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Consider an multi-million dollar endowment fund of a university that is required to pay out 5% of their market value every year to deserving students in the form of a scholarship. Thus, the university must make this 5% distribution in periods of strong as well as weak market returns. Talk to me about the risks of this investment portfolio and how the investment manager can manage this risk.

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Answer:

Please find the detailed answer as follows:

Explanation:

The risks are that their is a fixed rate of return which the university has to generate regardless of the prevailing interest rates.

This can be mitigated by diversifying the fund into high grade bonds and an actively manged equity fund. Bonds will return more in times of higher interest rates. Stocks will return more in terms of capital appreciatin in times of lower interest rates.