QUESTION ONE a). Technological changes have decreased the cost and increased the
ID: 2789374 • Letter: Q
Question
QUESTION ONE
a). Technological changes have decreased the cost and increased the speed of information dissemination in security markets. Why might one suspect that firms following the "traditional" approach to investment management would find it increasingly difficult to identify and acquire underpriced securities in this environment? (9 marks)
b). You have the following advice from two different advisors.
Advisor 1: "Longterm-asset allocation should be determined using an efficient frontier. Returns risks and correlations can be determined for each asset class from historical data. After calculating the efficient frontier for various locations, you should select the asset mix on the efficient frontier that best meets your fund's risk tolerance."
Advisor 2: "History gives no guide to the future. For example/everybody agrees that bond risk has increased above historical levels as a result of financial deregulation. A far better approach to the long-term asset allocation is to use your best judgment about expected returns on the various asset classes based on current. You should rely on your experience to determine the best asset mix and avoid being influenced by computer printouts. "
Advisor 1: Rebuttal: "Current market conditions are not likely to persist into the future and are not appropriate for long-term asset allocation decisions. Moreover, your use of judgment and experience can be influenced by biases and emotions and is not as rigorous a method as my efficient frontier approach."
Required: Evaluate the strength and weaknesses of each of the two approaches presented above. Recommend and justify an alternative process for asset allocation that draws from the strength of each approach and corrects their weaknesses. (16 marks)
Explanation / Answer
Solution a): i) The continues development in technology have great effects on market at many level. New technology development is providing ability that otherwise the existing traders would offer.
ii) Understanding vast amount of data to make investment decisions and rapidly taking various trading decisions are the among the benefits the new technology is providing to traders.
iii) The performance of financial service sector has changed due to rise in digital technology like banks are providing various financial planning and trading applications that help the investors to make there investment decisions wisely.
iv) Due to technology development people and devices are interconnected and merging of real time data is providing traders to use that data to make decisions.
Therefore we can say firms following "traditional" approachs for investment managment which is time consuming and restricted will find it difficult to identify and acquire under priced security.
Solution b) : I) Strenghts and weaknesses to advise first:
Strenghts: This approch will very useful to make comparative analysis for making long term asset allocation. Comparing the risk, return and correlation of each asset class will help in making statistical analysis and accordingly the final decision can be made.
Weaknesses: It will be time consuming therefore not recommented for making quick decisions.
ii) Strenghts and weaknesses of advice second:
Strenght: Completely depending on own experience will be less time consuming. Considering the outcomes ( positive or negative) of past decisions will currently help in making quick decision. Also with time situation changes therefore it is not necessary that what others have experienced in their past will certainly be current scenario.
Weakness: Only self reliance can sometimes lead to risky situations. Considering the experience of others that is considering the historical outcomes will have will better decision making.
Therefore considering the above strenghts and weaknesses of various advisor it is recommended to pursue the advise given by advisor 1.