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Investment Management assignment

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Question 1 - Risky

securities

The equity securities under your consideration are: Sainsbury is J Sainsbury PLC (Reg. no: 00185647). The principal activities of this company are grocery and related retailing. BAT is British American Tobacco PLC (Reg. no: 03407696). The company involves in the manufacture, distribution and sale of tobacco products. GSK is Glaxosmithkline PLC (Reg. no: 03888792). It is a research-based pharmaceutical group engaged in anti-infectives, central nervous system (CNS), respiratory & gastro-intestinal/metabolic areas, vaccines, oncology products, medicines, oral care products and nutritional healthcare drinks. (Source: FAME) Required: In preparing the report, you should consider both the risk and return of each security. Therefore, your report should include the following: a) Calculations of the monthly rate of returns for each security, namely, Sainsbury, BAT and GSK Your calculations should be using the monthly closing stock prices from August 2004 to July 2011 published in FAME. The figures in FAME have been adjusted based on the stock split/dividend ratio. The formula for monthly rate of return is given by Where r is the rate of return, P is the closing price, t denotes the current month and t-1 denotes the previous month. You can use Microsoft Excel functions to expedite your calculations. Please show answers up to three decimal places only.

(25 marks)

b) Based on your calculations in (a), calculate for each security: i. Average monthly rate of returns (Note: You can assume each monthly return for each security has equal chance of occurring). ii. Standard deviation of monthly returns. (You can use Microsoft Excel functions to expedite your calculations. Please show answers up to three decimal places only). (24 marks) c) By referring to reliable sources (e.g. historical data, annual reports, financial press or journal articles), identify and critically discuss: i. ii. One major source of risk facing each security. One major upside potential of each security. (51 marks) (Total: 100 marks)

Question 2 Hedging with gold Gold is a commodity which is widely recognised as safe-haven. You would like to assess the impact of incorporating gold into your clients investment portfolios. Your research assistant has provided you with the following monthly returns on gold: January February March April May June July August Septemb er October Novembe r Decembe r 2011 2010 2009 0.052 0.098 (0.020) 2008 0.108 0.037 0.050 2007 0.002 0.053 (0.015) 0.037 2006 0.078 0.009 0.004 0.096 0.106 2005 (0.041) (0.002) 0.026 (0.012) (0.017) 0.021 2004

(0.025) (0.015) 0.012 0.037 0.035 0.025 0.012 0.029 (0.020) 0.016 0.032 0.049 0.023

(0.032) (0.012) 0.019 0.045 0.056 0.021 0.016 0.050 0.047 0.080

0.063 (0.014) (0.002 ) 0.032 (0.054 ) (0.021 ) 0.072 0.041 0.030 0.014 0.012 0.037 0.045 0.006

0.015 0.007 0.073 (0.004) 0.003 0.070 You are also provided with the following monthly returns on FTSE100 index: 2011 2010 0.032 0.061 (0.022) 2009 (0.077) 0.025 0.081 0.041 2008 0.001 (0.031) 0.068 (0.006) 2007 (0.005) 0.022 0.022 0.027 2006 0.005 0.030 2005 0.024 (0.015)

2004

(0.013) (0.066)

0.010 (0.019) (0.050 ) 0.034 0.019 0.016 (0.004 ) 0.009 0.028 0.030 0.033 0.003 0.034 (0.029) 0.012

(0.007) (0.052) (0.038) (0.071) (0.002) (0.022) 0.069 0.085 0.065 0.046 (0.038) (0.037) 0.042 (0.130) (0.009) 0.026 0.039

(0.017) (0.107)

October Novembe r Decembe r Required: (0.026) 0.067 0.029 0.043 (0.020) (0.043) 0.034 0.004

a) Using the same formula you have used in Q1 (b), calculate the average monthly rate of returns and standard deviation of monthly returns for gold. (10 marks)

b) Calculate the beta for gold by using a regression technique as follows: From the Microsoft Excel menu, go to Data and click on Data Analysis, then this Analysis Tools box will pop up:

Choose the Regression tool and the following Regression box will appear:

Select all the monthly returns for gold as input Y range Select all the monthly returns for FTSE100 as input X range

Click on OK and you should then be able to see the regression output in the following format:

SUMMARY OUTPUT Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations ANOVA df Regression Residual Total Standard Error t Stat Upper 95% Lower 95.0% Upper 95.0% SS MS F Significance F

Coefficient s Intercept

X Variable 1 (Beta)

Pvalue

Lower 95%

(Note: Beta is the coefficient on the variable X or FTSE100) (40 marks) c) Justify why gold should be considered in an equity investment portfolio. The following items should be included in your answers: Comparison of the information you have gathered in (b) with those from Question 1(b) above, Your interpretation of the beta for gold calculated in (b) above, and Citation and explanation from, at least, one academic journal article to further support your opinion. (50 marks) (Total: 100 marks)

Question 3 Minimum-variance portfolios Instead of investing in a single security portfolio, you will also propose your risk-averse clients to invest in a minimum-variance portfolio. Required: a) Calculate the weighted average rate of return and standard deviation of returns for each combination of securities containing different weight of each: i. Sainsbury BAT ii. Sainsbury GSK iii. Sainsbury-Gold iv. BAT GSK v. BAT Gold vi. GSK Gold For example, for Sainsbury BAT portfolio: Weig ht Sainsbury Weighted average rate of return 1 2 3 4 5 6 7 8 9 10 11 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 Standar d Tick the deviation portfolio of returns with the lowest risk

Portfolio

BAT

(Note: You can use Microsoft Excel functions to expedite your calculations. Please show answers up to three decimal places only) (30 marks) b) (i) For each of the portfolio (i.e. i to vi), plot the portfolio risk-return for different weights of assets (Note: For the risk-return plots, return is on Y axis and risk is on X axis). (30 marks)

10

(ii) Show a two-asset portfolio that has lower risk than the risk of either single asset. Summarize your answers in the following table: Sainsbur y Sainsbury BAT GSK Gold Return Stdev Return Stdev Return Stdev Return Stdev (20 marks) (iii) Explain why the two-asset portfolio can have lower risk than the risk of either single asset. (5 marks) c) Based on the calculations you have done so far, propose and justify the best portfolio that meets your clients needs and risk tolerance. (15 marks) (Total: 100 marks) END OF QUESTION BOOKLET BAT GSK Gold

11

Investment Management

Trimester1, 2012/13

REPORT FORMAT [Title of Report] Introduction (You should mention the background and objective of this report) Risky securities (a) [Name of security e.g., Sainsbury] (1 mark for headings) Monthly closing prices (GBP): 2011 2010 January February March April May June July August September October November December 2009 2008 2007 2006 2005 2004

Monthly rate of returns (to three decimal points): 2011 2010 2009 2008 2007 January February March April May June July August September October November December

2006

2005

2004

(b) G S K

BAT

(c) (Your critically discussion on one major source of risk and one upside potential for each security. Support your opinions by citing from reliable sources). Hedging with gold a) (Report the average monthly gold returns and standard deviation of its monthly returns here) b) Present your regression output as follows and mention indicate the beta:

SUMMARY OUTPUT Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations ANOVA df Regression Residual Total Standard Error Upper 95% Lower 95.0% Upper 95.0% SS MS F Significance F

t Stat

Pvalue

Lower 95%

c) (Your answers should include the following: Comparison of the information gathered in (b) with those from Question 1(b) above Correct interpretation of the beta for gold calculated in (b) above Citation and explanation from, at least, one academic journal article to further support your opinion)

Minimum-variance portfolios a) [Name of portfolio e.g., Sainsbury-BAT] (1 mark for headings) (Note: Refer to spreadsheets for answers) Weig ht Sainsbury Weighted average rate of return 1 2 3 4 5 6 7 8 9 10 11 b) i. ii. Plot the portfolio risk-return graph for each table Minimum-variance portfolios Sainsbur y Sainsbury BAT GSK Gold Return Stdev Return Stdev Return Stdev Return Stdev (Your explanation) BAT GSK Gold 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 Standar d Tick the deviation portfolio of returns with the lowest risk

Portfolio

BAT

iii.

c) (Provide a recommendation on the portfolio that best suits your clients risk tolerance and investment horizon by including: A recommendation on the best minimum-variance portfolio Justification by reflecting on the analysis performed earlier (End the report with list of references in alphabetical order and consistent format).

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