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Question:

(1) the historical monthly rates of return for the market index only (monthly rates of return for the companies are given); and

(2) the historical average rate of return and standard deviation of returns for:

2. ii) the reference company; and
iii) the market index.
1. b) Calculate portfolio historical average rate of return and standard deviation assuming a portfolio of equal weighting for your case company and the reference company
2. c) Use CAPM to estimate the expected return for the shares of: 1) your case company; and 2) the reference company as at 28 February 2018. To do this, use the yield to maturity on that date of a 10-year Australian Treasury bond as a proxy for the risk-free rate, assume the market risk premium is 6.6% and use the company’s current beta. Assume that the reference company has a negative beta of -0.20.
Question:

Data collected and calculated for JB HI FI, Bega Cheese and AORD:

 Historical Monthly Returns of Market Index: Date Monthly Closing Index Monthly Returns Zi Z = [zi – z(i– 1)]/ z(i- 1) Sep-17 55459.75 Oct-17 57712.86 4.06% Nov-17 58813.50 1.91% Dec-17 60007.77 2.03% Jan-18 59809.19 -0.33% Feb-18 59916.01 0.18% Q.1.a: Historical Average Rate of Returns & Standard Deviation: Date JB HI FI Reference Co. (Bega Cheese) Market Index JB HI FI Reference Co. (Bega Cheese) Market Index Xi Yi Zi (X - Xi )2 (Y - Yi )2 (Z - Zi )2 Oct-17 -0.087% 7.61% 4.06% 0.130% 0.547% 0.062% Nov-17 3.10% 4.90% 1.91% 0.002% 0.219% 0.001% Dec-17 5.63% -6.23% 2.03% 0.045% 0.416% 0.002% Jan-18 17.20% -2.49% -0.33% 1.873% 0.073% 0.036% Feb-18 -8.28% -2.70% 0.18% 1.391% 0.085% 0.019% Average Rate of Returns 3.513% 0.220% 1.570% X = ΣXi/n Y= ΣYi/n Z=ΣZi/n Standard Deviation 9.27% 5.79% 1.74% σx = √Σ(x-xi)2/(n-1) σy = √Σ(y-yi)2/(n-1) σz = √Σ(z-zi)2/(n-1) Q.2: Date JB HI FI Reference Co. (Bega Cheese) (X - Xi ) (Y - Yi ) Oct-17 3.600% 7.393% Nov-17 0.413% 4.678% Dec-17 2.120% 6.446% Jan-18 13.687% 2.710% Feb-18 11.792% 2.915% Covariance 0.002842003 COV(x,y) =Σ(x-xi)(y-yi)/(n-1) Particulars JB HI FI Reference Co. (Bega Cheese) Weightage 50% 50% wx wy Average Rate of Return 3.513% 0.220% rx ry Variance 0.860% 0.335% σ2x σ2y Covariance 0.002842003 Cov(x,y) Portfolio Return 1.866700% R= [(wx x rx)+(wy x ry)] Portfolio Standard Deviation 6.64% σ = √(wx2 x σ2x) + (wy2 x σ2y) + [2wx x wy x Cov(w,y)] Q.c: Particulars JB HI FI Reference Co. (Bega Cheese) Beta A 0.48 -0.2 Market Risk Premium B 6.60% 6.60% Risk Free Rate C 2.58% 2.58% Expected Return D=C+(AxB) 5.75% 1.26% Q.d: Particulars Boral Ltd. Reference Co. Weightage A 50% 50% w1 w2 Beta B 0.48 -0.20 Portfolio Beta β1 β2 Portfolio Beta βp=(w1xβ1)+(w2xβ2) 0.14 Market Risk Premium B 6.60% Risk Free Rate C 2.58% Portfolio Expected Return D=C + (βpxB) 3.50%

For the case company, JB HI FI (JBH) has been chosen and for Reference Company, Bega Cheese Limited has been chosen. The report explains about the individual stock return as well as portfolio return to evaluate the risk and return. Firstly, historical monthly rate of return of the market index has been calculated. Further, average rate of return and standard deviation of JB HI FI, Bega cheese and market index have been calculated and average return and portfolio return of both the stocks have been evaluated. So that the associated risk and return of JB HI FI could be calculated efficiently.

Question 1:

Historical rate of return for market index

Calculation of historical monthly rate of return of the market index is as follows:

 Historical Monthly Returns of Market Index: Date Monthly Closing Index Monthly Returns Zi Z = [zi – z(i– 1)]/ z(i- 1) Sep-17 55459.75 Oct-17 57712.86 4.06% Nov-17 58813.50 1.91% Dec-17 60007.77 2.03% Jan-18 59809.19 -0.33% Feb-18 59916.01 0.18%

It explains that the highest return of the market index in last 6 months is 4.06% and the lowest return is -0.33% which explains about less volatility in return (Madhura, 2011).

Historical average rate of return and standard deviation

Calculation of average rate of return and standard deviation of JB HI FI, Bega cheese and market index are as follows:

 Date JB HI FI Reference Co. (Bega Cheese) Market Index JB HI FI Reference Co. (Bega Cheese) Market Index Xi Yi Zi (X - Xi )2 (Y - Yi )2 (Z - Zi )2 Oct-17 -0.087% 7.61% 4.06% 0.130% 0.547% 0.062% Nov-17 3.10% 4.90% 1.91% 0.002% 0.219% 0.001% Dec-17 5.63% -6.23% 2.03% 0.045% 0.416% 0.002% Jan-18 17.20% -2.49% -0.33% 1.873% 0.073% 0.036% Feb-18 -8.28% -2.70% 0.18% 1.391% 0.085% 0.019% Average Rate of Returns 3.513% 0.220% 1.570% X = ΣXi/n Y= ΣYi/n Z=ΣZi/n Standard Deviation 9.27% 5.79% 1.74% σx = √Σ(x-xi)2/(n-1) σy = √Σ(y-yi)2/(n-1) σz = √Σ(z-zi)2/(n-1)

It explains about the return and risk of JB HI FI, Bega cheese and market index. Here, the risk and return of JB HI FI stock is higher than other stocks (Kaplan and Atkinson, 2015).

Question 2:

Portfolio historical average rate of return and standard deviation

Calculation of average return and standard deviation of portfolio are as follows:

 Date JB HI FI Reference Co. (Bega Cheese) (X - Xi ) (Y - Yi ) Oct-17 3.600% 7.393% Nov-17 0.413% 4.678% Dec-17 2.120% 6.446% Jan-18 13.687% 2.710% Feb-18 11.792% 2.915% Covariance 0.002842003 COV(x,y) =Σ(x-xi)(y-yi)/(n-1) Particulars JB HI FI Reference Co. (Bega Cheese) Weightage 50% 50% wx wy Average Rate of Return 3.513% 0.220% rx ry Variance 0.860% 0.335% σ2x σ2y Covariance 0.002842003 Cov(x,y) Portfolio Return 1.866700% R= [(wx x rx)+(wy x ry)] Portfolio Standard Deviation 6.64% σ = √(wx2 x σ2x) + (wy2 x σ2y) + [2wx x wy x Cov(w,y)]

It explains that the average return of portfolio would be 1.87% and the standard deviation of portfolio is 6.64% (Horngren et al, 2005).

Question 3:

Calculation of CAPM

Calculation of CAPM of JB HI FI and Bega cheese limited are as follows:

 Particulars JB HI FI Reference Co. (Bega Cheese) Beta A 0.48 -0.2 Market Risk Premium B 6.60% 6.60% Risk Free Rate C 2.58% 2.58% Expected Return D=C+(AxB) 5.75% 1.26%

(Bloomberg, 2018 and Reuters, 2018)

It explains that the return of JB HI FI is higher than Bega cheese (Higgins, 2012).

Question 4:

Portfolio expected return and beta:

Calculation of portfolio expected return and beta are as follows:

 Particulars Boral Ltd. Reference Co. Weightage A 50% 50% w1 w2 Beta B 0.48 -0.20 Portfolio Beta β1 β2 Portfolio Beta βp=(w1xβ1)+(w2xβ2) 0.14 Market Risk Premium B 6.60% Risk Free Rate C 2.58% Portfolio Expected Return D=C + (βpxB) 3.50%

Question 5:

Risk and return:

Risk and return are highly correlated to each other in relation to investment. Arnold (2013) has defined that risk is the chance which would make few differences in the expected return and actual return of an investment. Risk is basically a possibility of losing some investment or even all investment. Risk is of two types: systematic risk and unsystematic risk. Systematic risk is un-diversifiable risk. It depends on the daily fluctuation of stock price. It could not be reduced by the investors (Garrison et al, 2010). On the other hand, unsystematic risk depends on the industry and market factors. It could be reduced by the investors through diversify the investment.

At the same time, return of an investment is either gain or losses which have been occurred due to investment and trading of a security. Several factors affect the return of a security. Diversification strategy could help the company to manage and enhance the return (Besley and Brigham, 2008). The given case of JB HI FI explains that the average monthly return of the stock is 3.513% whereas the monthly return of market index is 1.57% which explains that the JBH stock is offering more gain to the investors. A security which offers gain to the investors is best security in relation to the investment. On the other hand, as a measurement of risk, standard deviation of JB HI FI stock has been calculated. Standard deviation of JB HI Stock is 9.27% whereas the risk of market index is 1.74% which explains that the return of the company is less volatile. It explains that the risk of the company is lower.

Though, the risk and return of the company has been compared with the market index and Bega cheese to evaluate the stock performance and risk and return level of the company in relation with market (Baker and Nofsinger, 2010). The calculation of market index depicts that the market return is 1.57% whereas standard deviation of the market index is 1.74% which explains about lesser volatility in the market returns. Stock volatility is the main measure to identify the stock performance. More volatility of a stock represents about riskier position of the company. The comparison calculations among market index and JB HI FI explain that the stock of JB HI FI is riskier than market but at the same time, return is also higher of JB HI FI. On the other hand, the calculation of Bega cheese depicts that the market return is 0.22% whereas standard deviation of the stock is 5.79% which explains about lesser volatility in the market returns in comparison with JB HI FI. The comparison calculations of Bega cheese and JB HI FI explain that the JB HI FI Stock’s risk and return is higher. It explains that the risk and return is directly connected to each other. The more the return of a stock would be, the more the associated risk would be (Deegan, 2013).

According to the above analysis, it has been concluded that the risk of JB HI FI is quite higher in the market but at the same time, return of the stock is also higher. Ackert and Deaves, (2009) has explained into his study that returns and risk have positive relation with each other. With the increment in the one, other factor automatically enhances. Though, it has been argued by Brown, Beekes and Verhoeven, (2011) that risk and return of an organization are different to each other. If the stock price of a company is increasing than the return of the organization would be higher and the risk of the stock would be lower. Further, it explains that the required rate of return of JB HI FI is 5.75% which explains that if an investor invests into the stock of JB HI FI than the company would pay 5.75% dividend to the stockholders.

On the other hand, it has been evaluated that the required rate of return of Bega cheese is 1.26%. It explains that the return of JB HI FI is quite higher than the return of Bega Cheese. Further, it has been found that the betas of both the stock are 0.48 and -0.2 which explains that the risk of JB HI FI stock is higher (Reuters, 2018). It explains that the market return as well as required rate of return of JB HI FI is higher than the Bega cheese and market index (Besley and Brigham, 2008). It expresses that if an investor would invest into the stock of JB HI FI than the investor and trader both would be able to get higher return from the stock as the monthly return as well as dividend return of the company is higher than the other companies in the market and market index. But, on the other hand, the associated risk would also be higher as the stock price of the company is changing rapidly.

Diversification is a risk management technique which combines the numerous investments within a portfolio. Diversification technique reduces the event of unsystematic risk (Higgins, 2012). Further, it has also been evaluated that if the diversification strategy is adopted by the investor to reduce the risk and balance the return than the return of the portfolio would be 3.50% and in that case, the associated risk would also be 0.14. It explains that if the investor would invest into a portfolio of JB HI FI and Bega cheese with 50% and 50% weight than the return of the portfolio would be lesser in comparison of JB HI FI stock but at the same time, the risk would also be lower. So it is better option for the inventors to invest into the portfolio of JB HI FI and Bega Cheese rather than investing into a single security.

Conclusion:

To conclude, risk and return are financial factors which are directly and positively connected to each other. The comparison calculations among Bega cheese and JB HI FI explain that the return and risk, both is higher of JB HI FI Stock. Further, it explains that if the investor would invest into the portfolio than the risk for the investor would be reduced and balanced return would be got by the investors. So it is better option for the inventors to invest into the portfolio of JB HI FI and Bega Cheese rather than investing into a single security.

References:

Ackert, L. and Deaves, R. 2009. Behavioral Finance: Psychology, Decision-Making, and Markets. Cengage Learning.

Arnold, G., 2013. Corporate financial management. Pearson Higher Ed.

Baker, H.K. and Nofsinger, J.R. 2010. Behavioral Finance: Investors, Corporations, and Markets. John Wiley & Sons.

Besley, S. and Brigham, E.F., 2008. Essentials of managerial finance. Thomson South-Western.

Bloomberg. 2018. Government bond yields. [Online]. Available at: https://www.bloomberg.com/markets/rates-bonds/government-bonds/australia [Accessed as on 8th March 2018].

Brown, P., Beekes, W., and Verhoeven, P. 2011. Corporate governance, accounting and finance: A review. Accounting & finance, 51(1), 96-172.

Deegan, C., 2013. Financial accounting theory. McGraw-Hill Education Australia.

Garrison, R.H., Noreen, E.W., Brewer, P.C. and McGowan, A., 2010. Managerial accounting. Issues in Accounting Education, 25(4), pp.792-793.

Higgins, R. C., 2012. Analysis for financial management. McGraw-Hill/Irwin.

Hillier, D., Grinblatt, M. and Titman, S., 2011. Financial markets and corporate strategy. McGraw Hill.

Horngren, C.T., Sundem, G.L., Stratton, W.O., Burgstahler, D. and Schatzberg, J., 2005. Introduction to management accounting. Upper Saddle River, New Jersey: Prentice Hall.

Kaplan, R.S. and Atkinson, A.A., 2015. Advanced management accounting. PHI Learning.

Madura, J., 2011. International financial management. Cengage Learning.

Reuters. 2018. JB HI FI. [Online]. Available at: https://www.reuters.com/finance/stocks/overview/JBH.AX [Accessed as on 8th March 2018].

Cite This Work

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