Question

QUESTION 1

You and your workmates have come together to form an investment group called Pamodzi Investments; requiring each member to make monthly deposits into a pool account. You are planning to use these funds to create a portfolio of investments in preparation for you retirements.

Todate, the balance in the pool account amounts to K150,000-00 and you are about to make your first investment. However, there is a challenge due to different preferences of which securities to invest in. As a way towards consensus, a colleague proposes to consider the Collective Investment schemes that are available on the market. He has heard that this is a better way of accessing diversification benefits for small investors.

As an Investment Analyst in the group, you have been approached by your colleagues to advise on the options to consider and how to set up some investment guidelines for the operations of the group.

Required:

1. Explain the relevance of having an investment policy while highlighting its key component parts.

[15 Marks]

2. Explain the justification of the Modern Portfolio Theory approach to creating investment portfolios.

[15 Marks]

3. Explain diversification and how it could be achieved in this situation with reference to Zambian financial markets.

[10 Marks]

D)Explain the main investment asset classes available in Zambia while providing examples of the common securities available under each type.

Answer 1

a. Ans: Investment Policy - it is a guideline for the investors/portfolio managers which lead to the expected result or goal over a period of time. This covers the asset allocation, required returns, expected risks, time horizon. This can render the investor to make emotional decisions.

Components:

1) Scope and Purpose: defines who should be the investor. The assets in which the investments should happen. Defining the roles and responsibilities of the investment manager. Assigning the responsibilities.

2) Governance : defining the process for monitoring the investment. Appointing the authority for auditing the investments made from time to time. Assigning authority for risk management.

3) Investment: Defining the type to assets and the distribution of portfolio over the assets.

4) Returns: defining the expected returns from the investment strategy

5) Risk: defining the level of risk investment is exposed with the quality of investment in the portfolio

6) Risk Management : Chalking out appropriate risk mitigation strategy.

b. Ans: Modern Portfolio Theory - this theory says that the risk and returns of a portfolio and directly proportional to each other. The more the risk an investor is willing to take the more returns he can expect. However, a portfolio can be constructed for a risk averse investor with optimal/maximum returns at a certain level of risk. This can be achieved by combining assets with different risk levels and returns to create an efficient portfolio with optimal returns.

c. Ans: Diversification : "Not putting all your eggs in one basket" this is the literal meaning of diversification. In financial term it means the portfolio should have investments in different kind of assets, like, government bonds (low risk -low gain), equity (mid-high risk and mid-high return) .

As Zambia is a developing nation there are lot of opportunities in equity market with good growth potential. One can invest in mutual funds which have balanced portfolio with a higher exposure to equity. this can give good returns over long term as companies / industries mature of the period of time and will the investment grow.

d. Ans: Main investment class:

1) Property

2) fixed income - government bonds

3) money market - Publicly traded stocks

3)mutual funds - combination of fixed income and money market