How to Invest in Common Stocks and Treasury Bills - Assignment Example

Q1. For each company briefly explain the type of business it conducts and what industry it conducts its business in. Also, if there is any other information that you think your clients may be interested in, mention this too. The Boeing Company is the largest aerospace corporation in the world. Being in the manufacturing industry, Boeing makes the largest manufacturer of aircrafts in terms of revenues as well as deliveries to clients. The corporation contains various business units that include Boeing Defense, Space & Security and Commercial Airplanes. The Bank of American Corporation which is in the banking industry is among the largest American banks in terms of assets. The bank runs second in terms of market capitalization. The bank is also among those banks with the highest number of branches having close two 6000 branches in the United States and about 300 offices outside the US. By the year2010, the bank was the fifth largest corporation in terms of revenue and the 2nd largest US Company not producing oil. Chevron Corporation on the other hand is an oil company in the United States. This operates within the mining and extraction industry and produces about 2.8M oil barrels each day. Other areas of interest for the company include mining, chemicals, power production and pipeline businesses. The company which operates under Texaco and Chevron brands owns or is a shareholder of about 8,250 gas- stations within the United States. The main competitors for the company include ConocoPhillips, Devon Energy Corporation and the Anadarko Petroleum Company. Q2. Please calculate the monthly return and monthly standard deviation for each chosen stock. Which one is most risky? The monthly standard deviation for stock 1, 2, and 3 which represents the stocks for Boeing Company, Bank of American Corporation and Chevron Corporation are 18.31313, 11.14299 and 21.25343 respectively. The calculation is shown in the attached spreadsheet named ‘finance’. The monthly returns have been calculated for every stock, stock 1, 2 and 3 which are attached in the 3 named spreadsheets. Monthly returns = (share price at the end of the month/ share price at the beginning of the month)-1*100%. The most risky stock is stock 3 (Chevron Corporation) whose standard deviation is 21.25343 indicating the highest volatility. 3. The expected return is the performance of a financial investment made by an investor which may be in the form of a divided, interest or a profit. On the other hand, the risk on finance is the poor performance of an investment. In the above analysis, the return on investment in the portfolio made is promising. The investor is provided with an opportunity to spread the risks in the three industries of mining, manufacturing and banking. This way, the portfolio is diversified which ensure that risks are minimized and returns enhanced. This form of maximum diversification of the investment ensures that the investor is a successful one as it furnishes him/her with vital knowledge visa vi the right platform for investing. The information provided by the analysis assists the investor to identify the most risky venture in the three categories of stocks to be invested in the portfolio. The investment capital is $ 100,000,000 each in Boeing and American banking corporation and $800,000 in Chevron corp. Portfolio one- Asset 1=Boeing share with an investment value of $500.000 Asset 2=American bank corporation with an investment value of $500,000 Portfolio 2-Boeing $ 500,000 and $400,000Chevron Corporation Portfolio 3-Chevron $400,0000and American $500,000 Banking Corporation 4. Please calculate the monthly return and monthly standard deviation for each of your portfolios. Monthly return and standard deviation for portfolio 1 Standard deviation=square root of the variance (average of the portfolio) =5.32 Monthly return and standard deviation for portfolio 2 Standard deviation= =46.9111 Return and standard deviation for portfolio 3 Standard deviation= =46.9111 5. Please compare the return and the risk for the individual stocks and the portfolios and discuss the process and meaning of diversification A portfolio is taken to imply a collection of all the investments held by an individual investor or an institution and which are stocks, bonds, options, real estates among others, as opposed to the individual stocks where one hold a single stock in isolation in the market. This is the main drive behind investing in the Dow Jones Industrial Average Index in its three selected component companies. Extent of risks is high in the stocks held in isolation as opposed to a portfolio. This is because most assets in the portfolios are not held in isolation but as part of a portfolio which minimizes their volatility. With a minimized volatility, the rate of returns is high in portfolios than in the individual assets due to the aspect of diversification which protects against the risk of single securities. Diversification is the process of minimizing or eliminating an investor’s exposure to risks and moderating the short term effects of individual assets class performance on portfolio value (LLC, 2007). This process entails investing in a variety of assets, the proverbial adage of not putting all your eggs in one basket. The main reason for diversification is not to guarantee against a loss or ensure a profit but to reduce the volatility of your investment in any given portfolio. The process of diversification starts with holding different types of stocks in the market and then moving to different stocks in various countries. To reap maximum benefits from diversification, it’s recommended that one buys the market portfolio otherwise known as the maximum diversification. This is a process where you purchase the pro rata share of all the available market assets. The process of maximum diversification provided the investor with the benefits of having the portfolio determined by the securities entering the market as opposed to the underlying economic values and also escapes the problems of undervaluing and overvaluing of portfolios. In diversifying the portfolios, an investor has a range of assets classes from which to choose from. They include the stocks, bonds, short term investments and the international stocks and bonds. A mix of these classes assists an investor in constructing a diversified portfolio that got few extremes. 6: Please calculate monthly returns (do not worry that a 360 day year has been used, assume it is a 365 day year) and the standard deviation for 3-month Treasury bills using data from Jan 1, 2000 to May 1, 2011. (0.5 mark/ 20 marks) Monthly returns =2.39 Standard deviation for =1.921486435 7. Differences between stocks and the three month treasury bills Treasury bills are investment bonds issued by the government with maturities ranging from one to three months while stocks are long term investments in the form of shares issued by limited companies that are listed in the stock exchange market. The treasury bills are highly liquid and their rate of return is lower as compared to that one of stocks. Stock holders claims ownership in the company or business of investment as opposed to holders of treasury bills. This is because a share is a representation of ownership emanating from the investment made. Unlike a treasury bill, a stock is attached with some legal clauses such as voting rights for the holder. This conveys some management powers in the stock holders as he/she is involved in some aspects of policy making for the organization. Stocks earns a dividend at the end of the year while the treasury bills earns an interest on maturity and are issued by the government as an emergency source of revenue as opposed to stocks which are issued by companies to raise capital. 8.Calculate the return and standard deviation for the following portfolio: (0.5 mark/20 marks) 50% in stock (you can choose any of the three you have used previously, if you have particular reason to choose one, please address your reason) + 50% in 3-month Treasury bills Standard deviation for portfolio one= square root of the mean = =46.91 9. Compare the stock-Treasury-bill portfolio with the above pure stock portfolios. Discuss the attractiveness of each of these portfolios for potential investors? Think specifically about the different attitudes to risk and return that investors might have Then stock treasury portfolio has an edge over the pure stock portfolio because it combines the benefits of yield of returns of both the stocks and the returns. This implies that when the bonds and the stocks are doing well in the market, an investor in the stock-Treasury bill portfolio is assured of maximum returns as opposed to a counterpart in the pure stock portfolios, with the same economic factors being held constant. On the other hand, when stocks are operating in a volatile market and the rate of return is not high, and the treasury bills of which their interest rate is fixed and is not pegged on the economic performance, an investor in the stock-bon d category is assured of good returns from the bills. The investor is assured of fewer risks in the former category as the bills are less risky as oppose to stocks. He/ she is also assured of security in terms of returns as the treasury bills in the portfolio are issued with fixed terms with an assured faster rate of return as opposed to the other category of pure stock portfolio. This is attractive bait to an investor intending to make a quick kill from the investment made. On top of a guarantee of other benefits that accrue to their stocks such as the right to being a shareholder in the company of investment. References Dimson, P.R. et al. (2003) Millenium Book II: 101 Years of Investment Return, ABN. Dow Jones and company (2011) The Wall Street Journal. Retrieved on Thursday September 8, 2011 Joshua Kennon (2011), Investing for Beginners. Retrieved on 8th September 2011 from Marquie James and Bessie James (1954) Biography of a Bank: The Story of Bank of America. New York: Harper and Brothers. United States Exchange Commission (2010) Boeing Washington DC. Read More