Investment Management Report - Verizon Communications Inc. and Caterpillar

Instructions: This assignment is structured into two Parts that should be submitted separately. The maximum number of marks available for Part I is 100 marks.

The maximum number of marks available for Part II is 100 marks. Each Part counts for 50% of your final mark (your final mark is the average between your Part I mark and your Part II mark).

Word limit: 2000 words for Part I and 2000 words for Part II. This limit excludes the reference list and any appendices, but includes the references in the main text of the report.

Objective: Prepare a professional investment management report using data from Yahoo! Finance and the theory and practices presented in Part I.

Question: Assume that today is November 1st, 2020 and that you are employed as a financial analyst for a leading financial advisory company.

You are asked to prepare an investment management report by the end of the day for a client that has recently received an inheritance and is interested to invest in the capital market for the first time.

Briefly discuss at least two recent news stories about your Verizon Communications Inc. and at least two recent news stories about Caterpillar (specify the source) which would be of interest to your client. Present what type of information is discussed in each news story (past, public and/or private). For each news story, explain whether you would expect it to drive the stock price up, down or to have no price impact.  (10 marks)

Report the mean, variance and standard deviation of the weekly returns for each of the three assets (i.e. Verizon Communications Inc., Caterpillar and S&P500). Explain and compare each of the above statistics from a statistical point of view and how these are used in investment management. Also explain  which of the three assets is more attractive to the client if he or she seeks (i) maximum return, (ii) minimum risk, and (iii) the highest mean return per unit of risk.  (15 marks)

Report the weekly covariance as well as the correlation

(i) between the returns of the S&P500 and Verizon Communications Inc. and (ii) between the returns of Caterpillar Inc. and Verizon Communications Inc. Explain these statistics in a similar fashion as above. Discuss the kind of relationship in both cases, including appropriate XY plots (i.e. scatter plots).   (10 marks) 

Compute and draw the efficient frontier for Verizon Communications Inc. and Caterpillar and discuss its importance. Compute the minimum variance portfolio and show its position on the efficient frontier graph. Show and discuss the effect of correlation on the efficient frontier by changing the correlation coefficient between the two companies to the following values: -100%, -50%, 0%, 50% and 100%. Plot these new efficient frontiers on another graph.    (15 marks)

Compute the optimal risky portfolio which consists of Verizon Communications Inc. and Caterpillar. Compute the optimal capital allocation between the risk-free asset and the optimal risky portfolio for your client. How should the client allocate his capital among the risk-free asset, the stock of your firm and Caterpillar? How many shares does he need to purchase in each firm? Draw the capital allocation line and show the optimal capital allocation on the graph. How would the optimal capital allocation change if the client is risk neutral?   (15 marks)

The minimum variance portfolio is the natural choice for investors seeking the minimum risk in their portfolio. Is this statement also true when investors have access to a risk-free asset? Is there a better portfolio which is available to such investors who require the same risk as the minimum variance portfolio? If such a portfolio exists, how would the capital allocation of the previous question change?      (5 marks)

Capital Asset Pricing Model (CAPM)

Assume that the expected return on the market portfolio is equal to the average return on the S&P500 index for the given time period. Obtain the beta of Verizon Communications Inc. and that of Caterpillar from Yahoo! Finance and compute the fair expected return of each stock based on the CAPM. Draw the security market line and show the fair expected returns of the two stocks and of the S&P500 on the graph.      (10 marks)

Explain which of the two stocks (Caterpillar or Verizon Communications Inc) is less risky for a fully diversified investor. Compute the alpha of each of these two stocks, as well as the beta and the alpha of the optimal risky portfolio in the given time period. What do the alphas for the stocks and the portfolio indicate in terms of investment performance?          (10 marks)

Describe the implications for the optimal capital allocation if the CAPM holds. How would the optimal capital allocation and final portfolio change under this scenario? Given the evidence in all the sections of this report, would you advise your client to diversify or not?   (10 marks)