FINM2401 Financial Management, Semester 1 2018

Assignment due: 26 May 2018. Submit electronically on Blackboard – one assignment per group.

Group: This is a group assignment. Your group should contain 3-4 students.

Overview: This assignment consists of 2 questions covering Bond Valuation and Portfolio Analysis. The total marks are 100 and count towards 20% of your final grade. Bloomberg access is required for both questions.

Question 1: Bond Valuation (40 marks)

Let’s suppose today is 16/01/2018, and you are observing the information for an Australian Government Bond which will mature on 21/04/2024. The first coupon was paid on 21/10/2012. The information is sufficient for you to identify the bond. Now collect the bond's additional information:

• Coupon rate, coupon frequency, face value, bond rating, last price and lastyield to maturity as of today.

• Quarterly historical price/yield series of our bond from 31/12/2012 to 31/12/2017. (Bond Yield Series)

• Quarterly median forecasts on Australia Consumer Price by economists from 31/12/2012 to 31/12/2017. (Inflation Series AUCPIYOY Index)

Required:

A) Report the coupon rate, coupon frequency, face value, bond rating, price and yield to maturity as of today. (10 marks)

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• Westfield Corp (WFD AU Equity)

• National Australia Bank (NAB AU Equity)

• Commonwealth Bank of Australia (CBA AU Equity)

• Woodside Petroleum Ltd (WPL AU Equity)

• BHP Billiton Ltd (BHP AU Equity)

• Westpac Banking Corp (WBC AU Equity)

• Rio Tinto Ltd (RIO AU Equity)

• Transurban Group (TCL AU Equity)

FINM2401 Financial Management, Semester 1 2018

2. B)   Given the yield to maturity and other characteristics you have collected, calculate the bond price as of today, assuming the face value is $100.

3. C)   Report the correlation between Bond Yield and Inflation Series. Comment on the magnitude and implications of the correlation. (Hint: Your discussion should try to link nominal, real, and inflation rates.)

   (15 marks)

Question 2: Portfolio Analysis (60 marks)

You are a portfolio manager who has constructed an equity portfolio for a client who requires an annual return of 15%. Assume today is March 01, 2018 and you would like to determine how well your client’s portfolio has performed over the last couple of months. On 31/12/2017, your equity analysts gave you a list of potentially best performing Australian stocks in 2018 which you have used to construct an equity portfolio. The list of eight stocks are below:

On 31/12/2017 your client wanted a portfolio with only three stocks. To achieve this objective, you built a three-asset portfolio using the mean-variance framework by implementing a three-step process:

1) Data collection: For each stock, you obtained the following information:
• Historical monthly returns on each stock for the previous 5 years from

(15 marks)

31/12/2012 to 31/12/2017.

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FINM2401 Financial Management, Semester 1 2018• Price to Book ratio as at 31/12/2017.

2) Screening: As a big believer in value-momentum-quality, you used these attributes to pick the best three stocks. For each stock, you obtained:

• The ratio : This ratio captures value. The higher ratio indicates that a

stock is more expensive or less cheap.
• Historical monthly volatility: This measure aims to capture quality. The

lower volatility indicates better quality.
• Cumulative returns for the last 12 months up until 31/12/2017. The

higher measure indicates winners (stocks performing well in the past 12 months).

Your goal was to pick cheap, high quality, and high past performing stocks. You determined that the easiest way to do this was to first rank the stocks based on the individual attributes, so that the higher the ranking, the more desirable the stocks.1You then calculated the aggregate ranking score by summing up all three individual rankings for each stock. Finally, you chose the best three stocks based on this aggregate score.

3) Portfolio construction: After the screening process above, you constructed a three-asset portfolio relying on the mean-variance framework.

• Your client requires a portfolio return of 15% p.a. Also, you are not allowed to engage in any short-selling activities.

• The critical inputs for your portfolio construction are expected returns, volatility, and the correlation matrix. You use historical average returns, volatilities, and correlations to proxy for the expected values.

1 Let’s agree on that the highest ranking is 1 (most desirable) and the lowest is 8 (least desirable).3

FINM2401 Financial Management, Semester 1 2018

Finally, you would like to evaluate the performance of the portfolio by calculating the portfolio holding period return from 01/01/2018 to 28/02/2018.2

Required:

A) Report the average return and volatility for each stock - on an annual

basis.

B) Report the individual and aggregate ranking for each stock. What were the best three stocks that you chose on 31/12/2017? (10 marks)

C) Report the weights on each stock in the optimized portfolio.3 What is the Sharpe Ratio of your portfolio, assuming the risk free rate is 2.5% p.a.? You should demonstrate how you obtain these weights in Excel Solver.

D) Compute your portfolio holding period return for the first two months after the portfolio formation i.e. from 01/01/2018 to 28/2/2018.

E) TheanswerinpartDisdifferentfrom2.5%pertwomonthsrequiredby the client (15%). Your client demands an explanation for the difference.

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How would you explain the difference to him? Your explanation should demonstrate:

1. Your understanding of the relevant theories,

2. Your understanding of the practical implementation.

(10 marks)

4

(10 marks)

(15 marks)

(5 marks)

2 You need to collect the return data for the first two months of 2018 for portfolio performance

evaluation.
3 Please do the optimisation on the per annum basis.

FINM2401 Financial Management, Semester 1 2018

F) Comment on the characteristics of your portfolio. What advice could you give the client to improve the portfolio? Your answer should relate to the risks of the portfolio. (10 marks)

Submission

Excel: Your Excel file should include all workings and calculations. Formulas for the calculations should have cell references wherever possible. If you have computed a number incorrectly and just typed that number into the spreadsheet (or typed a formula using numbers when cell references could have been used), you will not receive partial credit for any portion of you computation that is correct.

Your Excel Solver should show the objective function and conditions that help calculate the optimal portfolio weights.

Written Report:

Please provide a written report (not exceeding 750 words). The report should provide answers to:

• Part D C of Question 1 (250 words),

• Part E of Question 2 (250 words), and

• Part F of Question 2 (250 words).

Your discussion must highlight your understanding of the theories and the use of theories to explain empirical results. Please provide references where appropriate. References are not included in the word count.

Final Submission:

• Teams should submit the entire assignment (ONE SUBMISSION PER TEAM) by attaching TWO files

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FINM2401 Financial Management, Semester 1 2018

o Excel on BLACKBOARD TEAM PROJECT: Please name the file “Assignment_FINM2401_TeamXXX.xlsx” where xxx is your team’s number); and

o PDF written report on TURNITIN TEAM PROJECT. Please name the file “Assignment_FINM2401_TeamXXX.pdf”.

• Please make sure that only ONE member of your team submits through Turnitin. If more than one team member submits the answer, Turnitin will treat it as plagiarism.

• You may re-submit as many as you like, but only your last submission will be graded.

• Each team member needs to submit a Peer Evaluation Form to get the assignment score.