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Relation Between the nominal rate of return & real rate of return :

Nominal rate of return= (1+ real rate of return) (1+ inflation rate) 1

What is investment? Describe Investors life cycle.

Investment: It is a current commitment of an account for a period in order to derive future earnings.

Factors investor consider while committing an investment: Uncertainty of future flow of funds, expectedrate of inflation & Time period for which the investment is made.

Investors life cycle: Life cycle includes time horizon of working careers of individuals. The four phases

of the cycle are described below:

1. Accumulation Phase: This stage consists of individuals early to middle years of working careers.In this phase their net worth is usually small. They attempt to accumulate assets to satisfyimmediate needs, long term goals e.g. childrens expenses, post retirement expenses. They can

make relatively high risk investment in the hope of making higher returns over time becausethey have future earning ability.

2. Consolidation Phase: This stage begins after the midpoint of careers of the individuals. Theirearnings are greater than the expenses & they have sufficient assets to pay off almost all of theiroutstanding debts. They plan to use their excess amount of assets to meet expenses afterretirement or make planning to build a house. Individuals are more concerned aboutpreservation of capital. So they dont want to take any high risk.

3. Spending Phase: This phase begins after the retirement. Living expenses are met by incomefrom prior investments. Because their earnings concluded they seek greater protection of theircapital.

4. Gifting Phase: In this phase individuals have sufficient assets to cover their current & futureexpenses. Excess assets can be used to provide financial assistance to relatives and friends & toestablish charitable funds or to fund trusts.

What are asset class and asset allocation decision?

Asset Class: An asset class is comprised of related securities that have similar characteristics. Abroad assets class is bond that can be divided into small asset classes e.g. Government bond andcorporate bonds.Asset Allocation Decision: It is the process of deciding how an investor allocates wealth amongdifferent asset classes for investment purpose. Strategy for asset allocation is based on somedecisions:

1. What asset class to consider for investment?2. What weight to assign to each asset class for investment?3. What amount of funds to allocate in each asset class based on its weight?4. What specific securities in each class to purchase for the portfolio?

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Describe different steps of Portfolio Management process/ Resource Allocation Process.

Answer: Different steps of the resource allocation process are described below:

1. Developing Investment Policy Statement : A policy statement is a road map that guides theinvestment process. An investor should develop it before making any investment decisions. Itincludes objectives of investors & constraints faced by them. An investor can evaluate theperformance of an investor on the basis of policy statement & to find out whether theinvestment is appropriate for the investor.

2. Examining financial & economic conditions : Before investing it requires to study short term &long term financial & economic conditions and forecast their future trends. Investor needs &expectations from the investment along with financial & economic conditions develop theinvestment strategy.

3. Implementing the investment plan : With the policy statement and financial forecasts theinvestor needs to implement the plan and allocate available funds across different securitiesof different asset classes. This involves the construction of portfolio that will minimize theinvestors risk.

4. Monitoring & updating the investment: Investors needs might change over time. So itrequires monitoring of the investment of the investors needs & financial market conditions. If

it does not meet the investo rs expectations it requires updating the investment portfolio.Investors might feel the need to drop securities from the portfolio and might add some newones. So that the policy statement can be modified accordingly that could meet the investorsexpectations.

Mention the objectives of investors.

1. Capital Preservation : Investors want to minimize the risk of loss of investment amount. Thatmeans they seek to maintain purchase power of the investment. So, they want the rate ofreturn not less than the inflation rate.

2. Capital Appreciation : Many investors want the amount to grow over time to meet somefuture needs. E.g. Investment in stocks.

3. Current Income : Many investors want the investment amount to concentrate on generatingcurrent income rather on capital gains. E.g. Investment in bonds.

4. Total Return : Many investors seek to increase the investment amount by reinvesting thecurrent income. E.g. Investment in deposit account.

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Mention the Investment Constraints.

1. Liquidity Needs : Investors may have liquidity needs that must be considered while makinginvestment plan. Investors may require liquidity to meet various current obligations whichmay hamper the investment plan.

2. Investment Time Horizon : Investors consider the length of time for which they invest theirmoney. Investors with short term investment generally favor less risky investment becauselosses are harder to recover during a short time frame. Long term investment carriesgreater risk and long term investors can tolerate long term risk because any short fall orearly losses can be overcome by returns in subsequent years.

3. Tax rate : Investors consider tax rate of the government while planning investment. If moretax is imposed on a particular investment, investors will be inclined to investment whichrequires paying less or no tax.

4. Uncertainty of Return: If the earnings from the investment is not certain then the investorswill require a rate of return to provide risk premium to cover the investment risk.

What is holding period return (HPR)?

Answer: It is the return on investment for the period for which the investment is done.

HPR= ending value of the investment/ beginning value of the investmentHPY= HPR-1Annual HPR= n (HPR) (n i s the number of years for which investment is made)Annual HPY= Annual HPY-1

Mathematical Problems:1. Investor invests $200 and gets $220 at the end of the year. Find HPY.2. Find the arithmetic mean and geometric mean of returns:

Year Beginning Value Ending Value1 100 1152 115 1383 138 110

3. Find the average return on overall portfolio.Stock No. of Shares Beginning Price Ending PriceA 100,000 $10 $12B 200,000 $20 $21C 500,000 $30 $33