Questions included in document uploaded
Microsoft Word - Investment Decision Assignment 1.docx FNCE2280 Investment Decision Assignment 1 (15%) As an investment advisor for Wealth Securities Inc., you had just met with a potential new client, Lisa Wilson. Your task was to help Lisa to analyze the current positions and returns of some of the securities currently held by her and recommend a new investment portfolio to her that is consistent with her risk and return objectives. THE CLIENT During the initial meeting, Lisa indicated that her investment return objective was to earn a 9% total return per year. You helped her assess her risk preferences and it was concluded that she could accept up to a 20% portfolio volatility, measured by standard deviation in her portfolio in any one year. PREVIOUS ADVICE Lisa indicated that she was seeking advice regarding the two existing investments she has. Below is the information regarding the two investments. Investment 1: A year ago, Lisa bought 100 shares of TD bank stock on margin at $80 per share. Initial margin is 50% and the maintenance margin is 40%. TD Bank paid an annual dividend of C$3.06 per share last year. Interest rate for the margin loan is 5%. The stock price drops to $62 now after one year. Due to the high growth in business, TD’s dividends are expected to grow by 10% for the next 3 years. From year 4 on, the dividends will grow constantly at the sustainable growth rate. TD bank follows a stable dividend payout ratio of 45%. As of the second quarter of 2020, The company has net profit margin of 27.5%, asset turnover of 0.0218 and equity multiplier of 17.84. The required rate of return of TD stock is 7.5%. Investment 2: 3 months ago, an independent investment counsellor suggested Lisa to take a short position in Cineplex Inc. as the revenue is expected to drop further in the third quarter of 2020 because of Covid-19. Lisa took the investment counsellor’s advice and sold short 1,000 shares of Cineplex for $14 per share. The stock currently pays $1 annual dividend. The initial margin requirement is 50%. FNCE2280 Investment Decision Assignment 1 (15%) YOUR RECOMENDDATION After thorough analysis on Lisa’s financial and personal circumstances, you suggest a new investment portfolio that includes Walmart Inc. (WMT) and Bank of America Corporation (BAC) stocks. You suggested the asset mix to be 40% allocation in WMT, and 60% in BAC. You supplemented this recommendation with the historical returns of the two stocks for last 4 years, as well as the expected dividends and expected values for $1,000 original investments in this portfolio. You have also calculated the correlation between WMT and BAC, which is 0.81. Exhibit 1 Historical annual returns of WMT and BAC from 2016 to 2019 Year Annual return Walmart Inc. (WMT) Bank of America Corporation (BAC) 2016 12.76% 33.33 % 2017 42.87% 35.67 % 2018 -5.67% -14.83 % 2019 27.58% 46.16% Exhibit 2 For $1,000 original investments in the suggested portfolio, the expected portfolio value in end of 2024 is $1,650 and the expecte dividends received from 2020 to 2024 are provided in the table. End of Year Expected Dividends 2020 20 2021 21 2022 23 2023 26 2024 30 FNCE2280 Investment Decision Assignment 1 (15%) CASE QUESTIONS Using the information provided in the case, assume that you are the investment advisor and answer the following questions. Regarding Investment 1: (20 marks) 1.1 At the time of purchase, what was the amount of equity Lisa has contributed and what amount has she borrowed? (2 marks) 1.2 At what price will Lisa be faced with a margin call? (2 marks) 1.3 After one year, what is the equity position (actual margin) as a percentage? (2 marks) 1.4 After one year, how much additional equity needs to be added to bring the account back to the maintenance margin? (2 marks) 1.5 Calculate Return on Equity (ROE) and retention ratio of TD as of the second quarter of 2020. 2 marks) 1.6 What was the return on invested capital of Lisa’s TD stock holdings last year? 1.7 Calculate the sustainable growth rate as of the second quarter of 2020. (2 marks) 1.8 Calculate expected dividends of TD for next 4 years. (4 marks) 1.9 Calculate the terminal value in the end of year 3. (2 marks) 1.10 Calculate the intrinsic value of TD stock. Based on your calculation, what’s your recommendation on TD stock (hold or sell)? (2 marks) Regarding Investment 2: (10 marks) 2.1 Lisa wants some advice and information about short selling. Describe and explain the steps involved in the short selling process. (3 marks) 2.2 Explain the advantages and disadvantages of short selling to Lisa. (3 marks) 2.3 What were the proceeds of the short sale and equity needed at the time Lisa sold short the stock? (2 marks) 2.4 What is the annual return of this transaction if Cineplex stock decreases to $10 after 1 year? (2 marks) Regarding Your Recommendation: (16 marks) 3.1 What is the sample standard deviation for each stock? (4 marks) 3.2 If Lisa follows your recommended portfolio mix, what was the annual portfolio return in 2019? (2 marks) 3.3 Using the standard deviations of the two stocks calculated in 3.1, calculate the portfolio standard deviation and evaluate whether your recommendation comply with Lisa’s risk tolerance. (3 marks) FNCE2280 Investment Decision Assignment 1 (15%) 3.4 Calculate the expected holding period return (HPR) of the portfolio for the next 5 years based on the expected dividends and portfolio value. (2 marks) 3.5 Estimate the IRR using financial calculator and determine If the portfolio can meet Lisa’s return objective? (3 marks) 3.6 Estimate the compound annual growth rate of dividend over the period of 2020 to 2024. (2 marks) Hints: For standard deviation for the stocks, use Sx function of financial calculator. For portfolio standard deviation, use this formula: SUBMISSION REQUIREMENTS A title page is required. The title page should ONLY include the following information in the following order: the name of your assignment, your first and last name, institution name, course name, course number, my name, and date. Complete the assignment in a question/answer format. Your assignment may be submitted as either a WORD document or PDF. No other format is acceptable. The length should not exceed 1500 words (approximately 6 pages double-spaced, Times New Roman, 12-point font, exclusive of title page and exhibits). Page numbers should be placed in the centre footer position. Page 1 will be the 1st page after the title page. A table of contents is not required. Spelling and grammar are always important. A penalty of 20% per day will be assessed for each day the assignment is past due. Key Equations Equation 2.1 Margin = Value of securities - Debit balance Value of securities Equation 2.1a = V - D V Equation 2.2 Return on invested capital from a margin transaction = Total current income received - Total interest paid on margin loan + Market value of securities at sale - Market value of securities at purchase Amount of equity at purchase Equation 4.1 Required return on investment j = Real rate of return + Expected inflation premium + Risk premium for investment j Equation 4.2 Risk@free rate = Real rate of return + Expected inflation premium Equation 4.3 Required return on investment j = Risk@free rate + Risk premium for investment j Equation 4.4 Holding period return = Income during period + Capital gain (or loss) during period Beginning investment value Equation 4.5 Capital gain (or loss) during period = Ending investment value - Beginning investment value Equation 4.6 Standard deviation = b a n t=1 aReturn for outcome t - Average or expected return b2 Total number of outcomes - 1 Equation 5.3 Expected return on investment j = Risk@free + c Beta for investment j * aExpected market return - Risk@free rate bd rate Equation 5.2 Total risk = Diversifiable risk + Undiversifiable risk Equation 5.1 Portfolio Return = • Proportion ofportfolio,s total Returndollar value * on asset invested in 1 asset 1 µ + • Proportion ofportfolio,s total Returndollar value * on asset invested in 2 asset 2 µ + Á + • Proportion ofportfolio,s total Returndollar value * on asset invested in n asset n µ = an j=1 • Proportion ofportfolio,s total Returndollar value * on asset invested in j asset j µ Z02_SMAR3841_13_SE_IDX.indd 1 15/12/15 5:59 PM Equation 5.4 Portfolio beta = ± Proportion ofportfolio,s total dollar value in asset 1 * Beta for asset 1 ≤ + ± Proportion ofportfolio,s total dollar value in asset 2 * Beta for asset 2 ≤ + Á + ± Proportion ofportfolio,s total dollar value in asset n * Beta for asset n ≤ = an j=1 ± Proportion ofportfolio,s total dollar value in asset j * Beta for asset j ≤ Equation 7.5 Inventory turnover = Sales revenue Inventory Equation 7.4 Accounts receivable turnover = Sales revenue Accounts receivable Equation 7.3 Net working capital = Current assets - Current liabilities Equation 7.1 Current ratio = Current assets Current liabilities Equation 6.6 Total return (in U.S. dollars) = G Ending value ofstock in foreigncurrency + Amount of dividendsreceived inforeign currency Beginning value of stock in foreign currency * Exchange rate at end of holding period Exchange rate at beginning of holding period W - 1 Equation 6.5 Total return1 in U.S. dollars2 =