East Coast Yachts uses Bledose Financial Services as its 401(k) plan administrat

Question

East Coast Yachts uses Bledose Financial Services as its 401(k) plan administrator. The investment options offered for employees are discussed below.

Company Stock: One option in 401(k) plan is stock in East Coast Yachts. The company is currently privately held. However, when you have interviewed with the owner, Ms. Larissa Warren, she informed you the company stock was expected to go public in the next three to four years. Until then, a company stock price is simple set each year by the board of directors.

Bledose S&P 500 Index Fund: This mutual fund tracks the S&P 500. Stocks in the fund are weighted exactly the same was the S&P 500. This means the fund return is approximately the return on the S&P 500, minus expenses. Since an index fund purchases assets based on the composition of the index it is following, the fund manager is not required to research stocks and make investment decisions. The result is that the fund expenses are usually low. The Bledose S&P 500 Index Fund charges expenses of 0.15% of assets per year.

Bledose Small Cap Fund: This fund primarily invests in small capitalization stocks. As such, the returns of the fund are more volatile. The fund can also invest 10% of its assets in companies based outside the United States. This fund charges 1.70% in expenses.

Bledose Large Company Stock Fund: This fund invests primarily in large capitalization stocks of companies based in the United States. The fund is managed by Evan Bledose and has outperformed the market in six of the last eight years. The fund charges 1.50% in expenses.

Bledose Bond Fund: This fund invests in long-term corporate bonds issued by U.S. domiciled companies. The fund is restricted to investments in bond with an investment grade credit rating. This fund charges 1.40% in expenses.

Bledose Money Market Fund: This fund invests in short-term, high credit quality debt instruments, which include Treasury bills. As such, the return on the money market fund is only slightly higher than the return on Treasury bills. Because of the credit quality and short-term nature of the investments, there is only a very slight risk of negative return. The fund charges 0.60% in expenses.

1- The returns on the Bledose 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?

2- A measure of risk-adjusted performance that is often used is the Sharpe Ratio. The Sharpe Ratio is calculated as the risk premium of an asset divided by its standard deviation. The standard deviation and return of the funds over the past 10 years are listed below. Calculate the Sharpe ratio for each of these funds. You may use the average of risk free rate from the Historical Return Excel file or assume risk free rate as 3%.

10 year Annual Return

Standard Deviation

Bledose S&P 500 Index Fund

Bledose Small Cap Fund

Bledose Large Company Stock Fund

Bledose Bond Fund

3- What portfolio allocation would you choose? Why? Explain your thinking carefully.

10 year Annual Return

Standard Deviation

Bledose S&P 500 Index Fund

Bledose Small Cap Fund

Bledose Large Company Stock Fund

Bledose Bond Fund

Explanation / Answer

1. A rational investor demands higher return for the additional higher risk born and therefore even if returns on the Bledose Small Cap Fund are the most volatile of all the mutual funds offered in the 401(k) plan then an investor can invest in the mutual funds for a high return then market. Expenses of the mutual fund directly affect the Net asset valuen and so does the return from investment. Thus the mutual fund with higher expenses are recommended not to invest.

2. standard deviation and Annual return are not provided in the space provided. However the sharpe ration can be calculated as the risk premium of an asset divided by its standard deviation. If standard deviation is provided then the risk premium can be calculated by deducting annual return from risk free rate. (Risk premium = Annual return - Risk free rate )

Sharpe ratio = Risk premium / standard deviation (for every portfolio or asset)

3. Portfolio allocation which provides the higher return on the similar risk is to be allocated. That is the one with higher return and compatibel risk than others, The answer could not be provided in absence of the actual figure of return and standard deviation.

Related Questions

Navigate

• Browse (All)
• Browse E
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.