Julia Valverde Case Scenario

Julia Valverde, CFA, is a trust officer at Royal National Bank (RNB). She recently met Luis Sevilla, age 45, owner of agriculture and real estate partnerships. Valverde hopes that Sevilla will bring his personal investment business to RNB, as well as that of his partnerships and perhaps also his family’s philanthropic foundation. Although Sevilla is fairly knowledgeable, he wants Valverde to analyze two stocks (Bici and Velo) which have been recommended by his broker at Ekimov Investment Partners. Sevilla tells Valverde that he will consider only those investments which are expected to return 10 percent pre-tax. Sevilla provides Valverde with the information in Exhibit 1.

Exhibit 1

Bici and Velo Stock Data Provided by Ekimov Investment Partners

Valverde begins her analysis by reviewing RNB’s 10-year expected annualized returns for various markets (shown in Exhibit 2).

Exhibit 2

RNB’s Benchmark Return Estimates

As Valverde conducts an analysis of Bici and Velo stock returns, Sevilla asks whether the assumptions of the Capital Asset Pricing Model (CAPM) are accurate. Specifically, Sevilla asked Valvarde about the assumptions that all:

1. assets can be traded without taxes or transaction costs.

2. assets are marketable in any quantity without affecting price.

3. investors have different views about the risk and return of risky assets.

Sevilla asks whether an Arbitrage Pricing Theory (APT) model can be used instead of a CAPM model. Valverde responds that the APT model offers a richer context for investors to make portfolio decisions and makes less restrictive assumptions than the CAPM. Specifically, the APT model assumes that:

A. returns are described by a factor model,

B. investors can construct portfolios that eliminate asset specific risk,

C. it is possible for investors to arbitrage among well diversified portfolios

Before she provides an answer regarding the two stocks, Valverde asks Sevilla to complete RNB’s required “know your customer” questionnaire. Using Sevilla’s responses, Valverde completes the listing of Sevilla’s total assets (Exhibit 3) and his investment profile (Exhibit 4). Based on Sevilla’s investment profile, Valverde also develops the Investment Policy Statement (IPS) shown in Exhibit 5.

Exhibit 3

Questionnaire Responses: Sevilla’s Total Assets

Exhibit 4

Investment Profile for Luis Sevilla

Exhibit 5

Sevilla’s IPS Developed by Valverde