Semester 1, 2013

FINC5001 Capital Markets & Corporate Finance

BUSINESS SCHOOL

THE UNIVERSITY OF SYDNEY

1. Executive Summary

This paper aims to examine Mean-Variance Analysis and Capital Asset Pricing Model in respect to expected return and risk for two stock portfolio. We have chosen to examine Woolworths Limited (Woolworths Limited 2013), and Cochlear Limited (Cochlear 2013).

We first discuss about Mean-Variance Analysis and how it is concerned with evaluating the mean, standard deviation and covariance of individual stocks (Markowitz 1952). Next, we discuss Capital Asset Pricing Model and how it is concerned with determining the market risk premium associated with higher expected return for individual stocks (Sharpe 1964).

[INSERT Analysis and Recommendation summary]

2. Mean-Variance Analysis

We will provide a background on Mean-Variance Analysis. Next, we discuss about our data selection choice and rationale. We then demonstrate calculating the individual returns, and standard deviations for each stock selected. Finally, we show combination of portfolios that consist of two stocks, and determine the expected returns and standard deviation.

Mean-Variance Analysis evaluates the expected return, risk and correlation to other assets by determining the mean, standard deviation and covariance of individual stocks (Markowitz 1952). A key difference of Mean-Variance Analysis is it focuses on total risk (Frino 2013).

We chose to use historical closing price and ASX200 Accumulation Index. We chose a five-year sample period with a monthly frequency. We chose this sample period and frequency to ensure we had a normal distributed data. Additionally, we also wanted to compare this approach to Capital Asset Pricing Model.

[INSERT Calculation of individual stock expected returns]

[INSERT Calculation of individual stock standard deviations]

[INSERT calculation of

References: Cochlear 2013, Cochlear Limited, Macquarie University NSW, viewed 30 April 2013, Mayfield, S. 2004, ‘Estimating the Market Risk Premium.’ Journal of Financial Economics, vol. 73, no. 3, pp. 465–496. Fama, E., and French, K. 2004, ‘The Capital Asset Pricing Model: Theory and Evidence’. The Journal of Economic Perspectives, vol. 18, no. 3, pp. 25-46. Frino, F. 2013, Capital Asset Pricing Model (FINC5001), The University of Sydney, Sydney, 18 March, viewed 30 April 2013, Markowitz, H. 1952, ‘Portfolio Selection’, The Journal of Finance, vol. 7, no. 1, pp. 77-91 Sharpe, W. 1964, ‘CAPITAL ASSET PRICES: A THEORY OF MARKET EQUILIBRIUM UNDER CONDITIONS OF RISK’, vol. 14, no. 3, pp. 425-442 Woolworths 2013, Woolworths Limited, Bella Vista NSW, viewed 30 April 2013, Appendices