“Mary and Nick Stalcheck have an investment portfolio containing4 investments. It was developed to provide them with a balancebetween current income and capital appreciation. Rather thanacquire mutual fund shares or diversify within a given class ofinvestments, 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 return ontheir investment and assessing how well they have done relative tothe market. They hope that the return earned over the past calendaryear is in excess of what they would have earned by investing in aportfolio consisting of the S&P 500 Stock Composite Index.Their research has indicated that the risk-free rate was 7.2% andthat the (before-tax) return on the S&P 500 portfolio was 10.1%during the past year. With the aid of a friend, they have been ableto estimate the beta of their portfolio, which was 1.20. In theiranalysis, they have planned to ignore taxes because they feel theirearn- ings have been adequately sheltered. Because they did notmake any portfolio transactions during the past year, all of theStalchecksAc€?cs investments have been held more than 12 months, andthey would have to consider only unrealized capital gains, if any.To make the necessary calculations, the Stalchecks have gatheredthe following information on each investment in theirportfolio.
Common stock. They own 400 shares of KJ Enterprises common stock.KJ is a diversified manu- facturer of metal pipe and is known forits unbroken stream of dividends. Over the past few years, it hasentered new markets and, as a result, has offered moderate capitalappreciation potential. Its share price has risen from $17.25 atthe start of the last calendar year to $18.75 at the end of theyear. 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 MoodyAc€?cs. 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 invest- ment income and$0.50 in capital gains. The fundAc€?cs 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 stock of acompany they follow. The value of these contracts totaled $26,000at the beginning of the calendar year. At year- end the total valueof the options contracts was $29,000.
a. Calculate the holding period return on abefore-tax basis for each of these 4 investments.
b. Assuming that the StalchecksAc€?cs ordinaryincome is currently being taxed at a combined (fed- eral and state)tax rate of 38% and that they would pay a 15% capital gains tax ondividends and capital gains for holding periods longer than 12months, determine the after-tax HPR for each of their 4investments.
c. Recognizing that all gains on the StalchecksAc€?csinvestments 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 tocompute JensenAc€?cs measure (JensenAc€?cs alpha). Use that measure toanalyze the performance of the StalchecksAc€?cs portfolio on arisk-adjusted, market- adjusted basis. Comment on your finding. Isit reasonable to use JensenAc€?cs measure to evaluate a 4-investmentportfolio? Why or why not?
e. On the basis of your analysis in questionsa, c, and d, what, if any, recommendations might you offer theStalchecks relative to the revision of their portfolio? Explainyour recommendations.”
Smart, Scott, Lawrence Gitman, Michael Joehnnk. Fundamentals ofInvesting, 12th Edition. Prentice Hall, 2014. VitalBook file.