IPM FINAL

Security Analysis and Portfolio Management

1. IntroductionFor portfolio evaluation we have selected the National bank limited and Fine foods because both of them are very old in the stock market. National bank was listed in 1984 under Dhaka stock exchange. The category of the stock of NBL and Fine Foods is “A”. On the other hand Fine foods listed on the year 2002. Both of them are very renowned organization in our country. We did not select these two companies only based on this information. By doing the trail & error method we have found negative correlation (-0.221908802) on these two stocks on different sector. One is banking sector and the other one is food sector. After getting the negative correlation we have selected these companies for portfolio management.

2. Macroeconomic Analysis

Attractiveness of the capital market for the investor depends on some macro economic variables like inflation, interest rate, unemployment rate, GDP and some other economic conditions. These are described below-

Inflation: Level of inflation has some positive effect on capital market regarding investors’ attraction to invest. In order to avoid regression, government monetary policies are made to ensure continuous increase in the inflation through recurrent rise in the money supply. To tame inflation, the government usually hikes interest rates. This tends to make debt instruments attractive relative to equities as the former carry a lower risk. Current inflation rate in our country 7.97% (June -2013), 7.70% Monthly average.

Interest rate: Generally when interest rate on savings account goes down, it is seen that, risk adverse investor feels encouraged investing in the stock market. On the other hand, when the interest rate goes up, they start saving their money in banks, as in banks there is a chance of getting risk free return. Though there is another type of investor who takes more risk than the risk adverse investor. They take risks in the stock market, because they want more return from their investment. Current Schedule banks' weighted average interest rates on deposits 8.65% (June 2013)

Unemployment: Unemployment always affect in the stock market. If the unemployment rate is less in the country, more people can invest more money in the stock market and the stock market has the chance to boom. But if the unemployment rate is much higher in the country, people don’t have much money to invest and it will surely affect in the stock market. In 2012 unemployment rate more than 5%.

Gross domestic product (GDP): Investment and GDP growth reciprocally affect each others. A rise in the investment level simply gives rise to the GDP. If GDP rises, established business entities found boomed with profit and part of those are rendered to the shareholders as dividend. Usually, capital market is more volatile than money market. Fluctuation in the stock index also depends on the

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demand and supply of securities traded in the stock exchange. GDP at Current Price: Tk. 9147.84billion.Annual per capital GDP US$772.GDP growth rate constant price : 6.32 per cent

3. Portfolio SelectionWe are assigned to select a portfolio that will minimize risk and maximize return, for this reason, we first selected some “A” categories stocks and then tried to find out the relations between their returns. We know that to minimize the risk, we have to select such a portfolio that has negative correlations between their stocks’ returns. So we tried to find out stocks that had negative correlations. After doing some research and calculations, we found negative correlations between the returns of National Bank Limited and Fine Foods and the correlation is -0.221908802. For calculating expected return, risk, and correlation, we used the real data of the last 10 years. Here, the price of a stock in January for a particular year = P0, the price of a stock in December for a particular year = P1, cash dividend= C, stock dividend=D

Table: 1(a)

NATIONAL BANK LTD

Year P0 P1 D CANNUL RETURN Expected Return (100%)

2003 238.75 227.75 0 45.55 0.144712042 14.47%

2004 227.75 475.25 0 95.05 1.504061471 150.41%

2005 475.25 746.5 0 224 1.042083114 104.21%

2006 746.5 760.5 0 380.25 0.528131279 52.81%

2007 760.5 1494.25 0 822 2.045693623 204.57%

2008 1494.25 1014.25 0 527.4 0.031721599 3.17%

2009 1014.25 646.25 0 355.44 -0.012383535 -1.24%

2010 646.25 191.6 0 182.02 -0.421864603 -42.19%

2011 191.6 66.8 0 43.42 -0.42473904 -42.47%

2012 66.8 21.4 0 0 -0.679640719 -67.96%

Average Return 37.58%

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Table: 1(b)

Correlation between NBL & Fine Foods -0.221908802

After choosing National Bank Limited and Fine Foods Limited, we tried to detect the most optimal Portfolio. We took combinations of stocks in terms of individual weights in the portfolio where they yield optimum returns compared to the risks taken. In this paper, There are ten combinations of portfolios (A,B,C,D,E,F,G,H,I,J) with different weights assigned to each one of them. After assigning weights, expected returns, portfolio risks (standard deviation) and returns per risk were calculated. Finally, we found that a portfolio combination yielded the most return per risk. Consequently, we selected this portfolio for investment purposes. The following table shows properties of portfolio alternatives.

Table: 2Portfolio NBL FINE

FOODSTotal Expected Return Port Var SD% Best portfolio

A 100.0% 0.0% 1 37.60% 0.724222139 85.10% 44.18%B 90.0% 10.0% 1 41.70% 0.559723636 74.81% 55.74%C 80.0% 20.0% 1 45.90% 0.51800994 71.97% 63.77%D 70.0% 30.0% 1 50.00% 0.599081214 77.40% 64.60%E 60.0% 40.0% 1 54.20% 0.802937295 89.61% 60.49%F 50.0% 50.0% 1 58.30% 1.129578238 106.28% 54.85%G 40.0% 60.0% 1 62.50% 1.579004042 125.66% 49.74%H 30.0% 70.0% 1 66.60% 2.151214707 146.67% 45.41%I 20.0% 80.0% 1 70.80% 2.846210234 168.71% 41.97%J 10.0% 90.0% 1 74.90% 3.663990622 191.42% 39.13%

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Fine Foods

YEAR P0 P1 D C ANNUL RETURNExpected

Return (100%)2003 15 8.4 0 0 -0.44 -44.00%2004 8.4 3.45 0 0 -589285714 -58.93%2005 3.45 3.3 0 0.165 0.0043478 0.43%2006 3.3 2.6 0 0 -0.21212121 -21.21%2007 2.6 2.2 0 0 -0.153846153 -15.38%2008 2.2 15.13 0.5 0.765 6.529545455 652.95%2009 15.3 45.3 1.5 0 2.647058824 264.71%2010 45.3 97.2 2.5 0 1.200883002 120.08%2011 97.2 54.5 1 0 -0.430041152 -43.00%2012 54.5 18.1 1 0 -0.648897058 -64.88%

Average Return 79.08%


After doing all the calculations, we found that portfolio "D" contains the highest return related to risk. It contains a return of 50% and risk of 77.40%. So, we can say that, for each unit of risk we get 64.60% Return. In our efficient portfolio we have 70% of NBL stock and 30% of Fine foods stock.

Exp Ret %

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

0.00% 50.00% 100.00% 150.00% 200.00% 250.00%

Exp Ret %

Figure: Expected return VS standard deviation

4. Portfolio Evaluation

In our assignment, we closely monitored the performance and closing prices of the stocks for seven days starting from 7th July to 18th July. We found that closing price of the National Bank was Tk 13.20 in July 7th, 2013 and Tk.13 in July 18th, 2013. There are many reasons for this stable price. In our monitoring, we saw that the traded volumes were unstable day to day and the highest traded was in 11 th July. And the highest price was 13.4. Another stock of our portfolio is Fine Foods Limited. The closing price of this company started from Tk.18.10 (in July 7th, 2013) and ended at Tk.17.40 (in July 18th, 2013). Below is a table which shows the prices of NBL and Fine Foods Limited stocks from July 07, 2013 to July 18, 2013.

Table-3

Portfolio Evaluation (Investment in NBL=70% and Fine Foods=30%)

Date NBL Fine Foods

Price Rate of Return

Price Rate of Return Portfolio Return

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7/7/2013 13.2 18.1

8/7/2013 13.1 -0.76% 19.5 7.73% 1.79%

9/7/2013 12.9 -1.53% 19.1 -2.05% -1.68%

10/7/2013 13.4 3.88% 18 -5.76% 0.99%

11/7/2013 13.3 -0.75% 17.6 -2.22% -1.19%

14/07/2013 13.1 -1.50% 17.2 -2.27% -1.73%

15/07/2013 12.9 -1.53% 17.3 0.58% -0.89%

16/07/2013 12.9 0.00% 17.4 0.58% 0.17%

17/07/2013 13 0.78% 17.2 -1.15% 0.20%

18/07/2013 13 0.00% 17.4 1.16% 0.35%

Holding Period Return(Real Portfolio Return)=Rp

-1.52% -3.87% -2.22%

Actual Risk 1.71% 3.70%

Portfolio Risk

1.2%

Risk free rate

8.45%

As a part of our assignment, we have to recommend whether to sell or to hold the stocks on our portfolio. We calculated the return of portfolio and index (Market) and found -2.22%for selected portfolio and 0.21%for Market. Therefore, our selected portfolio is doing bad compared to the market. There are many reasons behind this kind of scenario. One of the reasons may be the lower level of investor's confidence. Another reason is we are only dealing with two stocks for our portfolio while DSE is dealing with a large number of stocks therefore diversified which actually decreases the risk and increases the index. Lastly, a significant reason for the recent price fall may be our Central banks’ strict monetary policy which reduces the money supply and directly affects the price of the stock market.

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Below is a chart showing market portfolio risk and returns for 10 days. (Table-4)

Date DSE General Index point

Index Change (%)

Ri (%)

7/7/2013 4558.67

8/7/2013 4559.39 0.016%

9/7/2013 4683.76 2.728%

10/7/2013 4770.49 1.852%

11/7/2013 4684.48 -1.803%

14/07/2013 4603.46 -1.730%

15/07/2013 4736.04 2.880%

16/07/2013 4775.21 0.827%

17/07/2013 4754.12 -0.442%

18/07/2013 4568.47 -3.905%

Return from Market

Rp=

0.215%

Risk of Market ⱷm= 2.278%

Risk Free rf= 8.45%

Here is a chart which shows Sharpe ratios of market and our selected portfolio: (Table-5)

Sharpe Ratio Portfolio Actual Return

(%)Standard Deviation %

Risk free rate of return

Sharpe Ratio (%)

Selected Portfolio

-2.22% 1.22% 8.45% -872.09%

MKT 0.21% 2.278% 8.45% -361.5002%

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The portfolio shows a return of -2.22% with 1.22% standard deviation and the market return shows as 0.21%with 2.278% standard deviation.

We also calculated the sharpe ratio and got -8.7 for portfolio and -3.60for market. The sharpe ratio tell us that our portfolio is doing bad compared to market.

The Sharpe Ratio is a formula used to measure risk/return. The ratio describes the amount of extra return received for the extra volatility of a more risky asset. The higher the Sharpe Ratio, the greater returns are for each unit of risk. By using the Sharpe Ratio, investors can theoretically compare risk adjusted returns of investments or portfolios that have different returns and risk levels.

5. Conclusion

The objective of the Portfolio analysis is to reduce risk and maximizing return. We have invested in two stocks- NBL and Fine Foods Limited in the Dhaka stock exchange. Here Markowitz’s portfolio analysis can be applied to real life portfolio decisions. The optimal portfolios generated by the portfolio analysis represent the optimal policy for the investor who wants to use the target price estimates rationally. From our overall analysis optimal portfolio is 70% NBL and 30% in fine foods. Here we found that our expected return is 50% and Standard deviation is 77.40%.

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6. Reference

The official website of Dhaka stock exchange (www.dsebd.org)

Historical stock price site (www.bdstockprice.com)

Newspapers (Daily Prothom Alo and Others (from July 7 to July 18, 2013)

Bangladesh Bank website: (http://www.bangladesh-bank.org)

http://www.bangladesh-bank.org/monetaryactivity/index.php

http://www.bangladesh-bank.org/econdata/index.php

http://www.investorwords.com/6740/Basel_I.html

http://www.investopedia.com/terms/b/baselii.asp

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http://www.investopedia.com/terms/b/baselii.asp

http://www.investorwords.com/6740/Basel_I.html

http://www.bangladesh-bank.org/econdata/index.php

http://www.bangladesh-bank.org/monetaryactivity/index.php

http://www.bangladesh-bank.org/


Appendix

1. Expected return of Individual Security:

Where, E(R) =the expected Return on a security Ri= The ith Possible return Pri=the probability of the ith return Ri M= the number of possible return

2. Portfolio Expected Return:

Where, E(Rp)= The expected Return of the portfolio Wi= The Portfolio Weight for the ith security

E(Ri)=The expected Return on a security n= The Number of different securities in the portfolio

Risk:

1 .Individual Security Variance: i 2 = ∑(Ri - E(R))2pri

So, Individual Security Risk: i=√ i 2

Where,

i 2=The Variance of individual security

i= Risk of individual Security

2. Portfolio Variance

So, Portfolio risk: p=√

Where,

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= Variance of the portfolio

p= Risk of the portfolio

=Correlation coefficient of portfolio

3. Covariance and Correlation:

Where, E = the expected value operator, Cov =covariance Corr =Correlation or a widely used alternative notation for Pearson's correlation

Sharpe Ratio:

E = Expected Value R = Expected Portfolio Return Rf = Risk Free Rate

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http://en.wikipedia.org/wiki/Covariance

http://en.wikipedia.org/wiki/Expected_value

http://bp3.blogger.com/_c3wLWrVG2CA/RminOVAgXMI/AAAAAAAAABM/8RJfHDY3op4/s1600-h/sharpe_ratio.png

IPM FINAL

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