MAF101 Fundamentals Of Finance Trimester 3

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MAF101 Fundamentals Of Finance Trimester 3

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MAF101 Fundamentals Of Finance Trimester 3

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Course Code: MAF101
University: Deakin University

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Country: Australia

Question:

Your task is to answer the following questions by referring to your textbook, other finance books, the media, the internet etc.:

By using the information in TABLE 1:

(a) Calculate the historical returns for each of the above portfolios for the years between 2003 and 2017. Present the answers/numbers in the table.
(b) Calculate the expected (average) return, denoted by E(R), and risk (standard deviation), denoted by σ, for each of the four asset classes as well as those three portfolios. Present your answers in Table 1. The completed table SHOULD be submitted with your assignment. Students are encouraged to employ Microsoft Excel for these workings.

Explain what is meant by expected return and risk in finance. You need to address the relationship between these two concepts in your explanation. Use your answers from Question 1 (for both assets and portfolios) above to illustrate this relationship.
Discuss the meaning of diversification in finance and how it impacts the risk and the return. You need to address the concept of correlation and how the correlation coefficient impacts on the risk of a portfolio in your discussion. Refer to your answers from Question 1 to illustrate diversification.
How do we measure the systematic risk component of an asset? Assets A and B have betas of 0.5 and 2 respectively. Which asset is riskier? If the market return decreases/increases by 10%, how would such movement impact Assets A and B?
It is assumed that your investors are risk averse. Explain what is meant by ‘risk aversion’ as it relates to finance. Is risk aversion related to different stages of ‘investing life cycle’?
For each of the three customer types that you have, recommend the most suitable portfolio option and justify your choice. Use language here that the customers will understand. You should use a graph here to show the historical return performance of each of your portfolios to assist with your recommendation.

Answer:

Part 1:
1. Indicating how much money will be accumulated from the investment:

Particulars

Value

Current savings (A)

 $    15,000.00

Simple interest (B)

13%

Year (C)

                3.00

Interest (D=A*B*C)

 $      5,850.00

Amount at the end of 3 years (A+D)

 $    20,850.00

 

Particulars

Value

Amount at the end of 3 years

$    20,850.00

Compounded monthly

10.00%

R

0.83%

Year

12.00

T

144.00

Amount at the end of 15 years

20,850.00*(((1+(0.83%))^144))

Amount at the end of 15 years

$    68,881.08

 

Particulars

Value

Amount at the end of 15 years

 $    68,881.08

Compounded quarterly

9%

R

0.0225

Year

8

T

32

Amount at the end of 23 years

68,881.08*(((1+(0.0225))^32))

Amount at the end of 23 years

 $ 140,386.74

 

Particulars

Value

Amount at the end of 23 years

 $ 140,386.74

Compounded daily

15%

R

0.000410959

Year

2

T

730

Amount at the end of 25 years

140,386.74*(((1+(0.0.000410959))^730))

Amount at the end of 25 years

 $ 189,490.60

 

Particulars

Value

Bonus payment

 $         320.00

Time

12

Interest

12%

Future value (A)

 $      7,722.60

Amount at the end of 25 years (B)

 $ 189,490.60

Total Payment after 25 years (C=A+B)

 $ 197,213.20

Total money that will be accumulated after 25 years is at the levels of $197,213.20.
2. Indicating the investment needed for supporting the payment in future:

Year

No of week

Payment

PV of the Payment

1

52

                         2,00,000

 $      186,022.54

2

104

 

 

3

156

                         1,30,000

 $      104,604.43

4

208

 

 

5

260

                            96,000

 $         66,826.56

6

312

 

 

7

364

 

 

8

416

                         3,12,000

 $      174,758.87

9

468

 

 

10

520

                       12,50,000

 $      605,711.48

 Total Investment needed

 $    1,137,923.89

The current investment of $1,137,923.89 needs to be conducted for supporting the future payments in building the project.
3.a Calculating the marketing value of the bond:

Particulars

Value

FV

 $   100,000

Coupon rate

8.25%

C

0.04125

Years

             6.00

T

           12.00

Yld

11.50%

R

0.0575

Market price

((100,000*0.4125) * (((1-((1+0.0575)^-12))/0.0575))) + (100,000 / (((1+0.0575)^12)))

Market price

         86,188

3.b Calculating the marketing value of the bond if interest rate rises to 6%:

Particulars

Value

FV

 $ 1,00,000

Coupon rate

8.25%

C

0.04125

Years

           6.00

T

         12.00

Yld

6.00%

R

0.03

Market price

((100,000*0.4125) * (((1-((1+0.03)^-12))/0.03))) + (100,000 / (((1+0.03)^12)))

Market price

    111,198

3.c Mentioning why the bond value has changed with the change in the interest rate:
The calculations in the above tables directly represent the market value of the bond under two different interest rates. The change in the overall interest rate has a relatively altered the overall market price of the bond and increase the values from the levels of $86,188 to $111,198. The change in the overall interest rates from the levels of 11.50 % to 6% as a relatively altered the value of the bond. The interest rates are relatively considered the minimum interest rates that can be provided from restless treasury bonds. Therefore, the alterations in the market interest rate for directly increase or decrease the overall demand for the bones, which will affect their market price. The rising interest rates would eventually reduce the level of Bond price to the levels of $86,188, as the interest rates are higher than the coupon payments. Therefore, rising interest rates would reduce the bond price as risk free interest is more profitable than the corporate Bonds (Weber, Duffy & Schram, 2018). In the similar instance, the decline in interest rates would eventually increase the attractiveness of the corporate bonds as higher coupon payments are conducted in comparison to the risk free interests.
4. Calculating the price of the stock in 3 years and 15 years:

Year

Dividend

Discounting rate

Dis-dividends

1

       2.18

                    0.88

               1.91

2

       2.38

                    0.77

               1.83

3

       2.59

                    0.67

               1.75

3

       2.59

 

             51.80

Price in 3 years

 

 

             57.29

 

Year

Dividend

Discounting rate

Dis-dividends

1

       2.18

                    0.88

               1.91

2

       2.38

                    0.77

               1.83

3

       2.59

                    0.67

               1.75

4

       2.82

                    0.59

               1.67

5

       3.08

                    0.52

               1.60

6

       3.35

                    0.46

               1.53

7

       3.66

                    0.40

               1.46

8

       3.99

                    0.35

               1.40

9

       4.34

                    0.31

               1.34

10

       4.73

                    0.27

               1.28

11

       5.16

                    0.24

               1.22

12

       5.63

                    0.21

               1.17

13

       6.13

                    0.18

               1.12

14

       6.68

                    0.16

               1.07

15

       7.28

                    0.14

               1.02

15

       7.28

 

           145.70

Price in 15 years

 

 

           167.05

Part 2:
1. Calculating the historical returns of the portfolios, while deriving the average return, and standard deviation:

Year

Shares

Property

Bonds

Cash

Portfolio Alpha

Portfolio Beta

Portfolio Gamma

2003

15.90%

8.80%

3.00%

4.90%

13.38%

8.03%

5.11%

2004

27.60%

32.00%

7.00%

5.60%

26.28%

18.18%

11.30%

2005

21.10%

12.50%

5.80%

5.70%

17.84%

11.73%

7.09%

2006

25.00%

34.00%

3.10%

6.00%

24.90%

15.85%

10.73%

2007

18.00%

-8.40%

3.50%

6.70%

11.59%

5.47%

2.72%

2008

-40.40%

-54.00%

14.90%

7.60%

-38.32%

-15.47%

-2.53%

2009

39.60%

7.90%

1.70%

3.50%

29.65%

14.31%

3.84%

2010

3.30%

-0.40%

6.00%

4.70%

2.70%

3.91%

4.07%

2011

-11.40%

-1.50%

11.40%

5.00%

-7.78%

1.98%

5.62%

2012

18.80%

33.00%

7.70%

4.00%

20.16%

16.09%

10.91%

2013

19.70%

7.10%

2.00%

2.90%

15.50%

8.33%

3.47%

2014

5.00%

27.00%

9.80%

2.70%

9.17%

11.80%

9.69%

2015

3.80%

14.30%

2.60%

2.30%

5.75%

5.30%

4.79%

2016

11.60%

13.20%

2.90%

2.10%

10.97%

7.57%

4.56%

2017

12.50%

5.70%

3.70%

1.70%

10.06%

6.74%

3.10%

E(R)

11.34%

8.75%

5.67%

4.36%

10.12%

7.99%

5.63%

Risk

18.69%

21.71%

3.87%

1.79%

16.49%

8.10%

3.77%

Explaining the expected return and risk of finance:
Expected return of a stock or portfolio is calculated by analyzing its historical average returns, which helps in deriving their future returns. In the similar instance, the overall risk of the stock of portfolio is relatively calculated with the help of standard deviation formula, which utilizes their historical returns. This analysis of the expected return and risk attributes of the stock would eventually allow the investors to determine the level of investment that needs to be conducted. From the evaluation of the calculated expected return and risk, the cash is considered to the least risky investment, while investments in property are considered to be the riskiest investment (Gottschlich & Hinz, 2014). Furthermore, the analysis of the calculations directly indicates that from the created portfolios portfolio Gamma is considered to have the lowest risk involved in investment, while portfolio Alpha has the highest risk from investment.
Discussing about diversification, while detecting it impact on risk and return:
Diversification is an adequate measure that is used by investors for reducing the level of risk involved in investment while incorporating a higher level of risky assets in the portfolio. The diversification method is relatively allowed investors to accommodate high-risk investments and Risk free assets reduce the level of portfolio risk and generate adequate returns for investment. Impact of the diversification strategy can be seen in the above-calculated portfolio Alpha, portfolio beta, and portfolio Gamma. The diversification relatively uses the overall portfolio weight to determine the level of investments that need to be conducted in a particular stock. Moreover, the correlation of the different stocks is used in creating the diversified portfolio, which helps in minimizing the risk involved in investment. The correlation Coefficient relatively allows the investors to detect the level of impact market returns have on the particular stock. Utilizing the correlation Coefficient values while deriving the portfolio allows investors to minimize the negative impacts from market risk and maximize the level of income that can be generated from an investment. From the evaluation of the portfolios it can be understood that portfolio, has the least risk involved in investment while having the highest returns (Yu & Huiping, 2018).
Indicating the method for measuring systematic risk component of an asset:
Systematic risk is relatively considered as the overall market risk or undiversifiable risk, which negatively affects the overall return capability of a particular stock. The systematic risk is relatively calculated from the day to day fluctuations a stock’s share price, which is relatively influenced by the overall market actions. Asset B is considered the riskiest is asset, as its overall beta is relatively at the levels of 2, where the increment or decline in the overall market return by 10% will directly affect share price value of Asset B. On the other hand, the reduced beta value of Asset A will not negatively affect its overall share value, as its beta is valued at 0.5. The measure of systematic risk can be conducted with the help of different calculations, which allows investors to determine the negative impact capital market can have on the share price of the stock (Tokuoka, 2017).
Explaining what is meant by risk aversion and detecting the different stages of investing life cycle:
Risk aversion is human behavior is conducted by the investors for reducing the level of risk involved in investment. Investors relatively utilize different methods and strategies to minimize the level of uncertainty that could be  predicted from a particular investment. This overall protection from adverse price action is a relatively known as risk aversion, which is conducted by investors to secure their overall invested capital. Risk aversion is relatively conducted with the help of adequate measures the portfolio was created for minimizing the impact of capital market and maintains adequate returns from investment. However, the risk aversion does not reduce or minimize the risk of investment to zero, as there is relevant risk involved in investment. From the evaluation could be understood that is a part of the investing life cycle, as it allows investors to evaluate the different stages of investment and motivate them to diversify their exposure in accordance with the risk level (Wang et al., 2014).
Recommending the best possible portfolio for each of the customer types:
The Portfolio Alpha is selected for Stephanie, Portfolio Beta is selected for Harold and Meredith, while Portfolio Gamma is selected for Akhter. The selection process of the portfolio for the customers is based on the investment scope and risk criteria. Stephanie being young with a long and successful career will eventually have high-risk capability, where his aims would be to generate higher income and growth from investment, which is why Portfolio Alpha is best, suited for his investment criteria. In addition, the middle-aged couple would like to have secure investment with high growth prospects, which is why Portfolio Beta is best, suited for them. Lastly, Akhter will be retired in 18 months where his investment aim is to secure the capital and generate adequate constant returns to support his retirement, which is why Portfolio Gamma is selected for him.
References
Gottschlich, J., & Hinz, O. (2014). A decision support system for stock investment recommendations using collective wisdom. Decision support systems, 59, 52-62.
Hu, Y., Feng, B., Zhang, X., Ngai, E. W. T., & Liu, M. (2015). Stock trading rule discovery with an evolutionary trend following model. Expert Systems with Applications, 42(1), 212-222.
Sumaji, Y. M. P., Hsu, W. H. L., & Salim, U. (2017). Analys?s of Market R?sk in Stock Investment Us?ng Value at R?sk Method (Study on Manufactur?ng Compan?es in Lq-45 L?sted on Indones?a Stock Exchange). Asia-Pacific Management and Business Application, 6(1), 1-14.
Tokuoka, K. (2017). Is stock investment contagious among siblings?. Empirical Economics, 52(4), 1505-1528.
Wang, H., Zhang, J., Wang, L., & Liu, S. (2014). Emotion and investment returns: Situation and personality as moderators in a stock market. Social Behavior and Personality: an international journal, 42(4), 561-569.
Weber, M., Duffy, J., & Schram, A. (2018). An experimental study of bond market pricing. The Journal of Finance, 73(4), 1857-1892.
Yang, Y., & Wang, Q. (2018). Insurance Inclusion, Time Preference And Stock Investment Of The Chinese Households. The Singapore Economic Review, 63(01), 27-44.
Yu, J. I. A. N. G., & Huiping, J. I. (2018). Are securities companies’ stock investment ratings helpful? Evidence from A-share market. China Economic Studies, 4, 010.

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