INVESTMENT AND RISK MANAGEMENT

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MODULE: INVESTMENT AND RISK MANAGEMENT (NBS-7077B)Human Computer Interaction

Objective: This assignment asks you to prepare a professional investment management report using data from either Thomson Reuters Eikon or Yahoo! Finance. Your report should demonstrate that you have a solid understanding of the investment management theories, practices and tools covered in the module and that you can communicate this clearly.

Question: Assume that you are employed as a financial analyst for a leading financial advisory company. Your manager has asked you to prepare an investment management report by the end of the day for a client who has recently won the lottery.

This client wishes to invest in the stock market for the first time and is interested in investing in a medium-term portfolio composed by at least 5 stocks. To pick the five stocks you should focus on a specific country or on a specific industry sector as discussed during the lectures.

In order to prepare your report, you need to create an Excel workbook where you should download the monthly dividend-adjusted closing price for the 5 stocks for the period 01/01/2017 to 31/12/2022. You should also download the appropriate reference market (e.g. if you are focusing on the US market the S&P500, if you are focusing on the tech US industry the Nasdaq Index…). Lastly, download the risk-free rates, represented by the 3-months Treasury Bill rate (monthly frequency) that we have employed throughout the module for the same reference period.

Using this data, you should then compute the corresponding returns (in %) for the stocks and the reference market and transform in % the risk-free rate.

Throughout all the analysis, you should assume that your client has a risk aversion level of 10 (A=10).

Market trends and descriptive statistics

Using the returns data, report the Expected Annualized Return, the annualized volatility, the annualized risk premium and the Sharpe Ratio for each of the asset (your stocks and the reference market that you have chosen.

Explain each of the above statistics from a statistical point of view and discuss how these are used in investment management. Given these statistics about your firms and the US stock market, which stock should your client choose if he

(i) only cares about return, (ii) only cares about risk, and (iii) cares about the Sharpe ratio?

(10 marks)

Compute the correlation matrix for all the assets. Explain these statistics in the same fashion as above. Discuss the kind of relationship each pair of assets has. What are the implications for the level of diversification of a potential portfolio?

(5 marks)

Economic landscape and investment advice

The client wishes to know whether investing in stocks is a smart choice given the current investment environment. Discuss what information is reflected in the current price of each of the companies and the stock market that you have chosen. Your discussion should be based on several items of information (e.g. recent news stories, macroeconomic announcements) which are of interest to investors. Include at least two items for each firm and at least three items for the economy of the country or the industry chosen. Discuss the effect each item has on the asset’s price, the type of information it contains (past, public, or private), and whether it has any influence on the corresponding statistics estimated in the previous section. (Aim to allocate a minimum of 500 and a maximum of 1000 words to this answer)

(15 marks)

Portfolio selection (2 stocks)

Present and plot the efficient frontier for the two of five of the stocks that you have picked. Highlight on the graph the Global Minimum Variance Portfolio between the two assets. Describe the portfolio from a statistical and investment point of view.

(10 marks)

Portfolio selection (all the stocks)

With the stocks that you have picked compute an equally weighted portfolio (EWP). Provide the following summary statistics for the EWP:

  • The Annualized Expected Return
  • The Annualized Volatility
  • The Sharpe Ratio
  • The Beta
  • The CAPM predicted return
  • The alpha
  • The Information Ratio
  • The Treynor Ratio
  • The Unique Risk
  • The Diversified Risk

With the stocks that you have picked compute the optimal risky portfolio (ORP). Provide the following summary statistics for the ORP:

  • The Annualized Expected Return
  • The Annualized Volatility
  • The Sharpe Ratio
  • The Beta
  • The CAPM predicted return
  • The alpha
  • The Information Ratio
  • The Treynor Ratio
  • The Unique Risk
  • The Diversified Risk

Report the statistics into a unique table in two columns to allow a comparison between the two portfolios.

Explain each of the above statistics (except the Annualized Expected Return, the Annualized Volatility and the Sharpe Ratio, previously explained) from a statistical point of view and discuss how these are used in investment management.

Compare the summary statistics between the EWP and the ORP. Aside from the Sharpe Ratio how do they differ? What advice would you give to a client that is only concerned about risk?

(20 marks)

Compute the optimal capital allocation between the risk-free asset and the optimal risky portfolio for your client. How should the client allocate his capital among the risk-free asset and the ORP? Draw the capital allocation line (CAL) and show the optimal capital allocation on the graph. In the CAL you have to include the risk-free rate, the complete portfolio (the optimal capital allocation) and the ORP.

(10 marks)

Present the allocations of the complete portfolio, by detailing not only the risky and risk – free component, but also the weights of the single stocks. Present the Annualized Expected Return, the Annualized Volatility and the Sharpe Ratio. Compare the Sharpe Ratio of the ORP and the Complete portfolio. What does this mean from a statistics and economic perspective?

(10 marks)

Hedging Strategy

Price an at the money (ATM) put option (following the binomial tree methodology) on one of the stocks that you have picked. You should choose the stock based on the aim of this strategy.

You need to present the graph of the complete protective put strategy, including the option profit and loss function, the option total profit, the stock total profit and the strategy total profit.

Explain the strategy from an investment and risk management point of view. What are the risks involved in this strategy for your client? What is the maximum loss that your client can encounter?

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