Each of you has been allocated a company to study (see the spreadsheet file FoF_students_stocks.xlsx). Data on recent monthly stock returns for that company as well as data on returns of the FT All Share are given in the spreadsheet FoF_assessment_data.xlsx. With these data and through your own research on the company (and its industry) complete the following tasks.
Note that you will need to extract information from Thomson One (or a similar information source) to complete the tasks below. To answer some parts of the question, you will also need to do some research beyond the boundaries of the lecture notes and the recommended reading. If required in any part of the questions below, assume that the risk free rate is 1.0% per annum and the expected return on the market portfolio is equal to the mean return on the FT All Share from the data that you have been given.
1. Give a brief description of the main industry in which your allocated firm operates and detail its main domestic (and, if you wish, international) competitors. Proceed to give an overview of the firm's financing arrangements (i.e. the values of its equity and debt). [Write no more than ¾ page]
2. Using the data provided, describe the performance of your company's equity relative to the performance of the FT All Share. Compute and discuss the mean monthly return on the stock and on the index and the monthly return standard deviations. From these compute annualised mean returns and annualised standard deviations and then compute and comment upon Sharpe ratios for the stock and the market. Use plots to support your arguments. [Write no more than 1 page, not counting space taken up with plots and tables]
3. Write no more than 2 and ½ pages in total for question 3.
i. Compute the correlation between the returns on your allocated stock and the FT All Share. Interpret the sign and magnitude of this statistic.
ii. Compute and present the beta of your stock's equity to the FT All Share. Show how you have estimated it.
iii. Discuss what your computed beta implies for the market risk that this stock carries and the relationship between returns on the FT All Share and returns on the stock.
iv. Using your previous computations, and approximating the market portfolio with the FT All Share, estimate the expected annual return on your stock using the CAPM. Over the 5 years of data that you've been given, has the stock outperformed the CAPM prediction or underperformed it? What are the implications of this and what are the limitations of your analysis?
v. Given your previous computations, compute the return that you would expect for your stock if the market was to move up by 5% over the year from today? How would you expect the stock to react if the market was to move down by 10% from today?
vi. A hypothetical stock, X, has an estimated mean return of 10% and an estimated return standard deviation of 25% (both of these figures are annualised). If you wish to create a portfolio of X and your allocated stock that has an annualised mean return of 12%, what portfolio weight would you have to place on X. If the returns on X are uncorrelated with those on your allocated stock, what is the return standard deviation of this portfolio? If X has a beta of 0.75, what is the beta of the portfolio?
4. Your allocated company is considering a project that will cost it £120,000 per annum at the end of each of the next 5 years, but which will generate year-end revenues of £200,000 per year starting 3 years from now and lasting for ten years. If the immediate setup cost of the project is £0.5 million, should the company undertake it? Assume that the company's required rate of return is given by the expected return on its equity that you calculated via the CAPM.
5. Provide a multiples-based analysis of the value of the equity in your allocated company, using two or three companies operating in similar industries as comparators and price to forecast earnings as the comparison variable. What does your analysis suggest about the valuation of the company's equity? What are the limitations of your analysis? [Write no more than 2 pages]
6. Write no more than 2 pages for question 6:
i. Many stocks trade on many different trading venues. For example, UK stocks trade on the London Stock Exchange and may also trade on BATS Chi-X. What are the implications of absence of arbitrage for the pricing of the same stock on different venues? 5 marks
ii. An American Depository Receipt (ADR) is a security that trades in US Dollars on the US stock markets but which is essentially a portfolio of a specific number of shares of a foreign company. For example, the Tesco ADR that trades on US markets is a portfolio of three ordinary shares of the UK supermarket Tesco. Given that the ADRs trade in US Dollars and the ordinary shares of Tesco trade in Sterling, explain how you would expect the prices of the ADR and the ordinary shares to be related (using absence of arbitrage arguments).
Attachment:- Assignment Files.rar