, John L. Managing Investment Portfolios: A Dynamic Process. Hoboken, N.J: John Wiley & Sons, 2007. Internet resource. Reilly, Frank K, and Keith C. Brown. Investment Analysis & Portfolio Management. Mason, OH: South-Western Cengage Learning, 2012. Print. Sanwal, Anand. Optimizing Corporate Portfolio Management: Aligning Investment Proposals with Organizational Strategy. Chichester: John Wiley & Sons, 2007. Print. Read More