Answer Happy

When Lin Lin’s husband, Tun Tun, passed away about three monthsago he left behind a small fortune, which he had accumulated byliving a very thrifty life and by investing in ordinary shares. TunTun had worked as an engineer for a surgical instrumentsmanufacturer for over 30 years and had taken full advantage of thecompany’s retirement saving plan. However, instead of buying adiversified set of investments he had invested his money into a fewhigh growth companies. Over time his investment portfolio had grownto about 900,000 Kyats being primarily comprised of the stocks of 3companies. He was very fortunate that his selections turned out tobe good ones and after numerous stock-splits the prices of thethree companies had appreciated significantly over time. Lin Lin,on the other hand was a very conservative and cautious person. Shehad devoted her life to being a stay-home mom and had raised theirtwo kids into fine adults, each of whom had a fairly successfulcareer. Maung Maung, 28, had followed in Tun Tun’s footsteps. Inaddition to being gainfully employed as a engineer, he was pursingan MBA, at a prestigious business school. Hla Hla, 26, wascompleting her residency at Yangon General Hospital. Although LinLin and Tun Tun had enjoyed a wonderful married life, it was TunTun who managed almost all the financial affairs of their family.Lin Lin, like many spouses of their generation, preferred to focuson other family matters. It was only after Tun Tun’s passing onthat Lin Lin realized how unprepared she was for the complexdecisions that have to be made when managing one’s wealth. Upon theadvice of her close friend, Aye Aye, Lin Lin decided to call thebroker’s office and request that her account be turned over to BoBo, the firm senior financial advisor. Aye Aye, a widow herself,had been very happy with Bo Bo’s advice and professionalism. He hadhelped her rebalance and re-allocate her portfolio with the resultthat her portfolio’s value had steadily increased over the yearswithout much volatility. At their first meeting, Bo Bo examined theLin Lin’s portfolio and was shocked at how narrowly focused itscomposition had been. In fact, during the past year—due to thesignificant drop in the technology sector—the portfolio had lostalmost 30% of its value. “Tun Tun, certainly liked to flirt withrisk,” said Bo Bo. “The first thing we are going to have to do isdiversify your portfolio and lower its beta. As it stands you couldmake a lot of money if the technology sector take off, but thereverse scenario could be devastating. I am sure you will agreewith me that given your status in life you do not need to bear thismuch of risk.” Lin Lin shrugged her shoulders and looked blankly atBo Bo. “Diversify…Beta… what are you talking about? These terms arenew to me and so confusing. You are right, Bo Bo, I don’t need thehigh risk but can you explain to me how the risk level of myportfolio can be lowered? Bo Bo realized right way that Lin Linneeded a primer on the risk-return tradeoff and on portfoliomanagement. Accordingly, he scheduled another appointment for laterthat week and prepared the following exhibit to demonstrate thevarious nuances of risk, expected return, and portfolio management.Exhibit Expected rate of return Scenario Probability Treasury billIndex fund Utility co., High-tech Co., Counter-Cyclical Co.,Recession 20% 5% -10% 6% -25% 20% Near recession 20% 5% -6% 7% -20%16% Normal 30% 5% 12% 9% 15% 12% Near Boom 10% 5% 15% 11% 25% -9%Boom 20% 5% 20% 14% 35% -20% Discussion Questions (1) Imagine youare Bo Bo. How would you explain to Lin Lin the relationshipbetween risk and return of individual stocks? (2) Lin Lin has noidea what beta means and how it is related to the required returnof the stocks. Explain how you would help her understand theseconcepts. (3) How should Bo Bo demonstrate the meaning andadvantages of diversification to Lin Lin? (4) What would happen ifLin Lin were to put 70% of her portfolio in the high-tech stock and30% in the Index Fund? Explain. (5) If Lin Lin decided to investher money equally in High-Tech and Counter-Cylical stocks, whatwould her portfolio’s expected return and risk level be? Are theseexpectations realistic? Explain. (6) Based on these calculationswhat do you think Bo Bo should propose as a possible portfoliocombination for Lin Lin?