Advanced Financial and Investment Management

Advanced Financial and Investment Management

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Module Title: Advanced Financial and Investment Management

Title:

Investment Analysis of the FTSE 100 Listed Firms.

Objective:

To understand the key concepts, approaches, evidence and models of modern financial theory and practice.

Data:

You will draw the necessary data for this coursework from databases such as Yahoo Finance, FAME, and Thomson Reuters Datastream (This software is available on 3 PCs behind the library helpdesk ONLY. You can find the guidance from here).

Select any five firms from the FTSE 100 index components (you can find the eligible firms from here). Download adjusted monthly closing stock prices for each one of your five firms over the most recent period of five years (your price series should from June 2011 to June 2016 so that you can then obtain 60 monthly return observations in total for each stock). You are free to choose whatever stocks you want, irrespective of their characteristics and historical investment performance; this will not affect your grade. Also, download adjusted monthly closing price levels for the FTSE 100 as a proxy for the UK market portfolio over the same 5-year period.

In order to determine the risk-free rate, download the 3-month UK Treasury Bills monthly rates: open the Bank of England website, then select Statistics, Interest and Exchange Rates Data, Wholesale interest and discount rates, Treasury Bills (3 month) Sterling, End month – IUMAJNB – Monthly.

Description:

A wealthy UAE investor (diversified in terms of exposure to different sectors in the Middle East and North Africa region, but not diversified in terms of international geographical exposure) is considering the strategic decision of investing in a portfolio of five FTSE 100 firms.

You are employed by a leading financial institution and have been asked to advise this client. You will prepare an investment report in Microsoft Word for her containing all your work, results and arguments. All the relevant tables and figures should be contained and discussed in the main bodyof the report, not in some appendix. The report, which includes all of the following five sections, should not exceed 4,000 words in total apart from references and appendices. You can also find the suggestions about Tables/Figures you should at least include, and the relevant textbook chapters that you could start reading from in each section.

1. Your client would like you to discuss your opinions on active and passive investment strategies in the UK stock market, in particular, in the shadow of Brexit. Do not perform your own empirical analysis and testing but use the international and the UK empirical evidence from the literature to compare the performance of two strategies in the financial industry. You should then draw relevant theories in the literature to explain their performance. Finally, you should briefly address the potential impact of Brexit on active and passive investing.

Relevant Chapters: 11 to 13 (20 marks)

2. Use your sample data to form the following four portfolios: equal-weighted portfolio (EWP); market-value-weighted portfolio (VWP); global minimum-variance portfolio (GMVP); and optimal risky portfolio (P). According to the five stocks and risk-free rate, build and draw the optimal capital allocation line, the minimum-variance frontier and the efficient frontier in a graph (type: scatter with smooth lines) of expected returns against standard deviations. Further, mark the positions of the five stocks and four portfolios in that graph. Explain and discuss your results.

Table: Portfolio weights, returns, standard deviations, and Sharpe ratios.

Figure: One graph includes the optimal capital allocation line, the minimum-variance frontier, the efficient frontier, the five stocks and four portfolios.

Relevant Chapters: 5 to 7. (25 marks)

3. Determine the proportion of the overall optimal complete portfolio (C) in the UK financial market that should be held in the optimal risky portfolio (P) of the five stocks along with the proportion that should be held in the risk-free asset. Assume that your client has the same coefficient of risk aversion as yours and that you should determine this by using the Charles Schwab Investor Profile Questionnaire (you can find the questionnaire from here). Transform the questionnaire risk tolerance scores “X” (0 to 40) into risk aversion index “A” (2 to 4) by using the following transformation: A = 4 – X/20. Thus, a risk tolerance score of 30 becomes a risk aversion index of 2.5 (= 4 –30/20). Finally, draw a graph (type: scatter with smooth lines) to illustrate the relevant indifference curve, capital allocation line, optimal risky portfolio (P), and optimal complete portfolio (C). Explain and discuss your results.

Table: Portfolio weights, returns, and standard deviations.

Figure: One graph includes indifference curve, capital allocation line, optimal risky portfolio (P), and optimal complete portfolio (C).

Relevant Chapter: 6. (15 marks)

4. On the basis of the single-factor market model CAPM, estimate the beta coefficients for each one of the chosen five stocks. You are free to use whatever method you prefer in estimating the market model parameters (scatterplot trendline, intercept and slope functions, or regression analysis). Discuss if the beta values you have estimated are sensible given the nature of the business activities of each firm. Finally, discuss the relationship depicted in a scatterplot (type: scatter) between expected returns (use the average annualised returns here) and beta coefficients for the five stocks.

Table: Alpha & beta coefficients, and expected returns for the five stocks.

Figure: One scatterplot of expected returns against beta coefficients for the five stocks.

Relevant Chapters: 8 and 9. (15 marks)

5. Evaluate in absolute and relative terms the investment performance of each one of the four portfolios that created in Section 2 (EWP, VWP, GMVP and P) with the FTSE 100 benchmark over the five-year sample period:

(i) Compare the performance of the four portfolios in terms of return, standard deviation, beta, Sharpe ratio, Treynor measure, Jensen’s alpha, information ratio, and M2 measure. All metric components (e.g., average return and standard deviation) should be annualised as appropriate.

(ii) Determine which portfolio is more favourable for a most risk-averse and for a most risk-tolerant investor, respectively. Which portfolio would be the best for your client to invest in? Which portfolio do you consider the worst choice to your client? Justify and explain your recommendations.

(iii) Compare the best and worst portfolios to your client graphically by using wealth indices.

Table: Performance statistics for the four portfolios with the FTSE 100 benchmark.

Figure: Wealth indices (i.e. cumulative return) for the best and worst portfolios to your client.

Relevant Chapters: 24. (25 marks)