FINM2003 Investments Semester 2, 2022 Assignment
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FINM2003 Investments
Semester 2, 2022
Assignment
1. Assignment
The continuing global interest rate increase by the central banks has been one of the most important topics in finance this year. In this assignment we are going to conduct some analysis around this topic, including testing of CAPM and optimal portfolio construction. Please write a report with the following two components:
(Additional note beforehand: this assignment is written around an on-going financial event, some of my questions may be not that well thought, or out-dated in the near future due to unexpected central bank actions. So please do not hesitate to contact me when you find something is confusing, and I will make clarifications in the course announcement.)
Component 1: How well does CAPM work around FOMC meeting days? (12 marks)
In Lecture 4, we discussed that the CAPM model does not seem to work well in the real-life empirical data, but some studies show that the CAPM works better during the central bank meeting days when important information about interest rates are released. For example, in the U.S., the Federal Reserve Bank holds regular meetings roughly eight times a year, called the Federal Open Market Committee (FOMC) meetings1. The meetings review the economic situation and determine the monetary policies such as the interest rate changes.
In this assignment component, you are invited to conduct a very naive yet meaningful test of CAPM during the FOMC meeting days. Details are described below
❼ Please download the Excel file “FINM2003 2002S2 Assignment data” on Wattle
❼ On worksheet “FOMC days”, I have obtained the dates of FOMC meeting days from January 2000 to June 2022.2
❼ On worksheet “Stock prices and rf”, I have obtained the following daily data from Yahoo
Finance and Federal Reserve’s website
– The daily prices (adjusted closed) for five U.S. stocks: Boeing (BA), Walt Disney (DIS), Goldman Sachs (GS), Coca-Cola (KO), and Starbucks (SBUX)
– The daily index level for S&P500 Index
– The daily risk-free rate (proxied by 3-month U.S treasury bill rate).
❼ So the first step you need to do, is to compute the daily returns and excess returns for
each stock and the market index based on the price data.
❼ Important note: throughout this assignment, please simply stay with daily returns to
make your work easier, and you are not required to convert returns and variances into annual terms. But please note that you still need to be able to do frequency conversions in real life (See Lecture 2 page 17).
❼ At the meantime, the return numbers will be very small at daily frequency, therefore for
all the returns and alphas in your report, please either keep SIX decimal points, or express all returns in the form of “percentages” with FOUR decimal points.
For example: a daily risk free rate = 0.000145 = 0.0145%.
By the way, you can keep TWO decimal points for other variables like β, p-value or R2 .
❼ Next, I have merged the FOMC meeting days with the price data. In column B (FOMC
meeting), if the value = 1, it means there was a FOMC meeting on this day, otherwise its value = 0.
❼ Our target is to estimate the beta (β) and alpha (α) for each stock under two different
scenarios and then compare the effectiveness of CAPM
— On the days when there is no FOMC meetings (FOMC meeting = 0) — On the days when there is FOMC meetings (FOMC meeting = 1)
❼ In particular, for each stock, please run the following market model regression twice
ri,t _ rf,t = αi + βi (rM,t _ rf,t ) + ∈i,t
namely on the sub-sample when there is no FOMC meetings, and on the sub-sample when there is FOMC meetings, respectively. (Note that you can use the “Filter” function in Excel to separate these two sub-samples.) And then you can write down the estimated α, β and their corresponding p-value for this stock from two different regressions. Please also report the R-squared. Be careful about return functions when you split sub-samples.
❼ Note that you can run all the regressions in Excel, but it is also totally fine if you prefer
to use programs like R or STATA.
❼ Since we have five stocks, you need to repeat the above step five times (i.e. 10 regressions
in total). And then you can produce the following table. (Please order the stocks by their estimated β from low to high in each panel.)
Panel A: No FOMC days |
|
Panel B: FOMC days |
Stock A B C D E |
|
Stock A B C D E |
E(r) |
|
E(r) |
p-value |
|
p-value |
βˆ p-value |
|
βˆ p-value |
R2 |
|
R2 |
❼ Based on your results in the above table, please draw the security market line (SML) for
both panels separately. In particular
– In each plot, please compute the average value of rf and rM _ rf within the corre- sponding sub-sample, and they are the intercept and slope of SML. Draw the SML.
– Based on the estimated α (or E(r)) and β, please also display the location of each stock in the two SML figures. You can follow the figures on page 21, 29 in Lecture 4 as formatting example.
❼ Based on all the works you have done so far, it’s time to analyze and discuss how well
does CAMP work.
– Is higher beta always associated with higher expected returns in both scenarios (No FOMC days v.s. FOMC days)?
– Are all the alphas statistically insignificant in both scenarios?
– Based on the above analysis, does CAPM perform better during FOMC days? Please attempt to provide possible reasons to support your argument. Note: this question is only briefly taught in the class, you are encouraged to take this challenge and search for professional answers that are beyond what you know so far, since it is can be a valuable skill in your future career. In addition, the conclusion might not be clearly straightforward, so please do not constraint yourself to simple yes or no answers. You are free to be creative in this discussion, and answers can come from previous research studies, industry articles, limitations in the design of this test, and so on. You can also conduct additional statistical tests if you like.
❼ Important step: you have conducted all the filed works for this assignment component up
to this step, and now please write a formal report to explain and summarize your findings and analysis. Please try to assume that your team is currently working in the research department of a financial intuition, and your boss is waiting to see a professional report to explain how a standard asset pricing model works during periods with heavy interest rate news. Please try NOT to simply pile up answers in each step like exam answers.
❼ Optional suggestion: I strongly suggest each team double check the calculations / regres-
sions before writing the formal report, you never want to write an otherwise excellent report based on wrong results _ and receive an unnecessarily low grade.
Component 2: Portfolio construction (8 marks)
In this second component of assignment, we will explore the portfolio constructions during a period with great interest rate uncertainty. To make things easier, let’s only consider two stocks GS and KO. Please prepare a report covering the following analysis:
❼ Use the full sample period provided (i.e. include all days regardless of FOMC meetings),
compute the daily expected returns and standard deviations of the two stocks GS and KO, and also the correlation coefficient between them.
❼ Next, assume the daily risk-free rate is fixed at 0.0040%. Please use these two stocks to
construct (1) a minimum variance portfolio and (2) an optimal risky portfolio. Please show the weightings of each stock in these two portfolios, and compute the expected returns and standard deviations of the portfolios. In addition, please include a plot of the capital allocation line and display the locations of these two portfolios.
❼ Discuss the benefits of holding this optimal risky portfolio.
❼ Discuss your concerns of this optimal risky portfolio during a period with steep interestrate increasing trend, and please also provide suggestions to address such concerns.
❼ This is a less related but very interesting question and I hope you can include that into
your report as well: usually people expect stock prices to fall when interest rate increases. However, it is very common recently that the stock market index kept going up when there was an announcement of interest rate increase. Please try to explore one of such news (can be in U.S., Australian, China and etc.), and explain the reasons and discuss the investment implications. (Lecture 7 market efficiency hypothesis will be helpful).
❼ During the process of this assignment, you might also observed some other interesting
financial events / phenomenons that are related to the recent interest rate changes. You are very welcomed to use one or two paragraphs to summarize such stories into your report.
❼ Again, please try to write your report as a professional investment advisory report.
2. Submission instructions
2.1. This submission is due by Friday 14 October 2022, by 5pm Canberra time (Week 10), and
is to be made electronically via Wattle. Only one member of each group need to make the submission, and it will show up for all members.
2.2. Important note: Please make two submissions on Wattle
– Submit to “Assignment submission” the following two files: A Word or PDF doc- ument containing the written report, and an Excel file containing any calculations undertaken within the assignment. There is no need to show detailed workings within the report itself, but concise explanation of your methods, and usage of tables and diagrams are expected.
– Please also submit your written report to “Assignment similarity check”, this is only for the purpose of similarity check.
2.3. Please email your group member information to the lecturer, who will create a group in
Wattle. You can view your group ID (GA . . . ) in Assessments/Assignment group list.
2.4. Please name your files in the form of “Group ID + report/excel”, and include the Group
ID, all your names and student ID on the cover page.
2.5. Make sure your written report is sufficiently complete so that someone can easily under-
stand your findings and interpretation/discussion without looking any further. Do not simply state “see Excel spreadsheet for the results” . Make sure you include discussion throughout the report in reference to your findings. Although the Excel is required as part of the submission, it will only be used to check the accuracy of calculations, and will not be considered as substantive as the report when marking.
2.6. Please include a reference list containing any cited articles, and use subheadings where
appropriate. The reference list and any appendices are not included in the word limit.
2.7. Plagiarism is strictly not allowed.
2.8. Use a 12pt font size, and 1.5 or double line spacing throughout your document.
Important notice of academic integrity:
The interest rate increase this year has attracted huge attentions from both business and academia, and therefore you can easily find many articles readily online that give you very detailed introduction and analysis about this topic. You are encouraged to read these articles which can quickly give you a good idea, and it is part of the research process. But, please keep in mind that plagiarism is strictly not allowed. You can find further information about how to use sources properly in https://www.anu.edu.au/students/academic-skills/academic-integrity/using-sources
3. Useful resources
You will be provided with some of the data necessary to complete the quantitative aspects of your assignment. However, there are also plenty of resources available which may assist you in data searching and report writing
https://au.finance.yahoo.com/ http://www.anu.edu.au/students/learning-development/writing-assessment/report-writing https://www.business.unsw.edu.au/Students-Site/Documents/Writingareport.pdf
You might use a lot of online resources for this project, while the citation of online resources could be annoying. I find the following instructions from UNSW very helpful https://www.student.unsw.edu.au/how-do-i-cite-electronic-sources
4. Grading Criteria
Your assignment will be marked based on the correctness of the calculations, clarity and quality of your discussion, as well as overall presentation, format and style of your written work. Please ensure that you carefully proofread your assignment before submission. Guidance on the grading criteria is provided in the table below.
|
HD |
D |
CR |
P |
Quantitative Application |
Goes above and beyond to demonstrate sophisticated quantitative skills at this level. Tools used are accurately applied. |
Solid demonstration of quantitative skills with zero or minimal errors. |
Suitably applies the minimum requirements. Some errors in application. |
Basic application of some of the appropriate methods. Some aspects lack suitability to application. |
Interpretation of Findings |
Strong analysis and discussion of the findings, demonstrating a thorough understanding of the methods in context. Evidence of ample background reading. |
Excellent analysis and discussion of the findings. Demonstrates an understanding of what the results suggest. Some evidence of background reading. |
Describes the results well, beyond merely explaining the process. |
Minimal interpretation of findings. Largely descriptive of the process taken. |
Communication |
Exceptionally written, argued, and formatted. Clearly articulated with specific evidence, and a smooth transition throughout the report. |
Well written, with some specific evidence provided to support ideas. Appropriate style and format. |
All important information is included, but some disjoint throughout the report. Format could be improved to facilitate flow. Some spelling/written errors. |
Although most of the necessary information is included, written work lacks clarity and/or numerous spelling/written errors. |
2022-10-17