portfolio management

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FINM7403 Portfolio Management

Business School, The University of Queensland

Take-home Exam, Summer Semester 2020

Submission Due: 10:00 am AEST, Sunday 7 February 2021

Weight: this take-home exam is worth 40% of your final grade

Part 1: Portfolio Analysis

As a financial consultant, you will serve either Client 1 or Client 2 of your choice. Information

about the two clients is provided as follows.

Client 1: Alice is a retiree who has $500,000 to invest. Alice would like the capital to rise faster

than inflation to maintain the purchasing power of her wealth. She prefers stocks paying regular

high-dividends so that the dividends received can cover her living expenses.

Client 2: Andy and Sam are a couple, and both in their 40s. They have two main financial goals:

saving for retirement and saving for their five-year-old daughter's college education. Sam

recently inherited $400,000 from his aunt. They would like to invest this inheritance in hopes of

achieving a maximum return. Andy and Sam want to retire 20 years from now.

Assume the utility function for both Client 1 and Client 2 is: 𝐸𝐸(𝑈𝑈) = 𝐸𝐸(𝑅𝑅)− 1 2 𝐴𝐴𝜎𝜎2

Where E(R) is the expected return of the portfolio, 𝜎𝜎2 is the portfolio variance, and A is the

coefficient of relative risk aversion. Client 1's risk aversion level is 15 (A=15), and Client 2's risk

aversion level 8 (A=8). Assume short-selling is allowed in the investment strategy.

Activity: You want to construct an investment portfolio for the client of your choice in January

2021. The portfolio must consist of the risk-free asset and the tangency portfolio (constructed

using exchange-traded funds of SPY, VGLT, and SGOL).

You start with constructing the tangency portfolio using the three risky ETFs only. You then

allocate the client's capital between the tangency portfolio and the risk-free asset. Historical

monthly returns of SPY, VGLT, and SGOL are presented in the worksheet titled "ETF

RETURNS". The risk-free interest rate is currently 0.2% p.a.

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Requirement: Write a report to incorporate the answers to the following tasks. [word limit: 500]

1. Report your choice of the client. Communicate in writing on your consideration of the

recommended investment portfolio and how the investment is aligned with optimizing

your client's utility and achieving their financial goals.

2. Detail the procedures of obtaining the portfolio weights in the tangency portfolio using

Excel Solver.

3. Report the portfolio weights and dollar value of each risky security and the risk-free asset

for every $100,000 investment.

4. Evaluate the expected annual return and annual standard deviation of the recommended

portfolio.

Part 2: Fund performance evaluation

Activity: Assume today is 1 January 2021. You plan to evaluate the Australian foundation

investment company's (ASX: AFI) performance in the past twelve months. The dividends and

pricing information on AFI, the index levels of ASX200 (used as the benchmark of AFI), and the

risk-free interest rates are presented in the worksheet titled "AFI". In this performance evaluation

exercise, you will apply the CAPM model using ASX200 as the market portfolio.

Requirement: Write a performance evaluation report that incorporates answers to the tasks below

[Word limit: 500].

1. Use a table to report the 12-month cumulative excess return and standard deviations

(annualized) of AFI and ASX200.

2. List the regression equation with estimated alpha and beta for AFI using the monthly data

provided.

3. Show your workings on calculating AFI's performance metrics using annualized data:

Sharpe Ratio, 𝑀𝑀2, Treynor Ratio, Tracking Error, and Information Ratio; and summarize

your results in a table.

4. Based on the calculated results on the above tasks, if you want to invest all your wealth in

one risky security, will you choose AFI (i.e., active investment portfolio) over ASX200

(i.e., passive investment portfolio)? Evaluate the advantages and disadvantages of this

evaluation method.

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------------------------------- End of Take-home Exam ---------------------------------

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Submission Guide:

1. Take-home exam submission:

• Each student is to complete both two parts of the take-home exam INDIVIDUALLY, and

responsible for submitting the work online via Turnitin to the portal of "Assessment

Assessment Task 2: Take home exam  FINM7403 Take home exam submission

for grading".

• Combine your answers to part 1 and part 2 AS ONE PDF FILE before uploading the

file for submission. The take-home exam can be submitted multiple times to the Turnitin

portal, but only the last submission before the due date will be graded.

• The word count excludes Excel spreadsheets, footnotes, tables and figures. Please copy

and paste your excel spreadsheet to a Word document and attach it at the end of your

report before converting it to pdf format for submission.

2. Formatting: Your document should be typed in Times New Roman font, size 12. It should

be 1.5 lines spaced and has margins of 2.54cm.

3. Referencing: UQ academic integrity tutorial provides guidelines for referencing and

avoiding plagiarism. It is available at (https://www.uq.edu.au/integrity/). Use the APA

citation style to cite sources where needed: https://web.library.uq.edu.au/files/40589/APA-

6th-edition-style-guide.pdf

4. Other instructions:

• Please note that teaching staff will use Turnitin to analyze your answers for similarity

checks.

• Teaching staff will not answer any questions about the exam unless answering the

question clarifies the exam contents' ambiguity. In this case, you can post your question

to the "Discussion Board" on the Blackboard, and they will be answered by teaching staff

if appropriate.