Assignment 2
PORTFOLIO MANAGEMENT
Assignment No 2
Marks = 8
Instructions:
A. The following assignment must be done in group of 2.
B. The due date is Feb 20, 2012. Try to submit the assignment on due date otherwise 0.5 mark will be
deducted per day.
C. You are advised to comprehend each step thoroughly so that you answer any question at the time of
submission. Those who fail to answer the questions will face penalty of 2 marks.
D. The assignment must submitted to my email ims.assign@gmail.com . Remember the subject of the email should follow the following format:
MBA-BF Semester and then group member names and the file name should be the names of the group members
Students groups and Assigned Companies [ MBA B&F and MSC Econ: ]
Assignment
You are required to calculate 5 years return for the two companies assigned to you by including capital gains and dividends in the returns. Then do the following:
Calculate average return on each stock
Calculate standard deviation for each one
Make different portfolios of the stocks with weights ranging from 0 to 100% with gaps of 10% i.e
Stock A Stock B Portfolio
0 100% A
10% 90% B
20% 80% C
30% 70 D
40% 60 E
50% 50 F
60% 40 G
70% 30 H
80% 20 I
90 10 J
100 0 K
Calculate Average Return AND Standard Deviation for each portfolio
Make efficient frontier and discuss which portfolio (s) is superior to others
After making efficient frontier, you are supposed to invest Rs.100,0000 in a one of the portfolio on the efficient frontier. Suppose you are an aggressive investor, so you will select a portfolio on the upper right hand of the efficient frontier. After selecting a given porftolio, you need to tell how much are you going to invest in one security and how much in the other security based on the weights of the securities in the selected portfolio
l Video 1 l Capital Gain, and Dividend per share
l Video 2 l Arithmetic mean, geometric mean, standard deviation, covariance, correlations
l Video 3 l Portfolio Risk, Return and Efficient Frontier
Part 2 of the Assignment:
Required:
1. Calculating Required Rate of Return (Expected Return) with CAPM
2. Testing the validity of the CAPM
Calculating Expected return with CAPM
The Beta formula under CAPM is given by:
A. (Ri-Rf) is your dependent variable and (Rm-Rf) is your independent variable
B. Use regression technique to find the coefficient of (Rm-Rf), this coefficient is your beta
C. After finding beta, use the CAPM equation to find out the required rate of return on your stock
D. Compare this required rate of return with actual rate of return of the stock to find out whether the stock is overvalued, undervalued or fairly valued
To operationalize the above equation, follow these steps:
A. Obtain end of month share prices of the two companies assigned to your group for a period of 12 months for your assigned year
B. Calculate Ri = (P1-Po)/Po, for both companies individually
C. Take interest-free rate in your assigned year and divided that rate by 12 to make it a monthly rate
D. Deduct the monthly interest free rate (Rf) from the Ri and you will obtain Ri-Rf
A. Obtain end of month index points for KSE 100 index for a period of 12 months for your assigned year
B. Calculate Rm = (Index1-Indexo)/Indexo
C. Take interest-free rate (T-bill rates) of your assigned year and divide that rate by 12 to make it a monthly rate
D. Deduct the monthly interest free rates (Rf) from the Rm values and you will obtain Rm-Rf
E. Now apply regression equation to find the Beta
B. How to Check the Validity of CAPM
Applying CAPM to the data, we might get the following regression output:
The intercept has a value of -.007 which suggests that CAPM gives expected risk premium above the actual risk premium by a value of .7%. But this value is insignificant as the P-value is 0.76 which is above 0.1. The beta is highly significant as the P-value is 0.000001.
In the regression outputs of CAPM, the intercept values is insignificant, suggesting that the model correctly predict the risk premium on the given security.
Video Help for Part2 of the assignment
[You do not need to find HML and SMB because you are not required to estimate Fama and French Model]