Forum 2.

1-Case

1. What advantages do the mutual fund offer compared to the company stock?

As part of investing in the 401(k) plan, you would be better served investing in Mutual Funds
rather than company stock because of the following reasons:
 Mutual Funds offer Asset Diversification which means investing in a mix of asset
classes, maturities or sectors to reduce the impact of losses from one particular
class/sector on the portfolio, thereby reducing your overall risk. Asset Diversification is
not provided by investing in the company stock
 Since Mutual Funds accept investments from various investors, they are able to take
advantage of their buying and selling size thereby reducing their transaction costs. For eg:
If you purchase a few stocks, you have to pay commission on each of them which is very
high compared to what you pay as management charges while buying a unit of a Mutual
Fund.
 Since you pay management fee to a Fund Manager, you effectively have someone to
take charge of your investments to try and get you the best returns possible. This is
especially useful in case you don't have the time/knowledge to go through the financials
of every stock that you might want to invest in.
 You don't need to wait for long to have enough money to buy higher cost investments,
since Mutual Funds allow periodic investments in small denominations. for eg: The
Bledose Large Company Stock Fund would allow you to invest small denominations in
stocks of companies whose stock prices might be actually out of your budget if you
directly buy those stocks.

2. Assume that you invest 5 percent of your salary and received the full 5 percent
match from East Coast Yachts. What Effective annual rate(EAR) do you earn from
the match? What conclusions do you draw about matching plans?

The conclusion that I draw from the matching plan is that the expected return of the 401(k)
investment depends on the actual return of the plan.

3. Assume you decide you should invest at least part of your money in large -
capitalization stocks of companies based in the United States. What are the
advantages and disadvantages of choosing the Bledsoe Large - Company Stock
Fund compared to the Bledsoe S&P 500 Index Fund?

 The Bledose Large Company Stock Fund (BLCSF) has beaten the market in six out of
the past 8 years which means the returns are greater than the returns on the S&P 500 75%
of the time.
 However, the higher expense costs for the BLCSF means that if the performance of the
Index Fund is similar (or slightly lower) to the BLCSF for a particular year, then it would
generate higher returns for the Investor as compared to the BLCSF.

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  If you are looking for a growth strategy through Large Capital Company Stocks, then
BLCSF should be preferred since the Fund manager would be actively seeking to
increase returns from the fund rather than the Manager of an Index Fund who would take
a laid-back approach in researching since the composition of the fund stocks would be
similar to that of the S&P 500.

4. The returns on the Bledsoe Small-Cap Fund are the most volatile of all the mutual
funds offered in the 401(k) plan. Why would you ever want to invest in this fund?
When you examine the expenses of the mutual funds, you will notice that this fund
also has the highest expenses. Does this affect your decision to invest in this fund?

Small Cap Funds fund managers follow a more aggressive strategy for growth by seeking
out companies which are typically young and have an aggressive growth outlook. This is
entailed by the high management fee being charged because the research done needs to
extensive and thorough to ensure that the underlying companies have a strong
management and remain solvent. Inspite of their higher volatility, the returns on these
funds tend to surpass the returns of mid-cap and large-cap funds which makes them an
attractive growth opportunity. These kinds of funds are generally meant for investors who
don't have the time to research but possess the high risk-taking capacity.

5. A measure of risk-adjusted performance that is often used in the Sharpe ratio. The
Sharpe ratio is calculated at the risk premium of an asset divided by its standard
deviations. The standard deviations and return of the funds over the past 10 years
are list here. Calculate the Sharpe ratio for each of these funds. Assume that the
expected return and standard deviations of the company stock will be 16 percent
and 65 percent, respectively. Calculate the Sharpe ratio for the company stock.
How appropriate is the Sharpe ratio for these assets? When would you use the
Sharpe ratio? Assume 3.2 percent risk - free rate.

Risk Premium is the extra return that is given on an investment over and above the Risk Free
Rate. Sharpe Ratio being the Risk Premium divided by the Standard deviation:

Standard Sharpe
FUND Risk Premium Deviation Ratio

10.15-
Bledose S&P 500 Index Fund 3=7.15% 23.85% 0.2998

Bledose Small Cap Fund 14.83- 29.62% 0.3994

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 3=11.83%

Bledose Large Company 11.08-

Stock Fund 3=8.08% 26.73% 0.3023

Bledose Bond Fund 8.15-3=5.15% 10.34% 0.4981

6. What portfolio allocation would you choose? Why? Explain your thinking carefully.
From the above Sharpe Ratios, it is clear that the Risk Adjusted Return is the greatest

for the Bledose Bond fund. However, investing entirely in that fund might not generate

the returns that are enough to satisfy the investor. The greatest return comes from the

Small Cap Fund at 14.83% but the high standard deviation signifies how volatile the

returns from this fund can be. The portfolio allocation should be chosen by the student

keeping in mind his/her own risk appetite.

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