Case Studies in Financial Engineering

CASE 2

PORTFOLIO +





















Sept. 2014







PORTFOLIO +

Portfolio Plus Asset Management is a financial company managing several investment
funds. Two of these funds exhibit a low degree of diversification, as shown in Appendix 1,
comprising equity, bonds and, during a short period of time, derivatives for trading purposes.

The main difference between these two funds is the geographical basis of their investments.
While the Shark US investment fund is oriented to the North American market, the Shark EU
fund invests in the European market.

The rationale behind these portfolios was to permit a high profitability investment through
long term speculative investment, with a low frequency trading. Therefore, the scarce
diversification in these portfolios was planned in order to increase the exposure to risk and
simultaneously the profitability.

These two funds were created in October 2005 and two years after they were launched, the
Board of the management company intended to downsize its structure, by reviewing its
strategy regarding the allocation of funds to asset managers. Until then, Manager 1 was in
charge of Shark US, while Manager 2 was dedicated to Shark EU. Only one of them would
continue in the company, decision that had to be taken by the company.

In parallel, the company planned to initiate a strategy of disclosing risk indicators to its
current and potential investors.

Having this information in mind and the 2-year period before 30th Sept 2007, please answer
to the following questions:

1) Which manager should be kept in the company? (for this purpose, use a set of
indicators selected from Appendix2)
2) Should this decision change with a different analysis timeframe (e.g. considering only
the last 12 months instead of the last 24)?
3) Which indicators would you disclose to inform the market on the portfolio risk
profile? From the list presented in appendix 3, please exclude VaR and C-VaR.
a. How would you disclose them?
b. What would be the calculation basis and frequency?
c. What would be the reasons for these choices?
4) If you wish to change sharply the risk profile of Shark US and Shark EU portfolios
in the next 2 months, by reducing the risk exposure to levels corresponding to half of
those observed in the last year, which short-run measures would you propose? Please
detail, based on historical performance calculations and the expected impact,
considering the historical indicators used.
a. If futures or options contracts are used, please identify these contracts (number
and the type of contracts).
b. If portfolio changes are proposed, please identify the assets to be sold and
bought.

In order to solve the case, take into consideration the historical performance of the securities.
For the derivatives portfolio, if historical prices cannot be obtained, consider theoretical prices
obtained from adequate valuation models.


APPENDIX 1

Shark EU Fund
Buy Sell
Date
Volume /
Value
Date
Volume /
Value
Eurostoxx 50 shares
BASF 01-Out-05 80.000
DANONE 01-Out-05 70.000
DEUTSCHE BANK N 01-Out-05 25.000 20-Dez-06 25.000
ENDESA 01-Out-05 100.000 20-Dez-06 100.000
TOTAL 01-Out-05 50.000 25-Ago-07 50.000
FORTIS 04-J an-07 30.000
SIEMENS 04-J an-07 50.000
UNILEVER CERT 04-J an-07 25.000
FTSE 100 FUTURES CONTRACT (T=DEC/07) 15-J an-07 300
FTSE 100 CALL OPTIONS CONTRACT (K=6550; T=DEC/07) 25-Ago-07 400


Bonds
PORTUGAL OT 2003 4.375% 16/06/14 01-Out-05 100.000,00
ITALY P.96 3.7% 14/11/16 01-Out-05 250.000,00
BUNDESREPUB.DTL. AN 2000 6 1/4% 04/01/30 01-Out-05 500.000,00





Shark US Fund
Buy Sell
Date
Volume /
Value
Date
Volume /
Value
S&P 500 Shares
AMAZON.COM INC 01-Out-05 50.000
CIT GROUP INC (DEL) 01-Out-05 25.000
WALT DISNEY-DISNEY C 01-Out-05 150.000 15-J un-07 150.000
FORD MOTOR CO 01-Out-05 25.000 15-J un-07 25.000
GAP INC 01-Out-05 25.000
I T T CORPORATION 01-Out-05 80.000
KELLOGG CO 15-J un-07 50.000
MICROSOFT CP 01-Out-05 130.000
STARBUCKS CP 01-Out-05 25.000
WASTE MGMT INC 01-Out-05 40.000

Bonds
US TREASURY BOND 10 5/8% 15/08/15 S 01-Out-05 $250.000,00
US TREASURY BOND 7 5/8% 15/02/25 S 01-Out-05 $500.000,00




APPENDIX 2


Performance measures:
o Absolute Performance
o Portfolio volatility (s)
o Portfolio Beta ()
o Sharpe Index
o Treynor Index
o J ensens Alfa
o Tracking Error
o Information Ratio
o Drawdown
o Calmar (MAR) Ratio
o Sterling Ratio
o Burke Ratio
o Sortino Ratio
o Upside Potential Ratio
o Analysis vis--vis benchmarks



APPENDIX 3

Risk Indicators
o Total Risk (s)
o Specific Risk ()
o VaR and CVaR
o Trade Duration (liquidity risk)
o Turnover Duration (liquidity risk)
o Duration (interest rate risk)
o Modified Duration (interest rate risk)
o Convexity (interest rate risk)
o Greeks
. Delta
. Gamma
. Rho
. Vega (Kappa, Tau)
. Theta
. Speed
. Lambda
. Volga (Vega gamma)
. Vanna
. Charm (Delta Decay)
. Color
o Sensitivity Analysis to Portfolio Changes
o Scenario Analysis