Modern Portfolio Management: Theory and Case Study Analysis

MODERN PORTFOLIO
THEORY

TABLE OF CONTENTS
TABLE OF CONTENTS..............................................................................................................2
INTRODUCTION...........................................................................................................................3
MAIN BODY...................................................................................................................................3
QUESTION 1...................................................................................................................................3
a. Identification and explanation of factors affecting Maggie’s ability to take risk...................3
b. Problems identified with respect to current allocation of Maggie’s portfolio........................4
c. Calculation of return requirement for Maggie’s investment portfolio with respect to her
retirement phase..........................................................................................................................4
d. Identification of liquidity requirement, time horizons and unique circumstances for
Maggie’s investment constraint..................................................................................................5
e...................................................................................................................................................6
QUESTION 2...................................................................................................................................6
Calculation of one year forward rate three years from now and two-year forward rate one year
from now for the T-bills..............................................................................................................6
QUESTION 3...................................................................................................................................8
b. Computation of intrinsic value of stock..................................................................................9
c. Weaknesses of P/E ratio........................................................................................................10
REFERENCES..............................................................................................................................12

INTRODUCTION
Portfolio Management is an art for making the decision which would help in prosper the
company as well as the individual investor. It helps in managing out the allocation of assets
properly so that the objectives could be met. The individual investment could be made in the
form of bonds, shares, mutual funds, cash or a combination of two or more of these alternative
options to create modern portfolio (Rodríguez, Gómez and Contreras, 2021). The purpose of
creating portfolio while making investment is to maximize total returns. Modern portfolio theory
is an emerging concept in the field of investment suggesting a way for investment selection, so
that overall returns could be maximized at a level of risk acceptable to investor. The basic idea of
modern portfolio theory is to diversify portfolio among different investment options having risk
and return either high or low. The present report consists of three questions where the first
question is about investment portfolio management or wealth management with regards to the
case of Maggie where factors affecting her risk taking ability will be discussed along with
identifying the problems with her current portfolio allocation. Also, the calculation of required
return at retirement phase will be done. In second question, calculations pertaining to forward
rates for T – bills and Macaulay duration & percentage change in bond price will be done with
respect to a corporate bond. In the last question, that is the third one, industry analysis and
computation of company’s intrinsic value will be done for dividend paying stock listed on UK
stock exchange in order to extend investment advice to a client.
MAIN BODY
QUESTION 1
a. Identification and explanation of factors affecting Maggie’s ability to take risk
From the case study provided for Maggie, it has been determined that she is self-sufficient
in terms of meeting her living costs, no one is dependent over her, she is going to retire after 10
years and desire to give an amount of US $ 10 million at the age of 80 years when she will die.
Accordingly, the following factors could affect her risk taking ability:
Independents: Burden of debt can be taken as an independent factor affecting risk taking ability
of an investor. Therefore, as Maggie having no burden of debt and instead of that have constant
income through her employment as well as insurance coverage for the reimbursement of her

medical expenses must be having greater ability to take risk and accordingly, could invest in
riskier asset such as equities (Hawley, J. P. and Lukomnik, J., 2018).
Dependents: From the case of Maggie, it has been determined that no one is dependent on
Maggie instead her three children are having well-paid jobs. Accordingly, Maggie’s ability to
take risks would be higher on this ground because she is not the sole earning member of the
family instead having several earning sources such as employment income, investment income,
etc. Furthermore, she is not depending on investments for financing her emergency needs such as
for bearing medical expenses because to meet the same she has a separate insurance policy as
well. Therefore, in the absence of dependency, Maggie’s ability to take risks get increases (De
Bortoli and et.al., 2019).
b. Problems identified with respect to current allocation of Maggie’s portfolio
Portfolio allocation related problems with respect to Maggie are as follows:
No element of debt: Maggie has already attended 50 in terms of age and investing majorly that
is, around 70% of the investible fund has been allocated to equities of large and small caps stocks
and stocks of TESLA. However, there is no allocation made towards less risky or safe
investment alternatives such as fixed income securities and other debt instruments (Obeidat and
et.al., 2018). Accordingly, such a higher level of risk taking at the time of retirement planning is
not favourable and not at all recommended.
Huge allocation made to Cash or money market instrument: Maggie’s retirement has 10 years
to go which is quite long duration not demanding for holding large amount in the form of cash or
cash equivalents. However, Maggie has allocated excessively high that is, 30% towards the cash
and as a result of which she is not able to earn either fixed income or gain capital appreciation by
allocating this additional amount towards debt or equity instruments respectively (Malandri and
et.al., 2018).
c. Calculation of return requirement for Maggie’s investment portfolio with respect to her
retirement phase
 As Maggie targeted to gift US$10 million to her children at the time of death which is
expected to fall in the age of 80 years giving a time horizon of 30 years. In this duration
of 30 years, she interim focus must be on growing the value of her portfolio partly
through constant income and partly through capital appreciation by investing in stock