Chapter 25 Contemporary Issues in Portfolio Management

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Chapter 25Contemporary Issues in Portfolio
Management

• Business 4179

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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

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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.

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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.

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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.

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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.

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Question 25 -3

• If the market is efficient, no one can
  consistently time the market, and TAA strategies
  should be ineffective.

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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.

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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.

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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.

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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.

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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.

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Question 25 -9

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

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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.

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Question 25 -11

• They have usually not been given permission by
  the security owner.

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Question 25 -12

• Facilitating the matching up of those who want to
  lend stock and those who want to borrow it.

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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.

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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?

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Question 25 -16

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

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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.

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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.

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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.

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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.