After selling 12.75 million shares in Alibaba’s IPO founder Jack Ma received $86
ID: 2718255 • Letter: A
Question
After selling 12.75 million shares in Alibaba’s IPO founder Jack Ma received $867m which he wishes to invest wisely. He has contacted three young and very eager investment managers to research the market opportunities and propose an optimal investment portfolio. The best candidate will have the chance to become Ma’s wealth manager. Ma will not hire candidates that propose either inefficient or infeasible portfolios. Assume that all securities are priced according to the CAPM and that the risk free rate is 2%. The expected excess return on the market portfolio is 8% and the standard deviation is 20%. The three candidates proposed portfolios with the following characteristics: Expected Return Standard Deviation Candidate: Bo Expected Return: 8% Standard Deviation: 10% Candidate: Michael Expected Return: 12% Standard Deviation: 25% Candidate: Aditi Expected Return: 13% Standard Deviation: 30% 1. Who do you think will be hired by Ma and why? 2. How can the expected return of the wining portfolio be achieved? Specify the amount invested in each asset/portfolio of assets? 3. What is the beta of the winning portfolio? 4. If Ma holds his position for one year what is the total amount of money he expects to earn on his investment? Show all of your calculations and explain your approach.
Explanation / Answer
1) The Portfolios suggested by the candidates are plotted below:
Examining the values of expected return and risk of the three proposed portfolios, no portfolio is dominating the other, in the sense that none of the portfolios when compared with the other two, gives a higher return for the same risk or gives the same return for lesser risk.
Given such a situation it should be trade off between risk and return that Ma wants. How much risk he is willing to take for a particular return. This again would depend on the investment objective of Ma and his attitude towards risk taking.
However, the portfolio suggested by Bo gives better return per unit of standard deviation. In the absence of information on Ma's investment objective and risk assumption, it may be taken that Ma would select Bo.
3) The proportion of assets cannot be worked out in the absence of information about Ma's investment objective and risk assumption.
4) To find beta, the Correlation Co-efficient of the return of the portfolio with the return of the market is required, which is not available.
5) Total earnings cannot be worked out in the absence of information to find out (3) above.
Candidate Portfolio expected return - % Portfolio std deviation - % Bo 8 10 Michael 12 25 Aditi 13 30 Market 10 20