4Gitman/JoehnkFundamentalsofInvesting,NinthEdition

Chapter14
ManagingYourOwnPortfolio
Outline
Learning Goals
I.

PortfolioPlanninginAction
A) DaraYasakawa:WomanWonder
B) BonandGailWeiss:LotteryWinners
C) JulioandGinaVitello:Retirees
D) LucilleHatch:Widow
ConceptsinReview

II.

EvaluatingThePerformanceofIndividualInvestments
A) ObtainingNeededData
1. ReturnData
2. EconomicandMarketActivity
B) IndexesofInvestmentPerformance
C) MeasuringthePerformanceofInvestmentVehicles
1. StocksandBonds
a. Stocks
b. Bonds
2. MutualFunds
3. OptionsandFutures
D) ComparingPerformancetoInvestmentGoals
1. BalancingRiskandReturn
2. IsolatingProblemInvestments

5Gitman/JoehnkFundamentalsofInvesting,NinthEdition

ConceptsinReview
III. AssessingPortfolioPerformance
A) MeasuringPortfolioReturn
1. MeasuringtheAmountInvested
2. MeasuringIncome
3. MeasuringCapitalGains
4. MeasuringthePortfoliosHoldingPeriodReturn

Chapter14ManagingYourOwnPortfolio6

B) ComparisonofReturnwithOverallMarketMeasures
1. SharpesMeasure
2. TreynorsMeasure
3. JensensMeasure(JensensAlpha)
C) PortfolioRevision
ConceptsinReview
IV. TimingTransactions
A) FormulaPlans
1. DollarCostAveraging
2. ConstantDollarPlan
3. ConstantRatioPlan
4. VariableRatioPlan
B) UsingLimitandStopLossOrders
1. LimitOrders
2. StopLossOrders
C) WarehousingLiquidity
D) TimingInvestmentSales
1. TaxConsequences
2. AchievingInvestmentGoals
ConceptsinReview

Summary
PuttingYourInvestmentKnowHowtotheTest
DiscussionQuestions
Problems

7Gitman/JoehnkFundamentalsofInvesting,NinthEdition

CaseProblems
14.1. AssessingtheStalchecksPortfolioPerformance
14.2. EvaluatingFormulaPlans:CharlesSpurgesApproach
ExcelwithSpreadsheets
TradingOnlinewithOTIS

Key Concepts
1.

Therelationshipbetweeninvestorobjectivesandtheriskreturnprofilesreflectedinvarioustypesof
portfolios.

2.

Obtainingneededdata,indexesofinvestmentperformance,andtechniquesformeasuringthe
performanceofinvestmentvehicles.

3.

Themethodsusedtocompareinvestmentperformancetoinvestmentgoals.

4.

Thetechniquesusedtomeasuretheamountinvested,currentincome,capitalgains,andtotal
portfolioreturnrelativetotheamountofmoneyactuallyinvestedintheportfolio.

5.

StatisticalmeasuresofportfolioreturnSharpes,Treynors,andJensensmeasuresandtheiruses,
andtheimportanceofportfoliorevision.

6.

Theroleofcommontypesofformulaplansintimingpurchaseandsaledecisions.

7.

Theuseoflimitandstoplossordersininvestmenttiming,thewarehousingofliquidity,andthekey
factorsintiminginvestmentsalesinordertoachievemaximumbenefits.

Overview
Thischapterdescribeshowinvestmentportfoliosaremonitored,includingproceduresforevaluating
investmentperformanceandtimingportfoliotransactions.
1.

Thechapterbeginswithfourmodelportfoliosthatdemonstrateportfoliomanagementinaction.The
assetallocationofeachinvestor,alongwithacloselookattheirsecuritiesportfoliosriskreturn
characteristics,ispresentedinlightofhisorherinvestmentobjectives

2.

Theevaluationofanindividualinvestmentsperformanceisdiscussed.Suchperformancemaybe
measuredbycomparinganinvestmentsreturnagainstastandard.Twosuchstandardsmightinvolve
comparingactualwithanticipatedreturns,orcomparinganactualreturnagainstthereturnofanother
vehicleofasimilartype.Thetextstressestheneedforabroadrangeofdatatoassessperformance
accurately.

3.

Investmentperformancealsomaybemeasuredbycomputingandcomparingholdingperiodreturns
(HPR)beforeandaftertax.TheinstructormightworkoutHPRsfordifferentinvestmentvehicles
suchasstocks,bonds,mutualfunds,orrealestate.Itshouldbeemphasizedthatthecomparisonof
HPRsmustbeaccompaniedbytheconsiderationoftheassociatedrisk.Riskierinvestmentsshould
providehigherreturnsthanlowriskinvestmentstocompensateforthegreaterriskinvolved.

Chapter14ManagingYourOwnPortfolio8

4.

Next,theassessmentofportfolioperformanceisconsidered.Theinstructorshoulddiscussprocedures
forcomputingtheamountinvested,income,andcapitalgainsofaportfolio.Applyingriskadjusted,
marketadjustedrateofreturnmeasuresSharpes,TreynorsandJensensmeasuresallowsthe
investortocomparethebaseportfolioreturnfiguretoariskadjusted,marketadjustedrateofreturn.
Dependinguponitsperformance,aninvestormaywanttoreviseorrebalanceaportfolioinorderto
betterattainhisorherinvestmentgoals.

5.

Thefinalsectionofthechapterdiscussesthetimingofportfoliotransactions.Theinstructormay
wanttoindicatethat,eventhoughbuyinglowandsellinghighistheoreticallyagoodstrategy,itis
oftendifficultforaninvestortodeterminewhenthepriceistoohighortoolow.Apricemaydip
lowerorrisehigherinoneday,andtheinvestorhasnowayofanticipatingsuchachangeuntilit
happens.

6.

Techniquesinvestorsusetotimebuyandselldecisionsareformulaplans,includingdollarcost
averaging,constantdollarplans,andconstantorvariableratioplans,andlimitandstoplossorders.
Alsoemphasizedaretheroleofliquidityintheportfolioandtheimportanceoftaxconsiderations
whentiminginvestmentsales.

9Gitman/JoehnkFundamentalsofInvesting,NinthEdition

Answers to Concepts in Review

1.

Itisgenerallyrecognizedthatgivenfavorablelevelsofincomeayoungerinvestorwouldseek
growthoriented,longerterm,capitalgainsinvestments.Asaninvestorages,moresecureinvestment
returnsaresought.Finally,atretirementtheinvestorwillwantsecureincomeproducinginvestments.
(a) Theretiredinvestorwouldprobablyholdsecure,incomeproducingsecuritieswithlowrisk.
(b) Thehighincome,financiallysecureinvestorwouldholdadiversified,growthorientedgroupof
securitiesprovidingcapitalgainsandfavorabletaxtreatment.
(c) Ayounginvestorwithasecurejobandnodependentswouldprobablyholdacombinationof
diversifiedincomeproducingsecuritiesandwoulddependontheinvestorstaxbracketandneed
foradditionalcurrentincome.Iftheinvestorneedslittleornoadditionalcurrentincome,the
securitieswouldbeprimarilygrowthorientedofferingexpectedcapitalgains.

2.

Itisimportantforaninvestortocontinuouslymanageandcontrolhisorherportfoliotobesurethat
investmentgoalsarebeingmet.Overtime,thesecuritiesintheportfoliomaychangetheirinvestment
characteristics,therebychangingthecharacteroftheportfolio.Iftheportfolioperformanceis
inconsistentwithitsgoals,itshouldbeadjustedandrevisedtoremainconsistentwiththeinvestors
needs.Themanagementandcontrolprocessinvolvesassessingactualperformance,comparingitto
plannedperformance,revisingandmakingneededadjustments,andtimingtheseadjustmentsto
achievemaximumbenefit.

3.

Currentmarketinformation,suchasshareprice,dividendyield,andsimilarreturndata,arecriticalto
performanceevaluation.Regularlycheckingthisdata,aswellasfollowingacompanysearnings,
dividendpayments,andgeneralnews,providesawaytomonitorstockperformanceanddecide
whethertheinvestmentshouldbeheld.Changesineconomicandmarketactivitycanaffectthelevel
ofcurrentincomeandthemarketvalueofeachinvestmentvehicledifferently.Forsomeinvestment
vehicles,suchasrealestate,localeconomicactivityismostimportant.Bondsmaybemostaffected
bynationwideeconomicconditions.Goldismostaffectedbyinternationaleconomicandpolitical
conditions.Sourcesofeconomicinformationincludelargeregionalbanks,NewYorkCitybanks,
TheFederalReserveBanks,andinvestmentservices.Allinvestmentsareaffectedbynondiversifiable
riskwhichistiedtochangesinmarketactivity.

4.

Inevaluatingtheperformanceofhisorherportfolio,aninvestorshouldcompareittosomemeasure
ofgeneralmarketreturns.Forstocks,onecouldusetheDowJonesIndustrialAverage.However,itis
actuallynotconsideredthemostappropriategaugeofstockpricemovement.Includingonlythirty
stocks,itisnotbroadbased.AbetterindexistheStandardandPoors500StockCompositeIndexor
theNewYorkStockExchangeCompositeIndex.Forbonds,theDowJonesCorporateBondAverage
ordatafromStandard&Poors,Mergent,and/ortheFederalReserveareappropriate.Realestate
returnsaremorelocalized.Therefore,inrealestatemarketsonewouldanalyzelocalreturns.This
informationmaybeavailableatlocalrealestateboardsand/oragencies.Theinvestorshould
probablydistinguishbetweenincomepropertyandundevelopedproperty.

5.

Abondmarketindicatorisinformationand/oranindexwhichreflectsthegeneralbehaviorofthe
bondmarkets.Wherestockindexesarepresentedrelativetoanoriginalbase,bondindexesarestated
relativetothebondspar,orfacevalue,orastheyieldtomaturity.TheDowJonesCorporateBond
Indexisapopularmeasureofbondpricebehavior.Itisbasedontheclosingpricesof32industrial,
32financial,and32utility/telecombonds.ThisaverageispublisheddailyinTheWallStreet
JournalandweeklyinBarronsandreflectsthemathematicalaverageoftheclosingpricesofthese
bonds.BondyielddatamayalsobeobtainedfromStandard&Poors,Mergent,Yahoo.com,andthe
FederalReserve,andisalsopublishedinTheWallStreetJournalandBarrons.

Chapter14ManagingYourOwnPortfolio10

6.

Thedividendyieldmeasuresthecurrentyearlydividendreturnearnedfromastockinvestment.Itis
calculatedbydividingthestocksyearlycashdividendbyitsprice.Theholdingperiodreturn(HPR),
ontheotherhand,measuresthetotalreturn(incomepluschangeinvalue)earnedonaninvestment
overagiveninvestmentperiod.Thechangeinvalue(capitalgainorloss)neednotberealizedtobe
consideredinHPR.ThedividendyieldandtheHPRarenotequivalent.Theyareequalonlywhenthe
priceofthestockisthesameattheendoftheperiodasitwasatthebeginningoftheperiod.

7.

Mutualfundspayinvestmentincomedividendsandcapitalgainsdividends.Incomedividendsare
derivedfromtheinterestanddividendsreceivedbythefund,whilecapitalgainsdividendsarea
resultofgainsnetoflossesrealizedbythefundonitssecuritypurchaseandsaletransactions.These
dividendsarenottheonlysourceofreturnonamutualfundinvestment;theothersourceofreturnis
achangeinthevalueofthemutualfundwhichisattributabletounrealizedgainsthatexistinthe
portfolio.

8.

Aninvestmentholdingisacandidateforsalewhen:
(1) Itfailstoperformasexpectedandnomajorchangeinperformanceisanticipated.
(2) Ithasmettheoriginalinvestmentobjective.
(3) Theinvestornowhasbetterinvestmentopportunitiesavailableforthefunds.
Ariskyinvestmentmustprovideahigherreturnthanalowriskinvestmenttoattractarational
investor,whomustbecompensatedfortakingtheadditionalrisk.

9.

Aprobleminvestmentisonethathasnotliveduptoexpectations.Eithertheinvestmenthas
experiencedaloss,orhasprovidedanactualreturnlessthantheinvestorexpected.
Whenanalyzinganinvestment,theinvestorshouldfirstask:Hastheinvestmentperformed
reasonablyinlightofinitialexpectations?Thesecondquestionis:Wouldtheinvestmentbe
includedintheportfoliotodayifitwerenotalreadythere?Iftheanswertobothquestionsisno
foraspecificinvestment,itshouldprobablybesold.Anegativeanswertooneofthequestions
indicatesthattheinvestmentisaprobleminvestmentandshouldbewatchedclosely.

10. Activeportfoliomanagementistheprocessofbuildingaportfoliousingtraditionalandmodern
portfolioapproachesandthenmanagingandcontrollingittomeetinvestmentobjectives.Active
managementshouldimprovethereturnsearnedontheportfolio.Thiscontradictstheefficientmarket
hypothesis,whichstatesthatmarketsaresoefficientthatavailableinformationaboutacompany
and/oritssecuritiesisalwaysfullyreflectedinthesecuritysprice.Ifthisweretrue,investorscould
notexpecttoconsistentlyoutperformthemarketbymanagingtheirportfolios.
11. Portfolioperformanceismeasuredbycalculatingtheholdingperiodreturn(HPR)fortheportfolio.
Thisinvolves(1)measuringtheamountinvested,(2)measuringincome,(3)measuringcapitalgain,
and(4)combiningthesecomponentstofindtheportfoliosHPR.
TheHPRformulaincludesbothrealizedreturns(incomeplusrealizedcapitalgains)andthe
unrealizedcapitalgainsoftheportfolio.Further,portfolioadditionsanddeletionsmustbetime
weightedforthenumberofmonthstheyareintheportfolio.Unrealizedcapitalgainsarethosethat
havenotyetbeenreceived.Realizedcapitalgains,ontheotherhand,arethecapitalgainsaninvestor
hasreceivedfromsaleofparticularsecurities.Anunrealizedcapitalgaincanbecomeacapitalloss
wheneconomicconditionschangedrastically.

11Gitman/JoehnkFundamentalsofInvesting,NinthEdition

12. OncetheHPRfortheportfolioiscalculated,thereturnfigureshouldbeutilizedinariskadjusted,
marketadjustedrateofreturnanalysis.Thistypeofcomparativestudycanbeveryusefulbecauseit
providestheinvestorwithinsightintohowhisorherportfolioisperformingrelativetothestock
marketasawhole.Comparingthereturntoabroadmarketindexdoesnottakeriskintoaccount.
13. (a) Sharpesmeasurecomparesaportfoliosriskpremiumtoitsstandarddeviationofreturnto
assesstheriskpremiumperunitoftotalrisk.Theformulais:
Sharpesmeasure(SM)

Totalportfolioreturn Riskfreerate rp RF

Portfoliostandarddeviation
sp

Oncecalculated,SharpesmeasurecanbecomparedtotheSharpesmeasuresofotherportfolios
orthemarket.IftheportfoliosSMishigher,itisperformingbetterthantheotherportfolioor
themarket.
(b) Treynorsmeasurealsomeasurestheriskpremiumperriskunitbutusesbetaratherthanthe
standarddeviationtodoso.Itfocusesonnondiversifiableriskonlyandiscalculatedasfollows:
Treynorsmeasure(TM)

Totalportfolioreturn Riskfreerate rp RF

Portfoliobeta
bp

UsingtheTM,aninvestorcancompareherorhisportfoliotothemarketortoanotherportfolio.
AhigherTMindicatesbetterperformance.
(c) Jensensmeasure,alsocalledalpha,usesportfoliobetaandthecapitalassetpricingmodel
(CAPM)tocalculatetheexcessreturnthedifferencebetweentheactualreturnandtherequired
return.Theexcessreturnmaybepositive,negative,orzeroandiscalculatedasfollows:
Jensensmeasure(TotalportfolioreturnRiskfreerate)[Portfoliobeta
(alpha)
(MarketreturnRiskfreerate)]
JM(rpRF)[bp(rmRF)]
PositiveJMvaluesindicatetheportfolioearnedmorethanitsriskadjusted,marketadjusted
requiredrateofreturn;aJMofzeromeanstheportfolioearneditsrequiredreturn;negative
valuesmeantheportfoliofellshortofitsrequiredreturn.
14. JensensmeasureissimilartoTreynorsmeasure;bothfocusonlyonnondiversifiableriskbyusing
beta.Jensensmeasureispreferredbecauseitautomaticallyadjustsformarketreturnthroughitsuse
oftheCAPM.Thiseliminatestheneedtocomputeameasureforthemarket;nofurthercomparison
isnecessary.Aswiththeothertwomeasures,thehighertheJMvalue,thebettertheportfoliois
performing.
15. Whenaninvestordecidestochangethecompositionofaportfoliobysellingsomesecuritiesand
replacingthemwithothers,heorsheisengaginginportfoliorevision.Periodically,theinvestormust
checktoseeiftheportfoliocontinuestomeethisorherneeds.Suchdynamicportfoliomanagement
requiresportfoliorevision.
Aseconomicconditionsandindividualprioritieschange,aninvestormustrevisetheportfolioby
reallocatingandrebalancingit.Astheriskreturncharacteristicsofthesecuritieschange,theinvestor
shouldeliminateissuesthatnolongermeethisorherobjectives.Also,portfoliorevisionmaybe
neededtomaintainanadequateamountofdiversification.Allthesesituationsrequiremanaging,
controlling,andpossiblyrevisingtheportfolio.

Chapter14ManagingYourOwnPortfolio12

16. Formulaplansaremechanicalmethodsofportfoliomanagementthattrytotakeadvantageofprice
changesinsecuritiesthatresultfromcyclicalpricemovements.Formulaplans,partofaconservative
strategy,aredesignedprimarilyforinvestorswhodonotwishtotakeexcessiveriskbutwishto
quicklyandfavorablyadjusttheirportfolioinresponsetocyclicalsecuritypricechanges.

13Gitman/JoehnkFundamentalsofInvesting,NinthEdition

17. (a) Thedollarcostaveragingplaninvolvesinvestingafixeddollaramountinasecurityatfixed

timeintervals.Thisisapassivebuyandholdstrategyinwhichaperiodicdollarinvestmentis
heldconstant.Ifthesharepriceincreases,fewersharesarepurchased.Whentheshareprice
declines,moresharesarepurchased.Thehopedforoutcomeisgrowthinthevalueofthe
selectedsecurity.
(b) Aconstantdollarplanusesatwopartportfolio.Thespeculativeportionisinvestedinsecurities
havinghighpromiseofcapitalgain.Theconservativeportionconsistsoflowriskinvestments
suchasbondsormoneymarketaccounts.Ifthespeculativeportionoftheportfoliorisesacertain
percentageoramountinvalue,theconstantdollarplanusesitsprofitstoincreasethe
conservativeportion.Ifthespeculativeportiondeclinesinvaluebyaspecifiedpercentageor
amount,fundsaretransferredtoitfromtheconservativeportion.
(c) Theconstantratioplanestablishesadesiredfixedratioofthespeculativetotheconservative
portionoftheportfolio.Anindividualrebalancestheportfoliowhenevertheactualratiodiffers
fromthedesiredratiobyapredeterminedamount.Withthisplan,aninvestormustdecidewhatis
theappropriatetargetratioofthetwoportionsoftheportfolioandhowfarfromthetargetratio
theactualratioshouldbepermittedtostraybeforeonerebalancestheportfolio.Sinceone
expectsthespeculativeportionoftheportfoliotoincreaseinvaluemorerapidlythanthe
conservativeportion,thisstrategyshouldfunctionmuchliketheconstantdollarplan.
(d) Thevariableratioplanisamoreaggressivestrategy.Thetargetratiobetweenthespeculative
portionandtheconservativeportionoftheportfolioisvariedbytheinvestoranddependsonthe
expectedmovementinvalueofthespeculativesecurities.Iftheinvestorfeelsthemarket
movementwillbegenerallyupward,heorsheincreasestheproportioninspeculativevehicles.If
thefeelingisbearishadownwardmarkettheproportioninconservativevehiclesisincreased.
Thisstrategyisnotonlythemostaggressivebutalsorequiresmoreeffortbytheinvestor.
18. Alimitordercanbeusedtospecifytheinvestorsminimumsellpriceorthemaximumpricethe
investorwillpaytobuythesecurity.Thestoplossorderisatypeofsuspendedorderthatrequests
thebrokertosellasecurityatthebestavailablepriceonlyifittradesataspecificpriceorlower.A
stoplossorderisaparticularkindofalimitorderthatbecomesamarketordertosellifastocktrades
atthetriggerpriceorlower.
Ifaninvestorissuesastoplimitordertosellasecuritywithalimitpriceabovetheinitialpurchase
price,theinvestorlocksinorprotectstheprofitshehasearned.Iftheinvestorissuesastoplimit
ordertosellasecuritywithalimitpricebelowtheinitialpurchaseprice,theinvestoreffectivelyputs
aflooronpotentiallosses.
19. Thefirstreasoninvestorsshouldmaintainsomefundsinalowrisk,highlyliquidinvestmentis
simplytoprotectagainstthechanceofatotalloss.Thus,alowriskinvestmentactsasabuffer
againstpossibleinvestmentadversity.
Second,highlyliquidinvestmentscanprovidefundsforuseinpursuingfutureopportunities.A
suddenchangeineconomicconditionsmightmakeitconduciveforaninvestortoinvestmore
heavilyinvestinthestockmarket.Insuchsituations,ahighlymarketableinvestmentcanreadilybe
convertedintocashandtheproceedsinvestedinthestockmarket.Aninvestorwithliquidfundscan
takeadvantageoftheseopportunitieswithoutdisturbingtheexistingportfolio.

Chapter14ManagingYourOwnPortfolio14

20. Thetwoconsiderationsintiminginvestmentsalesaretaxconsequencesandcompatibilitywith
investmentgoals.Whenthereisacapitalloss,theinvestorreceivesthebenefitofataxdeduction.In
particular,capitallossesprovidetaxbenefitsbyoffsettingcapitalgainsandtherebyloweringthe
investorstaxliability.Fromthepointofviewofinvestmentgoals,asecurityshouldbesoldifitno
longermeetstheneedsoftheportfoliosowner.Forexample,ifaparticularsecurityincreasesthe
riskoftheportfoliotoanextentthatitisundesirable,thatsecurityshouldbesoldinthemarketplace.
Althoughtaxesareimportant,oneshouldnotforgetthatthedualconceptsofriskandreturnremain
theoverridingconcernsintheportfoliomanagementandadministrationprocess.

Suggested Answers to Investing in Action Questions

Taming the Portfolio Monster (p. 596)
Describeasystemforkeepingtrackofportfoliorecord.
Answer:
Thearticlesuggeststhefollowingapproachtohavinganorganizedsystem.Thefirstwouldbetoorganize
thepaperworkbyeachbrokeragefirmandmutualfund.Nextlistallofyourassetscategorizedbyasset
categories.Acrossthetop,makecolumnsforcash,domesticbonds,internationalbonds,domesticstocks
andsoon.UserowsforthesourcesuchasABCmutualfundandbrokeragefirm.Addupallofyourassets
bycategory,andcalculatethepercentageofyourportfolioforeachassetcategory.
Havinganorganizedsystemoftheportfoliocompositionwouldhelpaninvestortomakeainformed
investmentdecisionthatfitsintohisoverallinvestmentstrategy.Theorganizedrecordswouldalso
provideinformationonsecuritiessoldduringtheyearandwouldbeamajorbenefitduringtaxfilings.

Suggested Answers to Ethics in Investing Questions

Retirement at Enron (p. 601)
ShouldCongressrequirediversification?
Answer:
Investorsshouldbeeducatedtothebenefitsofportfoliodiversificationratherthanlegallyprohibitedfrom
investingalltheirmoneyinasinglecompanysstockshouldtheydecidetodoso.Thediversification
requirementwouldhavepreventedemployeesofcompaniessuchasMicrosoft,Intel,WalMart,or
SouthwestAirlinesfromreapinghugerewardsbyputtingtheirretirementmoneyinacompanystock.
Thosewhodidsowerehandsomelyrewardedbyobtainingannualizedreturnsseveraltimeshigherthan
diversifiedportfoliossuchasS&P500overthesameperiodoftime.

Suggested Answers to Discussion Questions

Sincethenatureofthediscussionquestionsareentirelydependentonwhatchoicesstudentsmake,
answerswillvaryforeachquestion.

15Gitman/JoehnkFundamentalsofInvesting,NinthEdition

Solutions to Problems
1.

InvestorAwouldmorelikelybetheretiredcouplebecausetheywouldwanttohavelowrisk.
InvestorBsportfolioismuchriskier,withaportfoliobetaof1.66vs.1.24forInvestorAsportfolio.

2.

PortfolioAismorelikelytobeownedbytheretiredcouple.Theywouldbelookingforlowriskand
steadyincome.PortfolioBpayslittleornodividends,buthashighcapitalgains.Thisismorelikely
tobeownedbysomeonewhodoesnotneedcurrentincomeandcanaffordtotakesignificantrisk.

3.

Capitalgain$2,500$1,762$738
Dividend CapitalGain
PurchasePrice
$200 $738

53.24%(fora15monthholdingperiod)
$1, 762

HPR

4.
A
Cost
$2,000.00

B
Proceeds
$9,500.00

BA
Profit
$7,500.00

HPR$7,480/$2,000
Annualized(12/6)
5.

HPR(beforetax)

Trading
Cost
$20.00

374%
748%

$2, 000 ($26, 746 $25, 000)

$25, 000

14.98%(13monthholdingperiod)
TaxCalculations
1. Interest
2. Aftertax(10.31)
3. Capitalgain
4. Aftertax(10.15)
5.

Aftertaxincome[(2)(4)]

$2,000
$1,380
1,746
$1,484
$2,864

Therefore,HPR(aftertax)

$2,864
11.46%*
$25, 000

*Fora13monthholdingperiod.

Profit
AfterCosts
$7,480.00

Chapter14ManagingYourOwnPortfolio16

6.

Sincetheinvestmentwasheldforoverayear,thelongtermcapitalgainsrateisappropriate.Under
thenewlaw,therateondividendsandcapitalgainsforanindividualinthe33percenttaxbracket
wouldbethesame(e.g.,15%).Theequationthatcouldbeusedforalltaxbracketsis:
DividendIncome(1dividendtaxrate)
CapitalGainsdistribution(1capitalgaintaxrate)
Changeinvalue(1capitalgainstaxrate)
PurchasePrice
IncorporatingthevaluesfromtheCharlotteSmidtssituationweget:
[(0.32(10.15))(0.38(10.15))(0.15(10.15))]/8.60
[0.2720.3230.128]/8.600.723/$8.608.41%
Salesproceeds Cost
Cost
($470 10Options) $4, 000 $4, 700 $4, 000

$4, 000
$4, 000
700

17.5%
$4, 000
$700 (1 0.15)
HPR(aftertax)
14.88%
$4, 000

7.

HPR(pretax)

8.

Interest0.12$100,000$12,000.Tax0.25$12,000$3,000.Aftertaxreturn$12,000
$3,000$9,000.$9,000/$100,0009%aftertaxreturn.

9.

Valueat1/1/05
Valueat12/31/05($250,00026,300)
Unrealizedcapitalgain

HPRp

InitialEquity
Investment

$264,000
276,300
$12,300

Dividendsand
Realized
Unrealized
InterestReceived CapitalGain

CapitalGain(Loss)
+(New#mos.inport) (w/drawn#mos.notinport.)
funds12
funds12

$12,500 $5,200 $12,300

$30, 000

$264,000 0 ($26,300 7 /12) $265, 000 $15,342

$30, 000

12.06%
$248,658

10. Sharpesmeasure(11.06.0)/182.78.Yourportfoliooutperformedthemarket,butnotona
risk/rewardbasis.Yourriskpremiumwaslowerrelativetoyourrisktakenthanthemarket.Thiscan
beseenbythehigherSharpesMeasureforthemarketthanforyourportfolio.

17Gitman/JoehnkFundamentalsofInvesting,NinthEdition

11. (a) Sharpesmeasure(SM)

Totalportfolioreturn Riskfreerate rp RF

Portfoliostandarddeviation
sp

11.8 6.2
0.397
14.1
(b) HectorSmithsportfolio,withaSMof0.43,performedbetterthanNikiMalones,whoseSM
was0.397.HectorreceivedmoreriskpremiumperunitofriskthanNiki.
9.0 6.2
0.298
(c) SMmarket
9.4
(d) BasedontheSMs,Nikisportfolioperformedbetterthanthemarket(0.397versus0.298forthe
market).

12. TreynorsMeasurefortheportfolio(12.06.0)/1.34.62.
TreynorsMeasureforthemarket(10.06.0)/14.0.
Congratulations,yourportfoliooutperformedthemarketsrisk/returnratio!
13. (a) Treynorsmeasure(TM)

Totalportfolioreturn Riskfreerate rp RF

Portfoliobeta
bp

8.6 7.3
1.44
90
(b) AnnasportfoliooutperformedStacys,withaTMof1.44versusoneof1.25.
9.2 7.3
1.9
(c) TMmarket
1.0
(d) ThemarketoutperformedAnnasportfolio;itsTMwas1.9,comparedto1.44forherportfolio.

14. JensensMeasure(13.06.0)[1.5(10.06.0)]7(1.54.0)761.
Theportfolioearnedanexcessreturnovertheriskadjustedrequiredrateofreturnof1%.
15. (a) Jensensmeasure(JM) (TotalportfolioreturnRiskfreerate)
Portfoliobeta(MarketreturnRiskfreerate)]
(rpRF)[bp(rmRF)]
(12.97.8)[1.3(117.8)]
5.1(1.33.2)5.14.160.94
(b) Cheesportfolio,withaJMof.94,outperformedCarrisportfolio,withaJMof0.24.A
positiveJMindicatesthattheactualreturnexceedstherequiredreturn.Thenegativerreturnon
Carrisportfoliomeansthatitdidnotearnitsrequiredreturn.
(c) BasedonitspositiveJM,Cheesportfoliohasperformedbetterthanthemarket.

Chapter14ManagingYourOwnPortfolio18

16.

Measure
(a) SM

rp RF
sp

FioFamily
12.8 8.1 4.7

13.5
13.5

Market
11.2 8.1 3.1

9.6
9.6

0.348
0.323
TheFiofamilysportfolio,withahigherSM,outperformedthemarket.
rp RF
12.8 8.1 4.7
11.2 8.1 3.1

(b) TM
bp
1.1
1.1
1.0
1.0
4.27
3.10
TheFiofamilysportfolio,withahigherTM,outperformedthemarket.
(c) JM (rpRF)
(12.88.1)
N/A
[bp(rmRF)]
[1.1(11.28.1)]
4.73.411.29
ThepositiveJM(alpha)of1.29indicatesthattheactualreturnonthisportfolioexceededthe
requiredreturn;itoutperformedthemarket.
(d) Basedonalltheabovemeasures,theFIOfamilysportfolioperformedbetterthanthemarket.
17. (a) 24months$300$7,200totalinvestment
(b) Tofindthenumberofsharespurchasedeachmonth,divide$300bytheshareprice:

Month
January
February
March
April
May
June
July
August
September
October
November
December
AnnualTotal

NumberofShares
Year1
Year2
25.8
26.4
26.1
25.5
26.1
25.0
27.3
25.0
25.5
24.7
25.0
24.0
24.2
23.5
24.0
23.1
24.5
22.6
24.0
23.1
25.3
22.4
26.1
22.2
303.9
287.5
591.4shares

19Gitman/JoehnkFundamentalsofInvesting,NinthEdition

$7, 200
$12.17 pershare
591.4
(d) Valueatendofyear2591.4$13.5$7,983.90

(c) Averagecostpershare

18. Withoutanyaction,thespeculativeportfolioisnowworth$25,000andtheMMfundisworth
$21,000.Thedifferenceismorethanthetrigger,sotheportfoliosshouldberebalanced.Thereis
$4,000moreinthespeculative,soyoushouldmovehalfofthattotheMMfund,or$2,000.
$2,000/$2580.Sell80sharesandpurchase95sharesoftheMMfund.
19. Youshouldtakenoactionbecausethetriggerhasnotbeenhit.
$25,000/$21,0001.19.
20. Thespeculativeportionnowrepresents61%ofthetotal,whichtriggerstherebalance.Thetotal
valueisnow($301,000)($191,000)$49,000.Youwant45%ofthistobeinspeculative,or
(0.45$49,000)$22,050.$22,050/$30735shares,soyoushouldsell265(1,000735)sharesof
stock.Thentaketheproceeds($7,95026530)andpurchase418sharesoftheMMfund
($7,950/19).Theresultingportfolioisasfollows:
TimePeriod

StockPrice

Shares

MMMutual
FundNAV

Shares

StockValue

MMValue

$30.00

735

$19.00

1418

$22,050.00

$26,942.00

Chapter14ManagingYourOwnPortfolio20

Thetotalvalueisnow$48,992,andthespeculativeportfoliois45%ofthetotal.

Solutions to Case Problems

Case14.1Assessing the Stalchecks Portfolio Performance
Thiscasegivesthestudentanopportunitytocomputetheholdingperiodreturn(HPR)forseveral
investmentvehicles.Thestudentmustrecognizethattheriskofaparticularinvestmentwillaffectthe
assessmentofitsactualperformance.Tothisend,thestudentisrequiredtouseJensensmeasure(alpha),
whichusesportfoliobetatomeasureriskandtheCAPMtoadjustformarketreturn,andthendraw
conclusions.
(a) BeforetaxHPRs
HPRforcommonstock:HPRt

C CG
V0

($0.20 $0.20 $0.25 $0.25) ($18.75 $17.25)

17.25
13.91%fora1yearholdingperiod
C CG
HPRforindustrialbonds:HPR
V0
HPR

HPR

$92.50 ($963.75 $970)

8.89%for1yearholdingperiod
$970

HPRformutualfund:
HPR

($0.60 $0.50) ($20.02 $19.45)

8.59%fora1yearholdingperiod
$19.45

HPRforoptions:
HPR:

($29, 000 $26, 000)

11.54%fora1yearholdingperiod
$26, 000

21Gitman/JoehnkFundamentalsofInvesting,NinthEdition

(b) AftertaxHPRs:
Stock(400shares):(Reducedrateondividends)
[400($0.90)(0.85)400(18.7517.25)(10.38)]/($17.25400)
($306$372)/$6,900$678/$6,9009.83%
Industrialbonds(8bonds)
AftertaxHPR8.89%(10.38)5.51%for1yearholdingperiod
Mutualfund(500shares):
(Reducedrateondividendandcapitalgaindistributions)
[500($0.60$0.50)(0.85)500(20.0219.45)(10.38)]/($19.45500)
($467.50$285)/$9,725$752.50/$9,7259.67%
Options:
AftertaxHPR11.54%(10.38)7.15%for1yearholdingperiod
($17.25400)($9708)($19.45500)$26,000
$6,900$7,760972526,000$50,385
$50,385
Totalcurrentincome ($0.90400)($92.508)($1.10500)$0
360740550
$1,650
Totalcapitalgain
($1.50400)($6.258)($0.57500)$3,000
$3,835
$1, 650 $3,835
10.89%fora1yearholdingperiod
HPR(portfolio)

$50,385

(c) Totalinvestment

(d) JM (rpRF)[bp(rmRF)]
(10.897.20)[1.2(10.107.20)]
3.69(1.202.90)3.693.480.21
UsingJensensmeasure,theactualportfolioreturnisbetterthantherequiredreturnbecauseitis
positive.Itisreasonabletousethismeasure,whichusestheportfoliosbeta,toevaluateafourvehicle
portfolio.
(e) Thisquestionshouldleadtodiscussionithasnopatanswer.Ingeneral,theportfolioisbalanced
betweencurrentincomeandgrowth.Theratioofcurrentincometocapitalgainis43($1,650/$3,835);
onemightwishtodiscusswhetherornotthisissatisfactory.Thereturnsoneachoftheinvestment
vehiclesappearacceptable;theonesthatmightrequireinvestigationarethebondsandthemutual
fund.TheyhavelowerbeforetaxreturnsthantheS&P500StockCompositeIndex,buttheymaybe
somewhatlessrisky.Probably,themostobviousrecommendationistomonitortheportfoliorather
thanchangeitatthistime.

Chapter14ManagingYourOwnPortfolio22

Case14.2Evaluating Formula Plans: Charles Spruges Approach

Thiscaseallowsstudentstouseasimplifiedportfoliotoevaluatethefourformulaplanspresentedinthe
text.Foreaseincomputationanddiscussion,wehaveassumedthatfractionalsharescanbepurchased.
Instructorsmaywishtorevisethenumberstoeliminatefractionalshares.
(a) PricePerShare
EndofPeriod
Period
1
2
3
4
5
6
7
8

ConCam
221/8
227/8
227/8
22
221/4
221/8
22
221/4

Fleck
221/82
241/2
253/8
281/2
217/8
191/4
211/2
235/8

1.
NumberofSharesPurchased
ConCam
11.30
11.43
11.43
11.36
11.24
11.30
11.36
11.24
90.66

Fleck
11.30
10.20
9.85
8.77
11.43
12.99
11.63
10.58
86.75

Note:RememberConCamistheconservativestockandFleckisthespeculativestock.
2. Totalinvestment:$5008$4,000
Averagecostpershare: ConCam $2,000/90.66$22.06
Fleck
$2,000/86.75$23.05
3.
Conservativestock(ConCam)
Speculativestock(Fleck)
Totalportfolio

YearendValue
$221/490.66 $2,017.19
$235/886.75 2,049.47
$4,066.66

PercentofInitialInvestment
(1) Conservativestock(ConCam) $2,017.19/$2,000.00100.86%
(2) Speculativestock(Fleck)
$2,049.47/$2,000102.47%
(3) Totalportfolio
$4,066.66/$4,000.00101.67%

23Gitman/JoehnkFundamentalsofInvesting,NinthEdition

(b) ConstantDollarPlan:Returnspeculativevalue(Fleck)to$2,000whentriggerpointsarereached.
Priceof
Speculative
Stock
Fleck
1.22.125
2.24.500
3.25.375
3a.25.375
4.28.500
5.21.875
5a.21.875
6.19.250
7.21.500
8.23.625

Priceof
Conservative
Stock

Valueof
Speculative
Stock

Valueof
Conservative
Stock

Total
Value

ConCam
22.125
21.875
21.875
21.875
22.000
22.25
22.25
22.125
22.000
22.25

Fleck
$2,000.00
2,214.80
2,293.90*
2,000.00
2,246.09
1,723.97*
2,000.00
1,760.03
1,965.75
2,160.03

ConCam
$2,000.00
1,977.50
1,977.50
2,271.40
2,284.48
2,310.44
2,034.32
12,022.89
2,011.46
2,034.32

$4,000.00
4,192.30
4,271.40
4,271.40
4,530.57
4,034.41
4,034.32
3,782.92
3,977.21
4,194.35

Transactions

{Sold11.58
speculative
shares}
{Bought12.82
speculative
shares}

Sharesin
Speculative

Sharesin
Conservative

90.40
90.40
90.40
78.82
78.82
78.82
91.43
91.43
91.43
91.43

90.40
90.40
90.40
103.84
103.84
103.84
91.43
91.43
91.43
91.43

*Triggerpoints(whenvalueofspeculativeportionfallsbelow$1,740orgoesabove$2,260).
Conservativestock(ConCam)
Speculativestock(Fleck)
Totalportfolio

YearendValue
$221/41/491.43$2,034.32
$235/891.43$2,160.03
$4,194.35

PercentofInitialInvestment
$2,034.32$2,000.00101.72%
$2,034.32$2,000.00108.00%
$4,194.35$4,000.00104.86%

(c) ConstantRatioPlan:Rebalancetovalueofspeculativeportionequaltovalueofconservativeportion
whenratiohitstriggerpoint.

Period
1.
2.
3.
3a.
4.
5.
6.
6a.
7.
8.
8a.

Priceof
Priceof
Speculative Conservative
Stock
Stock
22.125
22.125
24.50
21.875
25.375
21.875
25.375
21.875
28.50
22
21.875
22.25
19.25
22.125
19.25
22.125
21.50
22
23.625
22.25
23.625
22.25

Valueof
Speculative
Stock
$2,000.00
2,214.80
2,293.90*
2,135.81
2,398.85
1,841.22
1,620.27*
1,890.18
2,108.94
2,317.38
2,109.10

Valueof
Conservative
Stock
$2,000.00
1,977.50
1,977.50
2,135.81
2,398.85
2,172.27
2,160.06
1,890.18
1,879.46
1,900.82
2,109.10

Total
Value
$4,000.00
4,192.30
4,271.40
4,271.62
4,546.71
4,013.49
3,780.33
3,780.36
3,988.40
4,218.20
4,218.20

Ratioof
Speculative
Stockto
Conservative
Sharesin
Sharesin
Stock
Transactions Speculative Conservative
1.00
90.40
90.40
1.12
{Sold6.23
90.40
90.40
1.16*
speculative
90.40
90.40
1.0
shares}
84.17
97.63
1.12
84.17
97.63
0.85
{Bought14.02
84.17
97.63
0.75*
speculative}
84.17
97.63
1.00
shares
98.09
85.43
1.12
{Sold8.82
98.09
85.43
1.22*
speculative
98.09
85.43
1.00
shares}
89.27
94.79

*Triggerpoints(whenratioofthevalueofspeculativeportfoliotovalueofconservativeportfoliofallsbelow0.84orexceeds1.15)
Note:Numbersmaynotaddexactlyduetorounding.
Conservativestock(ConCam)
Speculativestock(Fleck)
Totalportfolio

YearendValue
$221/494.79$2,109.10
$235/889.27$2,109.10
$4,218.20

PercentofInitialInvestment
$2,109.10$2,000.00105.46%
$2,109.10$2,000.00105.46%
$4,218.20$4,000.00105.46%

Chapter14ManagingYourOwnPortfolio24

(d) VariableRatioPlan:Rebalancespeculativeportionto46%ofthetotalportfoliovalueeachtimethe
uppertriggerpointisreached;rebalancespeculativeportionto50%eachtimethelowertriggerpoint
isreached.

Period
1.
2.
3.
4.
4a.
5.
6.
6a.
7.
8.
8a.

Priceof
Speculative
Stock
22.125
24.500
25.375
28.500
28.500
21.875
19.250
19.250
21.500
23.625
23.625

Priceof
Conservative
Stock
22.125
21.875
21.875
22.000
22.000
22.250
22.125
22.125
22.000
22.250
22.250

Valueof
Speculative
Stock
$2,000.00
2,214.80
2,293.90
2,576.40
2,099.99
1,611.75
1,418.34
1,948.84
2,216.87
2,435.97
2,022.05

Valueof
Conservative
Stock
$2,000.00
1,977.50
1,977.50
1,988.80
2,415.21
2,493.34
2,479.33
1,948.83
1,937.76
1,959.78
2,373.70

Total
Portfolio
Value
$4,000.00
4,192.30
4,271.40
4,656.20
4,564.20
4,105.09
3,897.67
3,897.67
4,164.63
4,395.75
4,395.75

Ratio
0.50
0.53
0.54
0.56*
0.46
0.39
0.36*
0.50
0.53
0.55*
0.46

Transactions
{Sold16.72
speculative
shares}
{Bought29.43
speculative}
shares
{Sold17.52
speculative
shares}

Sharesin
Speculative
90.40
90.40
90.40
90.40
73.68
73.68
73.68
103.11
103.11
103.11
85.59

Sharesin
Conservative
90.40
90.40
90.40
90.40
112.06
112.06
112.06
88.08
88.08
88.08
106.68

*Triggerpoints(whenratioofthevalueofspeculativeportfoliotothetotalportfoliovalueeitherexceeds54%,theuppertriggerpoint,orfallsbelow
38%,thelowertriggerpoint.
Conservativestock(ConCam)
Speculativestock(Fleck)
Totalportfolio

YearendValue
$221/4106.68$2,373.70
$235/885.59$2,022.05
$4,395.75

PercentofInitialInvestment
$2,373.70$2,000.00118.69%
$2,022.05$2,000.00101.10%
$4,395.75$4,000.00109.89%

(e) FormulaPlan

Yearendportfolio
valueasapercentage
of$4,000invested

Numberoftransactions
torebalanceportfolio

DollarCost
Averaging

Constant
Dollar

Constant
Ratio

Variable
Ratio

101.67%

104.86%

105.46%

109.89%

Inthisillustration,theformulaplanshaveperformedmuchthewayonewouldexpect.Themost
passiveandlowestriskplandollarcostaveraginghasthelowestyearendvalueasapercentageof
the$4,000investment.Italsorequirestheleastrebalancingtransactions.Therefore,bothits
transactionsandinformationcostsarezero.
Theotherthreeplansshowincreasingyearendvaluesasonemovesfromtheonewiththelowest
activityandrisktheconstantdollarplantohighestactivityandriskthevariableratioplan.While
thelowriskconstantdollarplanrequirestworebalancingtransactions,thehigherriskconstantratio
andvariableratioplansrequirethreerebalancingtransactions.Thevariableratioplan,whichhasa
yearendvaluenearly10percentabovetheamountinvested,isclearlysuperior.However,onemust
recognizethatthevariableratioplanisclearlythemostriskyalternative.Charlesmayhavedecisions
tomake.Clearly,giventhesharepricedataprovidedandCharlestriggerpoints,thevariableratio
planwouldhaveprovedmostbeneficialtohimduringthepastyear.Itmaybeinterestingtospeculate
abouttheresultsifpriceactionshadbeendifferent.Theinstructormaywishtopursuethislineof
inquirytogainafurtherunderstandingofformulaplans.

25Gitman/JoehnkFundamentalsofInvesting,NinthEdition

Outside Project
Chapter 14Assessing Mutual Fund Performance
Whenriskadjusted,marketadjustedrateofreturnssuchasJensensmeasurearenoteasytocalculate,
othercomparisonsneedtobemade.Forinstance,itisgenerallydifficulttofindthebetavaluesofvarious
mutualfunds;thereforeJensensmeasureisnotausefulmeasure.Instead,performancecanbeevaluated
bycomparingtheHPRsofsimilarfundsthatareassumedtohavesimilarriskcharacteristics.Thisproject
asksyoutodojustthat.
UseTheWallStreetJournal,Barrons,orsomeothersourcetoobtainthorough,readableinformationon
mutualfunds.Obtainthisinformationdatedoneyearearlierandselectfivesimilarfundsmanagedby
differentfundmanagementcompanies.Calculatetheholdingperiodreturn(HPR)foreachfundoverthe
periodfromayearagotothepresent.Barronsandothersourcesprovidethedividendandcapitalgains
distributionsfortheperiod.Ifinvestmentperformanceisconsiderablydifferentamongthefunds,youmay
wanttofurtherinvestigatetheirmanagementsthroughsuchsourcesasWeisenbergerInvestment
Companies,whichshouldbeavailableinyourpublicoruniversitylibrary.Trytoassesstheriskandreturn
behaviorsofthesefundsandusethesecomparisonstoexplainanydifferencesyoufoundintheirHPRs