FNCE20003 Lecture 5: Asset Allocation Strategies

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Questions and Answers

What is the primary purpose of actively managing an equities portfolio?

To consistently buy and hold shares

To ensure compliance with regulatory restrictions

To lock in gains from share price movements (correct)

To maintain a fixed interest rate on investments

Which statement best describes a bond?

It is a contract that only involves interest payments.

It represents equity ownership in a company.

It is an agreement evidencing the obligation to make cash payments on specified dates. (correct)

It guarantees a fixed return irrespective of market conditions.

What distinguishes coupon-paying bonds from zero-coupon bonds?

Only coupon-paying bonds make interest payments at regular intervals. (correct)

Coupon-paying bonds have mandatory principal repayments.

Zero-coupon bonds are always riskier than coupon-paying bonds.

Both types of bonds provide fixed payments at maturity.

What factor primarily influences the specific equities investments made by an asset team?

The risk profile of the fund and regulatory restrictions Signup and view all the answers

Which of the following is NOT a characteristic of equity investments?

They provide guaranteed returns on principal. Signup and view all the answers

What is the primary focus of a defensive asset allocation strategy?

Minimizing risk exposure Signup and view all the answers

Which asset allocation strategy involves active management without stock selection?

Dynamic Asset Allocation (DAA) Signup and view all the answers

If an investment fund follows a passive investment strategy, what is likely to happen to the asset allocation over time?

It will remain largely unchanged barring significant market events. Signup and view all the answers

How much of the total funds is allocated to equities in the given example?

50% Signup and view all the answers

What does the Mutual Fund Separation Theorem relate to in investment funds?

The separation of asset allocation and security selection Signup and view all the answers

Which statement is true about Tactical Asset Allocation (TAA)?

It reacts to market conditions to enhance returns. Signup and view all the answers

In the provided asset allocation example, what is the percentage allocated to cash?

30% Signup and view all the answers

What is a potential impact of adopting a buy and hold strategy in asset allocation?

Long-term stability with low transaction costs. Signup and view all the answers

What is one recognized method for selecting specific stocks from the available range?

Fundamental analysis Signup and view all the answers

Which method of stock selection aligns with portfolio theory?

Random selection Signup and view all the answers

Which company should participants forecast for the Share Price Forecasting Game?

Bapcor Signup and view all the answers

What is the maximum bonus mark that a winner can receive in the Share Price Forecasting Game?

2% Signup and view all the answers

Which of the following industries can international equities provide access to?

Aeronautics Signup and view all the answers

What is the primary purpose of cash management trusts (CMT)?

To provide small investors access to diversified debt investments Signup and view all the answers

How do bond ETFs compare to cash management trusts (CMT) in recent trends?

Bond ETFs have become far more prevalent than CMTs Signup and view all the answers

What represents a residual claim on the cash flows generated by a firm's assets?

Equity Signup and view all the answers

Which of the following is NOT a method of raising equity capital?

Cash management trust Signup and view all the answers

What is a key characteristic of debt investments in relation to firms?

They impose a contractual obligation for regular payments Signup and view all the answers

In which method of equity capital raising might wealth be transferred from old shareholders to new shareholders?

Rights issue Signup and view all the answers

What differentiates equity investment methods in terms of their impact on shareholders?

Cost and time of implementation Signup and view all the answers

Equity can be generated from which of the following sources?

Retained earnings and new issues Signup and view all the answers

What is a common characteristic of zero-coupon bonds?

They make a single payment of principal at maturity. Signup and view all the answers

How is the coupon payment determined for a bond with a quoted rate of 7.75% p.a. and a face value of $100,000?

$3,850 every six months. Signup and view all the answers

What is the primary basis for valuing bonds?

Future cash flows discounted to present value. Signup and view all the answers

When quoting interest rates, how are they generally expressed?

As nominal rates, annually. Signup and view all the answers

In the context of bond valuation, what do basis points represent?

A unit of measure for changes in interest rates. Signup and view all the answers

What characteristic differentiates coupon bonds from zero-coupon bonds?

Coupon bonds pay interest regularly, whereas zero-coupon bonds do not. Signup and view all the answers

What does the formula $F - P$ represent in the context of zero-coupon bonds?

The effective interest earned at maturity. Signup and view all the answers

For determining the present value of a bond, which of the following variables is NOT a key factor?

Creditworthiness of the issuer. Signup and view all the answers

Study Notes

Asset Allocation Overview

Asset allocation can be categorized into four main strategies:
- Fully passive management with strategic asset allocation (SAA) and buy & hold.
- Passive SAA with trade-based stock selection.
- Active tactical asset allocation (TAA) with static stock selection.
- Fully active TAA with active stock selection.

Sample Asset Allocation

An investment fund manager with a $100 million allocation can opt for the following distribution:
- Property: 20%
- Equities: 50%
- Cash: 30%
Allocation must reflect investor risk profiles and market conditions.

Investment Philosophy

A passive strategy maintains the initial asset allocation over time, subject to periodic rebalancing.
An active management strategy adapts based on market forecasts to enhance profits via market timing.

Stock Selection

Stock selection involves determining specific investments within asset classes, like equities.
Strategies can also be active (trading) or passive (buy and hold).
Active management entails frequent buying and selling to capitalize on price fluctuations.

Cash and Bonds

Bonds defined as contracts where issuers promise to repay specific amounts to investors on set dates.
Key components include principal (amount borrowed) and interest payments.

Types of Bonds

Coupon-Paying Bonds:
- Provide regular fixed interest payments ("coupons") and repay principal at maturity.
- Interest rates are typically quoted annually although paid more frequently (e.g., semi-annually).
Zero-Coupon Bonds (ZCB):
- No periodic interest payments; only a lump sum payment at maturity.
- Issued at a discount to par value, with effective interest calculated as the difference between face value and purchase price.
- Common forms include commercial bills and treasury notes.

Bond Valuation Principles

Valuation based on present value methods, influenced by cash flows, time to maturity, and yield.
Changes in yield are often measured in basis points (1 basis point = 0.01%).

Equity and Debt Comparison

Debt obligates firms to regular interest and principal payments, whereas equity represents residual claims on cash flows.
Dividends are paid after fulfilling debt obligations, justifying an equity risk premium.

Equity Capital Raising Methods

Significant methods include:
- Initial Public Offering (IPO)
- Rights issues
- Private placements
- Dividend reinvestment plans
These methods vary in costs, implementation time, and impact on shareholder equity.

Risk in Equities

Diversification benefits exist beyond domestic markets, with international equities presenting additional investment opportunities.

Stock Selection Strategies

Investors can use:
- Fundamental analysis
- Technical analysis (charting)
- Random selection
Each method carries theoretical implications relevant to portfolio theory and diversification.

A voluntary game to predict closing share prices for Bapcor (BAP) and Karoon Energy (KAR).
Participants can earn bonus marks in the subject, enhancing academic performance.

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Description

Explore various asset allocation strategies discussed in FNCE20003, focusing on defensive approaches rather than aggressive ones. This lecture covers the spectrum from fully passive management to active strategies, providing a comprehensive understanding of investment allocation techniques.