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CASE 1: Topic: On Risk and Return When Sandara Parks husbang, Yuri, passed away about three Months

ago he left behind a small fortune, which he had accumulated by living a very thrifty life and by investing in common stocks. Yuri had worked as an engineer for a surgical instruments manufacturer for over 30 years and had taken full advantage of the companys voluntary retirement savings plan. However, instead of buying a diversified set of investments he had invested his money into a few high growth companies. Over time his investment portfolio had grown to about $900,000 being primarily comprised of the stocks of 3 companies he was very fortunate that his selections turned out to be good ones and after numerous stock splits the prices of the three companies had appreciated significantly over time. Sandara, on the other hand was a very conservative and cautious person. She had devoted her life to being a stay-home mom and had raised two kids into fine adults, each of whom had a fairly successful career. Mark, 28, had followed Yuris footsteps. In addition to being gainfully employed as an engineer, he was pursuing an MBA at a prestigious business school. Anna, 26, was completing her residency at a major metropolitan hospital. Although, Sandara and Yuri had enjoyed a wonderful married life, it was Yuri who managed almost all the financial affairs of their family. Sandara, like many spouses of their generation, preferred to focus on other family matters. It was only after Yuris passing our that Sandara realized how unprepared she was for the complex deci sions that have to be made when managing ones wealth. Upon the advice of her close friend, Alma, Sandara decided to call the brokers office and request that her account be turned over to Max, the firms senior financial advisor. Alma, a widow herself, ha d been very happy with Maxs advice and professionalism. He had helped her rebalance and re -allocate her portfolio with the result that her portfolios value had steadily increased over the years without much volatility. At their first meeting, Max exami ned the Parks portfolio and was shocked at how narrowly focused its composition had been. In fact, just during the past year due to significant drop in the technology sectorthe portfolio had lost almost 30% of its value. Yuri, certainly liked to flirt with risk, said Max. The first thing we are going to have to do is diversify your portfolio and lower its beta. As it stands you could make a lot of money it the technology sector takes off, but the reverse scenario could be devastating. I am sure you wi ll agree with me that given your status in life you do not need to bear this much of risk. Sandara shrugged her shoulders and looked blankly at Max. Diversify beta what are you talking about? These terms are new to me and so confusing. You are right, Max, I dont need the high risk but can you explain to me how the risk level of my portfolio can be lowered? Max realized right away that Sandara needed a primer on the risk -return tradeoff and on portfolio management. Accordingly, he scheduled another appointment for later that week and prepared the following exhibit to demonstrate the various nuances of risk, expected return, and portfolio management.

Scenario Recession Near Recession Normal Near Boom Boom

Probability 20% 20% 30% 10% 20%

Expected Rate of Return Treasury Index Utility bill fund company 5% 5% 5% 5% 5% -10% -6% 12% 15% 20% 6% 7% 9% 11% 14%

High-tech company -25% -20% 15% 25% 35%

Countercyclical company 20% 16% 12% -9% -20%

CASE QUESTIONS 1. Imagine you are Max. How would you explain to Sandara the relationship between risk and return of individual stocks. 2. Sandara has no idea what beta means and how it is related to the required return of the stocks. Explain how you would help her understand these concepts. 3. How would Max demonstrate the meaning and advantages of diversification? 4. Using a suitable diagram explain how Max could use the security market line to show Sandara which stocks could be undervalued and which may be overvalued. 5. During the presentation, Sandara asks Max Lets say I choose a well diversified portfolio, what effect will interest rates have on my portfolio? How should Max respond? 6. Should Max take Sandara out of investing in stocks and preferably put all her money in fixed-income securities? Explain. 7. Sandara tells Max, I keep hearing stories about how people have made thousands of dollars by following their broker hot tips. Can you give me some hot tips regarding undervalued stocks? how should Max respond? 8. If Sandara decided to invest her money equally in high-tech and counter-cyclical stocks, what would her portfolios expected return and risk level be? Are these expectations realistic? Please Explain. 9. What would happen if Sandara were to put 70% of her portfolio in the High-Tech Stock and 30% in the Index Fund? Would this combination be better for her? Explain. 10. Based on these calculations what do you think Max should propose as a possible portfolio combination for Mary? *Print the last page for the hardcopy of your individual grading sheet.

CRITERIA FOR GRADING Content 1 Response to Case Questions 2 Research Skills 3 Congruency to all Financial Management core topics Presentation 1 Quality of Powerpoint Presentation (style and format of the ppt) 2 Mastery of the Presentation (ability to present, knows what to say) 3 Over-all Presence (confidence, composition, tone of voice, etc)

30% 10% 10% 10% 10% 30%

Content Names
Response to Case Questions Response to Case Questions Congruency to all Financial Management core topics Quality of Powerpoint Presentation

Mastery of the Presentation Over-all Presence