Alex Sharpe's Portfolio Solution Essay

“The Benefits of diversification are clear. Portfolio theory has played a crucial role in explaining the relationship between risk and return where more than one investment is held. It also enables us to identify optimal and efficient portfolios.”

Investing behavior should be driven by information, analysis, and self-discipline, not by emotion or ‘hunch.’

This paper will provide a rationale for Dick’s Sporting Goods and indicate the significant factors driving my decision as a financial manager. It will determine the profile of the investor for which the company may be a fit. A selection of at least five financial (5) ratios will be utilized. The last three years of the company’s financial data will be analyzed. A determination of the company’s financial health will be assessed. A determination of the risk level from the investor’s point of view will be assessed. Key strategies will be suggested in order to minimize the perceived risks. A recommendation will be given regarding the stock as an investment opportunity.

If we were only to consider the expected return, then the S&P 500 appears to be the best investments since it has the greatest expected return. 3. The standard deviation provides a measurement of the total risk by examining the tightness of the probability distribution associated with the different possible outcomes whereas the coefficient of variation measures risk per unit. The coefficient of variation is a better

When we measure risk per unit of return, Collections, with its low expected return, becomes the most risky stock. The CV is a better measure of an asset’s stand-alone risk than because CV considers both the expected value and the dispersion of a distribution—a security with a low expected return and a low standard deviation could have a higher chance of a loss than one with a high but a high .

This shows that the company is looking to benefit their stockholders, but their debt is the highest of three. Although their stockholder equity is the lowest, the biggest thing to consider is that the earning per share is substantially higher than the other two companies by more than half. This will most likely make it the riskiest investment, but will the most profitable.

CAPM results can be compared to the best expected rate of return that investor can possibly earn in other investments with similar risks, which is the cost of capital. Under the CAPM, the market portfolio is a well-diversified, efficient portfolio representing the non-diversifiable risk in the economy. Therefore, investments have similar risk if they have the same sensitivity to market risk, as measured by their beta with the market portfolio.

Delta’s stock is greater than the S&P 500 index. It has been increasing from 2011 to 2015 closets to 4.60. Comparing with the competitors, the companies keep increasing their stock prices which indicates a steady source of income for investors. Delta comes second after American because American has been increasing their stock prices.

Investors hold diversified portfolios : One of the assumptions of CAPM model is that investors are holding only portfolios which are subjected to systematic risk , the unsystematic risk can be ignored , therefore the unsystematic risk has been ignored (Lakonishok & Shapiro , 1986)

This model is an expansion of the CAPM and it includes two additional variables, taking into account size and book to market factors, as explanatory variables expressed within the model as SMB and HML. The Capital Asset Pricing Model (CAPM) and Fama & French’s three factors model are both models account for the expected returns for stock albeit using different variables to distinguish and add reliability to the predictions of these estimated returns. However, the CAPM uses only one factor to determine the riskiness of the marketplace, Beta, whereas Fama & French expands on this model, incorporate another two factors to establish the risk, Small minus Big (SMB) and High Minus Low (HML), which take into account the relationships between market and share size. Hence, in Fama & French’s findings, stocks with higher beta did not always perform better. The Three Factor Model is indeed preferred at predicting the returns of stocks, in correlation with each models risk factor.

By comparing both the stocks, the riskiest stock in this case is Reynolds. It has the highest return as well as higher standard deviation and the higher variance. If we compare both stocks, Reynolds is riskier than Hasbro in this case. The higher variance indicates higher chance that the actual return on Reynolds will deviate from the expected return.

For estimation of betas, the above equation was run for the period from Jan, 2003 to Dec, 2006. Based on the estimated betas we have divided the sample of 63 stocks into 10 portfolios each comprising of 6 stocks except portfolio no.1, 5 and 10 having seven stocks each. The first portfolio 1 has the 7 lowest beta stocks and the last portfolio 10 has the 7 highest beta stocks. The rationale for forming portfolios is to reduce measurement error in the betas.

Rational behind selecting a company for purpose of investment in high growth portfolio that may span about a decade. Discuss possible return that may be expected and how it compares with more established companies with less risk.

According to the CAPM model:R_i=α+βR_m+ε, α represent the abnormal return gained by the portfolio. If the market is efficiency, the α has to be zero.

The correlation coefficient, called the quantity r, measures the strength and the direction of a linear relationship between two variables. The correlation coefficients among these companies are all in the [-1,1] interval that there is not exist any perfect positive and negative correlation. From the data we have calculated in Table 1.3, the correlations of Disney and Visa, Disney and Priceline are 0.382, 0.351 respectively, which are generally described as low degree of correlation. Whereas the correlation of Visa and Priceline is 0.541, it regarded as moderate degree. Thus, Disney is more correlated with Visa than it is with Priceline; Visa is more correlated with Priceline than it is with Disney. When it comes to portfolios, correlation describes the degree of relationship between the price fluctuations of those assets included in the portfolio. Securities with the perfect negative correlation would build a most diversified portfolio. By contrast, the worst diversified portfolio’s correlation is +1. Among three portfolios we have built up with each two companies, the most diversified one is Disney with Priceline while the worst one is Visa with Priceline.