ZionEastInc ZionEastIncisaFinancialServicesFirmrunbyCEOMorpheusMittalspecializinginlong datedbondtrading.CurrentlyittradesinCorporateBondsofsixcompanies.Thecompanies areAlpha,Beta,Gamma,Tau,Theta,andZeta.Itbuysaswellassellsbondsonthese companies.Belowisthebreakdownofitsinvestmentsinthesebondsasoftoday.
$mn Assets Liabilities Total 567.00 649.00 Alpha 134.24 176.19 Beta 72.52 122.59 Gamma 136.72 102.22 Tau 26.82 122.41 Theta 80.61 111.25 Zeta 116.09 14.34
Ithastobenotedthattheseareaggregatednumbersforbondsofallmaturities.Alsotobe notedisthefactthatthisisjustasnapshotofbalancesheet.Underpresentmandate, ZionEastdoesntdohedgingofanykindbelievingrisktobeminimal. MrNeoSinghhasbeenjusthiredasriskconsultantforthecompany.Hedoessome risk/returnanalysisforshortterm,andcomesupwithfollowingnumbersfortheportfolio heldbyZionEast.Thesenumbersareexpectedvaluesfornextyear.Forthisanalysis,Mr SinghassumesthatreturnsandvolatilityaresameforallmaturitiesheldbyZionEastas periodofanalysisisshort. ForBonds:
Bonds Returns Volatiltiy Alpha 1.53% 11.32% Beta 4.46% 2.71% Gamma 4.60% 5.07% Tau 2.81% 4.28% Theta 4.65% 6.95% Zeta 5.79% 8.93%
CorrelationMatrix:
Alpha Beta Gamma Tau Theta Zeta Alpha Beta 20% Gamma 15% 68% Tau 73% 2% 64% Theta 21% 67% 12% 13% Zeta 28% 69% 28% 80% 33%
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Nowseeingthesenumbers,MrMittalandshareholdersarealarmedandtheyhireMrNeo SinghhasChiefRiskOfficer.Undernewmandate,MrSinghcanbuy/sellcorresponding Equitiesofrespectivecompaniesforlimitofexposure.ForExample,forAlpha,MrSinghcan buy$42mnofAlphacompanyStock.AssumeMrSinghgoesandbuys/sells100%ofhis mandate.MrSinghbelievesitwouldchangetheirvolatility/returnprofile. NowMrSinghrunshispreviousanalysisonEquitiesportfoliotooandcomeswithup followingexpectedvaluesfornextyear. ForEquities
Equities Returns Volatility Alpha 6.96% 39.56% Beta 6.03% 31.64% Gamma 6.84% 37.48% Tau 1.45% 24.62% Theta 5.66% 32.59% Zeta 0.55% 22.05%
Correlation
Alpha Beta Gamma Tau Theta Zeta Alpha Beta 88% Gamma 19% 97% Tau 16% 85% 64% Theta 51% 49% 66% 91% Zeta 53% 67% 66% 97% 82%
Assumeastockis100%correlatedwithitsbondandthereisnocrosscorrelationbetweena stockandanyotherbond.
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Questions: 1)Shareholdersmeetingiscomingsoonandtheymightreviewcompanysvolatility/return policy,i.e.,whetherZionEastshouldfocusonhigherreturnsorlowervolatility.Givespros andconsofhedgingbyminimizingaveragevolatilityoftheportfolioormaximizesharpe ratiooftheportfolioforbothcases?Whatwouldyouchooseandwhy?(theoretical) 2)Calculateaveragereturn,volatility,andsharpratiofornextyearofZionEastsinitialbond portfoliousingnumbersrunbyNeo 3)Calculateaveragereturn,volatility,andsharpratiofornextyearofZionEastsfinal bond/equityportfoliousingnumbersrunbyNeo 4)Basedonyouranswersabove,adviceMrSinghwhetherheshouldacceptnewmandate ornotforeachoffollowingcases: a)Shareholdersgoforminimizevolatility, b)ShareholdersgoforMaximizeReturns, c)ShareholdersgoforMaximizeSharpeRatio 5)WhatshouldbeyouradvicetoMrSinghforafuturemandateforcompany(theoretical) PleasemailyouranswersinPPTFormat(5Slides)[email protected]
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