1. Ms Brown has an investment portfolio comprising Australian shares.
At a meeting with her investment advisor she requests explanations
of the following: (a)the definition of systematic risk and unsystematic risk and an explanation of factors that are responsible for the two types of risk? In its basic form, risk comprises components of probability, variance, volatility and uncertainty. Probability is a statistical estimate of a variance in an expected outcome. Volatility relates to the degrees of change that historically have occurred in outcomes overtime and uncertainty is the possibility that an unexpected outcome might occur. a. Systematic risk is exposures of a share portfolio to changes in the environment thathave the effect of impacting the majority of shares listed on a stock exchange. For example, changes in interest rates, exchange rates or economic activity. b. Unsystematic risk relates to exposures that specifically affect the share price of a particular corporation. For example, loss of key personnel or systems, or a downgrade of performance forecasts. (b)what is the rationale behind the assertion that an investor should not expect to be rewarded for the unsystematic risk element in a share portfolio? An investor is able to minimise unsystematic risk by holding a diversified investment portfolio; for example, a portfolio of shares, property and fixed interest investments. Within the share portfolio the investor can hold shares in a number of companies, a range of industry sectors, and across different countries. Therefore, as investors are able to hold diversified investment portfolios, prices will not incorporate a significant risk component for unsystematic risk 2. An investor holds the following shares in an investment portfolio JB HI FI $6500 Beta 1.2 Telstra $8600 Beta 0.95 ANZ Bank $7900 Beta 1.05 (a)What does each beta coefficient imply about the volatility of each companys shares relative to the overall market? a. Beta is the amount of systematic risk that is present in a particular share relative to the share market as a whole. b. The market has a beta of 1.0. c. In the above portfolio, JB Hi Fi and ANZ have betas greater than 1.00. As such, they are more JB Hi Fis price will increase (decrease) by 12 per cent or 1.20 times as much. Following the same market movement, ANZ shares will increase (decrease) in price by 1.05 times as much or, in this case, by 10.50 per cent. Because Telstra has a beta of 0.95, it will move less than proportionally with the market. (b)What is the portfolios beta?
(c) (d)If the investor added to the portfolio with the purchase of $5000 worth of shares in Myer (beta 1.60), what impact would that purchase have on the risk structure of the portfolio? (LO 6.1)
3. As an investment adviser for a managed fund that invests in
Australian resources shares, you must advise clients on the funds strategy of passive investment. Analyse and explain the concept of passive investment to your client , and describe how the fund manager uses an index fund to achieve a specific performance outcome. (LO 6.1) a. Passive investment involves the selection of shares in an investment portfolio based on shares included in a published stock market index, that is, a managed fund share portfolio is structured to replicate a specific share market index. b. An index is a grouping of shares listed on a stock exchange that shows changes in the overall prices of those shares day to day. c. Each stock market has its own set of indices. Well known international indices include the Dow Jones Industrial Average (USA), FTSE (UK), Nikkei 225 (Japan), and Hang Seng (Hong Kong). If a passive investor wishes to obtain returns on a share portfolio equal to the return achieved by the Dow Jones then the investor will purchase the thirty stocks included in that index. d. Another investor may replicate a sector index such as the telecommunications sector, or the industrials sector. e. A number of managed funds are index funds. Index funds use a range of sophisticated techniques to replicate or track the share market, including full or partial replication of a specified stock market index. f. Full replication occurs when a funds manager purchases all the stocks included in an index. However, with a large index such as the S&P500, the funds manager may only hold a percentage of the 500 stocks, so long as sufficient stocks are held to ensure the portfolio fundamentally tracks the index. g. The funds manager buys and sells shares in order to maintain the replication of the index over time 4.