Report

2)

Market Index Financial Ltd Construction Ltd

Mean (expected) return 0.0092 0.0156 0.0156
Standard deviation 0.0169 0.0275 0.0596

 1
̅ = (𝑅1 + 𝑅2 + 𝑅3 + ⋯ 𝑅𝑇 ）
Average Return/ Mean = E(R) = R 𝑇

 Standard Deviation of Return

1
i. ̅)2 + (R 2 − R
𝑉ar(R) = T − 1[(R1 − R ̅)2 + (R 3 − R
̅ )2 +
̅ )2 ]
⋯ (R T − R

ii. SD(R) = √Var(R)

A mean return is known as an expected return or how much a stock returns monthly.
From the 25 months’ shares price data from the table above, the expected return of
Financial Ltd (0.0156) is same with Construction Ltd (0.0156). According to Kapo
(2016), standard deviation is a measure of how much an investment's returns can vary
from its average return. The standard deviation for Financial Ltd is lower than
Construction Ltd which means it carries with lower risks. Moreover, the mean and
standard deviation of Financial and Construction Ltd will higher than market index
may be due to both of them is an individual stocks, but the market index is a weighted
average of several stocks or other investment vehicles from a section of the stock
market, and it is calculated from the price of the selected stock (Investing Answers
n.d.).
3)

Market Index Financial Ltd Construction Ltd

Coefficient of variation 1.8393 1.7627 3.8080

 Coefficient of variation =
Standard Deviation
Average Return

According to Bennett (2017), coefficient of variation is a measure used to assess the

total risk per unit of return of an investment and provides a standardized measure of
comparing risk and return of different investments. Based on the table, a risk-averse
investor would choose Financial Ltd because it offers the best risk/reward ratio which is
1.7627 and the lowest volatility percentage per unit of return. However, the
Construction Ltd carries high risk which is 3.8080 and more volatile than Financial Ltd.
4)

Financial Ltd & Construction Ltd

Correlation coefficient -0.1762

 Correlation Coefficient
(R i , 𝑅𝑗 )
(R i , 𝑅𝑗 ) = 𝐶𝑜𝑛𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒
𝑆𝐷(𝑅𝑖 ) × 𝑆𝐷(𝑅𝑗 )

The correlation coefficient is a statistical measure that calculates the strength of the
relationship between the relative movements of the two variables. It is helpful in
determining how well a mutual fund performs relative to its benchmark index, or
another fund or asset class. The correlation coefficient can range from -1 to +1 (Wilson
2018). When the correlation coefficient is positive 1, there is a high positive correlation
between two investments. For example, if one investment has positive returns during a
period, it is highly likely that the other investment’s returns will also be positive.
However, if two investments have a correlation of -1, the investments are negatively
correlated. Therefore, if one investment has a positive return one month, it is likely that
the other investment will have a negative return for that month. Moreover, if an
investment has a correlation approximately equal to 0, means that the variables are
independent of each other and not related. Therefore, if one investment is up, the other
could be either up or down.

The correlation coefficient between Financial and Construction Ltd is -0.1762 which
means if one investment has positive returns during a period, it is likely insignificant
that the other investment’s returns will negative. Therefore, when combine these two
shares in a portfolio the investor can gain diversification of unsystematic risk as these
two shares are negatively correlated.
5)

Financial Ltd & Construction Ltd

Standard deviation of portfolio 0.0305

 Variance of a two-share portfolio

𝑉𝑎𝑟(𝑅𝑝 ) = 𝑤12 𝑆𝐷(𝑅1 )2 + 𝑤22 𝑆𝐷(𝑅2 )2 + 2𝑤1 𝑤2 𝐶𝑜𝑟𝑟(𝑅1 , 𝑅2 )𝑆𝐷(𝑅1 )𝑆𝐷(𝑅2 )

 Standard deviation of portfolio

𝑆𝐷(𝑅𝑃 ) = √𝑉𝑎𝑟(𝑅𝑝 )

The standard deviation of portfolio measures the total risk or total volatility in the
portfolio (Xplaind n.d.). The portfolio consisting of Financial and Construction Ltd
has standard deviation of 0.0305, lower than the weighted average standard deviation
0.02745+0.05956
of shares of Financial and Construction Ltd ( = 0.0435). This indicates
2

that the level of risk is decreased by 0.013 (0.0435 − 0.0305). By combining the two
shares into portfolio, risk is reduced through diversification. As a result of
diversification, the unsystematic risk specific to different securities is eliminated
(MBA Knowledge Base n.d.). However, the market related risk known as systematic
risk cannot be cancelled out.
6)

Financial Ltd Construction Ltd

Beta Coefficient 0.1528 -1.2394

 Beta coefficient
𝐶𝑜𝑣(𝑅𝑖 , 𝑅𝑚 )
𝛽=
𝑉𝑎𝑟(𝑅𝑚 )

Beta coefficient is a measure of market risk of a security or portfolio in comparison to

the market as a whole (Financial Management Pro n.d.). It is a significant input in
capital asset pricing model (CAPM) to calculate the expected return of an asset.
Mullins (1982) states that a stock which with a beta equal to 1 has average level of
systematic risk and same volatility with the market. Stock with a beta greater than 1 is
more volatile than the market. Conversely, stock with a beta less than 1 is less volatile
than the market.

The beta coefficient for Financial Ltd is positive (0.1528), which means that the
company’s share moves in same direction as the general market. If there is 1% change
in the market return, financial share with beta of 0.1528 will only change by 0.1528%
followed the increase or decrease in the market. The share is less risky than the
market because its beta is less than 1 and probably gains less than the market gains. It
also has low systematic risk and less sensitive to market swings (Mullins 1982).

Construction Ltd has negative beta (-1.2394), indicating the share moves oppositely to
the general market. If the market return increases by 1%, construction share with beta
of -1.2394 will decreases by 1.2394% and vice versa. The expected return on
negative-beta investment will be less than the risk-free rate, which means investors
are paying for an investment that will give very low or even negative return (Morning
Star 2016). Negative beta will lead to negative return calculated in CAPM and also
negative present value which does not make sense. Therefore, the present value of
Construction Ltd cannot be imputed due to its negative beta.
7)
 Annualized market figure = 0.92% × 12 𝑚𝑜𝑛𝑡ℎ𝑠

 Capital Asset Pricing Model (CAPM)

E[𝑅𝑖 ] = 𝑟𝑓 + 𝛽𝑖 [𝐸(𝑅𝑀𝑘𝑡 − 𝑟𝑓 )]

Financial Ltd

E[𝑅𝑖 ] = 3% + 0.152807891 [(0.92% × 12) − 3%] = 0.042285754

Construction Ltd :

E[𝑅𝑖 ] = 3% − 1.239359213 [(0.92% × 12) − 3%] = −0.069644481

 Compound Annual Growth Rate (CAGR)

𝐸𝑛𝑑 𝑣𝑎𝑙𝑢𝑒 1
CAGR = ( )𝑛 − 1
𝐵𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 𝑣𝑎𝑙𝑢𝑒

Financial Ltd
1.15 1
( )4 − 1 = 0.035558076
1

Construction Ltd
0.74 1
( )4 − 1 = 0.053828931
0.60
 To find Dividend 1 (𝐷1 ), we use the following formula:

𝐷1 = 𝐷0 × (1 + 𝑔)

Financial Ltd

𝐷1 = 1.15 × (1 + 0.3555807634) = 1.190891788

Construction Ltd
𝐷1 = 0.74 × (1 + 0.05382893137) = 0.779833409

 Present Value (PV)

𝐷𝑖𝑣1
𝑃0 =
𝑟𝑒 − 𝑔

Financial Ltd

1.190891788
𝑃0 = = 177.0137881
0.042285754 − 0.035558076

Construction Ltd

0.779833409
𝑃0 = = −6.315800267
−0.069644481 − 0.053828931
 Financial Ltd Construction Ltd
CAPM 0.042285754 -0.069644481
CAGR 0.035558076 0.053828931
Dividend 1 1.190891788 0.779833409
Present Value 177.0137881 NA

After using CAPM and CAGR to calculate the asset’s rate of return as well as
dividend growth, the figure then can be used to discount the future cash flows of
investment to its present value. The present value is the current value of future
streams of cash flows given a specified rate of return (Merriam Webster n.d.). In the
result of calculation, present value of Financial Ltd’s share is positive (177.0138)
while Construction Ltd’s share is unable to value due to negative beta. According to
the table, we can identify that although Construction Ltd is having a good dividend
growth (0.0538) compared to Financial Ltd (0.0356) ,it was a negative return
(-6.3158). This scenario appeared as the margin dividend growth of Construction Ltd
is higher than Financial Ltd. In addition, beta coefficient is proceeded to calculate the
expected return of dividend. High-beta securities more risky than the market while
low-beta securities less (Swedroe 2012). Therefore, under CAPM high-beta stocks
ought to have higher returns to repay investors for their higher risk. Since the beta is
negative, investors would not invest Construction Ltd as it does not make sense when
the expected market return is lower than risk free rate.
Reference list

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Seeking Alpha, viewed 8 September 2018, <
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Financial Management Pro n.d., Beta coefficient, Financial Management Pro, viewed
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Investing Answers n.d., Market index, Investing Answers, viewed 5 September 2018,
<https://investinganswers.com/financial-dictionary/investing/market-index-1305>.

Kapo, CC 2016, Using the sharpe ratio and standard deviation when trading,
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en-trading-dfcb094032db>.

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September 2018, <https://www.merriam-webster.com/dictionary/present%20value>.

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<https://www.morningstar.in/posts/36419/can-beta-be-negative.aspx>.

Mullins, DW 1982, Does the capital asset pricing model work?, Harvard Business
Review, viewed 8 September 2018,
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Swedroe, L 2012, Do high-beta stocks produce higher returns?, CBS News, viewed
15 September 2018,
<https://www.cbsnews.com/news/do-high-beta-stocks-produce-higher-returns/>.

Wilson, LT 2018, Statistical correlation, Explorable, viewed 1 September 2018,

<https://explorable.com/statistical-correlation>.

Xplaind n.d., Portfolio standard deviation, Xplaind, viewed 7 September 2018, <
https://xplaind.com/268982/portfolio-standard-deviation>.