Answer all questions
The spreadsheet ‘Assignment 2 Data T1 2019’ contains financial markets data that is used for this assignment. The data is allocated into three tabs: Q1 relates to Question 1, Q2 relates to Question 2 and Q3 relates to Question 3. You are required to submit both an Excel spreadsheet that shows your workings and a word file with a report that summarises your responses to each question. The word file should be a stand-alone report; the Excel spreadsheet is only submitted so that your working out can be checked as required.
Question 1:Efficient Frontier (35marks)
You are employed as a research analyst and have been given tenstocks to analyse. The tenstocks are: Adelaide Brighton, Ramsay Health Care, ANZ Bank, AMCOR, Westpac Bank, Bank of Queensland, Fortescue Metals Group, Telstra, Bendigo & Adelaide Bank, Coca-Cola Amatil. Monthly total return indices ( ) for these sevenstocksfor the period January 2012 to January 2019are provided. Note that you have been given total return indices, not ‘prices’ or ‘total returns’. To calculate monthly total return use Data are collected from DataStream. Using the data provided, you are required to undertake the following:
- Use Microsoft Excel’s Solver add-in to derive the efficient frontier of risky assets for a portfolio comprising the tenstocks that you have been asked to analyse. When calculating expected returns for the stocks, you should use the historical average return. The market consensus forecast for the expected market return is 7.2% per annum (0.60% per month) and the risk-free rate of interest is 2.52% per annum (0.21% per month). (20marks)
- Discuss the limitations associated with using the Markowitz portfolio selection model (as applied above) when developing an investment strategy.(15 marks)
Question 2: Momentum strategy (35 marks)
US monthly stock returns across 12industries (labelled P1 through to P12) for the period from 1950 to 2018 are provided. You have been asked to back test a cross-sectional momentum strategy using this data. Within this strategy, you are required to demonstrate the monthly returns on a portfolio of past winners and the returns on a portfolio of past losers. The momentum strategy that you should apply is the 12/12 strategy, whereby industries are allocated into portfolios based on their performance over the past 12months and each portfolio is then held for the subsequent 12months and rebalanced annually. Monthly returns on the market index (Mkt) and the monthly risk-free rate (RF) are also provided.Data are collected from http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html.
- Create an equally weighted portfolio comprising threeindustries of past “winners” and three industries of past “losers” and report the historical mean and standard deviation of returns for these portfolios. Calculate and interpret the Sharpe ratio and Jensen’s alpha for these two portfolios.(20 marks)
- Discuss whether the evidence reported in Part [a] above is consistent with the empirical evidence on the momentum premium reported in pages 65-70 of Jegadeesh and Titman (1993) and Moskowitz and Grinblatt (1999, Panel B of Table II Raw Industry Momentum). In your answer, you should consider the effectiveness of industry momentum investment strategies by considering both the direction and magnitude of the momentum premium that you observe and providepossible explanations for yourresults. (15 marks)
Question 3: Seasonal Anomalies (30marks)
One strategy applied by investors is to exploit seasonal anomalies. You are required to test the significance of two seasonal anomalies: the month-of-the-year-effect (Rozeff & Kinney, 1976) and the day-of-the-week-effect (Cross, 1973).
- Daily and monthly stock market indicesforAustralia (TOTMKAU), China (TOTMKCA) and India (TOTMKIN) from 1991 to 2018aggregate stock market indices are provided. These are collected from Datastream. Conduct appropriate tests for the month-of-the-year-effect and the day-of-the-week-effect for these stock markets.Discuss whether yourresultsare consistent with previous empirical studies.(20 marks)
- Explain whether it would be possible for individual investors to profit from seasonal anomalies that you may have observed in part a. (10 marks)
Readings for Question 1
Bodie et al., Chapter 7
Readings for Question 2
Jegadeesh, N. and Titman, S. (1993). Returns to buying winners and selling losers: implications for stock market efficiency. The Journal of Finance, 48:65–91.
Jegadeesh, N. and Titman, S. (2001). Profitability of momentum strategies: an evaluation of alternative explanations. The Journal of Finance, 56:699–720.
Moskowitz, Tobias and Grinblatt, Mark (1999) Do Industries Explain Momentum? The Journal of Finance, 54, 1249-1290.
Readings for Question 3
Schwert, G. William, 2003. “Anomalies and market efficiency,” Handbook of the Economics of Finance, in: G.M. Constantinides& M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 15, pages 939-974 Elsevier.
Cross, F. (1973). The behavior of stock prices on Fridays and Mondays. FinancialAnalysts Journal, 29(6), 67–69.
Rozeff, M. S., & Kinney, W. R. (1976). Capital market seasonality: The case of stockreturns. Journal of Financial Economics, 3(4), 379–402.
Seif M, Docherty P, Shamsuddin A. (2017). Seasonal anomalies in advanced emerging stock markets’, Quarterly Review of Economics and Finance, 66 169-181.