Stable fund
Questions:
1.Identify the major asset classes that are likely to feature in each of the types of managed funds listed below. In addition, propose and briefly justify a “typical” asset allocation for each type of fund.
2.Identify the major asset classes that are likely to feature in each of the types of managed funds listed below. In addition, propose and briefly justify a “typical” asset allocation for each type of fund.
3.What is the duration, modified duration and dollar duration of this bond?What will be the estimated price change on the bond if interest rates increase by 0.10 per cent (10 basis points)?
4.Assume that the dividend is expected to grow at 20 per cent for the next 3 years and then settle down to 8 per cent per year. What price would the share sell for today?
1.Benchmark index for tracking the performance of securities/stock exchange
Australia – S&P/ASX 50
USA – NYSA Arca Major market Index
Hong Kong – Hang Seng Index
Japan – Nikkei 225
England – FTSE 100
China – SSE Composite Index
Major asset classes and asset allocation
Stable fund – the stable fund is more conservative investment which is aimed at outperformance of cash and boosting the returns through blending the cash with specific shares. Main goal of various investors are to increase the cash without increasing the considerable risk (Huang, Li & Shi, 2016). The major asset class under stable fund is cash that includes term deposits, bank deposits, cash management trusts and cheque and savings accounts. This is suitable for the investors those have the short-term preference and lower risk tolerance level. It offers low and stable risk income, generally in form of the regular payments of interest equally. Under stable fund the potential return as well as the risks both is low. No minimum timeframe is recommended for this fund.
Balanced fund – the balanced fund invests in the combination of specific selected fixed incomes, shares and the commodity investments in Australia and international market for providing long-term growth without much downs and ups. The major asset class under balanced fund is fixed interest that includes corporate bonds, government bonds, hybrid securities and mortgage securities (Samudhram, Siew, Sinnakkannu & Yeow, 2016). It is more volatile as compared to the cash, still it can be considered as relatively stable. It operates generally in the same way of loan. Return on income is normally in form of regular payment of interest for the agreed time period. Recommended time frame for this asset is minimum 1 to 3 years. Under stable fund the potential return as well as the risks both is moderate.
Balanced fund
Growth fund – the growth fund’s main objective is to offer long term growth of capital through investing in the high quality and large Australian organizations. It offers well-diversified investing portfolio in wide range of the industry sectors. The major asset class under growth fund is property that includes direct investment in commercial, residential and industrial property and the indirect investment like vehicles. It may also include equities that include international equities and Australian equities. Growth funds generally has the high return as well as the risk involved is high (Bateman et al., 2014) The property is of long term nature, generally 7 years or more and the exit and entry cost involved with this is considerably high. The returns under equity fund include the capital loss or growth and the income through the dividends. Further, the equities are considered to be most volatile class of asset over the long term time frame. However, it involves the part ownership for any company that enables the investor to share profits and the future growth.
Typical asset allocation
|
Asset class |
High growth |
Growth |
Diversified Socially responsible |
Balanced fund |
Stable fund |
|
Australian equities |
30% |
22% |
26% |
16% |
6% |
|
International equities |
37% |
29% |
24% |
21% |
7% |
|
Alternatives |
28% |
28% |
26% |
28% |
29% |
|
Fixed income |
0% |
10% |
18% |
20% |
20% |
|
Cash |
5% |
10% |
6% |
15% |
38% |
|
Total |
100% |
100% |
100% |
100% |
100% |
Justification for asset allocation
For allocating the assets, an active strategy is adopted to avail the advantages from the market conditions through temporary decreasing or increasing the exposures to the particular class of asset. This will help in protecting the investors from the risks of overexposures to the expensive market and get the additional return through increasing the exposures to class of assets while they will be attractive.
2.Taking into consideration the 1st derivative of the bond or any security that offers fixed income, the price (P) with regard to the yield to maturity (R) delivers the following –
(dP/P) / [dR/(1+R)] = – D
Economic interpretation of the above equation is D is the measure of percentage change in price of the bond for the given change in percentage with respect to yield to maturity that is the interest elasticity (Khalil et al., 2014). Further, the above equation can be written as follows for providing the practical application –
dP = -D[dR/(1+R)] P
To be stated in other ways, if the duration factor is known, the change in the bond price owing to the small changes in the rate of interest, R, may be forecasted through the above formula.
Duration
Duration of the treasury bond of $ 1,000 that is paying the semi-annual coupon rate of 10% per annum and selling at par at present with 11 years of maturity will be as follows –
|
Period |
Cash flow |
Period*cash flow |
PV of $1 @ 5% |
PV of cash flow |
|
1 |
$ 50.00 |
$ 50.00 |
0.95238 |
$ 47.62 |
|
2 |
$ 50.00 |
$ 100.00 |
0.90703 |
$ 90.70 |
|
3 |
$ 50.00 |
$ 150.00 |
0.86384 |
$ 129.58 |
|
4 |
$ 50.00 |
$ 200.00 |
0.82270 |
$ 164.54 |
|
5 |
$ 50.00 |
$ 250.00 |
0.78353 |
$ 195.88 |
|
6 |
$ 50.00 |
$ 300.00 |
0.74622 |
$ 223.87 |
|
7 |
$ 50.00 |
$ 350.00 |
0.71068 |
$ 248.74 |
|
8 |
$ 50.00 |
$ 400.00 |
0.67684 |
$ 270.74 |
|
9 |
$ 50.00 |
$ 450.00 |
0.64461 |
$ 290.07 |
|
10 |
$ 50.00 |
$ 500.00 |
0.61391 |
$ 306.96 |
|
11 |
$ 50.00 |
$ 550.00 |
0.58468 |
$ 321.57 |
|
12 |
$ 50.00 |
$ 600.00 |
0.55683 |
$ 334.10 |
|
13 |
$ 50.00 |
$ 650.00 |
0.53032 |
$ 344.71 |
|
14 |
$ 50.00 |
$ 700.00 |
0.50507 |
$ 353.55 |
|
15 |
$ 50.00 |
$ 750.00 |
0.48102 |
$ 360.77 |
|
16 |
$ 50.00 |
$ 800.00 |
0.45811 |
$ 366.49 |
|
17 |
$ 50.00 |
$ 850.00 |
0.43630 |
$ 370.86 |
|
18 |
$ 50.00 |
$ 900.00 |
0.41552 |
$ 373.97 |
|
19 |
$ 50.00 |
$ 950.00 |
0.39573 |
$ 375.94 |
|
20 |
$ 50.00 |
$ 1,000.00 |
0.37689 |
$ 376.89 |
|
21 |
$ 50.00 |
$ 1,050.00 |
0.35894 |
$ 376.89 |
|
22 |
$ 1,050.00 |
$ 23,100.00 |
0.34185 |
$ 7,896.74 |
|
Total |
$ 13,821.15 |
Growth fund
Therefore, the duration will be ($ 13,821.15/$ 1,000) / 2 = 6.91
Modified duration –
Modified duration = D / (1 + R/2)
= 6.91 / (1+ 0.10/2) = 6.581
Dollar duration –
Dollar duration = MD * P = 6.581 * $1,000 = $ 6,581
Estimated price change if –
Interest rate increases by 10 basis point that is, 0.10%
Estimated price change = – dollar duration * change in rate
= – 6,581 * 0.001 = – $ 6.581
Therefore, the new prices will be $ 1,000 – $ 6.581 = $ 993. 419
Interest rate decreases by 20 basis point that is, 0.20%
Estimated price change = – 6,581 * – 0.002 = $ 13.162
Therefore, the new price will be $ 1,000 + $ 13.162 = $ 1,013.162
|
Rate change |
Estimated price |
Actual price |
Error |
|
+0.001 |
$993.419 |
$993.369 |
0.099 |
|
-0.002 |
$1,013.162 |
$1,013.364 |
-0.203 |
Current price of the share –
P0 = ?, D = 0.20, g = 0.08, R = 0.16
P0 = D1 / (R – g)
= $0.20 (1.08)1 / (0.16 – 0.08)
= $0.216 / 0.08 = $ 2.7
Share price in 5 years –
P5 = D6 / (R – g)
= $0.20 (1.08)6 / (.16 – .08)
= $0.20 * 1.587 / 0.08
= $3.9675
Under non-constant growth –
The dividend is expected to grow at the rate of 205 for next three years and thereafter it will settle down at 8% per year.
Price of the stock at year 3 will be –
P3 = D3 (1 + g) / (R – g)
= D0 (1 + g1)3 (1 + g2) / (R – g)
= $0.20(1.20)3(1.08) / (.16 – .08)
= 0.373 – 0.08
P3 = $ 4.666
The stock’s price today will be the PV of 1st three dividends plus PV of the year three stock price. Therefore, the stock price today will be –
P0 = $0.20(1.20) / 1.16 + $0.20 (1.20)2 / (1.16)2 + $0.20 (1.20)3 / (1.16)3 + $4.666 / (1.16)3
= 0.207 + 0.214 + 0.221 + 2.989 = $ 3.631
References
Bateman, H., Deetlefs, J., Dobrescu, L. I., Newell, B. R., Ortmann, A., & Thorp, S. (2014). Just interested or getting involved? An analysis of superannuation attitudes and actions. Economic Record, 90(289), 160-178.
Bodie, Z. (2013). Investments. McGraw-Hill.
Huang, H., Li, M., & Shi, J. (2016). Which matters:“Paying to play” or stable business relationship? Evidence on analyst recommendation and mutual fund commission fee payment. Pacific-Basin Finance Journal, 40, 403-423.
Hyman, J., Dor, A. B., Dynkin, L., Horowitz, D., & Xu, Z. (2014). Coupon Effects on Corporate Bonds: Pricing, Empirical Duration, and Spread Convexity. The Journal of Fixed Income, 24(3), 52-63.
Jordan, B. (2014). Fundamentals of investments. McGraw-Hill Higher Education.
Khalil, R., Al Horani, M., Yousef, A., & Sababheh, M. (2014). A new definition of fractional derivative. Journal of Computational and Applied Mathematics, 264, 65-70.
Samudhram, A., Siew, E. G., Sinnakkannu, J., & Yeow, P. H. (2016). Towards a new paradigm: Activity level balanced sustainability reporting. Applied ergonomics, 57, 94-104.
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