Investing and Financial Market Behaviour
You will take the computer test in a computer lab in the University, in week 4 of the Spring semester during the first 1 hour of the seminar (w/b 28 February 2022). The test is open-book, takes 50 minutes and has 8 exercises that cover personal finance and investment analysis:
Basics of time and money
Bonds and stocks
Property investment and mortgages
Pensions annuities
You will be given a full practice test in UDo to try as many times as you want in the week leading to the test. Use it to identify what areas you need to do more work on and go through the associated seminar activities which are designed to ensure you are able to answer the test questions. Use the recommended reading to support your revision.
CW1 Part 2 (60% of CW1 and 30% of the total overall module mark)
The portfolio report will give you a chance to pick your own portfolio of equity investments, explore the rationale behind your choices and evaluate its performance during the first 6 weeks of the semester.
You must track the performance of your investments and keep an eye on market developments. You will use the Bloomberg terminals in our Bloomberg Finance Lab to inform your choices (when off-campus, use sources like Bloomberg www.bloomberg.com/markets/, Yahoo! Finance uk.finance.yahoo.com/investing and Ft.com.
You need to imagine that you have borrowed a total of £1,000,000 at 2% interest p.a. in perpetuity and that you need to invest this money with the aim of funding your retirement. You must build a portfolio with 10 investments only (sorry, no forex). If you are investing in individual shares, choose stocks with a market capitalization of at least £500 million each and 5 years of price and dividend data.
You will be charged commissions/bid-offer spread of 0.25% of the stock’s purchase price. If you are investing in funds, choose mutual funds with at least £500 million in total assets and a 5-year history of returns. You will be charged fund-specific fees (initial and administration). An Excel worksheet is available on Blackboard to help you keep track of your portfolio and its performance.
For the initial entry on 31/01/2022
Complete rows 8 through 13 for your positions in columns B through K. Use the commission rates indicated above for row 13. Column M will calculate your totals automatically. [n.b. Astrazeneca is given as an example – please remove it and replace it with one of your own companies.]
For the 28/02/2022 update:
Enter the new closing price and enter any dividends received.
In the report (maximum 1500 words)§ you will have to
Analyse your portfolio choices from a behavioural perspective and
Evaluate the asset allocation adopted applying the portfolio theory concepts studied.
Include a discussion of the purpose of the portfolio (i.e. long-term personal retirement savings) and how you believe that your portfolio fulfils the stated aim better than other possible portfolios. The report must discuss the biases that may have influenced your choice of assets. You must then make explicit reference to portfolio theory and analyse the portfolio allocation. Indicate how you think that your portfolio performance should be judged or benchmarked over the long-term and address whether the portfolio in its reduced state (see details below) will serve your retirement goal after paying back the loan with interest. Below is a step-by-step guide to the report including the marking criteria.
How to build your Excel spreadsheet
Start with the portfolio Excel spreadsheet you have used for tracking the performance of your investment choices between 1 and 28 February 2021. Add a new worksheet (a new tab) in your Excel file with your portfolio of 10 assets. Copy the entire sheet containing the tracked portfolio and paste it in the new worksheet. In the newly added worksheet, change the amounts invested in each asset to £100,000 (so that now they have equal weights in the portfolio).
Add a new worksheet (a new tab) in your Excel file with your portfolio of 10 assets.
Use the Bloomberg terminal (or Yahoo! Finance) to look up and download historical prices for your 10 assets – monthly data for the last 5 years. Put these in one single Excel sheet (just like I have done for the seminars)
Calculate the expected rate of return for each asset (mean) and its risk (standard deviation)
Calculate the correlation matrix for your 10 assets.
You will now build 2 different portfolios:
Portfolio A – pick your best 5 assets using Markowitz criteria; give weights to your 5 assets in a way similar your initial allocation – i.e. increase the weights of the remaining 5 assets by the amount ‘freed-up’ by the removal of five assets.
Portfolio B – pick the top 5 highest performing assets from your 1-month tracking sheet; give the following weights to your assets in descending order 35% (to the asset with highest return), 30%, 20%, 10% and 5% (to the asset with the lowest return).
Add a new worksheet (new tab) into your Excel file for each portfolio (A and B) and copy the historical data for the 5 chosen assets for each portfolio separately. For each Portfolio A and portfolio B:
Calculate the expected portfolio return and the portfolio risk (Markowitz equations)
Calculate the portfolio beta.
Calculate the Sharpe ratio assuming a risk-free rate of return equal to 0.5%.
How to analyse the portfolio in Word document
You must first analyse your portfolio choices from a behavioural perspective. Use around 500 words to discuss the biases that (may) have influenced your choice of assets. Typical biases to consider are overconfidence, representativeness, availability, ambiguity aversion, narrow framing, herding etc. You will need to cite literature sources (with references) in the discussion.
Next you must evaluate your portfolio asset allocation by applying portfolio theory (around 1000 words). You will need to cite theory and literature sources (with references) in the discussion.
First look at the initial 10-asset portfolio and
Analyse the diversification of the initial 10-asset portfolio
How well diversified was it across asset classes? How could you improve it?
How well diversified was it within the asset classes? How could you improve it?
How well diversified was it across international and domestic? How could you improve it?
How did your portfolio perform over your investment period (the month between 1-Feb and 1-Mar)? Would a naïve diversification strategy have yielded better a better result (see the equal weights portfolio)?
Discuss the correlations between your 10 portfolio assets – refer to the matrix (point 2.c.)
Comparing Portfolio A and Portfolio B,
discuss whether Markowitz diversification helped reduce risk (refer to the calculations in point 4.a.)
discuss the portfolio betas you calculated (point 4.b.) relative to the market risk.
discuss the Sharpe ratios you calculated (points 4.c.). Which allocation is the best – Portfolio A or Portfolio B, and why?
Going back to your initial 10-asset portfolio,
Would this portfolio be good enough for you to meet your retirement goal? Indicate how you think your portfolio performance should be judged or benchmarked over the long-term.
With explicit reference to active and passive management, how would you change it?
