1. i have a third part to a project in my finance 310 class
This is the third part of my finance 310 project that needs to be done using previous
information from part 1 and part 2.FINANCE 310: INVESTMENTSFall 2019PROJECT PART
3The Point of the ProjectYou are a portfolio manager, and you are trying to put together a
portfolio that is designed to beat the market (represented here by the S&P 500 index). To
do this you will first pick ten stocks, and then you will figure out how much of each of them
to buy, using monthly data from the last five years to make your decisions. You have 100
million dollars to play with and you will pick stocks before the start of trading on August
8th. You will decide if you have beaten the S&P 500 by looking at the performance of your
portfolio over the period August 8th–November 8th of this year (this is the ‘Evaluation
Period’). To do this you will compare the risk-adjusted returns of your portfolio with the
risk-adjusted return of the S&P. The project has three parts. Project Part IIIWe are now
going to find the optimal portfolio of risky stocks using the CAPM. We will also evaluate
your performance. You need to answer the following questions:(2 points) Find the optimal
portfolio weights using CAPM inputs. Calculate the Sharpe Ratio. If your portfolio is extreme
consider imposing short sale constraints. (2 points) Compare your optimal portfolio
weights using CAPM to the historical weights (Project II). Which set of weights seems more
reasonable? Which one would you select? Why? (2 points) You believe the CAPM is not the
perfect model, but useful as a baseline. Continue using the CAPM for eight of your stocks,
however, for the remaining two, substitute in your own estimates for expected returns. Give
at least one reason why you think these inputs are reasonable. How does your optimal
portfolio compare to the ‘pure’ CAPM portfolio in Question 1. (2 points) Re-estimate
the betas for all the stocks using two years of monthly data. Are these better estimates of
betas? What does your optimal portfolio look like with the 2-year betas? (3 points) Select an
optimal portfolio. Explain why you select it over the alternatives. (2 points) Assume you
invested in your optimal portfolio at the start of class and held it for almost three months
(August 8, 2019 to November 8, 2019). Calculate the all the performance measures from
class for your optimal portfolio: (i) Sharpe measure, (ii) M-squared, (iii) Treynor measure,
(iv) alpha and (v) the appraisal ratio. (2 points) Did your portfolio in #6 beat the market?
Why? Which performance measure is the most appropriate? Why?(3 points) Your client
asks you why the portfolio weights you are recommending make sense. Provide a short and
intuitive answer to his question. Use at most 100 words. P.(2 points) Presentation (i.e., see
the next paragraph) Make a title page that includes your name and section number and
anything else you deem helpful. You should hand in a hard-copy at the beginning of class.
2. Include answers to all the questions and any supporting material you think is helpful. Make
it presentable to a “client,― or a prospective employer. It should be user friendly,
concise, well-written, neat and convincing. Print only the relevant parts of the spreadsheet.
The answers should be brief, but convincing. Make it easy to find your answers. Include
supporting material in the appendix. Practice good printing etiquette. Write well. The
assignment should be maximum eight pages (including any appendix, but excluding any
cover page). Longer is not always better. DETAILED INSTRUCTIONSTry to follow these
instructions at closely as possible. Note that for Questions 1-5 below you should use
historical data from August 8th, 2014 to the end of trading on August 7th, 2019. You want to
use this data to find your optimal portfolio on August 8th, 2019. Find the optimal portfolio
weights using CAPM inputs. Calculate the Sharpe Ratio. Does imposing short sales
help?Compare your optimal portfolio weights using CAPM to the historical weights (Project
II). Which set of weights seems more reasonable? Which one would you select? Why? You
believe the CAPM is not the perfect model, but useful as a baseline. Continue using the
CAPM for eight of your stocks, however, for the remaining two, substitute in your own
estimates for expected returns. Give at least one reason why you think these inputs are
reasonable. How does your optimal portfolio compare to the ‘pure’ CAPM portfolio in
Question 2. Re-estimate the betas for all the stocks using two years of monthly data. Why
are they different? Are these better estimates of betas? What does your optimal portfolio
look like with the 2-year betas? Select an optimal portfolio. Explain why you select it over
the alternatives. Assume you invested in your optimal portfolio at the start of class and held
it for almost three months (August 8, 2019–November 8, 2019). Calculate all the
performance measures from class for your optimal portfolio: (i) Sharpe measure, (ii) M-
squared, (iii) Treynor measure, (iv) alpha and (v) appraisal ratio. Did your portfolio in #6
beat the market? Why? Which performance measure is the most appropriate? Why?Your
client asks you why the portfolio weights you are recommending make sense. Provide a
short and intuitive answer to his question. Use at most 100 words. To this we need the betas
for each stock. We will estimate betas using the Index Model from class (see Lecture Notes:
CAPM).Calculate excess returns for each stock and for the market. See the worksheet called
‘excess returns.’ Each column represents the difference between the asset returns
and the risk-free rates. In other words, you want columns of numbers that represent excess
returns. For example, if a stock’s raw return is in column B and the t-bill return is in
column Z, then to get the excess return, the formula for row 1 should be =B1-$Z1. Do not
forget the $ sign, since this ensures that you always subtract the t-bill (and not something
else) when you drag the formula across cells. To get the betas we will estimate beta using a
regression. You will have to run an index model regression for each stock. This is quite easy
in Excel. Simply choose regression from the “Data Analysis,― which can be found
under tools. Your “Y― variable will be the cells containing the data on the individual
stock’s excess returns, and the “X― variable will be the cells containing the data on
the S&P’s excess returns. Allow excel to open a new worksheet for each regression (this
is easier and is the default in excel; I have ten worksheets for this (one for each stock) in my
example after ‘excess returns’). The beta is now in B18. If you select labels it is the
coefficient on the ‘S&P’. If you did not select labels it the coefficient of ‘X Variable
3. 1’ (see also the Excel Example: Finding Beta).Enter your stocks’ betas into the
worksheet ‘CAPM Inputs.’ Enter the historical standard deviations. This spreadsheet
calculates the CAPM expected returns and covariances. Use the CAPM Inputs (returns,
standard deviations and covariances) to get the optimal portfolio weights. Follow the
instruction provided in Project Part II. The procedure is the same except that you have
different inputs. When you copy your covariance matrix make sure to paste ‘value’
(paste special); sometimes the formula references change. Also make sure the diagonal of
the CAPM Covariance Matrix is the historical variance (and not estimated using the CAPM
covariance formula). If you get crazy weights implement the Troubleshooting tips discussed
in Project Part II. Double check your covariance matrix and other inputs. Did you copy using
paste special to make sure formulas did not change?Make sure the diagonals of the
covariance are equal to the historical variance.Try copying in a fresh copy of the excel
spreadsheet and start again.Manually input an equally weighted portfolio as your starting
values. If none of this works then introduce additional constraints to place upper (and
lower) bounds on your weights to prevent them from getting too crazy. Example: (i)
weights can be no larger than 2 and (ii) no less than -1 (you can use other values). If you do
this please explain it in your project. Compare the weights obtained using CAPM inputs to
those obtained using historical inputs. Present both sets of portfolio weights in your write
up.There are three main factors to consider when deciding which one to select: (I) the
Sharpe Ratios, (II) the weights (see 3 above) and (III) the relative appeal of using the CAPM
vs. historical inputs (i.e. CAPM is forward looking, but not an ideal model). This is the
exactly the same as in Question 1 except that you replace to CAPM expected returns with
your own estimates. Remember that these are monthly returns!! To justify your estimate
use any available news story to come up with an estimate. Find at least one justification for
each of the two stocks. The grading of this question is not so much about how convincing
the estimate is, as how you answer the question. Most likely the optimal portfolio is now
going to change in the direction of your estimates. For example, if you are bearish on a stock
the portfolio program is going to allocate less weight to that stock. To estimate the betas
follow the instructions in Question 1 part c, but instead of selecting all 60 months of data,
select only the most recent 24 months as the inputs into the regression. To get the optimal
portfolio weights use the new betas to estimate the covariance matrix and expected returns
– and then follow the instructions in #1. How do you pick the optimal portfolio? There are
many alternative optimal portfolio weights that we have calculated: (1) historical, (2)
historical w/short sales, (3) green investing, (4) CAPM with 5 year betas, (5) CAPM with 2
year betas, (6) CAPM w/your own estimates and (7) CAPM without short selling. All the
optimal portfolios are found using historical data available on August 8th, 2019. Optimal
portfolios (1)-(3) are from Project #2. Factors to consider when choosing your optimal
portfolio are (1) Sharpe Ratios, (2) how reasonable are the weights, (3) how good are the
inputs, etc. It is important to convincing discuss why you think the portfolio you select is
superior to the other alternatives on August 8th (ex-ante). You want to evaluate the
performance of your portfolio during the ‘Evaluation Period’ (August 8,
2019–November 8, 2019). You want to:Download date from August 8, 2019–November
8, 2019 for all ten stocks, the S&P500 and T-bills.Calculate daily holding period returns.
4. Remember that T-bills are an annual percent!! To convert the T-bill return into a monthly
return divide by the number of trading days (251) times 100.Calculate daily portfolio
returns on your optimal portfolioCalculate the all the performance measures for your
portfolioSee Project Part I for detailed instruction on (i) and (ii). Daily returns on your
optimal portfolio are a weighted average (using the optimal portfolio weights from 5 above)
of the individual stock returns. To get the alpha and information ratio (appraisal ratio) you
need to run a SCL regression (see #1) using the excess returns on your portfolio (from Y-
variable) on the excess returns on the market portfolio (X-variable) from August 8,
2019–November 8, 2019. Select an appropriate performance measure. Explain your
choice based on the discussion in class. Based on this performance measure did you beat the
market? Assume your client has knowledge of the basics. Do not talk about why you initially
picked your stocks. Convince me that you have understood the calculations that you have
done. I am looking for intuition not mechanical explanations. Think of this as a two minute
opportunity (an elevator spiel) to persuade your client that the portfolio you are
recommending is sensible.
