When Lin Lins husband, Tun Tun, passed away about three months ago he left behind a small fortune, which he had accumulated by living a very thrifty life and by investing in ordinary shares. Tun Tun had worked as an engineer for a surgical instruments manufacturer for over 30 years and had taken full advantage of the companys retirement saving plan. However, instead of buying a diversified set of investments he had invested his money into a few high growth companies. Over time his investment portfolio had grown to about 900,000 Kyats being primarily comprised of the stocks of 3 companies. He was very fortunate that his selections turned out to be good ones and after numerous stock-splits the prices of the three companies had appreciated significantly over time. Lin Lin, on the other hand was a very conservative and cautious person. She had devoted her life to being a stay-home mom and had raised their two kids into fine adults, each of whom had a fairly successful career. Maung Maung, 28, had followed in Tun Tuns footsteps. In addition to being gainfully employed as a engineer, he was pursing an MBA, at a prestigious business school. Hla Hla, 26, was completing her residency at Yangon General Hospital. Although Lin Lin and Tun Tun had enjoyed a wonderful married life, it was Tun Tun who managed almost all the financial affairs of their family. Lin Lin, like many spouses of their generation, preferred to focus on other family matters. It was only after Tun Tuns passing on that Lin Lin realized how unprepared she was for the complex decisions that have to be made when managing ones wealth. Upon the advice of her close friend, Aye Aye, Lin Lin decided to call the brokers office and request that her account be turned over to Bo Bo, the firm senior financial advisor. Aye Aye, a widow herself, had been very happy with Bo Bos advice and professionalism. He had helped her rebalance and re-allocate her portfolio with the result that her portfolios value had steadily increased over the years without much volatility. At their first meeting, Bo Bo examined the Lin Lins portfolio and was shocked at how narrowly focused its composition had been. In fact, during the past yeardue to the significant drop in the technology sectorthe portfolio had lost almost 30% of its value. Tun Tun, certainly liked to flirt with risk, said Bo Bo. The first thing we are going to have to do is diversify your portfolio and lower its beta. As it stands you could make a lot of money if the technology sector take off, but the reverse scenario could be devastating. I am sure you will agree with me that given your status in life you do not need to bear this much of risk. Lin Lin shrugged her shoulders and looked blankly at Bo Bo. DiversifyBeta what are you talking about? These terms are new to me and so confusing. You are right, Bo Bo, I dont need the high risk but can you explain to me how the risk level of my portfolio can be lowered? Bo Bo realized right way that Lin Lin needed a primer on the risk-return tradeoff and on portfolio management. Accordingly, he scheduled another appointment for later that week and prepared the following exhibit to demonstrate the various nuances of risk, expected return, and portfolio management. Exhibit Expected rate of return Scenario Probability Treasury bill Index fund Utility co., High-tech Co., Counter-Cyclical Co., Recession 20% 5% -10% 6% -25% 20% Near recession 20% 5% -6% 7% -20% 16% Normal 30% 5% 12% 9% 15% 12% Near Boom 10% 5% 15% 11% 25% -9% Boom 20% 5% 20% 14% 35% -20% Discussion Questions (1) Imagine you are Bo Bo. How would you explain to Lin Lin the relationship between risk and return of individual stocks? (2) Lin Lin has no idea what beta means and how it is related to the required return of the stocks. Explain how you would help her understand these concepts. (3) How should Bo Bo demonstrate the meaning and advantages of diversification to Lin Lin? (4) What would happen if Lin Lin were to put 70% of her portfolio in the high-tech stock and 30% in the Index Fund? Explain. (5) If Lin Lin decided to invest her money equally in High-Tech and Counter-Cylical stocks, what would her portfolios expected return and risk level be? Are these expectations realistic? Explain. (6) Based on these calculations what do you think Bo Bo should propose as a possible portfolio combination for Lin Lin?