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Tutorial 3 (Week 4) Ch04 PROFESSIONAL APPLICATION QUESTIONS: 4.8: What are the four main factors identified as common to all investment scams. Four common attributes are: 1. they do not have a product disclosure statement 2. they promise high returns 3. the investments are often based overseas or must be kept secret 4. most require the prospective investee to provide a password or their bank account details

PROFESSIONAL APPLICATION EXERCISES: 4.12

Investment advice Examine the following portfolio of Daisy and Donald. Year 1

Year 2

Year 3

Year 4

Year 5

Daisy

12%

20%

6%

8%

22%

Donald

14%

18%

5%

8%

18%

a. Calculate the expected returns for both Daisy and Donald. b. Calculate the standard deviations for both Daisy and Donald. c. Discuss which is the safest security to invest in is. Year Daisy Donald Daisy

1 0.12 0.14 E(R) 0.68/5 = 14%

2 0.2 0.18 S.D.

3 0.06 0.05

4 0.08 0.08

5 0.22 0.18

Total 0.68 0.63

SD Formula: 7%

Donald

n

 

 ( X

 E( R) / n  1 2

i

i 1

0.63/5 = 13%

6%

The ‘safest portfolio’ in terms of simple, absolute risk is Donald’s portfolio at 6%.

4.13

Nominal and real rates of return Benedict told his friend Henry that he expected to receive an investment return of 9.5%. Henry suggested to his friend that 9.5% might not actually be the real return or the investment. Henry told Benedict that he had forgotten to consider the effect of inflation. a. Calculate the real rate of return for Benedict if inflation was 3.4%. Real rate of return = Nominal return – Inflation = 9.5% - 3.4% = 6.1% b. Suppose the rate of return of another investment that Benedict was considering was 4.5%. What then would be the real rate of return? Real rate of return = Nominal return – Inflation = 4.5% - 3.4% = 1.10%

4.14

Return expected from a portfolio Assume a portfolio has two investment funds as per below.

Expected return Standard deviation Percentage of portfolio

Apples 8% 4% 60%

Oranges 12% 7% 40%

Calculate the expected return for the portfolio. 0.6(8%) + 0.4(12%) = Expected return 9.6% CASE STUDY 1: AN INVESTMENT OPPORTUNITY NOT TO BE MISSED Xiaou got chatting with a man at the gymnasium who told him of a new motor engine that used revolutionary technology. Xiaou was interested in making money and gave his email to the man so he could get more information. In a few days, Xiaou received an email containing the business plan of the promoter and details of the revolutionary engine. Photos of the engine were attached along with details of how to invest in the new technology. The email gave a background of the development of the technology which was based on a powerful battery which needed charging only once a week and after 30 hours of driving. In addition, the engine would power a motor car at a top speed of 110 km per hour. The email also advised that the company behind the invention would soon list on the ASX and it was expected that share prices would rise quickly once the public was aware of the revolutionary technology. Xiaou decided to invest $5000 in the company. After six months he had heard nothing from the promoter and decided to email the company. His email bounced back. Xiaou then contacted ASIC for advice. Questions 1. What do you think is a common feature of email-promoted investment offers? They tend to have all or some of the following features:

• • • •

They do not give a Product Disclosure Statement They promise abnormally high returns They are promoted under the veil of secrecy They ask for the money upfront

2. If you were in Xiaou’s position when he received the initial email, what would you have done? I would have: • typed the address for the promoter directly into a search engine and not clicked on the link provided in the Email (This is one of the precautions suggested by ASIC) • Consulted the ASIC and other websites (such as Choice) to see if this was a scam that regulators were warning against • Checked the ASX to see if this company was on the list of impending IPO’s (The promoter seemed to be implying this would occur) • Telephoned ASIC and asked for their advice 3. What advice do you think ASIC might have given to Xiaou both prior to and after Xiaou had invested his money? The advice ASIC might have given to Xiaou: • Prior to investing his money – don’t do it! The promoter is displaying behaviours typical of scams ASIC has discovered in the past o If the rate of return on the investment sounds too good to be true – it probably is • and after he had invested it: o provide ASIC with all of the details of the scam including a copy of the Email that was sent o ASIC can also advise Xiaou of the steps to follow in order to attempt to recover the losses...