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  • Chapter 12: Case 2 - Calvin Jacobs Seeks the Good Life - pages 492-493
  • Chapter 13: Case 1 - Assessing the Stalcheck's Portfolio Performance - pages 526-527

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Case Problem 12.2 Calvin Jacobs Seeks the Good Life Calvin Jacobs is a widower who recently retired after a long career with a major Midwestern manufacturer. Beginning as a skilled craftsman, he worked his way up to the level of shop supervisor over a period of more than 30 years with the firm. Calvin receives Social Security benefits and a generous company pension. Together, these amount to over $4,500 per month (part of which is tax-free). The Jacobses had no children, so he lives alone. Calvin owns a 2-bedroom rental house that is next to his home, and the rental income from it covers the mortgage payments for both the rental house and his house. Over the years, Calvin and his late wife, Allie, always tried to put a little money aside each month. The results have been nothing short of phenomenal. The value of Calvin’s liquid investments (all held in bank CDs and savings accounts) runs well into the 6 figures. Up to now, Calvin has just let his money grow and has not used any of his savings to supplement his Social Security, pension, and rental income. But things are about to change. Calvin has decided, “What the heck, it’s time I start living the good life!” Calvin wants to travel and, in effect, start reaping the benefits of his labors. He has therefore decided to move $100,000 from a savings account to 1 or 2 high-yielding mutual funds. He would like to receive $1,000 to $1,500 a month from the fund(s) for as long as possible because he plans to be around for a long time. Questions a. Given Calvin’s financial resources and investment objectives, what kinds of mutual funds do you think he should consider? b. What factors in Calvin’s situation should be taken into consideration in the fund selection process? How might these affect Calvin’s course of action? Case Problem 13.1 Assessing the Stalchecks’s Portfolio Performance Mary and Nick Stalcheck have an investment portfolio containing 4 investments. It was developed to provide them with a balance between current income and capital appreciation. Rather than acquire mutual fund shares or diversify within a given class of investments, they developed their portfolio with the idea of diversifying across various asset classes. The portfolio currently contains common stock, industrial bonds, mutual fund shares, and options. They acquired each of these investments during the past 3 years, and they plan to purchase other investments sometime in the future. Currently, the Stalchecks are interested in measuring the return on their investment and assessing how well they have done relative to the market. They hope that the return earned over the past calendar year is in excess of what they would have earned by investing in a portfolio consisting of the S&P 500 Stock Composite Index. Their research has indicated that the risk-free rate was 7.2% and that 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 able to estimate the beta of their portfolio, which was 1.20. In their analysis, they have planned to ignore taxes because they feel their earnings have been adequately sheltered. Because they did not make any portfolio transactions during the past year, all of the Stalchecks’s investments have been held more than 12 months, and they would have to consider only unrealized capital gains, if any. To make the necessary calculations, the Stalchecks have gathered the following information on each investment in their portfolio. Common stock. They own 400 shares of KJ Enterprises common stock. KJ is a diversified manufacturer of metal pipe and is known for its unbroken stream of dividends. Over the past few years, it has entered new markets and, as a result, has offered moderate capital appreciation potential. Its share price has risen from $17.25 at the start of the last calendar year to $18.75 at the end of 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. The bonds have a $1,000 par value, have a 9.250% coupon, and are due in 2024. They are A-rated by Moody’s. The bonds were quoted at 97.000 at the beginning of the year and ended the calendar year at 96.375%. Mutual fund. The Stalchecks hold 500 shares in the Holt Fund, a balanced, no-load mutual fund. The dividend distributions on the fund during the year consisted of $0.60 in investment income and $0.50 in capital gains. The fund’s NAV at the beginning of the calendar year was $19.45, and it ended the year at $20.02. Options. The Stalchecks own 100 options contracts on the stock of a company they follow. The value of these contracts totaled $26,000 at the beginning of the calendar year. At yearend the total value of the options contracts was $29,000. Questions a. Calculate the holding period return on a before-tax basis for each of these 4 investments. b. Assuming that the Stalchecks’s ordinary income is currently being taxed at a combined (federaland state) tax rate of 38% and that they would pay a 15% capital gains tax on dividends and 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 Stalchecks’s investments were unrealized, calculate the before-tax portfolio HPR for their 4-investment portfolio during the past calendar year. Evaluate this return relative to its current income and capital gain components. d. Use the HPR calculated in question c to compute Jensen’s measure (Jensen’s alpha). Use that measure to analyze the performance of the Stalchecks’s portfolio on a risk-adjusted, market adjusted basis. Comment on your finding. Is it reasonable to use Jensen’s measure to evaluate a 4-investment portfolio? Why or why not? e. On the basis of your analysis in questions a, c, and d, what, if any, recommendations might You offer the Stalchecks relative to the revision of their portfolio? Explain your recommendations
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