Reference no: EM132681583

NBS-7077B Investment And Risk Management - Norwich Business School

The influence of the policy interest rate on the credit risk of banking through the business cycle: the case of America

Objective: This assignment asks you to prepare a professional investment management report using data from Yahoo! Finance. Your report should demonstrate that you have a solid understanding of the investment management theories, practices and tools covered in the module and that you can communicate this clearly.

Question: Assume that today is March 1st, 2020 and that you are employed as a financial analyst for a leading financial advisory company. Your manager has asked you to prepare an investment management report by the end of the day for a client who has recently won the lottery. This client wishes to invest in the stock market for the first time and is interested in two specific stocks. Your manager believes that the client should consider investing in a third stock as well.

In order to prepare your report, you need to create an Excel workbook where you should download the weekly dividend-adjusted closing prices for three stocks for the period 01-Jan-2015 to 01-Mar-2020 (see "Firm-Student ID.xlsx" for the three firms assigned to you). Using this data, you should then compute the corresponding weekly returns.

Throughout all the analysis, you should assume:
o a constant weekly risk-free rate equal to [see "Firm-Student ID.xlsx" for the risk-free rate assigned to you]
o the client's coefficient of risk aversion is equal to [see "Firm-Student ID.xlsx" for the coefficient of risk aversion assigned to you]
o the capital amount the client wishes to invest is $20,000,000
o for each portfolio, the client wishes to have a minimum 10% weight invested in any assets, both risky and risk-free (note: this last assumption should be ignored when estimating the weights of the risky assets as part of the complete portfolio)

In the report, you should include the following:

Market trends and descriptive statistics
• Using the weekly returns data, report the mean, variance and standard deviation for each of the following four assets: your three stocks and the S&P 500 index. Explain each of the above statistics from a statistical point of view and discuss how these are used in investment management. Given these statistics about your firms and the US stock market, what advice would you give to your client if he (i) only cares about return, (ii) only cares about risk, and (iii) cares about the reward per unit of risk?

• Report the covariances and correlations for each pair of assets considering the three firms assigned to you. Explain these statistics in the same fashion as above. Discuss the kind of relationship each pair of assets has. What are the financial implications?

Economic landscape and information in current prices

• Discuss what information is reflected in the current price of each of the three firms and the US stock market. Your discussion should be based on several items of information (e.g. recent news stories) which are of interest to investors. Include at least two items for each firm and at least three items for the US economy. Discuss the effect each item has on the asset's price and whether it has any influence on the corresponding statistics estimated in the previous section.

Portfolio selection (2 stocks)
• Compute and draw the efficient frontier for the two companies that the client is interested in. Show and discuss the effect of correlation on the efficient frontier by changing the correlation coefficient between the two companies to the following values: -25%, 0%, 25%, 50% and 75%. Plot these new efficient frontiers on another graph.

• Compute the minimum variance portfolio and the optimal risky portfolio which consist of the two companies that the client is interested in. Was the client right in choosing these two stocks? Compute the optimal capital allocation between the risk-free asset and the optimal risky portfolio for your client. How should the client allocate his capital among the risk-free asset and his preferred two stocks? Draw the capital allocation line and show the optimal capital allocation on the graph. How would the optimal capital allocation change if the risk aversion decreased?

Portfolio selection (3 stocks)
• Compute and draw the efficient frontier for the two companies that the client is interested in and the company proposed by your manager. Compute the new minimum variance portfolio, the new optimal risky portfolio, and the new optimal capital allocation. Draw the new capital allocation line and show the optimal capital allocation on the graph. Discuss the implications of considering the third stock proposed by your manager as opposed to just focusing on the two stocks that the client is interested in. Did your manager make a good suggestion?

Capital Asset Pricing Model
• Assume that the expected return on the market portfolio is equal to the average return on the S&P 500 index for the given time period. Obtain the betas of your three companies by using the LINEST function in Excel and compute the expected return of each stock based on the Capital Asset Pricing Model. Draw the security market line and show the expected returns of the three stocks and of the S&P500 on the graph.

• Explain which of the three stocks is riskier for a fully diversified investor. Compute the alpha of each of these three stocks, as well as the beta and the alpha of the three stock portfolio in the given time period. What do the alphas for the stocks and the portfolio indicate in terms of investment performance? Given the analysis done until this point, what investment strategy would you advise your client to follow?

Own strategy
• Your manager wants to offer the client a superior investment opportunity and decides to let you create your own portfolio strategy. Determine whether you can find two additional stocks that can be added to the previous three stock portfolio and achieve a superior risk-return profile. You may choose any stocks from the constituents of the S&P 500. You may select your additional stocks based on their historical performance and comovements. You may also manually change these statistics to account for other information (e.g. recent news stories) or your own personal views. You may use any measure of risk and return in your analysis, but you should include and discuss at least two different risk adjusted performance measures. Present and justify the process followed for selecting the two additional stocks and for creating the new optimal portfolios. Discuss the improvement these portfolios offer to the client.