Case 1
- Corporate Finance 1
Author:
Jerry Pettersson (970528) [email protected]
Sanna Persson (970716) [email protected]
Sally Nilsson (960825) [email protected]
Supervisor: Andreas Stephen & Maziar Sahamkhadam
Semester: HT18
Course: 2FE193
Table of Content
Introduction 3
Data case from Chapter 10 3
Question 2 3
Question 3 4
Question 4 5
Question 5 5
Question 6 6
Data Case from Chapter 11 7
Question 1 7
Question 2 7
Question 3 7
Question 4 8
Question 5 9
Question 6 and 7 10
Conclusion 12
Appendix1 13
Appendix 2 13
Introduction
In this assignment, we are going to collect information about historical prices of 12 different
stocks. The first main objective is to see whether the single stock is better or worse to hold
compared with an equal weighted portfolio of all 12 different stocks. The second objective is
to create the efficient frontier and find the tangency point (optimal portfolio) with the risk-free
line and analyze the weights we are coming up with, when we calculate the optimal portfolio.
With those objectives in mind we created these following questions for this paper:
What is the best investment according to volatility, single stock or portfolio with 12 different
stocks?
How has our portfolio weights been changing during the procedure to find our optimal
portfolio?
In the excel document we have followed the principle of starting from the left with the first
question and then go to the right as the questions are asked. At the beginning of the excel
document you will find answers to the assignment called “Chapter 10 Data Case” and the
second part of the excel document is answers to the questions in “Chapter 11 Data Case”. Our
disposition in this document is that every headline represents each question by themselves, to
make it easier for the reader to accompany. The whole paper is written in thousands of US
dollars and the calculation and further basic data is complete in an excel document enclosed.
Data case from Chapter 10
Question 1
In this assignment we have collected information about historical data and price information
for 12 different stocks during a period of 2013-03-30 until 2018-03-30. These numbers are
compiled in the beginning of our spreadsheet in the excel file. We took our data from:
http://finance.yahoo.com
Our stock symbols are:
ADM, BA, CAT, DE, GIS, EBAY, HSY, IBM, JPM, MSFT, PG, WMT
Question 2
We converted our data into monthly average return in percentage by using this following
formula:
Since this formula need a future and a current price, we didn't come up with a percentage
monthly return for the first month in our data.
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Question 3
We computed our mean monthly return by taking the average of the calculated returns for
each stock according to this formula:
-In excel we used the command “Average” for simplification.
To be able to analyze volatility for each stock we have computed standard deviation, which is
an equation with variance as a base. In excel we used the function called “STD.s”. To
calculate monthly standard deviation by hand, we can use this formula:
For easier interpretation we transformed our data from monthly into annual. You get annual
expected return by multiplying mean monthly return with 12 months, but to calculate annual
standard deviation you have to multiply the standard deviation per month with the square root
of 12 month.
One of our analyzed stocks has negative annual expected return (IBM) while the others are
positive.
Table 1: Annualized Average return
ADM BA CAT DE GIS EBAY
0,09915576 0,3171641 0,1748524 0,154841 0,053162 0,153968
HSY IBM JPM MSFT PG WMT
0,0608549 -0,0057871 0,2131925 0,2551377 0,0470183 0,0696336
Table 2: Annualized standard deviation
ADM BA CAT DE GIS EBAY
0,2116172 0,2352229 0,2262498 0,1863743 0,1571624 0,2577981
HSY IBM JPM MSFT PG WMT
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0,1844012 0,1768138 0,2002672 0,2059902 0,1318666 0,1844227
Question 4
A portfolio with equally weights is a portfolio that invest the same amount in every stock. The
main purpose of creating a portfolio can be to diversify away risk and minimize volatility to
get a safer investment. When one stock is decreasing in value another stock´s value might
increase, by invest in both of those stocks we can eliminate much of the volatility and get a
safer investment.
In the excel document we created a portfolio with equal weights of each stock:
Table 3: Weights of equally weighted portfolio
ADM BA CAT DE GIS EBAY HSY IBM JMP MSFT PG WMT
0,083 0,083 0,083 0,083 0,083 0,083 0,083 0,083 0,083 0,083 0,083 0,083
Sum 1
Annualized portfolio return 0,1327661
Annualized Portfolio Standard deviation 0,1013463
The standard deviation for our equally weighted portfolio is lower than the standard deviation
for each individual asset, that follow the theory about diversification described above, when
several different assets are added together their separate volatility can cancel out each other
and that was true in this case.
Question 5
Diagram 1
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Question 6
By investing in the equally weighted portfolio that has a standard deviation of 0,1013463 we
get a safer investment as described above. Our separately stocks volatility cancel out each
other which result in a safer investment with lower volatility. For example, if we invest in DE
or EBAY we will get approximately the same return but higher standard deviation. A risk
averse investor will choose to invest in the equally weighted portfolio instead of an individual
stock since that the equally weighted portfolio offers better return given the risk.
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Data Case from Chapter 11
Question 1
See Table 3 above.
Question 2
See Table 3 above.
Question 3
Table 4: Weights of portfolio with lowest standard deviation - Solver, no short selling
ADM BA CAT DE GIS EBAY HSY IBM JMP MSFT PG WMT
0 0,01167 0 0,15140 0,05134 0,07212 0,16640 0,12615 0,01869 0,09345 0,25497 0,05382
Sum 1
Annualized portfolio return 0,09394
Annualized Portfolio Standard deviation 0,09089
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Question 4
Table 5: Efficient frontier points - no short selling
Efficient frontier points - No shortselling
Portfolio SD Return
1 0,09700 0,05261
2 0,09301 0,07261
3 0,09089 0,09261
4 0,09160 0,11287
5 0,09372 0,13287
6 0,09732 0,15287
EQW 0,101346 0,1327661
7 0,10288 0,17287
8 0,11020 0,19287
9 0,11910 0,21287
10 0,12989 0,23287
11 0,14270 0,25287
12 0,15705 0,27287
13 0,17610 0,29287
14 0,22186 0,31287
15 No solution 0,33287
These fifteen portfolios creates an efficient frontier, an investor want to be as close to the
efficient frontier as possible since that line represent the investment with the minimized
standard deviation given a certain level of return. We used Solver to find portfolios that was
located on our efficient frontier, by minimize our standard deviation as a limitation. Since our
dots represent annual expected return versus annual standard deviation, Solver couldn't find a
solution for portfolio 15 since none of the stocks offered a return of 0,33287 or higher. Our
stock with highest return is called BA and has an expected return equal to 0,3171641.
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Question 5
Diagram 2
To make it easier for the reader to understand, we took the expected return and standard
deviation from our equally weighted portfolio and put that dot in our diagram above. Our
equally weighted portfolio is a bit to the right of us calculate efficient frontier, that indicates
that this portfolio take on too much risk and standard deviation than that amount of return
require. Portfolio 5 is represented by the dot in the same height, and therefore the same return,
as the equally weighted portfolio and that portfolio gives approximately the same return but
for a smaller amount of risk. We should invest in that portfolio instead of our equally
weighted portfolio if we want that amount of return. The optimal portfolio to invest in is the
portfolio that is found by computing the tangency point between our risk-free line and
efficient frontier. The tangency point is found on the capital allocation line that has the
steepest slope. The slope of the capital allocation line is called Sharpe ratio and calculated like
this:
By using Solver, we can find our maximum Sharpe ratio and those weights who create the
maximum Sharpe ratio, which are the weights of our optimal portfolio.
Table 6: Weights of Maximum Sharpe ratio portfolio
ADM BA CAT DE GIS EBAY HSY IBM JMP MSFT PG WMT
0 0,42277082 0 0,05348238 0 0 0,012701 0 0,11824142 0,39280439 0 0
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Table 7: Weights of optimal portfolio - Without short sells
Sum 1
Annualized portfolio return 0,2685693
Annualized Portfolio Standard deviation 0,15385421
Question 6 and 7
Allowing for short sale means that an investor can sell a borrowed stock to another investor
and then give back that stock in the future. The main reason for short selling is that the
investor who borrows and sells the stock believes that the price will decline in the future, so
he sells it with high price and buy it back when prices are low, to make a profit. See efficient
frontier weights and points with short selling in appendix 1 and for risk free line in appendix
2.
Diagram 3
When we allow for short sales, our efficient frontier get longer. The efficient frontier
calculated without short sales allowed had the highest point at approximately 32% expected
return and 22 % standard deviation. While our efficient frontier in the diagram that allows for
short sells above has the highest dot at approximately 90% return and 47 % standard
deviation.
Once again, we used Solver to find the maximum value of sharpe ratio to come up with our
tangency portfolio. Since our maximum Sharpe ratio is equal to 1,7921, the expected return
and standard deviation for that value of Sharpe ratio is 0,8918853 respectively 0,4641832. We
wanted to visualize our tangency portfolio in our scatterplot. To be able to do so we extended
our risk-free line calculations from 0,4 as the assignment requested with 0,5 and 0,9 (our
calculated risk-free line is based on 7 different portfolios instead of 5 portfolios as the
question required).
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Diagram 4
Table 8: Changes in the individual weights
Company ≈ Average return ≈ STD Investment changes
ADM 10% 21% Small Decrease
BA 32% 24% Huge Increase
CAT 17% 23% Medium Increase
DE 15% 19% Huge Decrease
GIS 5% 16% Huge Increase
EBAY 15% 26% Low Increase
HSY 6% 18% Medium Increase
IBM -0,5% 18% Huge Decrease
JPM 21% 20% Huge Increase
MSFT 26% 21% Huge Increase
PG 5% 13% Huge Decrease
WMT 7% 18% Huge Increase
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Our diagram above describes changes in each stock´s weights in the portfolio due to changes
in return. Those stocks that have the largest weight in the optimal portfolio are MSFT, JPM
and BA while PG and IBM have the lowest weights in our portfolio.
Conclusion
We can see in diagram 1 that our equally weighted portfolio gives the investor an investment
with decreased standard deviation compared to every single stock but also a decreased
expected return that is lower than 6 of the single stocks. Which investment an investor choose
depends on their risk aversion. If the investor is a risk lover, they may take all of their money
and invest in stock BA while a person with smaller risk willingness will invest in our equally
weighted portfolio to spread their risk over several stocks to decrease the overall risk.
When we change our target return our weights change with it. These changes are graphed in
diagram 4 that visually shows that the weights of MSFT, JPM, BA, PG and IBM are those
that changes the most when we change our target return.
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Appendix1
Riskfree line Weights
Portfolio SD Return ADM BA CAT DE GIS EBAY HSY IBM JPM MSFT PG WMT Rf
1 0 0,06 0 0 0 0 0 0 0 0 0 0 0 0 1
2 0,0223196 0,1 -0,0025218 0,04448868 0,0115726 -0,0084908 0,01890396 0,00529866 0,01682055 -0,096837 0,05266638 0,06311657 -0,0682892 0,01134723 0,9519241
3 0,0781188 0,2 -0,0091394 0,15598968 0,04090981 -0,0303857 0,06627879 0,01811659 0,0590722 -0,3387414 0,18457224 0,22083933 -0,2386234 0,03890137 0,83220988
4 0,1339175 0,3 -0,0152502 0,26702035 0,0697316 -0,0513773 0,11340456 0,03152378 0,10108152 -0,5809983 0,31621077 0,3786441 -0,4095504 0,067682 0,71187758
5 0,1897166 0,4 -0,0211341 0,37811703 0,09887492 -0,0733562 0,15944151 0,04519936 0,1436209 -0,823428 0,44828601 0,53608143 -0,579718 0,09656896 0,59144618
6 0,2455156 0,5 -0,0258273 0,48901299 0,12743049 -0,0933903 0,20784167 0,05827171 0,18472964 -1,0657984 0,57914358 0,69418691 -0,751852 0,1251098 0,47114128
7 0,4687112 0,9 -0,0529603 0,93423386 0,24314252 -0,1784246 0,39688613 0,11141474 0,35330308 -2,0336536 1,10609258 1,32531205 -1,4339494 0,23817468 -0,0095717
Appendix 2
Efficient frontier points - With
shortselling
Weights
Portfolio SD Return ADM BA CAT DE GIS EBAY HSY IBM JPM MSFT PG WMT
Minimum V. P 0,0906667 0,091733 -0,0065884 0,01254224 -0,0360527 0,17193486 0,06078315 0,07885575 0,16210276 0,13804077 0,01090932 0,10123913 0,25771533 0,04851774
1 0,0937255 0,05 -0,0069145 -0,0343728 -0,0508777 0,19024612 0,04389576 0,07742659 0,15243712 0,25115496 -0,0457312 0,03821304 0,34613796 0,03838468
2 0,0909731 0,1 -0,0063832 0,02113188 -0,0330093 0,16876819 0,06257962 0,07941503 0,16458552 0,11555825 0,0213522 0,11466869 0,23993352 0,05139955
3 0,1096187 0,2 -0,0060145 0,13461002 0,00238185 0,12448827 0,10454128 0,08253633 0,18713093 -0,1551109 0,15735584 0,26483221 0,02855879 0,07468992
4 0,1493236 0,3 -0,0110335 0,25225995 0,00318101 0,09578653 0,15592019 0,09148119 0,20527933 -0,4195605 0,29188496 0,42417707 -0,1846619 0,09528562
5 0,1978107 0,4 -0,0126436 0,3696417 0,00355871 0,06722277 0,20418035 0,09938506 0,22341518 -0,6844863 0,4261341 0,58377015 -0,397567 0,1173889
6 0,4641832 0,8918853 -0,052454 0,925375 0,2407192 -0,1766112 0,3932074 0,110211 0,3498807 -2,0142381 1,0954862 1,3128322 -1,4204322 0,2360236
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