RISK MANAGEMENTSTOCK TRADING REPORT

LECTURER: TAI TRAN

Vuong Minh Chau – s3461886Nguyen Hoang Phuc – s3461818

Le Duc Manh – s3461882Trinh Le Dung – s3345234

TABLE OF CONTENT

Introduction..................................................................1Purpose of the report............................................................................................1

Market..................................................................................................................1

Trading strategy....................................................................................................1

Research method..........................................................1Fundamental analysis............................................................................................1

Technical analysis..................................................................................................1

Fundamental analysis...................................................2Apple.....................................................................................................................2

Facebook...............................................................................................................2

Google...................................................................................................................2

Microsoft...............................................................................................................2

Amazon.................................................................................................................2

Ebay.......................................................................................................................3

Yahoo....................................................................................................................3

Risk Management Strategy...........................................3

Analysis........................................................................4Transaction record................................................................................................4

Technical analysis..................................................................................................5

Portfolio performance using Weighted beta evaluation.......................................6

Risk management – Index future..........................................................................6

Risk management – Option...................................................................................7

Conclusion....................................................................8

INTRODUCTION

1. PURPOSE OF THE REPORTThe function of risk management department of financial industry has become more and more important in recent years. This department is responsible for identifying, analyzing and providing a rational basis for better decision making in regards to all risks. Furthermore, risk management department is especially essential in stock trading market when there is a significant increase in this kind of market. This report will discuss the function of risk management and also point out risk strategies used to protect the trading profits during the period of stock trading in the market.

2. MARKETU.S Market is aimed to be traded which include five biggest market in the world: Dow, NASDAQ, NYSE, S&P 500 and Global Dow. In those market, NASDAQ and NYSE is chosen to be analyzed for conducting the portfolio about risk management. NASDAQ includes AMZN, EBAY, GOOGL, AAPL, YHOO, MSFT while NYSE includes TWTR. It is obviously that technology industries are becoming more and more developed in modern society, therefore, this is the first reason why NASDAQ is chosen. Also, based on the characteristics of this portfolio which conducts in short term, NYSE becomes the next ideal choice which is known as the biggest stock market around the world.

3. TRADING STRATEGYTwo strategies are used for conducting this portfolio: the fundamental analysis and technical analysis. Because of the characteristic of short term, technical analysis would be a main tools for prediction the flow of each specific stock in the market. Besides, fundamental analysis would be used as a supportive functions in the progress. The porfolio would be conducted from the beginning of March 2015 to the end of April 2015. Each different stock will be recorded at different time.

II. RESEARCH METHOD

1. FUNDATMENTAL ANALYSIS:The focus of fundamental analysis method is the market as a whole. This method will mainly concentrate on the factors that directly affect the value of the financial assets through the performance of chosen firms. Not only to the firms, but this method also takes into consideration those factors that affect the industry and the economy at a bigger picture.

2. TECHNICAL ANALYSIS:Unlike the above method, technical analysis will directly forecast the future value of financial assets based on their past price movements. Similar to weather forecasting, this method does not ensure absolute predictions about the future but instead, help investors anticipate what is “likely” to happen to the prices over time. The important criteria in this technique, according to Cory and Chad (n.d), are that: “The market will discount everything; prices move in trend; and history tends to repeat itself”.

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III. FUNDAMENTAL ANALYSIS

1. Apple (AAPL): The last quarter of 2014 was the biggest successful in the history of Apple with the increase of more

than 37% in the corporate profit and 9% in their shares price in the premarket trading (CNN, 2015). More importantly, Apple did repurchase $5 billion in shares in the 2014’s last quarter. This year, the firm will maintain and develop their capital return program, in the hope of boosting around 8-10% in their Earning per share (The Motley Fool, 2015). Investing in Apple is, thus, worth considering.

2. Facebook (FB): It is expected that in the first quarter of 2015, Facebook’s revenue will increase by 49%, compared to

the last quarter of 2014. Moreover, after reaching a peak of 82% in Advertise revenue (the key driver in its business growth), the company has acquire Parse - a mobile operating system, showing its ambitious to take over the internet industry (The Fool Money, 2015). However, the most important reason for choosing Facebook in this portfolio is that the company is not considered a rival of both Google and Apple as the 3 firms are in different areas.

3. Google (GOOGL) Google is known as a biggest searching engine on the internet with numbers of people use its searching

tool every day. However, Google seems is not satisfied with what it achieved, lately, Google decided to expand its operation into mobile network. According to Jain (2015), Google is planning to corporate with Hutchison, a company which provides global network infrastructure and technical support, to gain access into mobile network in England, Ireland, Italy and many other countries that have access to Hutchison’s network ( Jain 2015). Moreover, Google is considering to replace SIM on mobile phone with its software which enable clients to get into Google’s network from another available networks (Jain 2015). Therefore, with its plan to expand into mobile network, Google assists clients to easily access into its network for calling or texting or surfing websites without registered SIM or when they are in different countries where require available network in those countries. As a result, with the convenience provided by its software as well as expanding network, Google can gain a huge number of clients to join its network. Hence, it is believed that Google’s share will increase, thus, investors should to buy GOOGL.

4. Microsoft (MSFT) Microsoft Corporation is known as a multinational technology company that develops, manufactures,

supports and sells computer software. On the stock market, Microsoft also get great amount of shares. In the first quarter of 2015, Microsoft share price declined significantly due to two reasons. The first one was the decreased revenue from Windows (Neowin) and the second reason was window 10 would be a free upgrade for everyone (The street). This point made many experts to doubt about the issue how Microsoft can gain benefit when they set everything to be free. Fortunately, in the second quarter of 2015, thanks to the new system produced for mobile phone – Surface – increased the revenue to 1.1 billion USD, which rose 24% comparing to last year at the same period. Therefore, this is the suitable time to buy Microsoft shares.

5. Amazon (AMZN) In the first quarter of 2015, though the price of share fluctuates at some point, the development of

AMZN is expected to increase slightly. According to Thestreet, they report that comparing to the same quarter of prior year, the performance of AMZN is better through high revenue growth, good cash flow from operation. However, disappointing return on equity and high debt to equity in this quarter is also the weaknesses caused unstable share price. Hence, it is difficult to predict the price base on

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fundamentals. Moreover, in this year, AMZN has some projects to co-operate with their partners to release new Echo devices and film’s products which raise a hope to succeed in the future (Marketwatch 2015). As a consequence, the price may increase in the future.

6. EBAY Ebay is a multinational corporation and e-commerce company which provides service through

Internet. According to Larry, the first quarter of eBay will be quite bored with disappointing financial results because its financial data suggests below par growth in fixed price compared to the overall sector. However, this result is still better compare to the Q4 with 5% increasing buyer growth from last period (Larry 2015). In addition, on 15th April, Rebecca reported JD.com has announced that eBay will be among its partner to sell products in China’s marketplace. As a result, this cooperation will expand the global reach of eBay and give Chinese shoppers more chance to access popular brands and products from the U.S. Therefore, the company may do well in the future and encourage investor to invest in eBay.

7. Yahoo (YHOO) Yahoo Inc. is an American multinational Internet corporation which includes Yahoo Mail, Yahoo

Finance, Yahoo Group, etc. After a long decrease in share price from 2008 to 2011, in 2012, Yahoo could overcome the obstacles with the management of Marrissa Mayer. Especially, in 2014, Yahoo gain much benefit because Alibaba Group share increased prior to the IPO launch. (Forbes) It can be said that Alibaba Group – a Chinese Internet company to be Yahoo’s hero. Economists predicts that in 2015, Yahoo will keep soaring and this is the good time to invest in Yahoo

IV. RISK MANAGEMENT STRATEGY

In this report, we will both use option contract and future contract in order to hedge the risk related to the fluctuation of the price share. However, each type of contract also has some advantages and disadvantages and both of them will be discussed below.

The first one is an option contract. Option contract permits the holder to sell or buy an underlying product at a strike price. Moreover, option contract gives customers the right, which means they can either sell( or not) or buy(or not) at expire day. The price of the contract is directly affected volatility, risk free and time to maturity.

Advantages Disadvantages

Cost

The cost is inexpensive for investors, but investors can directly enter into the instrument market without pay for the stock.

The option may worthless if the expiry price does not match the exercise price in case of the investors buy option contracts.

Hedging Option contracts help to reduce the losses

The investor may forecast the time and direction of share price incorrectly and this will lead to losses as a result.

LeverageThe cost pay for the option contract is small; however the gain in the future may be unlimited.

If the gain also be unlimited, the downside that the loss could be the same.

ReturnOption helps investors gain more return because of right determination of time and direction of stocks.

If investors forecast the future stock price is wrong, the option will become useless.

Diversification If the portfolio including numerous of Diversification cannot reduce systematic 3 | P a g e

stocks, the investors can buy options for those stocks in portfolio as well.

risk possibly.

Regulation Terms and conditions of listed options are regulated, hence it is easy for users

Sometimes, there are some regulations that restrict the exercise (OCC, SEC, court, other regulatory agency).

Future contract is a contractual agreement that allows both parties to sell or buy commodities, financial instruments at at a specified price on a pre-determined date. Rather than giving a right as options, future contract is compulsory for both counterparties to complete the contract. Furthermore, the quantity of future contract is standardized and this is hard for customers to get exactly what the volume they want.

Advantages Disadvantages Less credit default risk: the job of clearing

house is to solve the fail of one party to pay its financial obligations, hence the risk is reduced to null or minimized.

Low transaction cost: cost savings from finding counter parties.

Hedging: as a function of future, it helps to match the need between the two parties.

Daily marking to market: the clearing house daily calculates the loss/profit for you, then easier to buyer/seller to calculate their remaining accounts.

Higher price visibility: because more people trade, so that it is more flexible for people to get the desired price.

Responsibility to complete the contract: the long and the short position holders have the obligations but not the option to carry out the transaction.

Less flexibility: as the quantity of futures are standardized that sometime it does not match the quantity of buyers and sellers.

Short term hedge: for the one who is looking for long term hedge, this hardly to happen.

Margin calls: introduce uncertainty of cash flow and potential higher transaction costs.

Hedging: due to different maturity, quantity and grade, mismatches are also likely to happen.

V. ANALYSIS

1. TRANSACTION RECORD

Adapted from the marketwatch (2015)

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2. TECHNICAL ANALYSIS

Period StockTrend Support

point ($)Resistance point ($) Recommendations

Fundamental analysis

resultDecisionEMA SMA Over price trend

20/3-20/4 AMZN Slightly constant

Down Fluctuate at some point, upward trend

in general.

$372.83; $373.59; $374.34

$383.79; $384.58; $385.25

Do not buy when the price above $385.

Price down Sell at $391.02

17/3-20/4 EBAy Down Down There was a downward trend

$56.04; $57.08

$58.34; $58.52 Buy at $56.04 and do not buy at $58.52

Price up Buy at $56.29

24/03 - 24/04 AAPL Slightly Constant

Slightly Constant

Reach its peak at $137, currently

upward

$123.04 $127.03 Buy if price is around $123.

Do not buy if price is around $126

Price up Short selling at $127.37

21/03 - 21/04 FB Constanly up

Constantly up

Cup with peak at $85.76, currently

upward

$81.39 $83.52 Buy if price is around $81.

Do not buy if price exceeds $83

Price up Short selling at $83.15

6/3-6/4 GOOGL Down Down Reached peak of $580.8 and currently

in the downward

541.21; 541.51; 545.72

559.83; 549.49; 550.56; 551.17

Buy if P is between $ 541 and $545 .Don’t buy if P is

around $549

Price up Buy at $544.63

13/3-13/4 TWTR Up Up Up 51.69; 51.77; 51.63; 51.76

52.38; 52.23; 52.16

Buy if P is $51.76 or less

Don’t buy when P is near to $51.16

Price up Buy at $50.86

20/3 – 20/4 MSFT Up Up Reached the lowest point at $40.44 and

currently in the upward

$41.65 $42.90 Buy when price is $41 or under. Don’t

buy when price is around $42 or above

Price up Buy at $41.14

20/3 – 20/4 YHOO Down Down Fluctuated, reached the peak at $45.78 and the downward

$44.35 $45.07; $45.70 Buy when the price is $44 or under.

Don’t buy when the price is over $45

Price up Buy at $44.72

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3. Portfolio performance using Weighted beta evaluation

Share Share β

Number of share in the portfolio Market price Market value Weighted

betaEBAY -0.78 -50,000 $57.02 -$2,850,750 0.2306FB -0.74 -12,000 $82.71 -$992,460 0.0762GOOGL 1.06 22,000 $541.04 $11,902,880 1.3087MSFT 0.88 49,000 $42.26 $2,070,495 0.1890YHOO 1.27 45,000 $45.73 $2,057,850 0.2711APPL -0.84 -20,000 $127.37 -$2,547,400.00 0.2220Total $9,640,615.00 2.2976Risk free rate 3%Market return 14.04%Expected value (*) 25%

4. RISK MANAGEMENT – INDEX FUTURE

At the time, index future strategy was constructed, portfolio contains following stocks

β=−0.78×−2,850,75012,188,015

+(−0.74 )× −992,46012,188,015

+1.06× 11,902,88012,188,015

+0.88× 2,070,49512,188,015

+1.27× 2,057,85012,188,015

¿1.64

The number of futures contracts needed = 1.64 ×12,188,0154,472.1×100

=44.695

NASDAQ market has been well performing through the strong impacts of energy price and change of dollar’s value with the help of strong technology stocks, thus, it is believed that the market will continue to outperform in next few months (The Wall Street Journal 2015). Therefore the market is bullish and due to positive beta, the portfolio is expected to increase its value, hence we underhedge. Due to the trading is taking place in short term. Therefore an index future contract which is expired at June 15 is chosen because it has the shortest time to maturity. In June, SPI is expected to increase to 4,690.

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Share Share β Number of share in the portfolio

Market price Market value

EBAY -0.78 -50,000 $57.02 -$2,850,750FB -0.74 -12,000 $82.71 -$992,460GOOGL 1.06 22,000 $541.04 $11,902,880MSFT 0.88 49,000 $42.26 $2,070,495YHOO 1.27 45,000 $45.73 $2,057,850

$12,188,015

Equity market Futures marketApril Portfolio value is $12,188,015 Underhedge and positive beta.

=>Sell 44 SPI Futures at 4,472.1 expiration June

Get 4,472.1×100×44=$ 19,677,240

June Index is expected to change from 4,488.15 to

4,690 => price change ¿4,6904,488.15

−1=0.045

β ¿1.64 => β in June =1.64 × (1+0.045 )=1.714 New value of portfolio ¿$12,188,015×1.714=$20,890,257.71

Close out short position: Buy 44 SPI Futures at 4,772.53 Pay 4,772.53×44×100=$ 20,999,132

Profit Profit ¿ $20,890,257.71−$ 12,188,015=$8,702,242.71

Future loss = $19,677,240−$20,999,132= −¿ $1,321,892

Net $8,702,242.71−$1,321,892=$7,380,350.71

Index future strategy is used to hedge portfolio, but this strategy reduces the profit that portfolio can generate. The value of portfolio increases as expectation before applying this strategy, and the index future created a loss. As a result, index future made a loss of more than 1 million, which could not occur if this strategy was not applied. Thus, entering index future contract is worthless.

5. RISK MANAGEMENT - OPTION

a. Risk arise and awareApplying the Black-Scholes Model to evaluate the option prices and following these conditions:

The option’s value on the expiry day is determined by the strike price and the spot price of the securities

Short-term risk-free rate is constant at 3% The time and trading are continuously following a random walk. The value at expiry cannot be negative and it is also intrinsic value

b. Apple (AAPL)

Based on both the fundamental and technical analysis, it is predicted that the prices of AAPL might increase in the future. In the current position of short-selling and having sufficient fund, the final decision is to use Call options contract to hedge. On April 9th, buy a Long Call option at $6.97, expired at May 1st and with the strike price of $123.

Strike price (X)= $123 Stock price (S) = $125.95

Risk-free rate (r) = 3% Volatility (σ) = 34.27%

Time-to-maturity (t) = 23 days (23/365)

d1= 1.1420 -> N(d1)= 0.8733 d2= 1.0560 -> N(d2)= 0.8545Call premium= $5.09

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Profit when not entering = (127.37 - 125.95) *20000= $28,400Profit when entering= (125.95 - 123 - 6.97) *20000 = -$80,400

CONCLUSION:The Call options were bought to hedge the risk that price of Apple would increase and therefore hurt our position. The price did not increase as expected; indeed it went down to $125.95. We made a loss of $80,400 from buying the call options (when we were supposed to make $28,400 in profit). Thus, entering into the option contract worsened our position. Solution: We considered not exercising the right and reselling the option contracts for - $1.88/contract ($5.09 - $6.97=). Profit= (127.37 – 125.95 – 1.88) *20,000 = -$9,200Instead of making a loss of $80,400 when exercising the options, we only lost $9,200 for re-selling those.

c. Google (GOOGL)Based on technical analysis, we were afraid that the price of Google might go down. As Google shares have been bought, declines in its prices may adversely affect our wealth. Therefore, on April 15th we entered into a Long Put contract priced at $12.30, expired on May 1st, with strike price of $550.0

Strike price (X)= $550.0 Stock price (S) = $537.96Risk-free rate (r) = 3% Volatility (σ) = 19.74%Time-to-maturity (t) = 16 days (16/365)

d1= -0.4831 -> N(-d1)= 0.6854d2= -0.5244 -> N(-d2)= 0.70Put premium= $15.77

Profit from not entering= (537.96 - 544.63) *20,000= - $133,400Profit from entering= (550 – 537.96 – 12.30) *20,000= -$5,200

CONCLUSION:When entering the Put option contracts, we were in fear that the price of Google would go down. The stock’s prices indeed have followed our prediction when declined to $537.96. The option contracts have offset our losses, so we only made $5,200 in loss, instead of losing $133,400. Transparently, the option itself has successfully fulfilled our purpose of hedging.

V. CONCLUSION

To conclude, throughout fundamental analysis and technical analysis, the portfolio includes EBAY, YHOO, APPL, GOOGL, FB and MSFT. In those shares, there is a risk control plan which uses Option. Option is applied on APPL since the profit can decrease and it hurt our portfolio. Also, option is applied on GOOGL to hedge. As a result, we would not lose much profit. Besides, applying Future to the rest of shares is worthless because it made a loss of more than one million. Therefore, the option contract is just still efficient with GOOGL and APPL.

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VI. APPENDIX

Holding portfolio

More transaction record

VII. REFERENCE

Aman J., 2015, “Google Inc (GOOG) Cuts Deal With Hutchison To Offer Americans Free Roaming”, Opptrends, viewed 7th April 2015 http://www.opptrends.com/2015/04/google-inc-goog-cuts-deal-with-hutchison-to-offer-americans-free-roaming/

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Amanda S, 2015, ‘Amazone.com (AMZN) Stock Gets Price Target Increase Today at Jefferies’, thestreet, 14 April, viewed 17 April 2015, <http://www.thestreet.com/story/13111379/1/amazoncom-amzn-stock-gets-price-target-increase-at-jefferies-today.html?puc=TSMKTWATCH&cm_ven=TSMKTWATCH>

Corrie D., 2015, “Nasdaq Composite, S&P 500 Close at New Highs”, The Wall Street Journal, viewed 28th April 2015 <http://www.wsj.com/articles/u-s-stock-futures-rise-putting-nasdaq-composite-on-track-for-more-gains-1429878630>

Daniel S., 2015, “Apple, Inc. Stock Reaches a New High -- 3 Reasons Not to Sell”, The Motley Fool, viewed 20th April 2015 <http://www.fool.com/investing/general/2015/02/02/apple-inc-stock-reaches-a-new-high-3-reasons-not-t.aspx>

Daniel S., 2015, “Mark Your Calendar: Facebook Inc. Earnings”, The Motley Fool, viewed 8th April 2015 http://www.fool.com/investing/general/2015/04/02/mark-your-calendar-facebook-inc-earnings-in-april.aspx

David G., 2015, “Apple just posted the best quarter in corporate history”, CNN Money, viewed 15th April 2015 <http://money.cnn.com/2015/01/27/technology/apple-iphone-earnings/>

Evan N., 2015, “Apple, Inc. Just Obliterated All Expectations”, The Motley Fool, viewed 20th April 2015 <http://www.fool.com/investing/general/2015/01/28/apple-inc-just-obliterated-all-expectations.aspx>

Gene M., 2014, “Here Is Why Yahoo Is Now A Most Enticing Stock To Buy”, Forbes, viewed 15th April 2015 <http://www.forbes.com/sites/genemarcial/2014/10/02/here-is-why-yahoo-is-now-a-most-enticing-stock-to-buy/

Greg B, 2015,’ Amazon Hints at smart phone home future through Echo Devices’, marketwatch, 8 April, viewed 17 April 2015 <http://www.marketwatch.com/story/amazon-hints-at-smart-home-future-through-echo-device-2015-04-08-111032251>

Index Performance: Return (%), Morning Star, viewed 29th April 2015 http://news.morningstar.com/index

Larry D, 2015, ‘Foreign Exchange To Dent eBay Inc (EBAY) Margins: SunTrust Robinson’, bidnessetc, 17 April, viewed 17 April 2015 <http://www.bidnessetc.com/40088-foreign-exchange-to-dent-ebay-inc-ebay-margins-suntrust-robinson/>

Leo S., 2015, “Facebook Inc Has Big Plans to Take Over the Internet of Things. “, The Motley Fool, viewed 10th April 2015 <http://www.fool.com/investing/general/2015/03/28/facebook-inc-has-big-plans-to-take-over-the-intern.aspx>

Michael S., “Risk Management...the What, Why, and How”, Business Improvement Architects, viewed 30th April 2015 https://www.bia.ca/articles/rm-risk-management.htm

Rebecca B, 2015, ‘eBay Partner With JD.com On New International Online Marketplace’, Thestreet, 14 April, viewed 17 April 2015 <http://www.thestreet.com/story/13112569/1/ebay-partners-with-jdcom-on-new-international-online-marketpla ce.html?puc=TSMKTWATCH&cm_ven=TSMKTWATCH>

Tony O., 2015, “Microsoft (MSFT) Stock Declines Today After Announcing Windows 10 as Free Upgrade”, Thestreet, viewed 25th April 2015

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<http://www.thestreet.com/story/13018156/1/microsoft-msft-stock-declines-today-after-announcing-windows-10-as-free-upgrade.html>

Trey W, 2015, ‘Amazon entices potential subcribers with free “Orphan Black”’, marketwatch, 15 April, viewed 17 April 2015 <http://www.marketwatch.com/story/amazon-entices-potential-subscribers-with-free-orphan-black-2015-04-15>

Vlad D., 2015, “Microsoft stock takes plunge after quarterly results”, Neowin, viewed 20th April 2015 < http://www.neowin.net/news/microsoft-stock-takes-plunge-after-quarterly-results

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