Please do this in APA format and save my semester for me.... Please review the c
ID: 2383639 • Letter: P
Question
Please do this in APA format and save my semester for me....
Please review the case study from chapter 10. In a 2-3 page analysis, answer the questions at the end of the case study. Be sure to compose your analysis in APA format with a title page, introduction, conclusion and references cited in text and in the reference section.
Case Study:
You recently graduated from college, and your job search led you to East Coast Yachts. Because you felt the company's business was seaworthy, you accepted a job offer. The first day on the job, while you are finishing your employment paperwork, Dan Ervin, who works in Finance, stops by to inform you about the company's 401(k) plan. A 401(k) plan is a retirement plan offered by many companies. Such plans are tax- deferred savings vehicles, meaning that any deposits you make into the plan are deducted from your current pretax income, so no current taxes are paid on the money. For example,assume your salary will be $50,000 per year. If you contribute $3,000 to the 401(k) plan, you will pay taxes on only $47,000 in income. There are also no taxes paid on any capital gains or income while you are invested in the plan, but you do pay taxes when you with-draw money at retirement. As is fairly common, the company also has a 5 percent match.This means that the company will match your contribution up to 5 percent of your salary, but you must contribute to get the match. The 401(k) plan has several options for investments, most of which are mutual funds. A mutual fund is a portfolio of assets. When you purchase shares in a mutual fund, you are actually purchasing partial ownership of the fund's assets. The return of the fund is the weighted average of the return of the assets owned by the fund, minus any expenses. The largest expense is typically the management fee, paid to the fund manager. The management fee is compensation for the manager, who makes all of the investment decisions for the fund. East Coast Yachts uses Bledsoe Financial Services as its 401(k) plan administrator. Here are the investment options offered for employees:
Company Stock
One option in the 401(k) plan is stock in East Coast Yachts. The company is currently privately held. However, when you interviewed with the owner, Larissa Warren, she informed you the company was expected to go public in the next three to four years. Until then, a company stock price is simply set each year by the board of directors.
Bledsoe S&P 500 Index Fund
This mutual fund tracks the S&P 500. Stocks in the fund are weighted exactly the same as the S&P 500. This means the fund return is approximately the return on the S&P 500, minus expenses. Because an index fund purchases assets based on the composition of the index it is following, the fund manager is not required to research stocks and make investment decisions. The result is that the fund expenses are usually low. The Bledsoe S&P 500 Index Fund charges expenses of .15 percent of assets per year.
Bledsoe Small-Cap Fund
This fund primarily invests in small-capitalization stocks. As such, the returns of the fund are more volatile. The fund can also invest 10 percent of its assets in companies based outside the United States. This fund charges 1.70 percent in expenses.
Bledsoe Large-Company Stock Fund
This fund invests primarily in large- capitalization stocks of companies based in the United States. The fund is managed by Evan Bledsoe and has outperformed the market in six of the last eight years. The fund charges 1.50 per- cent in expenses.
Bledsoe Bond Fund
This fund invests in long-term corporate bonds issued by U.S.– domiciled companies. The fund is restricted to investments in bonds with an investment grade credit rating. This fund charges 1.40 percent in expenses.
Bledsoe Money Market Fund
This fund invests in short-term, high–credit quality debt instruments, which include Treasury bills. As such, the return on the money market fund is only slightly higher than the return on Treasury bills. Because of the credit quality and short-term nature of the investments, there is only a very slight risk of negative return. The fund charges .60 percent in expenses.
What advantages do the mutual funds offer compared to the company stock?
Assume you decide you should invest at least part of your money in large-capitalization stocks of companies based in the United States. What are the advantages and disadvantages of choosing the Bledsoe Large-Company Stock Fund compared to the Bledsoe S&P 500 Index Fund?
The returns on the Bledsoe Small-Cap Fund are the most volatile of all the mutual funds offered in the 401(k) plan. Why would you ever want to invest in this fund? When you examine the expenses of the mutual funds, you will notice that this fund also has the highest expenses. Does this affect your decision to invest in this fund?
A measure of risk-adjusted performance that is often used is the Sharpe ratio. The Sharpe ratio is calculated as the risk premium of an asset divided by its standard deviation. The standard deviations and returns of the funds over the past 10 years are listed here. Calculate the Sharpe ratio for each of these funds. Assume that the expected return and standard deviation of the company stock will be 16 percent and 65 percent, respectively. Calculate the Sharpe ratio for the company stock. How appropriate is the Sharpe ratio for these assets? When would you use the Sharpe ratio? Assume a 3.2 percent risk-free rate.
What portfolio allocation would you choose? Why? Explain your thinking carefully.
Explanation / Answer
What advantages do the mutual funds offer compared to the company stock?
The biggest advantage the mutual funds have is instant diversification. The mutual funds have a number of assets in the portfolio. Diversification can reduce your overall investment risk by spreading your risk across many different assets. With a mutual fund you can diversify your holdings both across companies and across asset classes. Moreover, there are conveniences, low transaction costs, professional management… just named a few.
Assume you decide you should invest at least part of your money in large-capitalization stocks of companies based in the United States. What are the advantages and disadvantages of choosing the Bledsoe Large-Company Stock Fund compared to the Bledsoe S&P 500 Index Fund?
the advantage of the actively managed fund is the possibility of outperforming the market, which the fund has done over the past ten years. The major disadvantage is the likelihood of underperforming the market. In general, most mutual funds do not outperform the market for an extended period of time, and finding the funds that will outperform the market in the future beforehand is a daunting task. One factor that makes outperforming the market even more difficult is the management fee charged by the fund.
The returns on the Bledsoe Small-Cap Fund are the most volatile of all the mutual funds offered in the 401(k) plan. Why would you ever want to invest in this fund? When you examine the expenses of the mutual funds, you will notice that this fund also has the highest expenses. Does this affect your decision to invest in this fund?
The returns are the most volatile for the small cap fund because the stocks in this fund are the riskiest. This does not imply the fund is bad, just that the risk is higher, and therefore, the expected return is higher. You would want to invest in this fund if your risk tolerance is such that you are willing to take on the additional risk in expectation of a higher return.
The higher expenses of the fund are expected. In general, small cap funds have higher expenses, in large part due to the greater cost of running the fund, including researching smaller stocks.
A measure of risk-adjusted performance that is often used is the Sharpe ratio. The Sharpe ratio is calculated as the risk premium of an asset divided by its standard deviation. The standard deviations and returns of the funds over the past 10 years are listed here. Calculate the Sharpe ratio for each of these funds. Assume that the expected return and standard deviation of the company stock will be 16 percent and 65 percent, respectively. Calculate the Sharpe ratio for the company stock. How appropriate is the Sharpe ratio for these assets? When would you use the Sharpe ratio? Assume a 3.2 percent risk-free rate.
Risk-Risk-free rate = (.0486 + .0480 + .0598 + .0333 +.0161 +.0094 +.0114 + .0279 + .0497 + .0452) / 10
Risk-free rate = .0349 or 3.49%
The Sharpe ratio for each of the mutual funds and the company stocks are:
Bledsoe S&P 500 Index Fund = (11.48% – 3.49) / 15.82% = .5048
Bledsoe Small-Cap Fund = (16.68% – 3.49) / 19.64% = .6714
Bledsoe Large Company Stock Fund = (11.85% – 3.49) / 15.41% = .5422
Bledsoe Bond Fund = (9.67% – 3.49) / 10=.2072
What portfolio allocation would you choose? Why? Explain your thinking carefully
The asset allocation depends on the risk tolerance of the individual. However, most students will be young, so in this case, the portfolio allocation should be more heavily weighted toward stocks. In any case, there should be little, if any, money allocated to the company stock. The principle of diversification indicates that an individual should hold a diversified portfolio. Investing heavily in company stock does not create a diversified portfolio. This is especially true since income comes from the company as well. If times get bad for the company, employees face layoffs, or reduced work hours. So, not only does the investment perform poorly, but income may be reduced as well. We only have to look at employees of Enron or WorldCom to see the potential for problems with investing in company stock. At most, 5 to 10 percent of the portfolio should be allocated to company stock. Age is a determinant in the decision. Older individuals should be less heavily weighted toward stocks. A commonly used rule of thumb is that an individual should invest 100 minus their age in stocks. Unfortunately, this rule of thumb tends to result in an underinvestment in stocks