Investment and Calculations - Essay Example

Investment Rероrts and Саlсulаtiоns Name: Course: Institution: Tutor: Date: Investment Rероrts and Саlсulаtiоns Introduction The stock market is used by companies to raise much needed finance while allowing many businesses to be traded or raise extra capital for growth or expansion without taking a loan by selling shares on the organization in the open stack market. Often shares are initially bought from the underwriting stockbroker or bank, practice that is referred to as the initial public offering (IPO). Thereafter, any investor interested in making a sale or purchases of the shares can transact on the stock market. During the IPO, the prices are pre-set beforehand, however, in the stock market the forces of supply and demand are used to determine the prices of the stock. The trading in stock follows an auction market model where purchasers or buyers bids on a particular stock at specific price while the seller also asks for a specific price for the stocks on sale. If the bid and offer prices match, a sale may take place. There is no secret to identifying the stocks to buy, rather information is important. Having the right information and being able to interpret it are significant factors and can make all the difference. For instance, if an investor finds a company that is promising, they can postpone buying until later to take time to investigate before making the investment. The Companies Ansell Ltd (ANN) Bank of Queensland Ltd BlueScope Steel Ltd Qantas Airways Ltd Market Returns Analysis Beta CAPM Expected Return = Risk free + Beta*Market Premium Portfolio Value Investment Name Investment Value Investment Return Rate Investment Weight Total Expected Return 65000 Ansell Ltd (ANN) 12,000.00 2.5 0.18 2.5 Bank of Queensland Ltd (BOQ) 18,000.00 3.0 0.28 Qantas Airways Ltd (QAN) 15,000.00 2.5 0.23 BlueScope Steel Ltd (BSL) 20,000.00 2.0 0.31  Market Returns The stock market returns are the gains that an investor makes out of participating in the stock market. The returns can be realized either through trading with the stocks or through the payment of dividend issued by the company to the shareholders. At every end of each quarter of the year, companies announce part of the earning as divided accrual for the shareholders. It is a source of the stock market return that an investor could expect. An investor can also earn the stock market return by trading on the secondary stock market. The market returns are not ensured returns rather they are subject to risks depending on the volatility of the market. They are also not homogenous and are affected by changes from one investor to the other depending on the degree of risks that an individual is willing to take as well as the quality of the stock market analysis undertaken. The cardinal idea in plying the stock market is to buy cheap and sell high, however, the risk are integral parts of the market and individuals can expect to see some negative returns if their speculation is wrong. For instance, in the analysis above, the Bank of Queensland Limited reports a market return of 3% over the three year annualized returns making it a viable investment. Ansell ltd and Qantas Airways can also be considered possible investment destination. The CAPM model applies a single factor which is the beta to compare a given portfolio with the whole market; however, in making an analysis it is possible to add several factors to the regression model in order to have a better r-squired fir. The model that is often applied is the three factor model that was created by Fama and French. Fama and French observed that the stocks have a tendency to do better than the whole market, one on small caps and secondly, the duo observed that the stocks carrying high book-value or value stocks added to the CAPM analysis reflect the portfolio exposure to the two classes. Therefore: r-R1=beta3 (KM-Rf)+bs x SMB+bvXhml+alpha According to the formula, r represents the portfolio’s return rate. Rf represents the risk-free return rate, while KM represents the return presented by the encompassing stock market. Whereas the three factor beta is viewed as being analogous to the initial beta, it is not equal to it because there are an additional two factor in the equation (Bernstein, 2009). SMB and HML means small cap less big and high minus low. These factors measure the excess returns provided by small caps and the value stocks in the market. The bottom line is that the model sees high returns as the reward for high risk. Put simply, the stocks with high book/price ratio are high risk stocks and therefore, attract a high return. Beta and expected market returns Beta The Beta is used to evaluate the volatility of the specific stock as compared to the market. By applying the three factor model equation, the beta of the four organizations was arrived at by performing a regression on the excess return and the excess return which ideally should create a security characteristic line for the organizations. The slope should equal the beta. A beta of 1 often indicate that the stock’ price moves along with the market. However, a beta whose value is less than 1 indicates that the stock is less volatile compared to the market. For instance, a stock with a beta of 1.2 values would suggest that it is 20% more volatile than the whole stock market. On the converse, a beta of 0.65 would suggest that the stock is approximately 35% less volatile compare to the whole stock market. Consequently, the stocks excess return would be expected to underperform on the 35% benchmark in the up markets or outperform by a similar percentage in the down markets. Analysis ANN BOQ QAN BSL ORL Beta 0.26 1.25 1.17 0.21 -0.45 1st Method E(r) Month 0.25% 0.29% 0.12% 0.19% 0.24% E(r) Annual 1.42% 1.06% 1.29% 2.35% 2.90% 2nd Method E(r) Month 0.78% 1.23% 1.02% 0.36% -0.09% E(r) Annual 9.62% 15.68% 13.10% 4.23% -1.04% In arriving at the expected return, two methodologies were applied. The first test was the CAPM method that offered the monthly expected return. The next step was to average the expected return and then annualized to arrive at the annual returns for each stock. The results were lower than the risk-free rate of 1.27% per year (Bernstein, 2009). The consequences for such findings are negative low yield on the expected return. The second test was used to validate the findings. The test was to calculate the value by subtracting the original value from the last recorded value and then dividing the result by the initial value. The sum total would reflect the three year yield return. When the result is subjected to the valuation of the power of three, the result is the market return per year. The results are higher than the risk-rates and therefore, a better reflection of the stocks market reality. Calculate the weightings of the companies Weighting Portfolio Value Investment Name Weight 65000 Ansell Ltd (ANN) 18.46 Bank of Queensland Ltd (BOQ) 27.69 Qantas Airways Ltd (QAN) 23.08 BlueScope Steel Ltd (BSL) 30.77 The theoretical rationale for the weighting scheme is related to the CAPM approach that was developed by Sharpe in 1964. Its basic argument is that an investor does not have any better risk, as well as return trade-off, than what is availed by a portfolio that is made of all risky stocks in the give proportion: each stock in the portfolio should equal the market value of the stocks divided by the total value of the stocks. Consequently, weighted portfolios of the tradable stocks shiuld arrive at a mean-variance optimal. Portfolio weights have many applications. An investor can calculate the weight of the portfolios by sector, index exposure, geographical region or even the short or long positions and the type of security. Regardless, the portfolio weights determination depends on the investment strategy. Suffice to say, portfolio weights are associated with market values and, therefore, are as fluid as the markets whose value changes by the day. The weights also indicate how dependent the portfolio performance is on every individual stokes. For example, the day-to-day operation may fluctuate depending on a stoke that composes a 20% of the total portfolio than a stock that makes only 5%. Thus, when weighted stocks are performing, the portfolio is likely to go up fast. For instanc3e, a stock that has a 20% weight in a $50,000 portfolio, it would suggest a $10, 000 gains, however, should a stock make only 2% of the total portfolio contribution, it means a 1,000 gain even when the stock was a home run (Bernstein, 2009). On the other hand, when a heavily weighted stock drags on the portfolio down when the market is going through a tough time, a lower-weighted stock may be having a smaller effect. Plotting the Portfolio Frontier In order to draw the coefficient fr4ontier it is important that the constituent stocks are available. An analyst should gather the average return data, build a weighted covariance table, explore the standard deviation, and finally construct the portfolio that carries the highest Sharpe ration. Mean Return (Monthly) = 1.00% 1.20% -0.50% 1.10%     Fill in the data within the boxes and hit F9 (again and again !) Volatility (Monthly) = 3.00% 2.00% 5.00% 1.00%   Risk-Free Rate = 4% (annualized) See : http://www.gummy-stuff.org/sampling-Frontier.htm Table of Asset Prices     Dates  Ansell Ltd (ANN) Bank of Queensland Ltd Qantas Airways Ltd BlueScope Steel Ltd Jan-01 10.00 10.00 10.00 10.00 Feb-01 10.35 10.06 9.82 10.07 Mar-01 10.25 10.31 9.75 10.36 Apr-01 11.50 10.80 9.56 10.32 May-01 11.41 10.40 9.11 10.45 Jun-01 11.57 10.68 9.72 10.76 Jul-01 11.65 11.03 9.85 10.79 Aug-01 11.48 11.03 10.06 11.14 Sep-01 10.85 11.16 9.03 11.25 Oct-01 11.36 11.24 8.55 11.30 Nov-01 11.70 11.64 8.88 11.22 Dec-01 11.77 11.22 9.32 11.36 Jan-02 11.36 11.65 8.91 11.27 Feb-02 11.22 11.66 8.79 11.24 Mar-02 11.00 11.57 9.35 11.14 Apr-02 10.67 11.24 9.67 11.19 May-02 10.01 11.53 9.06 11.28 Jun-02 10.32 11.55 9.37 11.45 Jul-02 10.18 11.44 9.78 11.48 Aug-02 10.25 11.31 10.27 11.60 Sep-02 9.89 11.41 10.03 11.88 Oct-02 10.34 11.84 10.02 11.74 Nov-02 9.92 11.71 9.49 11.77 Dec-02 10.39 11.92 9.78 12.10 Jan-03 10.21 11.87 10.23 12.14 Feb-03 10.84 12.01 10.61 12.15 Mar-03 11.34 12.09 9.96 12.45 Apr-03 11.25 12.37 9.73 12.74 May-03 11.16 12.33 9.33 12.87 Jun-03 11.98 12.32 9.49 13.23 Jul-03 12.44 12.04 8.90 13.62 Aug-03 11.94 12.84 9.75 13.72 Sep-03 12.71 12.75 9.34 14.06 Oct-03 12.94 13.33 9.69 14.30 Nov-03 13.05 13.44 10.13 14.36 Dec-03 12.82 13.78 10.65 14.69                         Standard Deviation on frontier plotting Figure 1: Standard Deviation Graph, Fama and French Performance Data Coefficient of Risk Aversion of 2.5 Economic models often assume that people make their choices with the intention to maximize some stock investment on their preferred parameters among them the coefficient of risk aversion. The link between portfolio choices should be viewed through the lens of the reduction of stocks losses arising from investment mistakes, thus for every portfolio reviewed, there should be an alternate portfolio that examines the maximization of the next expected period functionality. As a consequence a correlation is evaluated between the observed portfolios in terms of the evaluation of compensative variations of the investment. Capital Allocation Line Investors often look at earning high returns on a certain level of risk that they can accommodate; therefore, they seek to allocate their capital in a maximal level where the risk-return profile gives the greatest yield and satisfaction. In an evaluative observation, the greater the standard of deviation, it has been noted, the high the risk (Bernstein, 2009). Often investors chose to take the route with minimal risks where a risk-return trade-off is most likely. One way of handling the riskiness of an investment portfolio is through the variation of the proportion of the risk-free stocks. The illustration below demonstrates the variation on risk-aversion versus the capital allocation line Figure 2: risk and investment curve with anticipated returns this matter.com money 2016. Critical Discussion The chosen companies have been traded on the stock exchange for some time, however, their fortunes, as far as the stock traders are concerned, have not been relatively volatile and, therefore, consist of low risks versus returns. The energy and aviation sectors represent some of the growth areas in capital development and, therefore, safe stocks to make an investment. Given the analysis that has been presented, BlueScope and the bank of Queensland make some of the possible investments hubs for investors that are looking at safe stocks, however, Qatar and Ansell represent stocks that an investor can consider if they are looking at long term investments with minimal market volatility. These stocks carry a guaranteed long term investment with reliable returns on investments. References Bernstein, W. (2009). The Investor's Manifesto: Preparing for Prosperity, Armageddon, and Everything in Between, John Wiley & Sons. Brandimarte, P. (2013). Numerical Methods in Finance and Economics: A MATLAB-Based Introduction, Hoboken: John Wiley & Sons. Cornuejols, G. & Tütüncü, H. (2006). Optimization Methods in Finance, Cambridge: Cambridge University Press. Read More