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FINC3017 Investments and Portfolio Management

In this assignment you are tasked with forming various portfolios during a ‘training period’ and evaluating the performance during a ‘test period’. You will be required to examine data using Excel and report on your methods and results.

To start with, you have an excel spreadsheet containing price data from Yahoo Finance for 15 large Australian firms, each posted on separate Worksheet tabs. The sample also includes a 30-day Bank Accepted Bill (BAB) yield to proxy for a risk-free asset from the RBA’s Statistical Tables (F1) and a market proxy (VAS). The sample period for these assets covers approximately five years from March 2021 until March 2026.

Part A: 6 marks

a. Describe in detail the steps that you took to create the table from the raw data, including selecting data, cleaning data, matching dates (ensure that all assets have the same date history as the stocks), return calculations and method used to measure statistics. If you used any Excel functions (not basic functions or copy-paste) to assist you in finding the data or matching dates, mention that here. Mention any assumptions that you make over missing observations (e.g. fill-forwards).

b. Create a table of sample means and standard deviations, annualised, over the training period (i.e. with the first return on the first trading day of 2022).

Assume that there are 252 trading days in the year for all assets.

Part B: 10 marks

b. Estimate a two-sided t-statistic and p-values for the alphas of the stocks. Are any of the alphas significantly different from zero at the 5% level? 

3. Estimate the expected return of the market (VAS) using the training period data. Using the sample average VAS return as the Expected market return is one option as the end of 2024 market expectation. We also know the risk-free rate at the end of 2024 (use the last date available).

a. Use the training period average market return and the risk-free rate at the last available date of 2024 as the market and risk-free inputs for the CAPM. Write down these values and thus your estimate of a market risk premium.

b. Estimate the expected return of your five stocks at the end of 2024. Comment on the estimates of expected return in comparison to the sample means.

4. Create a sample covariance matrix Σ for the five stocks using the daily return data over the training period, and report the annualised values.

Then, add a capital allocation line with your estimated risk-free rate from Q3. Make each of these points distinctly labelled. Also, plot the points for the individual stocks (each in the same colour, but clearly distinct from the portfolios).

Part D: 8 marks

a. The last digit of your Student ID (SID) is your stock of interest (e.g. if your student ID finishes with a 5, your stock is ALL). What is the stock that you are examining in this exercise? If we were to consider adding it to our portfolio of five stocks, would we expect that to help diversify the portfolio or change the risk and return profile (based on the profile of the stock vs the other five stocks)? Explain why or why not as your prediction in about 3 to 4 sentences.

b. Now, create the vector of returns for the new stock, and consider how it will change the composition of the original portfolio. For example, recompute the minimum variance portfolio with the sixth asset included, and compare the weights to those obtained using the original five assets.

c. Conduct additional analysis of your choice to evaluate whether the new asset improves the investment opportunity set. Clearly justify your approach and findings. This may include additional graphs or computations of the portfolio weights with different strategies to showcase the opportunity of adding an additional stock.

d. Evaluate the portfolio with the additional stock out-of-sample (using a buy-and-hold strategy over 2025). For example, in Q11, we looked at the return to Buy and Hold for our equal-weighted and tangency portfolios – conduct a similar analysis for the portfolio of six stocks, and provide some insight as to whether the additional asset was valuable. Note: In total Q12 should be 1 page or less.

13. Reflect on your findings across the assignment. What do your results suggest about the reliability of portfolio optimisation methods, the importance of diversification, and the value of adding new assets? Short reflections should focus on explaining key insights rather than restating numerical results. Answer in about 300 words or half a page.