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Chapter 25 Contemporary Issues in Portfolio Management

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Title: Chapter 25 Contemporary Issues in Portfolio Management


1
Chapter 25 Contemporary Issues in Portfolio
Management
  • Business 4179

2
Contemporary Issues
  • New issues are constantly emerging in finance
    that may have tangential application to portfolio
    management
  • Governance issues (stock options/abuse of
    position/proxy voting/transparency in reporting
    financial results)
  • Ethical issues
  • Recent ones in related to portfolio management
  • Hedge funds
  • Income trusts
  • Issues covered in your text (Chapter 25) include
  • Tactical asset allocation
  • Short selling
  • Program trading
  • Use of derivatives

3
Key Points
  • Tactical Asset Allocation, while generally
    conflicting with the efficient market hypothesis,
    is in vogue among investment practitioners, and
    all managers should know something about the
    technique.
  • Stock lending is an obscure part of the
    institutional money management business. The
    practice is both lucrative and full of potential
    for abuse. Increased regulatory supervision of
    this activity has already begun.
  • Long/short portfolios, like TAA, also seem to go
    against market efficiency. Still, many
    investment houses actively pursue them.

4
Key Points ...
  • The creation and transfer of stock certificates
    is increasingly expensive. There is a trend in
    the industry eventually to eliminate stock
    certificates, maintaining accounts in book entry
    form only.
  • Program trading continues to suffer from a bad
    image, largely due to a public misperception of
    what the term means and the effects of the
    practice.

5
Question 25 -1
  • We do not expect to find riskless profits in a
    well-functioning marketplace. Securities are
    priced based on their expected returns and their
    perceived level of risk. Security valuation is
    therefore, based on arbitrage arguments.
    Investments that dominate others will be
    preferred in the marketplace. It is the
    activities of security analysts and individual
    investors who eliminate arbitrage.

6
Question 25 -2
  • Increased volatility in the market is generally
    considered undesirable. A clear cause and effect
    would likely lead to calls for regulatory relief
    from program trading. Whether this would happen
    is a matter of conjecture.

7
Question 25 -3
  • If the market is efficient, no one can
    consistently time the market, and TAA strategies
    should be ineffective.

8
Question 25 -4
  • Asset class appraisal refers to an investigation
    of the relative merits of the various groups of
    securities into which an investment might be made.

9
Question 25 -5
  • With any active portfolio management strategy
    there is the potential that the active management
    might reduce returns rather than augment them.
    Failure to do at least as well as the market
    average is usually viewed as substandard
    managerial performance.

10
Question 25 -6
  • TAA can be consistent with any portfolio strategy
    that employs both fixed income securities and
    common stock. TAA is most commonly associated
    with an equity portfolio where capital
    appreciation is the primary objective.

11
Question 25 -7
  • You could switch between the long and short end
    of the yield curve, but this would be unusual.
    TAA is not normally associated with a fixed
    income portfolio.

12
Question 25 -8
  • Portfolio insurance requires alterations to the
    portfolio based on something that has already
    happened rather than on something that is
    expected to happen.

13
Question 25 -9
  • Selling short involves a potentially unlimited
    loss. Because of this high risk, most brokerage
    firms discourage small investors from doing so.

14
Question 25 -10
  • Most individual investors are only concerned with
    the security of their investment, its potential
    return and risk, and with their ability to trade
    out of it at will. Whether stock is lent is
    generally unimportant.

15
Question 25 -11
  • They have usually not been given permission by
    the security owner.

16
Question 25 -12
  • Facilitating the matching up of those who want to
    lend stock and those who want to borrow it.

17
Question 25 -13
  • It is essentially free money. There is no
    particular increase in risk, and it generates a
    reliable return. Only if one party defaults is
    there added risk.

18
Question 25 -14
  • What is the actual incidence of stock lending?
    Do some firms do more of this as a percentage of
    their assets than others? What rates of interest
    are paid, and how does this vary? What evidence
    is there that interest is ever credited to a
    customer account? What evidence is there that
    securities held in a cash account are sometimes
    lent?

19
Question 25 -16
  • Program trading seeks to eliminate arbitrage
    opportunities as they develop. Without
    arbitrage, program trading would be much less
    attractive.

20
Question 25 -17
  • A derivative asset is one whose value stems
    largely from the value of another asset. Calls,
    puts, and futures contracts are common examples.

21
Question 25 -18
  • Unless there is incremental benefit from the TAA
    program, the TAA manager can be accused of
    generating unnecessary commissions, which is not
    in the customers best interest.

22
Question 25 -19
  • Stock loans are marked to market. In the event
    of default, the lenders liability is the extent
    to which the stocks value exceeds the value of
    the collateral.

23
Problem 25 -2
  • A. 1,000 (1.0) (10 100 -0.317) 683
  • (equivalent to a long position of 683 shares)
  • B. Sell short 317 shares.
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