# 25721 Investment Management Assignment Part I

Finance Discipline Group UTS Business School

**Question 1 **(Asset returns and risk) - **5 marks**)

Extreme volatility and falling share prices have been experienced in share markets across the globe since late February. This is a dramatic change from the rising share prices that occurred over the twelve months prior to February. Rooster Wealthy Investors Trust provides you with share prices for eight (8) companies listed on the Australian Securities Exchange (ASX). They ask you to write up an analysis of these companies. In the analysis you must:

- Briefly explain, in your own words, whether or not it would have been wise to trade on the ASX since the start of 2020.
*Note: Australian newspapers have regularly printed articles on this.*(worth 1 mark) __Identify__the eight (8) companies in the EXCEL spreadsheet and in a table__list__their ASX industry group and__describe__, in your own words, two of their main products or services. The description for each company will require at least two sentences. (worth 1 mark)__Graph__the share prices of the companies and__provide your own opinion,__based on these graphs, whether it would be best to buy or short sell each of the companies. (worth 1 mark)__Estimate__the monthly average continuous returns and sample standard deviations of the monthly continuous returns for each of the companies and the ASX200 from July 2010 to July 2020.__Summarise__your estimations in a simple labelled table. (worth 0.5 mark)- Estimate the sample correlation based on the monthly continuous returns for each pair of the eight (8) companies.
__Summarise__your estimations in a simple labelled table and__identify__the pair that has the strongest relationship and the pair that has the weakest relationship. (worth 0.5 mark) - Based on your estimations in (d) and (e) select four (4) companies that you consider would be the best to create a portfolio with. Provide a
__brief explanation__of your decision. (worth 1 mark)

**Question 2** (Mean-variance optimization - **5 marks**)

The investors in Rooster Wealthy Investors Trust have a **risk aversion factor of A = 4**. Rooster Wealthy Investors Trust asks you to analyse a portfolio that consists of two risky assets and a risk-free asset. In the analysis you are required to

__Explain__what a risk aversion factor of A = 4 implies about the investors who buy units in Rooster Wealthy Investors Trust. (worth 1 mark)- The return and risk profile of investors in Rooster Wealthy Investors Trust can be described by the quadratic utility function covered in Lecture 2.
__Rank__the eight companies from the one most preferred by the investors to the least preferred.__Show__and__explain__why the companies are ranked in this order. (worth 1 mark)

πΌ_{π}(π¬(π), π) = π¬(π) β π/2 π¨_{π}ππ

- Construct a portfolio containing the two (2) companies that have the strongest relationship and a risk-free security. Use your estimations in Question 1 to calculate the percentage of funds that would be invested in each of the two companies and the riskfree asset. Assume the return on the risk-free security is the average cash rate. Do your calculations using trial and error (in a systematic way) in EXCEL
__and__by using EXCELβs Solver.__List__the percentage of wealth invested in each of the two companies and the risk-free asset__and__the return and risk of the two (2) companies; the risk-free interest rate security; the optimal risky asset portfolio and the optimal total portfolio (worth 0.5 marks)- In a simple labelled table
__list__the return, risk and utility of ten of the risky asset portfolios that lie near the optimal risky asset portfolio.__Explain__, in your own words, why these ten (10) portfolios are not the optimum risky asset portfolio

(worth 1 marks) iii. In a fully labelled mean-standard deviation diagram __show the positions__ of the optimal total portfolio, the optimum risky asset portfolio, the risk-free interest rate security, the efficient frontier and capital allocation line. The diagram can be hand drawn. (worth 1 mark)

- Provide a
__recommendation__, in your own words, to Rooster Wealthy Investors Trust on whether it would be better to invest in the optimum total portfolio; an ASX200 managed fund; or a risk-free interest rate security. (worth 0.5 marks)

**Question 3 **(Asset Pricing Theory - **5 marks**)

Rooster Wealthy Investors Trust asks you analyse whether any of the eight (8) companies are mispriced. You decide to use the security market line (SML) to test for mispricing. The equation below summarises the single index model (SIM).

π ππ‘ = πΌπ + π½πππ ππ‘ + πππ‘

π
_{ππ‘} is the excess monthly return of stock *i *above the cash rate

π
_{ππ‘} the excess monthly return of the ASX200.

- In your own words
__explain__how the SML can be used to test for mispricing__and__one weakness of using the SML to do this test. (worth 1 mark) - Use the excess monthly share returns for the companies from July 2010 to July 2020 to
__estimate__their πΌ_{π}and π½_{π}. In a simple labelled table__list__πΌ_{π}and π½_{π}for each of the companies in alphabetical order of the company names.*Note: The calculations that you will be using are discussed in Lectures 3 and 4. The calculations can easily be done in EXCEL using formula functions for βinterceptβ and βslopeβ or from a regression in*

*βData Analysisβ (the βY-rangeβ is the dependent variable, the column of excess stock return, and βX-rangeβ is the independent variable, the column of excess ASX200 returns)*. (worth 0.25 marks)

- Under the assumptions of the SIM and using your estimations in (b),
__calculate__the expected excess returns for each of the eight companies.__List__these in a simple labelled table. (worth 0.25 marks) - You run the regression equation below to test whether any of the companies is mispriced:

π
Μ
_{π }= πΌ + πΎπ½Μ_{π }+ π_{π}

π
Μ
_{π} is the estimated expected excess return of each company

π½Μ_{π}is the beta coefficient of each company

__Explain__ what your estimates for πΌ and πΎ as well as their *p* values and *t* statistics say about the relationship between π
Μ
_{π} and π½Μ_{π}. *Note: The regression can be done in βData Analysisβ (the βY-rangeβ is the dependent variable, the column of expected excess stock returns and βX-rangeβ is the independent variable, the column of betas)*. (worth 1.5 marks)

- Indicate whether any of the companies is mispriced by doing the following:

__Plot__the best-fitted line for the estimated π_{π}βs and π½_{π}βs and__show__the position of the companies on the graph.*Note: This can be generated by selecting the βLine Fit Plotsβ option when doing the regression and in Design adding the Chart Element βTrendline (linear)β*(worth 0.5 marks) ii.__Calculate__and__explain__the difference between the expected excess returns calculated in (c) and the π Μ_{π}estimated using the πΌ and πΎ in (d) and beta in (b). (worth 0.5 mark)

__Identify__whether the companies should be purchased or short sold.__Explain__why these trades would be profitable. (worth 1 mark)