Mary and Nick Stalcheck have an investment portfolio containing four vehicles. 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 investment vehicle, they developed their portfolio with the idea of diversifying across various types of vehicles. The portfolio currently contains common stock, industrial bonds, mutual fund shares, and options. They acquired each of these vehicles during the past three years, and they plan to invest in other vehicles 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 in 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 a they did not make any portfolio transactions during the past year, all of the Stalchechk'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 of the four vehicles I their portfolio.
Common stock: They own 400 shares of KJ Enterprises common stock. KJ is a diversified manufacturer of metal pipe and is know for its unbroken stream of dividends. Over the past few years, it has entered now 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 $.20, $.20, $.25, and $.25 were paid.
Industrial bonds: The Stalchecks own eight Cal Industries bonds. The bonds have a $1,000 par value, have a 9.250% coupon, and are due in 2021. They are A-rated by Moody's. The bond was quoted at 97.000 at the beginning of the year and ended the calendar year at 96.375%.
Mutual funds: The Stalcheks hold 500 shares of Holt Fund, a balanced, no-load mutual fund. The dividend distributions on the fund during the year consisted of $.60 in investment income and $.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 year-end the total value of theoptions contracts was $29,000.
a. Calculate the holding period return on a before-tax basis for each of these four investment vehicles.
b) Assuming their ordinary income is currently being taxed at a combined 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 investment vehicles.
c) Recognizing that all gains on their investments were unrealized, calculate the before tax portfolio HPR for their 4 vehicle 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 the Jensen's measure (Jensen alpha). Use that measure to analyze the performance of their portfolio on a risk adjusted, market adjusted basis. Comment on your finding. Is it reasonable to use Jensen's measure to evaluate a 4 vehicle portfolio? Why or why not?
