Corporate Finance & Portfolio Management - Term Paper Example

 1 a) BBY (BEST BUY) BBY is a leading brand in consumer electronics and it owns 1,069 Best Buy stores and 74 Best-Buy mobile stand alone stores as of February 2010. The company has printed it footsteps in the major continents including Europe and Asia. Its major revenues stem from consumer electronic items, home office appliances, and by selling entertainment software’s. BBY major products include televisions, digital cameras, e-readers, DVD Players and other accessories. Since its inception, the company has focused on providing customized electronic items catering to the needs of individuals and it has thrived in this competitive environment due to its focus on innovation and creativity. DUK (Duke Energy) Duke Energy Corporation operates in the utility sector and it holds companies of regulated electric and gas utilities. It delivers electricity to around 4 million customers and provides natural gas to half a million of the customers. It operates in Carolinas, Indiana, Ohio, and in the Midwest segment while across the borders it owns hydroelectric generation units in Latin America. DIS (Walt Disney Corporation) Walt Disney Corporation is a leading media conglomerate which holds its principle operations in themes parks, television, entertainment and merchandise licensing. The company’s leading brands include its theme parks: Disney World and it almost operates in all the major continents of the world. Within the domain of media network, it owns ABC broadcast network and the Disney channel. The company is focused on delivering high-quality entertainment and content through its parks and media channels and its ultimate objectives are based on innovation through leveraging the technology. S&P 500 Index S&P 500 index is an index of 500 leading stocks which are selected based on their market size, liquidity and other representative factors. This index is considered to be the leading indicator of United States equity market. The index is a market value weighted index which implies that the weightage assigned to each stock is proportionate to the market value. All of the above corporations discussed are part of the S&P 500 Index Holding Period Returns & Relationship with the market: The holding period returns for each of the stock will include any capital gains and dividends during the period in which the stock was held. We will only provide the dividend yields for the recent period. The capital gains depend on the period in which the security was hold by the investor. Company Dividend Yield (Recent Period) BBY 1.40% DUK 5.60% DIS 1% Table 1: Company & Dividend Yield The relationship of the market with the individual stock can be measured by the concept of beta. Beta represents the volatility of the stock with respect to market. If a stock has a beta of 1, then it will move in tandem with market. A stock with a beta 0f -0.4 shows if the stock market moves up by 10%, than the stock will on average move down by 4% since they are negatively correlated. Company Beta BBY 1.46 DUK 0.42 DIS 1.12 Table 2: Company & Beta In the above table DUK has the smallest beta because it has minimal price fluctuations or its revenues remain stable. In the utilities sector, consumers will tend to use electricity and natural gas regardless of how the economy is working. While the other two betas which are greater than 1 show that those sectors are cyclical and depend on how the economy performs. b) Before allocating the investment into different assets, as a portfolio manager I need to gather a lot of information regarding the client objectives and goals. This will provide a holistic view of what the client wants and how do I need to allocate the assets. A client is always preoccupied with fears, risks and ideas which he might want to share with the portfolio manager. First of all, I need to prepare a clear and precise statement of the goal and objectives of the client which can be expressed verbally but we can quantify them. If the client aims to double his income over the time period of 5 years than he needs to know the risks associated with it. There is a universal financial principle which states that higher the return demanded, higher will be the risk associated with it. Therefore, the client should know that an objective of doubling the income in such a short period can have negative repercussions as well. Before proceeding to the client’s return objective, I need to investigate the client’s risk preference or his tolerance of risk level. Risk tolerance of the client does depend on his/her psychological makeup but there are other factors as well which affect the risk tolerance level. It is affected by individual’s family situation such as his marital status, age and number of children. For instance, a person with a young age will preferably be a risk taker since he expects that he has a bright future with stream of incomes. Another significant factor that affects the tolerance of risk is the net wealth of an individual. Individuals with greater net wealth have a greater propensity to undertake risk. Hence it is important to examine the risk tolerance level of an individual investor and as a portfolio manager I need to examine all the dimensions. If he is a risk-averse investor, than I will prefer to invest in low-risk securities or assets such as T-bills or securities with low beta. For, the risk-averse client I will invest my major portion of the investment in Duke Energy Corporation since it is a less risky organization as compared to others. The beta of a stock is not only dependant on the cyclicality of revenues but it also contingent upon operating and financial leverage and they play a vital role in determining the value of beta. My second priority would be two invest a small proportion in Walt Disney Corporation since it has a much higher beta although it’s riskier than the Duke Energy Corporation. c) A conservative investor will aim to minimize the risk of loss therefore will seek to at least maintain the purchasing power of the investment. Therefore, he is willing to earn a rate of return equal to the inflation. In real terms, he/she will be trying to maintain his purchasing power which implies that the real rate of return for such an investor will be zero. Since the investor has a conservative mindset and he is risk-averse we will present the following points to ensure that he is convinced to invest aggressively. It is important to be concerned about the constraints such as liquidity needs, time horizon and tax concerns. An aggressive investor although aims for capital appreciation but he is also faced with issues such as liquidity concerns. An aggressive investor has a greater tolerance for risk and he can accept a greater time horizon but there are obstacles which might encounter within the investment time frame. Therefore, for an aggressive we need to ask about his future liquidity concerns and form a portfolio which suits his needs. Generally, liquid stocks are less risky such as T-bills therefore we will add some portion of less risky investments in the overall portfolio to meet the liquidity needs. Saving accounts such as term deposits and money market accounts have lower rate of returns as compared with other investments but the funds are more liquid therefore it can eliminate the issue of liquidity. An aggressive investor can put its assets in mutual funds and bonds which provide a higher rate of return. However, it is important for an aggressive investor to have a higher level of patience since as the economy collapses; the portfolio is also affected severely. However, in the long term as the economy becomes stable the value of the securities can counter the losses which occurred initially. If my client has 30 years left to retirement, than he should not be worried about risk since the future income can provide a way to sustain his living. However, for a 65-year old investor an aggressive strategy does not seem to be feasible. The table below provides rate of returns and the associated risk with each of the security over the time frame. Security Geometric Mean Standard Deviation (Risk) Large Company Stock (S&P 500) 13.33 % 17.92 % Small Company Stocks (S&P small Cap 600) 10.82 % 21.21 % Government Bonds (Lehman Brothers) 9.07 % 5.33 % Corporate Bonds (Lehman Brothers) 10.07 % 5.99 % Intermediate-term Corporate Bonds (Lehman Brothers) 9.25 % 4.37 % Intermediate-term Government Bonds (Lehman Brothers) 8.43 % 3.84 % 30-day treasury bill 5.23 % 0.64 % U.S inflation 3.01 % 0.81 % Table 3: Summary Statistics of Annual Returns. 1984-2003, U.S Securities Source: CFA Institute The above table provides us the risk and return characteristics of various stocks. For an aggressive strategy, we need to focus our attention towards the securities which have a higher return and the level of risk. Large company stocks are risky but they do provide attractive returns in real terms. A conservative strategy will just earn up to 5% but an aggressive strategy can grow the wealth at the rate of 17% as the data suggests. Therefore we will put our major portion of stocks in the large cap stocks. However, we further need to investigate about the individual risk and return structure of the companies. A companies earning growth should be at-least 15% per year as strong earnings are a key characteristics for building future consistent earnings. Also we need to look for individual companies which are expanding rapidly particularly in smaller markets. Furthermore, I as a portfolio manager will also focus on corporate bonds as they provide a greater return with lower level of risk. A key factor in this decision will be the credit rating of the company provided by the rating agencies. References CFA Institute 2010, Corporate Finance & Portfolio Management, Pearson Publishing: Boston Read More