The case offers student the chance to calculate the holding period return (HPR) for a number of investment vehicles. The student has to recognize that the risk of a precise investment will have an impact on the assessment of its actual performance. To stop this, the student has to apply the Jensen’s measure (alpha), which applies the portfolio beta to determine the risk and the CAPM to change for market return, and then come up with conclusions (Gurroy and Omer, 2001; Markowitz, 1959).

(a). Before-tax HPRs

HPR for common stock: HPRt =

HPR =

= 13.91% for a 1-year holding period

HPR for industrial bonds: HPR =

HPR =

HPR for mutual fund:

HPR =  = 8.59% for a 1-year holding period

HPR for options:

HPR:  = 11.54% for a 1-year holding period

(b). Stock (400 shares): (Reduced rate on dividends)

[400(\$0.90) (0.85) + 400(18.75 – 17.25)(1 – 0.38)]/(\$17.25 ´ 400)
= (\$306 + \$372)/\$6,900 = \$678/\$6,900 = 9.83%

Industrial bonds (8 bonds)

After-tax HPR = 8.89% ´ (1 – 0.38) = 5.51% for 1-year holding period

Mutual fund (500 shares):

(Reduced rate on dividend and capital gain distributions)

[500(\$0.60 + \$0.50) ( 0.85) + 500(20.02 – 19.45)(1 – 0.38)]/(\$19.45 ´ 500) =

(\$467.50 + \$285)/\$9,725 = \$752.50/\$9,725 = 9.67%

Options:

After-tax HPR = 11.54% ´ (1 – 0.38) = 7.15% for 1-year holding period

(c). Total investment       = (\$17.25 ´ 400) + (\$970 ´ 8) + (\$19.45 ´ 500) + \$26,000

= \$6,900 + \$7,760 + 9725 + 26,000 = \$50,385

= \$50,385

Total current income         = (\$0.90 ´ 400) + (\$92.50 ´ 8) + (\$1.10 ´ 500) + \$0

= 360 + 740 + 550

= \$1,650

Total capital gain     = (\$1.50 ´ 400) + (–\$6.25 ´ 8) + (\$0.57 ´ 500) + \$3,000

= \$3,835

HPR (portfolio)       =

(d). JM   = (rp – RF) – [bp ´ (rm – RF)]

= (10.89 – 7.20) – [1.2 ´ (10.10 – 7.20)]

= 3.69 – (1.20 ´ 2.90) = 3.69 – 3.48 = 0.21

Using Jensen’s measure, the actual portfolio return is more useful than the required return since it is positive. It is logical to apply this technique, which applies the portfolio’s beta, to assess a four-vehicle portfolio.

(e). This question should guide us to the discussion—it has no “pat” answer. In holistic, the portfolio is balanced between current income and growth. The ratio of current income to capital gain is 43 (\$1,650/\$3,835); one may desire to state in depth if or not this is beneficial. The returns on each of the investment vehicles appear satisfactory; the ones that may desire examination are the bonds and the mutual fund (Luenberger, 1997). They have lower before-tax returns than the S&P 500 Stock Composite Index, though they may be of s limited threat. Almost certainly, the most definite suggestion is to observe the portfolio as opposed to altering it at this time.