Case Problem 13.1
Assessing the Stalchecksâs Portfolio Performance
LG3 LG4 Mary and Nick Stalcheck have an investment portfoliocontaining 4 investments. It was developed to provide them with abalance between current income and capital appreciation. Ratherthan acquire mutual fund shares or diversify within a given classof investments, they developed their portfolio with the idea ofdiversifying across various asset classes. The portfolio currentlycontains common stock, industrial bonds, mutual fund shares, andoptions. They acquired each of these investments during the past 3years, and they plan to purchase other investments sometime in thefuture.
Currently, the Stalchecks are interested in measuring the returnon their investment and assessing how well they have done relativeto the market. They hope that the return earned over the pastcalendar year is in excess of what they would have earned byinvesting in a portfolio consisting of the S&P 500 StockComposite Index. Their research has indicated that the risk-freerate was 7.2% and that the (before-tax) return on the S&P 500portfolio was 10.1% during the past year. With the aid of a friend,they have been able to estimate the beta of their portfolio, whichwas 1.20. In their analysis, they have planned to ignore taxesbecause they feel their earnings have been adequately sheltered.Because they did not make any portfolio transactions during thepast year, all of the Stalchecksâs investments have been held morethan 12 months, and they would have to consider only unrealizedcapital gains, if any. To make the necessary calculations, theStalchecks have gathered the following information on eachinvestment in their portfolio.
Common stock. They own 400 shares of KJ Enterprises commonstock. KJ is a diversified manufacturer of metal pipe and is knownfor its unbroken stream of dividends. Over the past few years, ithas entered new markets and, as a result, has offered moderatecapital appreciation potential. Its share price has risen from$17.25 at the start of the last calendar year to $18.75 at the endof the year. During the year, quarterly cash dividends of $0.20,$0.20, $0.25, and $0.25 were paid.
Industrial bonds. The Stalchecks own 8 Cal Industries bonds. Thebonds have a $1,000 par value, have a 9.250% coupon, and are due in2024. They are A-rated by Moodyâs. The bonds were quoted at 97.000at the beginning of the year and ended the calendar year at96.375%.
Mutual fund. The Stalchecks hold 500 shares in the Holt Fund, abalanced, no-load mutual fund. The dividend distributions on thefund during the year consisted of $0.60 in investment income and$0.50 in capital gains. The fundâs NAV at the beginning of thecalendar year was $19.45, and it ended the year at $20.02.
Options. The Stalchecks own 100 options contracts on the stockof a company they follow. The value of these contracts totaled$26,000 at the beginning of the calendar year. At year-end thetotal value of the options contracts was $29,000.
Questions
a. Calculate the holding period return on abefore-tax basis for each of these 4 investments.
b. Assuming that the Stalchecksâs ordinary income iscurrently being taxed at a combined (federal and state) tax rate of38% and that they would pay a 15% capital gains tax on dividendsand capital gains for holding periods longer than 12 months,determine the after-tax HPR for each of their 4 investments.
c. Recognizing that all gains on the Stalchecksâsinvestments were unrealized, calculate the before-tax portfolio HPRfor their 4-investment portfolio during the past calendar year.Evaluate this return relative to its current income and capitalgain components.
d. Use the HPR calculated in question c to computeJensenâs measure (Jensenâs alpha). Use that measure to analyze theperformance of the Stalchecksâs portfolio on a risk-adjusted,market-adjusted basis. Comment on your finding. Is it reasonable touse Jensenâs measure to evaluate a 4-investment portfolio? Why orwhy not?
e. On the basis of your analysis in questions a, c,and d, what, if any, recommendations might you offer the Stalchecksrelative to the revision of their portfolio? Explain yourrecommendations
Case Problem 13.1
Assessing the Stalchecksâs Portfolio Performance
LG3 LG4 Mary and Nick Stalcheck have an investment portfoliocontaining 4 investments. It was developed to provide them with abalance between current income and capital appreciation. Ratherthan acquire mutual fund shares or diversify within a given classof investments, they developed their portfolio with the idea ofdiversifying across various asset classes. The portfolio currentlycontains common stock, industrial bonds, mutual fund shares, andoptions. They acquired each of these investments during the past 3years, and they plan to purchase other investments sometime in thefuture.
Currently, the Stalchecks are interested in measuring the returnon their investment and assessing how well they have done relativeto the market. They hope that the return earned over the pastcalendar year is in excess of what they would have earned byinvesting in a portfolio consisting of the S&P 500 StockComposite Index. Their research has indicated that the risk-freerate was 7.2% and that the (before-tax) return on the S&P 500portfolio was 10.1% during the past year. With the aid of a friend,they have been able to estimate the beta of their portfolio, whichwas 1.20. In their analysis, they have planned to ignore taxesbecause they feel their earnings have been adequately sheltered.Because they did not make any portfolio transactions during thepast year, all of the Stalchecksâs investments have been held morethan 12 months, and they would have to consider only unrealizedcapital gains, if any. To make the necessary calculations, theStalchecks have gathered the following information on eachinvestment in their portfolio.
Common stock. They own 400 shares of KJ Enterprises commonstock. KJ is a diversified manufacturer of metal pipe and is knownfor its unbroken stream of dividends. Over the past few years, ithas entered new markets and, as a result, has offered moderatecapital appreciation potential. Its share price has risen from$17.25 at the start of the last calendar year to $18.75 at the endof the year. During the year, quarterly cash dividends of $0.20,$0.20, $0.25, and $0.25 were paid.
Industrial bonds. The Stalchecks own 8 Cal Industries bonds. Thebonds have a $1,000 par value, have a 9.250% coupon, and are due in2024. They are A-rated by Moodyâs. The bonds were quoted at 97.000at the beginning of the year and ended the calendar year at96.375%.
Mutual fund. The Stalchecks hold 500 shares in the Holt Fund, abalanced, no-load mutual fund. The dividend distributions on thefund during the year consisted of $0.60 in investment income and$0.50 in capital gains. The fundâs NAV at the beginning of thecalendar year was $19.45, and it ended the year at $20.02.
Options. The Stalchecks own 100 options contracts on the stockof a company they follow. The value of these contracts totaled$26,000 at the beginning of the calendar year. At year-end thetotal value of the options contracts was $29,000.
Questions
a. Calculate the holding period return on abefore-tax basis for each of these 4 investments.
b. Assuming that the Stalchecksâs ordinary income iscurrently being taxed at a combined (federal and state) tax rate of38% and that they would pay a 15% capital gains tax on dividendsand capital gains for holding periods longer than 12 months,determine the after-tax HPR for each of their 4 investments.
c. Recognizing that all gains on the Stalchecksâsinvestments were unrealized, calculate the before-tax portfolio HPRfor their 4-investment portfolio during the past calendar year.Evaluate this return relative to its current income and capitalgain components.
d. Use the HPR calculated in question c to computeJensenâs measure (Jensenâs alpha). Use that measure to analyze theperformance of the Stalchecksâs portfolio on a risk-adjusted,market-adjusted basis. Comment on your finding. Is it reasonable touse Jensenâs measure to evaluate a 4-investment portfolio? Why orwhy not?
e. On the basis of your analysis in questions a, c,and d, what, if any, recommendations might you offer the Stalchecksrelative to the revision of their portfolio? Explain yourrecommendations
