Project

Part 1

Identify a company

Look at financial statements (from previous years, at least one year)

Conduct ratio analysis. Use Dupont equation from results.. Make a financial statement

Organize and Analyze Statements

Make recommendations – how will you improve the forecast

Strengths, weaknesses, etc.

Part 2

Forecasting – Statistical Analysis

Standard Goal of 10%

Determine location of new funds (borrowing, issuance of stocks, capital)

½ page to 1 page proposal before starting project

Chapter 2

Homework – (5 , 9) & Mini Case (a – i), (#12 for 08/31)

**Mini Case (j – m) for 09/12

Correlation Coefficient -> Degree of variability

Possibilities of economy on investments

ProbabilityRate of Return A

Pessimistic.2513%

Likely.5015%

Optimistic.2517%

Realized Rate of Return & Correlation Coefficient

***Calculate Correlation of Coefficient for these stocks

Stocks X, Y, and Z

Year 1Year 2Year 3Year 4Year 5Avgσ

X8%10%12%14%16%12%3.16

Y16%14%12%10%8%12%3.16

Z8%10%12%14%16%12%3.16

Correlation – A statistical measure of the relationship between the rates of return of two assets

Correlation Coefficient – A statistical measure of the degree of the relationship between the rates of return of two assets. Positively Correlated – Describes two rates of return that move in the same direction Negatively Correlated- Describes two rates of return that move in opposite directions

ρ= t=1n(ri,t-ri,avg)(rj,t - rj,avg)t=1nri,t-ri,avg2t=1nrj,t - rj,avg2

Yearr ̅xryrz

18%16%8%Rxy=

2101410

3121212Rxz=

4141014

516816

Diversifiable Risk

Company-specific risk

Unsystematic risk

S&P, NASDAQ, Dow Jones

Non-Diversifiable Risk

Market Risk

Systematic Risk

The risk of a portfolio depends on the correlation coefficient of returns on the assets within the portfolio.

1. If rate of return of two assets are perfectly positively correlated, R = 1

2. If rate of return of two assets are perfectly negatively correlated, R = -1

3. If rate of return of two assets are independent, -1 < R < 1

Beta Coefficient – b

Measure of the risk that one asset can contribute to a portfolio

ry = a + b(rM)

When beta is positive, it means that the stock moves with the market

And vice-versa if beta is negative

Beta measures the non-diversifiable risk of an asset.

Find Correlation Coefficient (as a portfolio)

Calculate beta - Use S&P

What should be the risk of the portfolio?

**Pick a pair

Exxon & BP

Walmart & Kroger

Verizon & AT&T

Toyota & Ford

CAPM – Capital Asset Pricing Model

A model that describes the relationship between the required rate of return and the non-diversifiable risk of a portfolio

rMrxryrz

55102.5

1010205

1515307.5

20204010

25255012.5

30306015

r17.517.5358.75

b1120.50

ρ111

bx= ∆rx∆rmρxm

= σxσmρxm

SML Equation - ri = rrf + (rm - rrf)bi

IF rm = 9%

RRF = 3%

bA = 0.5

bB= 1

bC= 2

Slope of SML line provides the riskiness of the market, aka market risk premium.

Chapter 3 – page 76 Optimal Portfolio

Homework (#7)

Covariance

COVAB = i=1nrAi- rArBi- rBPi

ProbabilityAsset AAsset BAsset CAsset DAsset E

.158%4%12%2%4%

.20861046

.3088878

.2081061210

.1581241612

r ̂88888

σ02.522.524.662.52

COV

COVxy= σx σy(ρ xy)

Solve COVBD, COVBE, COVCD

Calculate risk without beta

σp= wx2σx2+(1-w)y2σy2+2w(1-w)ρxyσxσy

Two key factors for investing

How much is the rate of return

What is the risk involved

If COV is large & positive

Portfolio standard deviation will be between the two stand-alone deviations

If COV is large...

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