Page 345 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Security Analysis and Portfolio Management

Notes market indices rather than the value of the aggressive portfolio. Still others use moving
averages of indicators. In order to illustrate the working of variable ratio plan let us
continue with the previous example with the following modifications:
The variable-ratio plan states that if the value of the aggressive portfolio rises by 20% or
more from the present price of 25, the appropriate ratio of the aggressive portfolio will
be 3:7 instead of the initial ratio of 1:1. Likewise, if the value of the aggressive portfolio
decreases by 20% or more from the present price of 25, the appropriate percentage of
aggressive portfolio to conservative portfolio will be. The table presents, in boxes, the
actions taken by our investor to readjust the value of the aggressive portfolio as per
variable-ratio plan.
Example of Variable-Ratio Formula Plan

(1) (2) (3) (4) (5) (6) (7) (8)
Stock Value of Value of Value of Total Value Value Revaluation Total
Price Buy-and- Conservative Aggressive of Constant of Action No. of
Index Hold Portfolio Portfolio Ratio Stock Shares in
Strategy (Col.5-Col.4) (Col.8xCol.1) Portfolio as Aggressive
(800shares (Col.3+Col.4) % of Portfolio
Total
xCol.1)
Fund
(Col.4+
Col.5)
( ) ( ) ( ) ( ) (%)
25 20,000 10,000 10,000 20,000 50 400
22 17,600 10,600 8,800 18,800 47 400
20 16,000 10,000 8,000 18,000 44.5 400
20 16,000 5,400 12,600 18,000 70 Buy 230 630
Shares
at 20
22 17,600 5,400 13,860 19,260 72 630
25 20,000 5,400 15,760 21,160 74.5 630
25 20,000 10,580 10,580 21,160 50 Sell 207 423
Shares
at 25
26 20,800 10,580 11,000 20,580 53 423
28.8 23,040 10,580 12,180 22,760 54 423
25 20,000 10,580 10,580 21,160 50 423

You may notice that the increase in the total value of the portfolio after the complete cycle
under this plan is 1160, which is greater than the increase registered under the other two
formula plans. The revaluation actions/transactions undertaken are also fewer under this
plan compared to other two plans. Variable ratio plan may, thus, be more profitable
comparable to constant-dollar-value plan and the constant-ratio plan. But, as is obvious,
variable ratio plan demands more forecasting than the other formula plans. You must
have observed, the variable ratio plan requires forecasting of the range of fluctuations
both above and below the initial price (or say median price) to establish the varying ratios
at different level of portfolio values. Beyond a point, it might become questionable as to
whether the variable ratio plan is less complicated than the extensive analysis and
forecasting that it was supposed to replace

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