ECF2226: Quantitative Analysis on two Australian Company - Investment Finance Assessment Answers

Investment Finance Assignment Help

Part-A Quantitative Skills

You are required to perform quantitative analysis on two Australian company included in the S&P/ASX 100 Index over a period of two years, i.e. from July 2014 to June 2016. The list of companies is given in the file ASX 100 Constituents by GICS.xlsx available on blackboard under Assignment Instructions-ECF2226.2016.1. These two companies must belong to different GICS.

This part requires you to model/calculate all the solutions using excel and also present the results in a word file. The final submission requires a document (pdf or word file) and the excel workbook.

Question-1: HPR, AAR and GAR.

Select one company from the list and download monthly prices from July 2014 to June 2016 from DatAnalysis database and save the data in an excel workbook. You can select any company from the list. Calculate the following in an excel workbook and also copy paste the final answers in the Part-A document.

1. a) Calculate monthly HPRs using the adjusted closing prices for the company during the

two year time period. Plot these results on a line graph. b) Calculate the following summary statistics for your returns

1. Variance and Standard Deviation ii. Minimum and Maximum returns c) Calculate the Arithmetic Average and Geometric Average returns for the company. d) Assume you had a savings of $50,000 and had invested the money in your selected company at the beginning of the period. Calculate the number of shares you bought given the brokerage fee of $30 for every transaction (buying or selling). e) You decided to hold your position for these two years and now decide to sell your shares in the market. Calculate the amount you will gain or lose based on the last market price of the share. You must adjust the amount for brokerage fee as given in (d).

Question-2: Daily Value at Risk

Select another company from a different GICS than the company selected in Question-1 and download daily stock prices (adjusted closing prices) from 1 July 2014 to 30 June 2016 for both the companies. The data can be downloaded from Yahoo Finance or DatAnalysis for both companies. You must mention the source in your solutions and use only one source for both stocks.

1. a) Calculate the daily 1% and 5% Parametric VaR (based on normal distribution) along

with 1% and 5% Historical VaR for time series returns for both the stocks. b) Suppose you invested $50,000 each in both stocks. Express the VaR calculated in (a)

as Dollar-VaR and compare the VaR for both stocks.

Question-3: Portfolio Selection

Use the daily stock returns calculated in Question-2 for the two stock and calculate the following

1. a) Correlation and Covariance for the stock returns b) Use various weight combination to plot an efficient frontier. c) Minimum Variance Portfolio weights for the portfolio with these two stocks.

Question-4: The Capital Asset Pricing Model

Download daily stock index values for ASX-All Ordinaries for the same period as of the two stocks. The data can be downloaded from Yahoo Finance, Google Finance, Quandl etc1. You must mention the source in your solutions. Assuming the risk free rate of 2.25% per annum;

1. a) Calculate the value of ? for both the stocks using regression analysis. b) Plot the security characteristic line for both the stocks. c) Compare the level of market risk ? of both of your stocks.

Show clearly the workings and the formulas used in deriving your results!

---End of Part-A---

1 There can be a difference in the number of stock index values and number of stock returns for both stocks. Use the excel vlookup function to match the dates of the stock returns to the index returns.

Part-B

Write an essay on the following topics. The maximum page limit for this part is 6 pages, excluding references. You are required to paraphrase the relevant literature to demonstrate your understanding of these topics. You should be able to refer to relevant literature and other material using ECU referencing guidelines.

The final submission requires a document (pdf or word file) submitted via the Plagiarism link.

1. Modern Portfolio Theory

Write a short note on Modern Portfolio Theory and minimum variance portfolio. Discuss the benefits of efficient diversification with examples from Part A (Question-3) and other sources.

The discussion should highlight the benefits of diversifications as a result of MPT. The actual Markowitz portfolio model should be presented with all important formulas/equations with a thorough understanding of all the components. You must discuss the results of Question-3 (Part-A) as an example.

2. The Capital Asset Pricing Model

Discuss the Capital Asset Pricing Model with examples from Part A and other sources.

You should be able to critically examine the Capital Asset Pricing Model and discuss the results from Question-4 (Part A) as an example. The discussion should include the major assumptions and components of CAPM and its advantages over MPT.

3. The CAPM and Multifactor Models

Discuss the Fama-French factor model. Compare and contrast CAPM and the Fama-French three factor model.

You should discuss the Fama French factor models including its components and major results. There should be a clear understanding of all the risk factors included in the Fama-French Model and its major assumptions. The discussion should compare The Fama French Model with the CAPM.

---End of Part-B---

Marking Guide

Part-A

This part requires you to model/calculate all the solutions using excel and also present the results in a word file. The final submission requires a document (pdf or word file) and the excel workbook.

Questiona) Calculate monthly HPRs using the adjusted closing prices for the company during the two year time period. Plot these results on a line graph.

1. b) Calculate the following summary statistics for your returns i. Variance and Standard Deviation ii. Minimum and Maximum returns
2. c) Calculate the Arithmetic Average and Geometric Average returns for the company.
3. d) Assume you had a savings of $50,000 and had invested the money in your selected company at the beginning of the period. Calculate the number of shares you bought given the brokerage fee of $30 for every transaction (buying or selling).
4. e) You decided to hold your position for these two years and now decide to sell your shares in the market. Calculate the amount you will gain or lose based on the last market price of the share. You must adjust the amount for brokerage fee as given in (d).

Question-2 a) Calculate the daily 1% and 5% Parametric VaR (based on normal distribution) along with 1% and 5% Historical VaR for time series returns for both the stocks.

1. b) Suppose you invested $50,000 each in both stocks. Express the VaR calculated in (a) as Dollar-VaR and compare the VaR for both stocks.

Question-3 a) Correlation and Covariance for the stock returns 4 b) Use various weight combination to plot an efficient frontier. 7 c) Minimum Variance Portfolio weights for the portfolio with these two stocks.

Question-4 a) Calculate the value of ? for both the stocks using regression analysis.

1. b) Plot the security characteristic line for both the stocks. 7 c) Compare the level of market risk ? of both of your stocks. 4 Penalties No Coversheet 5 Illegible Excel Workbook (Poor presentation) 5 Poor presentation of results in the word document (Includes language skills)

No Part-A Document 30

Part-B

Question-1Write a short note on Modern Portfolio Theory and minimum variance portfolio. Discuss the benefits of efficient diversification with examples from Part A (Question-3) and other sources.

The discussion should highlight the benefits of diversifications as a result of MPT. The actual Markowitz portfolio model should be presented with all important formulas/equations with a thorough understanding of all the components. You must discuss the results of Question-3 (Part-A) as an example.

Demonstrates the capacity to conduct relevant and wide research. Follows ECU Referencing convention for in-text and end-text citations

Question-2 Discuss the Capital Asset Pricing Model with examples from Part A and other sources.

You should be able to critically examine the Capital Asset Pricing Model and discuss the results from Question-4 (Part A) as an example. The discussion should include the major assumptions and components of CAPM and its advantages over MPT.

Demonstrates the capacity to conduct relevant and wide research. Follows ECU Referencing convention for in-text and end-text citations

Question-3 Discuss the Fama-French factor model. Compare and contrast CAPM and the Fama-French three factor model. You should discuss the Fama French factor models including its components and major results. There should be a clear understanding of all the risk factors included in the Fama-French Model and its major assumptions. The discussion should compare The Fama French Model with the CAPM.

Demonstrates the capacity to conduct relevant and wide research. Follows ECU Referencing convention for in-text and end-text citations

1. People often engage into the activity of investing their hard earned money into different options like shares, bonds, debentures, mutual funds etc. in order to earn a profit and enjoy capital appreciation. Sometimes an investment provides both in the short and long term. There are few popular theories that guide the investment decision of the individual. Risk plays a very important role in any investment decision. It is often said that no risk, no gain. The actual implication of the term is that investors will have to rest their funds with a certain amount of trust on entities in order to earn profits. However this trust entails a factor called risk. There are fair chances of earning huge profits and appreciation but that shall unfold in the future. The uncertainty factor revolving around today is precisely the risk that one investor puts in for his savings. The modern portfolio theory states that investor can construct portfolios in a manner suitable to earn their desired profits with a pre-decided level of market risk, keeping in mind that more the risk; better the return.

However this risk can be minimized to a certain extent by applying the technique of diversification. Diversification is the tool that employs assets of different kinds for investment. The sole reason behind employing this technique is to act prudent and dodge oneself from risks. There are two methods of diversifying the funds: between asset categories and within asset categories. Diversification between asset categories can be achieved by investing in the wide array of asset types such as stocks, bonds, T bills etc. The main purpose that gets served is the different mature of performance of these assets as they all belong to different market conditions. Diversifying within asset categories can be achieved by investing funds in a single asset but under different subheads. For example: Investing in different industries and firms stocks. However the main point to remember here is to undertake at least ten to twelve firms of different industries in order to successfully diversify the funds. Another two concepts that bear a great impact on the diversification process is the quantum of risk and time frame. Every stock is not going to perform same with time. The stock itself shall react differently to different time frames. Risk capacity of the investor too does not remain the same always. A youth is going to be far more aggressive that a mid aged man. With passage of time we gain experience, become patient but loose the capacity to be aggressive and think to settle for less return but higher stability. Investors seek more stability with age because they want a cushion against the market volatility and probable loss if the asset does not perform as per the expectations. However excessive diversification too shall distort the returns. As Charlie Munger correctly puts, “The idea of excessive diversification is madness. Wide diversification which necessarily includes investment in mediocre businesses only guarantees ordinary results. “

2. To earn profits the average investors need to carefully calculate the risk and provide for some risk free asset against the risky asset. An average investor would be cautious with his risk taking capacity in order to earn profits. There are economic models that help in deciding the quantity of risk and the corresponding returns. With every money invested in any option, the time value of money gets an equal importance and investor generally compensate for the this in order to earn at least the minimum returns. CAPM model advocates that expected return of a security should be equivalent to the rate on risk free asset including a premium. If the return generated from the investment does not equalize the required rate of return then the investment should not be made. The security market line of the CAPM model plots the results of the CAPM for all different levels of risks.

In its simplest form the CAPM is defined by the following equation: E(Ri) = Rf + ?i[E(Rm) – Rf],

where E(Ri) = The expected return of stock

?i = COV (Ri , Rm)

VAR (Rm) Rf = The risk free rate of return

E(Rm) = The expected return of the market

The major difference between CAPM and MPT is that MPT assumes that investors are reluctant to take risk and would prefer to invest in securities or options that have lower level of risks.

3. The Fama French Three factor model came into play to examine the performance of stocks that were small in size and were far from the market performance. An extension to CAPM model, this model proposes to explain the behavior of the small value firms who are not behaving near to the market performance and are capable to generate a higher return. Since the CAPM model considers only proportional market risk to explain the behavior of the stock prices and returns, the Fama French Three factor model used the multiple regression method to explain the reason of outperformance of small value firms. It is expressed via equation below:

Rit – Rft = ?it + ?iM (RMt – Rft) + ?isSMBt + ?ihHMLt +?it

where Rit = Average monthly return of portfolio

Rft = Risk free rate observed at the end of each month

?iM = COV (R , R) VAR (R)

RMt = Expected Market Return

SMB = Small Minus Big (proxy for company Size)

HML = High Minus Low (proxy for BE/ME)

?is & ?ih = Factor loadings (other than market ?). These loadings also represent the slope(s) in the time series regression.

?it & ?it = These represent the intercept of the regression and the error term respectively.

There are a host of risk factors in the investment decision. A precise explanation of the risk can be received if systematic price are attached to them. Returns, performance and pricing can be completely understood in such a case. Risk relating to market, size and value are often seen to the cause of concern for an investor. To compensate for the risk, investors are provided with the returns which portray the firms cost of capital. Generally the cost of capital for small firms is higher than that of the big firms. Similarly the firms having poor returns and shaky forecasts have a higher cost of capital as they tend to pay more. . Fama French model accepts the stock with high BTM i.e. book value to its market value to be value stocks. This theory views size premium to be the difference in return between largest stock and smallest stock in the CRSP list. Value premium is difference between the returns of the stocks.

The primary elements of the model are value premium, market premium, management impact, zero risk return etc. Size and value risks are different than the market risk and may not add on to the total risk of any portfolio. Thus the model effectively proves the fact that a portfolio formed far from the market may at differently and can be accompanied with more or less risks.