INV4801/101

ASSIGNMENT # 01

Unique Number: 301901

Due date: Friday, 31 May 2024, 11:00 PM

Aim: To evaluate your knowledge of some of the fundamental aspects of Chapter 1 to Chapter 10. Answer the
following questions and submit your assignment at https://my.unisa.ac.za

All responses must be typed, and handwritten answers will not be considered.

Question 1 [25 marks]

Sparkling Waters Ltd. is a South African based manufacturer. Sparkling Waters Ltd sponsors a defined-benefit
pension plan. The plan’s assets are invested in a broadly diversified portfolio of government and investment grade
corporate bonds. Pension plan participants include both active workers and retirees. Pension benefit payments are
not adjusted for inflation. The duration and market value of the pension plan’s assets are equal to the duration and
market value of the plan’s projected benefit obligation (PBO). Sparkling Waters Ltd believes that it has adequate
financial strength and profitability to maintain annual pension contributions based on the pension plan’s features
and Sparkling Waters’ workforce characteristics.

Sparkling Waters Ltd recently established the Mago Anoruma Foundation (MAF), a company-sponsored
foundation. MAF’s mandate from Sparkling Waters Ltd is to promote sustainable living through education and
research on renewable resources. MAF employs one person to administer grant applications but does not employ
full-time investment professionals. Sparkling Waters Ltd donated R10 million to MAF. Sparkling Waters does not
plan to make additional donations to MAF in the foreseeable future, although MAF is permitted to accept donations
from others. MAF is not restricted to spending only investment income. MAF’s board retains Erika Mashanda, an
investment advisor, to make recommendations for its endowment fund. After meeting the board, she summarizes
her understanding of MAF’s investment objectives and related information as follows:

• MAF’s board intends to make annual distributions equal to 6.5% of its average asset market value.
• The board adopted a goal to increase the value of the endowment by seeking a rate of return exceeding the
rate needed to maintain the real purchasing power of the portfolio.
• MAF’s investment policy limits the amount that can be invested in any single issuer’s securities to no more than
4% of the portfolio.
• MAF’s annual investment management expenses are 0.77% of assets.
• The annual rate of inflation is expected to be 6% for MAF’s overheads and costs in the fields of education and
research that MAF supports.

a) Formulate MAF’s return objective for next year. Show your calculations. (4)

b) Explain why the multiplicative approach to calculating the return objective is more precise than the additive
approach in a multi-period set up. (2)

c) Within the context of asset allocation, discuss the investment constraints that MAF is facing. Using not more
than 5 asset classes, advice on the most appropriate asset allocation for MAF. Justify your allocation. (15)

N/B: This question is not about formulating an investment policy statement. No marks will be awarded for not
responding to the question directly.

Use the following information for Questions (e) through (g).

Tebogo Kekana and Awelani Mudawu are portfolio managers for the largest mutual fund of Liberty Financial
Advisers. Liberty Financial Advisers provides a variety of mutual funds for both individuals and institutions. Kekana
has been a portfolio manager for eight years and has seen both bull and bear markets. Mudawu is his assistant

Open Rubric
and has been at Liberty Financial Advisers for the two years following his graduation from a prestigious Masters in
Finance program.

In their discussion over lunch, Kekana and Mudawu discuss the latest quarterly earnings announcements for
several firms in their portfolio. Despite optimistic projections for a few firms, most announcements were quite
disappointing. Mudawu though states that he is not convinced that their prospects are as grim as the
announcements suggest.

The next day, Kekana and Mudawu do a presentation for to Liberty Financial Advisers’ clients. Their guest
presenter is Ramuduguani Mpofu, an economist at the local university who frequently provides economic
commentary for national media outlets. During his presentation, Mpofu states that it is likely that South Africa will
enter a recession next year. He recommends that the clients shift their assets into investment grade bonds and
non-cyclical stocks. He states that he has been successful in predicting recessions over the past 20 years and is
certain of his forecasts. He states further that the only time he has been wrong in predicting the business cycle was
when the government unexpectedly increased spending beyond that expected. He states that if that had not
happened, his prediction of a mild recession would have been correct, instead of the mild expansion that actually
occurred.

During the afternoon session, Kekana discusses the various strategies at Liberty Financial Advisers. In the
value/neglected firm strategy, Liberty Financial Advisers seeks out firms trading at reasonable valuations with no
analyst following. Kekana states that several academic studies have shown these firms to be good investments
over a 5-year time horizon for the period from July in year t = 0 to June 30 of year t =+5. Kekana states that he has
adopted this strategy for his portfolio.

d) Describe the psychological trap that affects Mudawu. (2)

e) Discuss behavioral characteristics that Mpofu exhibit in this case. (2)

Question 2 [25 marks]

Tsaurai Makina, CFA, a senior analyst at JOSIE Investments, is reviewing the investment policy statements (IPS)
of two new JOSIE clients. The first client, Kelvin Pfende, is a 45-year-old seasoned investor who prefers to take a
strategic approach to allocating his assets. The second client, Benjie Manjengwa, is a 22-year-old recent college
graduate who believes in monitoring his portfolio on a daily basis and capitalizing on perceived mispricings.
Pfende has just moved his account from Aggressive Investments (AI) to JOSIE because he was uncomfortable with
the 12% return AI was promising their clients. Pfende knew that this return was only achievable with an increased
level of risk-taking. Makina interviews Pfende over the phone and inquires about his spending rate and his risk
aversion score on a scale of 1 to 10, with 10 indicating the lowest tolerance for risk. Pfende thinks that 3% should
about cover his spending needs on an annual basis and believes that his risk aversion score would be 8 out of 10.
Manjengwa has just opened his first investments account through JOSIE. JOSIE services were recommended to
him by one of his college finance professors. Although he would like to manage his own investments, Manjengwa’s
new job requires him to work 60 hours a week leaving him little time to day trade for his own account. For this
reason, Manjengwa has handed investing responsibilities to JOSIE and consequently, Makina. Makina asks
Manjengwa the same two questions that he asked Pfende. Manjengwa thinks 5% is enough to cover his spending
needs and rates his risk aversion score at 2 out of 10.
Makina begins to select a static asset allocation for each investor given the information he gathered from both
interviews. His first step entails specifying asset classes. Makina believes that the set of asset classes should
provide a high level of diversification and they should have a large percentage of liquid assets. However, he does
not think that a majority of all possible investable assets need to be included in a given portfolio or that assets need
to be classified into more than one class.
Makina then creates four portfolios and calculates their expected returns, standard deviations, and Sharpe ratios.
The portfolios are as follows:

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 INV4801/101

Corner Portfolio Exp. Return Exp Std. Dev Sharpe Ratio

1 6.50% 5.95% 0.756
2 7.25% 8.30% 0.633
3 8.00% 11.15% 0.538
4 8.75% 14.25% 0.474

a) Given an expected inflation rate of 2.5% and a tax rate of 25% for both Pfende and Manjengwa, what are the
minimum before-tax return requirements for both investors? (6)

b) Based only on Manjengwa’s risk-adjusted expected returns for the asset allocations and a threshold level of
6%, which asset allocation would Manjengwa prefer? (4)

c) Recommend and justify a strategic asset allocation for Manjengwa (6)

d) Given the four corner portfolios that Makina developed, calculate the standard deviation of a portfolio that can
achieve an expected return of 8.1%. (5)

e) Assuming no constraint against leverage, determine the weights that should be invested in the risk-free asset
and the tangency portfolio to achieve an expected return of 8.1%. (4)

©
UNISA 2024
 INV4801/101

ASSIGNMENT # 01

Unique Number: 301901

Due date: Friday, 31 May 2024, 11:00 PM

Question 1 [25 marks]

a) Formulate MAF’s return objective for next year. Show your calculations. (4)

The minimum objective for foundation return includes: the 6.5% annual rate of spending that is planned √,
plus investment management expenses of 0.77%√, and the 6% rate of inflation that is expected√.

Multiplicative approach: (1.065 × 1.0077 × 1.06) −1 = 13.76%.

Additive approach: 6.5% + 0.77%+ 6% = 13.27%.√

b) Explain why the multiplicative approach is more precise than the additive approach in a multi-period set up?
(2)

The multiplicative approach is more precise because it accounts for the effect of compounding √ in a multi-
period setting. The additive approach is an approximation. √

c) Within the context of asset allocation, discuss the investment constraints that MAF is facing. Using not more
than 5 asset classes, advice on the most appropriate asset allocation for MAF. Justify your allocation.
(15)

N/B: This question is not about formulating an investment policy statement. No marks will be awarded for not
responding to the question directly.

MAF needs liquidity equal to its planned, annual spending (6.5%), plus the expenses of generating
investment earnings (0.77%), less contributions. MAF does not expect contributions from Sparkling Waters
in the foreseeable future. Therefore, MAF’s liquidity requirement amounts to 6.5.00% + 0.77% = 7.27% √ of
assets: 7.27% x R10 million√ = R727, 000√. Which increase annually at the rate of inflation.

Time horizon: Long√ term as MAF is only permitted to spend investment income. √

Tax: If MAF is a charitable foundation it is not taxed √but if it is a private foundation and does not meet the
specifications of a charitable organization it will be taxed. √

Legal: None√

Unique circumstances: MAF can accept donations from other institutions. √

20% Equities, 30%government coupon bonds, 30% corporate coupon bonds, 10% cash, 10%
Derivatives.

1. Conversative √
2. Skewed toward income earning fixed income securities. √
3. Less than 30% of equities and derivatives√√
4. At least 5% cash √
5. Well diversified portfolio √
d) Describe the psychological trap that affects Mudawu (2)

Mudawu uses anchoring√. Despite the disappointing earnings announcements, he states that he is not
convinced that the firms’ prospects are as grim. He under-adjusts√ to new information because his
beliefs about the firms are anchored in his previous optimistic forecasts.

e) Discuss two behavioral characteristic that Mpofu exhibit in this case. (2)

Mpofu is overconfident. He states that he is certain of his forecasts and reports a remarkable (and
perhaps not fully disclosed) performance record. √

When professionals are overconfident, they tend to be susceptible to cognitive dissonance. The
professional will ignore information that conflicts with his image of being successful. Mpofu admits
only one past forecasting mistake in 15 years, which he then blames on an event outside of his control.
√

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 INV4801/101

Question 2 [25 marks]

a) Given an expected inflation rate of 2.5% and a tax rate of 25% for both Pfende and Manjengwa, what are the
minimum before-tax return requirements for both investors? (6)

Manjengwa’s spending rate is estimated to be 5%. With an inflation rate of 2.5%, Manjengwa’s after-tax
return requirement is equal to [(1.05 × 1.025) – 1] = 7.625%. Given a tax rate of 25%, Manjengwa’s
before-tax return requirement is equal to [7.625% / (1 – 0.25)] = 10.17%. √ √ √

Pfende’s spending rate is estimated to be 3%. With an inflation rate of 2%, Pfende’s after-tax return
requirement is equal to [(1.03 × 1.025) – 1] = 5.575%. Given a tax rate of 25%, Pfende’s before-tax return
requirement is equal to [5.575% / (1 – 0.25)] = 7.433%. √ √ √

b) Based only on Manjengwa’s risk-adjusted expected returns for the asset allocations and a threshold level of
6%, which asset allocation would Manjengwa prefer? (4)

Given Manjengwa’s risk aversion score of 2, his utility-adjusted return would be:

UP = 6.50% – 0.005(2)(5.95²) = 6.15%√

UP = 7.25% – 0.005(2)(8.30²) = 6.56%√
UP = 8% – 0.005(2)(11.15²) = 6.75%√
UP = 8.75% – 0.005(2)(14.25²) = 6.72%√

All the portfolios meet the threshold, but the best Utility adjusted utility is achieved by portfolio 3.

c) Recommend and justify a strategic asset allocation for Manjengwa (6)

(6.5 – 6)/5.95 = 0.084 = 8.4%√

(7.25 – 6)/8.3 = 0.15 = 15%√
(8 – 6)/11.15 = 0.179 = 17.9%√
(8.75 – 6)/14.25 = 0.193 = 19.3%√

Portfolio Allocation 3 has the highest expected utility√, but Allocation 4 has a higher probability of meeting the
threshold 6% return than Allocation 3. Therefore, 4 would be the recommended portfolio for strategic asset
allocation. √

d) Given the four corner portfolios that Makina developed, calculate the standard deviation of a portfolio that can
achieve an expected return of 8.1%. (5)

An expected return of 8.1% lies between Corner Portfolios 3 and 4, with expected returns of 8% and
8.75%, respectively. First, determine the weight that should be invested in these two corner portfolios
to achieve the expected return.

8.1% = w3 × 8% + (1 – w3) × 8.75% √

W3 = 87%,√ therefore w4 = 13% √

The standard deviation of the portfolio is the weighted average of the standard deviations of Corner
Portfolios 3 and 4. SD = (0.87)(0.1115) + (0.13)(0.1425) = 11.55%√√

e) Assuming no constraint against leverage, determine the weights that should be invested in the risk-free asset
and the tangency portfolio to achieve an expected return of 8.1%. (4)
 With no constraint against borrowing the expected return is the weighted average of the risk-free asset
and the tangency portfolio. The tangency portfolio is the portfolio with the highest Sharpe ratio which
happens to be Portfolio 1. The expected return of Portfolio 1 is 6.5%. The weights in the risk-free asset
and the tangency portfolio are as follows:

Using the Sharpe Ratio to calculate the Risk-free rate: Rf = 6.5-(5.95%*0.756) = 2%√

8.1% = WRF × 2% + (1 – WRF) × 6.5% √

WRF = –36%, therefore WT= 136% √

In order to achieve the desired expected return of 8.1% with no constraint against leverage, 36% should
be borrowed at the risk-free rate√ and 136% should be invested in the tangency portfolio.

©
UNISA 2024

-4-
ASSIGNMENT 02 Due date: Monday, 12 August 2024, 11:00 PM
Unique number: 146663

Answer the following questions and submit your assignment at https://my.unisa.ac.za

1.

a) Abigail case scenario

Abigail Mpofu is a pension consultant at ZB Bank, she is asked to evaluate the historical
performance of the following portfolios:

• Portfolio A is highly diversified, with 100 stocks representing 75% of the total
portfolio.

• Portfolio B is highly diversified with over 400 stocks, none of which represent
more than 1% of the total portfolio.

• Portfolio C is a diversified portfolio of 70 stocks, with the top 10 names

representing 30% of the total portfolio.

• Treasury bill yield is 5%.

The following investment results were recorded during 2023:

Required return Standard deviation Actual return

Portfolio A 42% 1.2 21%

Portfolio B 25% 0.4 18%

Portfolio C 16% 0.2 33%

ZSE Index* 13% 0.5 ?

*ZSE Index represents the market portfolio.

a) Compute the Treynor and Jensen measures for portfolio A, B and portfolio C
respectively. (8)

b) Which portfolio had the best risk-adjusted performance in 2023. Justify your selection
with three supporting arguments. (11)
Abigail, was recently hired by the University of Chedungwa which has a USD 50 million
global diversified portfolio. In a meeting with the University’s CIO, the CIO asks Abigail
which multi-manager strategy, Fund-of-Fund and Multi-strategy Fund, provides better
liquidity and offers more downside risk protection. To address the CIO's concern
regarding downside risk, Abigail evaluates two optimization approaches to overall
portfolio construction:

• mean-variance optimization using a maximum asset class weight constraint

(constrained MVO)
• mean-conditional VaR optimization (mean-CVaR).

c) Which optimization approach would better address the CIO's concern? Justify your
response with three reasons. (6)

2. Reuel Tawananyasha scenario

As part of an attribution analysis Reuel Tawananyasha, CFA, has accumulated the

following partial data for his portfolio.

Portfolio Benchmark Portfolio Benchmark

Country Investments Weight Weight Return Return
Zimbabwe Stocks 10.84% 7.67% 16.50% 16.47%
Kenya Stocks 38.92% 42.35% 23.16% 25.43%
Nigeria Stocks 29.86% 31.16% 11.33% 12.85%
South Africa Stocks 20.38% 18.82% 20.00% 35.26%
Total 100.00% 100.00% 18.26% 22.67%

For payment of performance bonus, Tawananyasha prefers to use the 7% return of on

the broad market index as determined at the end of the year as a performance evaluation
benchmark.

i) Using the available data, calculate and explain the total allocation effects. (6)

ii) Using the available data, calculate and explain the total Sector allocation effects.
(6)

iii) Using the available data, calculate and explain the total allocation /selection
interaction. (6)

iv) Evaluate the validity of the benchmark that Tawananyasha utilizes in assessing
his performance. (7)
Godfrey Marozva, CFA
DEPARTMENT OF FINANCE, RISK MANAGEMENT AND BANKING

UNISA 2024
 INV4801/201/3/2024

Tutorial Letter 201/3/2024

Investments: Portfolio Management
INV4801
Semester Course

Department of Finance, Risk

Management and Banking

This tutorial letter contains important

information about your module.

Bar code
ASSIGNMENT 02 Due date:

Unique number:

1.

a) Compute the Treynor and Jensen measures for portfolio A, B and portfolio C respectively.
(8)

0.42−0.05
𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐴𝐴 = 0.13−0.05 =4.625 √

0.25−0.05
𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 = 0.13−0.05 =2.5

0.16−0.05
𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐶𝐶 = 0.13−0.05 = 1.375 √

Treynor measure
0.21−0.05
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑟𝑟𝐴𝐴 = 4.625
= 0.0346 √

0.18−0.05
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑟𝑟𝐵𝐵 = 2.5
= 0.052√

0.33−0.05
𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑟𝑟𝐶𝐶 = 1.375
= 0.204√

Jensen measure

𝐽𝐽𝐽𝐽𝐽𝐽𝐽𝐽𝐽𝐽𝑛𝑛𝐴𝐴 = [0.21 − 0.42] = −0.21√

𝐽𝐽𝐽𝐽𝐽𝐽𝐽𝐽𝐽𝐽𝑛𝑛𝐵𝐵 = [0.18 − 0.25] = −0.07 √

𝐽𝐽𝐽𝐽𝐽𝐽𝐽𝐽𝐽𝐽𝑛𝑛𝐶𝐶 = [0.33 − 0.16] = 0.17√

b) Which portfolio had the best risk-adjusted performance in 2023. Justify your selection with
three supporting arguments. (11)

Portfolio C has the best risk adjusted returns.

Supporting arguments:

0.42−0.05
𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝐴𝐴 = 1.2
= 0.133√√

0.25−0.05
𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝐵𝐵 = 0.4
= 0.325√√

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 INV4801/101

0.16−0.05
𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑐𝑐 = 0.2
= 1.400√√

Given that Portfolio C √√is more concentrated it had the highest excess return relative to total risk
(measured by the portfolio standard deviation). For every unit of standard deviation, C’s return was
higher. Treynor and Jensen Alpha measure for Portfolio C√√ were highest meaning portfolio C had
the highest return relative to its systematic risk (expressed as beta). However, we cannot rely on
these measures as they are more reliable for highly diversified portfolios√

c) Which optimization approach would better address the CIO's concern? Justify your response
with three reasons. (6)
• Mean–CVaR √√

Justification:

• better captures negative skewness OR high excess kurtosis√√

• CVaR shows the expected/average loss in a negative tail event (when the VaR threshold is
breached) √√

2)

i) Using the available data, calculate and explain the total allocation effects. (6)
Total allocation effect:

R Total allocation = ∑(𝑊𝑊𝑃𝑃𝑃𝑃 − 𝑊𝑊𝐵𝐵𝐵𝐵 )𝑅𝑅𝐵𝐵𝐵𝐵 √√

= (10.84% − 7.67%) ∗ 16.47% + (38.92% − 42.35%) ∗ 25.43% + (29.86% − 31.16%)

∗ 12.85% + (20.38% − 18.82%) ∗ 35.26%

= 0.0329% √√

Tawananyasha has added 3.29 basis points by overweighting an outperforming country i.e.
Zimbabwe and South Africa despite losing in Kenya and Nigeria as he underweighted a performing
benchmark. √√

ii) Using the available data, calculate and explain the total Sector allocation effects.
(6)

Total sector allocation effect:

3
R Total Sector Allocation = ∑ 𝑊𝑊𝐵𝐵𝐵𝐵 (𝑅𝑅𝑃𝑃𝑃𝑃 − 𝑅𝑅𝐵𝐵𝐵𝐵 ) √√

= (16.5% − 16.47%) ∗ 7.67% + (23.16% − 25.43%) ∗ 42.35% + (11.33% − 12.85%)

∗ 31.16% + (20.00% − 35.26%) ∗ 18.82%

= −4.30%√√

Chirume lost -430 basis points by selecting stocks in countries that underperformed the benchmark
i.e. Kenya, Nigeria and South Africa despite a slight outperformance from Zimbabwe. √√

iii) Using the available data, calculate and explain the total allocation /selection interaction.
(6)

Allocation/selection interaction effect:

R Alloc/Select = ∑(𝑊𝑊𝑃𝑃𝑃𝑃 − 𝑊𝑊𝐵𝐵𝑖𝑖 )(𝑅𝑅𝑝𝑝𝑝𝑝 − 𝑅𝑅𝐵𝐵𝐵𝐵 ) √√

= (10.84% − 7.67%) ∗ (16.50% − 16.47%) + (38.92% − 42.35%) ∗ (23.16% − 25.43%)

+ (29.86% − 31.16%) ∗ (11.33% − 12.85%) + (20.38% − 18.82%) ∗ (20% − 35.26%)

= −0,139%√√

Tawananyasha lost -13.9 basis points by significantly underperforming due to outweighing South
Africa stocks that were underperforming despite slight outperformance in Zimbabwe, Kenya and
Nigeria. √√

iv) Evaluate the validity of the benchmark that Tawananyasha utilizes in assessing his
performance. (7)

A broad market index benchmark passes all the tests of benchmark validity.

• The market index is measurable. √√

• The market index can be specified in advance. √√
• It is investable and can serve as a passive alternative to holding the account that is under
analysis. √√
• The identity of the market index is typically known; therefore, the benchmark is unambiguous.
√√
• It is appropriate as the investment style it represents adequately corresponds to the account
being evaluated. √√

Maximum of 7 marks

Prof. Godfrey Marozva, CFA, Ph.D

DEPARTMENT OF FINANCE, RISK MANAGEMENT AND BANKING

2024
©
UNISA

4
INV4801 ASSIGNMENT 1 OF 2023 [342518]

https://www.stuvia.com/doc/2817073/inv4801-assignment-1-of-
2023-342518

https://studypass.co.za/product/inv4801-assignment-1-2023-
342518/
 INV4801/201/3/2022

Tutorial Letter 201/3/2023

Investments: Portfolio Management
INV4801
Year Course

Department of Finance, Risk

Management and Banking

Assignment 1 Solutions

This tutorial letter contains important

information about your module.

Bar code
ASSIGNMENT 01

1. The Goveros

a) Within the context of asset allocation, discuss the investment constraints that the Goveros are
facing. Using not more than 5 asset classes, advice on the most appropriate asset allocation for
the Goveros. Justify your allocation. (20)

N/B: This question is not about formulating an investment policy statement. No marks will be
awarded for not responding to the question directly.

Time horizon: Overall, the Goveros’ ages and long life expectancies indicate a long time horizon. √ They
face a multistage horizon√, however, because of their changing cash flow and resource circumstances.
Their time horizon can be viewed as having three distinct stages: the next five years from now (some assets,
negative cash flow because of their daughter’s college expenses), the following five years (some assets,
positive cash flow), and beyond 10 years (increased assets from a sizable trust distribution, decreased
income because they plan to retire). √

Liquidity: The Goveros need R50,000 now to contribute to the college’s endowment fund√. Alternatively,
they may be able to contribute R50,000 of Ruvarashe’s low-cost-basis stock to meet the endowment
obligation√. In addition, they expect the regular annual college expenses (R40,000) to exceed their normal
annual savings (R25,000) by R15,000 √for each of the next five years. This relatively low cash flow
requirement of 2.7 percent (R15,000/R550,000 asset base after R50,000 contribution) can be substantially
met through income generation from their portfolio, further reducing the need for sizable cash reserves.
Once their daughter completes college, the Goveros’ liquidity needs should be minimal until retirement
because their income more than adequately covers their living expenses. √

Tax concerns: The Goveros are subject to a 30 percent marginal tax rate for ordinary income √and a 20
percent rate for realized capital gains√. The difference in the rates makes investment returns in the form of
capital gains preferable to equivalent amounts of taxable dividends and interest.

Although taxes on capital gains would normally be a concern to investors with low-cost-basis stock, this is
not a major concern for the Goveros because they have a tax loss carry-forward of R100,000. The Goveros
can offset up to R100,000 in realized gains with the available tax loss carry-forward without experiencing
any cash outflow or any reduction in asset base. √

Unique circumstances: The large holding of the low-basis stock in Ruvarashe’s company, a “technology
company with a highly uncertain future,” is a key factor to be included in the evaluation of the risk level of
the Goveros’ portfolio and the future management of their assets. In particular, the family should
systematically reduce the size of the investment in this single stock. √ Because of the existence of the tax
loss carry-forward, the stock position can be reduced by at least 50 percent (perhaps more depending on
the exact cost basis of the stock) without reducing the asset base to pay a tax obligation. √

Using not more than 5 asset classes, advice on the most appropriate asset allocation for the Goveros. Justify your
allocation.

20% Equities, 30%government bonds, 30% corporate bonds, 10% cash, 10% Derivatives.

1. Conversative √√
2. Skewed toward income earning fixed income securities. √√
3. Less than 30% of equities and derivatives√√
4. At least 5% cash √
5. Well diversified portfolio √

a) Describe the psychological trap that affects Mugabe (2)

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Mugabe uses anchoring. √ Despite the disappointing earnings announcements, he states

that he is not convinced that the firms’ prospects are as grim. He under-adjusts to new
information because his beliefs about the firms are anchored in his previous optimistic
forecasts. √

b) Discuss two behavioral characteristics that Machemedze exhibit in this case. (3)

Machemedze is overconfident. He states that he is certain of his forecasts and reports a

remarkable (and perhaps not fully disclosed) performance record. √

When professionals are overconfident, they tend to be susceptible to cognitive dissonance.

√The professional will ignore information that conflicts with his image of being successful.
Machemedze admits only one past forecasting mistake in 15 years, which he then blames on
an event outside of his control. √

2. Gweru Innovations

a) Calculate GI’s corporate pension plan surplus. (2)

Surplus = Market value of plan assets - Present value of plan liabilities

= $280 million - $300 million
= - $20 million√√

b) Explain how the plan surplus could increase in a given year despite an actual return in short of
the long-term return objective. (5)
The amount of surplus will increase when the present value of plan liabilities rises at a
slower pace than the market value of the assets. √√√ Alternatively, when the value of
assets decreases slower rate than the decrease in the value of liabilities. √√

c) Calculate the nominal required rate of return and determine the percentage that would be
invested in each of the asset class based on the most appropriate strategic asset allocation.
(12)

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 Nominal required rate of return = (1+5%) (1+3%)(1+0.7%)-1 = 8.91%√√ or 8.7%

Corner portfolios 3 and 4 are the corner portfolios to be used in determining the most
appropriate strategic asset allocation for the YAPs Foundation. The portfolio that satisfies
YAPs’s return and risk objectives must lie on the portion of the efficient frontier located
between corner portfolio 3 and corner portfolio 4.

Using the corner portfolio theorem and the expected returns for corner portfolio 3 and
corner portfolio 4, solve the following equation for w:

8.91 = 9.4w + 8.8(1 – w) √√

The solution yields:

w = 0.18√ and 1 – w = 0.82√ where w represents the weight allocated to corner portfolio 3.
Therefore, most appropriate strategic asset allocation is 0.18% in corner portfolio 3 and
82% in corner portfolio 4.

The percentage invested in Intermediate term RSA Bonds given the most appropriate
allocation equals the weighted average of the Intermediate term RSA Bonds allocations
in corner portfolios 4 and 5:

RSA Equities = 0.18 × 33.7% + 0.82 × 31.4% = 31.81% √

Non-RSA Equities = 0.18 × 12% + 0.82 × 12% = 12% √
Long-term RSA Bonds = 0.18 × 36.7% + 0.82 × 26.7% =28.5% √
Intermediate term RSA Bonds = 0.18 × 0.0% + 0.82 × 13% =10.66% √
Non-RSA Bonds = 0.18 × 0.0% + 0.82 × 0.0% = 0.00% √
Real Estate = 0.18 × 17.6% + 0.82 × 16.9% = 17.03%√

d) Assuming no constraint against leverage, determine the weights that should be invested
in the risk-free asset and the tangency portfolio to achieve an expected return of 8.5%.
(6)

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With no constraint against borrowing the expected return is the weighted average of the risk-
free asset and the tangency portfolio. The tangency portfolio is the portfolio with the highest
Sharpe ratio which happens to be Portfolio 1. The expected return of Portfolio 1 is 6.9%.The
weights in the risk-free asset and the tangency portfolio are as follows:

8.5% = wRF × 2% + (1 – wRF) × 6.9% √ √

wRF = –33%√, therefore wT= 133% √

In order to achieve the desired expected return of 8.5% with no constraint against leverage,
33% should be borrowed at the risk-free rate√ and 133% should be invested in the
tangency/risk portfolio. √

Prof. Godfrey Marozva, CFA, Ph.D

DEPARTMENT OF FINANCE, RISK MANAGEMENT AND BANKING

2023
© UNISA

5
ASSIGNMENT 02 Due date: Friday, 18 August 2023, 11:00 PM
Unique number: 355371

Answer the following questions and submit your assignment at https://my.unisa.ac.za

1.

a) Stacey case scenario

Tadiswa Mpofu and Abigail Cephas are portfolio managers for Stacey associates.
Mpofu and Cephas are currently evaluating the expected performance of portfolio
managers they have hired for a subset of their clients' portfolios. For this subset, Mpofu
and Cephas have decided to pursue a core-satellite approach. The data below show the
manager's active returns and active risk. Tatenda management uses a value oriented
approach, Matipa advisors use a socially responsible investment approach, and
Kunofiwa managers use an enhanced indexing approach.

Active Tracking
Return Error Weights

Tatenda management 2.8% 5.2% 10%

Tawana Associates 0.0% 0.0% 20%
Takunda Investors 2.0% 3.1% 25%
Matipa Advisors 3.5% 6.8% 5.0%
Kunofiwa Managers 1.7% 2.5% 40%

Under Stacey’s current plan managers are paid 0.20% for the first R20 million under
management and 0.35% for assets amounts over R20 million. The primary concern at
Stacey is that managers are not provided proper incentives. Under a proposed fee
schedule, managers would be paid 0.40% for the first R15 million under management,
0.20% for assets amounts over R15 million but less than R50 million and 0.12% for
assets amount over R50 million plus 10% of all excess returns relative to the manager’s
benchmark.

During discussion of these items, Cephas makes the following comments:

• “Our proposed plan should contain low water marks provisions. These provisions
state that managers will be paid no less than the certain amount during bear
markets. This will prevent us from loosing good managers during markets
downturns.”

• “Your proposal to cap performance fees is illogical. The cap would discourage
your managers from taking the risks necessary to obtain higher returns. Rather
 than aligning the managers’ goals with your own this could have a very negative
effect.”

i) Calculate the expected active return, expected active risk and expected
information ratio of this subset of managers, given the above allocations. (5)

ii) State whether each of the comments made by Cephas is correct or incorrect and
explain your selection. (4)

iii) Given that assets under management is R100 million and excess return relative
to benchmark is -7%, evaluate the current and proposed fee structures. (4)

b) FBC Securities case scenario

Leeroy Chitseko, CFA is a Fixed income securities traders at FBC Securities. Chitseko
has decided to pursue a contingent immunization strategy over a 5-year time horizon.
He just purchased at par R10 million worth of 7.7%, annual coupon, 8 year bonds. The
current rate of return for immunized strategies is 8%, and he is willing to accept a return
of 6.4% (this is the safety net return).

i) Determine the cushion spread. (2)

ii) Compute the required terminal value and the required assets needed at initial
implementation. (6)

iii) Determine whether active management is still viable should interest rates
immediately rise to 9.8%. (4)
2. Chirume case scenario

As part of an attribution analysis Itai Chirume, CFA, has accumulated the following
partial data for his portfolio.

Benchmark Portifolio Portfolio Benchmark

sector sector sector sector
Sectors weight% weight% return% return%

Energy 10.55 6.45 -0.82 1.35

Consumer durables 8.52 8.99 -3.28 -4.34
Captial Goods 36.22 37.36 1.96 1.98
Agricultural 5.24 4.65 0.44 0.24

Total portfolio 1.34 0.56

For payment of performance bonus, Chirume prefers to use the 7% return of on the
broad market index as determined at the beginning of the year as a performance
evaluation benchmark.

i) Using the available data, calculate and explain the pure sector allocation value
added by the Capital goods sector allocation. (6)

ii) Using the available data, calculate and explain the within-sector allocation value
added by the Energy sector. (6)

iii) Using the available data, calculate and explain by the allocation /selection
interaction value added by the Agricultural sector. (6)

iv) Evaluate the validity of the benchmark that Chirume utilizes in assessing his
performance. (7)

Godfrey Marozva, CFA

DEPARTMENT OF FINANCE, RISK MANAGEMENT AND BANKING

UNISA 2023
 INV4801/201/0/2023

Tutorial letter 201/0/2023

Portfolio Management
INV4801
Year Module

Department of Finance, Risk

Management and Banking

This tutorial letter contains answers

to your assignment 2 questions

Bar code
 CONTENTS

1 INTRODUCTION

2 SUGGESTED SOLUTIONS TO ASSIGNMENT 02

3 EXAMINATION GUIDELINES

4 CONCLUDING REMARKS

1 INTRODUCTION

The purpose of this tutorial letter is to provide you with suggested answers to Assignment 01 and
Assignment 2, and give you guidelines for the examination. Also use the activities in the learning
units to prepare for the examination.

3 SUGGESTED ANSWERS TO ASSIGNMENT 02

1. a)

i) Calculate the expected active return, expected active risk and expected information ratio of
this subset of managers, given the above allocations. (5)

NB: To calculate the portfolio active risk, we assume that the correlations between the managers’
active returns are zero.

Expected active return:

(0.1 × 2.8%) + (0.20 × 0%) + (0.25 × 2%) + (0.05 × 3.5%) + (0.40% × 1.7%) = 1.64%√

Expected active risk:

√(0.1)2 (0.052)2 + (0.2)2 (0)2 + (0.25)2 (0.031)2 + (0.05)2 (0.068)2 + (0.4)2 (0.025)2
√0.000199 = 0.0141 = 1.41%√√

Expected information ratio:

1.64%
= 1.16√√
1.41%

ii) State whether each of these comments is correct or incorrect and explain your selection. (4)

The first statement is incorrect, Tatenda management and Kunofiwa managers constitute the 60%
core. Since Kunofiwa managers utilizes an enhanced indexing style, which is not classified as active
management, so Kunofiwa managers is also part of the core. √√

The second statement is correct, value managers tend to have greater representation in utilities
and financial industries. These industries typically have higher dividend yields and lower valuations.
√√

iii) Given that assets under management is R100 million and excess return relative to
benchmark is -7%, evaluate the current and proposed fee structures. (4)

Current Plan:

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0.2% x 20 million + 0.35% x 80 million = R320,000 √

Proposed Plan:

Excess return = 0.02 x 18 million = R360,000

10.0% x 0 = R0 excess return was negative

0.4% x R15 million = R60,000
0.2% x R35 million = R70,000
0.12%x R50 million = R60,000

Total fees R190,000 √√

Managers are better off with the current structure under the given assumptions. √

b)

i) Determine the cushion spread. (2)

The cushion spread is 1.6%√√ [i.e., the difference between the current rate of return on immunized
strategies (8%) and the return you are willing to accept (6.4%)].

ii) Compute the required terminal value and the required assets needed at initial
implementation. (6)

The required terminal value using the safety net return: (R10 million)(1.064)8 = R 16 426 045,58√√

Assets required at implementation, assuming you can invest at an immunized rate of 8%:
R 16 426 045,58
Assets required = =R 8 874 481,32√√
1.088
.

This is the minimum level of assets needed today to achieve the required terminal value if
locked in at the immunized rate. hence, the initial Rand safety margin is:

10,000,000.00 – R 8 874 481,32 = R 1 125 518,68√√

iii) Determine whether active management is still viable should interest rates immediately rise to
9.8%. (4)

If the immunized rate rises to 9.8% immediately following your initial purchase, you must determine
whether the present value of your assets still exceeds the present value of your liabilities. If not, you
can no longer use active management.

Calculate the current value of the portfolio at the current immunization rate. Using your financial
calculator:

Pmt = (R10,000,000.00)(0.077) = R770,000; N = 8; I/y = 9.8%;

3
Fv = R10,000,000; cPt → Pv = R8 871 461,71

The price of the bond portfolio will fall to R8 871 461,71as a result of the rate increase.

Calculate the value necessary to fund the minimum target value at the current immunization rate.

Required terminal value = R 16 426 045,58, calculated in question (ii).

R 16 426 045,58
Assets required = =R 7 775 248,94√√
1.0988
Since the current portfolio value is greater than the amount necessary to fund the minimum target
value (i.e., the dollar safety margin is positive:

R8 871 461,71-R 7 775 248,94 = R1 096 212,77√

There is no need to switch to immunization, hence you can continue with active management. √

2)

i) Using the available data, calculate and explain the pure sector allocation value added by the
agricultural sector allocation. (6)

Pure sector allocation effect:

R Capital,PS = (𝑊𝐶𝑎𝑝𝑖𝑡𝑎𝑙,𝑃 − 𝑊𝐶𝑎𝑝𝑖𝑡𝑎𝑙,𝐵 )(𝑅𝐶𝑎𝑝𝑖𝑡𝑎𝑙,𝐵 − 𝑅𝐵 )

= (37.36% − 36.22%)(1.98% − 0.56%)√√
= 0,0162%√√

Chirume has added 162 basis points by overweighting an out performing sector. √√

ii) Using the available data, calculate and explain the within-sector allocation value added by
the Energy Sector. (6)

Within sector allocation effect:

R Energy,WS = 𝑊𝐸𝑛𝑒𝑟𝑔𝑦,𝐵 (𝑅𝐸𝑛𝑒𝑟𝑔𝑦,𝑃 − 𝑅𝐸𝑛𝑒𝑟𝑔𝑦,𝐵 )

= 10.55%(−0.82% − 1.35%)√√
= −0,229%√√

Chirume lost -22.9 basis points by selecting different securities in the Energy sector outperformed
the benchmark. √√

iii) Using the available data, calculate and explain by the agricultural sector the allocation
/selection interaction value added by the Energy sector. (6)

Allocation/selection interaction effect:

R Agric,AS = (𝑊𝐴𝑔𝑟𝑖𝑐,𝑃 − 𝑊𝐴𝑔𝑟𝑖𝑐,𝐵 )(𝑅𝐴𝑔𝑟𝑖𝑐,𝑝 − 𝑅𝐴𝑔𝑟𝑖𝑐,𝐵 )

= (4.65% − 5.24%)(0.44% − 0.24%)√√
= −0,00118%√√

Chirume lost 0.118 bps by underweighting the Agricultural sector with his selection of outperforming
securities in the Agricultural sector. √√
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iv) Evaluate the validity of the benchmark that Chirume utilizes in assessing his performance.
(7)

A broad market index benchmark passes all the tests of benchmark validity.

• The market index is measurable. √√

• The market index can be specified in advance. √√
• It is investable and can serve as a passive alternative to holding the account that is under
analysis. √√
• The identity of the market index is typically known; therefore, the benchmark is unambiguous.
√√
• It is appropriate as the investment style it represents adequately corresponds to the account
being evaluated. √√

Maximum of 7 marks

4 EXAMINATION GUIDELINES

The examination paper will consist of 4 structured questions both calculations and theory. You will
be required to apply formulas to practical problems and a general formula sheet will NOT be
provided in the examination. It is not sufficient to know the theory behind any problem in the exam,
what matters most is the application of the theory.

5 CONCLUDING REMARKS

Work through all learning units. Use the problems at the end of the chapters in your learning units
to test your knowledge of the material in the learning units. Try to answer the questions on your
own before you look at the answers or the formulas used.

Godfrey Marozva, CFA

DEPARTMENT OF FINANCE, RISK MANAGEMENT AND BANKING

UNISA 2023