Financial Analysis Report for Finance Module - University 2017

This financial analysis report examines various factors that influence asset managers' risk-taking behavior, particularly in the context of market performance and investment strategies. The report delves into the concept of run risk within mutual funds, exploring its causes and potential mitigation measures, including policy recommendations and strategies to stabilize investments. Furthermore, the analysis addresses the challenges posed by illiquid assets in popular investment vehicles and proposes solutions such as the conversion of open-ended funds to exchange-traded funds (ETFs) and the introduction of authorized participants. Finally, the report provides calculations and interpretations of key financial metrics, including leverage ratios, volatility, and Sharpe ratios, to assess portfolio performance and risk exposure.

Financial Analysis
2017

1
By student name
Professor
University
Date: March 25 , 2018.
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Contents
Question 1………………………………………………………………….....................................................3
Question 2………………………………………………………………………………………………………………….…4
Question 3………………………………………………………………………………………………………………….…6
Question 4………………………………………………………………………………………………………………….…7
References.....…………………………………………………………….....................................................9
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Question 1
There are various factors that might induce the asset manager to increase the risk of his
portfolio management.
 The foremost that might affect the risk-taking capability of the managers is the fact that
the market is performing well, particularly the stock in which they are dealing. It is
important that managers must have through knowledge of the market and should have
the feel of it (YUAN, 2018). On analyzing the history, they can take decision whether
they want to invest in the funds or not. Based on the same they can increase their level
of risk.
 The market is captured by high net worth individuals that invest in the funds, in a
manner that the liquidity factor does not affect them, in those cases they provide high
rate of return through the compensation contracts and in that cases the managers are
induced to invest in risky bonds. They have the privilege to experiment in these cases
(Maynard, 2017).
 The overall movement of fund also affects the market a lot, and the asset managers
needs to understand the same. They have the option to invest in large number of funds
and various type of securities, a combination of different securities leads to a portfolio.
In those cases, it becomes important to see in which funds they can invest more and
vice versa, based on that they can increase the level of risk undertaken. The main aim
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should be to achieve stability, some assets will generate more return and vice versa
(Kusolpalalert, 2018).
Question 2
Run risk occurs when people have doubt on the solvency of the mutual funds, and withdraws
the funds that they have, leading to actual situation where the funds gets insolvent and sometimes they
don’t have so much funds to support the withdrawals. This is known as run risk and the same happens in
Banks also. After the financial crisis 2007-2008, the investors had a option to redeem their investments
at $1, at the end to any day, subject to potential run risk. This run risk existed because during that time
the market was not doing well, and therefore people had a fear of losing on their investments, thus
there was a situation where there was a chance of the mutual funds becoming insolvent and thus
accelerated by the same people withdrew their investments from such funds (Anon., 2017).
Potential measures that can help in mitigation of the risk involves:
 Forming of policies that can provide assurance to the investors about the flow of funds and for
that it is important that they should provide appropriate information to the investors, so that
they don’t withdraw their money fearing that the hedge funds might become insolvent.
 The hedge fund managers can consider increasing the total charges of redemption so that
people would be discouraged to redeem their money in this time of financial crisis (Maynard,
2017).
 Investor should be encouraged to invest in such funds in which the return is more stable and risk
is low, so that when these are channelized the chances of insolvency are as low as possible.
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 The managers should try to follow more tired and tested routes for channelizing the flow of
money that will earn stable returns to the investor and reduce the run risk that is faced by such
financial institutions (Chariri, 2017).
The most recommended policy would be to reduce the investment in more diversified portfolio and
following tried and tested routes that would help in reducing the risk and that will reduce the chances of
insolvency that the banks might face in any possible way. This would be the best way to reduce the
errors of run risk and provide adequate return to the investors and promote them not to redeem their
funds.
Question 3
The main problem that they have identified are that popular investment assets offer liquidity to
the investors when the underlying assets are not liquid. This causes a problem at the time of redemption
of these funds. There are chances that the fund managers can sell of these assets without a larger
liquidity premium to fulfil the redemption, but this may not be the case always. Also, when the investor
makes early exit from the portfolio, then the managers have to adjust the portfolio accordingly, and this
might cause pressure on the remaining shareholders who are left in the system. There is a risk of run
that arises because of the first mover advantage (Abbott & Kantor, 2017).
Yes, this is indeed a problem for the both the investors and the managers who must manage the
risk of low liquidity while adjusting the portfolio when they end up fulfilling the withdrawal needs to the
first exit investors. This is not correct for the people who are left behind in the portfolio as they have to
deal with low cost and less liquidity (Maynard, 2017).
The potential solution of the same would be to find an alternative to these open-ended funds
and look for such investment options that reduces the run risk and in which the option of redemption is
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as less as possible. The authors suggested that people should convert these open ended mutual funds
into exchange traded funds. Exchange traded funds are hybrids between open ended mutual funds and
close ended mutual funds. So this helps in reducing the systematic risks that are associated with open
ended mutual funds, as the level of illiquid assets reduces by the use of the same (Alexander, 2016). A
new class of participants can be introduced known as “authorized participants” (APs), that would have
the right to create ETFs new shares and redeem the old one. This would in a way help to maintain the
liquidity in the system.
The solution is potentially good, but the only point of concern is that investors fails to
understand that there is no guarantee of liquidity no matter how much the mutual fund be secure or
what measures are undertaken, there is an underlying risk that will always prevail. This is because
nobody knows how the market will function and thus it becomes necessary to invest in such funds
where the risk is considerably low.
Question 4
1) If (in excess of the risk-- free rate) on the portfolio is -- 10%, and the leverage ratio is 5, the‐ ‐
increase in return the shareholder would be (10%/5 = 2%)
2) If the monthly volatility of the portfolio is 2%, and the return on the same in excess of free rate
is -10%, then the volatility of the interest to the investor would be 10%/2% = 5%
3) If the monthly volatility of the excess return on the portfolio is 10%, the expected monthly
excess return on the portfolio is 2%, and excess returns are normally distributed, the chances of getting
a return bad enough would be 0.02%. This is based on the Sharpe ratio, that covers the volatility of the
portfolio with relation to the return that is earned by the portfolio and the investor. The formula for
Sharpe ratio would be
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(Mean portfolio return − Risk-free rate)/Standard deviation of portfolio return
= 2%/10% = 0.02%
4) Since there are no assets left to repay the borrowings at the end, the leverage ratio at the end of
the month would be -10%, if the excess return on the portfolio is 10%. This is because there are no funds
to repay the borrowings, so the volatility of the portfolio would affect the returns that the investor earns
in equal measures. This is because in case the company goes into liquidation, there will be no assets left
to repay the investors, this will expose the investors to more risk and thus they will be affected in equal
measures.
5) Rebalancing is a process by which the weights of the portfolio are resigned to stabilize the
portfolio and keep a check on the associated risk elements. Dynamic rebalancing helps to keep the
portfolio close to their targets by managing the inflow and outflow of cash. In case the managers sell of
their holdings when the prices fall, there will be a large outflow of cash and as the market has fallen
there may not be potential investors available who would be ready to invest in the portfolio. Thus it is
important that opting for rebalancing the hedger managers should study the market and then take the
decision accordingly (Chiapello, 2017).
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References
Abbott, M. & Kantor, A., 2017. Fair Value Measurement and Mandated Accounting Changes: The Case of
the Victorian Rail Track Corporation. Australian accounting Review.
Alexander, F., 2016. The Changing Face of Accountability. The Journal of Higher Education, 71(4), pp.
411-431.
Anon., 2017. Explaining auditors’ propensity to issue going-concern opinions in Australia after the global
financial crisis. Accunting and Finance, pp. Carson,E;Fargher,N;Zhang,Y;.
Chariri, A., 2017. FINANCIAL REPORTING PRACTICE AS A RITUAL: UNDERSTANDING ACCOUNTING
WITHIN INSTITUTIONAL FRAMEWORK. Journal of Economics, Business and Accountancy, 14(1).
Chiapello, E., 2017. Critical accounting research and neoliberalism. Critical Perspectives on Accounting,
Volume 43, pp. 47-64.
Kusolpalalert, A., 2018. The relationships of financial assets in financial markets during recovery period
and financial crisis. AU Journal of Management, 11(1).
Maynard, J., 2017. Financial accounting reporting and analysis. second ed. United Kingdom: Oxford
University Press.
YUAN, T., 2018. The Prospect for RMB Becoming One of the Two Center Currencies of the Dual-Center
Global Financial System. The Dual-Center Global Financial System, Issue 1, pp. 83-91.
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