Finacial Economics.

EC3314 Financial EconomicsAutumn 2016 Take Home Assignment (12.5% weight) The data for this coursework is found in the Excel file ‘EC3314 Portfolio Diversification Coursework Data’ in Moodle, under the slot for Lecture 5. Please submit your coursework in Turnitin by 17:00h on Wednesday 9th November 2016. The Turnitin link will appear in Moodle in the slot for that week. The Excel spreadsheet has data on end of the month adjusted closing price of stocks on five firms: British Telecoms (BT), British Petroleum (BP), J Sainsbury PLC and Barratt Developments PLC. The data covers the period 01-01-2015 to 01-09-2016. Assume that the risk free rate of return is constant at 0.1% per month throughout the period. Demonstrate clearly all the methods you are using for these tasks. Use the price data to find the monthly returns for each firm’s stock and then, combine two firms to form a portfolio that will give you the best diversification opportunities. Justify why you choose these two stocks for your portfolio. Explain all the assumptions you have made. Once you have formed this portfolio, calculate the following and demonstrate all your work. a) Find the expected return and the level of risk exhibited by the Global Minimum-Variance Portfolio. What proportions of your wealth are invested in the each of the two stocks? b) Plot the investment opportunity set of the two risky assets (You can do this either on Excel, or manually). Use increments of 10% over the range 0-100% in the weights (or investment proportions) for w1. c) Draw and label the Capital Allocation Line (CAL) that is just tangential to the opportunity set. Label this point of tangency P. Explain what P is. d) Use the solution derived from the maximization problem of the Sharpe Ratio (or slope of the CAL) to find the weights invested in each asset at P. You do not have to show the derivation here – simply use the results from the maximization problem. e) Calculate the expected return and the standard deviation at P. Calculate the Sharpe Ratio for this CAL. f) If your risk aversion parameter has a value of 3, find the composition of the complete portfolio C you would invest in. Comment on your answer and compare with what you would have earned if you were to invest all your wealth in a single stock. g) Calculate the standard deviation and the expected return of your complete portfolio C. h) How do your answers to part g) above change when the risk aversion parameter take on the values 0, 1, 2 and 4 respectively?