The Performance of Mutual Funds in the UK and US - Essay Example

ASSETS PRICING goes here] [Your goes here] [Due the paper] Question Part a) Bootstrap methodology is usually used toexplicitly separate the factors of skill and luck while assessing the performance of mutual funds. Bootstrap method has become an efficient technique to make statistical inferences and examining the performance of mutual funds is one of the main processes that require the use of modern computer power to do complicated statistical calculations. The main advantages of using this methodology include assistance in doing accurate statistical analysis and assistance in complex financial calculations. The performance of mutual funds in UK and US is somewhat different. In the US, the performance of mutual funds that are outside the US is not affected very negatively by diminishing returns to scale. In UK, the analysis of mutual funds shows a strong indication of underperformance. Part b) It is true that most investors pick funds that are ranked at the top in league tables. The reason is that such funds are likely to yield positive returns for the investors. They rarely withdraw money from underperforming funds in order to reap benefits when they reach a high performing state. One can test his/her persistence in fund performance by analyzing the previous records of accomplishment of the funds. Question 2: Part a) Bonds are not risk free because their value is associated with currency that value of which can go down because of inflation. Moreover, liquidity and reinvestment risks are associated with bonds. Although they can generate a high amount of money, but they investment in them cannot be fully guaranteed as risk-free. Interest rate risk, rating downgrades risk, and credit/default risk are some of such risks that have the potential to alter the decision of investing in bonds. These risks confirm the statement that bonds are not risk free. Part b) The difference between these two bonds is that a convertible bonds allows the bond holder to convert debt into the issuing corporation’s common shares, whereas callable bonds gives charge to the issuing corporation to buy back the bond at election (Barron 2012). A form wants to issue these types of bonds to raise money and to stabilize economy in case of fall in interest rate. Yield to maturity means that the bond will yield profit or loss only after repaying of the par value, whereas in holding period return, the return of investors from holding has less association with the coupon rate. Part c) The safety-first concept is based on the principle that development of a portfolio should be based on the minimum acceptable return. This rule helps companies in achieving their goals and objectives associated with their investments. On the other hand, stochastic dominance is also a good technique to create portfolios, as well as to help in assessing performances. This method of creating portfolios usually suits the approach and investment thoughts of risk-averse investors. Question 3: Part a) The Internal rate of Return is one of the main indicators of success that an investment decision can yield for the investor. However, investors should also consider NPV while appraising projects based on IRR. The reason is that a project with low IRR but higher NPV is better than the project with higher IRR and lower NPV. Therefore, investors should be careful in selecting project based on IRR. Part b) The effective interest rate is the actual rate of interest earned on investment. For example, a $100 bond having 10 percent effective interest rate will yield $10 annually on the compounded incomes. It means that for the next year, the 10 percent interest will be added in $110. However, the actual interest rate will be the original 10 percent for all years on investment. Part c) The Capital Asset Pricing Model determines the relationship between expected return on an investment and the risk associated with the investment. According to this model, the expected security return is equal to the risk free security rate including the risk premium. This model suggests that an investment alternative whose expected return is not equal to the required return should not be accepted. Fama-Macbeth has developed and put into place a two-step regression technique to assess value of the capital asset pricing model in proving the cross-sectional return. Question 4: Part a) Security market line is drawn on the risk and return at a specified time for individual stocks. Financial analysts use capital market line to represent the rates of return which are dependent on two factors which include risk level for a particular portfolio and risk free rates of return. Security market line shows efficient and inefficient portfolios, whereas capital market line shows only efficient portfolios. Part b) SML can be expressed as a one-period pricing model by representing risk and return at individual stock level. The equation derived will be Ks = Krf + B ( Km - Krf). Part c) We can test CAPM using Fama-Macbeth methodology because Fama-Macbeth has developed a two-step regression technique which effectively assesses the value of the capital asset pricing model. The technique helps in estimating the premium that is rewarded to a specific risk factor. Question 5: Part a) Yes, a UK based investor can diversify internationally in his/her larger interest. International expansion or investing in international projects is always beneficial for an investor if the decision is taken considering the financial analysis of the project related factors. International expansion of the business or taking steps to invest in foreign markets is a key decision for an investor if the financial analysis of the decision shows positive signs regarding investment. Part b) A risk-averse investor should make their asset allocation decision based on the mean-variance optimization concept by considering the project with lowest risks. There can be similar rates of return for the projects but one with lower risk should be accepted. However, in the real world, an investor will usually look for a project with a higher rate of return giving less attention to the level of risks associated with that particular project. References Barron, J 2012, Convertible Bond Vs. Callable Bond, viewed 11 January 2013, http://www.ehow.com/facts_6319834_convertible-bond-vs_-callable-bond.html Read More