Question

Question 6

1. Explain briefly why it is prudent for investors to create an Investment Policy Statement (IPS) when working with a financial advisor
2. Describe the strategic asset allocation you would recommend for a 45-year old investor who just won $50,000 and plans to invest it all. She has negligible personal debt but also no savings, despite wanting to retire at age 65. Her job does not pay particularly well but she also has no children to take care of. She lacks any type of financial education whatsoever but is not particularly averse to risk.
3. Assuming that you forecast a peak in economic activity over the next few months, what kind of tactical shifts would you make for the portfolio above? (1 mark)
4. If you believed that despite the peak in the broad market that shares in Potash Corp. would continue to outperform the Canadian mining sector, describe how you would structure a position to take advantage of its relative outperformance (1 mark). Also, how will the R² of Potash Corp.'s returns with those of the Canadian mining sector will impact this trade. (1 mark)
5. Why is international diversification less effective today at reducing portfolio risk than it was 50 years ago?

Answer 1

Answer with Explanation:

a. The purpose of an Investment Policy Statement is to elucidate the process to be used by the financial advisor in making investment decisions. While working with a financial advisor, it is advisable to make an IPS because provides guidance for decision-making and serves as both a roadmap to a successful investment strategy.

It specifies the investor's goals and investment preferences and helps in establishing a systematic review process that enables the investor to stay focused on the long-term objectives, even when there is a lot of volatility in the short term.

b. The money should be strategically allocated in both stocks and fixed-income investments.

The way to manage the risk for her should be to have both stocks and fixed-income investments in her portfolio and withdraw from the latter when the stock market is down.

Fixed income such as GICs, bonds, and interest-bearing loans from investors to governments or corporations.

Since bonds are generally less volatile than stocks the will soften the overall impact of stock losses on her portfolio.

c. In the portfolio above, one should reduce the value of bonds and allocate some of it to the stocks to enjoy the benefit which would reap out of the peak in economic activity.

d. This kind of investing is called relative investing, wherein one invests in stocks that have performed well relative to the market or benchmark . One should buy these stocks high and sell even higher.

Coefficient of determination R-squared (R^2) measures the correlation of a stock's movements to that of an index, R-squared values range between 0 and 100, where 0 represents the least correlation, and 100 represents full correlation.

As a result, if the correlation is high this means that Potash Corp. stock would move inline with Candaian mining sector index and low correlation would indicate vice versa.

e. The following are the reasons the international diversification is less effective :

1. Interconnectivity of Markets: Most of the markets in the world are fairly interconnected. A major downturn in one of the markets would potentially impact more or less the other markets in the world as well.

2. Rising political and economic risk: The political and economic risk in countries around the work is unexpected since most of the countries are going through a revolution and change in leadership, and political uncertainty can increase the risk.

3. Increased Transaction Costs